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Tuesday, May 5, 2009 Is all this market optimism justified? Consumers are becoming bolder...and returning to bad habits... How to live through the 'Greater Depression' in comfort and style... Thomas E. Woods, Jr. on what's driving the bust...and more! --------------------- Special Offer --------------------------- All Those People Laughed at You When You Bought Gold... Wouldn't you love to throw it back in their face? Drive past their house in your Lamborghini on the way to your private jet? So you can fly to your private island? Now's your chance. One simple move that can turn $10,000 into $1,509,000. But I warn you... Only 1 in 100 people can probably handle this. Are you one of them? Only you can decide... --------------------------------------------------------------- Market Deceptions by Bill Bonner London, England Happy days are here again! Enjoy them while they last... "Optimism builds," says a headline in the Financial Times. As predicted, the world markets are enjoying a bounce. People who had no idea there was anything wrong with the world financial system two years ago, now say the problem has been fixed. Who fixed it? The people who had no idea what was wrong with it, of course. What did they fix it with? The same thing that caused the problem they didn't see - debt. Who makes sure it won't break again? The people who didn't notice the wheels coming off the last time. Yesterday, the Dow rose 214 points. Oil closed over $54. Gold ended the day over $900. And dollar sank to $1.33 per euro. Most interesting...bond yields, though still pathetically low, are rising. The U.S. 10-year note yields more than 3%. The long bond yields more than 4%. The longer these trends go on, the more reasons people will find to believe that it is not just a bounce...but another major boom. New York-based Economic Cycle Research Institute says, "The U.S. is on the cusp of a growth rate cycle upturn," the article explains. Let's look at whether this optimism is justified. On the housing front...U.S. houses are down 30% from their highs. The Case-Shiller index of housing prices has fallen for 30 months in a row. Isn't that enough? Maybe. The latest data shows more sales - of new, as well as existing houses. And there are more housing starts too. But in the former boomiest states - California, Nevada and Florida - about half the sales are of foreclosed properties. These properties are hitting bargain prices...but pulling down the value of the entire housing stock. And there are still lots of houses to sell. So don't expect any major turnaround in prices. If prices have hit bottom - which we doubt - gains are likely to be very small...and they'll come very slowly. When the housing crisis began, we estimated that prices needed to come down about 40% in order to make the average house affordable by the average person. But that was before the average person's income came down. If the depression continues, as we think it will, house prices should come down a further 10% to 20%. And don't forget about the second wave of defaults headed our way. The Richebacher Letter's Rob Parenteau tells us that in 2011, the "Option ARM" and "Alt-A" home loans will reset at a higher rate...and some unlucky homeowners could see their mortgage payments as much as double. Millions will see their wealth disappear...and the ripple effect it will have on the banks and economy as a whole will be devastating. There is still time to protect your assets...read Rob's special report here: Super Shields Against the Next Round of Market Wipeouts. Besides, if the United States is entering the "worst downturn since the Great Recession," who will have the money to buy a house? But that's the issue. Maybe the world is not entering a major downturn, after all. Maybe it was just a case of mass hysteria...a panic, like the Y2K bug...or terrorism...or swine flu. Maybe people are now getting over it...and getting back to business, just like they did before. Consumers are becoming bolder. Consumer confidence measures are about 20% below the baseline metric of 1985...but that's a big improvement; they had been nearly 40% below the '85 standard. There is some evidence that consumers are returning to their bad habits, too. Consumer spending is picking up - at least, that's what recent numbers from the discount stores show. They're taking up cheap thrills and necessities again. But luxury shops are still reporting drops of about 20% per year. Major stock markets have rebounded 20% and more. But the real excitement has come in emerging markets. A few months ago, it looked as though China would be unable to decouple from the developed world. They were stuck, said analysts, like a rusty sink drain. The Middle Kingdom was headed towards recession just like everyone else. But then those clever Chinese seem to have found a wrench big enough to pop the joint. Almost unbelievably, China seems to have pulled off the much desired "V-shaped recovery." Instead, of contracting, China's figures show it expanding at a more than 8% rate. China might be lying, of course. It seems very unlikely to us that China could have recovered so quickly. This is not a recession, we keep saying. It's a depression. And depressions demand structural changes - the kind that takes time. Besides, eyewitness reports tell a story that sounds like a cross between "Grapes of Wrath and a repeat of Mao's Long March." That is Elliot Wilson's description after a recent trip into the heartland of the communist giant. More on this below, but first, we turn to Addison to see what's driving the S&P rally: "Ariba! Cinqo de Mayo herald's big news for the S&P 500 this morning: The S&P 500 is now registering a small gain for the year," writes Addison in today's issue of The 5 Min. Forecast. "After a manic 36% bounce from its March lows, the S&P 500 has turned positive for 2009. It's now sitting on a whopping 0.4% gain, thank you very much. "But before you down the Cuervo Gold and shimmy onto the parquet for a hat dance... consider this: "The resurgence in the S&P 500 is being driven by only three sectors: Consumer discretionary, materials, and tech. See for yourself. "It's hard to believe in a 'bull market' when 2/3s of the players are in the red. "We're taking a closer look at tech, but for the time being – as if you need another reason to turn off CNBC - healthcare, utilities and consumer staples, the classic refuge for mainstream money managers aren't such a good choice during this sucker's rally." Wanna make sure you get The 5 - in its entirety - sent to your inbox, every Monday through Friday? You can...by becoming a subscriber to one of Agora Financial's paid publications, such as Penny Stock Fortunes. Its latest special report details the easiest way to make money in this market - by focusing on stocks most investors overlook. Read all about it here. And back to Bill, with more thoughts: "Once-bustling malls are now empty," Wilson continues. "Plaza 66 in Shanghai, owned by Hong Kong-listed Hang Lung Properties, is a case in point. On a Friday afternoon, the 51,700 square meters of high-end retail space boasted exactly 11 customers... "Everywhere's the same. I talk to the concierges of Shanghai's leading hotels, always men in the know. At the JC Mandarin, occupancy is at 40 percent in early February, against 80% a year ago. At the vast JW Marriott, it's even worse; just 25%..." Office complexes too are "empty, empty, empty...Gemdale... 50 floors of office space completed last summer are all empty..." But what the heck? Maybe we're wrong. Maybe China is already recovering. It may be a structural depression - but only for the developed countries, particularly the United States. Maybe it's only a recession for China. And maybe it's over. Seems almost unbelievable...but now, with so many wonders to wonder about we wonder why we bother to wonder at all. Besides, other developing economies are reporting the same things - increases in exports after a catastrophic collapse at the end of the last year. You can measure the collapse easily just by looking at the Baltic Dry Index - which keeps track of bulk shipping rates. It fell by more than 90% last year. From its low, it's doubled - up 100%. But that still leaves it down 80% from a year ago. Stock markets in emerging markets show similar increases. Brazil's stock market is up almost 90% from its low. South Korean stocks are up 71%. And Chinese stocks - those listed on the Shanghai exchange - have gained 50%. Apparently, someone thinks the worst is over. Maybe that person is right. But we doubt that this rebound is the sign of a new, healthy boom. Credit expanded for half a century. The Bubble Epoch at its end caused trillions of dollars worth of errors. Many of those errors have already been corrected. But the economy the bubble built remains unreconstructed. Same mismanaged companies...same mismanaged regulators...same mismanaged banks. Exporting nations had gotten into the habit of earning net sales from the U.S.A. of $2 billion per day. Those earnings provided much of the speculative capital that created the Bubble Epoch prices. But that money has all but disappeared. And there's not much chance that it will return anytime soon. Instead of a healthy new boom, our guess is that the world is enjoying a sick echo of the old one. Governments, led by the U.S.A., attempt to reinflate the bubble with guarantees and giveaways equal to an entire year's annual output of the world's largest economy. Since every penny of this money is borrowed, it makes sense that every penny will have to be withdrawn from the world economy at some point. In fact, economists are already looking ahead to the moment when deflation fears give way to inflation fears. "Inflation Nation," is the title of an editorial in today's International Herald Tribune. In it, Alan Meltzer argues, "If President Obama and the Fed continue down their current path, we could see a repeat of those dreadful inflation years [the 1970s]." Professor Meltzer reminds us that cutting off the inflation of the '70s wasn't easy. The feds turned the screws...and let the prime rate go above 21%. Of course, today's Fed has this information. And Paul Volcker, who was Fed chairman during that period, is now an economic advisor to Barack Obama. Still, "I do not worry about their knowledge or technical expertise," continues Mr. Meltzer, "What I doubt is the commitment of the administration and the autonomy of the Federal Reserve ... Under Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury..." "The Fed's job is to take the punch bowl away," said an Eisenhower era chief. But we have come a long way since the Ike and Dick years. This time, the inflationary party is likely to get out of control, happy days will be here for a while...and then some very sad days are likely. When the I.O.U.S.A. team interviewed Paul Volcker in December of 2007, he said, "...when I look back on my lifetime, it is obvious that letting inflation get a little bit out of control and not dealing with economic problems effectively in the'70s led to a very uncomfortable crisis. We don't want to have to go through big recessions again to teach people fiscal responsibility. Instead, we should anticipate what needs to be done while maintaining the growth of the economy. And the threat will always be an unstable economy and an unstable currency. And that's not just destructive to economic life, but it can be destructive to America's position in the world, which to me is the greatest concern." You can read his full transcript in the companion book to the award- winning documentary film. Learn how to get the I.O.U.S.A. DVD, companion book - and your own personal bailout strategy by clicking here. "Bill, you should move to Argentina," said our old friend Doug Casey. "So should your Daily Reckoning readers. I really think people that come down here are going to fall in love with the place." We caught up with Doug in Buenos Aires. But, like your editor, Doug is looking forward to spending time away from the city...up in the wine area in the northwest of the country. "This place we're developing - Estancia - is turning into one of the most enjoyable places in the world to live, even if you can only spend a couple months a year there to recharge. It's got one of the best climates in the world, and I speak as someone who's been to 180 countries. It's a short horse-ride away from Cafayate, a town like Aspen. You wouldn't dare ride a horse into Aspen, trust me. Cafayate has a score of good restaurants and sidewalk cafes. "The key is that Estancia has everything a civilized person could want, right there. I wanted a mellow place to hang out, but couldn't find anything - anywhere - that suited. I've lived in Aspen for many years, but it's become, frankly, unacceptable. Way too expensive, too snooty. Incredibly over-regulated. Rife with class warfare. And, frankly, the United States is just not the place it used to be. But Aspen has elements worth retaining, like the restaurants, gyms, the intellectual activities. So I figured the only way to do it right was to build it myself. I'm a huge fan of spas in the Orient, for instance, so we're doing a fantastic health center, spa, and gym - including a parcours, and a lap pool. Yoga, pilates. I don't believe we've missed a trick, anywhere." We went to look at Doug's place the last time we were in Argentina. It's only about 2 hours from our ranch...and worth the drive. He's building what will probably be the finest place to live in South America. To disclose an interest, and admit a weakness for property...we were so impressed; we invested in the project...and even bought a lot. "I know people sometimes worry about the political and economic situation in Argentina. But it's actually a plus. Since the Falklands War the army, and the police have been held in low regard - a very good thing in Latin America. Most Argentines are of Italian extraction - the country is, at this point, perhaps the most demographically European in the world - and have a natural aversion to paying taxes. The place definitely has a gently anarchic flavor. The fiscal problems of the government don't affect foreigners, unless you lend them money - which I don't advise. "The Argentine government has been incredibly stupid for well over 60 years. The good part of that is the average person has learned to live with it, and work around it. The Argentines are much more able to adapt to the things the world is going into now - Americans are going to have an unpleasant learning experience." Doug is planning to live through what he calls 'the Greater Depression' in comfort and style: "We've got a Bob Cupp golf course, which we expect will be perhaps the best in Latin America. I've taken lessons, but don't consider myself a golfer. I've played polo for years, so we've got a couple of polo fields, for friendly farm-type games, rather than the type of thing they do near Buenos Aires. Salta is also an epicenter for Paso Fino and Peruana horses, which have the smoothest gates in the world; you can ride them for hours on our trails. Or days in any direction out of town, probably without seeing another person. Estancia answers the question of what you do after a golf, polo, or tennis. Some people (I'm among them) will shoot skeet. Others, including me, will relax at the library, or the cigar bar. Have a game of billiards, or croquet, or bocce. Or perhaps play bridge, chess, or poker. I like all of these things. We've got 200 acres of grapes, partially because they're economic, to keep the fees as close to zero as possible but, also because they're quite aesthetic. In addition we're putting in every description of fruit tree, berry bush, and veggy we can think of. Plus fresh dairy, Argentine beef - which is not processed in feedlots, and actually is the best in the world - and fresh fish from our own lakes; it's a chef's delight. Our concierge is a great Belgian chef who, coincidentally looks like a carbon copy of Jean-Claude Van Damme. "Best of all, so far we have buyers from 12 different countries. I've met many of them, and can tell you they're all the kind of people you want to hang around with - smart, successful, and libertarian oriented. It's a pace where a Renaissance man can feel at home. "If your readers want to find out more they can go to estanciadecafayate.com. Sign up to come on down this October." Until tomorrow, Bill Bonner The Daily Reckoning --------------------- Special Offer --------------------------- The Good Doctor Lives On... We lost an economic heavy weight in 2007: Dr. Kurt Richebächer. Many of you heeded his warnings and insightful forecasts about the coming housing bubble burst and subsequent credit crisis, and your portfolios were the better for it. Well, we would like to give you another chance to use the Good Doctor's warnings to avert or even recover from the later stages of financial catastrophe. We've just formed a brand new "wealth- protection" society, and named it in honor of Dr. Richebächer. Join this elite group of investors...click here for all the details. --------------------------------------------------------------- The Daily Reckoning PRESENTS: The economic stimulus plan may temporarily bolster the economy, but over the long term the profligate spending is more likely to drive us deeper into crisis than it is to save us. Read below to better understand how government intervention may be causing matters to get much worse... No, the Free Market Did Not Cause the Financial Crisis by Thomas E. Woods, Jr. Auburn, Alabama In March 2007 then-Treasury secretary Henry Paulson told Americans that the global economy was "as strong as I've seen it in my business career." "Our financial institutions are strong," he added in March 2008. "Our investment banks are strong. Our banks are strong. They're going to be strong for many, many years." Federal Reserve chairman Ben Bernanke said in May 2007, "We do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system." In August 2008, Paulson and Bernanke assured the country that other than perhaps $25 billion in bailout money for Fannie and Freddie, the fundamentals of the economy were sound. Then, all of a sudden, things were so bad that without a $700 billion congressional appropriation, the whole thing would collapse. In the wake of this change of heart on the part of our leaders, Americans found themselves bombarded with a predictable and relentless refrain: the free market economy has failed. The alleged remedies were equally predictable: more regulation, more government intervention, more spending, more money creation, and more debt. To add insult to injury, the very people who had been responsible for the policies that created the mess were posing as the wise public servants who would show us the way out. And following a now-familiar pattern, government failure would not only be blamed on anyone and everyone but the government itself, but it would also be used to justify additional grants of government power. The truth of the matter is that intervention in the market, rather than the market economy itself, was the driving factor behind the bust. F.A. Hayek won the Nobel Prize for his work showing how the central bank's intervention into the economy gives rise to the boom-bust cycle, making us feel prosperous until we suffer the inevitable crash. Most Americans know nothing about Hayek's theory (known as the Austrian theory of the business cycle), and are therefore easy prey for the quacks who blame the market for problems caused by the manipulation of money and credit. The artificial booms the Fed provokes, wrote economist Henry Hazlitt decades ago, must end "in a crisis and a slump, and...worse than the slump itself may be the public delusion that the slump has been caused, not by the previous inflation, but by the inherent defects of 'capitalism.'" Although my recently released book, Meltdown explains the process in more detail, an abbreviated version of Austrian business cycle theory might run as follows: Government-established central banks can artificially lower interest rates by increasing the supply of money (and thus the funds banks have available to lend) through the banking system. This is supposed to stimulate the economy. What it actually does is mislead investors into embarking on an investment boom that the artificially low rates seem to validate but that in fact cannot be sustained under existing economic conditions. Investments that would have correctly been assessed as unprofitable are falsely appraised as profitable, and over time the result is the squandering of countless resources in lines of investment that should never have been begun. If lower interest rates are the result of increased saving by the public, this increase in saved resources provides the material wherewithal to see the additional investment through to completion. The situation is very different when the lower interest rates result from the Fed's creation of new money out of thin air. In that case, the lower rates do not reflect an increase in the pool of savings from which investors can draw. Fed tinkering, in other words, does not increase the real stuff in the economy. The additional investment that the lower rates encourage therefore leads the economy down a path that is not sustainable in the long run. Investment decisions are made that quantitatively and qualitatively diverge from what the economy can support. The bust must come, no matter how much new money the central bank creates in a vain attempt to stave off the inevitable day of reckoning. The recession or depression is the necessary, if unfortunate, correction process by which the malinvestments of the boom period, having at last been brought to light, are finally liquidated. The diversion of resources into unsustainable investments out of conformity with consumer desires and resource availability comes to an end, with businesses failing and investment projects abandoned. Although painful for many people, the recession/depression phase of the cycle is not where the damage is done. The bust is the period in which the economy sloughs off the malinvestments and the capital misallocation, re- establishes the structure of production along sustainable lines, and restores itself to health. The damage is done during the boom phase, the period of false prosperity that precedes the bust. It is then that the artificial lowering of interest rates causes the squandering of capital and the initiation of unsustainable investments. It is then that resources that would genuinely have satisfied consumer demand are diverted into projects that make sense only in light of the temporary and artificial conditions of the boom. Adding fuel to the fire of the most recent boom was the so-called Greenspan put, the unofficial policy of the Greenspan Fed that promised assistance to private firms in the event of risky investments gone bad. The Financial Times described it as the view that "when markets unravel, count on the Federal Reserve and its chairman Alan Greenspan (eventually) to come to the rescue." According to economist Antony Mueller, "Since Alan Greenspan took office, financial markets in the U.S. have operated under a quasi-official charter, which says that the central bank will protect its major actors from the risk of bankruptcy. Consequently, the reasoning emerged that when you succeed, you will earn high profits and market share, and if you should fail, the authorities will save you anyway." The Financial Times reported in 2000, in the wake of the dot-com boom, of an increasing concern that the Greenspan put was injecting into the economy "a destructive tendency toward excessively risky investment supported by hopes that the Fed will help if things go bad." “The alleged remedies were equally predictable: more regulation, more government intervention, more spending, more money creation, and more debt.” When things do go bad, pumping more money into the banking system, thereby lowering interest rates once again, only exacerbates the problem, because it encourages the continued wasteful deployment of capital in unsustainable lines that will eventually have to be abandoned anyway, and it forces healthy, wealth-generating firms to have to go on competing with bubble firms for labor and capital. When interest rates are made artificially low, they encourage the kind of investment that would normally occur only if more saved resources existed to fund them than actually do. Continuing to force interest rates down only perpetuates the allocation of capital into outlets that the economy's current resource base cannot sustain. In response to the dot-com and NASDAQ collapses and the modest recession that accompanied them in 2000 and 2001 that Alan Greenspan and the Fed chose to embark on a robust policy of inflation, an approach that culminated in lowering the federal funds rate (the rate at which banks lend to each other) to a mere one percent from June 2003 to June 2004. Already by early 2001 the Fed had begun to ease once again. That year saw no fewer than 11 rate cuts. The unsustainable dot- com boom could not, in the end, be reignited, and thank goodness - the resource misallocations in that sector were unhealthy for the economy. But the Fed's easy money and refusal to allow the recession of 2000 to take its course led to an even more perilous bubble elsewhere. That was the only recession on record in which housing starts did not decline. Not coincidentally, that was also the moment at which people began to conclude that house prices never fall, that a house is the best investment one can make, and so on. By intervening in the market then, the Fed prevented the market from making a full correction, thereby perpetuating unsustainable investment and consumption decisions. In so doing it merely postponed what it was trying to avoid, and made the crash worse when it finally came. Fiscal stimulus, meanwhile, merely diverts resources from the productive sector in order to fund money-losing enterprises arbitrarily chosen by government. These artificial expenditures, moreover, interfere with the market's attempt to sort out genuine demand from bubble demand. "Stimulus" spending can in fact keep firms (construction companies, for example) in business that for the sake of genuine economic health need to be liquidated so their resources can be more sensibly employed in more urgently demanded lines of production. The claim that "stimulus" spending is necessary to bring "idle resources" back into use also misfires, since it fails to consider why so many entrepreneurs - who have survived as long as they have on the market because of their skill at anticipating consumer demand - should suddenly have become, all at once, such poor forecasters that they're all saddled with idle resources. The reason for the idle resources is, obviously, some prior act of miscalculation. And what could have created such systemic miscalculation? Could it be the Fed's artificially low interest rates, that distort entrepreneurial forecasting and encourage the wrong kind of investments at the wrong time? Consider a restaurant owner who mistakes the temporary demand for his product deriving from the presence of the Olympics in his city with real, sustainable demand. Suppose he opens a new location to accommodate all this new demand. When the Olympics are over, he's left with idle resources - labor with nothing to do and empty restaurant space for starters. Should we want to "stimulate" these resources back into activity? Of course not. They shouldn't have been allocated this way in the first place. We should want the market, guided by the price system, to redeploy them into sensible channels. The problem, therefore, isn't that we lack enough "spending" or "demand," and that we need government to fill in the "missing demand." The problem is that in the wake of Fed-induced misallocations of resources we wind up with structural imbalances, a mismatch between the capital structure and consumer demand. The recession is the period in which the economy repairs this mismatch by reallocating resources into lines of production that actually correspond to consumer demand. The modern preoccupation with levels of spending instead of patterns of spending obscures the most important aspects of the question. Had the market been allowed to work before the collapse, there would have been no housing bubble and no crisis in the first place. Had the market been allowed to work when the crisis hit, recovery would have been swift - as it was in 1920-21, when an even worse depression came to a rapid end without any open-market operations by the Fed, and without any fiscal stimulus. (In fact, the federal budget was cut in half from 1920 to 1922.) What, in short, should we do now? Exactly the opposite of what our so- called experts, who in a sane world would be forever discredited, urge upon us. Regards, Thomas E. Woods, Jr. for The Daily Reckoning Editor's Note: The above essay was adapted with permission from Tom's recently released Meltdown: A Free-Market Look at Why the Stock Market Collapsed, the Economy Tanked, and Government Bailouts Will Make Things Worse. According to Congressman Ron Paul, "There is no better book to read on the present crisis than this one." Get your copy here. Thomas E. Woods, Jr., is a New York Times bestselling author of nine books, and a senior fellow at the Ludwig von Mises Institute. He holds a bachelor's degree from Harvard and his master's, M.Phil., and Ph.D. from Columbia University. You can also visit Tom's website to get a free chapter of Meltdown. --------------------- Special Offer --------------------------- Here's How YOU Could Make Easy Forex Profits... On Monday, March 16, 2009 - at 4:05 P.M., I sent a short email to my select group of readers. In this e-mail, I recommended one simple FX trade... By 10 a.m. that Thursday, I told my readers to sell half their position for a 99% gain... You need to give this a try...get my next alert here...   The Daily Reckoning - Special Reports: Fiat Currency: Using the Past to See into the Future Investing in Gold: The 5 Best Ways to Invest in Gold Introducing the Single Best Way to Make Sure You'll Never Run Out of Money... Click to Learn More About Mobs, Messiahs and Markets.