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Today's Daily Reckoning: Obama's Bailout: Too Little, Too Late? San Jose de los Perros, Nicaragua Wednesday, February 18, 2009 --------------------- *** The market’s reaction to Obama’s bailout...stock prices are adjusting to a new psychology of a depression era... *** We have our Crash Alert flag flying high...all over the world, the search for the bottom continues... *** Gold: the best insurance against future shocks...looking back at our Five Big E’s...and more! --- 1 DAY LEFT --- Even if the Markets Go Nowhere... You can use this strategy to collect instant payouts – and lower your risks on the stocks you already own. And if you act before tomorrow, Thursday, February 20 at midnight , you can get in this ‘Millionaire’s Market’ at a significant discount. Keep reading... --------------------- Heads up: our Crash Alert flag is flying again. More about that in a minute. Our old friend, Lord Rees-Mogg, writes in the TIMES : “Daniel Webster’s opinion should never be forgotten. Of paper money he says: ‘We have suffered more from this cause than from every other cause or calamity. It has killed more men, pervaded and corrupted the choicest interests of our country more, and done more injustice than even the arms and artifices of our enemy.’ “In the 1930s some nations tried to beat the slump by competitive devaluations. In the present crisis, Britain has already experienced a very big devaluation of the pound, taking it down by a quarter against the dollar. Every country, led by the United States, has been issuing money, often in very large amounts, in order to bail out its banks. No one knows the total value of these national injections of cash into the banking systems. As the earlier injections have not restored stability to national economies, further injections inevitably will be made. All will be made in unconvertible currency, and over-issue will occur. “Governments need to create a new world system, in which gold, as a stabiliser, should play its part. For individuals, gold remains the best insurance against future shocks and the best store of value.” Yesterday, the Dow fell another 297 points...as the market continued to react to Obama’s $787 billion bailout. “Too little,” say some. “Too late,” say others. But the worst may not be over for this market. Earnings are falling...for the very simple reason that people are spending less money. People spend less. Business makes less. Lower revenues; lower earnings. As we mentioned yesterday, for the first time in history, S&P stocks are losing money. Savings rates are climbing in the United States. The trade deficit is falling. These are healthy trends for the long run. But they are hard to take in a depression. Not only are earnings falling, P/Es are falling too. Stock prices are adjusting not only to the lower earnings, but to the new psychology of a depression era. There are times when people will pay $20 for one dollar’s worth of earnings. Other times, they’ll be reluctant to pay even $5. We’ve seen the $20 figure as recently as a couple years ago. Now, the trend is moving in the opposite direction. We’re headed towards 5 bucks. That’s what people will pay for $1 of earnings when this market finally reaches its bottom. Or thereabouts. The combination of falling earnings and falling P/Es does to stock prices approximately what the Romans did to Carthage in the third Punic War. That’s why we have our Crash Alert flag flying. Stock prices delenda est Typically, depressions come with bear markets. And bear markets come with bounces and rallies. We expected an O! Bama! bounce after the election. We got one...but much less than we expected. Stocks only rallied about 15%. A stronger bounce will come, sooner or later. But we’ve put up our Crash Alert flag again – just in case. Stocks could go down another 30% – 50% first. The news from the economy is not all bad. The shipping index has rallied – up 147% from its bottom. So, somebody must be moving something. Beyond that, the headlines are grim. The automakers are headed down a dead end road, say the papers; they say they need $18.5 billion. Where are they going to get that kind of dough? The corporate bond market – to which corporate borrowers turn to raise money – is dead. When it comes to borrowing money, private borrowers just can’t compete with the U.S. federal government. Even the states can’t compete; they don’t have printing presses either. California is facing a “lockdown” of public services, Bloomberg reports. All over the world, the search for the bottom continues. Ireland seems to be edging towards default. And Japan is in a “dreadful state,” says the Economist . Things are so bad in Japan that the finance minister, Shoichi Nakagawa decided to drown his sorrows in drink. Alas, he chose the G7 meeting – at which he represented his country – to get drunk. Now, according to the New York Times , he is being forced to quit. From what we can tell, Nakagawa is the only G7 finance minister who should stay on the job. The rest of them clearly don’t know what’s going on. Otherwise, they’d be drunk too. *** Gold, as Lord Rees-Mogg notes, is the “best insurance against future shocks.” A lot of people seem to think so. Gold rose $25 yesterday, to $967, and soon will be crowding $1,000 an ounce again. Technical analysts are warning that gold is headed for a correction. “What should we do?” asks a colleague. “It looks like gold might go down in the near–term...but we don’t want investors to sell out and risk being out of the market when the big move comes.” Unless you enjoy the thrills and spills of trading in and out, we don’t recommend that you try to time the gold market. It’s too treacherous. Yes, gold may go down in the next few months. But that has been true for the last 10 years – ever since we began recommending it. It goes up. Then, it corrects. And then, before you know it, it goes up again. We don’t think that pattern is going to change anytime soon. Gold is in a bull market that will only end when the final bubble pops – the bubble in paper money. How that will happen is anyone’s guess. When it will happen is a matter of guesswork too. But the dollar delenda est too. In the meantime, we hold onto our gold and await developments. And we suggest you do the same. Yes, the price has gone up in the past couple of days...but that doesn’t mean you can’t still get the yellow metal at a bargain. In fact, you can still buy an ounce of gold with the change you find under your couch cushions...no joke. Learn all about penny-per-ounce gold here . *** Here’s an interesting little item: “US Military Will Offer Path to Citizenship,” says the New York Times . Why not? It worked for the Romans – for a while. Then, when the barbarians in the ranks became numerous and powerful, they took over. Richard Florida, writing in The Atlantic : “‘One thing seems probable to me,’ said Peer Steinbrück, the German finance minister, in September 2008. As a result of the crisis, ‘the United States will lose its status as the superpower of the global financial system.’ You don’t have to strain too hard to see the financial crisis as the death knell for a debt-ridden, overconsuming, and underproducing American empire – the fall long prophesied by Paul Kennedy and others. “Big international economic crises – the crash of 1873, the Great Depression – have a way of upending the geopolitical order, and hastening the fall of old powers and the rise of new ones. In The Post-American World (published some months before the Wall Street meltdown), Fareed Zakaria argued that modern history’s third great power shift was already upon us – the rise of the West in the 15th century and the rise of America in the 19th century being the two previous sea changes. “But Zakaria added that this transition is defined less by American decline than by ‘the rise of the rest.’ We’re to look forward to a world economy, he wrote, ‘defined and directed from many places and by many peoples.’ That’s surely true. Yet the course of events since Steinbrück’s remarks should give pause to those who believe the mantle of global leadership will soon be passed. The crisis has exposed deep structural problems, not just in the U.S. but worldwide. Europe’s model of banking has proved no more resilient than America’s, and China has shown that it remains every bit the codependent partner of the United States. The Dow, down more than a third last year, was actually among the world’s better-performing stock-market indices. Foreign capital has flooded into the U.S., which apparently remains a safe haven, at least for now, in uncertain times.” We remember our Five Big E’s from a couple of years ago. They were the underlying trends that we thought were unstoppable. Let’s see... 1. Our Experimental money system – with faith-based paper dollars at the foundation – was doomed 2. The U.S. Empire was peaking out 3. Energy was becoming more expensive 4. Wealth and power were moving to the East. 5. And the Economy was headed for a crisis. The only one of those that looks like a bad bet is number 3. Energy is a lot cheaper now that it was a year ago. But does that mean that the trend towards more expensive energy is over? Maybe...maybe not. The price of crude oil dropped below $35 this week. Yesterday, it traded at about $37. “I think we’ve seen the bottom,” says colleague Simone Wapler. Simone explains that many of the projects that were supposed to bring more oil on line have been abandoned. That will mean shorter supplies than forecast. Economic growth forecasts have been cut too...which will cut consumption. But inevitably, Asian economies will grow...and they will use more energy. There are 700 cars per 1,000 people in the US, she points out. In China, the figure is barely 20. One way or another, Asia is probably going to use more energy in the future...which is probably going to increase the price of oil. Until tomorrow, Bill Bonner The Daily Reckoning P.S. Colleague Byron King warns that although it’s easy to be lulled into believing that low energy prices are here to stay, he wouldn’t get too used to the idea. In fact, Byron thinks we are heading into what could easily be the most vicious and unpredictable financial cycle of the past 150 years. Learn how to prepare yourself (and even profit) from the ‘forever oil crash’ by clicking here . --- Special Offer --- You Can Still Have an Early Retirement Before you kiss your dreams of an early retirement goodbye, you’ll want to take a look the best ‘little-talked-about’ retirement secret out there. “Plan B Pensions” give you many, many times more options for rebalancing your portfolio in a shifting market than you’ll see in either the classic plans or more modern versions, like the 401(k) approach. You can get into some of these “Plan B Pension” programs with as little as $10 . Guest Essay: The Daily Reckoning PRESENTS: John Maynard Keynes once argued that, in a depression, it would be worthwhile to pay workers to dig holes, and to pay other workers to fill them up. But, as Nathan Lewis points out, below, when short-term “stimulus” becomes the focus, the effect is more likely to be short-term welfare. Read on... PUBLIC WORKS DONE RIGHT by Nathan Lewis In November of 1929, in reaction to the breakdown of the stock market, Herbert Hoover immediately called for a raft of economy-supporting programs including substantial spending on public works projects. This round of public spending resulted in San Francisco’s Bay Bridge, the Los Angeles Aqueduct, Hoover Dam on the Colorado River, and many other such projects. Hoover Dam is perhaps the most iconic of all of these efforts. Although environmentalists might argue, in terms of its benefits such as electricity generation and water supply for agriculture and eventually urban use, it is about as useful and worthwhile a public work as anyone could ever hope for. When it was completed, it was the world’s largest electric-power generation facility and the world’s largest concrete structure. Planning for Hoover Dam began in 1922, and was overseen by Herbert Hoover himself. Construction on the project was approved by Congress in December 1928 – long before the economic problems emerged. It was, in contemporary terms, as close to a “shovel-ready” project as you’d find. The initial appropriation for construction was made in July 1930. The project officially began in September 1930. The contract for construction was awarded to a joint venture of six private companies in March, 1931. The first thing they had to do was to make a small city for the workers who would be working on the project. Boulder City was occupied in the spring of 1932. Roughly 16,000 workers were part of the construction, and many brought their families to live in Boulder City. Initial construction on the dam project itself began with the upper cofferdam in September 1932. Construction was completed in March 1936. It was considered a great accomplishment to complete such an ambitious project so quickly. As a result of these spending programs, the Federal budget ballooned enormously. In 1929, the government had $3.862 billion of tax revenue, and spent $3.127 billion, enjoying a surplus of $734 million. In 1932, the government spent $4.659 billion, a 49% increase despite the “deflationary” environment. In 1931, the government had its first deficit in eleven years, of $462 million. Perhaps this, and the spending commitments upcoming, is why Hoover pushed through an enormous tax hike in April 1932, which was enacted in June of that year. The top income tax rate in the U.S. rose to 63%, from 25% previously. Inheritance taxes were doubled, corporate tax rates rose, and a long list of excise taxes were imposed. It was predicted to raise $1.1 billion in new revenue, in an effort to close the budget deficit. The tax didn’t help the economy much, however, and revenues remained weak. In 1932, revenue had collapsed to $1.924 billion, and were only $1.997 billion in 1933. The budget deficit exploded to $2.735 billion in 1932 and $2.602 billion in 1933. John Maynard Keynes once argued that, in a depression, it would be worthwhile to pay workers to dig holes, and to pay other workers to fill them up. But how is this different than paying workers to do absolutely nothing? The main advantages appear to be psychological. “Workers” maintain a better morality and work ethic, and are less likely to revolt, than “welfare recipients.” And, they can be counted as “employed,” while a welfare recipient might remain “unemployed” until they actually found something productive to do in the economy. We can see that it is not so easy to just “push money into an economy” via public works projects. The more useful they are, the more likely it is that they will take years of planning and construction. If the goal is to supposedly avoid some sort of downward spiral over the next six months, it is more likely that the funds will end up directed into something more like Keynes’ hole-digging exercise. Thus, we can see that, when short-term “stimulus” becomes the focus, the effect is more likely to be short-term welfare. There is nothing particularly wrong with welfare in a depression. Better than having people dying in the streets. But, increased welfare spending isn’t much of an economic program in itself. In retrospect, Hoover Dam was probably a worthwhile project. It produced something of value, and kept 16,000 workers busy over the 1931-1935 period, the worst part of the Depression. However, one effect of this aggressive deficit spending was an eventual rise in tax rates, which did additional economic harm. Roosevelt continued along the same path: spending soared up to $9.468 billion in 1940, and tax rates soared higher as well, with the top rate hitting 81% in 1940 (and 94% in 1945). Politicians always like to spend other peoples’ money, so it is no surprise that they – always and everywhere – flock around those economic advisors that tell them that enormous spending projects are the key to resolving economic difficulties. Nor is it a surprise that economists are quick to tell people what they want to hear. If you’re going to be wrong all the time, you might as well be popular, well-paid, and wrong. Economics being what it is, you can always argue later that you were wrong because “people didn’t do enough.” These ideas were solidified in a book written by John Maynard Keynes and published in 1936. Since governments had already been hard at work at “stimulus” for a half-decade or more already by that point, you could say that the book was a how-to guide for economists to justify policies that were already popular. When you get past the cloud of nonsense surrounding “stimulus spending,” with its output gaps, multipliers and so forth, it seems to me that government spending during a recession accomplishes roughly what it does during any other time. Mostly, it is a big waste of money, but it might keep some people employed and maybe you’ll even be left with something useful afterwards. I would suggest a decent rail system, at least as good as that of France. Since we’re spending trillions anyway, how about as good as the U.S. had in 1910? That would be, I argue, the least bad of all possible boondoggles. Regards, Nathan Lewis for The Daily Reckoning Editor’s Note: Nathan Lewis is the author of Gold: the Once and Future Money (2007), published by Agora Book Publishing and J. Wiley. Get your copy here. You can visit his website here. 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