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Monday, June 22, 2009 Two schools of thought on the bailout - guess which one we are in... Consumers are tightening their purse strings in a big way... Turning to Argentina to understand how financial crises work... The Mogambo on some frightening US financial numbers...and more! --------------------- Special Offer --------------------------- Do You Want to Retire in the Next 12 Months? Escape the rapidly failing US economy and discover a simple way to live the luxurious life most people only dream of... Cut your taxes...slash your monthly healthcare costs to as little as $25...and increase your quality of life-while reducing your daily expenses by up to 70%... Read on to find out how you can retire in luxury and comfort this year. --------------------------------------------------------------- Consumers are Thinking Smaller by Bill Bonner Paris, France There are two major schools of thought on the bailout: The first of which believe that the banks are still in trouble and need to be nationalized. (Roubini, Krugman) The second school of thought thinks that the banks are still in trouble, but that a public/private partnership can recapitalize them as they work their way out of the hole. (Geithner, Gross) As usual, we play hooky. Here at The Daily Reckoning, we're not in either school. In our view, the banks are in trouble because they lent too much money to too many people who couldn't pay it back. They should take the verdict of the market...and hang. Hey...won't this cause a depression? Ah...here is where we really part company with our fellow bipeds. We in a minority...such a small minority that all its adherents put together could probably fit into an elevator. Because we believe that a depression is just what America needs...and what it's going to get regardless of what the meddlers do. In fact, we think they will turn an ordinary depression into a great one. Or maybe even a "greater depression," as our old friend Doug Casey puts it. Stocks barely moved on Friday. The Dow lost 15 points. Oil lost $1.76. Gold and the dollar moved little - the former up, the latter down. California demonstrates what has to happen in an honest slump. They're preparing for "deep cuts" in school budgets, say the papers. Naturally, the education lobby is howling. But most of the money spent on 'education' is wasted anyway. Cutting back might even help kids learn something. Consumers are cutting back too. That's probably the most important new trend to come with the post-Bubble era. Consumers are thinking small...smaller houses, smaller utility bills, smaller cars, smaller debts, smaller retirements. That's a change that's likely to stick. They've seen where thinking big got them. Now, small is beautiful. More on the big trends...after the news: "Who is Scott Pattison?" writes Ian Mathias, in today's issue of The 5 Min. Forecast. "Not a man you should know, but certainly one worth listening to: He's the head of National Association of State Budget Officers, and he's rightfully freaked out. 'These are some of the worst numbers we have ever seen,' he lamented over the weekend. "The fiscal year will close in about two weeks for all but four states - New York, Texas, Michigan and Alabama. The 46 others have until midnight June 30th to figure out how to wrangle the $121 billion budget gap coming due over the next fiscal year. That task is so daunting, states have stopped increasing spending for the first time since the S&L crisis in 1983: "Cutting state government spending by a whole 2.2% certainly won't save our states. Personal income tax revenues are down 6.6% and corporate tax revenues have fallen 15.2%. The proposed $24 billion in new state taxes and fees for the fiscal year 2010 won't even cover a quarter of the projected shortfall - a projection, we hasten to add, that's counting on the recession to bottom sometime in the current calendar year. "We'll keep an eye on this crisis yet to be. In the meantime, watch for some bizarre budget tricks. Proposals in various states include: Furloughs, pay cuts, park closures, early prisoner release (seriously), benefit cuts, and odd new taxes (Kentucky is looking into taxing the purchase of cell phone ring tones.)" Ian 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 back to Bill, with more thoughts: Forgive us for repeating ourselves; but this is important. The main source of economic growth over the past 25 years was consumers' willingness to go into debt to buy things. This spurred industries in Asia to marvelous feats of production. In the United States, it caused a big increase in corporate profits. You see; labor is industry's biggest expense. Taken all together, U.S. companies pay U.S. employees who buy the goods and services their employers produce. So, businesses have the revenue from selling to employees on the right side of the ledger and the cost of paying wages on the left. But when employees began to buy more on credit, it was like a bartender who never asked customers to pay up. The companies had more revenue than ever. But they had no offsetting labor cost. Employees were spending money they never earned, so the extra sales went to the bottom-line as profit. Earnings rose on Wall Street over the last quarter century as customers went further and further into debt. The companies selling credit - the finance industry - did especially well. And now its payback time. The bartender wants his money! Earnings and sales are falling as customers try to get out of debt. They collect the same wages - for a while - and cut back on spending. Remember the chart we showed you on Friday? Consumers are saving more and spending less. This is a good thing for the individual consumer. But it is a bad thing to the economists who believe in consumer-led GDP growth. In fact, says The Richebächer Letter's Rob Parenteau, "Total U.S. retail sales have rolled back to levels we haven't seen since 2005." "The freeze in consumer spending and the consumer economy could actually take many more years to thaw." Keep reading Rob's special report on the total breakdown of American consumer culture by clicking here. All of a sudden, the consumer is acting as though he had some sense. Naturally, government officials are determined to put a stop to it. More banks were shut down last week. Banks go bust all the time. Nobody particularly cares. But some banks are said to be "too big to fail." If they go down, people believe, they take the whole economy with them. So the feds step in...either to nationalize the big banks...or to subsidize them. This, we are told, avoids worse damage. Does it? How? If a bank has made a bad loan, there is a real loss of capital. Money has been spent - perhaps on concrete...perhaps on software...maybe on champagne. It's not coming back. But, then come the bailouts. The people who made the mistakes are given an opportunity to make more of them - by the same people who were looking over their shoulders when they made the first ones. What exactly happens to the money they receive is a matter of hot dispute. Some goes to pay the bankers' bonuses. Some goes to pay their health spa fees and some gets lent out - in loans that are either better or worse than those that got them into trouble. None of this corrects the mistakes. Depression is a natural thing. In our lexicon, it is the end of a major credit expansion. It is the point in the economic cycle when it becomes clear that many of the things for which credit was used were not good uses of money. The losses, mistakes and bad investment positions need to be recognized, worked out and written off. It takes time. And it is painful. But like dentistry, it is sometimes necessary. You can paint a rotten tooth white and pretend you've fixed it. And there are a lot of people ready with a paintbrush. But that won't stop the pain. Better to yank it out...and get on with it. As consumers stop spending, business sales and earnings fall...and so does employment. The unemployment rate is now over 10% in more than a quarter of the states. It's sure to get worse. By the end of the year, it should be over 10% nationwide. As people lose jobs, they begin to think even smaller. Las Vegas holiday? Forget it! New car? Not without a subsidy; otherwise, we'll stick clunker. Go out for dinner? Nah...let's stay at home...and we'll plant a garden too! Welcome to a depression. Not such a bad thing, really. Just a period of adjustment...a time for fixing, re-organizing, downsizing, and mending. There's a time to every purpose under heaven. This is the time to take stock and shape up. But wait again. It doesn't FEEL like a depression. Where are the soup lines? Where are the Okies packing up and moving to California? Where are Ziegfield Girls, the Civilian Conservation Corps and Eleanor Roosevelt? How come this depression's not in black and white? Well...because this is a 21st century depression. This depression is in living color...and it comes to a world that is much richer than the world of the 1930s. Besides, it is just 1930...not 1932. Give it time. Capital & Crisis' Chris Mayer is calling it the 'Great Depression 2.0' - and he's created a "Wealth Recovery Program" for his readers to help answer any questions they may have about the downturn. Learn all about it when you click here. A note on the banking system from Strategic Short Report's Dan Amoss: "The popular narrative is that that the financial crisis was a failure of the free market, but this narrative glosses over the fact that banking is far, far from a free market," writes Dan. "The banking system hasn't been subject to free market discipline for decades, and it's still not. Case in point: Bank bondholders and shareholders were bailed out - at taxpayer expense - from the consequences of their poor lending and investing decisions. "Banks are supposed to be intermediaries between savers and borrowers, allocating credit in a manner at prices (interest rates) in line with default risk. But they largely failed in this role. Most banks - especially the 'too big to fail' banks - did a horrifically poor job of pricing credit risk at the peak of the credit bubble. Credit spreads were ultra low in early 2007, when it was one of the riskiest times in history to be making loans. "How did the banking system make such colossal errors in judgment about credit risk? Interest rates were sending a distorted signal about credit risk; all you needed to do was follow the new credit back to its ultimate source and ask the right questions about the connections (or lack thereof) between saver and borrower. One would think thousands upon thousands of federal banking regulators - and those responsible for designing our financial regulations - would have the resources at their disposal to identify the structural weaknesses in our financial system. "Unfortunately, instead of providing a road map to designing a system that connects savers with borrowers in a more sane, responsible manner, it looks like the proposed banking reforms will give us more of the same. Such economic power concentrated in the hands of banks not subject to enough free market discipline is a problem, and the real economy will likely suffer from it." For more from Dan, see here. And here's the latest from Argentina. The country faces a financial crisis with elections only a week away. Nestor Kirchner, husband of the present president, is running against a man who seems to know a lot about money. Francisco de Narvaez increased his own wealth 900% in the four years 2004-2008. How did he do that? Well...that's what everyone wants to know. De Narvaez has been accused of drug dealing...but so far nothing has been proved. We turn again to Argentina to try to understand how financial crises work. Studying major financial crises in America requires too much patience...and remarkable longevity. The last depression in the United States was in the '30s. And you'd have to go back to the War Between the States to find currency troubles anywhere near to those Argentina suffered in the last 25 years. "Argentina has a financial crisis about once every 10 years," say the locals. "And each crisis lasts about 10 years." If you had 100 billion pesos in 1983, you would have been a very rich man. And if you had held onto your pesos for ten years...at the end of the period you'd have just enough money to buy a cup of coffee. Then, in order to prevent further inflation, the American-advised Menem government started linking the peso to the dollar. One peso = one dollar. End of story? Not exactly. Since it had solved its currency crisis, the Menem government could borrow money again (people didn't have to worry about the inflation risk.) It barely hesitated. It borrowed heavily - though not as heavily as the US currently - and soon ran into more trouble. Then, in the early 2000s, another crisis struck. If you'd held your coffee money for the whole decade '93-'03, you got a shock at the end of it. The Argentine government froze your bank account and devalued the peso by 2/3rds. You'd have to go back to the Roosevelt administration to find a similar episode in the United States. The New Dealers reshuffled the deck, just like the Peronists would do on the pampas seven decades later. Team Roosevelt closed the banks, seized the gold, and then devalued America's money - again, by about 2/3rds. The up-coming election in Argentina could go either way, we are told. One poll puts Kirchner ahead by 10 points. Another puts him behind by 5 points. And who knows what will come out in the news! Until tomorrow, Bill Bonner The Daily Reckoning --------------------- Special Offer --------------------------- With Gold, Who's Laughing Now? With all the flak you've taken for singing gold's praises, wouldn't it be nice to laugh back? Well, today's your lucky day... an opportunity to make up to 20X your money. We have a VERY limited number of spots - so get in now! --------------------------------------------------------------- The Daily Reckoning PRESENTS: This week, the Mogambo is bombarded by a variety of fiscal numbers, from the velocity of money to US GDP. And as bad as they all are, it's no wonder they're giving him nightmares. The Mogambo explains... Nightmarish Financial Numbers by The Mogambo Guru Tampa Bay, Florida Minyanville.com had the headline, "Velocity of Money Comes to a Standstill." The report starts off with the news that "Current consumption, which at $8.2 trillion is around 70% of GDP, has fallen $150 billion from last year," and that investment, which represents things like building factories, is $1.3 trillion or 11% of GDP, and down 23.3% from last year." This is certainly bad news, although I am always leery of the concept of velocity, as it is just the plug number that makes Fisher's famous equation (MV = PQ) work out, namely that the Money supply times the turnover of the money (Velocity) equals the Quantity of things sold times the Price of those things that were sold. Simple. So since the Money supply (as measured by M2) is growing at almost 9%, Prices overall (as measured by the broad CPI) are not growing very much, and the Quantity of goods sold is way down as consumers stop consuming since they are out of money and credit, then Velocity must, by arithmetical necessity, be going down. Now do you know something that you didn't already know? But perhaps this seeming fascination with velocity has something to do with why Bloomberg.com reports that "U.S. household wealth fell in the first quarter by $1.3 trillion, extending the biggest slump on record, as home and stock prices dropped." Yikes! And in just the first three months of the year! You may be thinking to yourself, "Well, since the Worthless Mogambo Idiot (WMI) goes ballistic at the drop of a hat these days, probably as a result of his having such a tenuous and apparently transitory grasp of reality, maybe he is just over-reacting, and this is not so much." If you are one of those people who thinks such things, then I laugh - Hahaha! - in your face, and in response to the quizzical look on your face at my sudden rude arrogance, I hold up the rest of the article where it says, "Net worth for households and non-profit groups" is a nice, tidy $50.4 trillion, which seems like a lot of money, but which is actually the "lowest level since 2004," and which was down from $51.7 trillion in the fourth quarter. For some reason, they add, "The government began keeping quarterly records in 1952," probably as a reassuring way of saying, "If you ignore the staggering loss of buying power of the dollar, which one experiences as a rise in prices, and you ignore the costs of all the taxes, fees and expenses of the cost of holding and accumulating all this net worth, and you only look at nominal prices then and now, then it looks like you are a lot better off than you were in 1952, and we have records to prove it, no matter what that Stupid Mogambo Loudmouth (SML) has to say about it!" For homeowners, the bad news is that the report showed that "Owners' equity as a share of their total real-estate holdings decreased to 41.4 percent last quarter from 42.9 percent in the fourth quarter," which is bad news from the perspective of The Bad Old Days (TBOD) when Mortgage Equity Withdrawal (where homeowners were stupidly borrowing the increased "equity" that resulted from their houses going up in value so that they could spend it on sex, drug and rock & roll), was running in the hundreds of billions of dollars a year, fantastically super- charging the economy. The ugly bottom line is that "The economy contracted at a 5.7 percent annual pace in the first quarter and consumer spending rose at a 1.5 percent pace." Thus, the habit is engrained, as "Total borrowing by consumers, businesses and government agencies increased at an annual rate of 4.1 percent last quarter compared with a 6.2 percent gain the prior quarter. The gain was paced by a 23 percent surge in borrowing by the federal government, reflecting spending linked to the stimulus plan." And this doesn't even count, of course, "Borrowing by state and local governments increased at a 4.9 percent rate", as they continue their habit of spending more than they can take in. Bill Bonner here at The Daily Reckoning notes that, as we see, "some habits are hard to break. The habit of getting something for nothing is one of them," and at this rate, "The official US debt is exploding. Bill Gross says it will be 100% of US GDP within 5 years." "We’re all freaking doomed because the damned economy will remain at a standstill, at best, while the debt grows like a cancer, resulting in a debt-to-GDP exceeding 100%." Instantly my mind goes into some kind of weird dream and all I can see is three numbers floating around, bumping into one another. One of them is $14 trillion (which is GDP), and the other two are the number $11.3 trillion (which is the current national debt), and the last one is the number $3 trillion (which is how much MORE national debt will accrue this year alone) because of the sheer staggering amount of irresponsible deficit-spending the federal government will almost certainly commit this year, including the already-announced eye-popping $1.84 trillion in budget deficits and Another Freaking Trillion (AFT) or so in "surprise!" emergency supplemental appropriations as the year goes along, as is Congress's habit, altogether an insane amount of new money that guarantees ruinous inflation in consumer prices, which is the outward manifestation of the purchasing power of the dollar going down due to unprecedented creations of more and more money diluting the money stock, a devastating process which leads to social upheavals, a prospect which scares me so much that statistical analysis shows I usually pee in my pants in fear. That is why I usually wear an adult-sized diaper when reading economics news, a habit I suggest that you get into, too, if you are going to keep up with the economics stuff, because you are going to get some nasty shocks, such as Mr. Bonner saying that national debt exceeding GDP in 5 years is actually optimistic, and that his "guess is that it will reach that level even sooner" which is one of those dense oracular announcements that could mean anything, such as "We're all freaking doomed because the damned GDP may go down by a lousy 20%, making existing federal debt equal 100% of the economy Right Freaking There (RFT)!" Or he could mean that "We're all freaking doomed because the damned economy will remain at a standstill, at best, while the debt grows like a cancer, resulting in a debt-to-GDP exceeding 100%." Either way, the news is bad, except for those who have been buying gold, silver and oil, and for them the news will be good! Whee! This investing stuff is easy! Until next time The Mogambo Guru for The Daily Reckoning Editor's Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it. The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page. --------------------- 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. 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