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The Great Fire Sale of American Assets Has Begun


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Grasping at Stock Market Straws

by Gary North

www.lewrockwell.com

On Tuesday, November 27, the Dow Jones Industrial Average rose by 215 points. The next day, it rose by 330 points.

Why?

The financial press had an immediate answer on Tuesday. The news had broken that morning of the offer by the government of Abu Dhabi to pay $7.5 billion for 4.9% of America's largest and most prestigious bank, Citigroup.

The news reports failed to explain the 4.9% figure. It has to do with U.S. government rules against allowing any single purchaser of stock to buy more than 4.9% without getting permission from the U.S. government.

Abu Dhabi bought the limit of what it was allowed to buy. I have no doubt that it could have negotiated more than 4.9% for its $7.5 billion if there had not been a government-imposed limit, which would have eaten up precious time. The participants on both sides recognized that the bank was facing an emergency. It had squandered at least this much money and possibly much more in its ill-fated subprime mortgage lending schemes. Without warning, the bank in August suffered horrendous losses. There is no way that Citigroup would have sold 4.9% of the company last July. Citigroup was fat and sassy. Its president, the now-departed Charles Prince, was riding high.

The stock fund managers started buying as soon as the news hit. The official interpretation: "This decision by Abu Dhabi indicates that America's largest bank is in good shape. This is the end of the subprime crisis."

Here is my interpretation:

A small percentage of a gigantic pool of oil-generated capital, which is managed by government bureaucrats in a city-state whose nation did not exist as recently as 1970, was used to buy 4.9% of the largest bank in the United States because this purchase was perceived as a better deal than buying T-bills denominated in a falling dollar.

Here is a city-state that until half a century ago was an underdeveloped town in a desert. The Wiki Encyclopedia describes it in 1958.

Into the mid-20th century, the economy of Abu Dhabi continued to be sustained mainly by camel herding, production of dates and vegetables at the inland oases of Al Ain and Liwa Oasis, and fishing and pearl diving off the coast of Abu Dhabi city, which was occupied mainly during the summer months. Most dwellings in Abu Dhabi city were, at this time constructed of palm fronds (barasti), with the wealthier families occupying mud huts. The growth of the cultured pearl industry in the first half of the twentieth century created hardship for residents of Abu Dhabi as pearls represented the largest export and main source of cash earnings.

Today, the residents of Abu Dhabi are doing better financially. The net worth of each of the 420,000 citizens is $17 million. Of course, they can't actually get their hands on this money. It is administered on their behalf by salaried bureaucrats.

These bureaucrats are in charge of allocating billions of dollars worth of oil revenue. They have decided to get into the banking business, a profession that is prohibited by Islamic law: usury taking. They have no experience in banking. But they thought, "Gee, let's buy part of a bank that is suffering major capital losses." Result? The Dow rose 215 points. Why does Abu Dhabi have this kind of money to invest? Because oil is up, and the world's economy is repeating the experience of 1973–79: a massive transfer of wealth to Arab, Iranian, and other oil kingdoms. To this group, add Russia, which now has almost $500 billion in foreign currencies, third only to China and Japan.

In 1988, Gorbachev went begging to the West for money. Today, the West is at the mercy of the good graces of Putin. "Please sell us oil. Please sell us natural gas. We'll be good. We promise!"

The only thing that will send oil back to 2006's level ($55) is a worldwide recession. Supply and demand favor the oil exporters from now on. This is permanent. The world's economic power will shift inexorably to the oil kingdoms and to China.

Abu Dhabi's purchase points to the future: the sale of America's economic crown jewels to foreign owners. The profits from American-based companies will then flow to foreigners who own the companies. This scenario is unlikely to change in my lifetime or yours.

Yet this purchase caused a 215-point rally in the Dow. Investors are short-sighted. They regard as a cause of celebration the most visible private transfer of American capital to foreigners in our lifetimes.

WEDNESDAY

On Wednesday, November 28, the Dow climbed 330 points. Why? Because of a vague remark by a member of the FED's Board of Governors in a speech to the Council on Foreign Relations. He said that the FED should be pragmatic. So what? This has been the FED's position since 1933. Here is what he said: "In my view, these uncertainties require flexible and pragmatic policymaking – nimble is the adjective I used a few weeks ago."

This comment was interpreted to mean that the FED will lower the target rate for overnight bank loans by another .25 percentage point. Other than serving as a symbol of the FED's commitment to liquify the banks by a small percent, such a decline will have no impact on the massive, multi-billion dollar losses that have been sustained by the financial sector and which will continue, everyone admits, through 2008 and maybe into 2009.

Kohn's actual speech was anything but reassuring. He began with an open admission of what is now apparent: financial experts don't know what is happening in the capital markets.

Central banks, other authorities, and private-market participants must make decisions based on analyses made with incomplete information and understanding. The repricing of assets is centered on relatively new instruments with limited histories – especially under conditions of stress; many of them are complex and have reacted to changing circumstances in unanticipated ways; and those newer instruments have been held by a variety of investors and intermediaries and traded in increasingly integrated global markets, thereby complicating the difficulty of seeing where risk is coming to rest.

In other words, those AAA-rated credit instruments back in April may today be worth approximately what Abu Dhabi was worth in 1958.

The economy is facing uncertainty on a massive scale. Notice his phrase, "especially adverse outcomes."

Another consequence of operating under a high degree of uncertainty is that, more than usually, the potential actions the Federal Reserve discusses have the character of "buying insurance" or managing risk – that is, weighing the possibility of especially adverse outcomes. The nature of financial market upsets is that they substantially increase the risk of such especially adverse outcomes while possibly having limited effects on the most likely path for the economy.

When we see this sort of analysis from a high official, we had better understand what he is saying. Here is what he is saying:

"When great chunks of that AAA-rated paper turns into something suitable for fan-hitting, don't blame the Federal Reserve when it finally hits."

Then he launched into a theme made popular by Alan Greenspan: moral hazard. "Moral hazard" refers to a mental outlook that says, "The Federal Reserve will intervene to save the capital markets whenever it looks as though those markets are about to fall apart." Greenspan assured us again and again that this was not the FED's goal at all. Then he and the FOMC inflated the dollar, lowered the Federal Funds rate, and proved that the moral hazard effect was alive and well at the FED, as always. Kohn continued:

Central banks seek to promote financial stability while avoiding the creation of moral hazard. People should bear the consequences of their decisions about lending, borrowing, and managing their portfolios, both when those decisions turn out to be wise and when they turn out to be ill advised. At the same time, however, in my view, when the decisions do go poorly, innocent bystanders should not have to bear the cost.

Innocent bystanders: you know, the average Joe investor. Well, maybe the average head of Citigroup, who got a severance settlement of about $40 million. It's hazardous out there!

Asset prices will eventually find levels consistent with the economy producing at its potential, consumer prices remaining stable, and interest rates reflecting productivity and thrift.

That's what we need: productivity and thrift! And how will we get more productivity and greater thrift? By selling off our capital assets to oil-exporting governments that confiscated the oil in the name of the People 70 years ago.

To be sure, lowering interest rates to keep the economy on an even keel when adverse financial market developments occur will reduce the penalty incurred by some people who exercised poor judgment. But these people are still bearing the costs of their decisions and we should not hold the economy hostage to teach a small segment of the population a lesson.

Bearing the cost of their decisions, yes. Like the former head of Merrill Lynch, who walked away with $160 million for his trouble. It's tough being out there in the trenches!

The Federal Reserve's reduction of the discount rate penalty by 50 basis points in August followed this model. It was intended not to help particular institutions but rather to open up a source of liquidity to the financial system to complement open market operations, which deal with a more limited set of counterparties and collateral.

The "financial system," yes. But how was this accomplished in August? By lowering interest rates that banks charge to reach other, i.e., lowering capital costs for commercial banks. Banks, in fedspeak, are "the financial system." Unfortunately, things are looking a little dicey.

However, the increased turbulence of recent weeks partly reversed some of the improvement in market functioning over the late part of September and in October. Should the elevated turbulence persist, it would increase the possibility of further tightening in financial conditions for households and businesses. Heightened concerns about larger losses at financial institutions now reflected in various markets have depressed equity prices and could induce more intermediaries to adopt a more defensive posture in granting credit, not only for house purchases, but for other uses a well.

In other words, November's data point to a possible credit crunch, or, as he put it, "a more defensive posture in granting credit." How far will the ripple effect spread? He doesn't know.

The underlying causes of the persistence of relatively wide-term funding spreads are not yet clear. Several factors probably have been contributing. One may be potential counterparty risk while the ultimate size and location of credit losses on subprime mortgages and other lending are yet to be determined.

Do you recognize the phrase, "counterparty risk"? No? Let me clarify. It refers to contractual guarantees by major financial institutions to compensate holders of bonds and other credit assets if the market creates losses for them. Sadly, the net worth of most of the guarantors is far less than the contractual obligations incurred. Then who is holding the bag? Nobody knows: ". . . the ultimate size and location of credit losses on subprime mortgages and other lending are yet to be determined."

Finally, banks may be worried about access to liquidity in turbulent markets. Such a concern would lead to increased demands and reduced supplies of term funding, which would put upward pressure on rates.

What would be the effect of upward pressure on rates? A fall in the market price of bonds. Then the bond holders will contact the "counterparties" and ask them to cut a check for the loss.

If you do not understand what this means, think "fan."

All of this was the groundwork for Kohn's statement that caused a 330-point rise in the Dow.

In my view, these uncertainties require flexible and pragmatic policymaking – nimble is the adjective I used a few weeks ago. In the conduct of monetary policy, as Chairman Bernanke has emphasized, we will act as needed to foster both price stability and full employment.

He laid the groundwork to say that central banks are unable to do much about what is happening, because nobody knows what is happening, or to whom, or when it will end.

This is not the stuff of a 36,000 Dow. This is the stuff of stock fund managers' optimism, which as recently as July was shared by the head of Citigroup and the head of Merrill Lynch.

CONCLUSION

The investing community wants to believe that the FED and Abu Dhabi can change the fundamentals of the economy, thereby restoring confidence in the stock market. In other words, the fund managers believe that symbols are more fundamental than the reality of the highly leveraged, self-monitored debt market which has created so many liabilities that the solvency of some of America's largest banks is at stake.

The stock market will need many more interventions by Abu Dhabi and other Arab oil states, which now control the flow of funds America's capital markets.

The great fire sale has begun. Senior American managers have begun to sell the nation's seed corn to the Arabs. They will continue to do so as the economic agents of American people. The sale of 4.9% of Citigroup is a visible turning point.

Stock market investors cheered. They bought. Why? Because they expect to be able to sell later on to the Arabs.

This is the greater-fool strategy. "Buy now; sell to a fool later." But the greater fools are the American buyers who are planning to sell their claims to the future of America's productivity. The only way that the Arabs will turn out to be greater fools is if America ceases to be productive.

Without thrift, this is a real possibility. American households have been in a net negative position for two years. They are borrowing their way to the good life. In short, they are imitating the U.S. government.

This is not going to turn out well.

December 1, 2007

Gary North is the author of Mises on Money. Visit http://www.garynorth.com.He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Find this article at:

http://www.lewrockwell.com/north/north589.html

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Background on Gary North... who incorrectly predicted Global Chaos during Y2K but has since apoligized

for his over reactionary rants. Methinks this may be yet another case of "Chicken Little" claiming that the Sky

is Falling yet again, but that is just me.

"In the late 1990's, North predicted that Y2K would be a global catastrophe,[2] and promoted his theories in the media and in his Remnant Review newsletter and website. In December 1999 he retracted his position, and in a January 2000 ICE newsletter, he publicly apologized for his mistaken view of Y2K, saying he was baffled as to why the transition didn't bring global chaos."

Oh well... never mind.

Gary North

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Gary North For the bisexual rights activist, see Gary North (journalist)

Gary Kilgore North (born 1942) is a writer and publisher from the Christian Reconstruction movement.

[edit] Biography

North received a PhD in economic history (The concept of property in Puritan New England, 1630-1720) from the University of California, Riverside in 1972. He gained some wider notoriety for his inaccurate prediction of Y2K catastrophe before 2000. Starting in 1967, North became a frequent contributor to the libertarian journal The Freeman. His writings also appear on LewRockwell.com.

North is the son-in-law of R.J. Rushdoony, one of the founders of Christian Reconstructionism.

[edit] Theological beliefs

See also: List of people and organizations associated with Dominionism

Most Christian Reconstructionists hold to a type of Postmillennialism that holds that Jesus will return to earth only after Trinitarian Christianity has become the religion of the majority of the planet, with God's moral law as the civil standard for society. They believe that Old Testament moral and civil laws, such as those against adultery and sodomy and murder, should be presumed binding unless the New Testament says otherwise; this belief they call theonomy. Critics argue that what North is describing would be a theocracy, and that North and other Postmillennial proponents of Dominion Theology have influenced the growth of the Dominionist tendency among the much larger (and largely Premillennialist) Christian Right.[citation needed]

Theologically, Gary North is a Calvinist. He is president of the Institute for Christian Economics[1] which publishes many Christian Reconstructionist books online. Christian Reconstructionists are also presuppositionalists in their approach to Christian apologetics as taught by the Calvinist philosopher, Cornelius Van Til and oppose any natural law theory as a basis for civil law order. North is a member of the Presbyterian Church in America.

[edit] Predictions of catastrophes

In 1986, North co-authored with Arthur Robinson Fighting Chance: Ten Feet to Survival, a book urging the construction of backyard underground fallout shelters and stockpiling of gold and silver in anticipation of a nuclear war with the Soviet Union. In 1987, North predicted in Remnant Review that an AIDS epidemic would overwhelm the world's hospitals by 1992.

In the late 1990's, North predicted that Y2K would be a global catastrophe,[2] and promoted his theories in the media and in his Remnant Review newsletter and website. In December 1999 he retracted his position,[citation needed] and in a January 2000 ICE newsletter, he publicly apologized for his mistaken view of Y2K, saying he was baffled as to why the transition didn't bring global chaos.

[edit] Political beliefs

North argues for the abolition of the fractional reserve banking system, and a return to the gold standard. He also opposes the US Department of Education and Council on Higher Education Accreditation claiming it is a "cartel" and the group has, in part, caused higher education to "become uniformly secular, liberal, and mediocre: raising the cost of entry."[1] Furthermore, North believes that education and course work can be compacted on videos and DVDs and he sees the USDE and CHEA as preventing people from being educated through these media.

North's economic views are libertarian, and he is a believer in the Austrian School of economics. However, socially, he is an advocate of theonomic rule ("the rule of God's law") and proposes a strict legal system based on Biblical laws, which might execute people for violations of those laws (such as sodomy, adultery, witchcraft) that are not capital offenses under current U.S. laws.

[edit] Quotes

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"There is no doubt that Christianity teaches pluralism, but a very special kind of pluralism: plural institutions under God's single comprehensive law system. It does not teach a pluralism of law structures, or a pluralism of moralities, for this sort of hypothetical legal pluralism (as distinguished from institutional pluralism) is always either polytheistic or humanistic. ..."

"In this structure of plural governments, the institutional churches serve as advisors to the other institutions (the Levitical function), but the churches can only pressure individual leaders through the threat of excommunication. As a restraining factor on unwarranted Church authority, an excommunicaton by one local church or denomination is always subject to review by another, if and when the excommunicated person seeks membership elsewhere. Thus, each of the three covenantal institutions is to be run under God, as interpreted by its lawfully elected or ordained leaders, with the advice of the churches, not their compulsion." Gary North, Political Polytheism, pp. 576-577.

"The Bible does not allow the imposition of some sort of top-down bureaucratic tyranny in the name of Christ. The kingdom of God requires a bottom-up society. The bottom-up Christian society rests ultimately on the doctrine of self-government under God, with God's law as the publicly revealed standard of performance. It is the humanists' view of society that promotes top-down bureaucratic power. ..."

"Let's get this straight: Christian reconstruction depends on majority rule. More than this; it depends on overwhelming acceptance of the biblical covenant, perhaps as high as the 80% range of adult acceptance. In the initial stages of the Constitutional reform movement, such as today, Christians are under the civil rule of the majority. We must work within a covenantally alien system, and we must do so peacefully." Gary North, Political Polytheism, p. 586.

"It is not possible to ramrod God's blessings from the top down, unless you are God.... Only humanists believe that man is God. They do indeed believe in social salvation through ramrodding by the state. Christians are simply trying to get the ramrod away from them and melt it down." Gary North, Political Polytheism, p. 590.

"In winning a nation to the gospel, the sword as well as the pen must be used" (Gary North, Christian Reconstructionism, p. 198).

[edit] See also

Christian Reconstructionism

Christian Right

Dominion Theology

Theonomy

[edit] References

^ www.reformed-theology.org/ice

^ Y2K Alarmist: Wha' Happened?, Wired News, 1/5/2000

[edit] External links

North's official site

Articles by North

Mises on Money by Gary North

Gary North writings available free to read online

NNDB Profile

"Invitation to a Stoning: Getting cozy with theocrats" by Walter Olson, Reason (magazine), November 1998

A critical 1998 commentary on Gary North's apocalyptic Year 2000 views

"Super-Cheap Accredited Colleges" video by North

Retrieved from "http://en.wikipedia.org/wiki/Gary_North"

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