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Tuesday, July 14, 2009 Not a 'V' or 'U'-shaped recovery – 'X' marks the spot… Better go easy on that quantitative easing… Our forecasts may have been early, but we're facing sushi now… Thomas E. Woods responds to the "market failure" drones…and more! --------------------- Special Offer ---------------------------   The $2.5 Trillion Gorilla in the Room   This is vital. Because, you see, a lot of Americans - and a lot of people in the rest of the world - are counting on credit-card carrying American shoppers to jumpstart the global economic engine all over again.   But it isn't going to happen. And you don't want to bank your investments on the idea that it will. Or you'll risk even bigger losses than many Americans have suffered already.   Here's how you can save yourself and boost your profits during the coming time bomb...   ---------------------------------------------------------------   Preparing for the New Economy by Bill Bonner Waterford, Ireland     "America is beginning to consider a new stimulus program," said Irish television last night.   It was a rainy day in the Emerald Isle yesterday. The wind was blowing. Rain was coming down. By 7pm, it was time for a pub and a drink. The Irish know what to do in the evening...   "Welcome to Ireland," said the cab driver this morning. "Don't you love this summer weather?'   It would have passed for a bad winter in Maryland. Cool. Wet. Disagreeable.   "What happened to that global warming?" asked a colleague. "It was supposed to make Ireland hot and dry."   Meanwhile, back in the USA...people were wondering what happened to the stimulus program. It was supposed to stimulate.   Mr. Geithner says it is working. He says it's "too soon" to begin thinking about another stimulus program. But every time we pick up a paper someone is voicing the need for more stimuli. And the things that really matter in the economy are going in the wrong direction: Jobs are going down. House prices are going down. Consumer prices are going down too.   This from Robert Reich's blog:   "Recovery doesn't depend on investors. It depends on consumers who, after all, are 70 percent of the US economy. And this time consumers got really whacked. Until consumers start spending again, you can forget any recovery, V or U shaped.   "Problem is, consumers won't start spending until they have money in their pockets and feel reasonably secure. But they don't have the money, and it's hard to see where it will come from. They can't borrow. Their homes are worth a fraction of what they were before, so say goodbye to home equity loans and refinancings. One out of ten homeowners is under water -- owing more on their homes than their homes are worth. Unemployment continues to rise, and number of hours at work continues to drop. Those who can are saving. Those who can't are hunkering down, as they must.   "Eventually consumers will replace cars and appliances and other stuff that wears out, but a recovery can't be built on replacements. Don't expect businesses to invest much more without lots of consumers hankering after lots of new stuff. And don't rely on exports. The global economy is contracting.   "My prediction, then? Not a V, not a U. But an X. This economy can't get back on track because the track we were on for years -- featuring flat or declining median wages, mounting consumer debt, and widening insecurity, not to mention increasing carbon in the atmosphere -- simply cannot be sustained.   "The X marks a brand new track -- a new economy. What will it look like? Nobody knows. All we know is the current economy can't 'recover' because it can't go back to where it was before the crash. So instead of asking when the recovery will start, we should be asking when and how the new economy will begin..."   These comments sound sensible enough to us. In fact, colleague Rob Parenteau has been saying something quite similar in these pages. "Over the last three decades," he says, "we've taken one of the greatest industrial nations in history... and traded it off piece by piece. In its place, we became the world's #1 shopping nation.   "Even now, we're facing an economy in which 70% of our economic output depends on consumer buying. No buyers, no recovery.   "And yet, unlike other recent minor busts and even major corrections, the lesson hundreds of millions of strapped Americans are learning all over again is that same lesson our forebearers learned after 1929.   "Namely, that the law of personal and financial responsibility is as irreversible as the law of gravity. And it's the egg that no bureaucrat — no matter how popular — and no multi-billion dollar bailout — no matter how large — can unscramble.   "In short, the hearts and minds of the American consumer have been thrown into reverse. And it's this total psychological 'snap' that will make a back-to- baseline conventional recovery impossible any time soon."   [For more from Rob, see the latest issue of the newly-revamped Richebacher Letter…and learn about a move that can give you back double any further downturn in consumer sales. Click here.]   After a night of heavy drinking in the pub...and pious reflection in our hotel room...we woke up worried. What if our friend Hugh is right? What if the comments above are right? Heck...what if WE'RE right?   The most critical question an investor faces today is whether he wants to smash up on the rocks of deflation...or run aground on the hard place of inflation. Posed the question – inflation or deflation? – we have always answered 'yes.' We will have both. But it is gradually occurring to us that we will have both more abundantly than we realized. As Hugh reminded us: we know of no case where quantitative easing has actually worked. It seems to work only where it is applied to excess – where the results are catastrophic hyperinflation.   The feds are more incompetent than even we suspected. They are trying to cause mild inflation – say, 4%...maybe 6%...even 8%. But they aren't doing a very good job of it. Their efforts are too hesitant...they're too worried about what the anti-inflation hawks will say...and about what the bond vigilantes will do. "What if the Chinese dump their Treasuries?" Yikes, that is too awful to contemplate. "Better go easy on that quantitative easing."   The Chinese...unhampered by bond vigilantes [they are the bond vigilantes] or good sense...are increasing their own money supply three times faster than the United States.   Our Feds are trapped between the same rock and the same hard place as the rest of us. Either they run into the rocks of hyperinflation...or into the hard place of deflation. Just like Japan's central bankers and finance ministers. They COULD cause inflation...but the price of it is too high. So, they take baby steps...boosting the money supply too little to offset the natural deflation of a major correction.   Of course, this is what makes us fear hyperinflation too. There doesn't seem to be any safe channel between Sylla and Charybdis. If they are going to cause inflation...they have to really inflate the money supply. Not by 9% a year...but maybe by 900%. We don't know what it will take; neither do they. All we know is that what they are doing now is not working. Prices are falling, not rising. Bond prices are rising – indicating that the vigilantes don't think inflation is a problem. And the foreigners – notably, the Chinese – are still ADDING to their supplies of US Treasury debt.   So, dear reader, what should you do? Inflation could take much longer to arrive than most people think. A dull, sinking, dreary economy – like the weather in Ireland today – could be with us for years. The dollar could go up...gold could go down...for many moons.   Are you prepared to wait it out? We will leave you to think about that....   Meanwhile, more news from The 5 Min. Forecast:   "Here's what the headline in every paper in the country should read today:   "$1,100,000,000,000.00   "That's the record budget deficit the government has accrued on our behalf since the fiscal year began last October. The word 'record' really doesn't even do the number justice… $1.1 trillion is more than double all of 2008's all time high deficit of $454 billion – and as you know, 2009 ain't over. The CBO currently projects a $1.8 trillion budget deficit for the fiscal year, more than triple last year's record.   "Look at the recent history of the Treasury's numbers and the trend is obvious. Check out our government's book-balancing stupor over the last couple years:     "That's the kind of chart that should make a lot of sense to an active investor. What's the outlook for a volatile stock that's been making lower highs and lower lows?"   Catch up with all of Agora Financial's best and brightest at this year's Agora Financial Investment Symposium in Vancouver, B.C. The symposium promises to be the event of the year – so don't miss out! Secure your ticket now – before the event sells out! The clock is ticking…see here: Agora Financial Investment Symposium, July 21-24 And back to Bill, with more thoughts:   We're still troubled by Hugh's comments. The inflation narrative is "too easy to articulate," he says. Too many people see it coming.   "The market clearly is not worried about inflation right now," says colleague Chris Mayer. "That is the only way to explain 10-year Treasury yields of 3.30% as of last Friday. The deflationist view is the one that prevails. This view, which makes some compelling and elegant arguments, maintains that the credit losses far surpass the monetary and fiscal stimulus. All those trillions in destroyed debt, plus the yanking of credit from consumers and businesses, overwhelm new money creation."   Many years ago, we looked at the danger of a "Japan-like slump." We were early. We're facing the sushi now. Falling prices. Big output gap. Rising unemployment. On again, off again deflation.   When we considered the risk a few years ago, we came to the conclusion that the United States couldn't afford to wait it out the way the Japanese have. We have too many people who owe too much money to too many wobbly creditors.   But now we're in it. The feds are propping up the wobbly creditors just like they did in Japan. The banks have gotten trillions in loans and guarantees.   The feds have been trying to prop up households too. They recently approved 125% mortgage refinancing by Fannie and Freddie. In other words, they now officially condone...and finance...underwater homeowners. If your house is only worth $200,000...and you owe $250,000...the feds will refinance your mortgage in full. No need to sell and take the loss. No need to let the banks foreclose. No need to face reality. Now...you can just stay underwater – indefinitely.   The feds are preparing to keep the whole economy on life support – with oxygen provided by quantitative easing. Eventually, of course, they'll run out of gas. But that could be far in the future...   Government deficits are getting worse and worse. Tax receipts are falling. The US deficit for June came to $94 billion...a new record. And the budget deficit has topped $1 trillion for the first time ever. This is also exactly what the Japanese did. They ran the biggest deficits in history. And still the yen went up!   As we keep saying...inflation is no sure thing, at least not in the short-run. But Chris Mayer believes that "the problem with the deflation arguments long term, it seems to me, is that you are betting against a government's ability to destroy its own currency. Governments are seldom good at anything, but one thing they are undeniably good at is destroying their own currencies. The dollar has lost 95% or so of its value since 1913. That's a pretty darn good job. Other countries have been even more thorough."   It takes a determined and suicidal central bank to pull off hyperinflation. Like the Central Bank of Zimbabwe, for example.   Until tomorrow,   Bill Bonner The Daily Reckoning   P.S. You can read more of Chris Mayer's report on the inflation or deflation argument by clicking here.   --------------------- Special Offer ---------------------------   Options Made Simple   Let's face it - playing options can be tricky. But they can also be incredibly lucrative.   Well, in this report, we lay it all out for you. It's quite plainly, the easiest way to play options...ever. And the gains are just as big. Keep reading here.   ---------------------------------------------------------------   The Daily Reckoning PRESENTS: At the height of the recent boom, you couldn't get through to anyone that was profiting from it that the good times wouldn't last forever – trust us, we tried. But now that we are living through the bust, people are all ears. That's why clear, concise books written on this crisis – like the one Thomas E. Woods reviews, below – are invaluable. Read on…   Response to the "Market Failure" Drones by Thomas E. Woods Auburn, Alabama     "The time to worry about depressions," F.A. Hayek once wrote, "is, unfortunately, when they are furthest from the minds of most people." He's right, of course: imagine trying to tell a house flipper in 2004 that the housing market was a giant bubble that was going to burst. At best he'd smile politely, and then roll around in his fresh pile of Federal Reserve Notes.   It's during an artificial, unsustainable boom like the one we've just lived through that, unbeknownst to most people, the real damage is done to the economy. But that's when they're least likely to listen or care.   Now that we're living through the bust, on the other hand, many people are listening. That's why it's so important for economists of the Austrian School to redouble their efforts, whether in terms of writing, public speaking, media, or indeed whatever platform they can get, to promote a sound, free-market interpretation of what's happening. The drones who exist to repeat clichés about market failure need a robust and energetic reply from people who know what they're talking about.   Robert P. Murphy has done exactly this. His article archive at Mises.org has grown substantially during the crisis, and his blog is always a valuable read. In addition to all this, he managed to find time to write the recently released book The Politically Incorrect Guide to the Great Depression and the New Deal.   Murphy and I corresponded regularly late last year as we worked on our respective books. He got a kick out of the realization that he, the economist, was writing a work of history, and I, the historian, was writing a book (Meltdown) that gave the Austrian perspective on the current economic crisis. But he is a perfect fit for a study like this. Although many economists know little history, historians' knowledge of economics is confined, with few exceptions, to a catalogue of primitive fallacies. This episode in American history has needed the careful, book-length attention of a good economist — that phrase, sadly, is practically an oxymoron in the Age of Krugman, is it not? — for a long time now.   And it isn't just the court historians or the left-wing economists who need straightening out, either. Even otherwise free-market scholars of the Great Depression and the New Deal have a fatal soft spot for the Fed — whose failing, they tell us, was its failure to pump enough money into the system. Murphy will have none of this.   Thus, for example, the Chicago School has been critical of the Fed, but for the wrong reasons: the Fed supposedly failed to create enough money when the money supply began falling. This is not exactly a free-market criticism, but (surprise!) it's the only one the mainstream has bothered to acknowledge. As a matter of fact, in the nearly two years following the 1929 stock-market crash the Fed engaged in what were at that time the most aggressive rate cuts in its history. (This is in contrast to the Fed's rate increases during the 1920–1921 downturn, which was over quickly but which by Chicago's reasoning ought to have been more severe and persistent.) Milton Friedman and Anna Schwartz, Murphy concludes, gave birth to,   "a myth, namely that the Federal Reserve sat idly back and allowed the economy to implode. That myth — like the myth that Herbert Hoover sat idly back and watched the Depression unfold — is continuing to drive misguided policies today."   Murphy also includes in this chapter a very useful section on deflation, a subject nearly impossible to find treated without breathless hysteria. To blame the Depression on a decrease in the supply of money is to get the relationship exactly backward. Moreover, the money supply fell by the same percentage between 1839 and 1843 that it did between 1929 and 1933, but robust increases in real consumption and real GNP followed. Under the heat of Murphy's magnifying glass throughout this much-needed chapter, the arguments of the deflationphobes melt away.   Naturally, Murphy devotes considerable attention to the interventionist program of Herbert Hoover, the president whom most Americans, if they have heard of him at all, associate with laissez-faire. According to Paul Krugman, for example, "the federal government tried to balance its budget in the face of a severe recession." Murphy, in response, says "it would be difficult to render a more misleading account of Hoover's policies without actually lying." In Fiscal Year (FY) 1933, which ran from mid-1932 to mid-1933, the federal government ran a $2.6 billion deficit — at a time when it took in only $2 billion in tax receipts. So the deficit that Krugman represents as wild slash-and- burn budget cutting was in fact greater than the federal government's entire tax haul that year. That would be equivalent, Murphy observes, to a $3.3 trillion deficit in FY 2007, as opposed to the actual figure of $162 billion. “The drones who exist to repeat clichés about market failure need a robust and energetic reply from people who know what they’re talking about ” Now it is true that the FY 1933 budget included some minor budget cuts, but these relatively trivial cuts came only after Hoover's dramatic spending increases of the previous several years had failed to show any results other than a deepening of the Depression. Murphy's book has all the figures. By the time Hoover pulled back from what would later become standard Keynesian fiscal policy — a pullback that came in the form of minor spending cuts and major tax-rate increases — unemployment had already gone higher than 20 percent.   In a 1926 speech while secretary of commerce, Hoover had observed that Americans enjoyed both higher real wages and a higher standard of living than did people elsewhere. Like all too many others, though, Hoover drew the fallacious conclusion that the prosperity was the result of the high wages rather than the other way around. (This was the fallacy, exploded by Henry Hazlitt, that high wages promoted prosperity by providing workers with "enough to buy back the product.") The high purchasing power of American wages reflected American workers' productivity: because they were able to produce so much physical stuff, thanks to the amount of capital per worker in the United States, the resulting abundance made their paychecks stretch farther. "Unless workers have first physically produced the goods (and services)," Murphy writes,   "there will be nothing on the store shelves for them to buy when they attempt to spend their fat paychecks…. If more stuff is produced within America than within Mexico, obviously Americans are going to have a higher standard of living, regardless of 'wages policy.'"   It was this fallacy that later informed Hoover's disastrous high-wage policy, a policy FDR later codified with the National Industrial Recovery Act and that served to deprive countless Americans of employment.   On the New Deal itself, Murphy is just devastating. It's been amusing to watch the likes of Brad DeLong tell us how super the government's economic recovery efforts were. Let's see: cartelizing American industry, restricting production, imposing extremely high minimum wages via the National Recovery Administration, destroying crops to prop up prices, paying farmers to reduce their acreage, blowing billions on arbitrary projects in the name of "creating jobs," raising taxes — and that's only a bit of it. That combination was supposed to make Americans rich — and don't you try to say otherwise, you incorrigible extremist. Bob discusses all of this and much more (including Social Security and labor legislation), and raises evidence and arguments that, if the standard treatment of these subjects in every single American-history textbook is any indication, your delicate ears are not supposed to hear.   In addition to his merciless evisceration of the propaganda surrounding specific New Deal programs, Murphy assembles some suggestive evidence, in addition to the clear testimony of economic theory, regarding the destructive, growth- inhibiting nature of the New Deal in general. In particular, he lays to rest (to put it gently) the recent claim that FDR did make headway against the Depression, as indicated in the unemployment statistics, and that this progress resulted from his willingness to suck resources from the private sector and squander them on arbitrary things.   Readers will also enjoy Murphy's treatment of the banking industry during the Depression, since we're usually told that FDR's alleged cure for that distressed sector was just super. It was no cure at all; it addressed none of the underlying problems, which continued to fester for decades thereafter. The state governments, for their part, had contributed to banks' vulnerability by yielding to small institutions' demands for "unit-banking" laws prohibiting branch banking. These laws made it more difficult for banks to manage risk by diversifying their portfolios. Most of the thousands of banks that failed during the Depression were in states with unit-banking laws. The number of bank failures during the same years in Canada, on the other hand, which had no unit- banking laws, was zero.   Although many readers will be able to name at least several important titles on the Depression and the New Deal, I cannot insist strongly enough that there is no book quite like this one. I am not aware of any other book on this subject that both carries the story from the 1920s through World War II and is economically sound throughout. Murray Rothbard's America's Great Depression, still indispensable, covers only through 1932; and books critical of the New Deal typically adopt, probably thoughtlessly, the Chicago position on the Fed.   In the midst of an economic crisis that ought to be causing people to rethink much of what they thought they knew about the economy (e.g., the Fed is a great stabilizing agent!), Bob Murphy has written an accessible and persuasive Austrian account of an essential period of American history that most people know only in propaganda form. He deserves to be richly rewarded. Read this book and promote it wherever you can.   Regards,   Thomas E. Woods for The Daily Reckoning   Editor's Note: Tom 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 http://www.thomasewoods.com/ to get a free chapter of Meltdown.   --------------------- 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 - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future Introducing the Single Best Way to Make Sure You'll Never Run Out of Money...

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