Free market disciples (like me) believe that government intervention is anathema to a healthy economy. On the contrary, we believe genuine government stimulus comes from low taxes, stable prices, reduced regulation and low debt. Our economic policy makers have scrupulously avoided such remedies. However, in the short term, it is possible for government central planning to artificially boost GDP. But as the short term is coming to an end, Washington’s heavy hand is sending this artificial recovery down the drain.

When a country spends in order to stimulate growth it sources money from three methods: taxing its citizens; borrowing from the existing pool of capital, or borrowing newly created money from its central bank. All three options are economically poisonous.

The act of taxing one sector of the economy in order to redistribute wealth to another can never be considered stimulus. How can taking money from Citizen A and giving it to Citizen B improve the outlook for both? To think that it could assumes that the government knows the best way to allocate resources. But everything I have ever seen tells me that this is not so.

A government could instead distribute money borrowed from the private sector’s existing pool of capital into targeted areas of the economy. But this type of “stimulus” is simply a deferred tax with interest. Any money borrowed by government could have been utilized by the private sector to expand business and grow the economy. Instead, money spent by government makes no lasting economic impact.

Some liberal economists argue that funds left in the private sector would likely be saved, rather than spent, during an economic downturn—thus exasperating the recession–if not for government activism. This may be true, but necessity, in the form of weak balance sheets, is the factor that usually drives the private sector to save. Any interference with that deleveraging process has dire consequences in the long term. Government borrowing only delays the eventual pain because a significant tax increase will eventually be needed to pay down the added debt associated with public liabilities. If the private sector is prevented from paying down debt, the debts will simply be transferred, with interest, to the public ledger. Therefore, borrowing to spend should not be considered a genuine stimulus.

Finally, a government can acquire spending power from outside the existing domestic savings pool by borrowing newly printed money. That new money enters the economy in the form of deficit spending. However, the inflation created by the central bank printing has its downside.

At first, the economy experiences a combination of higher prices and growth. Producers raise prices as the domestic currency loses its value, while others are deceived into believing the value of money has remained unchanged; and so they increase their production and expand real GDP. However, the greater extent and duration in which the central bank perpetuates their printing, the less real growth and the more inflation the economy will experience.

This is precisely the recipe that we are currently following. Between 2008 and 2010, the Federal government borrowed over $3.1 trillion. It is expected to run-up another $1.5 trillion in debt this fiscal year. Meanwhile, the Federal Reserve has increased their balance sheet by nearly $2 trillion in order to accommodate the massive increase in public sector borrowing.

By borrowing printed money, the government had been able to perpetuate our consumption driven economy, while simultaneously levitating most asset prices—even home prices have been prevented from falling to a level that can be supported by the free market. The Fed’s desire to create inflation and support prices had at last driven up industrial commodity prices like copper to all-time nominal highs. Once oil prices crashed through the $100 per barrel level, the Fed was forced to ratchet down its inflationary rhetoric. The question now is whether actions will follow.

The Fed and administration have now reached the point of diminishing returns. Whatever anemic and temporary growth that was generated by borrowing and spending printed money is now being superseded by rising prices. Any further monetary stimulation from this point on will only serve to send aggregate price levels surging higher, as GDP growth falls. The bottom line is that borrowing and printing money can never increase productivity and labor force growth, which are the only ways to increase real GDP. Government intervention can only temporarily circumvent the deleveraging process that is necessary for viable growth.

The government’s window to artificially drive real GDP growth by borrowing and spending has closed. The U.S. economy now faces another recession head-on, as the private sector deleveraging process resumes and the public sector deleveraging process begins. Alternatively, the Fed can keep expanding their balance sheet and sending the economy deeper into stagflation. The salient question for investors is whether the next recession will be accompanied by inflation or deflation. But only Mr. Bernanke can answer that.

Regards,

Michael Pento

Michael Pento is Senior Economist and Vice President of Managed Products at Euro Pacific Capital. Besides blogging daily at europac.net, he writes a weekly market commentary that is carried by Forbes and the Huffington Post. Michael is a regular guest on CNBC, Bloomberg, and Fox Business, as well as regular guest host of The Peter Schiff Show.

Austerity American Style was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Since I have no desire to go to China, I am thankful for my contacts who do! (To paraphrase Chris Farley from the movie Tommy Boy, you can stick your head up the backside of a cow to see a good steak, but why not just take the butcher’s word for it?)

The nice thing about currencies is that the categories of information and the pricing structures vary little around the globe. For instance, if you were looking to add a retail stock to your portfolio, the numbers you’d look for in an American company may not be the numbers you’d think important in China.

Instead, the numbers that we care about when looking at currencies are bigger and easier to compare.  Is an economy expanding or contracting? More importantly, why is it doing so? Is it expanding because of government stimulus? What is the ratio of new stimulus to new growth? What likelihood is there that growth will continue if stimulus is removed? Is the stimulus about to be removed? Are rates falling or rising? What is the government policy toward the currency? How about debt ratios to GDP?

All of these are important considerations in the forecast of a currency. And we will consider some of them today in relation to China.

Now let me begin by saying that like with all good stories, China has two sides, a boom side and a bust side. There are those who are bullish on China, and those who are bearish. If I do a good job today, you’ll have a decent idea of the arguments from both sides.

Let’s begin with the headline figures.

China’s most recent numbers for growth as measured by GDP and posted by Trading Economics come in at 10.7%. But we also know that China’s growth has been based upon sizeable stimulus  — $586 billion at last count. It’s pretty remarkable, even if it comes nowhere close to U.S. stimulus spending. We spent 25% more in our first round of stimulus alone, and as much as $1.5 trillion (in various forms) altogether.

As a ratio to population, that makes the U.S. stimulus 10 times the size of the Chinese stimulus. So why aren’t we seeing 10% growth rates like the Chinese? Actually, if we’re spending 10 times per capita as much, why aren’t we seeing 100% growth rates? Seems like a straightforward equation, doesn’t it? It would be, if it weren’t for other “mitigating” factors. (Perhaps the most outstanding is debt, but more on that another time.)

China’s interest rate is 5.31%. Its inflation rate, 2.7%. Jobless rate, 4.3%. All told, some very nice numbers. But let’s continue: exports are reportedly up 45%; imports of crude oil nearly 60%. (Although, please bear in mind, China is no more free of number manipulation than any other country. And in this recession, we’ve learned a lot about number manipulation…)

So let’s summarize. China’s interest rate, while not as low as the rest of the world, is still low by recent standards. There was a time, only 20 years ago, that rates under 8% were considered absolutely bullish for equities. (Seems hard to imagine now.) So at just over 5%, that’s not too bad. Official inflation is not yet out of control… still below the 3% level, and most folks in the United States (especially the administration) would be doing cartwheels in the street for a jobless rate below 5%.

And yet all is not well.

ECONOMIC SHANGRI-LA: TOO GOOD TO BE TRUE?

The problem is, China has a bubble, which is inflating even as we speak, although the government is trying very hard to keep a lid on it. The bubble is similar to what ours was… real estate and housing.

Across much of the country, housing prices rose 10% last year. But in the special economic zone of Hainan (largely comprised of an island off the southeast corner of the mainland), house prices rose 50%! The geography and designation of Hainan is important. It is the largest of the special economic zones, where free enterprise is blossoming. But a 50% rise in housing prices is not “under control” by any definition. If houses are skyrocketing in the prosperous zones, it’s evident that the People’s Bank of China has no more clue on controlling price inflation than the Fed does. Also, how much more difficult does it become to translate the positive economic changes of Hainan to other less fortunate parts of the country without creating the same problems?

Also consider what has really been taking place. The Chinese government hasn’t really had to face how to export these changes to poorer, rural areas, since many of the peasants have flooded into the cities in search of the new jobs. After 1,000 years as an agrarian society, the country estimates it will be majority urban in just five years.

SAVING VERSUS SPENDING: WHAT WOULD YOU DO?

The Western media continues to perpetuate a popular myth — the myth of the Chinese consumer. In the United States and Europe, the average savings rate is very low. One reason is because the American and European consumer doesn’t need to save. If something happens to his job, he doesn’t need a rainy day fund. He has a myriad of social programs that he will eventually qualify for.

So while I personally have no desire to live in a country with a welfare “safety net,” one of the upsides is this: When the bureaucracy fumbles the ball and drops the economy on its ear, the unemployed just collect their benefits… and maybe eventually food stamps or heating assistance or whatever the government may dole out.

But up until relatively recently, China was not the same. You lost your job, you lost your income. Period. The government didn’t provide unemployment insurance. There weren’t any food stamps. Bills come in you can’t pay? Too bad. You lost your house. You went hungry.

Even now things aren’t much improved. The welfare that exists is inefficient and rife with corruption. So the Chinese are more inclined to put some money away for a rainy day instead of spending.

Here in the West, our GDP is 70% direct consumerism. In China, it is only 30%.

But do you think it is likely that the Chinese will undo generations of spending and saving habits overnight? No way. The American consumer is paying off the debt form his “big party”… I guess his European counterpart is as well. We will not continue to buy exports. And for the reasons just stipulated, the Chinese won’t be picking up their own slack domestically either.

THE ACE UP THEIR SLEEVE

All that being said, China is still able to fund more stimulus if it should so desire. But as King Solomon asked, “Can a man take fire into his bosom and not be burned?”

In other words, while China may be able to keep the illusion of growth going for some time yet, it has bought into the same failed model of Keynesianism that the West has used. It is already combating bubbles, even though its official inflation rate is not in the red zone. If it continues to put the brakes on its red-hot economy, we can certainly look for a second dip into recession.

Its first round of stimulus was equal to just under 15% of GDP. With the stimulus funds they created jobs. It can afford to keep going it from a treasury standpoint. It has to afford it from a social unrest and upheaval standpoint. But the big questions remain can they afford it — and can they control it — from an economic standpoint.

My vote is obviously, no. And there has already been some evidence of it. China used its last round of stimulus to build the largest shopping mall in entire world. It now sits 99% vacant. The Chinese government is not very proficient at allocating capital.

So they may be able to manipulate it for some years yet. But NO central bank, dealing with a FIAT CURRENCY, has ever won at this game.

Regards,
Bill Jenkins
Whiskey & Gunpowder

March 22, 2010

Is China Going Boom Or Bust? was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Those of us concerned about the ever-increasing level of government debt gasped at the astonishing $787 billion cost estimates for this bill. True to form it has actually cost 10 percent more at $862 billion. We heard over and over that government could not sit around and do nothing while people lost their jobs and houses. The administration claimed that unemployment would not go above 8 percent if the stimulus bill passed. Now, a year later, the government estimates that unemployment is over 10 percent. The real number is closer to 20 percent. It appears that those promises were total fabrications in order to close the deal.

In any case, the American people know that more government spending obviously equals more government. If the goal was to strengthen the private sector, Congress would have allowed businesses and individuals to keep more of their own money through meaningful tax cuts. Outrageously, the administration claims that they did “cut taxes” by reducing withholding, and that they have stimulated the private economy by increasing the amount of money in every worker’s paycheck. What they fail to mention is they did not change the total amount of taxes due. This means that all that money not withheld from paychecks will add up to a big unpleasant surprise when returns are filed this year. Many tax preparers are already seeing shocked taxpayers having to come up with big checks to the government when they normally expect a refund. Stimulus, indeed!

The administration also claims that thousands of jobs have been created or saved by this massive spending bill, but these are just more government jobs, and counterproductive in the long run. Funding for the public sector necessarily comes at the expense of an overtaxed private economy. But, it makes sense that government would seek to expand its payroll since every new bureaucrat becomes a likely advocate for big government, when an increasing number of Americans are demanding the opposite. But the more the burden, the closer the government parasite comes to killing its host.

Rather than learning the lessons of the past year, the administration is moving full-speed ahead to do even more economic damage. With the stimulus bill set as a precedent and victory declared, another “jobs” bill is in the works. And, in order to address the unavoidable issues of our massive deficit, the administration has named a bi-partisan commission to find ways to decrease it. Tax increases on the middle class are notoriously back “on the table,” exposing that campaign promise as another instance of merely saying what the people wanted to hear. If the obvious solution to our spending problems was seriously put forth, that is, getting back to the constitutional limitations of government, I would be shocked. More likely, this will be a tactic to increase taxes and spending in a way that passes the political buck.

Regards,
Ron Paul, LewRockwell.com
for Whiskey & Gunpowder

March 1, 2010

One Year After the Government Stimulus was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Bank bonus numbers are due out any day now. The revolt that I expected around the release of these numbers may come from a different place than I had imagined earlier — not from whatever remains of “normal” working people, but from the thought leaders and middling agents in administration (including the prosecutors) who, for one reason or another, have been diverting their attention, or watching and waiting, or making excuses for a couple of years now. When Frank Rich of The New York Times starts Calling for Robert Rubin’s Head, then maybe the great groaning tramp steamer of media opinion is turning in the water and charting a new course for the port of reality.

Anyway, the grotesque carnival of rackets and lies that the US economy has become — held together with the duct tape of stimulus cash, gamed accounting, mortgage subsidies, carry trades, TBTF bailouts, TARPS, TALFS, shell-game BLS reports, and MSNBC “green shoots” cheerleading — gives every sign of tipping into collapse at a moment’s notice. There are just too many obvious things that can go wrong, and that means there are many less obvious, hidden things that can go wrong, and isn’t it tragically foolish to tempt Murphy’s Law, since it operates so well without any help from us? The call is even going out lately for criminal prosecution of the current Treasury Secretary, Mr. Geithner, for Engineering AIG’S $14 Billion Credit Default Swap Payoff to Goldman Sachs as part of the AIG bailout. Okay then, why not Paulson, Bernanke, Blankfein…?

But the other rings of the circus are fully occupied by clowns and dancing bears, too. Even with sketchy-looking stock market prospects for 2010, it’s hard to explain why the world would run into US treasury bonds, especially a few months from now, after the initial rush-to-safety — that is, when you could just as easily buy Canadian or Swiss franc denominated short-term bills. And then what happens when the Federal Reserve has to eat all the uneaten treasuries, while it’s already choking to death on collateralized debt obligations and related worthless toxic trash securities? After all, the greenbacks we swap around are called Federal Reserve Notes.

Why would anybody think that the housing market is going to keep levitating? A big fat “pig” of adjustable rate mortgages (i.e. mortgages that will never be “serviced”) is about to move through the “python” of the housing scene, shoving millions more households into default and foreclosure. Meanwhile, local and regional banks are choking on real estate already in default that they are afraid to foreclose on and have been keeping off the market through 2009 in order to not send the price of houses down further and put even more households “under water” for houses worth much less than the face value of their mortgage. I doubt that the banks are doing this out of the goodness of their hearts, but whatever the motive, this racket of just sucking up bad loans can’t go on forever. At some point, a banking system has to be based on credibility, on loans actually being paid back, or it will break, and we are close to the breaking point.

The pathetic truth at the center of the housing fiasco is that prices have to come down further if any normal wage-earner will ever afford to buy a house again in America on anything like normal terms. Anyway, sooner or later the banking system is going to have to upchuck the “phantom inventory” of un-foreclosed-on houses, and sell them off for whatever they can get, or else a lot of banks are going to go out of business.

They may go down anyway, because the catastrophe of commercial real estate is following right on the heels of the fiasco in residential real estate. The vast oversupply of malls, strip malls, office parks, and other furnishings of the expiring “consumer” economy is about to become the biggest liability that any economy in world history has ever seen. Who will even want to buy these absurd properties cheaply, when they will never find any retail tenants for the badly-built structures, nor be able to keep up with the maintenance (think: leaking flat roofs), or retrofit them for anything? In a really sane world, a lot of these buildings would go straight to demolition-and-salvage — except that it costs money to do that, and who exactly right now will make a market for used cinder blocks and aluminum window sashes? I expect these places to become squats for the desperate homeless.

Then there are the bankrupt states, led by the biggest, of course — California and New York — but with plenty more right behind, whirling around the same drain (probably forty-nine of them with the exception of that fiscal Nirvana, North Dakota!). Even if they manage to con bailouts from the bailout-weary federal government, the states are still going to have to winnow down the ranks of their public employees (throwing more middle-class households into foreclosure and penury), while they hugely reduce public services, especially to the poor, the unwell, and the unable. That alone will redound into very visible realms of daily life from public safety (rising crime) to the decay of roads and bridges.

Perhaps the most troubling buzz in the air this first month of 2010 are rumors of coming food shortages due to widespread crop failures around the world in the harvest seasons of 2009 (Emergency Food Supply, Food Crisis for Dummies, 2010 Wall Street Predictions). If the US Department of Agriculture hasn’t flat-out lied about crop numbers in 2009, the signs are that their statistical reports are at least inconsistent with real grain storage numbers and commodities prices. And why would the USDA tell the truth if every other federal agency is reporting gamed numbers? Given the crisis in capital and lending, one also has to wonder how farmers will be able to borrow money to get their crops in this year.

Finally there’s the global energy scene. The price of oil starts this week over $83 a barrel. That puts it about $1.50 from the price “danger zone” where it begins to kill economic activity in the USA. Things and procedures just start to cost too much. Gasoline. Deisel fuel (and, by the way, that means another problem for food production going into the 2010 planting season). One especially eerie situation the past few weeks has been the de-coupling of moves upward in oil from moves in the value of the dollar. Lately, oil has been going up whether or not the dollar has gone up or down. Two weeks ago the dollar went below 1.42 against the Euro and today it’s above 1.45, and oil has been rising steadily from the mid $70 range all the while. 2010 may be the year that we conclusively realize that world oil demand exceeds world oil supply — and that global oil production cannot hold above 85 million barrels-a-day no matter what we do.

These are the things that trouble my mind at three o’clock in the morning when the wind rises and things bang around spookily. Gird your loins out there for a savage season or two.

Regards,
James Howard Kunstler

January 12, 2010

The Economy Has Six Months to Live was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

But perhaps we are quibbling over details. An inability to service its debt or pay off its long-term obligations, or just a willingness to do so by printing more money, is effectively a devaluation of the U.S. dollar. That’s what the currency markets have been telling us all year. (And that’s one reason why the yield curve is starting to look like an Olympic ski jump.)

This fear of the sustainability of the U.S. deficits is another reason investors and people who use their brain own at least some gold. And on that subject, we copped it a bit from a friend last night for our comments yesterday. He also trotted out a famous quote about gold from Warren Buffett.

“Don’t you think you were a bit self indulgent yesterday going after Pascoe?”

“No.”

“Well, it is a fair point.”

“What is?”

“If the world goes to hell like you say, you can’t eat gold. You can’t sleep on it, although you could sleep with it I suppose. How useful is it really going to be as a medium of exchange or a store of value if economic activity grinds to a halt?”

“I don’t know. I’m not Nostradamus. But I’m not recommending people convert all their equity holdings into precious metals either. I AM recommending they own some bullion and, for leverage purposes, some gold shares. That doesn’t seem so radical. Why would anyone find the idea of hedging your bets against monetary policy so kooky?”

“Because monetary and fiscal policy have basically worked, at least here in Australia.”

“Are you drunk?”

“I’m serious. The stimulus worked. It kept Australia out of recession. What more do you want?”

“Less. Less is more, mate. The stimulus increased the debt and maintained the appearance of growth. But the economy didn’t need growth. It needed to reduce personal debt levels and consumption and get a less leveraged balance sheet. The government encouraged the exact opposite.”

“Blah blah blah. Even Buffett thinks you’re wrong about gold. What’s that quote of his… ‘Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.’ What do you say to that?”

“Buffet is a better investor than I’ll ever be. And obviously he’s a smart guy. But surely he’s heard of Gresham’s Law.”
“Huh?”

“Gresham’s Law. Bad money drives out good. Or to quote the late, great Harry Browne, ‘If an individual holds two types of money of unequal value, he will spend the bad money and save the good money.’”

“I’m afraid I’m not following you.”

“That’s because you’re a moron. But it’s the argument between owning all paper and at least some gold. You don’t convert all of your wealth to gold because right now, that’s not useful. You need cash to conduct transactions in the real economy. And when the government is inflating away systematically, it makes absolute sense to get rid of cash before its purchasing power diminishes. Trade it for tangible goods that DO have value or utility like whiskey, cigars, and bullets.”

“How about something less revolutionary like houses?”

“Maybe not a bad idea if you’re using cash and not debt. And it would be a good idea if the price of the asset wasn’t going to collapse imminently. You don’t want to convert your cash into a capital asset that rapidly depreciates in value, which is possible with house prices.”

“But isn’t that possible with gold too? You convert your cash into a tangible asset whose value fluctuates? And it doesn’t even pay a yield! And you can’t exactly live in it either.”

“Of course that’s all true. But the reason central banks and households own gold, and the reason people have hoarded it for thousands of years, is that they KNOW intuitively that gold is good money, sound money, and that paper money is generally not good money – especially when it’s being actively destroyed by bad fiscal and monetary policy. Generally it’s not something you have to consciously think about. Most of the time the money in your pocket is exchangeable for the things you want.”

“So what’s the problem?”

“The problem now is that people are beginning to understand that monetary inflation is theft. If you trade your labor for wages paid in the form of cash, and the government devalues that cash, it’s stealing your productivity. It’s trading its paper product for the fruits of your labor at a discount. It’s cheating you. Gold doesn’t cheat you. It doesn’t love you either. It doesn’t do anything. That’s why people prefer to hold some of their wealth in that form, for those times when they are being cheated by government.”

“Well, that’s pretty much all the time isn’t it?”

“You know what H.L. Mencken said about elections in democracies? He said they are an advanced auction of stolen goods. There’s a whole lot of stealing going on these days. A fiat money system is systematic theft because it’s based on unsound money. That’s what’s being exposed by this financial crisis. The entire funding model of the fiscal welfare state is collapsing because it’s based on debt and fraudulent, counterfeit money.”

“Hey, do you want to go see Avatar?”

“Yes!”

We’re not saying people who don’t understand gold’s role as money are stupid – although maybe a few of them definitely ARE stupid. What we are saying is that it’s not rational to hedge against what you don’t know is coming. Most people have no experience with a currency collapse. So they don’t prepare for it. It seems so unlikely that it’s not worth hedging against.

Incidentally, until we start hearing this conversation in barbershops, we won’t be convinced gold is in a bubble. But in the meantime, if you are less dogmatic, a strategy for converting your equity holdings to something more tangible is just as practical.

Unfortunately for Ben Bernanke, the Fed can only make more dollars, not more gold. There are not many ready substitutes for precious metals. That’s part of what gives them their inherent value: their scarcity. Gold is not exactly unobtainable, like the “unobtanium” in Cameron’s Avatar. But it’s certainly getting a lot more desirable the more sovereign states go into debt they can never repay.

Regards,
Dan Denning
The Daily Reckoning Australia

December 21, 2009

Editor’s Note: This article first appeared as “Sustainability of U.S. Deficits Reason Why Investors Own Some Gold” in The Daily Reckoning Australia. To view the original article, please click here.

Stimulus Money Creation Makes Gold More Attractive was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

But with all the artificial stimulus money floating around, you can never be sure of what you see. Is this a real recovery or is it an artificially ripened tomato, and hence an imposter? When the stimulus money stops flowing will the recession get worse?

It’s hard to say, but let me give you a couple examples of distortions…

CNN’s bailout tracker reports that US government stimulus has totaled $2.8 trillion so far this year, with another $8.2 trillion in commitments. Most of this money has gone to the financial sector. Some of it has gone to infrastructure projects and to consumers (cash for clunkers, for example).

That is a lot of money. It is hard to say how all of this spending has artificially boosted economic activity in some sectors of the economy. It is obvious that such spending cannot continue indefinitely.

This has also been a worldwide phenomenon. There isn’t an economy of size that does not have some stimulus-spending program in place. Governments are spending money they don’t have. The result is widening budget deficits and higher debt levels.

First up, take a look this graph, from the Economist, which shows the industrial production of emerging Asia compared to the United States.

Looks like Asia is recovering pretty well. That chart shows the “decoupling” that became such a hot topic of discussion last year. The idea was that the emerging markets would not necessarily follow lockstep with the Western countries.

But this graph only tells a part of the story. China is one of the countries in “Emerging Asia.” China supposedly grew in the first quarter at an annualized rate of 15%. Yet, the government also spent a lot of stimulus money. As Eric Sprott writes in his latest letter to shareholders:

“The Chinese have injected a stimulus equivalent to 64% of their first half 2008 GDP in the first half of 2009… The Chinese government has effectively spent and lent enough in six months to buy 122 Ford Class aircraft carriers at US$8.1 billion a piece. It is akin to the US government injecting (and US banks lending) almost $4.5 trillion USD to its citizens and businesses before July 2009…an ungodly sum that would impact every asset class under the sun. Is it any wonder then that the Shanghai stock exchange has more than doubled from trough to peak since its November lows?”

Let me remind you that GDP is a clumsy way to get at an economy’s size. It is a figure that includes government spending. So, put another way, stimulus money this year is about 64% of the recorded economic activity in the first half of last year for China.

Where the Money is Going — Commodities

In some ways, the Chinese government spent well — investing in the commodities it craves. It’s locked down oil and gas assets, iron ore contracts, interests in rare earths and more. It’s put up power plants and laid down roads and pipelines. It’s made long-term investments in Africa and Brazil. Some of that will pay dividends down the road, if not already.

For instance, in the first six months of this year China became Brazil’s single largest export market. That’s the first time that’s ever happened. The Chinese and Brazilians are doing deals. For instance, China will lend $10 billion to Petrobras in return for 200,000 barrels of oil per day. China, in fact, has been active throughout South America, investing billions in mines, refineries, ports, and railroads.

These shifting patterns of trade always fascinate me. And we are living in an era of great change on that front, as new patterns emerge on a scale we have never seen.

It’s clear that China will have enormous needs for commodities over time. In the short-term, we are surely seeing distortions from the stimulus money. But the long-term demand is there nonetheless and the Chinese have a lot of money to spend.

Global Infrastructure is Still Getting Older Everywhere

In fact, infrastructure needs — especially in the areas of water and energy — are becoming more of a headline issue than ever. Not a week goes by where I don’t pick up a handful of stories of infrastructure falling apart somewhere. This, too, is a global story.

This week, for instance, there was a terrible accident in a Russian hydropower plant. Eleven people were killed and 65 were missing after water burst into a turbine room. It also destroyed the turbine. Besides the irremediable loss of life, it will take hundreds of millions of dollars and years to repair the demand.

As the FT reported, the accident “was a powerful reminder of Russia’s dire need for hundreds of billions of roubles in investment in its crumbling Soviet-era infrastructure.”

Putin’s government put aside $200 billion for infrastructure in two oil windfall funds, but that money is already being tapped for social spending programs and to help make up budget deficits. As in many places, including in the U.S., money set aside for infrastructure has been essentially hijacked by the political process and diverted to other uses.

Another story this week comes from Britain. Britain faces huge deficits in energy and the risk of widespread blackouts. Its energy complex is old and strained. The Economist reports: “The nuclear stations are simply too old to carry on: most are over a quarter of a century old. Around half have already been shutdown and are being decommissioned.”

About half of its electricity comes from natural gas, a legacy of its North Sea riches. But the North Sea peaked in 1999 and has been in steep decline ever since. Britain’s coal plants struggle under new pollution control rules and the effects of age. It’s an ugly situation that will cost a lot of money to fix.

The positive for investors is that there are several firms that are right in the sweet spot of this global infrastructure crisis. We own a few.

Regards,
Chris Mayer

August 25, 2009

The Effects of Epic Stimulus was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

A recent example from the British press: One of the first lottery millionaires punched a plumber and ended up in court, says The Telegraph. Michael Antonucci won 2.8 million pounds in 1995. But he “blew his entire fortune,” reported the paper last month. Now he’s reduced to stiffing tradesmen. The amount in dispute was just 400 pounds, what he was billed for a “gigantic ceiling mirror fitted above a whirlpool Jacuzzi.” He had the mirror installed when he was still flush. Now that he’s broke, he can’t pay…hence the altercation.

The phenomenon is little different when it happens on a national or even imperial scale. Any money that you don’t earn is stimulus. Without the sweat of honest toil on it, money seems to play a pernicious role in history. There are no examples – none – where it produced genuine prosperity. Instead, when a nation suddenly runs into some easy cash, it is soon spending more than it can afford…and getting into trouble.

The Roman Empire is in some measure a stimulus story. It conquered. It grew. Each conquest brought more booty…gold, silver, land and slaves. And each led to more conquests, which brought forth more booty. But the stimulus of this booty stimulated only the need for more stimulus. It did not stimulate real prosperity. Instead, it undermined it. First, slaves bought by rich landowners destroyed the free labor market and ruined small farmers. And then, imported wheat from the provinces – paid as tribute – put the large-scale farmers out of business too. Italy was then dependent on foreigners for its food.

In the first century AD, Roman conquests reached the point of diminishing returns; the stimulus came to an end. But borders still had to be protected. And Roman mobs, made up of displaced small landowners and out-of-work laborers, needed bread and circuses which drained the Treasury.

The first financial crisis of the imperial period came early. Caesar Augustus tried to solve it…with more stimulus. Neither paper money nor the printing press had yet been invented. So, Augustus increased the money supply in the only way he could; he ordered slaves in the silver mines in Spain and France to work around the clock! This extra money did not bring prosperity; it caused price inflation. In a period of about three decades, Rome’s consumer price index almost doubled. Then, when output from the mines could be increased no further, Augustus’s great nephew, Nero, found a new source of stimulus; he reduced the silver content of the coins. This source of stimulus proved ineffective, but enduring. By the time barbarians took over, the silver denarius contained almost no silver at all. Of course, Rome itself was played out too.

Another early and dramatic example of stimulus-in-action came in Spain in the 16th century. The conquistadors increased their supply of money in the time-honored fashion – by stealing it. Galleons brought treasure from the Americas; increasing the Spanish money supply substantially and fatally. The Spaniards had so much stimulus that they laid down their tools. Why should they work? They could buy things.

The discovery of a whole mountain of silver – Potosi – in the middle of the 16th century insured a supply of stimulus that would last for nearly a century. Results? Predictable. Inflation. In the “price revolution” from 1540 to 1640 the cost of living went up throughout Europe. In England, for which we have the most reliable data, prices went up 700%. And Spain, though it covered 40% of its state budget with this easy cash, still defaulted on its debts about once every 15-20 years, from 1557 for the next 10 decades. Spain, like Rome, welcomed stimulus; it never recovered from it.

Now we turn to the biggest misadventure in stimulus ever – the period after the United States ‘closed the gold window’ in 1971. In the 150 years before then, nations could stimulate their own economies with cash and credit, but only to a point. They could overspend; but they had to settle up in gold. After 1971, on the other hand, the sky was the limit – especially in the United States of America. The US could settle its bills in paper, which was then used by foreign central banks as monetary reserves. Since foreign banks were eager to add to their supplies of reserves, there was no effective limit on the amount of stimulus available. The Fed’s adjusted monetary base grew 900% since 1985, and more than doubled this year alone. Total US debt tripled – as percent of GDP.

As it did with Rome and Spain, more and more stimulus stimulated spending and speculation, but not real output. During the 2001-2007 period, for example, credit in the United States increased by $22 trillion. The nation’s GDP increased only by $4 trillion. For every extra dollar of output, Americans took on $5.50 of debt.

But now the bubble has blown up; the feds are on the case. What do they offer? More stimulus! Cometh a report this week that $23 trillion has already been put at risk in the various bailouts and credit guarantees. As for the US public debt, it is expected to increase until the country goes broke.

Future economic historians will look at these staggering efforts with awe and wonder; they will wonder what the Hell we were thinking.

Regards,
Bill Bonner

July 27, 2009

Romulus, Remus, Stimulus: A Brief History of Monetary Madness was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Early though it may be, however, it’s not too early to come right out and say what needs to be said: when it comes to the steps being taken to address the current crisis, Obama has no clothes.

Both President Obama and Timothy Geithner, the latest recipient of the Goldman Sachs Chair for Managing the Treasury, are on record as saying that the Japanese experiment in quantitative easing didn’t work. They say much the same about FDR’s New Deal. In both instances, they correctly point out that massive doses of government stimulus had no lasting effect.

If the history lesson stopped there, we could all nod our heads in agreement and go about our business.

Alas, the lips of Mssrs. Obama and Geithner keep moving… telling us with great confidence that the reason the fiscal exertions of Japan and FDR failed was only because in each case government didn’t act quickly enough, or with enough monetary vigor.

Having thus explained the shortcomings in prior adventures in stimuli, the administration promises that “this time it will be different” and wholeheartedly commits itself to acting decisively, quickly, and with stunning amounts of cash. By doing so, we are told, they will shock the economy back to life.

But this argument simply doesn’t hold water — there is zero historical precedent for the notion that applying blunt-force government stimulus will somehow mechanically “shock” an economy back into productivity. A couple of bullet points:

• When FDR came into power in 1933, unemployment in the U.S. had reached a high of about 25%. Despite tripling federal spending on the much heralded New Deal, the best unemployment number achieved was 14%, in 1937. By 1939, however, unemployment was back up to 19%. Now, there is some nuance in those numbers, because the calculations include some number of people on the payrolls of the New Deal’s many make-work programs. Yet, given the fact that those make-work jobs would have come to a quick end if the government had stopped its New Deal spending, the poor results of the FDR stimulus hold up.

• In the Japanese crash, the government spent hundreds of billions supporting banks and businesses, buying U.S. Treasuries in an attempt to keep the yen cheap and so their manufacturing sector at work. As the economic morass dragged on, the government cut interest rates to zero, then eventually accelerated spending in a five-year experiment in “quantitative easing,” which involved funding all manner of public works projects and other targeted infusions of government spending into the economy.

Using the equity market as a proxy for the broader economy, the Nikkei fell from around 38,000 at the height of the bubble in the late 1980s, down to around 7,000. During the five-year period of quantitative easing, 2001 to 2006, the Nikkei rebounded by about 100%, moving back to the 14,000 neighborhood. Importantly, however, the minute the Japanese government stopped the spending, the stock market came tumbling back down to around 7,500, near where it hovers today. Note that at no point did it get anywhere near the bubble high of over 38,000.

In sum, the evidence strongly suggests that there is no permanent benefit to be gained from throwing a lot of money at an economy, though there is one clear negative: a steep ratcheting up in government debt. Of course, because the government doesn’t actually make anything, what we’re really talking about is a steep ratcheting up of your debt… and that of your children… and their children.

So, what’s going on? Don’t you think all the Obama’s horses and all the Obama’s men know this?

Maybe they do.

In earlier editions of this missive, I have commented that President Obama may be the best politician in U.S. history. How else to explain how a virtually unknown black man could, in just a few short years, become president. And do so despite a foreign father and two given names eerily reminiscent of two of the most vilified individuals in the current American ethos? Impossible, most would have said, if asked a few years ago. But here he is… undeniable proof of his political skills.

Not to be cynical, but what if, on surveying the landscape, Obama and his inner circle came to the following conclusions about the possible paths they could take in regard to the dismal economy:

Path One: Stand aside and let Mr. Market put on the leather gloves, pick up the truncheon, and get to work pounding the economic dislocations out of the economy. Or…

Path Two: Observe that, during the period of Japan’s quantitative easing, the economy actually did pick up, albeit on a cushion of growing government debt. Using the same approach, one might push the worst of the economic problems past the next presidential election. Given his political skills, that approach syncs up nicely with what is almost certainly Obama’s most pressing personal goal: to avoid at all costs the ignominy of being a one-term president.

Besides, Team Obama could rationalize, even though the quantitative easing will have no lasting effect other than sending government deficits through the roof (a fact that Obama has been very candid about), it will at least buy the new administration some time to come up with another plan that might actually work.

I sincerely believe that just this sort of calculation has been made, and not for practical economic reasons – but almost entirely political ones. Supporting that contention, a large part of the spending in the latest stimulus bill is slated for 2011, the year before the next presidential election is held. Coincidence?

Then there is the $2 billion earmarked for ACORN in that same stimulus bill. While I tend to dismiss the allegations about ACORN’s purported voter fraud as desperate measures on the part of the failing McCain campaign, what we do know about ACORN is that their primary mission is voter registration, and that they are very friendly to President Obama.

It’s all a big win-win… as in “yes we can” win-win the next presidential election.

The way the current mess will actually get cleaned up is through the adoption of measures that support, or at least don’t hinder, entrepreneurs running or starting businesses and expanding into new markets. What we have instead is yet another experiment in more government.

In this matter, at least, Obama has no clothes.

Regards,
David Galland
Managing Editor, The Casey Report

February 23, 2009

Stimulus, Deficit and Elections: Obama Has No Clothes was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.