Die Hard Illusions by Navin Doshi (August 11, 2009)

We are in an age of bubble markets. Bubbles create both a highly over-priced and also a deflated class of assets at the same time. These formations are not new; in fact, the boom and bust of the Panama Canal and the Rail-Road are great examples of such occurrences. In the past there was a long period of moderated asset prices between bubbles, but this is not so nowadays. We had two bubble formations back to back in a short period of 16 years, thanks to former Federal Reserve (Fed) chairman Alan Greenspan (Maestro Greenspan, the Black Swan, by N. Doshi). The technology bubble occurred from 1992 to 2000 while the commodities were going through deflation. During the housing bubble which between 2001 and 2007, almost all classes of assets were going up in price. The current Fed chairman, Ben Bernanke, is pumping money into the system that could help generate the third set of bubbles. Bubbles make most investors feel rich, but only for a short time. Once the bubble bursts, investors feel poorer. Bubbles are a form of illusion, far away from reality.

Our eastern traditions proclaim that our awakened state of mind is an illusion compared to the fourth (Turya, selfless and desire-less) state, just as the dream state is an illusion compared to the awakened state. However, even in an awakened state of mind, we cannot escape Einstein’s relativity due to our existence in nature—nature creates a multi-dimensional space bounded by pairs of opposites. Our existence, individually as well as socially, in this space is not static but changing. Not only do we move in this space, but so do the boundaries move. Currently the economic space is shrinking. Our response as people should be to correct this so that we move closer to the center to reach balance and harmony. This correction is not to overspend, but to save. However, our government’s response does not seem to be appropriate—in fact it keeps increasing the spending in matters of energy (Flawed and protectionist carbon cap & trade bill) and health care. The government gave away $4500 for each older car that was turned in to help the auto industry get on its feet, but in the process, billions of tax payers’ dollars will be spent. As I understand it, they have been junking these old cars instead of exporting them to countries in which they can be used. Those who are taking the advantage now will not buy another car in year 2010 or 2011. The implication here is that we have pushed the problem to next year or the year after.

Based upon centuries of human experience, we know that the free market does the job much more efficiently than the government bureaucrats. Even though we are letting the government do the job, we know that our problem is with leverage, extreme borrowing and spending. Even so, government experts believe they can overcome the problem by borrowing or printing trillions more. Vice President Joe Biden said on CNN, “We have to spend money to keep from going bankrupt”. As of now around the first week of August 2009, they have about $12 trillion committed to one form or another. Adjusted for inflation, that’s more than twice the entire amount of money spent during WWII. The government is fighting deflationary forces tooth and nail by more credit and consumption, rather than accepting a painful adjustment period (as it so happened in the early 1980’s). This process adapted by the government is putting the entire nation at a great risk. As the private sector continues to pay back debt, the government printing money may not result in immediate inflation. However, over a period of time, all these unnecessary bailouts are going to cause a massive inflation.

In Economics 101 we learn that prices are determined by supply and demand. What is not usually taught in schools, however, is that the “price” – i.e., the purchasing power – of money is also established by these same two economic determinants. Economists focus quite extensively on the supply of money, which is the total quantity of dollars in circulation. The demand for money, however, is largely ignored. The demand should grow close to one and a quarter percent per year, since that is the growth rate of the population in USA. However, John Williams (www.shadowstats.com) estimates that based upon M3, the broadest measure of money supply, we have is about $15 trillion in circulation. That comes out to be about $50,000 per every American assuming the country’s population is 300 million. The money in circulation 100 years ago was about 200 dollars for every American. The growth rate of money on average in the last 100 years has been about six percent per year. However, the growth rate of M1, the money supply reported by Fed that includes currency and bank deposits, in the last 12 months alone is estimated to be over 18 %. So where has that money gone?

A good portion of the TARP money is used to strengthen the banks’ balance sheet and lift up the stock market. It has not yet significantly trickled down to the lower levels. However, the insiders, meaning the high level officers and owners of corporations, are selling heavily booking profit. However some market experts preach not to fight the tape and the Fed, implying to be a trend follower, and remain invested in the market, as long as the Fed keeps interest rate low. I would argue to be invested in markets of your choice only if you are agile, patient with strong guts, and have deep pockets. Rationally, it is good to buy at the bottom, but in reality it is much more difficult to catch the lowest of the low.

Late in Friday’s session (August 7th), the Fed reported that consumer credit fell a whopping 10.3 billion dollars. That was far steeper than estimates. Revolving debt (mostly credit cards) fell over 5 billion dollars. This was the tenth month in a row that credit card debt fell (an all-time record string). The drop in consumer credit is not good for the economy, since the U.S. consumer is traditionally 70% of the economy. The implication here is that the recovery may not be self-sustaining; it could drop again double dipping like the “W”.

Navin Doshi (August 11, 2009)
(Mr. Doshi is a writer, trader and philanthropist.)

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