Friday, September 18, 2009

French Kisses and Asset Inflation

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Rude Awakening

The Rude Awakening

Taipei, Taiwan

Friday, September 18, 2009


* The slow, undetectable rise of inflationary pressure,

* Revisiting the Ludwig Von Mises "crack up boom" theory,

* Plus, the trick to boiling frogs and plenty more...


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Joel Bowman, reporting from Taipei, Taiwan...

It is sometimes said that the only way to boil a frog is to do it slowly. If you drop the unsuspecting amphibian in scalding water, it will hop right out. So, goes the theory, you must turn up the heat gradually.

The main problem with this strangely amusing anecdote is that it is not true. Firstly, frogs dropped into boiling water do not jump out. They die. Secondly, as Friedrich Goltz, the German physicist from whose work the theory is thought to have originated, pointed out, you must first remove the frog's brain in order to successfully "slow boil" it.

Despite its fallacious nature, the metaphor is still useful to explain people's insensitivity to gradual changes in their environment, usually negative ones. Most commonly it is employed to describe a country's slow march to war or the gradual erosion of civil liberties. Equally, it might also be employed to describe the creeping debasement of a nation's currency, the kind that slowly bleeds investors' returns and visits inflation on those desperately trying to stay solvent or, "afloat."

Right now, inflation isn't a terrible concern for most people. They see asset prices falling across the board...except, that is, for the stock market, which threatens to boil over any week. They want the heat turned up a little bit. They want the government to pump through that stimulus so they can enjoy the Jacuzzi-like conditions of the bubble era.

Despite the Feds' best efforts, the dubious inflation metric known as the Consumer Price Index (CPI) only budged 1.4% over the past year. Stimulus totaling $2.4 trillion has already been deployed yet, for the average person, deflating prices – of their house, for example – remains the primary concern.

Right now, there is little doubt the dollar is slipping. And worldwide risk appetite is rising, along with gold and high-yielding foreign currencies like the Aussie and New Zealand dollars. This signals a definite return of confidence to the market.

Your editor would not presume to know where prices might go from here, but he asks the reader to imagine for a moment that this rally is not the exception to the rule of history. Imagine, for a second, that it falters, as every bear market rally before it has done. Imagine that risk appetite snaps back and stock market gains are again cut in half...

What will the Feds do then? The big question, as they stir those gurgling waters, will be whether they can provide "just enough" stimulus to keep the economy from cooling too fast, while simultaneously making sure not to pour in boiling water directly, which can result in scalding. It is possible investors will get their warm bath...but also that they may be boiled alive.

Add to this delicate balance the fact that, in our version of the "boiling frog" metaphor, it is not only that those in the water are slow to register changes in the temperature; it is quite possible that those in control of the gauges are lobotomy victims themselves.

Today's column, below, is an extract from the updated version of Bill Bonner and Addison Wiggin's book, Financial Reckoning Day: Fallout. In it, the authors examine what led us to the worldwide "crack-up boom" that inspired such unprecedented federal intervention in the first place. Please enjoy...

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French Kisses and Asset Inflation
By Bill Bonner and Addison Wiggin

A kiss is still a kiss…and a bubble is still a bubble. When a kiss is over, it's over. When a bubble pops…well…that's all she wrote! All kisses end — even the wettest "French" kisses. And so do all bubbles — even sloppy mega-bubbles of liquidity.

"This one will be no exception," we remember thinking before the carnage got underway. But, of course, it's not the certainties that make life interesting; it's the uncertainties — the known unknowns and the unknown unknowns, as Mr. Rumsfeld said. We are all born of woman and end up where all men born of women end up — dead. But that doesn't mean we can't have some fun between baptism and last rites.

The worldwide financial bubble we faced was both worldlier, and more financial than any in history.

And, in the summer of 2007, it was still very much alive. So much alive that the media could hardly keep up with it. Forbes magazine, for example, tried to estimate the wealth of the world's richest people. But the rich don't typically give out their balance sheets, telephone numbers, and home addresses. So, there's a fair amount of guesswork in the calculations.

When it came to guesstimating the net worth of Stephen Schwarzman, founder of Blackstone, the Forbes crew wandered off into fiction. They put his wealth at about $2 billion. Recent filings in connection with the new Blackstone IPO show he earned that much in a single year!

In that phase of the bubble, it is as if your neighbors were throwing a wild party and you weren't invited. You detest them…envy them…and want to join them, all at once. A very small part of the population is having a ball; everyone else is getting restless and wondering when the noise will stop.

Meanwhile, the experts, commentators, kibitzers, and analysts were saying that there is a whole new phase of the giant bubble about to unfold; things could get a whole lot crazier. Even many of our respected colleagues were pointing to a text by the great Austrian economist, Ludwig von Mises, for a clue. What we have here, they say, is what Mises described as a "Crack-Up Boom."

Before we go on, readers should be aware that the "Austrian school" of economics is probably the best theory about the way the world works. Like our newsletter, The Daily Reckoning, it is suspicious of efforts to control the natural workings of an economy, in general…and suspicious of central banking, in particular. The fact that it was a one-time "Austrian," Alan Greenspan, who became the most celebrated central banker in history, only increases our suspicions. He was able to master central banking, we imagine, because he understood what it really is — a swindle.

What Is a "Crack-Up Boom?"

Von Mises:

This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against 'real' goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.

Mises is describing the lunatic phases of a classic inflationary cycle.

At first, no one can tell the difference between a real dollar — one that is earned, saved, invested or spent—and one that just came off the printing presses. They figure that the new dollar is as good as the old one. And then, prices rise...and people don't know what to make of it. Later, they begin to catch on...and all Hell breaks loose.

You see, if you could really get rich by printing more currency, Zimbabweans would all be as rich as Midas, since the Mugabe government runs the presses night and day.

Von Mises died in 1973 — long before this boom really got going — let alone cracked up. He may never have heard of a hedge fund...or even a derivative, for that matter. A world money system without gold? He probably couldn't have imagined it. People spending millions of dollars for a Warhol? Twenty million for a house in Mayfair? Chinese stocks at 40 times earnings? He would have chuckled in disbelief. He understood how national currency bubbles expand and how they pop, but he probably never would have imagined how insane things could get when you have a whole world monetary system in bubble mode.

He'd have recognized the beginning of this bubble...and he'd have recognized the end, but the middle...or the beginning of the end — that would have dumbfounded him. During his lifetime he saw a Crack Up Boom in Germany in the '20s...and a few more here...but he never saw a worldwide Crack Up Boom.

No one, anywhere, has ever seen a worldwide Crack Up Boom. We're the first, ever. Pretty exciting, huh?

Joel's Note: Books forecasting the future only make it to a second edition if what they said in the first edition came to fruition. Fans of Bill Bonner and Addison Wiggin's bestselling books, Financial Reckoning Day and Empire of Debt, will therefore be pleased to see them updated for the second print.

Whether you are a long time "sufferer," or a first time fan, be sure to check out Bill and Addison's monumental works right here, complete with additional chapters and updated charts to reflect the predicted collapse and where to go from here. Financial Reckoning Day: Fallout and The New Empire of Debt

The interested reader may also wish to know that, under the stewardship of Rob Parenteau, Agora Financial has reopened the doors to The Richerbacher Society. Rob uses proven Austrian School economic analysis (as opposed to what the mainstream press dishes out) to arm readers for the troubling times ahead. If you haven't had a look through his work yet, you might like to consider applying for membership today right here.


[Rude Endnote: No frogs were harmed during the production of today's issue. We'll see you back here on the weekend.

Until then...


Joel Bowman

The Rude Awakening

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