Sprott's Last Decade Retrospective: It’s Déjà Voodoo Economics... All Over Again - This Weekend's Must Read

It’s Déjà Voodoo Economics... All Over Again

By: Eric Sprott & David Franklin

If you’re of a certain age, chances are you remember exactly where you
were when JFK was  assassinated. Similarly, if you’re from Canada or
the United States and have an even remote interest  in hockey, it’s
highly likely that you remember exactly where you were when ‘Sid the
Kid’ scored the  winning overtime goal in the Olympic gold medal game.
These were both "significant events", albeit  for different reasons. We
wonder, however, if any of you recall where you were on September
18th,  2008? Do you remember that day? We can’t seem to recall it
either, which is strange, because it was  one of the most important
days of the decade. October 7, 2008 is another day that should stick
out  in our memories, but we’re sure you don’t remember that day either
– and we’re in the same boat.  How is it, then, that we can’t recall
where we were or what we were doing on the two days the entire 
financial system almost collapsed?!? It boggles our mind. These dates
should have been emphasized  in every "review of the decade" written at
the end of 2009, but we’ve been hard pressed to find them  mentioned in
any mainstream publication. This is troubling to us, and makes us
wonder if people are  even aware of the incredible events that took
place on those fateful days only eighteen months ago.

The financial industry often prides itself on the hindsight principle.
We may not predict the future  with great accuracy, but when things
fall apart we’re very quick to explain why and how it happened  with
authoritative aplomb. "Hindsight is 20/20", as they say. But is it
really? Despite our seemingly  thorough analysis of past failures, the
financial industry seems to have an uncanny ability to make  the same
mistakes over and over again. Perhaps this is due to the fact that we
don’t properly review  events passed. Our obsession with predicting
future results impels them away into oblivion. The fact  remains that a
cursory look back on the last decade reveals an apparent cycle of asset
bubbles that  all grew and burst before our eyes, with little effort
made to actually address the underlying causes  that made them
possible. We have written at length about the next asset bubble now
forming in  government debt and currency. Looking back on the last
decade from 2000 to 2009, are there any  lessons that can provide some
guidance for the next decade? And are there any lessons that can  be
gleaned from September 18th and October 7th, 2008, when we almost lost
the entire financial  system? We certainly hope there are.

The seeds of the financial mess we are currently experiencing began in
the mid-to-late nineties.  As we approached year 2000, the widespread
belief developed that new technology would rewrite  economic rules. The
euphoric years between 1995 and 2000 blew the first asset bubble of the
21st  century in the technology-heavy NASDAQ Index. Alan Greenspan
first uttered his now famous  "irrational exuberance" warning in
December 1996 when describing stock valuations at the time.¹
It  wasn’t until mid-1999, however, that the U.S. Federal Reserve
actually increased interest rates in an  attempt to quell the
overheated stock market. The Fed actually raised rates six times
between June  1999 and January 2000 in an attempt to cool an already
overheated economy. The dot-com euphoria  burst on March 10, 2000, when
the NASDAQ peaked at 5,132, representing more than double its  value
from only a year before. We were watching the bubble closely at the
time, and wrote on March  9th 2000, "In the next few months, if not
weeks, we anticipate that the Nasdaq will capitulate to market 
liquidity. Valuations are screaming at us! Excessive speculation is
running rampant! DON’T BE A  PART OF IT!!!" It was a timely
recommendation.

In many ways, the NASDAQ bubble was somewhat conventional in that it
was born out of over- enthusiasm for the prospects of new technology.
The fact that the Federal Reserve actually tried to  cool the bubble
down, however feebly, in the years before its peak, is really what
differentiates it from  the bubbles that followed. The NASDAQ collapse
is well understood now, ‘in hindsight’. This collapse  compelled Alan
Greenspan and the Federal Reserve to embark on the largest rate cuts in
US history  in an effort to soften its impact. The inability to face
the economic pain of the market crash ultimately  set the stage for the
second bubble of the decade, this time in housing. The key point to
emphasize  here is that the Federal Reserve lowered interest rates thirteen
times between January 3, 2001 and  June 25, 2003 in order to cushion
the economy. These rate cuts allowed for increasingly easy access  to
credit on a worldwide scale. It didn’t take long for the second bubble
to develop, and it wasn’t hard  to see the warning signs. Even The
Economist magazine noticed, stating on June 16, 2005, that "the 
worldwide rise in house prices is the biggest bubble in history."²
Home prices rose at an annualized  rate of more than 11% from 2000 to
the peak on July 31, 2006 -more than doubling in that time  period.³
The financial sector became the US economy’s central economic driver,
generating up to  41% of all corporate profits and making it the
fastest growing sector of the economy.⁴ In July 2005, 
Greenspan described certain real estate markets as "frothy" and
recommended that the Federal  Reserve rein in lending standards.⁵
We wrote in response at the time that "(Alan Greenspan) should  be
careful what he wishes for… it may come true. It’s like throwing stones
in glass houses. It may  all end with the Federal Reserve having to
bail out the financial system, as it did with the savings  and loan
crisis a decade ago." We now know what transpired in the years to
follow – we’ve all lived  through it, and it ended with the biggest
bailout in financial history.

So what’s the point, you ask? In hindsight, it’s very safe to argue that the Fed probably shouldn’t 
have lowered rates thirteen times between January 3, 2001 and June 25,
2003. It proved to be an  extremely damaging policy. Artificially low
rates created a lending mania of enormous proportions  which dragged
consumers along for a debt-fueled buying orgy. In our January 2008
commentary,  aptly entitled "Welcome to the 2008 Meltdown", we opined
that "There are meltdowns occurring  everywhere: commercial real
estate… car loans…credit cards. It was all a massive Ponzi scheme 
sustained by overleverage. Because this has been one of the most
egregious bubbles ever, its impact  is likely to linger longer than
anyone expects. This is more than just a market failure. It’s a
systemic  meltdown." And it was. But the meltdown happened so fast that
it never seemed to burn into our  collective memory. Everyone remembers
that we went into a severe recession in late 2008, but do  they know
the details of what actually transpired? A quick review is needed to
appreciate how close  we really came to a full shutdown.

It was the Lehman Brothers bankruptcy on Sept. 15th that set everything
in motion. Most market  participants will remember that date - Bank of
America bought Merrill Lynch the very same day, so  it was certainly
memorable. What many people fail to appreciate, however, is the mayhem
that took  place during the following days in the US money markets. The
day after Lehman’s collapse, the  Reserve Fund, one of the oldest and
most high profile US money market funds, began to hemorrhage  money as
investors redeemed in panic. Large institutional investors soon began
pulling money out  of other major US money market funds fearing heavy
losses from Lehman Brothers debt. Almost  $173 billion was pulled from
such funds over the next two days, threatening to collapse the entire 
US financial system.⁶
Two weeks later, on Sept. 29th, investors sent the Dow Jones plummeting
778  points, representing the largest single-day loss in the history of
the index. In hindsight, it was somewhat  of a delayed response,
because the real damage had by then been averted by the Treasury’s
blanket  guarantees on all money market funds.

The fact remains that on Thursday, September 18th, the US financial
system almost completely  collapsed. The details of that day remain
frustratingly murky. The imminence of complete disorder  seemed to
scare Congress into action, but we can only piece the story together
through random  anecdotes that have been partially revealed through
subsequent interviews. In what has been dubbed  ‘the Kanjorski meme’,
Congressman Paul Kanjorski recounts a meeting that was held between
Ben  Bernanke, Henry Paulson and certain members of Congress where the
conception of the "Troubled  Asset Relief Program" (TARP) supposedly
took place. To stem the flow of money out of US-based  money market
funds, Paulson had to provide an almost instant guarantee on all money
market funds  held within the US. Kanjorski recounts, "If they had not
done that, their estimation was that by 2pm that  afternoon (September
18th), $5.5 trillion would have been drawn out of the money market
system of  the United States, [which] would have collapsed the entire
economy of the United States, and within  24 hours the world economy
would have collapsed. We talked at that time about what would happen 
if that happened. It would have been the end of our economic system and
our political system as  we know it."⁷
Further details of these meetings have been provided by Senator James
Inhofe, who  recounted that Paulson had warned of martial law and civil
unrest if the TARP bill failed.⁸ It is interesting  to note
that while Henry Paulson mentions several meetings that took place on
September 19th in his  book, the discussion of ‘imminent financial
collapse’ and ‘martial law’ was noticeably absent.

The official record of the events of September 18th, 2008 comes from a
research report issued by  the Joint Economic Committee. The reports
states, "On Thursday September 18, 2008, institutional  money managers
sought to redeem another $500 billion, but Secretary Paulson intervened
directly  with these managers to dissuade them from demanding
redemptions. Nevertheless, investors still  redeemed another $105
billion. If the federal government were not to act decisively to check
this  incipient panic, the results for the entire U.S. economy would be
disastrous."⁹
Between the official  record and the statements by members of congress
and the senate, we can piece together an almost  system-wide collapse
that was potentially hours away.

The second fateful date to remember was October 7, 2008, when the UK
almost collapsed. Bank  of England Governor, Mervyn King, describes the
situation: "Two of our major banks which had had  difficulty in
obtaining funding could raise money only for one week then only for one
day, and then on  that Monday and Tuesday it was not possible even for
those two banks really to be confident they could  get to the end of
the day."¹⁰
This was the justification given for the Bank of England to provide
secret loans of £61.6 billion to The Royal Bank of Scotland and HBOS to
maintain solvency.¹¹ Amazingly,  news of these loans was
never revealed until November 24, 2009, more than one year later.
Recalling  that fateful day, David Soanes, Managing Director of UBS
Bank, and part of the group assembled  to assist with the UK
government’s crisis response, stated, "We only really knew by probably
about  seven o’clock at night (October 7, 2008), that we, that everyone
was going to get through to the next  day."¹² These
revelations raise new questions about the true scope of bailouts
undertaken by the  major governments at the time. Lord Myners, the UK
Financial Services Secretary, alluded to similar  covert banking
operations conducted by the European Central Bank and the US Federal
Reserve.13  We have no idea what he is referring to, but we would
certainly be interested to learn more.

This type of activity by the leaders of our financial system certainly
helps to explain why those two dates  are not more ingrained in our
collective memory – strong efforts were obviously made to hide their 
severity. The fact that these details were left out of Henry Paulson’s
memoirs strikes us as astounding.  It also seems incredible that the
best we can do to understand those fateful days is to cobble together 
comments made after the fact. It serves to be reminded that the events
of September and October  2008 had previously been considered
unthinkable, and we must never forget that the ‘unthinkable’ can 
happen again. A complete banking collapse would not be pleasant – and
it’s certainly not an experience  we would ever wish upon ourselves,
but it must be remembered that WE ALMOST WENT THERE.

So where does this leave us for the decade ahead? In bad fiscal shape.
It seems as if we’re just  making the same mistakes over again, and on
a far larger scale. We have passed the debt obligations  of the
financial system onto the governments. We have liquefied the system
beyond any rational  explanation, more than doubling the monetary base
since the collapse of Lehman Brothers. Social  Security, which was in
balance in year 2000, is now underfunded by $15 trillion dollars. Total
unfunded  obligations of the US Government are now $104 trillion. If we
add the $6 trillion of outstanding Fannie  Mae and Freddie Mac debt and
the $12 trillion of outstanding national debt, we arrive at a total US 
government debt obligation of $122 trillion. It’s a truly preposterous
amount of money that will never  be paid off in today’s dollars. As we
wrote in our October 2009 article entitled "Dead Government  Walking",
the US Government is on a trajectory to default on their obligations,
and the same can  realistically be said for the UK and Japan. The
answer put forward by the US, UK and Japanese  governments? Quantitative Easing and 0% interest rates. Have they learned nothing from the past  decade?!

As our readers know, the flagship funds at Sprott have been managed
with the view that we entered a  long-term secular bear market in year
2000. We have never detracted from this view, and it remains in  place
today. We will not be bears forever, because the cycle will eventually
reverse, but a new secular  bull market will not, and cannot, emerge
until the world solves its debt problems. Our overarching  macro view
is strongly influenced by the Kondratieff Cycles. The ‘winter season’
began in the year  2000 and continues to this day. We have watched this
cycle unfold, and have noted the Kondratieff  Theory’s eery ability to
predict the debt defaults and banking collapses that we witnessed over
the  past two years. Our analysis suggests that we are only half way
through this Kondratieff winter, with  another approximate ten years
remaining. They will undoubtedly be an interesting ten years, and it 
should come as no surprise to our readers that gold is considered the
ultimate asset class to own  during the ‘winter cycle’. It has
certainly served us well up to now.

A review of the last decade would not be complete without our
predictions for the next ten years.  Rather than bore you with
prognostications, we would like to leave you with some titles we are 
considering for future editions of Markets at a Glance:

---

1. The Federal Reserve Board. Remarks by
Chairman Alan Greenspan (December 5, 1996). The Challenge of Central
Banking in a Democratic Society. Retrieved on March 10, 2009 from:
http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm
2. The Economist. (July 16, 2005) In Come the Waves. Retrieved from:
http://www.economist.com/opinion/displaystory.cfm?story_id=4079027.
3. Bloomberg, S&P/Case –Shiller Composite – 20 Home Price Index Not Seasonally Adjusted
4. Johnson, Simon (May 2009) The Quiet Coup. The Atlantic. Retrieved on
March 10, 2010 from:
http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/7364/

5. Andrews, Edmund (May 21, 2005) Greenspan is Concerned About
‘Froth’ in Housing. The New York Times. Retrieved on March 10, 2010
from:
http://www.nytimes.com/2005/05/21/business/21fed.html?_r=2&oref=slogin

6. Henriques, Diana (September 19, 2008) Treasury to Guarantee
Money Market Funds. The New York Times. Retrieved on March 10, 2010
from: http://www.nytimes.com/2008/09/20/business/20moneys.html?em
7. Kanjorski, Paul (January 28, 2009) Kanjorski: We came so close to
complete financial collapse. Pocono Record. Retrieved on March 10, 2010
from:
http://www.poconorecord.com/apps/pbcs.dll/article?AID=/20090128/NEWS04/9...

8. CNN iReport (November 20, 2008). Paulson Was Behind Bailout
Martial Law Threat. Retrieved on March 10, 2010 from:
http://www.ireport.com/docs/DOC-150837
9. United States Congress, Joint Economic Committee Research Report
#110-25 (September 2008) Financial Meltdown and Policy Response.
Retrieved on March 10,
2010 from: http://www.house.gov/jec/Research%20Reports/2008/rr110-25.pdf
10. BBC (September 24, 2009) Mervyn King and other key players reveal
true extent of financial crisis one year on . Retrieved on March 10,
2010 from:
http://www.bbc.co.uk/pressoffice/pressreleases/stories/2009/09_september...

11. Conway, Edmund and Monaghan, Angela (November 24, 2009) Bank of
England tells of secret £62bn loan to save RBS and HBOS. Telegraph.
Retrieved on March 10, 2010 from:
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/6646923/...

12. BBC (September 24, 2009) Mervyn King and other key players
reveal true extent of financial crisis one year on. Retrieved on March
10, 2010 from:
http://www.bbc.co.uk/pressoffice/pressreleases/stories/2009/09_september...

13. BBC (November 25, 2009) Alistair Darling defends secret loans
to RBS and HBOS. Retrieved on March 10, 2010 from:
http://news.bbc.co.uk/2/hi/business/8378087.stm

Comments

[rubearish10]

What in the World? What's scary is the more we discover, uncover and read over all this great analysis, logic and forecasts (on post it notes or whatever), the more we should worry about it never happening or not happening soon enough.

My fear is that we're so right that we're wrong and all of us with "skin in the game" backing up our collective thesis will get roiled yet again. Don't get me wrong I'm hedged with a short bias and growing daily but I bet if I covered today, you'll all get rich tomorrow because after a while you begin to think they're waiting for you to cover. 

The problem is, I'm not gonna do it, so I'll leave it to some other fool. Ok, who's it gonna be, hey? Come on, who wants to capitulate and trigger this thing. Man, I'm beginning to freak out out, we're so right! Greta job Sprottsky!

[Gimp]

Ponzi masters had to come up with a few fall guys to cover-up their scheme. Now it is deflect and don't recollect as they feed the masses more disinformation so they can get back to business as usually behind the curtain. Toto where are you when we need you? - Nothings changed until it all collapses.

[Anonymous]

Kanjorski: "It would have been the end of our economic system and our political system as we know it."

And wouldn't that be a shame.

[Clinteastwood]

Ever notice how there's really never any news? 

That's because the "news" is completely managed at all times.

[SDRII]

Kanjorski is a shill. Period. His stories are simply unbeliveable and to the post above where was the money going? To T-bills? Enter GE.  Kanjorski tries to replicate Buffet's folksy charm - apparently popular with 40 something CNBC anchors - and won himself some choice airtime to push his avuncular know nothingness.

Meanwhile in another devlopment the US is condeming Israel for new settlements as Turkey slide into its own orbit. With every rebuke , Clinton eyes roll around and land on $150 oil

[No More Bubbles]

Late reading this piece.   Decent stuff, but he's too bullish.

[mark456]

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