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.
OK, 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.
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
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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As the devil-may-care bravado of Wall Street marches on, history warns that -- in the end -- there will be the devil to pay.
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