Eating Fair Traded, Shade Grown, Free-range, Crow

One unfortunate feature of being an economic gadfly is the the field of economics is fraught with prediction, most of it coming from the third bend in an economist's colon.  At the Institute For Economic Reality, the convocation of macro-economic realists strives not to source its predictions in the same manner.  Even so, reality often intrudes in the most obsene fashion for those of us trying to politely cajole the mildly curious out of the dark arts of economic superstition and down the marble colonnade to economic reality.  Even the IER's predictions did not take into account the serialized criminal actions by the financial elites in this country to prevent the collapse of the debt-fueled consumption binge of the last 20 years.

That's a fancy way of saying that we didn't think the FED and US Treasury would resort to freebasing several trillion dollars worth of economic crystal methamphetamine to keep the party going. 

The IER's predictions of an 80% (minimum) peak to trough decline in sexy, bicoastal residential real estate by the end of 2010 is a bust.

Yes, the IER was wrong.  You heard it here, first.  The homes of the vainglorious twits (the ones that drone on endlessly about how valuable their homes are and how they are special and immune from the macro economic forces that subjugate the rest of us) only collapsed 30-40%, which is 80% lower than where said twits thought they would be.

As one of my favorite hockey players, Grant Marshall, would say when the Dallas Stars would lose a hockey game, "They didn't beat us; we just ran out of time."  He was implying that the Stars were better, but didn't get enough time to demonstrate it.

The same is at work here.  2010 has come and gone, but the game isn't over.  The only part of "20 cents on the dollar by 2010" that isn't true is the time element.  Make no mistake - we are going to 20 cents as soon as the FED runs out of ammo, and they are running out of ammo.

There is no better time to gun the financial markets higher than in the low volume trading days surrounding Christmas.  Even with this, the debt markets are getting crushed, and equities aren't exactly rebounding like they should.  With the FED now holding in excess of a cool trillion in US debt, they are very, very sensitive to the value of that debt.  Some students of this phenomenon have predicted that the FEDERAL RESERVE is going to be frozen solid if the 10 year US Treasury hits 4.5%.  Absent some flood of money hitting the debt auctions over the next few months, we should be there by Spring 2011.

How would you like to sell a home in a market that doesn't have loans available at any price?  If the FED freezes up, we get to find out.

Just as any tweaker knows, once you start meth, you have to keep on it to get the same high, while at the same time, your brain's ability to manufacture its own "happy drug" is essentially detroyed.  That's the situation with the Treasury and the FED.  13% of GDP is borrowed money, and that gets us a 2% growth rate.  Think about that and what happens when the government can no longer borrow 40% of what it spends.

The economy is just reacting to government spending, rather than to a genuinely expanding manufacturing base.  The deficit spending is killing off the private economy because the risk/reward is distorted.

So, for the record, and so everyone on "Rain City Guide" and the detractors on "Seattle Bubble" can rub my face in it, "20 cents on the dollar by 2010" is dead. 

Recipies for crow are being accepted.  In the interest of the sensitivities of those living on the southern 7 miles of SR-305, the crows must be fair traded, shade grown, and free range.

The Printers Are Coming! The Printers Are Coming!

EX NIHILIO credit is the mechanism most of the pundits confuse with "printing." 

When you go to your community bank to get a loan for a new Subaru Outback AWD, complete with "Wag More, Bark Less" and "COEXIST" stickers, your banker is extending you credit.  The banker is loaning you money he borrowed from someone else at a lower rate (depositors).  You take the money you borrowed from American Marine Bank Columbia Bank and give it to the seller of the Subaru.

They deposit that money into Frontier Bank Union Bank, who loans out the money to someone wanting to send the next generation of debt zombies to a degree mill.  The degree mill deposits the money into Washington Mutual Chase-Manhattan, who lends it out to someone wanting to build an iJunk manufacturing plant in China to sell to Americans with a 17% unemployment rate being paid by the government not to look for a job.

The money is cycled from China back into US Treasury bonds to keep Americans buying stuff they don't need, that they can't afford, with money they don't have.  The US taxpayer pays interest on that debt so China can buy weapons to kill the children of the debt zombies graduating from American degree mills with PhDs in Ethnic/Gender studies.

That's how "normal" banking works.  That same money deposited in American Marine Bank Columbia Bank is claimed by many different entities, which is called "velocity."  The greater the velocity, the greater the money supply.  As long as there is GDP underpinning all those people claiming the same dollar, we don't get inflation.

The FED has that ability, but also has the ability to generate credit out of thin air (ex nihilio).  Most people who know only enough to get them a talk show on cable or AM radio confuse this with "printing" money.  Sure, it looks, smells, walks, talks, and tastes like money printing, but it is not.

Here is how it works.

The US Treasury, under the steady hand of Turbo Tax Timmy Geithner, needs $100,000,000 in cash printed up for buying nudie scanners for TSA.  Timmy is the exchequer for the United States government, and he goes to the same place you would go to get some Benjis for a wild weekend in Vegas - the bank.  His checking account is at the FEDERAL RESERVE.  Timmy calls Ben Bernanke and orders up his money, but Ben doesn't do the printing - the US Treasury does. 

Ben waives his magic wand and "presto" there is $100,000,000 credit issued to the United States Treasury that appears as an asset to the Treasury and a liability to the FED.  So far, the books for that transaction are kinda balanced.  We can clearly see where the $100,000,000 came from and where it is now.  Timmy issues Ben a Treasury Bond worth $100,000,000, shown as an asset to the FED and a liability to the Treasury.

For those playing the home edition, we have:

Ben has an asset (Timmy's T Bond) worth $100,000,000 and a liability of the same (ex nihilio credit entry).
Ben's books are balanced.  The FED is worth no more today than it was last week.

Timmy has an asset worth $100,000,000 (Ben's credit that he may convert to a million C-notes if he wants via the US Bureau of Engraving), as well as a $100,000,000 liability (the IOU that he gave Ben).  The US Treasury is worth no more today than it was a week ago.

So far, so good?

There is, however, $100,000,000 more money in circulation today than we had last week.  GDP isn't up $100,000,000 in the same time frame, so we have some inflation.  Circulation/GDP has gone up.

The gold bugs, AM/cable talk show hosts, and Ron Paul all have a grand mal, foam at the mouth, and bloviate endlessly about the FED "printing" our way to eternal fiscal damnation.

Here is what they are missing.

The US Treasury, through its 110,000 thugs called IRS Agents, scurry about the private economy shaking people down to part with their money and giving them nothing in return, other than the courtesy of not dragging them out of their house and shooting them.

Money is being taken out of the economy after GDP is produced, which is deflationary.

That money goes to the Treasury and back to the FEDERAL RESERVE to extinguish the T Bond.  Once Timmy pays Ben the $100,000,000, the T Bond is put in the round file, the ex nihilio credit entry is erased, and $100,000,000 worth of GDP is now circulating in the economy and chasing the extra $100,000,000 that Timmy put in there.  The money that appeared out of the ether, now disappears into the ether.

The FED's books are clear and balanced.
The Treasury's books are clear and balanced.
The private economy has $100,000,000 of extra money in it covering $100,000,000 worth of new GDP, which all other things being equal, means the dollar is the same it was before we began this little exercise.

Where is the "print?"

The problem comes when the FED generates SO MUCH ex nihilio credit that it can't drain it due to the sheer size of the credit entry.  If the credit doesn't actually produce anything, but just goes to bail out other bad debt, the economy can't "grow" its way out of the mess.  That pretty much sums up what we have been doing.  The IER does admit that the potential for a de facto "print" to take place, but that would only happen in the complete collapse of both the underlying economy and the dollar itself.  When that happens, it's August 24, 410 AD all over again, and the Second Dark Age is upon us.

As of now, the collateral the FED is holding against the ex nihilio credit is more than sufficient to keep things afloat, provided a complete collapse of the value of US debt is avoided.  The FED, while telling us member banks were solvent and assets at the member banks were close to face value, only took those assets as collateral after a reduction of at least 80% off the face value.  This is not to be taken as an endorsement for current monetary policy or bail outs, but just as a reality check.  That which is not sustainable shall ultimately cease or fail, and our current trajectory through fiscal history certainly applies.  Eventually, the bad debt will be defaulted, the dollar will rise, prices will fall, interest rates will rise, and we will rebuild.  The IER seriously doubts that the current paradigm will last long enough to destroy our society.  The fate of our society rests in politics and the general approval of living beyond our means, and a population being set against itself for the deliberate destruction of Western Civ.

Those issues are beyond the scope of the Institute For Economic Reality.

Stay solvent,

Ernst Stavro Bloviator, Senior Fellow, IER

Is QE 2 Really The Titanic?

As the vast and loyal readership of Clearcut Bainbridge already know, the Institute For Economic Reality has been a pretty good fade for calendar year 2010.  The IER predicted a rising US dollar and falling "everything else."  This wasn't lost on the senior fellow level of the IER, and I had a short, but prosaic posting where I would be eating large helpings of corvus brachyrhynchos.  The mighty US dollar was the Pee-Wee Herman of Venice Beach, and the equity, debt, and commodity markets were Rambo on a 'roid rage.  Capping off all that was the two weeks prior to The FED announcing yet another asinine program to prevent the price discovery of banking assets (Quantitative Easing 2.0, or QE2), I took an unfortunate spill body surfing and spent my fortnight's leave in Hawaii lying in bed with a shattered shoulder and bombed on pain meds.

Just as I was going to press with my "101 Ways To Eat Crow" article, I placed a call to the IER's Great Lakes Associate Fellow to see what she had to say, and she told me to stand down from admitting defeat and check out the European bond spreads in the more dysfunctional economies (that's everyone but Germany).  Apparently, after a few liters of Irish single malt, things get a little foggy on the concept of actually paying back money you borrow to live beyond your means.

Sure enough, Ben Bernanke's idiotic plan to thwart the normal restorative properties of a free market and credit based hard currency system has blown up in his face almost as fast as a dumb insurgent tinkering with a roadside bomb.  Stocks are mixed, but the bond market appears to be treating Ben the same way the American voters treated Nancy on November 2.  Everything in Bondville is getting sold, especially closed ended mutual funds (hattip to Karl Denninger of the "Market Ticker").

Ostensibly, the entire idea of Ben issuing credit to buy debt in the amount of $100B/mo for 6 months, is to keep Treasury rates from climbing and continuing the charade of deficit spending papering over the contracting economy.  He also needs to keep prices of assets held by member banks high, and his member banks hold a trainload of Treasury bonds.  If those sell off, there aren't any accounting games you can play with those, like you can on mortgage-backed-securities.

Ben either continues to buy everything, or Ben's buddies go BOOM.

The problem is for the past few weeks, Ben's bluff has been getting called.  Check out these graphs.

10 Year Treasury Yield
(click to enlarge)

This is the 10 YEAR US Treasury bond as viewed from a yield point of view.  This is one of the biggest things driving mortgage rates on Bainbridgeislanddreamhomes.  Ben and the Boys announced the second round of "QUANTITATIVE EASING" on the low tick of this chart.  Since then, the interest rates have gone straight up.  That's pretty cool, but the object of QE2 is to keep rates LOW by the FED creating credit ex nihilio and purchasing these securities.  Rates move inversely, by definition, from price.  It would seem that the overall demand for this kind of debt is drawing down.

That's not good.  Not good at all.  Granted, Ben isn't going on his buying spree for a few more weeks, but normally bond traders front-run large purchases by the FED to sell to Ben at higher prices.  The real test is when he actually starts buying.  If rates still go up, he's done.

Why would Ben be so obsessed with buying US government bonds at the short duration?  The reason is that he has been stuffing the Federal Reserve wholesalers (called Primary Dealers) with government debt all during these bailouts.  It's an easy way to get money via the taxpayer, and since they get to keep the money that is the difference between the rate they bought in for, and that of ex nihilio credit, why not?  What is the downside?

10 Year Treasury Price
(click to enlarge)

This is the downside.  This is how Ben sees the bond market.  Those of us in the Great Unwashed only see the bond market in terms of how much it costs to borrow money to buy goodies, baubles, and Bainbridgeislanddreamhomes.  Ben and the banking cartel see the bond market in terms of price, which is what you see to the right.

Pretty ugly, huh?

Someone had better plug that hole STAT! or we are going to have a full-on bond collapse which will seriously imperil the government's ability to function.  Remember, Barry, Harry, and Nan have been spending almost twice what they collect via the thuggish IRS, which means that the Tax Cheat-in Chief (Geithner) has to borrow almost half of all federal expenditures.

Ben has been stuffing the PDs with US Treasury debt and as long as the coupon pays enough to keep things liquid, it works.  It also works as long as the price of the debt is high enough to sell into the market to raise cash.  When the price of debt falls (yields rise), those PDs holding the debt can't sell because they will take a capital loss, and believe it or not, all that ex nihilio credit creation needs to be paid back, or The FED blows up.  The banks find themselves in the same predicament they had when they were holding tons and tons of worthless mortgage backed securities, that were backstopped by the never ending rising of residential real estate.

Oops.

Ben has to keep the market price of US debt high enough to keep his wholesalers liquid, otherwise it's TARP:  The Sequel, which would go over about as well as a disabled Iraqi War veteran marching in the 2004 Grand Old Fourth parade.

The Yankee Lira has been marching around in circles, looking for direction, and the contest is between Ben driving the currency into the ground (collapse of demand), and the circulation drop as debt defaults and the economy delevers (collapse of supply).  I am still firmly in the latter camp, and believe most of the hype around the impending doom of the US dollar is a bunch of nonsense.

The dollar has been tanking because of a bad risk-reward environment brought on by the FED using ex nihilio credit to keep the price of asset classes high as return on investment shrinks.  This elevates risk against declining reward, which can only find relief in abandoning dollar denominated assets en masse.  Ben ends up as the buyer of last resort, rather than the lender of last resort.

In fact, if any of the vast readership is still investing "for the long haul," you need to know that the only thing you are investing in is getting out of your assets before The FED does.  If you think you can hit the exits before the guy that actually knows when to exit does, you are one brave and foolish man.  That is all you are doing - betting you can get out before Ben does.

Good luck with that.

Being short isn't much better.  You need to be able to meet margin with real money and you are fighting a man with the ability to generate ex nihilio credit.  The only thing you have going for you is that your money can outlast Ben's credit-from-heaven.  Yeah, right...

That being said, if those charts of interest rates don't turn soon, the shorts will clean up.

[EDIT:  In order for Ben to get yields down and prices of bonds up, he must be able to generate ex nihilio credit faster than it is being destroyed in the private sector.  Failing that, he must generate some form of financial panic to drive money out of certain asset classes and into short term US bonds.  Look at Aug-Nov 2008 to see what that looks like.  Stock prices would come apart to foment such buying in short term Treasuries.  Equities are at eye-popping multiples and margin compression, brought on by rising commodity prices via dollar selling, will also bring in multiples.]

As the bottom falls out of dollar denominated asset prices, the risk of holding them goes down, and the rate of return on those assets rises.  This brings risk/reward back into balance, and the dollar will rise rapidly.  This is essential for the formation of capital to start the new economic cycle, and hopefully it won't be us flipping assets back and forth to one another and calling that wealth production.

The IER has been a pretty good fade for 2010, and that realization is a swift kick to the crotch.  It took several trillion dollars borrowed from our children, but the FED and US taxpayer made a monkey out of the IER...

...for now.

This isn't over.  Nothing has been solved.  Couple that with a narcissistic disaster on the verge of a nervous breakdown in the White House, 2011 should be an E-Ticket ride.

Sobering Up: A Policy Advocacy Series By The Institute For Economic Reality

Roman Bacchanalia
(early incarnation of the modern day "Rager")

This entry is the first in a what will hopefully be a multi-installment feature on Clearcut Bainbridge. The Institute For Economic Reality will be exploring and discussing with its vast readership how we can extracate our nation from the current economic clamity of our own creation. This is what you will NOT be hearing from our politicians and wanna-be politicians.

We keep hearing that public policy needs “fresh ideas“ in order to deal with our current financial imbroglio, yet the very people advocating for such “fresh“ ideas are the very ones hell-bent on reliving the past. These hopeless romantics are nothing more than the DJs spinning the top 40, Golden-Oldies of their youth, and the musical metaphor holds especially true since the old policies were hokey when they were new and now they just plain suck. Just as the music from their youth was only good if you were stoned, their economic policies were only good if you were stupid.

Those Americans that are presently in the “tribal elder” role of our society (born before 1955) and who live within the orbit of our modern binary star of stupidity (DC and NYC) have pretty much decided that the rear view mirror is the best place to look to navigate around our financial Tule Fog-40 car pile-up,

Permit me to disagree.

We do not find ourselves trapped in these debt-laden tar pits out of a set of unforeseeable circumstances. Hank Paulson, Tim Geithner, Ben Bernanke, Alan Greenspan, Bonnie Fwank, Dick Cheney, et al have all, in some matter, plead ignorance of how we arrived at our point in history. These are all brilliant men (at least by judging by the perspectus - actual market performance has been disappointing) and they have all been in a position to know the consequences of modern economic policy. To feign incredulity is either a bald-faced lie or gross malfeasance - take your pick.

The Institute For Economic Reality, Kitsap County‘s public policy think tank, saw this coming several years prior to reality intruding on our debt-fueled, arrogance-driven, drunken rampage of unbridled financial idiocy. It wasn’t rocket science, nor was it a lucky guess. Any student of history, basic economics, and public policy is more than sufficiently equipped to understand the problem. It would seem that it takes a stint at a New England degree mill, a career in DC or Wall Street or membership in The NAR NOT to see it coming. That ain’t education folks - that’s brainwashing.

In fact, the ONLY thing that was not entirely knowable in advance was the various government interventions (often illegal) to keep the party going. If you attempted to trade this mess, the only variable you were trading against was the government, which also includes the Federal Reserve (yes, I know…the FED isn’t a government institution, but for the sake of brevity, it will be considered such for the purposes of this analysis).

We can blame the dolts born against the backdrop of WW2 for the problems, and that blame would be well placed. However, to truly lay the blame at the feet of those that are responsible, we need to visit our bathroom mirror. WE GET THE GOVERNMENT WE DESERVE AND THE GOVERNMENT WE DEMAND!!!!

WE have voted and agitated for Washington to give us something for nothing. Politicians love handing stuff out and they hate asking you to fund it. Getting something for nothing is always a big hit with the Great Unwashed and politicians comply.

Back in the Roman days, the Roman government would send their legions out on a conquest binge and the spoils of war (stuff produced by other people) would come crashing into the Empire - something for nothing. Romans would gather on the streets of Rome as the Senate would allow the victorious general to parade his army and all the spoils before the crowd of shrieking Romans in what they called a “triumph.”

That wasn’t enough. Romans were fed and entertained by government edict - something for nothing. It was popular for obvious reasons. One third of Rome were slaves producing great works that were unequalled for almost two millenia - something for nothing.

Modern America has discovered the same thing, but in a different manner. We have generally eschewed wars of conquest and pillage (despite stupid Leftist protestors claims to the contrary), but we have perfected the art of getting something for nothing as far as our economy goes.

We love debt, cheap labor, speculating, and government subsidy. We have pulled money from the future to the present, undercut the domestic labor market, grifted our way to “prosperity,“ and hid the true cost of our addictions - all forms of “something for nothing.” It is these things that are causing our problems and the “tribal elders” among us look in the rear view mirror and give us even more.

Alcohol cures hangovers. Death cures alcoholism.

Just because something has always been done in a certain way doesn’t preclude it from being incredibly stupid, and looking to our recent past (which is the cause of our problems) for a cure to our problems is beyond insane, even for this bunch. I guess when you have a generation of people with minds warped by LSD and clogged with bong resin, you have to expect such results.

Consumption is fun and production isn’t. Everyone loves to hit the mall and nobody likes to go to work. This isn’t new nor has it changed at any point in human history. I love to go to Hawaii, eat at nice restaurants and buy stuff for the kiddies. That’s much more enticing than dragging 140 Whine-O-Matics in and out of Dallas/Fort Worth for 19 days a month while getting a public colo-rectal from the TSA. I’m guessing that my ancestors liked eating codfish, sleeping under reindeer pelts and getting liquored-up on a long winter night, but were probably adverse to building boats, hunting reindeer and growing grain. That would explain why Anglos have blue eyes, as those savage Norsemen found it easier to take the stuff produced by folks in the British Isles than to produce them on the Baltic coast.

Understanding wealth is easy. Producing it is hard. Wealth is the difference between what you produce and what you consume. If your consumption exceeds production, you are in debt, which leads us to one of the foundational maxims of The IER:

Debt is the antithesis of wealth.

If you live in a pimped-out house on Rockaway Beach and the speculative frenzy in local real estate afforded you the opportunity to go to a local debt merchant for a cash-out refi so you can buy a vacation house and a pair of his/her Escalades while sending the next generation of debt zombies to Westsound Academy, you are not wealthy. You are in debt and your future production (claim on wealth) will be taken from you to pay down your egomaniacal shopping spree. You have moved consumption from the future to the present without producing a thing. Negative wealth (from your point-of-view) was created by this action.

The banker that made this dream possible produced nothing, as all he gets is a claim on your future production in excess of what he loaned you, and the merchants who sold you the new plasma TV, Sea-Doo, and cellar full of Three Buck Chuck only had their production go up based upon your premature consumption. They won’t be able to move any more units to you because you have already spent the fruits of that production.

For a real life example of this, see the Detroit auto makers in 2002 and their “60 months, 0% financing” scheme. They flat out busted themselves when that ended. AM radio idiots will blame the UAW for the entirety of the mess, but outside the defined benefit retirement programs, the blame resides with the financial geniuses that forward sold production into a satiated market.

By my count, the only “winner” in this is the debt merchant, Someone remind me what “industry” has seen inordinate growth since the mid-80s. Oh, yeah…Wall Street.

This is a long winded way of saying that going further into debt (official US government policy to deal with this “crisis”) isn’t going to do anything but make the bankers rich at your expense. It is important to note that banking stocks have done well since the various bailout packages were announced. We are deficit spending (pulling forward demand and falsely stimulating production as did GM/Ford/Chrysler in 2002) to the tune of 11% of GDP. All we have to show for it is a paltry 2% growth rate.

Folks, that 11% deficit spending is moving production to the parts of the economy it doesn’t want to flow thus making the eventual realignment of the economy that much more painful. All the Obama-jobs that are being created as a result will eventually disappear and the absent-production that they are papering over will not be present to fuel future consumption.

Even worse, that 11% is with interest and is all coming out of future production. That is AT LEAST 11% of future GDP that will not benefit the contemporary population, which is a textbook way of ensuring the next generation will not surpass previous generations in standard-of-living. Why do I think “respect your elders” isn’t going to be a societal value in the not-too-distant future?

There isn’t anything magical about government “stimulus.” It is nothing more than taking tomorrow’s demand and putting it where it will garner the most votes for the incumbents, ensuring two disastrous outcomes: tomorrow will need even more “stimulus” to keep out of recession and that the cretins that brought you this outcome will still be in power to do it again.

When you are in a hole, drop the shovel.

If debt is the antithesis of wealth, wouldn’t getting out of debt be something that would benefit everyone? Isn’t that the best way to promote “the general welfare?” If what we produce today goes to increase our wealth and consumption, rather than pay off yesterday’s consumption and the interest on that consumption, should that not be a high priority public policy?

Such is the official position of The IER. That’s why getting the debt destroyed by any means necessary is the centerpiece of economic recovery. It will take more than just debt redemption and repudiation to fix our economy, but without climbing out of debt, the rest is just academic filler.

In the next installment, the IER explores how to comport public policy to correct the debt-fueled idiocy weighing down on us. It won’t be pretty or popular, but after the 40 year financial acid trip, it is time for a little economic reality.

Until then, stay solvent.

Ernst Stavro Bloviator,
Senior Fellow, IER

(PS:  I will try to update more than quarterly)

Judgment Day: Quick Update (and it is not good)

In last quarter's posing (am I so lazy, I'm down to posting every 13 weeks?), The IER layed out a road map on how the financial beating we will take will present itself.

The short version:

Dollar rises and causes,
-commodities to get crushed.
-then equities (that's stocks for you RE agents) get positively smashed
-then debt (bonds) get horrifically sold, which takes interest rates up
-finally, everything that isn't nailed down gets sold to raise dollars to extinguish debt.

I have also insulted the state religion by saying that Bainbridgeislanddreamhomes will also be taken out and shot. 20 cents on the dollar...you have heard it before.

Let's look at the charts

That's the S&P500, and it is obviously uglier than a Bremerton meth-head in a prom dress. I suspect that a bounce is coming as nothing goes in a straight line. People with the power to borrow at the point of a gun are looking at this chart as well.

That's oil. If we were in "recovery," we would see oil demand driving, but instead, we are just seeing bankers that are long oil trying to offload their inventory (being held in leased supertankers) into a world that is in decline. I expect oil to retest its lows and give Prius drivers something else to get pissy about.

That is gold.  Gold is getting sold right into the teeth of Euro stress and the currency vaporizing before our eyes.  Why?  When you are scared, you don't want bling - you want dollars.

Food is also getting cheaper.  Commodity speculators are getting a lesson in currency trading.  That is wheat.  The commod market is getting smashed in hard and soft commods.  Spreads are blowing out between fair-trade, shade-grown, hip-n-trendy organic food and normal food everyone else eats.

That's the US dollar, which all the AM radio folks are saying is going to be worthless (just as they said the housing market would never retract because of the "Ownership Society).  Yeah...right.  This is what is causing the mess, as everything in the world is essentially a dollar denominated asset.

This should be a relief to all the high-minded Progs that live on Bainbridge and like to vacation in Europe for the sole purpose of sounding smarter than they really are.  This is what happens when the welfare state breaks along ethnic lines.

Greece was a warm up.  Spain is next.  Germany isn't going to put up with this crap forever.

The money is currently running into the safety of US government debt, which is a temporary phenomenon.

This will reverse when we get the bounce and the dwindling money supply temporarily reverts to stocks before they hammerhead stall and head down for a retest of the March 09 lows.

The Institute For Economic Reality holds the minority belief that interest rates are inversely correlated with inflation.  As money becomes more scarce (and valuable), the price goes up.  The price of money is money, which is to say interest rates.  It is times of high liquidity that asset prices rise, and bonds are a major asset price.  More money in circulation means more money chasing bonds, which means LOWER interest rates.  The inverse also holds true.

As the US Dollar rises, rates will rise with it.  Remember, this is over a longer term, as day-to-day fluctuations take into consideration other things, such as fear.  Rates dropping in short bursts in a rising dollar environment are no more significant than any other price going up due to finding temporary favor relative to other classes.  Do not confuse asset specific pricing moves with overall monetary moves.  One is wave action, the other is tidal.

Please, oh please, let Goldman Sachs do a Bear Stearns.  Their client base can run faster than Goldman's HFT machines can front-run your trades, and without a deposit base, they are going to die a mercifully fast death.  I fervently pray that Lloyd The Dark Lord, will come out and declare Goldman to have ample liquidity.

Come to think of it, Lloyd The Dark Lord has been throwing around the cash quite a bit lately.  Perhaps he knows something...

If we get both Lloyd The Dark Lord and Jim "The Ultimate Fade" Cramer singing the praises of Goldman, that is an "all in short" signal like none other.



We should see some form of a bounce, with commods still tanking.

I also expect Bainbridgeislanddreamhomes to still get whacked.  For 1Q10, 10% of homeowners that make payments failed to do so at least once.  That is up from 9.5% in the previous quarter.

Recovery?  My elbow...

Stay solvent.  Stay nimble.  Hoard cash.

-Ernst Stavro Bloviator, Senior Fellow

2010: Financial Judgment Day

Housing, Gold, Stocks, Interest Rates, Currency - An Intermediate Outlook.

Last month, the Institute For Economic Reality held a discussion on why the current fascination with commodities, especially gold, is a game that is about to turn. Since then, we have seen the stock market peak on January 19th, and then take a turn for the worse. While this was knowable, it is very difficult to determine the time frame for such a peak.

The high octane flim-flam rally that has occurred since March of 2009 has shown to be hollow, as the most basic indicator in technical analysis, showed the rally was inversely correlated with volume. As prices rose, fewer and fewer people could, or were willing, to participate. This smelled of the large zombie banks in New York throwing stocks back and forth to one another in an attempt to sucker in the remaining dumb money. It appeared to work at first, but people appeared not to be fooled. It's tough to speculate in stock wreckage when you have lost much of what you have saved over your life, and your Bainbridgeislanddreamhome is 35-40% below what it was at the peak of the stock market. Speculation is done with money you can afford to lose. Your survival stash isn't something you are going to throw at an enterprise that is less predictable, and has a higher risk/ROI ratio than a roulette wheel.

At the Institute For Economic Reality, we are always trying to push back the frontiers of economic cluelessness in an effort to improve our community. When you have one of the largest contributors to Congressional campaigns constantly dumbing down the population with mindless twaddle such as "real estate always goes up" and "buy now or be priced out forever," someone has to offer an alternative view.

For the past year, we have seen the dollar tank, while everything else has rallied. This would include gold, stocks, other currencies, and bonds. Even Bainbridgeislanddreamhomes managed to perform about 30% above what they would have, had it not been for the epic manipulation by every financial power on the planet to keep them above water. With all that, they still dropped in price. Imagine what it would have been without the manipulation...

Over the President's Day weekend, a discussion was held at the Senior Fellowship level of the IER between the Worldwide Headquarters in Poulsbo, and the currency trading division in Seattle. The subject matter was the intermediate term movements of the macro markets and the most strategic way to capture the movement of the various markets. Normally, the IER does not discuss trading strategies, and the following discussion is not to be construed as trading advice, but an intellectual exercise and explanation of where we find ourselves in the economic morass foisted upon us by the economic illiterate that traffic in such matters.

The IER Chairman asked that the senior fellows discuss how the recent drop in the equity markets is a short term phenomenon and a counter rally will occur and challenge the recent January high. Traditionally, the first drop off the high in the equity markets sucks in the shorts with mindless abandon, and then a squeeze ensues where the shorts pull the ejection handles to avoid getting killed. This happens over and over during the bear market rally, and eventually the short squeeze FAILS to take out the previous high, creating a "double top," or "failing rally," and then both the shorts and longs bail on their positions, sending the markets into the tank. Witness the second half of 2007, or early 2000 as recent examples.

The IER's senior fellow in the currency division did manage to grab most of the dollar rally/euro swoon in the past few weeks, but has since reversed the position to capture the rise of the euro and drop in the dollar. Why? The (Powers That Be - PTB) will not allow Greece to drop everything they have worked for over the past two years and will commit all their resources to keep the fraud functioning. This will cause the shorts in the euro to cover and sell the dollar in the process to cover that short. However, this will likely cause the PTB to spend everything they have to keep the Greeks in the lamb, gyros and Ouzo they have come to expect. That works right up to the point where the Germans run short of patience and money to bail out Portugal, Spain, Italy, Ireland, and the Greeks. Since it is no longer fashionable for the Germans to invade every time they get pissed off, they will resort to withdrawing liquidity.

Why now? What is different now than a year ago? The US debt.

Over the past year, when we have had an international funding crisis (Dubai and Portugal), "mystery money" has magically appeared and buoyed the US debt market, especially US Treasuries. Had it not been for this "mystery money," US bond auctions would have failed to the point where rates would have to rise to fund the auction. The "mystery money" has shown up at the most opportune times to prevent this, BUT other damage has occurred. The IER believes this to be related, and is strong evidence that the perception of global liquidity is a mirage (hat tip to IER's North Texas Adjunct Fellow). Given the Bacchanalia happening in the halls of Congress regarding their spending, the dry patches in the worldwide liquidity pool will become larger, more frequent, and more persistent. The PTB will have to decide which debt debacle will kill them first - the US, or the rest of the world. They know it is the US.

If it aligns with the technical analysis, this would cause a failing rally in relation to the January high. If we take out the January high with elan, this view needs to be broomed and we re-rack and try again. Mulligans are allowed in macro-economic financial analysis.

Looking back to 2008, specifically July-October, we see a pattern that has all the elements of repeating, but on a MUCH larger scale. Here is the IER's take on that time frame.

The markets are made by traders of varying competence. The major markets are currency, debt, equity and commodities, and that is essentially the pecking order sorted according to intellectual firepower. Currency traders have to be right, or they are dead. The leverage they use is the equivalent of playing with high voltage. Know what you are doing, or you get planted the next day. The bond traders need to understand what the currency traders are doing and how the interest rate complex moves, since liquidity is a major player in setting interest rates.

Next up, we have the guys that spent their college years perfecting the beer bong, and think CNBC is actual news - the equity traders. The trade isn't so much on what the underlying company is doing, but the perceptions on how other traders believe traders will view how the stock will trade with traders expectations of what future traders will think. In other words, they are playing a game of finding the "greater fool." What skill they do posses, is largely confined to convincing the general public that stocks are a good buy, "and always go up." (where have we heard that before???)

Finally, we have the commodity traders. These folks are truly the last to know, and the first to get run over. These guys are the ones at the poker table wondering who the mark is.

This is also the order of liquidity, as currency is the most liquid, and commods are the least. This phenomenon lends itself to be an inverse indicator of the ability to manipulate the price.

In the summer of 2008, we had an interesting destruction in the market place. In late July, oil peaked in the high $140s and then was taken out into the alley and shot, but equity continued to run right into August. That's when equity had a local peak. In September, bonds came into the killing zone in such a fashion that Paulson and Bernanke called Pelosi and her crew into a room and told them that absent a $700B tribute, the bond market was going to detonate. The dollar had it's relative peak in October.


See a pattern?

We, at the IER, believe this pattern will repeat in 2010. Here is the blow-by-blow of how it will likely go down.

Equity peaked in January 2010, and then rolled over as European financial stress, as well as political instability (from the banker's perspective) hits the market. The dollar starts to get squeezed (rising in price from being freakishly oversold), taking commods down.

Greece gets bailed out by someone, causing the euro to rise and the dollar to get sold. Commods rise, as well as stocks and other currencies as related to the dollar. Given the manipulated interest rates, the dollar resumes as the major funding mechanism for the worldwide "carry trade" causing it to be inverse to every other store of value on the planet. Traders see this weakness and pile on - shorting the dollar to fund speculative purchases in equity and commodities.

These carry traders are both long commodities/stocks/currencies and short the dollar, which works very well, right up to the point it doesn't. Keep this in mind, as this is EXACTLY what happened with the yen in 2008, but the yen wasn't the world's reserve currency - the Yankee Lira is.

If anything, anything at all, goes haywire, fear (risk) will hit the market place with little notice. This market place is short dollars, and long everything else. The US dollar will be at low interest rates, signifying anticipation of little or no risk going forward, which means complacency has set in and the trade is lopsided.

-Iran could do something stupid.
-China or Japan could try to raise funds by selling US denominated debt (raising dollars).
-Congress could go completely around the bend with its spending. Al-Queida could uncork another one (US.gov told everyone that we are going to get hit in the first half of 2010).
-Europe could blow up.
-Australia could go down the pipe (clockwise).

Anyway...something is going to happen, and the PTB have already shot their wad on Greece and US Treasury auctions (the last 30yr was a failure). When that happens, the dollar, being the world's reserve currency and home to over half of worldwide defense spending and 6000 nuclear warheads, to say nothing of the world's largest economy, third largest population, and despite recent activity, one of the most stable legal systems in history, gets bought out of fear.

We get a short squeeze of cosmic proportions, setting off cascading margin calls as both dollar shorts and commod/equity/currency longs get sent to market in a panic to close out positions. If this happens in proximity to the January high in the stock market, we get a "failing rally/double top," and the "all in short" signal goes out. The rapidity of this will be unprecedented, as anyone offside on this trade (the bulk of the banks in the US and Europe) will exsanguinate in seconds.

Remember, the trade is lopsided and that ALWAYS, without exception, is a prelude to the herd getting slaughtered en masse.

The dollar rises, and everything else gets crushed. Commodities will go first, just like they did in 2008 when the yen got covered. Stocks go next as money that rotated from the commodity market runs dry. Finally, all the shenanigans in the bond market stop as Bernanke moves to save The FED. The accounting gimmicks won't save him this time, as the world finally realizes the money is gone, and has been for some time. He, and his criminal banking cabal use the chaos in the equity markets to get the last pop out of bonds, and then the floor disappears from them.

Everyone dials 1-800-GET-ME-OUT, as the fear is real because we just saw a top and failed to extend it. Failure is fresh in everyone's mind.

We don't need to spill a lot of electrons on how Bainbridgeislanddreamhomes will fair in this bloodletting. They will be on the killing floor, covered with the gore from the bond, stock, and commodity markets. Interest rates will pop hard, without relenting, as money is evaporating all over the globe, at the same time everyone is trying to cover their dollar shorts. Stock charts will look like Moses turned Yosemite Falls into blood, with large, long red candles going straight down, destroying confidence and killing off one leg of the triad of Boomer retirements. Gold, silver, oil, grains, copper, etc all get sold into a worldwide economy in serious retreat. We are looking at $20 oil, $300 gold, $4 silver, and $150K Bainbridgeislanddreamhomes. Given that credit will be temporarily frozen solid, those prices are optimistic.

While currency, bond and stock markets are obvious determinants to the Bainbridgeislanddreamhome market, the commodity market isn't as obvious. Certainly, owner-occupied homes are not going to get margin called, but all the bank REO inventory will, sending prices straight down. Your Bainbridgeislanddreamhome is a place to drink white wine, park your Prius or Nisssan LEAF, and display Obama '08 yard signs. To the bank, it is an entry on a ledger, and nothing more.

That's how we see the debacle unfolding. These are merely predictions, and your mileage may differ. The IER is not a registered investment advisory institution, and this is NOT trading advice. This is nothing more than putting real world landmarks on our current situation in an attempt to educate the inquiring public about the status of our financial landscape.

The IER is largely flat, as we await the failing rally in stocks. Once we see a definite break in commodities (oil and gold will be the best to watch, but silver may very well presage both to the down side, as it is an industrial metal as well as a numismatic metal), attention will turn to the stock market double top. If it fails, it confirms the commodity break, the shorts go out on the SPY, QQQQ, banks and Cramer's famous "Four Horsemen." (AMZN, GOOG, AAPL, and RIMM - BTW, the "Four Horsemen" in the Bible are apocalyptic in origin, so take that for what it is worth). Speaking of Cramer, if he is chirping about new highs in close proximity to the January high, that is about as close to "short with impunity" indicator that there is. If Goldman Sachs is offside (and I doubt it, as they are the ones moving the markets), that will be the kind of short that will land you at the Adventurer's Club sipping brandy and smoking a stogy with Commander McBragg as the ballsiest move in 4 generations. McBragg will be speechless because this is your world, the rest of us are simply passing through...quite.

Dollar long-calls as well as puts on foreign currencies should pay huge, as premiums on the trade will be next to nothing when the double top is made. Remember, everything is a dollar denominated asset, including foreign currencies. That's what "reserve currency" means in practical terms.

Stay solvent. Stay nimble. Stay skeptical.

Ernst Stavro Bloviator
Senior Fellow, IER

Local NAR Hints at Housing Time Bomb???

Today's Kitsap Sun had a great article by Rachel Pritchett discussing the direction of Kitsap's troublesome home resale market. It was surprising, not because Pritchett did some fine journalism (as that is her baseline), but that the real estate professionals seemed to be telegraphing an ominous development in real estate.

While December’s numbers were encouraging, it’s too soon to say the market has bottomed out, said Mike Eliason, association executive of the Kitsap County Association of Realtors.

“The big issue in the pond is the foreclosures,” he said.

I'd rather say "A" big issue... rather than "The" big issue... because there are scads of problems bearing down on real estate. Among these are: rapidly rising interest rates, discontinuance of government life support, rising unemployment, falling stock market, adverse demographic changes, and acceptance that "real estate can, AND DOES, fall in price."

Let's talk about foreclosures. On that score, Eliason probably doesn't know how correct he is.

The Market Ticker , by Karl Denninger, is one of the best sources for the play-by-play of this horrific debt implosion we are all witnessing. Earlier this week, he noticed that the US Treasury is lobbing a financial nuke into this year's housing resale market.

Come the spring selling season you're going to see the inventory of homes that were "HAMPd" and failed for whatever reason hit the market.

This is not a trivial number of houses - there are close to 750,000 homes currently under trial modifications, and only a tiny number of them - something like 30,000 - have converted to permanent payment changes.

Thank Treasury for not telling you about this until the "selling season" had ended and we were in the middle of the winter months when sales are slow - and timing the "required start" date for April 1st, right into the maw of the spring selling season.

If you need to sell your house in the next year this is something you need to take into consideration. A flood of nearly 3/4 of a million houses appear poised to hit the market as short sales and "deed in lieu" sales beginning in April.

It appears that the US Treasury is going to do something prudent, which is to force the market to clean up this mess, and not allow "extend and pretend" programs to continue as institutionalized denial.

The resale market is likely to get hit with an avalanche of low priced sales, which will overwhelm the bid and crush prices. This doesn't include houses that were not subject to HAMP, but are distressed nonetheless.

Rumors are floating around that Bank of America will push 600,000 foreclosures into the market in 2010, up from 100,000 in 2009. I guess they saw that Treasury release. You can bet if BoA is going to disgorge 6X what they did in 2009, other banks will as well.

Remember from ECON 101 - Supply isn't just the number of units for sale, but the eagerness of the owners of those units to sell at the current market price. He who sells first, sells best. Put another way, "sell now, or be locked in forever."

If you bought a home in the past few months thinking you were really getting a good deal because rates were low, prices are "at the bottom," and you got $8000 of free government cheese, you are going to realize how expensive that $8000 cup of financial hemlock was when you find the homes in your neighborhood are dropping 20% below your price in very short order.

Eliason continues:

Eliason said bankers are warning his organization that the number of foreclosures and short sales is expected to grow locally in 2010 and 2011, working against a market that otherwise is attempting to recover.

Eliason estimates that 25 percent of homes selling now have been foreclosed on, are short sales, or are selling for less that what was owed on them.

Yup. Looks like Eliason got the memo. Remember, our market is one of the "healthiest" in the nation, which is to say we are in the last car on the roller coaster. Those 25% are with all the government backstops, and enormous financial engineering being done at the Federal Reserve, and being the "last car on the roller coaster." The backstops are going to end when interest rates rise and the US Treasury can't roll its debt. The Institute For Economic Reality is predicting rising rates as money comes into short supply and deflation sinks its talons into the flesh of the productive economy.

Here is a thought experiment: ask yourself how many of your acquaintances are holding their homes off the market until housing recovers? What is the ratio of that number to those you know equally well that are facing forced foreclosure or distressed sales? Extrapolate from the 25% that Eliason is quoting and see what is really out there UNDER CURRENT CONDITIONS.

Now expand that with local unemployment rising another 5-8% and home mortgage rates pushing 7% for short term loans, or 9% for 30yr fixed?

“Yes, it will still pull down the prices because of the appraisal problem,” agreed Heather Holmen, an agent with Windermere Real Estate of Silverdale. She explained that a homeowner who wants to sell will have to adjust the asking price based on homes that have recently sold in the neighborhood, which likely includes distressed properties with low prices.

Appraisals are the least of our problems. Sure, the outright fraud that was foisted upon us during the go-go years is over, with Realtors and lenders no longer being able to twist arms to get appraisers to "hit the number," but the real problem with prices will not be in the appraisal. It will be in the inability of people to find the money to pay. Appraisals will trail the market as prices will continue to fall due to lack of liquidity. Remember, appraisals are a lagging indicator. They tell you what HAS happened, not what IS happening or WILL happen.

Holmen continues:

Holmen is among many local professionals who believe that continuing tax credits and low-but-rising interest rates will help the market hobble along this year, especially for homes in the $200,000 range in Silverdale and East Bremerton, the most active segment of the market.

“We’ve actually had some multiple offers,” she said.

She expects interest rates to approach 6 percent by mid-year.

Delusional. The tax credits are not indefinite and only go through the end of April. The Congress is in the process of foisting upon us the largest tax hike in our history, which will certainly weigh on our ability to scrounge up money to buy Bainbridgeislanddreamhomes. However, the most glaring evidence that Holmen is under the influence of "hopium" is that "low but rising interest rates will help the market hobble along this year."

Excuse me? How do interest rates rising off a low base "help" home prices? I'd like for Holman to chime in, with her HP 12C in hand, and 'splain that to me. I realize that I went to Port Orchard schools, but the math on that is elusive.

If the county median home price is in the low-mid $200K range, and the most active $200K range is slightly below the median, that screams two likely possibilities: first time buyers are using the free government cheese and VHA backstop to buy homes they can't afford, or that flippers are descending on homes in that range. Rising rates will scare off the flippers like soap scares off hippies. Without flippers, or first time buyers, those foreclosures and distress sales are going to have an increasingly difficult time finding suitors.

Holmen continues:

It may take up to a decade, she said, for the market to genuinely return to normal, when homeowners can expect a modest-but-steady 3 percent to 5 percent annual rise in home values.

Source? Why a decade? Why would homeowners expect 3-5% What drives that return? (something must) I'd like to see the basis for such a fanciful prediction.

Additionally, I'd like for someone from the NAR to clarify what "normal" means. Was 2006 normal? I hardly think an unending torrent of brain-dead Californians armed with truck loads of money that was borrowed into existence against the self-delusional hope of ever rising home prices is "normal."

Holmen starts to find reality:

Even then, the days of easy home loans are gone forever, she said, and consumers need to be ready.

This is undoubtedly true (at least for our lifetime). If easy loans are a thing of the past (thank God), then home prices are about to revert to a very short orbit around declining disposable incomes. Consumers are not the ones that need to be ready - homeowners need to be ready. Their home isn't going to recover anywhere near the 2007 peak. That is not an opinion. That is a mathematical fact every bit as valid as AxA+BxB=CxC.

“People are going to have to get used to the fact that it’s not going to be as easy to get a loan,” she said.

Banks will take longer to check out prospective borrowers. Would-be homeowners will have to clean up their credit and do away with multiple loans on boats and RV’s, for example.

I guess lending based upon the premise of being paid back with good collateral as a backing will replace the 20 year old paradigm of lending against anticipated future appreciation and refinancing. Yup, that will leave a mark. Loan officers are going to actually have to do homework and learn to say "no." They will no longer be able to securitize their ineptness and greed.

In the go-go years, you borrowed more on your home to finance your his/her Sea-Doo, Disney Cruise and Whistler weekends. Soon, those boondoggles will cost you the ability to buy a house. Ironic, isn't it? Imagine the stories you can tell your grand kids.

Grandpa: "Well, back at the turn of the century, we used to borrow money against our house to buy lifestyle toys and bling without ever having to worry about paying it back."

Grand kid: "That's insane! Are all old people as dumb as you? Is that why I'm in debt beyond my comprehension and our standard of living hasn't improved in 40 years?"

Here is the money quote (no pun intended)

And most of all, homeowners from now on will have to plan for a down payment, she said.

This is going to be the killer for home prices. If we are paying down debt, and our debt service is pretty close to our disposable income, there simply won't be any savings worth mentioning. There can't be in that scenario. If banks won't lend without a substantial down payment, and the lunatic practice of borrowing the down payment, or buying PMI (an even dumber idea), is a relic of a fool-laden era, how do you get rising home prices?

You don't.

If banks settle on 20% down (and we would be lucky if they stopped there), you can borrow 4x your savings. Think about this. How many people have, as liquid and disposable assets, $40K? Seriously, how many people do you know that could have 400 Ben Franklins in their hands by the end of the week? We are not discussing lines of credit, but actual cash they have saved over the years. Not many, and those that can are likely living in the upper tier of real estate in Kitsap County. Under this metric, that upper tier is worth $200K, provided you can get the loan and are content to blow your entire life's savings on your down payment.

Good luck with that.

How about $25K? That pencils out to $125K house.

What do you think a "first time" home owner has as savings? Let's review: these people need to get $8000 from Obama's Stash and VHA loan to buy their home. They don't have squat. If they have $10K in real cash savings, I'd be surprised.

Think about this some more. Every house in Kitsap County would necessarily be valued at 5X the cash savings of the occupant (on average), and that presupposes they can service the debt on 4X their savings with no reserves of any kind.

There is no recovery coming in housing. Prices are going to continue to fall until debt burdens are relieved such that disposable incomes can rise to create savings and enough to service debt at 2-3X income. That's an awfully tall order if we consider where we are in this cycle and the FACT the government remedies for all of this have just piled on even more debt in a failed attempt to prevent the market from clearing.

It actually breaks my heart to see so many friends and family continue to buy into the insane notion that you have to own a home at these prices. Many have had the great fortune of being able to sell their homes in this environment, only to blow it by rushing in to buy something else.

The people that have bought in the past few months are going to be very P-Oed. 2010 is going to be a year people won't soon forget.

I still hold to my prediction of "20 cents on the dollar by 2010." I have 359 days left on that, and it is going to be tight, but I still like my chances.