Friday, December 19, 2008

Help Save The Freedom

A special thanks to Will Bonner for the following:

Fifty years ago, Leonard E. Read urged Americans to "help save the freedom mankind is so unhappily losing."

Read, the founder of the Economic Foundation for Freedom, was warning of the dangers of central planning, statism, interventionism, socialism - whatever you want to call it.
His words seem more relevant now than ever.

I, Pencil

My Family Tree as told to Leonard E. Read (1898-1983)

I am a lead pencil—the ordinary wooden pencil familiar to all boys and girls and adults who can read and write.

Writing is both my vocation and my avocation; that's all I do.

You may wonder why I should write a genealogy. Well, to begin with, my story is interesting. And, next, I am a mystery—more so than a tree or a sunset or even a flash of lightning. But, sadly, I am taken for granted by those who use me, as if I were a mere incident and without background. This supercilious attitude relegates me to the level of the commonplace. This is a species of the grievous error in which mankind cannot too long persist without peril. For, the wise G. K. Chesterton observed, "We are perishing for want of wonder, not for want of wonders."
I, Pencil, simple though I appear to be, merit your wonder and awe, a claim I shall attempt to prove. In fact, if you can understand me—no, that's too much to ask of anyone—if you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing. I have a profound lesson to teach. And I can teach this lesson better than can an automobile or an airplane or a mechanical dishwasher because—well, because I am seemingly so simple.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn't it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year.

Pick me up and look me over. What do you see? Not much meets the eye—there's some wood, lacquer, the printed labeling, graphite lead, a bit of metal, and an eraser.

Innumerable Antecedents

Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents. But I would like to suggest enough of them to impress upon you the richness and complexity of my background.

My family tree begins with what in fact is a tree, a cedar of straight grain that grows in Northern California and Oregon. Now contemplate all the saws and trucks and rope and the countless other gear used in harvesting and carting the cedar logs to the railroad siding. Think of all the persons and the numberless skills that went into their fabrication: the mining of ore, the making of steel and its refinement into saws, axes, motors; the growing of hemp and bringing it through all the stages to heavy and strong rope; the logging camps with their beds and mess halls, the cookery and the raising of all the foods. Why, untold thousands of persons had a hand in every cup of coffee the loggers drink!

The logs are shipped to a mill in San Leandro, California. Can you imagine the individuals who make flat cars and rails and railroad engines and who construct and install the communication systems incidental thereto?

These legions are among my antecedents.

Consider the millwork in San Leandro. The cedar logs are cut into small, pencil-length slats less than one-fourth of an inch in thickness. These are kiln dried and then tinted for the same reason women put rouge on their faces. People prefer that I look pretty, not a pallid white. The slats are waxed and kiln dried again. How many skills went into the making of the tint and the kilns, into supplying the heat, the light and power, the belts, motors, and all the other things a mill requires? Sweepers in the mill among my ancestors? Yes, and included are the men who poured the concrete for the dam of a Pacific Gas & Electric Company hydroplant which supplies the mill's power!

Don't overlook the ancestors present and distant who have a hand in transporting sixty carloads of slats across the nation.

Once in the pencil factory—$4,000,000 in machinery and building, all capital accumulated by thrifty and saving parents of mine—each slat is given eight grooves by a complex machine, after which another machine lays leads in every other slat, applies glue, and places another slat atop—a lead sandwich, so to speak. Seven brothers and I are mechanically carved from this "wood-clinched" sandwich.

My "lead" itself—it contains no lead at all—is complex. The graphite is mined in Ceylon. Consider these miners and those who make their many tools and the makers of the paper sacks in which the graphite is shipped and those who make the string that ties the sacks and those who put them aboard ships and those who make the ships. Even the lighthouse keepers along the way assisted in my birth—and the harbor pilots.

The graphite is mixed with clay from Mississippi in which ammonium hydroxide is used in the refining process. Then wetting agents are added such as sulfonated tallow—animal fats chemically reacted with sulfuric acid. After passing through numerous machines, the mixture finally appears as endless extrusions—as from a sausage grinder-cut to size, dried, and baked for several hours at 1,850 degrees Fahrenheit. To increase their strength and smoothness the leads are then treated with a hot mixture which includes candelilla wax from Mexico, paraffin wax, and hydrogenated natural fats.

My cedar receives six coats of lacquer. Do you know all the ingredients of lacquer? Who would think that the growers of castor beans and the refiners of castor oil are a part of it? They are. Why, even the processes by which the lacquer is made a beautiful yellow involve the skills of more persons than one can enumerate!

Observe the labeling. That's a film formed by applying heat to carbon black mixed with resins. How do you make resins and what, pray, is carbon black?

My bit of metal—the ferrule—is brass. Think of all the persons who mine zinc and copper and those who have the skills to make shiny sheet brass from these products of nature. Those black rings on my ferrule are black nickel. What is black nickel and how is it applied? The complete story of why the center of my ferrule has no black nickel on it would take pages to explain.

Then there's my crowning glory, inelegantly referred to in the trade as "the plug," the part man uses to erase the errors he makes with me. An ingredient called "factice" is what does the erasing. It is a rubber-like product made by reacting rape-seed oil from the Dutch East Indies with sulfur chloride. Rubber, contrary to the common notion, is only for binding purposes. Then, too, there are numerous vulcanizing and accelerating agents. The pumice comes from Italy; and the pigment which gives "the plug" its color is cadmium sulfide.

No One Knows

Does anyone wish to challenge my earlier assertion that no single person on the face of this earth knows how to make me?

Actually, millions of human beings have had a hand in my creation, no one of whom even knows more than a very few of the others. Now, you may say that I go too far in relating the picker of a coffee berry in far off Brazil and food growers elsewhere to my creation; that this is an extreme position. I shall stand by my claim. There isn't a single person in all these millions, including the president of the pencil company, who contributes more than a tiny, infinitesimal bit of know-how. From the standpoint of know-how the only difference between the miner of graphite in Ceylon and the logger in Oregon is in the type of know-how. Neither the miner nor the logger can be dispensed with, any more than can the chemist at the factory or the worker in the oil field—paraffin being a by-product of petroleum.

Here is an astounding fact: Neither the worker in the oil field nor the chemist nor the digger of graphite or clay nor any who mans or makes the ships or trains or trucks nor the one who runs the machine that does the knurling on my bit of metal nor the president of the company performs his singular task because he wants me. Each one wants me less, perhaps, than does a child in the first grade. Indeed, there are some among this vast multitude who never saw a pencil nor would they know how to use one. Their motivation is other than me. Perhaps it is something like this: Each of these millions sees that he can thus exchange his tiny know-how for the goods and services he needs or wants. I may or may not be among these items.

No Master Mind

There is a fact still more astounding: the absence of a master mind, of anyone dictating or forcibly directing these countless actions which bring me into being. No trace of such a person can be found. Instead, we find the Invisible Hand at work. This is the mystery to which I earlier referred.

It has been said that "only God can make a tree." Why do we agree with this? Isn't it because we realize that we ourselves could not make one? Indeed, can we even describe a tree? We cannot, except in superficial terms. We can say, for instance, that a certain molecular configuration manifests itself as a tree. But what mind is there among men that could even record, let alone direct, the constant changes in molecules that transpire in the life span of a tree? Such a feat is utterly unthinkable!

I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human master-minding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.

The above is what I meant when writing, "If you can become aware of the miraculousness which I symbolize, you can help save the freedom mankind is so unhappily losing." For, if one is aware that these know-hows will naturally, yes, automatically, arrange themselves into creative and productive patterns in response to human necessity and demand—that is, in the absence of governmental or any other coercive masterminding—then one will possess an absolutely essential ingredient for freedom: a faith in free people. Freedom is impossible without this faith.

Once government has had a monopoly of a creative activity such, for instance, as the delivery of the mails, most individuals will believe that the mails could not be efficiently delivered by men acting freely. And here is the reason: Each one acknowledges that he himself doesn't know how to do all the things incident to mail delivery. He also recognizes that no other individual could do it. These assumptions are correct. No individual possesses enough know-how to perform a nation's mail delivery any more than any individual possesses enough know-how to make a pencil. Now, in the absence of faith in free people—in the unawareness that millions of tiny know-hows would naturally and miraculously form and cooperate to satisfy this necessity—the individual cannot help but reach the erroneous conclusion that mail can be delivered only by governmental "master-minding."

Testimony Galore

If I, Pencil, were the only item that could offer testimony on what men and women can accomplish when free to try, then those with little faith would have a fair case. However, there is testimony galore; it's all about us and on every hand. Mail delivery is exceedingly simple when compared, for instance, to the making of an automobile or a calculating machine or a grain combine or a milling machine or to tens of thousands of other things. Delivery? Why, in this area where men have been left free to try, they deliver the human voice around the world in less than one second; they deliver an event visually and in motion to any person's home when it is happening; they deliver 150 passengers from Seattle to Baltimore in less than four hours; they deliver gas from Texas to one's range or furnace in New York at unbelievably low rates and without subsidy; they deliver each four pounds of oil from the Persian Gulf to our Eastern Seaboard—halfway around the world—for less money than the government charges for delivering a one-ounce letter across the street!

The lesson I have to teach is this: Leave all creative energies uninhibited. Merely organize society to act in harmony with this lesson. Let society's legal apparatus remove all obstacles the best it can. Permit these creative know-hows freely to flow. Have faith that free men and women will respond to the Invisible Hand. This faith will be confirmed. I, Pencil, seemingly simple though I am, offer the miracle of my creation as testimony that this is a practical faith, as practical as the sun, the rain, a cedar tree, the good earth.

Leonard E. Read (1898-1983) founded FEE in 1946 and served as its president until his death. "I, Pencil," his most famous essay, was first published in the December 1958 issue of The Freeman. Although a few of the manufacturing details and place names have changed over the past forty years, the principles are unchanged.

Thursday, December 4, 2008

Architects of Destruction

Many thanks to Ian and all the guys at Energy and Capital for the image.

All the above people are in the group I like to call "the few." "the few" is not limited to the pictures above, but to be a member of the few takes one special circumstance - you got filthy rich, I mean filthy "live on your yacht sailing the world for the rest of your life" rich, by creating the financial mess the world has only begun to experience.

What these people did was to create an environment which culminated with fraudulent bonds sold to unsuspecting investors. The story begins many years ago, and many accomplices were involved. Subtle changes to national lending laws meant to help the disadvantaged, elimination of regulatory controls over banks, creation of obtuse and opaque accounting rules were all used by those at the top of financial corporations to rig the system for profit, and lie to investors.

I say lie because "the few" gamed the system by conning the ratings agencies to give the same rating to risky bonds based on consumer debt as the rating given US Treasury Bonds. At the same time, they also convinced those in charge of policing them, ie. the SEC, the Fed, The Senate Banking Committee among others, that this was the new world order, the fantastic paradigm that the US would enjoy.

In fact, the economic model for the US since 1981 has been the elimination of good paying jobs here, in exchange for cheaper imported products in combination with more government spending via sale of US Treasuries, thus increasing the National Debt. In the 1980's, the US was able to increase GDP only through the massive increase of military build-up, which was funded increasingly by foreigners through the sale of US Treasury bonds, which they bought with the profits from the increasing exports we bought from them.

The benefit to the US economy came only after we increased the National Debt, and that money was filtered through military spending, not free market productivity. Our automobile manufacturers were not making more money, they were actually losing money in the 1980's, GM to the tune of $10 Billion per year from 1981-1990. We ceded electronics production to Asia and Latin America, textiles to the Indian sub-continent, and automobile advances to the Japanese and Germans. The swiftness of the manufacturing base dismantling was only buffeted by the increase in military spending.

Next, we began to get the Chinese on board. They relished having foreign capital, mainly from the US, pour into their country. US corporations took the savings they realized by eliminating good paying jobs here, and built shiny new state of the art factories there. It has grown today to such proportions that Peter Schiff calls it the "Tom Sawyer Effect." Schiff likens it to Tom convincing his friends that there was such joy in painting the fence, that his friends actually paid him to paint. Well, the sad part is there was only so much of the Sawyer's fence. That job was finite. And for Tom, he hoped they would finish before they realized painting was really not that joyful.

Unfortunately, the US economy, and the global economy, are not that finite. In 2007, the pace of production in China supported the consumption in America at a 5:1 ratio. That means it took 5 Chinese to meet the buying demands of 1 American. By November 2008, 50% of the toy factories in China have closed. The percentages for other goods is rapidly approaching that level. Just ask your local overhead fan supplier how sales are this year. Ask the hardware store. Ask your furniture store. All these businesses, plus most others based on the consumer, are not just slowly dying, they are at the grim reaper's door. And they all get the majority of the goods they sell from China.

Wall Street used this system to gain huge profits. American corporations that could eliminate jobs here the fastest were the ones whose stock price rose quickest. Bad news is the party could never last. Unless you have a consumer base that makes enough money to buy all the goods, the model would stop working. By 2000, we were at the end of that model. We no longer had enough good paying jobs to trade for cheaper imports.
Congress was convinced by Phil Gramm that Banking deregulation was the answer. Eliminate the wall between investment and commercial banks and large amounts of money will create more jobs was his argument. In 1998, passage of the Gramm, Leach Bliley Act accomplished just that, and removed one of the last vestiges of post-depression laws meant to keep the banking industry sound. Enron was a direct consequence of this law being passed.
In the late 1990's, many more banking regulations were removed by congress, yet nothing was keeping the economy from sinking into recession.

In comes the Fed. Greenspan recognized the need for a spark to rekindle spending. But how to create that spark was the answer. All the data pointed to wages going down. Less money = less spending. So in January 2001, at the behest of Wall Street and the incoming Bush Administration, Greenspan lowered the rate at which banks could borrow money. To fund this, he increased the number of US Treasuries for sale.

For a short time, it worked. Homeowners, under constant advertising from mortgage lenders, refinanced their homes en masse. There were even some homeowners who refinanced 6, 7, 8 times and more within a few years span. They were able to do so because as the stimulus of the lower Fed rate wore off, Greenspan, under encouragement from the White House, would lower the Fed rate again, and again, and again. Each time the rate lowered, it provided a little stimulus. Until the Fed rate got to 1%.

The Fed could not really go any lower. There is always a certain cost to doing business. For mortgages, the processors, underwriters, office space, office machines etc all need to be there to do business, so mortgage rates could not get any lower. Some money must be there to support the organization.

Now Wall Street needed something else. Since the lowering of interest rates had the effect of allowing more buyers into the real estate market, real estate was making dramatic climbs in value. At the same time, since the Fed rate was so low, so were the Treasury yields low. Wall Street, hungry for more profit, and knowing certain investment vehicles such as annuities, pension programs and the like needed a guaranteed rate of return much higher than the the 3.5% of Treasuries, went to work.

First, in order for the plan to work, the ratings agencies must agree. The largest pools of money available for investing reside with entities that, by law in most cases, are allowed to buy only AAA rated securities. So a plan was hatched that the ratings agencies could be convinced to give certain securities, otherwise deemed risky, the highest ratings. The Mortgage Backed Security was born. MBS were, in theory, structured in a way that they contained both good (prime) mortgages and bad (subprime) mortgages, and the argument Wall Street used was since only a portion of the MBS had risky mortgages, and historical models show only a certain rate of default, then if we plan for that default as reflected in the overall rate of return, then the MBS is extremely safe.

Next, Wall Street began selling MBS at a rabid pace. Investors were clawing for greater returns than government bonds. Soon, all the mortgages that could be securitized had been securitized. Wall Street needed more.

The birth of the CDO now came. Several MBS were combined, and packaged as a new type of bond. An average MBS may have contained between $50 - $100 Million worth of mortgages. The CDO's would be a bet on the performance of as many as 10, sometimes more, MBS in one single bond. Most CDO's were sold for more than $1Billion. Wall Street sold these new bonds, the CDO's, CLO's, CMO's, as the way for fixed income investments to realize the rate of return they needed. What Wall Street did not tell these investors is the underlying MBS owned the mortgages, not the CDO. Wall Street did not tell them the CDO was only a bet on the positive performance of the underlying MBS.
The fees were enormous. The demand from pension funds, money market account managers, sovereign wealth funds, annuity funds etc. for higher yield than Treasuries was increasing. Wall Street needed more loans. So the system expanded. Some banks, such as Wamu and IndyMac, already were realizing greater profits from lowering guidelines, and Wall Street was buying all of their loans. Some dealers set up internal channels to service loans they could then package into MBS, and then CDO's. It got to the point that people with very poor credit histories were being given loans that exceeded the value of the property by as much as 25%. Debt to income ratios, forever at the 35% or less level, were raised sometimes to as high 60%. Some people were even allowed to have three, four or more properties at one time with these new guidelines.
Very few people lied to get a mortgage, they did not have to. Wall Street and the banks were eager to let someone into a house, fully knowing the terms would never be filled, because they were selling the risk of that loan defaulting to someone else.
Again, Wall Street was selling the risk to someone else, at huge profits. They were doing everything they could to get more loans in, even giving loans to people they knew never had a chance of fulfilling the obligation.

The real problem with all of this is housing values must keep increasing at an escalating rate greater than at the time of origination of the MBS. If a plateau is reached where housing prices remain steady, the people who had been given loans that exceeded their ability to pay had no way to get out of the house without default. If they had borrowed more than the house was worth, and housing prices remained flat, they could not flip the house for profit.
This was compounded by the credit card companies giving new homeowners cards with $10,000 to $50,000 limits. This practice escalated in 2005 when the banks figured out that a lot of people were buying houses, putting in granite counter tops and new appliances and selling the house for profit as the market rose. Why not give them a seperate line of credit through a card which would be used at Home Depot, then paid off at the closing when they sold the house?
Well, as we all know, housing prices not only have remained flat, they have fallen. More than 25% nationally. This has grave consequences for the buyers of CDO's. Since the MBS that the CDO is a bet on owns the mortgages, the CDO gets nothing from a short sale, deed in lieu or loan modification. The CDO is a 100% loss.
A 100% loss.
Among the coming casualties will be any and all pension funds. If you have money, or are being paid from any pension program, get ready. Most pension programs are near half the value they were one year ago. And the bottom is nowhere in sight. Money market accounts - find out today if they have anything besides US Treasuries. If they do, it is only a matter of time before that account will be valued lower. Most insurance companies bought these to bolster their annuity funds - Guess what - sometime in the near future the billions represented by derivatives will be marked down.
Here is why I call "the few" the architects of destruction. There are somewhere over $500 Trillion in derivatives that have been sold over the last 6 years by American Investment Banks.
There isn't enough money in the world, let alone the US Treasury, to replace the capital losses of even half of the derivatives. In most cases, derivatives will have a 100% loss by the end of this.
It is hard to believe that "the few", who have been called "the smartest people on the planet" by many, did not know what they were creating.

That's the really scary part

Bailout Fill'up

"I better go now, I'm almost at the wall"
Bailout the automakers. The Big Three crash test dummies are sitting in front of Congress, answering questions, and know they will get the money. What a sham, scam and complete boondoggle.


Because if these guys are smart enough to run an efficient company, how is it they are begging for money in the first place? Why did not one of them see this coming? What kind of cars have been the best sellers in the world, not just the US, and why don't we make those here. Why do Hondas and Toyotas last 200,000 miles and more with minimal maintenance, and American cars have trouble getting to 100,000 miles of use without thousands of dollars in repair?

Who chose these guys as the CEO's? I guess the same people that decided it was a good thing to ramp up production of gas guzzling super-sized SUV's that use much more gas, which we buy from Saudi Arabia. SUV production and sales more than doubled between 2002 and 2005. Am I the only one that realized it was Saudi Arabians that flew those planes into the WTC Towers?

When did we cede making the best cars in the world? And more importantly, why? The answer to that question is not a riddle to many. History will show Honda and Toyota got a foothold in this country when American automobiles began to show wear and suffer repairs around three years after they were made. Funny, that is the average length of an auto loan.

This is not a coincidence (my wife says there are no such things as coincidences).

And, please, do not tell me US auto workers are compensated at $72 per hour and foreign workers make $42 per hour. That is a big lie. Those that wish to see all unions die use a funny method when devising that number. They take all the money that is paid to retirees through pensions, and take all the medical benefit money paid to retirees, and take all monies used for retraining and unemployment, and every penny of benefit given to anyone who has ever received money from the US auto companies, add that to to the money paid current workers and divide by the number of currently employed auto workers.

They don't use that method when calculating for Honda, or Toyota, or BMW or..... When calculating how other auto companies pay their employees, they use only the current wages paid to current employed workers.

That is not only disgusting, it is immoral. Why? Because Japanese autoworkers are actually paid more per hour than US auto workers, and they have as good if not better benefits. Ever hear one of these guys who use these numbers point that out? No. It would alert the listeners or readers to the fact that they are a liar.

Such is the circumstance of what we hear for news everyday.

Tuesday, December 2, 2008

The Legacy of Keynesianism

As we wait for the other, or more accurately the many other, shoes to drop, blame flies in all directions. The reality is there is only one place for it to rest. Temptation of that which glitters can be strong, and our leaders have fallen under the spell.

What is happening in the world markets is the utter climax of supply-side economics. Trickle down theory is a lot like the most beautiful woman in the world working as a prostitute, asking only pennies for service, in all the neighborhoods.

So seductive, so sexy, and so within your means that you succumb. Few can resist her.

She is beyond compare, the experience unequaled. Those who enjoined her charms tell others. The line for her wiles grows.

The problem resides in the fact she charges so little for she is disease-ridden. Once you partake, the disease begins to eat away at you. Slowly at first, almost undetectable, the disease grows.

Soon, others you know have also fallen for her charms. The disease spreads, everyone infecting others, especially loved ones, until the first infected begin to outwardly show signs of deterioration. All the others, whether directly, or indirectly infected, ignore the signs for they will not acknowledge the ugly truth. Surely their ailments are not that. Surely there is an easy cure.

The secret must not come out.

Unfettered, the disease reaches proportions beyond control. The beautiful prostitute dies, yet the disease grows. Those that partook deny involvement. Those that are but innocent participants refuse to believe their beloved infected them, even as the symptoms grow.

Simple, ineffective cures are tried. An aspirin here, some antibiotic there. Even more of the same is tried as the healers suggest another trip to the den of iniquity may cure the infected, just as the disease started, so may it end. Of course it does not help, but spreads the infection yet further.

All the while the healers remind all those that enjoined the beautiful woman of her great charms, and did they not want those again? They respond "Yes, Yes, we want those charms again."

Soon the infection is complete. Almost all who joined in the activity, whether guilty of sin, or not, will whither to dust. All who played no part will suffer the same fate.

The few who survive were those who created the infection, gave it to the beautiful woman, and then made her a prostitute. Yes, they also partook of her charms, yet were guarded by the prophylactic, only passing the risk on to the next in line. The few never raised alarm, nor warned of the risk, because they were able to sell tickets for the line.

As the infection grew, these few took the treasures of the infected. Their vaults busting at the seams, these few just built more vaults, all the while telling the infected all was good. Society is strong, resilient, and will be better than before.

Of course, society was in trouble. Resilience was less than needed. Society would not be better than before. The many who never even saw the beautiful woman would suffer the most. Yet, all would suffer, except the few. The world would be changed, dramatically, forever, all in the fews' favor.

All because the few wanted more than they should have.

All because the many wanted to be like the few.

The many believed the swan song of the few, thinking they could not be like the few if they did not believe.

The world is close to the end of this story. The only way this ending changes is the many gather and change the few. The few must be held accountable, and their system denied. The other shoes of the world markets are very close to dropping. The many does not have much time left.
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