Citibank Bailout

Mike Shedlock continues to be prompt and insightful in reporting developments in the financial crisis. Here he reports the summary of the terms of the Citibank bailout this past weekend (it always happens on a weekend). In an earlier post he had the following to say about the bailout.

I am not in favor of this bailout of course, but it is a far better scheme on the surface than blowing another $350 billion. The pertinent question is just how bad those $300 billion in assets will be. I doubt the Fed will disclose the assets it is guaranteeing.

One of the main causes of the downward spiral in the markets is that no one knows (not even the banks) what the value of their intangible assets and off-balance sheet obligations of the banks are. And the Financial Accounting Standards Board has postponed a rule requiring their disclosure. The markets and the government operatives are driven by fear of the unknown and, not knowing, they must assume the worst case consequences of telling the truth.

Philip Davis in "Options Trader:Monday Outlook" says

90-95% of [Citibank's troubled assets being guaranteed] are part of C’s $Tn in assets that are "on balance sheet." The bank has another $1.2Tn of assets that are not reflected in their books, many of which are tied to mortgages that will still need to be addressed down the road. The assets affected under the government plan are largely loans and securities backed by residential and commercial real estate. "With these transactions, the U.S. government is taking the actions necessary to strengthen the financial system and protect U.S. taxpayers and the U.S. economy," the Treasury Department, Fed and FDIC said in a joint statement issued late Sunday.

Whether this is enough to inspire long-term confidence in US financials or whether it leads to panics out of banks that are not given $300Bn by the government remains to be seen, but the immediate upshot of this is it is finally occurring to investors how far the US is willing to go to save the markets. Just looking at the mechanism put in place on the C deal, we can now see that $300Bn in TARP money can be leveraged by the Fed and Treasury into $4.5Tn of bailout funding WITHOUT further Congressional approval. The net effect of this is that gold is flying up in pre-markets as global investors are finally seeing how wet this flood of dollars might make us all (have I mentioned I like gold lately?).

If you are an ardent follower of market developments and are interested in keeping current, return here frequently and check the Recommended Commentaries at the left of this page.

Reggie Middleton's BoomBustBlog has a good comment on the Citibank bailout-- "It's the government version of 3 card Monte - Betcha 'ya can't guess which company the cash is under"
So does Naked Capitalism -- "US Agrees to Bail Out Citi"
And Seeking Alpha -- "Citi's Underwhelming Bailout"

Are Bernanke's Pants on Fire? I hope so.

Recently Congressman Ron Paul cross-examined Ben Bernanke on a new currency regime and the Gold Standard:

Ron Paul: Just last week there was a report that Iran purchased 75 billion dollars worth of gold, took their reserves out of Europe, bought gold and put it in Asia. So is that a sign of the times, is that moving on?

My question is, in your meetings, and you had a meeting just recently with other central bankers, does this thought come up about a new international world reserve currency, and if so, does the subject of gold ever come up?

How do you restore the confidence? Have you recently had conversations with any central banker, and is there a move on to replace the dollar system, because the dollar system is essentially declared dead, because it’s not working, but this indeed was predictable because of these tremendous imbalances that were never allowed to be corrected, and they were always patched up. We always came in. We’d spend, we’d inflate, we would run up deficits, and since ‘71 we’ve been able to correct these problems.

Could you tell me what kind of conversations you’ve had regarding a new reserve currency?

Ben Bernanke: Yes, Congressman. I don’t think the dollar system is dead. I think the dollar remains the premier international currency. We’ve seen a good deal of appreciation in the dollar recently during the crisis precisely because there’s been a lot of interest in the safe haven and the liquidity of dollar markets.

And the Federal Reserve has been engaged in swap agreements to make sure there’s enough dollar liquidity in other countries because the need for dollars is so strong. So I think the dollar system remains quite strong.

I do agree with you very much on one point, which is about the current accounts. The current account imbalances have proved to a very serious problem. It was in fact the large capital inflows in those current accounts which created a lot of the financial imbalances we saw and have led to some of the problems we are seeing, and one of the silver linings in this huge gray cloud is that we’re seeing some improvement and greater balance in our current account deficits.

Ron Paul: But does the subject of a new regime ever come up?

Ben Bernanke: No, it doesn’t.

Ron Paul: And does the subject of gold ever come up in any of your conversations?

Ben Bernanke: Only in terms of the sales that the central banks are planning.

I am not going to beat a dead horse by repeating explanations of why we need some kind of monetary standard tied to gold; but the bottom line is this: Either Bernanke is lying to the Congress (liar, liar, pants on fire) or we are doomed. We might escape a cataclysm greater than the Great Depression this time. We shall see. But there is no way to sustain a monetary system that is not tied to objective value and is run by politicians and bankers who reap the benefits of inflation and bubbles and pass the losses on to the little old ladies on fixed incomes and taxpayers.

The Republican/Conservative Loss -- What went Wrong?

The Republicans debate what went wrong. The obvious answer is that they did not have a message that resonated with the majority of voters. While Obama’s message (Change, Hope) was exceptionally vague, people were dissatisfied with the status quo and the message resonated. Countering that message with the “maverick” image apparently was not good enough. The Republican position on the issues to a great many people was indistinguishable from the Democrats and the Republicans did not appear to propose any significant change from the Bush policies. And the conservatives are too fragmented in their approach to the ill-defined “conservatism” to present any clear political philosophy that gives the voters an alternative, more optimistic view of the world. McCain was unable to distinguish himself from Bush and the Republicans were unable to distinguish themselves from the Democrats.

Last year Robert Bidinotto published an award winning article dissecting conservatism and identifying its fragments. His analysis is helpful in understanding why these people are having a hard time developing a unified approach. See “Up from Conservatism” linked here under Good Web Posts in the left-hand column.

The article below, Let's have some Real Change for a Change, explains why the Republicans are not able to distinguish themselves from Democrats.

In the U.S. we are in a Republic where the majority rules, limited only by the Constitution. If you can’t persuade the majority, your ideas -- even your ideas about the constitutional limitations on government -- can’t set the direction for the government because, as a practical matter, those limitations are only as good as majority support for them.

If you think that the ideas (or lack thereof) of the majority have begun to change the nature of the Republic, you need to become active and speak out in a way that will persuade other people to adopt your point of view. Either become vocal and politically active or stop grumbling, join the silent minority and suffer.

You are the Enemy of the State

There has been a raging debate about whether we have inflation or deflation. Likely, we have both. It depends on whether you define inflation as monetary inflation or price inflation. It is confusing because the press commonly uses inflation to mean prices going up and economists use it as meaning the money supply is going up (which eventually causes a bubble or prices generally to go up). For a more detailed explanation read Inflation, Deflation and Chaos.

The controversy centers around whether the Fed’s many actions to add liquidity to banks and restart the credit markets are inflationary. Those who say the actions are not inflationary say that the Fed is not increasing the supply of money and credit because the fed is taking collateral of equal value from the banks and, in any event, the loans are temporary. Those who say that it is inflationary include those who point out that the loans are proving not to be temporary and the collateral given to the Fed by the banks is garbage – so the banks are getting more than they are giving up. That means that the Fed is supporting the inflated values of paper held over from the credit bubble or they are adding new, good money to the system, which is an increase in value over the garbage it replaces. So it would seem to be important to know whether the collateral taken by the fed is worth the money loaned on it or whether the collateral is garbage as some allege.

Bloomberg, the financial news service, submitted a Freedom of Information Act request to the Fed to disclose information about the collateral it has taken from the banks. The Fed refused because much of its activity was undertaken using the Federal Reserve Bank of New York. So Bloomberg sued to get the information. It is noteworthy that the Fed argues that the Federal Reserve Bank of New York is not subject to the FOIA because the New York Fed is not a government agency. This is another official confirmation that the Federal Reserve System is a cartel of private banks, as I reported to you in March. Bloomberg is not giving up and political pressure is building for them to disclose the information.

The Fed is refusing to reveal information vital to us all – we need to know whether to be alert for and plan for the inflation that is going to be caused by the Fed’s actions. It is also refusing to allow the public to know whether taxpayers’ money is being poured down a black hole by taking clearly inadequate collateral from entities that under any rational accounting rules are already serious financial risks if not bankrupt.

As if granting a monopoly over money and credit to a cartel of private banks were not bad enough, allowing the national deficit to explode in one year and taking your money and giving it away in secret (part of which funds the bonuses of the clowns responsible for this mess) is beyond outrageous.

Secrecy is important when the enemy is a hostile foreign power. However, the enemy here is you -- they don't want you to know because you would act rationally to defend yourself and demonstrate that they are not acting upon your behalf but on behalf of their twisted concept of the greater good. In other words, the information is important to your financial well-being, which the government has placed in peril, and they don't want you to know it.

Making the citizenry the enemy is not unprecedented. When gold was confiscated in the 1930s, the World War I vintage Trading with the Enemy Act was amended to declare domestic gold “hoarders” enemies of the state when the President declared a “national emergency,” a term which is left undefined. Note the consistent position of the government that the current financial crisis is a national emergency.

As a general proposition, the politicians are learning that they can always get more power in an atmosphere of crisis. So the power-hungry will seek out and elevate crises before they seek more power. There are a great many potential crises out there, and there are a great many people promoting their special issue as an emergency. Just yesterday, former Vice President Gore said that President Obama “must make this January to begin an emergency rescue of human civilization from the imminent and rapidly growing threat posed by the climate crisis.” When someone cries emergency and crisis, it is a signal for you to look out. Once they frighten the population into giving the government more power and impairing the freedoms citizens once enjoyed, they never give them back.

Same Old Same Old

The solution to campaign finance, lobbyists, cronyism and the like is not to constrain your political rights to contribute as much as you like to your candidate or your right to try to influence legislation. The solution is to have a Constitution that limits what the government can do so that government will not become a magnet for the corrupt. (What? I thought we already had that. Maybe not. Apparently the magnet is still there.)

Let's Have Some Real Change for a Change

For decades, contemporary liberals have stopped conservatives dead in their tracks by claiming ownership of the moral high ground. The liberals are the self-declared defenders of the children, the poor, the infirmed, the handicapped, the aged. They want to give a hand up to the unfortunate and the victims of discrimination and greed. Liberals will change the era where the rich and powerful exploited the weak and powerless and give them hope. To oppose such lofty goals is to be stingy, greedy, corrupt, and just plain mean. And that is how they present conservatives and Republicans to the voters.

It works because many conservatives have accepted the premises that greed is bad and that “society” has a moral obligation to help the children, et al. Then they proceed to counter the liberals' political programs by arguing that liberals need to temper their idealism with fiscal responsibility and recognize that they could wreck the engine of prosperity by excessive taxation and deficit spending. They also argue that too much paternalism will destroy individual incentives to work hard and create taxable wealth. In other words, they concede that the liberals own the moral high ground but argue that they need to be practical.

The left will always own the high ground under these circumstances and the political battles will continue to be fought only over how to keep from killing the goose that lays golden eggs.

The Christian right argues that life, liberty and pursuit of happiness are God given rights recognized in the Declaration of Independence and because they come from God those rights have moral superiority over others. These rights include the exclusive right to the fruits of one's labors. However, their arguments are inconsistent with the religious ethics of self-sacrifice and selflessness, to which many Christians subscribe and which should make them eager to support altruistic government programs. And the notion that property rights is a principle that is morally superior to self-sacrifice is not necessarily seen by all Christians as sanctioned by God. Even the Pope is a socialist.

Libertarians (including some self-styled conservatives) have much better arguments about limited government, property rights and individual freedom, but they stop short of supporting “greed is good” with an ethical philosophy. They argue simply that the political principle of freedom allows people to be greedy as long as they to not coerce others. Libertarians lose the moral argument because they do not make it.

The opponents of the left will never own the moral high ground unless they win it on the merits of their moral arguments. And unless they own it, they will fail progressively to defend your right to earn as much as possible and to keep your property and the fruits of your labors.

How can they persuade the majority of voters that their moral and political positions are superior to those of the left? First of all, they need to subscribe to a morality that accepts rational self-interest as one of the foundations of ethics and morality. The logical consequences of a failure to do so will keep us on the road to serfdom and cede the political system to those who wish to pretend that it is moral to redistribute your wealth (i.e., to take your property and give it to their political favorites, whether they be poor people or Wall Street investment banks).

Libertarians and conservatives need to change attitudes and shine the light of day on the unstated false assumption that people who are less fortunate than you have a right to your property and your life. And that change starts with you. Changing popular understanding begins in your neighborhood, in your business circles and in your associations. It is a daunting undertaking, but it most certainly will not be accomplished if those who understand its importance shrink from the task or retreat into cynicism.

Here are some suggestions:

Start using the word “force” when referring to the government and its actions. Make a point of noting that whatever the government mandates involves coercion. Taxation, especially taxation to pay for something that could be accomplished by private individuals, is money extracted from you at the point of a gun that would not otherwise be given voluntarily. To understand what “point of a gun” means, consider what would happen if you did not pay your taxes or obey government mandates.

Because the government holds a legal monopoly over force in order to defend your individual rights to be free from force, taxation is one way to fund the police and military. But taxes should be a way to raise revenue to cover the cost of that legitimate function, not a way to achieve a social agenda. Social trends should be left to the spontaneity of free individuals.

Avoid collective, anonymous abstractions like “public” and “society” when you can communicate your message better with more specific words like “government” and “individuals” – as, for example, in government schools rather than public schools, “the individuals in charge of the government” instead of “government.” Always use the most specific term appropriate.

Point out that there is no positive morality where there is no choice. Even if one assumes that giving to the poor is an act of moral virtue, there is nothing virtuous about giving to the poor at the point of a gun. That is not sacrifice. It is being sacrificed. The morality of undertaking to be your brother’s keeper is irrelevant when you are forced to do it. So the left has no moral argument – none, none – upon which to base the government’s claim to your property to support the children, the poor, the sick, homeowners, the banks or anyone else.

Challenge the morality of redistribution of wealth. It is not some abstract notion. “Wealth” is not a natural resource owned by the government. Government “benefits” represent money taken from you and your neighbor’s children by force and given to someone else (or given back to you less a huge fee for administration). Rush Limbaugh has come close to making that argument -- but he does not go far enough and explain why our right to our own property is more than a political principle. Rights is a moral principle deriving from our nature as individual entities. (See, e.g., “Is there a Right to HealthCare?").

A complete challenge to the left requires an ability to debate the nature of morality because that is their claimed source of their power over you. And understanding the nature of morality is fundamental to the political system that you want. By what moral principle do they justify laying claim to the money that you earned to support yourself and your family? What are their premises – that you are the property of the state, that the unfortunate have a claim on your property merely because they are unfortunate? The burden of proof of their moral superiority ought to be on those who propose to take your earnings and property.

Make people define the term “greed” every time you hear it. Use their attempt at a definition (or their attempt to evade defining it) to initiate an argument about a person’s right to keep the fruits of his honest labors, no matter how intently he pursues them. Why, you should ask, is it wrong to seek to profit from a voluntary exchange – even a huge profit if the other party is willing? (Of course, if he is not willing, that is his choice. If he is not able, then there will not be a huge profit.)

Defend every person’s right to be self-interested, even greedy. Why are you complaining about executive salaries and bonuses (unless you are paying for them)? What business is it of yours what terms strangers have agreed to in their private transactions? Don’t allow the left to appeal to your envy of others to justify their efforts to take money from the wealthy. Envy is for losers – ambition is for winners.

Be ready to distinguish coercion from voluntary transactions. For example, the antitrust laws are justified in part using the theory that a seller can “force” a buyer to purchase something simply because the seller has it and the buyer wants it. That’s absurd. The government can "force" an exchange because it has the guns. A commercial seller can’t. This is a major left-wing argument: that economic power is the equivalent of a gun, that need gives someone a right to your property, that your refusal to turn it over is coercion and justifies the application of a superior force (more guns) to make you give it up at the price the needy want to pay. It is simply not true that someone who possesses goods and wants to charge his own price is the equivalent of a thug with a gun. The proponents should bear the burden of proving the morality of why need justifies the use of force.

Demonstrate the foolishness of the “but what about . . ., who is going to take care of . . .” argument: “But what about the retarded and mentally ill?” The answer is, well, what about them? “But who is going to take care of them?” The answer is, well, whom do you suggest – me? “No, the government will do it?” Then you mean me; you mean my tax money. What if I don’t want to? What if I refuse to pay? “But you can’t” And why is that? (Silence. Silence because the answer is “we will force you to.”) Don’t get me wrong. I have spent over 30 years working with private nonprofit organizations that take care of the retarded and mentally ill but I have done it voluntarily, and that is how it should be done. And there is a similar answer for every group of victims that the left wants to force you to support.

Stop advocating government solutions to social problems by suggesting that your neighbor needs to be coerced. "There ought to be a law" is a bad idea. There are already sufficient criminal laws. All other laws are suspect.

The foregoing certainly requires a change in perspective for most people. But unless the majority of people change their perspective, the politicians will continue to have the ability to fool them into believing that it is moral to exploit and victimize you and your neighbors.

Inflation, Deflation and Chaos

Too many pundits are confused about the condition of the economy. It’s no wonder. The economy – the global market – is a chaotic system. Those of you who have read James Gleick’s Chaos understand that when multi-quadrillions of individual decisions and transactions are occurring, patterns develop, evincing a form of order that becomes predictable, sort of.

The science of chaos began when scientist Edward Lorenz was attempting to develop a computer model for weather. One phenomenon he observed was that when a tiny individual variation occurred, it could cause a huge reaction somewhere else in the system. It was called the “butterfly effect” after the idea that a butterfly flapping its wings in Tokyo could eventually cause a hurricane in the Caribbean. The problem is figuring out which butterfly is going to influence what kind of result. The scientists are still working on that one – there are too many butterflies, birds, sneezes and every sort of variable imaginable to contribute to the cause of who knows what. If it were possible to take into account every variable, accurate prediction would be possible. Alas, it is not. We still can only make educated guesses.

A butterfly flapped its wings in March with the bailout of Bear Sterns, setting in motion a chain of events the results of which remain to be seen. Those who warned of a moral hazard were correct. And the failure to go with the flow and bail out Lehman Brothers was another variable that changed the direction of the result, whatever that might have been or may be. (See http://216.157.72.249/index.php/2008/11/03/pandoras-box-is-open/) You might call that event a “tipping point” – much like the final grain of sand that causes an avalanche.

One variable influencing the economy is the supply of money and credit. Another variable is the aggregate view of businessmen regarding the direction of the economy and the investment choices they make based on that view. Another variable is consumers’ aggregate views about their own personal situations and futures. Another variable is the scarcity of natural resources. And there are many more, each of which can influence the other. Even the propagation of popular misconceptions is a variable because, notwithstanding the truth, those misconceptions can influence other variables.

One popular misconception is the definition of inflation. The popular understanding is that inflation is a general rise in the price levels of goods and services. That definition leaves one to wonder what caused the prices to rise and it allows demagogues to lay the blame on their favorite scapegoats. But when one understands inflation as monetary inflation, it is easier to identify one cause for a general increase in prices – an increase in the supply of money and credit, which is the Austrian economists’ definition of inflation and the one to which I subscribe.

Inflation does not necessarily cause a general increase in prices. There could be other, countervailing influences that keep the prices of goods and services down in an economy. And an increase in money and credit does not necessarily result in a runup in prices of consumer goods such as it did in the 1970s. In the past decade the prices of many (but not all) consumer goods in the U.S. were kept low by foreign imports while excessive credit caused a massive runup of prices in the real estate market. In the 1920s, consumer price levels remained low while there was a stock market boom fueled by inflation. So prices can increase in one segment of the market while they remain stable, or even decrease in another.

Deflation is the reverse of inflation. It is a contraction in the supply of money and credit. Today, we are experiencing a contraction of credit in a wide variety of areas. That contraction has originated within the banking system and it is affecting real estate prices and vice versa. Bank contraction of credit will also affect credit cards, commercial loans, municipal loans, student loans, etc., which in turn will affect consumer demand for goods and services, business investment, local and state taxes, university finances, etc., which eventually will influence the prices and business activity in the areas affected. They will be lower that they otherwise would have been.

“They will be lower that they otherwise would have been.” That is another concept that you need to get your arms (mind) around. Inflation does not cause prices to go up. It ultimately causes prices to be higher that they otherwise would have been. How do you tell, then, if there is inflation when the prices are stable? The answer is that you watch the supply of money and credit and you do not define inflation as prices going up. Otherwise, you could fail to be on the lookout for where the consequences of inflation will show up (as in – another bubble).

Another point of confusion is the fact that it takes months and sometimes years for an increase in the money supply to work its way through the economy and affect the general price levels. Thus an increase today may appear to have no effect. Indeed, some analysts predict that price inflation is a long way off because the countervailing deflation from the unwinding of the credit markets will take a very long time. As demonstrated over the past few months, however, the consequences of a decrease in the supply of money and credit can happen relatively quickly and be immediately visible.

We are in the middle of a deflation caused by a contraction of bank lending at the same time the Federal Reserve is inflating by pumping money into the system, trying unsuccessfully to get the banks to lend. (Check out these commentaries for more information: http://www.gold-eagle.com/editorials_08/ash110308.html and http://www.gold-eagle.com/editorials_08/degraaf110308.html and http://www.gold-eagle.com/editorials_08/captainhook110308.html .)

The pundits have been busy debating whether we have inflation or deflation. Those who fear the consequences of inflation argue that the Fed needs to stop pushing money and credit onto the banks, worrying that once the banks do begin to lend, the money will hit the market causing price to be higher than they otherwise would have been and/or creating another bubble somewhere. Those who fear the consequences of deflation argue that prices are not going up and they support the Fed’s efforts to unfreeze the credit markets to forestall a recession or, worse, a depression. Deflation is clearly occurring with the consequences visible in the near term. Inflation is also occurring with the consequences to come. Investors need to worry about both – how far down the current deflation will take the economy and, at the same time, where the inflation that is occurring simultaneously will take us in the longer term. It is confusing, but that’s chaos for you. You need to look for patterns.

Deflation historically has caused recessions and even depressions, stock market declines and crashes, bank and business failures. It also is an era of relatively low interest rates as the authorities attempt to forestall market corrections for the mal investments that resulted from the preceding inflation and get business activity moving.

Inflation historically has generated the boom and bust cycle, which tends to get progressively worse with each cycle – first inflation, then deflation, then inflation, etc. until inflation cannot be brought down. The “crack up boom” occurs, the currency is destroyed and with it the middle class, and a depression occurs. The aftermath of hyperinflation and currency destruction is a time ripe for a man on horseback.

A deflation brought on by market forces and allowed to return to equilibrium through the market, even if it causes a depression, is always preferable to resisting the deflation with inflation, which can end in a crack-up boom, hyperinflation and a depression. In the former case, the depression is painful but short-lived. In the latter, society as we know it could be over and, at a minimum, many things will be influenced in a direction that you will not like.

The Fed's attempts to forestall deflation by inflating are beginning to take effect. Banks are starting to lend again although demand for credit has been dampened. This might signal the end of the deflation scare that has panicked Washington. At some point down the road we should begin to see evidence of the consequences of the inflation in the prices of commodities and other assets and in an increase in market interest rates. If a public inflationary mentality develops, that would be the time to be alert to the signs of a crackup boom.

Those with a thirst for knowledge should read an account of Germany’s 1923 inflation and follow its consequences through the 1930’s. The Great Inflation is a great, concise book but it is out of print. Maybe it’s in your library.