Americanly Yours

My friend, Jim Davidson sent me this chart yesterday.

Ok, clearly the chart above indicates that something unprecedented and drastic has been happening in our banking system for the past two years.  But you are likely asking “what does this mean?”

The United States’ banking system is a fractional reserve system, meaning that banks are not required to hold 100% of the money deposited.  Currently, the reserve requirement (the percentage of deposits that banks are required to maintain) is 10% for checking accounts.  Thus, if you were to deposit $100 of your money into a checking account, the bank would legally be required to keep $10 and could lend out $90 to those borrowing money from the bank.  Any amount they kept on hand above $10 would be considered “excess reserves.”

For those interested, the data used to make the above graph can be found here.  A quick glance at either the data or the graph shows that for most of the past 50 years, banks have maintained reserves at levels very close to the levels mandated by the Federal Reserve.  On August 1st, 2008, banks maintained excess reserves of $1.875 billion.  One month later, excess reserves shot up to $59.482 billion.  On October 1st, excess reserves equaled $267.159 billion, reaching $558.821 billion on November 1st, and $767.332 billion on December 1st.  On April 1st, 2010 (the last date for which data is available), excess reserves totaled just over $1.05 TRILLION, or around 1000 times higher than they were 20 months earlier!

You are likely still asking what all this means.

Well…

What this means is that banks are keeping reserves on hand above and beyond the ratios required by the Federal Reserve.  Banks are likely doing this for several reasons:

1)  The banks know that many of they loans they initiated over the past several years are likely to default.  These loans were purchased by these banks using the cheap credit made available by increases in the money supply and low interest rates.  Thus, banks are keeping the “excess” capital on hand so that they can pay the interest on the money that they borrowed to make these faulty loans–even if there is a large number of loan defaults.

2)  This ties in with the reason above, but these banks are worried about the consequences of asking for another large bailout from American taxpayers.  The government bailed out these banks a year and a half ago, despite widespread public opposition and used the rationale that doing so would save the economy.  However, since this bailout, the economy has only worsened.  The banks know that it is unlikely that the American people would be as willing to allow their government to hand rich bankers taxpayer money again.

OK, so the banks arent lending right now, but what does this mean?

There is another major reason why the banks arent lending: we are in the midst of a pretty serious recession.  No one knows how long it will last, and my guess is that no one really knows just how bad it is right now.  With the exception of the Austrian Economists, not too many economists out there even say this crisis coming–much less lasting this long.

With so many people unemployed, so many businesses failing, and so few businesses expanding (or new businesses being opened), there just isnt a massive demand for loans.  This gives banks another reason to continue to hold “excess” reserves.

But, the economy is slowly starting to pick up.  As this happens, banks will begin to loan out more money and will eventually start to lower their reserves until they reach levels of excess reserves near the historical rate (in other words, near zero).  In fact, it is already happening:  On February 1st, excess reserves were $1.162 trillion, on March 1st, excess reserves were $1.120 trillion, and on April 1st, excess reserves were $1.05 trillion.  In other words, banks decreased their excess reserves by about 9.6% between February 1st and March 1st.

As the economy recovers and banks make additional loans, this will increase the supply of money in the economy.  An artificial increase in the supply of money is, simply put, not good.  When there is more money in the economy chasing after similar amounts of goods and services, the result can be nothing else but an increase in prices (relative to what prices would have been without the increase in the money supply).

The effects of the increases in lending brought about by an economic recovery will increase the money supply by much much more than $1 trillion.  As mentioned above, under our fractional reserve system, banks are only required to hold 10% of checking deposits and are able to lend out the remaining 90% to borrowers.  However, the process doesnt stop there:  if you deposit $100, the bank holds $10 and loans out $90 to someone else.  When that person deposits their money in a checking account, their bank is then able to loan out $81 while only holding $9, and so on.  As this process continues, banks effectively create (out of thin air) over 9 times the money that is held in their vaults and your $100 becomes nearly $1000 in the economy:

Thus measure of money supply is known as the M2 money supply.  Thus, if banks return to their historical activities and maintain reserves at a level just above the reserve requirement rate, the result could be an increase in the M2 money supply of around $10 trillion.  Currently, the total M2 money supply is just over $8.4 trillion, thus if banks start to lend out their excess reserves, the M2 money supply will more than double.

The implications of this are quite sobering.  If the economy does not improve and continues to muddle along, things will be bad.  Unemployment will remain high or possibly even creep higher, the stock market will continue to drop, people will continue to suffer and so on.

However, if the economy shows marked improvement and begins to accelerate, things will be much worse.  At first, this might seem counter intuitive, but we must remember to take the above information into account.  When the economy improves, banks will start to lend out their “excess” reserves.  Because of the fractional reserve nature of the United States’ banking system, each dollar that banks hold in excess reserves has the potential to become nearly $10 when loaned out.

At first, this will make it look like the economy is growing at a very fast rate.  After all, the newly created money is being spent by lenders to purchase things that werent being purchased before.  The increased demand for these goods raises their prices (and initially the profits of the businesses selling these goods).  This may result in a rise in wages for the employees in that sector of the economy.  However, when monetary inflation occurs at a rate as high as the rates we are likely to see, this phenomena spreads throughout the whole economy.  Thus, prices and wages will generally rise throughout the economy.

Anyone who thinks that this is a good thing is fundamentally wrong.  We often are presented with the argument that increasing the money supply increases incomes and is necessary because without such increases “there wouldnt be enough money to go around.”  As economist Tom Woods wrote in his best selling book, Meltdown, “It is to misconceive the nature and purpose of money completely to think its supply needs to expand in order to allow more transactions to take place.”  In fact, in a system with a stable money supply, “prices fall over time and the value of money rises.”  The reason for this is that “as output increases, the monetary unit simply gains in purchasing power.”

Monetary inflation (and the resulting price inflation) does not mean greater standards of living–the opposite is true.  What monetary inflation does do is destabilize the economy, increase the inequality of wealth distribution, and make society less better off than it would be under a stable monetary system.

Just ask the citizens of Zimbabwe if the massive increase in their nation’s money supply have made them better off.  In 1980, each Zimbabwe dollar was worth $1.59.  After 30 years of constantly increasing the money supply, their economy is in shambles, and their money is worth less than the paper it is printed on.   “In March 2007 Zimbabwe’s inflation rate passed 50% a month, a good threshold for defining “hyperinflation” and equal to 12,875% a year. Since then, it’s gotten much worse.” In late 2008, their price inflation rate reached the incomprehensible rate of “80 billion percent a month. That means around 6.5 quindecillion novemdecillion percent a year–or 65 followed by 107 zeros. To get a handle on it, realize that it’s equivalent to inflation of 98% a day. Prices double every 24.7 hours.”

Well then, if the argument that printing new money makes everyone in the economy better off has even a slight grain of truth in it, then Zimbabwe must be among the richest country in the world!  After all, Zimbabwe is following the economic philosophy of the “brilliant” John Maynard Keynes and his disciples who have argued that increases in the money supply bring about prosperity by accelerating spending.  Everyone knows that this is not the case, however.  Zimbabwe is among the poorest nations in the entire world and recorded a 94% unemployment rate last January.

Does this same fate await America?  Lets just say that something like this is possible.  The Federal Reserve has been printing money for too long and has accelerated these practices in recent years and months.  With a low reserve rate of only 10%, the Federal Reserve is just asking for trouble; when the economy recovers, things have the potential to spiral out of control quickly and result in a massive and destructive hyperinflation.

Yes, this can be slowed or even stopped.  But, before you get your hopes up, ask yourself  if the US government has ever learned from its mistakes or the mistakes of others.

Americanly Yours,

Phred Barnet

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How exactly did we get to the point where government owned banks started charging credit card holders fees for paying off their balances every month?

The government passed laws like the Community Reinvestment Act which essentially mandated banks to loan to people who would not have been able to obtain loans otherwise.  Then, the government and the Federal Reserve created money out of thin air and lent it to banks at absurdly low rates.  Flush with new and cheap money, these banks massively increased their lending to “sub-prime” borrowers (begin bubble).  With the money supply growing at unprecedented rates in the 1990’s and this decade, there was always enough money for banks to make loans.  Borrowers were able to take out second mortgages at very low rates.  Home builders rapidly built houses to meet soaring (bubble-induced) demand.

As with all bubbles, this one burst, leaving home builders unable to sell newly built houses and borrowers unable to meet their obligations.  Banks had sold off the rights to their lender’s payments so they would have more money to make new loans.  This left the banks in the same boat as homeowners who could not make their payments.  But, while homeowners and home builders had to file for bankruptcy and sell off their assets to pay their debts, the banks used their lobbyists, fear, and their ownership of the Federal Reserve to convince our government to bal them out.

The government and the Federal Reserve then printed up a bunch of money–they simply created it out of thin air–and gave it to the banks in exchange for ownership.

This happened on October 3rd, 2008.  I can understand the government’s perverse rationale that led it to bail out these banks.  What I can not understand is why, over a year later, the government continues to own large stakes in these banks.

The government has now taken to regulating the salaries of banking officials, as well as the actions and practices of these banks.

So, it comes as no surprise to the observant that the government would use its power and control to create perverse incentives.

Bank of America and Citigroup–two firms now under the ownership of the federal government have begun implementing new fees.  These fees are not on late payments, gong over one’s credit limit, or cash advances.  Instead, these government owned banks have announced fees for customers who regularly pay off their balances.  Customers who leave monthly balances on their cards will not be charged the fees.

A fee is similar to a tax (especially if t is levied by a government owned entity).  Both taxes and fees use pricing to create incentives to change behavior.

Because Bank of America and Citigroup are owned by the government, a fee on those who pay off their balances regularly can be viewed as a tax on them.  Because those who leave monthly balances on their cards are exempt from these fees, this can be viewed as a subsidy for those who leave balances.

Our government is creating perverse and dangerous incentives: they are incentivizing debt and discouraging good and proper financial habits.

But, you cant hardly be surprised by this.  After all:  our perverse government’s perverse actions do tend to lead to perverse incentives.

Americanly Yours,

Phred Barnet

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Im sure that everyone has heard about the “Cash for Clunkers” program.  This is another one of those government programs that sounds like a good idea until you really think it through.

In an effort to both stimulate the economy and aid the environment, Congress and the Obama Administration enacted a $1,000,000,000 [$1 billion] which allowed people to trade in old cars with low gas mileage and receive a discount of up to $4,500 on new cars with high gas mileage.

Because protecting the environment was one of the goals of this program (and to protect against fraud), dealers were required to pour a solution into the engine of the car that was traded in which permanently disables the car.  The car is permanently taken off the road and is recycled.

Sounds good, right?  Not quite.

Who buys new cars?  People with money, of course.  The rest of the driving population buys their cars used from people who feel the need to buy a new car every few years.  By disabling used cars, the government is permanently removing their supply from the market.  Doing so prevents lower and middle class Americans from buying that vehicle, and has the net effect of raising the prices for used cars.

Someone who is still driving the 1995 Cadillac DeVille that they bought from their neighbor 7 years ago probably isnt very likely to go out and buy a 2010 Honda Accord, even under this program.  But, they would be much more likely to purchase the 2003 model DeVille that their neighbor bought after selling the 1995 DeVille 7 years ago.

But, rather than allowing the market to work in this fashion, the “Cash for Clunkers” program removes the 2003 DeVille–a perfectly good car–from the market and makes it tougher for the person still driving the 1995 DeVille to find a used car that fits his budget.

My personal opinion was that one of the reasons that this bill was passed was to protect the United States’ “investments” in [read:  theft of] General Motors and Chrysler.  It is clear to all that Congress and the Administration intended for this program to stimulate the economy and help the environment.  But I also believe that the government wanted to use this program to inflate the revenues at GM and Chrysler to make the American people less uneasy about the bailouts of those firms.  Think about it.  If you had just made a hugely unpopular move like taking over two iconic American automakers, you would do anything possible to convince the public that it was a good decision.  This includes funneling money to those companies to make their revenues look good.

My guess is that this program will actually hurt GM and Chrysler as compared to their competitors, namely Ford.  Why?  Well for one, a new Rasmussen poll found that 66% of Americans have at least “a somewhat favorable opinion of Ford.”  The same poll found that “General Motors is viewed favorably by 38%… and unfavorably by 56%”  It also found that 34% have at least somewhat favorable opinion of Chrysler “while 55% see the company unfavorably.”  The American people are angry at the other two companies for taking taxpayer funds, and Ford is now perceived as the only American automaker that isnt owned by the government.

They also make much better cars now than they used to.  I love my 2007 Ford Fusion.

In another poll that was published on the same day, Rasmussen also found that 46%of Americans are more likely to buy a Ford because they did not take a government bailout (13% said they were less likely and 37% said it didnt make a difference).  41% OF Americans also believe that quality of GM’s cars will get worse now that the government owns the company, while only 19% think it will get better.

[Investors like me know this.  For the sake of disclosure now that the FTC has announced that it is going after bloggers, I am a proud stockholder of Ford Motor Company and have seen the stock rise by about 18% in the last week.  Still, I am 100% opposed to this program.]

Additionally, the government’s intention was to get people to purchase cars with much better fuel efficiency and the new Ford Fusion Hybrid gets 41 MPG and was rated higher than the Toyota Camry Hybrid, making it an attractive choice for anyone who decides to trade in their clunker.

If the intention was to increase the revenues at GM and Chrysler, this program will backfire, as do most government programs.  My prediction is that the market shares of Ford, Toyota, Honda, Hyundai, and Kia will rise at the expense of GM and Chrysler.

This program also raises further questions about the competency of the government.  Love or hate this program, it was administered poorly.  No, this doesnt “prove that government cant run our health care system.”  It should, however raise at least some concern about the capability of government to administer programs.  It should also serve as a warning that when the government offers people a massive discount to use a service, people will take advantage of it (people respond to incentives).  The government and taxpayers should at least use the example of this program to think about what the effects of what will be perceived by many to be free health care will have on an already strained system.

This program should remind us to be weary of government estimates.  The $1,000,000,000 [$1 billion] allotted for this program was expected to last at least until the program’s anticipated end date of November 1st.  Instead of lasting for 4 months as estimated, it lasted less than one month before it exhausted its funding.  If the government was this wrong–way wrong–on estimates for its costs of giving out coupons for discounts on cars, can you imagine how far off could its estimates of the costs of administering a $1,000,000,000,000 [$1 trillion] “free” health care program be?

Its worth thinking about.

Americanly Yours,

Phred Barnet

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General Motors declared bankruptcy yesterday morning. This move had been much anticipated and probably didnt surprise anyone.

Presidents Bush and Obama gave General Motors billions of dollars to help it avoid bankruptcy, yet the inevitable still happened. No matter what your stance on bailouts and government interventions are, you probably agree that this money was wasted.  If you support bailouts and nationalizations, then you would probably argue that the money was wasted because the government could have and should have) bailed out and taken over GM six months ago.  If you are opposed to bailouts and nationalizations, then you would be opposed to any and all government assistance for GM.  More money will be wasted on GM in the future.

According to the Washington Post:  “During the GM bankruptcy, the United States aims to raise its investment in the company to $50 billion, take a majority stake in it and name most of its directors, giving the government unprecedented control over one of the nation’s largest manufacturers.”

I dont think that you can seriously deny that the United States is no longer a Capitalist Nation.  We have now officially morphed into a socialist country.  Yesterday was another sad day for Capitalists who again were forced to watch while the government continued to destroy this once great Nation.

President Obama and other supporters of these interventions have promised that they will be temporary.  I dont believe this and neither should you.  Thomas Sowell says that “nothing is so permanent as a temporary government program.”  Historically this has proven again and again to be true.  There are still programs in effect from the Great Depression which were said to be temporary at the time.  A 3% excise tax on phone use was enacted as a temporary measure in 1898 to help pay for the Spanish-American War.  This “temporary” tax lasted 108 years until it was finally ended in 2006.

Government programs, actions, and interventions tend not to end.  It is important to oppose them as they happen, while these actions are still fresh in the minds of the public.  If the government does not sell its stake in General Motors within the next few years the vast majority of people will cease to care, opposition will subside, and the government will continue to control General Motors forever (or at least for quite a long time).

Even if our government sells its stake in General Motors within the next few years, there will still be a tendency for future administrations to use Presidents Bush and Obama’s actions as precedents for future interventions and nationalizations.

President Obama told NBC’s Brian Williams that the government would be taking a controlling stake in General Motors. He also said that he essentially had no choice but to do so.

But, President Obama did have a choice.  A liquidation bankruptcy of GM might have caused temporary stress for the economy, but this stress would have been temporary and would have smoothed out in the long run.  Under a liquidation bankruptcy, General Motors would have been broken into pieces and sold off piece by piece to the highest bidder.  Every brand name, factory, patent, and all real estate owned by GM would have been sold off.  The money recovered from these sales would have gone to pay as much of the money owed to GM bondholders–who  to the company in good faith–as possible.

The brand names would have been sold–probably to existing car companies, although they possibly would have been sold to venture capitalists who were looking to start a new car company.  The factories would have been sold to new owners (or the same venture capitalists) who would either continue to make cars in them or would refit them for some other kind of production.  GM’s patents would have fetched lucrative amounts of money at auction.  Purchasing these patents at a discounted auction price could have helped move other automakers years forward in their research and development, saving them billions of dollars.  For example, GM was years ahead of the competition in developing fuel cell cars.

The auction process might have been stressful while it was being sorted out, but it would have been an efficient way to deal with General Motors.  Instead, our government has pledged to loan GM an additional $50,000,000,000 [$50 billion].  However, GM owes creditors $172,800,000,000 [$172.8 billion], meaning that the government’s invenstment will be unlikely to stop at $50,000,000,000 [$50 billion], just as AIG’s initial $85,000,000,000 [$85 billion] bailout ended up doubling.

You can argue that government control of General Motors will save American jobs, although this argument is tenuous at best. General Motors is losing money for several reasons including: their cars are not up to par with those of Honda, Toyota, Nissan, and Ford, their union contracts force them to pay their current and former workers much more money than similar workers at Honda, Toyota, and Nissan, and they have been slower to innovate than have their Asian rivals.

Toyota, Honda, and Nissan have been continually building more and more of their cars in America, while General Motors, Chrysler, and Ford have been building less. Last November, I wrote an article detailing my opposition to all bailouts, but said that if the government had to bailout auto companies, I would rather it bailout the successful ones (ie Toyota and Honda).  At least this way money would be flowing to innovative companies who have a chance of paying back the loans, rather than to sluggish companies who refuse to adapt and will be unlikely to repay any loans.

The United States government now has a controlling stake in General Motors and a very large stake in Chrysler.  General Motors, the world’s second largest automaker, is now owned by the United States government (with a minority stake being held by the UAW).  Chrysler is now owned by the UAW (with a sizable minority stake being held by the US government).  Additionally, a significant percentage of Nissan is owned by the French government (the French government owns 15.7% of Renault which owns 44.4% of Nissan).  This is not fair to Ford, Honda, and Toyota. These three companies have to compete with three large automakers who are owned by large and powerful governments who have made it a matter of public policy to ensure that the automakers they own do not disappear.  As a Ford stockholder, I’m pretty mad that a company that I have invested in (because I believe in its products and its management) now has to compete with a powerful government which can print money to pump into Ford’s competitors as it sees fit.  Additionally, the US government also had the right to increase regulations on the auto industry which can hurt Ford and benefit its government owned competitors.

As unfair as this is to Ford’s shareholders, this is extremely unfair to the taxpayers who will have to foot the bill for these bailouts.  The tens of billions of dollars in additional funding for GM are not the whole picture.  American consumers will have to pay thousands more for their cars in the future due to the inefficiencies being created by the government bailiuts.  The United States government is keeping car companies in business which have no business being in business.  It is also mandating that certain GM models now be produced in America, rather than in foreign countries.  While this may sound like a good thing in an economy that is hemorrhaging jobs, it is not.  GM has chosen to produce cars overseas becaue it is cheaper to do so.  Simply put, forcing GM to produce cars here will raise the cost of those cars and will make American consumers poorer.

Americanly Yours,

Phred Barnet

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We all knew it would happen. Chrysler has declared bankruptcy. Big surprise.

The government has announced that Chrysler wont be paying back the $7,200,000,000 [7.2 billion] in aid that it received. $3,200,000,000 [3.2 billion] of that money was given to Chrysler just last week–its hard to believe that the administration was ever planning on getting this money back.

But, in yet another case of the government not learning its lesson, it has actually pledged to “loan” Chrysler another $4,700,000,000 [4.7 billion]!  And on top of this, Chrysler is planning on asking for an additional $1,500,000,000!

What is going on here?

The government has received an 8% in the bankrupt company–which it claims is compensation for the taxpayers for risking taxpayer money.  The whole company isnt worth the amount of money that the government has loaned to Chrysler!  Chrysler is bad news and has been for years.  Did you know that Diamler AG actually paid Cerberus nearly $700,000,000 for Cerberus to take over the company in 2007?

Heres an idea, how about you compensate us by not wasting our money on bailouts!

But it gets worse.  President Obama’s administration has allegedly “strong armed” Chrysler’s investors to force them into agreeing to a deal.

Form Businessinsider.com:

“The sources, who represent creditors to Chrysler, say they were taken aback by the hardball tactics that the Obama administration employed to cajole them into acquiescing to plans to restructure Chrysler. One person described the administration as the most shocking “end justifies the means” group they have ever encountered.  Another characterized Obama was “the most dangerous smooth talker on the planet- and I knew Kissinger.”  Both were voters for Obama in the last election.

One participant in negotiations said that the administration’s tactic was to present what one described as a  “madman theory of the presidency” in which the President is someone to be feared because he was willing to do anything to get his way. The person said this threat was taken very seriously by his firm.”

The Wall-Street Journal reports a similar story–and also reports the lack of media coverage about this.

Basically, many bondholders have agreed (willingly or after being forced) to give  up their claims.  Many of their positions in Chrysler’s debt have been wiped out because of this deal.  These bondholders were individuals, companies, and pension funds who loaned Chrysler money, risking their own wealth to help Chrysler through a bad situation.  If Chrysler’s bankruptcy is accepted by the judge, these lenders will lose the money they loaned Chrysler.   This is nothing more than the government stealing money from one group and handing it to another.

In the future, lenders will think twice about loaning money to aid struggling businesses, especially if there is a chance that the government will cancel their loans.

And that group that got the handout just happens to be the UAW.  Under the administration’s plan, restructuring, the UAW now owns 55% of Chrysler.  The US and Canadian governments also own large stakes in the company.  The UAW endorsed President Obama and actively encouraged its members to vote for him.

But what sunk Chrysler in the first place?  If you guessed the UAW, you guessed correctly.  According to Chrysler’s own numbers from 2007, their average worker cost the company $75.86 per hour.  Around the same time, Toyota’s workers were costing the company about $40 per hour.

President Obama’s administration stole money from bondholders and equity from Chrysler’s investors and gave it to the UAW.  This is thievery and should be condemned as such in the strongest terms possible.

Americanly Yours,

Phred Barnet

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