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August 26, 2009

Pivotal Events
by Bob Hoye

The following is part of Pivotal Events that was published for our subscribers Thursday, August 20, 2009.

Signs Of The Times:

Last Year:

"Apartment Buildings Lose Their Immunity to Housing's Chill"

- Wall Street Journal, August 20, 2008

"U.S. Commercial real estate prices fell for a fourth straight month in June, bringing values to 11.8% below their October 2007 peak."

- Bloomberg, August 20, 2008

Note that commercial property prices peaked with the stock market, and began what is likely to be a lengthy bear market. And according to the NBER the recession began virtually with the stock market high. Usually the business cycle lags the cycle for share certificates by 8 to 12 months. Hitherto, the only time both have peaked together has been at the start of a Great Depression. Will it be different this time?

Martin Mayer, who has written a number of serious books on banking, was one of the speakers at last Spring's CMRE Dinner, and Bob enjoyed meeting him. His book THE FED was published in 2002. In it he observed "The truth is that liquidity is the only significant weapon in the central bank's arsenal, but it will not necessarily go where you want it to go."

Anyone who has read financial history would make the same conclusion. For example, this was the condition during the post-1929 contraction when the attempts by the Fed to supply liquidity were summed up by Barron's in 1932:

"The Federal Reserve policy of cheapening credit through the purchase of government bonds has been unable to make a dent in the conservatism of borrower or bank lender, in short, every anti-deflationary effort has yet to provide positive results. The depression is sucking more and more bonds into its vortex."

More than likely, the liquidity injections shored up impaired bank balance sheets and/or went into bonds on the "carry" against exceptionally low short-term rates.

The establishment, without Mayer's insight, still insists the Fed was "tight" in the early 1930s. The Fed was not tight but the contraction overwhelmed all artificial attempts to inject liquidity into the system. In so many words, accounts still alive avoided "losers" and some speculated in "winners" until there were no winners.

An interesting subset of this is Washington's "Cash for Clunkers" intervention. Folks are not buying "Detroit" cars, with value impaired by their monopolistic unions, but are buying US-made Japanese cars.

* * * * *

The Long Bond found support at the 115 level - with that our target became around 120. The price is now in the 120s and has further to go.

Shorter maturities - "prices are fixed in quiet trade" describes the action.

The three-month bill has been at 0.18 percent since May 1. A way back then dealer commercial paper was 0.90 percent. After spending most of June at 0.45%, it's been at 0.35% since late July.

A year ago this week, it was at 2.75% and in the October hit it soared to 5.20%. One wonders about the remarkable decline. Has the credit quality of the underlying companies improved to that of pure gold? Doubt it, but it is likely representing the huge amount of "stimulus" sloshing around out there.

And as noted above, "stimulus" does not fix the losers, but chases short-term trading tactics, which gets this page into the nonsense of interventionist economics.

The market does not know that audacious economists have brilliant ideas about what the economy should be doing. It is the equivalent of giving a race horse an exciting name so that it will run faster. Man O'War did not know his name and it had no incentive, but his winnings became legendary. On the longer term the market will have its way.

Another point is that financial history does not know that it is supposed to be random, and continues to record great booms and great busts that show remarkable replication on each transition from good to bad. Even leading policymakers responses to the transitions have been the same. They take credit for the boom, find scapegoats on the bust, try stimulation, suffer a fit of recriminatory regulation and then turn to years of protectionism.

One of the great errors in intellectual history has been the notion of a national economy that can be manipulated by uniquely gifted policymakers. Over the past 300 years booms and busts have been shared by all advanced countries. The mania of 1720 afflicted France, Holland and England. As trade expanded so did the geographic influence of huge financial events.

Impractical mental speculation need not be limited to just intellectuals. One outstanding irony that argues against the notion of a national economy is that virtually all policymakers are interventionist economists with the same recipes. By establishment reckoning, the only way a national economy could exist would be through only one country being run by interventionists. Contrarily, their international presence argues for coordinated boom and busts. That's if they all succumb to the same recklessness.

There is even a pattern in the influence of central planners. During the latter years of a great boom, politics trends authoritarian - in every country. For example, in the full-command Soviet economy the experiment in Communism ran until the global boom in commodities blew out in 1920. With the contraction there was a global swing away from the command economy. The US privatized previously nationalized railroads and Russia turned from Communism to socialism. As represented by the fall of the Berlin Wall, a wave of political reform swept the world. Commodities recorded an important high in late 1988 and the wall came down in late 1989.

Then with the global boom that launched in 1996 the world has gone to the left, with the US, for example, on the most aggressive push against its natural freedom to intrusive government in its history. With this, Russia has been returning to its native authoritarian habits.

However, as the post-bubble contraction continues all of the interventionist potions will be seen to fail and political power will begin to return to the individual. As with the contraction, political reform will be universal.

The latest global "sure thing" in the markets has been the "carry" against the curve and spreads - this is close to reversing.

"It [the State] has taken on a vast mass of new duties and responsibilities; it has spread out its powers until they penetrate to every act of the citizen, however secret; it has begun to throw around its operations the high dignity and impeccability of a State religion; its agents become a separate and superior caste, with authority to bind and loose, and their thumbs in every pot. But it still remains, as it was in the beginning, the common enemy of all well-disposed, industrious and decent men."

- Henry L. Mencken, 1926

In a 1909 editorial opposing income tax, The New York Times wrote, "When men get into the habit of helping themselves to the property of others, they cannot easily be cured of it."

Mencken would not have changed his principles.

Obviously, the NYT has been corrupted.

Link to August 21, 2009 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1347

Bob Hoye
Institutional Advisors

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