While I share the great concern about her destructive economic policies of this administration, I am getting a contrarian tick about the dollar and gold.

Every right wing talk show and business TV show is flooded with adds selling gold to consumers.  “The dollar decline is inevitable” the pitchmen warn, “Gold is the only safe money.”

When there is this much noise and whenever anything is inevitable it is time to be cautious.

I remember during the seventies when inflation seemed inevitable. The doomsday newsletters like Harry Brown and Howard Ruff had middle class investors buying gold coins, opening us accounts in Swiss banks and investing in Swiss Franc CDs.  Gold reached over 800 dollars an ounce.

And then the inevitable did not happen.

Volcker and Reagan wrestled inflation out of the system, the dollar soared and gold plummeted. Silver which ran as high as $50 an ounce came crashing down to under $5. The real reason for its rise and spectacular bubble was not the desire for sound money but the manipulations of the notorious Hunt brothers.

Middle class investors who bought into the fear and invested heavily in foreign currencies and gold were badly damaged.

It is challenging enough to get accurate information about domestic stocks. Understanding the factors affecting currency values and foreign markets are far beyond the scope of middle class investors (and most professional investors as well.)

Interest rates are near zero. They cannot go down any further, and given the deficit will likely go up.  When interest rates go up the costs of holding a non interest bearing asset like gold goes up, and this puts down ward pressure on the price of the metal.

While the dollar may seem vulnerable its value on world markets are relative to other currencies. As we see the Dubai fantasy teetering on the brink of bankruptcy and countries like Greece nearing default, the dollar may start looking better if for no other reason than other countries are looking worse.

The amount of uncertainty multiplies greatly when you leave our borders. If you are concerned and want some gold limit your exposure to 10% of  your assets and even dollar average that to avoid buying at a top. Consider gold stocks like Newmont or Goldcorp that you can sell easily and quickly if the market turns against you.

Do not put gold in your 401k or retirement account. The tax protection is better suited to income investments, even low yielding but secure Treasuries. If you think interest rates are going up (I do) avoid long term bonds of any nature. Bond face values drop as interest rate rise.

Successful investing requires controlling your emotions.  Anger and fear over this administration’s policies can easily influence your investment decisions.  Rarely does such emotional influence lead to better decisions.

With the clarity of time we can look back at the brink of the collapse that hit us just prior to the last national election.  In the midst of the collapse we were stunned and angry, and tended to blame the party in power. Although the Democrats had controlled both houses of Congress since 2006, the disaster took its bigger toll on the Republicans.

While the roots of this collapse extend back through many administrations of both parties, it is important to know what did not cause this as well.

Some blamed the deficits, others blamed deregulation, but many just saw the main cause as unbridled greed.  I contend that while there were deficits, and there was greed, none of these played a critical role in fomenting this crisis.

As Thomas Sowell noted, blaming this crisis on greed is like blaming an airplane crash on gravity.  It is true but it doesn’t really explain anything. Worse if we just blame the undeniable then there is no need to examine human error, design flaws, or study ways to keep it from happening again.

Greed has been with us since the dawn of man. Why did it decide to show its ugly face in September of 2008? Greed is encumbered by the limits of a rational society and in a capitalist system it is encumbered by competition.  I may want to charge $2,000 a ton for steel, but competition keeps me from charging what I want, and even forces me to keep my payroll and expenses in line.

Our government tries to contain the fear of greed with regulations. If we are to blame greed we must face the failure of our regulations, or we may even need to face the possibility that our regulations fostered greedy behavior.  The second most common blame was the laissez faire attitude that had fostered deregulation of the financial markets.   Usually this is directed at the repeal of the Glass Steagal Act which separated lenders from investment banks. This law was repealed under The Gramm-Leach-Bliley Act, also known as the Financial Services Modernization Act of 1999, which was signed by President Clinton.

But other nations, notably Canada, also repealed similar legislation and they did not experience the financial crisis we did. But Canada also did not suspend prudent lending standards to force the spread of home ownership beyond its natural market.

Nor was deregulation the norm under George W Bush. In fact just the opposite was true.

Elliot Spitzer noted that we did not suffer from the lack of regulators or regulations. There were plenty to do the job, but they seem to lack the courage and the will to do the job.  We needed better regulations, not more of them.  In many cases the regulated industries such as Fannie Mae  (exempt from SEC and FDIC regulation) spent enormously on lobbyists and campaign contributions to thwart efforts to regulate them.  It was successful for them.

The biggest recipient of campaign contributions from AIG was Barak Obama. The biggest recipient of the PAC assembled by the largest mortgage lender for Fannie Mae, Country Wide Finance,  was Barak Obama. The largest recipient of campaign funds from Fannie Mae was ….. yes, Barak Obama. The second largest recipient in these three cases was Chris Dodd, Chairman of the Senate Banking Committee.

The deficits which seemed so irresponsible at the time now look like pocket change.  Deficits do matter but it depends how long they last, how large they are relative to GDP, prevailing interest rates, and what the deficits are spent on.  Personal debt spent on a house or investment equipment may seem prudent, the same debt spent on a boat or jewelry would not.

While the debt incurred under George Bush was arguably bad, it was not a critical factor in causing the meltdown.  We incurred controversial debts under Ronal Reagan and incurred little repercussion from the financial industry.

Bubbles are nothing new and may just be a part of the pricing mechanism. The Federal Reserve was created to bring stability to our financial system. It first test was the Great Depression of 1929, and it failed miserably.  Nearly 80 years later with the value of the dollar down 95% and in the middle of the worst financial crisis in our adult lives, we should ask if it is part of the problem.

Eliminating commonly perceived causes should help us focus on solutions that will work. If we delude ourselves into blaming greed, deficits, and individual demonas we risk designing solutions that not only will not work, but will like make the problem worse

“Could free markets have sorted out the mess without extraordinary government action? Yes, but only by destroying the remains of the financial system and possibly putting tens of millions of people out of work. Despite virulent public opposition to the Bush bailouts, society would not have tolerated the price that a sudden free-market correction of decades of financial excess would have exacted. The consequences of standing by while the markets did their work, correcting their own and government’s mistakes, would have been disastrous.”

“The administration’s response may have staved off depression, though that outcome is not assured. But the government has severely damaged four elements upon which free markets and the future well-being of the nation depend: prices, disclosure, failure, and fairness. Lawmakers and regulators have harmed the faith of global investors and regular citizens alike in American free markets- a faith essential to growth and progress. President Obama has made the problems worse.”

From After the Fall:  Saving Capitalism from Wall Street- and Washington by Nicloe Gelinas

If you have to read only one book about the recent financial  fiasco, this is it.

Here is an idea for our times.

We create a Federal Agency called the Consumer Investment Information Corporation.

It is funded by a fee on all banks and institutions needing an independent investment rating.

It is governed by nine people; three selected from each political party representative group in the Congress, and another three selected from the first six. The last three can be academics or professional analysts.

The CIIP can hire investment services like S&P and Moody’s to rate the financial institutions. The rating service would no longer be hired and paid by the institutions they rate; they would be serving the consumer.

Over a period of say 5 years, the FDIC protection would be removed from banking institutions. During that time a CIIP rating would be given on those institutions on their relative stability and strength.  Banks could then compete on the basis of stability and financial strength. Higher rated banks could sell CD’s with lower yields since they provide value through their strength. Lower rated banks would have to pay a higher interest rate to compensate for their higher risk.

Current FDIC protection has replaced market information. Consumers do not care about the strength of their banks because they have federal insurance protection. It has encouraged reckless banking behavior. Every time the FDIC limit is raised the banking sector acts more irresponsibly.

It is time to let the market function by providing information, rather than rendering the information irrelevant by guaranteeing incompetence.

I am constantly amazed at how sitting political leaders and naive citizens think that the government can create jobs. If the government could create jobs why would we ever tolerate any unemployment?  Either the leaders are economically ignorant or liars.

If you only read one economics book I recommend ‘Economic in One Lesson’ by Henry Hazlitt. Hazlitt was not an economist, but a reporter and he wrote this book in 1946.  This passage explains why the government is incapable of creating jobs without sacrificing at least the same number of jobs from the private sector.

This is what is immediately seen. But if we have trained ourselves to look beyond immediate to secondary consequences, and beyond those who are directly benefited by a government project to others who are indirectly affected, a different picture presents itself. It is true that a particular group of bridgeworkers may receive more employment that otherwise. But the bridge has to be paid for out of taxes. For every dollar that is spent on the bridge a dollar will be taken away from taxpayers. If the bridge cost $10 million the taxpayers will lose $10 million. They will have that much taken away from them which they would otherwise have spent on the things they needed most.

Therefore, for every public job created by the bridge project a private job has been destroyed somewhere else. We can see the men employed on the bridge. We can watch them at work. The employment argument of the government spenders becomes vivid, and probably for most people convincing. But there are other things that we do not see, because, alas, they have never been permitted to come into existence. They are the jobs destroyed by the $10 million taken away from the taxpayers. All that has happened, at best, is that there has been a diversion of jobs because of that project. More bridge builders; few automobile workers, television technicians, clothing workers, farmers.

This sounds so logical and obvious that I fail to understand why anyone would swallow the government promises to create jobs.

“Fannie and Freddie played the political game even more fiercely than their opponents, spending millions of dollars on armies of lobbyists on Capitol Hill. Each company was a revolving door for the powerful in Washington- both Republican and Democrat. Newt Gingrich and Ralph Reed, among others, worked as consultants for Fannie or Freddie; Rahm Emanuel was a board member of Freddie.”

“By the 1990’s, Fannie’s chief executive could boast, without much exaggeration, that “we are the equivalent of a Federal Reserve system for housing.”  At their pinnacle the two mortgage giants- neither of them and originator of loans- owned or guaranteed some 55 percent of the $11 trillion U.S. mortgage market.  Beginning in the 1980’s, the two companies also became important conduits for the business of mortgage- backed securities.  Wall Street loved the fees it collected from securitizing all kinds of debt, from car loans to credit card receivables, and Fannie’s and Freddie’s portfolio of mortgages were the biggest honeypot around.”

“But in 1999, under pressure from the Clinton administration, Fannie and Freddie began underwriting subprime mortgages. The move was presented in the press as a way to put  homes within the reach of countless Americans, but providing loans to people who wouldn’t ordinarily qualify for them was an inherently risky business.”

From Too Big To Fail by Andrew Ross Sorkin

“Despite elite concerns of a public backlash against capitalism, it has been the public, not Wall Street or Washington, that has supported capitalism all along.  Financiers were disconcertingly quick to run straight into the governments arms, while the public has stuck up for markets and fought against taxpayer subsidy of failure. The hope for free markets is “political constraint,” says former St. Louis Fed president William Poole.”

“The public intuitively grasps unfairness when it sees it. In poll after poll, citizens have opposed bailout after bailout, not just for the banks but for their own neighbors.  This opposition is not a reflection of a heartless and mindless populism. Ordinary people understand that bailouts have perversely punished individuals and companies that acted responsibly, creating an incentive to act irresponsibly in the future.  They can perceive the difference between a government that acts as an honest, transparent referee of competitors and one that acts as a guarantor of perceived favorites.”

From After the Fall:  Saving Capitalism from Wall Street- and Washington by Nicole Gelinas

Economic growth hit 5.7% in the last quarter of ‘09.  We should be hitting a rebound at this point in the cycle, but Wall Street is still in the midst of a losing streak. What gives?

First,  it is always dangerous to assess the economic scene by a short term move in the stock market; there are just too many factors affecting the market. But there are other reasons for caution.

Part of the pickup could be a ‘dead cat bounce.’  This could be that inventory levels have been depleted so low that businesses have no choice but to buy inventory  in order to keep the doors open. In the metal and some commodity businesses an uptick in prices had many scrambling to get inventory in before the price increase.

But if backorders are not increasing and end users are not  buying more, this bounce will be temporary.

Some projects that had been put on hold during the initial economic shock are moving forward, especially in businesses such as electric utilities that must keep pace with maintenance and demand and do not have problems getting credit or still showing a profit.

You may have put off replacing you old car, but if you still drive you will eventually need a new car, or at least new tires for your old car.

If we can grow 5.7% with record unemployment, what does this say about business demand for new employees? Employers who see no strong end user demand will keep employment lean, and will shun capital investment.

Inventory pickup is often the first sign of a recovery, but that assumes that the end user demand is there to justify it. Housing demand and employment should soon follow. If it doesn’t this recovery will flatten out soon.

“In moving, even tentatively, into this new area of lending (subprime) Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government -subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s”  (New York Times in 1999)

“The success of the two companies (Fannie and Freddie) in both the financial and political arena inevitably fostered a culture of arrogance. “We always won, we took no prisoners and we faced little organized political opposition,” Daniel Mudd, then president of Fannie Mae, wrote in a 2004 memo to his boss. That overconfidence led both companies eventually to move into derivatives and to employ aggressive accounting measures. They were later found by regulators to have manipulated their earnings, and both were forced to restate years of results.  The CEOs of both companies were ousted.”

From Too Big To Fail by Andrew Ross Sorkin

We clearly need financial reform. Yet Obama’s reckless, populist, anti-business pronouncements only serve to harden the prevailing attitude that business growth and job generation is just too risky.

Financial reform should be thoroughly vetted and discussed in the appropriate House and Senate committees.  Piecemeal pronouncements only add to the uncertainty that is killing this economy. The 550 point drop in the Dow last week following his pronouncement should be of concern, although it is never totally clear what moves the market.

The objective is not just to reduce risk, but to isolate it.  We want to protect critical banking and credit functions from the raw speculation.  Yet it is hard to return to the days before the Glass-Stegall bill, separating banking and investment activities, was overturned under Clinton.

There is no substitute for better regulations.  Higher capital requirements  to reduce leverage and better control of private contracts and derivatives that increase leverage and systemic risk are likely to come.

But let them come after the careful deliberation and consideration of the necessary functions our financial system provides.  Reckless announcements from the president in the critically weak economy we still face is destructive and counterproductive.