Straight Talk

Straight Talk with Jesse: Concentration of Wealth & Power Is the Root Problem

Monday, March 28, 2011, 6:30 PM

"Straight Talk" features thinking from notable minds that the PeakProsperity.com audience has indicated it wants to learn more about. Readers submit the questions they want addressed and our guests take their best crack at answering. The comments and opinions expressed by our guests are their own.

This week's Straight Talk contributor is 'Jesse', founder and proprieter of Jesse's Café Américain (jessescrossroadscafe.blogspot.com), one of the more esteemed and veteran econoblogs. Jesse publishes regular observations on the macroeconomic factors impacting the financial markets, as well as exceptionally rich technical analysis - his price forecast charts of gold and silver are 'must reads' for anyone who seriously invests or trades precious metals. Recently, his site was rated as the fourth-most-influential blog in financial media by Mindful Money.


1. Jesse’s Café Américain has emerged as a well-regarded source for insight into the key indicators driving the markets. Can you summarize your overall outlook for the economy and what macro trends investors and traders should be following most closely?

Stagflation has been my forecast for quite some time as the most likely outcome, with a real protracted deflation or hyperinflation as lesser probabilities.  

The reasoning behind this is fairly straightforward.  In a fiat monetary regime, the central banking authorities license the shadow banking system to create money through their credit expansion mechanisms.  There is a money multiplier, or a natural credit expansion, in a normal growth economy.  In the event of a recession due to a business cycle, the Fed can relax reserve requirements and interest rates through their open monetary operations, essentially lowering the standard for credit creation, also known as the interest-rate hurdle, for a profitable return. 

In the event of a financial crisis or a credit collapse such as the one in which we are now, the Fed has the ability to monetize existing and new government debt by purchasing it at extraordinary (non-market) prices, adding it to its balance sheet.  Additionally, the ability to pay interest on bank reserves gives them a little more fine control on the effects, and even keeping some liquidity out of the system by paying banks to retain a greater amount than they ordinarily would, and raising the bar a little on interest rates.  People also forget that the Fed has always had the power to set reserve and margin requirements.  This extraordinary monetization effort by the Fed requires a significant amount of cooperation from bondholders and those external entities who hold dollar assets in their currency reserves.  

The problem, of course, is that the Fed is only a part of the bigger picture.  It is the responsibility of the Congress and the Executive to set fiscal and regulatory policies for the country and the real economy, including import export, jobs, taxation, and so forth.  Today, the government, both the Executive and the Congress of both parties, is presiding over a broken system, made so by a relatively tight coterie of monetary interests who have been promoting an outsized, over-dominant financial sector, and the undermining financial regulation since the early 1990's.  

I think a particular event occurred around 1996-7 which I have referred to in the past as a 'financial mystery, a coup d'etat.'  I prefer not to speak of it more now, but it involves US government officials and China, and Clinton's chief financial people Greenspan and Rubin.  It was at roughly the time of Greenspan's 'irrational exuberance speech,' after which he shortly changed his tune and began the expansion of the money supply, which culminated in the tech bubble.

2. You seem to see the root causes of today’s economic troubles stemming from unnatural imbalances and distortions of free market principles – engineered ‘financialization” that exists for the benefit of insiders, not society. Can you elaborate?

Yes.  It is fairly well documented that a massive lobbying effort had been undertaken by the Wall Street banks to remove the last restrictions that had been placed on the financial sector by the government in the aftermath of the Crash of 1929 and the Great Depression.  PBS Frontline has done a good job of documenting this.  

Promotion of such romantic notions as the 'efficient market hypothesis' and the power of self-regulation to free economic growth were promoted actively by thought leaders and by a few well-placed officials and public figures.  Regulatory capture proceeded along with the erosion of such principles of the 'fairness doctrine' in the media, and the concentration of power in fewer hands.

We now have an economy in which five banks control over 50 percent of the entire banking industry, four or five corporations own most of the mainstream media, and the top one percent of families hold a greater share of the nation's wealth than any time since 1930.  This sort of concentration of wealth and power is a classic setup for the failure of a democratic republic and the stifling of organic economic growth.

3. What do you see as the necessary elements for a solution? What do we need to embrace or enact in order to return to a sounder, more sustainable, and fair system?

The concentration of wealth is not sustainable in a democracy.  This concentration has been enabled by the campaign financing rules, and the lack of enforcement of existing laws.  

One can cast about at the branches of the problem for years, or they can strike at the root of it, and break up the big financial institutions, reinstituting what Paul Volcker called 'narrow banking.'   

We must recognize that a partnership between corporations and government is a dalliance along the road to fascism, inimical to the freedom of the individual. Corporations do not and must not have the same rights of individuals, because it is the Bill of Rights that was meant to balance the power, to protect the individual from powerful combinations and concentrations of wealth and power.   

Campaign finance reform, a reform of the civil service, and reform leadership, rather than lip service, from the top down are all essential.  It will take a more vigorous effort by the Justice Department to punish criminal activity.  There should be little surprise that no one is going to jail, or even being indicted, for some of the most egregious frauds that we have seen since the S&L crisis.  

The United States, in what I call a credibility trap, in which no substantial reforms can take place because both political parties are compromised, I am not optimistic that real change will occur until the economic situation get much worse and a genuinely independent third party movement threatens the status quo with serious investigations and criminal indictments.  The Tea Party started as a movement for financial reform, but became quickly co-opted by powerful financial interests and slick public relations campaigns.  You hardly ever hear about real financial reform from them anymore.

An example was made of Eliot Spitzer to dampen the enthusiasm of reformers for this sort of independent third party movement, so it may be a long time coming.  And of course there is always the danger of a 'reformer' whose cure is worse than the disease.

4. Your regularly-published charts forecasting anticipated price movement in gold and silver have been spookily accurate lately. Can you explain your current opinion of the precious metals? And where do you see them going from here?

The precious metals will continue to go higher as long as the fundamental economic situation remains the same.  How high they will go depends on how much the US is willing to debase its bonds and its dollars, which are nothing more than bonds of zero duration.   Actually I think it is more a matter not of 'how much' but 'how quickly' they are debased.  I suspect that the dollar will fall until a new dollar is issued in exchange for the old dollar, with a couple of zeros knocked off, much as what had happened in Russia with the reissuance of the rouble.

Until the financial system is reformed and balance is restored to the economy the dollar will continue to decline.

5. You publish some of the most elegant and useful technical analysis on the Internet. What are the most important lessons you’ve learned as a trader? Do they still hold in today’s liquidity-drunk markets?

Thank you for this.  It took me about ten years to create the type of technical analysis I use today.   I had looked into almost all the existing systems and even historical systems no longer used, and decided to create my own style that suited my personal needs and preferences.  I had been trading the futures, options, and currency markets rather actively since 1999, and spent many hours watching the 'action' in a variety of markets in real time.  I researched charting and systems, even gaming systems, very heavily, from Elliot waves to classical charting.  

I  settled on what I call the Babson System, in honor of  Roger Babson the economist, who was also a very successful trader.  He did not document his method, so it really is my own creation, but I drew the original idea for it from some descriptions of his methods of charting the markets.  Along the way I have studied the trading greats and read their methods.  I would estimate I read over 200 books on the subject and much more as it became available on the web.

I have given up trading actively in the futures, so some of the time elements are much less interesting to me now than they have been, and this is reflected in my charting.  I used to publish ten minute charts six or seven times a day and spent much more effort on timing.  Now I am down to daily charts once a day.   

6. What’s your advice to the average investor (not the power-trader) looking to protect and perhaps grow their wealth in today’s turgid markets?

I would give the advice I give to myself.  Understand that in the short term, the market as it is now is a game of deception and gambling, and most gamblers go broke.  Be very careful about following gurus and systems.  Learn from others, but always own your trades so you can hold them with conviction.   There are a lot of very smart and highly paid people with the best tools who are playing against you, and they view the market as a zero sum game, with you as the mark.  So, ideally pick an area where you know quite a bit, ideally through your own work or some avocation you have, and then invest in it using a long term view and whatever informational advantage you can obtain.  Above all, play the longer trends, and do not watch the daily fluctuations in the markets.  Never lose your position in a primary trend bull market. 

7. Few know the man behind the moniker “Jesse.” Can you tell us a bit about your background and where you developed your expertise in predicting market developments?

I had a somewhat unusual formal educational experience that was more diverse than most, supplemented heavily by independent study.  I had a classical education as an undergraduate, heavy in the natural sciences, literature, classical language and history, and philosophy. 

My engineering study was almost all post-graduate.  After a long stint as a boy programmer and a systems analyst, I was recruited to be an engineer in advanced communications research, specializing in what is called information encoding and compression.  Basically the notion was to take any type of information, whether it be data, a picture, speech, or a video, and transmit it cost effectively from one place to another generally by first compressing it, perhaps even encrypting it, and then transmit it to its destination with the right kind of network wrappers using a variety of media from copper wires to satellite links and fiber optics.  I spent quite a bit of time working with the ITU in Geneva and the domestic standards bodies in the US, Japan, and Europe to promote more aggressive standards for communications. For those in the computer science racket, I had worked primarily on the bottom four layers of what is called the ISO model with a lot of emphasis on the basic plumbing.

I had a dual career ladder of following innovation from the lab into the marketplace, managing it, and then going back and working on new variations and improvements.  I went back for an MBA along the way, ran a major business unit with billions in revenue, rode a couple of Silicon Valley startups with a couple of notable successes, and that was that.  I had the chance to do a lot of M&A work during the height of the tech bubble, which was very interesting, indeed.

So I think I have some talent in systems work and pattern recognition.  I have always had a knack for taking a problem and tearing it down, developing some approaches to solving it, and finding those areas where it is most likely to fail.  This served me well in business.   And all the pattern recognition work I did in the labs helps me in charts as well as in understanding the flows of money through an economy.  At least I think this is the case.

8. You often look at the “human” – some would say spiritual – factor in your outlook into today’s financial crisis. What role do you think this dimension played in creating the current crisis, and what role do you see it playing in the solutions to it?

I have been very fortunate to have the opportunity to speak with and obtain a passing friendship with a number of very worldly wise people in my life, from politicians to inventive geniuses, businessmen to billionaires.  I think this was because I was always ready to listen to the wisdom of experience, and so obtained mentors along the way by asking questions.  I once posed this question about the human factor in social change to Pierre Rinfret, who was an economist and quite knowledgeable with regard to worldly things like politics.  He thought that there is always a mixture of personality types in any culture.  The culture rewards and promotes certain types at various times, and this often moves in cycles.  These types can obtain power and wield quite an influence on the rest of their society in terms of policy and values, and popular thought.  

He believed that the same type of people who had risen to prominence in the 1920's were back at it again in the 1990's, and that we would pass through a similar cycle.  We differed quite a bit on the potential outcomes, but I resonated heavily to this thought, based on some early exposure to cycle theory I had obtained from the work of


Pitirim Sorokin and of personal observations after 25 years in a Fortune 100 corporation.  

People are mostly the same around the world, but certain cultures reward and emphasize certain types, so that the culture takes on a different flavor from one to another, and from this time to that time.  Japan and the United States are quite different, but I would submit that the distribution of natural personality types are roughly the same.  They are just trained and restrained differently, and people will dampen or encourage their own mixed tendencies and preferences in accord with social norms.

Quite simply, this cycle will continue until things get bad enough, and then it will change or be changed.

9. Jesse’s Café Américain was recently rated fourth in a ranking of the most influential blogs in financial media by Mindful Money. What is your goal for the site?

I still don't understand how that happened, and since Time Magazine has subsequently ignored my site completely, I am gratefully relieved.  I suspect it was because I have a heavy element of international readership, although the traffic volumes are much less than the big sites.  

My goal for the site is to make my site obsolete, because the market will be so efficient and transparent that one could roughly calculate the relative risks and rewards of most investments with something like an improved Capital Asset Pricing Model, although the trick will always be in estimating the risks which do not lend themselves easily to measurement.  

I doubt this will happen.  I suppose that at some point I will become so tired of this that I will do something else, and then will no longer have time for the site as I will be absorbed in other things.  I have made major career changes about every nine years in my life, so I am now overdue.  So far this has not happened, and not for lack of my trying.  

Being involved in these markets is a very discouraging experience at times, with the things it shows you about human nature.  Its almost as disgusting as politics.   There must be a God, because only something so powerful could have a love vast and durable enough for those who are otherwise so unworthy of it.  And if not, well then, there is always Pascal's wager.

But while I am trading these markets it makes sense to share my own work, if nothing else than to obtain feedback, and introduce the impedance of having to show it to others to make me do the diligence to actually make it credible.

10. What question didn’t we ask, but should have? What’s your answer?

What was the key influence in my life, the greatest influence?  I think a lot of credit would have to go to my godfather, who had studied at Harvard under the great Renaissance scholar Douglas Bush.  I was always a voracious reader, and he exposed me to quite a few authors early on that shaped my thinking.  As he always said, you have to bring the young mind 'flush up against the mind of genius.'   Other than that, marrying my wife of over 35 years has been my best decision ever.  I can safely say that every good thing that I have has come to me because of her. 


If you have not yet seen the other articles in this series, you can find them here:

Readers can submit their preferences for future Straight Talk participants, as well as questions to ask them, via the Straight Talk forum.

Related content

26 Comments

plato1965's picture
plato1965
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Information, entropy.. and posters.

typo alert -  the ( link ) should be 

http://jessescrossroadscafe.blogspot.com/

Interesting, especially the background.. here's a crazy thought.. ever tried finding the best compression algorithm for market data ?

Say a discrete sampling frequency, how much entropy , how much self similarity... try a range of algorithms like bzip, discrete-cosine etc on the bare numbers.. hourly, daily, weekly..

The reason I mention this is that I'm a fan of a guy called Gregory Chaitin  ( http://en.wikipedia.org/wiki/Algorithmic_information_theory ) , and one of his ideas is that a "theory" is basically a compression ... of data.. the better the theory/program, the smaller the number of bits needed to encode it.

Oh one more thing, love the french poster art... and the title, but why ? Art lover, francophile, or is it just the food  ?

sundarb's picture
sundarb
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very interesting interview

For those interested in reading further links surrouding the financial mystery that Jesse is referring to, here are the links:

Greenspan speech:

http://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm

Jesse's relevant posts from his blog:

http://jessescrossroadscafe.blogspot.com/2009/10/pbs-frontline-presents-warning-roots-of.html

http://jessescrossroadscafe.blogspot.com/2010/04/reich-levels-broadside-at-greenspan.html

I think the extent of corruption is so spread out, with a lot of players who gained in the action. Inside Job documents these events in detail, however the connection with China that Jesse is referring to in the above interview -- still remains a puzzle to me, how it fits in the overall picture.

Would be glad if anyone can clarify more on that note.

Jesse's advice on investing is spot-on. As George Carlin remarked "The game is rigged".

 [Warning: some swear words in the video].

Adam Taggart's picture
Adam Taggart
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url fixed

Thanks for flagging.

plato1965's picture
plato1965
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@sundarb - Noticed something

@sundarb - Noticed something in that link

"Fiat justitia ruat caelum." Let justice be done though the heaven's fall. This is the principle of English law that says that expediency, that appeals to a false 'national security,' that executive privilege and the secrecy of the powerful interests, are not to deter the light of exposure and the consequences of justice for all. This is the difference between a republic and a dictatorship of the oligarchy.

and it reminded me.. of

Speak the truth though the heavens fall. -Frederick Soddy, 1935

We differ from the ancients notably in only two ways, one our science and
the other our system of fictitious credits.
-Frederick Soddy, 1940

I have never understood the claim of economics to be independent of ethics
and morality, except in an extremely narrow sense that no amount of good
intentions or benevolence will excuse or bolster up a physically impossible
or naturally ridiculous system of economics.
-Frederick Soddy, 1937

"For Soddy, banks do not really make loans, because a loan implies that the
lender gives up what the borrower receives. When a bank lends money it gives
up nothing, creating the deposits ex nihilo up to the limit set by reserve
requirements. {3} The real "lender" is the community at large whose money
balances lose in purchasing power with the issue of new money. We know the 
new money will be spent and increase demand, because the borrower who gets
it would not pay interest just to increase his idle balances. Prices are bid
up since ex nihilo creation of money (demand) can increase much more rapidly
than can the ex materia creation of new physical wealth (supply). But the
more direct line of causation is simply that relatively constant Virtual
Wealth divided by more pounds means each pound is worth less. Money should
not bear interest as a condition of its existence, but only when genuinely
lent by an owner who gives it up to a borrower. Banks are like
counterfeiters who lend false money, accept their own false money in
repayment and destroy it, but receive the interest in real money transferred
to them by the rest of the community, and which is not destroyed
. Banks
create and destroy money with no understanding of the "laws that correlate
its quantity with the national income" (Wealth, page 296). Also by
continually changing the value of money as they create and destroy it, the
banking system converts the pound sterling into a rubber yardstick, in
effect making a mockery of all physical measurement standards, since "yards
per pound" or "gallons per pound" become variable magnitudes, even though
yards and gallons be fixed.
"

and speaking of physical units.. and reference points..

http://fofoa.blogspot.com/2011/03/reference-point-revolution.html
bwahaha's picture
bwahaha
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Plato, I think the name

Plato, I think the name Jesse is a play on Jesus Christ...'the root of Jesse...', and the crossroads are the cross, and a choice we all must make.  (Just a guess mind you).

Great interviews, read them all! 

bwahaha's picture
bwahaha
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firefly's picture
firefly
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I'm glad to see this - I've

I'm glad to see this - I've been following Jesse's blog regularly for some time now.

I think it's worth repeating his two mantras:

"The Banks must be restrained, and the financial system reformed, with balance restored to the economy, before there can be any sustained recovery"

and

"Need Little - Want Less - Love More"

(@bwahaha - the name Jesse is from Jesse Livermore, a famous financial trader)

Thomas's picture
Thomas
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Yo!

Just sayin' "Hey" from a parallel universe.  

Thomas's picture
Thomas
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BTW-Jesse...

Your link to this article disappeared from one of the boards (at least I cannot find it).

nestor_andreu's picture
nestor_andreu
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Excellent!

Excellent interview and thanks Sundarb for the links. This site is a pleasure. I always recommend it.

SagerXX's picture
SagerXX
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Really chewy stuff here

Thanks for another thought-provoking Straight Talk.

Now I only wish I had a couple of days free to sit down and google myself stupid about the "mysterious coup d'etat"...

Viva -- Sager

bwahaha's picture
bwahaha
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Thanks Firefly.  I've been

Thanks Firefly.  I've been reading up on the Laurence Livermore Nuclear Research Lab,  their studies on mice and cancer....(radiation is the only known cause), wow, whodathunk?

plato1965's picture
plato1965
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New dollars for old ?

( excuse any incoherence in earlier homebrew-fuelled posts..  *blush* sober now!)

jesse wrote:  "The precious metals will continue to go higher as long as the fundamental economic situation remains the same.  How high they will go depends on how much the US is willing to debase their bonds and their dollars, which are nothing more than bonds of zero duration.   Actually I think it is more a matter not of 'how much' but 'how quickly' they are debased.  I suspect that the dollar will fall until a new dollar is issued in exchange for the old dollar, with a couple of zeros knocked off, much as what had happened in Russia with the reissuance of the rouble."

Actionable response,  have a reasonable supply of coinage.. especially nickels, both as insurance against devaluation and chaotic bank-holiday type situations.

 

Nate's picture
Nate
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request

Sager,

The line "mysterious coup d'etat" peaked my interest too.  If you find the information, please post it!

Nate

RogerA's picture
RogerA
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chinagate?

Maybe he is refering to chinagate.

watch from 1.17.00 in this movie. Bill & Hillary Clinton: Their secret life.

http://video.google.com/videoplay?docid=-2819829376783659846#

sundarb's picture
sundarb
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found this link useful

Reference: Chandrashekar Tamirisa, “The Crisis: A Reply to Alan Greenspan, Part 1,” Transformations, LLC Blog.

Relevant Content from the link above:

Clinton wanted to aggressively expand American economic power into the newly opened foreign markets to improve the living standards of Americans. International economic policy was seen as the principal vehicle to transition post-Cold War countries to democratic capitalism. Bill Clinton had passed the North America Free Trade Agreement (NAFTA), repeatedly gave China the Most Favored Nation (MFN) status that culminated in China’s admission into the World Trade Organization (WTO) by the end of the Clinton presidency in 2000, while putting off Russian integration into the European West or the WTO by acceding to the political sensitivities of the Western Europeans, including the United Kingdom.

Economic instability abroad had clear and present benefits for the United States. Cheap foreign labor which produced cheap imports would reduce product inflation because expensive American production could mostly be supplemented by foreign labor.

Alan Greenspan’s and Bill Clinton’s economic success felt good while it lasted because equity appreciation that is subject to the vicissitudes of political and social risks abroad and domestic investment in equities at home through borrowing, as he himself concedes in his paper, is unsustainable.

Here is the Greenspan paper that the author is critiquing:

http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2010_spring_bpea_papers/spring2010_greenspan.pdf

The last line the paper: Tax payers should not be at risk.

Unbelievable!

pinecarr's picture
pinecarr
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Thanks Jesse; interesting

Thanks Jesse; interesting read!

SagerXX's picture
SagerXX
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Posts: 2120
The mystery?

sundarb wrote:

Here is the Greenspan paper that the author is critiquing:

http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2010_spring_bpea_papers/spring2010_greenspan.pdf

The last line the paper: Tax payers should not be at risk.

That sounds about right.  Nice dig, Sundarb!

Viva -- Sager

sundarb's picture
sundarb
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Some more info

Wikipedia's article on Robert Rubin has an interesting line: (http://en.wikipedia.org/wiki/Robert_Rubin)

In 1997 and 1998, Treasury Secretary Rubin, Deputy Secretary Lawrence Summers, and Federal Reserve Board Chairman Alan Greenspan worked with the International Monetary Fund and others to effectively combat and contain financial crises in Russian, Asian, and Latin American financial markets. In its February 15, 1999, edition, Time Magazine dubbed the three policymakers "The Committee to Save the World."

This is what I think actually happened. I admit, there's speculation on my part -- but the speculation is based on sound reasoning and inferring conflict of interests surrounding this saving the world committee.

Dollar as the world reserve currency directly means that the United States has to run deficits to facilitate world trade. Now, they can decide who they run these deficits with, that's a choice they have. Clinton obviously played a very critical role in ensuring China was the country of choice to run these trade deficits, because China's labor, price and wage controls ensured that the goods were manufactured for cheap, exported for cheap and then sold in developed countries for higher prices. In the Wikipedia quote above where they say "effectively combat and contain financial crises", basically this committee saw an opportunity in this crisis and by trade agreements with China, they could let the financial ponzi scheme based on the debt money go on.

As always, the question is who benefits?

Is it really the American people? 

I have a feeling that financial firms who were heavily exposed to emerging markets were involved in facilitating this deal. There is no way to confirm this, but Robert Rubin was a former CEO of Goldman Sachs. Larry Summers is one of the core members within the financial power circle.

Alan Greenspan, as we all know -- is at the epicenter of generating bubbles (1987 stock bubble, tech bubble, housing bubble).

land2341's picture
land2341
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The reason this is so powerful still

The reason this is so powerful still is that it was not a conspiracy or a planned coup,  so much as it was the development of an ethos that led to the coup.  This took real time and took root because it met what people wanted to believe and still do....

http://video.google.com/videoplay?docid=-1087742888040457650#

Now that Ayn Rand has a new movie coming out, brace yourself  this is only round one.

zenglen's picture
zenglen
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Help! Please explain the first part of the interview...

I need help folks. Will someone please explain the first part of the interview to me in plain english?

This interview opened with a question I was keen to hear the responder's answer to. Basically, it was: "As someone who clearly has a deep understanding of this stuff, what's your outlook on the economy?"

The first sentence hooked me because it created cognitive dissonance... 

Stagflation has been my forecast for quite some time as the most likely outcome, with a real protracted deflation or hyperinflation as lesser probabilities.

Stagflation? What the deuce is that?... I had to look it up.  Apparently it means:

"a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation)"

Oh, ok, that sounds reasonable.  But wait, I've been preparing for hyperinflation, not stagflation.  Do I need to go back and review the sources that led me to conclude hyperinflation was the most likely outcome?  Do I need to alter my plans?  How do I deal with and prepare for an extended period of Stagflation?  What if I need to prepare for multiple contingencies? How can I prepare for all these possible outcomes at the same time?  Is that possible?  Am I supposed to just place my bets and hold my breath? 

As you can see, I'm on the hook now, please tell me why you came to the above conclusion.

The reasoning behind this is fairly straightforward.

Thank heavens!  A complicated, jargon filled explanation of your reasoning would only confuse me. 

In a fiat monetary regime, the central banking authorities license the shadow banking system to create money through their credit expansion mechanisms.  There is a money multiplier, or a natural credit expansion, in a normal growth economy.  In the event of a recession due to a business cycle, the Fed can relax reserve requirements and interest rates through their open monetary operations, essentially lowering the standard for credit creation, also known as the interest-rate hurdle, for a profitable return. 

In the event of a financial crisis or a credit collapse such as the one in which we are now, the Fed has the ability to monetize existing and new government debt by purchasing it at extraordinary (non-market) prices, adding it to its balance sheet.  Additionally, the ability to pay interest on bank reserves gives them a little more fine control on the effects, and even keeping some liquidity out of the system by paying banks to retain a greater amount than they ordinarily would, and raising the bar a little on interest rates.  People also forget that the Fed has always had the power to set reserve and margin requirements.  This extraordinary monetization effort by the Fed requires a significant amount of cooperation from bondholders and those external entities who hold dollar assets in their currency reserves.  

The problem, of course, is that the Fed is only a part of the bigger picture.  It is the responsibility of the Congress and the Executive to set fiscal and regulatory policies for the country and the real economy, including import export, jobs, taxation, and so forth.  Today, the government, both the Executive and the Congress of both parties, is presiding over a broken system, made so by a relatively tight coterie of monetary interests who have been promoting an outsized, over-dominant financial sector, and the undermining financial regulation since the early 1990's.

What? (scratching head)

I'm sorry, but none of that made any sense to me whatsoever, but it sounds terribly important. I sincerely want to know what it means.  Will someone please explain it to me in plain english?  Which is to say, at the level of say, a high school dropout? 

Sincerely,

Glen

sundarb's picture
sundarb
Status: Bronze Member (Offline)
Joined: Jan 10 2011
Posts: 72
Hedging outcomes

Glen,

There's a tendency in today's main stream economic news to paint whatever'flation' (inflation/deflation/stagflation/hyperinflation) as some kind of a black and white picture. This or that. In reality it is not at all that way. You could have assets that were previously in a bubble (say housing for example) deflating/contracting for many years to come, while food prices continue to rise simultaneously due to supply shortages, disruptions due to energy shocks etc. etc. Essentially, planning towards any specific outcome alone is not a wise thing, because in the mean time, we could be taking several other paths. So we hedge against all possible outcomes, at the same time keeping in mind what is the most likely and knowing when to fine tune our investments towards the likely future as it unfolds. Short-term horizon and long-term horizon planning also helps, See Chris's article on 'Taking control of your finances' for a detailed explanation.

You don't just place these bets and hold your breath, we have to constantly be aware of the current events and the likely future events that may manifest. Plan accordingly. CM website's 'what should I do' series is very helpful towards reducing anxiety and having concrete plans for a sustainable and resilient future.

Now to the jargon:

The Federal Reserve has nothing 'Federal' about it. It is a private entity, whose shareholders are participating member banks. The premise is that they are a central monetary authority, who help retain economic stability in the country. They have a dual mandate, which is that they have to ensure stable prices and low unemployment. They fail miserably at both and in fact, they are the cause of economic instability in the country. You can read the book -- 'End the Fed' by Ron Paul for a very detailed yet approachable description of what the Fed does and why it should be abolished.

What Jesse is saying is that the Federal Reserve has extraordinary powers to intervene the market and when they do intervene -- they have serious effects not just the US economy, but the global economy. US Dollar is still the world reserve currency, so everyone in the world who holds dollars get affected by the US monetary policy. The Fed can do what they are doing now, only if all these global participants (China, Japan among others) can oblige. They clearly do not like what the Fed is doing now (quantiative easing), because it causes them to inflate their own domestic currencies. Remember, these foreign nations can only strive for one of the two -- exchange rate stability or domestic price stability. They all choose exchange rate stability, because they don't want to lose the value of their US dollar reserves. This system as you can see, is highly fragile and prone to serious disruptions, when participants do not oblige.

But the Federal Reserve itself is in control of private banking cartels. Combine these cartels with a government that is engaging in reckless spending, you have a thoroughly broken, morally corrupt monetary system. Financial sector is the strongest/wealthiest lobby in the US Congress, so they always get their way. A broken, unethical monetary system has led to staggeringly increasing imbalance of wealth. Concentration of wealth and power within a few people leads to economic policies that suit just them while the rest of the populace suffer at their expense.

Massive private gains and equally massive public losses is the end result.

Hope this helps.

zenglen's picture
zenglen
Status: Member (Offline)
Joined: Feb 24 2011
Posts: 2
Whew! Ok thanks...

Whew! Ok thanks SunDarb.

I thought that there was new information... which is to say, knowledge that was not part of my current understanding... embedded in that cryptic message from Jesse. 

Glad to see that there's really not. 

Thanks for decoding it for me.  After re-reading it, I see how your explanation connects up the pieces that I couldn't put together. 

There's a lot in Jesse's phraseology that I still don't understand, but at least I know I'm not missing anything important. 

One thing you helped refine in my understanding was the mechanism by which world currencies are tied to US monetary policy, and how they have to choose between exchange rate stability and domestic price stability. 

What I'm trying to figure out now, is how the banking system in the country where I live, Thailand, is affected by US monetary policy. 

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