Friday, January 26, 2007

'Bubble kings' prosper by loading the world with debt


“Behind every great fortune lies a crime.”-Balzac

January 26, 2007

by Bill Bonner
The Daily Reckoning
Copyright 2007

You can tell a leopard by its spots. But can you tell a boom by its fattest cats?


But, first, how do cats get fat?

It is not the goodwill of the baker that puts bread on a man’s table. And thank god. Otherwise, we’d all go hungry. Nor does the busboy bus for the benefit of mankind. Instead, everyone schleps, humps, sweats and toils for reasons of his own.

This insight - that people can pursue their own interests, and in so doing improve the lot of everyone - is the central insight of modern economists, at least those who aren’t idiots. The theory is simple enough; a man bakes bread not to put bread on others’ table, but to put it on his own. That others have bread to eat too is merely the happy consequence of a virtuous system. Likewise, the electrician doesn’t fix your wiring because he likes to see sparks fly. He has to earn a living too, and he does it by providing something useful to others.

The symmetry of it is elegant. The morality of it is appealing. Do unto others...and they will do unto you. And the more you do for others...the more you can expect them to do for you. That is why a properly functioning economy does seem to deliver something close to rough justice. Henry Ford brought the benefits of automobile transportation to the masses. He deserved to make a lot of money. Andrew Carnegie provided the nation with steel. John D. Rockefeller rolled up and rationalized an early market in oil. Who can say these tycoons of yesteryear did not deserve what they got?

Just look along the ‘Gold Coast’ of Connecticut. By the early 20th century, you could find the mansions built by the kings of industry and commerce of the period. Greenwich was home to the Simmons family, who made a fortune in mattresses...the Phelps Stokes family, who made their money in copper products...the Milbanks of Borden Condensed Milk...and ‘Sugar King’ Henry O. Havemeyer. Their grand houses were testament to their grand contributions; they were the people who built the wealth of America.

The rich got their money honestly back then...or, at least most of it. They put their family names on their products and spent their loot grandly. Silk shirts, top hats, spats...great limousines with chauffeurs...grand balls with orchestras...and servants dressed in proper outfits.

But now, what’s this? A new bunch of kings have taken its place in Greenwich, dressed in perma-pressed khaki pants with blue, open-collared shirts. They are richer and busier than any group of bees the honey-pot nation has every produced. Still, don’t bother to look for their last names on your refrigerator...or on your armchair...or even on your liquor bottles.

Paul Tudor Jones, who lives in a house in Greenwich that resembles the mansion in ‘Gone with the Wind’, is a very rich man. But what did he do for the money? He is not a king of industry. He does not bring milk to the masses; nor does he provide copper pipes for their water systems...nor mattresses to rest their weary bones. Mr. Jones is a Bubble King, who manages a $15 billion hedge fund.

In another little town favored by the new moneyed classes, Norwalk, the granite mansion of steamship magnate and head of U.S. Steel, James Augustus Farrell, has fallen into the hands of another Bubble King - Graham Capital Management, a hedge fund with $5 billion in assets and only 150 employees.

Graham’s chief financial officer lives on the other side of Long Island Sound and is said to commute to work by boat. We wonder why. At this point in the credit cycle we are convinced that bubble kings can walk on water!

Last week we argued that the present boom is a ‘fraud.’ This week, we look at those whom the fraud is rewarding so generously. If they are so richly paid, says the theory of modern capitalism, they must richly provide. But what?

Take Lloyd Blankfein. The Goldman Sachs man took the wheel at the firm after Hank Paulsen went on to greater glory at the Treasury Department. In the six months from the time he took the job until the end of the year, he is reported to have earned $53.4 million. Let’s see, that is about $9 million per month...nearly $2 million per week...or about $400,000 every working day.

And here...our eyes roll up to heaven as we wonder: What hath this man done? This is where the theory of meritocratic markets begins to pinch the common man like a starched shirt at a summer wedding. He’s sure it’s what he wants to wear; but he’s beginning to get uncomfortable in it. There is no better system than free and unfettered capitalism, he tells himself. He loathes the thought of mobs at Mr. Blankfein’s door...and thinks he is clever enough to resist the meddlers who want to put a limit on how much a man can earn. Still, he senses that there is something not quite right.

How is it that - in a free market system, where people are supposed to be rewarded according to how much they provide to others - today’s biggest prizes go to those who provide so little? Mr. Jenkins and Mr. Blankfein do not add in any appreciable way to the world’s wealth. Instead, they merely move it around - from middle and lower class taxpayers to the super-rich...from householders to speculators...and, by loading up the world with debt, from the future to the present.

The answer is to be found in the details of modern finance.

Since 1995, the U.S. money supply has risen at about 10% per annum. The world’s supply of gold, meanwhile, has risen at only about 2% per year. And the world’s supply of goods and services only about 3%. A free market presumes that money itself is an honest measure. Otherwise, all the “information” that free prices give is distorted and untrustworthy.

“The introduction of a non-market driven money controller into the financial system invalidates the assumptions on which free-market economic theory is based,” writes Martin Hutchinson. “In 1929-32, as Milton Friedman and Anna Schwarz demonstrated in their ‘Monetary History of the United States’ that non-market player, the Federal Reserve system, kept money too tight and precipitated a depression of a duration and severity that should, under the classical theory have been impossible.”

Central authorities have kept money too loose, deceived a whole generation, and redistributed more wealth than ever in history. Like a cosmetic surgeon moving fat around, they’ve fashioned a financial world so lumpy and lop-sided, its own mother wouldn’t recognize it.

Hutchinson adds:

“Lax monetary policy has continued for far longer than would normally have been possible, fully 12 years, a period of monetary ease and low real interest rates entirely without precedent. For more than a decade price signals have been distorted and resources have flowed in artificial directions....

“Globalization and the greater ease of outsourcing have kept wages down at the bottom of the scale in the [United States] and Europe (an effect which excessively lax immigration policy has compounded.) However at the top of the scale those able to benefit from IPOs, those with excessively large homes, the managers of hedge funds and private equity funds and above all the gatekeepers such as Goldman Sachs, who control access to the overwhelming flood of liquidity, have all benefited far more than they should have in a well-functioning economic system...

“The [United States] and world economic system [have] been distorted in these people’s favor for more than a decade, to the excessive benefit of their net worth. They have enjoyed a bubbling bull market for twelve years, and the wealth of the world has been artificially redistributed into their pockets. They have come to expect such benefits; the Goldman Sachs participation in the Initial Public Offering for the Industrial and Commercial Bank of China, in which the firm and its partners, mostly the latter individually, made a $6 billion profit due entirely to its insider position in the world financial markets, might have landed them in jail for insider trading in a more stringent environment but in this market only further fattened their bonus pool.”

Neither central bankers nor bank robbers create wealth. They merely redistribute it.

The mob idolizes holdup men; then, often, it lynches them. What they will do to the central bankers and their accomplices in the financial industry, we wait to find out.

© 2007 The Daily Reckoning:

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