WSJ: "So What Exactly Caused The Financial Crisis"

February 23,2010 "So What Exactly Caused The Financial Crisis" By David Wessel

Interesting Article in the Wall Street Journal 


The article implies that this crisis is apart of a natural cycle adding a calming effect to what has happened to our economy and what will happen in the near future. I am still not convinced that we should be calm. This sort of crisis happened in the 1930's and was only saved by a "freak occurrence"(WWII).

I see either mass deflation ahead of us or, if the government is lucky enough, another "freak occurrence".
...Im not sure either scenarios will be very pleasant.


Some Key Points:

** “It’s wrong to blame this crisis on subprime mortgage lending, he says. Rather, this crisis is best seen as the latest of a series of banking crises throughout history.”

** “Repo is money… But, like other privately created bank money, it is vulnerable to a shock, which may cause depositors to rationally withdraw en masse, an event which the banking system — in this case the shadow banking system — cannot withstand alone.” 

** “The fundamentals of subprime [mortgages] were not bad enough by themselves to have created trillions in losses globally.”

** “The crisis was not a one-time, unique, event. The problem is structural.”

** “There have been banking panics throughout U.S. history, with private bank notes, with demand deposits, and now with repo. The economy needs banks and banking. But bank liabilities have a vulnerability.”

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More on Fiat Currency -There's a lot you DO NOT UNDERSTAND

Some what of a follow up to my Japan articles on deflation and government debt:

I found this blogger, Joe Firestone, that explains rather thoroughly the myths and truths behind fiat currency.


Here’s the link to his Article : Myths, Scares, Lies, and Deadly Innocent Frauds: Part One




Some Key Points:


** “All the deadly innocent frauds (difs) are frauds in light of the changeover of the United States to a fiat money system during the Nixon Administration.”


 

** “Under a fiat monetary system, money is an accepted medium of exchange only because the government requires it for tax payments.” - Warren Mosler


** “The federal government has no more money at its disposal when the federal budget is in surplus, than when the budget is in deficit. Total federal expense is whatever the federal government chooses it to be.” - Warren Mosler




** “The government is no more able to spend money when there is a trust fund than when no such fund exists. The only financial constraints, under a fiat monetary system, are self imposed.” -Warren Mosler


** “Put simply the Government declares it (Fiat Currency) into existence, in whatever quantity it likes. (It has no boundaries)”

** “Since the Government has an unlimited authority to create its own currency, it is obviously false to say that it is or must be constrained in its spending by its ability either to tax or to borrow.”


** “The Government never can have any solvency problem”


** Why is Obama putting monetary restraints on stimulus? Does he not understand the power of our fiat currency? Does he not want to take on criticism from people who do not understand the power of our fiat currency? Is he being too cautious? Or is it just what is best for our economy?


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Japan's Economy Part II -Is Their Debt Really That Bad?

With the understanding that deflation is not necessarily a horrible force but a needed and natural force that keeps the economy in line, we can now move on to debunking the common view of government debt:

The Japanese economy is much like the United State's so, once again, I will refer to our economy instead of Japan’s to analyze the economic style. 

In the US economy the consumer strengthens the business which strengthens the government: 

*If consumers do not have money to spend, then businesses do not get paid; If businesses do not get paid, then they weaken; Weak businesses lead to a weak government. 

*If businesses become weak and do not have money to pay employees, then the consumer will no longer have money to spend; The consumer becomes weak and this leads to a weak government. 

*The strength of the government relies completely on the flow of cash between businesses and consumers. 

In our current (US) economy the consumer is weak, businesses are weak, and the government is weak. This weakness stems directly from debt (the result of past unaffordable purchases with credit). -Our economy has fallen into what seems to be an unbreakable cycle of debt because businesses and individuals do not have enough money to boost the economy. 

What if the government could boost the economy with their money though? Wait, I thought the government has hit a debt wall too. Where would they get the money from? Won’t the dollar default if the government lends too much?

The common belief that the US government risks defaulting on its currency as it lends out more money is a myth. This belief only held true when the US government used a fixed currency, like during The Great Depression when the run on banks occurred. At the time, currency was fixed and paper money was backed by gold. The run exposed banks that were lending out more paper representations of gold then actual gold stored in their reserves, resulting in many individuals losing money. That was under a FIXED CURRENCY though, a run on the banks is no longer a concern because the US now uses a fiat currency. This means that the amount of paper money in circulation is no longer limited to a fixed amount. 

The value of a single dollar, under fiat currency, does not correspond with a concrete substance -like fixed currency does. It corresponds directly with the perceived worth of the US economy divided by the total dollars in circulation. An economies perceived worth is how much the country’s services and products are worth to other countries, not the strength of their currency against other currencies (US economic value = US currency value = US perceived worth = how much other countries need the US). For example, a country is not going to stop paying for a service that the US provides best just because one hundred paper representatives of their currency equals a thousand paper representatives of ours. This means that the amount of dollar bills in circulation does not effect the value of US currency as a whole; in other words, the US can never default on its currency through debt to its economy because it can always just create more money. 

If the US government cannot default on its currency through debt, it can safely relieve the debts of our businesses and consumers by taking in debt. This can be done by reducing taxes. (The extra money saved from not paying the normal taxed amount can go towards paying off debt.) 

The cleansing of business and consumer debt will ultimately strengthen the economy. Obviously, this will exponentially raise government debt but as business and consumer debt diminishes the government will slowly move into good standing (government strength as a direct reflection of its businesses’ and consumers’ strength). The only “downside” to this would be mass deflation, which, as explained in part I, is actually not a “downside” at all, but a part of the natural flow of a healthy economy.

This is exactly what Japan’s government did and is still doing to fix its economy. It reduced tax intake so that its economy can strengthen. Now, the common belief is that Japan is living miserably but because they are moving away from unhealthy amounts of inflation they benefit from a lower crime rate and a lower unemployment rate then the US -among other things. 

Lower unemployment rate? ..Here’s a graph for you:

Now, the US criticizes Japan for its actions. Is that fair? What is really going on here? 

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Japan's Economy Part I -Is Deflation Really that Bad?

In the January 19, 2010, The Wall Street Journal Alison Tudor along with Kenneth McCallum ("Rating Agency Knocks Japan's Outlook") described how Standard & Poor’s warned Japan of a downgrade, unless “policy makers can reverse [the] deflationary spiral”. It reads that, “Investors began to raise questions about the sustainability of government debt”.

Uh.. Wait, What? Why are we knocking Japan? In my opinion, they are doing a better job with their economy then the US is with ours. 

So why do I think this? Well, contrary to common belief I do not think their deflation or debt is a problem at all. I also think their economy is a lot more natural then ours, and because of that, a lot healthier too.


First I will touch on deflation, then government debt will follow in the next post:

The Japanese economy is much like the United State's so I will refer to our economy instead of Japan’s to analyze the economic style. 

Why does deflation have to be bad? Everyone is always painting deflation as a bad, horrible, retched force -why? 

Deflation is natural. It is the natural force that follows inflation, this can be seen in any 10 year graph of the Dow Jones Industrial Average (the one represented below is from the wsj.com website). These fluctuations between inflation and deflation are commonly recognized as the business cycle.

The business cycle explains that the economy is always pushing itself towards a neutral, or beginning point. For the sake of this article, we will call this beginning point: point zero (zero).

The economy is the product of all past inflationary and deflationary changes:

Economy = (inflation - deflation)

So, with the natural (beginning) point of the economy being zero:

(Inflation - Deflation) = 0     or    0 - 0 = 0

In looking at the Dow Jones decade chart it can be seen that the market inflated upwards. Let’s say it inflated 5 points.

5 - 0 = 5

Here the economy inflated away from its natural point of zero -To remedy this, it deflated.

5 - 5 = 0     ...The business cycle did its job and equalized the economy. This is a very simple idea that is understood and counted on by many investors. 

But What About The Big Picture?

If we look at the Dow Jones Chart dating back to the 1900s (around its inception), we can see that from the 1900s to the 1930s the economy inflated and deflated many times but always ended up around the same point. This changed after the 1930s though when the economy began an upward trend.

After the Great Depression (around 1930) the government stepped up its control over the economy through various bills, acts, and boards. The goal was to keep another large depression from happening again and to keep the economy growing (inflating). The government found a way to manipulate the natural cycle of the economy so that it worked in their favor. They turned deflation into an always losing villain and inflation into the hero that always prevailed in the end (hence, our current view that deflation is bad). 

If we take a look at the economy equation again, with government manipulation now considered, we would find something like:

(80,000 - 0) = 80,000

For the economy to equalize itself it would have to deflate by 80,000, but the government suppresses this natural force. It is important to understand that as inflation grows to new heights, its deflationary counter force grows stronger. How long can the government keep a force that grows stronger the longer it is suppressed from breaking through and bringing the economy back to its natural state?

It seems to me that inflation is the power hungry villain here and deflation is the honest, dignified, man that might (will?) prevail in the end. 


The question needs to be asked, would you rather an economy that is higher then nature intended and backed by man made elements -therefore making it prone to failure? or would you rather an economy thats natural and backed by natural elements -therefore giving it a more solid base (less prone to failure)?


**The US is still manipulating their economy to inflate it every year, Japan is letting its economy fall back into an un-manipulated (natural) economy.  

..more on the government debt in my next post


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WSJ: "The Profit and Pain of Stimulus"

The article “The Profit and Pain of Stimulus” (The Wall Street Journal), by Tom Laureicella, explains the skepticism investors have “concerning how much of the market’s rebound was driven by improving fundamentals and how much by government stimulus.” -A topic I talked about back in September (A + B = Get Ready For Another Market Dip).

The article can be located in section C1 of the 01/25/10 issue. Here is the online link: The Profit and Pain of Stimulus

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Buy Low-Sell High Stock Pick 01/25/10

Based on company quality and low price, relative to its 52-week high, todays Buy Low-Sell High company to look at is Gilead Sciences, Inc. (NASDAQ: GILD).


Some information, courtesy of yahoo finance:


Description: 


Gilead Sciences, Inc., a biopharmaceutical company, engages in the discovery, development, and commercialization of therapeutics for the treatment of life-threatening infectious diseases. Its products include Truvada, Viread, Atripla, and Emtriva for the treatment of human immunodeficiency virus infection in adults; Hepsera, an oral formulation for the treatment of chronic hepatitis B; AmBisome, amphotericin B liposome injection to treat serious invasive fungal infections; Flolan, an injected medication for the long-term intravenous treatment of primary pulmonary hypertension and pulmonary hypertension; and Vistide, an antiviral medication for the treatment of cytomegalovirus retinitis in patients with acquired immunodeficiency syndrome (AIDS). The company also offers Tamiflu, an oral antiviral for the treatment and prevention of influenza A and B; Macugen, an intravitreal injection for the treatment of neovascular age-related macular degeneration; Letairis, an endothelin receptor antagonist for the treatment of pulmonary arterial hypertension in patients with WHO Class II or III symptoms; and Cicletanine, which is being evaluated for the treatment of pulmonary arterial hypertension. Gilead Sciences has operations in North America, Europe, and Australia. The company has research collaborations with Abbott Laboratories, Inc.; Novartis Institutes for BioMedical Research, Inc.; Novartis Vaccines and Diagnostics, Inc.; Genelabs Technologies, Inc.; Achillion Pharmaceuticals, Inc.; Japan Tobacco, Inc.; Parion Sciences, Inc.; LG Life Sciences, Ltd.; and University of Texas System. It also has commercial collaborations with Astellas Pharma, Inc.; Emory University; F. Hoffmann-La Roche, Ltd.; Pfizer, Inc.; Dainippon Sumitomo Pharma Co., Ltd.; OSI Pharmaceuticals, Inc.; GlaxoSmithKline, Inc.; Japan Tobacco, Inc.; and Bristol-Myers Squibb Company. The company was founded in 1987 and is headquartered in Foster City, California.




One Year Graph:

Some Stats:

01/25/10 Open: 46.15

52 Week Range: 40.62 - 53.28

6 Month Range:  42.55 - 49.81

3 Month Range: 42.55 - 47.49

P/E Ratio: 17.96

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I think it's time to reconsider my very first post on blogspot...

The debt problem is still present. Why has the economy been on the rise? is it just consumer faith pushing the market up? will we ever realize our debt?

I suggest reading the post again before considering your 2010 options...


http://anotheropinion-investing.blogspot.com/2009/09/b-get-ready-for-another-market-dip-how.html