This is the growth of the Monetary Base, as reported by the Federal Reserve Bank of St. Louis. As you can see, the money supply has grown steadily over the years. But in the past 18 months it has more than doubled.

What are the implications of this?

The title refers to the creation of the US Federal Reserve Bank, which took place at a then-secret meeting in 1910 (later confirmed by the participants), at a resort on Jekyll Island, just off the coast of Georgia.

Most of us grew up thinking of the Federal Reserve as a quasi-government organization that helps stabilize our money supply. How it does that is often a bit of a mystery, although it involves interest rates, and possibly reserve requirements. And it isn’t always clear what the relationship is between the Federal Reserve and the US government.

Griffin argues that, in point of fact, the Federal Reserve is a private cartel created by the banks, with the sole purpose of maximizing bank profits. Inherent in its design are the seeds of periodic financial disaster (and inevitable, eventual collapse), which result in a massive transfer of wealth from depositors and taxpayers to bank executives. This is not an accident; it is the way the system is designed.

While this may seem an extreme view, Griffin’s evidence is undisputed, his logic is sound, and his arguments are highly convincing.  Much of the banking system which is ordinarily difficult to understand becomes extremely clear and transparent when viewed through this lens.

The energy business (more specifically the oil industry) can be split into two main areas: Upstream and Downstream. The Upstream business acquires “crude” oil (the raw material removed from the ground), while the Downstream business takes the crude oil and “refines” it, turning it into a finished product that end users want to purchase, and sells it to them.

Upstream

The Upstream business deals with finding and acquiring oil from the earth.  These are the “wildcatters” who use geological sciences, predictive modeling, and other means to find underground locations where there is likely to be a lot of oil.  Often, that oil is in an area of the world that is difficult to get to, either for political or engineering reasons, or both. It may be in an area that has a lot of political unrest, or a corrupt government, or simply a government that is hostile to the energy industry. Or it may be very difficult to access, such as deep underneath an ocean plate.

The Upstream business unit must make financial arrangements to get legal access to the underground oil, then must acquire the necessary equipment to access the oil, and finally must actually drill for and extract that oil. These are huge capital-intensive operations that can often cost many tens of billions of dollars.  And unfortunately, the lead time is so long to get the rights to drill, as well as to line up the equipment, that by the time they are able to drill, the market price of the oil they intend to extract may be too low to justify actually removing the oil.

Then there is the uncertainty they face about the type and quality of the oil they will extract.  Since some oil is easier to process than other (depending upon contaminant, for example), and some oil produces more of the more desirable and expensive final products,

However, once they have extracted the oil, the Upstream business can sell it on the open market for the going rate, which fluctuates daily.

These can often be highly profitable businesses, but they are subject to a lot of market risk, since the global market price of oil is often unknown when the businesses need to make key expenditure decisions.  The key to this business is the ability to find the best sources of oil, manage risk, and time your operations so that the market price of crude oil is as high as possible when you are ready to sell it on the market (typically right after you’ve extracted it).

Downstream

The Downstream business acquires oil on the open market from someone who has already extracted it. They know what quality oil they are getting, and what they can make from it (different grades of gasoline, jet fuel, diesel, kerosene, etc). Their job is to refine the oil into a variety of finished products, package it up, ship it to its destination, and market and sell it.

These businesses are highly competitive, and require extremely careful operational efficiency.  They are typically not as profitable as the Upstream businesses, but the business is often more steady and predictable than the Upstream businesses are.

Companies

There are a handful of “supermajors” or “big oil” companies who have both significant Upstream and Downstream operations. These include ExxonMobil, Chevron, BP, ConocoPhillips, Royal Dutch Shell, and Total, SA.

There are also many Upstream-only companies, such as Occidental, XTO, Anadarko, and so on.

There are also a handful of regional Downstream-only companies. However, the downstream market has largely consolidated, with most of the well-known brands belonging to one of the major integrated energy companies.

Under this program, people will receive $3,500 to $4,500 when they trade in a car and buy a new car that gets better gas mileage than their trade-in did. That covers approximately 500,000 new cars.

If you are thinking of purchasing a new car, this may be a nice additional incentive.

Of course, the skeptic in me notes the irony that the Federal Government is working to boost demand of an industry in which it now has a major financial stake. (Where are the $500 rebates for trading in an older computer, or television, for a newer model that uses less power?)

There seems to be no end to the efforts to rescue dead business models and dying industries.

www.nytimes.com/interactive/2009/07/02/business/economy/20090705-cycles-graphic.html

This graphs plots the relative amount of industrial output against the change in industrial output over a running 6-month period. As you move through the 9 images, you can see how various recessions have progressed.

It’s a neat visual, and shows some interesting patterns, but doesn’t provide much fundamental insight.

It’s a pretty ignominious accomplishment. And since the year is not yet over, and the US continues to spend, the debt is continuing to pile up. Based on current spending projections, this year’s debt is expected to hit nearly $2 Trillion by October.

How much is $2 Trillion? It’s about $6,500 per person in the US. For a family of four, that’s about $26,000 in debt accumulated this year.  That’s on top of all previous debt, as well as any consumer or household debts.

But does it really matter? It isn’t like the taxpayers will ever have to pay this debt, right?

Wrong.

The US government’s credit rating is so good it is considered “risk free” by most of the world. The people who loaned the US this money absolutely expect to be paid back. If they are not, it will rock the worldwide financial markets so strongly it will make the recent financial crisis look tame by comparison.

The only ways the US government can pay back that debt are 1) by raising taxes and / or lowering spending, or 2) by devaluing the US dollar through inflation. Higher taxes means less money to hire employees, and less money for those employees to take home and spend.  Inflation makes the dollar worth less relative to other commodities, goods, or services. But while it makes the US debt effectively smaller, it also lowers the value of everyone’s existing savings, investments, and retirement funds.

Given the politics of Washington, DC, which do you think is the more likely scenario?

Recently, we’ve learned that Steve Jobs had liver transplant surgery in Tennessee two months ago.  This has led to a public debate about whether or not Apple’s board should have revealed the extent and significance of Steve’s ongoing health issues.

On the one side are professional investors, such as Warren Buffett, who say the information is material, and therefor should have been revealed.

On the other side is Apple’s Board, supported by many members of the public, who say Steve’s health issues are a personal and private matter, and really nobody’s business.  It’s a compelling argument, and is consistent with most people’s beliefs that health matters should always be private.

But they are wrong.

The issue here is one of fiduciary duty in the face of material information.  Fiduciary duty is a concept that most people in the public are unfamiliar with.  But anyone who has served as a board member, or as a senior officer of a company (such as a CEO, CFO, etc), has had to grapple with it.

In essence, a fiduciary is supposed to put the needs of their beneficiary ahead of their own – much the way a parent often puts their child’s needs ahead of their own.  It is a unique relationship in business and in law, and the normal rules of the business world do not apply in a fiduciary relationship.

“Material information” is simply information that a typical investor would be likely to include in a decision of whether to buy or sell a company’s stock.

In this case, it’s really impossible to argue that Steve Jobs’ health is not material information.  There are many, many people who would include Steve’s health in their decision to buy or sell Apple stock.

And because he is CEO (even if on leave), he is a fiduciary.  That means he is obligated to put the needs of the shareholders ahead of his own.  There are no exceptions to that rule for health, or privacy, or anything else.

I realize this has to be a personally difficult time for Steve and his family.  So it may be difficult for him to keep a clear focus on such abstract concepts.  But that’s where Apple’s board has failed.

Apple’s board members are also fiduciaries for the shareholders.  They have monitored his progress, and have had an ongoing obligation to report his condition to the shareholders.

And they have failed spectacularly.

What’s worse, they have actually argued that they have an obligation to keep Steve’s personal health information private.  But they do not.  When they joined Apple’s board, each of them willingly took on the role of a fiduciary.  These are sophisticated business people, who understood that role (or ought to).  To argue as they have that their primary obligation is to Steve, and not the Apple shareholders, is really abhorent.

We seem to be living in a time when people are confused about the fiduciary relationship.  And yet it was that very breakdown in the fiduciary concept that caused such enormous problems at companies like Enron, Worldcom, and even HP, which resulted in the backlash of Sarbanes-Oxley.

I have admired the business decisions Apple has made over the past decade.  They have shown a great deal of vision, and have revolutionized multiple markets.  It’s been a joy to watch them grow, both as a shareholder and as a consumer.  And I wish Steve the best in his health struggles.

But I do hope that the Apple board is held accountable for this clear breach of their fundamental fiduciary duty.  Because ultimately, that will make Apple stronger, and will send a message to other boards in the marketplace that they need to respect their primary obligation to the shareholders above all others.

Moral hazard is a the observed phenomenon whereby, because something is insured, it becomes more likely to occur.  If a bad event (e.g. breakage or theft) will cost a certain amount, then if that event is insured, it will cost a bit less.  This makes the bad event less bad–which is the point of insurance.  Unfortunately, it also means that the insured person will not work quite as hard to prevent the bad event from happening, or, in extreme cases, may even cause the bad event to occur.

A silly illustration: if a grocery store could somehow insure every dozen eggs for $1000 against breakage, “Moral Hazard” is the insurance industry’s way of recognizing that there would somehow be a lot of broken eggs.

The industry tries to adjust for this in several ways.  One is by charging different premiums to different people depending upon their beliefs about the customer’s risk.  That’s why 16 year-old boys pay more for car insurance than 45 year-old married men.  Insurers also try to make sure there are other reasons the insured would not want the event to occur.

I had occasion to visit Lloyd’s in London a while back, and I learned that there are only two types of insurance that Lloyd’s will not place.  The first is life insurance, because the purchaser is betting someone will die–and in a world of moral hazard, Lloyd’s are uncomfortable with that idea.  The second is a pure financial guarantee.  In other words, they will not make someone financially whole simply because they lost money.  They must instead insure the events that might cause them to lose the money (fire, theft, etc.).  Over hundreds of years as the world’s foremost insurance marketplace, Lloyd’s has found the moral hazard associated with pure financial guarantees to be too great.  That’s because if all that is at stake is money, and the insurance will make one financially whole, then there is no alternative reason to prevent the loss event.

Which brings us to the FDIC.

The Federal Deposit Insurance Corporation insures depositors who put money in a US bank against loss, up to a certain limit.  Another way of saying this is that they insure the banks against loss, so that the banks will be able to repay their creditors (the depositors) in the event that the bank loses money.

This is a financial guarantee.  They are not insuring against an underlying event; they are making a pure financial guarantee–the type you could not buy at Lloyd’s in London.

But it gets worse.

The FDIC charges the same premium to all participating banks regardless of their perceived risks.  Of course, the “risks” involved are basically the risks associated with the bank’s loans.  So the bank is free to make any loans it likes, and it will not see a change in premiums.

The result is that all banks face the exact same downside potential, regardless of their business decisions.

Since banking is a somewhat competitive market, banks will try to get a higher return by charging more for the loans they make.  This force moves them toward making bigger and riskier loans, where they can charge higher fees and interest.

Under ordinary market forces, this would also increase their downside potential, which would be a force reducing the risks banks take in their loan decisions.  However, with FDIC insurance, we’ve eliminated this force, leaving only the force toward making riskier loans.

The result is that banks compete against each other by making riskier and riskier loans.  They may not realize they are doing this, but that is the market they are in.

The result is a steady increase in the risk levels of bank loan portfolios.  And that can only lead to one conclusion: a collapse in the loan portfolios of many banks.  Specifically, it leads to a collapse in the portfolios of the most competitive banks.  In order to be competitive they took on the risky loans.  And because they are successfully competitive, they are also the largest banks.

Does any of this sound familiar?

Customers who refused to send copies of their personal tax returns to American Express have had their accounts closed with prejudice.  They lose any reward points they may have accumulated, are required to immediately pay off the balance of any revolving credit, and have a negative report sent to the credit rating agencies, which results in a drop in their credit score.  If they fail to immediately pay off the revolving credit in full, they are sent to collections and face additional penalties.

“Do You Know Me?”

In many cases, these demands have been sent to cardmembers of more than 20 years, who have never missed a payment, or carried excessive balances.  These are not delinquent cardholders.  They are ordinary people with accounts in good standing who were simply customers of the wrong company.

For years Amex held out that it was not a bank, and so it was not subject to the same regulation as ordinary banks.  This allowed them to offer financial services (including credit cards and investment products) which would not ordinarily be possible at a bank, and without the unpleasant government oversight.  However, when the banks were being bailed out, Amex changed their tune and applied to become a bank, in order to get bailout money.

It’s pretty reasonable for Amex to want to reduce their risks.

But it is also reasonable for consumers to want to reduce their own risks.  And choosing a vendor who may suddenly make unreasonable demands under threat is a risk many people may not want to take.

You have a choice of what company to use for credit services.  Choose wisely.  Choose someone else.