The Dow fell 140 points. This was baaaad…because it shows that the stock market does not really buy Bernanke’s storyline.

You’ll recall that when we left off last week, Ben Bernanke assured the world that while the recovery was not exactly what he had hoped for, he nevertheless had the situation in hand. He said he had the tools necessary to fix the problem and would do whatever was required.

The initial reaction was positive. The Dow rose more than 160 points on Friday. Some analysts thought the market’s downward trend had been broken. But it needed follow-through on Monday. Instead, the market fell.

The fact is, there is no recovery…and no recovery is possible…and investors are beginning to realize it.

Then what is going on? A “Great Recession,” say some analysts. A “depression,” say others.

There is a good article in The Financial Times that helps understand what is really going on. It’s by Ken Rogoff and Carmen Reinhart; you’ve heard of them before, dear reader. They are the ones who researched dozens of episodes of financial crisis and sovereign default throughout history.

Today, they write in the FT about what happens after a financial crisis. Well, what do you think? Do you think you get a “recovery”? Do things go back to normal? Is the recession over quickly and painlessly?

Not at all. Instead, there is rarely anything you would recognize as a “recovery.” Things do not go back to normal because they weren’t normal before the crisis. Crises are caused by abnormal conditions — usually too much credit, too much debt, too much spending and too much speculating. Then, when the bubble blows up, it typically takes a long time for the economy to get back on its feet.

Over the following ten years, unemployment usually stays higher than it was before the crisis.

Growth rates are usually lower.

And ten years after a blow-up in real estate house prices are still usually BELOW where they were when the crisis hit.

But what if the feds really get on the ball and try to turn things around? Then, watch out!

We read an article on dying yesterday. Here’s a question for you, dear reader. Would you rather live in a recessionary economy or die in a booming one? We’ll take the recession. Probably most people would. Heck, make it a depression.

There are a lot of illnesses for which there are no cures. Still, people will spend a fortune…and endure unspeakable treatments…in the hopes that they will be the one in a thousand who survives.

So too are people ready to believe that Dr. Bernanke can cure what ails the US economy. We don’t think so. Because we don’t think the economy is “sick.” We think it is healthy…and finally correcting the mistakes of the Bubble Epoque.

Leading economists and the feds have believed, for example, that there was some problem of “liquidity” that was temporarily blocking the flow of cash and credit. They believed the problem could be solved by making more money available. That was why the Fed bought an extra $1.4 trillion of the banking sector’s suspicious “assets.” They wanted to make sure the banks had money to lend.

Well, now the banks have plenty of cash. Businesses too have record holdings of cash. Even households are rebuilding their cash accounts.

But who’s borrowing? Who’s spending? Who’s buying new houses, for example? (New house sales are currently taking place at the slowest rate ever measured.)

CNN: “Credit if finally available, but no one wants it.”

Why don’t people borrow?

Because it’s not a liquidity problem. It’s a debt problem. A solvency problem. And it won’t go away by making more cash and credit available. Instead, all those bad decisions, bad loans, and bad investments have to be cleaned up. And that takes time. And while the economy is de-leveraging, people are becoming more cautious…more risk-averse…more modest in their expectations.

What do Rogoff and Reinhart say about governments’ efforts to fix these problems? What does history show?

They say the feds often make the situation worse.

Not only do governments typically pour bad money after good, they also disrupt the process of correction. Insolvent banks are kept alive. Big businesses that ought to go broke and be sold off are instead propped up…the lights are kept on by government subsidies, preventing new competitors from occupying the space. Consumers and investors keep waiting for the promised “recovery”…for the cure…for the fix. Instead of quickly adjusting to the new circumstances, they delay…they hesitate…they postpone unpleasant changes.

They might quickly sell a house at a loss, for example. They could then go on with their lives. But when they hear the feds tell them they have a new program in the works…or a new stimulus bill in Congress…or new action by the Fed…what are they supposed to think?

“Maybe I should wait and see if this new effort does the trick…” they say to themselves. “I’ll feel like a real fool if I sell now and then the feds get a new bull market going.” “Maybe I should wait before accepting a job at a lower salary; it says in the paper that the economy should recover by summer…”

The economic setbacks of the 19th century were sharp, but fairly short, affairs. The contribution of modern economics has been to stretch them out and make them worse.

Regards,
Bill Bonner
Whiskey & Gunpowder

September 1, 2010

What’s Bad for Bernanke Is Worse for You was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

1. At the current rate of taxation, even if nothing deteriorates, how much money does your wife need to live on after you are gone? The classic rule is “80% of your highest income plus a paid for house.” Right. If you make $100,000/year, you need to accumulate through savings or insurance $1.6M in capital at 5% interest. Problems: inheritance taxes are due to cut back in, and Uncle definitely wants a chunk of $1.6. Worse, the interest will be taxed as income and she isn’t going to find 5% interest. Let us suppose that she has $1000/mo in Social Security—a little over the average, but you’ve got a good job. A loving government will take roughly 10% of that away from her immediately too pay for Medicare and has already announced a 20% increase in fees over the next three years…with no increase in COLA, or the “Cost Of Living Allowance.” According to the Feds there is no inflation, hence her costs will not rise. We would love to know where those who make such pronouncements buy groceries, gasoline, socks, and tires. Supposing naively that she pays no income tax, if she puts the $250,000 in insurance you may have arranged for her in a CD at 1.5%, at the end of the first year she will have $3,750 in interest plus the theoretical $11,100 in Social Insecurity, for a total income of $14,850. Social Security probably won’t cover the house note you almost certainly have, and houses aren’t selling well. Her alternatives are to find a job or live on what she has for three years and hope she can find husband. That is certainly neither a safe nor a dignified plan, although it may make more sense than buying lottery tickets. The worst part is, that’s the best I can foresee for her.

2. The Greater Depression arrives, as it almost certainly will. It doesn’t matter whether you’re married or single, how safe is your job? 26,000,000 of the things have disappeared already in this century, and unless you are among the 40% of the populace which works for some governmental entity or a CEO you night want to do a little worrying. Japan is on the twenthieth year of their last depression, with a brand new government devoted to the project of becoming an economic block with India, and a few sprats such as Hong Kong, Taiwan, hunks of Indonesia, and so forth. Yup, our little island nation friend is going to grow up, leave the nest, and devote itself to destroying the dollar. What they plan to do with the two trillion or so they hold I have no idea, but if they knock the dollar out as the reserve currency they have some notions. The ironic part is that those dollars have little value at present and are under pressure from all sides, from Bernanke and Geithner’s government-sanctioned counterfeiting and money-laundering (swooshing the new cash around through Treasuries and the market, for example), to cheerful plots in the Middle East and BRIC. It’s coming, get ready for it.

3. The stock market takes a 40% thud at the year’s end, the bond market crashes, the ARM supply has 80% set to re-arm, commercial real estate looks like a yeast vat it bubbles so freely, and a lot more banks are set to fail. Some may even be “set up” to fail. These government-made disasters are pretty much set in stone and will coincide with your other choices.

4. Government revenues are down 17%, the jobless rate is at 17% by rational accounting methods, and a great many states have balanced budget requirements. They will have only two recourses: raise taxes again, or cut jobs and “services.” ARE we having fun yet? 25% of those working are paying all of the income taxes and virtually all property taxes—and schools and bureaucracies demand more money every year. Protests against government spending and taxes are becoming more visible.

5. OPEC members have been running on the American Plan in large part, tossing around bread and services to keep their citizens from expressing noisy opinions of fleets of silver Mercedes Benze automobiles, some of them diamond studded. At one point in the last year it took Saudia Arabia, as I recall, $70/barrel just to cover the “social services” portion of their budget. Basically, every dime the Sauds get for a barrel these days is already committed to welfare, which means it is rather expensive to give away their declining oil supply. Throw the peak oil mess and the miraculous never-depleting “reserves” OPEC nations claim into this bucket. Meanwhile, back on the home front, the Greens are fully in control; drilling rights that had been negotiated were blocked recently, coal is threatened under cap and tax, don’t even mention nuclear power, and hydroelectric dams stand idle because the water has been flushed uselessly to help dear little fishies. Oh, and the crops failed in California when the water was diverted from irrigation.

6. The citizenry of these “united” states turns ugly for a variety of reasons, ranging from food or energy scarcity, taxation, the avalanche of new socialistic legislation, union members who have priced themselves out of jobs, racial or religious riots, and/or a hearty disinclination to put up with this any more. For an eyeful, ask Google how many states and a group of islands have strong secessionist movements. Funny Hawaii ne! Seems like they want Queen Liliuokalani’s throne back, and who can blame them? The real situation is that Hawaii has belonged to Japanese Democrats since I was graduated from the University of Hawaii, all those decades ago.

7. Some combination of the above appears, and the government proves that a government no longer strong enough to give the masses what they want is still strong enough to implement everything from the War Powers Act to the “PATRIOT” act, and turns completely totalitarian on us. Obama declares a national emergency, dismisses Congress (don’t come back boy and girl millionaires; your cushy jobs have been abolished), and pursuant to Executive Order 11921, armed, uniformed thugs show up on your doorstep and loot your house of all foodstuffs, alcohol, tobacco, firearms, valuables, and anything else any member of the team fancies. De facto gun registration is becoming de jure as it is being sneaked quietly through Congress disguised as “a simple IRS measure.” It requires a tax of $50 a year on every gun you own—or admit owning—your fingerprints, and submitting to government psychological examinations on demand, as well as other unsavory regulations. Penalties for being in possession of “untaxed” guns will be quite severe. This section has two possible outcomes: the rednecked, gun owning, Bible-thumping, smoking, drinking, butter-and-red-meat-eating, bluejean-wearing, Limbaugh-listening, homophobic, racist domestic terrorists (description courtesy of Janet Napolitano and assorted government agencies) are in open revolt, and either win, or they don’t. My money is on the armies in Kevlar and Corcorans armed with up-to-the-minute genuine assault weapons, riding around in AP carriers and tanks, including the all-volunteer forces, the 100,000 or so Blackwater has, assorted UN “peacekeeping” forces, and the Canadians who are pledged to come to the aid of the president if asked. Oh…I forgot the two battalions of the Praetorian Guard assigned to the president’s personal use, the secret service, the FBI, Homeland “security,” and the BATF.

8. The depression and embargos on oil are so devastating that not even the government can muster the money to pay armies, and we drift quietly into The Greater Depression, with perhaps forty or more percent unemployment, irregular power services, little to buy in the stores, devalued dollars, cessation of Social Security and then drastic cuts in welfare, food, water, and fuel shortages, and a seething populace.

9. At some point, cauldrons roil over, the always-happy-to-riot sectors of “society” prevalent at Watts, Katrina, and Ike, and ghettos jump in happily, and the food supply is exhausted in the cities after three days, maximum. Millions die from heat, cold, thirst, tainted water, rampant disease, and assorted natural and man-made disasters.

10. In the fullness of time something on the order of 40,000,000 are dead from the aforementioned conditions, having argued with violent, hairy strangers, or been shot for fleeing like locusts from Detroit, Los Angeles, New York City, and Houston (for starters) to spread out over the land attacking farm houses and taking over small towns. The farms will lose their future crops in most instances, and little towns will be barren of food, as well. When the population has been reduced sufficiently, the remainder will eke out an unpleasant existence grubbing in the soil attempting to learn to grow plants with not many seeds available, learning to raise animals and slaughter them (that being illegal by that time), discovering that medical care is almost nonexistent and is paid for in chickens and barter is the established method of commerce since the value of the dollar is on the order of that in Zimbabwe, and the LE (Law Enforcement) officials will likely not have enough manpower to say wearily more than “You shot it, you bury it.”

There y’are, the ten things which exercise my mind the most. You decide which one you’re going to worry about, and I’ll come back later and address the problems one by one. In the meantime, divest yourselves of dollars. Turn them into anything durable which you will need later.

Drearily yours,
Linda Brady Traynham

November 16, 2009

The Top Ten Things to Worry About Surviving in a Bad Economic Climate was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

“Is that rain?” asked a co-worker the other day.

“No. It’s the sound of leaves blowing down the street,” we speculated.

And it was.

Huge drifts of leaves have accumulated on the footpaths in the past week, swirled around by the wind and piling up in banks along the street. All the leaves on the plane trees that line Melbourne’s streets seem to have died at once during last week’s heat wave. Normally, in the autumn, the leaves fall at a statelier pace. The days get cooler and the seasons change at a more natural rhythm.

But not this year. They fell all at once. The whole natural cycle was condensed into just a few days, thanks to the heat wave that scorched the trees last week. And alongside huge piles of dead leaves burnt brown you’ll find the occasional dead brown possum.

We stumbled on three the other day, walking up St. Kilda Road. It’s a veritable banquet of organic matter for the flies. The poor little possums lay on the ground, their prehensile tales curled up in a tidy little spiral. By the looks of things, dead possums do not bounce.

The plane trees are not native to Australia (they were imported from Britain to Victorianise the place). The possums ARE native. But neither one is suited to the kind of extraordinary heat that set upon the city last week.

Sure, there are hotter places in the world. But if something is designed to live in one environment and finds itself in another, it probably won’t last long if it’s not adaptable. Tomorrow is expected to be another 43-degree day in Melbourne. Which brings us to the economy.

Recessions are perfectly natural in the business cycle. Human beings take risks with borrowed money during a growth phase. Some risks pay off. Some don’t. A recession is a reckoning up of the risks. The bad investments are liquidated, asset values readjust, and the next cycle begins.

You can only get a depression when the government and the monetary authorities take unusual steps-driven by political motives-to prevent the natural process of recession. This is why today’s policy moves are setting us up for a Depression. And it’s not the first time.

It’s widely believed that the Great Depression had its origins in the slow response of the Fed to the banking collapse that followed the stock market crash. That failure, so the theory goes, was followed by too little fiscal innovation and government spending by then U.S. President Herbert Hoover.

But all of that claptrap is exactly wrong, we humbly suggest. The Depression was a foregone conclusion the minute the business cycle was hijacked by manipulation of the credit cycle. A recession is natural. A Depression is always man-made.

That’s right; the origin of the Depression is in the credit boom that preceded it. The credit boom of the 1920s made it inevitable that the natural rhythm of the business cycle would be amplified and made more severe. The boom was boomier. The bust was…worse than it had to be.

It was made worse by government policies that put America into debt, allocated capital in the most inefficient hands possible while crowding out business investment, and locked in wages and prices higher than they ought to have been, further delaying the vigorous rebound in employment and wages you usually get in a recovery.

To repeat, recessions are a natural and unavoidable part of the business cycle. Depressions are the bill you pay for trying to avoid recessions with even looser monetary policy and more government spending to stimulate consumption. What you need is a cleansing break. What you get is a money-induced fever of pointless economic activity, full of noisy cash registers, signifying nothing.

So here we are on a Friday, waiting for the Depression. How seen we get one depends, in some small part, on what Timothy Geithner comes up with next week and world stock markets receive it. Geithner unveils his plan to rescue America’s banks and get the credit crisis behind us on Monday. It had better be a good plan.

What can you expect? Well, for one, we’d be really surprised if there wasn’t a suspension-at least for a period-of mark-to-market accounting. This would prevent the banks from having to realise losses on securities they don’t intend to sell, but are currently held on the books at values well below market value.

Another element will be buying “toxic” assets from the bank. At what price? You’ll find out soon enough. It probably won’t be fair value. But it won’t be so far below fair value that it forces the banks to realise huge losses and require even larger infusions of taxpayer capital.

Not to be a stick in the mud, but do you get the feeling that the Feds are already one or two steps behind in the game of “prop up the falling asset values”? Bloomberg reports that, “Moody’s Investors Service is reviewing the ratings of $302.6 billion in commercial mortgage-backed securities as real-estate values drop and property owners fall behind on payments.”

Yes. It all feels a bit like the chart below. It’s the dreaded “Black Swan Formation.” We have asked Swarm Trader Gabriel to take a look at it and will let you know next week what he has to say.

Finally, we have been dodging the question of how you deal the infinite growth in a system with finite resources. We’ve been dodging it mostly because it’s such an abstract and theoretical subject that we fear we will bore you to death, and it is not good to kill your present or future customers. But since we are fundamentally optimistic about the answer, let’s push on!

The answer is in the architecture of the system you’re talking about and the energy inputs it requires. We have a global economy that’s developed a great deal of complexity thanks, in part, to an abundance of credit. It’s a system of systems built on two key inputs: credit and energy.

The more important input to the current world order is cheap energy. It began when Colonel Edwin Drake drilled his first oil well at Titusville, Pennsylvania in the spring of 1858. The world has never been the same.

With the huge amounts of energy available from petroleum came the Industrial Revolution, the acceleration of the division of labour with mechanisation, dramatic increases in agricultural yields (allowing for a major structural shift in employment as fewer people were engaged in growing food and more in making things), the growth of large urban population centers (and later the exodus to the suburbs and the housing boom as the cities went bad), and all the many capital investments and institutions that are somehow related to the fact that energy has been cheep and abundant for the last one hundred fifty years.

So is all that really collapsing now because of the fundamental physical limits on the amount of energy we can get from oil? Can an economy that’s evolved around oil as the chief energy input survive when its rate of growth has been so artificially accelerated by easy credit and fractional reserve banking? See. We told you. It’s a pretty ambitious question.

John Robb posts an answer over at his Global Guerillas blog. Robb quotes from Joseph Tainter’s book, The Collapse of Complex Societies. “The method of collapse favored by Tainter as a tipping point is defined by a fundamental change (assumption level) in the underlying costs of running the society. He maintains that every great society is driven to the heights of its organizational potential by leveraging a ‘free’ (for all intents and purposes) energy input.

“Unlimited access to this energy resource allows them essentially ‘free’ problem solving and rapid recovery from mistakes. However, once that ‘free’ energy becomes erratically available or expensive, the cost/benefit equations of many (if not most) of that social system’s evolved solutions turn decidedly negative. Collapse, at that point, is inevitable. In our case, this ‘free’ energy input would be fossil fuels (the negligible cost of which underwrites all social solutions).”

In a closed system, the amount of energy available to you is finite. In an open system, it is not. The Earth is an open system. Energy rains down on the planet everyday in the form of solar radiation. We do not, however, have a global economy that’s scaled to live and produce off this kind of energy.

Your editor’s guess is that we are headed to a fundamental reorganisation of the world’s economy that will be driven by how we get and use energy. The current system of production is based on cheap energy for the production of goods which are consumed with the help of cheap credit.

A graph of the growth of Wal-Mart stores across the U.S. from 1965 to today (where Wal-Mart became the largest private employer in America) reminds us of that scene in War Games with Matthew Broderick.

Only in the Wal-Mart example you have little nuclear explosions of consumerism. They should probably be red though, instead of green, those “store strikes”. America bombing itself to debt by cheap Chinese goods imported on container ships (efficient transportation) and distributed via Wal-Mart’s warehouse network (cheap energy and good logistics).

Add to this whole system the historically cheap cost of labour inputs (mostly in the Far East), and you have a global system buckling under its own excess and complexity after an enormous but abnormal rate of growth and innovation. As Bill points out below, creative destruction is a normal part of the business cycle. It’s essential, in fact.

And while the Austrian theory of the credit cycle is becoming vogue now for its successful prediction that a boom in credit leads to a later bust, a lot of Austrian theory is also focused on entrepreneurship and human action and wealth creation. If you spend some time in that part of the Austrian textbook, you might actually be encouraged about the future. Why?

Entrepreneurs love recessions. Not only is it a chance for investors to buy assets at a discounted price, it’s a time of reorganisation of economic life. People still have everyday wants and needs. And in a recession, there is much less competition. Most people are inclined to be conservative and take fewer risks with their capital.

This is why the entrepreneur is the hero of Joseph Schumpeter’s capitalism. The capitalist provides surplus capital. But real business innovation and risk-taking comes from the entrepreneur. During a recession, he can form a long-lasting relationship with his customers. But what does that have to do with the current situation?

For the better part of one hundred years global trade has expanded, bringing more and more people into the world trade system. We suspect now that it must contract and eventually reorganise itself into smaller, more scalable systems. These smaller systems will produce and use energy more efficiently because they have to.

Of course no one is sure what it will look like yet. But it’s likely to be a lot different than what we’re used to. It will have to be, if we’re going to successfully adapt. We have an idea of what the characteristics of these smaller systems will be and will tell you about them next week.

But from an investment perspective, your Permanent Portfolio ought to maintain some small allocation of capital for aggressive growth stocks, especially in the energy space. They will be key to the success of any system which evolves out of the disintegration of the present one.

So yes. In a closed system without new energy inputs, there are inescapable limits on growth. We reckon the rate of growth is about to slow down dramatically (contract) as the complex systems and institutions supported by cheap credit and cheap energy collapse. But this does not mean we plan on finding a cave to hide in so we can curl up and die.

Far from it. There is only one way through a time like this. You have to have a plan. You have to use your own brain. And you have to have some idea of what’s coming so you can put yourself in a position to avoid the calamity and profit from the opportunity.

All easier said than done. But what else are you going to do? Wait for your government check? More on “The Plan” next week. And in the meantime, keep an eye on the efforts of the people who have the most at stake in the current system-the banksters and the Feds-to keep it alive. We reckon there is only one logical way for them to go, and we’ll tell you about it next week too.

Regards,
Dan Denning
Daily Reckoning Australia

February 6, 2009

The Real Causes of Depression was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The elephant in the room blasted out a mighty honk this weekend in a report by Access Economics, as reported in today’s Australian. “Batten the hatches,” Access says. “This is not just a recession. This is the sharpest deceleration Australia’s economy has ever seen.” Access adds that the federal budget is “buggered.”

“Leading economic forecaster Access Economics warns in its quarterly Business Outlook, released today, that the nation’s economic boom will ‘unwind scarily fast’, halving corporate profits, costing more than 300,000 people their jobs and blowing out the current account deficit to more than $100 billion.”

Dire stuff indeed. But the question from last week remains, is this massive dose of negative news already priced into Australian stocks? Or is it a further hammer blow that will drive them to new lows?

So far, the market seems to be taking the prospect of a prolonged earnings recession fairly well. Or maybe it’s just in denial. The Access report correctly points out that the fall in commodity prices will dry up government royalties and corporate taxes. This will lead to higher budget deficits, more unemployment, and a contraction in the mining industry after four years of break-neck expansion.

Australia’s government is now in the same pickle that Gordon Brown and Barrack Obama find themselves in: how do you distribute enough borrowed loot to keep your economy from shrinking without igniting inflation and a weakening of your currency? And if you accept that the government really can step in and spend money while households and businesses are not, where does it spend it? Roads? Bridges? Booze? Pokies?

Those are mostly political questions. Economically, it’s hard to see how corporate earnings will recover this year. Demand is falling. Miners are winding up projects. All this being the case, don’t look for earnings to lead to a big bear-market rally.

In fact, as we mentioned last week, we think it’s likely that you’ll see a large exodus of institutional money out of common stocks and into corporate bonds. Corporate bond yields are now much higher than what you’ll find in U.S. government bonds. And it is the habitual thing to do, changing asset classes rather than liquidating altogether.

The big sleeper so far this year is oil. Oil prices have fallen 25% since rallying to just over $50 last week. The leverage is out of the oil market. And with a global recession, the IEA now predicts oil demand will fall for the second year in a row. It’s the first time that’s happened since 1983.

But the real story is how the falling oil price is hammering oil producers. Multinational oil companies are cutting back exploration programs. They’re not looking for oil. And you can’t produce what you can’t find.

As for the national oil companies in Mexico, Venezuela, and Russia, well they too are being hit hard by the falling oil price. During the big run up to $150, national oil companies were cash cows. But it now appears that little of the oil bounty was reinvested in new production or even maintenance of existing production.

So what do we have now? We have a situation here. A situation where the falling oil price is leading a big reduction in oil production. This will match, for a while reduced demand for oil. But we also think it’s baiting the trap for a huge blowback in oil prices. And the spark for that could be geopolitical. More on that next week.

It didn’t seem possible, but things are getting worse for Americas largest commercial banks, Citibank and the Bank of Amerika. “The U.S. government, recognizing that the banking crisis is far larger than originally thought, is laying the groundwork for a second phase of its rescue attempt, with plans to purge bad assets that are paralyzing the financial system,” reports the Wall Street Journal.

Aha! Remember that phrase from last week, “incorporating the public debt?” This was the alchemical process by which a huge slab of outstanding debt was transferred to a new entity and converted into, ahem, “capital” in 17th century Britain. It now looks like you’ll see a new large national financial institution in America this year. It may even resemble a giant vacuum, or a garbage dump.

No matter what it looks like, it will be the receptacle for the metastasizing debt that is killing the financial sector. The Journal says that the discussions for the new “Bad Bank” between the Fed, the Treasury, and the FDIC, “show how the rapid deterioration of bank assets is outpacing the government’s rescue efforts. Banks are now struggling not only with the real-estate investments that sparked the crisis, but also with the car loans, credit-card debt and other consumer debt that have taken a hit with the faltering economy.”

We may as well get on with full nationalisation of the financial system. Thus far, it’s been incremental. But the end game is increasingly obvious now. Governments will either begin guaranteeing all mortgage lending and corporate debt (as plans in the U.K. suggest) and/or assume responsibility for the toxic assets impairing financial balance sheets (in exchange for equity).

What this means for stocks, paper currencies and gold bears more discussion. More on that next week.

Regards,
Dan Denning

January 22, 2009

The Coming Oil Backdraft was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The recent jobs report is letting us know that the “Great Receding” is continuing.  The winds of change are a-blowin’.  The question remains, however, “What kind of ‘repairs’ will be made, and how will the market respond?”

We are now approaching 2 million jobs lost in the US.  The most in over 25 years.  The number came in at -533K, meaning 25% of all jobs lost were in the last month alone.  An interesting thing about receding tides and receding economies – as long as the winds keep blowing – they keep receding.  But even after the winds stop, things don’t return to normal right away.

It appears now that we are in for yet a deeper and longer recession than previously thought.  Each week that passes, more and more people say that exact phrase.  But let’s stop for a minute and review what we have at hand.

-A negative GDP

-A 50% cut in the Equity Market

-A new weekly high in the dollar

-2nd Highest Monthly Job loss in History

-Moving toward Highest Annual Job Loss in History

-A President-Elect who responds by saying that this catastrophe points out the need for more stimulus, job creation, and provides an opportunity to “transform the economy”. (translated, “God save us all…”)

The government has done such a good job with everything else they’ve touched, we just can’t wait to see what happens when they get their socialist mitts around the throat of a gasping economy.

While I hate to see such things as a “government transformed economy”, my first concern here is what will the market’s reaction be?  As long as the FX remains unfettered, we have the opportunity to be free marketeers.
When we look at the equity indexes we see that they have not hit a new low since around the 3rd week of November.  They are up 7 of the last 9 sessions, 6 of which are at or near their session highs.  A market bottom in place?  Or forming?  Let’s hold our horses.  If we compare this to a few elements of the Great Depression, some stark contrasts stand out.  Now I was not alive during that dour period of American History, so like you, I am dependant on the written accounts to guide me.  Unemployment was accounted as high as 25%.  Currently, it is 6.7%.  With a present loss of 1.9 million jobs, that would equal a total loss of nearly 6 million jobs if we were to reach a 25% unemployment rate.  So interims of sheer unemployment, we have only gone 1/3 of the way.

The next question is this. How about other fundamentals?  Are they likely to drive us further into higher unemployment?  Here’s one consideration.  As many seem to think it was WWII that got us from the Great Depression, we have to realize that the US government had at its disposal a much larger arsenal of economic weapons than it does now.  Essentially, as the gold standard was “relaxed”, government inflation could now assume a pedal to the metal position.  Government jobs were created at breakneck speed during the depression to get people back to work, with success based on this simple equation: More workers = more revenue.  The plan of course, was that what the workers produced would more than offset the cost of job creation and maintenance.  Wow! And the government could actually make a profit by employing this plan.  Holy Moses!  The government produce a profit?  What a wonderful idea!

Ok, enough of the sarcasm.  The point is, it didn’t work.  Were it not for massive inflation over the last nearly 80 years since then, we would not have the current illusion of wealth.  And this brings us to the next problem:  The illusion of wealth.  For most people wealth itself is “relative”.  Men always measure their wealth by what other men have.  We may never reach the levels of a Bill Gates or Warren Buffet…but most of us are not troubled by that.  We just want to know, that we have enough to care for ourselves by whatever standards we deem as being wealthy.  We also want to have more than our neighbors and co-workers.  Very few of us have a life goal of being the richest person in the world.  So our view of wealth is relative.  In the end, it isn’t really the money we want, or the house or boats or whatever.  We want the joy that such things bring us.  We want the “peace” that they offer us, that everything is going to be OK.  In the end, what we want from our wealth is the ability to enjoy our lives.  Philosophers and theologians have searched for millenia for the meaning of life.  King Solomon puts it this way.  “There is nothing better for a man, than that he should eat and drink and that he should make his soul enjoy good in his labor.  This I saw also was from the hand of God”.

I say all that to say this.  In America, the poorest among us are richer than 99% of all those who have ever lived in the history of mankind.  Yet we are still inclined to call them poor.  In contrast, we consider ourselves rich.  Not by just what we own, but because we have knowledge to increase our wealth.  We have our health.  We have a long life expectancy.  And up until recently, we had a better expectation for our children than we had for ourselves.  Because wealth is not only relational, it is generational.  We want to leave something to our children.  Something better than what we had.  It is becoming more and more apparent that this will not happen.

As the Fixer-Uppers of our time continue to manipulate and convolute the economies of the world, they cannot make it better unless they simply leave it alone.  But as that is not going to happen, we may have a lot of unfolding yet to do in this unwinding of mistakes.  Because the truth of the matter is, the markets are just like a bungee cord.  You can only stretch it so far before it shoots you in the opposite direction and there is nothing you can do. The markets will correct their inefficiencies, and all the manipulation in the world can’t stop it.  Just like the fool who petitioned congress to repeal the Law of Supply and Demand, only to find out that it is a law established by God, so will the modern tinkerers find that their “solutions” are ridiculous.

For us, we will continue to trade our trend.  Next week will bring us more opportunities.  So enjoy the weekend.

Until next time,
Bill Jenkins

December 10, 2008

Government Tries to Outrun Recession… Again was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The Bureau of Labor Statistics (BLS) reported another sharp increase in producer prices during March. Finished goods were up 1.1 percent and intermediate-level goods rose 2.3 percent, pushing the year-over-year rates to 6.9 percent and 10.6 percent, respectively, in the month of March — the biggest yearly increases in this price indicator since 1981.

U.S. consumer prices rose four percent year over year, pushing the high end of a 15-year range. And you can bet the reality is worse than what the government data will confess.

The U.K. also reported a 6.2 percent year-over-year gain in its headline PPI. I mention it because the pound has been stronger than the greenback in recent years — but the inflation story is not just about the dollar. The buildup of inflation pressures overseas will soon be evident — when the foreign currency bubble pops.

You’re seeing a price revolution unfold before your very eyes. Media reports of truckers and consumers angry over escalating fuel prices are becoming more frequent and intense, as are the reports of riots over soaring food prices in some corners of the world. Cost inflation continues to ravage mining project economics, hampering the industry’s ability to increase production in response to higher prices.

The ultimate cause of both price inflation and the business (boom-bust) cycle lies in the constant manipulation of money supply and interest rate levels by central banks and their governments.

The economic data, meanwhile, continue to point to recession. Instead of letting the market correct the dislocation — heaven forbid — central bankers, under pressure from the electorate, are but fanning the flames with price pressures already at two-decade highs.

Working off the same defunct Phillips Curve dynamic (the consumptionist theory of a trade-off between inflation and unemployment) that formed the monetary policy playbook of the ‘70s, the Federal Reserve is hoping a weak economy will weigh down prices. Yet even using this theory, one can see that if the Fed is successful at averting recession, what will keep prices down?

There is no end in sight for this vicious cycle but hyperinflation if the policy continues.

But more relevant to the present, the idea that slower economic growth might relieve price pressures that are concomitantly fueled by monetary policy is limited by global factors that many have alluded to over the past year or two — a worldwide slowdown in the growth of the real pool of savings, a switch from mercantilism to consumption policies in developing countries and slower productivity growth.

As one economist recently put it (emphasize mine):

“Past bouts of expansion have created bubbles in the financial sector, plus other sectors such as housing and state-dominated sectors like medicine and education. But a high dollar internationally, the growth of the international division of labor as well as technological advance kept the prices of consumer goods down, even falling. All these effects have been absorbed already, and the falling dollar relative to other international currencies has meant a higher price on imports. Lower productivity contributes, as well, as does the general recessionary environment. So the downward price pressure on consumer goods is at an end.”

So a contraction in production just makes the situation worse. Tell it to the Fed. Or just buy gold.

Your golden bull,

Ed Bugos
April 30, 2008

Inflation in a Slowdown was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

The peculiarity of the Great Depression of 1929-33 was that the American economy proved not to be self-stabilizing, although some other major economies of the period, including the British, did recover spontaneously in the early 1930s. Indeed, for Britain, the 1930s, with industrial expansion in automobiles and extensive building of houses, was a record decade.

However, recovery in the United States was later and weaker. When one compares Franklin Roosevelt’s first term, from 1933-37, the performance of the U.S. New Deal was not as good as that of Germany, rearming under Hitler, or of the United Kingdom, building cars and houses under Stanley Baldwin and Neville Chamberlain.

This is important, because there appear to be two types of depression, one of which is much stronger and longer lasting than the other. Panics, like those of 1907 or 1987, are steep, but relatively brief; great depressions can last for a decade or more. As Irving Fisher observed — prematurely — “The Depression out of which we are now (I trust) emerging is an example of a debt-deflation depression of the most serious sort.”

He argues, “The debts of 1929 were the greatest known, both nominally and really, up to that time. They were great enough not only to “rock the boat,” but to start it capsizing. By March 1933, liquidation had reduced the debt about 20%, but had increased the dollar about 75%, so that the real debt — that is, the debt as measured in terms of commodities — was increased about 40%.”

Obviously, the combination of the need for debt liquidation with falling prices means that debt has to be redeemed in money that is harder to earn. By contrast, debt can be liquidated by currency inflation, as happened in the 1970s. The relationship between the level of U.S. debt and the level of the U.S. dollar, therefore, becomes critical. Fortunately, the dollar has been very weak, allowing excess debt to be repaid in depreciating dollars. The length of the Japanese depression after 1990 must have been affected by the high relative price of the yen, so that debts in the 1990s were being repaid in terms of a high-value currency.

Irving Fisher argues that the “big bad actors” in the Great Depression were “debt disturbances and price level disturbances.” In 2008, we certainly have debt disturbances, though these are more important in the housing market than in the stock market. However, the global economy is, on balance, in an inflationary stage, with energy prices very high and the dollar weak. China is experiencing significant inflation, and commodity prices are high, if somewhat nervous.

This is a relatively favorable situation, in that the global authorities have to deal with debt and inflation, rather than debt and deflation. As inflation helps to liquidate excess debt, these conditions are more likely to generate panics than great depressions. At any rate, one can hope so.

Regards,
Lord William Rees-Mogg
March 31, 2008

Lessons of the Great Depression was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

Complicating matters is the fact that both adversaries have powerful allies. The Fed has the Treasury and the government, as well as the Wall Street elite, as allies. The government could implement massive tax cuts in order to stimulate economic activity; the Treasury could bail out financial institutions, which in reality should be punished by bankruptcy; and the moneyed Wall Street elite will ensure that politicians and the Fed make it possible for them to continue their con game.

The private sector has allies in the form of inflation, a weak dollar, and a dissatisfied public (declining consumer confidence and lack of trust in government, which is reflected in the strong showing of Ron Paul), all of which form a powerful phalanx when battling the Fed’s reflation attacks. Inflation is a powerful ally for the private sector, because it squeezes corporate profits and curbs personal consumption.

The war between the Fed and the private sector will, in my opinion, be very protracted. The Fed will win some battles, which — along with much brouhaha in the media — will see Pyrrhic victories such as the stock market rally of August-early October, which led in dollar terms to new highs, but failed to do so in euro and gold terms, and was followed in euro terms by renewed severe weakness.

Other battles will be won by the private sector, which through its contraction (recession) amid inflation will lead to sharp downward movements in equity prices. I am well aware that the Bureau of Labor Statistics and the Bureau of Economic Analysis will continue to use bogus figures when reporting inflation, and hence real GDP growth, but they won’t be able to hide the squeeze on corporate profits and the consumer from rising prices.

Cost of living increases vastly exceed the reported inflation figures and are squeezing the consumer, which leads to revenue pressure for the corporate sector. According to the Kaiser Family Foundation, health insurance premiums have risen 78% since 2001, while wages have gained only 19%. At the same time, corporations are faced with a squeeze on margins due to rising costs. Cost pressures contributed to the dismal performance of earnings in the third quarter of 2007.

For example, Starbucks increased coffee prices by an average of nine cents per cup in July. However, customer visits to U.S. stores fell 1% for the quarter ended Sept. 30. According to the CFO, “Unbeknownst to us, we saw economic head winds that, quite frankly, came up probably stronger than I thought.” Earlier, Starbucks’ CEO had remarked: “The consumer is being faced with rising costs in every sector of their lives, and so part of that is reflecting on us.” An informed friend of ours suggested that declining traffic at Starbucks stores in the U.S. is of particular concern, since Starbucks serves all income levels. Therefore, declining traffic is not just a “subprime problem”!

This rate of economic contraction would seem to be consistent with the impending slump in corporate profits, and with the observation that the U.S. economy is already in recession.

Investment Observations

On one side of the new inflation war, the Fed is pumping liquidity into the system via rate cuts and repurchase agreements. On the other, the financial sector is withdrawing liquidity from the system via huge write-offs and newly timid lending policies. This war should lead to increased volatility. Ten percent market moves will be the order of the day.

As was the case in the 1970s, we can expect the stock market to sell off by more than 20%. At the time, the two adversaries facing each other were “easy monetary policies by the Fed” and “consumer price inflation.”

Nobody won that war decisively, since stocks in 1982 were at about the same level they had been in 1964. However, since U.S. equities had declined in real terms by 70% from their real 1966 peak to their real August low, one can now assume that the Fed lost that war. Today, the adversaries are the private sector, which with its inflated asset values now wants to deflate, and the Fed, which under Bernanke and Greenspan, never quite understood that larger and larger injections of liquidity into the system, leading to excessive debt growth, brings about a gross misallocation of capital.

I have no doubt that the Fed will lose this war as well — if not in nominal terms, then in real terms, or adjusted for the sinking value of the U.S. dollar. More to the point, the Fed has already lost this war: U.S. equities fully recovered after October 2002 and made an all-time high in October 2007 in dollar terms, but even at their recent highs they were down by 37% in Euro terms (measured by the S&P 500) and by 60% in gold terms.

Still, we have to be mindful that even if the present economic and financial environment doesn’t look particularly enticing, as was the case between 1964 and 1982 when the market didn’t make any headway, plenty of investment opportunities will present themselves from time to time for the nimble trader and for the long-term investor who will be positioned in the few asset classes that will perform well.

Moreover, it would be wrong to simply assume that recession and slumping corporate profits will inevitably knock down equity prices. Other factors such as negative real deposit rates and negative real yields on Treasury bonds because of the Fed driving down the Fed Funds rate, a weak dollar, and “bubbly” emerging markets could make U.S. equities a relatively attractive proposition compared to other financial assets.

With Bernanke at the Fed and Paulson at the Treasury, and a Euro that could face some problems (a breakup, some believe) because of badly deteriorating economic conditions in Italy, Spain, Portugal, and Greece — precious metals are likely to outperform financial assets for some years to come, resulting in the persistent decline of the Dow/gold ratio.

As Michael Berry remarked, “Gold is no friend to the world’s central bankers. The printing press is their friend.” In fact, I would be very surprised if the Dow Jones Industrials/Gold Ratio didn’t decline to between 5 and 10 within the next three years. Therefore, I should like to reiterate my recommendation to accumulate gold.

Other commodities that could come to life this year are sugar, cotton, natural gas, and palladium. Moreover, uranium is unlikely to disappoint the longs. In general, some special situations aside, I am not positive on industrial commodities in a slow growth or recession type of environment.

Among commodities and currencies, my preferred asset remains physical gold held outside the U.S., for the simple reason that — depression or inflation — it is very likely to outperform financial assets. For gold, I believe the best is yet to come!

Best regards,
Marc Faber
March 4, 2008

The Struggle Between Inflation and Lending was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.

When, inevitably, the errors start to be corrected, the result is an economic downturn. It will be called a “recession” if the government succeeds in preventing widespread bankruptcies and unemployment through one more dose of inflation.

Or it will be called a “depression” if today’s economic tempest slips out of the government’s control. From a financial point of view, a depression is a period when the distortions of an inflationary boom are liquidated — a mass die-off of the economically misbegotten. From an economic point of view, it’s a period when the general standard of living decreases significantly.

The point is that the more highly taxed, regulated, and inflated an economy is, the more likely that it’s eventually going to experience a real depression.

Perversely, the more control a government has, the longer it can put off the day of reckoning. But the longer the artificial structure is propped up, the bigger the mess will be when it eventually collapses. From my point of view, what will happen next is almost written in stone. The only real question is: When?

In 1980-82 things almost did go over the edge. But the recession was serious enough, and some subsequent extraneous positive events (the collapse of the USSR, the coming of age of China and now India) were significant enough to pull things out.

But now, more than a generation after the last serious crisis — and four full generations after the Great Depression — I think there are lots of reasons to be afraid. Very afraid.

Am I predicting the Greater Depression may be upon us? Let me preface my response with a disclaimer. I’m not a fortuneteller. But my gut feel is: Yes. I’m not going to mount all manner of statistics to buttress the assertion. My point here is to draw your attention to the fact that there’s a lot that’s likely to go wrong besides the central problem of the business cycle, a problem that is now evidenced in the collapsing housing sector and all the pain associated with that collapse.

The “other” problems now include the Forever War against Islam, Peak Oil, increasing political control over virtually all aspects of life, the potential for social unrest (within the U.S. Mexican community, for instance), the historically high level of foreign holdings of U.S. dollars, a rise in nationalism and protectionism, etc. While not always obvious, all of these things are related, so it’s likely that when one of them starts running out of control, so will the others.

What will, in fact, happen? Nobody knows, including me. But I’m quite afraid we’re in for truly stormy weather in the next few years. Most people aren’t adequately, or even at all, aware of this prospect.

I suggest you stay with the approach we advise that has a foundation in gold and carefully selected gold stocks.

As I am in for the long haul at this point, selling only reluctantly and when absolutely necessary to keep Caesar mollified or for portfolio rebalancing, I still view any weakness positively.

Making mid-stream adjustments to your portfolio based on these buying opportunities is important. Being bold when others are timid can make a big difference.

In my opinion, gold isn’t just going through the roof in the next few years. It’s going to the moon. And gold stocks are a leveraged way to capitalize on it.

Regards,
Doug Casey
Chairman, Casey Research, LLC
February 4, 2008

From Recession to Depression was originally featured on Whiskey and Gunpowder. Visit Laissez Faire Books for the best selection of libertarian book titles.