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The Daily Reckoning | Friday, January 14, 2011 The muni bond crack up - why more taxes won't solve the problem, Oregonians dance in the street...as state revenue plummets, Plus, Bill Bonner on MONEY's golden mistake and plenty more... ------------------------------------------------------- Patrick Cox Reveals His 2011 Predictions... Offer Expires Midnight TONIGHT, January 14... Five Market "Wealth Quakes" Could Land You 10,720% Gains in the Next 13 Months New presentation reveals shocking 2011 predictions! These five "Wealth Quake" events could make you 10,720% richer in the next year...just for starters. But you must hurry! This epic presentation expires soon. For the biggest shot at huge wealth - watch this right now. MONEY Misses the Mark Why Gold Is Still a Good Investment Bill Bonner Reckoning today from Cologne, Germany... Nothing much in yesterday's market news...so we turn to a remarkable article that appeared in MONEY magazine, proving that MONEY doesn't know anything about money. (MONEY Magazine) - Can you tell when a boom has turned into a bubble? One clue: When pop culture starts paying attention. The housing bubble, for example, brought both the TV show Flip This House and a rival on another network, Flip That House. So if you own a lot of gold, you might regard a recent episode of Saturday Night Live as your first warning. In the opening skit, Bill Hader as China's President Hu Jintao declares that Glenn Beck was right and that "my government should have bought gold. Unfortunately, all our assets were tied up in US Treasury bills." Back in the real world, gold is trading at about $1,400 an ounce, up from less than $500 five years ago. That's a 23% annualized return, far outstripping the gains on stocks (1.1%) or bonds (6.1%). Fear is driving a lot of the rise. MONEY has a point. But not a good one. When pop culture gets excited about an asset class - tech stocks in '99 or housing and finance in '06 - you know it's late in a roaring party. It's just a matter of time before the neighbors get mad and call the cops. But the MONEY writer missed the point. Pop culture has to take the bubble asset seriously. Not as a joke. The author admits that the magazine tried to persuade readers to dump gold last year at this time. That was a costly mistake. Gold went up nearly 30%. But it just shows how hard it is to get to the top of a bubble market. Yeah, but gold is not in a bubble market. It's in a bear market. It will turn into a bubble market later. So far, almost no one is at the party. Ask your friends, dear readers. Ask your relatives. How many of them own gold? Ask the cab drivers, the insurance salesmen, the auto dealers and the psychiatrists. Ask the readers of MONEY magazine. Do they hold gold? Nope. It may have just completed its 11th year of a bull market, but people have still not caught on. They think there's something weird about gold...something almost unpatriotic. It is as if you didn't trust Ben Bernanke or something. MONEY goes on to tell readers why they shouldn't buy gold now. Reason #1: "Bad economic news may not make you very much money. Good news could crush you." Of course, it depends on what kind of bad news. And how bad. Historically, gold is a refuge against bad news. And we can't think of anything we'd rather have in bad news...unless the news were so darned bad that we'd rather have a farm far out in the country with a cow, a pig, a flock of chickens and an arsenal of weapons. But how about the good news? Yes, gold would go down in a good news environment. The author talks about the '80s and '90s...as if a re-run of those good news years were possible. Oh boy! This fellow must have read Peter Lynch's advice about not paying any attention to macroeconomics; he must have taken it seriously! Poor lump! You can ignore the macro weather forecast, but only when the weather is good. When the hurricanes and tornadoes start to blow, you need to know what's going on so you can nail up the plywood and head for shelter. What is the likelihood of a repeat of the '80s and '90s fair weather? Well, we'd need to begin with the high interest rates of the early Reagan years (they're extremely low now). Then, we'd need low stock prices (they're 1,100% higher now). We'd need relatively high inflation (CPI touched 13% in the early '80s) rather than the 1.1% core CPI we have now. We'd need a monetary base of about $600 billion (rather than the $2.5 trillion Bernanke is building). We need total debt at about 120% of GDP, instead of 400%. And we'd need a Fed that was determined to stop inflation rather than one that was dead set on causing it! And we'd all have to be 30 years younger, too. All things considered, we'd gladly go back to the '80s - if we could do it. But who could possibly believe we could? Only a writer for MONEY magazine. Yes, if things do go back in time to the '80s and '90s, gold will be crushed. That's a chance we will gladly take. His reason # 2 is no better. "Sure, the dollar has problems. But just look at the other guys." We're not sure what that is supposed to mean. The whole planet's monetary system is based on paper currencies, with the dollar at the center of it. Yesterday, the dollar turned down against foreign currencies. But so what? We can't tell you which of these paper currencies will shrivel up and blow away first...but they're all going to do so. How do we know that? Well, in all modesty, we admit that we don't know for sure. We don't know nothin' for sure. But every paper currency ever tried - apart from present company - has always disappeared. And none has ever survived a complete credit cycle. They're okay on the upside. They fall apart on the downside. We're on the downside of the credit cycle now. Or not far from it. The dollar won't survive. And when it begins to limp and cough badly, some investors may go to Chinese yuan or Swiss francs. Most will want to go to real money...the kind you can trust...the kind that never goes away... ..the "last man standing" in a monetary crisis - gold. MONEY has other reasons for telling readers to stay out of gold. They are no better. And at the end of the article, as if the author were not convinced that he had made his case, he tells readers that if they must get into the yellow metal, they should do so with only 1% of their portfolio. And put the money into an option, not into the real stuff. Then, if the bet pays off, the MONEY reader would get a big payday. Wait a minute. Picture the MONEY reader. He's got a $200,000 portfolio. On MONEY's advice, he keeps it fully invested in a balanced portfolio of equities. Then, he takes $2,000 and buys an option on gold. If gold goes up dramatically, his $2,000 option turns into, say, $20,000. But what has happened to the rest of his portfolio? We don't know, but there is a good chance that either his option expires worthless - in which case, he loses his $2,000. Or, if it pays off...and gold is soaring...the rest of his portfolio could register far bigger losses than he recovers from his gold play. Again, MONEY is missing the point. Ordinary people have no business speculating on gold. They should buy the metal as a safety device - to protect themselves from all the dumb policies and speculations of the banks and the Fed itself. The Fed is no longer doing its job. Its reserves are trash - bonds to be paid off by the federal government (which is insolvent) or by underwater homeowners. Since the Fed is derelict, people need to have their own reserves of real money. Gold, in other words. Meanwhile, California is in the same situation as Portugal, Ireland and Spain. It can't print its own money. So, it has to take the austerity route. Here's the latest from Bloomberg: California's Brown Unveils $12.5 Billion in Spending Reductions California Governor Jerry Brown's budget will cut spending by $12.5 billion, including as much as a 10 percent pay reduction for most state employees, aides said. The plan, which Brown is to unveil today, will also raise $12 billion by retaining tax increases due to expire and making other modifications. Some of the revenue will go to cities and counties as part of Brown's plan to transfer spending authority from the state to local governments. More on state funding catastrophes in today's guest column. Please enjoy... Outstanding Investments Introduces... Nine Simple Ways You Can STILL Get Rich With Gold in 2011 Even as gold soars to record new highs, a respected Harvard geologist reveals how you can STILL use gold nine different ways to get rich. Get the details on this epic profit forecast - right here. The Daily Reckoning Presents Illinois is No Peter Pan Frederick J. Sheehan "I'll never grow up, never grow up, never grow up, Not me!" - Peter Pan, Lyrics from play "I knew Peter Pan and you're no Peter Pan." - Vice-Presidential candidate Lloyd Bentsen, (sort of), 1988 "Top Illinois Democrats have agreed to push a plan that would temporarily boost income taxes by 75 percent and double cigarette taxes," harked CBS Chicago on January 6, 2011. The proposed plan would increase Illinois' personal income tax rate from 3 percent to 5.75 percent for the next three years. After that, it would drop back to 3.25%. So they say. Illinois is a state in which the legislators have so betrayed the taxpayers that a lifetime on Devil's Island would be too good for them. For instance, the liability of the four state pension plans is calculated at $151 billion or $280 billion, depending on the assumptions used. The $280 billion figure is analytically controversial but deductively compelling given the efforts to deny and confuse bondholders and the public alike respecting the coming collapse of the municipal bond market. Springfield, the capital of Illinois, is a nice town. As state capitals go, it is strikingly uninhabited with a population of 110,000 (and falling, but not as fast as its benefit obligations are rising). Farm country starts about three blocks from the state house. Illinois has more representation in its capital than any other state. The politicians raised pension benefits faster than poker bids in Macau. Presumably, they have boosted their own benefits faster than the state's public servants, who, once they retire, no longer pay one cent for health insurance. Clay ducks would have done better at funding promises than the elected representatives. There are $70 billion of assets to support the $280 billion of pension obligations (See The Liabilities and Risks of State-Sponsored Pension Plans in which Professors Novy-Marx and Rauh lay forth their provocative and engaging argument). Illinois borrows from the bond market each year to pay benefits, a total of $16 billion since 2007. Bondholders have been paid $550 million (on the first $10 billion) for funding this pyramid scheme. In other words: Illinois taxpayers have paid a $550 million late-fee that, if there were justice in this world, would be paid by the Illinois legislators. These legislators - and this is true across the country, not just Illinois - cannot conceive of a time when there will be no buyers of bonds to pay benefits that the politicians failed to fund. By borrowing to meet current payments, the "top Illinois Democrats" have fostered the national charade of limitless taxing authority. State General Obligation (G.O.) bonds are backed by the "full faith and credit" phrase, stamped on their offerings. Wall Street research would have it that a G.O. bondholder can take that phrase to the bank. It is from this precipice that bondholders hang by their fingernails. Goldman Sachs research chips in: "[G]eneral obligation debt is backed by a state or local government's pledge to raise taxes to service that debt if necessary." Barclay's wrote to its California-averse clients that the state is obligated "in good faith to use its taxing power as may be required for the full and prompt payment of debt service." There are four problems here. First, the State of Illinois had accumulated over $5 billion of unpaid bills by the end of 2010. Electricity to the governor's mansion will be cut off if the politicians don't grow up. Second, the authority to raise taxes to meet bond payments often does not work. The most recent instance is the State of Oregon. In early 2010, voters increased tax rates on high earners and businesses to fill a $700 million deficit. Civil servants danced in the streets: "We're absolutely ecstatic," said Hanna Vandering, a physical education teacher from Beaverton and vice president of the statewide teachers union. "What Oregonians said today is they believe in public education and vital services." (The Oregonian, January 26, 2010) On December 16, 2010, the state of Oregon had received one-third less than was expected from windfall tax receipts. Those Oregonians who weren't talking while Hanna Vandering was spouting decided they would rather leave town than contribute to this scandalous love-in between legislators and public unions. Third, the authority and inclination of courts to issue a writ of mandamus (ordering state officials to raise taxes) is not a topic discussed in brokerage firm research. It is hereby suggested to municipal bondholders who are recipients of such reports to ask why this is so. There have been many decisions in which the court concluded it did not have the authority (or inclination: because efforts, such as in Oregon, are generally unsuccessful) to demand tax increases. The decisions are too varied to discuss here. (See, as a start, Tax Increases in Municipal Bankruptcies, Kevin A. Kordana, Virginia Law Review, volume 83, No. 6, pp. 1035-1107.) Readers may recall that states cannot file for bankruptcy. This is true, but an insolvent body that reneges on its obligations to bondholders will sit in the dock. Municipal decisions are the obvious precedents for the courts. Fourth, a Sword of Damocles hovers over all transactions and contracts in the United States today: who still trusts the "full faith" of any government body? And, this is the worst situation of all: politicians who think they can fly. Regards, Frederick J. Sheehan, for The Daily Reckoning Joel's Note: Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession and "The Coming Collapse of the Municipal Bond Market." ------------------------------------------------------- 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 atjoel@dailyreckoning.com Good Only Until Midnight Saturday, Jan. 22 - Give This Profit Engine a Risk-Free Try $100,000 fits on a dinner plate. $1 million fits in a grocery bag. Act before midnight Sat., Jan. 22 and find out how you can start stuffing your own grocery bag with cash. Amazing? Preposterous? Get all the details, and find out how easy it really is, right here. The Growing Fiscal Disparity Between Insiders and Outsiders As far as we know, this is the first time it has been explained. So pay attention: as a wealth-producing society degenerates into a wealth redistributing society...and then finally, a wealth-destroying society, the difference between insiders and outsiders becomes more pronounced. Societal Influences on the Creation of Wealth Global Wealth Shifts as Asians Stock Up On Bad Debt Economic Ruination from Money Creation to Price Inflation ohn Rubino at Dollar Collapse.com obviously thinks, like I do, that inflation is a Terrible, Terrible Thing (TTT). To prove it, and to simultaneously prove to my wife, kids, relatives, co-workers and neighbors that I am not the “weirdest man who ever lived” as concerns inflation, I call him up on the phone! US National Debt: The Missing Years The Benefits of Gold and Silver Not Lost on the Chinese Commodity Currencies Retreat on News from China As I look out over the landscape of the currencies this morning, I have one thought in mind... Buy the commodity currencies on the dips, of which this is one! But then that’s just me, as I say... I could be as wrong as two left shoes! Mr. Mizuno Retires (Part Two of Two) Economic Ruination from Money Creation to Price Inflation The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. Cast of Characters: Bill Bonner Founder Addison Wiggin Publisher Eric Fry Editorial Director Joel Bowman Managing Editor The Mogambo Guru Editor Rocky Vega Editor