Dollars Are the Perfect Government Tool

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It is strange and curious as to how we arrived at the point where privacy is the equivalent of pedophilia. Only a few weeks ago, the chief of Chicago's detective squad, John Escalante, was warning that the new iPhone 6s or any Apple device running its iOS8 would feature apparently too much technological prowess to keep communications out of police hands. Showing hyperbole that is typical of this upside down arrangement, Detective Escalante shouted, "The average pedophile at this point is probably thinking, I've got to get an Apple phone."

He was not alone in equating the starting condition of a sovereign citizen with one of the worst forms of reprehensible criminal. FBI director James Comey was similarly incensed at the idea that people might want privacy. Tellingly, Comey said, as quoted by the Washington Post, that he could not understand why companies would "market something expressly to allow people to place themselves beyond the law."

Crime and anonymity go hand in hand, but so too does the private realm. Our lives are not meant to be an open door to every single bureaucrat that might want entrance, legally obtained warrant or not. Both law enforcement officials should be far more concerned about doing their job effectively and in a manner that preserves privacy, not derides it with the lowest form of argument through fallacy of absurdity.

For that matter, given the strains evident in these lines of thinking, both Director Comey and Detective Escalante should be aiming their ire at the Federal Reserve. This point has been occasioned before in the brief public flirtation with Bitcoin. Then, as now with iOS8, Bitcoins were assailed persistently as being a tool for "going outside the law." Government officials, notably in the Treasury Department that holds the legal right to all legal tender currently (with the Fed just borrowing it both literally and ZIRP-style interest rate subsidy), were among the loudest protesters that Bitcoins allowed the "baddest" criminals to keep being that without the awareness of the totality of hypocrisy in that sentiment.

The largest tool for allowing criminals vital anonymity is the Federal Reserve Note itself. Cash, physical currency, is, without danger of hyperbole, 99.99% the means of choice to make private criminal affairs viable. It is also responsible for far, far, far more legitimate business, but no one (yet) seriously proposes cracking down on the physical possession of cash.

The reason for that disparity is that "dollars" are so traceable today as to be the perfect government tool. Even cash itself is marked and stamped to provide at least a limited insight into origin and flow, especially where cash intersects banking and finance. But, for the most part, physical currency has become more of the past, with ledger "money" the growing feature in commerce. Tracking and privacy in commerce, with the IRS gleefully in approval (it was only a few years ago where a part of the "Affordable Care Act" meant to saddle businesses with reporting all expenses over $600 to the IRS via 1099's; less privacy means more taxes), is that much easier in a cashless society where an electronic trail is part of the very structure.

So there is a very clear demarcation between government authority and property. The old joke is that in a democracy possession is nine-tenths of the law; in despotism it is ten-tenths. The reason for that is clear, as property rights, as traditionally understood, forces government or state power into the light of day. You cannot alter property ownership or consistency without doing so in an obvious manner.

Almost immediately, thoughts about such things are limited to our current experience with property, such as a house or vehicle. But it applies, or did, just as much if not far more importantly in commerce and wealth. Money, properly understood, is property - it belongs to you and no one else with clear title. Again, a monetary system of property forces monetary affairs into the light of day.

Last Friday I went through the Dawes Loan, a particularly egregious affair during the worst days of the Great Depression. There was no complexity in hiding what was really a scandal because it was immediately recognizable for what it was. This was no AIG, where bailouts of financial giants could be muddied by the inability of the common layperson to understand what had taken place and what might follow it. Sure, the same principles were attempted in both cases, as Dawes in 1932 and the Fed in 2008 both proclaimed very bad things should either not get their way. At least in the former, there wasn't much mirk, as was clear shortly thereafter as Dawes' bank went under anyway; but in the AIG world of the latter, no one could even figure out what AIG did, who it did it with, why or how, and to what degree. That confusion and ignorance extended not just to the "man on the street" but to almost every member of Congress tasked with legal authority to violate financial laws (as some AIG shareholders still allege).

A full manner of this intricate web of esoteric function is that we cannot even define what a dollar is right now. AIG did not owe just "dollars" to various counterparty firms, it was taken apart by collateral calls, the actual interbank currency that was in such short supply starting in August 2007. But even that understates the complexity of the situation at that moment, particularly as it relates to both the operational and theoretical notions of "money supply."

Starting backwards, the idea of liquidity in banking today, as seven years ago, almost has little to do with "dollars" as anything ever seen. True liquidity is/was as much about intangible concepts of risk absorption and balance sheet capacity as it is/was even the number on account at the Federal Reserve - certainly so far removed from any bank actually having to produce a Federal Reserve Note upon someone filing said claim.

Given the transactional nature of systemic price setting, liquidity dealers were at the center of the storm, but liquidity is a very esoteric concept in the shadow framework of modern wholesale banking. The quaint notions of currency elasticity just don't apply, relegating traditional concepts (and understanding) to operational exile. Hedging and risk control/absorption are far more prevalent factors than "dollars", since those are what made (make) these participants "willing" or, as in 2007-08, "unwilling" to engage and at particularly noteworthy moments.

For instance, a dealer might not be agreeable to add to a position during less than ideal conditions if there is no easy and cheap method for at least laying off some of the risk for doing so. That goes for not just dealers but hedge funds and all the other various parts of the liquidity system. You might be far more willing to take in a large MBS position that is trending downward if you can also at the same time appeal to IR swaps or eurodollar bundles or futures packs (of whatever color) to make the risk of doing so more "manageable" for your risk calculations.

So the dealers are essentially supplying far different than "money" or middling the securities "flow" in repo, rather providing risk capacity to the various pieces of this opaque system. Thus, if the dealers become "shy" because their own activities elsewhere have worn themselves too thin, whatever changes in the greeks including and especially theta, they may be less willing to supply that risk absorption through derivatives (taking the opposite position as to what the "market" wants to lay off) and other hedging techniques. And you can pretty well bet that if dealers become shy about risk in hedging, they will be doing the same in terms of extending leverage broadly.

I think that was one of the great and still misunderstood parts of the panic, as the interconnected nature of all of this locked the credit and flow system into a positive feedback loop that was very likely inescapable beyond a certain point (which I think was as early as August 2007). Balance sheet capacity itself was tied to the ability to lay off risk through hedging, but that also applied to pricing all this illiquid "stuff" via derivatives (which were the primary source of risk flow and hedging); themselves tied directly to liquidity (largely of dealers). So the initial "shock" caused an increase in the desire to lay off risk and increase hedges, which only caused prices to go further the "wrong" way, led, as positive feedbacks do, to an even greater desire to lay off more risk, causing prices to go even further the "wrong" way, etc. At the same time that is happening, the collective ability of the system to provide risk absorption was eroded by the same process since dealers were in on both sides (or all sides). So they were all trying to lay off risk to each other, in essence, when nobody was "taking."

That was the margins of "liquidity" that created the first bouts of crisis, but inevitably the margins expanded to erode even the foundation of risk and balance sheet capacity. That became far worse once some of the standalone providers reached saturation; the monoline insurers being the most obvious piece of that. Everything snowballed from there, including pricing anomalies in correlation trading as well as even short selling of the bank stocks (if you can't lay off risk by buying protection from Merrill Lynch, you can at least attempt to do so from shorting Merrill Lynch's stock since the firm's reticence itself tells you a lot about what is going on internally there). It all fed back to each other because the system's capacity to absorb additional risk calculations was fatally compromised by this incestuous setup.

If someone can point to a "dollar" in any of that impenetrable mess, they are more than genius. In fact, through all of it, various pieces and segments all exhibited "money-like" behavior at times. What was the real "currency" that was in so short of supply as to create a massive downdraft globally? You can simultaneously make the case that it was eurodollars (a heavy corruption itself), accumulating bank theta, accounting notions of bank capital (though that would have been obviated if liquidity had been somehow tamed and changes to FAS 157 appeared far earlier), balance sheet capacity based on something other than statistical regressions, and a method to truly balance risk that didn't require dealers to be on the same side during the worst moments. None of those great and growing imbalances could have been "solved" by an historically huge pile of physical cash or even a swimming pool-sized block of gold (flow vs. stock).

If we try to relay this mess back to something more familiar to what is taught in schools and believed conventionally about banking, it all just breaks down. Currency is supposed to be a claim on money, which is, again, property. There were no exchanges of property or even claims on property in anything I asserted above - they were all just numbers on a balance sheet looking to become equal. That's it. The modern bank is just a means to get the whole thing to balance without much regard (especially direct) to what is actually owned (this is more than just rehypothecation of collateral).

The reason this can continue as it has, leading the evolution from implicit "too big to fail" to explicit "too big to fail" to now the sanctioned "too big to fail", is that nobody really knows what all this means, and certainly nobody can track it in anything like a meaningful manner or method. So it is just left alone to do as it does, with nothing but recency bias as comfort (nothing bad has happened recently, so nothing bad will happen).

There is nothing by which all of this can be anchored, so everything in it is relative to something else in it; which is likely a paradox if you could only find a logical starting point by which to compare and analyze. In truth, we arrived at this because the legitimate functions of money included the derived-property right to privacy, and that was antagonistic to the growing reach of "the state" seeking more "effective" tools for its schemes. There is no way that all this could evolve as it has under those constraints whereby actual claims on property had to be respected by force of law (at least by a regime that respected those inalienable rights as such instead of Director Comey's veiled assertion that privacy is equitable to outlaw status). That is why MF Global was so instrumental in demonstrating the difference between property and finance as a matter of law and settlement.

But that was always the intent. The true and historical functions of money, including store of value, imposed significant restrictions on the ability of the state to act as it wanted or wished for whatever policy it was pursuing. Indeed, that has been the rallying cry against all such restraint, as in "they" know what is best and seek to remove all impediments to giving it to us as hard as they can. In economic and monetary terms, the key point to all central planning and socialized economy, such that it is now, was reducing money to nothing more than a unit of account - one that could now easily be bent to the whims of whatever political authority proclaimed.

Like the iOS8, gold was destroyed by a relentless attack on how bad it was for an economy, including the idea of "deflation" as the incarnation of all evil (despite the entire history of human progress marked by people "spending" less resources for basic needs). In the Great Depression, it was "hoarders" of gold that were given specific legal scorn in the authorization for Executive Order 6102 under the Emergency Banking Relief Act of 1933; people simply exercising their rights to remove themselves from the realm of banking and central banks' past short-sightedness.

By taking "money" down to nothing but that one basic function, to the exclusion of all others, our central bank somehow claims to undertake the goal of price stability, as if taking only a 2% per year debasement amounts to anything short of sanctioned theft. If a robber "only" steals 2% of your currency, it still remains theft regardless of whether the same thief comes back next year for the exact same.

With money so withered as it has been there is no shelter, but more importantly there is no escape. That is the important point of privacy and property, in that the state has appropriated all economic and monetary space for itself. What you claim as your wealth in your accounts, whether that be a bank account or a 401(k), is nothing more than a government unit of measure, pliable at the whims of Ivy League PhD's who have shown little understanding of any of this in favor of total subservience to nothing more than overly simplistic regression equations. And so if their statistical models tell them you need to become poorer because that is for "the greater good", there is nothing in between that outcome and your right to avoid it; a fate all the more galling given how "the greater good" has a universal empirical track record of never turning out that way.

In that respect, you have to have some appreciation, repulsive as it may be, to this process that has taken place over time. People have become so conditioned to it that the very idea of money as property is so very foreign as to be thought absurd and fringe. More worrisome, its effects have taken that paradigm as well; for example the price of energy, oil or gasoline, that now seems "normal" at a level that should be rightfully reserved as utterly insane. Three dollars, fifty cents a gallon for gasoline should be earmarked for signaling recession (as it may be now, a persistent one) and dysfunction, not what passes for everyday reality.

We miss the absence of money, not just in a monetary policy devoid of all concepts and functions of it, but in fact of democratic and republican principles that clearly divided where the government ended and where sovereign citizens begin. If you cannot have rights over your wealth and accumulated toils and endeavors, you can have no rights - that it has been lost in money leads to a situation where the FBI Director nearly criminalizes simple privacy and it goes mostly without notice or with only the most minor of disturbance. It also solves the primary economic problem of our age, a comical condition where the very same people in favor of nothing but a unit of measure cannot understand the arrival and persistence of stagnation. Given the state of banking and "money," that sorry observation actually passes for the ceiling of what we can hope.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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