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Kingston, NY, Wednesday, Dec. 16, 2009

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Dear Friend and Reader:

Planet Waves
Tomorrow, the College of Congressional Cardinals is scheduled to vote on the Pope of the Federal Reserve. This may seem like an obscure government policy decision, except for the fact that everyone agrees that the issue we need to be doing something about is the economy.

So the choice of who to make chief of the nation's central bank, which is basically a private enterprise, is a big deal. The one moment that the government has an opportnity to really and truly influence Fed policy is with the person it installs as its chief.

Tonight I've got an article for you published today on the Planet Waves daily page. I wanted to make sure you saw it tonight, before the vote, so you have a clue what's at stake. Notably, we are not voters in this process; we are spectators until we figure out a way to participate. One way is through being informed.

The piece grew out of an ongoing email correspondence on banking and economics between me and it's author, Kelly Cowan. Kelly's been whispering bits of wisdom in my ear about what banks are and how they work for a while. She's is an artist, investor and observer of the economy and capital markets. Although she left the professional investment world behind long ago, she is a close watcher of economic and market trends. She maintains close contacts with a number of individuals there.

This is what she's written.
Eric Francis

Planet Waves
Seduction. Photo by Kelly Cowan.

The Temple of Debt
By Kelly Cowan

FROM THE TEMPLE OF DEBT a prayer rings out. It is the busiest time of year for the Cathedral of Commerce. 'Tis the season of Debt.

A critical issue facing this nation is our debt problem. Excessive levels of both private and government debt exist today. There are two ways to deal with debt: service the debt or default on the debt. With default can come deliberate debt reductions or bankruptcy. Current debt levels are unsustainable and there is no way to service all this debt. The debt cannot and will not be repaid. The wealth just isn't there. We are living in an era of negative equity.

All this debt was accumulated for consumption and speculation on asset prices. It was not used to expand production. This increased debt burden did nothing to add to productive capacity. So where did the money go? The debt was secured by asset values that were never really there (no, your two bedroom house that hadn't been remodeled since the 50's was never worth $1 million; it was an arbitrary number created in speculative ecstasy). The choir of lenders sang borrow, borrow, borrow. The money borrowed against these assets was used to purchase stuff, and useless stuff at that. Much of that stuff came from China; we shipped dollars to China and China shipped stuff to us. US consumers consumed more than they produced, using borrowed money (much of it from China) to pay the difference. Chinese consumers produced more than they consumed and saved the difference. America borrows China's savings.

The solution is to unwind the debt and allow the necessary hits, however painful. Pain management will require a lot of emotional resources. The adjustment period is underway. The dynamic is in play and we need to decide how this will occur. Instead, we are pushing the problems down the road and expecting a miracle

The Federal Reserve Bank (the Fed) is the temple where this miracle is being preached, and Ben Bernanke, its chairman, is the High Priest. The stated mission of the Fed is "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." Perhaps Bernanke and friends didn't receive the memo.

The dollar is being nailed to the cross, sacrificed for our belief in debt. The desecration of the dollar will not save us. It will lead to inflation (perhaps, hyperinflation) down the road. Inflation is a hidden tax; it is a transfer of funds from the poor and middle class to the wealthy.

Have you heard the "good suit" story?

The cost of a good suit in 1920 was about an ounce of gold, or around $20. Today, the value of an ounce of gold is $1,125, more than enough to buy a good suit. In 1920 the purchasing power that allowed an American consumer to purchase a good suit, in today's dollars, would be $216.18. Hardly enough to purchase a good suit. the real price difference between a suit then and a suit now is inflation. This is a link to calculate inflation and purchasing power. Feel free to play with it.

We can see from the suit story that the suit costs more in today's dollars. That $20 in 1920 would put $216.18 in your hands today. While your great-grandfather could purchase a good suit for $20, today with the $216.18 you would not be able to purchase a good suit. Up and down the line, businesses take more of a profit. The price increase certainly isn't due to the cost of production. Labor costs are not higher-adjusted for inflation.

Technology and overseas production (often at slave wages) have decreased the costs of manufacturing. Inflation hides these manufacturing cost decreases. Today, a smaller proportion of the population can afford suits; suits have become a luxury. But the profit on each suit is higher for a long string of business owners, from the industrial fabric weaver in Italy to your local department store (which is probably not owned locally, and as part of a chain has much greater economy of scale than if it were owned locally). We think of inflation like air — that it is a necessary part of life: but it is not. Yet it's not just inflation. Those on the purchasing end are hurt both by the value of the dollar going down, and by manufacturers taking higher profit.

High Priest Bernanke is in basement of the Temple. He is furiously printing money. Inflation is caused through the increase in the money supply. It dilutes the value of existing dollars. This is a way to avoid addressing the excessive debt problem. Bernanke has chosen the tool of inflation to hide and shift the debt burden on to the consumer. He is a conjurer.

Meanwhile, as wages and incomes fell and inflation and prices increased, credit was pushed to fill the gap. Consumers didn't notice, as they could still purchase their car.

We need to address our debt problem: to face it head on. Delaying and praying are not viable solutions to the mess we have made by living beyond our means over the last few decades. Americans have worshipped at the altar of debt and leverage for far too long. The tipping point has arrived. We must learn how to share the Earth's resources with the rest of the world. But as someone once said, "It is not necessary to change. Your survival is not mandatory." History is filled with believers who have sacrificed themselves for their beliefs. It is not a new story.

Just this past week, President Obama, in a speech outlining his new stimulus proposal, said that the nation must continue to "spend our way out of this recession." We all remember President Bush in the days following 9/11 encouraging Americans to go shopping. This is the gospel preached by our leaders: shop and spend. Jim Rogers, a noted global investor and an expatriate American, recently commented, "The idea you can solve a problem of too much debt and too much consumption with more consumption and more debt defies belief. I cannot believe that grown-ups would stand there and say that."

Here some numbers to think about:

Household consumption in the US is 70-72% of the economy. In Europe it is 55-65% and in China it is 35% of its economy. America is the orthodox branch of the debt religion. We have practiced faithfully. Individuals and businesses have started to delever. A closer look at the numbers, however, might point to something different: a transfer of leverage rather than a deleveraging.

Households have reduced borrowing by $351.3 billion, businesses have reduced borrowing by $238.9 billion and the financial sector has reduced borrowing by $1,532.6 billion in the past year. Over the same time the federal government has increased borrowing by $1,484.9 billion and the state governments have increased borrowing by $115.9 billion (these figures are from the Federal Reserve, Flow of Funds Accounts, for the third quarter 2009).

The gospel of "spend" lives on.


Who is accountable for this debt trap?

Let's step into the confessional box, shall we.

The definition of the word ac·count (ǝ-kount) is a narrative or record of events. To "call to account" is to hold answerable for.

A narrative is a story. The debt crisis, it is a collective story. It is our story. We are all involved. Each of us has a part in the story. Our roles are based on the individual choices we have made. The altar of debt seems to have been quite seductive. The 19th century Danish philosopher and theologian, Kierkegaard, once depicted seduction as a sacred and religious practice, but he also wrote that the seduction requires the permission of the seducee. All of us are accountable for the debt world we have created.

So what is the debt story? What do we tell ourselves? What do we tell each other? What story should we tell? We need to have one narrative based on the record of events. This takes emotional honesty. Building a story requires time and reflection. It demands awareness and decisions.

To do this we need to begin to "call to account" those who were the key architects of the debt world. We need a public forum to hold them answerable for their decisions. But it can't stop with the CEOs, members of Congress or the regulators. The discussion must include everyone who has taken on debt. This has been a collaborative series of events and we are all stakeholders, even if we feel that our stake is diminishing.

The process would eventually create a healthy boundary and allow for a way forward. We certainly need a boundary as we are currently on the slippery slope of moral hazard. Neither path is easy, but the path of moral hazard never gets any easier. In fact, it often gets worse. Both paths have economic and emotional prices to pay, but the path of moral hazard has spiritual consequences. The path forward will eventually have spiritual rewards.

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