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Archive for the ‘State Sovereignty’ Category

Depending on Central State/central bank borrowing and spending to prop up the Status Quo is a doomed strategy.

I think the thread between these three seemingly disparate stories is clearly visible.I am indebted to longtime correspondent Joel M. for sending me these articles:

A Dimly Flickering Light in a Darkened Downtown. An Ohio mill town’s once-bustling main street is now a ghost town; people are desperate to sell their family heirlooms to one of the downtown’s few remaining businesses, a vintage shop, to raise cash.

A Fight for Post Offices and Towns’ Souls. Even as the number of family farms rises for the first time in decades in the U.S., long-standing services to rural communities such as post offices and schools are being slashed.

With Work Scarce in Athens, Greeks Go Back to the Land. As Greece’s economy plunges and unemployment rises, many Greeks are fleeing to the countryside and looking to the nation’s rich agricultural past as a guide to the future.

The thread that connects these stories is the devolution of centralized concentrations of control and the power of localism to fill the void.

As I have often noted here, the expansive Central State is on an S-curve of decline, and this is most apparent in places such as Greece that cannot print a couple trillion dollars a year to fund a bloated Status Quo like the U.S. can (at least for now).

But the Central State is on an S-curve even in nations such as the U.S. and “socialist” France, where rural post offices are also being closed or their hours drastically slashed for budgetary reasons.

Though few believe it possible, Wal-Mart is also on an S-Curve of decline; right now it has topped out, roughly comparable to the centralized corporations that owned and operated the mills in the 1960s. Though these conglomerates seemed eternal, beneath the surface they were already in decline.  So it is with the Wal-Mart model of centralized distribution of goods sourced via long global supply chains.  The decline just isn’t visible yet.

It is instructive to consider how the tiny village in the south of France where my brother lives is responding to the closure of rural services and the devolution of centralized funding.  The village has actively constructed subsidized housing on village-owned land to attract young families with children so the village school and post office won’t be closed.

Those who depend on a strategy of pleading with central authorities to continue funding at old levels are doomed to disappointment–all systems follow an S-Curve of rapid expansion, stasis and decline. The Central State is no different.

The solution is localism.  By creating cheap housing with its own modest tax resources, then the village attracts young families, whose children will keep the village school from closing, and the commerce brought to the village and its post office will keep it above the “closure” threshold.

Passively hoping that centralized concentrations of wealth and power will return to pre-eminence is a losing strategy, the equivalent of a cargo cult ritualistically hoping for a return to World War II-era bounty. Focusing local resources on obvious bootstrap solutions is the winning strategy, not just in the U.S. but globally.

That old mill town could do worse than to gather its resolve and institute a tax on all retail stores with more than 50,000 square feet of sales area. That would levy a special tax on one retailer, Wal-Mart.  As long as the tax was modest, Wal-Mart would resist and threaten but it would be highly unlikely to close a profitable store.

Then the town could use that revenue  to begin condemning all those empty buildings downtown via eminent domain and leasing them out for $1 a year to entrepreneurs. With no prospect of tenants, the buildings are essentially worth zero, so the owners would be lucky to get any sum. Most of the businesses would fail, as do most small businesses, but with nothing to lose, why not trust to capitalist energy and experimentation?  Maybe something good would start happening as creative juices were given a chance to flow. Something would be much better than nothing.

When the devolution of the Central State and central bank (and indeed, all centralized concentrations of wealth and power) picks up speed, as it has in Greece, then people migrate back to where localist solutions are possible.

Breaking the mindset that Central State subsidies is the solution to every problem is difficult, but as reality intrudes then clinging to broken models of the past is not the way forward.

In many minds, Greece is a failed state and the U.S. is successful. To my mind, Greece is a state in a positive transition to dealing with reality, and it is the U.S. which is the failed state, borrowing and blowing 10% of its entire GDP each and every year to fund its bloated, corrupt Status Quo ($1.5 trillion in Federal borrowing annually, plus state and county borrowing and corporate/consumer borrowing).

Failed states depend on endlessly rising debt to prop up their bloated, corrupt Status Quo. That no longer described Greece, but it still describes the U.S.

Charles Hugh Smith – Of Two Minds

Systemic causes of global financial instability include the “normalcy bias,” super-low interest rates, central-bank induced inflation and loss of faith in institutions.

Some causal factors of global financial instability are mental constructs, others are pernicious policies. Money is the ultimate mental construct, of course; it is our faith in the promises issued by central banks and governments that gives paper money its value.

The same can be said of markets: it is our faith in their transparency which makes them “free markets.” Once we discern that a market is manipulated, then we lose trust in it and exit that market for good.

The most pernicious policy is central-bank engineered inflation, which rewards debtors and punishes capital accumulation, a.k.a. savings. Push these incentives to debt hard and long enough, and you get a crippled, top-heavy economy like the U.S. economy, crushed by debts so staggering that the only way to service the debt is to borrow more money at insanely low rates of interest.

This is an excerpt from my new book An Unconventional Guide to Investing in Troubled Times which has just been issued in Kindle ebook format; a print edition will follow in September. (You can read the ebook now on any computer, smart phone, iPad, etc.–see below.The 30% discount expires tonight.)

Here are six systemic causes of global financial instability. (Here is yesterday’s list: The Coming Global Instability, Part I.)

1) The human mind has a number of default settings which have proven advantageous as “short cuts” in most circumstances, one of which is called “the normalcy bias.”  As events spiral out of control and dangers rise exponentially, our tendency is to underestimate the risks and potential losses. As long as a few shreds of normalcy remain intact, we view these as evidence that “it’s really not so bad.”

Most of the time, this trait pays off as most systems are self-correcting and catastrophe is avoided. But when self-reinforcing negative trends take hold, this complacency is ultimately self-destructive.

2) The financial Status Quo, already discredited in the eyes of most well-informed observers, will eventually lose all credibility, and global stock markets will languish as participants abandon them.

If this sounds farfetched, recall that 70% of all shares traded in the U.S. stock market are exchanged in opaque “dark pools” operated by Wall Street and “too big to fail” banks, and high-frequency trading executed by “black box” algorithms account for the majority of the remaining 30% of publicly traded shares.  This means that some 90% of stock market activity is hidden from non-insider investors.

The idea that we can rely on opaque markets for our financial security will increasingly be discredited.  As  heavy-handed interventions fail to restore stability, public faith in these institutions will decline. This delegitimization will further destabilize global markets, and those who accepted the implicit guarantees of stability, transparency and liquidity may find instead that their financial security has vanished in a cloud of “impossible” disruptions and dislocations.

This loss of faith is already evident.  As the U.S. stock market doubled from its March 2009 lows, U.S. households withdrew hundreds of billions of dollars from domestic equity mutual funds, and quadrupled their holdings of “safe” U.S. Treasury bonds.  If you look at a 10-year chart of volume in U.S. stocks, you will see a steady erosion of participation in the stock market.  These are the actions of people who have lost faith in the stock market, the nation’s financial and political institutions and the official “story” of permanently rising prosperity.

Once trust is lost, it cannot be won back easily or quickly.

As the financial authorities attempt to keep the system from crumbling beneath their feet, they will take increasingly drastic actions as markets destabilize: investment rules that were presumed to be eternal will be changed overnight, without warning, and then changed again. Decades of low volatility that encouraged people to buy long-term bonds, annuities and dividend-paying stocks will be upended by unprecedented financial and political volatility.  Seemingly permanent low interest rates that lured investors to pile into high-risk gambles will suddenly leap up, wiping out gamblers who weren’t even aware they were playing a game rigged in favor of the “house.”

Such expectations are well-grounded in history. Most investors have forgotten that the U.S. stock market was summarily closed for months during World War I, and that in 1933, the Federal government seized “hoarded” privately held gold.  These actions were, at the time, considered necessary and prudent by the authorities. More recently, in 2008 speculating that banking stocks would decline (that is, shorting banking stocks) was summarily banned. The rules governing the market were changed to defend the Status Quo, and speculation was only allowed if it flowed in one direction—the one favored by the financial authorities.

3) Stripped of mumbo-jumbo, central banks and States have only two buttons to push: Keynesian fiscal stimulus, i.e. governments borrowing and spending vast sums in an effort to stimulate demand and the “animal spirits” that drive private borrowing, and monetary easing, i.e. lowering interest rates to near-zero, and printing or creating credit electronically to flood the economy with “liquid,” easy-to-borrow money.

Central banks and States are hitting these two buttons like frenzied laboratory rats, but the machine is out of cocaine-laced pellets.  In effect, central banks and Central States are both addicted to exponential expansion of credit, intervention and Central State borrowing and spending. Each is only exacerbating the system’s risks, and as the authorities ratchet up these interventions to ever-higher levels, they’re insuring an even greater collapse.

There is a pernicious agenda at work in setting interest rates near zero while  boosting money supply and deficit spending to create inflation. By robbing savers of any return on their savings and sparking “sustainable, orderly” inflation of around 4%, central banks are in effect transferring 4% from the owners of cash to reduce the debt of the central bank/State by this same amount every year.  In a decade of this monetary scheme, savers’ wealth will be reduced by roughly 50% while the debt created by the central bank/State will decline by 50%.

“Purchasing power” is a concept while helps us understand the results of low interest rates and “politically benign” inflation: the owner of cash will find their money buys only half of what it did ten years before, while the government debt has also fallen in half.  The net result of this slight-of-hand is that government debt that was crushing becomes manageable again as savers’ wealth was invisibly transferred via carefully engineered inflation.

The key phrase in this sub rosa agenda of transferring private wealth to reduce government/central bank debt is “politically benign:” since the loss of wealth and the rise in consumer prices is “only” 4% a year, the consequences are not severe enough to trigger political resistance.  Financial and political authorities know that people quickly habituate to an “orderly” reduction in wealth and an “orderly” inflation in prices; that is, this erosion of purchasing power soon becomes “the new normal” and people plan around it.

The purpose of this central bank/State agenda is to avoid the two endgames that would destabilize the Status Quo: outright default on the Status Quo’s staggering debts, and hyperinflation, or loss of faith in a paper (fiat) currency. Either of these events would destroy the credit markets that form the foundation of the global economy.

We can see how successful this strategy of engineering orderly, “normal” inflation has been: 30 years ago, a Federal debt of $15 trillion would have unimaginable. Today, it is accepted as “sustainable” because it will never be paid back in today’s dollars, and low interest rates insure that the carrying costs of that debt remains small enough that no other government spending need be sacrificed to pay the annual interest.

This agenda has worked like magic for the past 30 years, but beneath the apparent success, the foundations of the current system– cheap energy, globalization, financialization, monetary expansion, fiscal stimulus, opaque markets and constant State/central bank intervention–are all eroding. As they dissolve then so too will the Status Quo’s implicit promises of permanent stability, low interest rates and limitless growth.

The point here that the levels of intervention required to create inflation in a  deflationary, deleveraging-of-debt era are not just stupendous– they must ratchet up to ever higher levels to maintain superficial stability as the system becomes increasingly precarious.  Ironically, increasing the heavy-handed centralized interventions only  increases the system’s precariousness—the exact opposite of the Central Planners’ intentions. This is the result of trying to manage non-linear systems with linear-system tools: all that manipulation can achieve is to extend surface stability at the cost of a more severe system crash later on.

4) The investment world is keen on probabilities as reliable guides to the future. But low-probability events occur with remarkable regularity, so it’s prudent not to put too much faith in statistical or probabilistic reassurances. All such models are based on the idea that the recent past is a reliable guide to the future. But if the thesis that the next 20 years will necessarily be very different from the previous 60 years, then this faith that the recent past offers a roadmap of the future is dangerously misleading.

5) The uneven, unpredictable process of destabilization and devolution will play out over many years as periods of apparent stability are punctuated by the re-emergence of crises which were supposedly resolved in the previous cycle of central bank/government intervention. Every era of stability will be less enduring than the last, and come to rest at a lower level of security and prosperity than the last. Every intervention will be larger, more desperate and more intrusive than the last, and much less effective.

6) Periods of creative destruction are inherent to Capitalism, indeed, essential  to its long-term success. Just as we cannot fool Mother Nature for long–for example, by reckoning we can eliminate forest fires–we cannot manipulate the global economy to eliminate creative destruction.  All the unprecedented efforts of central financial authorities to eliminate risk and instability are simply piling up more deadwood in an already tinderbox forest.

Financial risk is like water in a closed system: it cannot be compressed. As pressure mounts, the risk builds up and eventually escapes, often through whatever part of the system was considered “safe.”

Periods of great transition in which existing systems are consumed by creative destruction and a new paradigm emerges offer great opportunities as well as great risks.

If I had to summarize this book in a few sentences, I would say this: Money is a  tool; make it work for you. Don’t invest in Wall Street’s false promises, invest  with an unblinking eye on systemic risk. Invest in your own life and in the lives of others. This book explores how to do just that.

Of Two Minds

Charles Hugh Smith’s new book An Unconventional Guide to Investing in Troubled Times is available in Kindle ebook format.

The Revolt of the States

By Alan Caruba

President Obama, his weird circle of advisors (czars), and the ideologues within the Democrat Party led by Speaker Nancy Pelosi and Majority Leader Harry Reid only have a few months left to completely destroy the separation of powers between the States and the federal government.

A major battle is looming over the Tenth Amendment which declares that “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.”

Almost everywhere one looks today, the States are in rebellion to the overreaching of the federal government. The process involved is called nullification, a legal theory that a U.S. State has the right to nullify, i.e., invalidate, any federal law deemed unconstitutional. Since the Supreme Court moves at a glacial pace, the States through their legislatures have taken the lead in many cases.

Nullification is not secession as in the case of the Civil War, but there is a history of nullification that includes the Kentucky and Virginia Resolutions against the Alien and Sedition Acts. Thomas Jefferson and James Madison both argued that the States are the ultimate interpreters of the Constitution, arguing that the States could “interpose” themselves to protect their citizens from unconstitutional national laws.

Much of the discord in the nation today has its roots in the vital difference between a conservative attachment to traditional values and a liberal ideology that would impose a One World Government on our sovereign nation.

The great philosopher of American conservatism, Russell Kirk, wrote “True conservatism is the antithesis of ideology. It is the negation of ideology. For conservative is grounded in the past. Its principles are derived from the Constitution, experience, history, tradition, custom, and the wisdom of those who have gone before us—‘the best that has been thought and said.’ It does not purport to know the future. It is about preserving the true, the good, the beautiful. Conservatism views all ideologies with skepticism, and the more zealous and fanatic with hostility.”

A case in point is the way that State after State has lined up to oppose through the courts and by individual legal action the imposition of the president’s healthcare legislation, passed on strict party lines by the Democrat Party and only after the most vile revelations of bribery and backroom deals. It is a bill whose content Speaker Pelosi said Americans should supinely consider only after it was passed.

There has been a rapidly growing awareness and rejection of the assertion that the federal government can “own” General Motors or that the government should be in the business of buying and selling mortgages.

Pending financial reform legislation would permit the federal take over any company to install its own board of directors and thus control the economy. The failure to exercise existing regulation of the financial sector hardly calls for more regulation. It calls for stronger enforcement of existing laws.

The increasing awareness and rejection of the false “theory of global warming” is being rejected on the basis of the widely perceived cooling of the earth during this decade and the wild projections of warming 25, 50, a hundred or more years into the unknown future. More and more Americans now know it is based on feeble and deliberately false “computer models”.

That is why the Cap-and-Trade bill, a huge tax on energy use, awaiting action in the Senate, even if imposed in the same fashion as the healthcare bill, will be rejected by the States. There is no need to regulate carbon dioxide, a natural gas that has nothing to do with “warming”, but a rogue government agency, the Environmental Protection Agency, is set to assert this falsehood through massive regulation that will destroy the nation’s economic base.

With increasing pace, the States are demanding that the Second Amendment protecting the right to own and bear arms be respected and asserting their right to pass laws permitting gun ownership, including the right to carry concealed arms for self defense. States that have enacted such laws have seen a dramatic decrease in crime.

The assertion of unconstitutional federal powers lies at the heart of the State’s rejection of these efforts. Unfunded federal mandates are bankrupting the States and they want an end to them. The rapacious taking of State lands is crippling theirs and the nation’s ability to access our natural resources.

A growing spectrum of federal laws intruding upon the sovereignty of individual States is being challenged and this is a good thing. We should all take heart from these challenges as well as the spontaneous occurrence of the Tea Party movement that is a dramatic demonstration that the spirit of individual liberty and of States rights is alive and well in America.

A new generation of Americans is learning that the Constitution was designed to ensure a small and limited federal government and that the States, like the Union, are individual republics.

The battle has been joined.

More Evidence that Banks Create Credit Out of Thin Air

Reality Check in California, Michigan and Other States – Except One

In December 2009, the National Governors Association (NGA) and National Association of State Budget Officers (NASBO) issued their latest biannual Fiscal Survey of States, assessing their economies and presenting their outlook for the year ahead, a very glum one in their opening statement saying:

“States are currently facing one of the worst, if not the worst, fiscal periods since the Great Depression. Fiscal conditions significantly deteriorated for states during fiscal 2009, with the trend expected to continue through fiscal 2010 and even into 2011 and 2012.”

They say tax revenues are drastically lower from all revenue sources, and collections are expected to fall further in the current year. Citing a $256 billion budget gap between FY 2009 and 2011, they’ve had to enact sharp spending cuts and find new revenue sources. The federal American Recovery and Reinvestment Act of 2009 (ARRA) made up $135 billion of the shortfall. Another $87 billion in Medicaid funding facilitated critical health and human services spending.

Even so, programs across the board were cut with more coming in 2010 as governors and budget officers prepare for the worst. According to NASBO Executive Director Scott Pattison:

“We expect a continued deterioration in all financial indicators including revenues, balances and expenditures.”

As a result, the fiscal health of America’s states is dire with little in the way of expected relief. Across the country, governors say federal stimulus money is running out, yet conditions are worsening so more spending cuts and revenue increases are planned at a time opposite measures are needed.

However, unlike the federal government, states must balance their budgets, making up shortfalls by borrowing, taxes, and/or cuts in vital services. While constitutional, statutory, or traditional practices vary, three general kinds of balanced budget requirements exist, differing only in detail:

– the governors’ proposed budget must be balanced;

– the enacted one must be as well; and

– the fiscal or biennium fiscal year one must be also, with no deficits carried forward.

Given today’s conditions, that makes for cantankerous debates producing compromises and delicate juggling, satisfying no one, especially households hit hardest by the results.

One state alone stands out in the current environment, North Dakota, with its governor, John Hoeven calling a December 15 news conference to explain that the state has so much money (a $1.3 billion FY 2009 surplus, its largest ever) that individuals and businesses will average $650 in 2009 tax savings from income and property tax cuts enacted by its legislature. In addition, seniors and disabled people who own property or rent will get additional savings from an expanded Homestead Property Tax program.

According to Tax Commissioner Cory Fong:

North Dakota has been able to weather the economic crisis. “While other state governors and legislatures are looking for ways to raise revenue through raising taxes and cutting services, we just came through a historic session of funding both our important priorities and substantial tax relief….The winners are families, businesses and the State of North Dakota,” because it’s unique in one important respect.

It’s the only one with a state-owned bank (The Bank of North Dakota – BND) that sustains its distinctiveness and strength. As a result, it had the nation’s lowest unemployment rate of 4.1 at year end 2009 and created jobs throughout the crisis.

Established in 1919, it’s been a “credit machine” ever since, according to financial writer Ellen Brown, delivering “sound financial services that promote agriculture, commerce and industry,” something no other state can match because they don’t have state-owned banks.

With one, BND “create(s) ‘credit’ with accounting entries on (its) books” through fractional reserve banking that multiplies each deposited amount magically about tenfold in the form of loans or computer-generated funds. As a result, the bank can re-lend many times over, and the more deposits, the greater amount of it for sustained, productive growth. If all states owned public banks, they’d be as prosperous as North Dakota and be able to rebate taxes and expand public services, not extract more or cut them.

Brown explains that the BND:

“chiefly acts as a central bank, with functions similar to those of a branch of the Federal Reserve,” that’s neither federal or has reserves as is owned by major private banks in each of the 12 Fed districts, New York by far the most dominant with Wall Street’s majority control and a Fed chairman doing its bidding.

In contrast, BND is a public bank, 100% owned by the state, operating in the public interest and those of the state. It “avoids rivalry with private banks by partnering with them.” Local banks do most lending. “The BND then comes in to participate in the loan, share risk, buy down the interest rate and buy up loans, thereby freeing up banks to lend more. (One of its functions) is to provide a secondary market for real estate loans, which it buys from local banks. Its residential loan portfolio is now $500 to $600 billion” in a state with around 700,000 people and thriving.

Its function in the property market helped it “avoid the credit crisis that afflicted Wall Street when the secondary market for loans collapsed in late 2007 and helped it reduce its foreclosure rate….(Its other services) include guarantees for entrepreneurial startups and student loans, the purchase of municipal bonds from public institutions, and a well-funded disaster loan program.” When the state didn’t meet its budget “a few years ago, the BND met the shortfall.”

In sum, state-owned banks have “enormous advantages over smaller private institutions….Their asset bases are not marred by oversized salaries and bonuses, they have no shareholders” demanding high returns, and they don’t speculate in derivatives or other high-risk investments. As a result, BND is healthy with a 25% return on equity, paying “a hefty dividend to the state projected at over $60 million in 2009″ and well over five times that amount in the last decade, so it begs the question why other states don’t operate the same way. If enough of their residents demanded it, they might and not suffer the way nearly all of them are today, two notably – California and Michigan.