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Friday, May 8, 2009 Don't try quantitative easing at home, kids... The Bubble Epoque can't be revived - so stop trying... China's market may be subject to more risk than is understood... Bill Bonner on managing the biggest deficit of all time...and more! Government Counterfeiting by Bill Bonner London, England The important news: Yesterday, both the Bank of England and the European Central Bank announced moves to boost the economy. They're both falling in line behind Mr. Bernanke, who is "pulling out all the stops" in order to avoid a deep depression. Both the BoE and the ECB are going to take up forms of QE - quantitative easing - in which the banks buy government debt directly. Don't try QE at home, dear reader; you'll be arrested for counterfeiting. QE so closely resembles old-fashioned printing press money that you couldn't tell them apart in a police line up. Both are ways to increase the supply of money...which, according to theory, leads to consumer price inflation. The Dow fell 102 points yesterday too. The bear market rally has gone on for nearly 9 weeks. It's probably ready for a rest...and maybe a pullback. We doubt it's over though. There is still far too much money and far too many suckers who have not been pulled back into the stock market. The next leg down of this bear market will have to wait - most likely. Another ominous thing that happened yesterday was that bond yields increased. The yield on the 10-year Treasury note - at 3.3% - is more than a full percent above its low. The yield on the 30-year bond is at 4.26%. These yields are still very low. But they seem to be moving higher. They are ominous because at some point in the future we expect all Hell to break loose in the bond market. The slippage we're seeing now in bond prices (when prices go down, yields go up) may or may not be an early warning. But we probably have a few new readers of The Daily Reckoning...let us backtrack in order to bring them into the picture. We begin by going back half a century. America emerged the world's biggest, strongest, most innovative and dynamic economy after WWII. Then, it went from strength to strength...to weakness. Gradually, Americans turned their attention away from production and towards consumption. And gradually, America's most profitable businesses shifted from making things to financing them. That's why GM created GMAC...and why GE staked its future on GE Finance. And it's why the center of American economic power moved from the manufacturing hinterlands of Detroit and Cleveland...to the financial centers on the coast...notably the big one in Lower Manhattan. The financial sector boomed by supplying credit. Americans borrowed. And so, their debt increased. From being the world's leading creditors in the '50s and '60s...they became the world's leading debtors in the '80s and '90s. Gradually, the consumer economy required more and more debt to produce an extra unit of output. Debtors had to borrow not only to buy...but also to pay back, or pay the interest on, previous borrowings. In the Eisenhower years, it took only an extra $1.50 or so of debt to spur an extra dollar's worth of GDP. By the end of the century, the cost had risen to over $4...and then to $6 a few years later. Total debt, which had been about 150% of GDP before Ronald Reagan took office, shot up to 370% in the final years of G.W. Bush. By the late '90s and early 21st century, the American economy had entered the Bubble Epoque. The financial industry - aided and abetted by the Fed - was providing so much 'liquidity' it was causing asset prices to bubble up everywhere. Of course, bubbles always blow up - without exception. And when the dot.com bubble exploded in 2000, at first, we thought that was the end of the Bubble Era. Little did we realize, the biggest bubbles were still to come. Then came the bubbles in housing, art, emerging markets, oil, and commodities. All blew up. But the biggest bubble of all - the bubble in credit - blew up too, bringing the Bubble Epoque to a close. Capitalism giveth. Capitalism taketh away. The process of what Schumpeter called "creative destruction" continues. We are now in the post-bubble era. The financial industry has been bombed out. It can no longer create bubbles. Governments all over the world are propping up the walls...and shoring up the foundations. But the Bubble Epoque can't be revived. Is that the end of the story? Not at all. The feds' efforts to stop the progress of capitalism will have some spectacular consequences. The fireworks will start when the bond market cracks...sending yields through the roof. And that's all we have to say about it today...stay tuned. Now, over to Addison, who gives us the full scoop on the bank stress test: "Nothing like peeling a band aid off slowly," writes Addison in today's issue of The 5 Min. Forecast. "The Treasury concluded their painstaking six week stress late yesterday and announced (gasp) that 19 American banks under stress need to raise $75 billion if they plan to stay in business. "Ten of the 19 banks under TARP "protection" will be REQUIRED by the U.S. government to raise capital. They include: Bank of America, Citi, PNC, Fifth Third, GMAC, Wells Fargo and a couple more. Notably absent are JP Morgan and Goldman Sachs. "The best part: Under the government's 'worst case' stress test, the 19 banks stand to lose another $600 billion... an amount large enough to require at least a few bankruptcies and or nationalizations. "What's the 'worst case' according to Timothy Geithner? 10.3% unemployment, a GDP contraction of 3.3% for the year and another 22% fall in housing prices. "Heh, that's it? That's not far off our best-case scenario. In fact, with a modicum of imagination it's not hard to envision much worse. "The Bureau of (be)Labor(ed) Statistics says 539,000 Americans lost their jobs in April. That's a horrendous number, but still below the 600,000 forecast earlier in the week. And it's actually the best jobs number since October." "The official unemployment rate still fell in line with Wall Street estimates. At 8.9% it's a 25-year high and just a hair below the 1975 peak of 9%. "Since the beginning of 2008, 5.7 million Americans have lost their jobs. A record 6.3 million people are currently filing for unemployment benefits." Addison writes every day for 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. It's a free service available only to subscribers of Agora Financial's paid publications, such as the Hulbert #1 Performing Investment Letter, Outstanding Investments. And more thoughts from Bill in London: One of the reasons people believe the "worst is behind us" is because the Chinese economy seems to be growing. This from the Financial Times: "Perhaps more than any major economy, China is showing signs of improvement, writes Geoff Dyer. Indicators suggest that the economy began to recover in March with industrial production rising 8.3 per cent from 2.8 per cent in January-February. "But could it all be a bit of false hope? Could we, in fact, be misinterpreting a temporary stimulus-induced economic pick-me-up as an actual sustainable recovery?" China says it is growing. But if it were really growing it would be using more fuel and more electricity. Instead, industrial demand for gasoil, used by factories and commercial plants, fell 12.6% in the first quarter. Our old friend Sean Corrigan, chief investment strategist over at Diapason Commodities, also points out that electricity generation has been going down too. The last seven months' power output has been 8.5% below that of a year ago. Another old friend, Jim Rogers, believes China - along with commodities - is still the best place for your money. He may be right. But we don't speak Chinese...and we fear the Chinese market may be subject to more risks than is popularly understood. One of the risks we think is especially understated for China is the risk of central planning. Investors tend to favor China - over, say, India - because they think the Chinese government - even in the hands of communists - is capable of guiding the economy to prosperity. That is, in China's case, they believe central planning is a plus and pay a premium for it. But central planning is always a mistake as near as we can tell. It is only not a problem when it is carried out so clumsily that it is ineffective. "China's head honchos tout a rosier future for the 'Red Dragon' economy than seems possible," says The Richebächer Letter's Rob Parenteau. "Over 15,000 factories in the Chinese provinces of Shenzhen, Guangzhou, or Dongguan have already shut down... with many more slated to close over the months ahead. "It's an epidemic that's happening all across Asia, though you might not be hearing about the full scale of their meltdown on the evening news. 'Half of China's toy factories have shut down. In fact, at least 67,000 factories overall closed in the last six months of 2008. With another 60,000 factories in the Wen Zhou Province alone about to shut down. "As many as 27 million Chinese are already out of work - with 20 million of them streaming out of the cities and back to the abandoned farms of the Chinese countryside." Keep reading Rob's full report and learn about two simple moves to protect yourself. One takes about five minutes to set up and, in one play, gives you a proxy hedge against the entire Asian downturn. The other is a key "super shield" against a new collapse in Asian currencies. Get all the information here. Remember the 1980s? Then, too, investors were willing to pay a premium for central planning. Then, it was Japan that was doing the planning. Investors sold U.S. stocks - on the theory that the United States couldn't get its act together - and bought Japanese stocks, because MITI, the Japanese bureaucracy in charge of economic planning, was supposed to be doing such a fine job of guiding the country to eternal success. It didn't seem to bother them that this same agency had advised Japanese carmakers to stay at home and not try to penetrate the U.S. auto market. Of course, in 1989, the Japanese market...and its economy...cracked. Then, the Japanese turned their central planning skills to the task of avoiding the kind of creative destruction that capitalism had in store for them. In this they were more successful - preventing the necessary restructuring for the next 20 years. Brain dead banks were kept alive. Zombie companies remained in business. And an amount of money equal to more than an entire year's total output of all the Japanese people was spent in futile 'stimulus' efforts. Today, Japanese stocks are still selling for 75% less than they were in 1989. Japanese property, too, is only worth about a quarter of what it was worth at the top of the boom. Keep reading for today's essay... --------------------- Special Offer --------------------------- You could have turned $5000 into $1 million in just over five years... Each week, readers to make just one investment buy. And since November 2006, not one pick has lost value! It's no wonder readers of this newsletter could have turned $5,000 into $1 million in just over five years! Now, they're quickly closing in on $2 million! Join them... --------------------------------------------------------------- The Daily Reckoning PRESENTS: The gods are laughing at us. We're sure of it. They are wondering where we think we're getting the money to pay for the all these rescue efforts. We're wondering too. More than that...they're wondering why we bother. The Bubble Epoque was grotesque and absurd. Why try to revive it? Bill Bonner explores... Better Dead Than Alive by Bill Bonner London, England When Ronald Reagan moved into the White House, total U.S. debt equaled 168% of GDP. The next 27 years took the total to 370%; it was heralded as a triumph of the Anglo-Saxon free enterprise system, but it left people with an additional $27 trillion of debt. And now, the economic system that created so many heavy balls and such long chains is in the recovery room - looked after by quacks and prayed for by most of the world. You can explain the model in a few simple sentences: Encourage people to spend. When they run out of money, encourage them to borrow. When they tire of borrowing and spending, lend them more at lower rates. As a way for people to build wealth, this economic model of the Bubble Period was as ineffective as a bad banker. It was a 'have your cake and eat it too' school of financial success with an obvious flaw. People noticed it when the correction began. They went to their cupboards and found there was nothing there. Homeowners - who had borrowed heavily against their houses - found their equity had disappeared. Capitalists found they had no capital. Workers lost their work. And this year, governments' tax receipts are collapsing too. In the United States, they're down 14% in the first half of this fiscal year. Expenses, on the other hand, are exploding. This leads to a question: governments must borrow on a Herculean scale - but from whom? The United States is expected to float a record $2 trillion in I.O.Us. for 2009 - about 15% of GDP. If the downturn persists, as it has in Japan, we could see the U.S. national debt rise to Japanese levels - close to 200% of GDP. In London, the numbers are smaller, but the math is the similar. The government has projected $175 billion deficits over the next two years. But this might be just the beginning. If deficits continue at this rate, Britain too could find itself back in the 1950s' - after two world wars, with public debt at two times GDP. "You can explain the model in a few simple sentences: Encourage people to spend. When they run out of money, encourage them to borrow. When they tire of borrowing and spending, lend them more at lower rates." What justifies such sacrifices? In time of war, citizens collect scrap iron...sell their jewelry...and buy bonds - anything to help pay for bullets and keep the Huns East of the Rhine. But what now? People clamp even bigger balls and longer chains on themselves...and for what? Taking flowers to the recovery room, they look in on the bubble model as though on a weary friend. "He supported us all," says an anxious relative... "We must do all we can to save him." "Pull the plug," is our advice. Of course, when he was in his prime the bubble was fun - laughing, singing, spending...a grasshopper on stilts! And there were all those friendly ants in Asia ready to lend him money. At the peak, the U.S.A. had net borrowing of some $2 billion per day (trade deficit/365). But now, take America's anticipated budget deficit and divide it by 365. You get a figure of nearly $6 billion per day. Even at his peak, the old bug didn't bring in that kind of money. And now, the foreigners are in recession too. They've got their own aches and pains to cure. So, how will the United States finance the biggest deficit of all time? How has Japan done it? Japan's economy has been locked up for 19 long years. It financed its confinement itself - drawing on the savings of a remarkably long- suffering population. Stimulus packages came and went. On average, they cost about 3% of GDP per year. The biggest came in 1998 - with a price of 6% of GDP. Financing this house arrest was easy - Japan began the period with a savings rate of 14% of GDP. America, on the other hand, began with a savings rate of zero. More recently, the savings rate has been reported as high as 5% - as middle- aged squirrels desperately hide a few nuts for a long winter retirement. But the gods can add it up. Even if every dollar of U.S. savings is tossed down the public hole, it will still be two thirds empty. Anticipating the problem, the Fed has already leapt into the hole itself. It offers to buy the government's bonds itself. Of course, the Fed has no real money. It must 'create' money to make the purchase. It's the latest miracle treatment, say the quacks in charge. If the Fed creates enough new money, it will offset the losses caused by the downturn. Then, happy days will be here again. The whole world seems to believe it. Stocks are rising. Ben Bernanke, this week, said the U.S. economy would recover before Christmas. The convalescence may be long, he continued, with his vision apparently restored; but it will be steady. How the gods must howl! "In the Bubble Epoque people tried to get something for nothing... Imagine, they thought they could get rich by borrowing money and spending it. Have you ever heard of something so ridiculous? Ha ha! Now, they think they can get rich by spending money that doesn't even exist." "But that's not the half of it," one of them is sure to notice. "They're digging themselves deeper into debt - trying to revive the very oaf who pushed them down in the hole in the first place. Ha ha. Ha ha." Enjoy your weekend, Bill Bonner The Daily Reckoning P.S. Our annual Agora Financial Investment Symposium in Vancouver, British Columbia is rapidly approaching...and this year marks the 10th anniversary of the newsletter you're reading today, The Daily Reckoning. So, this July, the Symposium will be focused around a "Decade of Reckoning"...four days that will help you to gain greater insight on how to turn important investment ideas into the most profitable opportunities of the next decade. This event is sure to sell-out...secure your spot now. Click here for all the info: The Agora Financial Investment Symposium: July 21-24 Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis. Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here: Mobs, Messiahs and Markets