Captive bidding at the auction: How bond vigilantism was swamped

Time flies when you're making money: 19 years have sped by since the start of the great bond bull market. So traumatic was the preceding bear market (it spanned the administrations of U.S. Presidents from Harry Truman to Ronald Reagan, 1946 to 1981) that fixed-income investors took a pledge: Never again would they be the dupes of a central bank. They would henceforth sell at the first sign of inflation.

So market interest rates would increase before the U.S. Consumer Price Index could spurt. The Fed might nod off, but the bond market vigilantes pledged they would never sleep again.

Now look at them. With a generation's worth of capital gains tucked under their ample belts, they are snoring in hammocks or swatting golf balls. Financial markets the world over are worse off for their unannounced retirement. James Grant

Many financial commentators have opined on the absence of the "bond vigilantes" from the US Treasury market. Bond traders now willingly accept low yields in the face of broad based commodity inflation, which hitherto would have, according to Mr. Grant, whose views I highly respect, above, inspired significant selling from the now "sleeping" bond vigilantes. I've been doing a bit of checking on the US bond market and think I have a few answers to the question, "where did the bond vigilantes go?," although a better question might be, "whose efforts have swamped bond vigilantism in the Treasury markets?"

The good old days

In 1955, US federal debt totaled $234B, of which $163B (70%) was tradable on the open market. The biggest single player was the Fed, which, in 1955, carried $24.4B worth of Treasury Securities on its balance sheet, or just under 15% of marketable debt.

Is the Fed the culprit?

Federal Reserve acquisitions of debt rose steadily from 1955 to 1970, when holdings peaked at just over 25% of marketable debt. But, as standard closed system economic theory argues, Fed purchases, i.e. debt monetization, did not keep yields down. 10 year yields rose from under 3% in 1955 to well over 7% in 1970 while consumer price inflation rose from -0.4% in 1955 to 5.7% in 1970. Bond vigilantism was apparently alive and kicking back then and Federal Reserve debt monetization led, as it should, to inexorable inflation.

Thus, we can chalk off the Fed as player whose efforts swamp bond vigilantism.

Are the foreigners to blame?

Of late, the presence of foreign purchasers, in particular, foreign official purchasers, have been cited as a reason behind the lack of bond vigilantism, even (in hindsight, partially erroneously) by me.

In 1955, foreign official holdings (the foreign private sector was not yet involved) of Treasury debt totaled $5.8B, or 3.6% of marketable debt. Foreigners were not yet players.

By 1980, this had changed. Foreign official holdings rose to just under 18% of marketable debt, while total foreign holdings rose to 20.4% of marketable debt. Despite this support, 10 year yields rose from 4.2% in 1965, when foreigners began to ramp up their purchases, to well over 12% by 1980. Consumer price inflation rose from 1.6% in 1965 to 13.5% in 1980. The decline in real yields at the back end of the curve, excluding other factors (which is rarely wise), suggests that foreign buying might have kept rates lower than they otherwise would have been, in a closed system.

Foreign acquisitions of US debt have increased dramatically since 1980. As of Q2 2007, 44% of marketable US Treasury securities are in foreign hands. 31.3% of marketable US Treasury securities are in foreign official hands. The coincident rapid increase in foreign holdings of US debt with a multi-decade decline in yields suggests that these purchases kept yields lower than they otherwise would have been. Yet, the data from the 70s, when bond yields rose despite foreign inflows, suggests that this is not the whole story.

Enter the captive bidders

Something besides increased foreign acquisitions of US debt, happened between the early 80s and the present day which slowly but inexorably swamped bond vigilantism. That something was an increase in social security (and related programs) net income which, I argue, dramatically changed the US bond market.

From 1955 through 1980, the US Treasury market was a mainly open affair, by which I mean, most of the issued debt was marketable. In 1955, non-marketable debt made up 30% of the total and in 1980 non-marketable debt made up 33% of the total. Bond prices were, in the main, set in open markets.




Captivating the Trust Funds

In the mid 80s, in accordance with the recommendations of ex Fed Chairman Greenspan's Commission of Social Security (boy this guy's fingers are in a lot of pies), social security taxes were raised which raised the percentage of national income flowing into social insurance programs from 7.2% to 8.5% (source BEA). While a 1.3% increase in national income flow (it amounts to an increase in income from 4.8% of GDP in 1987 to 5.6% of GDP in 2006) is substantial, it doesn't fully explain the substantial rise in social insurance assets.

If changes to the income side don't fully explain the dramatic rise in social insurance holdings, something must have coincidentally reduced the outflow, which fell from 4.6% of GDP in 1993 to 4.1% in 2006. That something was a change to inflation calculations upon which cost of living adjustments (COLAs) in social security payments are made.

According to John Williams' Shadow Stats site:
In particular, changes made in CPI methodology during the Clinton Administration understated inflation significantly, and, through a cumulative effect with earlier changes that began in the late-Carter and early Reagan Administrations have reduced current social security payments by roughly half from where they would have been otherwise. That means Social Security checks today would be about double had the various changes not been made.

Assuming Mr. Williams' estimate is correct, a doubling of SS outflow from the actual $549B, which produced a SS surplus of $185B, to $1,097B, assuming no changes on the income side, would have created a deficit of $363B. In turn, this would have forced the US Treasury to sell about $800B of securities into the market instead of the $250B they actually sold in 2006. I doubt current US Treasury yields would be at such low levels if such was the case.

But it is the case. Non-marketable debt has risen from the afore noted 33% of total debt to 49%. That's right, half of Treasury bidding comes from captive bidders. So much for a free and open market in US Treasuries.

In sum then, the cumulative effects of SS tax hikes, which inflated SS income, and reductions in outflow due to recalculated COLAs are, I believe, the primary cause of our strangely low bond yield environment in the US. As one who has cited with alarm the growth of Chinese reserves to and above the $1Tln mark, I was amazed to find that Social Security holdings have grown even faster, and now total some $2Tln.

Forget about China's, here's a sovereign wealth fund just waiting to happen.

But, as the saying goes, it isn't just the size of the ship that matters, the motion of the ocean does as well. Many financial commentators have (rightly so, in my view) worried about diversification out of $s among foreign countries with large reserves, yet few worry about a similar risk consciousness coming from within the US.

Imagine a financial world in which the managers of the SS Trust were able to diversify out of US assets. Minimally imagine a financial world in which the managers of the SS Trust were able to pick and choose amongst domestic investments. In that world, I doubt the chosen mix would be (as is currently the case) a virtually all US Treasury portfolio with an average interest rate of 5.2% and duration of 7.2 years. Simply shifting to a much shorter duration fund would cause the US yield curve to steepen dramatically.

Captive bidders and the Enron effect

That is, I argue, the captive nature of the SS Trust fund in conjunction with its size has been the main cause which engendered our low and reasonably flat curve yield environment. For it is the US Treasury itself which manages these funds. As those who lost all their retirement funds at Enron could tell you, captive trust funds invested in the company itself does not a diversified portfolio create- just the opposite effect is, in fact, created. When foxes (invariably from Goldman Sachs these days) guard the chicken coop, ultimately you have no chickens.

This too, however, shall pass. According to the SSA (Social Security Administration) by 2017, barring any further increases in taxes or calculation changes in COLAs, outgo will exceed income for SS and DI (Disability Insurance). National Health Insurance (HI) costs will deplete the funds even more rapidly. By 2041 SS and DI will have exhausted their funds and by 2019 HI funds will be depleted. So, within a decade there will no longer be additional surplus funds to be used to purchase US bonds which will have to then be sold on the open market. Call it peak SS Trust Funds, although peak trust might be even more apt.

In Greenspan we trusted

It is, perhaps, fittingly ironic that the same Greenspan who bemoans increased federal spending, recommended and oversaw the conditions which allowed such spending to occur outside of a free market mechanism. The same man who proclaimed, in his oft cited, Gold and Economic Freedom: 

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.


oversaw a tremendous confiscation of wealth, but not from the wealthy, from the common man. He has repeatedly said that he still stands by the views he expressed back in 1966 and I believe him. He (and others) used the lack of a monetary standard to confiscate wealth from us- wealth which was used, inter alia, to finance the current wars. Atlas, in this case, didn't shrug, he stole.

I expect, as increases in trust fund surpluses slow, US interest rates will rise, most likely dramatically in the years to come.

Four dead in Rangoon-o

Tin soldiers and Than Shwe coming,
We're finally on our own.
This summer I hear the drumming,
Four dead in Rangoon-o.

Gotta get down to it
Soldiers are cutting us down
Should have been done long ago.
What if you knew him
And found him dead on the ground
How can you run when you know?

Four killed as Burma Troops open fire

Wouldn't it be ironic, in a world where Zionists, Christian Fundamentalists, and Islamic radicals are all reaching for the Theocratic Ring of power, if the Buddhists were the group to inspire a re-think of the relationship between government and the people?

What a perilous situation for China. The Burmese Junta uses Tiananmen-like tactics on its dissidents and China's leaders are caught between the rock that they too might need to follow a similar path to retain power in the future, and the hard place that these tactics are, in a world, far removed from 1989, with instant communication open not just to the wealthy but to virtually all, ultimately self-defeating. If a Saffron revolution gets going, I suspect the Burmese Junta might not be its only victim

What a perilous situation for any oppressive regime. How can the Burmese Junta be wrong, but others right?

Has a butterfly just flapped its wings?

On Gary North's curious deflation call

My opinion was requested on Gary North's analysis that the Fed is deflating, contained in How Bernanke has snookered us all, so I went to his site to check out his views. To my surprise, I discovered that he now charges for his views (fortunately I still get a twice weekly blast, including the article in question from the Daily Reckoning). The cynic in me says that a shift to fee based commentary tends to engender overstated simplistic analysis and the argument that the Fed is deflating when growth in the monetary base is slowing but still positive seems to me an oversimplified overstatement.

But I'll add my two cents worth anyway, and given that my views are still free to you, 2 cents worth for nothing seems like good value to me. Of course, those 2 cents don't buy what they used to.

I assume that Mr. North argues within the framework of the quantity theory of money, i.e. crudely put, more is inflationary and less is deflationary. His conclusion of deflation also assumes stable money multipliers such that a decrease in the monetary base leads to decreases in broader money. If the MBase can fall while broader money supplies rise, the MBase will not be a good predictor as was the case when the money multipliers broke down when the Fed was aggressively adding reserves in the early 90s with little increase in inflation.

Of late the multiplier between the MBase and M2 is rising. Assuming John Williams' Shadow Stats are correct, that between what used to be M3 and the MBase is rising even faster, which suggests, a la, Doug Noland, that things are a bit out of the Fed's control.

I tend to agree with Mr. Noland's view that the monetary system is out of control, although I take a more narrow view of the transmission mechanism. During the Asian crisis, the Asian CBs, once they were forced to admit they had a problem, tried hard to tighten, but resolution of their international deficits swamped their efforts. Their currency overvaluations had first to be resolved before the tightening could have an effect. Thus we saw a large almost one step spike in inflation, as a result of previous monetary easiness and currency overvaluation, followed by a normalization.

The problem, in my view, with traditional quantity theory is that it was based on a far more autarkic model, or at least one in which international imbalances would tend towards balance, as IMF policy requires. Open capital accounts make such analysis much more complex in the event, such as exists now with the US, when international imbalances are large and growing.

I like to think of the accumulated foreign official sector holdings of US$s as "stored deflation" in that it gives these foreign CBs bonds to sell (the quantity of which, in toto, is far in excess of what the Fed currently holds, btw) which, when sold, will withdraw liquidity from the market, other things equal.

If and when the accumulation of these holdings goes into reverse, as they must, assuming the current system isn't changed, the Fed will face a similar dilemma as the Asian CBs. If they want to stop an inflationary spiral, they will need to tighten internally while the international markets are tightening for them. That is, US bonds will need to find their clearing yield based on private sector preferences, a yield I believe will have 2 digits, not 1.

But the Fed faces a problem the Asian CBs didn't have to worry (much) about, the derivatives monster. A spike in interest rates will push the big banks' derivatives books into insolvency, and as the derivatives books go, so do the banks themselves.

Assuming the Fed doesn't want that to happen, they will need to be the buyer of last resort in the bond market. That is, in order to keep the financial system functioning reasonably smoothly, without letting interest rates spike, the Fed will need to take these foreign official sector holdings released into the market on its balance sheet, which means the monetary base will rise.

In a sense, this is almost the reverse of the problem Greenspan faced in the early 90s as foreign holdings started to rise dramatically. The buzz phrase back then was "pushing on a string", the Fed let the MB grow by double digits for years without much effect on inflation. Now, using the same metaphor, if the Fed pulls on that string, it will break.

The underlying problem is this- bond yields are, due to years of public sector intervention, way too low to attract private sector interest. Somebody has to eat this loss, and in the event, as I suspect, this somebody is the Fed, Gary North will see the monetary base expand rapidly (as he notes at the end of his analysis, with agreement from me) and inflation will be the result, whether Bernanke likes it or not.

Is the globalization put expiring?

Whose put is it?

Many readers of financial commentary are likely familiar with the phrases "Greenspan put" and "Bernanke put." These phrases refer not to an actual contract but to a belief that the two successive Fed Chairman would ensure that fear of cascading defaults should not be part of the calculus of financial speculators.

In my usual role as an iconoclast I take a different view of the source of this put. It is not, I argue, faith in the abilities of these two men and their money machines which has kept a floor under equity and bond markets over the past 15 or so years, but faith in the economic virtues of globalization.

This isn't to argue that Greenspan and Bernanke haven't done their job of enforcing the faith, they have. Each time faith in the current experiment in monetary globalization fades, the Fed punishes the unbelievers. But the faith which backs the put is not, I contend, in these two men, but in the virtues of a globalized economy- economies of scale and reductions in redundancies.

I argue that the faith is not in the Fed Chairmen because there have been other Fed Chairmen who played fast and loose with policy, Arthur Burns comes to mind, who did not inspire the same effects. Loose monetary policy during Burns' time, when economies were more autarkic, led much more rapidly to domestic inflation- an effect I believe will become more prevalent as time passes.

War and free trade as opposites

Although there are many bumps in the road to a truly globalized economy, notably impediments to the free movement of labor, and the desire to retain sovereign rights to issuing debt, which most nations are loath to lose, in my view, the stake in the heart of the current attempt to globalize, which mirrors the cause of the end of last attempt in the early 20th Century, is war, and the fear it engenders, loss of sovereignty.

The commercial benefits of economies of scale arise, in part, due to the reduction in redundancies. David Ricardo's work on free trade and comparative advantage speaks to these benefits. And, I believe, the willingness of the financial world to accept what would, in other eras, have been considered imprudently loose policy, as prudent, is due, in large part, to the hoped for benefits at the end of the globalization rainbow. Nor, I believe, is this faith misplaced, in theory. Sadly, for those invested in globalization, theory needs to become practice for the benefits to accrue. Redundancies need to be reduced in order for the hoped for future to materialize and war is the greatest impediment in their reduction.

Waging war effectively requires just the opposite intent as free trade commerce- redundancies become necessary because you cannot rely on your enemy to trade with you. You cannot partake in your enemy' comparative advantage nor can he in yours as they will both be used against each other.

US military might as accepted comparative advantage and its loss

The US, in the aftermath of the first Gulf War, due to the wisdom of Bush the elder's administration in operating under the aegis of the United Nations and opting for a police action rather than a change in sovereignty, found itself in the position of both having a comparative advantage in warfare, and having the trust of other nations that the advantage would not be used against them. Other nations of the world, back then, did not, in the main, fear that comparative advantage. They were content to pay the US for its services when the need arose as the US would pay the Saudis for their comparative advantage in producing oil.

The change in tactic by the team of Bush the younger, away from the UN, and towards unilateralism, has engendered this fear of the US' comparative advantage in war. This fear has led to a resurgence in military spending in other nations- redundancies are coming back into vogue.

And it is this return of redundancies, from military might, to energy and food, which signals the expiration of the globalization put to me. Resources will not be seen as something which are shared and directed to those with comparative advantage at using them, but things to be hoarded by each group, for fear of getting left out.

Moreover, globalization requires a breakdown of national boundaries, such as partially occurred with the Euro, the imposition of which was, in my mind, the high point for this round of globalization. Of late, the trend seems more towards the breakdown of previously unified political blocks. Iraq itself seems ready to degenerate into 3 separate countries, which will engender further redundancies. If the current intra-European tensions become more intense, due to further inflation, et. al. and the Euro itself is abandoned, globalization will be truly dead, for this era. I'm not forecasting this, but the possibility seems open.

Why should the put expire?

If, instead of betting on the expected reality of the virtues of free trade, which have been slow in coming of late, people had merely hoped for the virtues of free trade, there would be no put to expire. But massive bets, built on the faith that international imbalances would not be a problem in a globalized economy, which would be, to some extent, true if such would come to pass soon, have been placed. Each of these bets, as with all financial transactions which settle in the future, has an expiration date, so too, conceptually, do the aggregate of those bets.

As faith in the realization of imminent globalization fades, concern over the resolution of international imbalances will grow. What used to be considered un-problematic (Cheney's purported quip that deficits don't matter) will be seen in a new light, call it financial revelation. Failure to resolve these imbalances gracefully will only exacerbate the growing distrust between nations. In extremis, international trade itself will decline and a new round of autarkic minded governments could come to power as happened during the days of FDR.

Of course, current trends need not be continued. The US could reduce its presence in Iraq and let them operate under their own sovereignty, and avoid further confrontations with Iran. The US could, that is, come back to the UN and use its military as a UN police force of sorts. Unfortunately, having invaded one country, it will be far more difficult to earn the same trust which was evident after Gulf War I. Moreover, the domestic drive for war is difficult to stop once war finance has metastasized through an economy and significantly altered the flow of funds. These changes will be difficult to make, and thus I don't see much hope for the globalization put living much longer.

Brass Tacks

Although I suspect the globalization put is expiring I don't think this will mean that Bernanke will stop enforcing the faith as he has been doing. Rather, I believe that their efforts in adding liquidity will create more inflation than they have in the past, as seems to be happening now. Faith in the virtues of globalization masked concerns over imbalances and monetary laxity, and the lack of faith will have the opposite effect, the leaving Bernanke and his successors in the "anguished" position of Arthur Burns.

A breakdown of trust between nations, such as might occur if international imbalances are not resolved gracefully, may well reawaken faith in the virtues of hard money. One doesn't need to trust in a foreign nation's monetary policy when imbalances are settled in Gold, rather than currency.

As a practical matter, investments in the precious metals and commodities in general should thrive if the scenario I've painted comes to pass. On the flip side, the current period of low interest rates will likely end, which will weigh heavily on both bond and equity prices.

Northern Rock queuers: Don't they get it?

Meanwhile, anxious Northern Rock customers, who waited through the night to take out their savings this morning, were branded "irrational" by the chairman of the Financial Services Authority. This is London

Why, you might be wondering, would the Chairman of the FSA brand those queueing to withdraw their savings from Northern Rock, "irrational?" Surely it isn't irrational to worry about one's deposits in a bank with a very imbalanced balance sheet?

Perhaps the people queueing to withdraw their deposits didn't get the memo.

"What memo?" you ask.

The memo which said that all deposits in the anglo world's financial system would be made good, guaranteed by the government, as is being done to the remaining deposits at Northern Rock. As the deposits at Northern Rock, and likely those at any other financial institution caught in this mess, are to be made whole, in more fiat money, of course, the queuers deserves to be branded irrational. Right?

Not so fast. While in small doses, such actions will not have a large effect, en masse, a policy of this sort will lead to significant currency debasement. In that case, at current rates of interest, getting one's deposits out of the system and into the precious metals seems quite rational indeed.

Gordon Brown might be pleased to have dodged this bullet, but I wonder how he feels about selling off Britain's gold, under $300 per oz. Who knows, Gordon, that stuff might come in handy some time soon.

Open letter to Tom Engelhardt

Tom,

I admire your courage in broaching the topic of the Zionist influence on American policy outlined by Mearsheimer and Walt.

When I read their book, Barbara Tuchman's almost wistful memories of her assimilationist-minded family, described in Practicing History, came to mind.

In my view, the promise of the modern world- transcending the tribal aspects of religion without losing the lessons therein, applied to all men, died when the Zionists wrestled control of public Judaism from the assimilationists. The radical, retrograde dreams of a tribal Islamic theocracy, which seemed to be dying a well deserved death with the dissolution of the Ottoman Empire, were thereby revived, as were the always slumbering dreams of a Christian Theocracy in America.

The unintended irony of supposed monotheists who proclaim, a la, Boykin, that "my god is bigger than your god," would be comical if its effects weren't so tragic.

I still have faith that the public discourse of man will, one day, come to accept the truth of monotheism- all the great religions are but different reflections of the same eternal truths. And that day can't come soon enough for me. Tribalism is such a drag.

I wish the assimilationists success in their philosophical counter-attack on Zionism. More importantly, I pray on behalf of all my Jewish friends, and the millions of other good people of that faith, that the pendulum doesn't swing too far the other way. In our still tribal world, this is a perilous tightrope to walk.

dreaming of a day when we can all live together accepting our differences,

The Dude

Greenspan the collectivist forgot about Gold

The human race has never found a way to confront bubbles. Alan Greenspan

It has been a few decades since Al Greenspan was a devotee of Ayn Rand, and it shows. I'm not much of a fan of Rand as I found her philosophic views tended to steam roll over the, in my view, important questions of consciousness and totally missed Hume's point on the failure of reason alone, however, she did have her moments. Her steadfast defense of gold as money is a case in point- a point obviously lost on Greenspan over the decades.

Greenspan's quote above is, in my view, true if one assumes that confronting a bubble means stopping it entirely thereby saving all participants from its nasty effects. The interplay of ignorance, deception and concentration of power with respect to money makes me doubt that we ever will find a way to avoid such problems, en masse. Of course, the same can be said for many of the ills mankind faces. As the saying goes, you can lead a horse to water but you can't make him drink (or in this case, think).

I wonder from whence Greenspan came up with this idea of saving everyone, which is a very collectivist conception. If freedom means anything it must include the freedom to fail as well as succeed. Perhaps Greenspan thought of himself as a monetary messiah.

However, there is another way to interpret the quote above. The human race did come up with a way to confront bubbles but the Central Bankers have been endeavoring to take it away- Gold.

Moving one's savings out of a financial system run amok and into Gold is a way to confront bubbles. Those, like me, who have taken this route have managed to preserve far more purchasing power than those who stayed in the system, despite the best efforts of the Central Banks. They apparently believe that truth is a matter of faith- the more people who believe a proposition, the truer it becomes.

Gold's ability over the millennia to retain purchasing power was, I believe, one of the key reasons it was chosen as a basis for western monetary systems as commerce emerged from Feudal Europe.

Although a gold standard will not stop bubbles from forming, its effects on the behavior of people in such systems tended to facilitate the termination of the bubbles which did form- making their duration shorter and the end result clean up faster. It did this by giving the people a way to both escape the system and vote on it at the same time, which in turn tended to keep the bankers on their toes. I doubt the derivatives mess would have grown nearly as large, thus making its clean up easier, had such a system been in place- a point worth considering whenever you read some commentary on the intractable problems appearing as the world tries to fix this disaster.

Greenspan's faith in the abilities of central bankers, who, as another of his mentors, Arthur Burns, warned in The Anguish of Central Banking, must operate in a political climate, is his blind spot in this regard as it leads him to the collectivist view that they should govern the many. I hope the human race learns once again that we did find a way to confront bubbles, we just threw it away.

On uncertainty of the Orwellian variety

During times of universal deceit, telling the truth becomes a revolutionary act. George Orwell

I suspect when Frank Knight wrote about uncertainty he was referring to that which occurs inadvertently. There is, however, another variety of uncertainty which is evoked by language intended to deceive- the uncertainty of which George Orwell wrote. War is peace. Freedom is slavery. Ignorance is strength- you get the picture. The aim of those who employ these tactics is to confuse the masses, which they do. But, as Orwell warned, if thought corrupts language, language can also corrupt thought. This type of deceit usually backfires because to tell a lie convincingly you must believe it yourself.

Take the most recent case of Sen. "wide stance" Craig, who wants us to believe that a resignation is not a resignation, or to be fair, an intent to resign is not really an intent to do so. The cynic in me argues that his true intent was to give the masses what they wanted and when things calmed down to remind us that he didn't really resign. While I find the gestapo tactics of the police in this matter to be a bit harsh I find his attempts to wriggle out from under even worse. Better, I think, to be straight up front- of course this is difficult when you're trying to distract people from the skeleton in the closet (who apparently doesn't want to come out).

Moving to economics, I find the linguistic gymnastics deemed necessary by the powers that be quite comical. Having massaged the statistics, or in the case of M3, dropped them down the memory hole altogether, and having declared the economy to be strong, robust, best ever (take your pick of positive adjectives) and not wanting to shout "fire" in a not yet burning theater, our economic solons are in something of a bind. They can't say that the financial infrastructure of our nation is teetering on the brink, or that the sub-prime loans problem is becoming a mess for the broader economy so they declare it contained. Heck, we can't even use the phrase "bail-out" when the government bails out the banks and their victims. If our economic managers ever wish to get ahead of the game they are going to have to try to tell the unvarnished truth and avoid managing expectations.

On the topic of sub-prime loans, I wonder if our foreign creditors would have been so eager to buy them in packaged bulk if they had been properly named- poorly collateralized loans to people unlikely to repay. I suspect bonds bearing that name would not have sold nearly as well.

Of course, the fun doesn't end there. The whole infrastructure of finance has been torn apart by Orwellian confusion. Banks, by virtue of all the linguistic gymnastics, as Paul Krugman and then BBK President Axel Weber put it, are no longer banks. Paul Kedrosky calls the current mess a non-bank bank run, a styling of which Orwell would be most proud.

The root cause of the mess, in my view, was a desire to do an end run around the Depression-era baking regulations by changing the names. If a bank was forbidden to do something a new entity was created, think Mahonia Ltd. and Enron, and it was done, all off balance sheet and outside of regulations. The US government is no slouch in this department either, although they simply declare more and more deficits to be off balance sheet. Thus a US$425B (through July) increase in the public debt becomes a deficit of US$157B.

Of course, as we are now learning, just because something is off the "official" balance sheet does not mean it won't have an effect. Rather, it means that the traditional tools we had used to solve such problems are no longer effective because the problems are "hidden" in the newly created non-bank financial sector. As Axel Weber put it:

The current turmoil in the financial markets has all the characteristics of a classic banking crisis, but one that is taking place outside the traditional banking sector.... the only difference between a classic banking crisis and the turmoil under way in the markets is that the institutions most affected at the moment are conduits and investment vehicles raising funds in the commercial bond market, rather than regulated banks. These entities were inherently vulnerable to a sudden loss of confidence on the part of their funders because “there is a maturity mismatch” on the part of financial institutions that have invested in long term mortgage-backed or asset-backed securities using short-term finance.

The rhyme from Sir Walter Scott's Marmion comes to mind: Oh what tangled webs we weave when first we practice to deceive.

I'm glad I stuck with my Gold, which, by the way, isn't non-Gold gold, but the physical variety.