Saturday, February 7, 2009

The Shape of Things to Come -- Part 4

The caverns of the Grave I've seen
And these I showed to England's Queen.
If now the caves of Hell I view,
Whom shall I dare to shew them to?

William Blake

Don't get me wrong. I voted for Barack Obama and retain the highest respect for him. He is probably the most intelligent, well informed, well intentioned and charismatic leader we've had since FDR. He has brought this nation together as has no other political figure in our history and he amply deserves his unprecedented popularity. If my vision of the future differs from his, it is not because I consider myself smarter or better informed, but simply because I am not encumbered, as he is, by all the political baggage any president must carry -- the sort of thing that makes it all but impossible for certain outcomes to even be considered, much less advocated. If at times I come across as disrespectful or sarcastic, I apologize, because disrespect is not my intention. Nevertheless. To quote a once widely circulated satirical poem, by E. B. White: "'I paint what I see,' said Rivera."

The "stimulus" will get passed, in one form or another, to the tune of anywhere from $700 to $900 billion. The package will be a welcome temporary relief for many of the unemployed, and will pay for some badly needed infrastructure repairs, along with a boatload of equally worthwhile projects (what the Republicans are all too predictably and unfairly dismissing as "pork"). But it won't be nearly enough to compensate for the millions of jobs now being lost and the thousands of companies either going out of business or drastically cutting back. It certainly won't restore all the retirement investments (401 (k)s and the like) so severely clobbered when the Dow sank from 14,000 to 8,000 in less than a year.

What most people don't realize, however, is that the stimulus package, as huge as it is, will only be the beginning. Waiting in the wings is yet another installment of the TARP funding, designed to rescue the rapidly sinking banking industry and "get credit flowing again." Let's see now, roughly $800 billion for TARP, plus roughly $800 billion or so for the stimulus package, for a grand total of, say, $1.6 trillion, give or take a hundred billion or so.

That's an awful lot of money. "Taxpayer" money, so they say, despite the fact that no tax increases are involved, or even envisioned, since, God forbid, the wrong taxpayers (the wealthy) might get stuck with too large a proportion of the bill. Better to call it "money diverted from programs that will soon be badly needed by impoverished senior citizens, desperate welfare mothers, millions of unemployed workers, grotesquely underpaid minimum wage workers, families with no health insurance, dispossessed homeowners, etc., not to mention hundreds of billions already pledged for future redemption by foreign citizens, businesses and governments heavily invested in US Treasuries" -- only that doesn't sound quite as harmless and impersonal as the word "taxpayers."

But this too will just be a beginning. Because the crisis facing the banks is only one part of a far larger crisis facing the financial system as a whole, and the problems go well beyond the much discussed but little understood issue of "getting credit to flow again." The real problem is all those so-called "toxic assets" out there that no one, apparently, knows how to value. According to a recent article in the Wall St. Journal,

It is no longer just subprime mortgages and exotic credit-boom securities that are considered toxic. A wide range of other assets -- from certain prime mortgages to commercial real estate to plain old credit-card loans -- are now experiencing soaring defaults as the economy worsens.

Indeed, Goldman Sachs Group estimates that troubled assets could exceed $5 trillion, if defined as assets that could show a loss rate close to, or above, 10%.
I don't know about you, but I don't recall a time when a value could not be placed on any assets of any kind. When in doubt, put your assets on the open market -- via an auction, say -- and see what sort of offers come up. But this is the one thing no one wants to do -- obviously out of fear that there will be no offers at all. The argument has been made that such assets may have little or no value now, but that in the future, as the overall climate improves, they could have a substantial value. If investors believed that to be true, however, they'd be bidding on those assets now in the hope of collecting a substantial profit later on. No such bidding is taking place, however. Maybe the likes of Warren Buffett and George Soros know something Msrs. Gaithner and Bernanke do not: the "toxic" assets are not simply toxic, but also worthless. Which means the banking system we are hoping to save could be bailed out only via an infusion of many more trillions of "taxpayer money."

In for a penny, in for a pound. The $800 billion targeted for TARP will clearly not be enough to cover all the "toxic" (i.e., utterly worthless) debts incurred by the bankers and rogue investors deemed "too big to fail." When the financial markets figure that out, the Dow will once more take a nosedive, most likely from 8000 to 7000, or less.
And once again, the fed, or the treasury, or congress will be prevailed upon to save the day by coming up with yet another TARP, even larger than the first. Once again we will be warned of the "dire consequences" that will inevitably ensue if yet another bailout isn't engineered -- as soon as possible, natch.

Many experienced economists can see the handwriting on the wall and are ringing the alarm bells these days. One example is Peter D. Schiff, author of an especially alarming article, The Fed’s Bubble Trouble Will Cause Rates to Spike and Spawn Hyperinflation, published recently in Money Morning:
Just as the U.S. government issues mountains of new debt to finance the multi-trillion annual deficits planned by the incoming Obama Administration, speculative holders of existing debt will be offering their bonds for sale as well. In order to prevent a complete collapse in the bond prices, the Fed will be forced to significantly increase its buying.

However, since the only way the Fed can buy bonds is by printing money, the more bonds it buys, the more inflation the central bank will create. As inflation diminishes the investment value of low-yielding Treasuries, the scenario will become apparent and will kick off a downward spiral. But the more active the Fed becomes in its quest to prop up bond prices, the bigger the incentive to hit the Fed’s bid.

The result will be that all Treasuries sold will be purchased by the Fed.

But with the resulting frenzy in the Treasury market, and with inflation kicking into high gear, we can expect that demand for other debt classes that the Fed is not backstopping - such as corporate, municipal and agency debt - to fall through the floor, pushing up interest rates across the board.

In order to “save” the economy from these high rates, the Fed will then have to expand its purchases to include all forms of debt. If that happens, runaway inflation will quickly turn into hyperinflation, and our currency will be worthless and our economy left in ruins.

(to be continued)

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