Dear Readers,
Something of a potpourri today, but I guess that’s true most days.
First, a quick note to our New Zealand readers. Doug Casey, a resident there at this time of year, will again host an informal after-work drinks party in Auckland on Thursday, Feb 18. Joining him will be Rick Rule, another seasonal resident, and a guest, John Pugsley, co-founder of The Sovereign Society.
We haven’t finalized the time or the place, but I suspect it will run pretty much along the same lines as the last time. We’ll send out more details when we have them, but for now, mark the date for what should be an agreeable, entirely informal get-together.
The concept of entropy is one of the most useful terms for understanding just about everything. While it has its origins in natural law – thermodynamics, specifically – the concept holds true pretty much across all closed systems.
In the simplest of terms, every closed system will ultimately degrade toward a state of maximum entropy.
I’ll use the current political system of the U.S. as a convenient example. When American democracy was first shoved out of the nest by the founding fathers, it was new, fresh, and energetic. It took the world’s breath away at its boldness and unlimited promise, and set the wheels turning on tangible change across much of the world.
Before the ink dried on the Constitution, however, the degradation began. From the beginning, the country’s political operations fell into the hands of a strictly limited number of parties, which quickly coalesced into just two. Since then, they have essentially shared power, with only minor differences in policies between the two. Simply, absent a disruptive external force, the closed political system quickly matured into an institutionalized “sameness” that all but assures no serious challenges – leading, ultimately, to the certainty it will degrade to only a shell of its former self.
It was, perhaps, because of his own understanding of natural law that Thomas Jefferson was heard to remark, “The tree of liberty must be refreshed from time to time with the blood of patriots and tyrants. It is its natural manure.”
That doesn’t mean I am advocating revolution, dear reader – just pointing out the fact that any closed system, no matter how well constructed, will degrade. To expect the United States of America to avoid this fate is to expect the impossible.
Switching to a corporate example, I used to be a regular buyer of Toyota cars. They were well made, innovative, and suited my changing needs over the years. And I wasn’t alone – in 2007 they became the world’s largest automobile maker, with a global manufacturing and distribution system that made them appear dominant. Behind the scenes, though, entropy was at work.
In 2008, when the time had come to lease a new car, I reflexively headed over to the local dealer fully expecting to drive off with yet another Toyota, just as I had done several times over the previous decade or more. But as I walked around the showroom, it was impossible not to notice that the company had lost its edge. The cars on offer were not only more expensive than the competition, but even the newest models had that “so yesterday” look about them.
Surprising even myself, I walked out and ended up leasing from another company. I remember vividly at the time saying to my wife that we should short Toyota’s stock. Of course we didn’t – but if we had, it would have been a good play, as you can see in the chart of the company’s stock price here. Note that Toyota’s share price peaked in 2007, almost concurrently with it becoming the world’s largest car company.
As I said at the onset, you can see entropy at work in virtually every closed system. Consider the U.S. dollar, which became the world’s de facto reserve currency as a result of Bretton Woods. What an amazing advantage for the United States – this unique ability to provide the world’s central banks with their primary reserve component! And to have all the world’s commodities dealt in dollars. In short, the dollar became the centerpiece of the global economic system.
It was, of course, damned to entropy, with Nixon’s ending the dollar’s gold backing just being part of the natural progression. And if he hadn’t done it, one of his successors would have – due to some “emergency” or as a “temporary” measure, or some other flimsy political cover. Regardless, the degradation of the currency gained speed and, systematically, it’s been all downhill since.
You may also want to think about entropy when pondering the Chinese miracle. No question, China is having a heck of a run. As James Quinn writes in his article “Is China’s Recovery a Fraud?” in this month’s edition of The Casey Report, in 1970 that country’s GDP was just $92 billion. Today it is $4.9 trillion!
“Unstoppable!” cheers the punditry. The Chinese leadership, whose capable hands are very much on the levers of the macro-economy, are cut from special cloth, they add.
In answer to that, Quinn points out that despite China being an export-based economy, purpose-built to supply goods to a U.S. population engaged in a mad rush to spend themselves into debt and default – which is to say, an economy now only a memory – there is currently 30 billion square feet of commercial real estate under construction in China.
I’m not sure if bowling is popular with the Chinese, but with all that spare space, some enterprising individual might want to consider promoting it as the coming thing. Roller rinks? Indoor laser tag centers?
Meanwhile, back in the U.S., we the people are no longer content with a free-market system that embraces periodically burning down the house in order to rebuild stronger and better – a system which has been proven to create wealth, and lots of it. Instead, we are hell bent on adopting the closed economic system of a socialist model where everything and everyone is tightly controlled.
On that point, an article in today’s edition of the Wall Street Journal titled “No Exit in Sight for U.S. as Fannie, Freddie Flail” sheds light on the continuing degradation in the free market that used to underpin the nation’s hugely important housing sector…
Fannie and Freddie, for their part, remain at the core of a housing-finance system that inflated a dangerous housing bubble. After prices collapsed, sending shock waves around the world, the federal government put America's housing-finance system on life support. It has yet to decide how that troubled system should be rebuilt.
On Dec. 24, Treasury said there would be no limit to the taxpayer money it was willing to deploy over the next three years to keep the two companies afloat, doing away with the previous limit of $200 billion per company. So far, the government has handed the two companies a total of about $111 billion.
The government is willing to tolerate such open-ended exposure for two reasons. First, it sees the companies as essential cogs in the fragile housing market. Fannie and Freddie buy mortgages originated by others, holding some as investments and repackaging others for sale to investors as securities. Together with the Federal Housing Administration, they fund nine in 10 American mortgages. Worries about potential insolvency would cripple their ability to fund home loans, which would hamstring the market.
Second, the companies are a convenient tool for the administration to use in its campaign to clean up the housing mess.
"We're making decisions on [loan modifications] and other issues, without being guided solely by profitability, that no purely private bank ever could," Mr. Haldeman said in late January in a speech to the Detroit Economic Club.
Besides playing a key role in the loan-modification program, Fannie and Freddie have jump-started lending by state and local housing-finance agencies by helping to guarantee $24 billion in debt. They also are lending support to the apartment sector by becoming the main funders of loans to builders and buyers of apartment buildings.
By using Fannie and Freddie for such initiatives, the White House doesn't have to go to Congress for funding. The Treasury and White House can simply issue instructions to Fannie and Freddie via their federal regulator, the Federal Housing Finance Agency, or FHFA.
The government is "running Fannie and Freddie as an instrument of national economic policy, not as a business," says Daniel Mudd, who was forced out as Fannie Mae's chief executive in September 2008 when the government took control.
Can’t you just smell the entropy? The results are not just predictable, they are evident – just look around.
As investors, it is, I would contend, important to understand the notion of entropy – and to watch for it in your portfolio companies, in your bureaucracies, and, on a more personal level, your relationships and your health. On that last point, the human body is very much a closed system and so, as we all are too painfully aware, will degrade until it ceases to exist.
You can slow the degradation by taking care of yourself. But it’s also worth remembering that it’s a one-way slope, so enjoy yourself while you are fit and able to.
As a follow-up on yesterday’s musings about the failure of the state to maintain the appropriate separation with the religion of hyper-environmentalism, I thought you might appreciate the following, from the excellent website wattsupwiththat.com.
The article includes a link to a video segment by John Stossel, long my favorite reporter, on a mind-boggling conflict of interest in the Department of Energy. You simply have to watch it and pass it along, because it shows just how degraded our politics have become.
Here’s the setup from wattsupwiththat.com…
Sunday we all got a chuckle (or a scare depending on your world view) from the Superbowl Green Police commercial. Some thought it was fine satire, others thought it hit a little too close to reality.
After watching this report about Cathy Zoi in the Obama administration, perhaps the “too close to reality” worry has merit. In this report from John Stossel, she visualizes and vocalizes the need for “swat teams” in neighborhoods to enforce energy efficiency retrofits for homes and businesses.
Zoi, formerly of the “Alliance for Climate Protection”, formerly Al Gore’s point person for his “Repower America” nationwide campaign, now heads up Obama’s DOE energy efficiency/renewables division.
Cathy Zoi, center, Al Gore, at right. Photo via Flickr
Treehugger has a report on her move from GORE to DOE.
So why is John Stossel reporting about her? It seems some cronyism might be afoot related to company that’s been getting some government handouts as part of the “stimulus”. Watch John Stossel’s eye opening report below.
David again. Still on the topic of environgelicals, I have received some excellent letters from you, dear readers, on this topic, as well as many others – and will share some of the best later this week.
Thanks to all of you who wrote for taking the time to do so, and to do so intelligently. Even if I can’t always respond, I can assure you I read all the emails addressed to me at David@CaseyResearch.com .
Moving on, the following is from our own Doug Hornig, commenting on a politician he actually respects, and a political proposal that actually makes sense – anomalies, both.
By Doug Hornig
Since the stunning result of the Massachusetts senatorial race, President Obama has softened his tone quite a bit, essentially saying to Republicans that if they have any good ideas, “Bring ’em on.”
Whether he’s sincere or not remains to be seen, but the implication is that he’s unworried, because in his opinion the opposition party only knows how to criticize and doesn’t have anything constructive to say.
He needs to call Wisconsin Congressman Paul Ryan, ranking member of the Committee on the Budget, and have him over for tea.
Ryan is a representative who appears to take his job – overseeing the federal budget – seriously. In 2008, he introduced legislation called “A Roadmap for America’s Future.” It died, so he’s reintroducing it this year. It won’t pass, unless the Democrats somehow manage to lose control of the House. It’s just too simple.
It’s also breathtakingly visionary. In one fell swoop, Ryan takes on taxes, health care, Social Security, and the federal deficit, and fixes them all. He puts the government on the road to solvency, something no other plan comes close to achieving.
And he does it while slashing taxes. Anyone want to file on a postcard? If the Roadmap were adopted, you could. Single filers would pay 10% on income up to $50,000 ($100,000 for joint filers) and 25% thereafter, with a generous standard deduction and personal exemption. That’s it, no loopholes, deductions, credits, or exclusions. But, in what must have been a delicious lighter moment, he decided to allow those who love the present system to continue using it if they want to.
Beyond income taxes, he also cuts corporate taxes, eliminates taxes on interest, dividends, and capital gains, and abolishes the death tax.
We don’t have space to go into all the aspects of the proposal, but interested readers can get a capsule version of the plan here.
There has been immediate criticism from Democrats, mainly centered around cuts to Medicare. And some of the objections could be valid; maybe the plan could be tweaked a little to bring more of the opposition on board. Or maybe they’ll just continue to complain because reducing the size of government doesn’t sit well with them.
But the thing is, even the critics have been forced to admit that the plan would probably work. How do we know? Ryan had the confidence to submit it to the Congressional Budget Office for analysis. As you probably know, even the CBO’s most conservative projections for continuing along the current path lead to unsustainable deficit levels and bankruptcy for the country.
Ryan’s plan is not a quick fix. It’ll take decades to fully realize all the benefits. But one thing that will happen as soon as 2015 is stabilization of debt as a percentage of GDP. It will remain at levels only slightly higher than today, for the next 30 years or so, then begin to decline. Compare that to the alternative: according to CBO projections, debt will spike sharply upward in 2015, rising – relentlessly and unstoppably – to over 700% of GDP in 2080. Of course, the economy will be destroyed and government forced to default long before then.
If you’re in the mood to wade through all the details today, here’s a link to the CBO report on the Ryan proposal.
So the president is wrong. There is another idea out there, and according to the government’s own budgetary watchdogs, it’s a good one. Now we’ll see what happens to it.
As I sign off, I see the U.S. markets are having another volatile day, with the stock market up over 200 at one point. While it has fallen back somewhat, it seems as though it will close well up. It seems Ms. Market is joyously anticipating that the EU will bail out Greece. This expectation of further monetary excess has also buoyed the precious metals – and the gold stocks, virtually all of which are in the green on the day.
Of course, Greece is not the only EU country struggling under its debt load; Portugal, Spain, Italy, and Ireland are too. Which makes one wonder, will the EU – i.e., Germany – actually save Greece, knowing that once it does, a line will form outside the door?
The next couple of weeks should be interesting.
Until tomorrow, thanks for reading and for being a subscriber to a Casey Research service!
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David Galland
Managing Director
Casey Research