Inflate Or Financial Tsunami
Jay Taylor
Bill Gross Calls On Ben’s Helicopters
To Avoid A “Financial Tsunami”
On Thursday, September 4, Bill Gross wrote at http://www.pimco.com/Default.htm that the U.S. government needs to start using more of its money to support markets to stem a burgeoning “financial tsunami.” That is some kind of language coming from such an establishment person as PIMCO’s top guy. PIMCO is, after all, the world’s biggest bond fund.
Gross noted that banks, securities firms, and hedge funds are dumping assets, driving down prices of bonds, real estate, stocks, and commodities. He said, “Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami.” Then he said, “If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.”
Gross was employing his Keynesian economics here when he said that the government needs to replace private investors who either don’t have the money to buy new assets or have been burned by losses. As I recall, Gross talked about jumping into the Fannie Mae and Freddie Mac paper recently after U.S. Treasury Secretary Henry Paulson arranged a rescue package for those two government-sponsored institutions that together hold over 50% of mortgages in the U.S. Paulson arranged that bailout package as concern escalated that the government chartered companies didn’t have capital to withstand the housing slump. Treasury pledged to pump unlimited debt or equity into the companies should they need it.
Gross took advantage of that fascist economic move by Paulson to enrich his firm by buying Freddie and Fannie paper after he knew losses would be socialized at the expense of average Americans. But now he apparently sees that even that massive pledge won’t stop the deflationary implosion that is starting to grow ever more powerful. In his latest essay he said, “There is an increasing reluctance on the part of the private market to risk any more of its own capital,” Gross said. “Liquidity is drying up; risk appetites are anorexic; asset prices, despite a temporarily resurgent stock market, are mainly going down; now even oil and commodity prices are drowning.” So now Gross is calling not only for this massive and unprecedented bailout of Freddie and Fannie but also for a bailout of “Mom and Pop on Main Street U.S.A.,” by subsidizing rates on home loans guaranteed by the Federal Housing Administration and other government institutions.
Of course, underlying this debacle is the massive housing fiasco created by Alan Greenspan’s exceedingly easy monetary policies. Because home prices were so artificially high, we are now seeing a decline in home prices that has not been seen since the Great Depression. In June, home prices fell 15.9% from a year earlier in 20 of the largest U.S. metropolitan areas. And as Gross noted, that drop translates into an even bigger decline in overall wealth as the effects ripple through markets.
In other words, our economy is in deep, deep trouble. The $64 trillion question is, Will Bernanke fire up his helicopter to bail out the U.S. economy? Or a question my good friend and deflationist Ian Gordon would raise is, “Can Bernanke keep us from heading into a deflationary depression, given the massive amount of debt the U.S. economy is saddled with?”
I can’t help remembering Bob Hoye’s constant refrain that when the global economy runs into trouble, the senior currency gets stronger. Why so? Bob reasons that debt is really a “dollar short” position. When the debt has to be repaid, everyone scrambles to sell assets and buy dollars to answer the call of margin clerks. We would add to that factor the notion that America’s creditors would be mad as hell if the trillions of U.S. dollars we gave them in exchange for real goods turned toward their real intrinsic value of zero.
So what we are faced with is a huge tug of war between the enormous forces of deflation on the one hand and Keynesian economics, or demand side economics, on the other. Were the U.S. not such a net debtor nation, it could more easily stimulate the economy with deficit spending. But with foreigners holding so many dollars, the U.S., which is already hated for our geopolitical posture by several important creditor nations, would find itself even more at odds with other growing powers on the world stage. Which way will the scales tip? We don’t know. But for now, as our IDW illustrates, we are heading toward a deflationary implosion. As such we are going to make some portfolio suggestions following our IDW update.
September 6, 2008
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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