Big Ben’s Dilemma

The Sovereign Society Offshore A-Letter
Monday, July 20, 2009

Financial “Hindsight” Set to Ruin Investors:
The Inconvenient Difference between
What the Fed Does and what the Media Says

Dear A-Letter Reader,

Hindsight’s a funny thing…

I mean now, today, it seems painfully obvious that the business of loaning money to people who can’t pay you back…well, that’s bound to fail. Today, it’s pretty obvious that auction-rate securities can be prone to the “stampede” effect. And it’s also pretty obvious that selling hundreds of trillions worth of Credit Default Swaps (bankruptcy bets) introduces serious systemic risk…

And yet, we did all these things for years.

Financial analysts toted the value of AAA-rated securities…Cramer & CNBC lauded bank stocks and REITs while the U.S. real estate market was clearly in bubble mode.

But then something funny happened…

When the bubbles came crashing down…when average investors like you and I pushed retirement back by another year…when the mom & pop pensioners went broke…it all became “clear as day” to the financial media.

In the heat of the moment, most commentators offered advice that was little better than a coin-flip (and often disastrously worse). But in hindsight, the pundits all really were the people their marketing promised to be.

They talked about the ‘bubble’ like scholars. As though it’d always been a fact of life…not a multi-trillion dollar booby trap that somehow suckered ‘em all in.

In the eyes of the uneducated observer – one that doesn’t remember Cramer’s Bear Stearns buy in early March of last year – this is where they get their credibility. They talk smart…they mention metrics and news that the professionals are keen on. And if you’ve got a short memory…well, they’ve got you hooked.

But what if this isn’t your first rodeo?

What if you know these guys are missing something…you just can’t put your finger on it. What if you don’t want their stupidity costing you in the long run? It’s only fair.

Well if that’s what you’re looking for, then you need to understand…
Big Ben’s Dilemma…

The realization first struck me when I read about Big Ben Bernanke’s photo-op today, and what’s expected of him…

To bring you up to speed; remember that Ben needs low interest rates. Why? Because the mortgage market is still garbage, and an impending wave of resets and recasts could send defaults through the roof and torpedo any chance of recovery. The higher the rates, the more intense the damage.

So Ben pulled every last rabbit out of the hat when it came to keeping rates low…even going to the extent of printing money to buy government debt (something like Weimar Germany did in the '20’s and Japan did in the '90’s).

But this puts Ben in a tight spot…

Think about it; he could open up the printing press and literally flood the world with dollars. This would cure any mortgage problems in the U.S., but it would also avail us of meaningful economic activity. In other words; this option is kind of fixing a broken leg by chopping it off.

But – if he’s mindful of inflation…and he keeps his printing to a minimum – then all his effort so far could become worthless. As an academic, he insists that this very reluctance to print money was what made the Great Depression of the 1930’s so brutally intense.

In the short-term, Bernanke’s actions saved us from wholesale failure of the U.S. financial sector last year.

But at what cost?
The Difference between Stabilization and Recovery

That very question is on the tip of everyone’s tongue here lately; how much is this going to cost us in the long run?

Ultimately, concern over the answer served to lengthen the Great Depression of the 1930’s. These days, it’s on the brink of forcing Bernanke to show his hand…namely; whether he’s playing toward stabilization…or he’s playing toward recovery.

To calm fears about what Bloomberg calls, “the biggest monetary expansion in history,” Ben is prepared to tighten the belt on his pool of funny money. One of the most prominent options for making that happen would be, “establishing term deposits at the Fed designed to induce banks to keep money there rather than lending it out.”

Wait a second. Hit the brakes…

Did he say that he was going to incentivize banks not to lend out money?

That’s curious.

I mean; hasn’t the general party line – the phrase spouted so often by Obama and his posse – that we need to “get lending going again,” that we need to “spur on lending…”

Then there’s my personal favorite… “Credit is the lifeblood of our economy.”

So let’s work this out practically; if credit is the lifeblood of our economy…and the forces of bankruptcy and default are slowly causing us to bleed out…then doesn’t recovery necessitate growth in credit?

You just got it. Right there…Ben’s not talking about recovery.

Obama and Bernanke aren’t saying the same thing. Bernanke and CNBC aren’t saying the same thing. Obama and CNBC are the only two out of the three that actually agree…

Bernanke – through his cautious actions and statements – is acting in the interest of stabilizing the U.S. financial system. Even after spending so many billions, bailing out so many slimy bankers…the man’s still got a full plate. He’s “monkey-in-the-middle” between the threat of inflation and a rapidly deteriorating U.S. housing market.

Obama and CNBC – on the other hand – apparently missed the memo…because they skipped ahead to “hindsight” on the stabilization bit.

After saving a handful of prominent campaign contributors like Goldman and AIG, both seemed to take the optimistic tack, sometimes declaring “the worst is over,” or even declaring an outright end to recession.

Why they would think to do this is beyond me and the page I have left for today’s A-Letter. Call it a matter of vested interest…an occasion of “say it ain’t so”…or a repeat of the early days of the Great Depression.

Some might even observe the fact that if you and I buy into this recovery – with what’s left of our portfolios – then it will be more likely to succeed; that there’s something vaguely conspiratorial about this whole arrangement. To that I shrug…and remind you of Clark’s law (Never assume malice where sufficiently advanced incompetence will do).

Instead, the most important thing for you to remember now is this; if you’re out there investing today, you’re investing amid active stabilization of the economy—and not during a recovery.

For a few words on what that means to you, I talked to our Chief of Research, Andrew Packer…
Stabilization & Your Portfolio

“Stabilization is the renunciation of a process known as ‘creative destruction’ – something seen today in the form of bankruptcies and defaults. On a deeper level though, creative destruction is what allows economies to succeed over time…

“Defaults may be bad…even punitive to the parties involved. But they’re the penalty in a free-market system for poor choices. Those who correctly recognized the risk and shorted were rewarded. It’s all part of the profit system as defined by a system of capitalism (as opposed to the profit system as defined by investment banks).

“At first, creative destruction might seem painful or even unfair. But in the long run it opens up an economy for innovation and new industries…contributing to greater efficiency and an economy better fit to serve a changing populace.

“The renunciation of creative destruction – often euphemized as ‘stabilization’ – tends to correspond to a shift toward state intervention…one which destroys capital, innovation, and freedom.

“It’s the process by which bad loans are kept on the books of banks that should be bankrupt. It’s the process that keeps things frozen, or moving at such a slow pace that true recovery is delayed—potentially for years.

“Ultimately, the only thing that’s being stabilized here is failure.

“For the sovereign investor, the implications are clear: stabilized markets make for poor investment returns. Since that can happen at any time, diversification and liquidity remain your best defense against this type of market performance. Markets that involve physical ownership, such as silver and gold, offer slightly more safety from stabilization than paper markets—including debt and equities.”

Yours in Personal Sovereignty,

Matthew Collins