All Government Experiments Come to an End… Eventually’

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‘I just don’t get how someone can see it as a viable solution’ your editor’s girlfriend told no one in particular. But nobody taking part in the massive trade union protest in London seemed to care about what was viable or not. They were too busy stimulating the economy by throwing objects into glass windows.

Further proof of the broken window fallacy, not that it’s needed, was exposed during the riots. Having paid lip service to the government’s stimulus efforts, bankers decided to arm their branches with reinforced glass to hold off any Keynesians looking to stimulate the window business.

How hypocritical.

But a politically correct correction is in order. The protest was peaceful until ‘anarchists’ got violent. Dan Denning grumbled that the vandals ‘give anarchists a bad name’. But what on Earth were anarchists doing amongst trade union members in the first place? Aren’t they diametrically opposed? One group wants more government and the other wants less – or none.

Those who ignored the protesters did so at their peril. Some tourists were reportedly threatened because they kept eating salmon sandwiches without acknowledging the chaos around them.

Anyway, protesting against public sector budget cuts really isn’t based on a viable aim. If the money isn’t there, it isn’t there. Borrowing more increases the risk of a complete funding crisis. And government has to be the most spendthrift institution ever… so it must be cutting for good reason.

On that note, back of the envelope calculations put the updated cost of Melbourne public transport’s new ticketing system at over $1000 per user. That’s the set-up cost. Combine this type of public transport efficiency with a new EU plan that calls for ‘Cars [to] be banned from London and all other cities across Europe … to cut CO2 emissions by 60 per cent over the next 40 years,’ and you have complete mayhem.

Lucky we don’t have Australian politicians who aspire to such policies…

But back to the withdrawal symptoms of past Keynesian stimulus; austerity, riots and currency crashes. Central bankers are the trump card in the debt game. The US and UK have aces up their sleeves in Mervyn King and Ben Bernanke. The Euro nations have a little less room to counterfeit their way out of debt. But, ironically, it seems the EU is having trouble with inflation.

Remember all that discussion of central banks working together to an unprecedented extent to ward off the financial crisis? Well can you guess when central banks began the habit of colluding to inflate the money supply? The 1920s – in the lead up to the Great Depression.

Back then the UK was trying to inflate its way to prosperity and monetary dominance in Europe. But it needed the backing of a strongman. That strongman was Benjamin Strong of the Federal Reserve, who agreed to join in the inflation to make the UK’s policies look less ridiculous. But two wrongs didn’t make a right. So German and French central bankers didn’t go along with the inflationary policies, secret meetings or no. This led to gold flows between the countries that made the global financial system an awkward place. In the end, the inflationary policies led to the Great Depression.

Federal Reserve policy makers don’t seem worried about repeating past mistakes. But that’s changing. The US dollar’s role as a dominant currency and safe haven can now genuinely be questioned. Just as the UK Pound’s was in the 1920s. After crises in Japan, northern Africa and Europe, the dollar continues to fall.

It’s supposed to be where the safe haven investors flee to in times of uncertainty – times like these.

Just to be clear, the US dollar isn’t safe. We’re talking about a public perception here… and whether a flight to safety is still synonymous with a flight to the dollar.

Here is a prediction for what the trigger for the end of dollar dominance will look like. When the term ‘petrodollar’ loses the ‘dollar’, you will know the tide has turned on the world’s reserve currency. OPEC will be the determining factor.

Why OPEC?

There’s a long list of reasons. Politically, oil rich nations don’t like the US much. But the US has been their main client and the US dollar the currency of their dealings. As they find markets elsewhere, the importance of the ‘forced marriage with benefits’ will be reduced and OPEC’s political clout will increase. No doubt that in the mind of many OPEC members, they have some payback to dish out for America’s past (and current) behaviour.

There are more reasons why OPEC will herald the dollar decline. Like the effect of Bernanke’s printing presses on OPEC members. While the price of oil is rising, the purchasing power of the dollar is falling. And the more money Bernanke prints the less all that accumulated revenue is worth… no matter how many extra dollars are tacked on to the oil price. Even massive gold holdings can’t inflation proof revenue streams the size of the OPEC members’ petrodollar fund (1 trillion this year). But take note that the personal accounts of dictators who siphon off petrodollar revenue for themselves happen to feature much gold and similar assets.

This is one way to think about the effects of a rapidly falling US dollar: Did the US economy grow in terms of Australian dollars?

Let’s look at the fourth quarter of 2010. US GDP grew at almost 3% annualised, but the US dollar fell about 5% against the Aussie in that time. To an Australian, in Australian dollars, the US economy shrunk about 4.25%!

Of course, it’s all just paper in the end. So what about in real money? Any guesses how US GDP stacks up in terms of gold?

You get pretty much the same result… Surprise!

If the economy is shrinking in terms of foreign currencies and real assets, that belies some real weakness. With Utah and other state governments legislating to encourage gold and silver as legal tender, you’d think this actually matters. But don’t think that will stop Bernanke.

Tweets and Twits

According to the reputable sounding website ‘Social Times,’ Twitter can be used to predict stock market moves with 87% accuracy. The race is on to implement the trading system that feeds off the analysis. One willing investor is forking out 25 million pounds.

But what do economists make of all this?

Keynesians will argue for stimulus by mass positive tweeting (not outsourced of course). Classical economists will argue expectations will soon render the system useless as it becomes widely practiced. Econometricians will change the model to factor in the increase in positive tweets of the Keynesians. And the Austrians will bemoan the efforts and predict the coming stock market crash.

It’s all rather comical, but quite representative of the different schools of thought.

A question for the Keynesians among you: If the Federal Reserve creates inflation in an economy with high unemployment, isn’t that a dampener on consumption – the very thing Chairman Bernanke is trying to stimulate? As prices rise, wages will not, as there are plenty of people bidding down the cost of labour.

Add to this the nature of the inflation that is emerging, as Bill Bonner reported on Wednesday:

‘The feds wanted inflation. Apparently, they’ve got it. The latest figures show consumer prices rising at 0.5% per month. Doesn’t sound like much. But multiply by 12. It’s over 6% per year.

‘Producer prices are going up even faster – at a 20% annual rate, if you extrapolate from last month.’

With PPI rising at 20% and CPI at 6%, there’s one hell of a squeeze on corporate profits going on (as discussed last week) further discouraging hiring. Then there is this common inflation symptom, reported by the New York Times: ‘Chips are disappearing from bags, candy from boxes and vegetables from cans.’ You may be paying the same price, but there is less in the packet. Mother of nine Lisa Stauber reports her usual purchases are falling embarrassingly short at the dinner table and she has been investigating the widespread ‘sneaky’ practices ever since.

But as long as Bloomberg spits out these headlines, you’d think there is no reason to worry: “U.S. Consumer Spending Increases More Than Forecast.”

Then again, if you read the article itself, much is revealed:

‘More than half the gain in spending last month reflected higher prices, one reason it will be difficult for households to contribute as much to economic growth this quarter as last.’

This article sums it up nicely: ‘Consumers Spend More, Earn Less In February’

Falling profits, low wages, unemployment, content cutting and inflation are a recipe for disaster. A big disaster when the government’s funding is called into question as a result of the above. We know how this ends. Think Weimar Germany and Bolshevik Russia, which ‘forgave’ the amounts lent to the Tsarist government by foreigners. For a more recent indication of how the nearer future will look for nations around the world, Greek two-year bonds are yielding over 15%. And remember, that’s above and beyond an ECB policy rate at a historically low 1%.

The Fed Exposed

Having lost the lawsuit to keep its ‘secret lending’ secret, news has emerged of the Federal Reserve’s lending programs during the crisis. Here are the highlights, as your editor sees them:

  • JPMorgan Borrowed at Least $5.9 Billion From Fed Window’
  • Arab Banking Corp., a lender part- owned by the Central Bank of Libya, used a branch in New York to borrow at least $5 billion from the U.S. Federal Reserve as credit markets seized up in 2008 and 2009′
  • Goldman Sachs: ‘We used [the discount window] one night at the request of the Fed to make sure our systems were linked with their systems, and it was for a de minimis amount of money.’ (The other four times were small amounts.)

In a similar vain to Goldman Sachs, JPMorgan, Bank of America and Wachovia claimed to have used the loans ‘to display the effectiveness of the facility’. Bank of America had also claimed ‘it used the program only to help stabilize the financial system.’

These days it’s not only central bankers colluding over money creation. Lufthansa flight attendants have been smuggling reassembled Euro coins into Europe after Chinese companies got their hands on the ‘zerschreddert’ remains. One got caught with one thousand Euros worth of coins in her bag!

We’re not sure whether to be more outraged by the banks or the Euro luggers.

P.S. Thanks for the positive feedback on last week’s article on PE ratios and corporate profits. Those of you who enjoyed it, you can find an interesting related discussion here.

Nick Hubble
For Daily Reckoning Australia

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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