Wealth of Nations and the Wizards of Oz

This article was originally published in the August 2012 edition of the Gloom, Boom & Doom Report and is reprinted with the kind permission of Dr. Marc Faber.

 

I recently learned that The Wizard of Oz was written as a satiric commentary on the financial crisis of 1893. I am not sure if Frank L. Baum did mean to write his book for that reason. However, the idea that there are people who believe they can lever the machinery of markets has not disappeared. Today, the curtain behind which these wizards used to stand is very transparent.

 

Recently, a very renowned wizard held tenure at the Fed beginning with the crash year of 1987, departing just months before the collapse of the subprime bubble. The collapse was, however, not in just one single class of speculation, but rather an entire edifice of debt created over the last 100 years. In the history of boom and bust, he and his cohorts hold the not so glorious record for the greatest intervention the world has ever known.

At one time the machinery of banking and finance was housed inside a rather closed shop. Only your broker or your banker held the keys to the City. This speech by Michael Burry, delivered to the 2012 graduating class in the Department of Economics at UCLA  reminded me just how much has changed over the years, especially in the way the market makes its decisions today.

 

 

 


 

 

Michael J. Burry at the UCLA  Economics Commencement 2012

 



I remember how difficult it once was to obtain corporate filings or to see a chart showing the history of a company’s price. Just these two seemingly unimportant data points might take days or weeks to uncover.

Today, it is very simple to find them quickly at www.sec.gov or www.stockcharts.com, even as the exercise has fundamentally changed from parsing complicated P&L and balance sheets, to some allencompassing Risk-on or Risk-off.

The panic of 1893, and the crises of 1907, 1923, 1929, 1933, and the others occurring along the path to 1987, 1998, 2000, 2003, 2007, share many similarities, clearly booms and busts, with much doom and gloom´before the next boom, and, like today, the rocky calm following.  We ask ourselves will the cycle break to another bust, another boom, or some kind of gloom this time.

In 1893 the railroads were overbuilt, cotton over-planted, silver over-mined, and bank reserves weak; the latter circumstance made quite clear, once depositors made the all too familiar run for their money. In the aftermath, speeches like this were made:

 

„The Constitution of the United States guarantees to all citizens the right to peaceably assemble and petition for redress of grievances, and furthermore declares that the right of free speech shall not be abridged.

We stand here to-day to test these guaranties of our Constitution.

We choose this place of assemblage because it is the property of the people. . . Here rather than at any other spot upon the continent it is fitting that we should come to mourn over our dead liberties and by our protest arouse the imperiled nation to such action as shall rescue the Constitution and resurrect our liberties.

Upon these steps where we stand has been spread a carpet for the royal feet of a foreign princess, the cost of whose lavish entertainment was taken from the public Treasury without the consent or the approval of the people.

Up these steps the lobbyists of trusts and corporations have passed unchallenged on their way to committee rooms, access to which we, the representatives of the toiling wealth-producers, have been denied.

We stand here to-day in behalf of millions of toilers whosepetitions have been buried in committee rooms, whose prayers have been unresponded to, and whose opportunities for honest, remunerative, productive labor have been taken from them by unjust legislation, which protects idlers, speculators, and gamblers.

We come to remind the Congress here assembled of the declaration of a United States Senator, “that for a quarter of a century the rich have been growing richer, the poor poorer and that by the close of the present century the middle class will have disappeared as the struggle for existence becomes fierce and relentless.”

 

— Jacob S. Coxey, “Address of Protest”, on the steps of the Capitol, from the Congressional Record, 53rd Congress, 2nd Session (May 9, 1894), 4512.

 

The conversation then, like today, included a debate over the devaluation of the gold standard. There were accusations of rigging the silver ratio in the bi-metal backed currency of the time. That world economy, whose goods traveled along the routes of the soon ending empires of the prior 100 years, was measured in the current accounts of nations by the amount of gold accumulating in country vaults, and, when not in balance, by a corresponding pile of grain, or cotton, or steel, sometimes thrown off balance by price collapse in one or the other, or when the paper currency became so dear, demand overwhelmed supply, or when the amount of currency was found to be out of alignment with the convertible standard in bricks of gold.

When the bust occurred, thousands upon thousands of miles of rail track became suddenly redundant. Many miles of rail had been laid only to claim land and market share, for which there was no other purpose, or the revenue to support them. The cotton market collapsed because of over-planting and the flood of Egyptian cotton crashing the price.

As the calls on deposits and on loans went out, they radiated across the nation, from the land to the banks, to England, Australia and Europe. Then finally the malinvested capital was wiped clean, and the investments reorganized into a proper natural size and function.

Today we call it contagion, though without reorganization. Some 535 U.S. Banks were run into closure or suspension. The call on the currency was so great, certificates were issued in lieu of cash. In the election year that followed in the choppy wake, the mass population’s representatives wrote and spoke:

 

 „There is to be a presidential election this year; in view of which it may be well to remark:

That working men will not be taxed less under a Republican president than they have been under a Democrat. That there will be no more opportunities open to labor in the next four years than there have been in the past four. That it will be just as difficult to “make ends meet” in the four years coming as in the four years going.

That there will be no more flour in the bin with a McKinley in the White House than there has been with a Cleveland. That concentration of wealth will rather be accelerated than otherwise by the change.

That the election of a Republican or a Democrat as president of this “republic” will have no more effect on invention and the use of more machinery, than the kick of a gnat on the Rocky Mountain.

We admit that this is rather a gloomy forecast; but experience warrants it and events will justify it.“

 

The Coming Nation,

March 21, 1896

 

After 1893 and thereafter, the crisis of 1907, in the United States, we, the people, and the habitually overstretched banks, were partially indemnified with deposit insurance, and by the bank of banks known as the Federal Reserve. The bank of banks became the ultimate backstop along with all kinds of government mandates for the people, beginning with Social Security, such that today, nearly any speculation gone wrong is made right.

Of course, this magical guarantee is not extended to you or to me. We, you and I land in the poorhouse, or jail, because we, you and I are not too big to fail. Our risk is not transferable.

In the last 100 years a system devolved ever so slowly to replace the penance one was once upon a time required to pay when ignoring moral hazards, contract law, or the duties required of any fiduciary officer, let alone a bad investment. Today, between the central banking Put, government guarantees and debt spending, in lieu of spending that is productive, markets are bound to these programs.

Unfortunately, there is no longer the ability to pay for this Paradise Lost. And yet there is an unwillingness to reorganize the great experiment. We wander like Samson, powerless and blind, asking for some, as yet invisible, guiding hand to solve this crisis without equivocation.

Meanwhile, the bankers and the sovereign leaders would like to borrow even more of what remains of their citizens’ wealth (not to save it, but to spend it). The debt mountain continues to grow; the wizards engineer elaborate schemes and anything that will avoid, for the moment, the undoing of multigenerational malinvestment along with all of the guarantees taken so lightly for granted over these many years.

The great maestro, who once lectured his junior central bankers the world over, knew a thing or two on how to regulate the market mysteriously. Once retired, he was replaced by a successor with vast knowledge of only one crisis. This younger man, and all of the current brethren in the industry of guaranteed spending and riskfree malinvesting, probably did not quite understand they were charged with a credit account gone well past a sustainable limit.

Business would be as usual, so they thought. For four years, they have lurched awkwardly from solution to solution while diluting the last of the wealth that supports what is left of confidence in all things commerce. Their machinations have distorted not only their supposed mandate, but ours, as investors, while the weight of debt and unsupportable spending handicaps their every decision and ours too.

The famous Put has become the nightmare that drives what was once a market of decision makers. The zero cost of capital, easy money, and the guarantee offered by the Put has made the market as dependent as any retiree on social security. Take it away, the market falls. Offer it again, the market rises.

Governments have devolved to act in kind, just as tied to the Put as they are to all of the promises made to voters to spend what they do not have.

We know more and more, much wealth is on the move and very frightened. It is moving from investments that might support innovation, real products, bemployment, and tax receipts, to dormancy in bricks of cash, 60 million dollar single works of art, in agricultural land, ingots of gold, diamonds, guns, and prime real estate. These are long-term, illiquid investments. They are not meant to earn anything at all. They are meant to preserve, as best they can, merely the principal amount.

This wealth is threatened by the slow piling up of laws which seek to make everyone equally vulnerable to a process which continues to avoid the reorganization of badly run banks, social programs, and nations. These laws do nothing other than feebly attempt to keep the Put in place on the assumption that somehow the great malinvestment, our great depression, will, in time, go away.

It is the nature of these institutionalized guarantees that when the reorganization does inevitably occur, the institutions themselves will no longer exist in the forms we recognize today. Not only are wealth and its capital threatened, but it and the body of law once serving to protect it, the ideas of contract and ownership, are being abridged and abrogated in this process, killing the patient it once so highly esteemed, Free Enterprise.

Our current central banker, who holds the renowned chair once kept so mysterious, has sought a new transparency. He speaks plainly. He allows a question and answer session four times each year. His board members speak publically and often, sometimes daily.

So do all the other central bankers of the world, and the sovereign leaders, and more and more, all of the people they represent via twitter, web page, and cell phone.

No one, however, discusses, even mysteriously, the Great Foreclosure once the Great Malinvestment is seized, and the Great Reorganization is allowed to begin. What has happened in nearly every past crisis is a second round, where prices fall, one way or another, to some natural place, the second often more severe recession/depression, once the malinvested capital is finally clearing.

Nobody then knew where the natural place was going to be, and there is no one yet who knows now what it will be.

As every vested interest, which is everyone, clamors for what is left of the severely damaged Put, the Great Malinvestment will continue to erode fundamental confidence required in sustainable and free enterprise. It will drain productive capital as surely as pools of wealth attempt to hide in any place they can find outside the broken system they fear.

I believe the second act of the Great Malinvestment purge will soon begin to emerge. One should prepare accordingly, as best one can; stay focused; refrain from listening too closely to the words of central bankers and sovereign leaders until that day comes when they honestly recognize what, in fact, they cannot change. Beware of wizards, even transparent ones.

 


 

 

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16 Responses to “Wealth of Nations and the Wizards of Oz”

  • jimmyjames:

    Nobody then knew where the natural place was going to be, and there is no one yet who knows now what it will be.

    **************
    The market knows-

    • E. F. Vidocq:

      Indeed it eventually will.

      • jimmyjames:

        Indeed it eventually will.

        ***************

        EF–First thnx for the post-

        IMO–The market always knows what to do and where it wants to go and it is never wrong-
        It is so far ahead of us that all we can do is try to understand it as best we can and follow it-
        It seems like it isn’t working today-but it is working in its always random ways-
        It can make the mighty Hank Paulson puke in the office garbage can-
        Is it giving the criminals/bankers/politicians just enough rope to lead to their eventual demise?
        Will it bring affordable living to the people?
        I think it wants to do all of that and if we just left it to work smoothly/violently/whatever-we wouldn’t be long turning around-

        • JasonEmery:

          Jimmie–The market is telling me that my decision to start developing some land into a working farm was a good decision. Go to stockcharts.com and look at $corn, $soyb, and $wheat………..

          • jimmyjames:

            Jason-full bins of grain this year is as good as gold-likely a better payout-
            My favorite grain (in this northern climate) was always oats-never a huge winner but always a safe bet-
            You could plant in early May (it can take more frost then any other grain) pasture it quick in early/mid June and still harvest or swath graze it in late fall-

  • JasonEmery:

    What happened before 1971 has little bearing on what is happening now, unless you have a pure fiat monetary system to hold up as an example. It is quite clear that the masters have chosen the hyper inflation path.

    My guess is that this will end with a 1-world currency, and 1-world govt. Most of the institutions are already in place: United Nations, World Bank, B.I.S., Interpol, world-wide-web (you’re on it right now, lol), NATO, World Health Org. etc. the list goes on and on.

    Is is pretty much unavoidable, at this late date.

    • They can’t even have a 1 world Europe.

      • JasonEmery:

        In the fairly near future, many tens of trillions of dollars worth of debt is going to be defaulted upon or inflated away. We’re talking several multiples of the world’s annual economy.

        I suppose it is possible that we just sink into a morass of a world with about 1/3 of the present population surviving, and the survivors lifestyle at a level of the typical Zimbabwe resident.

        More likely, TPTB let it drop just enough for the masses to DEMAND a 1-world solution. I’m just guessing here, nothing more.

        Regarding your comment, why aren’t the PIIGS leaving the Euro? Hint-see the above message about Zimbabwe, lol……..

        • worldend666:

          Much more likely the strong countries will leave first. The mother has to kick the runts off the teat.

          I don’t see a one world anything, nor an apocalypse. I simply see hyperinflation and a change in the ownership of real things, after which things will reboot with a return to traditional values, and a healthy distrust of Greeks bearing gifts. All in all it will be a much better place to live in than today.

    • E. F. Vidocq:

      That may well turn out to be the result aka Zimbabwe as one of the most recent examples.

      And in some quarters, folks are counting on just that, as you can well see.

      They may well be early, as the crow flies.

  • Somebody posted the Burry address on another page a month or so ago. I listened and saved the link. Anyone reading that hasn’t listened, the man had something to say.

    • E. F. Vidocq:

      I thought it a great speech, and all things considered, a good and credible voice. Sometimes, pure is just what it is. Even if it is not “particularly” new. I’m glad his talk made the rounds.

      There is nothing new right now at all in fact. Nothing at all.

  • Belmont Boy:

    This is old news, not illuminating at all. And the prose is turgid, barely readable.

    • E. F. Vidocq:

      Being from Belmont might have something to do with it. Can’t cater to every taste; a failing to be sure.

      Thanks for your contribution.

    • E. F. Vidocq:

      The essay was actually about this, though not particularly “new” for those who need “new,” it seemed worthwhile to actually write something to the effect that in fact, none of this is new. As to style, see the other reply.

      Wealth of Nations and the Wizards of Oz, by E.F. Vidocq
      Our newest guest author takes a look at the history of democracy and capitalism in the US, noting that there really is nothing new under the sun. The speeches and petitions of yore could just as well have been delivered today – their complaints all sound eerily familiar. And yet, there is a decisive difference between now and then, as we are obviously further along in the very processes our forefathers proved unable to stop in their tracks. Today, the ‘progressive ideal’ of a fully flexible currency and all it enables policymakers to do has been reached. Lobbyists are more successful than ever in directing lawmakers to enact laws that keep established businesses in clover while proving an ever greater obstacle to upstarts.
      Even though the watchword of our modern-day wizards of Oz is ‘transparency’, they are not any more trustworthy than their predecessors – in fact, they may be far more dangerous. And while they are trying to prove to us that their theories really work, we are relegated to waiting and preparing for the reckoning that is sure to come.

      • rodney:

        Well said. Apparently for some people only news are illuminating. There is nothing to learn from history. This is probably a commom view among average people. I once thought that fellow was smart. Oh well.

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