The government finance shell game

USAID gives dollars to China.

That's to say, we borrow money from China to give to China. Oh, don't worry. It's only a few million, and most of it goes to "promote clean energy." It sounds so reasonable when you put it like that. Who among us hasn't borrowed money from his loan shark in order to buy his loan shark a hybrid?

Have to say I agree with this: "Government finance has become a giant shell game in which there is no ball to find."

Wasting a mint at the US Mint

"The only thing more shocking than the waste in this video is the fact that the report came from the MSM" - American Glob blog.



Short course: The US Mint, in compliance with a 2005 statute, spends $600,000 per day to make presidential dollars that are immediately placed into storage, not circulation. The Mint spends millions of dollars just transporting the dollar coins to storage and is about to spend another potful of money to build another warehouse.

The coins, of course, are made of an alloy of base metals and are therefore worthless in themselves.

The solution, ISTM, is to get the Mint out of making coins in denominations higher than 25 cents unless they are made of silver or gold proportional to their face value.

Fine silver or gold US Mint coins sell out completely. Example: in 2008 the Mint was authorized to strike and sell 2009-dated Ultra-High Relief Gold Eagle coins of one ounce of .999 pure gold. But the authorization did not continue after a specified run to be completed in 2009 - there were no 2010 coins or later.

These were collector, bullion coins denominated at $50 and are legal tender. Needless to say, the Mint did not sell them for $50! Spot gold was just under $1,000 then, and the coins sold for a premium above that. (I bought one, the limit per household, for $1,280 in February 2009, and it still sits in my lockbox. You can buy one on eBay if you wish, but gold spots now at almost $1,800.)

If the government wants dollar coins to circulate, it needs to make them with a dollar's worth of silver. That means that the government would have to take steps to stabilize the price of silver (leaving high-profit sales of gold coins as collectibles). Should the Mint buy silver every month or so at the spot price? Of course not; that would not stabilize silver's price.

But say the Mint was to strike a billion silver-alloy dollars. The government could announce it would buy silver at $30 per ounce, which is about where silver's spot was earlier this month. That would be a purchase 33,333,333.3 ounces, so that each dollar contained 1/30th ounce of silver. (The days of the one-ounce silver dollar being worth a dollar are gone forever.) This would stabilize the value of the dollar immediately and people would take them off the Mint's hands - no warehousing required.

Of course, there are some issues:

1. If the Mint is to buy silver at $30/ounce, what will it use for payment? Can't use silver for obvious reasons. Paper dollars? Why would a silver refiner take paper dollars to hand over silver metal that will be converted to hard dollars? (It would make sense in this way: paper money can be electronically transferred so that actual printed dollars need not actually change hands, but hard money can't.)

2. Silver has production costs that are incurred regardless of the spot price or the government's prospective price. A fixed buying price may depress rather than increase raw production of silver ore.

This highlights the difficulty of moving to gold- or silver-backed dollars that most hard-money advocates overlook.

Is gold a bubble or a new normal?

Harry S Truman said that he wanted a one-armed economic adviser because then he never have to listen to the adviser say, "But on the other hand..."

And so it seems to be with gold. On the bubble side, Dennis Gartman:

Dennis personally sold a lot of his gold in the course of the last 54 hours, and actually states that he wishes he sold everything. Dennis says that the way this market has traded, the manner in which the public got aligned with it and came into the gold market, the manner in which you had all signs replicating periods in the past when other markets made their tops, the fact that the SPDR Gold ETF (NYSE:GLD), became a more greater capitalized event than was the SPDR S&P 500 ETF (NYSE:SPY) — more value — you get at market tops.

Gartman feels we’re in a period of low growth and low inflation. that is not the right recipe for gold. He thinks the public was sold a very false supposed safe harbor in gold, and this is going to be a painful down move. Quote, “we have a lot further to go.”

On the "new normal" side, Tim Seymour:

Even counting the 2008-9 recession and the more recent downturn, emerging markets (NYSE:EEM) generated annualized performance of 18% a year since 2003.

Compare that to the S&P 500 (NYSE:SPY), which has delivered 5% a year over the same period: not terrible, but not great.

Meanwhile, it turns out that gold (NYSE:GLD) has surged an annualized 23% since 2003, with less volatility.

This is not just a bubble run for gold. It has been a structural shift in the way the world’s markets work and the way global risk is managed.

Yer pays yer nickel and ya takes yer chances. For the record, I am not invested in gold in any way.

Update: Another perspective:

Of particular concern is that the general public probably got into the gold trade during the later innings. “The public owns gold at high prices – and now any rally will be met with sellers,” Gartman says. He also thinks big hedge funds will be damaged by the sharp decline. Hedge funds who say they are long in a position if they hold it longer that 15 minutes stand to lose huge amounts of money in gold and that too could generate liquidation pressure.

I suspect this is true - members of the general public who heeded the incessant advertiements to buy gold now probably have, as a class, gotten into that market too late to avoid taking either small or negative gains when the selloff begins (if indeed a selloff does begin, of course).

People who invested in physical gold rather than gold funds or trusts will be cut up particularly rough because it will be very difficult for them to liquidate quickly. It will be a buyers market and you should expect to be offered no more than two-thirds of the spot price at the time you sell, maybe less.

End this welfare for the rich!

Glenn Reynolds links to NYU finance professor Viral Acharya's call to fix the housing market by ending income-tax deductions for interest charges on home mortgages.

The less told story on such subsidies is what they have done to generate more demand and push up prices, he says. “One the one hand you are actually getting all your subsidies, but you are actually paying more for the property you would have liked to consume,” says Acharya. “Therefore the real subsidy goes only [to those] at the very top. It is for people who are buying a second house. It is for people who are buying more land than they would otherwise.”

Not only have government subsidies failed to really help everyday people, except to “prop up the housing market artificially,” says Acharya, but the big question also remains: Who’s paying for all these subsidies? “It’s sort of a Ponzi scheme, because the current generation is reaping all its benefits, but we’re basically scaling up our government debt in response, and someone else is going to pay for it down the road.”

I called for ending the mortgage-interest deduction in January 2003, but went into detail in November of that year.

As for the mortgage-interest deduction, that needs to go too, and I own my home and benefit from it. The main objection to its elimination is that home values would plummet if the deduction is removed.

But what that really says is that the presumed tax savings are really ephemeral because the deduction is inflating home prices. So you have to pay more than the home is worth because of the deduction. That means that the deduction is skewing prices and hiding the true value of homes, and that alone is sufficient reason to eliminate it, IMO.

However, various studies (link, link, link, for example) show that eliminating the interest deduction would have very little effect on home values, and the effect would be temporary. Most taxpayers are not in the highest tax brackets, so their deductions are relatively modest.

Moreover, normal swings in the housing market are likely to swamp the effects of tax code changes. ... when marginal tax rates were decreased in the early and mid-1980s, reducing the benefit of the mortgage interest deduction, housing prices actually rose.

Glenn concludes, "[I[f the GOP wants to let the blue-state crowd experience the joy of tax increases, they should get behind plans to eliminate or cap the mortgage interest deduction, which will hit residents of higher-priced blue-state houses harder."

The question always comes down to, Whose ox is being gored?

No representation without taxation!

That seems to be what Jerry Pournelle is saying:

I have no great objection to decreasing the large gap between rich and poor, but I do have an objection to raising government revenue by soaking the rich. If you want to make a case for distributism, in which enormous fortunes are confiscated and distributed evenly among the population, I will listen, and even find you some favorable arguments for having a smaller gap between rich and poor: but I will continue to object to having a larger percentage of the GNP go to government. It is the size and power of government that concerns me as much as anything else. I do not want to feed the beast.

More, I do not want to encourage entitlements; I do not think a Republic can survive when those who pay little or no tax determine the size of government and the entitlements to the citizens. I do not want to encourage a society in which all men are paid for existing, and no man must pay for his sins – or for his dinner, for that matter.

I don’t even object to the dole and the creation of a social class that does not work and does not intend to work, which is entirely subsidized by those who do produce – so long as that class forfeits its political control. You will argue that if that happens, those who control the government will not give enough to the non-producers; that only the entitled can determine how much they are entitled to. The counter argument is that only those paying the taxes should be represented when it comes to fixing the taxes; that there needs to be a minimum tax paid before you get to vote on just what the taxpayers will give you.

Well, something must be done about taxation and the whole idea behind it. Taxes may be, as Justice Holmes said, the price we pay for civilized society, but there is a swelling chorus today that civilized society should not cost so much.

What the Left never has grasped is that wealth is created, it does not just appear. When President Obama talks of " the most fortunate among us can afford to pay a little more," he displays his real belief:

Whenever President Obama discusses the wealthy, he refers to them in a manner that assumes they simply fell into piles of money and didn’t have to work for it. They are just “fortunate, ” or “benefitted most from our way of life.”

Rep. Eric Cantor explained the Democrats' basic world view this way to the Wall Street Journal:

"The assumption . . . is that there is some kind of perpetual engine of economic prosperity in America that is going to just continue. And therefore they are able to take from those who create and give to those who don't."

But, as former marketing professor Thomas Stanley pointed out, 80 percent of American millionaires were not born into money. They earned it. Wealth and well being are not resources that can be mined. They are creations. They do not just happen. They are made to happen. As I heard growing up, "money does not grow on trees," although I am convinced that Democrats think it does.

Does Dr. Pournelle have a point that "only those paying the taxes should be represented when it comes to fixing the taxes?" Or is that unacceptably undemocratic? Almost half of American households today have no to negative income-tax liability, meaning that they either pay no taxes at all or show a profit when they fill out their Form 1040.

In 2009, roughly 47% of households, or 71 million, will not owe any federal income tax, according to estimates by the nonpartisan Tax Policy Center.

Some in that group will even get additional money from the government because they qualify for refundable tax breaks.

The ranks of those whose major federal tax burdens net out at zero — or less — is on the rise.

In 2007, CBS News was moved to declare that "The Income Tax System is Broken" because then a mere 43 percent of Americans paid no income taxes. The two-year-old figure of 47 percent is probably about 50 percent today. Couple that with the fact that nearing one-third of Americans depend on direct government payments for all or some of their income, including almost 17 percent of Americans receiving what used to be called charity, and half of all Americans receiving some form of government assistance, and we the people have clearly become addicted to the dole.

How long before the golden geese, who make the money that the government takes away to give to someone else, decide to opt out? We are already seeing increasing numbers of doctors refusing to accept Medicaid and Medicare insurance because those programs are no longer covering costs incurred in providing many services and care. How long before the "wealthy" - an extremely elastically-defined standard by this administration - decide that the government and the people in general believe that "The duty of the wealthy is to be robbed by the government"? And they are no longer willing to participate?

Then what?

Finally, if tax "fairness" is the main issue, as Obama has said explicitly that it is, then should not the tax burden fall on pretty much all income groups? Of course, it will never fall equally on all Americans - the people who make more money are always going to pay more, even under a flat tax system.

But why do we disincentivize people from making more money by using a "progressive" tax system? Today we do the opposite. We incentivize people to:

a. forego making more money (meaning that we are keeping net national wealth creation down, which leads to lower tax revenues because of progressive rates)

b. incentivizes tax cheating

c. incentivizes an unreported, underground economy, which is presently estimated to be greater than the defense budget

So lets turn things over and use the tax code to make people want to earn more money instead of less, and stabilize the marginal tax rate. See here, but warning: your head will explode.

Blame the doctor!

Source. Hat tip: Gerard

Fed to meet Tuesday - the portent

Financial Times summarizes the five possible things the Fed can do at its meeting today.

First, the Fed could launch an “Operation Twist” on the yield curve, selling short-term Treasuries and buying long-dated bonds with the aim of driving down long-term yields. ...

Second, the Fed could cut the rate it pays on banks’ excess reserves from 25 basis points to 10bp. That again is an option it explicitly rejected last November. ...

Third might be a third round of quantitative easing or “QE3”. But imagine that the Fed bought another $600bn of assets. ... If there is any doubt about inflation, then the Fed will be reluctant to tie its hands so far into the future.

A similar objection applies to option four: a promise to keep rates lower for even longer than the current “extended period” or to make a similar promise about its balance sheet.

The earliest such a pledge could be reversed is September. ...

That leaves the final option: acknowledgment of the weaker economic data and a robust signal, delivered either on Tuesday or in the chairman’s speech at Jackson Hole on August 26, that the Fed is willing to act to counter any deflation risks that emerge. ...

But the crucial point is that none of these options are especially appealing. They all come with costs and those that are easier to do will not impart much stimulus to the economy.

The problem is not what the Fed can or can't will or won't do. The problem is that American business are over-regulated and suffer the world's highest tax rates. Couple that with an administration that continually talks about raising taxes still further, regulating evermore strictly and comprehensively, and it's no wonder that business managers are not hiring and are just hunkering down.

It's not the Fed's fault. It's the fault of a hyper-regulatory regime that thinks "that there is some kind of perpetual engine of economic prosperity in America that is going to just continue. And therefore they are able to take from those who create and give to those who don't."

So why create? is the question. And the answer is, don't.

As a matter of fact, we do miss you yet. Both of you!

The state of the union:

These posters can be taken much more seriously now than when they first appeared:

Yep, Bill, sure do!

If we are that disengaged, why does he think we're listening to him?

According to President Obama, Americans are so uninterested by or disengaged with the financial issues of our country that, he said last night,

[W]hat makes today’s stalemate so dangerous is that it has been tied to something known as the debt ceiling – a term that most people outside of Washington have probably never heard of before.

"Debt Ceiling" debates and issues have been the nearly non-stop topic of news coverage for weeks on end now, so much so that for awhile I thought that Debt Ceiling might have been an unusual name of a blonde college gal gone missing on a Caribbean island.

But no matter - in Obamaland, we are not paying enough attention to matters political even to have heard the term, "debt ceiling," and so we thankfully listen to this president pedantically explain it.

But I have to wonder - if we really are that tuned out to matters Washingtonian, then why would Obama expect that any of us would even turn on the TV to hear him talk?

Just sayin' ... .

The Oil Price Bubble - When Will It Pop?

Why have petroleum prices soared so high so fast? Presently we are seeing the highest spot price for crude oil ever in the month of March. Is it because there is a decreasing supply of oil coming onto the world market?

2010's figures are not yet compiled for worldwide production, but this table tells the tale. Oil production has held steady since 2004 except for a small surge in 2008 (when prices topped $150 per barrel, so you can bet anyone with a derrick was pumping). But even 2008's production was significantly less than 1 million bpd more than 2007's. When oil prices fell in 2009, so did production, but only back to about the same level as before.

Of course, production is only half the equation of whether there is a shortage. The other half is demand. Just as oil production fell in 2009, so did consumption, though not quite as much. But production and consumption are very closely correlated with supply keeping up with demand. There are, after all, no long lines at gas stations. In fact, as gasoline prices have risen, there are pretty much no lines at all at gas stations.

Are oil prices rocketing skyward because of unrest in the Middle East - Egypt, Libya, Syria, Bahrain, even some in Saudi Arabia? Partly, but the unrest does not account for nearly as much of the price increase as you might think. After all, supplies from the Middle East have remained almost entirely uninterrupted. Egypt's hardly burbled and Libya's disruption accounted for such a tiny proportion of world supply that its effect was marginal. IMO, the oil futures market, which is an aggregated risk assessor, has already discounted the possibility of future unrest regarding supply.

No, it seems the real reason oil prices have risen so much is because we, the American people, gave hundreds of billions of dollars to banks that then turned around and put our billions into investments in oil and other commodities funds rather than making loans to businesses. It all started with Ben Bernanke (no surprise):

This run-up in oil prices started with Fed Chairman Bernanke`s Jackson Hole speech where the big banks realized they were going to get a bunch more juice in the form of POMO operations by the Federal Reserve to play around in markets with.

And what did the large financial institutions do with this newly created juice? Instead of allocating the almost zero percent money they are all borrowing to productive activities such as lending loans to small businesses which will create jobs and stimulate the economy, the big banks have decided that since the fed is electronically printing money and providing extra liquidity/juice for financial markets that this is inflationary and devalues the dollar.

All Fed Juice Leads to Commodities

And just to make things worse, the big banks have decided to take their cheap capital they borrow at basically zero percent , and invest into commodities, i.e., agricultural futures like Wheat, Corn, and Soybeans, energy futures like Oil (NYSE:USO) and Gasoline (Fig. 2), and industrial and precious metals like Copper (NASDAQ:CU), Gold (NYSE:GLD) and Silver (NYSE:SLV).

Hence, inflationary pressure on those commodities resulted, which explains why food prices have risen along with oil prices. The rise in oil/commodity prices is being driven by investors and speculators (maybe not much of a diff).

What we have here is a 2008 redux. The Brent contract on the ICE exchange is being used to engineer prices up, as it is an unregulated exchange with no real transparency on position limits by the Big Banks. The Big Banks are also piling a bunch of money into commodity related ETF`s and mutual funds, which in turn have to buy exposure to the futures market in all these commodities. Add in the hedge funds, pension funds, money managers, and retail traders, and voila! you have these bubbles created which have no relation to the underlying fundamentals.

This situation is very much like the loose money policy of the Fed under Alan Greenspan regarding mortgage leveraging, and we know how that turned out.

Speculative bubbles always pop. The problem is that no one knows what the trigger will be or when it will come. But watch for signals from the Fed that its monetary policy might get tightened up some. The bubble might not pop, but it won't get bigger, either.

History is not encouraging - "PIIGs R Us"

News item: "Cables show China used debt holdings to press US"

Harvard history Professor Niall Ferguson says that history is not encouraging when it comes to the debt crisis: "Fiscal Fiscal Crises and Imperial ollapses: and Crises - Historical Perspectives on Current Predicament" (PDF slides, transcript here).

Specializing in economic history, Prof. Ferguson identifies the only six ways that nations can find their way out of debt crises, but he lines out the first three because only the UK accomplished them and only with the benefit of the industrial revolution, going on 200 years ago. Hence, there are really only three ways out today.

Presently, the US Congress is at no. 4, and that only very tentatively. The Fed has already been doing number 5, calling it quantitative easing, the second cycle of which will end in June. Since there is pretty much no chance of a "QE3" to follow, the fiscal pain of number 4 will increase after QE2 expires. And there is no way to ensure we don't get to step 6 to some degree no matter what we do.

As I said before, it's grimmer than you think. Related: Jeff Grundlach says that "The US Economy Is A Complete Horror."

You want to work forever?

One of the bennies of being under appointment in the UMC is that I get free financial consultation and planning through Ernst and Young, who are contracted by the UMC's General Board of Pensions and Health Benefits.

Recently I spoke with an E&Y advisor and told him I wanted to plan to retire at age 67 with at least $XX,000 per year of income from all sources. So they worked up an extensive plan and emailed it to me. Bottom line: if I want to retire at 67 with that income, I have to work until I am 80.

Just kidding. Actually, I am only slightly under glidepath. But tens of millions of Americans are far behind that. If you are still in your 30s or younger, understand one central fact: you cannot later ever make up years that you are not now using to build your retirement security. No matter how tight your budget is or what kind of lifestyle you are leading, if you are not putting at minimum between 5-10 percent of your gross income toward a retirement plan, you will almost certainly seriously regret it later. By the time you are in midlife, it needs to be 15 percent.

So read and heed, "Retiring Boomers Find 401(k) Plans Fall Short," because that could be you without proper stewardship of your resources.