The whole discussion.

Here is where it gets interesting — despite the collapse of shadow bucks, the shadow banking system still dwarfs the official banking system. That means the process of people fleeing to dollars could continue longer than many first assumed. Or conversely, it also means there is a time limit. At some point, should the shadow banking system fail completely or the economy recover and assets reverse direction, there are no more economic refugees from the shadow banking system and the bid currently supporting the dollar market disappears. But more importantly, should the flow of refugees continue, there is also no fixed reason these people must trade their shadow bucks for US dollars. They could just as easily buy any other currency or form of money. So in trying to determine whether the US dollar will withstand inflation and quantitative easing without collapse, the question is reduced to whether the supply of refugees will continue and whether they will continue to choose US dollars.

Here is where it gets really interesting — given the extent to which the shadow banking system still dwarfs the official banking system, you would be shocked to know the extent to which the official banking system dwarfs the gold market. If even a few players drop some pocket change into the gold market, the price will soar. There is no guarantee this will happen, but there is also no guarantee they will buy dollars. The problem with forecasts in our current state is that we no longer have free markets, we are largely gambling based on the future decisions of powerful people we have never met. All we can do is guess, but the reality of our current global economy is that many other currencies are equally challenged, if not more so. The best alternative to US dollars as a means for savings and exchange, anywhere in the world, should the need for an alternative arise, is gold.

In order to understand how I see the world, you must come to the conclusion (as I have) that many businesses currently “idle” should never have existed in the first place, they only exist because demand has been skewed by years (or decades) of government interference and stimulus of other forms (including monetary). Each time the government intervenes these businesses become more convinced of their soundness, but in reality it was always an illusion from the beginning, they are addicted to government heroin. These businesses are like an infection, the infection wants to live, it wants to grow and thrive, but it damages the body (the economy) and survives by consuming resources other beneficial cells could have used more productively. If our immune system (the market) attacks the infection or takes away its resources, we shouldn’t complain that it’s idle, we should let it die. The process of killing it isn’t fun, we could get a fever and a headache and feel like crap (recession) but ultimately we emerge stronger without that weight holding us down. A business that consumes resources and loses money makes the whole country poorer.

The economic argument is basically Hayek’s argument that interest rates are not an arbitrary number, but serve a coordinating function in the economy. It’s a signal to producers about the relative willingess of people to consume today or in the future. When people save, the cost of capital goes down and long term projects become economic. When people spend, cost of capital increases and businesses can only get funding for short term projects intended to meet current demand. When both long term and short term projects are economic at the same time (low interest rates, stimulus) we get booms that inevitably lead to excess capacity and busts. The bust is not the problem, the boom is the problem. The government stimulus argument says we must create demand to fill the capacity. The Austrian argument is the capacity should never have been created in the first place and must be liquidated for mis-allocated resources to be freed for more productive purposes. Each time we strap on another bandaid the more infections survive the bust and the larger the imbalances ultimately become. The transition is painful, but the longer we delay the restructuring the greater the pain will be. It’s just a matter of time. Again, excluding the potential of game changing miracles (like cold fusion or something).

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There are millionaires and billionaires at the top of every industry. Whether you like it or not, the means of production are owned by the rich. In fact, it is the very ownership of these major income generating assets that made them rich. Private business taking risk with private capital is the best way yet devised by man to create wealth. If you don’t take risks, you can’t create wealth. The likelihood poor people would risk bailout money creating their own cash cows, and succeed, is exceedingly small… especially during difficult economic times. And thus the likelihood bailouts will help poor people overcome their poverty is also exceedingly small. It may provide temporary relief, but eventually the bill must be paid, and in the mean time the rich get richer.

What distinguishes this economic recession from downturns in recent memory is the depth and breadth of the stock market collapse and other bubbles bursting all around us. If rich people are able to preserve their income streams (as a result of government intervention) but refuse to contribute towards losing equity positions, where will their money go? So long as real estate prices, global consumption and the stock market continue their descent to oblivion, the answer can only be bonds and gold. If the underlying problems are not resolved before governments are forced, either by excessive debt or inflation, to pull the plug on their stimulus, the answer can only be gold. A government forced to abandon stimulus for financial reasons is not a good investment. And after years of government subsidized income streams businesses would likely become dependent on those subsidies. Take away the stimulus and the businesses die, along with their bonds.

I recognize there are many “ifs” in this post, but if we have learned anything from this debacle it should be never to discount the probability of the improbable. Gold is traditionally weak during the summer and there are varying scenarios that create peaks at varying levels, but I still don’t see any major obstacles in the years ahead.

In Dubai, however, since most of the wild speculative risk was taken by foreigners, as they default on their obligations, they leave the country. That means they don’t require state assistance and their abandoned assets (cars, real estate, etc) are seized and sold for a second time at a lower price. Prices will crash, but locals earn money off the first sale and locals earn money off the second sale. As long as the lenders are abroad, the loses are felt by foreigners and it’s win-win for Dubai. They get to keep the assets paid for by people no longer in the country without any of the negative societal baggage associated with poverty.

The catch is how much debt was assumed by the state and associated businesses. Dubai is known to have used quite a bit of leverage on its mega projects. They always have the option of taxation to repair the state balance sheet, but that will delay any potential future recovery. Despite the freeze, Dubai is still one of the more attractive business destinations in the world. The infrastructure is already first class and with lower prices and less traffic, even more so.

In other words, short term pain will be severe as consumption plummets, but so long as Emiraties are solvent and Dubai survives, the pain will be felt mostly by fleeing foreign investors, deported foreign workers and irresponsible foreign lenders. The city is likely to empty out considerably and lose some of its mystique, but it’s also likely to be one of the first places to recover when the sun returns… if it returns. When prices in Dubai hit bottom (not even close, yet) it could be a leading indicator of global economic recovery.

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Despite the use of foreign currency, the Zimbabwe dollars are in acute shortage, resulting in many people sleeping outside their banks hoping to get money the following day. – CNN

Economics 101 tells us that reducing supply should increase price, but that doesn’t seem to apply in this case. Perhaps it’s because most banking happens electronically, or perhaps it’s because hyperinflation is as much psychological as monetary. They have lost confidence in the Zimbabwe dollar and there is nothing the government can do about it. Once the process gets going, even if you take away the punch bowl nobody cares.

I seem to remember Bernanke making the case US dollars will not lose their reserve currency status because there is a shortage around the world.

It appears Stephen’s great argument in favor of a bailout boils down to the US government’s successful campaign against Hitler. He’s not comparing economic recession to Nazism (I think, although it’s a curiously convenient analogy) his point is that sometimes big government spending programs can accomplish something. However, unfortunately for Stephen, his argument is ridiculous because even had Germany or Japan won it still would have a been a victory for big government. When big governments go to war, should you really be surprised a big government won? I’ve never heard of a government waging war against the market.

Not to mention all the other differences, like forcing people to ration consumer products in support of increased production. At the war’s conclusion American standard of living would rise dramatically because it was suppressed artificially. The new manufacturing base would flood the world with inexpensive and high quality products, despite paying workers more than any other nation, because the new factories were the most productive in the world. Today, rather than limiting consumption the government is subsidizing consumption with tax rebates and other stimulus plans at the expense of production by absorbing all the legitimate savings and diverting capital away from productive private industry towards unproductive failing companies, which is the exact opposite of FDR’s World War 2 policy.

Oops.