"DOW at 3,500? Turn out the lights..."
“One year ago the Dow reached an all-time closing high of 14,164, most people were bullish, and I remember that some analysts were even hypothesizing about some sort of super bull market, whereby the Dow surges up to 20,000 or even as high as 25,000. These giddy projections were made with the knowledge that some problems already existed, and they were adversely affecting the housing industry. Appreciating home prices allowed Americans to refinance mortgages on a regular basis, taking out liquidity in order to consume well beyond their means. This consumption was directed toward imports in general and China specifically. In return China, along with the rest of Asia, bought trillions of dollars worth of US debt. In short, the US housing market functioned as the life blood of the world’s economy. If housing had continued to rally, then no one would have discovered America’s dirty little secret.In order to understand where we are today, and where we’ll be in a year or so, you must have a clear understanding of how we arrived at this point in time. You can go all the way back to the Long Term Capital Management crisis and you’ll see the foundation laid for present day fiscal and monetary policy. Enter a problem and the Fed immediately responds with lower rates and substantial increases in the money supply. Not one minute’s thought was given to the idea of simply letting the market sort things out. It was decided that instant gratification would become the order of the day. This type of policy wouldn’t work for most countries, but the US wasn’t just any country; they possessed the world’s reserve currency and therefore could print to their hearts content. Unfortunately, printing alone wouldn’t get the job done, so they decided to flood the world with debt. After all, it takes a lot of money to engage in empire building, while fighting a war on two fronts. One thing would have been to sell debt backed by tangible real assets, but think of how much more you could sell if the debt, like the currency, didn’t have to be backed by anything!
Greenspan, Paulson (when he was at Goldman Sachs), the SEC and the ratings agencies, all got together and collectively set out to defraud the rest of the world. That’s an important distinction: there was intent, and that makes it criminal. They loaned money to folks, who had no business receiving loans; they packed them into CDO’s and other innovative instruments, devised a mathematical model to come up with a end-of-the-month value for an otherwise completely illiquid instrument, stamped them “AAA” when they were really one step below junk, and sold them to foreign institutions, who relied upon them for reserves. We can go into philosophical discussions as to whether or not they should have known better, but that misses the point. Do you know how business is done in the real world? The head of Goldman Sachs calls up the head of UBS and says “I have got a deal for you”. They generally agree to the terms and then order an underling to “get the deal done”. They take it on faith that the product is a good one.
According to the Bank of International Settlements, kind of a central bank for all the central banks, there are currently US $550 trillion in derivatives floating around out there, and almost all of them are unregulated and traded on a very illiquid over-the-counter market. A lot of this stuff was underwritten by Lehman Brothers, Goldman Sachs, Merrill Lynch and so forth, and no one ever bothered to wonder what would happen if someone actually had to pay off on these derivatives. The general line of thought was that it would never happen, while others simply chose not to think about it at all. It was that same line of thinking that allowed people to claim the Titanic was unsinkable, and we all know how that turned out. When the problem first began to surface one year ago, it was met with a tax rebate, an increase in the money supply, and everyone saying that it was over before it started. I seem to recall that Citibank wrote off US $4 billion, while Merrill wrote off US $2 billion, and everyone applauded for their straightforwardness in getting all the bad news out right at the beginning. I’ve lost count, but I believe that Citibank has now written off more than US $45 billion, and Merrill Lynch was handed over to someone else for what is was really worth, i.e. next to nothing.
The economy is shrinking so fast that tax revenues will decline in any event, and neither will even attempt to balance a budget. The next president will surely have a US $1 trillion budget in 2009, and I would not be surprised to see it reach US $2 trillion before it’s all said and done. I suppose the Fed could have a negative interest rate, and they probably already do, given how the economy is slowing, but it won’t help. Print all the money you want, but no one can use it; you have a society that only consumes, producing little other than debt. Then there’s the Fed. They’re so far behind the curve, that it would be funny if it wasn’t so sad. They issued so many statements about inflation that they began to believe their own lies and forgot the real problem was deflation. Now they’re out of time and tools. I think the real plan is simply to try and capitalize a few institutions with free money, so they can somehow survive the wash out. I don’t think it will work. Once the Dow bottoms, it will rally for 60 to 90 days, and then fall even harder taking pension funds and most companies with it. Somewhere along the line, the price of the Dow will cross with the price of gold; I would guess around 3,500. My only question, who will be left standing to see it?”
Greenspan, Paulson (when he was at Goldman Sachs), the SEC and the ratings agencies, all got together and collectively set out to defraud the rest of the world. That’s an important distinction: there was intent, and that makes it criminal. They loaned money to folks, who had no business receiving loans; they packed them into CDO’s and other innovative instruments, devised a mathematical model to come up with a end-of-the-month value for an otherwise completely illiquid instrument, stamped them “AAA” when they were really one step below junk, and sold them to foreign institutions, who relied upon them for reserves. We can go into philosophical discussions as to whether or not they should have known better, but that misses the point. Do you know how business is done in the real world? The head of Goldman Sachs calls up the head of UBS and says “I have got a deal for you”. They generally agree to the terms and then order an underling to “get the deal done”. They take it on faith that the product is a good one.
According to the Bank of International Settlements, kind of a central bank for all the central banks, there are currently US $550 trillion in derivatives floating around out there, and almost all of them are unregulated and traded on a very illiquid over-the-counter market. A lot of this stuff was underwritten by Lehman Brothers, Goldman Sachs, Merrill Lynch and so forth, and no one ever bothered to wonder what would happen if someone actually had to pay off on these derivatives. The general line of thought was that it would never happen, while others simply chose not to think about it at all. It was that same line of thinking that allowed people to claim the Titanic was unsinkable, and we all know how that turned out. When the problem first began to surface one year ago, it was met with a tax rebate, an increase in the money supply, and everyone saying that it was over before it started. I seem to recall that Citibank wrote off US $4 billion, while Merrill wrote off US $2 billion, and everyone applauded for their straightforwardness in getting all the bad news out right at the beginning. I’ve lost count, but I believe that Citibank has now written off more than US $45 billion, and Merrill Lynch was handed over to someone else for what is was really worth, i.e. next to nothing.
The economy is shrinking so fast that tax revenues will decline in any event, and neither will even attempt to balance a budget. The next president will surely have a US $1 trillion budget in 2009, and I would not be surprised to see it reach US $2 trillion before it’s all said and done. I suppose the Fed could have a negative interest rate, and they probably already do, given how the economy is slowing, but it won’t help. Print all the money you want, but no one can use it; you have a society that only consumes, producing little other than debt. Then there’s the Fed. They’re so far behind the curve, that it would be funny if it wasn’t so sad. They issued so many statements about inflation that they began to believe their own lies and forgot the real problem was deflation. Now they’re out of time and tools. I think the real plan is simply to try and capitalize a few institutions with free money, so they can somehow survive the wash out. I don’t think it will work. Once the Dow bottoms, it will rally for 60 to 90 days, and then fall even harder taking pension funds and most companies with it. Somewhere along the line, the price of the Dow will cross with the price of gold; I would guess around 3,500. My only question, who will be left standing to see it?”
- Orlandini, Dow Theory Analysis SAC, Nov. 02, 2008
http://www.gold-eagle.com/editorials_08/orlandini110308.html
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