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The Daily Reckoning | Wednesday, December 1, 2010 Greece, Ireland and all the clods that will eventually call the sea their home... Why the possible successes of QE2 are more detrimental than its failures... Plus, Bill Bonner on what's driving the gold market and whether or not you should buy farmland... Global Debt Erosion Observing the Spread of the Sovereign Debt Crisis Joel Bowman Reporting from Puerto Vallarta, Mexico... Do you have some protection, Fellow Reckoner? An escape plan? A little hideaway in some tropical clime? Some shiny stuff under the mattress? Good. Remember: When it comes to the theater of global economic collapses, it is gold that buys the best seats in the house. Of course, you could always just watch the show from a deserted beach somewhere, lazing in a hammock with a long book and a broad smile. Whatever your perspective, this show promises to be a box office hit. News out of Europe tells us the continent is coming apart at the seams. What the modern economists told us was contained to Greece has spread to Ireland...and is beginning to infect Portugal and Spain, too. The disease, as we all know, is debt. And the continents peripheral limbs are gangrenous with the stuff. Despite the euro-meddlers' plan to extend 200 billion euros ($260 billion) in emergency lifelines to Greece and Ireland - countries, mind you, that couldn't pay their debts in the first place - the specter of continental collapse has only come into sharper focus. Markets across Europe continued to sink yesterday. The euro - temporary lifeline for some, eventual anchor for all - yesterday traded near an 11-week low against the dollar. Meddlers, being meddlers, say they have the situation under control. But the bond traders are not buying it. Yields on Spanish debt ballooned yesterday, reaching above 5.55% from just 5.21% the previous day. Italian yields rose too and credit default swaps on Irish, Portuguese, Spanish and Italian debt all jumped to new records. Even supposedly "stronger" nations are feeling the pinch. Word is that Belgium and even Germany are not immune. "In recent days, investors have been selling the debt of Germany, whose economy remains relatively robust, because of worries it will bear much of the burden of the ever-higher costs of bailing out weaker countries," reports The New York Times. "While German bonds recovered by the end of Tuesday, the cost to an investor for insuring against an unlikely German default also rose, signaling growing nervousness." Just how deep is this crisis, investors want to know? "If a clod be washed away by the sea, Europe is the less," mused the English poet, John Donne, in (the meditations that would become) his famous "For Whom the Bell Tolls." And if the tides of debt were to wash away the whole continent? Well, Donne didn't say. We'll have to wait and see. Shouldn't be long now... Back on the other side of the pond, Americans who are worried they might be left out of the impending crisis needn't feel jilted. That bell tolls for thee too! According to the latest data, the much- ballyhooed "recovery" in US housing - thanks mostly to Federal bribes and paper-mâché loans - seems to be faltering. "We're getting the clearest view yet that a double-dip in housing is under way," writes Dave Gonigam in our sister publication, The 5-Minute Forecast. "The Case-Shiller Home Price Index fell in September at double the pace the Street was expecting. "This is important," Dave observes, "because we now have data completely unsullied by the homebuyer tax credit. Buyers had until June 30 to close...and Case-Shiller is a three-month moving average." So what are we to do, Fellow Reckoner? To where do we flee? Everywhere we look the tides are rising. The banks are eroding. Ireland-sized clods have already washed away in the sea. California-sized clods look set to follow. Do you buy farmland and retreat inland, to more fertile ground? (Bill lends some thoughts on that below.) Or do you stake a claim under a palm tree somewhere and hope the coconuts last? The last time the whole world was in this kind of financial funk, back in 2008, we were trekking along a forgotten coastal stretch of Viet Nam. In the seaside town of Nha Trang, about 8 hours bus ride north of Saigon, we came across a few fellow refugees. Mostly they were ex- bankers from The City of London who suddenly had a whole lot of spare time on their hands. We met a dozen or so of them, all riding out the storm under the shelter of $20 per night accommodation and $2 poolside cocktails. "Beats paying five quid for a pint back home," one chap told us. "An the weather ain't half bad either." We half expected to see a similar crowd here in Mexico, seeking a cheaper safe-haven where their eroding dollars can still buy a taco lunch and a nice view. The place is not empty...but neither is it jam- packed. Maybe folks haven't heard the news yet. Maybe they don't care. In today's issue, special guest essayist, Vitaliy Katsenelson, lends us his insights on yet another assault on your money. The way we read it, it's just one more reason to "Get outta Dodge." Please enjoy... The Daily Reckoning Presents QE2: Bad in Theory...And in Practice Vitaliy N. Katsenelson Over the next eight months the Federal Reserve will conduct QE2 - quantitative easing, the sequel. It will buy $600 billion worth of US long-term bonds in the open market, close to 7% of all Treasuries in public hands. $600 billion is also roughly equivalent to the total amount of net debt the federal government will issue during the Fed's QE2 campaign. The Fed has already taken short-term rates down to zero, pushing income-seeking investors and savers to chase after higher-yielding, higher-credit-risk and/or higher-duration (riskier) bonds. Now, with the magic of QE2, the Fed wants to drive long-term rates down to unseen levels and push investors of any Treasuries (short or long) towards higher-risk assets - junk bonds, real estate, stocks, and commodities. The Fed also hopes (that is all it can do at this point) that low interest rates will nudge businesses to invest and to hire. That's unlikely. The value of any asset is the present value of its future cash flow. As my favorite philosopher, Yogi Berra, (allegedly) said, "In theory, there is no difference between theory and practice. In practice there is." In theory, lower interest rates decrease the rate that businesses use to discount future cash flows - making future cash flows more valuable today - and that is what the Fed is betting on. In practice, however, the fickle source of lowered interest rates is not lost on businesses. Rising government debt levels and overheating printing presses don't generate confidence about future cash flows. High government debt eventually leads to higher taxation, higher interest rates, and lower growth. So the Fed's action may produce an opposite result from what it intends. QE2 is like a drug prescription that comes with the list of side effects that are often worse than the disease it was supposed to cure. It is difficult to know all the side effects and unintended consequences of QE2, but it may result in a substantial decline in the dollar, stagflation (inflation will show up not where the Fed wants it - i.e., in house prices - but where the Fed does not want it: in prices for things like food, gasoline, clothing, electricity etc.), lower economic growth and much higher interest rates. Yes, paradoxically QE2 may actually result in higher interest rates - investors expecting higher inflation will demand higher interest. Despite the Fed's efforts, the dollar may or may not decline against the euro. As in a race to the bottom, the US is racing with PIIGS rampaging through Europe. The Fed's artificial manipulation of short- term and long-term interest rates creates a long-term problem for the economy. Government intervention (be it Chinese or US) in the free market creates excesses that are not allowed to self-correct and thus, leads to bubbles. QE2's possible success worries me more than its failure, because it will come with all the side effects I just mentioned, plus the eventual popping of newly created stock market and real estate bubbles. The Fed wants to create asset bubbles, praying for the wealth effect - stock and real estate appreciation to make people feel wealthier (at least on paper, for a while) so they will spend their phantom wealth. However, the Fed is like a Judas goat leading gullible (yield-deprived) savers to the slaughterhouse. The paper wealth that is created will vanish as bubbles burst (they always do), wealth will be destroyed, and consumers will find themselves further in debt. Japan was QEing from 2001 to 2006 and created a bubble in Japanese bonds that partially burst, but the economy did not lift out of stagnation. Eventually, Japan stopped hiding its true intentions of propping up the equity market - on November 4th of this year the Bank of Japan announced it will be buying Japanese stock ETFs and REITs. The Fed's actions over the last two decades remind us of Scarlett's famous line from Gone with the Wind: "I can't think about that right now. If I do, I'll go crazy. I'll think about that tomorrow." Unfortunately, the Fed's toolbox is missing a very important, must-have tool to fix the current problem: the "do nothing" tool. The "do nothing" tool would let the economy self-heal, even if unemployment stayed at 10% for a while and housing prices found (declined to) their true level. However, that is unlikely to happen, as it requires pain. Americans have little tolerance for pain - after all, the most prescribed drug in the US is Vicodin, a painkiller. This is why, regrettably for the US, QE2 is unlikely to be the last QE: as the QE2 effect wears off (assuming it succeeds at all), then QE3, 4...10 and so on will follow. What should investors do? If the Fed "succeeds" and creates a short-term bubble in stocks and other asset classes, investors' true time horizons and investment disciplines (i.e. adherence to the investment process) will be put to the test. They will have to engage in the game of looking-for-a-bigger- fool-to-buy-your-overvalued-assets. In the giddy phase of a bubble, ignorance is wonderful bliss and knowledge and adherence to the investment process are a curse - as disciplined investors will always sell too soon and will not partake in the bigger fool game. However, when the bubble bursts, the money will flow to its rightful owners. The Fed doesn't want you to be in cash, it wants you to reach for yield and to speculate - but don't. In the absence of good investment opportunities, the worst thing you can do is take guidance from the Fed. Regards, Vitaliy N. Katsenelson, for The Daily Reckoning Bill Bonner A Gold Buyer’s View of the Lopsided Risk-Reward Ratio Bill Bonner Reckoning from London, England... What a beautiful city! We're talking about London. It was all dressed up for Christmas last night. And we got to see quite a bit of it. Student protestors blocked the streets around Trafalgar Square...and there was so much snow and ice...taxis must have stayed home. We walked from Mayfair to Southwark, using one of the pedestrian bridges to get over the river. It was snowing - large flakes floated down and settled on the sidewalks. There were Christmas trees and toys in the shop windows...along with the usual fashions, paintings and jewelry. People gathered in warm pubs and cafes to escape the cold; they looked so inviting, we wanted to stop in each one and have a drink. The Royal Festival Hall was brightly lit up...as were all the major buildings along the Thames. We've never seen it so lovely. Too bad we're leaving town this morning...on our way to Mumbai (aka Bombay.) Uh oh... What's this? Gatwick Airport is closed. Our flight is delayed. Well...more time to reckon! But what are we reckoning with...oh yes...money. Alas, the world of money looks much less attractive than the world outside our snow-bound window. In fact, it is downright ugly. The stock market seems to be rolling over. Yesterday, the Dow fell 46 points, not enough to make much of a difference. Gold rose $18. Here's what we see - Big Risks/Little Rewards. That is probably what gold market buyers see too. You'd expect gold to rise when there is consumer price inflation. And there is quite a bit of it. But not in the US...nor in most of the developed countries. Maybe some people are buying gold to protect themselves from inflation, but it looks to us as though they are buying it for another reason - because they are fearful that something is going to go wrong. Right now, world financial authorities have a number of balls in the air - China's property bubble...its excess capital investment...its rising inflation; Europe's collapsing bank debt...the euro...government funding problems; America's continued housing decline...high unemployment...overpriced stocks and bonds...Ben Bernanke and QE2. Gold market investors are betting that the authorities are going to drop one of these balls. Maybe more. Remember, these are the same klutzes who saw no trouble coming...and then misunderstood it when it arrived...and made things worse. And in Europe alone, they will need more than two hands. Here's the latest from the Telegraph: Contagion strikes Italy as Ireland bailout fails to calm markets Spreads on Italian and Belgian bonds jumped to a post-EMU high as the sell-off moved beyond the battered trio of Ireland, Portugal, and Spain, raising concerns that the crisis could start to turn systemic. It was the worst single day in Mediterranean markets since the launch of monetary union. The euro fell sharply to a two-month low of €1.3064 against the dollar, while bourses slid across the world. The FTSE 100 fell almost 118 points to 5,550, while the Dow was off 120 points in early trading. "The crisis is intensifying and worsening," said Nick Matthews, a credit expert at RBS. "Bond purchases by the European Central Bank are the only anti-contagion weapon left. It needs to act much more aggressively." And more thoughts... Meanwhile, in Ireland, the public mood is turning as dark as December. Irish voters are threatening to turn away the rescue boats and instead throw the bankers overboard. The Telegraph report continues: One poll suggested a majority of Irish voters favour default on Ireland's bank debt. Popular fury raises the "political risk" that a new government elected next year will turn its back on the deal. Premier Brian Cowen said there was no other option. "We are not an irresponsible country, " he said, adding that Brussels had squashed any idea of haircuts on senior debt. Irish ministers say privately that Ireland is being forced to hold the line to prevent a pan-European bank run. There is bitterness over the EU-IMF loan rate of 5.8pc, which may be too high to allow Ireland to claw its way out of a debt trap. Interest payments will reach a quarter of total revenues by 2014. Moody's says the average trigger for default in recent history worldwide has been 22pc. *** If Ireland shirks its debt load, others will too. And then, the euro will collapse. (It fell below $1.30 yesterday.) And if the euro goes...so does world trade. And if world trade collapses so do the US stock market and the US economy. And remember, that's just one of the risks. There are more. So what should you do? Easy. Buy gold on dips. Sell stocks on rallies. Don't worry. Be happy. *** "Should I buy farmland," asks a Dear Reader. Answer: yes and no. There. Always trying to be helpful. Farmland has been a great investment for many years. But yields - from renting out farmland - are near record lows. This suggests that capital gains will be low over the years ahead. There's a time for every purpose under heaven; this is probably not the best time to buy farmland. On the other hand, farmland isn't going away. And over the long-term it is likely to hold its value...and perhaps increase. Here's a report sent to us yesterday from the heartland of the homeland: (Globe Gazette) - Mark Newman of Forest City has been an auctioneer for farmland auctions since 1981, but never has it been as exciting as it is now. "The atmosphere is just electric," said Newman referring to public auctions. "It's fantastically exciting for buyers and sellers." The current market for farmland is exciting because farmland values have gone up at least 13 percent in Iowa since October 2009, according to a recent survey by the Federal Reserve Bank of Chicago. Specifically in the North Iowa area farmland values are up 11 percent, with the western part of the area seeing a 17 percent increase, according to the report. "I think we could safely say that report from the Chicago Bank is pretty indicative of what's happening here in North Iowa," said Sterling Young, farm manager and farm real estate broker with Hertz Farm Management Inc., Mason City. Farmland prices in North Iowa have ranged from $3,000 an acre for poorer land and up to $7,000 an acre for really good land, said Young, Newman and Fred Greder, owner of Benchmark Agribusiness, Mason City. Average farmland has been in the middle at around $5,000 an acre, the three men said. Farmland values in Iowa declined for the first time in 2009, according to an annual survey released by Iowa State University Extension in December 2009. However, it began to rally at the end of 2009 and has been doing so since then, Greder said. The rally began because there wasn't very much land for sale and investors were looking to land as a more stable investment, he said. "People that have cash are finding CDs and savings account interest rates aren't strong," Young said. "The return from land investments is better. They feel more comfortable with placing it there." Farmland values have also gone up because of commodity prices. "It really started to take off mid summer 2010, and it's not a coincidence it's at the same time the grain prices started to go up," Greder said. "I've always been surprised that the long-term investments like land is so responsive to grain prices." North Iowa sellers have definitely decided to take advantage of the higher prices. "There have been quite a few auctions and quite a few yet to come before the end of the year," Greder said. Newman, an auctioneer and attorney at Newman Law Office PC, Forest City, agreed and said there is a big push right now not only because of the prices but because capital gain tax rates are expected to increase next year. "For some of those sales we have significant penalties if they fail to close by the end of the year," he said. "It can mean $15,000 on a somewhat typical farm or $20,000 on a better farm if it closes after Jan. 1." While many people are pushing to sell yet this year to avoid higher capital gain tax rates, farmland values might increase even more next year. "I think the best is yet to come," Newman said. His reasoning is that more people will hold onto their land because of higher capital gain tax rates, which will create a shortage in land and drive up the prices. However, as Newman admitted, it's always hard to know what the markets will do. "Then again I don't have that crystal ball," he said. 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 US Dollar Fights the Euro in a Battle With No Victor Alas, all the currencies are unruly mutts. The dollar won’t go down, even though Ben Bernanke pulls the rug out from under it and gives it the old “bitch slap” with the back of his hand. And the euro won’t go down because the Germans don’t want it to go down. The European Debt Crisis at a Glance Cutting Expenses to Borrow More Money The Dual-Mandated Failures of the Federal Reserve I thought I knew everything about the foul Federal Reserve in that I knew they cause inflation in prices by deliberately creating too much money, which is the One Big Thing (OBT) that you do not want because of the social upheaval of people starving to death and rioting in the streets. Consumer Price Inflation: The Wolf at the Door Why the Government Hates Deflation India: Land of Hope and Growth Indian markets have rebounded nicely from the crisis, outperforming both the U.S. and China over the past three years. As of November 23, India’s Sensex was up just over 6 percent for the past three years, while the S&P 500 Index was down more than 16 percent and China’s Shanghai Composite Index was down 43 percent over the same time period. Putin Suggests Russia Could Join Euro Zone, Make Euro World’s Reserve Currency There is No Food Inflation; the BLS Made Sure of That 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