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The Daily Reckoning | Thursday, October 27, 2011 Europe is fixed...again...but for how long this time ’round? Fighting excess debt with more debt...and other boneheaded ideas, Plus, Bill Bonner, back from Cyprus with thoughts on his General Theory of Zombieism... ------------------------------------------------------- Presentation to be removed from the web TONIGHT... Offer Closes Thursday, October 27, 2011... Patrick Cox’s Breakthrough Technology Alert Presents: Codename: Panakeia 604 — Is It the Biggest Breakthrough in History? This breakthrough just hit the market. The story is gaining steam. It could be the biggest breakthrough in history. That means you get an incredible wealth chance... If you act before midnight Thursday, October 27. Find out why that date is so special by clicking right here. Heads, I Win; Tails, You Lose. Gold Rallies During “Risk-On” Trading Eric Fry Reporting from Laguna Beach, California... Why did the Dow Jones Industrial Average soar 162 points yesterday? And why is it rocketing another 300 points this morning? Was it because Consumer Confidence for October plummeted from 46.0 to 39.8...or was it because the number of Americans who signed contracts to buy homes fell for the third straight month? Neither, according to the newswires. The market is rallying because the deadlocked euro rescue plan became UN-deadlocked. Adding to the euphoria was a rumor that the Chinese would buy some of the European debt that would finance the rescue. Bravo for that. “After more than eight hours of hard-nosed talks between European heads of state, the International Monetary Fund and bankers,” the Associated Press reports, “the [rescue] deal foresees a recapitalization of hard-hit European lenders and a leveraging of the bloc’s rescue fund to give it firepower of 1.0 trillion euros ($1.4 trillion).” This news kicked off a monstrous rally in Europe that vaulted most of the major stock indices 5% to 6% higher. We Yankees joined the celebration by bidding our homegrown stocks higher as well. So for the moment, investing is fun again. But as your editor’s mother used to say, “It’s all fun and games until someone gets hurt.” Today’s knee-jerk rally is fun indeed. But we’ve seen this show before...or at least a version of it. Today’s European summit was the 14th such powwow in the last 21 months. And nearly all of them produced some kind of “breakthrough agreement” that thrilled investors for a day or two. But each of these relief rallies proved fleeting, as the “breakthroughs” yielded to deadlocks and bickering about the details of the supposed breakthrough. The process of unifying 17 countries — while also unifying a variety of disgruntled, self-interested constituents inside each of those 17 countries — has made the rescue process a little bit like herding cats — or more like herding cats, chimpanzees, rhinos and rattlesnakes...all at the same time. This time around may be different...but it may not. For starters, the breakthrough arrived only after German Chancellor Angela and French President Nicolas Sarkozy coerced European banks into accepting a “voluntary” 50% haircut on their Greek bond positions. Around midnight in Europe, the European Banks’ representative at the summit, Charles Dallara, fired off an email stating categorically, “There is no agreement on any element of a deal.” But shortly thereafter, according to the AP, “Sarkozy said the bankers were escorted in ‘not to negotiate, but to inform them on decisions taken by the 17 and then they themselves went on to think and work on it.’ Luxembourg Prime Minister Jean-Claude Juncker said the banks’ resistance was broken by a threat ‘to move toward a scenario of total insolvency of Greece, which would have cost states a lot of money and which would have ruined the banks.’ Armed with this “voluntary” agreement, the rescue plan was good to go...and the markets were sprung to rally. So for now, it’s all smiles and high-fives. Whatever the actual prospects for an enduring rescue package — “enduring” being something longer than a week — investors are growing tired of fear. So they are shifting into “risk-on” mode. Treasuries are selling off; the dollar is dropping; stocks are rallying. This is classic “risk-on” trading action — meaning that market participants are becoming slightly less skittish and slightly more eager to take some chances. But here’s a curious data point: During the most recent phase of the risk-on trade, gold has also rallied. In so doing, gold has broken ranks with its “risk-off” companion: Treasury bonds. Ever since the credit crisis of 2008, investors have flocked to both gold and Treasurys whenever macroeconomic conditions started looking a little dicey — i.e., “risk off.” As such, both assets tended to rise or fall at the same time. But during the last few weeks, when the risk-on trade was gaining traction once again, gold also rallied. Treasurys did not. Something has changed here. We’re not sure what it is but, as usual, we have a guess. First, a little background... Throughout most of the last four decades, the price of gold and the price of Treasurys traded inversely from one another. Whenever gold rallied, Treasurys fell, and vice versa. This “inverse correlation” as professionals call it, stemmed from the fact that T-bonds tended to thrive during deflationary periods, while gold tended to thrive during inflationary periods. But after the credit crisis of 2008 — when neither deflation nor inflation were theanxiety du jour — these two asset classes started tracking each other much more closely than usual. They became “flight-to-safety” assets, more than anything else. While very dissimilar, both assets satisfied a particular appetite for risk aversion — much the same way that Eggs Benedict and a bran muffin, though different, both satisfy an appetite for breakfast. So what does the recent gold rally mean, given the fact that Treasurys are falling? Perhaps it means that investors are starting to brace for a different sort of risk. Perhaps it means that investors are beginning to anticipate a sustained inflationary response to the euro crisis — whether or not that response succeeds — or just a crisis. In other words, either the governments of Europe rescue the euro with a massive inflationary effort or they fail, in which case the euro breaks apart and the most reliable money around would becomes the ancient money: gold. That’s what you call, “Heads, I win; tails, you lose.” Why the warning behind this image could... Forever change the way you think about the stock market... Open your eyes to what you can and can’t expect from the United States government... And even change the ease at which you’re able to buy and sell things... Click the image play button to first learn the warning...and some simple ways to prepare for the uncertain times ahead. The Daily Reckoning Presents Truisms of a Financial Crisis Bill Bonner So much information and so many ideas come to us daily in the financial press. We’re able to fill up our trash basket in just minutes. In The Financial Times, for example, Larry Summers recently offered a solution to America’s housing debt problem. And in The Herald Tribuneour favorite comedian, Thomas L. Friedman, tells us about the next Internet revolution and what a wonderful world it will create. Meanwhile, stocks appear to be on the march again. The Dow is up over 4% for the week. And oil is back over $90 per barrel. Once again, ‘recovery’ hopes are building. The Europeans just have to sort out their debt mess. And Americans too! And that should be easy. There are so many smart people on the job! In Europe, Monsieur Sarkozy and Frau Merkel — not to mention an army of technicians, bankers and delusional incompetents — are finding ways to solve Europe’s debt crisis. How? By adding more leverage...debt...and confusion. To simplify, today’s bad debt will be guaranteed by tomorrow’s bad debt. The authorities are just hoping that between today and tomorrow is sufficient time for them to get away. It may be a bigger problem, they say to themselves, but at least it will be someone else’s problem. And who knows, maybe Mr. Friedman will be right. He’s wrong with such conviction and such regularity that there is bound to come the time when he is right by accident. Now he tells us he sees another ‘tech revolution’ coming, this one based on ‘the cloud’ and the social media. Surely this one is going to make us all rich...or make the world a better place...whichever comes first. He hardly mentions the last tech revolution, which he also thought would make us all rich. It did nothing of the sort, of course. Against all odds, the last decade bucked the course of 300 years of history. With the help of the new technology — at their fingertips — Americans got poorer! But that’s a long story. So, let’s turn to Mr. Summers. He tells us that the problem with the US economy is that people have lost too much money on their houses. And if house prices sink further there is little chance that the economy can get out of its present low-growth slump. Right so far. But what to do about it? The man with all the answers steps boldly forward and proposes to make a bad situation worse. How would he address the problem of too much mortgage debt? By increasing the amount of mortgage debt! “It is a central irony of financial crisis that while it is caused by too much confidence, too much borrowing and lending, and too much spending, it can only be resolved with more confidence, more borrowing and lending, and more spending.” That may seem stupid to you and other sensible mortals, dear readers. But Mr. Summers sups with the gods, where the rules that cover the rest of us don’t apply. He says the problem with public policy is its “inability to appreciate this truism.” The real truism is that Larry Summers has never understood what is going on. Nor will he. His whole career is based on not understanding. It’s served him well so far; he’ll stick with it. The idea behind Mr. Summers’ solution is that you subsidize what doesn’t work; you reward failure. So, instead of abolishing Fannie and Freddie, for example, you give them more money... Failed mortgage lending is a big drag on the economy. So, you lend more! You could apply the same logic to other failed industries — such as education. Education spending has soared over the last 40 years. But test scores show there has been no payoff...no improvement at all. One of the ways the feds shift resources to this zombie sector is with student loans.Bloomberg has the report: William Prince, of Rosenberg, Texas, knows just how inescapable student loans can be. The 52-year-old father of two started paying off $51,000 in college debt 15 years ago and now owes $57,000. “I don’t expect to pay these loans off in my lifetime,” he says. Prince, a criminal justice major who works in private security, had to defer payments during three bouts of unemployment, and the accumulated interest left him deeper in debt. Americans now owe about $950 billion in student loans — more than their total credit-card debt. The weight of those IOUs is a frequent refrain for Occupy Wall Street protestors and their online supporters. On the “We Are the 99 Percent” Tumblr blog, which features hundreds of pictures of people holding handwritten signs describing their desperate financial situations, student loan concerns exceed those about children, unemployment, and health care, according to an analysis by Mike Konczal, a fellow with the nonprofit Roosevelt Institute. Desperation may have something to do with that outcry. Two out of five Americans with federal student debt can’t make monthly payments and either defer, default or are delinquent, according to Mark Kantrowitz, publisher of Fastweb.com, a free scholarship-matching service, and FinAid.org, a source of student financial aid information... We’ll save Larry Summers some thinking. What to do about this trillion-dollar weight of student debt? Lend the students more money! Regards, Bill Bonner, for The Daily Reckoning Little-known “loophole” could triple investing income In 1986, Ronald Reagan signed a little-known “loophole” into law. Today, the special “10-86 Payback Plans” it created are allowing some Americans to collect as much as three times the income that regular bonds and stocks pay. We’re talking solid yields — without even touching the stock market. Click here now for all the details. Bill Bonner Why the US Economy is No Place for Small Business Growth The Dow jumped 162 points yesterday. Up, down...up, down...when will it stop? Never. That’s what prices do. They go up and they go down. Discovering...discovering...the markets will never cease discovering... And the end of all their discoveries will be, to return to the place where they began, and to know it for the first time... Poetry! Yes, dear reader, poets are probably better able to tell you what is going on in the world than economists. Today’s economists are tied to their worn-out, crack-pot theories. They won’t give them up...even though they do not work. Poets at least are on the right track...probing deep into the soft, easily corrupted tissue of the human heart. We’ll come back to that in a moment. First, we would like to tell you why unemployment is so high. Yes, dear reader, the pieces of the puzzle are coming together. Why is unemployment so high? Well, who creates jobs? Small businesses. Big businesses cut jobs. That is how they maintain profit margins so they can pay bonuses to their over-paid managers. Small businesses...growing businesses...businesses that are adding value and building wealth...create new jobs. Why so few new jobs now? Because more and more money — capital allocation decisions — are in the hands of the feds. The feds always favor existing businesses...big businesses that make campaign contributions and whose lobbyists take them to lunch. They never favor small start-ups. The start-ups don’t have any money...or any lobbyists. The start-ups have no political power. The feds favor big businesses in direct, obvious ways — such as tax credits, bailouts and government contracts. They also favor big businesses by making it hard for the start-ups to compete with them. Let’s just say, dear reader, that you wanted to start a new kind of bank. You saw that the big banks are ripping off their clients...losing money...and getting bailed out by the feds. So, you figure you’ll do to the banks what Napster did to the music business or Amazon did to the book business. After all, moving money around is just an electronic, digital process. It should be dirt cheap to run a bank. You could even create a much better way for customers to hold their money. You could allow them to choose whatever currency they would like...or they could hold their cash in gold...just with a few clicks on a computer keyboard. You could set it up so no customer would ever lose money...because his account would be backed by, say, 100% physical gold. And you could cut credit card transactions and banking fees down to a fraction of what they cost today. And you know what else? You could end inflation. And end the worry about choosing currencies...or hedging against one currency or another. You could create your own gold-backed currency! Heck, it’s all information. A few computers. A few programmers. You could revolutionize the banking business and send Bank of America into bankruptcy even faster than it is going on its own. Do you think you could do that, dear reader? Well, the answer is no. You can’t. Because the regulators — put in place with the conniving cooperation of the banking industry — would stop you. Otherwise, some enterprising entrepreneur would have wreaked creative destruction on the banking industry years ago. And the dinosaur banks that remained would have been wiped out in the crisis of ’07- ’09. Instead, the feds came to the rescue of the big banks. The start-ups were shut down by the regulators. And the new jobs never happened. That’s just banking...an obvious example. But in every industry the story is about the same. Existing businesses colluded with the feds to set up barriers to entry and to absorb savings, which could otherwise be used to start small businesses. The US government runs a deficit that is greater than the total savings of the nation. It decides where these resources go. And one place they never go is to businesses that haven’t been created yet. Government always favors the past. It is always reactionary. It is always backward looking...trying to protect industries that were developed a long time ago. It always tends toward “zombieism,” in other words... Many dear readers probably thought our focus on ‘zombies’ was a joke. But we’re as serious as we are about anything. And the more we look at what is going on in the US economy, the more convinced we are that zombies are behind it. Zombieism refers to a tendency of things to become paralyzed and parasitic. When anything ages it becomes less adaptable, less flexible, more ‘stuck in its ways.’ You know the expression: ‘You can’t teach an old dog new tricks.’ That’s partly because the old dog is tired and doesn’t want to learn any new tricks. And it’s partly because he doesn’t need to. Old dogs just lie around. They eat, but they don’t hunt. Their joints are stiff. Their ambitions are few. They’ve figured out how to get the bone without much effort. Likewise, old people often distrust anything new. They’ve seen that most new things don’t work out very well. And they often become parasitic. They eat. But they don’t produce. It’s just natural. Often, old people mimic the grave before crawling into it. They don’t move. They don’t think. They shuffle around...like zombies. Now, magnify these natural tendencies onto a whole economy, a whole society, a whole nation. The US has been in business for nearly 250 years. Is it any wonder it is a little fusty? But today, instead of explaining the General Theory of Zombieism in detail, we are going to begin by asking you some questions, dear reader. How come university tuition rose more than 8% last year, when most prices rose only half as much? How come so few new jobs are created...in a society where so many intelligent, well-educated people are looking for work? How come health care costs go up year after year — like education expenses — at twice the rate of the CPI...and people are no healthier? How come the government now consumes more than $41 out of every $100 of national output...making it by far the largest allocator of capital in the world — when it is supposed to be a free enterprise system? How come the US government — which is supposed to be the best system that 300 million smart people can come up with — is actually a system that no sane person could possibly want? All those questions have the same answer. The whole system has become zombified...taken over by unproductive, parasitic tendencies. More to come... Regards, Bill Bonner, for The Daily Reckoning