The Skip Bureau

Much has been made recently in the libertarian press about the so-called 'Plunge Protection Team', often abbreviated PPT. This team allegedly steps into the stock market to provide derivitive support that drives essential indices up and thus triggers a recovery. In other words, they issue promises to buy stock that cause an increase in investor confidence by increasing the future valuation of stock without any stock changing hands. This increases one of the more closely watched indices and thus the market goes up.

They stand ready to buy stock outright if necessary and have already allegedly done so. So, on one hand, we have major government banks allegedly conspiring to repress the value of gold, industrial interests conspiring to repress the value of silver, a bond market that is rather transparently manipulated by government interests to the point that the US goverment buys US Treasury bonds using recently printed money, and now we have a Plunge Protection Team.

But, the good little socialist says, what's wrong with the government putting money in the stock market, anyway? Well, in a word, inflation. Yup, here we go again.

When the PPT buys a future, it attracts further investment capital, which is bad because periodically companies issue stock on that valuation. They then receive a greater share of the investment than they should and proceed to drive prices up by bidding against everyon else who is constrained by real, revenues-based spending. It is particularly bad because it causes overvaluations at stunning levels.

So, if I have a stock with a P/E of 30:1, meaning that the price of the stock is thirty times its average earnings, I am making a yield of 3.3%. After taxes, it is a money-losing proposition. It got valued that way because people invested in the stock market on the assumption that the prices in the stock market reflected reality when they have been artificially inflated for political purposes.

However, it isn't real money. First, continued inflation in any security market causes inflation elsewhere as I've already pointed out. Second, the actual value of that security is less, meaning that any liquidation event will cause that security to plummet, destroying massive amounts of capital. Third, it offers yet more chances for politically-connected companies to receive government money.

So, I invest in the market. I see my stock appreciate by 5% in concert with a P/E of 30:1. That means that the total appreciation is somewhere near 8%, as the increase in value of the company causes an increase in the price, so alters the P/E, in this case by about 1.5, taking the P/E to 31.5:1 or about 3.2%, as earnings remain unchanged. As the stock continues to appreciate, its P/E continues to get worse. What I'm trying to say is that the value of the stock is not tracking the price.

It's like taking a diamond and adding mud to it. It is bigger, but not worth more. This tactic works until you try to liquidate the value by selling a major portion of the stock. At that point, either you find other money to replace your money you are removing from the market or you see that you can't get as much money as you thought. In this case, the fed steps in and provides incentive and, if necessary, cash to ensure that there is enough money for you to cash out. What this means is that the difference between the real value of the security and the value you received is now pure inflation, often created out of thin air by some agency of government, either as a debt-backed security that a trader is using for carry trade or through printing of more money by the treasury.

Whether the money was printed or was loaned doesn't matter; the fact remains that the increase in monetary supply is the same. When the system crashes that loaned money will be all gone anyway.

Anyway, as I said, the security was severely overvalued based on the production of the company it represents. I chose to sell to prepare for my retirement. I wished to use it to buy burritoes. Well, while my money was locked up, burritoes cost a given amount because my money locked up in the market was not being used to bid up the price of burritoes. Now that my money is no longer locked up, I am bidding up the price of burritoes. As I have said before, a convenient and only slightly simplistic way of looking at things is that the price of a given thing is the number of things divided by the number of dollars bidding for those things. So, since there are now more dollars bidding for burritoes, there will be an increase in the price of burritoes. Note that the value of the burrito did not change and neither did the underlying relationships of labor and materiel.

So, as before, what we see is a simple increase in price, price inflation. Now, the company I held made burritoes, to simplify things, so sees its revenue go up. This means its P/E ratio begins to return to what it was. And, voila, the stock becomes worth exactly what it was before it inflated. This happens by the money value reducing, not the stock price reducing, meaning that people who are not correctly interpreting market moves in relationship to inflation will still be of the opinion that they are getting richer from the increase in price and that, at the P/E it is now, it is a value.

What this creates is an 'overhang of liquidity', a lot of money that is 'owned' by interests that could pump that into the economy at any time. In a sane market that was not interfered with, selloffs cost dearly. Each investor that is involved in a selloff loses personal money. It is difficult to liquidate a large position in stocks without triggering a reduction in price, which would cost the owner of the stock, so large stock transactions tend not to happen except by agreement with existing purchaser. With the system as it stands, any stock holder can liquidate his position with relatively little worry that it will damage the market and use the proceeds to do whatever he likes. In the old system, money in stocks and bonds were considered 'tied up'. In the new system, they are highly liquid.

More importantly, in a system not distorted an investor must be more careful with his investment. Money invested by the average investor goes into stocks that are considered 'safe', not stocks that are sexy and on a roll, many of which have little or no substance, just the promise of profit. This means a slower growth in the market, to be sure, but it also means that the valuation of the securities more closely reflects the actual valuation of the company.

For this and many other reasons it is not a good idea to let government mess around in private markets. However, it has happened, and now the pragmatist must try to figure out what to do about it in order to protect him and his.

First off, it is reasonable to assume that the stock market will continue to increase slowly for the near term, at least the next two to five years. No real crash of the market is expected, but a growing stagnation is likely as companies become entrenched and inefficient. This trend will prolong the already visible precious metal bull market as there will be continued industrial demand.

The government will continue to meddle with statistics so that mostly sweetness and light plays out of Washington. This, in turn, will drive ever more money into the stock market, which won't go down, so by and large it won't come out. However, at some point in time, we expect to see baby boomers retire, taking money out of the stock market. The fed will ensure that it doesn't go down, so the only possible thing is that the rest of the economy suffers price inflation.

Coupled with a reduction in use of the dollar as the world reserve currency, this could lead to an actual currency collapse, but I think that unlikely. Instead, due to hedonic adjustment and other meddling, our CPI rate will be reported as very low while real inflation roars and the economy stagnates, pretty much like it did in the 1970s. I expect to see ten to fifteen years of this, during which most people develop better spending habits. It is the fabled 'soft landing', known to some of us as the 'slow death'.

This is particularly bullish for silver, as it is both a money metal and a commodity, used all over the place. Expect it to continue to rise. Also, as real inflation becomes ever more apparent, expect gold to rise. Also, prepare to have trouble getting fuel, and, indeed, anything imported, as the country is hit by wave after wave of foreign dollars coming home, devaluing the currency. A lot of that devalued currency will cart off more of our precious metals and real estate. Good luck, America.

Note: this is in no wise investment advice. The reader is strongly encouraged to read elsewhere and make up his or her own mind.