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The Daily Reckoning Monday, February 1, 2010 Government spending goes nuts: What this insider says may shock you, Finally...this year's DR Financial Darwin Awards grand champion! Plus, Bill Bonner on gravity-defying growth and the secrets of foreign tongues... Joel Bowman, reporting from Tokyo, Japan... It is said that the only two certainties in one's life are death and taxes. You might, through some clever accounting and creative domiciling, mitigate the curse of the latter but, so far as we know, nobody escapes the grave. Empires...pop divas...authors of books starring Holden Caulfield; on a long enough timeline, we're all reduced to fleeting moments in the imagination of another time. As Jim Morrison once famously observed, "No one here gets out alive." But we are not here today to bemoan the inevitability of death. Rather, to celebrate it. (Not our own, of course...that would be morbid.) No, fellow Reckoner, we are here today to celebrate the death of a corporate giant...an ill-fated, poorly adapted industrial dinosaur that, last year, finally found a tar pit of its own. Readers will recall that we've recently been pondering the nominations for this year's Daily Reckoning Financial Darwin Awards. In short, it is our chance to thank those companies that were kind enough to remove themselves from the corporate gene pool, either through Kamikaze-like dedication to self destruction or, more often, through a stubborn refusal to change with the times. It is, after all, in the fertile aftermath of such creative destruction that the cycle of free market capitalism blooms anew. Readers wrote in from all over the country and, indeed, the world, with nominations for this year's award. By the time we got around to tallying the votes this past weekend, our DR inbox was brimming with so many accounts of idiocy and uncompromising incompetence that we briefly considered nominating it for a government post. And, as you might expect, there were nominations aplenty for just about every level of government...from the usual partisan politician bashing to the lever-pulling loonies at the Fed and the Treasury. Much as we'd like to give them all their due recognition, we had to cull the field a bit. "On a sheer vote count, Ben Bernanke won hands down," we noted in the Weekend Edition. "Alas! We regret to inform that he must be disqualified from this particular competition. Remember, we are here to praise the extinct. But Bernanke is not extinct; he is thriving...like a cockroach in the fallout of a nuclear blast. His prognostications might have been way off the mark...he might have forecast a period of 'Great Moderation' during the bubbliest decade in history...and he also did more to rescue hideously mutated financial species from extinction than any central banker in history. However, Bernanke was just ushered in for his second term. In Darwinian terms, he is adapting to the Big Government era, toxic as it is, as well, if not better, than just about anyone else in the ecosystem. "Nor can we bestow this year's Financial Darwin Awards on any of the financial mutations or extinctions that occurred in 2008 and before," we continued. "So, as much as we empathize with the fellow who wrote in to raise a hand for 'the year 1913, for spawning the Fed,' we simply must impose some parameters." [If you'd like to see a brief list of those honorable mentions that fell short of qualifying for this year's grand prize, check out the Weekend Edition here.] In the end, and notwithstanding the exceedingly strong field, the choice was rather easy. We are pleased to bestow this year's Daily Reckoning Financial Darwin Award on a company that, through a lethal combination of union concessions, bloated bureaucracy and an unrivaled dedication to fiscal and automotive inefficiency, last year became the largest industrial bankruptcy in American corporate history. The award goes, if you haven't guessed by now, to General Motors - also known, since July of 2009, as Motors Liquidation Company. Reading through the history of this once mighty American icon is a bit like watching a car wreck in slow motion... After William Crapo Durant founded the company back in 1908, GM went through a series of high profile management evolutions, including the twice removal of Durant himself, the second time for good. Nevertheless, the early years for GM were, by and large, years of innovation, of expansion and seemingly unstoppable growth. The twenties saw a slew of acquisitions for the Detroit company, including the German automaker, Opel, and Britain's Vauxhall. Market share grew enormously, both domestically and abroad. The wind and the ingenuity of the can-do American was behind her. Then in 1937, something curious happened. Workers in GM's Fisher Bay Plant in Flint, Michigan, sat down. They weren't standing up again, they told managers, until their demands were met: better work conditions, hours and benefits. It seemed reasonable enough, said many. General Motors is large enough. It can afford a few extra bob for the poor souls on the production lines in Detroit. And so the first battle with the union was fought: United Automobile Workers - 1; GM - 0. But by the time the score could be tallied, much less properly understood, WWII had rolled around. General Motors stopped making cars for American people and began making tanks for Allied soldiers. As history would have it, GM found itself on the winning side this time and, by the time its factories were again pumping out Chevys and Caddys, they were the biggest game in town. By 1954 GM's share of the American market, then the largest in the world (before China overtook it last month), stood at a whopping 54%. One in every two cars started in a GM factory. Through the '60s and early '70s, GM cruised along. In 1961 she sold more than half of all the cars AND trucks in the US. With the introduction of the GTO Pontiac Tempest in 1964, Detroit's darling set about ushering in the era of the muscle car. Then something else happened: the energy crisis. All of a sudden people didn't want a V8 engine in a medium sized American body; they wanted a four-cylinder engine in a small-sized Japanese body. A continuation of that shift through the '80s saw GMs market share in the US drop from 45% to 35% and, for the first time in 59 years, the company actually reported a net loss. Then, in 1990, those workers sat down again. By the time they stood up again, GM had signed a contract guaranteeing nearly full wages and benefits for workers, whether or not they showed up at work. UAW - 2; GM - 0. Later that same decade, in '98, the workers scored their 3rd victory. After seven weeks of UAW protests, it was three strikes and you're out for GM. General Motors might have been conceding ground to its union workers...but it would be damned if it was going to look like a sissy to its competition. In 1999, GM bought Hummer, making every mom's dream of driving a military vehicle closer to a reality. SUV sales peaked in 2002...but GM pressed on with its giantmobiles, rolling out new Surburbans and Escalades even as market sales dwindled and the price of oil marched higher and higher. At a time when it most needed to adapt, GM stuck to its guns. But by then it was unable to move. The more it struggled, the deeper it sank into the tar pit. Finally, investors began fretting about legacy costs and, in 2005, credit agencies downgraded both GM and Ford. By the time it became eligible to contest this year's Daily Reckoning Financial Darwin Awards, GM was at Washington's door, begging for handouts, bridging loans and credit extensions. Bush gave more money. Obama gave more time. But the ride was over. Shares of GM, which had peaked in 2000 at around $94, fell to 75 cents. What was once the richest company on the Fortune 500 was now a penny stock awaiting bankruptcy. Much has happened since then...GM sold Hummer to China and Saab to the Swedes...dealerships across the country were closed by the hundreds...and yes, tens of thousands of GM workers now cash food stamps in Detroit. Ideally, marketplace extinctions would occur quickly and quietly, with little or no life support financing from the poor ol' American taxpayers. Alas, it was not to be the case for GM. General Motors Corporation is now General Motors Company...and the majority owner is the government of the United States of America. Congratulations to Washington. Commiserations to taxpayers. [Ed. Note: Before we get into today's essay, below, we'd like to remind all readers (including the new, taxpaying owners of GM) that we're holding our Financial Darwin Awards Strategic Short Report $1 Offer open until midnight tonight.] As you may recall, Dan's investment service actually seeks to profit when foolish and/or negligent corporations come clean with the kind of "creative accounting" that leads to GM-like extinctions. When we first presented the offer, back at the start of this year's Financial Darwin Awards, we noted that Dan had his eyes on a trucking company that had "expanded too aggressively during the bubble years." Dan instructed his readers to buy put options on the company...a play he then told them to exit last week...for a cool 92% gain. Not bad for a buck, eh? Right now, Dan is helping his readers to bet against an overleveraged hotel company. "I'm sure you've stayed in one of their rooms in the past," he reveals, "and you'll be shocked to see what they're hiding in their balance sheet. Act now and you could see gains as high as 100% by Mid-February." The $1 offer to Dan's Strategic Short Report is good until midnight tonight...and not a minute after. Here's a quick sign-up sheet if you want in. --------------------------------------------------------------- The Daily Reckoning PRESENTS: Speaking of creeping bureaucracy, unsustainable spending habits and addiction to debt, here's David Walker, former Comptroller General for the United States, with a few words of caution for that mob in Washington, DC. Please enjoy... America 2030: Why We Must Act - Now By David Walker New York, New York Those of you who are parents (and I'm a parent) may want to reject out of hand the idea that we are in effect stealing from our children's future and bequeathing to them a far less prosperous life. But if we don't begin to address our fiscal challenges soon, it's only a matter of time before the consequences begin to show up, most likely starting with higher interest rates. As things get worse, our children will slowly see their living standards decline. We can still prevent these things from happening. The ultimate goal of cleaning up our fiscal policy is not to avoid a recession or even to balance the budget per se - it's to pass on the kind of healthy, vibrant nation that we inherited. It's easy to fall back on generalities - that America is a great country, and that we always rise to great challenges and will do so again. True, but we can only succeed by taking action, and we have a lot of action to take. Let's say we do take only small steps to address our fiscal crisis. Let's say we stop cutting taxes, but we don't increase them radically either. Let's say our government continues to take in about the same level of historical revenues, but we hold discretionary spending to 2008 levels as a percentage of the economy, and we don't expand health care or other entitlements any further. That sounds pretty benign, but it's actually a disaster scenario for our children. Let's take the example of kids born in early 2000, when our national budget was in balance and the technology-powered future seemed bright. During the first eight years of their lives, we have learned, the nation's financial hole grew by 176 percent to $56.4 trillion. And the number is not standing still. That was its size as of September 30, 2008 - before the official declaration of a recession, before the significant market declines of October 2008, and before the big stimulus and bailout bills designed to jump-start the economy and address our immediate financial crisis. In fiscal 2007, recall, our budget deficit was $161 billion, or 1.2 percent of the economy. By 2009, the deficit soared to $1.42 trillion, which is about 9.9 percent of the economy. Just think about that for a second. Our federal deficit grew by almost nine times in the past two fiscal years! Given our scenario - no benefit cuts, no tax hikes - the government would have to finance this gaping hole mainly by borrowing money from domestic and foreign investors, with interest. Don't forget, according to the GAO's latest long-range budget simulation, even without an increase in overall interest rates, our interest payments would become the largest single expenditure in the federal budget in about twelve years. And what do we get for that interest? Nothing! Of course, something will have to give before we get to that point. However, the government has overpromised and underdelivered for far too long. How can we fix things? Will we cut benefits, those mandatory payments that are chiseled into law? Or will we raise taxes to onerous levels? We will probably have to do some combination of both. That is, we will have to renegotiate the social contract with our fellow citizens and raise taxes. However we do that, our kids will pay the price. And the bigger the bill we pass on to them, the bleaker the future we will bequeath to them. Let's assume that Washington policy makers continue to punt on making tough spending choices and ultimately raise taxes to address the growing deficits. Nobody will reach in our kids' pockets and take their money because the government will take it before it even reaches their pockets. What will that mean for their after-tax income? Right now, on average, Americans pay about 21percent of their income in federal taxes and another 10 percent to state and local governments. By 2030, to pay our rising bills, that amount could be at least 45 percent - higher even than the average 42 percent that most Europeans pay. By 2040, it would be at least 53 percent and climbing. In reality, total taxes in 2030 and 2040 would be even higher than these estimates because of the fiscal challenges facing state and local governments - such as Medicaid costs, unfunded retiree health care promises, underfunded pension plans, deferred maintenance and other critical infrastructure needs, and higher education funding. With reductions in disposable income like that, the children of 2000 will inherit a much different kind of America in 2030. That's when they will be turning thirty, entering their most productive years. So much of their money will be devoted to keeping the government afloat that they'll have relatively little for everything else in life. Their homes will be smaller and drabber. There will be less to spend for cars, vacations, dinners out, and big TV sets, all of which their parents took for granted. They'll still read about the consumer society and conspicuous consumption, but mainly in history texts. Maybe it's a good idea for America to become less materialistic - but the idea should be to give our children that choice, not to impoverish them. Regards, David Walker, for The Daily Reckoning Joel's Note: Mr. Walker served as United States Comptroller General from 1998 to 2008 and is now the President and CEO of The Peter G. Peterson Foundation. He is also the author of Comeback America: Turning the Country Around and Restoring Fiscal Responsibility, from which the above essay is excerpted. You may also be interested to know that we've just confirmed Mr. Walker as a key speaker at this year's Agora Financial Investment Symposium, to be held in Vancouver from July 20-23. If you haven't done so already, make sure to reserve your spot at the conference. Tickets to our annual event are already selling fast and the early release discount won't last long. In the meantime, be sure to tune in next Monday when we bring you Part III of Mr. Walker's series on fiscal responsibility. --------------------------------------------------------------- And now to Bill who has today's reckoning from Baltimore, Maryland... Well, it's a new world, after all... Maybe we were wrong. Maybe the mainstream economists are right. You know, up to now all they've been good at was explaining why the forecasts they made in the past didn't work out. But maybe they're right, after all. Maybe up IS down. Maybe better IS worse. Maybe you can squander trillions of dollars and yet have more! It is all too much for us. Our head aches thinking about it. But there it is, right there on the front page of the weekend news: "US growth accelerates..." announces The International Herald Tribune. Right there in black and white. And it must be true. The newspapers wouldn't lie, would they? And, the economists who fiddle the numbers for the US government wouldn't hit a false note on purpose, would they? Nah, that never happens. But how is it possible for the economy to go right back to Bubble Era growth rates after taking only a couple percentage points off of US GDP? We all know it was a credit bubble, right? We all know it couldn't last, right? We all know, too, that the fuel for that growth - bubbly gases coming out of the banks and the real estate sectors - has disappeared. So where is this growth coming from? On Friday morning, the stock market got excited about the stronger- than-forecast growth numbers, along with news that Ben Bernanke was around for another four years. The Dow rose more than 100 points. But by the afternoon, investors were asking questions again. If the economy really is recovering, maybe the feds will reduce their stimulus... If the economy really is heating up, mightn't it melt all that money and credit frozen by the depression? Doesn't that increase the odds of inflation - and higher rates from the Fed...? If the feds tighten, won't the US economy fall back into the second part of the W-shaped recession...just like Paul Krugman says? By the close of business the Dow had lost 53 points, which makes us think the final push to the bottom has begun. Even good news can't stop it. When 5.7% growth - after the worst slump since the '30s - doesn't get investors excited, there's something wrong. Wait a minute... "The biggest lift to economic activity," continues The New York Times, "came because businesses ran down their stocks of unsold goods at a much slower rate than earlier in the year..." In other words, the 'growth' came because businesses restocked their shelves at a faster rate. So, there's more on the shelves to buy. Hmmm. Wonder if it will sell...? The only way you could have real, sustained growth is with a recovery in employment - and earnings. Looking at it broadly, Americans were earning a certain amount of money in 2007. Then, they discovered that much of what they were doing was not worth doing. They were building houses for people who couldn't afford them, for example. And they were spending money that was "taken out" of their houses. At the peak, a substantial part of US GDP - and virtually ALL the growth - came from these sources. That money has disappeared. People aren't getting paid to build houses that no one will buy anymore. And shops aren't selling to people who pay with money from mortgage equity extraction. They've already extracted so much that there's nothing left. Or less than nothing. Many homeowners have net negative equity. What does this mean? It means that people are earning less, borrowing less, and spending less. What else could it mean? A substantial part of the economy, 2003-2007, was fraudulent - in which excessive consumer credit masqueraded as real purchasing power. That part of the economy has gone away. So should that portion of the GDP. In theory, GDP should go down and stay down until new industries, businesses, and jobs are found. --- Outstanding Investments Gold Report --- From Hulbert's No 1-Ranked Advisory Letter Over 5 Years, Our Most Shocking Forecast Yet... GOLD $2,000 "I'm so sure gold will soar higher I'll even make you a guarantee... Plus, I'll give you five entirely new ways to play the trend..." "Including one hidden way to snap up gold... for less than one penny per ounce..." How can that be possible? Give me the next four minutes and I'll show you how... --------------------------------------------------------------- And more thoughts... America's president proposes a tax credit to businesses that take on new employees. We never met a tax cut we didn't like. This one is no exception. It lowers the cost of labor, making it easier to hire and pay people. So far, so good. But is Mr. Obama proposing to cut government spending also? Not really. He's pretending that the feds can have their cake and eat it too...that they can forgo the income given up by the tax credit...and yet, still spend it. How is that possible? It's not. It's the feds' old shell game. It won't do the economy any good because the resources represented by the tax credit can't be in two places at once. They can't be available to the employers and be available to the government too. But 10% unemployment tells us that wages are too high. They should fall - along with stock prices and housing prices. But it's hard to cut wages. That's the real secret to the Keynesian's fiscal stimulus. Government spending causes inflation...which lowers wages surreptitiously. Everybody likes fiscal stimulus. Economists like it because it makes them look like they know what they are doing. Politicians like it because it makes it look like they are doing something to help the masses. And the masses like it because they believe them! Finally, even employers like it because it reduces real wage costs. Trouble is, inflation doesn't work very well in a real depression. The Fed increases the monetary base. Congress showers boondoggles over the nation. But the money moves likes molasses. The median price of an existing house sold in 2008 was $196,600. In 2009, the price fell to just over $170,000. But this seems to have brought out the buyers. At $170,000, reports Floyd Norris in the NYT, the housing market corrected all the way back to 1997, adjusted for inflation. Twelve years' worth of real pricing gains have been wiped out. But when people realized they could buy at '97 prices, they stepped up to the plate; 4.6 million houses changed hands last year - 5% more than the year before. The real problems were in the new housing sector. Only 373,000 new houses were sold last year - fewer than in any year since 1963. Prices sank, but not quite as much as in the used house market. New houses, of course, are not the subject of foreclosures. You can't foreclose a mortgage that hasn't been written yet. This permitted the housing industry to control sales and prices - at least to some extent. While foreclosed houses flooded the used-house market and drove down prices, builders must have held back inventory waiting for better prices. What will happen in 2010? Most likely, the inventory of unsold houses...along with the 'hidden inventory' of houses that owners would like to sell...will probably continue to hold prices down. One way or another, the average house has to go down to a level where the average owners can afford it. Where that level is, we don't exactly know, but it's probably lower than today's prices. Remember, millions of homeowners are underwater. Some of them will drown. Others will get out through the windows...leaving the house to sink, along with the housing market. We were feeling nostalgic for the pampas last week. So we went to dinner at El Sur a restaurant in the heart of Paris. It's the real thing. The décor, the wine, and best - the meat - are all authentically porteno (pertaining to Buenos Aires). We went with our Spanish teacher, son Jules, and some friends. The conversation was in Spanish. "Jules, your Spanish is very good," we said afterwards. "Five years of it in school. But, Dad, I don't know how much you can learn from these sessions..." "Well, learning languages is cumulative. You just keep at it. Little by little it sinks in..." "I wonder if it's worth all the effort..." "Sure it is. Languages hide the accumulated wisdom of generations of dead people. Each word is an idea. And different languages have different words...and different ideas... The more languages you know, the more ideas you've encountered. The more you know, generally... Besides, if you don't speak the language you can't enter into a culture and discover its secrets." "Oh...." Regards, Bill Bonner, for The Daily Reckoning --------------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com   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.