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The Daily Reckoning Friday, October 9, 2009 Gold was the most profitable major asset over the last ten years... Asia is attempting to slow the dollar fall. Good luck with that... Why are people buying bonds with such puny yields? Bill Bonner shows that Greenspan is as blind as ever... A Deflation Story by Bill Bonner London, England "It was at Rome, on the 15th of October, 1764, as I sat musing amidst the ruins of the Capitol, while the barefooted friars were singing vespers in the Temple of Jupiter, that the idea of writing the decline and fall of the city first started to my mind." - Edward Gibbon Warren Buffett famously says that people do not make money by betting against the US economy. But two years ago we decided to take a chance. "We are short the United States of America," we announced from the comfort and safety of our headquarters in London. "Sell its stocks. Sell its bonds. Sell its money. Sell its real estate. Sell the equity. Sell the debt. Sell everything." What we saw was an over-stretched empire getting ready to snap. But we were also allowing ourselves to be lazy. Rather than deconstruct the capital structure of the world's largest economy, we decided to sell the whole damned thing. All Hell broke loose in September 2008. Since then, US stocks have gone down about a third. Real estate too. Unemployment has doubled. Consumer prices are going down at the fastest rate since the '50s. And the economy is in the worse recession since WWII. Meanwhile, Americans' per capita wealth has fallen from $172,000 in September from $212,000 two years earlier. And the UN reports that the quality of life in America has gone down too...from #5 on its list in 2000, it fell to #13 in 2007. No doubt it is below #20 now. Buffett has lost billions betting on the US economy while our gold positions are handily up; gold was the most profitable major asset over the last ten years. So you see, we were right; America was a sell two years ago. And now it is the dollar that is falling. It's gone down 12% in the last six months - a huge move for a major currency. "Asia tries to slow dollar fall," is the lead story in today's Financial Times. Today, a buck and forty-seven cents will buy you only 1 euro. Ten years ago, you could have gotten a euro for less than a single dollar. A falling dollar makes imports more expensive, say analysts...raising the cost of living in the homeland. But you wouldn't know it from walking around on the streets of Miami or Las Vegas. You can get a house at 50% off its price three years ago. As for the breakfast special - for less than 3 euros you can get enough food to kill a Pakistani. By European standards, America is cheap. "Europeans again interested in Florida houses," says a headline in The New York Times. House prices are down 30% to 50%. The dollar is down about a third too. That makes the United States a bargain. But is the United States of America about to become even cheaper? One thing we were wrong about when we issued our 'sell America' call two years ago was US debt. Treasury bonds have resisted the general downward trend of things with the stars and stripes on them. Bonds have not gone down; they've gone up. Private households are buying them for their retirements. Banks are buying them for risk-free profits. Speculators are buying them in anticipation of deflation. David Rosenberg: "The big story yesterday was the further massive $12 billion decline in outstanding consumer debt in August - the consensus was looking for an $8 billion contraction. This was the seventh month of debt retrenchment in a row. In other words, the tidal wave of the credit collapse continues unabated, and this is the primary reason why bond yields are still in a fundamental downtrend. "Over the past year, consumers have run down their debt by a record $113 billion (and this does not include mortgages). This is an absolutely epic shift in household attitudes towards credit and discretionary spending." Americans are saving. And they're buying US Treasury bonds. (More below...) But how safe is their money? Is it a good idea to buy US debt now? On Wednesday, Latvia tried to raise a trivial amount of money. It offered $17 million worth of 6-month bonds. How likely is it that Latvia will default before Easter? We don't know, but investors judged it not worth the risk. Not only did the bond auction failed, it failed with no bids. That's what happens when lenders lose faith in a government. They refuse to lend it money - except at high rates of interest. But the high rates of interest work like a noose on the neck of a cattle rustler. They block the vital flow of oxygen - not to mention breaking his neck. Note that the US federal government is still functioning like an empire at the peak of its power. The Pentagon is still rustling up trouble all over the world - at a cost of trillions. US government employees are growing more numerous and richer - with twice the annual incomes of the private sector. And the Obama Administration - apparently unaware that the total unfunded debts and obligations of the federal government have soared to nearly $120 trillion - is considering new ways to get rid of cash. Remarkably, investors still lend the US government money - asking only 4% annual yield on a 30-year loan. As for 91-day money, they practically give that to the feds for free; it sports only a yield of 0.066%. This will surely be a point of puzzlement for the financial historian of the next century. It is certainly a point of puzzlement for us. [We wrote a book with Addison Wiggin, Empire of Debt that looked at the similarities between the United States and the Roman empire - right before its fall. We recently updated this New York Times bestseller...and you can get your copy here.] More below, after the news, from The 5 Min. Forecast: "Thirteen months ago, the government took over Fannie Mae and Freddie Mac, both on the verge of failure," writes Ian Mathias in today's issue of The 5. "What have we learned since then? Jack... "The Federal Housing Administration, 'appears destined for a taxpayer bailout in the next 24 to 36 months,' Edward Pinto said at a Congressional hearing yesterday. As the former chief credit officer for Fannie Mae, he should know. "But it doesn't even take an industry insider to figure this one out. Just a year after bailing out the overleveraged Fannie and Freddie, the FHA has managed to paint itself into the exact same corner. When the free market - in its infinite ignorance - stopped issuing easy money home loans last year, the FHA stepped in and became a huge player in the mortgage loan biz. They went from insuring 6% of new mortgages in 2007 to over 21% last year, and even more in 2009. "Now the FHA insures 5.4 million single-family home mortgages - most of which require only a 3.5% down payment - at a value of $675 billion. Their cash cushion? Oops... Must have forgotten to beef that up too... It's just $30 billion. That's the same 20-1 leverage our government's been pooh-poohing on Wall Street. Funny how that works. "And since the FHA has become the insurer of last resort, famous for their crazy-low down payments, the loans they cover are souring at an accelerating pace. The more recent the loan, the worse it's performing... Can you hear the wind sucking out of this one? "So what happens if the FHA goes belly up? Hey, don't call us alarmists: 'Let's be clear,' said Congresswoman Maxine Walters at the hearing, 'without the FHA, there would be no mortgage market right now.' As we've forecast before, look for the FHA to be the next multi- billion dollar bailout." 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 our newest service, BRIC by BRIC. We have assembled four "go-teams" of in-country experts in the world's fastest growing markets. People who know first-hand all the ins and outs of investing in Brazil, Russia, India, and China. Get your charter membership for 50% off the regular price...see how here. And back to Bill, with more views: Yesterday, gold hit a new record at $1057. Doesn't gold go up when inflation rates rise? And don't bonds go down when inflation goes up? So why are people buying bonds with such puny yields? There is a lot of whispering in this market. Gold is trying to tell us something. Bonds are trying to tell us something. The dollar seems to have something on its mind too. Stocks are just babbling. If gold is trying to signal that inflation is coming, the bond market is not paying attention. Bonds seem to be saying that it is deflation we should be worried about; but the stock market doesn't seem to hear. And there's the dollar. The greenback is in the same choir with stocks and gold, as near as we can tell. They all seem to be chanting about inflation coming back. But what if they're all wrong? Just look at what is going on in Washington, if you can bear it. The feds have a budget that anticipates inflation and growth. Spending is supposed to remain flat until 2013. Tax receipts, which are no higher today than they were 10 years ago, are supposed to rise, gradually filling in the Grand Canyon of deficits. The number crunchers think we're headed back to the Reagan years - when the tough-love policies of the Volcker Fed squeezed out inflation and created a real boom. Then, tax revenues rose 9% per year between 1984 and 1989. How likely is that today? Not very. Instead, what is likely to unfold is a deflation story. Instead of staying flat, federal expenses are likely to rise as one failed stimulus gives way to another failed stimulus. Then, instead of going up, tax revenues will go down...digging an even grander canyon between out-go and income. Then, or long before, there will be a panic out of bonds, the dollar, stocks - practically everything. Everything goes down! At this point, the US will be in about the same situation as the Roman Empire as it approached retirement. Expenses kept rising. Rome had to pay the Blackwater-type military contractors of the era...in addition to keeping Roman mobs supplied with food stamps and unemployment benefits...while its tax base fell. Gradually, the empire lost the ability to defend itself. When Edward Gibbon began his history of Rome's decline and fall, Roman real estate had probably been in a bear market for at least 1300 years. Rome's population fell from over a million to under 20,000. Politically, Italy had broken apart more than 1,000 years before Gibbon was born, and it wouldn't be put back together again until nearly 100 years after he was dead. It's far too early to write the story of America's decline and fall. That job will fall to some future historian, perhaps seated on the ruins of the Lincoln Memorial, wondering how people made such a mess of things. Our guess is that he will come to the same conclusion we have: Stocks? Bonds? The dollar? Investors should have sold them all! [But we'll hang onto our gold...and you should do the same. Don't be turned off by the high price of the precious metal...there's a way you can get gold at just a penny per ounce. See how here.] Keep reading for today's essay... The Daily Reckoning PRESENTS: The maestro himself, Sir Alan Greenspan, has declared a recovery underway in the United States. The same man who didn't see the world's biggest financial bubble until it exploded in his face. This revelation seals the deal for Bill Bonner: the country is clearly not recovering. Keep reading... Chronic Depression by Bill Bonner London, England This week, the Australian central bank became the first to declare victory. It raised its key lending rate 0.25% and gave a whoop...signaling an end to the slump. The European Central Bank fidgeted and vaguely threatened to raise rates too. But the Americans stayed in their trenches. New York Fed governor Bill Dudley said that even though the economy is recovering, any rate hikes in the United States would be over his dead body. Then, word came that even Alan Greenspan thinks a recovery is underway. "This is what a recovery looks like," said the maestro. That settled the matter as far as we are concerned. Alan Greenspan didn't see history's biggest financial bubble until it exploded in his face. In the following few words we undertake to show that Greenspan is as blind as ever. "Great time for US consumers, America is on sale," says an item at YahooFinance. The "discounts are unbelievable," adds a blogger known as Frugal Rhode Island Momma. All across the nation, merchants are no longer selling the merits of their products; they're selling price. McDonald's advertises its "dollar meals." Hotels have cut room prices by 20% in the last year. House prices are down about 30% since 2006. Sellers are offering bargains and they want buyers to know it. "Sold for $365,000 in 2006. Now $195,000," says a typical house ad. Foreigners have noticed too. Colleagues in London say they are thinking of moving to Florida where they will get far more for their money. The dollar falls; foreign purchases go up. Stocks, for example. In the first quarter, foreigners were unloading US shares. Now they're buying more than $100 billion worth per month. It is a deflationary world, at least that part of the world between the Rio Grande and the 49th parallel. The CPI in the United States is negative and falling faster than at any time in 59 years. Households can only be induced to spend money by cutting prices. "Cash for Clunkers" cut prices on new cars by about 20%. As soon as it ended, so did auto sales. Most new house sales could be traced to a tax credit - which reduced the down payment by at least 20%. That program is scheduled to end in November. And now, the White House frets about jobs. Unemployment is supposed to be a lagging indicator, but this time it seems to have dropped out of the race all together. Still, Congressional elections are coming up. Unemployed voters are surly and unreliable. So, the Obama administration is considering a $3,000 tax credit to bribe businesses to hire them. If the typical employee costs his firm about $40,000, this effectively reduces the cost of labor by 7.5%. It's beginning to look more and more like the Roosevelt years. By the end of this year, all the jobs created during the bubble era - 2002- 2007 - will have been eliminated, making it the first decade with no job growth since the '30s. We're expecting a fireside chat any day. "The authorities still do not understand what is going on. They are used to fooling most of the people most of the time. They think they can dupe them again – with bailouts and boondoggles." Typically big businesses cut workers in a recession. Then, when the economy recovers, small businesses are quick to take them back. But this is unlike the typical post-war recession. This time, deprived of capital as well as customers, small businesses don't have a chance. Neither does a genuine recovery. The authorities still do not understand what is going on. They are used to fooling most of the people most of the time. They think they can dupe them again - with bailouts and boondoggles. But real demand has vanished as households try to pay down their debt. That is not going to change anytime soon. Not while the federal government is sabotaging a genuine recovery. It's savings - capital - the US economy needs. A capitalist economy in which the capitalist have no capital won't work. Why is there no capital? Because the feds take it. Supplying cash-for-this and cash-for-that is an expensive proposition, especially when tax receipts are falling. The money has to come from somewhere. As it turns out, the feds borrow it from the very people who are trying to rebuild their personal balance sheets. Of the $1.6 trillion the US government will borrow this year, the biggest single lender is the private sector, chipping in $700 billion. But instead of being put to use in a way that might stimulate a real recovery - providing credit for small business and consumers - it is taken up by the US government and then frittered away. The banks are happy to play the government's game too. They can borrow overnight money from the Fed at only one quarter of 1%, annualized. But lending to small business is hard work. And it is risky. Why bother? The US Treasury will pay them 4 % for lending back to the government, long term. This is practically free money to the banks. Both the bankers and politicians end up ahead - with a bigger piece of the economy under their control. Meanwhile, the real economy staggers. "Drought of credit hampers recovery," summarizes The Wall Street Journal. The United States needs to create a million and a half new jobs each year just to keep up with population growth. Currently there are 15 million people without jobs already...and a couple hundred thousand more unemployed every month. And if this recovery continues long enough there won't be a single person left in America who still has a job. Even if the economy could be stabilized, it will leave millions without jobs - more or less permanently. Add the people working reduced hours, and those who have been looking for work so long they are no longer counted, and their families, and you have a quarter of the population without money to spend. That's why this slump is not going away any time soon. As in Japan in the '90s, we may have to live with this depression for the rest of our lives. 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 Empire of Debt, can be found here. The Daily Reckoning - Special Reports: The US Trade Deficit: Fort Sumter...And The U.S. Trade Deficit 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.