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The Daily Reckoning | Friday, May 21, 2010 Global bubble contagion and the ultimate cost of the supposed solutions, The advantages of letting the whole system collapse, Plus, Bill Bonner on firing Chinese-made AK-47s and plenty more... TARGETED BY "FINANCIAL TERRORISTS" Re-pricing the World's Credits A look at the global phenomenon that is the Great Correction Bill Bonner Reckoning from Beijing, China... Wham! Bam! Whack! Smack! Markets took a beating yesterday. The Dow got walloped for a 376-point loss. Tellingly, gold lost only $4. Proportionately, it should have gone down nearly $40. The story was the same all over the world. Here in China, stocks fell...as they did everywhere else. And not just stocks - commodities went down too. Why? Traders and pundits are talking about trouble in Europe. According to the Reuters report, the sell-off came after Germany banned naked short selling. Those Germans! Always the party poopers. But when markets are ready to roll over, they'll do so. Commentators and analysts can look for the 'cause,' but they are just making noise. Still, we suggest that they take their eyes off the naked Germans. Instead, they might want to take a look at what is going on in the US of A... The Great Correction is a worldwide phenomenon, but it is centered in America. The US economy is changing. As a result, all the world's credits need to be re-priced. What does that mean? Just that much of the world economy was geared to a trend that has come to an end - the growth and leveraging of the US consumer economy. Here in China, for example, much of the export apparatus is set up to service US households. Much of the rest of it faces the opposite direction - towards Europe. But the old world and the new world are both beginning to look a little stale. Both have too much debt. Both have made too many promises to too many people. We are now, broadly speaking, in the process of debt de-leveraging. The private sector in America is paying down and defaulting on debt. In the housing market, for example, delinquencies and foreclosures are at peak levels. And demand for new mortgage loans is at a 13-year low. Since so much of the wealth of the country rested on housing prices, it is not surprising that a write-down in house prices would be as unwelcome as Chinese wallboard. In fact, it's hard to find a place that hasn't been affected. People have less money; they spend less. They have too much debt; they borrow less. Sales go down. And the banks that hold much of this debt go bust. The FDIC says it has 775 banks on its "problem" list. When sales go down, so does employment. The latest figures show jobless claims rising again. Among the poor and uneducated, the unemployment rate is over 30% Meanwhile, the de-leveraging process is clearly seen in falling consumer and wholesales prices. Demand goes down; so do prices. Both indexes are down, with less consumer inflation than at any time in more than 40 years. In Europe, the process of de-leveraging focuses on governments. By and large, households are much sounder, financially, in Europe than they are in America. But governments are just as shaky...and sometimes in worse shape than in the US. The credits of Greece, Spain, and Portugal have already been marked down considerably. Most likely, the credits - bonds and currencies - of the others will follow. Governments tried to appease the market gods by offering to sacrifice virgins, widows, orphans, the rich and other taxpayers. Higher taxes and austerity measures are expected to give investors confidence. Naturally, neither the virgins nor the taxpayers were willing to go along. Neither were government employees, whose salaries and pensions are supposed to be cut. The process of de-leveraging is going to be long and hard, in any case. Most likely, it will end in bankruptcy, default and write-downs of public debt. At least Euroland has taken up the issue. On the other side of the Atlantic, few politicians, taxpayers, or investors see a problem. They believe the credit of the US is not only elastic, but with unlimited stretch. Wait 'til it snaps back! The Daily Reckoning Presents A Successful Collapse Bill Bonner The fixes are more costly than the problems. "Systems of problem solving develop greater complexity and higher costs over long periods... the destructive potential is evident in historical cases where increased expenditures on socioeconomic complexity reached diminishing returns, and ultimately, in some instances, negative returns...where [the system] starts to become vulnerable to collapse" Joseph Tainter - The Collapse of Complex Societies We have ridiculed bailouts. We have railed against them. It did not seem fair to pay off bankers with the sweat of labor's brow. With privilege comes responsibility. It was the privilege of the banker to stay at the Four Seasons while lending someone else's money to the Greeks. His bet failed. Now, it is his responsibility to take his beating like a man. But today, we appeal neither to the dear reader's sense of humor nor to his sense of justice. We appeal to his sense of futility. As W. C. Fields put it: 'If at first you don't succeed, try, again. Then give up. No sense in being a damned fool about it.' Little appreciated in the economic literature are the benefits of giving up and letting things collapse. This is a pity. While successful fixes are celebrated, it is to the failed fixes that we owe much of our contentment and our progress. Joseph Tainter explains, for example, that while the first fix may be beneficial, later ones often produce negative returns. Then, you're better off letting the whole system collapse. By examining ancient human bones, for example, he reports that nutritional levels actually improved, for most people, after the collapse of the Roman Empire. But the financial history of the last 20 years is a story of one successful fix after another, each grander than the last. The Asian debt crisis and the LTCM crisis were solved at trivial cost. But, trailing each solution, like shame following indiscretion, was a new problem. Two years after the Asian crisis came the dot.com blow-up. Then, the cause of the problem of sub-prime debt in 2007 was the solution to the problem of the post dot-com debt-driven recession of 2001. Bailing out the US economy with low interest rates begat a bubble in housing. Within 5 years, banks all over the world found themselves with too much mortgage debt and too little assurance of getting paid back. This problem was solved by the bank bailouts of 2008-2009. The bailout of Bear Stearns cost $29 billion. The TARP program cost more than $700 billion. Soon after, bad bets in the banking sector became bad debts in the public sector. Now, the bailers themselves are sinking. In particular, Europe's seaside states are taking on water. This led to the biggest bailout ever -Euro-TARP - at a cost of $1 trillion. As yet little noticed by investors is the gaping hole in America's hull. James Davidson reports that while the Greeks need to raise an amount equal to more than 20% of their GDP this year, the US funding requirement is more than 32% -- more than any of Europe's storm toss'd states. Each story has its unique twists. But the outcome is always the same: the world's total debt increases every time. And now, the returns on solutions are negative. Bob Janjuah, chief strategist at RBS, sees where this leads: "We are trapped in some horrendous Keynesian/monetarist nightmare, where policymakers, aided/abetted/advised by their buddies in the media, in the lobbyist cabal and in financial system, have YET AGAIN decided to go down the route which merely delays the problem/pushes it down the road, but which virtually guarantees that when the NEXT bubble collapses...there is NO pleasant way back." With so many frightful successes we wonder if it isn't time to give up. So, we look south of the Rio de la Plata for inspiration. When it comes to financial failure, Argentina is a model of success. In 2001, instead of getting a successful bailout, it collapsed -- defaulting on nearly $100 billion of debt, the largest default ever. Judging from a recent visit, the world did not come to an end. People took the streets, beat on pots and pans, and lost 2/3rds of their savings. By some accounts, the middle class was virtually wiped out. But life went on. And today, life in Buenos Aires seems about as agreeable as ever. And last week, Argentina celebrated a happy milestone. The country gave its creditors a last chance to re-coup some of their losses. They could swap their old Argentine paper for new Argentine paper - and recover about 30 cents on the dollar. Take it or leave, said the Kirschner government. Apparently, enough creditors took the offer to permit the nation to re-enter the global debt markets, we will know for sure in a few days. Soon, the Argentines may be able to repeat their mistakes. Compared to the bailouts, the Argentines' failed fix looks more and more like a success. Bill Bonner, for The Daily Reckoning Bill Bonner Give Your Kids a Leg Up... Teach Them Japanese Bill Bonner Still reckoning from Beijing, China... Kapow! Boom! Bang! While the markets were beating up investors, your editor got his hands on some Chinese military hardware. No kidding. We went out to an old military base, now a weapons testing laboratory. We wanted to try out the Chinese equivalent of the AK47... As near as we could figure, the Chinese are hoping to make a market in military equipment. They are the leading exporters of nearly everything that can be made of steel or plastic. Why not weapons? Potential buyers are invited to test the firepower. No cameras, pls. So we got in the back of an olive-drab military vehicle and drove out to the firing range. The gun is heavy. But it handles well. Not that we are experts. But at least we hit the target. As to how useful it would be in combat, we can only imagine. We like reading about battles; we don't think we'd like to be in a real one. (Maybe that's why the War on Terror was such a hit with the public. In 10 years, the US was attacked by a smoking shoe, one pair of flaming underpants, and a dud car bomb!) *** Jim Rogers is right. You want to give your children an advantage? Teach them to speak Chinese. That may not be a very big advantage. There are millions of Chinese who speak perfectly good Chinese. You don't really need to speak the language. One dear reader from South Carolina now lives here in China. He doesn't speak Chinese. Still, he makes a lot of money by investing in Chinese firms. ("I look for 100% gain in 6 months," he says.) And he lives well. "Oh yes, you can live very well. Not so much here in Beijing. Too much traffic. But out in cities to the west of here. They are comfortable. Relaxed. It's easy to get around. You can get plenty of household help. And you eat very well." If we heard him correctly, China has 160 cities with more than 1 million people. Beijing has 17 million. As far as you can see, there are skyscrapers... And yet, in the center of town, it is fairly quiet, clean and orderly. Mumbai is about the same size. But it seems hot, dirty and chaotic by comparison. The Chinese capital is more modern than we expected. There are more fancy cars...more sparkling new buildings...more luxury shops...more of this, more of that...more of everything. The pleasant surprises began when we arrived at the airport. We expected long lines, confusion, and delays. Instead, a pretty young woman was holding up a sign with our name on it, just outside the airplane door. She escorted us through the airport. We were whisked through immigration control; within a few minutes we were seated in the back of a big black Audi on our way to the hotel. There were no delays anywhere. The roads were clear. Even the tollbooths were efficient. Our smooth transit continued through the hotel lobby all the way to our room. People smiled. But not the sloppy smile of the marginal American service industry worker. On US airlines, for example, you will often find hostesses who are excessively friendly without being genuinely courteous. Many are overly warm and underly competent. Here in China, at least in the good hotels and restaurants, employees tend to be crisp, trim, polite and efficient. The west is doomed. It is already second rate. It just doesn't realize it yet. The Chinese work harder. They save more. They are better organized...and probably smarter. And there are more of them... They are not burdened by 2 centuries of success...neither by expensive social welfare programs, nor by a Goliath military-industrial complex, nor by thousands of lobbyists, lawyers, and educators. The return on investment capital is higher. You just have to pay off an official or two. In America and Europe, you have to pay off the entire establishment...the unions, the politicians (local, state and national), the hacks, the regulators, the pentagon, the meddlers, the do-gooders, the unemployed, the contractors, the public employees, the poor, the rich, the halt, the lame...every leech in Christendom, to say nothing of the others. It is just a matter of time before the Chinese take over. Soon, they will be the richest, most advanced, most accomplished people on earth...its leading innovators, its greatest artists and architects...its standout scientists...and its top military power. Of course, anything could happen. But that is what it looks like to us...after 4 days in Beijing. Regards, Bill Bonner, for The Daily Reckoning