Page 2 of
2 Bulls, bankers blind to inevitable
bust By Doug Wakefield
(with Ben Hill)
time in history,
all the major currencies of the world floated
solely on trust, with nothing to slow up credit
and debt expansion. Though history had shown time
and again the destructiveness of such a course of
action, the gold-exchange standard was abandoned
and paper money ruled the day.
In
examining national and international experts'
speeches over the past several years, we see a
recurring theme: as the "almighty" dollar goes the
way of all fiat currencies, how should global
capitalism prepare?
Since our tendencies are the same today as
they were in the 1920s and 1930s, we should expect
to endure many failed government attempts at
sticking duct tape on the wings of this plane. As
the natural forces of science and psychology
collide with financial engineering over trillions
of dollars of debt, the government will continue
to try to help every one of their "major
supporters" through one more day. As they try to
rescue us with some new scheme for the world
capital markets, we're sure to see government's
role expand. And since the world's capital markets
have made us more dependent on each other than
those living in the 1930s, the next market and
currency "solution" will be global, rather than
national, in scope.
So, does all of this
support the hypothesis of prices unwinding slowly?
A look at the plummeting value of two of the
largest holders of mortgage paper in the US,
Federal Home Loan Mortgage Corporation, or Freddie
Mac and Federal National Mortgage, or Fannie Mae,
with share prices that have more than halved since
early October, suggests otherwise. Declines in two
of our nation's largest bond insurers - MBI, whose
share price has halved in the same timeframe, and
Ambac Financial Group, down since May from above
US$95 to below $22 - tell a similar story.
Twelve months ago, most investors surmised
that only a slow unwind, not a sharp plunge, was
in the cards. Besides, planning for such extreme
conditions was only being espoused by
"gloom-n-doomers".
All the king's
horses On Tuesday, less than two hours after
the famed wizards of modern finance spoke, the Dow
shed more than 300 points. On Wednesday, December
12, the morning after the Federal Reserve cut the
Fed Funds Rate for the third time this year, the
Dow opened up almost 300 points from the Tuesday
close before rolling over to fall more than 300
points during the day. Was there anything that
could be learned prior to these swings? Were these
purely random events? Or could those who
understand the way banking and finance works have
factored these swings into their investment
strategy and thinking, before the headlines sought
to explain what happened?
Exceeding its
speed of ascent during the August 16 to October 11
run, the Dow has moved up over 1,000 points in
less than 11 trading days. Evaluating the Dow's
speed of ascent and descent would have warned
investors and advisors that something unhealthy
and unsustainable was developing. Those who look
at the markets' reactions through the lens of
history know that today's central banking actions
are not natural and sustainable but unnatural and
unsustainable. A December 12 Bloomberg article
states:
The Federal Reserve, European
Central Bank and three other central banks moved
in concert to alleviate a credit squeeze
threatening global growth, in the biggest act of
international economic cooperation since the
Sept 11 terrorist attacks. Central bankers took
the action after interest-rate reductions in the
US, UK and Canada failed to allay concerns that
banks will reduce lending, sending the US into
recession and hobbling growth abroad. Borrowing
costs have climbed as mounting losses on
securities linked to subprime mortgages caused
lenders to conserve cash.
The plan
involved a pledge to offer as much as $64 billion
to financial institutions.
In our August
issue of The Investor's Mind, quoting an
August 10 Yahoo Finance article, we noted the same
thing.
The Federal Reserve pumped $38
billion into the banking system Friday, marking
its biggest operation since the week of the 9/11
terror attacks, as it vied to shore up the US
financial system. The US central bank acted
after injecting $24 billion Thursday into the
market, amid sharp falls on global stock markets
which were triggered by fears over the
multi-trillion dollar US mortgage market and a
related credit crunch.
And again with
an August 9th Financial Times article, we quoted:
The European Central Bank scrambled
to head off a potential financial crisis on
Thursday by pumping an emergency 94.8 billion
euro($131 billion) into the region’s banking
system after liquidity in the interbank market
started to dry up, threatening banks' access to
short-term funds. The cash injection was the
biggest in the ECB's history, exceeding the 69
euro billion provided the day after the
terrorist attacks of September 11 2001. The ECB
also made an unprecedented one-day pledge to
meet 100 per cent of all funding requests from
financial institutions.
But as I
stated in the beginning of this article and in
Herb Greenberg's May 10, 2007 Wall Street
Journal column, the real problem lies in our
natural tendencies:
The reason we don't believe the
markets will crash is because we do not want to.
Simply put, we enjoy the illusion of wealth that
easy credit creates. And who wouldn't? With easy
credit, there is no need to work for years and
save, no need for politicians to ever say no,
and no need to wait and do without. We don't
have to look below the surface and examine the
foundation of our markets and economies. If the
system is experiencing a problem, liquidity is
always the answer. If we encounter a slowdown,
just add more liquidity. After all, it's been
working for years. And the longer this
arrangement persists, the more this belief is
reinforced.
Though most financial
professionals know very little of Ludwig Von
Mises, in his 1952 edition of The Theory of
Money and Credit, he says as much. Originally
written in German, in 1912, one year prior to the
establishment of the Federal Reserve, Von Mises
observed: "If one wants to avoid the recurrence of
economic crises, one must avoid the expansion of
credit that creates the boom and inevitably leads
into the slump."
After the close of World
War I, in his 1919 work, The Economic
Consequences of Peace, even good old John
Maynard Keynes agrees:
Lenin is said to have declared that
the best way to destroy the capitalist system
was to debauch the currency. As the inflation
proceeds and the real value of the currency
fluctuates wildly from month to month, all
permanent relations between debtors and
creditors, which form the ultimate foundation of
capitalism, become so utterly disordered as to
be almost meaningless: and the process of
wealth-getting degenerates into a gamble and a
lottery.
So if what we are watching is
more of a casino, what should we do? One week
prior to this week's rate cut by the Federal
Reserve, Clive Briault, managing director of
retail markets for the Financial Service
Authority, the English equivalent of the Federal
Deposit Insurance Corporation or the Securities
and Exchange Commission, stated:
You need to consider contingency
plans against the worst outcomes. These plans
might include the very practical issue of how
you would cope with an upsurge in retail deposit
withdrawals, both from your branches and over
the Internet; how you could access emergency
funding; and the circumstances in which you
might need to curtail or wind down your
business. Again, any such plans need to be
considered well before you are engulfed by a
crisis since by then it will almost certainly be
too late to develop practical responses.
italics mine
(I would like to extend a
special thanks to Dr Mark Thornton, of the Ludwig
Von Mises Institute, for his assistance regarding
Von Mises.)
Doug Wakefield is
the president of Best Minds Inc, a registered
investment advisor. He can be reached at
doug@bestmindsinc.com
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