Dana Blankenhorn

The Oil Standard

Think of this as Volume 11, Number 18 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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I have long been intrigued by what stands for value. (Picture from The Zoo.)

Throughout the 19th century, gold was the standard of value.

The 1896 Crisis, the Cross of Gold speech, these were outgrowths of the 1895 gold loan by J.P. Morgan to the U.S. government in exchange for bonds, which Morgan then sold at the "usurious" interest rate of 4%. With gold as the standard of value, the value of other commodities (like wheat) withered. Farmers suffered, bankers gained. The farmers' uprising was called Populism, and it made Democrats dominant in the farm belt for decades.

Today we have a new standard of value. Oil. And the impact is much the same. For wheat read dollars, for farmers read Americans, and for J.P. Morgan read the Saudi sheikhs, Hugo Chavez and Vladimir Putin.

What makes a "strong" store of value is the fact that its supply is limited, that it doesn't inflate. It's stable. It's sound.

The U.S. dollar is no longer sound. It's being tossed out by Helicopter Ben the way farmers a century ago tossed wheat on the market, and the result is very predictable. The age of the "dollar standard" is over, and while the world seeks a new safe haven, oil will do nicely.

There can be only one response.

Class War

What was the most amazing statement in this week's ABC debate?

For my money it was anchor Charles Gibson's assertion that $200,000 is a middle class income. It is, in fact, within the top 4%.

The Census Bureau estimates the current median family income at $62,228. It varies by state. As high as $78,000 in New Jersey, as low as $46,000 in Arkansas. A median income means half of all families make more than that, half make less. It's a true, real-world average.

But I have no doubt that, to Gibson, his statement was right-on. Half the people he knows make more than $200,000, only half less. Which is precisely the problem.

If you make your living as a talking head, on network or cable TV, it's almost certain that you are, by most common definitions, wealthy. This is true for those so-called "newspaper" people you see on TV, not to mention nearly all the pundits and "strategists" who populate the political chat shows. (For the record, our family is doing just fine -- nowhere near $200,000, though.)

This is a very important point to understand when you're looking at today's media. If there is a class war -- and I would argue that there has been for many years -- everyone on the tube is on the rich side of that divide. Everyone, whether they're claiming to argue for conservatives or liberals.

This was not always the case. When I was a kid journalists were truly middle class, their incomes close to the median. Top editors were a bit above, reporters were always below. Our job was to identify with the middle class, and with those who had middle class aspirations. We could do that because that's where we lived -- in the middle.

No more. Now those paid to supposedly advocate on behalf of the middle class are themselves far above that station.

Housing Bailout, Dollar Bubble

Here's how it's all going down. (Picture from Rev2.org.)

The Federal Reserve prints enough money so that banks can write-off the Big Shitpile and acquire the liquidity they need to make new mortgage loans.

That's what is in fact happening. The Fed has opened its lending facilities to investment banks as well as commercial banks, and is taking whatever junk these guys have for collateral. That's a nice CDO based on Las Vegas sub-prime mortgages you have there, I'll loan you 100 cents on the dollar for it.

It's possible that J.P. Morgan is telling the truth, and the loans being passed to the Fed's hands in the Bear Stearns deal aren't the worst of the worst. But that's just the tip of the iceberg. The IMF estimates there's $1 trillion of dodgy paper about, most of it American (although some is British, which is why the Pound is under $2 while the Euro climbs to near $1.60.)

The consumer aim in all this? To keep nominal home values at a level such that millions more home loans won't go underwater. That is, say your $300,000 home should really be worth $150,000 in a real market, as it should. The Fed pumps enough new dollars into the system that it's still worth near $300,000, and you feel pretty good. Trouble is the $300,000 is really worth what $150,000 was worth before the bailout started. The market has done its job but you don't notice until you do the math.

Bias Doesn't Help

Having been a business reporter for 30 years this summer I understand the natural bias to identify with your subject.

The job of a journalist is to organize and advocate an industry, place or lifestyle. Thus, a certain bias favoring the political views held by the group you write about is natural.

But at some point your ideological blinders have to come off, or else you're doing your readers and viewers a disservice.

This has plainly happened with the financial press.

Media coverage of the Big Shitpile has ignored the Big Fact. This happened because unregulated markets were allowed to be created, to grow, to soak up much of the world's capital. When two brokers or hedge funds repackage mortgages or other things into new types of trading instruments, they are printing money, just as the Federal Reserve prints money. They're doing it in the same way, by declaring the existence of new paper, by putting a price on it, and making a market in it.

Anyone who does this has a fiduciary responsibility. You become the trustee of your investor's interest, which is supposed to trump your own. Ethical rules can police such a responsibility. So can laws and regulations.

What happened in this decade is entirely new markets and new instruments were allowed to be created, which lacked these controls.

Nothing I have seen, either from the Administration or the financial press, addresses this key point. Nothing I've seen endorsed from either is designed to control these markets. It's all window-dressing, pushing papers and organization charts around in the appearance of doing something while in fact doing nothing.

This guarantees the scandal will happen again, sooner rather than later.

Will you read this in Forbes? Will you see this on CNBC? No you won't. Jim Cramer won't tell you either. The ideological blinders of all these outlets cause them to hide from this simple truth.

We must regulate our markets, or we will lose them.

Let me put this in a way Cramer might understand. You have two casinos. One is regulated. The other is not. Where will you place your bets? Will you do it at a place where, if the casino plays 3-card monty on you they will be caught and punished? Or will you do it where the game is crooked and there's no cop on the beat?

Regulators are cops. When conservatives go on this knee-jerk "anti-regulation" jag they're arguing for lawlessness. Markets which can't guarantee transparency, which act as unregulated casinos, will over time be rejected in favor or markets where honesty is assured.

The growth of the U.S. financial industry over the last 80 years has been driven by its honesty, by its transparency, by the wealth of information on players and games which regulators of all types have imposed. Eliminating these regulations, or going around them, does not make markets more efficient. It makes them more crooked.

Law good. Lawlessness bad.

Halfway Through the Process

The first part of our national economic nightmare is over.

But only the first part. (Picture from Cashflowrollercoaster.com.)

What we've seen in stocks is a classic bear market. Prices fell roughly 20% from their highs, from over 14,000 to (briefly) under 12,000. They then re-traced about a quarter of that loss, and if they go higher still it's no all-clear signal. Most bear markets retrace half their initial loss.

What happens next is a test of the lows. This is just what happened nearly a decade ago in the dot-bomb. It's what happened in the "Asian contagion" of the late 1990s, and in nearly all previous bear markets. If the lows hold it's over.

But the lows don't always hold. That was true for Japan after 1987. It was true for Wall Street after 1930. And in this case there is real fear that the lows may not hold.

The reason is that under all this crap is the Big Shitpile, the mortgage derivatives created by unregulated markets over the last few years. Basically investment banks were creating money on their own, with no controls, by simply defining new securities based on these mortgages and selling them as though they were worth something. The ability to do this inflated home prices, because lenders didn't have to consider the risk a borrower wouldn't pay. The unregulated market was hungry for any new collateral.

Federal Reserve intervention staved off the first phase of panic, but there could easily be more to come. Millions of mortgages will re-set this year. Millions more are "underwater," more money owed than the value of the home. These are both opportunities for speculators to get-out, and since the bankruptcy law of 2005 made home debt less important than credit card debt (you have to pay the credit cards in bankruptcy now, but you can walk away from the home) there may be millions more foreclosures to deal with.

Each one of those foreclosures will have a ripple effect. Each mortgage is tied to other securities, all of which default or lose value when a homeowner walks away. How many are there? No one really knows.

So far home prices have dropped about 11%, and newspapers are saying this is a disaster, but it's really not a big deal. I think prices will fall by at least 20%, probably more, meaning lots more mortgages go underwater, as lenders tighten their standards, knowing they may have to hold the paper themselves for a while.

We have yet to see the second leg of this thing, in any market.

It's Not That They're Clueless

Think of this as Volume 11, Number 11 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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My blog friend Oliver Willis calls those in charge of our financial house clueless.

That's an easy mistake to make.

In fact, it's in the nature of our economic system that you go right up to the line of legality in order to maximize profit. Anyone who doesn't do that is an economic loser, either in the short run or the long run.

You want to go right up to the line, peer down over the edge, and maybe move your toes back a bit. That's what your lawyers are there for, to move your toes back a bit.

This is fine so long as the law is reasonable. If the law is reasonable and cops are on the beat, walking right up to the line of legality and staring down into the canyon is both legitimate and good business. It's what makes markets efficient.

The problem in this case is the law was made unreasonable, and the cops chose to look the other way.

All the problems Bear Stearns caused were through the creation of new, "unregulated" markets. An unregulated market is a market that's looking for scandal. Because there is no reasonable line you can walk right up to, it's easy as heck to become Wile  E. Coyote in such a market -- everything is fine so long as you don't look down.

The defaults on sub-prime mortgages last year were when we started to look down.

A Bigger Crime Than Iraq

With very little fanfare, a bearded bureaucrat about my age recently committed a bigger crime than our entry into the Iraq War.

Ben Bernanke, whose title is Chairman of the Federal Reserve Board, is committing half your country's capital -- $400 billion -- against securities  he knows are bogus, home mortgages that should never have been made, collateral instruments that should never have been created.  He compounded this crime yesterday by explicitly bailing out Bear Stearns, the investment bank which more than any other created this Big Shitpile.

The excuse, given even by liberals like Paul Krugman, was that Bear is "too big to fail."

Bullshit.

The Manchurian Presidency

The Manchurian Candidate is about a Communist plot to install a dupe, played by James Gregory (left in the photo at right), as President. He claims to be fiercely anti-communist, but he's really controlled by the communists through his wife, played by Angela Lansbury. (Sorry if I spoiled it. Watch it for Frank Sinatra next time -- one of his best roles.)

Ever since the movie returned to vogue politicians have been warning that their opponents are secretly working for the other side. The claim is made this cycle about Barack Obama. That is, Barack Hussein Obama.

Of course, this deliberately misses the plot. The James Gregory candidate is a perfect conservative, a neo-McCarthyite. In 2008 parlance, he's McCain.

But what if the Manchurian Candidate has already been elected? What if, in fact, he's been in office for over 7 years?

The Virtuous Cycle of a War Against Oil

Think of this as Volume 11, Number 10 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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Right now the U.S. economy, and the U.S. in general, is in a vicious cycle. (Picture from DC Fred  .)

Wealth is decreasing, so sales are slowing. Sales are slowing, so the economy is tanking. The economy is tanking, so the dollar is tanking. The dollar is tanking, so we're importing inflation. Prices are rising so we can't cut interest rates. High interest rates causes wealth to decrease...lather, rinse, repeat.

What if we could replace this vicious cycle with a virtuous one, as we had in the 1990s?

We can, but it can't be the same. Back then we were building the Internet. That's built. We could improve it, add lanes, add competition, and that would be a very good thing indeed, but it won't provide the kind of virtuous cycle we got back in the day. Sorry.

But we can get that virtuous cycle if we commit to a War Against Oil.

What does a War Against Oil mean? It means a total commitment, on the order of a real war (not the kind we've been fighting in Iraq) to eliminating the use of hydrocarbons in our lives. That's the clearly defined victory, and (as the current President likes to remind us) nothing less than victory will do.

How do we do it?

Seeking Bottom

Markets are a lot like alcoholics. They can't start their recovery until they hit bottom.

In an auction market, like stocks, this happens fairly quickly. The buyers disappear, and sellers capitulate, those who were burned by the bubble lick their wounds.

The bottom is not reached until you have an honest "buying opportunity," based on fundamentals, usually at a valuation of about half what the commodity was worth before -- often less. Often this bottom will be tested, and for years after a bust your gains will be modest, even if you got what looked at the bottom like a bargain.

The End of Impunity

One thing which has marked the last two decades, and it's as true for ordinary people as for our leaders, has been a sense of impunity.

Democrats complain often of how the Bush Administration displays impunity. The rules don't apply to them. They make up their own reality. The President cannot break the law.

We talk a lot less about our personal impunity. We can buy what we want. We can walk away from our debts. We don't have to make hard choices.

Democrats most fear talking about the impunity inherent in their own positions. We'll get out of Iraq on our own schedule, and stay in Afghanistan "to win," they say. We'll give ordinary people tax cuts and raise spending on health care and education.

The end of all this impunity is a big theme in our current crisis and all of us -- Democrats, Republicans, consumers, businesses -- remain in the denial stage of the process.

Last week's biggest story may have been Joseph Stiglitz' (above) estimate of the Iraq war's cost -- $3-5 trillion. (It's all here in his book.) The figure seems unimaginable so let me put it into perspective.

It's going to cost the U.S. its autonomy. It's going to cost our currency. It's going to cost you your life savings, and me mine. It's going to end the era of American impunity.

Through the Looking Glass

For 75 years, since the depths of the Great Depression, American economists and policymakers have offered just one cure for economic problems.

Liquidity.

Liquidity means the injection of new money into the economy. This is done through monetary policy, cutting the cost of money directly by the Federal Reserve, or through fiscal policy, spending more than the government takes in.

Of course, there's another word for liquidity, and that word is inflation. The film above, produced in 1928, illustrates the hyper-inflation which began the rise of Hitler in Germany.

Once a nation goes through hyper-inflation its people get the message through suffering. Your life's savings disappear. You can't afford food or other necessities. The government can't really help anymore because they're using the same worthless currency you are. Pretty soon you're down to barter and the use of foreign currencies. It's happened many times, especially in Latin America, and the answer of American policymakers was to peg those currencies to the dollar. The dollar was the strong currency.

Is it?

When you're running deficits of $300 billion or more a year, you print money to make up the difference. When you cut interest rates below the rate of inflation, you're printing money. When you offer tax cuts -- to the rich, to the poor, to anyone -- or a "stimulus" package you're printing money. When you tell banks, give us your broken-down loans and we'll lend you 100 cents on the dollar on them, you're printing money.

Nearly everyone across the political spectrum, with the notable exception of Ron Paul, thinks these policies are dandy. And they offer little else in response to them. Paul, however, is a nutcase -- getting rid of the Federal Reserve and going to a Gold Standard won't solve the problem either.

The answer is to start paying down debt. The answer is to start producing more goods. The answer is to turn around our current accounts deficits, and our fiscal deficits, and start paying down our loans. This is what worked in the 1990s, and yet no one has proposed it in 2008.

Instead we get whining when lines of credit which aren't being used correctly are cut off. (Borrowing on your house to pay for pre-school is stupid.) We get nods of approval for more deficits from people like James Surowiecki, who should know better. We get predictions of doom from Nouriel Roubini, but no clear course out.

What can be done?

The Unstoppable Power of Communication

The most powerful force in the world is communication.

This medium brings more of it within reach of more people than any medium has before. (Pictured, the capital of Rwanda.)

When George W. Bush was in Africa this week reporters were astounded by the number of people there who supported Barack Obama, who seemed to know all about him.

And why not? Africa is filled with Internet cafes. Africans don't have to listen hopefully for a word from the BBC anymore. They can pick up The New York Times.

Recently I mentioned the idea that Obama should go to Kenya and try to sort out the growing crisis there. Turns out he's been there, via radio. He made a statement and took questions at the end of last month. This has not yet had an impact, as the struggle has morphed into a tribe-on-tribe war over land. But he was there, and could be again, at any time.

It's not just politics where this medium is making enormous change. It's in every facet of life. The turnaround in Rwanda is being driven as much by information as anything else. The use of sympathy to reach markets, and the opening of an online stock exchange,  is enabling capital to reach all of East Africa. Trouble in Kenya can now quickly move capital to Rwanda and vice versa. Rapid capital flows can create a gigantic incentive to make peace.

Al Gore as a King in New York

One of the most important, least understood stories of this year has been Al Gore's reluctance to endorse anyone. (Picture from The Atlantic, originally taken by the World Resources Institute under a Creative Commons license.)

There are all sorts of theories, but only one theory makes sense.

He has better things to do.

As I wrote in November, Al Gore is focused on market solutions to the War Against Oil. He has learned, through his work on An Inconvenient Truth and all the opportunities which flowed from it that the power of money can actually be greater than the power of government. He has also learned that money follows credibility.

During 2007 Al Gore signed some very, very interesting deals. He signed deals with venture capitalists, and hedge funds. The core of those deals was that Gore, and people working with him, would go through all sorts of alternative energy proposals, not just those in the market, but those seeking market funding and those still in the labs. He would offer his considered opinion on the validity of each idea, helping to make sure that capital flowed efficiently toward ideas which made the most sense. And he would profit from that.

The Next Shoe To Drop

Since the Big Shitpile appeared, almost a year ago now (real estate markets move slowly) we've seen the damage move from mortgage lenders to home builders to banks, to Wall Street.

The next shoe to drop is going to be the construction industry.

This becomes clear in reading the whining of Michael Hill, CEO of "luxury homebuilder" Emerge Homes, which was printed in my daily fishwrap today but apparently originated at The Washington Post. Please, get out the violins and hankies:

There may never be enough capacity to absorb all of these homes and other existing homes using 30-year mortgages, because there simply aren't enough people with the incomes to meet the requirements. Prices could not roll back far enough without damaging the economy irreparably.

Irreparably means beyond repair. It means a problem lies beyond any solution, ever. Kind of like the problems of the dinosaurs are irreparable, or those of the British Empire.

He's right in this respect. It's very likely that Michael Hill, and many people like him, will be unable to survive the adjusting of home prices to market, the 50% haircut of a balloon market. Somehow the dot-coms survived it and the biotechs survived it and even the Japanese survived, it, but such a haircut would do "irreparable"  damage to the U.S. economy.

Hill's suggestion? Create new kinds of financial instruments, like, say, 50-year mortgages, so that home prices can stay where they are, with maybe a tiny little adjustment.

Three words for Mr. Michael Hill. Suck on it.

Have You Heard The Good News About Pakistan?

Pakistan has recently taken on the role Americans once reserved for Iraq, Afghanistan, Serbia, Iran, and (before that) the Soviet Union.

It's the unknowable, foreign, other, dangerous in the extreme. It frightens the children. It's meant to.

We're told, for instance, that Pakistan harbors Al Qaeda, its government is unstable and autocratic. It's the world's most dangerous place.

Maybe. But when you see Pakistan through Pakistani eyes, as it is my privilege to do, it's not so black-and-white.

My friend Tariq Mustafa IM'ed me from Karachi this morning with some of the good news:

• Every corporation in the Karachi area filed their tax returns electronically for 2007. I'll bet you money that's not true in Georgia. Many companies here haven't even started in on their returns.
• A job board launched by two Pakistani emigrants to Stanford now powers some of the biggest blogs in the valley. Silicon Valley, that is.
• oDesk is illustrating their outsourcing capabilities by showing off opportunities in Pakistan.

First Real Recession of the Internet Age

The proof is in. We're entering the first true recession of the Internet Age.

It's true there was a technical recession early in 2001, six months of negative growth caused by the dot-bomb. But this was mainly a product of the Internet itself, a relatively small excess that was quickly squeezed out.

The current recession is something very, very different.

First understand what recessions are. They're excess. They're a process by which the economy squeezes some form of excess out of the system, the way you would wring a mop, before continuing on with the job.

Second, the Internet allows markets to re-adjust very quickly. Back in the day we had recessions every few years, due to an imbalance between inventory and sales. When you have bar codes in the cash registers which can interface with demand to the factories, that can't happen.

The same sort of thing happens in other types of market speculation. The 24-hour market day means a panic in one place is seen as opportunity somewhere else, and the vacuum is filled as fast as a thunderclap.

Generally this is a good thing, just like airbags in a car are good things. But just as airbags cause gasbags to just drive faster, the recession prevention of the Internet causes bad policymakers to make things worse. And they have.

It took an enormous conspiracy to create this recession. The causation chain starts with Fannie Mae and Freddie Mac, which first collateralized groups of mortgages into salable instruments. But Wall Street sharpies took this one step further, creating other instruments based on that collateral, creating insurance of that collateral, and essentially creating the Big Shitpile we see today.

Why the Smart Guys are Panicky

The mood at the end of the annual Davos retreat of big moneybags was, in a word, scared. (Picture from Freakingnews.com.)
 

They're looking at the world economy the way New Orleanians looked at the TV weather shows a day before Katrina hit. They see the thing blossom before them, they're told it's headed right for them, but there are no freeways out of the money business. You gotta own something.

Why panic? The cataclysm has two components:

1. Big Shitpile, the corruption and greed which created the housing bubble; and
2. Stagflation, our dependence on oil and its suppliers' ability to manipulate the price.

History shows that whenever excess, a bubble, is found within the market, you can't turn things around until that excess is wrung completely out. Think about the dot-bomb. Some of the best companies lost half their value. Some lost 90%. Many went under completely. Now that the housing bubble is obvious that is what has to happen.

And the impact of making that happen is catastrophic. Think about it. You've got a $250,000 house. Before this is over it might be worth $125,000, it might be worth far less. Your buyer has to qualify for a fixed-rate mortgage, and put down a substantial down payment. Now how much do you owe on that house? I'd venture to say very few mortgages are half-paid off. And what happens to a loan when the value of the collateral falls below what you've borrowed? Well, on Wall Street they call that a margin call.

What we're seeing right now might be just the tip of the iceberg. Because all the excess has to be wrung out -- in home prices, in the mortgages underlying them, in the derivatives and other crap made with those mortgages.

Yet that's just half the problem.

Hershey Bars for Rich Kids in Harbour Green

Think of this as Volume 11, Number 4 of A-Clue.com, the online newsletter I've written since 1997. Enjoy.

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This is my Alex Baldwin story.

Not Alec. Alex. The father.

When I knew him, I was a toffee-nosed rat-faced git of 15, and he was running the summer camp program for the Massapequa Schools. The rest of the year he was a gym teacher at McKenna Jr. High.

We were coming back from some camp trip on a yellow school bus. (I think we'd harassed the gays on Fire Island or something.) We were full of brio (or our own youthful bullshit) and talking up doing a fundraiser. We had lots of ideas to raise money -- car washes, product sales, babysitting.

Mr. Baldwin brought up the question of what we were raising the money for. "Are you going to give Hershey Bars to all the rich kids in Harbour Green?" he asked. He wanted us to think of those less fortunate, rather than other privileged people, who he assumed could get their own Hershey Bars.

I thought this hysterical at the time, and I still get a chuckle out of it. But these days the joke's on us.

The Rough Justice of a Crash

Both political parties are rushing to bail-out the losers in the present economic crisis.

• Bail out my friends who insured the Big Shitpile, begs Jim Cramer.
• Bail out the rich, says George W. Bush.
• Bail out the poor, say the Democrats.

Unfortunately there's a sort of rough justice which takes place during these market crashes. I have seen it during every single crash I've ever covered, from the oil crash of 1981 through the dot-bomb of 2001 through today.

We don't want idiots bailed-out. Those of us with cash, or those who stayed on the sidelines, want the chance to pick through the wreckage at our leisure. Analysts claim there are two emotions, fear and greed, which determine where prices will go. There's really only greed and greed.

During a boom everyone wants to be venture capitalists.

During a bust everyone wants to be vulture capitalists.

Myth, Value and the Overton Window