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Warning shot

The fallout from the bursting of what many call "the bubble" (dot.com implosion, tech/telecom blow up and finally recession in the general economy) left us with an enduring symbol of what can go horribly wrong in modern, leveraged, business. That symbol is Enron, the energy trader that went from Wall Street darling to nuclear fallout site seemingly overnight. The fallout of course, was people's retirements going up in a radioactive dust cloud. People who thought their futures were safely tied to this "highly successful" icon of new American business, were left with the harsh reality that leverage and an insistence on always telling Wall Street what it wants to hear can build some very unsound fundamentals into a company.

Aside from our poster boy for American corporate blow ups, we witnessed improprieties, mismanagement, and/or ill-advised, unsafe leveraged speculation at such well-known major American corporations as Worldcom, Tyco, Putnam Funds and many more. Who can forget the made-for-TV image of Adelphia founder John Rigas being led away by police?

But that was then, what about now? Did we learn anything? People who think the bubble was then and this is now have got a rude awakening in store. We are still dealing with the bubble, only now it is far worse in just 4 short years. Bubble excess in the bond markets, and by extension the mortgage and real estate markets, have allowed America to do what it does best, think positive, put the past behind it and move forward with business as usual. The economy is humming along, credit is abundant and it appears people generally feel good about the future.

Warning shot #2

But every silver lining has a dark cloud, or in this case several dark clouds gathering on the near term horizon. The Fed has gone about its duty and initiated a rate hiking regime, but the speculative playground atmosphere of the bond market's yield spread has remained intact as hedge funds, banks and speculators of all stripes have used it as no-brainer profit machine. This can continue as long as rates at the long end stay tame. Our oft-used chart of the spread between long and short rates will tell the story:

At the very least, it appears to be bottoming. At worst, this ratio will turn up and then we would see how solid the balance sheets are of those individuals who were lured into the "ownership society" by cheap rates for overvalued homes (a primary landing place for inflation's effects), were enticed to keep up with the SUV driving, home remodeling, generally good life living Joneses through home equity extraction or credit card max out. We would also see just how much protection paper (Federal Reserve Notes, stocks, corporate bonds) offers in the face of deflation. The dollar, or FRN, would be a short term hiding spot, but ultimately it denominates the most jaw dropping level of debt in history; our nation's massive debt! This is why exposure to precious metals is important. But on with the main theme for this article....

FNMron, GMron and AIGron

So now we have the potential for another deflationary impulse, a contraction of liquidity, the inflationary liquidity that this supposedly healthy economy has used as life support since 2001. You can once again hear little cracking sounds, creaks in the background behind all the day to day noise. Who will be the next Enron, Fanny? GM? AIG? Maybe we Gloomy Guses read too much into such things, but I do not like the combination of mind boggling debt at America's leading companies (companies that touch MOST Americans in one way or another) and a Fed bent on raising interest rates. Rampant speculation in derivatives only confuses and compounds the issue. This deflation, or contraction of liquidity, must not be allowed to become anything more than a tactic to show speculative interests that the Fed means business for now. Where once deflation was a normal part of the economic cycle, it has been bungled, botched (by too much inflation over the decades) and reassembled into a sort of Frankenstein's Monster, and if it gets loose into the countryside (pun intended - think about it), it will not stop until the entire financial system has been thoroughly shocked by a domino effect of major corporate failures.


Meanwhile, the copters wait, quiet and dark, for the right time. Ben Bernanke has spoken of "curing deflation" (read his 2002 remarks) and will surely take action when the fallout from corporate and household America's leveraged position begins to create panic. He will try to save us again, with all the liquidity we need. With inflation. Do you see how the game goes? It is and has been one long exercise of spigot open, spigot closed, spigot open, spigot closed, and so on. But the fact that debt has not only not been repudiated, but has been embraced and used as fuel for growth has resulted in ever-increasing risks to the cycle. Be ready to buy and have what you will need before the hueys take off, because it will all be a lot more expensive once they get off the ground.


America is nothing if not a free capitalist (I am one) society built around its business enterprises. The idea that anyone could come here, make a life for themselves and succeed meant that the American dream was real. But it is both sad and scary to think about how wrapped up the entire country is in debt. Free enterprise and hard work used to be about self-reliance. Now, as a collective, we are held captive by debt. Those creaking sounds over at Fanny Mae could soon get a lot louder, and with the intertwined nature of the financial system (GM, through GMAC holds the balance of my mortgage and I held significant funds in an AIG policy until last year) there will be a domino effect to any single large institution going the way of the dodo bird, leisure suit, pet rock, 8-track or Enron. While no sure thing, this should trigger yet another attempt at reflation if Dr. Bernanke does as he has stated he would do.

Don't be a dodo bird, make preparations! If reflation is successful yet again, you may see home prices rising yet again, and even Dow at all-time highs for all I know. But keep your eye on the ball and remember what you need, not what you want. It will likely be the last chance in a good long while. Hyperinflation is a bitch.

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