Author: Bill Bonner

Trichet to Greece: Drop Dead!

Obama to California: Uh…

Yesterday, stocks lost 103 points on the Dow. This looked like a confirmation to us. The stock market appears to have begun its next and final phase…

AP seemed to think so too:

“Stock investors see threats from all directions,” said the headline.

We didn’t bother to read the article. We already know the directions.

From the north, investors worry about falling consumer demand. Consumers are in a funk – they have more debt, less income, fewer jobs, and less access to credit. The only news on that front we have today is that even jumbo housing loans are going bad…delinquencies are up to 9.6%.

From the east, investors worry about the continued invasion of cheap consumer goods and cheap services. China’s economy is said to be growing at double-digit rates. How can US firms compete? And what if China is a bubble, as Jim Chanos believes? When it blows up, US stocks will come down too.

From the south comes the threat of higher interest rates. The poor dopes think the recovery might be for real. If so, inflation will rise and the feds will increase interest rates…possibly cutting off the new boom.

And from the west what do they have to fear? Well, there’s that business in Europe. You know, Greece and all. The PIIGS – Portugal, Italy, Ireland, Greece and Spain… Europe’s peripheral countries are in trouble. Lenders fret that they might be forced to default on their debt. So, they want higher interest rates. This, of course, just makes state finances worse…pushing the PIIGS closer to default.

The PIIGS owe $2 trillion, which might need to be restructured. Yes, dear reader, the sovereign debt problem is a big one – much bigger than Bear Stearns, Lehman Bros. and AIG. But the biggest porker of all – the USA – has fives times as much sovereign debt as all the PIIGS put together.

It won’t take investors long to figure out that there isn’t a whole lot of difference between Greece’s finances and those of the US. Each has about the same amount of debt and the same size deficit, relative to GDP. The big difference is that the US ultimately controls the currency in which its debt is calibrated. Greece does not. Neither does California.

Both California and Greece borrow long-term at about the same rate…around 6%. Lenders know that when their backs are to the wall, both governments will have only two choices, not three. They can cut spending. Or, they can default. What they can’t do is wiggle out of their obligations by inflating their currencies.

Jean Claude Trichet has already made that clear:

“…belonging to the euro area, you…have an easy means of financing your current account deficit. You share a currency that is credible, so that you have a quality of financing that corresponds to that of a credible currency.”

He went on to say that Greece contributes only about 3% to the total output of the euro-zone. If push comes to shove, Greece will be pushed out rather than allowed to weaken the euro.

Then, Mr. Trichet made an odious comparison. California is a much bigger part of the US economy than Greece is of the euro economy. In fact, it is more than four times as large. Will the US come to California’s aid? Mr. Trichet didn’t say.

It is possible, of course, that Mr. Obama will say to the Golden State what Gerald Ford said to the Big Apple. In 1975, New York City’s back was to the wall. It appealed to Washington for help. “Ford to City: Drop Dead,” was the famous headline in the New York Daily News, reporting the president’s response.

New Yorkers were incensed. Later, they realized that by vowing to veto a bailout President Ford had done them a great favor; he forced New York to clean up its act. The city went on to its greatest years. Likewise, the feds would be doing all of us a favor by letting failure fail with dignity.

Will Obama help California mend its ways? Or will he turn it into a zombie state?

Bill Bonner
for The Daily Reckoning Australia

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By the time the first snowflakes appeared about 11AM on Friday, we almost felt sorry for them. They were met by such overwhelming firepower from the local highway snow removal teams, they didn’t have a chance. But they kept coming. Like soldiers at the Somme they threw themselves on the barbed wire. They took the salt! And their comrades- in-arms kept coming.

By 3PM, the highway crews were still in charge…giving themselves thumbs up when they passed each other. The roads were wet, but clear. Crews laid down salt as the snowflakes – more numerous than the stars in the heavens or the dollars in the federal deficit – kept falling to ground. But by 4PM a white coating began to appear on the road. Temperatures were falling and the snow was beginning to stick.

Snow built up slowly…then more quickly. The salt trucks were running out of time and ammunition. And by 6PM the battle turned. Now, the snow came heavily – and stuck. The road crews switched to using their blades. But it was no use. They were outnumbered and outgunned. The snow kept coming. First the side roads were lost to a thick blanket of snow. Then, the major roads were lost too. Finally, US I-95 – the nation’s main East Coast artery – was in enemy territory.

We drove down I-95 about 7PM. We had picked up Maria at Pennsylvania Station in Baltimore. She came out dressed like a movie star…in a wool coat with fur collar and cuffs. The cab drivers stared as she got in the pick-up and gave her father a kiss on the cheek. Then, we were off.

The highway was a total mess by that time. There were casualties on both sides of the road…abandoned vehicles, cars stuck in ditches, tow trucks and rescue crews trying to get people back on the road. We had taken the precaution of loading some cement blocks in the back of the truck. It slipped a few times, but it never slid off the road. You couldn’t tell the road from the shoulder. There were no lanes…and little traffic. We just tried to stay away from other drivers…and steer our pick-up in the tracks of the big truck in front of us.

By 8PM the snow was master of the field. The road crews admitted defeat. There was not a single road in all the Baltimore-Washington metropolitan area that was safely passable. They were beaten. Radio announcements told civilians to get off the roads and stay off…until the snow removal troops could regain control of the situation.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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It was “snowmaggedon” here this weekend. On Friday the city was on the verge of panic. Governor O’Malley announced that snowfall might reach 30″… Salt trucks were everywhere… They were lined up around the beltway like the National Guard waiting to stop an invasion…

..and everywhere people went home – or went out to buy food, movies…the essentials…

“How much wine do we have stocked up,” we asked Elizabeth.

“Not enough…” More below…

There was a storm raging on Wall Street too. And by the end of the day, traders, investors and speculators probably wished they had stocked more alcohol for the weekend.

The Dow was up 10 points. After being down 100 points. Gold fell $10.

“Clearly we have entered the worry, fear camp,” said one pro.

Unfortunately, today’s action was not as clear-cut as we would like. There was no bounce back. And no further decline. Our guess is that stocks will probably trend downward for a long time. Most likely, the long-awaited – at least by us! – resumption of the bear market has begun. We’ve had our crash. We’ve had our bounce. Now, we’ll take the long slide down to the ultimate, final, this-is-where-it-stops end.

Listening to the radio this morning, the announcer told us that only “essential” government employees had to report for duty this morning. We wondered if any of them really were essential. Surely, not the fellows who are watching after the African horned beetle. Surely, not the ones who are designing a new health care overhaul for the nation. Surely, not the ones who are coming up with a revision to subsection 4.503.02 of the Internal Revenue Code dealing with unlicensed backdated further codicils of provisions dealing with gifts to one-armed wonton turners who are beneficiaries of insurance policy proceeds upon which sufficient basis has been revoked because they failed to read the fine print. Or something like that.

Take out all the non-essential federal employees? Who’s left?

Anyone? Probably a couple guys in the Pentagon who make sure the Canadians are not amassing troops on the border.

But that is another subject, isn’t it? Not exactly. The federal payroll is the only payroll in the nation that is expanding. Government is a growth industry. Just about everything else is in decline.

Wait. The latest number from the feds tells us that joblessness declined by 0.3% last month. Do you believe that, dear reader? Where’s the SEC when you need it? Aren’t the feds misleading investors – intentionally?

There was another ad on the radio this morning asking for census takers. More federal employees! Why not get the non-essential employees to count people?

We don’t have a separate count, but we wouldn’t be a bit surprised to find that the feds’ unemployment number hides as much as it reveals. After all, as near as we can tell, we’re still in a period of private sector de-leveraging. That means fewer jobs. The mistakes of the bubble era must be un-done. Jobs must be eliminated. And employment won’t rise again until the private sector can find ways to put people back to work at a profit.

But how?

What a delight it would be to have some inflation! Yes, dear reader, that’s the real reason that fiscal stimulus appears to work. That is, that’s the reason inflation can sometimes boost employment. It creates inflation. And inflation lowers wages. Lower wages make it cheaper to hire people. And they make US output more competitive on the world market – so exports tend to increase.

And one other thing. Inflation reduces the debt burden. Right now, debt is crushing the private sector…and the whole economy. But it will soon crush the public sector too. Nouriel Roubini says government debt is a “ticking time bomb.” He’s right.

That’s why the government would love to have some inflation. Trouble is, inflation is harder to conjure up than you might think.

The more we see the Geithner, Bernanke, Summers team in action, the more convinced we are that the nation is headed for serious trouble.

Alan Greenspan was a knave, no doubt about it. But he understood how money worked. He was even a follower of Ayn Rand and a member of the libertarian ‘collective’ in New York. When he joined the president’s council of economic advisors, Rand was on the scene. She said she had ‘her man in Washington.’ Trouble was, her man was a sell-out. His convictions were no more solid than ocean foam. They disappeared as soon as he got to the capitol. After that, he spoke in gobbledygook sentences that no one could decipher…and played the game.

Here at The Daily Reckoning we don’t particularly like sell-outs, hypocrites and turncoats. We have our principles. And we wouldn’t turn our back on our own convictions. Not for less than, say, $10,000.

The current team, on the other hand, are not sellouts. They’re fools. They really have no idea what is going on. They think the problem with the economy is that consumers and bankers have gotten the jitters. They believe that a lack of demand is the root cause of a weak economy. So, all they have to do is to replace the missing private demand with demand from the government.

Anyone who bothered to think about it seriously for a few minutes would see that demand is not what causes an economy to grow…or what makes people prosperous. People always have demand for goods and service. Demand is always, theoretically, unlimited. It’s the purchasing power that is lacking.

And purchasing power comes from earnings – both accumulated and current.

The key to a real recovery is to increase earnings – not increase demand/consumption. How do you do that? Well, if you’re a government economist, you can’t do a bloody thing but get out of the way. You have to let private businesses find ways to make money…which they then share with their employees.

Think Summers, Bernanke and Geithner will get out of the way? Not a chance…

Bill Bonner
for The Daily Reckoning Australia

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Last August, it was reported that deflation in Japan had reached a new record. Prices were dropping at the fastest pace 38 years. By November, it was duration, rather than depth, that got the press’s attention. Prices had been going down for 10 months in a row. Then, last week an update:

“Japan Deflation Hits a Record Pace,” reported the BBC. Prices in Japan were falling faster than they ever had since they began keeping track in 1970. The tide has gone out so far; beachcombers can’t remember when there was so much beach to comb. But what follows is not offered as a prediction, but only out of curiosity. We don’t know how this will turn out. Could it end in hyperinflation? Maybe.

Prices fall in Japan. The yen rises. And the government uses every trick in the book – and some as yet unpublished – to knock it down. If you are in a position to borrow money from the central bank, the bankers will give it to you at practically zero interest. And if your neighborhood wants a bridge or a community center, that too will be forthcoming from the Japanese government. No government has ever been so generous. At least, not without going broke. For every yen the government squeezes from its taxpayers, it returns more than 2 yen in public spending.

Investors must think the trend is eternal. Or perhaps they don’t think at all. They lend money to the world’s most spendthrift major government for 10 years in exchange for a yield of only 1.310%.

The drama of this story is an old and familiar one. Deeply flawed heroes at the world’s central banks and treasury departments think they can do a better job of guiding the economy than the markets themselves. It is they who set the price for short-term money, for example, not willing borrowers and lenders. They are the ones who fight the correction every inch of the way. They are also the ones you don’t want to stand behind; every shot they take backfires.

In France, the savings rate, as percentage of revenue, has gone up for the last 16 months, to 17% – the highest rate in 27 years. This comes as the Sarkozy government follows the lead of the US and Japan, with a deficit of about 8%…compared to 10% in the US and even higher in Japan. This is not the first time this has happened in France. The previous savings rate peak came when the Mitterrand government was trying to stimulate the economy out of the slump of the early ’80s. The more the government tries to stimulate spending by running deficits, the more people try to protect themselves by saving.

While the drama continues throughout the world, the story is most advanced in Japan. Which is to say, the central bankers have gotten themselves into deeper trouble. Martin Wolf of The Financial Times and Richard Koo of Nomura Securities applaud their performance. But by trying to suppress a correction in the private sector, Japan’s central bankers have stretched out a slump over two decades and set up the nation for a bigger crisis in the public sector. And there is nothing they can do about it. Their fiscal stimulus no longer stimulates. Their monetary inflation no longer inflates. And every quack cure they offer brings the patient closer to the grave. You might think they’d give up. Instead, they increase the dosage. Fiscal stimulus hits a new record, right along with deflation.

But it’s the final act that interests us. With public debt at nearly 200% of GDP and 700% of tax revenues, we shouldn’t have to wait much longer. Given the track record, we have to assume that it will be the exact opposite of what central bankers expect. They are aiming for the whimper of newborn growth. More likely, they will get the bang of hyperinflation.

The Japanese were recently among the champion savers of the world. Directly or indirectly, these savings financed the government’s stimulus efforts. Banks, pension plans, insurance companies – all bought government bonds as a safe way to store wealth. The government then drew upon this stored up wealth to finance its bridges to nowhere and its other boondoggles. The result is a misunderstanding on its way to becoming a disaster. The typical Japanese person looks forward to his retirement with a mountain of savings in his backyard. He believes he still has his cake. The government, however, has eaten it.

Higher savings rates typically produce lower prices, for a while. Currencies rise. Even in Weimar Germany, there was a period in 1920 when the mark rose. Falling prices would seem to be proof that the money is still there. But the real money is gone. Then, suddenly, people notice that their savings are nothing but paper. The tide turns. Confidence disappears. The big wave of accumulated savings hits the marketplace like a tsunami. Desperate people try to get rid of paper. They want something solid to hold onto. Long-term bonds, the most vulnerable to inflation, are exchanged for cash. Cash and government securities flood the market. Prices soar. Middle-class savers drown. Meek debtors, relieved of their burdens in the flood, inherit the world. So do the arrogant debtors in the government. And the shrewd speculators. And then central bankers return to their desks and come up with a new plan.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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The bust in the economy ain’t so bad either. Credit default swap spreads are widening. Bond yields are rising…especially in Europe.

The service sector in the US is performing below expectations.

Oh…and listen to this:

“More weigh walking away from mortgages,” says The New York Times. As anticipated, people are warming up to the idea of stiffing their mortgage lenders. Why not? Millions of houses are underwater; let the mortgage company deal with them.

Delinquent mortgage payments have risen to over 10%.

The Baltic Dry Index is dropping, too.

And Dr. Copper is ‘set for catastrophe,’ says a copper expert.

Copper, you’ll recall, is the metal with a Ph.D. in economics. It’s the metal that you find in home wiring, refrigerators, offices, automobiles, cell phones – just about everything. So, when the price of copper goes down it means something. Usually, it means business is slowing down.

Copper has fallen more than 10% in 2010. It will probably go down a lot further. Chinese companies stockpiled the metal last year, causing its price to double. Now, they’ve got more than enough.

And if the world economy is still slowing down, which is what the Baltic Dry Index is probably telling us, you can expect the price of copper to collapse.

Stay tuned.

Washington is waiting for a big storm. They’ve been talking about it on the radio all week long. More than a foot of snow is expected.

School children look forward to a holiday…not to mention sledding and snowball battles. Adults are hoping for a little time off too…but dreading the drive home from work.

Here at The Daily Reckoning, we can’t help ourselves; we look at it like the onset of a bear market…or a depression. It’s going to be rough. They’ll be some wrecks along the highway. Some people will get stuck. Some will get hit by snowballs or slip on the sidewalk.

See, it’s going to be fun!

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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Here’s a cartoon sent by one of our dear readers. We have readers all over the world. But Pamela must be one of the most remote. She lives on a tiny island in the middle of the Pacific. We’ve seen the photos. It looks stunningly beautiful. A South Pacific paradise.

It’s a little surprising that someone who lives in such a paradise setting would trouble herself worrying reading The Daily Reckoning and worrying about macroeconomics. But the world of money is fascinating. And probably a lot more entertaining if you’re not in the middle of it.

Yesterday, investors must have felt like they’d rather be somewhere else. The Dow registered a loss of 268 points. Gold took a $49 beating.

We won’t know for sure until tomorrow. If tomorrow is another bad day – as it probably will be – then it will be clear that the last stage of the bear market has arrived. This should be the final drop…when stocks should go down to their ultimate bear market low.

Where will that be? We don’t know. Maybe Dow 5,000. Maybe lower. One way or another every major bull market needs a major bear market. The two go together like yin and yang, Abbott and Costello, or gin and tonic. Take one out of the picture and the other one no longer makes any sense.

We’ve had our bull market. It took the Dow from under 1,000 to over 14,000 in the space of 26 years. We’ve had a bubble too. The party was a lot of fun for everyone.

Now, it’s time to clean up. It’s time for the bust in the economy…and the bear market in stocks. That’s just the way it works. Sorry.

If this bear market is going to correct the entire bull market from 1982 onward, it has to take prices back to the levels they were when it began. Back then, you could buy the Dow (from memory) for about 5 times earnings. Now, (we’re not doing any research here…just broadly remembering the figures…) it’s at about 20 times earnings. If those numbers are correct, you’d expect the final low to come in about a quarter of where it is now…or about 2,500.

Another way to look at it is to ask ourselves what the Dow of ’82 would be today, adjusted for consumer price inflation. We don’t know the answer to that either…but we’ll guess that it would be about 4 times what it was then – or about 4,000.

So, now we have a range… We know roughly where this market could be headed – if it is the yang we’re expecting. And if that’s where it is going, a South Pacific island paradise would be a good place from which to watch it get there.

Bill Bonner
for The Daily Reckoning Australia

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“Whooppee! This is a lot nicer than in France. We never got a snow holiday in France. Never. Whoopee!”

Edward is delighted with his new life in America. At least he was at 7AM when we reported to him that the Montgomery County schools were closed because of the snow.

Your editor and family are rediscovering the United States of America. Last night, we went out to a nice restaurant.

“If I order a hamburger…will you cook it medium rare for me?” we asked the waiter.

“What? We don’t serve hamburgers….”

“Darling…this is a good restaurant,” said Elizabeth. “They don’t serve hamburgers. And please don’t get in a fight with the waiter.” “I wasn’t getting in a fight. I just wanted to know if it was some sort of health department regulation…”

“No, it’s not. Remember, we went to Fuddruckers the other day. We got hamburgers medium rare, I think. They were very good.”

“Oh…well…this country has changed so much. It’s so strange. I don’t know what to think…”

Regards,

Bill Bonner
for The Daily Reckoning Australia

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Dear, dear reader…we’re sorry to write so much. We would have written less…but we just didn’t have time.

As expected…the Bubble Era was followed by the Bust Era. We’re in it now.

And as expected…the feds swung into action, busily making things worse. The last budget from the Obama Administration beats even our cynical expectations. We anticipated something stupid. But this is suicidal. Scandalous… More about that later…

And we expected that the crash on Wall Street would be followed by a bounce on Wall Street. We even guessed that it would recover about half of what had been lost – which it did. What surprises us is that it went on for so long. Even now, we’re still not sure it is over.

Yesterday, the Dow went down 26 points – after a couple of days of 100+ gains. Gold fell $6, which wasn’t bad considering how strong the dollar has been.

The dollar has gone up – but not exactly as expected. We thought it would go up as investors fled stocks and commodities. Instead, the dollar rose long before stocks and commodities began to fall.

Either the last phase of the bear market has begun. Or it won’t be long before it does. Stocks can go any which way they want in the short run – depending on investors’ delusions. But in the long run, reality catches up to them.

And the reality is: we’re in a depression. Stocks gotta get with the program.

But since the depression is invisible to most economists, the burden of proof is clearly on us:

“Retail sales continue to soften,” says one headline.

“Home ownership level falling to 67%,” say another.

“Personal bankruptcies up 15% from January ’09,” adds a third.

Bear in mind that a year and a half has gone by since the slump began. If this were a normal recession, we’d be recovering by now.

Instead, another report tells us that the unemployment rate has topped 15% in 19 different states. Now, that’s beginning to sound like a depression, isn’t it?

Another report tells us that now half the states are insolvent. Why? Tax revenues have collapsed, while the politicians failed to cut spending.

The latest GDP growth report came in at a surprisingly high reading over 5%. But take out the restocking of inventories…and the federal stimulus…and you have a negative number. Which means, the stimulus isn’t stimulating. It’s displacing. The private economy is giving way to the government economy. This week, for example, the federal payroll hit a new record – 2.15 million.

What do all those people do? More on that some other time…

Which brings us back to the federal budget deficit. At 11% of GDP, it’s matched only by the deficits of the war years – the War Between the States, WWI and WWII. Each time, lenders were willing to go along with such high deficits because the future of the country was at stake (or so they believed)…and because they were confident that the deficits would disappear after the killing stopped.

But this new deficit is a whole ‘nuther animal. First, there is no real war going on. Second, there is no end to the deficits. The Obama administration itself candidly admits that the deficits stretch out as far as the eye can see.

Now, a question: since this is not like the deficits of the war years…why would lenders act as though they were? Why would they accept the same rates of return? The deficits are shocking enough in themselves. But while the quantity (in GDP terms) may be equivalent to those of the war years, the quality is totally different.

Which makes us think lenders are making a big mistake. They look at the deficits and say: ‘we had deficits that big before…we survived.’

But these deficits are different. They are serious deficits without a serious war… They just get bigger and bigger. And they don’t go away.

Investors are going to be sorry they bought US debt…

Here at The Daily Reckoning headquarters we’re happy with a depression. It makes us feel at home. Baltimore has been depressed for the last 40 years. Ever since the riots of the ’60s, the city’s been going downhill. There are whole blocks that could be bulldozed to the ground…no one would object. No one would be displaced.

The city probably peaked out in the ’20s. That was when the suburbs began draining off its best people. Then, WWII brought in different people – poor, uneducated, uncivilized hicks from the mountains and field hands from the South. They worked Baltimore’s factories and destroyed its neighborhoods. Then, the best of them moved out too. Now, there’s not much left.

Depression ain’t so bad. You get used to it. You even get to like it. Restaurants empty. Parking lots deserted. Offices, movie theatres, houses – all abandoned. There’s a sort of end-of-the-world, Zombieland quality to the city. Certain neighborhoods, we’re convinced, are inhabited by zombies. During the daytime they are deserted. The Zombies must come out at night…who knows?

Is the US headed towards a 40-year downturn like Baltimore? Probably not. Baltimore’s decline came about because its industries were no longer profitable…and its middle class moved out. America’s middle class isn’t going to leave. Who would take it?

On the other hand, her industries are clearly in trouble. When it comes to making things, other countries can make them better, faster and cheaper. The only exception we can think of is movies…and we’re not sure about that.

In the Bubble Era, fantasists such as Tom Friedman imagined that the US had a lock on innovation and invention. Even that seems to be slipping away. What’s the biggest new thing in transportation? The electric bicycle! No kidding. They are catching on in Asia and in Europe. Soon, you’ll see them in America too. Well, that is if drivers don’t run over too many bicyclists before learning how to share the roads with them.

Where were the electric bicycles developed? In China… Now, western firms are trying to copy the Chinese designs!

Bill Bonner
for The Daily Reckoning Australia

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“You’ve been out of the country for a long time. Maybe you notice it. Most people don’t.”

The subject was hamburger. At a hamburger joint in Rockville, Maryland, the server had asked:

“How would you like that burger cooked?”

“Medium rare,” we replied.

“I’m sorry. We don’t do medium rare,” was the reply.

Why doesn’t a restaurant cook a hamburger the way the customer wants it cooked?

Recently, in Baltimore, we ran into the same sort of thing. At the Peabody Court hotel, we asked the desk clerk if he could have someone pick up our laundry. We had left it neatly on the bed, with a laundry slip all filled out.

“You have to bring it down here,” was his reply.

“What?”

“You have to bring it down yourself.”

“What? Isn’t this a hotel? Aren’t you in the hospitality business?”

Our protests were useless. They wouldn’t pick up the laundry because they had a policy against it. The policy was designed to protect them against customers who tried to take advantage of them by claiming laundry had not been returned. Now, a guest has to bring his dirty laundry to the front desk and have it inspected!

The restaurant had similarly taken measures to protect itself from customers who might get sick from uncooked beef. As at the hotel, the precautions are for the benefit of the business, not the customer.

“Oh…and I heard something on the radio…” we continued with our conversation with a colleague. “There is a proposal in Maryland to make it a criminal offense to smoke in a car in which a child under the age of three is riding. Already, you can’t smoke in bars or restaurants. There doesn’t seem to be any limit to the improvements a legislature can make, does there?”

“Yes. And the most amazing thing is that people will go along with anything. There is no resistance. Nobody thinks anymore, they just follow silly rules and procedures. I was just on a trip outside the US with a group of older people. We traveled around other countries with no problem. But coming back to the US was a hassle. They carefully searched all these old people…as if they really thought these folks posed a threat to homeland security.

“This war against terror probably conditioned Americans not to question authority. It’s been going on for 9 years now. As far as I can remember there were only two incidents in all that time…and they were almost comic. One guy set his underwear on fire…the other lit his shoes…”

Regards,

Bill Bonner
for The Daily Reckoning Australia

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Here’s another mystery: Homeowner defaults. Not that there are so many…the mystery is why there are so few…

In Nevada, for example. Two out of three homeowners are underwater…which is hard to do in the desert. Some of them owe hundreds of thousands of dollars on something that doesn’t exist anymore – the equity on their houses. Still, most of them continue making mortgage payments. What gives?

It’s a case of “asymmetrical ethics,” says The New York Times. Lenders don’t hesitate a minute to maximize their earnings – using every tool available to them and every trick in the book (including some tricks that have never been published). They default whenever it suits them.

But homeowners? They plod along. Maybe they think their house will come back in price. Maybe they think they’ll suffer some awful penalty if they default. Maybe they are just too proud and too honest to take advantage of the non-recourse mortgage provisions. So, they keep paying.

But for how long? Mortgage rates are based upon past behavior. In the past, people regarded mortgage payments as an inescapable, moral obligation. You paid as long as you were able.

It won’t be long before the ethics of Wall Street catch on all across the country. Gaming the mortgage system will become as common as signing up for food stamps. When people see that house prices won’t go back up…and when they see their neighbors shedding hundreds of thousands of dollars’ worth of mortgage debt – and getting away with it – they won’t be far behind.

Bill Bonner
for The Daily Reckoning Australia

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Got money?

You might find it hard to hold onto. Americans with money are caught in a vise. On the one side is the de-leveraging economy. On the other is the government.

The depression squeezes everything – asset prices, businesses, earnings. And it’s going to be with us for years – no matter what the papers tell you. Get ready for a 20% decline in stock prices, says our old friend Marc Faber. Another analyst puts the current P/E at 22…also implying a loss of about 20% just to get down to ‘normal’ levels.

But “this isn’t a normal environment,” says a senior analyst at Ned Davis Research.

Well, it’s normal – for a depression. When word gets around, you’ll see stocks lose ground. Housing will probably go down in price too.

Meanwhile, over on the other side of the vise, Mr. Obama says he wants to raise taxes on the rich and on businesses by $1.9 trillion. Let’s see. We’ll make some guesstimates. There are about 100 million families in the US. Of those, about half are net taxpayers. And the top 10% are said to own half the wealth in the US and already pay 66% of its total taxes. Looks like they’re going to get whacked again. Each of the ‘rich’ families will pay nearly $200,000 more in taxes.

The idea is to make the tax system more ‘balanced,’ says the president, by taking more money from the people who pay the lion’s share of US taxes…and giving it to people who don’t pay anything.

Here’s a comment from Chris Edwards of the Cato Institute:

“President Obama has introduced his budget for next year. He proposes that the government spend $3.83 trillion in fiscal 2011. To put that number into context, let’s take a trip down memory lane.

“Pres. George W. Bush…came into office when annual federal spending was $1.86 trillion. He proposed to increase spending at a healthy clip, rising to $2.71 trillion by 2011.

“Bush and his team started blowing their budget almost immediately. They kept spending more and more – wars, a giant new homeland-security bureaucracy, a big-government response to Katrina, the prescription- drug bill, doubling K-12 education spending, big pay raises for federal workers, financial bailouts, and so on. I can’t think of a single crisis that occurred on President Bush’s watch that the Bush-Rove team didn’t have an interventionist and big-spending response to.

“In Bush’s last year, FY2009, the government spent $1 trillion more than the Bush-Rove team had originally planned. It is true that 2009 spending included $112 billion for the Obama stimulus bill, so let’s take that out. With that adjustment, the Bush-Rove team ended up spending $916 billion more annually by 2009 than they had originally planned. Note that the wars in Iraq and Afghanistan cost only about one-fifth of that 2009 excess spending amount.

“Then Obama comes into office and turns out to be Bush on steroids with respect to federal spending. Obama is calling for spending $3.83 trillion in 2011, or $1.1 trillion more than the federal budget nine years ago had promised. That’s a 41 percent forecasting error.

“The lesson from all this is that an administration’s promised spending beyond the first year is meaningless. Obama is proposing a freeze on a very small part of the budget, for example, but his budget plan next year will likely find reasons to break that promise. It scares the hell out of me that federal spending down the road could be 41 percent higher than even the huge increases projected by Obama…”

We understand the larceny of the tax increases. What we don’t understand is the economics.

The idea of a $3.8 trillion budget is to stimulate the economy. The Obama team knows as well as we do that this ‘recovery’ is mostly a mirage. Without jobs…and housing…you can’t expect real growth.

Monetary stimulus has failed. Mr. Bernanke supplies the banks with all the free money they want. All they do with it is pay themselves bonuses. What more can Bernanke do? Rates are already at zero; they can’t go lower.

That leaves fiscal stimulus. “Spend more money!” That’s what economists such as Nobel prize winner Paul Krugman, The Financial Times’ lead economist Martin Wolf, and Japan expert Richard Koo are whispering in Obama’s ear. Spending supposedly boosts sales and creates jobs.

But if you’re just taking money from one pocket and putting it another, what’s the point? There is no net increase in spending power. Still, economists argue that the rich don’t spend their money; they save it! And we know what an awful thing saving is…

Taking money from ‘the rich’ actually retards a real economic renaissance. The rich are the ones who consume the most…because they have the most to spend. More importantly, they’re the ones who fund the small businesses that do the hiring. Banks won’t take a chance. It’s the relatives…and ‘the rich’ themselves…who put their money on the line.

Either someone forgot to explain this to the Obama administration or they just don’t care. In Washington, politics trumps economics every time…

And now, both politics and economics are putting pressure on Americans with money…

Bill Bonner
for The Daily Reckoning Australia

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“I’m glad you’re home, darling,” said Elizabeth when we got back to the house on Saturday.

“I kept having to call the landlord…

“I called him first because there was a leak in the basement…and then because the fire alarm went off and I couldn’t figure out how to turn it off. And then, calling him just got to be a habit, I guess…because you weren’t here…

“So when I got stuck in the snow, I didn’t know who to call. So I called him. And he came right over with a couple Latin Americans. They helped push me out of the snow…

“And then, I got my finger stuck in the corkscrew. I know this sounds silly. But I was opening a bottle of wine and a bit of my skin got caught in the mechanism… And the more I tried to get it out, the more stuck it became…

“What could I do? It wasn’t an emergency…I couldn’t go to the emergency ward… Or, I guess I could have gone to the hardware store…or maybe to the kitchen appliances department…

“I didn’t know who to call, so I called the landlord… I guess I’ve come to depend on him…”

“Sounds like I got back just in time…”

Regards,

Bill Bonner
for The Daily Reckoning Australia

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What a marvelous recovery! But there are so many unresolved mysteries! GDP growth over 5%…but, mysteriously, no jobs…and no rally in the housing market.

And now, to compound the mystery, Mr. Obama has come forward with a $3.8 trillion budget.

The markets like it. Stocks rose 118 points on the Dow yesterday. Gold went up $21. Investors see more hot money on its way…a Vesuvius of it…

The amount of the budget itself is staggering. That’s a lot of money. But even more staggering is the glaring omission: the Obama administration is planning to spend $1.6 trillion it doesn’t have. And that’s on top of the $1.35 trillion it didn’t have, but nevertheless spent, last year. Where is all this money coming from? Another mystery…

Let’s see…put those two deficits together and you’ve got a budget hole as big as the Milky Way… Nearly $3 trillion, or more than 20% of GDP.

Another thing that is mysterious about this galaxy of debt is that it comes just as the economy is supposed to be recovering. If you thought the economy were recovering, why would you risk such a huge, record- shattering deficit?

Nothing quite adds up. The GDP is expanding at a healthy pace – according to the numbers handed out by the feds. But people have few jobs and little income.

“Wage and benefit growth hits historic low,” reports The Wall Street Journal.

Employers aren’t employing. Workers aren’t working. And houses are no longer throwing off cash. That leaves more and more people with empty pockets.

Apparently, not even the feds themselves believe the economy is really out of the ditch. We are already rolling along on the recovery road – supposedly. Still, the feds send out the most expensive tow truck in history!

And now The Financial Times draws the obvious conclusion:

“US Deflation No Longer Seen as a Risk.”

You wanna bet?

The world’s number one economy is running huge deficits. But the world’s number two economy is running even bigger ones. Not much bigger…but slightly bigger.

In Japan, deficits are a bit larger than tax receipts. In America, they are a bit smaller. In both cases they are enormous…and growing.

For all its colossal deficits, Japan has not bought its way out of depression…or out of deflation either. Au contraire, the more it spends fighting deflation the further prices fall.

How could this be? Another mystery. How could government be so inept as to shoot itself in the foot whenever it pulls a trigger? How could it be so near-sighted as to aim for one thing and hit the thing it was meant to protect? How could it be so lame-brained as to do exactly the wrong thing at exactly the wrong time?

We can’t answer those questions…at least, not this minute.

So, let’s turn to the evidence. There it is in yesterday’s news report from Bloomberg:

“Consumer prices in Japan in record fall.”

And there you have another mystery, don’t you? Japan inflates the money supply with its zero rates over more than a decade…and its Godzilla budget deficits. And what happens? Its economy sinks and its consumer prices go down!

And so here comes the US of A following the Japanese lead…in the sincerest form of flattery…

Will it not get the same results?

We don’t know. But we wouldn’t be surprised.

We have a lot more to say about this…

..about how the economic theories behind these moves are corrupt, linear and superficial (if not downright stupid)…

..and about how the real driving force behind these deficits is politics, not economics. Economists are just useful idiots. The politicians are using them to grab more money and power for themselves and their friends…

..but let’s go directly to the denouement of this mystery story. Here’s what is really going on:

First, the GDP growth story is one part statistical noise, one part counterfeit, and one part damned lie. We’re in a depression. It will take years to resolve itself.

That’s why unemployment remains high…and why there will be no recovery in housing prices. They may go up. They may go down. They won’t ever get back to the bubble highs of 2006 – not in real terms. Not in our lifetimes.

Second, the mystery of the $1.8 trillion deficit – it too is a mixture of mendacity, audacity, and intellectual laxity. In short, the feds are spending so much money for one reason only: because they think they can get away with it.

Can they?

Of course not…not really. Here’s what is going to happen…

The reality of the non-recovery is going to catch up with this market. Stocks were down in January. Most likely, they’ll sink for the rest of the year too.

The economy will slide as the de-leveraging process continues. It won’t be straight down. But by fits and starts, the mistakes will be corrected…

..but that brings us back to this $3.8 trillion government budget. Its purpose, in large part, is to prevent the corrections from occurring. The feds will try to turn the US into Zombieland, just like the Japanese feds did. You’ll see massive federal spending taking up some of the slack from the private sector – but essentially wasting money on useless projects. And you’ll see major zombie corporations – GM…AIG…etc – propped up with taxpayer’s money.

Speaking of AIG, special agent Neil Barofsky is on the case. He’s ‘probing’ 25 cases of possible fraud involving TARP funds. The AIG bailout is one of them. The original price tag for saving Goldman’s speculative positions with AIG was $85 billion. The whole tab later came to $182 billion.

The flatfoot Barofsky wants to know where the money went. To tell you the truth, we’re curious too – although we doubt there will be any surprises.

But back on our beat…how the mysteries get resolved…

..we know why the economy is winding down…and we know why the feds are running such huge deficits…

..but big deficits aren’t pushing up prices in Tokyo; they’re having the opposite effect. They’re pushing them down. Does that mean US deficits will get the same results – the economy and prices lower instead of higher?

We don’t know…but our guess is that ‘yes’ is the right answer. More on this later in the week.

Bill Bonner
for The Daily Reckoning Australia

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We were feeling nostalgic for the pampas last week. So we went to dinner at El Sur a restaurant in the heart of Paris. It’s the real thing. The décor, the wine, and best – the meat – are all authentically porteno (pertaining to Buenos Aires).

We went with our Spanish teacher, son Jules, and some friends. The conversation was in Spanish.

“Jules, your Spanish is very good,” we said afterwards.

“Five years of it in school. But, Dad, I don’t know how much you can learn from these sessions…”

“Well, learning languages is cumulative. You just keep at it. Little by little it sinks in…”

“I wonder if it’s worth all the effort…”

“Sure it is. Languages hide the accumulated wisdom of generations of dead people. Each word is an idea. And different languages have different words…and different ideas… The more languages you know, the more ideas you’ve encountered. The more you know, generally… Besides, if you don’t speak the language you can’t enter into a culture and discover its secrets.”

“Oh….”

Regards,

Bill Bonner
for The Daily Reckoning Australia

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America’s president proposes a tax credit to businesses that take on new employees. We never met a tax cut we didn’t like. This one is no exception. It lowers the cost of labor, making it easier to hire and pay people. So far, so good.

But is Mr. Obama proposing to cut government spending also? Not really. He’s pretending that the feds can have their cake and eat it too…that they can forgo the income given up by the tax credit…and yet, still spend it.

How is that possible? It’s not. It’s the feds’ old shell game. It won’t do the economy any good because the resources represented by the tax credit can’t be in two places at once. They can’t be available to the employers and be available to the government too.

But 10% unemployment tells us that wages are too high. They should fall – along with stock prices and housing prices. But it’s hard to cut wages. That’s the real secret to the Keynesian’s fiscal stimulus. Government spending causes inflation…which lowers wages surreptitiously.

Everybody likes fiscal stimulus. Economists like it because it makes them look like they know what they are doing. Politicians like it because it makes it look like they are doing something to help the masses. And the masses like it because they believe them! Finally, even employers like it because it reduces real wage costs.

Trouble is, inflation doesn’t work very well in a real depression. The Fed increases the monetary base. Congress showers boondoggles over the nation. But the money moves likes molasses.

The median price of an existing house sold in 2008 was $196,600. In 2009, the price fell to just over $170,000. But this seems to have brought out the buyers. At $170,000, reports Floyd Norris in the NYT, the housing market corrected all the way back to 1997, adjusted for inflation. Twelve years’ worth of real pricing gains have been wiped out.

But when people realized they could buy at ’97 prices, they stepped up to the plate; 4.6 million houses changed hands last year – 5% more than the year before.

The real problems were in the new housing sector. Only 373,000 new houses were sold last year – fewer than in any year since 1963. Prices sank, but not quite as much as in the used house market.

New houses, of course, are not the subject of foreclosures. You can’t foreclose a mortgage that hasn’t been written yet. This permitted the housing industry to control sales and prices – at least to some extent. While foreclosed houses flooded the used-house market and drove down prices, builders must have held back inventory waiting for better prices.

What will happen in 2010? Most likely, the inventory of unsold houses…along with the ‘hidden inventory’ of houses that owners would like to sell…will probably continue to hold prices down. One way or another, the average house has to go down to a level where the average owners can afford it. Where that level is, we don’t exactly know, but it’s probably lower than today’s prices. Remember, millions of homeowners are underwater. Some of them will drown. Others will get out through the windows…leaving the house to sink, along with the housing market.

Bill Bonner
for The Daily Reckoning Australia

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Well, it’s a new world, after all…

Maybe we were wrong. Maybe the mainstream economists are right.

You know, up to now all they’ve been good at was explaining why the forecasts they made in the past didn’t work out. But maybe they’re right, after all. Maybe up IS down. Maybe better IS worse. Maybe you can squander trillions of dollars and yet have more!

It is all too much for us. Our head aches thinking about it. But there it is, right there on the front page of the weekend news:

“US growth accelerates…” announces The International Herald Tribune.

Right there in black and white. And it must be true. The newspapers wouldn’t lie, would they? And, the economists who fiddle the numbers for the US government wouldn’t hit a false note on purpose, would they?

Nah, that never happens. But how is it possible for the economy to go right back to Bubble Era growth rates after taking only a couple percentage points off of US GDP? We all know it was a credit bubble, right? We all know it couldn’t last, right? We all know, too, that the fuel for that growth – bubbly gases coming out of the banks and the real estate sectors – has disappeared. So where is this growth coming from?

On Friday morning, the stock market got excited about the stronger- than-forecast growth numbers, along with news that Ben Bernanke was around for another four years. The Dow rose more than 100 points. But by the afternoon, investors were asking questions again.

If the economy really is recovering, maybe the feds will reduce their stimulus…

If the economy really is heating up, mightn’t it melt all that money and credit frozen by the depression? Doesn’t that increase the odds of inflation – and higher rates from the Fed…?

If the feds tighten, won’t the US economy fall back into the second part of the W-shaped recession…just like Paul Krugman says?

By the close of business the Dow had lost 53 points, which makes us think the final push to the bottom has begun. Even good news can’t stop it. When 5.7% growth – after the worst slump since the ’30s – doesn’t get investors excited, there’s something wrong.

Wait a minute…

“The biggest lift to economic activity,” continues The New York Times, “came because businesses ran down their stocks of unsold goods at a much slower rate than earlier in the year…”

In other words, the ‘growth’ came because businesses restocked their shelves at a faster rate. So, there’s more on the shelves to buy. Hmmm. Wonder if it will sell…?

The only way you could have real, sustained growth is with a recovery in employment – and earnings. Looking at it broadly, Americans were earning a certain amount of money in 2007. Then, they discovered that much of what they were doing was not worth doing. They were building houses for people who couldn’t afford them, for example. And they were spending money that was “taken out” of their houses. At the peak, a substantial part of US GDP – and virtually ALL the growth – came from these sources.

That money has disappeared. People aren’t getting paid to build houses that no one will buy anymore. And shops aren’t selling to people who pay with money from mortgage equity extraction. They’ve already extracted so much that there’s nothing left. Or less than nothing. Many homeowners have net negative equity.

What does this mean? It means that people are earning less, borrowing less, and spending less. What else could it mean? A substantial part of the economy, 2003-2007, was fraudulent – in which excessive consumer credit masqueraded as real purchasing power. That part of the economy has gone away. So should that portion of the GDP. In theory, GDP should go down and stay down until new industries, businesses, and jobs are found.

Bill Bonner
for The Daily Reckoning Australia

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Science and technology have produced many wondrous breakthroughs. But there are some things it cannot improve. A kiss from natural lips is still the lover’s choice. Baby formula proved no match for the real thing. Ersatz money is a flop too. That last item is not so much a fact as a prediction.

The first modern competition between gold and paper money ended like the pre-modern ones. Gold won. Herewith, a short summary:

A rogue, John Law, was the protagonist of the story. He killed Beau Wilson in a duel. Then, he went on the lam…first to Scotland…then to Amsterdam…and finally to Paris. Like Alan Greenspan or Ben Bernanke, he made himself useful to people in high places – in this case the Duke d’Orleans, who needed money. Law had a way to get it:

“I have discovered the secret of the philosophers’ stone,” he is said to have remarked, “it is to make gold out of paper.”

We need to look no further. Law may have been good with figures; it was at philosophy that he failed. A thing cannot be both one thing and a different thing at the same time. It is either gold. Or it is paper. Rarity and durability give gold value – as money. Paper’s most conspicuous properties are just the opposite – it is common…and has a tendency to curl up and blow away.

Law’s new, easy money helped France to an economic recovery – or so it seemed. But in the end, the philosophical error caught up with him. Gold has real value. If you can create it at will, why not create more of it? It was just a matter of time before he had created too much. Soon, there was an angry mob outside Law’s office on the Rue Quincampoix. People who held his paper gold had come to see it in a different light. Where once they cherished it as paper gold…now they despised it as nothing but paper.

Law’s scheme increased France’s money supply – including banknotes and shares in his Mississippi company – by 300%. Prices in Paris doubled between 1718 and 1720. Then, when the new money system began to give way, the Duke d’Orleans “cranked up the printing press.” By 1721, Law’s money was worthless. “Banque” was a dirty word in France for the next 200 years.

The current experiment with paper money began on the 15th of August 1971. Henceforth, said Richard Nixon, foreign countries that wished to exercise their right to trade US dollars for gold could drop dead. From that point forward, the dollar was worth only what someone would give you for it. Philosophers held their breath. But nothing happened. Many have died since, waiting for the dollar to succumb first. Still, the millstones of monetary history may grind slowly, but the more slowly they grind, the more fingers they pinch.

The new paper money standard allowed for a worldwide credit boom – just as in Paris following the establishment of Law’s scheme. The US created dollars. Its citizens spent them. The dollars accumulated as reserves all over the world…and every central bank raced to keep up. Soon, the exporters were producing too much. The importers were consuming too much. And there was too much money and credit everywhere.

The Japanese economy was the first to blow up – in 1989. The tech sector on Wall Street was next to go – in 1999. Finally, in 2007, the planet-wide bubble popped. Suddenly, the whole world was Japan. And now, every nation in Christendom, to say nothing of the others, is following Law’s example. All issue paper gold – in the form of bills, notes, and bonds – as if they were the Banque Royale. Europe is estimated to need $2.2 trillion in deficit funding this year. America will need at least a trillion more. If the depression deepens, maybe $2 trillion. How long can this go on? Where will it lead?

“There are no means of avoiding the final collapse of a boom brought about by credit expansion,” wrote Ludwig von Mises. “The alternative is only whether the crisis should come sooner as a result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

On Tuesday, the S&P rating agency issued a warning. If Japan continues in the direction it is going, it will have Hell to pay. Japan leads the way into the future. And into a monetary minefield. Her current deficit – a record – is more than her tax revenue. And her public debt is nearly 7 times as great. Her feet grow larger.

No natural life survives the lifecycle. And no paper currency standard has ever survived a complete credit cycle. It is just a matter of time until we hear the explosion and see body parts flying.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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“They are married…” said our companion, “but not to each other.”

We were sitting in the Café des Dames…having a coffee with a female colleague. Nearby, the red-haired bum was drinking his own coffee.

At the next table, a group of middle-aged communists was trying to figure out what caused a financial crisis; they had no more idea than Ben Bernanke.

A couple entered the bar. They looked around, trying to find a quiet corner. The way they looked around, it was obvious that they have never been in the Café des Dames before, which meant that they were not from the quartier. In this neighborhood, everybody knows the Café des Dames. It is right on the main drag, across from the subway stop.

They could have been business colleagues too. They were in there 40s…maybe the woman was a year or two older than the man. They wore dark clothes; they dressed as if they were going to a meeting. Attractive. Probably competent. The kind of people who keep the wheels of modern commerce turning.

But there was something furtive about their regards. They were in a place they didn’t know; probably because they didn’t want to be known. These were not young lovers. Nor were they husband and wife.

When they sat down, the woman took the man’s face in her hands and put her own head down. Whatever they were up to, it made them feel under pressure…maybe guilty.

Having an affair must take a lot out of you. You have to watch where you go and what you say. It must make you worry and fret…and wonder…

Is something wrong with your spouse? Is something wrong with you? What if your spouse finds out? Then what? Will you leave your spouse? Will your lover join you? Will things be better? Or will they soon be worse? What about the children?

Yes, dear reader, having an affair must cause a lot of tension – even if it remains a secret. But what do we know? Maybe it’s worth it.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

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In the Café des Dames…

The damned bum takes a coffee break!

He spends all day, sitting on the sidewalk outside our office in one of the city’s marginal neighborhoods. His back to the Communist Party headquarters building, he sits on a duffle bag. Red haired. Not bad looking. About 35, maybe 40, years old…he doesn’t ask for alms. He doesn’t do anything. He just sits there. Day after day.

But every day, at about 11:30, he comes into the café on the corner. That is also where your editor sometimes sits and thinks…and where, sometimes, he just sits. The bum orders a cup of coffee. So do we.

We almost forgot. Our beat is money. And we won’t make any money hanging around the Café des Dames watching people come and go. So let’s turn to the financial world…

Yesterday, the Dow was down 150 points the last time we checked it. And this morning, Asian stocks are falling again. China’s stock market has fallen below its 200-day moving average – a bad sign.

Is this a little correction in the long upward climb of stock prices? Is it a pause in humanity’s march to perfection? Or is it a resumption of the bear market that began 2 years ago?

The way we see it, things go up and down…round and round…back and forth. Human life may become more comfortable, with technical progress and innovation. But every life still ends in the same place it did a million years ago. Ashes to ashes…dust to dust…

And what about the life of a company? Or a stock? Or a bull market? You know the answer. They end up where they began, nowhere. Everything ends up in the same place…back where it started. The challenge, as near as we can tell, is to get there with grace and dignity.

Speaking of stocks, the Dow hit a low of 6,547 on March 9th of last year. Most observers believe that was THE low…the nadir of the bear market movement. We doubt it. Even at its low, investors were still fairly confident that stocks would perform well ‘over the long run.’ They saw the problem as a banking crisis…a liquidity crisis, not a fundamental failure of the economy.

And even at 6,547 the Dow had lost only about half of its value…leaving P/E ratios well above typical major bottoms. At major bottoms, you can buy almost any stock on the exchange for 5-8 times earnings. If you were buying the whole company, you’d get a yield on your investment of 15% to 20%. Nice deal.

But in March of last year, when the bear market found its first resistance, corporate earnings were falling too…leaving investors with P/E ratios closer to 20 than to 5.

The bounce lasted more than 9 months and recovered about half of what stocks had lost. If the bulls are right, stocks could correct here…and then go back to their bullish trend. If we’re right, on the other hand, they will fall all the way back to their March 9 low…and keep going, until they finally arrive at their ultimate low. Then, you’ll be able to buy major listed companies and get a decent return on your money – from the dividends.

If we’re right, the economy is in a multi-year period of correction, de-leveraging and depression. The stock market has to notice, sooner or later. And it is bound to get a little gloomy when it realizes what is going on. That should take the Dow down to about 3,000-5,000 on the Dow index. It could be much lower…

The latest figures – keeping in mind that we don’t believe any statistics unless we fiddled them ourselves – show new jobless claims down last week, but not as much as expected. Bloomberg quotes a ‘senior economist’ who tells us that the numbers are going in the right direction, but ‘very slowly.’ The four-week average number, meanwhile, is going in the wrong direction – it shows increased unemployment.

And what about the housing market?

It’s hard to get a clear picture of what is going on. According to Case/Shiller prices are rising in many areas. But so are inventories. It now takes a record 13.9 months to sell a new house – up 50% from a year ago. This must discourage a lot of sellers. Those who can afford it may prefer to hold houses off the markets – waiting for a better season.

The housing market is probably like the stock market, in other words. Just a little slower. The first wave down was driven by defaults, foreclosures and marginal, desperate sellers. The next wave down will be driven by inventories…population trends…and the depression. Many owners still believe prices will come back, when the ‘recovery’ really gets underway. Most likely, they will be disappointed.

If there is any recovery at all…it will be weak, lame and tentative. People wanting to buy houses will look for bargains. Owners will take advantage of every positive move to release more inventory – depressing prices for many years ahead.

What would change things? Well, there is little hope that the crisis will go away. Mistakes gotta be corrected. Leverage gotta go. Depressions gotta do their stuff.

But the nature of the depression could shift suddenly – from deflation to hyperinflation. We don’t expect it. But it could happen. And if it did happen, people might rush to get rid of paper dollars as fast as possible. You’d see a big boost in prices for just about everything – including stocks and real estate.

Even in this case, however, the increases may be less than the losses on the paper money itself. Very hard to predict. In hyperinflation all bets are off.

Do we expect hyperinflation in the US anytime soon? No. We expect years of Japan-like suffering. But we could be surprised…

Bill Bonner
for The Daily Reckoning Australia

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Where we are now is a matter of great debate: Are we in recovery? Or is the depression deepening?

No one knows for sure. Investors stumble around in the dark, bumping into data and knocking over lamps. It would be nice if someone would turn on the lights. But that’s not how it works.

The best we can do is to try make out the shapes of the biggest pieces of furniture in the room. What else is out there? We don’t know.

Broadly speaking, the period we are in is deflationary. It is a period of credit contraction (at least in the private sector), de-leveraging and depression. How can we be sure? Well, let’s turn on the lights…

Take a look at this chart, for example. What it shows is not a ‘jobless recovery.’ It shows no recovery at all.

This slump is worse than any since World War II because it is correcting an expansion that dates all the way back to 1945! Credit began increasing right after the war. It kept increasing until 2007. Then, in the private sector, it began going the other way.

That trend continues.

It makes sense from a theoretical point of view, too. Every big credit expansion is followed by a big credit contraction. As credit expands, more and more mistakes are made. You can see how this works by looking at the mortgage industry. The first borrowers were solid. Subsequent borrowers were not-so-solid, but they were still generally reliable. The last borrowers – at the height of the frenzy in 2006 – often had no jobs, no income, and no plausible way of repaying their mortgages. Those mistakes are now being corrected.

Overall, credit is still expanding – thanks to the US federal government. But credit is contracting sharply in the private sector…where it counts most. Business lending is falling at a 16.6% rate… the steepest plunge since 1948 (when businesses stopped borrowing for war production). But government borrowing is more than making up for the shortfall in private borrowing. Overall, credit- market debt is up 5.5% in the seven quarters since the business cycle peak in December 2007.

Private sector credit down. Public sector credit up. What to make of it?

We can presume that eventually the government will run into the same wall the private sector hit in 2007-09. Looking through the history of economic crises, so well documented for us by Carmen Reinhart and Ken Rogoff, we see that crises in the private sector typically lead to crises in the public sector. As the private sector sobers up… the public sector goes on a spree. It won’t be long before it, too, crashes and burns.

We can anticipate how this crash in public debt will come about. This passage, from a brief account of French financial history called The Undying Debt by Francois Velde, is a story of the past. It may also be a story from the future:

With the opening of hostilities [in WWI], the Bank of France suspended the link between francs and gold, and part of the war was financed with large issues of paper currency. When France’s prime minister Poincare re-established the link in 1928, he could only do so at 20% of its pre- war parity.

In other words, the French got into a fix. They got out by defaulting on 80% of their obligations. The history of French financial management is not so different from that of any other nation. Time after time, France found itself a little short. And time after time, it defaulted…devalued…and reneged on its promises. Over nearly three centuries, a government debt equal to ten ounces of gold – with a present value of about €7,850 – was reduced, says Velde, to €1.20. That’s about “enough to buy a café crème at the bistro on the way out from the Treasury.”

(I don’t know what bistro Velde is talking about. A café crème usually cost me twice as much!)

Returning to the image we led off with, investing is not just like trying to find your way through a room in the dark. It’s like trying to find your way through a room in the dark…when the furniture is all moving! Trouble is, in the here and now there is so much furniture moving around, it is hard to make a move without tripping over something.

Under these conditions, I’m not sure we can come to any useful conclusions about how one price will move relative to the others. Which will go down most, the dollar or the euro? Will copper rise in dollars? Or fall against cotton? Will bond prices go up before they go down? We can’t say.

But we can say that governments are very good at borrowing…and not so good at re-paying. So even if credit-contraction and deflation is the trend of the moment in US financial markets, government credit-creation is rapidly expanding…and that’s inflationary.

That’s why we are wary of government debt. We own no US Treasuries…or any other form of government obligation. Shorting US and European government bonds is probably a good speculative play.

Regards,

Bill Bonner
for The Daily Reckoning Australia

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