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Keeping Capital in a Depression.

Keeping Capital in a Depression

by Doug Casey

Recently by Doug Casey: Save, Invest, Speculate, Trade, or Gamble?

 

 

 

Nothing is cheap in today’s investment world. Because of the trillions of currency units that governments all over the world have created – and are continuing to create – financial assets are grossly overpriced. Stocks, bonds, property, commodities and cash are no bargains. Meanwhile, real wages are slipping rapidly among those who are working, and a large portion of the population is unemployed or underemployed.

The next chapter in this sad drama will include a rapid rise in consumer prices. At the beginning of this year, we saw the grains – wheat, corn, soybeans and oats – go up an average of 36% within one month. In the same time frame, hogs were up 30.7%. Copper was up 29.1%. Oil was up 14%. Cotton was up 118%. Raw commodities are the first things to move in an inflationary boom, largely because they’re essential to everything. Retail prices are generally the last to move, partly because the labor market will remain soft and keep that component down, and partly because retailers cut their margins to retain customers and market share.

We are in a financial no-man’s land. What you should do about it presents some tough alternatives. “Saving” is compromised because of depreciating currency and artificially low interest rates. “Investing” is problematical because of a deteriorating economy, unpredictable and increasing regulation, rising interest rates and wildly fluctuating prices. “Speculation” is the best answer. But it may not suit everyone as a methodology.

There are, however, several other alternatives to dealing with the question “What should I do with my money now?” – active business, entrepreneurialism, innovation, “hoarding” and agriculture. There’s obviously some degree of overlap with these things, but they are essentially different in nature.

Active Business

Few large fortunes have been made by investing. Most are made by creating, building and running a business. But the same things that make investing hard today are going to make active business even harder. Sure, there will be plenty of people out there to hire – but in today’s litigious and regulated environment, an employee is a large potential liability as much as a current asset.

Business itself is seen as a convenient milk cow by bankrupt governments – and it’s much easier to tap small business than taxpayers at large. Big business (which I’ll arbitrarily define as companies with at least several thousand employees) actually encourages regulation and taxes, because their main competition is from small business – you – and they’re much more able to absorb the cost of new regulation and can hire lobbyists to influence its direction. Only a business that’s “too big to fail” can count on government help.

It’s clearly a double-edged sword, but running an active business is increasingly problematical. Unless it’s a special situation, I’d be inclined to sell a business, take the money, and run. It’s Atlas Shrugged time.

Entrepreneurialism

An entrepreneur is “one who takes between,” to go back to the French roots of the word. Buy here for a dollar, sell there for two dollars – a good business if you can do it with a million widgets, hopefully all at once and on credit. An entrepreneur ideally needs few employees and little fixed overhead. Just as a speculator capitalizes on distortions in the financial markets, an entrepreneur does so in the business world. The more distortions there are in the market, the more bankruptcies and distress sales, the more variation in prosperity and attitudes between countries, the more opportunities there are for the entrepreneur. The years to come are going to be tough on investors and businessmen, but full of opportunity for speculators and entrepreneurs. Keep your passports current, your powder dry, and your eyes open. I suggest you reform your thinking along those lines.

Innovation

The two mainsprings of human progress are saving (producing more than you consume and setting aside the difference) and new technology (improved ways of doing things). Innovation takes a certain kind of mind and a certain skill set. Not everyone can be an Edison, a Watt, a Wright or a Ford. But with more scientists and engineers alive today than have lived in all previous history put together, you can plan on lots more in the way of innovation. What you want to do is put yourself in front of innovation; even if you aren’t the innovator, you can be a facilitator – something like Steve Ballmer is to Bill Gates. It will give you an excuse to hang out with the younger generation and play amateur venture capitalist.

This argues for two things. One, reading very broadly (but especially in science), so that you can more easily make the correct decision as to which innovations will be profitable. Two, building enough capital to liberate your time to try something new and perhaps put money into start-ups. This thinking partly lay in back of our starting our Casey’s Extraordinary Technology service.

Hoarding

In the days when gold and silver were money, “saving” was actually identical with “hoarding.” The only difference was the connotation of the words. Today you can’t even hoard nickel and copper coins anymore because (unbeknownst to Boobus americanus) there’s very little of those metals left in either nickels or pennies – both of which will soon disappear from circulation anyway.

We’ve previously dismissed the foolish and anachronistic idea of saving with dollars in a bank – so what can you save with, other than metals? The answer is “useful things,” mainly household commodities. I’m not sure exactly how bad the Greater Depression will be or how long it will last, but it makes all the sense in the world to stockpile usable things, in lieu of monetary savings.

The things I’m talking about could be generally described as “consumer perishables.” Instead of putting $10,000 extra in the bank, go out and buy things like motor oil, ammunition, light bulbs, toilet paper, cigarettes, liquor, soap, sugar and dried beans. There are many advantages to this.

Taxes – As these things go up in price and you consume them, you won’t have any resulting taxes, as you would for a successful investment. And you’ll beat the VAT, which we’ll surely see.

Volume Savings – When you buy a whole bunch at once, especially when Walmart or Costco has them on sale, you’ll greatly reduce your cost.

Convenience – You’ll have them all now and won’t have to waste time getting them later. Especially if they’re no longer readily available.

There are hundreds of items to put on the list and much more to be said about the whole approach. The idea is basically that of my old friend John Pugsley, which he explained fully in his book The Alpha Strategy. Take this point very seriously. It’s something absolutely everybody can and should do.

Agriculture

During the last generation, mothers wanted their kids to grow up and be investment bankers. That thought will be totally banished soon, and for a long time. I suspect farmers and ranchers will become the next paradigm of success, after being viewed as backward hayseeds for generations.

Agriculture isn’t an easy business, and it has plenty of risks. But there’s always going to be a demand for its products, and I suspect the margins are going to stay high for a long time to come. Why? There’s still plenty of potential farmland around the world that’s wild or fallow, but politics is likely to keep it that way. Population won’t be growing that much (and will be falling in the developed world), but people will be wealthier and want to eat better. So you want the kind of food that people with some money eat.

I’m not crazy about commodity-type foods, like wheat, soy and corn; these are high-volume, industrial-style foods, subject to political interference. And they’re not important as foods for wealthy people, which is the profitable part of the market. Besides, grains are where everybody’s attention is directed.

But there are other reasons I’m not wild about owning any amber waves of grain. Anything you want to plant will practically require the use of a genetically modified (GM) seed from Monsanto. I’m not sure I really care if it’s GM; all foods have been genetically modified over the millennia just by virtue of cultivation. And $1 paid to Monsanto typically not only yields the farmer $5 of extra return, but produces lots of extra food – which helps everybody. But I wouldn’t be surprised if someday the giant monocultures of plants, all with totally identical purchased seeds, don’t result in some kind of catastrophic crop failure. This is a subject for another time, but it’s a thought to keep in mind.

In any event, agricultural land is no longer cheap. But I don’t suggest you look at thousands of acres to plant grain. Niche markets with niche products are the way to fly.

I suggest up-market specialty products – exotic fruits and vegetables, fish, dairy and beef. The problem is that in “advanced” countries – prominently including the U.S. – national, state and local governments make the small commercial producers’ lives absolutely miserable. Maybe you can grow stuff, but it’s extremely costly in terms of paperwork and legal fees to sell, especially if the product is animal based – meat, milk, cheese and such. Niche foods are, however, potentially a very good business. Eternal optimist that I am, I see one of the many benefits of the impending bankruptcy of most governments as again making it feasible to grow and sell food locally.

Above all, though, this isn’t the time for business as usual. You’ll notice that “Working in a conventional job” didn’t occur on the list above. And I pity the poor fools working for some corporation, hoping things get better.


Get more valuable advice on how to survive in a crisis in The Casey Report – a monthly newsletter brimming with top-notch analysis of U.S. and world events, economic research, trend forecasts and investment advice for the big-picture investor. Details in this free report.

April 14, 2011

Doug Casey (send him mail) is a best-selling author and chairman of Casey Research, LLC., publishers of Casey’s International Speculator.

Copyright © 2001 Casey and Associates

The Best of Doug Casey

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Out-greeking the Greeks. PMCO now betting against U.S. government debt.

The US government shutdown debate is a distraction.  Bill Gross, co-chief investment officer of the world’s largest bond fund, nailed the problem succinctly.  "We are smelling $1 trillion deficits as far as the nose can sniff," if the government fails to address the biggest entitlement programs: Medicare, Medicaid and Social Security, Gross said in his outlook.  These three programs alone will destroy the U.S. government.  They are immoral, unconstitutional, massive Ponzi schemes that will bankrupt the U.S. government.  And grandma is dependent on them!!

Mr. Gross knows that granny votes and that congressmen fear granny’s wrath at the polls.  Granny will get her Medicare, Medicaid, and Social Security until the younger voters outnumber granny.  It will take many years for the younger vote to outnumber granny.  Therefore, he is betting against the U.S. government debt.  Interest rates for U.S. government bonds will rise once the Federal Reserve ends its QE2 program.

U.S. government bonds are not safe.  They are one of the next bubbles to pop.  You should purchase high dividend stocks with earning power and strong balance sheets instead of bonds.  Many stocks yielding 3-4% right now will become high dividend stocks when the stock market crashes again.

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PIMCO now betting against U.S. government debt

On Monday April 11, 2011, 11:36 am

NEW YORK (Reuters) - The world's largest bond fund began betting against U.S. government debt last month on the expectation that shaky finances will jolt interest rates higher.

PIMCO, through its outspoken co-chief investment officer, Bill Gross, has been raising alarms about a lack of buyers for Treasuries once the Federal Reserve ends its own bond purchase program, also known as QE2, in June.

In February Gross revealed his ultra-bearish view on the United States by dumping all of his fund's U.S. government-related debt holdings.

The portion of PIMCO's $236 billion Total Return Fund held in long-term U.S. government debt, including U.S. Treasuries, declined to "minus 3" percent in March from zero in February and 12 percent in January.

In a short position, an investor sells a borrowed security on a bet it can buy the bond back later at a lower price.

Cash equivalents, including Treasury bills and other debt with maturities of less than a year, rose to 31 percent of the fund's assets from 23 percent in February.

PIMCO also expects the lingering U.S. budget deficit and the Fed's easy monetary policy will fuel faster inflation and hurt the dollar.

PIMCO's vote on the state of U.S. finances comes just as Washington narrowly averted a government shutdown on Saturday after Democrats and Republicans agreed on cutting $38 billion in spending for the fiscal year.

The 11th hour compromise probably had little impact on the investment strategies of Gross, who said in an April newsletter that the U.S. government was "out-Greeking the Greeks," a reference to the out-sized government debt in Greece that forced the country to ask for a bailout.

"We are smelling $1 trillion deficits as far as the nose can sniff," if the government fails to address the biggest entitlement programs: Medicare, Medicaid and Social Security, Gross said in his outlook.

PIMCO's move mirrors a broader dislike of U.S. Treasuries. Some exchange-traded funds that bet against the Treasury market have seen a jump in volume lately. Volume in the ProShares Short 20+ year Treasury (Pacific:TBF - News), which shorts the Barclays Capital U.S. 20+ Year Treasury Bond Index, on Thursday of last week had its most active session since February 24.

And speculators went net short on Treasuries for the first time in six weeks as of April 5, according to the latest data from the Commodity Futures Trading Commission.

U.S. Treasury yields have moved higher since the Fed began purchases of the securities in its second quantitative easing program in November. Yields on 10-year Treasury notes have risen 80 basis points since then to 3.59 percent.

(Reporting by Al Yoon and Richard Leong in New York, and Kevin Plumberg in Singapore; Editing by Padraic Cassidy)

Link to original article: http://yhoo.it/h7VFpE

Printing Money to Save the World.

Printing Money to Save the World

by Bill Bonner
Daily Reckoning

Recently by Bill Bonner: No Hope for a Consumer-Driven Economic Recovery

 

 

 

The Dow rose 50 points on Friday. Gold rose too.

As we ended the week, the Dow was over 12,000…gold was over 1,400…and oil was over $100.

And all seemed to be headed up.

But there’s trouble afoot.

Housing in the US, the foundation of most household wealth in the country, has gone into a double dip…which could drag millions more homeowners underwater.

In other words, the speculative markets are moving one way. The economy is moving the other. The markets are going up. The economy is going down.

Oh…and you can imagine what this does to the poor householder. He’s caught in the middle. The real economy pushes the value of his main asset down…while the feds push up the cost of his most important supplies – food and energy.

“Don’t worry about it,” says Bernanke, Geithner et al. The economy is recovering. But is it?

Nah…

It’s going to turn out very, very badly.

As predicted here, the feds’ easy money is making things much harder for most people. It’s pushing up costs…and prices. The feds can tell American households that the inflation rate is under 2%, but the poor consumer knows better. He knows that his real cost of living is going up at a rate probably more than 5%. Maybe, as John Williams tells us, more like 9%.

So, thanks to the feds’ pro-inflation policies, the consumer can’t buy as much stuff…so stores don’t sell as much stuff…and the economy weakens. And then, what do the feds do? They push even more inflation into the system.

This is not going to end well. Inflation is increasing…while inflation expectations are still low. Sometime in the future…inflation expectations will get ahead of inflation. And then, the Fed, if it is to get control of the situation, will have to put rates up above the real rate of inflation. In other words, the Fed will have to get ahead of inflation.

Is that going to happen? Not likely. Not in an economy that is slumping.

And along the same line…

We love Japan. Yes. Count on the Japanese to do things that are both great and horrible at the same time.

To put the following news item in perspective, the Japanese are in even worse straits than Americans, at least in some ways. Their government debt equals 220% of GDP. Savings rates are falling to zero. The annual government budget dwarfs tax receipts. And the Japanese face a huge bill for rebuilding after the earthquake, the most expensive natural catastrophe in history.

Where are they going to get the money?

Well, there are two possibilities. The first is bad for Japan. The second is bad for the US.

Like the US, Japan can print its way out of the problem. Some Japanese officials are all for it. Others aren’t. Bloomberg has the report:

Bank of Japan Governor Masaaki Shirakawa is under fire for refusing to consider 1930s-style purchases of government bonds to fund reconstruction from the nation’s record earthquake.

Shirakawa repeatedly attempted to quash direct buying of government debt, a step allowed in extraordinary circumstances with the permission of the Diet, in appearances before lawmakers this week. The policy would undermine confidence in the yen and provoke a surge in consumer prices, he said at parliamentary fiscal and finance committee hearings.

“If this isn’t a special situation, what is?” Kozo Yamamoto, a Diet member with the opposition Liberal Democratic Party, said in an interview this week. Yamamoto advocated a 20 trillion yen ($247 billion) reconstruction program funded by BOJ debt purchases. A group of ruling-party lawmakers submitted a similar proposal to Finance Minister Yoshihiko Noda on March 18, according to a web log posting by DPJ member Yoichi Kaneko.

The debate parallels discussions last year in the US and Europe, where the Federal Reserve and European Central Bank adopted bond-buying programs.

The report mentions how Japan paid for its military build-up in the ’30s. It printed money! Eventually this led to runaway inflation…and economic as well as military disaster.

But what’s the choice?

Well, there’s another option: Japan should dip into its “rainy day fund,” say economists Carmen and Vincent Reinhart. While the Japanese bought Japanese government debt, the Japanese government bought the debt of other governments – primarily, the USA.

Now, it has about a trillion dollars’ worth of it. Why not just sell some of it in order to rebuild the country?

Well, yes… But then, you see the problem, don’t you, Dear Reader? What happens to the price of US government debt? It goes down, right?

And then the US has a hard time funding its deficits.

But wait. It can print money too.

Oh joy…we’re saved!

Reprinted with permission from The Daily Reckoning.

March 29, 2011

Bill Bonner is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and The New Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007). Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning.

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Marc Faber's March Outlook: Falling Stocks, Wicked Inflation, and Middle East Turmoil.

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Marc Faber’s March Outlook: Falling Stocks, Wicked Inflation, and Middle East Turmoil

By Nathaniel Crawford Mar 1, 2011, 12:48 AM Author's Website  

Marc Faber is out with his latest issue of the Gloom, Boom and Doom Report, which is always a must read for serious investors. This month’s report covers his outlook for the stock market, gold, oil, and the future for the US and global economy. Here are some of the highlights:

1. Stock Market–Still bearish in the short-term. Faber cautions against being bearish longer-term as long as the world is printing money, which will continue to inflate nominal stock prices. That said, technical indicators suggest a market correction. In particular, Faber notes the declining number of new 52 week highs, overly optimistic sentiment, and breakdowns in major stocks like Hewlett-Packard and Wal-mart. Furthermore, corporate insiders are selling stocks at a furious pace (855-1), indicating that they believe now is time to take profits, not risks.

2. Emerging Markets—Faber is still bearish on emerging markets in the short-term, and he expects world markets to correct further. However, emerging markets should be bought on the decline, especially since many of them are already down from their November 2010 highs. He notes that many institutions have been rotating out of EM and into developed markets, despite EM having better fundamentals. Some EM stocks have fallen 20-30%, which makes them a good value compared to US stocks. EM markets with the lowest forward PE ratios are Russia, Hungary, Turkey, and Brazil, which are good places to invest. Other markets to consider are Malaysia, Thailand, and Singapore where you can get good dividend yields.

3. Gold—To Faber the risk concerning gold is not whether it goes up or down, but the risk lies in not owning any of it in your portfolio. Gold could face a correction, but this does not bother him. He advises people to continue to accumulate gold and silver by dollar cost averaging every month. Strong fundamentals favor gold long term–not just because of money printing by central banks, but also because demand from emerging markets like China are increasing at an extraordinary rate. In 2010 China and India accounted for 50% of total gold demand in 2010. This number will only increase, providing strong support to the gold price.

4. Oil and Energy Stocks–The price of oil will remain high for the foreseeable future because of the unrest and likely further deterioration in the Middle East, along with inflationary policies by the world’s major central banks. Faber postulates that Pakistan could be the next domino to fall which would be a catastrophe for the world as it has nuclear weapons. While oil has spiked to $100 recently (WTI Crude), Faber thinks it will remain above $90 due to these these factors. Regarding energy stocks, they have a had a nice run, and investors should take profits or wait for a pull back before initiating new positions. Favorites are Chesapeake Energy and Suncor Energy.

5. Retail Stocks–Faber thinks retails stocks are vulnerable right now as rising food and oil prices reduce consumer spending. Wal-Mart is the classic example of difficult conditions for retails stocks, after the retailer reported another decrease in same store sales. If you want a real proxy for how the economy is doing, follow Wal-Mart’s stock price which has been flat for the past 2 years.  Faber even advises people to short the Retail Index (RTH) with a tight stop-loss.

Link to original article: http://wallstreetpit.com/64261-marc-fabers-march-outlook-falling-stocks-wicked-inflation-and-middle-east-turmoil

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Farrell Predicts Market Crash 2011: It Will Hit by Christmas

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Paul B. Farrell

Feb. 22, 2011, 12:01 a.m. EST

Market Crash 2011: It will hit by Christmas

Commentary: The S&P 500 is worth only 910. Get out or lose big

Mr. Farrell, behavioral economics columnist and former Morgan Stanley investment banker, recently wrote a damning commentary on the lies that Wall Street and the Federal Reserve continue to feed you.  Ignore it at your own peril.

There will be another opportunity to buy high dividend stocks at or near the bottom of the next phase down in this Federal Reserve induced bust (bear market).  Keep your invested savings on the sideline in a money market fund.  Make sure you are raising your trailing stops on your winning high dividend stocks.

http://bit.ly/BearMarket

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(Hat tip to Larry)

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Bad News for Mortgage REIT AGNC. Housing Prices Headed Lower.

The financial press is reporting today that house prices are headed back down following the ill conceived government stimulus known as the “First Time Home Buyer” subsidy.

http://www.reuters.com/article/2011/02/22/us-usa-economy-confidence-idUSTRE71L3XL20110222

I believe these continued adverse developments in the broader residential mortgage market will negatively impact the earnings of high dividend stock American Capital Agency Corp. (AGNC).  The following risk excerpt from AGNC’s 2009 annual report states the risk quite succinctly:

Continued adverse developments in the broader residential mortgage market may adversely affect the value of the agency securities in which we invest.

In 2008 and 2009, the residential mortgage market in the United States experienced a variety of unprecedented difficulties and changed economic conditions, including defaults, credit losses and liquidity concerns. Many of these conditions are expected to continue in 2010. Certain commercial banks, investment banks and insurance companies announced extensive losses from exposure to the residential mortgage market.  These losses reduced financial industry capital, leading to reduced liquidity for some institutions. These factors have impacted investor perception of the risk associated with real estate related assets, including agency securities and other high-quality RMBS assets. As a result, values for RMBS assets, including some agency securities and other AAA-rated RMBS assets, have experienced a certain amount of volatility. Further increased volatility and deterioration in the broader residential mortgage and RMBS markets may adversely affect the

performance and market value of our agency securities.

We invest exclusively in agency securities and rely on our agency securities as collateral for our financings.  Any decline in their value, or perceived market uncertainty about their value, would likely make it difficult for us to obtain financing on favorable terms or at all, or maintain our compliance with terms of any financing arrangements already in place. The agency securities we invest in are classified for accounting purposes as available-for-sale. All assets classified as available-for-sale are reported at fair value, based on market prices from third-party sources, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders’ equity. As a result, a decline in fair values may reduce the book value of our assets.  Moreover, if the decline in fair value of an available-for-sale security is other-than-temporarily impaired, such

decline will reduce earnings. If market conditions result in a decline in the fair value of our agency securities, our financial position and results of operations could be adversely affected.

There really is a double-dip recession.  It never went away.  Federal Reserve counterfeiting and government stimulus just papered over the problems for many months.  The structural problems caused by fractional reserve banking and government deficit spending are not only present, but they have worsened.  Prices must drop to clear markets and to bring supply and demand into balance.

There is a glut of unemployed people, there is a glut of houses, and businesses are not hiring.  These facts are finally imposing reality on some people.  More people will default on their mortgage payments when housing prices decline.  They will join a growing number of strategic defaulters (people who could make their mortgage payments but chose not to).  This occurs because their loans exceed the dollar price of their homes and also due to the resentment against bankers who receive Federal Reserve and US government bailouts.

Look at this chart.  The trend is clearly down.  Keep this in mind as you watch the short video clip at the end of this article.

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[D]ata showed single-family home prices fell in December, bringing them closer to the low seen in 2009.

The S&P/Case Shiller composite index of 20 metropolitan areas declined 0.4 percent in December from November on a seasonally adjusted basis, as expected.

For the year, prices fell 2.4 percent, slightly more than the 2.3 percent decline analysts had forecast.

While the composite held above its 2009 low, 11 cities hit their lowest levels since home prices peaked in 2006 and 2007, the report showed.

Unadjusted for seasonal impact, home prices fell 1 percent for the month, leaving them just 2.3 percent above their April 2009 troughs, S&P said.

VIDEO: House prices drop; Case-Shiller: 10 city index

Robert Shiller, Yale University Professor of [Keynesian] Economics, and David Blitzer, S&P 500 Index Committee chairman, discusses [housing price] declines in the 10 and 20 City Indices.

VIDEO http://on-msn.com/HousingDown

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How the Fed Fuels Unemployment.

Read this excellent, short article on how the Federal Reserve policies fuel unemployment past and present.  A basic understanding of Austrian economics can save you thousands of dollars by preventing you from being hoodwinked by the Fed and its shills in the financial press organizations (CNBC, Wall Street Journal, etc).

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How the Fed Fuels Unemployment

by Thomas J. DiLorenzo
by Thomas J. DiLorenzo
Recently by Thomas DiLorenzo: Another Court Historian’s False Tariff History

Testimony of Dr. Thomas DiLorenzo
Professor of Economics, Loyola University Maryland
Committee on Financial Services, Subcommittee on Domestic Monetary Policy and Technology
Wednesday, February 9, 2011
2128 Rayburn House Office Building

Mr. Chairman and members of the committee, I thank you for the opportunity to address the issue of today’s hearing: "Can Monetary Policy Really Create Jobs?" Since I am an academic economist, you will not be surprised to learn that I believe that the correct answer to this question is: "yes and no." Monetary policy under the direction of the Federal Reserve has a history of creating and destroying jobs. The reason for this is that the Fed, like all other central banks, has always been a generator of boom-and-bust cycles in the economy. Why this is so is explained in three classic treatises in economics: Theory of Money and Credit by Ludwig von Mises, and two treatises by Nobel laureate economist F.A. Hayek: Monetary Theory and the Trade Cycle and Prices and Production. Hayek was awarded the Nobel Prize in Economic Science in 1974 for this work. I will summarize the essence of this theory of the business cycle as plainly as I can.

When the Fed expands the money supply excessively it not only is prone to creating price inflation, but it also sows the seeds of recession or depression by artificially lowering interest rates, which can ignite a false or unsustainable "boom" period. Lower interest rates induce people to consume more and save less. But increased savings and the subsequent business investment that it finances is what fuels economic growth and job creation.

Lowered interest rates and wider availability of credit caused by the Fed’s expansionary monetary policy causes businesses to invest more in (mostly long-term) capital projects (primarily real estate in the latest boom-and-bust cycle), and there is an accompanying expansion of employment in those industries. But since the lower interest rates are caused by the Fed’s expansion of the money supply and not an increase in savings by the public (i.e., by the free market), businesses that have invested in long-term capital projects eventually discover that there is not enough consumer demand to justify their investments. (The reduced savings in the past means consumer demand is weaker in the future). This is when the "bust" occurs.

The economic damage done by the boom-and-bust policies of the Fed occur in the boom period when resources are misallocated in the ways described here. The "bust" period is actually a necessary cure for the economic miscalculations that have occurred, as businesses liquidate their unsound investments and begin to make decisions on realistic, market-based interest rates. Prices and wages must return to reality as well.

Government policies that bail out businesses that have made these bad investment decisions will only delay or prohibit economic recovery while encouraging more of such behavior in the future (the "moral hazard problem"). This is how short recessions can be turned into seemingly endless ones. Worse yet is for the Fed to create even more monetary inflation, rather than allowing the necessary economic adjustments to take place, which will eventually set off another boom-and-bust cycle.

As applied to today’s economic situation, it is obvious that the artificially low interest rates caused by the policies of the Greenspan Fed created an unsustainable boom in the housing market. Thousands of new jobs were in fact created – and then destroyed – giving an updated meaning to Joseph Schumpeter’s phrase "creative destruction." Many Americans who obtained jobs and pursued careers in housing construction and related industries realized that those jobs and careers were not sustainable after all; they were fooled by the Fed’s low interest rate policies. Thus, the Fed was not only responsible for causing the massive unemployment that we endure today, but also a great amount of what economists call "mismatch" unemployment. The skills that people in these industries developed were no longer in demand; they lost their jobs; and now they must retool and re-educate themselves.

The Fed has been generating boom-and-bust cycles from its inception in January of 1914. Total bank deposits more than doubled from 1914 to 1920 (partly because the Fed financed part of the American involvement in World War I) and created a false boom that turned to a bust with the Depression of 1920. GDP fell by 24% from 1920–1921, and the number of unemployed more than doubled, from 2.1 million to 4.9 million (See Richard Vedder and Lowell Galloway, Out of Work: Unemployment and Government in Twentieth-Century America). This was a more severe economic decline than was the first year of the Great Depression.

In America’s Great Depression economist Murray N. Rothbard demonstrated that, once again, it was the excessively expansionary monetary policy of the Fed – and of other central banks – that caused yet another boom-and-bust cycle that spawned the Great Depression. It was not the Fed’s subsequent restrictive monetary policy of 1929–1932 that was the problem, as Milton Friedman and others have argued, but its previous expansion. The Fed was therefore guilty of contributing greatly to the massive unemployment of the Great Depression.

In summary, the Fed’s monetary policies tend to create temporary and unsustainable increases in employment while being the very engine of recession and depression that creates a much greater degree of job destruction and unemployment.

February 10, 2011

Thomas J. DiLorenzo [send him mail] is professor of economics at Loyola College in Maryland and the author of The Real Lincoln; Lincoln Unmasked: What You’re Not Supposed To Know about Dishonest Abe and How Capitalism Saved America. His latest book is Hamilton’s Curse: How Jefferson’s Archenemy Betrayed the American Revolution – And What It Means for America Today.

Copyright © 2011 by LewRockwell.com. Permission to reprint in whole or in part is gladly granted, provided full credit is given.

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Here is the link to the original article: http://www.lewrockwell.com/dilorenzo/dilorenzo200.html

These charts show the continuation of the housing crisis. This spells trouble for REITs.

The information in these charts below can't be good for high dividend mortgage REIT stocks like American Capital Agency Corp. (AGNC).  Make sure you read the five important points at the end of the charts.
 
I believe that Fannie Mae, Freddie Mac, and Ginnie Mae pick up the tab (pay off the mortgage) when homeowners with these mortgages walk away from their loans.  This results in an acceleration of prepayments to owners of government backed agency securities like AGNC.  Prepayments can also occur from refinancing.  AGNC does not like prepayments.  It hurts their profits.
 
This excerpt from AGNC's 2009 annual report explains prepayments for those of you who have never heard of them:
 

Agency securities differ from other forms of traditional debt securities, which normally provide for periodic payments of interest in fixed amounts with principal payments at maturity or on specified call dates. Instead, agency securities provide for a monthly payment, which may consist of both interest and principal. In effect, these payments are a “pass-through” of the monthly interest and scheduled and unscheduled principal payments (referred to as “prepayments”) made by the individual borrower on the mortgage loans, net of any fees paid to the issuer, servicer or guarantor of the securities.

 

The investment characteristics of agency securities differ from those of traditional fixed-income securities. The major differences include the payment of interest and principal on the securities on a more frequent schedule, as described above, and the possibility that principal may be prepaid at par at any time due to prepayments on the underlying mortgage loans. These differences can result in significantly greater price and yield volatility than is the case with traditional fixed-income securities.

 

Various factors affect the rate at which mortgage prepayments occur, including changes in the level and directional trends in housing prices, interest rates, general economic conditions, defaults on the underlying mortgages, the age of the mortgage loan, the location of the property and other social and demographic conditions. Generally, prepayments on agency securities increase during periods of falling mortgage interest rates and decrease during periods of rising mortgage interest rates. However, this may not always be the case. We may reinvest principal repayments at a yield that is higher or lower than the yield on the repaid investment, thus affecting our net interest income by altering the average yield on our assets.

 

When interest rates are declining, the value of agency securities with prepayment options may not increase as much as other fixed income securities. The rate of prepayments on underlying mortgages will affect the price and volatility of agency securities and may have the effect of shortening or extending the duration of the security beyond what was anticipated at the time of purchase. When interest rates rise, our holdings of agency securities may experience reduced returns if the owners of the underlying mortgages pay off their mortgages slower than anticipated. This is generally referred to as extension risk. 

New Credit Suisse Recast Chart

 
Credit Suisse has released an updated version of their popular Mortgage Reset & Recast Chart.

Here is the new one:

9085247 New Credit Suisse Recast Chart

Here is last year’s chart:

CreditSuisseResetMarch09 1024x721 New Credit Suisse Recast Chart

And, here is the original:

IMFresets New Credit Suisse Recast Chart

There are some thoughts to consider:

  1. There are about 2.5 years of huge resets and recasting ahead.  Because the foreclosure pipeline is already so backlogged, people who stop making payments during this stretch could easily end up waiting another 1-2 years before their homes are actually foreclosed upon.  Even without all of the foreclosures still to come from unemployment, it is easy to see this foreclosure crisis being with us well into 2014-2015.
  2. Because mortgage interest rates are low, “resets” are less of a problem right now. Today, “recasts” are the real threat.  A recast refers to the changing of payment options for Option-Arm loans.  Many borrowers bought the biggest home they could “afford”, using minimum payments to qualify. When the minimum payment option disappears, their monthly expense will “recast” to a substantially-higher amount, regardless of what interest rates do.
  3. Most Option-Arm loans were concentrated in higher-income areas and generally used to buy more expensive homes.  Banks that are holding lots of these on their books, like Wells Fargo, have been fairly proactive in modifying these loans now, while long term rates are low.  It will be interesting to watch, however, if many of these high-end borrowers will walk away from their mortgages as high-end prices continue to fall.
  4. Though rates are currently low, you can see how sensitive the market would be to rate hikes.  The Fed’s MBS repurchase program, the Euro, Greece, Spain, China’s Treasury holdings…all of these factors will likely weigh on mortgage rates in the coming years and have profound effects on our overall economy.
  5. Note the volume of Agency, Alt-A, and Prime loans that will be resetting over the next few years.  These were generally to more qualified buyers with good credit.  If this crowd begins to feel that walking away from their mortgages is socially acceptable, then the housing market will suffer substantially.

Link to original article: http://bayarearealestatetrends.com/2010/03/new-credit-suisse-recast-chart/

 

Do You Need an Oil Stock for Your High Dividend Stock Portfolio?

SeaDrill (SDRL) caught my eye as a high dividend stock.  This deep water oil drilling company currently yields 7.54%.  It paid over $0.60 for the past three quarters.  However, it only has a three quarter dividend record.  Time will tell if this stock will be a reliable dividend payer.

Here is the description from Google Finance:

SeaDrill Limited is a Bermuda-based company active within the oil and gas industry. Its activities are of an offshore drilling contractor. The Company operates a fleet of 36 offshore drilling units, including eight units under construction, which consist of 10 jack-up rigs, 10 semi-submersible rigs, four drillships and 12 tender rigs. It operates three business segments. The Mobile Units business segment offers services including drilling, completion and maintenance of offshore wells. The Tender Rigs business segment operates self-erecting tender rigs and semi-submersible tender rigs. The Well Services business segment provides services using platform drilling, facility engineering, modular rig, well intervention and oilfield technologies. SeaDrill Limited operates through subsidiaries in Bermuda, Norway, Cayman Islands, British Virgin Islands, Cyprus, Nigeria, Liberia, Hungary, Singapore, Brazil, Hong Kong, Panama, the United Kingdom, Denmark, Malaysia, Brunei and the United States.

This stock’s price will correct when the price of oil corrects.  A continuation of the global recession, government debt crisis, and or a busting of China’s real estate and construction bubble will cause the price of oil to go down.  War with Iran (coupled with Iranian government sinking of oil tankers in the Straits of Hormuz), Keynesian money printing, large oil spills (Gulf of Mexico), and commercial banks resuming lending like in 2006 will all lead to higher oil prices.

The P/E is reasonable at 12.06.  Debt is less than 50% of assets.  I will analyze earnings and balance sheet in great detail in the future.

If you can’t wait for my analysis of their earnings power and strength of their balance sheet, then wait for this stock to pull back to below $20.00 per share like in May through July 2010.

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