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Wednesday, June 10, 2009 What a marvelous time to be an economist! Banks are feeling well enough to give the feds back their money... The public sector is building the biggest debt bomb ever seen... Dr. Marc Faber on the mindset of economic policymakers...and more! --------------------- Special Offer --------------------------- The Anti-Stock Market was up 71% in 2008 ... were you? It's averaged 56.3% gains every year since 2002... And, just cashed in another 100% winner! Sign up by Thursday, June 18th and These Gains Are Yours - GUARANTEED. --------------------------------------------------------------- The Triple Crown of Financial Catastrophes by Bill Bonner London, England What a great time to be an economist! Yesterday was another dull day in the markets. The Dow was steady. Oil rose a buck. Gold went up $3. But there's nothing dull about the economic news. Already, we've been able to see things we never thought we'd see. It is as if our strange neighbors had invited friends, and even some animals, over for a night of fun - and left their curtains open. So far, we've seen a stock market crash and what looks like the beginning of another depression, already marked by the biggest bailouts and nationalizations in history. We're getting an eyeful! And with a little luck we'll probably see a bout of hyperinflation too. Crash, Depression, Hyperinflation - this is the Triple Crown of Financial Catastrophes! It is remarkable enough that we have been able to witness a genuine market crash. The crash of '87 barely counts. It sent prices down as much as a third all around the world. But it was a very short-lived affair. Bread put in the oven at the beginning of it was still doughy when it was over. Then, it kept rising for the next 20 years. The last real crash in America occurred 80 years ago. We never thought we have the privilege of seeing another one. Especially since nearly three generations of economists and financial authorities have been working to prevent them. They set up their safety nets and perfected their formulae... Fed monetary policy was thought to be such a finely tooled instrument that it was widely believed that the feds had mastered the business cycle - thereby eliminating the need for crashes or recessions. When the economy heated up, the feds turned on the air conditioning - higher rates, stricter credit standards, and even higher taxes. When it cooled down, the switches were thrown in the opposite direction and on came the heat. The economy was supposed to maintain a constant temperature all year round. With such perfect climate control systems in place, many thought the cold shivers and hot sweats were over. But something seems to have gone wrong.... And now we're enjoying the show. From one spectacle to the next...you can't say it isn't entertaining. But what might keep us from realizing our goal - and seeing all three major catastrophes that give economists the willies? Uh-oh...what's this? "US banks to repay $68 billion to Treasury," says the lead headline in today's Financial Times. "Move marks turning point in economic crisis." The banks are now feeling healthy enough to give the feds back their money. All is well, we guess. And what's this...? "OECD says statistics point to recovery," begins an item in the Financial Times. The organization says most advanced economies are indeed past the worst part of the downturn. The "possible trough" was reached in April, it says. OECD is looking at the same data as everyone else. They say it points to growth and prosperity. We wonder; how could that be? What about all those investments that still haven't been written off...written down...and restructured? What about all that debt that is still carried on tired shoulders? What about all those homeowners still yearning to sell - as soon as they can catch a break? What about all that debt that the feds are adding to the system? What about the credit contraction? What about the de-leveraging? What about all those balance sheets - household and corporate - that need to be cleaned up? What about those falling corporate earnings? What about...what about... Richard Russell tells us that the Transport Index has still not confirmed a new bull market - well, that's a good sign - but that the usually reliable Coppock Index is signaling an end to the recession and rising stock prices ahead. Oh my...what if we're dead wrong? What if something is going on that we don't understand at all? What if there is no depression...no hyperinflation...no Triple Crown of Catastrophes that we were yearning to see? "There's more under heaven and earth than is contained in your philosophy," wrote Shakespeare. No matter you think, things are always more complex than you imagine...with interpretations very different from those you impose. But what really could go wrong on the road to the Triple Crown? Will we go to our graves without ever having seen a real depression or a real hyperinflation? More on this, below. But in the meantime, check out our latest report - it explains why the stock market rally isn't all it seems - and provides you with a limited risk strategy to make average gains of 71% over the next three weeks - turning every $5,000 into $14,300. Get all the information here. More news from Ian at The 5 Min. Forecast: "The Dow crashed 1.4 points yesterday, wiping out Monday's 1.3 point moonshot. Desperate for something beyond these 0.014% 'swings,' the market's putting China in the driver's seat today...and these guys still have quite a lead foot: "Chinese auto sales soared 34% in May, year over year. According to the China Association of Automobile Manufacturers, the Red Nation scooped up 1.12 million vehicles last month, outpacing any nation in the world. Consider the course of the last 12 months, and then look at this chart...is China even part of the global slowdown? "We don't want to get too excited about this growth, as much of these sales are a product of Chinese government stimulus. But I.O.U.S.A. is certainly throwing a bunch of money at this crisis as well, and the same measure of auto sales here fell 34% in May...so they must be doing something right over in Beijing. "Chinese property sales rose 45% in the first five months of 2009 compared with the same period in 2008, their National Bureau of Statistics announced today. Heh, notice a trend? "Again, these numbers are manipulated by government intervention...but 45%? That's pretty big. We also note that real estate investment over the same period rose 6.8%, a rise the U.S. certainly can't claim. "Thus, the market story today is 'buy whatever China wants.' Namely, commodities. Oil's up to $71, a 2009 high. Copper is at an eight-month high of $2.36 a pound. Aluminum, lead, zinc and nickel are all in the same boat. "Stocks like Alcoa and Exxon Mobil helped the Dow to open up 1%." 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. Their 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 for more thoughts: What if we are wrong? For example, we believe stocks are getting ready for another big fall. As we wrote yesterday, the smart money is short the stock market. "If you think that, how come you're not 100% short the stock market?" asked a friend. In fact, we've still got about a quarter of our family wealth in stocks. Why? Well, the simple answer is: we may be opinionated, but we're not crazy. It's one thing to have an idea about what will happen. It's another thing to stake your whole financial future on it. Also, we treat our family money differently from our own, personal money. Why do we own stocks, even though we think the stock market will probably go down? 1) We know someone who is at least as smart as we are who believes that buying stocks - at bargain prices - is the safest, surest way to wealth over the long term. He and his team spend all day, every day looking for extremely undervalued companies. He operates a private, family office...not available to the public...and only buys when they're priced so cheap that even if they had to be broken up and sold off in parts the shareholders would still come out ahead. We figure our children's money is at least as safe with him as it is with us. 2) While we expect a downturn in stocks, we're not sure how this downturn will be expressed. A big increase in inflation could send stocks' nominal prices up. As we explained yesterday, you can deleverage in one of two ways...the old-fashioned honest way...by repaying your debts. Or, you can inflate your debts away. If the feds succeed in causing substantially higher rates of inflation, stocks could go up as investors buy them in order to escape inflation. Of course, the best defense against inflation is gold. But gold doesn't pay dividends. And gold has no earnings. And gold doesn't send you quarterly reports that you can use to light a fire. However, our intrepid correspondent, Byron King, has recently released a report on how to turn a tidy profit with gold - and all you have to do is take one simple action this month. The last time players used this move, they saw a 15,090% gain in less than two years. Get the full report here. We think there will be no recovery...that the feds WON'T succeed in causing inflation soon...and that stock prices will fall. Still...we hedge our bets in some very cheap stocks...just in case. While the private sector deflates and deleverages...the public sector is building the biggest debt bomb the world has ever seen. Here are the numbers we promised yesterday: US private debt is at a record high, about $44 trillion. Compared to that, the federal government's $11 trillion of official national debt doesn't seem so bad. And, the states have about $2 trillion more - which, in round numbers, doesn't seem like a cause for worry. But last week, Gov. Schwarzenegger said California's 'day of reckoning' had come. He's looking at a $24 billion hole in the Golden State's finances. And at least he's proposing to close the gap honestly - by cutting back on services and raising taxes. What else can he do? The federal government has options...and a little "technology called a printing press," as Ben Bernanke famously put it. But California can't counterfeit the money to pay its expenses; instead, it has to borrow it from willing lenders or steal it from unwilling taxpayers...there's no other way. The feds are convinced that they can spend as much as they want. This week alone, for example, they're selling $65 billion in Treasury bonds. And this year, a total of about $2 trillion are to be auctioned off. Who's going to buy these things? Beats us. And consider this: in addition to the fed's 'official' debt, there's some $100 trillion more of unfunded liabilities, commitments and obligations. Those are mostly things such as Social Security and health care commitments that the government has sworn to honor. If all those "debts" are put together...well, it comes to one helluva number - about $157 trillion of debt in America, or more than 10 times total annual GDP. "Ymmmm...this lamb is very good," we said at a dinner party in France the last time we were there. "Oh...yes...it is good," said our old friend, Pierre. "It's from New Zealand. And it almost got me arrested. "Back in the '80s, I was raising sheep. Even then it wasn't a great business. Sheep are a pain in the neck. You can never turn your back on them. They are either getting stuck in the fence or coming down with a terrible illness. You have to be on the job 24 hours a day...7 days a week. No vacations. No holidays. Never a day off. "And to make it worse, you don't earn any money. At least not in France. "Anyway...as poor as the sheep business was, it got poorer in the '80s. The British exported lamb to the French market...and they undercut our prices. Because they were part of the European Union, we couldn't do anything about it. It's a free trade zone. But the British couldn't produce lamb that cheap either. What they did was import it from New Zealand and then sell it all over Europe as 'British lamb.' It was outrageous. And I was very mad about it. "So about a dozen of us decided to take political action. We found out where the British lamb was shipped from...a place in Poitiers...and we decided to block the roads. "Well, it didn't go so well. We drove up and waited for one of their trucks to come along...and then we put our cars in the middle of the road. But we left a little gap...actually, a fairly big gap between a couple of the cars... Then, when the truck came up, the driver stopped...and he yelled... 'What the Hell are you guys doing?' Or something like that. We explained that we were blocking the road so he couldn't distribute British lamb. Well, he got back into his truck...put the big rig in gear...and smashed through our cars.... "The next time, we did stop one of the trucks...and we decided that we were going at least to let them know in Paris that we were upset about these lamb shipments... So we took the truck to the train station...dumped the lamb out onto the tracks and set fire to it. It was a huge fire...so hot the rails glowed red. We had the police...fire department...news media... But...it was nighttime...and we just pretended to be spectators when the police arrived. "Then, we really decided to go big time. We planned a commando raid on the British embassy in Paris. I was supposed to distract the guards...while one of our trucks got through the gates. It was all planned out to the second. And we even had one an insider...someone who had a pass to the embassy...I don't know how he got it... "But that went bad when there was a terrorist attack in Britain...and all the embassies were on alert...so we called it off. Instead, we decided to target the French minister of Agriculture. What a waste of time. The media didn't even cover it. They were used to it. The chicken farmers had been there the week before. And the dairy farmers tried to demonstrate the same day we did. You practically had to get in line and take a number if you planned to do a demonstration at the Agricultural ministry... "Later we tried one last thing at home. This time we stopped one of the trucks with British lamb and set the whole truck on fire. This time the gendarmes were really mad. They came and surrounded us. They took our names and addresses and let us go. They were planning to arrest us later. But that just shows how the police operate in France. We knew someone in the police headquarters. He went on the computer and erased our names... So I was never charged with anything..." 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 - 356 to be exact - so get in now! --------------------------------------------------------------- The Daily Reckoning PRESENTS: Hegel pointed out, people and governments have learned nothing from history and still believe that things are better done by the intervention of governments than by individuals left to themselves. 200 years later, this remains true. Dr. Marc Faber explores, below... The Frame of Mind of American Economic Policymakers, Part I by Dr. Marc Faber Hong Kong, China I seldom become depressed, but when I consider that prosperity is created by "peace, easy taxes and a tolerable administration of justice" I really think that the U.S. and other Western governments are doing their very best to impoverish their countries. A friend of mine, Michael Berry, whose missives I always read, could not have phrased this better than in "Importance of the Individual", a recent report in which he quotes Milton Friedman (whose views I fully share in this particular instance) in an interview with Phil Donohue According to Berry, "On February 11, 1979 Milton Friedman took 2-1/2 minutes to explain the critical importance of the individual and choice in the free enterprise system to a doubting Phil Donohue. I wonder what Dr. Friedman would say 30 years later about our current predicament and the role government is assuming in our lives? The individual's freedom and ability to choose and take risks to create value are, of course, all important life elements and a cornerstone of our country. "Individual ability to choose and take risk is being suppressed. It is increasingly evident that it is the government that is defining risk and the taking of risk. The sanctity of Moral Hazard has now been repeatedly breached by both recent administrations. We must guard these life elements jealously. Please take time to ponder the Friedman interview. "Unfortunately in the current partisan atmosphere in Washington the role of the individual and that of individual risk taking is being suppressed. When the President of the United States uses the 'Bully Pulpit' to criticize institutions for not 'playing ball' (Chrysler debt holders) and forces a CEO to resign (GM's Wagoner), when a Treasury Secretary and Chairman of the President's Economic Council team up to run an auto company (General Motors), and when no institution is too large to fail (the other side of individual risk taking) something is seriously amiss. Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual. No one is noticing. "This is not, 'Change We Can Believe In.' It is 'change we must be wary of.' Where is Milton Friedman when we really need him? Think carefully about the following interview which was conducted 30 years ago. Another read of Friedman's 'Free to Choose' is in order for all. We pray that Washington will not stray too far." Phil Donohue: When you see around the globe the mal distribution of wealth, the desperate plight of millions of people in underdeveloped countries. When you see so few haves and so many have-nots. When you see the greed and the concentration of power. Did you ever have a moment of doubt about capitalism? And whether greed is a good idea to run on? Milton Friedman: Well first of all tell me, is there some society you know that doesn't run on greed? You think Russia doesn't run on greed? You think China doesn't run on greed? What is greed? Of course none of us are greedy. It's only the other fella that's greedy. The world runs on individuals pursuing their separate interests. The greatest achievements of civilization have not come from government bureaus. Einstein didn't construct his theory under order from a bureaucrat. Henry Ford didn't revolutionize the automobile industry that way. In the only cases in which the masses have escaped from the kind of grinding poverty that you are talking about, the only cases in recorded history are where they have had capitalism and largely free trade. If you want to know where the masses are worst off, it's exactly in the kind of societies that depart from that. So that the record of history is absolutely crystal clear, there is no alternative way, so far discovered, of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system. Phil Donohue: Seems to reward not virtue as much as the ability to manipulate the system. Milton Friedman: And what does reward virtue? You think the Communist commissar rewards virtue? You think a Hitler rewards virtue? Do you think... American presidents reward virtue? Do they choose their appointees on the basis of the virtue of the people appointed or on the basis of political clout? Is it really true that political self- interest is nobler somehow than economic self-interest? You know I think you are taking a lot of things for granted. And just tell me where in the world you find these angels that are going to organize society for us? Well, I don't even trust you to do that. Well, for sure you won't find any angels at central banks around the world and in the economics faculties of universities. I needed quite a stiff drink after reading a Wall Street Journal article by Harvard Professor Gregory Mankiw, who advocates creating negative real interest rates through inflation and seems to have great sympathy for the outright expropriation of savers. Professor Mankiw needs no introduction. His great intellect was revealed on February 1, 2000, dead ahead of the NASDAQ collapse, when he expressed the view in the Wall Street Journal that "when you look at the mistakes of the 1920s and 1930s, they were clearly amateurish. It is hard to imagine that happening again - we understand the business cycle much better." "Under the guise of saving the economy, there is a not so stealthy encroachment on the rights of the individual. No one is noticing. This is not, 'Change We Can Believe In.' It is 'change we must be wary of.'" The mindset of the US Federal Reserve and of a very large number of economists is perfectly reflected in the views of Mankiw, according to whom, "It May be Time for the Fed to Go Negative" (see Wall Street Journal of April 19, 2009). For the ease of the reader I have added some comments, which will be noted in italics and with a 'MF'. Mankiw: With unemployment rising and the financial system in shambles, it's hard not to feel negative about the economy right now. The answer to our problems, however, could well be more negativity. But I'm not talking about attitude. I'm talking about numbers [MF: He means negative interest rates]... What is the best way for an economy to escape a recession? Until recently, most economists relied on monetary policy. Recessions result from an insufficient demand for goods and services - and so, the thinking goes, our central bank can remedy this deficiency by cutting interest rates. Lower interest rates encourage households and businesses to borrow and spend. More spending means more demand for goods and services, which leads to greater employment for workers to meet that demand. There is no clear evidence that interest rate cuts stimulate lasting employment gains, because "lower interest rates encourage households and businesses to borrow and spend." If an industry is plagued by overcapacities (the oil and mining industry in the 1980s and 1990s), lower interest rates (interest rates fell throughout the 1980s and 1990s) are irrelevant. (The same applies for autos now.) In addition, interest rate cuts that encourage households to borrow and spend may not help employment in the country that implements such policies (the US after 2001) but instead in another country (China), where production costs are lower and where a large pool of savings is available for capital spending. (Also, it is not consumption that creates prosperity but capital formation.) To his credit, Mankiw recognizes this problem. He writes: Mankiw: The problem today, it seems, is that the Federal Reserve has done just about as much interest rate cutting as it can. Its target for the federal funds rate is about zero, so it has turned to other tools, such as buying longer-term debt securities, to get the economy going again. But the efficacy of those tools is uncertain, and there are risks associated with them... So why shouldn't the Fed just keep cutting interest rates? Why not lower the target interest rate to, say, negative 3%? At that interest rate, you could borrow and spend $100 and repay $97 next year. This opportunity would surely generate more borrowing and aggregate demand. The problem with negative interest rates, however, is quickly apparent: nobody would lend on those terms. Rather than giving your money to a borrower who promises a negative return, it would be better to stick the cash in your mattress. Because holding money promises a return of exactly zero, lenders cannot offer less. Unless, that is, we figure out a way to make holding money less attractive. At one of my recent Harvard seminars, a graduate student proposed a clever scheme to do exactly that. Imagine that the Fed were to announce that, a year from today, it would pick a digit from zero to 9 out of a hat. All currency with a serial number ending in that digit would no longer be legal tender. Suddenly, the expected return to holding currency would become negative 10%. That move would free the Fed to cut interest rates below zero. People would be delighted to lend money at negative 3%, since losing 3% is better than losing 10%. Of course, some people might decide that at those rates, they would rather spend the money - for example, by buying a new car. But because expanding aggregate demand is precisely the goal of the interest rate cut, such an incentive isn't a flaw - it's a benefit. [MF: I think that most people would choose to invest in another country where savings wouldn't lose 3% per year.] The idea of making money earn a negative return is not entirely new. In the late 19th century, the German economist Silvio Gesell argued for a tax on holding money. He was concerned that during times of financial stress, people hoard money rather than lend it. John Maynard Keynes approvingly cited the idea of a carrying tax on money. With banks now holding substantial excess reserves, Gesell's concern about cash hoarding suddenly seems very modern. Silvio Gesell (1862-1930) was a rather obscure economist, but a cult formed around his more outlandish socialist and land nationalization ideas. He was the author of Die Reformation des Münzwesens als Brücke zum Sozialen Staat (The Reformation of the Monetary System as a Bridge to a Social State - read "socialism"). In fact, I had forgotten about him until Mankiw brought him up, but I remember well how my history teacher in high school - who also had a socialist tick, but was an outstanding historian - discussed him at length in the context of socialism and land reforms through expropriation. (Right throughout the course of history, this has never worked. Also, Gesell's tax on cash had more to do with soaking the rich than stimulating consumption.) In 1919, Gesell was called to take part in the Bavarian Soviet Republic by Ernest Niekisch. The Republic offered him a seat on the Socialisation Commission and later appointed him as the People's Representative for Finances. Fortunately (for the world), his term of office lasted only seven days. After the bloody end of the Soviet Republic, Gesell was held in detention for several months and was later acquitted of treason. Unfortunately, he never had the opportunity to read George Orwell's Animal Farm - published in 1945 - which refuted most of his arguments for a "social state". Regards, Dr. Marc Faber for The Daily Reckoning P.S. Stay tuned for the second part of this essay in tomorrow's issue of The Daily Reckoning. Editor's Note: You can catch Dr. Faber at this year's Agora Financial Investment Symposium in Vancouver, British Columbia. This year's event promises to be the best on record, and it is already 70% sold out...so secure your ticket now. Get all the information you need here: Agora Financial Investment Symposium, July 21-24 Dr. Marc Faber, an Asian-equities sleuth and the original bear on Japan, is the editor of The Gloom, Boom and Doom Report. Dr. Faber has been headquartered in Hong Kong for nearly 20 years, during which time he has specialized in Asian markets and advised major clients seeking down-and-out bargains with deep hidden value - unknown to the average investing public - and immense upside potential. Dr. Faber is the author of the bestseller Tomorrow's Gold. Get your copy here. --------------------- Special Offer --------------------------- Only 63 People Know Why These Six Tiny Companies Will Change the World... You're #64 - and you're about to become Ultra-Wealthy. This will go down in history as the "story of our era..." - and you'll be rich because you took decisive action in 2009. See the full report right here.   The Daily Reckoning - Special Reports: Fiat Currency: Using the Past to See into the Future US Consumer Spending: Consuming America Introducing the Single Best Way to Make Sure You'll Never Run Out of Money... Click to Learn More About Mobs, Messiahs and Markets.