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The Daily Reckoning | Friday, February 26, 2010 Dr. Inflation Or How I Learned to Stop Worrying and Love the Depression Bill Bonner The depression is alive and well! Unemployment claims just came in higher than expected. And new house sales in January were at their lowest ever. Pundits were quick to blame the snow. But sales were off even in areas that had better-than-usual weather. Household income has gone nowhere in 10 years. Stocks have suffered a lost decade too. And now Ben Bernanke says we’d better be careful...because the recovery ain’t no sure thing. The Fed chief has no idea. But average people know what’s going on. They know how hard it is to find a job. If you’re in the building trades...or you have only a year or two of college...you’re pretty much out of luck. You may have to retire before you ever start work again. That’s why there was such a big drop in consumer confidence. But look on the bright side. Building more houses for people who couldn’t afford to live in them was not exactly the greatest business strategy. And all those people who were appraising, mortgaging and selling houses can now find more useful work. Real jobs. Doing something more useful. What are those real jobs going to be? We don’t know yet. But it could take a long time to find out. And in the meantime, we have a depression on our hands... So, let’s enjoy it... How do you enjoy a depression? Well, the first thing is to make sure you’re not in its way... Dear readers may not know this, but in addition to writing The Daily Reckoning your editor also has a serious job... Yes, in the morning he is a moral philosopher...gratuitously insulting public officials, whole professions, and entire nationalities. He is grateful to them all...they make life so entertaining! Imagine what kind of world we would have if people minded their own business and got on with their lives... People would be richer and happier, we don’t doubt it...but at whom could we point a finger and laugh? No, dear reader, the world needs its bumblers, fools, politicians (are we repeating ourselves?), grifters (sorry...we did it again!), and megalomaniacs. It needs someone to challenge the gods from time to time. Otherwise, the gods wouldn’t have the fun of whacking them. And we wouldn’t have the fun of watching. But getting back to the point...what was the point? Oh yes, the point is we have a serious job to do too. In addition to writing about the world of money, we actually have to live in it. You see, we have a Family Office...a little group of researchers and analysts that actually has to make decisions... In the afternoon, we have to decide. What to do? Long or short? Buy or sell? One thing we need to be on guard against is allowing our emotions to take over. For all our deep thinking and cynical detachment, we’re human too. We get emotionally attached to our own ideas. Then, we’re very reluctant to give up on them...no matter how bad they turn out to be. We remember...sadly...our own feet dragging after the bull market in gold of the late ’70s. We didn’t want to sell. So we delayed...we hesitated... By the time we realized how wrong we were we didn’t have to sell. The bear market in the yellow metal was over! Gold had hit bottom. Gold was down 70% from the top. Much more in real terms. But there’s nothing like a 20-year bear market in your favorite asset class to sharpen your wits. We realized that we needed a better way... More on that after today’s essay...but first, we’ll go to the news. Here’s Addison Wiggin, reporting in yesterday’s issue of The 5-Minute Forecast... FICO, the outfit that computes your vaunted “credit score,” has just noticed that consumers with high scores are more likely to default on their mortgages than their credit cards. Last year, the firm says, folks with FICO scores of 760 or higher defaulted on real estate loans at three times the pace they defaulted on plastic. This shouldn’t be any surprise to FICO. We noticed a few days ago that the number of consumers current on their cards but delinquent on their mortgages exploded by 50% in the year after Lehman went belly up. FICO has access to this data in real time. But it appears flabbergasted by this development, marveling in the first paragraph of a press release that “most credit cards are unsecured credit and mortgages are secured by real estate.” Earth to FICO: If you’re in an underwater home, why wouldn’t you commit strategic default and use the difference between a mortgage payment and rent on a similar home to pay down those cards? You might not even have to move if your mortgage lender doesn’t want to follow through on foreclosure and book the loss! Still, FICO’s CEO told Bloomberg TV he’s stunned the phenomenon isn’t limited to subprime: “Now we’re starting to see at the high end of the marketplace people with good FICO scores having serious delinquency problems.” There’s a hint of panic in the man’s words, as if he senses his entire business model is going down the toilet. Good riddance. Millions of mortgages were issued in the last decade on the basis of nothing more than the “score” issued by this company, which reveals exactly nothing about a borrower’s income, or how his debt load compares to his income. FICO wasn’t the cause of the housing bubble, just a trifling enabler. [Joel’s Note: We just got word that Addison is ready to launch his new research service, tentatively titled Apogee Advisory. The project is geared towards, in Addison’s words, “Providing investment research for individual investors that will not only cover the nexus between money and politics, between Wall Street and Washington, but would crush even the finest research published by the Wall Street houses, such as they are.” Addison will begin this new service with three “beta” issues, starting next month. Importantly, he’d like to test the idea to get your feedback. To that end, he’s offering these initial issues free of charge to a select group. If you’re interested in providing feedback, you can get the details here. The first issue is due out in early March and, as usual, positions are limited.] The Daily Reckoning Presents A Propensity to Screw Up Bill Bonner Poor Ms. Cosgrove. The Florida woman wrecked her car in 1976. While driving under the Brooklyn Bridge a tarp filled with rainwater fell on it. Then, she lost the $17,500 compensation check from the insurance company. Her luck seemed to change last week – 33 years later. She found the check in a drawer. But now she discovers two disagreeable things at once – that her insurance company has gone out of business...and the check would be worth barely $5,000 – if she were able to cash it. What follows is a brief reverie on the way credits go bad. There are accidents. There are mistakes. There are acts of God and acts of parliament. To give readers a preview, we suspect that the world’s savers and investors are about to follow Ms. Cosgrove – losing money due to bad luck, bad judgment, bad management and bad policy decisions. We leave God to explain His own acts, if He cares to. Our attention is on Ms. Cosgrave’s claim check. Price movements are neither good nor bad; it depends on the cause of them. In a properly functioning economy, prices go up and down. Rising prices suggest scarcity, signaling to consumers that they should switch to substitutes. And they tell producers to get on the ball and stock the shelves with new supply. Falling prices send the opposite message...trimming profit margins and telling producers to cut back. Here at The Daily Reckoning, when we go into a liquor store and find lower prices, we are delighted. We stock up. But we are clearly out of step with mainstream economists. Most economists want to see higher prices in the liquor store. And they think they can improve the economy by forcing prices upward. Their beef with falling prices is that they trigger what Keynes described as a “propensity to save.” Consumers see lower prices, he theorized; they then delay spending in the hopes of a better price. Demand falls, incomes go down. And you have a depression on your hands. “Unfortunately, most historians and economists are conditioned to believe that steadily and sharply falling prices must result in depression...” writes Murray Rothbard in hisHistory of Money and Banking in the United States. Mr. Rothbard noted that falling prices were neither cause nor effect of depression, but a natural feature of prosperity. In the decade of 1879 to 1889, for example, wages in America rose by 23% – in real terms. “No decade before or since produced such a sustainable rise in real wages,” comments Rothbard. In terms of improvements to material well being too, the economist R. W. Goldsmith concluded that no decade matched the 1880s...with 3.8% annual gains. But this was also a decade when prices fell. Prices at the wholesale level fell 10%. Retail prices dropped 4.2%. How come falling prices didn’t cause a depression? In 1884, several big Wall Street banks...including Grant and Ward, the Marine Bank of New York and Penn Bank of Pittsburgh...along with 10,000 businesses across the country...went broke. There was panic on Wall Street. But even this did not cause a depression. The government did nothing. Thanks perhaps to its incapacity, within weeks the economy was back on its feet and the decade of prosperity continued. This is just the way of the world, when the world is allowed to have its way. In a normal economy, prices are honest. They tell capitalists where and how to invest their money. Businesses increase capacity. They get better at what they do. Unit costs go down. Increased productivity brings higher wages and lower prices – prosperity, in other words. If that is all there were to it, the world would be more prosperous, but less entertaining. There are honest price movements. And there are the other kind, prompted by changes in the money supply. Natural price movements send useful information; inflation (or deflation)-driven signals are a form of economic counter-intelligence – fraudulent signals intended to mislead. Monetary inflation pushes prices up; but only because money is becoming more abundant, not because goods are becoming more scarce. Businesses, investors and consumers get the wrong idea. Typically, consumers overspend and businesses over-invest. The consumer thinks he sees increasing scarcity. The businessman thinks he sees rising demand. Both are wrong. Both lose money. Even the government is misled by its own flimflam; it sees increasing tax receipts and expands services. The planet has never seen so much monetary inflation before. In just the last 7 years, worldwide monetary reserve assets have tripled – from less than $2.5 trillion to more than $7.5 trillion. And yet, consumer prices continue to fall...as they have for the last 27 years. In January, despite the Fed’s target, The Wall Street Journal reports that “consumer prices [in the US] actually fell by 0.1%....” Last week, leading economists at the IMF and the Fed wondered aloud they shouldn’t deceive the public even further, by setting higher inflation targets. Currently, central banks aim for 2%. Talk is of doubling it to 4%. Maybe they know what they are doing. Maybe they don’t. Advice to readers: if you get a large check, don’t wait 33 years to cash it. Regards, Bill Bonner for The Daily Reckoning Joel’s Note: Once again, Bill Bonner will be presenting his thoughts at this year’s Agora Financial Investment Symposium in Vancouver. If you’ve attended the event in the past, you’ll know what a fantastic week it is, jam-packed with contrarian investment ideas and out-of-the-box thinkers. If you’d like to join us this year – July 20-23 – make sure to get in early. Seats fill up pretty quickly. Bruce Robertson, our conference director, has all the details on this year’s eventright here...including the special Early Bird discount. Depression Causes a Shift in Economic Models By Bill Bonner Consumer confidence just registered its lowest reading since 1983. People don’t have jobs...and they’re beginning to worry that it could be a long time before they work again. Mortgage demand just fell to its lowest point in 13 years. State tax receipts are still falling – for the 5th quarter in a row. And the number of problem banks just rose 27%. Recovery? Forget it. There is no real recovery. This depression has to run its course, like it or not. You’ve heard us say that a depression is a period of transition from one economic model to another. You might ask: what’s an economic model? And what economic model are we leaving behind? What economic model are we going towards? And what’s this got to do with monetary and fiscal stimulus? Read the full article here. Prepare for Slim Annuities By Frederick Sheehan Barclays Capital recently published its annual Equity Gilt Study. The paper includes data for asset returns in the United Kingdom back to 1899 and in the United States since 1925. In the February 12, 2010 edition of the Financial Times, columnist John Authers wrote a summary of Barclays’ conclusions. Read more... On Display in the UK: The Failure of Keynesian Economics By Rocky Vega The very birthplace of John Maynard Keynes, the United Kingdom, has become a petri dish in which to test his every economic prescription in a time of financial crisis. With a large and growing budget deficit, a declining pound, and accelerating inflation, the UK has been scrambling for a cure. And, for the most part,as in the US and elsewhere, the nation’s leadership has been looking to Keynes’ theories for guidance.Read more... China’s Patience is Wearing Thin Over US Arms Sale to Taiwan By Rocky Vega China has apparently noticed the tiny $6.4 billion military equipment deal the US recently inked with Taiwan. Unsurprisingly, it’s not happy about it. The Pentagon informed Congress about the transaction knowing full well it would upset the Chinese government and could spur retaliation. Read more...