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The Daily Reckoning Friday, October 2, 2009 Greed investments are topping out...fear investments head up... Gold could go either way at this point... A new wave of defaults is about to hit the mortgage industry... Bill Bonner looks on the bright side of a depression...and more! Red October by Bill Bonner London, England Uh oh...maybe it will be a Red October after all... Two important things happened yesterday, both of which cast a crimson light on things. First, the Dow dropped again; it has only gone up one of the last 7 days. It went down 203 points. Could be nothing. Could be something big...the beginning of the long awaited 'next leg down' for the bear market...the opening day of a bloody Red October. Charts of oil, commodities, copper, the dollar, and Treasury bonds tell us the same story. The greed investments are topping out. The fear investments are headed up. What's a 'greed investment?' It's anything that benefits from an improving outlook for the economy and inflation - oil, commodities, and stocks, mainly. What's a 'fear investment?' It's something that goes up when people begin to suspect the boom is a phony - namely the dollar and US Treasury bonds. The dollar is rising. So are Treasuries. Yesterday, 30-year US Treasury bond yields fell below 4% for the first time since April. And what about gold? Well, that's the other important thing that happened yesterday. Gold held above $1,000. So what? So what?? Well, dear reader, you are in a prickly mood this morning, aren't you? This is important because gold could go either way. Gold is a refuge in times of fear - especially when people fear inflation or a falling dollar. Gold is also a target of greedy speculators sometimes, even when the going is good. According to a study done by the World Gold Council, you never know what gold will do. That study was a great comfort to us here at The Daily Reckoning; we thought we might have missed something. But no. We may not know what gold will do, but neither does anyone else. Looking around, we see no sign of consumer price inflation. So gold's recent rise must have been driven by optimistic speculation - along with oil and stocks. Now, when oil and stocks go down... we have to wonder whether gold will go down too. The answer, given yesterday, was what we expected - yes, but not as much. There's substantial risk in gold as well as stocks. The ultimate low for the Dow should be below 5,000. That is, let's say, about a 50% haircut from current levels. And let's assume that gold does what it did yesterday...let's suppose that it goes down only 40% as much as stocks. That would still be a drop of 50% of 40%, or 20% - to the $800- an-ounce level. If you would be gravely upset by a drop of that magnitude...you probably shouldn't buy gold at this level. And, of course, you should have sold your stocks already. Stick to cash - and gold, if you're long-term oriented - until this next phase is over. The economic news was mixed, as usual...with nothing to make us think that our basic outlook is wrong. On the optimistic, bullish side...consumer spending rose in August. Pending homes sales went up too. But on the pessimistic, bearish side... "September auto sales plunge," says a Reuters headline. Yes, auto sales drove off a cliff last month - just like we said they would. GM reported a 47% drop. What happened? The clunkers program was an economic fraud. Like all attempts to boost consumption, it merely shifted sales from the future to the present (now the past). Which is a big reason why August consumer spending looked good too. But wait a few weeks for the September consumer spending numbers. Especially if the stock market continues to fall... Then we'll find out how sustainable those retail sales numbers really are. As you know, here at The Daily Reckoning headquarters...in the building with the gold balls on the south side of the Thames...we are often accused of 'pessimism.' We deny it. We're optimistic about the fate of mankind. But we are pessimistic about many of his current pretensions - such as health food, enlightened central banking, contemporary art, mass education, global climate control and progressive democratic government. But maybe we are wrong to be optimists. Pessimists always have the last laugh - when the optimists die. "I told you so," they say, under their last breath. [But our dear readers know better than to be overly optimistic about the current economic situation. That's why many of you have taken our advice to set up your financial defense strategy, so you can protect (and build) your assets, while everyone else is losing their shirt. If you haven't already, get your free 'Rescue and Recovery' bundle here.] More news from The 5 Min. Forecast: "China could be the world's second biggest economy as soon as 2010 and the world's largest in as little as twenty years," writes Ian Mathias in today's issue of The 5. "This altered trajectory is courtesy of the IMF, which revised its World Economic Outlook yesterday. In short, emerging nations with strong export economies (like China) will drive global growth in the next two years while more established economies like the US, Eurozone and Japan will lag behind. "Specifically, the IMF expects China to continue growing around 8-9% a year as Japan - the world's second largest economy - will be lucky to grow much faster than 1.7%. Plug that in some fancy charting software, and you get this: "With Japan a foregone conclusion, China now sets its sights on I.O.U.S.A. The IMF has no projections that far away, but researchers at the Nomura Institute of Capital Market Research proclaimed this week that China will pass the US sometime between 2026-2039, depending on yuan appreciation. "We're skeptics, if only because it's such a widely held belief nowadays that China will inevitably rise to the top. Before they get there, they'll have to rewrite their entire economic credo, the current staple of which is American over-consumption. And it was only 20 years ago when every broker was convinced Japan would soon be the world's economic powerhouse. Eight of the world's ten biggest companies were Japanese in 1988. Today, the biggest (Toyota) is 22nd and only five others are in the top 100. "But there is one thing that might 'make it different this time': people. 1.3 billion Chinese people, to be specific: "If China can ever monetize its massive population, they'll leave us all in the dust." 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: Meanwhile, from Phoenix comes news that a new wave of defaults is about to slam into the mortgage industry. Commercial properties, retail space, office complexes, apartment buildings are hard to rent. You can see why. In 2007, America was already outfitted with far more retail space than it actually needed. Americans had gone on a shopping spree for the previous ten years...prompting builders to add more and more space. By 2006, the United States had 10 times as much retail space per person as France. This was the bubble phase of a boom in consumer credit that began in 1945. When you get to the bubble phase, few people stop to ask questions. Instead, everyone assumes that the trends in place will remain...and even intensify. So even into 2008, in Phoenix as well as other growing areas - principally in the sand states - the building continued. And now it is 2009. Where are the shoppers? Where are the renters? Alas, they are thinner on the ground than anticipated...and the developers are having trouble paying their mortgages. Commercial mortgage backed securities are carrying 5 times the unpaid balances they had in June '08, says Bloomberg. Imagine how disappointed lenders will be when these loans default. And then, imagine how American investors will feel when a new wave of mortgage defaults and foreclosures is hits the commercial property market. A new wave of foreclosures and falling house prices may be approaching the housing market too. Alan Abelson, in this week's Barron's, reports on the outlook as described by Amherst Securities. The research group estimates an overhang of 'hidden inventory' of some 7 million units. These are properties owners would like to sell - if and when the market strengthens. Trouble is, the market may not strengthen soon enough. Then, many of these hidden properties could come right out in the open, as mortgages are reset, marriages break up, and people move on. Amherst says these people are in the "delinquency pipeline" which eventually flushes out the market. And it calculates that another 300,000 properties enter the pipe every month. Falling prices have reduced 'owners' equity' - the part of the house the homeowner owns free and clear of a mortgage - to only about 43%. This number includes people who have no mortgage at all - more than 50 million of them. Abelson speculates that the actual equity in the hands of the 'owners' of mortgaged houses must be substantially less. Pushed by joblessness...not to many life's other, normal hazards...many of these people are surely going to default. Of those in the "delinquent pipeline," nearly 10% haven't made a payment in more than two years. Sooner or later, the banks and mortgage holders will be forced to take action...and more houses will come onto the distressed property market. [Rob Parenteau, over at the newly revamped Richebächer Letter has been warning of this wave of defaults and foreclosures headed our way - and his latest special report details how to shield yourself and your wealth from this impending disaster. Get the report here.] Eager to put this recession behind us? Hey, don't be in such a hurry. Recessions do good work. Depressions are even better (see below....) More and more people get something from government. Fewer and fewer are net taxpayers. This is the basic formula that bankrupts democracies. The political system becomes skewed towards spending; then, there's no stopping it. Once the majority of voters and special interests has an interest in increasing spending - even by borrowing - rather than in limiting taxes and debt, the game is practically over. USA Today reports on the number of children whose lunches are furnished partly at taxpayer expense. The figure rose from 24 million in 1990 to 31 million today. That is, the welfare program increased by a third during the biggest boom in history. Think what will happen during the bust. Keep reading for today's essay... The Daily Reckoning PRESENTS: In today's essay, we do something different: look on the bright side. That is, the bright side of a depression - it's not as bad as you think, and is surprisingly good for your health! Bill Bonner explores... Hooray, It's a Depression! by Bill Bonner London, England The God of Abraham may rule the Vatican. But another group of gods rules finance. They are like the Greek gods...playful and mischievous, with a keen sense of humor. They look down from heaven not like a benevolent shepherd watching his flock, but like a cackling gawker betting on mud-wrestlers. Here at The Daily Reckoning, this is not the first time we've paid homage to these lesser deities. Nor is it the first time we've mentioned their perverse method: Those whom these gods wouldst destroy are first cursed with good luck. Today, we look at the bright side: later, they are blessed by misfortune. According to a pair of researchers from the University of Michigan, a depression does more for longevity than diet or exercise. Life expectancy during the worst years of the Great Depression increased from 57.1 years in 1929 to 63.3 years in 1933, says the report by Jose A. Tapia Granados and Ana Diez Roux. It didn't matter whether you were a man or a woman, black or white. And it didn't matter if you were in the US during the Great Depression or in Spain, Japan or Sweden during their economic downturns. The results were the same. By contrast, life expectancy declined during the boom years. For most age groups, "mortality tended to peak during years of strong economic expansion (such as 1923, 1926, 1929 and 1936-1937)," they wrote in the "Proceedings of the National Academy of Sciences." Conventional wisdom holds that recessions are times of stress. People do not eat as well. They skip medical check-ups. They should drop dead earlier. Instead, they live longer. Perhaps it is because the economy slows down, allowing people to live at a more comfortable pace. Maybe the unemployed get more sleep. We don't know. But if you want to live an extra six years, nothing works like a slump. When it comes to economic health too, nothing beats a depression. Last week, World Bank president, Robert B. Zoelick, explained to Washington how the dollar made Americans wealthy: "The United States is incredibly fortunate that the dollar enjoys this special status [as the world's reserve currency.]" It made it possible for Americans could buy things abroad with dollars and then, rather than come back to the United States as a claim against US assets, the dollars stayed in foreign central bank vaults. It was as if the Untied States, and the United States alone, could issue IOUs and never have to pay up. An "exorbitant privilege," Valery Giscard d'Estaing called it. "But if you want to live an extra six years, nothing works like a slump. When it comes to economic health too, nothing beats a depression." Since the end of WWII, the world had no real alternative. It had to use the dollar in its international transactions, just as it once used gold. This had a marvelous effect on world trade and roughly the same effect on America as a winning lottery ticket. And like a lottery winner, she was ruined by it. With no effective limit on the number of IOUs they could issue, Americans issued far too many. From a low of around 2% of disposable income in 1945, US debt service rose to nearly 15% in 2007. In terms of total debt/GDP, the ratio was only about 150% in 1945, but that was with public debt from the war years at 120% of GDP. By 1950, the war debt had been cut down to about 70% of GDP, with private debt still at about 35%. At the height of the bubble years - 2005 to 2007 - total debt in America hit 360% of GDP, only 60% of it owed by the federal government. Of course, most economists saw nothing to worry about. Instead, they set to work proving that such a 'dynamic' and 'flexible' economy would never fail. They even won Nobel Prizes for elegant formulae that showed investors how to beat the market, year in and year out. Then, the bottom fell out of asset prices in '07-'09. In March of this year, Americans found that their stocks had fallen back to real values not seen since 1968. Their houses were sinking fast too. By May 2009, one out of every four US homeowners was 'underwater' - with a mortgage greater than the value of his house. Incomes and profits were falling, along with the net worth of the typical American household. Everything was falling - except debt. How the gods must have roared when they saw the looks on their faces! In the biggest, longest boom of all time - even with a monopoly on the world's reserve currency - Americans had lost ground. But while Americans were once damned by good fortune, they are now blessed by bad luck. "Looking forward, there will increasingly be other options to the dollar," says Mr. Zoelick. Thank the rascal gods. Americans are saving again...rebuilding their balance sheets...and, eventually, their economies. They can even look forward to living longer. And with a little more bad luck, maybe their moron economists will wise up too. 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, an update of Financial Reckoning Day, co-authored with Addison Wiggin, is now available for purchase by clicking here: Financial Reckoning Day Fallout: Surviving Todays Global Depression   The Daily Reckoning - Special Reports: History of Financial Disasters: Will you be Wiped Out? US Recession: By far the Weakest Recovery "THE GREAT AMERICAN RECOVERY RP-OFF" Brace yourself for what's about to go down as the BIGGEST FINANCIAL SWINDLE in world history.