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The Daily Reckoning Friday, September 18, 2009 How can you refinance when you are underwater? What happens when the feds' only trick stops working... The financial system "still has the same disease"... Bill Bonner on the likelihood of gold's day in the sun...and more! An Ordinary End to a Post-Crash Bounce by Bill Bonner London, England David Rosenberg: "The incoming economic data in both the US and Canada have improved and for the most part [are] bettering expectations. The dilemma is that market pricing has moved far beyond the fundamentals. Despite the temptation to jump into a 'liquidity-induced' rally...they cannot be sustained without a durable organic economic expansion. The problem is that the global economy in general, and the US economy in particular, is operating on so much medication that it is difficult to conduct an appropriate examination of the patient at the current time. All we know is that the markets seem to have very rapidly now priced in three years worth of recovery. "The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation - usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs - during this extremely flashy move, the US has shed 2.5 million jobs (as many as were lost in the entire 2001 recession)." The markets rise. The economy sinks. It is not sinking as fast as it was. But it is still going down. Month after month, the number of people without jobs increases. Even Paul Krugman says that unemployment won't reach its peak until 2011. And house prices? Hard to tell what is going on. As Rosenberg puts it, this patient is so hyped up on drugs it's not possible to make a diagnosis. Still, he doesn't look good. There are millions of mortgages that still haven't been tested. Interest only...Alt A...commercial...even prime mortgages. They are facing reset...and refinancing...with collateral prices down 20-30-40%. How can you refinance when you are underwater? Let's look at the basics. We had a nice thing going. From 1945-2007, consumer spending and credit increased. As long as lenders were willing to lend...and consumers were willing to go further into debt...the economy expanded. Towards the end, it got a little crazy. And then it blew up. As predicted, the feds rushed in to save the situation. But they only have one trick - adding more cash and credit. That works every time...until it stops working. And it stopped working in 2008. Banks don't want to lend against falling house prices. And consumers don't want to borrow when their incomes are going down. Ergo...the end of consumer credit expansion. Get over it. But the feds keep at it. And with their help, the markets have bounced up. Of course, a bounce is one of the most reliable features of a market economy. A 50% bounce in the Dow - roughly equal to the bounce after '29 - would take the index to 10,300. We're not there yet. So, there's nothing unusual or unexpected about this situation. The markets have done what they were supposed to do. The feds have done what they're supposed to do. So what next? Ah...dear reader...if only we knew the answer to that question... Here we are in uncharted territory...terra incognito... Never before has there been an international monetary system based purely on paper. And never before has it been run by people who believe they can force the market to do their bidding. They are convinced that they can avoid the Japan situation - where the economy dragged along for twenty years - by adding more cash and credit. Bernanke said he would drop it from helicopters if necessary. Just one problem.... Bernanke can inflate...but only until the Chinese tell him to stop. When China pulls the plug on the bond market, the party comes to an end. That's why the helicopters are still on the ground. And it's why they will only take off when the situation becomes desperate. In the meantime, we await the ordinary...that is, an ordinary end to a post-crash bounce. That will come with another crash. And another. And another. Until stocks finally hit bottom...and bubble-era delusions are finally all crushed out. [This post-crash bounce is just another aspect of what's being called the "great American 'recovery rip-off'". It's a sham recovery, perpetrated by flim-flam artists. And it's important you know how to protect yourself from it. Be on the lookout for a special report arriving in your inbox tomorrow morning that details how to defend against this wealth swindle.] And now for some more news from The 5 Min. Forecast: "The demise of the credit card crisis has been greatly exaggerated," writes Ian Mathias in today's 5 Minute Forecast. "Here's one for those recovery cheerleaders: "Bank of America and Citigroup - which comprise 35% of the entire credit card industry - announced this week that customers are defaulting on their credit cards at the highest rates since the recession began. Bank of America's charge-off rate registered a whopping 14.5% in August. In other words, for every $7 in credit card debt on BoA's books, they expect $1 to be lost. "Other mega-banks and creditors like JP Morgan, Discover, Amex and Capital One revealed similar August numbers. It's an extra-harsh dose of reality for the Street, which enjoyed improving credit default rates this summer, especially in July. We're a bit less surprised... Nearly every measure of loan losses at US banks is still soaring into record territory: 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 Breakthrough Technology Alert. Their latest report details an epic piece of news that could make life better for the entire human race - and could give you your shot at incredible wealth. But you must act before Wednesday, September 23. Get all the details here. And back to Bill with some more thoughts: Taxes are going up. Governments have gotten themselves in a new trap. Well...several traps. When you intervene in a place like Iraq, it is like a bad marriage. The first few nights are fun. But soon you're looking for a graceful way to get out. Trouble is, there isn't any easy way out. So you stick with it. Time goes by. And the costs mount up. Before you know it, the cost for the Iraqi adventure is more than $1 trillion...and then it goes to $2 trillion. Now, the feds have intervened in the economy too. And, likewise, they are trapped. By pumping in trillions of dollars - not just in America, but also in Britain and China (which have both intervened even more forcefully) - they have made it look like things are okay. They have kept zombie companies alive. The big banks haven't had to own up to their own mistakes. Companies haven't had to cut back quite as much as they would have. As our friend Nassim Taleb puts it, the financial system "still has the same disease." But it's being kept alive with massive doses of very expensive medicine - provided by the feds. So what are they going to do now? They claim to have prevented catastrophe. They say they've engineered a recovery. And yet, if they let up on the drugs...the patient dies. They're trapped...they'll have to keep pumping in money for years...until the money runs out. [When this happens, you'll want to be holding something you know will maintain its value. And no matter how much phony money gets pumped into the system, there's always one thing you can count on: gold. This week it hit $1,020 an ounce. We suggest you get some before it goes any higher. Click here for more info.] Naturally, the feds want to raise as much money as they can. So, like bank robbers, they go where the money is - to the "rich." Steve Sjuggerud tells us what has happened back at home...in Maryland. "The state of Maryland couldn't balance its budget last year. So the state decided the right way to raise tax dollars was to fleece the millionaires... Maryland state politicians created a 'millionaire' tax bracket. "Maryland Governor Martin O'Malley of course expected tax receipts to go up. He said Maryland's 3,000 millionaires were 'willing to pay their fair share.' The Baltimore Sun said the rich would 'grin and bear it.' "But the opposite happened... "Instead of 3,000 Maryland millionaires filing taxes in April 2009, only 2,000 did. According to The Wall Street Journal: 'Instead of the state coffers gaining the extra $106 million the politicians predicted, millionaires paid $100 million less in taxes than they did last year - even at higher rates.' "A friend of mine lives here in Florida. He is not an American citizen. He pays US taxes while he lives here. But under the threat of higher national income taxes, he is contemplating giving up his green card and moving elsewhere. "When Maryland's governor raises taxes, Maryland residents leave and government income goes down. "When the nation's President raises income taxes, foreigners like my friend leave and government income goes down. "Unfortunately, YOU CAN'T LEAVE. "Wait a minute. This is America, land of the free, right? "Not so fast... The US government will track US citizens everywhere to get tax money. If you leave to work in another country, you still pay US income taxes. America and North Korea are the only countries that tax you on your worldwide income. "If it gets bad enough, you can just give up your citizenship, right? Nope, you can't do that either. At least, you can't do it without paying a potentially massive 'exit tax.' "The exit tax acts like an estate tax. If you want to give up your citizenship, you have to give up nearly half your wealth above a certain level. The Economist magazine calls it 'America's Berlin Wall.' Nice, eh? "Want some more nice? Once you're gone, you're not legally allowed to come back and visit family and friends. Yes, if the government decides you have renounced citizenship for tax purposes, a federal law prohibits you from entering the country ever again. (You can look up the rule under 8 USC 1182(a)(10)(E).) "You can escape states with oppressive taxes. But 'escaping' the US - the land of the free - is much more difficult. And you can bet it won't get any easier as the government needs more and more of your income to pay its bills." Keep reading for today's essay... The Daily Reckoning PRESENTS: Now that the dollar is the world's 'hot money' the world's surviving gold bugs see their moment of rapture fast approaching. But will it really come to fruition? Bill Bonner explores... All That Glitters by Bill Bonner London, England Of all the many miseries that man faces on his journey from cradle to grave, few of them can be eased by enlightened central banking. And a credit contraction is not one of them. Japan proved it. After the Japanese market collapsed in 1990, public officials went to work with their characteristic energy and incompetence. They lowered the cost of borrowing to nearly zero. But did consumers take up the money and add to the demand for bread and bicycles? No. They didn't want to borrow. They wanted to save. They had speculated during the previous bubble years and lost money. Then, with retirement approaching, a penny saved was worth even more to them than a penny earned. They saved more than ever...and the consumer economy sank. The Japanese persisted. They lent so freely that the yen became the 'funding currency' for a worldwide boom. Prices rose all over the planet - except in Japan itself. The land of the rising sun couldn't seem to get up in the morning. Property investors lost money. Stock market investors lost money. Japanese consumers sewed their pockets shut. And now that the dollar is the world's 'hot money' the world's surviving gold bugs see their moment of rapture fast approaching. Gold is not an investment category. It is no investment at all. Instead, it is more like a religion or a political position. True believers stick with it through thick and thin. When gold goes up, they are insufferable. When it goes down, they are unrepentant. "No monetary system lasts forever. This one – an impromptu experiment, at best; premeditated larceny at worst – has already lasted longer than most marriages." The price of gold peaked out in real terms in 1979 at over $2,000 in today's money. Briefly, an ounce of gold was so loved - and stocks so despised - that you could buy all the stocks in the Dow index for just a single ounce of gold. But then, the gold martyrs suffered a terrible persecution - nearly two decades years of steadily falling prices. Not just in real, inflation adjusted terms, but in absolute terms. By the end of the period, it took 43 ounces of gold to buy the Dow stocks, and gold bugs were gathering in small groups praying for salvation and awaiting the end of time. It seemed as though the cult might be extinguished; few were still alive. Fewer were still solvent. Of those, even fewer were still sane. But then, like Christians huddled clandestinely in an unheated Soviet apartment, the wall fell. Gold began a comeback. What inspires this little reflection, apart from a night of heavy drinking, is the price movement. At the beginning of the week, gold closed comfortably above the $1,000 an ounce mark. Then, on Wednesday morning...it shot up. The end of the world has been delayed, perhaps indefinitely. And yet, gold - an option on financial chaos - trades as if it were coming next week. What gives? Here on the back page we keep an eye on the yellow metal. Not because we expect the end of the world. Still, you never know; maybe the gold bugs are onto something. No monetary system lasts forever. This one - an impromptu experiment, at best; premeditated larceny at worst - has already lasted longer than most marriages. The bust-up, when it comes, threatens to be nasty and expensive. The easiest story to sell in the current marketplace is the inflation story. In an effort to revive the go-go economy of the bubble era, the feds are adding to the money supply. They will continue doing so until inflation rates go up. They make no effort to hide it. They have as much as warned the world: prepare to be robbed. According to the popular story line, the gold market now anticipates inflation. Investors should too. We have told this story ourselves; we still believe it. But today, we caution readers: there may be a plot twist. The problem with inflation is that there is none. Consumer prices are falling in China, Europe and America. And if we look harder, we find out why. The feds are pumping the money supply as hard as they can. David Rosenberg reports that the monetary base rose at a 141% annual rate over the past four weeks. But the money fails to reach the real economy. The money supply figures that relate to actual cash in people's hands - M1, M2, and MZM - are shrinking, at -28%, -4.9% and - 6.2% respectively. Why? Because the banks don't lend and consumers don't borrow. In short, the feds' money goes into cool bank vaults and hot speculative trades. When it tries to find its way to the consumer, it gets lost. As Rosenberg explains it, the transmission mechanism has broken down. We live in a bust economy, not a boom one. In a bust, consumers cannot borrow. They have nothing to borrow against. Both their wages and their assets are going down. Who would lend to them under those conditions? Not a bank that almost went broke itself 12 months ago. And even if consumers had access to credit, they wouldn't take it. Consumers too, almost went broke a few months ago. Instead of saving money during the boom years, they spent it...or gambled with it. Then, when the bust came in '08, they realized that they were 10 years closer to retirement with little money saved. Now they have to make up for that lost decade, by cutting spending and saving as much money as they can. Still, gold speculators think they've got God on their side. They march into the coliseum confident that the feds will inflate consumer prices and cause the price of gold to soar. Maybe gold will rise. If so, it will be thanks to speculators and Chinese central bankers, not consumer price inflation. The smart money is still on the lions. Enjoy your weekend, Bill Bonner The Daily Reckoning Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis. He is also the author of, along with Lila Rajiva, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics. Bill's latest book is an update of Financial Reckoning Day, co-authored with Addison Wiggin. And tomorrow you will have an exclusive opportunity to receive your copy...completely free of charge. Be sure to check your inbox tomorrow morning for this very special offer. 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...

AGORA Financial Resources: The Daily Reckoning Is: Economics & Politics Crisis & Opportunity Gold, Oil & Energy Growth, Tech & Medical Options Investing Founder: Bill Bonner Editorial Director: Addison Wiggin Publisher: Rocky Vega Managing Editor: Kate Incontrera Web Editor: Greg Kadajski