Britannia Radio

Tuesday, May 26, 2009 Obama takes a look under the hood of the auto industry... Innocent frauds of capitalism vs. the brute force of government... Saving money: the wrench you need to repair a balance sheet... Nathan Lewis on what to really make of a Japan-like slump...and more ----------------------- Special Offer ------------------------- Your "30-Day Retirement Plan" Your Chance to Turn $500 into $14 Million. It's happened before. It could happen again - starting as early as next week... And for until Tuesday, May 26th, you get six months free. --------------------------------------------------------------- The Used Car Industry Salesman by Bill Bonner London, England Yesterday was a holiday in the US. Little news from that quarter. But while Americans were enjoying their backyard barbecues, the rest of the world turned. "Obama plans 'leaner' car industry," says the BBC. While most readers will focus on the last three words of that sentence, we direct your attention to the first two. The subject is the important part...not the predicate. That the car industry may or may not get 'leaner' is of little interest to us. It will do what it needs to do. But that the president of the United States of America is now creating the business plan for an automobile company is surely a sign of something big. The world has already turned...perhaps more than we realize. It was only a few months ago...we're almost sure...that a private company figured out for itself how it would compete. If it was well- managed - and lucky - it would grow. If it made a serious mistake, it would go out of business...leaving the premises vacant for another entrepreneur. Americans not only accepted this model, they applauded it. They thought the "free enterprise" system was the best in the world. They believed it was responsible for their wealth...their progress...and their place in the world. Now, they seem to have come to believe something else: that the president of the United States - an elected politician - should have a direct say in how individual private enterprises are organized and run. But these are the same people who elected Bill Clinton and George W. Bush - twice! They'll believe anything... "Power Pendulum Swings Toward Washington," says another paper. People think capitalism has failed them. They never understood what capitalism was...and wouldn't have wanted it at all if they had known what it was all about. Still, that doesn't mean they won't come up with something worse... Capitalism is full of what Galbraith called "innocent frauds." The capitalists try to exploit the workers. The workers try to take advantage of the capitalists. And the managers try to put one over on them both. But now, the innocent frauds of capitalism are being replaced by the brute force of government. Now, the Obama team is calling the shots itself. What does Barack Obama know about the car business? Ha...ha...ha... Oh, you and your silly questions... The role of government is commonly misunderstood. It is thought to be an impartial judge...an objective arbiter between competing interests, always asserting the common interest over the narrow interests of the competitors themselves. It is nothing of the sort. It has its own interests...its own delusions of competence...its own lusts for power and money. When the pendulum swings towards Washington it is always bad news. For no matter how big a mess GM's owners, managers and workers made of the auto business...Washington is sure to make a bigger one. And now over to The 5 Min. Forecast, for some more news: "Almost a year ago today," writes Ian in today's 5, "we forecast the 'second wave' of the housing crisis - a flood of option and Alt-A ARMs due to resent in early 2010. This chart was our pièce de résistance: "Today, we admit we were wrong... The second wave of the housing crisis will likely be even bigger then we expected. Analysts at Credit Suisse have updated this cult classic chart. Check it out: "Now, they've done you no favors with this whole color scheme/format change, so here's the meat of the updated chart. Credit Suisse added an 'unsecurtized ARM' category to the coming wave of resets, a move that bumps monthly loan resets up $2-5 billion. Monthly resets are now larger across the board. "What's more, the 'second wave' crisis that was thought to be over in late 2011 is now crashing down well into 2012. According to the group, the swell of option and unsecuritized ARM resets will not only be bigger than the subprime fiasco, but now it's forecast to last twice as long. Hmmm..." Each day, Ian Mathias writes for The 5 Min Forecast, a daily executive series e-letter that provides a quick and dirty analysis of economic and financial developments - in five minutes or less. It's a free service available only to subscribers to Agora Financial's paid publications. One such newsletter, Bulletin Board Elite, details 30-day financial plan that could easily fund your retirement. And right now, you can grab 6 months of this service, absolutely free. But you must act now; this offer is only available for the next few hours. Click here for all the information. Back to Bill in London: A hedge fund manager came by the office yesterday. "There's a new theory making its way around Wall Street," he explained. "Some people think that the government will succeed in reflating the bubble. They're putting so much money into it that they're going to be able to create one last super-bubble...a little like the 2004-2007 period." Anything is possible. We were surprised the feds were able to inflate the last bubble. Back in 2002, we thought the bubble days were over - instead, the biggest bubble of all was still ahead. The dotcom bubble had exploded. Stocks were going down. The economy was in recession. But the recession turned out to be very, very mild. Most people seemed unaware that there was a recession at all. Spending never went backwards...not an inch. In fact, all the trends already in place continued...and got much, much larger. It is very different now. "There's a major change going on; most people have not noticed," said our new friend. "People are spending money differently. First, it is obvious that they are forsaking the higher priced stores. Our fund is taking advantage of this in a very simple way. We're short the luxury retailers and long the discount stores. Because people are changing their shopping habits. And we expect this to go on for a long, long time. "They're also buying different things. Everyone knows that sales of guns and ammunition are going through the roof. There are actual shortages of some items. But people are also stocking up on gardening supplies. They're planting gardens in order to grow some of their own food. And they're buying home entertainment systems - videos...sound systems and so forth. Instead of going out to the restaurants or the movies...they're staying home. So, they're making their homes more comfortable...and safer. "Speaking of safer...sales of home safes are also taking off. They want to protect what they've got. "And speaking of restaurants...have you looked at what is happening? Same phenomenon as in the retail sector. The lower priced, fast food places, such as MacDonald's, are doing fine. But just look at the 'casual' dining places - the places where middle class people go to eat...places like Appleby's and Friday's. They're losing a lot of business. "What I think is happening is this: people are reorganizing themselves for a different, less expensive lifestyle. They're spending less already...but they're preparing to spend even less in the future. Instead of going out to the mall or to a restaurant...they're going to stay home." Whence cometh this desire to stay home? Remember, this is not a recession...and not even a phony recession such as we had in 2001-2002. This is different. It's a balance-sheet depression. People are cutting back in order to repair balance sheets. How do your repair a balance sheet? It's not as easy at taking it in to the Pep Boys...or the muffler shop. Instead, you have to pay down debt and increase equity. You have to become wealthier by saving money, rather than spending it. That's what companies are doing. That's what individuals are doing. And that's what the government ought to do. Americans were saving almost nothing a couple years ago. But in the first quarter of this year, they saved 4.2% of disposable income - or $453 billion (annualized). That's up from just $20 billion a year before. Saving money is the wrench you need to repair a balance sheet. After a very long time, finally, American grease monkeys are getting to work. "Americans are making big structural changes in the way they live. These changes are going to have a big impact on the economy for many years to come," our friend concluded. Until tomorrow, Bill Bonner The Daily Reckoning P.S. Bottom line: things are going to get worse before they get better. Particularly when the bond bubble bursts, which seems a likely scenario. Our advice is to take advantage of opportunities as they come. That's why our latest report from the Retirement Recovery Series details precisely how the collapse of the bond bubble could actually make you money. Find out more here. Sign up is completely free. ----------------------- 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: Many people are pointing to Japan as a morality tale lately - but as Nate Lewis points out, below - they are missing the major point. Read on... The Japan Baloney by Nathan Lewis Binghamton, New York Everyone's a Japan expert these days. It is a morality tale, supposedly, of banks and government "refusing to deal with the problem" - the problem is usually "bad debt" - resulting in endless stagnation. It is a total fantasy. "Inflation is always and everywhere a monetary phenomenon," we are told. Almost everybody understands that when a currency loses value, it eventually takes more and more currency to buy things. It works the other way as well. When a currency rises in value, it takes less and less currency to buy things. Let's call this process "monetary deflation." This hardly ever happens. Inflation has natural temptations, but there is normally little political support for sustained deflation. Beginning in 1985 - with a bit of international arm-twisting known as the Plaza Accord - Japan experienced probably the longest and most dramatic monetary deflation (rising currency) in the last 500 years, if not all of human history. This is obvious in foreign exchange rates. Beginning in late 1985, the yen soared above 250/dollar level that it traded in the early 1980s, eventually peaking at 80/dollar - a threefold increase - in 1995. Ouch. The yen's rise is more definitively described by the ratio of the yen to the eternal measure of value, which is gold. This may puzzle some people. Wasn't the Japanese economy roaring into a bubble in the late 1980s? Indeed it was - driven in part by the 300 basis point decline in interest rates that resulted from the soaring yen. You can imagine the effects on the already-overheated property sector. Also, the government was engaging in a series of dramatic tax cuts, in line with the similar Reagan tax cuts in the U.S. This, plus a healthy dose of irrational exuberance, was enough to keep the economy humming even though the CPI hovered around a negative 2.0% in 1987, 1988 and 1989 (when adjusted for an increase in the consumption tax). However, once the asset bubble popped, the full effects of the monetary deflation were felt. The yen kept rising, eventually hitting a peak near 28,000/oz. of gold in 2000. This was about a seven-fold rise in the yen's value from its 1980 nadir near 200,000/oz., and a threefold rise from the mid-1985 value of about 90,000/oz. I think it is fair to characterize the property market of the late 1980s as a "bubble" similar to the one we've experienced in the U.S., but it did not die naturally. No, the Japanese property market was pushed. The government, aware of unsustainable asset valuations, embarked in a draconian series of steps to depress property prices throughout the 1990s. This not only blew away the froth of unsustainable valuations, it also demolished the real, fundamental value of property. They began with a series of tax measures on January 1, 1990 - the first day of the bear market - which eliminated certain preferential capital gains tax treatments for property. To take a few of a great many such steps which followed: In 1992, the tax rate on short-term capital gains (under 2 years) on property was raised to 90%. Long-term gains were taxed at 60%. A 0.3% National property tax was introduced (this was several multiples greater than existing property taxes). A City Planning Tax of 0.3%. A Registration and License Tax of 5% of the sale value of a property. A Real Estate Acquisition Tax of 4%. An Office Tax of 0.25%. A Land Ownership Tax of 1.4%. Even the regular property tax, the Fixed Assets Tax, was effectively raised by several multiples. From 1990 to 1996, Japanese property values imploded by as much as 70%. However, the revenues from this tax rose by 46%. You can do the math. All of this resulted in epic levels of bad debts at banks. For some reason, the banks managed to get the blame for this, as if they were responsible for the unprecedented monetary deflation during the decade, or the tax assault on property owners. Banks wrote off and liquidated loans continuously during the decade. However, the economy was unable to improve due primarily to the hideous monetary deflation, so more bad debts kept piling up as one borrower after another reached the end of their resources. This gave the appearance that the banks "weren't doing anything about their bad debts." As fast as they bailed out their boat, new water was coming in. In 2000, the government, still convinced that banks "weren't doing anything about their bad debts," undertook an extensive audit of bank assets on a loan-by-loan basis. They wanted to determine if there were any "hidden bad debts," borrowers that had effectively gone bust but were being carried as performing loans. Then, having dug all the skeletons out of the closet to their satisfaction, they mandated that the banks resolve all these bad debts over the course of the next few years. Banks were required to state their progress under this plan in their financial statements. "This performance is spookily similar to the policies of both Herbert Hoover and Franklin Roosevelt, both of whom raised taxes throughout the 1930s and squandered boatloads of money on public works and other such spending 'stimulus,' with little long-term effect." Thus, we can see with great precision what banks were up to. As of September 30, 2000, Sumitomo Mitsui Financial Group had "bankrupt and quasi-bankrupt assets" of 653 billion yen. These were the real bad loans - those that had defaulted. There were another 2,594 billion of "doubtful assets" - these were loans that were paid in full, but where the borrower was in some difficulty (a large cohort after 10 years of recession). By March 31, 2003, SMFG had reduced this original group of "bankrupt and quasi-bankrupt assets" to 144.5 billion, a decline of 78%. Problem solved? As of March 31, 2003, the bank had 524.9 billion of "bankrupt and quasi-bankrupt assets," with the difference made up not by leftovers from a decade earlier, but the brand new bad debts caused by the recession of 2001-2002. Banks were doing more-or-less what they should have been doing. The government, far from "doing nothing" about the problem, was actually carpet-bombing the economy with the most destructive sorts of new taxes, on top of the horrible monetary deflation that persisted until about 2003. The Bank of Japan eventually figured out the problem and implemented its "ryoteki kanwa" plan, which was translated into English as "quantitative easing." With the decline of the yen beyond its 10- and 20- year moving averages, monetary deflation was not a problem in Japan after 2003. Finally free of the crushing monetary deflation, the economy managed a modest rebound. Yet, the economy has been strangely moribund, even taking into account the difficulties happening worldwide since 2007. Is the government still "doing nothing?" Hardly. The Japanese government's tax barrage continues to this day. Already there is an annual rise in payroll taxes, scheduled for every year between 2004 and 2017, which will eventually take the payroll tax rate from 13.6% to 18.3%. (Employers match this, and there is no maximum income to which it applies.) And what about the increase in taxes on dividends from 10% to 20%? Or the introduction of a brand-new capital gains tax on equities of 20%, which had effectively been tax-free before? Or the effective 25% increase in personal income taxes, the result of the elimination of a 20% tax cut introduced in 1998? On top of all that, politicians are talking about increasing the consumption tax (similar to a sales tax) from 5% presently to 10% or higher. Until a 3% consumption tax was introduced in 1989, there was no consumption tax at all in Japan, not even at the prefectural or municipal level. This performance is spookily similar to the policies of both Herbert Hoover and Franklin Roosevelt, both of whom raised taxes throughout the 1930s and squandered boatloads of money on public works and other such spending "stimulus," with little long-term effect. There is certainly a lesson to be learned from Japan, but it is not the one that most people think. The lesson is: keep your money stable, and taxes low. When Japan was on the gold standard in the 1950s and 1960s, and reduced taxes steadily, it was the growth wonder of the world. Regards, Nathan Lewis for The Daily Reckoning