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The Daily Reckoning Monday, September 28, 2009 Still no sign of the Chinese coming to the rescue in the gold market... The economy of the Bubble Era cannot be revived... Why the trashing of the dollar is not bullish for America as a whole... The Mogambo revisits the economy of this time last year...and more! What Causes a Depression? by Bill Bonner London, England It is a gray morning here in London. We sit in the building with the golden balls, look out the window, and wonder... ..how does it all work? We're doing some serious thinking this week. What is it that actually causes a depression? A stock market collapse? Or too much debt? How come government can appear to cure the problem sometimes - 2001-2007 - but not other times? How come the Japanese were not able to increase consumer prices? Even now...Japan's inflation rate is negative. And why is it, despite the most massive effort at monetary inflation ever undertaken, the US bond market still forecasts an inflation rate of less than 2%? An interview with Richard Koo, author of The Balance Sheet Recession, and a new book by Ken Rogoff and Carmen Reinhart are helping us understand what it going on. More to come... In the meantime, the Dow went down 42 points on Friday. Gold dropped $7. Still no sign of the Chinese coming to the rescue in the gold market. "Global rally shows signs of running out of steam," says The Financial Times. Reuters says the job data will "test the rally." The New York Times says the ratio between job seekers and jobs available has never been worse. The Wall Street Journal, on the other hand, tells us that greater than expected profits will support the rally. So far, the increase in stock prices has not come from increased earnings. It's come from increased P/Es...based on the hope of higher earnings. In terms of forecast earnings, the Dow is selling at a P/E ratio of 27. But in terms of actual, reported earnings...the ratio if 180. A friend made the mistake of asking us what to expect from the economy. We said it would go do down. "You mean, you expect a W-shaped recovery," he said... "A double-dip recession?" "No...we expect no recovery at all. It's a 'W' without the last stroke..." Of course, we were exaggerating. But not much. We do not think that the economy of the Bubble Era can ever be revived. It will never recover...because it is dead. But that's doesn't mean we will march backward forever. The economy may lose 10% of GDP...maybe 20%. But we do not expect to be slithering in the mud of the Middle Ages, with each man is planting his own wheat and brewing his own beer. No, not at all. It only means that the depression must continue until it comes to an end. "But when will it come to an end?" you ask. "When it is over." A depression ends when it has done its work. It must correct mistakes. It must punish errors. It must destroy the bubble economy...and the mindset of the Bubble Era. Only then can new real, sustainable growth begin again. So far, in 2009, 95 banks have gone broke. How many more need to go broke before the depression is over? We don't know. This is where is gets complicated. Because the feds are determined to keep us from finding out! Here's how it works. The Fed lends the bankers money. Then, the bankers turn around and lend it back to the feds. The banks are happy; they're making money on a risk-free trade. The regulators are happy; what could be safer in a bank's vault than US Treasury bonds? Investors are happy; it looks like the financial sector is making money again. And the feds are happy; they're able to finance their deficits. Who's not happy? So far, so good. But hold on... "This is not a sustainable recovery," says fund manager Crispin Odey in The Financial Times. What a spoilsport! You mean you can't build a lasting recovery on debt and shell-game finance? Nope. Apparently not. Just look at what has happened to the auto industry. The feds borrowed money to help Americans pimp their rides. And this Thursday, when September sales figures come out, we find out how sustainable that boost was. Many Americans got new wheels. But now they don't need new wheels. And now the feds are out of the auto- incentive business. So now we get to see what happens next. Stay tuned... [In the meantime, if you'd like more of a sneak peek of what's ahead for our economy - and what you can do to set up a financial defense strategy - check out our 'Rescue and Recovery' bundle. In it, you'll find the tools you need to weather the economic storm, including a free copy of the recently updated Financial Reckoning Day Fallout. Don't miss out on this chance to take charge of your financial future. See here.] More news from The 5 Min. Forecast: "No matter which way you measure it, unemployment among Americans aged 16-24 is now at a post-WWII high," writes Ian Mathias in today's issue of The 5 Min. Forecast. "As typical in these kinds of stats, we're seeing numbers all over the place... The NY Post reported yesterday that the rate has 'exploded' to 52%, while the government's latest tally (set to be revised this week) claims its closer to 25%. Neither stat includes students not looking for work. "Both ends of this spectrum still mark the highest youth unemployment rate since at least 1948, when the government started keeping track. That's especially interesting given the 'official' unemployment rate for the total population - a 26-year high of 9.7%. "This has the Obama Administration worried enough to shell out $1.2 billion - an earmark in the stimulus bill which has (if anything) only kept the situation from getting REALLY ridiculous. In the meantime, the masses of disgruntled youth swell by the day. How dangerous is that in modern times? Ask Mahmoud Ahmadinejad. "So why do our youth have it so tough? For starters, competition for jobs is at a record high. Here's a worthy alternative way to examine our jobs crisis: "There are 14.5 million officially unemployed in the US and 2.5 million job openings. In other words, for every six people looking for work, there is one job to fill - not counting those already employed who are looking for a new gig. And we hasten to add, these are Labor Department numbers... if the reality was twice as bad, it'd be no surprise. "So pity the youth. That English Lit. degree might be useful one day, but not up against 5 other resumes with real work experience. Summer internships are over, and all that's left are a few hourly, low wage gigs. According to Northwestern University, half of college grads under 25 that do hold jobs are working in a position that doesn't require a degree - also the highest portion on record. "Our biggest fear is that these jobless youth lose all hope and make the ultimate mistake - law school." 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 Options Hotline. This publication has been on an epic winning streak: no losing picks in 2009...2008...or 2007! Learn how you can multiply your options trading portfolio at least TEN times this year - guaranteed, or your money back. Get all the info here. And back to Bill, with more thoughts: Across the river is the great "City" of London...where finance is the #1 industry... ..where earnest men and women toil long hours in glass towers. What are they doing? 'Look at this chart,' they tell clients. 'It shows how much you can expect to make at different risk levels. And see this curve? It is what we call the 'efficient frontier,' where the risk/reward relationship is optimized by proper asset allocation.' 'Wow,' you say. 'You must have some pretty smart cookies working for you.' 'Well, we do our best,' says the young man, modestly. In a normal economy, 'finance' performs a useful function - helping to match up people who have capital with people who need it. But even when it is on the level, the profession is full of bombast and flimflam. Those numbers, presented so confidently to customers, were 9/10ths smoke and 1/10th mirror. The new book by Rogoff and Reinhart confirms a point made by our friend Nassim Taleb: both the theory and practice of modern portfolio analysis were flawed. The theory was flawed because people are not reliable. They don't always react in the way their models predict. What they did in the past may or may not be what they do in the future. And the practice was flawed because the past that the number crunchers looked at was limited to the last 25 years; it was the period since 1980, for which they had the figures! In other words, their models were based on numbers only from the boom years. The US dollar is getting trashed, Strategic Short Report's Dan Amoss tells us. The greenback "is increasingly being viewed as a 'funding' currency in the carry trade," Dan continues. "In other words, leveraged speculators are borrowing US dollars in the short-term money markets at near-zero rates to buy bonds in higher- yielding currencies like the Australian dollar or the euro. If this trend remains in place, it will continue to drive down the exchange rate of the US dollar, and drive demand for gold up. "This trashing of the dollar is not bullish for America as a whole. It's dangerous for the viability of the middle class. It's good for exporters of agricultural products, specialized manufactured products, and energy producers, but bad for everyone who pays for lots of imported products, or imports that are incorporated into the supply chains of businesses that sell to US consumers. "I think this claim that 'a weak dollar is good for exports' is narrow- minded and misleading. It ignores the fact that a weak dollar would drive capital out of the US, into economies that are paying a real return on their currencies." [For more from Dan, check out his latest report. In it, he details a strategy that actually does better when the economy is in a downswing. Might come in handy now...see here.] "Oh Daddy, I felt so sorry for Annabel..." Maria was on the phone. She was telling about one of her friends...and money worries... "She was sitting on the couch. And all of a sudden she burst into tears. She was crying because she is out of money... "Her car broke down and she doesn't have the money to get it fixed. And she had to go and have some medical work done. She just doesn't have any money left... "And she's already working all she possibly can. She works with me at the studio. And she picks up bartending jobs on the side. She works all day...and then works at night too. But I think it is getting to her. She just can't go on... "I asked her if her folks could help her out. But she said that her father lost his job in the recession...and they don't have any money to lend her. "Honestly, I felt so lucky to have you behind me. I don't know what I would do if I didn't have the family supporting me. I guess I just wouldn't be able to keep going either. I'd have to give up the idea of being an actress because it's almost impossible to support yourself and still go to all the castings and try-outs." Elizabeth added a comment: "I was talking to [a French friend]. He thinks it is typically American to expect each generation to make it on its own. Americans think they should put aside enough money to pay their retirements, and that's all. They don't worry about their children. They think the children should take care of themselves. Anyway, that's what he thinks Americans think...and he's probably mostly right about it. "The French attitude is much different. They keep the children closer...and help them more. He's got five children and he wants to be able to leave them something. He's just begun a new business venture, because he says he wasn't able to earn enough in his job. "He makes a good point: when you have to start from nothing, you just won't get as far. You know, it's a bit like what Newton said. He was able to make spectacular progress because, as he put it, he could 'stand on the shoulders of giants.' But that's true for everything. One generation stands on the work of the one that came before it. And if there is nothing to stand on...they have to start from scratch. They are able to do more...if they have a firm foundation to stand on. And there are something things they couldn't do at all without it. Maria, for example, would be forced to get a more serious job, if we weren't helping her with her bills while she's getting established. And Jules, too. He wants a career in music. But if he couldn't count on us to help him, he'd probably have to do something that pays better now. "There's a lot to be said for the American can-do emphasis on self- reliance. But there's something to be said for the French attitude too. The ideal is to give your children the spirit of self-reliance and the confidence that comes from making it on their own...but also to give them something to work with...so they don't have to start at the very bottom." Until tomorrow, Bill Bonner The Daily Reckoning The Daily Reckoning PRESENTS: While a lot has happened the last year, not a whole lot has actually changed. As you'll be able to tell from this Mogambo Classique - originally published on September 29th, 2008 - many of the problems facing the US then, are the same problems it's facing now. And some of the solutions aren't too different, either. Read on... The World's Most Powerful Currency? by The Mogambo Guru Tampa Bay, Florida The economic slowdown has been characterized as "consumers are de- leveraging", which is an interesting turn of phrase that means that people are not borrowing money to spend. The importance is dependent on your perspective. Those people who are not borrowing money to spend are thus suffering the pangs of a lowering of their lifestyle, which depended on borrowing money to spend; and then they come around, whining about stupid things like, "Daddy, things have gone up so much in price that I need more money, which you would give me if you loved me. Don't you love me? I love you! Won't you please love me, daddy?" And so I ask, "Can't you love me if I don't give you any money?" and they say, "No. You could borrow the money, and then we would love you", and I reply, "I have been borrowing money and now I can't pay them back" and so the kids say, "Then borrow some more!" And, in a terrifying revelation, I realized that it is not only my children, but all the rest of the economy that is totally dependent on everybody else borrowing money to spend, too. So now you see how Chaos Theory was right, and that all things are connected to all things? If not, then pay attention to how they will now commence to all drag each other down into the Nightmarish Hell Of Inflationary Insolvency (NHOII). "Another reason that I cry so piteously and drink so abusively is that all this new government borrowing will create so much new money that it will destroy the dollar’s buying power..." And it doesn't take a real genius to see why, but the point is not that the American people were stupid enough to think they could get a perpetual free lunch by borrowing money to pay for it, or even that a smaller subset of those who are suffering the pangs of a lowering of their lifestyle is composed of those who also think that they can call me on the phone and either 1.) Ask to borrow some money from me, or 2.) Ask me to pay them back the money I borrowed from them. My response is the same, in that I give neither one of them any money because I don't have any money; so to one I laugh in scorn, and to the other I say that I have just put a check in the mail to them, and that they will get their money soon, and if it hasn't arrived in a few months, call me back and I'll write you a new check and get it right into the mail. The point is that a much larger subset of those who are suffering the pangs of a lowering of their lifestyle is composed of those people who think that they can elect government representatives who legislate all problems out of existence, that will tax me and then give the money to them, or the Federal Reserve will create more money to loan to investors with which to buy government debt so that the government can spend, spend, spend us into blessed Utopia. Either way, it's Bad, Bad News (BBN). And, alas, one way or the other, they are right. Unfortunately. And that is one reason that I weep, alone, in the Mogambo Bunker Of Bunkers (MBOB), doors locked, radio blaring, machine guns cocked and loaded, mostly drunk or nearly so, soon to be blissfully comatose. Another reason that I cry so piteously and drink so abusively is that all this new government borrowing will create so much new money that it will destroy the dollar's buying power, taking my own country down with it. The only reason that I stop bawling like a little crybaby is the knowledge that the people who own gold, silver and oil will get rich, rich, rich, and since I own gold, then people will want me to loan them a few bucks out of my huge stacks of money because they are starving, and their children are starving, and I will say, "No!" and it will be thin gruel indeed for them to hear my mocking voice again echoing in their heads, "Buy gold, silver and oil, you morons, because your stupid government is letting a private bank (that misleadingly calls itself the Federal Reserve when it is, in fact, neither) to create so damned much fiat money that it will produce catastrophic inflation in consumer prices that will destroy the country, just like it has done to every other stupid country in the last 4,000 years that let its stupid government increase a fiat money supply at its whim! Hahahaha! Now you see why I always said you were freaking doomed! Hahaha!" But I feel terrible, as this constant infliction of inflationary pain by heedless expansion of the money supply is so unnecessary, and that is why I was pleasantly surprised to read in The Wall Street Journal the headline "Central Banks Consider Gold" in its Commodities Reports column. The reason is easy to see if you read the article backwards, in that there was a question about central bank buying "last week, when gold saw a record single-day gain", especially Chinese central bank buying of gold, which is already the ninth-largest holder of gold in the world but which holds only 1% of its foreign-exchange reserves in gold, although it actually said it would like to hold more. And Mark O'Byrne at Gold & Silver Investments says that he would "be surprised if the Chinese hadn't been nibbling at the gold market," which leads to the news that Asian banks "are seen as keen buyers" of gold, which leads to the news that "other central banks are now far more likely to be holders of gold", which leads us back to the second paragraph that "Turbulence in the financial markets and recent US dollar weakness are helping the precious metal claw back its reputation as the central monetary anchor within the international monetary framework", which leads to the opening paragraph of "Central banks may be starting to turn one of the few assets in which they can invest; gold." In short, those crafty Chinese, a fifth of the world's population, may be getting ready to issue a gold-standard money, which will instantly make their currency the strongest in the world, which is just what a country needs if it wants to import a lot of things cheaply so as to respond to demand for internal economic growth without stoking inflation in prices! And, fortunately for those of us who both love to have large profits handed to us and who also own gold, a Chinese gold-standard may soon make a dream come true as gold would skyrocket when priced in suddenly depreciated dollars. Whee! This investing stuff is easy! Until next time, The Mogambo Guru for The Daily Reckoning Editor's Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it. The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page. The Daily Reckoning - Special Reports: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.