Monty Pelerin's World

Economics, Finance and Politics Through The Prism of Classical Liberalism

March 2011 - Posts

ObamaCare Showdown with Judge Vinson
In a post a couple of days ago entitled ObamaCare -- The Final Straw That Keeps on Giving I speculated on the possibility of impeachment for violation of the oath of office for any Congressperson voting to expend funds on what was declared an unconstitutional law. Subsequent to that post, the mainstream media reported that Judge Vinson had granted a motion for stay. It is likely, if all you read was the "Pravda" version of the news that you might believe that the Judge Vinson has blinked and the Administration has been relieved of any responsibility pertaining to his first ruling. Nothing could be further from the truth. The Administration is brazen in its words and actions. Judge Vinson was obviously angry in his second opinion. He should be because as Avik Roy states (my emboldening):
Judge Vinson acknowledges that other judges have upheld the law, and that none of us know how Obamacare will fare at the Supreme Court. But this much we do know: The stakes in this case are as high as any in the last 35 years. Will we have a federal government with unlimited powers, including the authority to regulate “mental activity”? Or will the Supreme Court find that the Constitution still contains one or two constraints on federal power?
From the Constitution and The Rule of Law flow all the greatness and goodness of this country. Without them, we are finished. For this reason, it looks as if Judge Vinson served up an ultimatum rather than backing off as conveyed via the mainstream media. Karl Denninger, in his inimitable fashion, has his usual no-holds barred take:

Now We're Cooking: Judge Vinson

If you remember, I questioned whether Obama was crossing the line into sedition with his statement that he intended to ignore a declaratory judgment. Well, they apparently (after stalling) asked the Judge for a stay, and got something a bit different than they asked for in reply. Judge Vinson began with:
My order of January 31, 2011 (Order), granted summary judgment for the plaintiffs (in part); held the individual mandate provision of The Patient Protection and Affordable Care Act (the Act) unconstitutional; and declared the remainder of the Act void because it was not severable. The defendants have now filed a motion to clarify this ruling (doc. 156) (Def. Mot.). During the four-plus weeks since entry of my order, the defendants have seemingly continued to move forward and implement the Act.

Yep.  That's exactly what Obama did - he basically gave you the finger Judge.

As Judge Vinson continues...

Even though I expressly declared that the entire Act was void, and even though I emphasized that separate injunctive relief is not necessary only because it must be presumed that the Executive Branch will adhere to the law as declared by the court, which means that declaratory judgment is the functional equivalent of an injunction, the defendants have indicated that they do not interpret the Courts order as requiring them to immediately cease [implementing and enforcing the Act]. See Def. Mot. at 4; see also id. at 6 (we do not understand the Courts declaratory judgment of its own force to relieve the parties to this case of any obligations or deny them any rights under the Act). They have reportedly continued with full implementation of the Act.

They sure have.  How's that middle finger look to you, Judge Vinson?

A litigant who tries to evade a federal courts judgment --- and a declaratory judgment is a real judgment, not just a bit of friendly advice --- will come to regret it. Badger Catholic, Inc. v. Walsh, 620 F.3d 775, 782 (7th Cir. 2010).

Oh, I think I'm starting to get the picture here - you're a wee bit pissed.  Well, I would be too.

So to clarify my order and judgment: The individual mandate was declared unconstitutional. Because that essential provision was unseverable from the rest of the Act, the entire legislation was void. This declaratory judgment was expected to be treated as the practical and functional equivalent of an injunction with respect to the parties to the litigation. This expectation was based on the longstanding presumption that the defendants themselves identified and agreed to be bound by, which provides that a declaratory judgment against federal officials is a de facto injunction. To the extent that the defendants were unable (or believed that they were unable) to comply, it was expected that they would immediately seek a stay of the ruling, and at that point in time present their arguments for why such a stay is necessary, which is the usual and standard procedure. It was not expected that they would effectively ignore the order and declaratory judgment for two and one-half weeks, continue to implement the Act, and only then file a belated motion to clarify.6

One sentence reduction: Up your ass with your dishonest argument, Mr. President.

After careful consideration of the factors noted above, and all the arguments set forth in the defendants motion to clarify, I find that the motion, construed as a motion for stay, should be GRANTED. However, the stay will be conditioned upon the defendants filing their anticipated appeal within seven (7) calendar days of this order and seeking an expedited appellate review, either in the Court of Appeals or with the Supreme Court under Rule 11 of that Court. See, e.g., NML Capital Ltd. v. Republic of Argentina, 2005 WL 743086, at *5 (S.D.N.Y. Mar. 31, 2005) (district court granted motion to stay its own ruling, conditioned on as prompt as possible appeal and a motion for an expedited appeal).

Reduction: You can have your stay.

But - you must either shit or get off the pot.  Right now.

Madison is Merely the Opening Act
Madison, WI may be taking up most of the domestic headlines with its budget battles, however that will change. All states and municipalities are, to various degrees, similar to Wisconsin. Government spending is not sustainable. The fantasy world of the last couple of decades produced higher GDP as a result of debt expansion. Neither the GDP nor the tax revenues generated are coming back any time soon. Governments at all levels spent like drunken sailors, assuming the cornucopia of excess tax revenues would never close. It has. Now hard decisions must be made. There is not enough revenue to pay for current spending no less add new government programs.  There are no easy solutions for the profligacy of the past. Rollback of government is painful. It can either be managed via the political process or it can be imposed via draconian action. Democrats not in power better learn to cooperate in managing the cuts lest they be cut out of the process completely. Cuts are coming. They must. Here is an example of what one municipality plans: Providence School Superintendent to Send Dismissal Notices to All 1,926 Teachers; Providence is Bankrupt. Unless cuts can be managed via the political process, drastic actions like Providence will be imposed. There is no other choice! Taxpayers are unwilling to be exploited by government anymore. Increased taxes are not a solution. Nor is delay. Hopefully the protests can be limited to Madison-style and not progress to Cairo or Tripoli events.
Economic Mess is Structural Not Cyclical
[caption id="attachment_9670" align="alignleft" width="97" caption="Chris Martenson"][/caption] [caption id="attachment_16437" align="alignright" width="100" caption="John Williams"][/caption] For more than a year, I have argued that regardless of what you want to call our current economic crisis, it is not current and not cyclical. It is secular. That is, the problems that surfaced began many years ago, back in the 1970s. Chris Martenson, who interviewed John Williams of, obtained the following quote from Mr. Williams:
If you look at the government’s latest statistics - the poverty survey of 2009, which is the most recent release, with average and median household income adjusted for inflation (and they use a really gimmick low inflation rate with that one) - it shows that not only has household income been falling the last year or two, but it’s below its near-term peak before the 2001 recession. Household income has not recovered above that, and if you use the CPI-U (the usual inflation rate to deflate that by instead of the gimmick one) it shows that household income today is below where it was in 1973. Again, the average household has not been able to keep up here. If income growth is not keeping ahead of inflation, very simply you can’t have consumption growing faster than inflation on a sustainable basis.
Many will attack median household income, claiming that there are more single head of households today than in the past. That is true, if you go far enough back, and probably true for the period under discussion.  The War on Poverty started the disintegration of families in the mid 1960s. A different measure, not dependent upon families, is weekly wages. Real weekly wages today, using the government's arguably understated inflation figures, are lower than they were in 1964. This drop is not a function of the current economic problem because they dropped below in the early 1970s and never recovered. In the interview (podcast), Williams and Martenson discuss the how the following came about:
  • John came to understand how changes in the way the key economic indicators are calculated has resulted in an outcome in which they no longer reflect reality. No one believes, values or knows how to accurately apply them anymore.
  • There is rampant precedent for political manipulation of how these indicators are calculated. Past administrations forced changes in the forumlae for many reasons - a common one being optics.
  • Using erroneous indicators is dangerous - not just for the governement, but for everyone. When inflation is running higher than most expect (as it is today), investors are cheated out their returns, wage earners wonder why their paychecks buy less goods, and fixed income earners suffer greatly. Unfortunately, there are myraid incentives for politicians and corporations to embrace artificially-low calculations - as they justify reducing obligations owed.
  • The key approaches to calcualting inflation are especially convoluted, especially the practice of applying hedonics. If we instead calculate inflation according the formula used in 1980, we would see a number closer to 8%+ vs today's 1.5% rate.
  • Similarly with unemployment, John calcualtes the true rate in the country today is 22% (vs the reported 9%).
  • In sum, he sees the US suffering from structural issues that are extremely hard to address - but impossible if we continue to let fantasy data be our guide. Our circumstances are not sustainable and, in his eyes, have us on an inexorable path to higher inflation - and likely hyperinflation.
Martenson provides additional commentary on his site or you can read the linked article here.
The Canary is Dying and So Is Our Future
Wikipedia describes the use of animals as early warning sensors. Canaries were used by miners:
The classic example of animals serving as sentinels is the canary coal mine. Well into the 20th century, coal miners in the United Kingdom and the United States brought canaries into coal mines as an early-warning signal for toxic gases including methane and carbon monoxide. The birds, being more sensitive, would become sick before the miners, who would then have a chance to escape or put on protective respirators.
Early warning signals can be useful in finance and economics, although they are difficult to find.  Established and reliable relationships are key. When an established relationship begins to fail, it could provide the same warning as a dying canary in a coal mine. For miners, a dying canary was a sign to take protective action, including leaving the mine. For investors, failing established relationships could provide the same signal. More than a few sophisticated investors consider the dollar as the key variable to watch. Because prices are the transmission mechanism for economic allocation and change, shifting value in the purchasing power of the dollar will reflect inter-country changes. In effect, the dollar is their early warning mechanism. It is their canary.

The Dollar Relative to Other Currencies

The dollar and Treasuries are considered safe havens. That mantra is one of Wall Street's favorites. The belief is grounded in many years of history. Since the end of World War II, the US has been considered economically stronger, politically more stable and fiscally more responsible than other countries. When world risk and uncertainty increase, foreign money tends to move into lower risk areas. Dollar-denominated assets, particularly Treasuries, is a preferred destination. There is nothing inherent in the US that makes it a safe haven. Nor is there any assurance that it will continue to be regarded as such. Just as this status was earned by relatively prudent fiscal and economic behavior, so it can be lost by profligate behavior. The last decade or two, and especially recent years, has dramatically altered the financial condition of the US. Perception seems slow to change, although astute analysts now consider the US to be no safer than some other areas of the world. Irresponsible behavior on the part of the US government has jeopardized the country's financial condition. As a result its fiscal condition no longer differs from many other countries. For those who follow such matters closely, the US appears to be the beneficiary of the gap between its actual financial condition and its perceived condition. Many consider the dollar and Treasuries as "the canary in the coal mine." To understand the irresponsibility of the US, the dollar's performance against a basket of other currencies is all that is required: {Click on Chart to enlarge} The weakness of the dollar versus other currencies since 2002 is apparent from this chart. From a high of about 120, the dollar dropped to a low of around 72 by 2008, a loss of almost 48%. This loss is a relative one, not an absolute one. That is, it represents a loss against other fiat currencies not against a fixed standard. Given that most fiat currencies were losing purchasing power during this period, the absolute loss is larger, although difficult to measure. What is reflected in the chart is the dollar losing purchasing power faster than other currencies (which also were losing but not at as fast a rate). Some interesting observations are available from the above chart. The rebound in the dollar in 2008 reflects the financial crisis. Reflexively, there was a run to dollars as a safe haven. Once it was apparent the world was not ending, the dollar reverted to its pattern of decline. In late 2009, the dollar rallied again. That rally reflected the fear that various countries in Europe were going to default and the fear that the Euro might not survive. Once that crisis stabilized, the dollar returned to its longer-term pattern.

Implications of The Decline in the Dollar

The implications of this loss in value of the dollar are significant. A few comments should suffice to provide an understanding:
  • During this period, foreign investors in the US stock market would have had to earn 48% to break even on their investment. Their funds in the US declined by 48% relative to the currency they were repatriated to.
  • US investors in foreign markets, if they broke even in those stock markets, would have realized a 48% gain when they repatriated the funds.
  • In terms of global purchasing power, Americans lost 48% of their purchasing power. This loss reflects a reduction in the standard of living of each American relative to their international counterparts. Their counterparts gained 48% relative to Americans.
The phenomenon of measuring currencies relative to each other is equivalent to measuring the rise and fall of particles floating in a septic tank. At any particular time, one particle may be rising or falling relative to others. At a different time, it may be doing the opposite. This is relative measurement. It is also an appropriate analogy if you understand what a septic tank contains. There is no better analogy for fiat currencies than particles in a septic tank.

The Dollar Relative to Gold

No absolute measurement of the decline in the dollar is perfect. Comparing the dollar to the price of gold is probably the closest one can come. Throughout history, gold has represented either actual money or an alternative currency. Gold has unique properties because it has little industrial demand to drive its value and its supply is relatively fixed. Fluctuations in gold's value represent primarily its demand as an alternative to fiat money. The price of gold is shown in the following chart:Click on Chart to enlarge} From 2002 until today the price of gold rose from about $300 per ounce to over $1,400. In terms of gold, the dollar lost 79% of its value.


For those who think a price index is a more reasonable method to approximate the decline in the dollar, The practical problems of creating and maintaining a proper index are overwhelming and impossible to circumvent. The Consumer Price Index, a well-known index is replete with flaws. It is also highly politicized and manipulated for political advantage. (See for criticisms of the CPI.) The US government's own data shows that the dollar has lost 96% of its purchasing power since 1913, when the Federal Reserve was created. Most of this loss occurred subsequent to 1975.

The Value of the Dollar

Regardless of what method you use, the value of the dollar has dropped precipitously. For the period 2002 to 2008, it dropped 48% versus other currencies. We know this figure understates the absolute drop because the comparison (the basket of currencies) was itself deteriorating. This measure alone is indicative of failed policies and a faltering country relative to other countries.

The Dollar as a Canary

Analysts who believe an economic apocalypse is in our future are hard-pressed to describe when and how that unfolds. Almost all, however, point to the dollar as playing a central role in the drama. If the dollar is the transmission mechanism to the next stage, it would appear to be the economic equivalent of the miner's canary. In retrospect, the dollar has been a dying canary for a number of years. It may be one of the longest deaths on record as it has been in critical care from 2002 until today. Interestingly, for most of this period, the economy appeared to thrive. The illusion of  economic health was generated by the world's largest credit boom. Credit expansion produced increases in GDP and other macro indicators. It also created distortions at lower levels of statistical aggregation. Macroeconomics looked good; the neglected microeconomics did not. While macro gets the headlines, micro eventually wins the game. Distortions at the micro level eventually break through to create the crisis. That is exactly what happened in 2008. For the period 2002 until 2008, financial markets reflected the underlying damage the government was inflicting on the economy via their continuing devaluing of the dollar. The astute investor heard this canary chirping and looked behind the dollar decline to understand what was happening. The credit expansion was obvious. Less obvious was the hollowing out of the economy that was occurring as a result of distorted prices and interest rates. Mispriced assets and credit cause faulty economic decisions.

Crossing the Rubicon

Even less obvious to most observers was the government crossing the financial Rubicon. Rather than allowing the economy to adjust and purge itself of its excesses and misallocations, government decided to try and cover these up and restart the boom. Current government policy is geared at suppressing the adjustment in distortions by heaping more credit onto the fire. Thus far, it has managed to increase reported GDP while suppressing the coming correction. By embarking on this course, the government has committed to a continuous policy of increasing credit. Not only must credit continue to be increased, it must be increased by ever greater amounts. This course cannot be stopped or altered without plunging the country into a Depression. Supplying more credit is akin to providing more drink to an alcoholic. All it does is defer the "drying out" period at the cost of making it that much more painful. Understanding the fact that  simple trend and recognizing that government committed to a treadmill that it had no ability or intention of getting off, Investing in gold for the past ten years was a dramatic winner without a down year. But that is history. Will it continue? Probably, but no one knows for sure. For those who say that gold is a bubble, there are two rejoinders. First, are you watching Ben Bernanke and what he is doing? Second, bubbles typically end with parabolic type moves. Gold has not shown that kind of movement yet.

The Dollar as Continuing Canary

While government can continue to supply unlimited amounts of credit, it cannot control the value of the dollar. Markets are already in the process of writing off the dollar. At some point massive inflation, possibly hyperinflation, will occur if the current course is not altered. Markets are bigger and stronger than governments. They discipline economies and governments, not the other way around. Is it possible to utilize the dollar as miners used to utilize a canary? There probably is. Bill Bonner of the Daily Reckoning focuses on a key relationship -- the behavior of the dollar vis a vis gold and geopolitical events. Given what is happening around the world, especially the unrest in the Middle East, one would have expected the dollar to have strengthened. Mr. Bonner points out:
This could be important: the dollar has NOT gained from the unrest in the Arab nations. People no longer seem to see the dollar as a haven of safety. Instead, they turn to gold…
According to Mr. Bonner, we may have reached the point where the dollar is being increasingly recognized as just another junk fiat currency, afflicted with all the ills that have always plagued fiat currencies. Instead of running to the dollar as in the past, Mr. Bonner points out:
The smart money is buying gold. But the dumb money – which is most of it – is still against gold. It doesn’t understand that monetary systems are temporary…that they ALL fall apart eventually…and that, when they do, people turn back to real money – gold.
He utilized this chart to show the decisive separation of the dollar and gold which coincided with Bernanke announcing QE2:

Dollar vs. Gold after QE2

One thing we know already is that the dollar and gold parted ways last summer, right about the time Ben Bernanke stood before the Grand Tetons at Jackson Hole and announced his grand design to continue debasing the dollar until something good happened.
This chart is the sign of a canary dying. The US no longer has a currency believed in by the rest of the world. It has destroyed its reputation as a fiscally responsible nation and hollowed out its economy with questionable tax and regulatory policies. It is managed by a corrupt class determined to enrich themselves and maintain their positions no matter what harm they inflict on the country. Our short-term destiny has been written by the Fed and government. We are headed for a Great Depression that will likely make the 1930s look minor. For the last couple of years, everything has been a charade to make the sheeple believe that matters are getting better. In Mr. Bonner's words:
The party’s a flop. It’s a fraud. A bunch of stuffed-shirt zombies are standing around with drinks in their hands. Listening to awful music. Talking a line of guff. And no one is listening.
Our standard of living will continue to decrease. That is certain. How much is uncertain and a function of government meddling. The canary may not be dead yet but it is terminal. Take appropriate action now!