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The Daily Reckoning Wednesday, September 16, 2009 If producer prices are rising...consumer prices follow, right? How would the economy look without the phony demand? Bernanke declares the recession has ended... Bill Jenkins with a close look at the US banking system...and more! The Credit Cycle Has Turned by Bill Bonner London, England These are the times that try our souls... ..well, maybe not our souls...but at least our convictions. But look at gold this morning! Yesterday, we got word that the PPI rose 1.7% in August. Let's see, if producer prices are rising...consumer prices follow, right? Well...usually... ..but these are strange times... We also got word that retail sales were up...that's UP...2.7% last month - the biggest increase in three years. Now hold on. We've been saying that retail sales were going down. Not up. Our view of the big picture has a consumer in the center of it. And it's a consumer who is NOT increasing his spending. Instead, he's reluctant to buy anything. There's a reason for that. He's a guy who didn't save anything over the last 10 years. Now, he's 10 years older...facing retirement with insufficient funds...and scared to death that he'll run out of money before he runs out of time. The US consumer was counting on rising house prices to pay for his retirement. Now, he's disappointed...and worried. What can he do? He has to cut back. He has no choice. He can't depend on his house. He can't expect pay increases. Having neglected his savings during the fat years...he has to tighten up in the lean ones. He has to save at the worst possible time - in a downturn! We don't see any way around this situation. We don't see any shortcut. We don't see any way to make it disappear or ignore it. THE CREDIT CYCLE HAS TURNED...from expansion to contraction. Meanwhile, the feds are muddying the waters. They're trying to fool the consumer...to trick him...to make him think that up is down and down is up. They want him to believe that the fat years are coming back...that he doesn't have to save. In fact, they want to cause inflation...to encourage him to get rid of his money as soon as possible. That's why that PPI figure is important. If they can successfully inflate consumer prices (not just producer prices) the whole picture might change. Then, we'd have an inflationary depression rather than a deflationary one. Our commodities man, Alan Knuckman, was on Bloomberg Television yesterday, talking about this very phenomenon. (You can watch the whole interview here.) "What do you make of the PPI numbers?" the host asked him. "They did come in higher than expected. Is inflation going to be a concern for the market?" "That is always a question," answered Alan. "The fed was trying to spark inflation and get money moving again. There is a delicate balance there, but we're coming off record lows and inflation numbers from last month. That is to be expected. I am not that concerned, but I think you are touching on something very important as far as the market momentum. If the market momentum is so strong right now - the one disconnect is crude oil. It is failing to make the highs, even though the market is. That is something to really pay close attention to I think." [For more insights from Alan, check out his latest report - and learn how to get on the inside of the financial world's best kept secret. See here.] For now, it appears to us that retail prices are still going down. And we doubt that the feds can cause a genuine recovery - simply by throwing money into the economy. You can boost spending when you're in a credit expansion...but not when you're in a credit contraction. That's why we're suspicious of that retail-spending figure. How much of that is just spending funded and coaxed out by the feds? 60%? 80%? 100%? David Rosenberg says it's 100%. He's probably right. And what would the economy look like without the phony demand ginned up by the feds? It would be shrinking at a 6% rate. And what will happen when the feds stop goosing it up? It will fall back. But can't the feds continue stimulating the economy indefinitely? Maybe. Even so, the lesson we learned from the Japanese is that even with huge inputs from the government (the Japanese passed 11 separate stimulus measures totaling some $30 trillion yen) the real economy won't budge. Over nearly 20 years, the Japanese economy went from on- again, off-again recession to on-again, off-again deflation. The government muddied the waters. Still, consumers saw clearly what they needed to do. They had lost money in the crash of '90. Their Bubble Era stocks went down first. Then, their property went down too. They needed to save money for their retirements. This they did, resisting all of the government's efforts to get them to save. Will the situation be any different in the United States? Probably not. More news from The 5 Min. Forecast: "'From a technical perspective, the recession is very likely over,' Ben Bernanke assured the world after a speech at the Brookings Institute yesterday," writes Ian Mathias in today's issue of The 5. "If you'll spare us a few seconds, we'd like to start today's news with a semantic gripe: "Is there any point in saying something is 'technical,' unless you're just trying to put a pretty mask on an ugly reality? When our mechanic told us last month that the brake pads on our old Honda Civic were 'technically' useable, we grimaced and reached for our wallet. Picture an anxious young couple in the doctor's office post examination, when their trusted physician announces, 'Well, technically, you're pregnant.' Mmmmm...how assuring. "So the economy is technically just fine, but 'it's still going to feel like a very weak economy for some time,' Mr. Bernanke hesitantly added, 'as many people will still find that their job security and their employment status is not what they wish it was.' "In Bernanke-speak summary: Technical economy = what you wish it was. Real economy = not what you wish it was. "Here's another serious indicator that the powers that be will soon be declaring an end to this recession: Capacity utilization inched up for the second month in a row in August. In data announced by the Fed today (no way Mr. Bernanke got a peak at this beforehand) the US manufacturing sector utilized 69.6% of total capacity during August, its highest level since February. "We've noted this several times before, but it bears repeating. In post war history, when capacity utilization rebounds, the technical conclusion of the recession has already occurred... just a matter of time before the NBER calls it: "So we wonder... How long until the next one technically begins?" 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: Without extra earnings, the only way the consumer can increase his spending is by going further into debt. He is unwilling and unable to do that himself. The banks won't lend him money and he wouldn't take it if they would (at least, that's our view). So what's happening? The feds are borrowing big time - IN HIS NAME. They're running up federal debt - that he'll have to pay, one way or another. This money is then funneled to him in various devious and mostly ineffective ways...resulting in enough activity to make it look like something is happening in the economy. It's a fake. It's a fraud. It's fundamentally counterproductive. But it's all it takes for people such as Ben Bernanke to believe the economy is recovering. Today's headline news: "Bernanke says recession 'very likely' has ended." And so, our convictions are put to the test. Everything seems to be improving. The numbers - many of them - show an increase in business and retail activity (New York's manufacturing index is at a 2-year high...). The commentators, economists, and analysts all say things are getting better (except for those who know what they are talking about)... And the stock market is still going up. The Dow finished up 56 points yesterday. Gold closed at $1006 yesterday. This morning, it's up to $1017. (More about gold later in the week...we've done a lot of drinking on the subject...) And oil is just under $71. So, who's right? Who's wrong? Us? Or them? We say there is no real recovery going on...and there won't be one. They say the recovery is already here. Stay tuned. [You don't have be a victim of the government's bailout spending. In fact, you can use it to your advantage, because of a perfectly legal 'loophole' that will allow you get your share of the bailout money - up to $17,500 this year alone. See how here.] "You can still sell property," said brother Jim. "But only if you're willing to discount it." Jim is visiting from Virginia. He is a real estate agent of some renown in Charlottesville, VA, dealing only with large farms and estates. His customers are on the golden side of the light spectrum; they tend to pay cash. "Yes, these are not people who need to mortgage property. But the story is not very different. They still have their lives...and their problems. "What's happening now is that there aren't many buyers and those who are buying expect to get very good deals. So, you can still sell a nice property, but only if you're willing to heavily discount it. "Prices are down, say, 20-30% from where they were a few years ago. But the buyer wants another 30% discount. Not many sellers are willing to give up that much, so in my area there aren't many sales that go through. "I'm lucky because I've been at it a long time. People know me. So when they want to move a property...or to buy one...they contact me. But I have to tell them what's going on. And I tell them that if they're not willing to sell at a big discount, it will be hard to sell at all. "As I said, most people just sit tight. But a few get into situations where they don't have a choice. One poor woman has gotten sick. She is going into a nursing home and apparently the children need the money to pay her medical expenses...so they're forced to sell. Sometimes there's a divorce that forces a couple to sell a place. Otherwise, not much activity. "And I feel sorry for all those real estate agents who came into the market over the last ten years. What do they do? There aren't enough transactions to keep them in business. But what else can they do? They're not a lot of jobs open in other areas either. "My guess is that they are all treading water...hoping for a change...living off savings...until they have to make a big change." We wonder how much of the economy is treading water...hoping for a lifeline...hoping that all this talk of 'recovery' is going to make it possible to avoid any unpleasant changes... hoping that things go back to the old normal...that somehow, everything will be all right again... Until tomorrow, Bill Bonner The Daily Reckoning The Daily Reckoning PRESENTS: Worldwide, there were plenty of skeletons in the closet. And it doesn't really matter which closet you look in - North America, Europe, Asia - they are all wearing the same outfits, and they are all hiding the same secrets. Bill Jenkins explores... An Appetite for Risk by Bill Jenkins Pylesville, Maryland The world is awash in credit and debt. What I mean is, credit had been extended to anything with a shadow. Almost every Tom, Dick and Harry participated in it. From the central banks around the world to the man in the street, everyone has done exactly the same thing: finance whatever needs to be bought. And when we ran out of money, no problem! There was more where that came from. In one sense we couldn't spend money fast enough. As soon as it was gone, there was more suddenly available. So we just finance the house again, take out some equity (which always rises) and do one of two things - Pay off credit cards (so we can load more debt on them) or just spend the cash on things a home improvement (that is no longer reflected in the price of the home) or a vacation. Remember how MasterCard taught us that those memories were priceless? Hope you got some good ones... because you "done bought something you can't eat," as one of my teachers used to say. At a time when we are drowning in debt, we are also out of money. When a debtor is out of money, he has no ability to repay. And when a creditor has borrowers who are out of money, the creditor has no income. No earnings. No power to make better loans. So how are banks in America posting "profits"? How did Citigroup, Bank of America, AIG and Wells Fargo jump 400% in stock price? Are they worth 400% more? Are their earnings up 400%? And where in the world did all this money come from? These companies were just bankrupt... yet found a way to get back above water. And not just above water - they are making moon-shots! Their share price should be zero (or less, if possible!). How are they worth so much more now? As I have written before, mark-to-market accounting rules were repealed in favor of a fictitious slight of hand. Banks no longer have to list their distressed assets at the fire sale price they should be worth. Instead they get to record their value as the price they bought them, or what they believe they will be worth in the future. In other words, it's like me refinancing my house, but doing my own appraisal and assigning it whatever value suits me. I want cash out? Just pad the value of the house. I can't afford a higher payment? No worries, I just pad my reported income. Two years down the road I can't afford my payments anymore? Easy, just follow the same refinancing procedure all over again. But my family and I would only have one toxic asset to deal with. The banks have them coming out the wazoo! They are still in possession of the faulty loans and derivatives that caused this entire mess in the first place. Nothing has changed - except the accounting! The banks always counted on that. This time, however, they are the ones left holding the bag. What are they going to do with all this JUNK? How can they unload it without attracting suspicion? How can they clean up their books without the short sellers making a profit off their downfall? They can't. It's a Catch-22. But the real problem is that the US banking system would come crashing down in a minute if this were known and understood by the general public. The banks know it. The Fed knows it. I suspect that there are some congress people who know it. But here's where the rubber meets the road. Government engineered a bailout. They wanted the banks to lend to Joe Consumer. But the banks didn't. And frankly, Joe Consumer didn't want it. He was too busy trying to figure out how he was going to repay all the money he had already borrowed against his house. Especially with the boss breathing down his neck, threatening job terminations if he wasn't more productive than some cheap labor in India. So the banks were sitting on a good deal of the money from the Fed in order to protect them from future losses. Some of them have even paid it back. But the truth is, from an accounting standpoint, they don't need it anymore. From an accounting standpoint, their mortgages and derivatives are all valued at a big fat surplus. Why keep federal money? Why incur interest charges when "all is well"? If they can show a profit from an accounting standpoint... and if they can repay their bailout money (plus interest)... and if they can still service the customer at the drive-in window or the teller counter, what's the big deal? What am I crying about? It's all because those toxicities still exist. And they all have to be accounted for, whether the government says so or not. We should have learned, or have been reminded of, one of the greatest lessons in the world from convicted felon Bernie Madoff: "Be sure your sin will find you out." Even the greatest engineered schemes on the planet come undone at some point. No Ponzi scheme can continue forever. But if you are very bright (as Madoff was), you can keep the game going for a long, long time. But what if you're not brilliant? After all, I doubt the government is as smart as Billionaire Bernie. Luckily, if that's the right word, the government has another way to keep the game going, using one thing it has that Madoff didn't. Cash. Gobs and gobs of it. "But the real problem is that the U.S. banking system would come crashing down in a minute if this were known and understood by the general public. The banks know it. The Fed knows it. I suspect that there are some congress people who know it." The government's massive wad of cash is what keeps the game going. And foreign investors lending us money. And millions of pensioners happy as long as they receive their check on the first of the month. And the multitudes of purchased votes that are blissfully sitting on the dole. But it's not just the United States. Every country in the world is in the same pickle - because every developed nation believed they could successfully manipulate the game. The problem now is that the governments are running out of money. The United States has been broke for a long time, of course, but it could still trade on the value of its good name... and it did. Other nations are not so lucky. The United States still possesses the reserve currency status; other nations aren't so lucky. We still boast the largest GDP; other nations are not so lucky. I'm pretty sure we still have higher tax receipts, and more room to raise taxes than other nations. But somehow, I can't bring myself to call that lucky... But as it is an "option," I have to think that whatever smarts our government does have, someone will eventually realize it. Good Lord, deliver us. I do not honestly think that anyone can seriously contest us in the role of reserve currency, no matter how many times China rattles the saber. Twenty years ago, China couldn't even feed its own people or keep them employed. Now it is boasting a 7% annual growth rate. Despite the massaging that may be done to the numbers before they are released, we can already see that a country growing solely on stimulus cannot grow very long. The weaknesses in China's underbelly are already becoming apparent. She is an export economy. And people are not buying. She cannot save the world, whatever her strength might be. There is another round of destruction coming. The banks will have to come clean. If you thought the residential crunch was stunning, wait till you see what's coming on the commercial front. It will be a tsunami of epic proportions. Banks are not lending now, and the chances of business expansion are lower than at any time in recent history. No one will be buying excess of anything except maybe food and precious metals, so businesses will not continue to post profits. Without profits you can't service the loans you have, and rolling them over will be out of the question. The day is coming... don't let it catch you by surprise. But until that day arrives, we must deal with what we have. Regards, Bill Jenkins for The Daily Reckoning Editor's Note: Bill Jenkins, founder and managing editor of Master FX Options Trader, knows the Forex currency markets inside and out. After 20 years and a string of losses following other people's crack advice, Bill created his own system for cashing in on tiny currency fluctuations between the British pound and the US dollar. Now you have a chance to benefit from his "lifetime" of hard-earned experience. As Agora Financial's resident currency specialist, Bill's advice has led readers to gains of 33% in a week... 70% in four days... and 100% practically overnight. And we've broadened the service to include the euro, yen and other currencies in these volatile trading markets. To see the latest issue of Master FX Options Trader, see here. The Daily Reckoning - Special Reports: History of Financial Disasters: Will you be Wiped Out? US Recession: By far the Weakest Recovery Introducing the Single Best Way to Make Sure You'll Never Run Out of Money...

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