The Fed Is Bluffing... Interest Rates Won't Rise in 2015

BY BILL BONNER
POSTED 
AUGUST 20, 2015

BALTIMORE, Maryland – What did we tell you…

The Janet Yellen Fed will not raise interest rates in any meaningful way anytime soon. Instead, she will announce new QE programs.

Yesterday, red was showing up just about everywhere – U.S. stocks, European stocks, Asian stocks, emerging markets stocks, crude oil…

But it could have been worse…

U.S. stocks recovered some of their losses for the day, after the minutes of the most recent Fed meeting showed Yellen and team still won’t pull the trigger on a rate hike until certain unspecified conditions are met.

According to the Fed, the conditions for a rate increase are “approaching” but haven’t been met yet.

Well, guess what… Conditions will never be met.

It doesn’t work that way. This economy will never recover – not as long as it is under the current Keynesian management. It is like a patient attended by quack doctors – doomed to get sicker from their quack “cures.”

Market Morphine

Today’s economy depends on large doses of cheap credit…

And like morphine, you have to up the dosage just to stay in the same place. Take away the drugs, and the pain rises.

The pain caused by falling stock prices, for example.

Take away the cheap credit… and the buybacks on Wall Street dry up. That means earnings per share – the ultimate driver of stock prices – fall, too.

With falling corporate earnings and stagnant household incomes, the inevitable direction for stock prices is also down.

As we discussed in last Friday’s Diary, we’ve already seen that today’s stock prices are not the result of sober reflection on the part of investors.

They do not sit down with a yellow pad and a No. 2 pencil and calculate streams of income over the next 10 years. Instead, they count on the cronies to rig the market for their benefit.

As regular readers know, corporate execs have been borrowing at ultra-low rates and using the money to buy and cancel shares in their own companies. This clever piece of financial engineering reduces the count of outstanding shares and pushes up their value.

The insiders get bonuses… by looting the company’s capital and replacing it with debt. And shareholders get a nice bump in their portfolios.

Since 2009, the market cap of the S&P 500 has risen by almost $11.7 trillion.

And according to a new report from Aranca Investment Research, S&P 500 companies have spent almost $2.3 trillion on buybacks over the same period.

So about one-fifth of the increase in market cap is due to buybacks.

Cheap credit is essential to the looting process. Take it away and the flimflam falls apart. So do stock prices.

The “Recovery” Illusion

But the Fed can’t allow a real crash in the stock market. The “recovery” illusion is based on rising prices for equities.

Supposedly, this leads to a “wealth effect.” According to Fed doctrine, as investors see the values of their investment portfolios rise, they start to spend like drunken capitalists.

The economy is then supposed to explode with growth as “animal spirits” return to shoppers… leaving shiny coins all over the street for the poor to pick up.

Of course, it doesn’t happen…

Instead, the real spoils of cheap credit go to the C-suite cronies, who manipulate the stock market by pumping borrowed funds into buybacks. Stocks go up. But the real economy goes nowhere.

At the Sprott-Stansberry Natural Resource Symposium in Vancouver last month, our friend and Stansberry Research analyst Dr. Steve Sjuggerud debunked the idea that a rising interest rate cycle always coincides with falling stock prices. He pointed out that stocks have tended to rise in value during periods of rising rates.

Don’t worry about the Fed tightening, he told the audience. It doesn’t have to mean lower stock prices.

We don’t doubt that Steve is right. Typically, when the economy heats up due to organic growth, interest rates rise… and so do stocks.

But this is no typical bull market… and no typical economy.

The stock market is being driven higher by ultra-low rates, QE, and clever financial engineering. And the economy is not in the kind of healthy expansion mode that pushes up stock prices and interest rates at the same time.

Instead, much of today’s economy is as cold and lifeless as a corpse.

Commodities are plumbing record lows – most notably oil and “Dr. Copper,” widely seen to signal a deteriorating economy worldwide.

Shipping and freight prices reveal a slowdown in trade. (See today’s Market Insight below for more on that…)

A strong dollar, slowing exports, and falling commodities prices are hammering many of the emerging markets.

And China is struggling to avoid its own Great Depression.

That’s why Ms. Yellen is reluctant to raise rates. She knows it will be painful when she does.

Instead, she’ll administer another dose of morphine…

Bill Bonner

Source: Daily Reckoning

Follow us on Twitter: @blacklioncm

6 Major Flaws in the Fed’s Models

6 Major Flaws in the Fed’s Models
by James Rickards

For now, the U.S. dollar is the dominant global reserve currency. All markets, including stocks; bonds, commodities, and foreign exchange are affected by the value of the dollar. The value of the dollar, in effect, its “price”, is determined by interest rates. When the Federal Reserve manipulates interest rates, it is manipulating, and therefore distorting, every market in the world.

The Fed may have some legitimate role as an emergency lender of last resort and as a force to use liquidity to maintain price stability. But, the lender of last resort function has morphed into an all-purpose bailout facility, and the liquidity function has morphed into massive manipulation of interest rates. 

The original sin with regard to Fed powers was the Humphrey-Hawkins Full Employment Act of 1978 signed by President Carter. This created the “dual mandate” which allowed the Fed to consider employment as well as price stability in setting policy. 

The dual mandate allows the Fed to manage the U.S. jobs market and, by extension, the economy as a whole, instead of confining itself to straightforward liquidity operations. Janet Yellen, the Fed chairwoman, is a strong advocate of the dual mandate and has emphasized employment targets in the setting of Fed policy. Through the dual mandate and her embrace of it, and using the dollar’s unique role as leverage, she is a de facto central planner for the world. 

Like all central planners, she will fail. Yellen’s greatest deficiency is that she does not use practical rules. Instead she uses esoteric economic models that do not correspond to reality. This approach is highlighted in two Yellen speeches. In June 2012 she described her “optimal control” model and in April 2013 she described her model of “communications policy.” The theory of optimal control says that conventional monetary rules, such as the Taylor Rule or a commodity price standard, should be abandoned in current conditions in favor of a policy that will keep rates lower, longer than otherwise.

Yellen favors use of communications policy to let individuals and markets know the Fed’s intentions under optimal control. The idea is that over time, individuals will “get the message” and begin to make borrowing, investment and spending decisions based on the promise of lower rates.

This will then lead to increased aggregate demand, higher employment and stronger economic growth. At that point, the Fed can begin to withdraw policy support in order to prevent an outbreak of inflation. The flaws in Yellen’s models are numerous. Here are a few:

1. Under Yellen’s own model, saying she will keep rates “lower, longer” is designed to improve the economy sooner than alternative policies.
   
   But if the economy improves sooner under her policy, she will raise rates sooner. So, the entire approach is a lie. Somehow people are supposed to play along with Yellen’s low rate promise even though they intuitively understand that if things get better the promise will be rescinded. This produces confusion.

2. People are not automatons who mindlessly do what Yellen wants. In the face of the embedded contradictions of Yellen’s model, people prefer to hoard cash, stay on the sidelines and not get suckered by the bait-and-switch promise of optimal control theory. The resulting lack of investment and consumption is what is really hurting the economy. Economists call this “regime uncertainty” and it was a leading cause of the length, if not the origin, of the Great Depression of 1929–1941.

3. In order to make money under the Fed’s zero interest rate policy, banks are engaging in hidden off-balance sheet transactions, including asset swaps, which substantially increase systemic risk. In an asset swap, a bank with weak collateral will “swap” that for good collateral with an institutional investor in a transaction that will be reversed at some point. The bank then takes the good collateral and uses it for margin in another swap with another bank. In effect, a two party deal has been turned into a three-party deal with greater risk and credit exposure all around.

4. Yellen’s zero interest rate policy constitutes massive theft from savers. Applying a normalized interest rate of about 2% to the entire savings pool in the U.S. banking system compared to the actual rate of zero, reveals a $400 billion per year wealth transfer from savers to the banks from the zero rates. This has continued for six years, so the cumulative subsidy to the banking system at the expense of everyday Americans is now over $2 trillion. This hurts investment, penalizes savers and forces retirees into inappropriate risk investments such as the stock market. Yellen supports this bank subsidy and theft from savers.

5. The Fed is now insolvent. By buying highly volatile long-term Treasury notes instead of safe short-term treasury bills, the Fed has wiped out its capital on a mark-to-market basis. Of course, the Fed carries these notes on its balance sheet “at cost” and does not mark to market, but if they did they would be broke. This fact will be more difficult to hide as interest rates are allowed to rise. The insolvency of the Fed will become a major political issue in the years ahead and may necessitate a financial bailout of the Fed by taxpayers. Yellen is a leading advocate of the policies that have resulted in the Fed’s insolvency.

6. Market participants and policymakers rely on market prices to make decisions about economic policy. What happens when the price signals upon which policymakers rely are themselves distorted by prior policy manipulation? First you distort the price signal by market manipulation and then you rely on the “price” to guide your policy going forward. This is the blind leading the blind. The Fed is trying to tip the psychology of the consumer toward spending through its communication policy and low rates. This is extremely difficult to do in the short run.

But once you change the psychology, it is extremely difficult to change it back again. If the Fed succeeds in raising inflationary expectations, those expectations may quickly get out of control as they did in the 1970’s. This means that instead of inflation leveling off at 3%, inflation may quickly jump to 7% or higher.

The Fed believes they can dial-down the thermostat if this happens, but they will discover that the psychology is not easy to reverse and inflation will run out of control. The solution is for Congress to repeal the dual mandate and return the Fed to its original purpose as lender of last resort and short-term liquidity provider. Central planning failed for Stalin and Mao Zedong and it will fail for Janet Yellen too.

Regards,
James Rickards

Source: Daily Reckoning

Follow us on Twitter: @blacklioncm

The Currency Wars of the 20th Century

The Currency Wars of the 20th Century
by Addison Wiggin

Jim Rickards is no ordinary hedge fund manager. Lots of guys can boast 35-year careers on Wall Street.

Only Rickards is also a lawyer who was the chief negotiator during the 1998 rescue of Long-Term Capital Management — in which 14 of the world’s biggest banks ponied up $3.6 billion to prevent a global financial meltdown. And only Rickards is a consultant to the Pentagon who walked senior military planners through their first-ever “financial war game.”

His best-selling book Currency Wars opens with a two-chapter account of this war game — held at the Warfare Analysis Laboratory in Laurel, Maryland — a strategy room whose website boasts “14 plasma displays for defense exercises” and “3-D scenario modeling and visualization.”

The financial war game was made more intense by the fact it took place amid the market panic in late 2008 and early ’09. We won’t give too much away here; suffice it to say Team Russia announced it would accept only gold in exchange for its oil and gas — no dollars. Then Team China made its own move to “tighten the noose around the U.S. dollar’s neck.”

As it happened, on the second and final day of the war game, Russia’s Vladimir Putin declared of the dollar, “The one reserve currency has become a danger to the world economy: that is now obvious to everybody.”

Rickards believes the real currency war presaged by Putin began in early 2010. He labels it Currency War III.

“Currency wars,” Rickards writes, “are fought globally in all major financial centers at once, 24 hours per day, by bankers, traders, politicians and automated systems — and the fate of economies and their affected citizens hang in the balance.”

Both previous currency wars both took place within the last century. Currency War I erupted from the ashes of World War I in 1921 when Germany began its epic devaluation of the mark — the one memorialized in pictures of wheelbarrows full of paper money that weren’t enough to buy a loaf of bread.

Thus did the rest of the world race to devalue their own currencies to remain “competitive.” France leaped first in 1925, devaluing the franc. Britain abandoned the gold standard in 1931. The United States infamously devalued the dollar against gold in 1933 — from $20.67 an ounce to $35. France and England devalued again.

Rickards believes the real currency war presaged by Putin began in early 2010

“In round after round of devaluation and default,” Rickards writes, “the major economies of the world raced to the bottom, causing massive trade disruption, lost output and wealth destruction along the way.”

Currency War I ended in a whimper in 1936 with a three-way deal between the United States, Britain and France. Germany by that time was goose-stepping to its own drummer, and a shooting war followed three years later.

Currency War II blew up in 1967 when Great Britain devalued the pound against the dollar. Soon the dollar itself was under pressure — a matter complicated by the fact the dollar was still tied to gold in international trade.

The rest is monetary history: France turned in scads of dollars for America’s gold, nor were the French alone. The Treasury’s gold supply dwindled from 20,000 metric tons in 1950 to barely 9,000 when President Nixon “closed the gold window” in 1971. The entire world was now on a floating fiat currency standard.

The dollar sank throughout the ’70s, but soared in the early ’80s under Federal Reserve Chairman Paul Volcker. The world’s other principal currencies, the Japanese yen and West German mark, went on a roller-coast ride the whole way. Exhaustion set in. The Plaza Accord of 1985 set the dollar on another downward trajectory, and the Louvre Accord of 1987 resulted in equilibrium — more or less.

“There was relative peace in international monetary matters,” Rickards writes, “yet this peace rested on nothing more substantial than faith in the dollar as a store of value based on a growing U.S. economy and stable monetary policy by the Fed.”

That faith finally broke in early 2010.

On Jan. 27, 2010, President Obama fired the first volley of Currency War III in his State of the Union speech. He announced the National Export Initiative. Its aim — to double U.S. exports in five years.

“The traditional and fastest way to increase exports had always been to cheapen the currency,” Rickards writes in Currency Wars. And everyone around the world knew it.

Later in 2010, the Federal Reserve stepped in with a second round of “QE,” or money printing. “By using quantitative easing to generate inflation abroad, the United States was increasing the cost structure of almost every major exporting nation and fast-growing emerging economy in the world all at once.”

And so began another race to the bottom, a new round of competitive devaluations. “We’re in the midst of an international currency war,” declared Brazil’s finance minister Guido Mantega in September of 2010, “a general weakening of currency.”

No one will be left untouched by Currency War III, but Rickards says it will take place in three major theaters. In two of the theaters, the combatants have mutual aims. The third is the most likely source of outright conflict.

The Atlantic theater is the balance between the United States and the eurozone. “The euro and dollar,” writes Rickards,” are best understood as two passengers on the same ship… moving at the same speed, heading for the same destination.”

The euro topped at $1.59 in July 2008 and bottomed at $1.10 in June 2010. As we go to press, it’s at $1.29 — essentially where it was in early 2007, and again in early 2011.

That relative stability is no accident: Washington aims to prop up the euro to the point of the Fed engineering a secret bailout of European banks in 2008 — $3.08 trillion in loans that became public only in 2011.

The Eurasian theater of the war, meanwhile, is the balance between Europe and China. “China has a vital interest in a strong euro,” Rickards writes — not least because the European Union is China’s largest trading partner, larger even than the U.S.

Bottom line: “Europe, China and the United States are united in their efforts to avoid a euro collapse despite their mixed motives and adversarial postures in other arenas.”

Which brings us to the Pacific Theater — the big show.

The U.S. trade deficit with China was less than $50 billion in 1997. By 2006, it swelled to $234 billion. Politicians grandstanded about American jobs “lost forever to China” and Chinese leaders “manipulating” their currency.

Never mind that the evidence linking currency value to jobs is, er, slim at best. Even if the yuan doubled in value, Rickards points out a Chinese furniture maker would be making $236 a month — and a furniture maker in North Carolina still wouldn’t be competitive.

If we still had a gold standard — or even the Bretton Woods system in place between 1944-71, such yawning trade gaps would be impossible. The flows of gold between creditor and debtor nations — consider our example at the start of the issue — would, naturally, maintain an equilibrium.

Meanwhile, manipulation is a two-way street: “China’s policy of pegging the yuan to the dollar,” Rickards writes, “was based on the mistaken belief and misplaced hope that the Fed would not abuse its money printing privileges.”

Fool me once…

“Given the choice,” Rickards writes, “between uncontrolled inflation with unforeseen consequences and a controlled revaluation of the yuan, the Chinese moved steadily in the direction of revaluation beginning in June 2010, increasing dramatically by mid-2011.”

You can see the result in the chart nearby. Through mid-2010, it took 6.8 yuan to equal one U.S. dollar. But with the conscious decision to strengthen the Chinese currency, it now takes barely 6.1 yuan to equal a dollar.

Thus, “the United States had won round one of the currency wars.” There will be more to come.
“Everything’s a cross rate,” Jim says. “There’s a dollar euro cross rate. There’s a dollar yen cross rate. There’s a dollar Chinese yuan cross rate, Swiss francs and so on. And it’s dynamic. The dollar could be going up against the Euro, which it has been lately but going down against the Chinese yuan.

“Is the dollar going up or down? Well, the answer is compared to what? And this is what we do in currency wars. We look at this. We understand these dynamics. We understand that any two currencies are a zero sum game.”

Regards,

Addison Wiggin

Source: Daily Reckoning

Follow us on Twitter: @blacklioncm

How a Central Bank Really Shapes the Economy

BY DAVID STOCKMAN 

POSTED APRIL 16, 2014

Among the many evils flowing from the serial bubble machine ensconced in the Eccles Building is the stupendous boom and bust cycles that it unleashes among so-called “risk assets”.

This is not the free market at work in the slightest. Under a regime of honest interest rates and two-way price discovery (that is, absent the central bank put) there never would have been the legion of dotcom billionaires of the first Greenspan Bubble, nor the multi-billionaires who won the Big Short prize when the Fed’s housing bubble collapsed in 2007-2008. And the tens of millions of retail investors who got lured into these get rich manias would not have parted with nearly so much of their accumulated savings, either.

When the central banks turn the money markets and the capital markets into carry-trade driven casinos in this manner, the result is inherently a massive, dead-weight loss to economic output and national wealth. That’s because capital and other economic resources are drastically misallocated to pointless secondary market speculation and pure economic waste. For example, there are now upwards of a trillion dollars of assets managed by so-called “funds-of-funds”.

The latter skim off several percentage points of profit on top of the 20% that the underlying hedge funds extract on their winnings in the central bank casino. Yet they provide no free market based economic value added whatsoever — except to deliver to their wealthy clients the equivalent of race track tips regarding which hedge funds are likely to win, place or show during the coming weeks or quarters.

Mr. Levin’s astonishing win did not result from inventing something unique…like Bill Gate’s desktop software.

And so, living high on the hog from these unearned rents, the operators and owners of funds-of-funds—pure artifacts of financialization— consume the services of swank resorts, office chefs and chartered Gulf Streams that would not be demanded on the free market. There could never be enough profit in honest two-way markets in “risk assets” to absorb the cantilevered fee layering that exists in the Wall Street casino today.

By contrast, in a real free market the principal features of the Fed’s serial bubble machine would be precluded in the first place. The gambling windfalls which result from short-run speculation in risk assets funded primarily with ZERO-COGS—cheap, short- term repo and wholesale funding — would not exist because there would be no pegged money markets offering the economic absurdity of free money for seven years running. Likewise, the abject plundering of the slow-footed home-gamers who get lured into these speculative ramps would also not exist because chronic “pump and dump” schemes could not survive in honest two-way markets.

Yet absent the inherent checks and balances of the free market these central bank enabled casinos do not simply boom-and-bust randomly—they do so chronically and predictably. With the ever increasing confidence levels developed over the bubble cycles since the early 1990s, an entrenched class of permanent, professional speculators has learned to front-run the maneuvers of our monetary politburo almost perfectly.

Accordingly, they do not hesitate to ride the bubble on the way up until they see the lights go off in the Eccles Building, nor plunge back into the post-crash carnage at cents on the dollar when the Fed re-opens the sluice gates, as it did in the winter of 2008-2009. So what has emerged is a permanent moveable feast of speculation where the same so-called “risk assets” are strip-mined over and over as these massive and artificial central bank financial bubbles wax, wane and wax again.

Exhibit number one at the moment might be the $119 million annual paycheck that 30-year old Jimmy Levin earned recently trading “structured credit” at Ochs-Ziff Capital Management. During the year in question his winnings apparently exceeded by 25% the combined $94 million that was hauled down by the CEOs of the largest 6 banks in the US—that is to say, the well-coddled crony capitalists who run JPM, BAC, GS, MS, C and WFC.

But when you strip away the euphemisms, it becomes clear that young Mr. Levin’s astonishing win did not result from inventing something unique, useful and permanent like Bill Gate’s desktop software. No, the entire windfall resulted from the utterly transient trading fact of being audacious and lucky enough to be standing around in the vicinity of a Fed enabled “third dip” on toxic sub-prime securities.

During 2012 Levin’s 14-person team of speculators apparently made a $2.0 billion profit on a short-term bet on about $7.5 billion of busted loans and bonds— mainly the smoking remnants of subprime CDOs and private labor MBS. As head of the trading group, Levin’s share was apparently the aforesaid $119 million, and this swell outcome was truly a gigs-to-riches story.

It seems that only a few years back Jimmy had excelled at teaching the son of the joint’s founder, Daniel Och’s, how to water-ski at summer camp. Levin then got himself a “computer science” degree at Harvard, an intern job at stepping-stone firm and eventually a gig at Ochs-Ziff Capital Management— where soon the sub-prime triple-dip presented itself. And then, lickety-split, Levin landed among the top 0.0001% of wealth holders in what is surely no longer Horatio Alger’s America.

Here’s the point. In an honest free market there would not be a Ochs-Ziff Capital Management with $40 billion of casino chips. There would not be tens of billions of busted financial assets laying around the streets of Wall Street for Fed front-runners to scoop up when the timing was propitious.

Likewise, in an honest two-way market, no one in their right mind would bet $7.5 billion on financial drek using high leverage and minimal hedges. And no 30-year old would be given leave to close his eyes and bet the ranch, as apparently Levin did, based on merely the “housing recovery” word clouds being emitted by the monetary politburo and its echo-boxes in the financial press.

In short, free market capitalism is not about something for nothing.

Once upon a time no honest capitalist tycoon would… demand that taxpayers fund his polo ponies…

The central bank casino that gave rise to the Levin fortune has also rendered an even more noxious offspring: namely, a culture of entitlement among the casino gamblers that fuels insensible crony capitalist plunder throughout the land. So today comes forward one Vincent Viola, founder of the HFT firm, Virtue Financial, demanding a $100 million ransom from the hapless taxpayers of Florida — a burned-over economic province that might as well be labeled ground zero of the Fed’s serial bubble machine.

It seems that only a few months ago, Viola purchased the Florida Panthers hockey team for $750 million — notwithstanding the fact that it appears to be losing about $25 million annually. Needless to say, during the 5-years he was building Virtue Financial, Mr. “Viola” — who is blessed with the happenstance of a truly resonant family name — did not have much experience losing money. According to his IPO filings, Virtue Financial was profitable on 1,277 days out of 1,278 days it has operated in its current firm.

That’s a win rate of 0.9992175.

Only in Bubbles Ben’s casino!

The point is simple. Once upon a time no honest capitalist tycoon would have had the gall to demand that taxpayers fund his polo ponies and players. So add the noxious culture of entitlement and political corruption to the list of ills that our monetary central planners have created.

People like Vincent Viola should make true believers in liberty and free enterprise downright ill!

The worst thing is that the Vince Viola story is just par for the course.

Try this nightmare of plunder that came out of the crony capitalist bailout of GM: the fast money boys reaped billions from the busted securities of a bankrupt auto supplier based on outright blackmail of the White House. From The Great Deformation: The Corruption of Capitalism In America, pp 662-665:

Delphi was comprised of the former parts divisions—radiators, axles, lighting, interiors—that had been spun out of GM in the late 1990s by investment bankers claiming it would make GM look more “focused” and “manageable.” In truth, Delphi was a dumping ground for $10 billion of GM’s debt, pension, and health-care obligations, as well as dozens of hopelessly unprofitable UAW plants and billions more of hidden liabilities such as parts warranties.

Not surprisingly, Delphi hit the wall early, entering Chapter 11 in the fall of 2005. That this spin-off company was intended all along to be a financial beast of burden for GM is evident in its reported financials for its prior six years of existence as an independent company. During that period its sales totaled $165 billion, mostly to GM, but it recorded a $6 billion cumulative net loss and generated negative operating free cash flow. Indeed, saddled with $60 per hour UAW labor costs against non-union competition at $15 per hour, it was kept alive only by an intra-industry Ponzi scheme: Delphi floated bad trade credit to GM and GM massively overpaid Delphi for parts.

Needless to say, Delphi was an economic train wreck that had no prospect of honest rehabilitation, but under pressure from GM and the UAW it remained mired in bankruptcy court for the next four years. In the interim it continued to float billions of GM’s payables on the strength of its DIP facility, yet was ultimately able to emerge from Chapter 11 only because the White House auto task force saw fit to pump billions of taxpayer money into its corpse as part of the GM bailout.

The first-order effect of this terrible abuse of state power, of course, was a few more $60 per hour UAW jobs in Saginaw, Michigan, and a few less $15 per hour non-union jobs in Tennessee and Alabama. But the real evil of the bailout lay in its rebuke to free market discipline and the powerful message conveyed by the White House fixers that failure in the market-place no longer mattered. Even complete zombies like Delphi could be spared, so long as crony capitalism was alive and well in Washington.

The self-evident fact is that Delphi should have been liquidated, with its few viable operations auctioned off and its dozens of uncompetitive and obsolete UAW plants shuttered. The billions of trade credit it had foolishly extended to GM should have been written off, not paid in full by the taxpayers (with GM bailout funds). Yet this capricious assault on the free market was only one of the evils that came from the auto bailouts.

After Delphi was unnecessarily resuscitated with what turned out to be $13 billion of taxpayer money, including $5 billion from TARP and $6 billion from the Pension Benefit Guaranty Corp.’s takeover of Delphi’s busted pensions, an even more obnoxious turn of events unfolded. A marauding band of hedge fund speculators were able to scalp an astounding $4 billion profit from a company that under the rules of the free market and bankruptcy law would never have seen the light of day after its original Chapter 11 filing.

Indeed, just one of the investors, a so-called vulture fund named Elliot Capital, appears to have realized a 4,400 percent gain, or $1.3 billion, on its Delphi investment, which was taken public in an IPO in the fall of 2011.

The particulars of this case, in fact, reek with the stench of crony capitalism. They powerfully illuminate how the Fed’s boom and bust cycling of the financial markets wantonly showers ill-gotten wealth on the 1 percent. According to the SEC filings, Elliot Capital picked up its Delphi position for $0.67 per share in the midst of the auto industry collapse and while both GM and Delphi were still in Chapter 11. It had the good fortune to sell stock to the public two years later at $22 per share.

Perforce, what the filings do not disclose is that in the interim Elliot Capital and its confederates had gained control of the Delphi bankruptcy by buying up the so-called fulcrum securities for cents on the dollar. They then threatened to paralyze GM by not shipping certain irreplaceable precision-engineered parts like steering gears, where GM technically owned the tooling but it was physically hostage in Delphi plants.

Needless to say, in a regular way bankruptcy a judge would have come down on the Elliot Gang like a ton of bricks for contempt; a tough judge might have even figuratively put them in shackles. But under the ad hoc rules of crony capitalism, the law counts for little and political hardball is the modus operandi. This meant that the hedge funds were literally able to strongarm the Obama White House into providing the $13 billion bailout to the Delphi estate. Even auto czar Steve Rattner, who was himself busily fleecing the taxpayers, described the hedge fund position as an “extortion demand by the Barbary pirates.”

Winnings of the Elliot Gang are an obscene lesson in how crony capitalism and Fed money printing perverts the free market. Without the $13 billion fiscal transfer Delphi would never have emerged from bankruptcy; and without the flood of liquidity from the Eccles Building there would have been no frothy market on which to unload the Delphi IPO.

As it happened, however, the other vultures in the Elliot Gang had a good feed, too. In particular a credit-oriented hedge fund and spin-off from Goldman Sachs called Silver Point gained a $900 million profit from the deal, and this was not an atypical result: it was one of the most adroit speculators in the busted loans and bonds of overleveraged train wrecks miraculously brought back to life by the Fed’s flood of fresh money.

Another huge winner was John Paulson’s fund. This time its big short was against the American taxpayer and the gain was a reputed $2.6 billion. But the most egregious windfall was the $400 million gain racked up by Third Point Capital. This hedge fund is run by one Daniel Loeb who had been an Obama supporter in 2008, but had since noisily denounced the president for unfairly picking on the 1 percent.

Given the history here this might have put an uninformed observer in mind of biting the hand that feeds you. Except Loeb didn’t stop with his supercilious but widely circulated critique of Obama’s purported “class war.” Instead, he held fund-raisers for Romney and contributed $500,000 to the GOP campaign.

In so doing, Loeb helped clarify why crony capitalism is so noxious and pervasive. It turned out that another winner from the Elliot Gang’s 40X return on the carcass of Delphi was an allegedly passionate opponent of the GM bailout; that is, the author of a famously penned New York Times op-ed called “Let Detroit Go Bankrupt.”

The ease with which the vultures made their billions from this crony capitalist raid on the US treasury is evident in Mitt Romney’s $15 million of Delphi winnings. Based on the timing of this saga, it appears they were obtained while Romney was on the chicken dinner circuit honing his anti-Big Government rhetoric for the upcoming presidential campaign. Call it the Detroit Job.

It goes without saying that with friends like these the free market does not need any enemies. More importantly, under the financial repression and Wall Street–coddling policies of the Fed there is no free market left. Instead, it has been supplanted by a continuous and destructive cycle of boom and bust emanating from the monetary depredations of the state’s central banking branch.

In the process of inflating stocks, leverage, and speculation to absurd heights, the Fed finally loses control, transforming the financial markets into economic killing fields. Yet in its panicked reflation maneuvers, it then fosters a vulture capitalist harvest of such magnitude as to be unthinkable on the free market. This is the absurd end game of Greenspan’s wealth effects monetary policy and specious claim that bubbles can’t be seen, but only left to burst. This is how recovery for the 1 percent happens.

Regards,
David Stockman

Source: Daily Reckoning

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The Real Reason the U.S. Dollar Has Value

BY CHRIS MAYER
POSTED APRIL 8, 2014

I was at a conference when I took out a dollar bill and waved it in front of the audience. I asked, “Why does this piece of paper have value?” It’s interesting the range of answers I got.

One person said “gold,” which has nothing to do with it. There was a time when you could demand a fixed weight in gold in exchange for a dollar, but those days are gone. Another said, “You can buy things with it” — an answer that only begs the question why that it so. “Faith,” said yet a third. Not quite.

The answer is one that (some) economists have known about for a long time. I’ll tell you about it below along with three other counterintuitive and seemingly bizarre conclusions about the twisted world of modern money. I don’t think you would draw it up this way if you had the chance — but it’s the way the system works.

Government debt… is a form of savings for the private sector.

Tax liabilities give otherwise worthless paper value. The U.S. dollar has value because the government levies $3 trillion in tax liabilities annually and accepts only U.S. dollars in payment — which only it issues. And there is the credible threat of penalties if you don’t settle up with dollars. In so doing, the government turns all of us into dollar chasers. It’s how a state, any state, can turn worthless pieces of paper into valued currency.

“The modern state can make anything it chooses generally acceptable as money,” economist Abba Lerner wrote in 1947. “If the state is willing to accept the proposed money in the payment of taxes and other obligations to itself, the trick is done.” Brilliantly devious, isn’t it?

A dollar is, essentially, a tax credit. Economists call this the tax-driven view of money, and it is at least as old as Adam Smith. It is also one of the core principles of Modern Monetary Theory, or MMT. (This is a macroeconomic school of thought that has taken the deep dive into the plumbing of how modern money works.)

The principles of MMT have a certain forceful logic. And they can lead to some shocking and uncomfortable conclusions…

One example is that government deficits increase financial savings. It sounds outrageous. How can government deficits increase savings? Well, how else is the nongovernment sector supposed to get dollars? The only way is for the government to spend more than it collects — thereby leaving money in the economy.

Or think of it this way, as economist Warren Mosler puts it: “When the government spends, only two things can happen to that money… the money can be used to pay taxes, or it isn’t used to pay taxes. In which case, somebody out there still has it.” So deficit spending equals financial savings at the macro level.

Government debt, then, is a form of savings for the private sector. Everywhere there is a Treasury security there is someone who owns it. For that holder, it is a part of his financial wealth, or savings.

But aren’t government deficits and debt too large? They can be too large, which then causes the dollar to lose value. However, in a fiat currency system, it is natural for the government to be in deficit, because the private sector usually wants to save something.

In fact, there is a good argument that any attempt to balance the budget is futile. It will simply lead people to cut spending in an effort to get back to a desired savings level. This also has the effect of contracting the economy and driving tax receipts lower, thereby putting the government back into deficit.

The trouble with budget surpluses is they take money out of the economy. That puts pressure on private-sector balance sheets. It may not be so surprising to learn, then, that economic depressions have followed every major surplus in U.S. history.

Another conclusion is that Government doesn’t need taxes and bond sales to finance spending. Most people think that the government collects taxes and sells bonds to finance its spending. But remember, the government issues dollars. It can’t run out. This sounds scary, but it’s the naked truth of a fiat currency system. The U.S. government faces zero solvency risk. It can always meet all of its bills.

Of course, there are consequences when government spends. If it spends “too much” relative to what dollars can buy and the desire to save, then the dollar can lose value. (Which is what’s happened over the last century. I see no reason why this trend will end.) But the government clearly doesn’t need to borrow or collect something it issues in order to spend. That’s the point.

Further, think about it from the beginning: What must a government do before it collects its own money in taxes? It has to spend the money first. That’s how people get the dollars to meet the tax. So logically, spending precedes tax collection.

There is a classic paper by Stephanie Bell (now Kelton) that demonstrates that “proceeds from taxation and bond sales are technically incapable of financing government spending” and that governments actually finance their spending by creating money directly. (See “Can Taxes and Bonds Finance Government Spending?”). It’s a bit technical, but I believe it is correct and I mention it here in case you want to hunt it down. It’s free online.

There is another key insight that follows from this.

The U.S. government never borrows from the Chinese to “finance” its budget deficit.

The U.S. government is not at the mercy of foreign creditors. You’ve surely heard that the U.S. is in debt to China, because China holds some large amount of U.S. Treasury debt. Politicians even used this rhetoric around election time, saying how we are borrowing from the thrifty Chinese to pay for our lavish lifestyle.

It’s not true. And in fact, it can’t be true. Let me cite economist L. Randall Wray, who put it in no uncertain terms:

Those who claim that the U.S. government must borrow dollars from thrifty Chinese don’t understand basic accounting. The Chinese do not issue dollars — the United States does. Every dollar the Chinese “lend” to the United States came from the United States…. The U.S. government never borrows from the Chinese to “finance” its budget deficit.

Again, think through how the Chinese got the dollars. They sold stuff to Americans. Presumably, they did this because they wanted to acquire dollars. That can change, and the foreign exchange value of the dollar will change, too, to reflect the desire of foreigners to hold dollars. But the point I want to make is simply that the U.S. issues dollars; China and other foreign governments do not. Therefore, the U.S. doesn’t rely on foreign creditors to finance its spending.

As I told you, the world of modern money is a seemingly bizarre world, but it does have its own logic and principles. I’ve only touched on a few of the most surprising conclusions here. (I would humbly suggest that the best introductory guide to this monetary maze is Wray’s Modern Money Theory: A Primer on Macroeconomics for Sovereign Money Systems.)

At least you have a good answer why the U.S. dollar has value — albeit, a value that bleeds out over time. It’s a currency, not an investment vehicle.

Regards,

Chris Mayer
for The Daily Reckoning

Source: Daily Reckoning

Follow us on Twitter: @blacklioncm