The Greenspan Debate, Starbucks, Hyperinflation And More

It is said that Greenspan is increasingly trying to defend himself from charges (including from people like me) that he intentionally (or ignorantly) mismanaged the various crisis situations over the years when he was Fed Chairman, essentially blowing bubbles on purpose through his entire tenure at The Fed.

I believe this criticism is unfair.

It gives Greenspan cover for what he really did, which is far worse.

Greenspan's tenure included the now-infamous period in 1991 when the last pieces of Glass Steagall was repealed and the lines blurred between banks and investment banks, and his willful embracing of that reckless loosening of regulatory oversight.

It includes the willful refusal to regulate any portion of the OTC derivative markets.

Now let me be clear - I have no problem with speculation and speculators, so long as when they blow it, they fail in the free market without government intervention.

But these bankers intentionally, willfully, and with malice aforethought stuck their speculative tentacles into the regulated banking sector, with the most egregious portion of this being the credit default swap market, where margin supervision has been essentially zero.

Nor did it stop with hedge funds and investment banks. We allowed the same games to be played with so-called "monoline" insurance companies, who quickly seized on the opportunity to take what was a stodgy business (selling wraps on municipal obligations) and blow it into an insanely profitable one (selling the same wraps on CDOs and RMBSs.) The only problem with this is that the "stodgy" business model, when extended to these CDOs, was in fact insanely risky because you in fact need ten or even one hundred times the capital to support such policy writing, but the rules were not changed to reflect that.

And now we have everyone involved, from Greenspan to Bernanke to Congress trying to duck their responsibility for what they did (and didn't) to fuel an insane credit-driven "crack up boom."

Unfortunately this is the common thread that always seems to run through Washington DC when things go bad. Nobody wants to take "credit" for the immense cock-ups that they create, but they're all happy to bask in the sun during the good times.

What people never seem to understand is that you can't create "overly good" without there being "overly bad" - the common law of business balance prohibits you from getting something for nothing. It cannot be done, although people over the years have continually made claims that they have discovered the financial equivalent of perpetual motion.

It would be nice if we had some even coverage of this in the media, but that would require that people tell the truth, and be challenged openly when they don't. Our "financial media" has no interest in that, because it destroys their ability to hang on every word that comes out of Bernanke's or Greenspan's mouth and treat it as if it came from Caesar - or perhaps even from the mouth of Jesus.

Yeah.

Small business optimism came in at levels not seen in 26 years (which would be when they started recording the data!), and I'm not talking about positive levels either. I guess "bubble TV" didn't get through to them eh? Then again as someone who has run a small business (that turned into a medium-sized one) I can tell you that the cash register never lies, and when there's nothing in The Till you tend to give the finger to the BubbleHeads - and hiring plans.

This is a serious problem for America and our economic prospects, because despite what Bubble TV will parade out there small business is responsible for a huge chunk of employment in this country, in fact, more than "big business." When small business pulls in the "Now Hiring" sign you better watch out..... and if what I've seen around here is any guide, the "Space Available" and "Going Out Of Business" sign is the one that is most prevalent at the moment.

AMD warned and Alcoa missed yesterday, with Apple getting a downgrade. Rumors are that iPOD growth in the present quarter are in fact zero. Market saturation is a beautiful thing no?

Gee, its about time. What have I been talking about with regards to "analysts" always being behind the curve?

One thing I've learned through my more than 20 years in the Capital Markets is that you may as well ignore so-called "Analysts" unless you're daytrading and using their calls as very short-term trading tool to "piggyback" on the idiots who listen to them. Yet they continue to have jobs because retail investors continue to get their pockets picked and come back for more, over and over again. Barf.

This morning Starbucks (Nasdaq: SBUX) has a nice "feature" on CNBC talking about their new coffee. As a coffee connoisseur my opinion of Starbucks (and Peets for that matter) is that both are worthless for the person who truly cares about their coffee.

The key to truly good coffee is found in the beans. They have a roughly 2 week "shelf life", if kept in a sealed container, from the time of roasting until the time that they deserve to go straight into the trashcan. This creates some serious problems for cafes such as Starbucks that wants to have coffee in bags in their stores, because turnover can't be controlled that tightly.

So what does Starbucks do? They overroast the beans, essentially turning them into hunks of charcoal. Once burned the sensitivity to time is reduced, but what you start with is, in my opinion, undrinkable. In recent years they also replaced all their quality espresso machines with "superautomatics" that make a drink with the push of a button, thereby allowing them to hire far cheaper help.

But a superautomatic will never, irrespective of how expensive it is, produce a cup that has the quality that a person who knows what they're doing will. At best a superautomatic will make "decent" espresso - but never great espresso.

The true test is whether you can drink a straight espresso shot from any of these places and taste flavors like nut and chocolate. Yes, chocolate. Most good beans, when properly roasted and extracted will have a hint of chocolate and nut flavor in the cup and a solid 1/4" or more of crema at the time of extraction.

If you've never had good espresso (or a drink made with it) then you simply don't know what its supposed to taste like. This is somewhat like eating at McDonalds and determining that a hamburger should taste like a Big Mac, because that's the only hamburger you've ever had.

Then one day you go to a friend's home and he's grilling burgers made from prime rib on his BBQ out back. You take one bite and about fall over backwards at the difference from what you've been eating for the last 20 years.

The light goes on, and from that point forward McDonalds is a place you go when you're starving, but it certainly isn't where you go for a hamburger.

Starbucks will never fix this until they address the root of the problem, which is coffee and training. You can't get there from here while paying your baristas $7/hour, nor with superautomatics in the stores. It takes the average person a solid month of effort behind the handle of a portafilter to get to where they can produce espresso that is drinkable with reliability and little variation from cup-to-cup. If you have college students with an average tenure of 6 months in the place your customers will simply never get good coffee on a consistent basis.

Sorry.

If you've not had a truly good shot go find one of the coffee bars out there in the wild - run by a proprietor - and sit down for a treat. No milk, just coffee. Order it up and take a sip. If it tastes sour or burnt the people who are making it don't know what they're doing - get up and walk out, and try a different place.

Or just drop by my place sometime and I'll pull you a shot off my Vetrano, and you'll understand.

I also want to comment on metal merchants and the continued screaming about "hyperinflation."

See, on The Internet nobody knows if you're a dog. Or what you're selling. Or maybe, they do but just don't care.

So let's put on our thinking caps and talk for a bit about the premise of the "metalheads", who, along with many others, are absolutely convinced that metals are "going to the moon" while Bernanke and Company hyperinflate the currency here into dust.

I wish to ask you, dear reader, to perform the following mental exercise before we get into the meat of the matter regarding what has actually happened over the last few years.

Let us say that you are a lender. You have some money - let's just put forward that you have $100,000 to lend, to keep the numbers nice and round.

I come to you and I would like to borrow your money in order to buy a house. You give some consideration to that request, check my credit, find that I have a good job, good character, that the house is worth well more than $100,000, and you and I agree that I can borrow the $100,000 for 30 years at a fixed 6% interest rate.

Fine and well; we work the amortization schedule and I start paying you.

Now, having made that loan, which scenario would you, the lender prefer:

• A stable monetary system where the monetary inflation rate is held to somewhere between 0-2%.
• A deflationary environment where monetary inflation is actually negative - that is, the monetary base increases at a rate less than the GDP growth.
• A seriously inflationary (or even hyperinflationary) environment where monetary inflation is very high - say, 20% a year or more.

I assure you that the last choice you would make is the hyperinflationary one.

Think about it for a minute - you loan me $100,000 for 30 years at 6% interest, but the monetary base is being increased at a far greater rate. You get your $100,000 back and your interest, but when you are done that pile of money buys far less than it did 30 years ago! You have actually lost for having lent me the money!

Now in case (1) The Banker makes an ordinary rate of return, and there is just enough monetary inflation to incentivize me (the consumer) to spend and utilize your debt-origination service. Why? Its because if I sit in cash I slowly erode my purchasing power - therefore I may as well consume.

But what about Case #2?

In that scenario I as the borrower probably default. Why? Because my wages likely go down, and yet my payments do not. The interest and principal consume ever more of my purchasing power until I simply run out of ability to pay. At that point I default on the loan and you get the collateral back, plus whatever I paid thus far.

The only scenario that you absolutely do not want as a lender is the hyperinflationary one. If you are faced with a situation that will result in either hyperinflation or deflation - where "stability" can no longer be maintained (say, for example, because there was a huge speculative credit bubble that has now popped), you will do your level damnedest to insure that deflation, not inflation, is what ensues.

But wait a second - how come our dollar has depreciated if we're not "hyperinflating"?

Well that's quite simple.

We have been outsourcing our manufacturing, effectively "burning our furniture" for years. This sounds great if you're the company that is getting jeans sewed for 15 cents/hour to sell, but in fact it sucks for the broader economy, although the "bad" isn't immediately apparent.

Let's consider what The Dollar really is - it is, in effect, a call option of zero maturity and zero expiration on the future earnings power - the GDP - of America.

Think about it - the dollar is backed by "The Full Faith and Credit" of the United States. But what is that "full faith and credit"? It is in fact the power to levy and collect taxes from the citizens of this nation.

Yet without production and earnings by consumers - which inherently is what GDP devolves down into - there is no power to tax, because there is nothing to levy taxes upon!

So we cheerlead about the "great earnings" of corporations over the last 20 years, but in fact we have offshored and outsourced our productive capacity, and our "great earnings" have been a sham - created from the misallocation of capital and degradation of our future earnings and creative power. We claim we "replaced" this manufacturing with "FIRE" service jobs, but those in fact create nothing - they simply push money around from one person to another, stealing a piece in the process.

In response to this the dollar goes down in value because long term earnings capacity, and thus tax-bearing capacity, has decreased. (It doesn't help when you promise to buy every senior citizen's drugs with the government teat.) In effect the S&P500s earnings are "stolen" from the dollar's value.

Of course this distortion cannot be maintained, because the distortions in the market that lead to these "outsize" profits, specifically FX gains, dissipate as the "offshoring" completes. Its a one-time gain, albiet over a fairly long period of time, and can't be repeated. Shifting production from China to, say, Zimbawbwe won't create a new "credit" back to the US, since there's nothing coming from here.

The era of these outsized "earnings" is essentially over as we've now "offshored" pretty much everything that we can offshore.

Don't believe for a minute that we're going to see "hyperinflation"; the metalheads have been calling for this for over fifty years, and they've been wrong for 50 years. They point to the decline in purchasing power of the dollar in the last 100 years, but in fact the annual rate of depreciation is only 1-2%; it is the power of compounding that leads to that result, and let's face it - 1-2% monetary inflation isn't "hyper" anything.

Bankers - including central bankers - are not about to allow the only thing they sell to become worthless.

What they will (and have) allowed, however, is "financial innovation" in the form of unbridled credit creation, which appears to be hyperinflation. It is, however, no such thing - because when the debt cannot be serviced it explodes in the face of the issuer, taking real wealth out in the process.

So why did they permit it? Because the bankers earned an insane amount of money through fees, and they frankly didn't care whether these products "worked" or not. It is the same incentive that mortgage brokers had to give you a "liar loan" - they made their money not off your performance on the mortgage but on the up-front fees, and sold off your loan to someone else who then bore the risk of you not paying the money back. This "originate to sell" model is profitable for the financial institutions but they do not care if you can perform or not so long as they can keep originating - and until the bubble bursts, the party goes on.

Of course human nature being what it is, eventually some of these "geniuses" started to eat their own cooking, and at that point they contaminated themselves. They saw their customers making a great return and forgot that the reason they sold these things off in the first place was that they knew damn well they would never perform in the long-term!

This of course has now "blown back" on these financial geniuses. In fact every one of them was running nothing more than a fancy Ponzi scheme, and that our regulatory authorities refused to do anything about it speaks to the utter depravity of those who are in charge of doing that regulating. The only justice is that the participants who ate their own cooking will get sick or die just as their dupes will.

There are a few people who "get it", but of course their pique is a bit late. Here's just one example:

"Americas Watchdog is demanding the the Securities & Exchange Commission & every State's Attorney General start investigating "auction rate preferred shares" & the fact that citizens in every US state were sold these extremely risky investments by a bank or stock broker as, "same as cash". Now tens of thousands of US citizens are being told by a bank or stock broker, "we don't know when you will get your money back". Why is this the biggest single case of fraud in US history? Its because the investors did not want risk, they wanted safety, and instead of that they were given an exotic risky investment device by greedy Wall Street investment houses & US banks. Why does this story deserve to be on NBC, CBS, ABC, & CNN? Its because this is by far the largest case of outright fraud in US history."

Where were you five, ten years ago? Being a "lap dog" instead of a "watch dog"? One wonders.

Maybe - just maybe - we the people will finally stand up and insist that "The Cops" do their job.

Maybe.

And maybe - just maybe - we'll see those who were duped by these "merchants" come after them with landsharks a-blazing.

After all, last time I checked Ponzi Schemes were illegal, no matter how complicated or well-disguised.

Hope springs eternal.

PS: Pending home sales down 1.9% month/over/month. Oh, and The Realtors now expect that housing will "improve" in the latter half of the year. Gee, the stupidity continues among these people, does it? Or is that yet more intentional deception?

PPS: Fed minutes are out, and we've got this:

"Indeed, some believed that a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market"

No kidding? You mean they just figured it out?

So let me see if I get this right - pundits think we should buy stocks given this outlook eh, even given how late to the party these tards are?

Oooook - I think not.