The Humpty Dumpty Economy

This was posted Nov. 29th, 2008. I like posting these because the people who write these articles hint at coming changes, both good and bad. I like to go back and read them later to see how they turned out. There are many more at my old LiveJournal.

The Humpty Dumpty Economy - Citibank is just the beginning

“There’s much ruin in a nation.” ~ Adam Smith

We’ve gone from a Goldilocks economy to a Humpty Dumpty economy. I see years of stagflation ahead. At best, expect a combination of slow growth and renewed inflation over the next few years.

America in 2009 will never be the same. Barack Obama is right when he said that as president he doesn’t look like any of the faces on the dollar bill. We are entering stage two of the New Deal. Obama recently spent time reading about the emergency measures Franklin Delano Roosevelt took when he became president in early 1933.

FDR started his New Deal by declaring a week-long bank holiday. The way things are going, Obama may have to do the same on January 20, only it will be an invisible bank holiday. Today the Feds rescued the nation’s largest bank by making an emergency loan of $20 billion, but more importantly, TARP (the Treasury’s Troubled Assets Relief Program) guaranteed $306 billion in Citigroup’s troubled assets. (This is the problem when the fed guarantees a failing institution's problems. The company has a $306B cushion. They will, and have, used it. The $20B bailout for Citibank turned into a $300B bailout.)

Essentially, the Federal government was sending a message to Wall Street: “We are guaranteeing the assets of all major banks in the United States, starting with the largest.” That’s why the stock market rallied for the second day in a row. It was like Washington setting a price floor on the economy and Wall Street.

The price for this “bleeding heart do-gooder” bailout mentality will be steep. Expect deficits to exceed $1.5 trillion in 2009 and beyond. Much will depend on how many other bailouts the government will undertake. The list of handouts could be long -- commercial banks, insurance companies, auto makers, credit card issuers, states and municipalities.

The new Obama administration and the Democratically-controlled Congress probably can’t say no to the "Big Three" auto makers, since a bailout is really a payback to the UAW. Expect the government to pay for the legacy costs of retiree’s pensions and medical expenses and to get back into the business of running businesses “too big to fail.” Failure to rescue Detroit could be the tipping point toward the big D (depression).

Once the economy stabilizes (notice I didn’t say grow), expect Obama to increase taxes on investors and wealthy entrepreneurs in a vain effort to reduce the growing deficit.

The Fed is doing its part by injecting billions (or is it trillions?) into the monetary system through the Discount Window and Open Market Operations.

Both fiscal and monetary policy are highly inflationary. Initially, the impact will be a stock market recovery….but the long term impact is more inflation and much higher gold prices (the ultimate inflation hedge).

FDR also took the United States off the gold standard and forced Americans to turn in their gold. Thankfully, nobody is talking about gold confiscation right now, although if “speculators” (gold bugs) double or triple the price of gold, don’t rule out this possibility.

I just returned from a trip to Bogota, Colombia, where I gave a lecture on the financial crisis. I said that America started this crisis, and America can end it. It requires the U.S. government to (a) establish a long-term stable monetary policy, with neither easy money or tight money -- the Fed should adopt a Goldilocks “just right” monetary policy, a steady monetary rule that stabilizes the price of gold; (b) pass a flat tax that becomes permanent and dependable; (c) institute just and tolerable “rules of the game” so that business and financial institutions can make long-term plans for success; and (d) adopt an open and non-interventionist foreign policy.

Adam Smith said it best: “Little else is required to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, [sound money], and a tolerable sense of government.”

Tragically, America could go in the opposite direction toward a road to serfdom if we are adopt a constant policy of war, taxation, inflation, and over-regulation.

History is holding its breath to see which way we will go.

The fed absorbed the debts of dozens of corporations, going into debt to the tune of $15,000,000,000,000. I used the Zeros to put a fine point on this. That's 15 Trillion! Mostly by printing money when we didn't have any more left.
In 1988 people were screaming about Reaganomics. He was the first president to suffer a 1 Trillion national debt. But after 12 years of Reagan/Bush the principle of the national debt had been reduced by more than half. He had lowered taxes as much as a liberal congress would let him. He brought Jimmy Carter's 22% Prime Rate down to a manageable 9.5%. At that rate there would have been no debt in another 12 years. The national debt was teetering on $550 Billion, less than it had been since Nixon in '68.
Enter Clinton: Sell back the debt that had been paid plus borrow $800,000,000,000, that's 800 Billion dollars, in bonds from China. At the end of his 8 years we were up to nearly 2,000,000,000,000. $2 Trillion!
Then we went to Iraq and Afghanistan after 9/11. There were a lot of pros and cons there, and I will not take the time or effort to discuss them here. Suffice it to say that we have been there too long and suffered too much for no gain. We did not learn the lessons of Sun Tzu, Korea, or Vietnam. We had a 73% approval rating in America and a 55% approval rating from the UN. We should have gone in without the politically correct restrictions, got the job done, and got out. End of comment. At the end of Bush's term we had a debt of $4 Trillion.
This is the scary part. Enter Barack Obama. In the same way that Reagan ran as a Republican but was really a Libertarian, Obama ran as a Democrat but is really a Socialist. A man who is an admitted Marxist and an admirer of Islam, if not Muslim. A man who has not even proven that he is qualified to be president. He appoints a socialist administration. In 2 years he ran the national debt from $4 Trillion to $15 Trillion. Is this the change we wanted?