The Sovereign Society Offshore A-Letter Monday, July 20, 2009 Financial âHindsightâ Set to Ruin Investors: The Inconvenient Difference between What the Fed Does and what the Media Says Dear A-Letter Reader, Hindsightâs a funny thing⦠I mean now, today, it seems painfully obvious that the business of loaning money to people who canât pay you backâ¦well, thatâs bound to fail. Today, itâs pretty obvious that auction-rate securities can be prone to the âstampedeâ effect. And itâs also pretty obvious that selling hundreds of trillions worth of Credit Default Swaps (bankruptcy bets) introduces serious systemic risk⦠And yet, we did all these things for years. Financial analysts toted the value of AAA-rated securitiesâ¦Cramer & CNBC lauded bank stocks and REITs while the U.S. real estate market was clearly in bubble mode. But then something funny happened⦠When the bubbles came crashing downâ¦when average investors like you and I pushed retirement back by another yearâ¦when the mom & pop pensioners went brokeâ¦it all became âclear as dayâ to the financial media. In the heat of the moment, most commentators offered advice that was little better than a coin-flip (and often disastrously worse). But in hindsight, the pundits all really were the people their marketing promised to be. They talked about the âbubbleâ like scholars. As though itâd always been a fact of lifeâ¦not a multi-trillion dollar booby trap that somehow suckered âem all in. In the eyes of the uneducated observer â one that doesnât remember Cramerâs Bear Stearns buy in early March of last year â this is where they get their credibility. They talk smartâ¦they mention metrics and news that the professionals are keen on. And if youâve got a short memoryâ¦well, theyâve got you hooked. But what if this isnât your first rodeo? What if you know these guys are missing somethingâ¦you just canât put your finger on it. What if you donât want their stupidity costing you in the long run? Itâs only fair. Well if thatâs what youâre looking for, then you need to understand⦠Big Benâs Dilemma⦠The realization first struck me when I read about Big Ben Bernankeâs photo-op today, and whatâs expected of him⦠To bring you up to speed; remember that Ben needs low interest rates. Why? Because the mortgage market is still garbage, and an impending wave of resets and recasts could send defaults through the roof and torpedo any chance of recovery. The higher the rates, the more intense the damage. So Ben pulled every last rabbit out of the hat when it came to keeping rates lowâ¦even going to the extent of printing money to buy government debt (something like Weimar Germany did in the '20âs and Japan did in the '90âs). But this puts Ben in a tight spot⦠Think about it; he could open up the printing press and literally flood the world with dollars. This would cure any mortgage problems in the U.S., but it would also avail us of meaningful economic activity. In other words; this option is kind of fixing a broken leg by chopping it off. But â if heâs mindful of inflationâ¦and he keeps his printing to a minimum â then all his effort so far could become worthless. As an academic, he insists that this very reluctance to print money was what made the Great Depression of the 1930âs so brutally intense. In the short-term, Bernankeâs actions saved us from wholesale failure of the U.S. financial sector last year. But at what cost? The Difference between Stabilization and Recovery That very question is on the tip of everyoneâs tongue here lately; how much is this going to cost us in the long run? Ultimately, concern over the answer served to lengthen the Great Depression of the 1930âs. These days, itâs on the brink of forcing Bernanke to show his handâ¦namely; whether heâs playing toward stabilizationâ¦or heâs playing toward recovery. To calm fears about what Bloomberg calls, âthe biggest monetary expansion in history,â Ben is prepared to tighten the belt on his pool of funny money. One of the most prominent options for making that happen would be, âestablishing term deposits at the Fed designed to induce banks to keep money there rather than lending it out.â Wait a second. Hit the brakes⦠Did he say that he was going to incentivize banks not to lend out money? Thatâs curious. I mean; hasnât the general party line â the phrase spouted so often by Obama and his posse â that we need to âget lending going again,â that we need to âspur on lendingâ¦â Then thereâs my personal favorite⦠âCredit is the lifeblood of our economy.â So letâs work this out practically; if credit is the lifeblood of our economyâ¦and the forces of bankruptcy and default are slowly causing us to bleed outâ¦then doesnât recovery necessitate growth in credit? You just got it. Right thereâ¦Benâs not talking about recovery. Obama and Bernanke arenât saying the same thing. Bernanke and CNBC arenât saying the same thing. Obama and CNBC are the only two out of the three that actually agree⦠Bernanke â through his cautious actions and statements â is acting in the interest of stabilizing the U.S. financial system. Even after spending so many billions, bailing out so many slimy bankersâ¦the manâs still got a full plate. Heâs âmonkey-in-the-middleâ between the threat of inflation and a rapidly deteriorating U.S. housing market. Obama and CNBC â on the other hand â apparently missed the memoâ¦because they skipped ahead to âhindsightâ on the stabilization bit. After saving a handful of prominent campaign contributors like Goldman and AIG, both seemed to take the optimistic tack, sometimes declaring âthe worst is over,â or even declaring an outright end to recession. Why they would think to do this is beyond me and the page I have left for todayâs A-Letter. Call it a matter of vested interestâ¦an occasion of âsay it ainât soââ¦or a repeat of the early days of the Great Depression. Some might even observe the fact that if you and I buy into this recovery â with whatâs left of our portfolios â then it will be more likely to succeed; that thereâs something vaguely conspiratorial about this whole arrangement. To that I shrugâ¦and remind you of Clarkâs law (Never assume malice where sufficiently advanced incompetence will do). Instead, the most important thing for you to remember now is this; if youâre out there investing today, youâre investing amid active stabilization of the economyâand not during a recovery. For a few words on what that means to you, I talked to our Chief of Research, Andrew Packer⦠Stabilization & Your Portfolio âStabilization is the renunciation of a process known as âcreative destructionâ â something seen today in the form of bankruptcies and defaults. On a deeper level though, creative destruction is what allows economies to succeed over time⦠âDefaults may be badâ¦even punitive to the parties involved. But theyâre the penalty in a free-market system for poor choices. Those who correctly recognized the risk and shorted were rewarded. Itâs all part of the profit system as defined by a system of capitalism (as opposed to the profit system as defined by investment banks). âAt first, creative destruction might seem painful or even unfair. But in the long run it opens up an economy for innovation and new industriesâ¦contributing to greater efficiency and an economy better fit to serve a changing populace. âThe renunciation of creative destruction â often euphemized as âstabilizationâ â tends to correspond to a shift toward state interventionâ¦one which destroys capital, innovation, and freedom. âItâs the process by which bad loans are kept on the books of banks that should be bankrupt. Itâs the process that keeps things frozen, or moving at such a slow pace that true recovery is delayedâpotentially for years. âUltimately, the only thing thatâs being stabilized here is failure. âFor the sovereign investor, the implications are clear: stabilized markets make for poor investment returns. Since that can happen at any time, diversification and liquidity remain your best defense against this type of market performance. Markets that involve physical ownership, such as silver and gold, offer slightly more safety from stabilization than paper marketsâincluding debt and equities.â Yours in Personal Sovereignty, Matthew Collins *Internal Sponsorship 2-10x Your Money on the Greatest De-leveraging Since 1929. Not only are we facing a financial crisis, we are also facing a banking, credit, food, energy and a commodity crisis. Last year we saw $10 trillion wiped off global stock exchanges in just a month. And now the next demon derivative is about to whip down Wall Street and wipe a further $20 trillion off global exchanges, spinning the world into what might end up being a global deflationary collapse.