The Fog of the ’Flationary War is Lifting

The fog of war – that is, in the “war” between inflation and deflation – is lifting. We’re beginning to see more clearly which way the battle is going.

“America’s giant mortgage companies nationalized,” is how Le Monde treated Monday’s big story. “The biggest bailout in history…” it went on.

But what does it mean when the world’s most free-market government nationalizes its largest finance industry? It means a couple things:

First, that the days of “laissez-faire “, even ersatz laissez-faire, are over. No more deregulation. No more tax cuts. No more free trade agreements.

Second, that the feds are running scared. They are in retreat. The battle between a natural market correction…and an unnatural, inflationary boom…is going against them.

We were right all along – or almost right; when the bubble burst it marked the beginning of the end – the end of the bull market on Wall Street…the end of the credit expansion that began in ’82…and the peak of American power and influence in the world.

The decline since then has been delayed and disguised – by a flood of new liquidity from the feds. But now, there’s no stopping it. And it’s much worse than it would have been eight years ago…since Americans became more and more used to spending money they didn’t have; they have more debt than ever. And because the Chinese and other foreigners became more and more used to selling things to people who couldn’t pay for them; now their new apartment buildings are empty and their new factories are quiet. And now, the downturn is global…and it will be longer, and harder, than practically anyone imagines.

This just in: “Top China developer’s sales fall sharply.” Maybe it was the distraction of the Olympics, but China’s biggest listed property developer, Vanke, said sales fell 35% last month.

And this too: Yesterday, gold fell more than $30 – to $757. The euro rose to $1.40. Oil is rising this morning, on fears of Hurricane Ike, but it closed yesterday at $102. Our guess is that it will sink to the $70 range.

*** And here’s Le Monde again:

“Good news, finally…almost everywhere, inflation remains under control and in retreat.”

Wrong. Wrong. Wrong. Inflation may be in retreat. But it’s not good news. It means the whole world is sinking into a slump – not just the United States and Britain.

And that’s what the feds are afraid of. Sec. Paulson justified the takeover of Mac and Mae on the grounds that the markets and the taxpayers needed “protection from a systemic risk.”

What was the risk? That both Freddie and Fannie would go broke, that houses would fall to what they were really worth, and that – when the federally-chartered agencies stopped paying their debt to foreign lenders – the whole world financial system would melt down. Driven by fear…Paulson took the bold action…

And now…for the next act:

The U.S. economy has grown during these last two decades. But it has grown only because consumers have been willing to go deeper into the debt. This was not good growth. It was not healthy growth. But at least it was growth.

You get growth by spending money. If the consumer spends – it is growth in retail, consumer items, services, and so forth. If business spends – you get more jobs, more capital equipment, more buildings, trucks, computer programs, etc.

But what if neither consumers nor business is willing to spend?

Sunday’s government takeover of the U.S. mortgage finance industry looked like a godsend to many investors – and to Le Monde. The government made it clear – if it weren’t already obvious – that it wasn’t going to abandon its two federally-sired mortgage twins, Fannie and Freddie. More importantly, it signaled that the feds were ready to spend.

Bill Gross’s PIMCO made $1.7 billion by betting on the bonds of Fannie, Freddie and other agencies. You could have made some money too. We explained the “Paulson Doctrine” in these pages – which guaranteed the bonds would eventually be saved – several weeks ago. The Paulson Doctrine maintains that the feds will let the shareholders take losses – but not the bondholders. Why? Because the largest bondholders are foreign countries – notably China. And America desperately needs more credit from these large, overseas financiers. Foreigners hold trillions of U.S. dollars and U.S. dollar-denominated debt. If they begin to fear the government is not behind it, they’ll dump it fast – which would be the end of the current dollar-based monetary system.

So, the move to bring Fannie and Freddie under direct government control was widely seen as a plus for everyone. Foreign lenders know the game is still rigged – so their money is safe. Homeowners think they’ll be able to continue living at someone else’s expense. And investors hallucinate that the government has “done something” to put this mess behind us.

But we have a question: Where do the federales get the money? The slump – though it has barely begun – has already clipped corporate and individual tax receipts. Plus, social welfare programs are becoming more expensive.

As unemployment increases – it was recently tallied at over 6%, the highest level in five years – the safety net catches more and more people.

*** “I’ll tell you how it works,” said a taxi driver. “You’re lucky you live overseas, cause this country is a mess…”

We had been taking a snooze in the back seat. Then, we noticed a jerky movement in the car. When we opened our eyes, we found the cab had drifted to the middle of the road. On the long drive from Charlottesville, VA, to Dulles Airport, our driver was falling asleep.

In attempt to revive him before it was too late, we made conversation.

“I’ll give you just one little thing I know from personal experience,” the cabbie went on, “I had a call to pick a woman up here in Charlottesville. She’s a Medicare customer. Do you know about that? Well, she had lost her car and she had come up here to the hospital. And then she was ready to go home. But she didn’t have a car. And I guess she didn’t have anyone to pick her up. She called a cab.

“So I drove her home…all the way down to North Carolina! The fare was $1,100 – which is a lot for a taxicab. But then, she didn’t have to pay it. She just signed one of these vouchers. (He showed us a simple white form…) And then I turned it into the government. So you see, you paid $1,100 to drive her down to North Carolina in a cab!”

The feds have dozens, maybe hundreds, of these absurd programs. When the sun shines, they grow like kudzu. Rain falls upon them like Miracle-Gro.

Fannie and Freddie, between them, have assets of $5.4 trillion and debt of $1.7 trillion. No one knows how much it will cost to keep them in business, but it is bound to be a big number. And the federal deficit is already as big as it has ever been – and growing. Where will the feds get the additional money to support U.S. housing?

We all know where – they have to borrow it. And now another question: We saw what happened when individuals borrowed too much; all of a sudden lenders didn’t want to extend them any further credit. Even Wall Street giants – such as Bear Stearns…and now, Lehman Bros. – can go bust if they borrow too much or speculate too wildly.

Can the U.S. government go bust too? Well…there is that printing press… The federal government can’t go broke, technically, because it can pay off its debts with money it prints up, just for the occasion. But in the event, the dollar itself would collapse in value. Foreign lenders would cease to extend credit. And then, the only choices open to the United States would be to cut back…or to print up even more money.

We’re a long way from the end of this show…but this takeover of Mae and Mac is a big step toward the final curtain.

*** Our old friend, Michel, is writing a history of the United States.

“Does the U.S. Constitution authorize the federal government to finance mortgage loans?” he asks.

He might have asked a broader question: is there anything that the U.S. government cannot do? It can arrest people, put them in jail, and torture them – without even charging them with a crime. It can regulate any business. It can takeover any asset. It can tax and spend – as much as it can get away with.

“At the end of 1817,” Michel continues, “Congress passed a law authorizing the federal government to finance several canal routes, to which no one took exception. Monroe, who had just been elected for 1818, supported the law. But President Madison, ‘Father of the Constitution,’ decided that the law was contrary to the Constitution (or that an amendment was needed) so he vetoed it.

“My goal in this book is to show how, contrary to the intentions of the founding fathers, the Constitution has been interpreted, and twisted, in order to permit the federal government to do all it wanted to do, and that the doctrine of limited government, with powers exhaustively enumerated, has been undermined thanks to the use of two unfortunate expressions in the Constitution – ‘necessary and proper,’ and ‘general welfare,’ from which flows the statist doctrine of ‘implied powers.’

“It began with Hamilton (and a few texts of Madison in the ‘Federalist Papers’), who defended the interests of New England merchants, parenthetically, and it was developed by chief justice John Marshall who, although a Virginian, worked for 34 years at the Supreme Court to make it a very effective weapon against constitutional liberties (subject to some nuances).

“I continue my research, but I think it’s all there…that all the arguments for or against ‘implied powers’ were furnished during the period 1790-1800.”

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

Latest posts by Bill Bonner (see all)

Leave a Reply

2 Comments on "The Fog of the ’Flationary War is Lifting"

Notify of
Sort by:   newest | oldest | most voted

But where did the constitutional basis of US legal extra-territoriality come fom?

The boom in house prices has not been reflected in CPI figures (I know this in the U.K and I suspect it is the same in the U.S). Since CPI was weighted to give the impression of low inflation purely as a means to self fulfill the politicians prophecy, it was designed as a large stick with which to beat wage demands. The logic went, inflation is at 5% but CPI is at 2.5% and so wage demands come in at or around 2.5%. Between 2000 and 2003 in many parts of the U.K house prices doubled. This is the… Read more »
Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to