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The Daily Reckoning Weekend Edition Saturday, November 20, 2010 Buenos Aires, Argentina ------------------------------------------------------- Forget bailouts and quick-fix solvents; let the banks eat cake for once, Homeowners get owned: a look at the underwater American borrower, Plus, all the reckonings from the week past, neatly stacked below for your TSA-free, in-flight reading... ------------------------------------------------------- OFFER EXPIRES TOMORROW, NOV. 21 Revealed: How to Double Your Money With A Secret 18-Digit "Windfall Code" With "Windfall Codes," readers could have made as much as double their money on average - every week! This free presentation tells you exactly how you could start collecting huge weekly payouts as early as this coming Sunday! But hurry, this exclusive information is only available until Sunday, November 21st. Click here for the full details. ------------------------------------------------------- Joel Bowman, from Buenos Aires, Argentina... "Do as I say, not as I do." That was the basic gist of Bernanke's speech yesterday, which he delivered to a banking conference in Frankfurt, Germany. The man who has embarked on the most aggressive scheme of systematic currency debasement since Gideon Gono imploded the Zimbabwean dollar, set out to defend his actions against the growing concerns of those who fear a full blown currency war may be nigh. "In taking that action," Mr. Bernanke said of his plan to inject $600 newly created dollars into the financial system over the next 8 months, "the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery." Translation: We need to promote inflation to spur job growth and economic recovery. If we may be so bold, we'll presume to sum up the collective reaction of our Fellow Reckonings: "Huh?" Intuitively, those of us without Ivy League PhDs in economics know that nations cannot inflate their way out of debt. The pages of history are strewn with the failed attempts of central bankers/planners to inflate their way to prosperity. You'd think, judging by their willingness to revisit the practice again and again that it must have worked once. Nope. Never has. Never will. But don't try telling them that. The old Robert Heinlein quote comes to mind here: "Never try to teach a pig to sing; it wastes your time and annoys the pig." No. Pigs, must learn for themselves...and that goes for non-central planners, too. In this weekend's guest essay, long-time friend of The Daily Reckoning and Hong Kong-based money manager, Puru Saxena, drills down into the real problems facing the developed world today. As you've probably guessed, a strong currency, honest political class and lack of debt do not feature among them. Puru shares his thoughts below. Please enjoy... Band-Aid Solutions By Puru Saxena Hong Kong, China Let's face it, governments always try to 'kick the can down the road'. Rather than deal with economic issues in the here and now, they prefer to postpone the pain. Unfortunately, in their attempt to avoid painful economic recessions, the policymakers sacrifice the purchasing power of their currencies and they end up creating even bigger troubles for the future. Look. The 'Great Recession' in the developed world was brought about by excessive debt and consumption. In the boom years, millions of Americans borrowed copious amounts of money to buy real-estate; they used their homes as a source of funding (home equity withdrawals) and spent way beyond their means. In those heady days, everyone was convinced that real-estate prices could not decline on a country wide basis. Unsurprisingly, the bankers gladly supported this misconception by providing cheap fuel to the raging speculative fire. The end result was that unworthy debtors were able to purchase several properties and real-estate prices appreciated considerably. Unfortunately, when interest-rates went up and credit became scarce, the house of cards collapsed. When boom turned to bust, millions of American homeowners were left with negative equity (see chart below) and the entire banking system came to its knees. When that happened, the American policymakers embarked on a fear-mongering campaign and they misled the public into believing that it was essential to save the banks. During the depth of the financial crisis, we were repeatedly told that the 'too big to fail' banks had to be saved, or else the consequences would be dire. After the establishment succeeded in its scare tactics, it unleashed its 'stimulus' and used tax payers' money to bail out the insolvent financial institutions. In the name of national interest, the Federal Reserve created trillions of dollars out of thin air and it purchased toxic mortgage-backed-securities from the commercial banks. Furthermore, instead of marking down the value of these securities, the American central bank bought the dubious assets at face value! Thus, the American taxpayers bailed out the banks and the risk was transferred from the private-sector to the state. In addition to nationalising the bank's losses, the Federal Reserve dropped the short term interest rate to near-zero and it started buying US Treasury securities. Supposedly, these Band-Aid solutions were necessary to prevent an economic depression and somehow they would revive the world's largest economy. By dropping the Fed Funds Rate to almost zero, the American central bank hoped to achieve the following benefits: a. Reduce the borrowing cost of the banks (so they paid next to nothing for deposits) b. Stimulate private-sector credit growth In hindsight, the Federal Reserve succeeded in lowering the banks' borrowing cost but it failed in reviving private-sector credit growth. After all, American households were already leveraged to the hilt and they refused to go even deeper in debt. In our view, these drastic policy measures were unnecessary and they failed to get to the root of the problem - too much debt. Instead of nationalising the banks' losses by using tax payers' money, the American government should have restructured debt in an orderly manner. Insolvent institutions should have been allowed to fail, bondholders should have received a hair cut on their bad loans, and the total outstanding debt should have been reduced. If anything, in order to help the masses, the American establishment should have guaranteed all the bank deposits and taken steps to assist the distressed homeowners. Instead, the American policymakers focused on helping the banks, and in the process, they increased the public's debt burden! Furthermore, by transferring private sector risk on to the public's balance-sheet, the American establishment has seriously undermined the quality of the nation's balance-sheet. It is noteworthy that over the past decade, America's federal debt has more than doubled! Today, it stands at US$13.64 trillion and has morphed to 93.5% of GDP! The fact that this surge in debt has produced pathetic economic growth and done very little to bring down unemployment, is proof that Keynesianism does not work. Unfortunately, the American establishment has not learnt from past mistakes and it continues to follow disastrous economic policies. By now, it should be clear to everyone that the first round of quantitative easing failed to stimulate the world's largest economy. So, if the initial 'stimulus' did not work, what are the odds that additional quantitative easing will do the trick? The truth is that quantitative easing has never worked and this time around, the end result will be no different. In fact, we are prepared to bet our bottom dollar that quantitative easing will fail miserably in reviving economic growth in America. To make matters worse, if the Federal Reserve continues to create money like there is no tomorrow, the stage will be set for an inflationary inferno. As an investor, it is crucial for you to understand that although monetary inflation causes asset prices to rise in nominal terms, it does not impact them uniformly. For instance, when inflationary expectations are low and confidence in the government is high, monetary inflation benefits financial assets (stocks and bonds). Conversely, when inflationary fears are elevated and investors have lost faith in the government, monetary inflation tends to benefit hard assets (precious metals, energy and soft commodities). The nearby chart captures this inverse correlation between financial assets and gold. As you can see, between 1980 and 2000, monetary inflation benefited the Dow Jones Industrial Average (Dow) and during that period, gold performed poorly. However, since the turn of the millennium, monetary inflation has benefited hard assets and American stocks have underperformed relative to gold. At present, the Dow to gold ratio is at 8.4 and if history is any guide, over the following years, gold should continue to appreciate more than American stocks. In our view, the ongoing bull market in hard assets will carry on for as long as the Federal Reserve and its counterparts continue to engage in quantitative easing. Now, it is conceivable that over the following months, several central banks in the developed world will announce further stimulus and this should turbo charge the commodities boom. It is our contention that as long as the bond vigilantes are asleep at the wheel, the 'risk trade' will continue to flourish. However, no boom lasts forever and at some point, when the bond vigilantes get spooked, sharply higher interest rates will end up killing the commodities bull. When that happens is anybody's guess, but we suspect that the good times will continue for another 2-3 years. Despite the fact that quantitative easing will not succeed in the developed nations, we remain optimistic about hard assets and continue to favour the stock markets of the developing economies in Asia. Regards, Puru Saxena for The Daily Reckoning Ed. Note: Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription here. Puru is also the founder of Puru Saxena Wealth Management, his Hong Kong based firm, which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs. --- Outstanding Investments Presents: Gold's Untold Story --- With over 40,000 copies now in print, read your free online review copy of the brand new breakthrough financial report from Gold, Silver, and Energy expert Byron King... The Curse of the Incas Gold's Untold Story and the Shocking New Role It Could Play in Your Financial Survival A 476-year old mistake could soon cost you your retirement. How so? To understand, you have to let me share a little-told story. It starts like this... --------------------------------------------------------------- ALSO THIS WEEK in The Daily Reckoning... Inflation Is Coming! Inflation Is Coming! By Chris Mayer Gaithersburg, Maryland If Paul Revere were around, maybe he'd get on his horse and start yelling, "Inflation is coming! Inflation is coming!" I think it is coming. In fact, in many ways, it's already here, just not yet widely recognized. The deflationists still hold sway in the bond market, where investors happily accept puny yields. Fixing Social Security... Some Other Day By Ian Mathias Baltimore, Maryland How exactly does one unwind a Ponzi Scheme? People like Bernie Madoff have done a fine job showing investors, and eventually the American public, how to build one up. Essentially, you use the contributions from incoming investors to pay "profits" out to departing investors. And you repeat this process for as long as the incoming checks are larger than the outgoing checks. When the inevitable tipping point finally arrives - and there isn't enough new money to pay off all the old money - you skip the border and leave your clients waiting for their next share of the profits...and waiting...and waiting. The Best Ways to Buy Foreign Real Estate By Ronan McMahon Waterford, Ireland There has never been a better time to buy development land in Latin America. It's a buyer's market...and there are many creative ways to buy - for large and small investors alike. Many landowners in Latin America are under financial pressure...and buyers are thin on the ground. Sales in many markets have slowed as a result of financial and economic problems in the US. This has kept land prices artificially low, and means that many developers need to tap alternative sources of finance. Dear Uncle Sucker... By Barry Ritholtz Manhattan, New York Well, Uncle Sam, you delivered a motherload of cash. Considering the dollar sums involved, your actions were remarkably ineffective. What was left over afterwards was a wildly over-leveraged consumer whose credit limits had been reached; State and municipal budgets were heavily dependent upon that excess consumer spending, creating huge budget holes because of it. Net net: The resultant economy was in the worst recession since the Great Depression. Debt Delenda Est By Bill Bonner Baltimore, Maryland The subject is debt; it needs to go away. Debt was the market's bete noire, this week and last. In Europe, it snatched up the Irish and carried them off. Then it attacked the Portuguese. Everyone knew the periphery states were going broke. Their cost of borrowing soared. Then, when the search parties reached them, the Irish turned them away. Debt has it usefulness, the Irish figured. They held out until Wednesday, apparently negotiating terms of their own rescue. ------------------------------------------------------- Here a Way YOU Can Beat The Bastards At Their Own Game... Hidden Gov't Documents Let You Predict Stock Moves Imagine what you could do with this intelligence... Roger Barnes of Colorado used one of these hidden documents to bank $237,000 in just 6 days... It's all perfectly legal and you can do this too! Click here to watch this shocking presentation right now. ------------------------------------------------------- The Weekly Endnote: [Readers are warned that the following story contains graphic imagery and content that may not suitable for children.] Councilman Takes the Cake Earlier this week, we came across the story of young Andrew DeMarchis and Kevin Graff, a couple of 13-year old students who were caught selling cupcakes and baked goods at their local market. The two hoodlums were discovered peddling a range of treats, from cookies to brownies...even Rice Krispies. As is often the case with aspiring criminals, this was not the first time the boys had flouted the law. Readers may be shocked to learn that this was actually the secondtime these would-be ruffians had conducted their illicit activities in public. On the first occasion, another bake sale, the boys managed to net a cool $120 in profit. And, like greedy capitalists the world over, the team invested half the loot to buy a cart from Target and even expanded their operations to include the sale of water and Gatorade. Who knows how many treats the boys might have sold or how large their empire of dough-sponsored delinquency might have grown if left unchecked by the authorities. They had, according to one report, told a few members of their trusted inner circle (their Moms and Dads) of their intentions to one day open their own restaurant. Clearly, something had to be done. Enter our hero, local Councilman Michael Wolfensohn. Upon hearing of the boys vast and expanding operation down at the local market, Cr. Wolfensohn, his superhero cape sewn with the very threads of truth and justice, decided to act. Doing what any unquestioning citizen living in a police state would do after learning that two boys had decided to sell cupcakes, Wolfensohn called the cops. On Saturday, October 19, after about an hour of business - during which the perpetrators had raised around $30 (in cash) - police arrived on the scene. The store - and the seed of a crime syndicate that may one day have rivaled all the government agencies of the world combined - was shut down. Justice: 1; Kids trying to sell brownies: 0. "All vendors selling on town property have to have a license, whether it's boys selling baked goods or a hot dog vendor," explained Wolfensohn. When asked by the boys' parents whether he might have just informed them that they needed a license rather than calling the police, Wolfensohn laid out his watertight case. "In hindsight, maybe I should have done that, but I wasn't sure if I was allowed to do that," he said, demonstrating an admirable incapacity to think for himself. "The police are trained to deal with these sorts of issues," he added. We can only hope their brush with the law sets these two lads back on the right path, one that excludes entrepreneurial ambition and fosters a healthy fear of the state. As for Wolfensohn, this editor would like to formally recommend him for a senior position with the TSA, where no incident is too small to completely blow out of proportion and no threat, imagined or actual, is too big to miss altogether. Enjoy your weekend. Cheers, Joel Bowman Managing Editor The Daily Reckoning P.S. Fair warning: Steve Sarnoff's half-price Options Hotline offer ends tomorrow night, right after he releases his next play. Get in before then, here. ------------------------------------------------------- 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: Gold: The Truth About Gold Fiat Currency: Using the Past to See into the Future Have You Heard of the OTHER Government Backed "Pension Program?"