A real cliff of incompetence, excuses

As the stakes for our financial future ratchet higher, so do the rhetoric, political posturing and hypocrisy. And still the Federal Reserve and lax regulators escape blame.

By Bill_Fleckenstein Dec 7, 2012 3:01PM

Image: Dollar bills floating over U.S. Capitol © CorbisOK, everyone, buckle up. This is going to be a bumpy ride.

 

First off, I would like to turn to our eventual funding crisis. Yes, I have been talking about this for some time, and no, it hasn't started yet. But it will. One day the markets will take the printing press away from central bankers by spurning their bonds, and governments needing to get their debt funded will see rates rise dramatically.

 

Whether it will start here, in Japan or somewhere else I don't know, nor do I know when it will start. But I do know that the catalyst will most likely be the world losing its fear of a deflationary accident.

 

I decided to bring up the subject, thanks to the most recent letter from Hayman Capital -- that's the money-management firm run by Kyle Bass, who made millions betting against subprime loans. In it, he talked about the funding crisis, and I wanted to share his thoughts because they dovetail quite well with my own.

 

This Bass is not biting

In the letter, Bass summed up the financial predicament the world is in by saying, "We have a hard time understanding how the current situation ends any way other than a massive loss of wealth and purchasing power through default, inflation, or both."

 

He next quotes John Maynard Keynes on the subject of money printing: "'Thus, we might aim in practice at an increase in capital until it ceases to be scarce, so that the functionless investor will no longer receive a bonus.'" To that, Bass responds, "This is nothing more than a chilling prescription for the destruction of wealth through the dilution of capital by monetary authorities."

 

He continues, "It is both our primary fear and unfortunately our prediction that the quixotic path of spending and printing will continue ad infinitum until real cost-push inflation manifests itself. . . .Given the enormity of the existing government debt, it will not be possible to control the very inflation that the market is currently hoping for. As each 100 basis points in cost of capital costs the U.S. government over $150 billion, the U.S. simply cannot afford another (former Federal Reserve Chairman) Paul Volcker to raise rates and contain inflation once it begins . . .

 

"Our belief is that markets will eventually take these matters out of the hands of central bankers. These events will happen with such rapidity that policy makers won't be able to react fast enough. . . . A handful of investors and asset managers have recently discussed an emerging school of thought, which postulates that countries, as the sole manufacturers of their currency, can never become insolvent, and in this sense, governments are not dependent on credit markets to remain fiscally operational. It is precisely this line of thinking which will ultimately lead the sheep to slaughter."

 

Where there's a 'will,' there may not be a 'soon'

One thing I would like to point out is that while events will happen fast once they begin, this does not mean they will begin anytime soon. Look at what has transpired in Greece: It took quite some time to spin out of control, but once that occurred, events moved quickly. That will also be the case when the markets take the printing press away from the central bankers -- which does not mean that will happen shortly, though it could.

 

Bass also made an interesting point about the moves to the left by our government (ditto Europe), though he didn't quite set it up that way. Let me emphasize that I detest politics (and politicians), but from time to time it impacts economics, and thus becomes part of the financial equation and consequently must be analyzed. From that standpoint, I believe the country is in the process of making a strong economic move further to the left, and as such, is part of how I view the landscape.

 

Bass writes, "The current modus operandi by central banks and sovereign governments threatens to take us down Friedrich von Hayek's 'Road to Serfdom.' Published in 1944, its message, that all forms of socialism and economic planning lead inescapably to tyranny, might prove to have been prescient." (Research the book on Bing.)

 

"The genius in the book was the argument that serfdom would not be brought about by evil men like Stalin and Hitler, but by the cumulative effect of the wishes and actions of good men and women (emphasis added), each of whose interventions could be easily justified by immediate needs. We advocate social liberalism, but we also need to get there through fiscal responsibility (which is exactly how I feel). Pushing for inflation at this moment in time will wreak havoc on those countries whose cumulative debt stock represents multiples of central government tax revenue."

 

Unfortunately, we are pursuing the wrong policies, both fiscally and monetarily, which is a recipe for terrible stagflation, which is where I believe we are headed. That won't be good for financial assets, though certain stocks could do OK. But it is exactly that sort of environment that gold provides protection against.

 

Two-faced tax talk pays dividends

Turning now to the policy side, I have been particularly irritated lately by what I view as the disingenuousness of certain people regarding tax policy. To cite one example, last week the op-ed section of the Wall Street Journal noted Costco's (COST) board of directors announced that it would pay a special dividend in December (before higher tax rates kick in), and summed up the issue as follows:

 

"Here we have people at the very top of the top 1% who preach about tax fairness voting to write themselves a huge dividend check to avoid the Obama tax increase they claim it is a public service to impose on middle-class Americans who work for 30 years and finally make $250,000 for a brief window in time. If they had any shame, they'd send their entire windfall to the Treasury."

 

(On a related note, as long as we're talking about the supposed rich in America, I think that $250,000 of income is a non-sequitur. Granted people who make that much are doing pretty well, thank you, but that does not make them rich, especially if they live in an expensive city with bad public schools.)

 

Speaking of tax BRKs

Coincidentally, in a Nov. 30  Forbes article by Daniel Schuchman, the author does a little sleuthing to illuminate just how, shall we say, "evolved" Warren Buffett's thinking has become on taxes. Schuchman analyzes the recent op-ed Buffett wrote for The New York Times in which he derisively noted that, "Never did anyone mention taxes as a reason to forgo an investment opportunity," and "Only in Grover Norquist's imagination" do people modify their investment plans based on tax decisions.

 

However, that is certainly not what he thought when he was building his net worth. In a 1963 letter to his investment partners he wrote, "My net worth is the market value of holdings less the tax payable upon sale. The liability is just as real as the asset. . . . Investment decisions should be made based on the most probable compounding of after-tax net worth with minimum risk" (emphasis added).

 

It strikes me as a bit unfair that, now that he has all his money, he is less in favor of other folks having a chance to make some for themselves. In that same 1963 letter, he also wrote, "I am an outspoken advocate of paying large amounts of income taxes -- at low rates." Obviously, his philosophy has changed.

 

'Do not imagine, comrades, that leadership is a pleasure'

The point I am trying to make is about inconsistency of telling folks to do one thing while doing something else yourself. It reminds me of my favorite line in George Orwell's "Animal Farm" on the propensity of certain people in power to think that their views are so good for society as a whole (even if their policies are detrimental to many) that they themselves should be exempt from them, i.e., "Some animals are more equal than others."

 

This is not to say there has not been a huge disparity in wealth creation, as the folks that are rich have gained to the disadvantage of the middle class and the poor. That is all true, but it wasn't as though people who made lots of money created the conditions to prosper at the expense of others. That was caused by the gross policy errors of the Federal Reserve.

 

Granted, many banksters in the world of Wall Street effectively broke laws in what they got away with running their financial institutions (and should have gone to jail). But that is no reason to set up a policy that might disadvantage the country as a whole. There is no point in punishing those with money or trying to earn money just because the Fed was incompetent and eviscerated the middle class.

 

To be clear, this rant is not about higher taxes, but rather about their politicization (which borders on class warfare). The maddening part of all the tax-rate posturing is that higher taxes by themselves are not going to solve the financial mess the U.S. finds itself in. They could be part of a solid, comprehensive plan, but that is not what any of this is about.

 

The public at large has been hurt not by the current tax regime but by a grossly incompetent Fed and government regulators who didn't do their jobs. While folks with a lot of money can afford to pay more (and will), it would certainly serve the country better if we could intelligently discuss the real roots of the problems and stop all the demagoguery.

 

103Comments
Dec 9, 2012 12:57PM
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This should be re-titled: "WHAT RICH PEOPLE SAY".
Dec 9, 2012 12:46PM
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Back in 1963 federal income tax rates were drastically higher on the rich - 91% to be exact so naturally, THAT would make a difference when investments are sold.  Today, not so much.
Dec 9, 2012 12:00PM
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Add criminal to incompetent. New revolution needed. Oust all the crooks/lawyers  lining their pockets with common sense individuals like 1776 ideaology. We can't afford to be world cops, NATO, UN,  allow outsourcing by US companies, or allowing foreign bank accounts by US citizens and US companies. Can't spend or borrow more than you make. Couldn't be any simplier than that. Contrary to the unemployment numbers, housing data, stock market data, CPI, and all the other hyperbol we have been in recession since 2000. Numbers can be manipulated to keep the biggest ponzi scheme we call these UNITED STATES going.
Dec 9, 2012 11:47AM
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 Libya, Syria, and Greece are,   examples of what could happen. When the wealth is not distributed in a fair way, while expecting all to wok for the good of all. Egypt, Italy, and even North Korea, is other examples.  All these countries have a disparity,  of wealth concentrated at the top percent of the people. The younger parts of the population, lives from hand to mouth with no other recourse in most cases. This is a disaster waiting to happen! The USA has many opportunities for people to build good lives for themselves, but when corruption wipes out everything they worked for for many years, it leaves these people facing years of hardship, trying to recover. Some or most will not have enough time in their working lives to get back to what they had before the great robbery took place. We will not have to wait very long to see the results of these events! We are already seeing some of them now! I wont go on and on about this, but I would not be surprised if one day someone in a life threatening situation, were to cry out for help, and someone passing by would laugh,   and yell out "**** you help yourself !"  
Dec 9, 2012 8:12AM
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Welcome to Obamaville where being the leader means you don't have to be.
Dec 9, 2012 2:34AM
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All of this would never have happened and can only be corrected if people in influence and power understand the true role of government [I doubt if even Bill knows that one]and see that only that role is done, while at the same time, government is allowed to have its own economy and not one that is completely controlled by the private sector and their lobbyists. 
Dec 9, 2012 2:31AM
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Great article Bill with excellent cross references for 'food-for-thought'.  I am not looking forward to the spending and printing presses the next 4 years!  The phrase of 'We are from the government and we want to help' makes for economic chaos!  How is everyone's survival plan?
Dec 9, 2012 2:23AM
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Another good article. If the cliff gets higher then the fall will be further with more damage. Get shoved off, fall off or kick it down the road until only the rich & poor are left to pay taxes. 1.7% cost of living raise for seniors proves the schools need schooling & politicians need to go back school on inflation costs in the real world. The cost of living raises for teachers & politicians should be the same as what seniors get in a country with justice for all.
Dec 9, 2012 1:48AM
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The bottom line is if the Romneys of the world [ceo`s} didnt steal all of the money and pay workers the lowest wage they can and still get people to work for them we wouldnt be in this mess!! Nobody needs all that money!! Thats the problem..too much money in the hands of too few people!! Yeah break all the unions so you can get us to work for wages like Chinese!!
Dec 9, 2012 1:08AM
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going over the fiscal cliff is the best option!
Dec 9, 2012 12:10AM
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Hi,

Mr. Fleckenstein, you’re very good at identifying investments to bet against, that’s because you’re that A one typical voice of the contrarian. But to be honest with you you’re not an economist nor do you have a good grasp of government and government economics. You have been behind the 8 ball in everything you have said regarding the great recession and again you’re behind the 8 ball on your bets against the government. Right now the government spending and debt reminds me of the late 80's and early 90's where every voice of the contrarian was spitting out their views and or beliefs that the world’s financial system was going to collapse that the United States was headed for the fiscal cliff with no option in sight. Low and behold President Clinton turned the whole ship around. President Obama is not a President Clinton but he is turning the whole ship around, he might not be the President that see's the day of government surpluses but its President Obama and his team that are the ones that will have made it happen.

Very few things do you say do I agree with, your ideas of returning to the gold standard is completely impossible, we do not have enough gold on the planet to back all the currency in circulation, this at minimum would drive the price of gold, a mostly worthless substance to the point that governments would be the only owners of gold, that governments would have to seize all the gold to guarantee currency. It never ceases to amaze me how we think gold is so valuable because someone a long time ago told us that it was, ie aliens or whomever, what better way to keep us, dumb humans from taking for the real valuable materials, all you have to do is tell us that the heavy worthless shinny material is extremely valuable. duh. In approximately 6,000 years of trying we still haven’t found anything to do with gold other then make jewelry which isn’t a necessity it’s a luxury and really isn’t very valuable. Not to mention investing in gold is a joke between the buyers and sellers premiums and the return per investment dollar it’s a big loss for the investor unless you plan on sitting on it for a decade or more.

What it is, is your a spokesmen for big investors and get a cut of their profits if you market their hype nothing more nothing less.

But enough of that I do agree with your views on taxing the top 2%, that the bottom 1.9% of the top 2% cannot really afford it. Or maybe you read my views of taxing the top 2% and agree with me.

 

Dec 8, 2012 11:49PM
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We know the problem,  slow inflation eating people.  It has been going on for over 100 years.

 

No wonder old folks are poor, they worked for a $ a day and inflation ate money up  faster than they could save it. Granddaughter makes more in a day than I use to make in a month.

 

That's slow inflation in action. 

Wait till you see hyper inflation, look at Germany after WW1 and WW2.

 

Keep printing paper and it will come.  May already be here??

Dec 8, 2012 11:02PM
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I believe that Rick Santelli - who is awesome on CNBC, check him out sometime - believes we should return to the gold standard.  Now, I believe that we need something to constrain the number of dollars in circulation.  Hell, use silver for all I care so that there is an upper bound.
Dec 8, 2012 10:52PM
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The federal Government could pay everyone, who is unemployed six hundred dollars per week tax free for two years! Then take 28% from the top, and give that to the states each week, not to be paid back! to help them pay their budget deficits, and to hire city and state workers! This will stabilize all the states, and it would stimulate the economy, while generating more tax revenues! Allow these people to work, while collecting this money, but pay taxes on any money they earn while working! This will stimulate business, and create more demand for manufacturing; while generating more taxes! The taxes the country, would take in with so much demand in the markets would generate money to pay off the budget deficit. This would be a perfect time to cut waste and reduce federal spending with the majority of the country receiving the money they need to live and pay their bills. this might sound a little crazy, but If you think about it, it would save on food stamps and other monies the government and states would not have to pay, like unemployment, food stamps, housing subsidies, and it would keep crime down saving money in less court cases, and housing criminals etc. It would pump billions of dollars into the markets each week for two years. This plan would more than pay for itself, while helping to rebuild the lower wage earners, and people who have lost everything in this recession! It would also leave all the states in A really stabile condition, as the wars wind down, and the people returning to their families, who have fought in these wars start to look for work, they should at this point have a much better chance to find work! This plan could solve a lot of problems the country is facing.

Everyone would benefit by this ! They could also give these people new cars, and smaller size trucks that they would be required to pay one hundred dollars per month, for two years, to own them,saving the government, some of the cost ! This would save them money at the pump, reduce carbon, save them money in repairs, and upkeep; It would boost manufacturing, the tire companies would make millions of tires, the monthly service would help small and big business, and the cities would also benefit selling tags-and the insurance companies would get a boost, this would be a good way to restart this economy! It would raise the money to pay off the budget deficit and it would more than pay for itself! show me where it would not work!

Dec 8, 2012 10:18PM
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I don't always, matter of fact usually don't, agree with the guys on MSN Money but this one is spot on from where I stand.
Dec 7, 2012 10:22PM
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   Fleckenstein reveals himself to be a total ignoramus- he does not understand macroeconomics, debt dynamics, or Modern Monetary Theory, except insofar as he vaguely is aware of the fact that sovereign currency issuers cannot go bankrupt (unless, of course, they WANT to). As for the Funding Crisis, that is like waiting for Godot- as even he admits- but he does not know why. The only ways that a funding crisis is possible under a sovereign fiat money system are: 1) if foreigners will no longer accept payment in your sovereign currency for NEW debts (they are contractually obligated to accept such payment for existing debts); or 2) if aggregate effective demand chronically exceeds aggregate supply at full employment. Since neither of those conditions are likely to be met under any reasonable assumptions, we can only conclude that Fleckenstein is a sort of headless Chicken Little, hysterically warning about purely fanciful things (the sky is falling), whilst ignoring the real crises afflicting the system today, as well as those looming on the horizon. Anybody who really knows how money is created and destroyed in the modern economy knows that under capitalism, the probability of a "deflationary accident" (debt deflation) greatly exceeds the probability of a Weimar/ Zimbabwe style hyperinflation. Actually, by adopting MMT (Modern Monetary Theory), there would be no chance of either outcome if we proved to be willing to levy the possibly confiscatory tax rates that might be necessary if we ever were to reach "overfull" employment.
Dec 7, 2012 9:34PM
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Bill Fleckenstein "gets it".  Great article Bill!

Dec 7, 2012 9:02PM
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The federal Government could pay everyone, who is unemployed six hundred dollars per week tax free for two years! Then take 28% from the top, and give that to the states each week, not to be paid back! to help them pay their budget deficits, and to hire city and state workers! This will stabilize all the states, and it would stimulate the economy, while generating more tax revenues! Allow these people to work, while collecting this money, but pay taxes on any money they earn while working! This will stimulate business, and create more demand for manufacturing; while generating more taxes! The taxes the country, would take in with so much demand in the markets would generate money to pay off the budget deficit. This would be a perfect time to cut waste and reduce federal spending with the majority of the country receiving the money they need to live and pay their bills. this might sound a little crazy, but If you think about it, it would save on food stamps and other monies the government and states would not have to pay, like unemployment, food stamps, housing subsidies, and it would keep crime down saving money in less court cases, and housing criminals etc. It would pump billions of dollars into the markets each week for two years. This plan would more than pay for itself, while helping to rebuild the lower wage earners, and people who have lost everything in this recession! It would also leave all the states in A really stabile condition, as the wars wind down, and the people returning to their families, who have fought in these wars start to look for work, they should at this point have a much better chance to find work! This plan could solve a lot of problems the country is facing.

Everyone would benefit by this ! They could also give these people new cars, and smaller size trucks that they would be required to pay one hundred dollars per month, for two years, to own teh cars or trucks, saving the government, some of the cost ! This would save them money at the pump, reduce carbon, save them money in repairs, and upkeep; It would boost manufacturing, the tire companies would make millions of tires, the monthly service would help small and big business, and the cities would also benefit selling tags-and the insurance companies would get a boost, this would be a good way to restart this economy!

Dec 7, 2012 8:40PM
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If you dig a hole so deep that you cannot get out of........ Stop digging.
Dec 7, 2012 8:37PM
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Welcome back to the 17th century. All the horses they are complaining about here in Northern Nev
had best be coddled and fed by the complainers, because they will need them to get from place to place sooner than they think!!! The Serferdude!!

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ABOUT BILL FLECKENSTEIN

Image: Bill Fleckenstein, MSN money

This column is a synopsis of Bill Fleckenstein's daily column on his website, FleckensteinCapital.com, which he's been writing on the Internet since 1996. Click here to find Fleckenstein's most recent articles.

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