Britannia Radio

Thursday, July 16, 2009 Back to a place that we know well: China's heading to bubble land… Americans aren't buying; so China's not selling… What is at the root of the current crisis? Stimulus… Barry Ritholtz views on the free market system…and more! --------------------- Special Offer ---------------------------   Build Huge Wealth This Year… I haven't bought a single stock in over 10 years. Why? Because here's a safer way - a way to make a fast 100%, or 23.39% in just two days, or bigger gains like 122% or 136%…   Today only we're offering more than 6 FREE MONTHS of picks…on the house! URGENT: You must reply BEFORE Midnight tonight! Act Now...   ---------------------------------------------------------------   This Too Shall Pop by Bill Bonner Waterford, Ireland     The monsoons came to an end yesterday afternoon...more below...   In the meantime, the Financial Times, on the final page of the first section, reports the big news:   "China...is back in bubble land."   After the expansion comes the contraction. After the bubble comes the clean- up. After the storm comes the sun.   But what is going on in China? What comes after the biggest export-led bubble ever? Another bubble?   It doesn't seem possible. China's number one customer is broke. It has far too many factories for those that are left. It should be closing up shop...and waiting out the bad weather. And yet, China is growing. A combination of hot money...and hot financial policy...is falling on everyone's favorite green shoot like Miracle-Gro. Its trade surplus and foreign direct investment – the usual source of reserves of foreign currencies – are only half what they were last year. But the speculators are coming in...and they are bringing cash. This has boosted Chinese reserves past the $2 trillion mark...and provided the liquidity for another round of bubble-like conditions. Trading volumes in Chinese stocks, for example, are running three times last year's.   The world's investors and economists think they are looking at the Second Coming. Chinese growth will power the world out of its slump. Hallelujah...we're saved! Things will be 'back to normal,' soon. Stocks rose yesterday in anticipation – with the Dow up.   Daily Reckoning readers are warned: this too shall pop.   Back to normal is not where we want to go. 'Normal' in the bubble years was perverted...odd...queer...weird...and unhealthy. What really makes people wealthier is capital formation – the accumulation of machines, resources, and skills. But instead of forming capital, the bubble economy consumed it. As the longer the 'normal' bubble years went on, the poorer and more vulnerable people became.   But the big bubble has already popped. And these echo bubbles won't bring it back. For behind the bouncy figures are the same limp facts we have been looking at all year. Americans aren't buying. Mortimer Zucker in the Wall Street Journal:   "Households, overburdened with historic levels of debt will also be saving more. The savings rate has already jumped to almost 7% of after-tax income from 0% in 2007, and it is still going up. Every dollar of saving comes out of consumption. Since consumer spending is the economy's main driver, we are going to have a weak consumer sector and many businesses simply won't have the means or the need to hire employees. After the 1990-91 recessions, consumers went out and bought houses, cars and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won't be able to get the financing for the big expenditures, and those who can borrow will be reluctant to do so. The paycheck has returned as the primary source of spending."   Americans aren't buying; so China isn't selling. Exports...the source of its real wealth...are down. And there's no reason to think they're coming back anytime soon.   But what about buying from inside China itself...and from its neighbors? Ah, we knew you were going to ask that question. So we prepared an answer:   It will come...but not right away. The typical Chinese consumer doesn't want the same things the typical American wants. His house does not look like the typical American house, either. And it is full of different stuff too. It will take a while to restructure the Chinese export machine for the domestic market. In addition to the factories, the distribution and sales channels need to be restructured. And it will take a while for the Chinese consumer to change his habits. While the American consumer becomes an ant – busily stocking away food for hard times...the Chinese consumer must become a grasshopper, a spendthrift with an eye for luxury.   And as for China's neighbors…such as Korea, Singapore, Taiwan, Vietnam, Thailand, Malaysia and Indonesia... they all soared thanks to the China boom. Now they're going bust in kind.   "Korean production alone is already down 14%," The Richebacher Letter's Rob Parenteau tells us. "Japan is off 20%. Taiwan's exports have dropped 28.5%. Singapore is already deep into recession. Thailand's decayed into political crisis.   "Until US and European consumers come out of their shells, the new Asian meltdown doesn't end any time soon." [Read more about this round of market wipeouts – and learn what protective steps you should take before the 'new Asian meltdown' reverberates here in the United States. See Rob's latest report here.]   'Creative destruction' is what it takes – with the usual bankruptcies, disappointments, workouts, and dislocations.   The transition won't be easy...or quick. Unemployment rises. The export economy must be destroyed before a new economy can be created. And while this is going on, the Chinese consumer is actually losing income. There may be riots and or even civil war.   Eventually, this will probably turn out okay. In the meantime, there is Hell to pay.  Now, for more news from The 5 Min. Forecast:   "The Chinese economy expanded at a dizzying 7.9%, their government announced today," writes Ian Mathias in today's issue of The 5. "That far exceeds analysts expectations and China's still-impressive 6.1% first quarter growth. Conveniently, the second quarter jump -- plus revised GDP growth expectations of 8% in the third quarter and 9% in the fourth – puts China perfectly on track for the 8% annual growth they promised earlier this year.   "Looking through the fine print of today's data… oy, these are some la-la land numbers: New lending in the first half soared 201% compared to the year before First half property sales up 53% per annum Chinese home prices are growing at a 10% annualized pace First half auto sales up 17% per annum Retail sales up 15% in the first half Inflation down 1.1% from a year ago "Of course, not all is well over there. Exports, the backbone of the Chinese economy, are down 22% so far this year. Construction starts, another staple of Chinese growth, just ended 11 straight months of decline. But still, today's numbers show nothing short of a v-shaped recovery for China. Too good to be true? Maybe."   You can get The 5 in your inbox 5 days a week, free of charge. It's one of the many perks that come along with being a subscriber to Agora Financial's paid publications, such as Master FX Options Trader. Our newest options trading research service has been on the hot streak of the year, booking 122%, 76%, 100%, 136%, 124%, 84%, and 100% (again) in just three months. And, only until tonight at midnight, you can get over 6 months of picks – free of charge. Act now… And back to the Emerald Isle, with more thoughts from Bill:   "This is not normal for Ireland," said a colleague. "We're used to rain, but this is not Irish rain. This is coming down hard."   It came down hard – off and on – for three days. Then, about 3PM yesterday, the monsoons ended. The clouds parted; the sun came out.   Ireland has been hit hard by financial storms too. Its inflation rate has turned negative...for the first time since the Great Depression. Unemployment – which we reported near 14% earlier this week – is said to be closer to 12%, according to the local paper. That's still more than twice what it was during the boom years.   "We see it everywhere," explained an Irish colleague. "The roads used to be crowded with lorries (trucks). Now, they're pretty empty. House prices are down about 30% (about the same as the US). And the Poles have left."   The boom in Ireland attracted immigrants from Eastern Europe. For the first time since the English conquered the country, people from the outside were moving in. Ireland – a major exporter of people for hundreds of years – was flattered. Then annoyed. When we last visited practically all the waitresses and barkeeps we saw were Polish. There were signs in Waterford written in Polish. There was even a Polish language TV station.   "The place was being taken over by the Poles," grumbled an Irishman.   But now the Poles were gone.   But when we went to a fancy restaurant last night, the waitresses were...you guessed it...Polish.   "Well, the Poles and the Irish always got along," continued our colleague. "Catholic...on the margins of Europe...uncivilized... We understand each other."   Ireland was transformed in the boom years; it will never be the same. Prices rose and attitudes changes. Thousands of houses were built – in a dreadful style. Office and apartment buildings went up too – also with little concern for how they looked. Or maybe the Irish like ugly houses; we don't know...we didn't like to ask. American tour groups still come. But the people on the tours are older and grayer. The younger generation of Irish-Americans is less Irish and more American. They feel less attachment to Erin's Isle... They have married Jews and Italians...gone on the Pill...and take their vacations in Paris and Cancun.   Meanwhile, in America, the citizens are increasingly turning to their government to fix the mess that the country is in. But the irony here is that the our friends on the Hill knew exactly where this speeding train was heading…and let it just keep right on going, turning a blind eye to wreck that would inevitably occur. As our own Addison Wiggin recently told an interviewer, "The House of Representatives did an investigation in 2005, following a paper that was published on their own website, showing that the derivatives risk that both Fannie Mae and Freddie Mac had exposed themselves to was potentially a disaster for the mortgage market.   "And they buried that paper, and fired the guy who wrote it. So, they were well aware of what was going on in 2005, but the market for mortgage-backed securities continued for two more years.   "They [the government] could have put the breaks on there."   You can watch Addison's full interview here.   [Editor's Note: Many of our dear readers have written in to point out that in last week's essay http://dailyreckoning.com/casting-blame-part-i/ from Barry Ritholtz, he seemed to be arguing that the current crisis was caused by a failure of regulation.   Here are a couple of snippets from readers:   "The 'market' certainly has a way of regulating itself. If these bloodsuckers and hucksters were allowed to go under as they deserve this country could possibly already be on the way to recovery. Of course this cleansing could and should have happened in the past."   And another:   "Barry is like a lot of smart people on the left - they can identify the bankers as villains, and even the Fed chairman in some cases, but it never gets through their heads that what just happened was NOT the result of 'deregulation' (more like mal-regulation) of any kind of 'free market'."   So why did we choose to run this essay – and run the second part as today's guest essay? Because for better or worse, Barry's argument is what the vast majority of the country believes, and we need to deal with it. This is an important discussion, whether you agree or disagree. Read today's essay, and let us have it. Tell us what you think…send your comments to dr@dailyreckoning.com. Let's keep this discussion going…it's bound to be a lively one.]   In the USA, the deadheads are at it. They didn't see the crisis coming. Then, they didn't understand it when it hit. But that doesn't stop them from trying to fix it – by giving the world more of what caused the crisis in the first place: stimulus!   What caused U.S. consumers to go so deeply into debt? Stimulus. What caused the Chinese to build so many factories? Stimulus. How come Americans have so many malls, so many houses, and so many bills they can't pay? Stimulus! They were stimulated to borrow by low interest rates and rising house prices – both produced in whole or in part by federal policy.   In the old days, a country would have to settle up its trade deficit in gold. As gold was called away by surplus countries, deficit countries would have to raise rates to attract more gold and reduce consumption. They system always rebalanced itself. Then, when the United States went off the quasi-gold standard, the imbalances became huge. Americans were able to go deeper and deeper into debt...while the foreigners built up more and more capacity (and more and more dollars).   But who cut the dollar lose from gold? The feds. Who made it possible for US consumers to spend far more than they earned for far longer than they could afford? The feds. Who held down the prime rate below the inflation rate for nearly four years – long after the supposed "emergency" that called for such drastic action? Oh dear reader, we don't have to tell you, do we? The feds.   That was how the feds caused the bubble in the property and the financial sector. But after the bubble blew up, they blamed Wall Street, called for more regulation, gave Wall Street trillions that taxpayers hadn't even earned yet...and provided more stimulus! And now they're talking about a "son of stimulus," yet more stimulus to an economy that is already fritzed out on stimulus.   Dead companies are kept alive. Smelly, dead-fish assets are kept on the books. And brain dead economists find employment in the Obama administration... explaining why more stimulus will set everything right again. Has the average taxpayer seen any of that 'stimulus'? Not likely. [Which is why we've given you all the tools to set up your own 'personal bailout'. You certainly can't wait for the feds to do it for you…find the resources you need, here.]   And for a while, it looked liked a summer day in Ireland. We looked out the window, delighted. "See how pretty it is...wet...and glistening in the sun..." Then, the monsoon rains started up again...we turned...and went back to work. Until tomorrow,   Bill Bonner The Daily Reckoning   --------------------- Special Offer ---------------------------   The "Forever Oil Crash" Has Already Begun   The era of "cheap oil" is long gone...but there are two investments that could give you a powerful shield against the fallout ahead - and have the potential to soar, despite the current market turmoil.   Keep reading...   ---------------------------------------------------------------   The Daily Reckoning PRESENTS: In the second part of Barry Ritholtz's guest essay, he offers his opinion on how markets can get it wrong—and not by just a little, either; occasionally they can be wildly wrong. Keep reading for Barry's particular view on free markets and regulation in the face of the epic financial crisis…   Casting Blame, Part II by Barry Ritholtz New York, New York     Structured financial products, from residential mortgage-backed securities (RMBSs) to collateralized debt obligations (CDOs), lay at the heart of the global credit and financial meltdown. The process of creating, rating, and selling this paper is complex. As we have learned after the fact, the rating agencies were not (as they claim) passive participants who just happened to underestimate the likelihood of future defaults. Rather, when they placed precious triple-A ratings on all sorts of mortgage-backed and related securities, they were active participants—collaborators, according to The Wall Street Journal.   The subprime paper that eventually collapsed found its way onto the balance sheets of many banks, funds, and other firms. Had "the securities initially received the risky ratings" they deserved (and many now carry), the various pension funds, trusts, and mutual funds that now own them "would have been barred by their own rules from buying them."   Nobel laureate Joseph Stiglitz, economics professor at Columbia University, observed: "I view the ratings agencies as one of the key culprits. They were the party that performed that alchemy that converted the securities from F-rated to A- rated. The banks could not have done what they did without the complicity of the ratings agencies."   In 2008, the House Oversight Committee opened a probe into the role of the bond-rating agencies in the credit crisis, and Congress held a hearing on the subject, featuring a now-infamous instant message exchange: "We rate every deal," one Standard & Poor's analyst told another who dared to question the validity of the ratings process. "It could be structured by cows and we would rate it."   When they are not rating bovine structured products, the rating agencies can be found belatedly downgrading junk paper into bankruptcy. In March 2009, Moody's Investors Service came out with a new ratings list: The Bottom Rung.   "Moody's estimates about 45% of the Bottom Rung companies will default in the next year," The Wall Street Journal reported. Perhaps the cliché about analysts is better applied to rating agencies: You don't need them in a bull market, and you don't want them in a bear market.   While it was the investment banks that sold the junk paper, it was the rating agencies that tarted up the bonds. It was the equivalent of putting lipstick on a pig: This paper could never have danced its way onto the laps of so many drooling buyers without the rating agencies' imprimatur of triple-A respectability.   Yet considering the massive damage they are directly responsible for, the rating agencies have all escaped relatively unscathed. Given their key role in the crisis—were they corrupt or incompetent or both?—one might have thought an Arthur Andersen-like demise was a distinct possibility. Warren Buffett should consider himself lucky—he is the biggest shareholder of Moody's, and is fortunate the scandal hasn't tarnished his reputation. “The free market actually worked as it should—firms that managed risk poorly were demolished by market forces. The trouble was, none of the erstwhile free market advocates had the stomach to live through the creative destruction Mr. Market was serving.” Of course, none of this would really have mattered if a few hedge funds and a much larger number of institutional investors—including foreign central banks—didn't suck up so much of this suspect paper (China evidently bought $10 billion in subprime mortgages). Through the indiscriminate use of leverage and by failing to know what they owned, the purchasers of the triple- A-rated junk paper must also shoulder some of the blame.   How did so much of the investment world manage to overlook these issues? Didn't anyone do any due diligence? Or was it simply a case of the casinos keeping the securitization process rolling? I've had conversations with CDO originators and insiders, as well as money managers, who unabashedly claimed: "We knew we were buying time bombs."   So we can rule out sheer ignorance. Rather, it appears that as long as deal fees could be generated, Wall Street kept the CDO factories running 24/7.   Talk about your misplaced compensation incentives. This is precisely the kind of self-destruction that Alan Greenspan believed was impossible in a free market system. The flaw he misunderstood was simply this: It wasn't that the free market would prevent it from occurring; it was that relentless competitive forces would drive such firms out of business. That is what began to happen in 2008. The free market actually worked as it should—firms that managed risk poorly were demolished by market forces. The trouble was, none of the erstwhile free market advocates had the stomach to live through the creative destruction Mr. Market was serving.   That is the risk that excessive deregulation brings: We can eliminate regulations that might prevent systemic risk. However, the free market advocates whine when the market doesn't do their bidding. Bad choices by management led to failure. That failure brought on a global recession, bankrupted over 300 US mortgage companies, and turned many of the biggest banks and investment firms into tapioca.   The firms that allowed excessive risk taking and leverage found themselves on the wrong side of the corporate version of Darwin's laws— which was precisely where they belonged.   Several of the states with the biggest foreclosure problem today had an opportunity to confront the problem when it was much smaller. These are the states that now lead the nation in foreclosures. Their regulatory agencies had long lists of complaints brought to their attention. None acted upon them.   A 2008 expose by the Miami Herald revealed that Florida allowed thousands of ex-cons, many with criminal records for fraud, to work unlicensed as loan originators. More than half the people who wrote mortgages in Florida during that period were not subject to any criminal background check. Despite repeated pleas from industry leaders to screen them, Florida regulators refused.   And in California, attempts to regulate the many subprime mortgage lenders working in the state were beaten back, primarily by Democratic lawmakers who were protecting the then fast-growing industry.   Today, California and Florida are the nation's leading foreclosure factories.   Then there is Arizona. When Internet real estate service Zillow began publishing online housing price estimates in the state, it received a cease and desist order from the Arizona Board of Appraisal. Zillow's site makes it clear that its data are merely estimates and not actual appraisals. Regardless, misguided Arizona pols did not want some online firm horning in on their local business. It is no wonder Arizona is ranked fourth in the nation in terms of defaults and foreclosures listed by RealtyTrac.   The misguided deification of markets is the primary factor that led us to being a Bailout Nation. Markets can and do get it wrong—not by just a little, either; occasionally they can be wildly wrong.   Recall those two Bear Stearns hedge funds that blew up in June 2007. The S&P 500 stumbled in August 2007 at that early sign of a brewing credit crisis. But in the market's infinite wisdom, it determined that credit wasn't such a significant problem after all. The S&P 500 and Dow Jones Industrial Average proceeded to set all-time highs a few months later, peaking in October 2007. That they got cut in half over the next year makes one wonder why anyone would call the stock market prescient.   This was not the only time Mr. Market has managed to get things precisely wrong. There are far too many examples to enumerate here.   In the final analysis, allowing markets to set policy is inherently antidemocratic. Free people are entitled to elect a representative government, which then enacts legislation on their behalf. Those elected representatives go to Washington, D.C., to do the people's will. If it is the people's will to prevent testosterone-addled traders from saddling the taxpayers with trillions in losses, that is their choice.   Americans have long recognized the advantages of economic freedom. We want the markets to be relatively free to operate. However, we do not want to allow the worst of human behaviors to have free rein. Complaints about regulating markets are actually objections to proscribing the worst behaviors of the people who operate in those markets. We want markets to operate intelligently, but not run roughshod over us. Blame the radical free-market extremists who insist on replacing representative government with the so- called wisdom of markets. This has proven to be misguided.   What the actual result of market-based decision making does is to eliminate those pesky human voters from exercising their will through a representative government. Ultimately, the free-market zealots are not only antiregulation, they are antidemocracy and antirepresentative government. Taken to illogical extremes, they would create a market-based dictatorship.   One part bad philosophy, one part mob rule. That pretty much sums up the financial markets, circa 2008–2009.   Regards,   Barry Ritholtz for The Daily Reckoning   Editor's Note: The piece above is an excerpt from Barry's book, Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy. To get your copy, click here.   You can catch Barry, along with Agora Financial's best and brightest, at this year's Agora Financial Investment Symposium in Vancouver, B.C. But, time is running out and this is nearly your last chance to attend the event of the year – so don't miss out! Secure your ticket now -- here:   Agora Financial Investment Symposium, July 21-24   Also, you're invited to join The Daily Reckoning's Twitter page, where we'll be updating you with juicy details live from the symposium...you can sign up for free here.   Barry Ritholtz is CEO of FusionIQ, a research firm that provides web-based services to individual investors and traders. He has personally witnessed the world's biggest firms in action, and knows that they have teams of professional investors working with the kind of resources that really stack the odds in their favor against the little guy.   Fortunately, Barry offers a service that levels the playing field for you. Barron's describes it as able to, "determine the strength of some 8,000 publicly traded equities… the most tradable issues and sectors with the lowest component of risk." And, he's making his powerful service available at unique discount to Daily Reckoning readers.   If you would like to learn more about his system, called FusionIQ, and his special offer for Daily Reckoning readers…click here.   --------------------- Special Offer ---------------------------   Get in on the Hot Streak of the Year!   Our newest options research trading service is on fire lately – racking up gains of 122%, 76%, 100%, 136%, 124%, 84% and 100% (again!) – in just three months.   You can see triple-digit gains like these as well…until midnight, tonight, we are offering readers a chance to get over 6 months of picks – completely free of charge.   But you must act by midnight tonight – don't delay!   The Daily Reckoning - Special Reports: Introducing the Single Best Way to Make Sure You'll Never Run Out of Money...

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