While U.S. embassies were under attack did you notice the key financial events of the week? Across the pond, the German court ruled on the constitutionality of the European zone bailout funds. Germany has been a barrier to open-ended bailout funds which are used to bailout bankrupt countries like Greece, Spain, and Italy. The ruling was worded in a way that appears to provide some cover domestically for making Germany (which really means all Germans) joint and severally liable for the debts of other countries.
Would you go in joint and severally liable with your Uncle Joe knowing he is unable to manage his finances, balance his budget, and borrows money routinely? This is precisely the position the German people are now in. The Germans are on the hook for another country’s fiscal decisions. While there is more to be seen regarding the consequences of this decision the camel’s nose is in the tent. Germany wants more control over the fiscal policies of those countries it would bail out or a more powerful European Union with more authority. If either of those fail to come to fruition it will be interesting to see whether the EU stays together or not.
Meanwhile, Ben Bernanke, the four trillion dollar man, announced an open-ended Fed program to purchase mortgage backed securities, continue Operation Twist, and ultimately expanded the Fed’s balance sheet to four trillion dollars by the end of next year.
The plan is to purchase $40 billion of mortgage backed securities every month. This was an open-ended position announced by the Fed. This may last one year, five years, or longer. Operation Twist is the buying of longer dated bonds (i.e. 10yr, 30yr) and selling shorter dated bonds. In other words buy $100 billion of 10 year bonds and sell $100 billion of 10 year bonds. The Fed is already acting as the buyer of last resort as many auctions result in the Fed actually buying the securities being sold because no one else will buy them.
Alternatively, the primary dealers buy the securities and and repo them back to the Fed for cash. The primary dealers then use the new found cash for hedge funds, their proprietary trading desks (which are often hedged positions against their client’s positions), derivative trading and other higher risk investments. There is no longer any moral hazard as poor decisions don’t result in failure or bankruptcy. Instead the government provides bail outs. This is akin to a person gambling in a casino and choosing between one game with 2 to 1 odds vs. a game with 10 to 1 odds. It is a risk/reward proposition. If the person knows they’ll be bailed out if they lose their money why not take a shot at the game with the higher reward.
What does all this mean for the average citizen?
- The continued debasement of the currency. Which means the purchasing power of a federal reserve note will decrease. Real goods and services will cost more.
- Expect a rise in the price of precious metals.
- Expect the price of crude oil to rise. If you pay attention to oil and gold prices you’ll see they’ve been pegged to one another for many years. If gold rises, oil rises and vice versa.
- Commodity prices are at record high levels. Especially corn. As I covered in another article corn is not only used as feed for animals and food for people it is used in ethanol production. Expect to see a renewed call for more ethanol as crude prices rise.
- Expect an increase in worldwide starvation and deaths in third-world countries due to the increase use of corn in ethanol which means less food supplies worldwide.
- Expect more rhetoric from politicians claiming they are acting in your best interests. To save the economy. To stimulate the economy.
- Expect more people to be on food stamps.
- The Fed’s short dated bonds coming due over the next 1 to 4 years has increased substantially over the past couple years. This will continue under the extended Operation Twist. Which increases risk as the shorter dated bonds come due they must be paid with interest. Mostly likely this will force the Fed to sell more short dated bonds. But who will be doing the buying?
Today the Fed and the primary dealers are taking down significant portions of bond auctions. There has been a significant decrease in debt purchases by countries like China and Japan. Which begs the question that Treasury Secretary Tim Geithner once posed; What happens if nobody shows up to the auctions.
Sadly, we may all find out the answer in the coming years.
The current financial and monetary problem was created by the central planners and elected officials in Washington. Fiscal policy drives up debt. Borrowing drives up interest payments. The Fed controls both the money supply and the cost of money (i.e. interest rates). The arrogance and hubris of a few elitist academics is leading the country to ruin. We the people do not need central planners controlling the money supply and the cost of money. Moreover, we the people are forced to use their currency through unconstitutional legal tender laws.
Alternatively, we the people should determine the currency we want to use. The people along with those willing to lend money should determine interest rates. Ultimately, we the people should determine whether we control the money supply or the central planners control it. While I’m not an advocate of a pegged gold standard at least under a gold standard the people control the money not the central planners.
As Ayn Rand famously quipped, “you can ignore reality, but you can’t ignore the consequences of ignoring reality.” Well we can’t ignore the reality of the consequences of the current monetary system, fiscal policies, and a centralized authority that acts arbitrarily and capriciously. It is our lives , liberty, and property that are at stake. Our unalienable rights to freely chart our course in life, to freely choose how we employ our physical and intellectual abilities, and the right to keep what we produce – our property.
The stock markets may like easy money. Politicians and central planners certainly like easy money. But we continue to creep closer and closer to the fiscal cliff as we teeter back and forth like a see saw on a fulcrum before the tipping point arrives and the arrogant, self-righteous, sociopaths in Washington leads us all over the fiscal cliff. The Great Depression will be a walk in the park compared to this. This is the path we are on. Slowing it down isn’t the answer.
A complete derailment is needed to restore fiscal and monetary sanity and constitutionally limited government. To restore freedom and liberty to the people, the people cannot continue to act as lemmings and follow the herd wherever it leads. Societies collapse. Nations collapse. Currencies collapse. The road of history is littered with failures.
We are not too big to fail. We are too big to succeed. Too many see the country as invincible. The country is not invincible, it is fragile. It is being held together with chicken wire and string. There are too few people willing to explain the truth to the American people. There are too many people that are polarized by politics and ideology or simply cannot overcome their own normalcy bias to believe the truth.
The four trillion dollar man is working his magic, sprinkling his fairy dust everywhere hoping that things will magically improve. He is ignoring reality. We are going to have to live with those consequences.