“There is a worrisome precedent for this shifting mix of foreign capital inflows from private to official funding. The last time it happened in the context of a US current account problem was in the months leading up to the stock market crash in October 1987. During the pre-crash period, private foreign buying of US securities started to falter as America’s external adjustment put further downward pressure on the dollar….

….As this earlier episode reveals, official support for currencies of economies that have large current account deficits turned out to be a last-gasp, losing effort. The lesson: For economies in disequilibrium, the venting function of financial markets ultimately cannot be denied.”

Morgan Stanley - The Funding of America

“NEW YORK (CBS.MW) — Wal-Mart Stores said Monday it expects August same-store sales to range between flat to 2 percent higher, a reduction from the retailer’s week-ago forecast of 2 to 4 percent growth and well off the year-ago growth figure of 6.9 percent.

The Bentonville, Ark.-based company cited the impact of Hurricane Charley, which forced 75 stores to close and affected a total of 200 stores. Back-to-school sales are tracking below management’s plan.

In its weekly sales update, Wal-Mart said Labor Day falling later on this year’s calendar also has hurt sales, as has reduced clearance merchandise and later child-care tax credit checks.

The strongest categories in the past week were food, household paper goods and pet supplies; also back to school uniforms, and athletic shoes. The Midwest and South were the strongest regions for the week.”

In its latest report, the Paris-based Petrologistics said OPEC’s output of crude oil in July averaged slightly below 29.5 million barrels a day, down slightly from June’s 29.6 million barrels a day, mainly because of a decline in output from Saudi Arabia.

Petrologistics had previously expected the OPEC to pump more than 30 million barrels a day in July.

Despite pledges to increase its output, Saudi Arabia, OPEC’s largest producer and exporter, produced about 9.13 million barrels a day of oil in July, down from 9.52 million barrels a day in June, according to Petrologistics.

E-Commerce Times

There seem to be two parallel universes. One of them, let’s call it the Greenspan Universe after its leading prophet, is a financial Garden of Eden. The other, let’s name it in the same way the Prechter Universe, is more of a financial Armageddon.

Who lives in the Greenspan Universe? Well, nearly everyone, it seems. Certainly the financial press, the analysts, Wall Street, the government and most politicians of all stripes except for Ron Paul.

This universe has a strong global economic expansion underway, thanks to a Fed Chairman with an outsize ego and a talent for obfuscation, supported by miracles of structured finance and derivatives. Inflation is non-existent, job growth is strong, equity markets expect a continuing bull market despite historically high valuations, and debt markets are buoyant. The U.S. currency is strong because of hinted-at rate increases. U.S. consumers, having sustained the economy throughout the mini downturn, continue to spend and spend. Housing seems to throw off the talk of rate increases as starts and sales seem immune to any slowdown, rising to new records in sales.

Who lives in the Prechter Universe? Some of the greatest (and wealthiest) investors of all time; Warren Buffett, Sir John Templeton, Jim Rogers, Jeremy Grantham, Michael O’Higgins, Bill Fleckenstein, Ron Paul, Steve Roach. Austrian economists, the disciples of von Mises.

In this universe, the US is a nation living beyond its means, with a net international deficit position as of 3/31 to $5.2 trillion. In this other universe the reported inflation numbers in the U.S. are regarded as fictitious and “real” numbers in the 5-7% range are bandied about. For example, Sysco, the largest supplier to the hospitality industry, measures an 8% inflation rate in the cost of their product mix, which is a good proxy for household non-durables. The “measured” future rise in rates from the current 1.25% will never bring about the “neutral” position the Fed talks about, but simply aggravates an already serious inflation problem. Many argue that the expansion is flawed by malinvestment, particularly in residential real estate. A few see potential for a massive increase in bad loans, particularly in the consumer arena, which mught not be fun given that domestic banks now have over 75% of their assets in consumer-related loans, i.e. morgages, mortgage-backed securities, consumer direct and credit-card loans.

There is no communication between the two universes. Neither listens to the other.

The universes are superposed. In quantum physics, superpositions disappear when a measurement is made. This process is called decoherence. In financial market situations like this, the superposition disappears at the “Point of Realization” (POR).

Armageddon is a metaphor for the final conflict between good and evil. In this case, it is the final conflict between Keynesian economics and Austrian economics. One view or the other will have a POR.

Thanks for the original idea, and some of the text, to Edmund M. McCarthy, President and CEO of Financial Risk Management Advisors Company

Follow the link History of the Federal Reserve for a self-congratulatory history of the Fed.

Charged with maintaining the stability of the currency (which was stable as a rock for the preceding century), the Fed has proceeded to devalue the dollar by 95% since its inception in 1913. Used to the steady ravages of inflation, we don’t notice any more that the government steadily steals away the value of our money, just as governments have done throughout history by debasing the coinage.

It seems to be true that the incidence of panics, crashes and depressions has lessened since the institution of the Fed. Not that they have gone away, there are just fewer of them. Many argue that although they are fewer, they are much longer-lasting and so there has been little real change. But anyway, that’s not the point.

Over the years, Fed Chairmen have mostly tried to regulate both interest rates and money supply. Money supply, or credit supply, is used to stimulate the economy by making it easier and cheaper for people to borrow money. Keynesian theory basically says that if you put money in people’s hands through direct borrowing, or by indirect borrowing through government deficits, they will consume more and therefore stimulate economic activity. In Keynesian theory, this growth process will become self-sustaining and the stimulus can then be removed. However, the risk is that, if there is too much money and credit floating around, chasing a limited supply of goods and services, then prices are bid up and the general price level increases. (Technically, this increase is not “inflation,” which is actually the increase in money supply, although most people don’t make the distinction because they seem to go hand-in-hand). As a result, Fed chairmen have tried to juggle interest rates and money supply at the same time. Some Fed chairmen (Paul Volcker, for example, who broke the 1970s “stagflation”) have focused almost entirely on the money supply, allowing interest rates to go where they will.

Greenspan’s innovation or experiment has been to completely ignore any regulation of the money supply but instead to fix interest rates, supplying whatever quantity of credit is need to keep the price of credit (interest rates) at the targetted level. The result has been a huge expansion in money and credit. Total debt in the US now amounts to 3210% of GDP. The previous record (264%) was only reached during the 1930s Great Depression after GDP had fallen by half. The following chart graphically shows the explosion in credit.

Greenspan’s Credit Explosion

Interest rates in Austrian theory are an expression of time preference; at some price I am willing to defer my consumption and lend you my money so that you can consume or invest now rather than later. If my time preference is weak, then I ask a low rate of interest, and vice-versa. Greenspan’s continuous use of artificially low interest rates to stimulate the economy has distorted people’s behavior. Time preferences are distorted and as a result non-productive investment - malinvestment - occurs. A bubble, in other words. Greenspan’s response to incipient collapse of his bubble has been to pump more credit into it. This defers the collapse, but the Austrian theory believes that the ultimate collapse is aggravated because there is that much more distortion that has to be purged from the economy.

We’ll see.