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Tuesday, April 21, 2009 He's baaack...Bill returns with a full Argentine report... What effect the $13 trillion in government spending will have... The middle class cuts back worldwide... Rob Parenteau on the consumer's contribution to recovery...and more! Getting in the Spirit of the Depression by Bill Bonner Buenos Aires, Argentina Just got back from our trip to the ranch. (About which, more below...) As near as we can tell, the financial world conveniently remained on hold while we were gone. As of Sunday night, little had changed. Gold, stocks...economists...politicians - they're all about where we left them. That is to say, the bear market rally on Wall Street continued. The feds continued to pervert the economy with their bailouts. Economists continued to call a spade a petunia. And politicians and commentators continued to blab and bluster about nothing. But yesterday, the rally on Wall Street got smacked in the chops. The Dow fell 289 points. Oil dropped to $45. Investors were selling stocks - mostly financials - and turning to the dollar and gold for safety. The dollar rose to $1.29 per euro. Gold returned to $887. The most important fact still sits like an alien spaceship on the White House lawn - so monstrous and dumbfounding that people don't know what to make of it...so they simply ignore it. The U.S. government is spending $13 trillion - nearly an entire year's output - to 'fix' the problems caused by the worldwide financial meltdown. Of course, they can't actually fix anything. Companies that are losing money are still going to be losing money. Investors are still going to take losses on stocks and bonds that were overpriced. Bad debts are still bad. Bad investments are still bad. A kiss is still a kiss. A smile is still a smile. Time goes by just like it always did. But this $13 trillion of extra spending is bound to have some big effect. What? A Financial Times article, written by one of Obama's advisors, makes a guess: "The unprecedented explosion of the US fiscal deficit raises the spectre of high future inflation. According to the Congressional Budget Office, the president's budget implies a fiscal deficit of 13 per cent of gross domestic product in 2009 and nearly 10 per cent in 2010. Even with a strong economic recovery, the ratio of government debt to GDP would double to 80 per cent in the next 10 years. "...the potential inflationary danger is that the large US fiscal deficit will lead to an increase in the supply of money. This inevitably happens in developing countries that do not have the ability to issue interest-bearing debt and must therefore finance their deficits by printing money. In contrast, when deficits do not lead to an increased supply of money, the evidence shows that they do not cause sustained price increases. "But now the large US fiscal deficits are being accompanied by rapid increases in the money supply and by even more ominous increases in commercial bank reserves that could later be converted into faster money growth. The broad money supply (M2) is already increasing at an annual rate of nearly 15 per cent. The excess reserves of the banking system have ballooned from less than $3bn a year ago to more than $700bn (€536bn, £474bn) now. "The deep recession means that there is no immediate risk of inflation. The aggregate demand for labour and goods and services is much less than the potential supply. But when the economy begins to recover, the Fed will have to reduce the excessive stock of money and, more critically, prevent the large volume of excess reserves in the banks from causing an inflationary explosion of money and credit." If that was a bit hard to follow, here is our friend, Ron Paul, with a more succinct explanation: "When I talk to many teenagers, [and] grade schoolers, they seem to have no problem comprehending the fact that if you just create a lot of money, it'll be like monopoly money and it won't have value," he told the I.O.U.S.A. crew when they sat down with him for an interview for the film. "Governments do that for all kinds of reasons, especially to enhance political power to fight wars we shouldn't be fighting or to be passing welfare programs that aren't deserved. When you print that money, the value of that dollar has to go down and then one of the consequences of inflating the money will be higher prices. But there are a lot of other problems with inflating, it causes financial bubbles and it causes a lot of economic distortions and unemployment - but inflation is very simple. When governments create new money out of thin air, you have inflation." Inflation? When? How much? No one can say. Maybe not for a long time. But when it comes...it will take our breath away. That's why we urge you to protect yourself and your money while you can. Especially now, with just shy of $11 trillion in debt already piled up... another $8.5 trillion already committed to the bailouts... and $3.6 trillion more in new spending on the table. To help protect our dear readers for these government shenanigans, we have formed a new wealth protection society. We named it in honor of our dear friend, Dr. Kurt Richebächer, whose insights and forecasts helped the readers of his Richebächer Letter protect their assets (and build upon these assets with new wealth) from the financial meltdown we are still experiencing. We want to offer you a very special opportunity: to become a member of The Richebächer Society at $200 off regular membership fees. But we can only offer this for a very limited time...and the clock is ticking. You only have until 5 PM today, April 21, at 5 PM to secure your spot in this elite circle of investors. Act now... More news from Addison on the possible end of the sucker's rally: "German investor confidence hit a two-year high last month," writes Addison in today's issue of The 5 Min. Forecast. "The Zew Center for Economic Research in Mannheim reports today that their gauge of investor sentiment perked up to a score of 13 in March, from negative 3.5. That's the first positive score since July 2007 and the highest since June 2007. "We have to wonder: Are German investors seeing value where others fear to tread... or just hopped on pilsner and schnitzel and thus easily beguiled by the sucker's rally? "In the States, the major stock indexes in fell as much as 4% yesterday. "Bank of America reported better than expected earnings, but apparently the mob has grown tired of the smoke and mirror parlor tricks being staged by the big Wall Street banks the past few weeks. "The Dow's 3.6% plunge was its biggest since March 9th, the day it hit a 12-year low. As we've forecast before, we expect another trip down to those lows. The sucker rally may have had less leggage than we previously expected. Many investors, we suspect, just want to book profits from the last six weeks - and get out." Each weekday, Addison brings readers the The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. The 5 is free to subscribers of our paid publications, including the newly revamped Richebächer Letter. Dr. Kurt Richebächer could often be found in the pages of the DR, or his newsletter, The Richebächer Letter, calling for the demise of the dollar...along with the collapse of the housing market and the end of the over-extended American consumer, as far back as 2000. Many of you felt the void left by Dr. Kurt Richebächer when he passed away in 2007, so in his honor we've formed a brand new 'wealth protection' society. For a short time, we'll waive the membership fees to the Richebächer Society - but only to those who act before TODAY, April 21, at 5 PM. Get all the information here. And back to Bill, with more thoughts: We got up before dawn. We kissed Maria, Anna, and Marta...gave Jorge a manly hug...got in our pickup truck and took off. We looked back and waved, and then we were off. Down the tree-lined driveway...out between the stone walls...and on our way. The drive to Salta airport began badly. We had barely left the house when we almost got stuck on the mud. Even with 4-wheel drive, we sank into mud up to the axels. It didn't seem like we were going anywhere. "Boy is this stupid...to get stuck in the mud in the middle of a desert," said Elizabeth. But the rivers are running high and wide in Salta province...about which, more later in the week. When we arrived back in civilization...or at least back in Salta, Argentina...we were happy to see that nothing much had changed. Just as well. We didn't want to write much about the financial world anyway. Up in the Andes, the world of money seems a million miles away. Especially at roundup time. Nobody has any money...and nobody seems to need it. But the subject came up anyway. We discovered that one of our dear readers - lovely and cultivated, like all our dear readers - lives next door, which is about 45 minutes away. Her husband, a wine producer, brought up the subject: "My investments weren't hurt directly. I don't like buying stocks and bonds. I don't want to check stock prices. So I invest in my business...or in art. Things I know about...things I like. "But what is happening in the wine business is that the upper middle part of the market is downscaling. The upper end is okay. People who spend more than $100 for a bottle of wine don't really care that much. It's an incidental expense. Sales at the upper end are okay. They're okay at the bottom too. A guy loses his job; he figures a cheap bottle of wine is a good way to forget his worries. But in the middle, people are watching their expenses closely. So when they go to a restaurant, they order a cheaper bottle of wine. Or they don't go out to eat at all. They invite friends over to the house...and go to liquor store and pay a few dollars for a bottle of wine that would have cost them $30 in a restaurant. The market between $50 and $100 has collapsed." The wine market is probably similar to many other markets. The middle class is downsizing. They need to save money. They've got to cut expenses anyway they can. So, instead of buying a $75 bottle of wine, they buy one for $29. Instead of buying a new car every three years, they wait 5 years. Instead of staying at the Ritz, they stay at the Marriott. When we went to Buenos Aires, we used to stay at the Four Seasons - which was fairly cheap by international standards. Now, with the worldwide financial meltdown, we're looking for savings just like everyone else. So this year we stayed at a little hotel in the Palermo Soho section of town called the Ultra...which also happens to be near our Daily Reckoning outpost down here. As you may know, we are very interested in Argentina. If there is any mistake in finance that the Argentines haven't made, we don't know what it is. So, we study the history of the Argentine economy to try to figure out what to expect next in the rest of the world. We maintain a little staff of researchers and writers down here to help. The Ultra is not the Four Seasons. It is barely a single season...maybe from January to June. Still, it is not a bad place to stay - especially if you want to save money - and available for about a third of the price of the Four Seasons. In a global financial meltdown, it is a good way to save money. Palermo Soho is a young, hip, stylish part of the city. The streets are cobblestoned. Practically every other building is a fashionable clothing store or a restaurant. It's a bit like the area of Los Angeles inland from Venice Beach - but more lively and interesting. On our way to the ranch, too, we saved money. We typically stay at a Starwood hotel in Cafayate. This time, we found another hotel nearby - not quite as nice, but less than half the price. We also flew a different airline - the Brazilian airline TAM, rather than British Airways. It was cheaper and just as nice. The only problem was we had to stop over in Sao Paulo before going on to Buenos Aires. Your editor could probably afford to stay at the Four Seasons or the Starwood Hotel if he wanted. But he is getting in the spirit of the depression. If he can save a buck...he is happy to do so. There must be millions...billions...of others doing the same thing. Until tomorrow, Bill Bonner The Daily Reckoning --------------------- Special Offer ---------------------------- The $2.5 Trillion Gorilla in the Room This is vital. Because, you see, a lot of Americans - and a lot of people in the rest of the world - are counting on credit-card carrying American shoppers to jumpstart the global economic engine all over again. But it isn't going to happen. And you don't want to bank your investments on the idea that it will. Or you'll risk even bigger losses than many Americans have suffered already. Here's how you can save yourself and boost your profits during the coming time bomb... --------------------------------------------------------------- The Daily Reckoning PRESENTS: For the last few years, the U.S. economy has counted on the American consumer to keep spending until their credit cards went up in smoke, just to keep the economy healthy. However, Rob Parenteau asserts, below, that consumer's contribution to economic recovery will be 'muted'. Read on... Bounce to Nowhere? by Rob Parenteau San Francisco, California The message from the March/early April macro news continues to be one of the free-fall phase ending, while the economy remains in a severe recession. Retail sales, for example, though disappointing in March, are stabilizing on a year-over-year rate of change, while the six-month rate of change is struggling back from an over-20% pace of contraction. Consumer spending is looking like it will grow 1-1.25% in Q1 real GDP, and a sequential 5-5.25% retrenchment in Q1 real GDP will mark a small improvement from Q4 2008. To be sure, the larger theme we believe will dominate the consumer sector is the need to reduce leverage, which will require a higher gross saving rate than households previously achieved. In a recent issue, we introduced a base case estimate that "The key point here is that the consumer contribution to any future recovery is likely to be muted by these debt head winds, regardless of the degree of fiscal and monetary stimulus applied." $1.2 trillion of household debt would need to be paid down over the next three years to return the household debt-to-income ratio to the pre-housing bubble trend. French banking group Societe Generale, however, estimated that a return to the trend of the past five decades would require nearly twice that level of pay down we expected. The key point here is that the consumer contribution to any future recovery is likely to be muted by these debt head winds, regardless of the degree of fiscal and monetary stimulus applied. Equity investors using the regular playbook and running into consumer discretionary stocks should make sure their long- run earning growth expectations reflect this likelihood. For example, this is shaping up much more as a U-shaped housing recession than the typical V-shaped one, as the inventory overhang this time around has proven difficult to manage. The National Association of Home Builders reports slightly improved home traffic, reflecting mortgage rates' drop below 5% again as the Fed has ploughed deeper into Treasuries. Nonresidential construction, however, is just turning into a head wind for U.S. GDP growth, with commercial construction leading the way down. This is typically a late-cycle development, and nonresidential construction tends to remain a head wind well in to the next recovery. One-third of manufacturing capacity utilization has been idled in this recession - something the U.S. economy has never seen in the post-World War II period. Capital equipment production is particularly hard hit, although the most recent monthly figures show the first sign of a turn in the momentum for both this sector and consumer goods production. Consistent with that is the pickup over the past two months of the percent of production sectors showing gains, as the one-month diffusion index has turned up and the three-month is beginning to make the turn. Small business is arguably the most entrepreneurial segment of the economy, and there is as yet no sign of any stabilization to be found here. Plans to net hire are the lowest ever recorded, and capital spending plans are as punk as they were in the deep recession of 1973- 5. We suspect the credit crunch is hitting this sector especially hard, as banks tend to ration credit to their largest customers during such periods. While we believe the policy emphasis on renewing lending to the private sector is misplaced - private sector debt loads, especially household debt, need to be paid down - if there is a sector where this policy thrust is relevant, it is the small business sector. "Deflation" remains the watchword for 2009, with headline inflation having dipped into deflation for the first time since the 1950s and the PPI crude material series still deep in deflation, though beginning to stabilize on a six-month rate of change basis, even ex energy. As the Fed trashes cash and drags down mortgage-backed securities and U.S. Treasury yields by expanding its balance sheet, it is at the same time pushing professional investors into riskier asset classes and inflation hedges. The more we think about it, the more we wonder whether the Fed has painted itself into a corner with its quantitative easing initiative. Despite the current deflation, the ballooning of the central bank's balance sheet is encouraging many professional investors to increase exposures in tangible assets like precious metals, industrial metals, energy products and agricultural land. That means the cost of inputs to production will rise before the prices of final products rise. In addition, higher energy and food prices are likely to reduce the discretionary income of households already facing wealth destruction, credit constraints and job losses. We are perplexed. How does the Fed expect these impacts of higher prices for inflation hedges on either supply or demand to be supportive of economic growth? Put plainly, quantitative easing may have a built-in contradiction: The inflation expectations it is most likely to generate are in commodities that are either inputs to production or in consumer necessities. How either of these effects increases profit expectations, and hence induces a revival in production in output and employment, still escapes us. The complexion of the U.S. macro results, while still severely recessionary, is generally better than what is coming out of Asia and Europe. Still, there are a few straws in the wind, like Japanese machine tool orders, which are showing several months of stabilization, along with Japanese consumer sentiment. These are surprising green shoots in what otherwise looks like scorched earth. We've proceeded on the assumption that the darker the macro news flow gets, the larger and more dramatic the policy push will be. A fiscal package on the order of 2-3% of GDP is under discussion in Japan, which will contain the damage, but we expect yen depreciation will need to be pursued, along with an escalating quantitative easing program to stabilize the Japanese income. We've expected some retrenchment in equities, given technically overbought conditions and our view that the second derivative trade would give way under the Q1 earnings deluge. That concern is looking premature, although we are not yet in the thick of the earnings releases. Corporate bond spreads have not moved in synch with the equity rally, which is an anomaly we felt confirmed our decision not to chase the rally. So if we are wrong and the equity rally continues or is only briefly interrupted (say, because institutional investors that did not get on the bus early decide they need to get on quick or face career risk), the better way to hedge our view may be through a long position in corporate bonds. Alternatively, there are segments of the financial sector that have large long positions in corporates, like nonlife insurers, that could be played as well. Best regards, Rob Parenteau for The Daily Reckoning Editor's Note: Rob Parenteau is the new editor of The Richebächer Letter and mind behind the Richebächer Society. Mr. Parenteau, an avid disciple of Dr. Richebächer, continues the legacy. Parenteau, in his own right, digs into the mind-numbing details of public financial information and macro-economic data to extract the precious insights that lead to intelligent investing - both avoiding risk and seizing opportunity. Based on his latest analysis, Mr. Parenteau believes the current credit crisis has not yet run its course. But he is not panicking; he is preparing...and is helping his subscribers to do the same...just as the Good Doctor did. So if you'd like to get The Richebächer Letter on your side, learn how below...but you must act now. Until 5 PM today, we are offering $200 off the regular price...get all the details here.   The Daily Reckoning - Special Reports: Fiat Currency: Using the Past to See into the Future US Recession: By far the Weakest Recovery Introducing the Single Best Way to Make Sure You'll Never Run Out of