I’m still musing about value protection. There are really two kinds of monetary risk – one is the tradable, if not benign, common or garden inflation and exchange rate issues, but the other is the real threat – what I might term monetary catastrophe – Weimar, Latin America and Zimbabwe style, where a currency is essentially destroyed. That kind of currency destruction is always associated with a government failing to conduct its affairs sanely – implying that government securities cannot be trusted any more than the currency. Under those circumstances, there is no safety in debt securities – any security which represents a money value, rather than a share of a business or a physical asset.

These destructions have all been caused by what is being touted today as “economic stimulus.” That is, massive increases in government spending while economic output is shrinking. In the Weimar example output shrank as a result of a general strike, while the government paid the strikers. In the Zimbabwe example, farms and mines were seized, cutting off their output, while the government continued to pay the military. In Latin America, the same story with numerous variations. Economists are repeating a mantra, that the risk is not doing too much spending, but too little. What nonsense, but I’ve plowed this field before and see no need to repeat myself. The question here is what to do about the consequences.

As is well documented on this blog, I’ve been a deflationista for a long time. But now the government is shaking me off that particular perch. The expansion in government debt and the monetary aggregates is truly unprecedented, to the best of my knowledge. The domestic monetary base has expanded from about $870 billion in September 2008 to nearly $1.8 trillion, more than doubling, as of last week’s St. Louis Fed reports. The most recent flow of funds report only covers through 3Q08, but as of that point total credit market debt was continuing to expand, courtesy of ballooning government borrowing. Since September of last year, M2 has grown by 6.5%. All indications seem to be saying that the Fed is winning the battle against (monetary) deflation.

Even the average bright four year old should now be able to figure out that monetary inflation – expansion of money and credit – doesn’t necessarily result in consumer price inflation. It can just as easily flow into asset prices – as we recently saw with house prices, for example. This means that consumer prices can continue to decline as unemployment rises, even in the face of monetary inflation, at least for a while. I suggest that commodity prices can rise – food, energy – while wages fall. Housing prices will fall from oversupply, as will services prices (we really are well supplied with nail salons), so that the CPI can fall until its profile looks more like that of the less developed economies, with necessities such as food and energy taking a larger and larger share of income, until they start to become significant enough to halt and then reverse the CPI trend. If we get that far, then the Weimar/Zimbabwe model can start to take hold. And we could get there, because declining consumer prices would encourage the Fed to think that it should “do more,” keeping the pumps running until they blow up in Mr Bernanke’s face.

To me, this is a plausible (internally consistent) scenario. To protect against this means accepting the volatility that goes along with maintaing a chunky position in real assets, and positioning monetary assets in currencies and domiciles whose authorities have not yet run amuck. And, needless to say, watching those authorities closely for any flecks of foam around the mouth.

President Obama was on the television this morning talking about his economic stimulus plan. It looks to me that the markets are starting to realize that an enormous amount of government debt is about to be dumped on them. Whether it is in the form of Treasuries or just dollar bills, it is all government debt. The increase in supply is likely to drive prices down – dollar, bonds or both. From an aggregate credit point of view, it probably won’t be enough to more than temporarily slow down the decrease in money and credit as defaults continue. But there is a rate issue here, over the short term which will be faster?

I’m short the bonds via TBT, and currently wondering where I should put my excess USD cash – I want safe and secure (and liquid), but not US dollars. Considering my shareholdings are mostly all Canadian companies, I’m probably over-exposed to Canadian dollars already. Swissie? Euro? Under study.

Visiting my brother-in-law in Punta Gorda, FL, we noticed an ad for new condos on the way into the restaurant for dinner: $299,900 now $151,800. Brother-in-law verified that the previous asking price was factual as of last week.

Amateur real estate investors are snapping up foreclosed properties in California.

“This week I made four offers (for clients), and two went pending even before we submitted our offers,” he said. “Some of the deals are incredible. You can buy a three-bedroom house in Oakland for $60,000 cash and rent it for $1,200. That leaves you with $1,000 a month after property tax and insurance, so you would recoup all your money in five years.”

Perhaps, except the market is already flooded with rentals and all the other knife-catchers will be competing with you. Rents fell in the fourth quarter, for the first time in years in the Bay Area.

Now the competition is intensifying among landlords, with some already offering things like $99 move-in specials and free credit checks to would-be tenants, Latham said.

“I think we’ll see more of that competition for tenants, so (landlords) better know how to manage it and give tenants the service and value they think they’re paying for,” she said.

If it sounds too good to be true, it probably is.

One of the questions I am really curious to see answered in this debacle is how the so-called “service economy” will unravel. A piece in the NYT talks about the decline in what I would call personal services:

Responsible for roughly 18 million jobs nationwide, according to 2006 Census Bureau data, these companies have long been seen as engines of America’s economic growth. Yet after years of explosive expansion, many beauty salons, dry cleaners, landscapers, dog walkers, nanny services and restaurants experienced slower sales growth or even decline in the final months of 2008.

Professional dog walkers are a significant industry in Mill Valley, where it seems mandatory for every household to have at least one pooch. The kids have Hispanic nannies (I know because a lot of them congregate with their charges in the town square mid-morning), but the dogwalkers are chic young white women. Go figure.

Anyhow, back to the subject at hand. What I was going to say was that the real interesting question is to see to what extent the services businesses have been built by outsourcing. For example, 15-20 years ago it was very popular for companies to sell off their IT organizations, computers and all, to an outsourcer like EDS. These were disguised financing transactions, in which the corporation received a tidy sum of cash from the outsourcer and, in return, signed a long-term “take or pay” contract for IT services. This practice boosted apparent GDP (the outsourcer showed the contract as services revenue, not interest), probably to a significant extent because the practice was widespread. One of the biggest deals was GM, with EDS. What were previously internal expenses (IT staff costs and interest) became EDS’s revenue, although nothing really changed. The same people went to the same offices doing the same work, they just got new business cards. But this change in counting shows oneof the big pitfalls of econometrics – double-counting is really easy. And then when the counting is unwound, the numbers which went up fast go down fast.

Now there were many, many other kinds of outsourcing. And of course there is the financial services industry which became huge (40%  of S&P earnings by one estimate) and is now collapsing.

But in an era where automated manufacturing has vastly reduced the need for labor, what do people do all day? We’ve built all the structures we will need for a long time. What else is there? Back to the land?

What makes the cornfields glad; beneath what star it befits to upturn the ground, Maecenas, and clasp the vine to her elm; the tending of oxen and the charge of the keeper of a flock; and all the skill of thrifty bees; of this will I begin to sing.

Virgil’s Georgics – Roman “back-to-the-land” propaganda, ca. 29 B.C.E.

You can’t turn on the television without seeing coverage of Mr Obama’a triumphal procession to Washington, as he wraps himself in the auras of Lincoln and Kennedy. In autocratic and oligarchic states, such as the U.S., such ceremonies, and their attendant pomp and circumstance, are powerful propaganda tools used to establish and reinforce legitimacy.  This elaborate progress reminds me of the first television program I ever saw, the coronation of Queen Elizabeth II in 1953. I do find it quite disturbing, not only because of the echoes of autocratic states, but also because it is showing an intensely narcissistic Mr Obama.

It is too bad that he is apparently intending to dissipate the political capital he has created in an attempt to keep the economic Ponzi scheme going. He could have used the unique opportunity he has in the “honeymoon” to persuade the nation to take the unpleasant medicine that is needed to restore economic soundness. He is, unfortunately, like poor old Ethelred, not well advised.

His advisers (and Bush’s, for that matter) have completely abandoned any goal of stable monetary conditions. Random spending and bailouts are the rule of the day. I used to be convinced that deflation would rule for a while, simply because the pace of credit destruction would be higher than any sane Fed would attempt. Well, the Fed is no longer sane. Now, I don’t know. All these programs say that the risk of holding dollars is extremely high. It could still go either way, but why take chances. The chances of a Zimbabwe outcome are rising daily. That is what happens when government spending increases while economic output is falling.