How to Survive and Prosper in the Coming Global Depression
By Bill Bonner and James Dale Davidson
With special presentations by Rick Rule and Lord Rees-Mogg
Right Now You Stand at a Crossroads
Imagine it is one year into the future, November 4, 2009, to be exact. One year after the US presidential elections. President Obama and his new Treasury secretary, Tim Geithner, are struggling to cope with the greatest economic catastrophe the United States has ever seen.
The Dow is down at 5,231 points. Federal Reserve chairman Ben Bernanke is furiously printing dollar bills to pay for the bank, auto industry and homeowner bailouts. Investors who plunged back into the sucker’s rally following Obama’s swearing-in have been completely wiped out in the following stock-market plunge.
But not you, because you knew better. You saw the writing on the wall. You understood that government bailouts couldn’t save the economy…that they would only prolong the pain. Instead of jumping into one of the biggest bear-market rallies in history, you bided your time, because you understood the nature of this kind of crisis. And you knew that following the crowd would get you slaughtered in this crisis. And now as millions more Americans lose their jobs…and millions more baby boomers lose their nest eggs…and the purchasing power of the dollar hits new lows…you are calm.
Your own nest egg is safe. Because you understood that during a financial crisis of this magnitude, smart investors hope for the best…but they prepare for the worst.
Now, we know what you’re thinking…
Things can’t get that bad. We’re too smart these days to suffer a ‘real’ crash like in the 1930s.
The Fed is on the case. The government bailouts just need time to work.
Maybe you’re right…
But think about this. So far, the assurances of government and the mainstream financial press have proved to be dead wrong. Investors who put their faith in these assurances have been seriously burned. This crisis has erased trillions of dollars from retirement savings and trillions more from investors’ portfolios. Of course, you could have taken Federal Reserve chairman Ben Bernanke at his word when he said in May 2007 that the developing crisis in subprime mortgage defaults would be contained. Or Hank Paulson…In May 2008, he told Americans they were “closer to the end of the financial turmoil than the beginning.”
You could have tuned into CNBC’s stock guru Jim Cramer on March 11 and taken him at his word that Bear Stearns was “not in trouble.” Or…you can ignore the politicians and the Wall Street cheerleaders and read the writing on the wall.
You can trust your instincts. As they say in the Westerns, you can get the hell out of Dodge…
James Dale Davidson
Bill Bonner
A Financial Vesuvius Is Erupting
When Mount Vesuvius startled rumbling in AD 79, it was time to get out of town.
Sure, there were those who said it would all blow over. As it turned out, they were wrong. The volcano erupted and buried the whole city under lava and ash.
Now a financial Vesuvius is erupting.
We are in the middle of the worst financial crisis in living memory. And we face a global slump on the scale of the Great Depression. Never before has so much wealth disappeared in such a short time. The planet’s losses from the sell-off of equities have now reached more than $32 trillion.
Lord Rees-Mogg is the former editor-in-chief of The Times newspaper and a member of the British House of Lords. His book, The Reigning Error: The Crisis of World Inflation (1974) outlined the fallacy of relying on printing press money to achieve prosperity. He accurately forecast glasnost, the 1987 crash and the fall of the Berlin Wall. He is currently the editor of the Fleet Street Letter, the oldest newsletter in the English language.
That’s more than twice the GDP of the United States of America. Since the beginning of the year, the Dow is down 35 percent. The S&P 500 is down 40 percent. The meltdown has hurt even the world’s smartest investors. Take Warren Buffet’s mighty Berkshire Hathaway. It’s down 40 percent since January.
This is a crucial moment.
Because decisions we make now will affect the rest of our lives. The losses are staggering. But they are just the beginning. Most of the damage is still ahead. In just a moment, we´ll explain why…
The Government Can’t Fix This
Most people have no idea how financial crises work. They believe the calming words of Bernanke, Paulson and Bush. They think the whole thing will “just blow over.” They say to themselves, “The government will save us. Everything will be fine.” This crisis is moving fast.
Stay on top of events with critical updates. Learn how to live beyond yourself, not beyond your means.
But there is simply no evidence in the historical record that the financial authorities can stop a “great unwinding” like the one we are in the grip of right now. They can hold it off for a while. They can distort it. They can make it worse. But there is no evidence that they can make it better. Why?
Because losses are losses and mistakes are mistakes. They don’t go away when government throws money at them. As president of Euro Pacific Capital Peter Schiff puts it, “History clearly shows that borrowed or printed money only has the power to destroy.” Besides, we don’t recall Ben Bernanke warning that the world faced a meltdown when he took over at the Fed in February 2006. And wasn’t Barney Frank the chairman of the House Financial Services Committee when Wall Street was running amok and inflating the biggest asset bubble in history?
We don’t remember Congressman Frank holding hearings about the dangers it presented until after the thing blew up. And while all this was going on wasn’t Hank Paulson the head of Goldman Sachs, one of the biggest innovators of exactly the type of toxic mortgage-backed securities that are now bringing the stock market to its knees?
No, dear reader, Government didn’t have the answer to previous financial crises. And it doesn’t have the answers to this one either.
Audio Commentary from Resource Investor Rick Rule Key points summary:
* Cause of the difficulty is hubris and confidence
* In the excess of the 1920s, the consensus was that risk and pain should be socialized. People who make the mistakes should not be punished
* In 1910, the panic was extremely painful but very short because people were allowed to fail
* Misery is prolonged by government intervention
* Depression ended not by New Deal but by greatest public works project of all time… WWII.
Rick Rule is chairman of Global Resource Investments. He has dedicated his life to all aspects of the natural resource industry. His contacts and knowledge of this market are unmatched.
This is a painful truth. And it’s one that millions of Americans don’t want to face up to. But it is critical to surviving the years ahead.
Most Investors Will Be Stunned By Their Losses
The shocking reality is that Americans who have prepared for the future in traditional ways could soon be completely wiped out. In fact, we are convinced that most investors will be stunned by their losses before this financial storm passes. Others will be utterly destroyed.
But we are equally convinced that a small number of investors will not only survive but also prosper in this crisis.
The good news is you are well on your way to being one of the survivors. You are reading this report because you are perceptive enough to sense something is terribly wrong. You have a growing sense of unease about the future. The institutions you always trusted are now giving you a queasy feeling. You know all is not well. We congratulate you for your insight. We share your feelings. It’s now critical you act to protect your wealth. We hope this report will help you do just that. It has three objectives…
About James Dale Davidson
Davidson is a self-made multi-millionaire, venture capitalist and best-selling author. He has predicted and profited from dozens of earth-shattering political and financial events since the 1970s. He also wrote, along with Lord William Rees-Mogg, a number of best-selling books including Blood in the Streets, Financial Reckoning Day, and The Sovereign Individual. He is the founder and chairman emeritus of the National Tax Payers Union, the largest and oldest grassroots taxpayer organization in the nation. Along with his war against taxes and deficits, his forecasts have earned him frequent invitations on programs such as Good Morning America, The Tonight Show and MacNeil-Lehrer.
1. To understand how we got into this mess
2. To look at what will happen next
3. To detail ways you can protect your wealth and prosper in this period in our history.
Baby Boomers Will Suffer the Brunt of This Crash
Let us make one thing clear before we move on. This crisis will hit America’s 78 million baby boomers hardest. We are both boomers. Most of our friends are boomers. And what strikes us most about them right now is that they are afraid.
“I don’t know what boomers are going to do,” said a friend of ours recently.
“I know I’m in good shape. I’ve saved a lot of cash. I began reading The Daily Reckoning about two years ago…and actually started following Bill’s advice. I sold almost all my stocks. I’m in cash in and gold. I don’t even have a mortgage.
“So I don’t have too much to worry about. But I’m worried anyway. I don’t know…maybe it’s just catchy. I’m cutting back as much as I can.
“For example, I was going to buy a new car. I went in the showroom and picked one out and everything. But I think I’m going to cancel the order. Well, the salesman’s not going to get his commission. And I’m going to start doing my own yard work.
“It’s silly in a way because I don’t have to.
“But it makes me nervous to spend the money. Which means, there’s some minimum-wage guy who’s wages are about to become even more minimal.
“And I figure that if I’m thinking that way, there must be millions of other baby boomers in worse shape than I am, and they’re probably cutting back as fast as they can.
“Businesses have got to be cutting back too. And when employers look for fat to cut, they’re bound to find the baby boomers. And then what do these people do? They don’t have savings. And they’re not likely to get another job…not in a major downturn. It could be pretty grim all around.”
Has the future ever looked so grim for the boomer generation?
Dreams of a life of ease and luxury over a long retirement have been shattered for many of us. Congress’s top budget analyst estimates Americans have lost as much as $2 trillion from their retirement plans over the past 15 months. That’s about 20 percent of their value. Let’s not beat around the bush. Retirement security is one of the greatest casualties of this financial crisis. That’s why we urge you to read this report carefully. You can also forward this report to anybody you know whose savings are at risk. It is critical that more damage is not done because unlike Wall Street execs, boomers don’t have a golden parachute to fall back on.
“It’s a culture shock,” says KPMG demographer and author Bernard Salt. “Baby boomers could well morph into the disappointed generation.
“They’ve had, with a few exceptions, 30 years of prosperity, and maybe this is their time of adversity that arrives the moment they are ready to retire.
“Working hard, paying taxes, saving money for their retirement - they get to retirement and their nest egg is cut in half.”
In fact, the situation is so bad that many boomers are now being forced to put off their plans for retirement altogether. At least seven in ten Americans older than 45 already expect they will have to continue to work beyond 65.
“Baby boomers, particularly, are finding that they need to delay their retirement or come out of retirement to come back to work, in large part because of the decline in their assets,” says Tim Driver, director of RetirementJobs.com, which helps retirees find a job.
The Fed Actually Provoked This Crisis
One of the most important things to grasp right now is that this is no ordinary market correction.
The problem is much deeper and more complex than that…and probably not even one investor in one thousand truly understands it. You see, what’s actually happening is the bear market that began in January 2000 is finally getting down to work.
The most worrisome thing about the vulnerability of the US economy circa 2008 is the extent of official understatement and misstatement - the preference for minimizing how many problems there are and how interconnected we are.
- Kevin Phillips, author of Bad Money
Stocks have been going down. And they will probably keep going down until they finally hit rock bottom - probably at about 5,000 points on the Dow. Maybe we’ll even see a correction to the entire bull market run that began in 1982. If so, you can expect the Dow to sink down to about 3,000 (adjusting the 1982 level to inflation). Of course, we are likely in for a big “sucker’s rally” first - just like the one that lured in doomed investors back in 1929.
The Dow plunged 47 percent from its high of 381 in September 1929 through November 1929. It then started its famous sucker’s rally of the spring of 1930 before plunging to 41 in July 1932.
Japan also had plenty of sucker’s rallies during the country’s economic slump in the 1990s.
In fact, stocks there rallied at least 30 percent higher five times after 1992. They then found new lows again…and again…and again.
Why do we believe the Dow will drop to 5,000 points?
We don’t have any inside information, nor do we have a crystal ball. But if you study a long-term chart of the Dow, you will notice something very peculiar. It tends to go way down after it has been way up – in 15- to 20-year waves. The top of this wave washed over us in January 2000. Since then, the index has been higher…but not when you adjust it for inflation. It probably would have corrected to the 5,000-point range already. But the feds intervened.
This is critical to understanding the current crisis.
It’s not an insight you’re likely to pick up on CNN. Nor is it something Barack Obama or George Bush or Ben Bernanke wants to admit. But in trying to head off a bear market back in 2001, the Federal Reserve actually provoked a housing bubble, a financial bubble a commodities bubble and a worldwide credit bubble.
As Bill wrote in his 2006 best-seller, Empire of Debt: The Rise of an Epic Financial Crisis:
What the Greenspan Fed had accomplished was to put off a natural cyclical correction and transmogrify an entire economy into a monstrous economic bubble. A bubble in stock prices may do little real economic damage. Eventually, the bubble pops and the phony money people thought they had disappears like a puff of marijuana smoke. There are winners and losers. But in the end, the economy is about where it began - unharmed and unhelped. The households are still there and still spending money as they did before. Only those who leveraged themselves too highly in the bubble years are in any trouble.
But in Greenspan’s bubble economy, something awful happened. Householders were lured to take out the equity in their homes. They believed that the bubble in real estate prices created wealth that they could spend. Many did not hesitate. Mortgage debt ballooned in the early years of the twenty-first century - from about $6 trillion in 1999 to nearly $9 trillion at the end of 2004 - increasing the average household’s debt by $30,000.
The US economy faced a major recession in 2001 and had a minor one. The newborn slump was strangled in its crib by one of the most central planners who ever lived. Alan Greenspan cut lending rates. George W. Bush boosted spending. The resultant shock of the renewed, ersatz demand not only postponed the recession, it pushed consumers, investors and businesspeople to make even more egregious errors. Investors bought stocks with low earnings yields. Consumers went further into debt. On the other side of the globe, foreign businessman worked overtime to meet the phony demand.
Wealth Without Work
It´s no secret that the engine that drives the US economy is the American shopper. Consumer spending makes up about 70 percent of GDP.
It’s no secret, either, that spending is way down.
This year, third-quarter spending fell 3.1 percent. It’s the first drop in spending since 1991. It’s also the sharpest drop since second-quarter 1980.
The spending slump is hitting US retailers hard. In October, the sector posted its worst month of sales in eight years.
We don’t need to tell you that this spells big trouble for the economy. But what many don’t fully grasp is that consumer spending - the backbone of the boom years that lead to the recent collapse - is nothing more than an illusion. Because instead of being based on real wage increases, as you would expect, it is based on debt - a mountain of it.
Back in 2003, Bill dealt with this another national best-seller, Financial Day of Reckoning: Surviving the Soft Depression of the 21st Century. Throughout 2001, the Greenspan Fed did what it had to do, and the only thing it could have done: It cut rates. Month after month, sometimes 25 basis points were cut, sometimes 50 basis points …
Consumers took the bait offered to them by the Fed: lower interest rates … By mid-2001, private-sector debt equaled 280 percent of gross domestic product - the largest debt pile in economic history. Then, in the first quarter of 2002, consumers borrowed at an annual rate of $695 billion - breaking all previous records. Their incomes, on the other hand, rose at an annual rate of only $110 billion. And for the 12 months ending in April 2002, $5.9 of debt was added for every $1 of growth of GDP. By the end of 2002, private sector debt had hit 300 percent of GDP.
What was remarkable about the 2001 recession - triggered by the terrorist attacks of September 11 - was that consumers were spending with abandon.
In 2000 alone, they borrowed another $198 billion against their homes. Two years later, the total was $1.2 trillion.
In other words, the problem wasn’t that consumers lacked confidence, it was that they had too much of the stuff. They had taken the Fed’s little “coup de whiskey.” And it went to their heads.
This Is a ‘Credit Cycle’ Bust
One of the saddest lessons of history is this: If we’ve been bamboozled long enough, we tend to reject any evidence of the bamboozle. We’re no longer interested in finding out the truth. The bamboozle has captured us. It is simply too painful to acknowledge - even to ourselves - that we’ve been so credulous. We turn here to the words of American astronomer Carl Sagan because they so aptly describe our current economic predicament. Americans have come to believe the particular bamboozle that we can get rich by spending…that we can get something for nothing.
As Bill put it in Financial Day of Reckoning, “Americans can no more retreat from this dream than Napoleon could have brought his troops back from Germany, Italy and Spain and renounced his empire.”
And here’s where our story gets really interesting.
Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works.
John Stuart Mill
Because what becomes clear is that this is no ordinary downturn. You see, the markets are natural phenomena. There is a wonderful simplicity about them. Failure follows success. What goes up eventually comes down. Like a tree, they cannot continue to grow forever. We can easily illustrate this by describing the pattern of pig farmers.
When the price of pigs rises, pig farmers naturally raise new pigs to increase production. About 18 months later, these new creatures arrive on the market. This increase in supply causes prices to fall. Farmers decide to cut back, which caused prices to rise again.
This is nothing more than the cyclical boom-and-bust cycle that defined the US economy from the end of World War II to 2001.
Then something changed radically. The Fed, under eager-to-please chairman Alan Greenspan, decided it could avoid the bust part of the cycle altogether. The result is a different beast from your garden-variety downturn. You get a “credit cycle” bust instead.
This is exactly what we are experiencing now. And it’s more like the post-bubble depression of the 1930s than the downturn of 1973 to 1974 or 1981 to 1982…
‘Catastrophic Acceleration’ of Losses
Here’s the big worry.
The severity of this kind of bust depends on the magnitude of the bubble that preceded it. And the bubble that came before this bust was the biggest ever in history.
In fact, it wasn’t really a bubble at all. It was a “hyper-bubble.” Now this hyper-bubble has popped, and the losses are catastrophic.
Billionaire investor George Soros recently explained just how dangerous the unwinding of these kinds of bubbles can be.
The typical sequence of boom and bust has an asymmetric shape. The boom develops slowly and accelerates gradually. The bust, when it occurs, tends to be short and sharp.
The asymmetry is due to the role that credit plays. As prices rise, the same collateral can support a greater amount of credit. Rising prices also tend to generate optimism and encourage a greater use of leverage - borrowing for investment purposes.
At the peak of the boom both the value of the collateral and the degree of leverage reach a peak.
When the price trend is reversed, participants are vulnerable to margin calls and, as we’ve seen in 2008, the forced liquidation of collateral leads to a catastrophic acceleration on the downside.
Of course, all this was inevitable.
Bill repeatedly warned the more than half a million subscribers of his newsletter, The Daily Reckoning. No doubt, many got tired of hearing his warnings. But all he was doing was pointing out the obvious.
A Monster of Deleveraging
About Bill Bonner
Bill has written two New York Times best-selling books along with his colleague Addison Wiggin: Financial Reckoning Day and Empire of Debt. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance.
Since 1999, Bill has been the editor of The Daily Reckoning, a free daily e-letter that now has more than 500,000 subscribers. Instead of getting a typical bear market in 2001, we now face a monster of deleveraging as the biggest credit boom in history unwinds.
Deleveraging is simply the cutting back on the amount of money borrowed compared to equity.
In the case of this crisis, financial institutions sell off assets to recoup losses inflicted on their balance sheets by toxic mortgage-related securities.
These forced sales push down asset prices, hurting the balance sheets of other investors, forcing more asset sales and so on. Nothing can stop this process. It’s a necessary cure for the credit bubble that Greenspan puffed up.
The problem is it is devastating the wider economy.
As The Economist magazine puts it, “What hurts finance affects the rest of the economy in spades.” Because of leverage, a shortfall of bank capital of around $100 billion may reduce the potential supply of credit by $1 trillion.
This assumes banking system leveraging of around ten times…the geniuses running Lehman Brothers leveraged 25 times to equity.
But let’s assume that leverage of ten times to equity is about right.
So far, financial institutions have admitted to about $600 billion in credit-related losses and writedowns (net of re-capitalization via new equity issues).
This means cuts of $4 to $6 trillion to the potential supply of credit.
This, in turn, leads to higher cost and lower availability of credit to the real economy. And it forces consumers to reduce debt and consumption, most of which was based on borrowing in the first place.
This is bad enough. But it doesn’t end there…
So-called “negative feedback loops” mean the reductions in consumer spending and investment further hurt the economy. This puts further financial stress on corporations and individuals and triggers more debt defaults and more losses for the financial system. These then reduce lending capacity.
And so on…
Like a giant forest fire, the deleveraging process can’t be extinguished. And although the government believes it can put the fire out with bonehead bailouts, at the very best all it can do is create firebreaks that limit the damage until the fire burns itself out.
Right now, the bailouts are stopping companies such AIG and Citigroup from going under. But banks are still refusing to lend to each other despite all the money the government is giving them.
The bottom line?
Audio Commentary from Resource Investor Rick Rule Key points summary:
* The crisis is not limited to mortgages… Financial institutions are over leveraged
* There is a wipe out of shareholder equity in financial services
* Financial service companies don’t know what their derivatives are worth
* They are keeping liquidity for themselves because they don’t know value of derivatives of others banks
* The US is the leading edge of a worldwide trend of over-leveraged financial services
* An extreme example of over-leverage is Iceland
This massive unwinding is nowhere near finished.
Remember, Wall Street has only admitted to a small fraction of its mortgage-related losses and write-downs.
And the very, very bad news is total losses are estimated to clock in at $2.5 to $3 trillion…
Home Prices Have Further to Fall
This would be bad enough. But these losses will pile up even further as home prices plunge further. The problem, of course, is property is worth what people can pay for it. The average home has to be affordable for the average buyer. The idea that home prices could rise perpetually was pure bunkum.
For the 100 years from 1896 to 1996, home prices kept in line with GDP, inflation and income growth. It was only in the following ten years or so that they rose remarkably.
Then between 1996 to 2006, home prices rose sharply while real incomes remained stable.
It was obvious a correction was coming.
And when you saw how lenders were concocting mortgages and how people were buying much more property than they could afford, you knew that the correction would be a doozy.
How far will home prices fall?
Probably another 20 percent. Maybe another 25 percent.
About 20 percent would put them in the range of affordability. But prices tend to overshoot on the downside, just as they do on the upside. And if the housing sector continues on its downward spiral, it’s going to bring the value of your savings and investments down with it.
A Vicious Circle That Spells More Pain
Few people understand the US housing market better than billionaire real-estate investor Mortimer Zuckerman.
He is the co-founder of Boston Properties, the largest US office real-estate investment trust. He was also an associate professor at Harvard Business School for nine years.
Here’s what Zuckerman had to say about the US housing market back in March.
We are looking at the worst set of macroeconomic conditions since the Great Depression. I don’t know where the bottom is. The most dangerous part in my judgment is what is going on in the housing world, where we’re now running foreclosures at the rate of two million a year, where nine million homes, according to the government, have either no equity in them or negative equity. That will go up to 15 million if housing prices continue to go down this year as they’ve done last year.
Well, guess what… Prices have continued to decline. And the rate of decline is snowballing. In September, house prices tumbled by 17.6 percent on year-over-year basis, according to the Standard & Poor’s/Case-Shiller 20-city housing index. It was the largest drop since the index started measuring prices in 2000.
And there is little indication of a turnaround in sight.
In the third quarter alone, US foreclosure filings increased 71 percent, setting yet another grim record. That means banks sent 765,558 US homeowners a default notice, a warning of a pending auction or a foreclose notice between the beginning of July and the end of September.
Here are October’s worst performances as gathered by PropertyShark.com:
• Los Angeles: 2,389 foreclosures, up 11 percent from September
• Miami: 861, up 35 percent
• New York City: 336, up 50 percent (interestingly, almost entirely in Queens)
• Seattle: 150, up over 100 percent
Falling prices are not the only thing putting pressure on homeowners. Stricter mortgage standards now make it harder for homeowners to sell or refinance. Worse still, a tanking economy, massive job losses and record lows in consumer confidence are now feeding back into the housing market.
This, in turn, triggers further job losses.
Talk about a vicious circle.
Speaking to Bloomberg recently, Jay Brinkmann, the chief economist for the Mortgage Bankers Association, said, “The housing bust is the main reason more than 98,000 jobs in Florida and 77,700 in California were lost in the year through August.”
Our advice?
Hope for an additional drop of only 15 percent to 20 percent. Expect a drop of 30 percent.
All this is straightforward. But it gets more complicated…
We Face a Decade-Long ‘L-Shaped’ Slump
As we’ve said already, corrections are always proportional to the booms that go before them.
Or as Bill has warned in his The Daily Reckoning e-letter, “A correction is equal and opposite to the deception that preceded it.”
Austrian economist Gotfried Haberler put it best in his 1937 book Prosperity and Depression:
The length and severity of depressions depend partly on the magnitude of the ‘real’ maladjustments, which developed during the preceding boom and partly on the aggravating monetary and credit conditions.
This is just Newton’s Third Law applied to economics.
Actions produce appropriate reactions. A bubble pops and becomes an anti-bubble.
When wild spending and borrowing caused the bubble, the resulting anti-bubble will be marked by exaggerated thrift, debt cancellation and pessimism.
And herein lies the rub…
Given the crazy things leading up to the correction, you simply have to expect that this correction will be devastating. How will it play out over the coming years? What will it look like?
A V-shaped recession is short and shallow like in 1990 to 1991. These recessions lasted about eight months. A U-shaped recession is longer and possibly deeper. A W-shaped recession is a double dip such as the one that hit in 1980 and 1981/1982).
An L-shaped recession is like the experience in Japan in the 1990s.
Nouriel Roubini, one of the few economists that saw this crisis coming, says the current crisis could trigger a Japanese-style slump.
The crisis was caused by the largest leveraged asset bubble and credit bubble in the history of humanity – where excessive leveraging and bubbles were not limited to housing in the US but also to housing in many other countries and excessive borrowing by financial institutions and some segments of the corporate sector and of the public sector in many and different economies.
A housing bubble, a mortgage bubble, an equity bubble, a bond bubble, a credit bubble, a commodity bubble, a private equity bubble, a hedge funds bubble are all now bursting at once in the biggest real sector and financial sector deleveraging since the Great Depression.
At this point, the recession train has left the station; the financial and banking crisis train has left the station. The delusion that the U.S. and advanced economies contraction would be short and shallow – a V-shaped six month recession – has been replaced by the certainty that this will be a long and protracted U-shaped recession that may last at least two years in the US and close to two years in most of the rest of the world.
And given the rising risk of a global systemic financial meltdown, the probability that the outcome could become a decade long L-shaped recession – like the one experienced by Japan after the bursting of its real estate and equity bubble – cannot be ruled out.
And as contrarian investor and colleague Mish Shedlock argues, the US experience could be even worse than Japan’s “lost decade” for the following reasons.
• US consumers are in much worse debt shape than Japan.
• There is global wage arbitrage now that did not exist to a huge degree in the mid to late 1990s. Even white-collar jobs are increasingly at risk.
• The savings rate in the US is in far more need of repair than what Japan faced. This will be a huge drag on future spending and slow any recovery attempts.
• Japan faced a huge asset bubble (valuation) problem. The US faces both a valuation problem (what debt on the books is worth) and a rampant overcapacity issue as well.
• Japan had an internet boom to help smooth things out. There is no tech revolution on the horizon that will provide a huge source of jobs.
Booms Can’t Go On Forever
Like death, no one likes economic corrections. But like death, they clear away the old mistakes and the old wood. And in doing so are essential and helpful. We are well aware that this goes against the grain. But let’s face it. You can’t win ‘em all. Losses are inevitable.
“Loss is nothing else but change, and change is Nature’s delight,” as Roman emperor Marcus Aurelius once wrote.
Booms cannot go on forever…and nor should they.
When people borrow too much money, the day eventually comes when things change and they have to pay it back.
Audio Commentary from Resource Investor Rick Rule Key points summary:
* Global credit markets are broken
* A world existing on credit is going to have to adjust to living within its means
* The asset class everyone is concerned about is residential mortgages. They should be concerned about commercial mortgages
* Rent payments reflected economic good years… That won’t continue
* There will be defaults on commercial mortgages
* Same with consumer debt. As income is reduced, there will be defaults
* That consumer debt has been securitized and sold to pension funds and mutual funds. This will exacerbate the current situation.
* Leveraged buyout loans will suffer… Re-pricing by 10-15% wipes out equity.
Or to put it another way, when the party gets too wild for too long somebody inevitably ends up in rehab. In this period of rehab, corporations, investors and households pull themselves together. They need to get rid of houses, projects, businesses and speculations that they can’t afford. The credit-cycle bust then enters a “balance sheet recession,” as economist Richard Koo puts it, not a standard business cycle recession. It is a time when businesses, investors and householders realize that if they don’t cut back they could go broke. Balance sheets must be repaired. Debts must be paid off. And expenses, so that revenues can support them. And something needs to be left over to pay down debt and build up savings.
This is difficult, because revenues are falling too. And because one man’s expense is another man’s income.
The man who saves a dollar by not taking a cab denies a taxi driver a dollar of revenue…who then buys a dollar less of gas…or a dollar less of clothing…or a dollar less of beer. It’s what economists call the “fallacy of composition” - the mistaken idea that what is good for one person is necessarily good for the whole lot. Cutting back on spending is clearly good for the individual. But it does to an economy what a visit from a sniffling grandson does to a bedridden great-grandmother.
Soon, the old lady is dead.
Of course, the feds are fighting this every step of the way. Just as the Japanese did in the 1990s… We Are Now Japanese Too
If you think it’s bad being an American right now, spare a thought for the poor Japanese. The Japanese investor who bought stocks in 1982 when he was 35 years old is now 61…and his stocks are not worth a cent more!
And this week he got the news that the Japanese economy is once again in recession.
During its own post-real-estate-bubble slump, Japan ran deficits of six percent of GDP
Its central bank took interest rates down to near zero and left them there for years.
Sound familiar?
Still, Japanese investors are about $15 trillion poorer than they were 18 years ago.
President-elect Obama is about to follow the lead of Hata, Obuchi, Mori and Murayama. He is promising to throw good money after bad - taxpayers’ money, of course - to ‘fix’ the economy.
Ben Bernanke, too. He is slashing rates…just as the Bank of Japan did. He is also now adopting Japanese style “quantitative easing.”
This is central bank speak for flooding the system with excess liquidity. It’s little more than a last ditch effort to puff up credit used by central banks that have already dropped rates to near-zero levels and are running out of options for ‘stimulating’ the economy.
But there is a crucial difference between Japan and the US: Japan had a healthier economy with a positive trade balance and huge savings. The government could easily spend six percent of its GDP trying to replace private spending with government spending. The Japanese saved 19 percent of GDP. So, the government could simply borrow from its own people - as the US did to finance World War II.
But America can’t finance huge deficits internally.
It doesn’t have the money…
Its people don’t save…
Any money the government gets from Americans will have to come from current private spending or from other investments. Obviously, this is not going to do much good, since there is no net increase in spending or investing. Nor can the US government expect to bring in unlimited financing from foreign sources. Foreigners save. But they need their money to rescue their own economies. And not only did Japan have a cushion of cash to comfortably sit out the correction, it also had no reason to do otherwise. With money in the bank, total economic breakdown never really threatened the Japanese. What money they owed, they owed to themselves.
The United States does not have this comfort.
Post-1929 Rescue Didn’t Work Either
Uncle Sam didn’t do much better in ‘fixing’ the Great Depression.
Why?
It’s simple, really: Presidents Hoover and Roosevelt lacked faith in the marketplace.
In this respect, they were no different to President Bush or President-elect Barack Obama.
Just like their 21st century successors, Hoover and Roosevelt acted as though government management of the economy was the only solution the country’s economic problems.
But the real problem was, and still is, government intervention.
Hoover’s introduction of international trade tariffs under the Smoot-Hawley Tariff Act is an obvious example.
Rather than helping protect the wounded US economy, as Hoover had hoped, it cut American imports and exports in half and is widely recognized as a catalyst for the Great Depression.
Roosevelt’s government programs were also to blame for drawing out America’s economic woes.
That’s not to say all were a disaster. Some, like the establishing of the Securities Exchange Commission, had a stabilizing effect at the time. But as Bloomberg columnist Amity Shlaes points out in her history of the Great Depression, The Forgotten Man, “Other institutions, such as the National Recovery Administration, did damage.”
The NRA … sought to solve the monetary challenge through price setting. NRA rules were so stringent they perversely hurt businesses. They frightened away capital, and they discouraged employers from hiring workers. Another problem was that laws like that which created the NRA - and Roosevelt signed a number of them - were so broad that no one knew how they would be interpreted. The resulting hesitation in itself arrested growth.
Sprawling government programs designed to fix the economy. Laws “so broad that nobody knew how they would be interpreted.”
Ring a bell?
As Roosevelt put it in his second inaugural address, he “sought unimagined power” to turn the economy around. But Roosevelt wasn’t a patch on Henry “Hank” Paulson Jr…
On October 3, 2008, Public Law 110-343 bestowed upon Paulson perhaps the most incredible powers ever bestowed on one person over the economic and financial life of the nation.
The 451-page law created not only created the $700 billion Troubled Assets Relief Program, it also gave the US Treasury Secretary almost dictatorial powers.
Consider this passage from the first draft of the bill. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
Or these two humdingers…
The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this act without regard to any other provision of law regarding public contracts.
Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.
Roosevelt may have sought “unimagined power,” but he was never brave enough to try to sign such powers into law.
You see, Bush, Paulson, Bernanke and Obama really do believe the best path to calming the current crisis is to throw huge amounts of taxpayers’ money at banks, credit card companies, automakers and anyone else with a lobbyist with deep enough pockets to get his foot in the door of the Treasury Department.
But they’re all missing a fundamental point.
As Shales puts it:
The big question about the American depression is not whether Germany and Japan ended it. It is why the Depression lasted until the war. From 1929 to 1940, from Hoover to Roosevelt, government intervention helped to make the Depression Great.
Austrian School economist and father of modern Libertarianism Murray Rothbard reviewed the record of the post-1929 rescue team and came to the following conclusion.
The Hoover and Roosevelt administrations met the challenge of the Great Depression by acting quickly and decisively, indeed almost continuously … putting into effect the greatest program of offense and defense against depression ever attempted in America [using] every tool, every device of progressive and enlightened economics, every facet of government planning to combat the depression. Yet the depression didn’t go away. It intensified. Real wage increases and higher government spending smothered an expected recovery in 1931. The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy and placed where it properly belongs: at the doors of politicians, bureaucrats and the mass of ‘enlightened’ economists. And in any other depression, past of future, the story will be the same.
A Titanic Rescue
Yet on the announcement of the US government’s $700 billion bailout plan, stock markets all over the world breathed a sigh of relief…albeit brief.
This is not unusual.
As we’ve already pointed out, after the October crash in 1929, stocks rallied until April. Then they started to slide again and did not fully recover until the 1950s – more than 20 years later.
Investors can always find reasons for optimism…when they’re in the mood. After so many years of rising prices, the momentum of a bull market keeps them hoping. It was as though the passengers on the Titanic had seen in the distance what looked like a flotilla of rescue boats on the horizon. Hats were tossed in the air. Life preservers were cast off. Investors cried “Hosanna!” and shouted “Yippee!” The band broke off playing Nearer Thy God to Thee and picked up a soaked version of Laissez les Bon Temps Roulez! A couple of days later, the rescue boats drew closer…and passengers jaws dropped when they realized they were just more icebergs! Stocks sold off again.
Roughly $8 trillion, the credit crisis already clocks in as the most expensive endeavor in American history. It’s more than the country spent fighting Hitler and his allies in World War II.
And banks still aren’t lending!
Washington simply doesn’t get it.
As Rothbard puts it:
The depression is the ‘recovery’ process, and the end to the depression heralds the return to normal and to optimum efficiency. The depression, then, far from being and evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom, then, requires a ‘bust.’
But after sinking the Titanic of Wall Street and the dinghies of homeowners by giving away too much easy credit, our modern-day rescuers have come to the scene with life preservers of lead - more easy credit.
The Dollar Has Become a Faith-Based Currency
This time around, the markets are not just correcting speculative excess, as they did in the panic of 1907 or in the crash of 1987. Nor is this just a bear market like the one that followed the great bull-market peak of 1966. That would be bad enough. The 16-year post-1966 bear market took the Dow down to a level it hadn’t seen – in terms of price to earnings – since the 1930s. If that were to happen now, you could expect prices to fall for another eight years – or until 2016. You could also expect the Dow to drop to under 5,000 points.
No. It’s not just that you have to worry about.
There’s also that little event that happened in the middle of that bear market – on Sunday, August 15, 1971.
Do you remember? We do.
The Nixon administration had its back to the wall.
Inflation rates were growing as the government spent more and more. Soon, they were bumping over ten percent a year. At this rate, bonds – including US Treasury bonds – were getting wiped out. Treasuries carried a coupon of only five or six percent. At ten percent inflation, the owner was losing money. As a result, investors dumped bonds, which soon earned the moniker “certificates of guaranteed confiscation.” The lesson wasn’t lost on the foreigners. Every time an American bought something from overseas, dollars ended up in foreign hands.
Does that sound familiar?
It should. About $2 billion a day now leaves the US.
Of course, the amount was much lower back in then. But the principle was the same.
When French president Charles de Gaulle saw what was happening, he told his ministers to get right over the Washington and redeem their dollars into gold at the rate fixed by the US Treasury: $35 an ounce. The Nixon administration was aghast. The French were calling away US gold. And behind them was a whole line of foreigners. If this continued, Uncle Sam soon wouldn’t have any more gold.
Rather than do the honorable thing, Nixon reneged on the solemn promises of six generations. He refused to exchange gold for dollars at the promised rate. Since 1971, it has been impossible to exchange dollars for gold at a fixed rate. The dollar has become a “faith based” currency instead. It floats on sentiment, like everything else in the marketplace. It buys whatever people are willing to give you for it. Including gold.
We add an obvious footnote here. The difference between dollars and most other assets is that dollars are exceptionally cheap to produce. In fact, the profit margin on a $100 bill may be about the highest in the world.
As Ben Bernanke puts it, the government can produce dollars at “negligible expense.”
Therein, of course, is a great temptation. If you can produce cash at no cost, why not produce more?
And this is where our story takes another twist…
Because now, just as they had the idea that inflation would always be a problem in the 1970s, investors have come to believe it is always under control in the 2000s.
People fear dandruff now more than they fear inflation.
They could to be right. But not for long…A Mountain of Debt
There are 10^11 stars in the galaxy. That used to be a huge number. But it’s only a hundred billion. It’s less than the national deficit! We used to call them astronomical numbers. Now we should call them economical numbers.
- Richard Feynman
According to Bloomberg, the US government has already committed more than $7.7 trillion on behalf of American taxpayers to ‘fixing’ the economy - or half the value of everything produced in the nation last year. How much these rescues will ultimately cost is a mystery.
But Bloomberg has provided a useful breakdown of the bailout bonanza so far:
• $4.75 trillion by the Federal Reserve
• $1.55 trillion by the Federal Deposit Insurance Corp
• $947 billion by the Treasury Department
• $300 billion by the Federal Housing Administration
• As much as $200 billion to bolster Fannie Mae and Freddie Mac hasn’t been allocated to any agency
Where does this money come from?
Certainly not from savings as during Japan’s lost decade. The US now runs an overwhelming current account deficit of nearly $2 billion a day! And it just posted a new record budget deficit of $455 billion.
National debt just passed the $10 trillion level.
The numbers are so staggeringly high, the folks who own the national debt clock in New York had to add a digit!
US debt is now feeding on itself. It grows even when the feds keep spending flat. This happens because the interest is so great – about $1 billion every day – that the government now has to borrow to pay the interest.
Meanwhile, unofficial national debt – what’s known euphemistically as the “financing gap” – is over $50 trillion. And it’s rising very fast.
It gets worse.
Next year’s actual deficit will be closer to $2 trillion than $1 trillion.
This is the estimate put out by Morgan Stanley’s lead economist, who merely assumes that things don’t go exactly as planned.
A $2 trillion deficit equals 12 percent of GDP.
Where will the government get this money?
Not from its citizens - they’re flat broke. And not from Europe, either. Germany, Italy and France still have savings – about ten percent of GDP – but they need every penny to cover their own deficits.
Even the entire pile of Chinese-held dollars would finance only about half the US deficit.
What about energy exporters Russia, the Persian Gulf states and Venezuela? Forget it.
At the height of the oil bubble, net capital imports into their sovereign wealth funds were running at something like $2 billion a day. At that rate, an entire year’s worth wouldn’t cover the anticipated US deficit for four months. Even if it were possible to borrow the kind of money the US needs to service its debt, it would raise serious problems.
It’s the same problem faced – and ignored – by government in 1929 and 1990. In both cases government spending rose and private spending fell.
It makes sense. There are only so many resources in an economy. Either people use them for their own ends, or the government commandeers them. When government takes them, it is taking away from somewhere else. This happens through taxation or borrowing.
Everybody, sooner or later, sits down to a banquet of consequences.
- Robert Louis Stevenson
This will come as a shock to American and British readers who are accustomed to the “win-win” ethos of the Reagan/Thatcher years.
But the pie of savings has limits. Take a slice away and you’ve got less left. Take that slice and use it to fund more concrete, pay more educators or prop up more zombie banks, and you’ve got a “lose-lose” situation. The resources disappear, and you have nothing to show for it.
In short, people get poorer when the government tries to ‘rescue’ the economy with borrowed money.
Interest Rates Will Rise
There’s still one other problem.
Borrowing money on such a scale carries serious consequences for the debt markets. If lenders are still willing and able to lend, of which there is no guarantee, they will want higher rates of interest. Interest rates respond to the law of supply and demand just like everything else. Increase the demand for loans, and the price of them – interest rates – are bound to go up. But higher interest rates slow down the economy. This is just the thing the government is trying to avoid.
In this sense, borrowing is not inflationary at all. It’s deflationary. It doesn’t increase the supply of money, only its cost. But don’t worry dear reader. The United States of America is not really going to borrow trillions more dollars to stop the correction. It’s not going to because it doesn’t need to.
“We have a little technology called the printing press,” mused Ben Bernanke…
The Road to Disaster
Eventually, the unyielding logic of printing-press money is going to get the best of America’s financial leaders. Just as Roosevelt did back in the 1930s, they believe they have to spend trillions of dollars to ‘save’ the economy. But what the economy needs is new money that isn’t taken from somewhere else. It needs more spending power, not just spending power than has been shuffled around. No government has been able to resist the appeal of printing more money – not for more than a few decades. Thanks to Paul Volcker, the US has done exceptionally well. The government hasn’t backed the dollar with gold since 1971…and the fiat currency still isn’t worthless.
But as this global financial crisis deepens, the ability of foreign creditors to pay for America’s nationalizing programs will be greatly reduced.
At the beginning of November, China announced an economic stimulus package of its own. The communist dictatorship that runs the place wants to spend $586 billion on various Japanese-style public works projects.
China holds roughly $1 trillion in US securities. This includes $541 billion in US Treasuries and a further $200 billion in so-called “agency securities.” These are securities issued by American GSEs such as Fannie Mae, Freddie Mac or the Federal Home Loan Banks.
If China decides to sell these securities, at a time when the US government is already expected to issue large amounts of debt to finance its own economic stimulus measures, America is going to find itself in deep, deep trouble.
Why?
Because this would further raise borrowing costs, such as mortgage rates, which are benchmarked to bond yields.
The effect could be cataclysmic. A raising of rates would trigger more mortgage defaults, more bank writedowns, more stock plunges and more unemployment.
This nightmare scenario is keeping John Whitehead awake at night. Whitehead, now 86, is a former chairman of Goldman Sachs and deputy secretary of state under Ronald Reagan. Our government doesn’t have the spare cash to bailout a lemonade stand, let alone a bloated and failing financial industry that is losing tens of billions of dollars per month. Washington can only offer funds that it has borrowed from abroad or printed. Unfortunately, the nation is in the grips of a delusion that money derived from these sources has the power to heal. But history clearly shows that borrowed or printed money only has the power to destroy.
- Peter Schiff, president of Euro Pacific Capital
Like us, he believes the US economy faces a slump deeper than the Great Depression. He also believes that the growing deficit threatens the credit of the United States itself.
In a recent interview with Reuters, Whitehead said, “I see nothing but large increases in the deficit, all of which are serving to decrease the credit standing of America.
“Before I go to sleep at night, I wonder if tomorrow is the day Moody’s and S&P will announce a downgrade of US government bonds. Eventually US government bonds would no longer be the triple-A credit that they’ve always been.”
Make no mistake about it: The bankruptcy of the US government is well within the realm of possibility.
The US government is playing a game of Russian “debt roulette” that it can’t afford to lose.
There is already a funding crisis. And the country will have to sell a lot more bonds next year to finance the bailout packages that have already been signed off. But there’s one more strong argument that makes us believe that, sooner or later, the feds will turn to the printing presses rather than foreign borrowers to fund its spiraling bailout costs…
This Kind of Crisis Runs Downhill
In the beginning, the financial crisis mainly hurt investors and Wall Street institutions. But as it has spread, the meltdown in the financial sector has started to hammer the wider economy.
Now, businesses and consumers are cutting back – and cutting back hard. As our friend Doug Casey said recently, “This kind of crisis runs downhill. First, it was only the bankers who were panicking. Then, it was investors. Now, it’s businessmen. And soon, it will be consumers.” (Doug knows about financial crises. In 1979, he wrote a book about them called Crisis Investing. This became the largest selling financial book in history. It was number one on the New York Times Best Seller list for a total of 12 weeks.)
As unemployment rises, it will become harder and harder for the average person to pay his bills.
And, boy, is unemployment rising.
According to David Leonhardt in The New York Times, “the share of adult men with jobs - which has been gradually falling for much of the last few decades - is now at its lowest level since the Labor Department began keeping records in 1948.”
It’s not just blue-collar workers who are being axed either. Wall Street big spenders are also getting whacked in record numbers.
Big banks have already fired about 150,000 workers. And they are reportedly planning to lay off at least an additional 15 percent.
Goldman Sachs recently showed 3,200 suits the exits, about ten percent of its workforce.
Citigroup – the latest bank to go with its begging bowl to Capitol Hill - now says it will axe more than ten times that amount – 52,000 employees – by early 2009.
And just about every economist on the planet says the jobs situation is only going to get worse from here.
Leonhardt says this puts us on the path to the worst recession since the early 1980s.
But there’s a twist…there almost always is.
Former Oppenheimer analyst Henry Blodget says the recession in the early 1980s came after then Fed chairman Paul Volcker raised rates to nearly 20 percent. You can reasonably expect jobless numbers to rise under these circumstances. But the current tsunami of job losses is happening at a time when the Fed, joined by central banks around the world, is doing the exact opposite. The Fed is so desperate to reflate the economy; it is actually bringing interest rates down toward zero!
This makes the comparison with the 1980s ridiculously optimistic.
It brings us back to the vicious circle at the heart of this crisis…
By the end of the first quarter this year, nearly 2.5 percent of all US mortgages were in foreclosure. And the news keeps getting worse.
In the July to September quarter, 18 percent of all properties with a mortgage were “upside down.” They were worth less on the market than what the owner owed on the loan. That 18 percent represents more than 7.5 million homes. And another 2.1 million mortgages were within five percent of shifting upside down. All told, nearly one quarter (23 percent) of US mortgages were upside down or were in a near-negative-equity position.
Nevada (48 percent) and Michigan (39 percent) led the nation with the highest percentages of negative equity, followed by Florida (29 percent), Arizona (29 percent), California (27 percent), Georgia (23 percent) and Ohio (22 percent).
And house prices are still falling. If they go down another 20 percent, the number of “upside down” homeowners could go to one in three.
Now, imagine that the unemployment rate keeps climbing. And imagine those 30 million or so unemployed people – with their mortgages, their credit cards, their home equity lines, their student loans – and ask yourself, “Which way will they vote?”
Audio Commentary from Resource Investor Rick Rule Keypoints summary:
* The grandaddy of the problems in the US will be state and local bonds.
* Local governments enjoyed a bull market in property and retail taxes.
* Demand for services from governments goes up in recession.
* California needs $7 billion. Revenues are falling.
* We’ll see a wave of muni-bond defaults without equal since the depression.
* It’s a prefect storm, with income down and no ability to refinance.
* It’s setting up biggest bailout in history.
* But, who is going bailout the Fed?
For the man who offers to protect the dollar? Or for the man who offers ‘relief’?
How Democracy Works
George Bernard Shaw was right: “A government which robs Peter to pay Paul can always depend on the support of Paul.”
Gradually, people come to get more and more benefits. They ask for subsidies. They look for angles. They expect jobs. They want free health care and old age pensions. And gradually, the nature of democracy changes as more and more voters come to rely on the government.
In the 1980s, the Reagan administration found it could get support for tax cuts…but only by promising that it wouldn’t cut spending. In fact, the Reagan administration argued that tax cuts would produce more money to spend! Cut the rates, argued Reaganite economist Art Laffer, and the revenue will increase.
Now the process of democratic corruption has gone even further…
The government is giving out more food stamps than ever before. There are more people on Social Security than ever before – with a huge increase coming as the baby boomers retire. And more people than ever before now expect healthcare giveaways and free drugs from the government.
Finally, there are more people getting money from the federal government than there are taxpayers.
Well…you can see where this leads.
“Democracy is a system where two wolves and one sheep vote on what to have for dinner,” said one wag. He must have been thinking of modern US government. That’s why Republicans and Democrats in the recent election campaign both promised more spending. Deficits be damned!
Just as the logic of democracy leads inexorably towards more spending, the logic of democratic economics leads to inflation. You see, more voters will gain from inflation than who will lose from it. Inflation will relieve the debts of the multitude of debtors. But it will destroy the savings of the creditors, too.
There are fewer creditors than debtors…and many of the biggest creditors are foreign governments, who don’t vote in US elections.
This Is Not a Crisis…It’s a Collapse
One last thing…
Try now to imagine what America will look like in the coming bad years.
Imagine houses down another 20 percent. Imagine the Dow at half today’s level. Imagine over one in ten workers without a job.
Imagine another eight years of falling stock prices…and two or three more years of falling housing prices…and more and more government bailouts.
Imagine consumers going on a rampage of thrift…credit cards in the trash…the nation’s malls going silent…even more bankruptcies.
Now try to imagine Barack Obama…or the hacks in Congress…or the Bernanke Fed saying “No” to the demand for more money, “No” to more bailouts, “No” to more rebates and “No” to more spending.
Imagine a Paul Volcker striding into the Fed and saying, “No more credit! We’re going to protect the dollar and the financial integrity of the United States government.”
Can you imagine it? We can’t.
Start Getting Critical Updates to This Report Now
This crisis is moving fast.
Stay on top of events with critical updates from James Dales Davidson. These will be delivered via Abundance, a new email service that reveals how you can prevail in the coming bad years.
Learn how to live beyond yourself, not beyond your means. We believe Bernanke will be true to his word when he said he’d “drop money from helicopters” rather than see the US in a Japan-like slump.
In fact, although there have been no helicopter sightings in the sky above Wall Street, Bernanke’s adoption of Japanese-style “quantitative easing” amounts to the same thing – throwing unlimited amounts of money at the problem. This is when this correction shifts from correcting not only the biggest bubble in history but also the entire post-1971 money system.
Here is what Austrian School economist Ludwig von Mises had to say about the dire situation now facing the US economy. There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner, as a result of the voluntary abandonment of further credit expansion, or later, as a final and total catastrophe of the currency system involved.
This was not merely an academic observation. Mises had been a first-hand witness to the economic and social collapse of hyperinflation in Germany and central Europe in the years after World War I.
Now, similar conditions loom in the US.
The dollar is rallying now. But it’s a fake rally.
Speaking to the Financial Times recently, famed investor Jim Rogers said the dollar rally is due to massive short covering and an unprecedented flight to cash, not because of underlying strength.
President of Euro Pacific Capital Peter Schiff agrees. Schiff has been accurately predicting this crisis since mid-2006. And we think he is right about the dollar, too.
Speaking on CNBC recently, Schiff said, “The dollar is rallying for the same reason that real estate rallied or that dot coms rallied – it’s not because of the fundamentals.”
He also warned that the “total catastrophe” of the US currency system is fast approaching.
In fact, according to Schiff, the “credit crunch” is not the problem at all.
The problem is much, much bigger government under President Obama. It’s the trillions of dollars the US is borrowing that it can’t pay back. It’s the gaping hole in the government’s entitlement programs that will leave millions of baby boomers without a safety net. It’s that all the stimulus packages and all the bailout packages that have passed so far are making the underlying problem worse and setting us up for a much bigger disaster. It’s not that people will go to the bank and not be able to take out money. It’s that people going to the bank will be able to take out money, but they won’t be able to buy anything with the money they take out. You have been warned. Unlike the ill-fated residents of Pompeii, you need not wait until the eruptions overwhelm your world before you try to escape.
Now it’s the time to act.
The Known Unknowns
So far, we have attempted to address how we got into this mess and what will likely happen next as the global financial meltdown progresses. Here we take a shot at telling you how to avoid losing what money you have (how not be a turkey) and maybe how to even make some.
Of course, the scope of this report is limited. What we want to share with you here are some investing principles that will help you avoid being chomped by Wall Street as the global economic depression takes hold. It may come as a surprise, but experts say that 90 percent of traders eventually lose their money. It doesn’t surprise us much. We have been around the investment markets far too long. In fact, the number seems to us to be rather low.
Markets are unpredictable. They are infinitely complex and often chaotic systems. And that’s before you take into account the recent ballooning of complex financial instruments such as credit default swaps, collateralized debt obligations and other leveraged derivative contracts.
Unfortunately, most investors refuse to accept this. Don’t just take our word for it. According to one of the pioneers of financial derivatives Nassim Taleb, “Never before in the history of the world has there been so much complexity combined with so much incompetence and lack of understanding the problems this causes.”
We think this is probably a sound start.
The truth is we live in a world we don’t understand. But we refuse to behave accordingly. (Often there is the appearance of stability…but it should never be taken for the real thing.)
Making matters worse is that the financial world is now precariously interconnected.
Globalization means there is now the prospect of global financial collapse. Consolidation in the banking system means that all it takes is one big bank to fail for the entire banking system to be at risk. Heck, according to mathematicians, the behavior of economic phenomena is now more complicated than the behavior of liquids or gases!
Survival Is Key
There is one very important question you need to ask yourself before we move on…
What do you really want? You might say that you want to be rich. Who doesn’t? But we urge you first to think carefully about the best way of achieving this. If you had money in stocks, you most likely lost some of it in the great stock-market crash of 2008. Given that world stock values have dropped by about 40 percent, you may have even lost your shirt.
By now, you’ve probably realized stocks are no “sure thing.”
Another popular way you might have being going about getting rich was by going into debt.
Debt is king right now in America. The average Joe is saddled with tons of the stuff. A rate of debt to disposable income of about 140 percent is now the national average. This has risen from 70 percent in the early 1990s to 100 percent in 2000.
But as we’ve seen over recent months, this method has its drawbacks.
Instead, we suggest another route to wealth: spend less.
This is tried-and-tested method carries very little downside…other than being deeply unpopular in a world where spending is king. In fact, most Americans have come to believe that they need never save again.
And why wouldn’t they?
During the boom years, one of the easiest ways of feeling rich was to spend – whether it is with a credit card or a home equity loan. And spend we did…so much so that personal bankruptcies are now skyrocketing. It turns out plummeting home values, falling incomes and the near disappearance of credit is a potent mixture. So potent that the number of personal bankruptcy filings jumped nearly 34 percent in October from a year earlier. This works out as an average of 4,936 Americans a day who filed for bankruptcy in October.
Thrift may not have been very popular during the boom years when the Fed was splashing credit around like cheap bubbly at a party. But it is one of the best ways we know of avoiding the bankruptcy courts.
Survival is the key right now. Then, maybe, years from now, we can put our financial lives back together again…and get on with things.
Don’t Follow the Crowd
Follow the crowd and you’ll get slaughtered in this crisis.
If you do what everyone else does, you will get the same returns as everyone else. And giving the state of the markets, that means negative returns.
If you want to do better – that is keep your head above water and even make some gains – you’ll have to do something different.
As contrarian fund manager Rick Rule puts it, “You’re either a contrarian or a victim.”
So get some good advice. Find an independent investment guru with a good track record and stick with him.
As Bill wrote last year in Mobs, Messiahs and Markets:
What dooms the average investor is the same mushy quality that seems to be ruining the whole country. He will wait in line – without a word of protest – while the guards frisk Girl Scouts and old ladies for dangerous weapons. He cheers on the troops as though they were a football team. And he will believe any line of guff – no matter how fantastic - as long as everyone else falls for it. Dow at 36,000? House prices always up? Interest-only neg-am mortgage?
Investors who follow newsletter gurus have no guarantee of making money. But those who follow the crowd are practically guaranteed that they won’t!
If an investor merely recognizes the way mob sentiment works, he is way ahead of most punters.
Never Play on a Level Field
At the other extreme, investors who are unaware of the dangers of the crowd lose money because they become patsies in the public spectacle.
They read the newspapers. They watch the TV. They listen to the network pundits. As a result, they become the buyers to whom the elite sell. They become the sellers from whom the elite buy. They watch Jim Cramer and forget to smirk. They are nothing more than mass-market speculators. Keep these investors in your sights, the way a hunter targets a deer. You need to know what they are doing…and do the opposite. The real speculator therefore has an advantage. He knows his mass-market competition. And this tilts the playing field in his favor. He knows you don’t get rich by predicting the future. The mark of a real speculator is he looks for bets that are not fair.
Buy Cheap Hard Assets and Valuable Commodities
They say a low price is a sign of inner grace. And one sector that’s cheap right now is commodities. This is really nothing more than what Bill has been calling the Trade of the Decade: “Sell stocks. Buy gold.”
Bill has been advising readers of The Daily Reckoning to do just this for years. The decade has some months to run yet. But from where we stand now, it’s still looking like a pretty sensible call.
We see no reason to drop this advice. As DailyWealth editor Steve Sjuggerud put it, “Buy commodities now. Sell them in 2016.”
It’s a long-term play. But we think Steve is dead right.
Commodities prices are way down now. But this is a necessary correction to recent speculative excess. It’s not the end of the bull market that started about seven years ago.
Commodities have not reached their peaks yet…not by a long shot.
Audio Commentary from Resource Investor Rick Rule Key points summary:
* There are great opportunities in panic sold commodity equities
* We are in a secular bull in commodities
* The industry is living off of mines developed 30 years ago
* Credit crisis limits new supplies of base metals and energy
* Developing nations didn’t get entangled in financial crisis
* Poorer people spend money on things that have large inputs of natural resources
* Competition from developed nations will only increase
* Credit will be difficult to obtain for natural resource projects for the next 2 to 3 years
* Very bullish on gold in 3 to 5 years
Demand for food will keep increasing as the world population grows and urban sprawl eats up more and more farmland.
Take grains.
The average Chinese person consumes about 2,500 calories a day. Same as the Taiwanese. The difference is the average Taiwanese person eats about nine times more meat.
The Chinese, of course, are catching up. Meat consumption in China is rising at a rate of about 20 percent a year.
The outcome for grains is obvious. Demand is rising. (It takes nine units of grain to produce on unit of meat.)
Or take water.
We believe one of the most dynamic and profitable themes for the rest of this decade will be investing in water.
As commodities investor Chris Mayer puts it, “Clean drinking water is a far more precious commodity than oil.”
Although water makes up the majority of the Earth’s surface, less than three percent of it is drinkable. Pollution and disease has made much of that water undrinkable.
And unlike oil, recessions don’t make demand for drinkable water go away.
Same goes for food. Investing in a company that supplies grains to hungry people looks like a better bet to us than investing in one that sells mortgages to people who can’t afford them. The US economy has become far too dependent on the finance sector, on easy credit and on the real-estate market. Now the chickens are coming home to roost.
This phony formula worked for a while. But now America has caught one on the chin thanks to its over reliance on these sectors.
As a result, we believe the post-depression profits will be in exactly the opposite places – in hard assets, in food, in precocious resources. The focus will shift to things we need, rather than things we want.
Buy Gold
There has been a lot of hand wringing about gold recently. At about $820 an ounce at the time of writing, gold is a long ways off its March 2008 peak of $1,030.80.
But the bull market in gold – the long-term uptrend since 2001 - is intact. Gold would have to close below $650 to break it
Sure, gold and gold stocks have been hammered along with everything else in this crisis as investors and institutions seek cash. But as we have already covered, the Fed and the Treasury are flooding the system with money as they try to resuscitate the flat-lining credit markets.
And when we say flooding, we mean flooding.
As Jim Grant of Grant’s Interest Rate Observer recently observed, the Fed took 75 years – from 1914 to 1989 – to get its balance sheet up to $100 billion.
From there, Alan Greenspan took only another ten years to bring it to $500 billion.
Eight years or so later, the Fed’s balance sheet hit $1 trillion. And within the space of just three weeks in late 2008, Ben Bernanke doubled that from $1 trillion to $2 trillion.
“So a second order effect which might not be subtle,” Grant suggests, “might be inflation.”
As our colleague Martin Hutchinson - an investment banker with more than 25 years’ experience on Wall Street - puts it, “Gold is not a safe haven against recession. It’s a safe haven against inflation.”
Of course, deflation – not inflation – is the immediate threat. But there are no two ways about it. The Bush administration is spending like a drunken sailor right now as it tries to reflate the economy.
And Obama is going to spend even more. This is long-term bearish for the dollar and long-term bullish for gold.
The Coming Depression Forecast in a Nutshell
We’ve covered a lot of ground. So, let’s pause for a moment and catch our breath while reviewing the main points of this emergency report:
• The last seven years of ‘growth’ were actually a Fed-inspired hyper-bubble, not a legitimate boom. Investors’ losses have already been profound. But they will deepen.
• House prices have further to fall. This will cause more mortgage-related write-downs and losses and further tighten credit.
• We can expect the Dow to bottom somewhere around 5,000 points. This may not happen immediately. We may see a giant “sucker’s rally” first. This will be a good time to sell.
• Extreme volatility will most likely continue throughout 2009.
• If the feds manage to avoid a deflationary spiral by cranking up the printing press, inflation and a declining dollar are unavoidable.
Thank you for reading.
Good luck.
P.S. Remember, you can get critical updates to this report from James Dale Davidson by joining the Abundance email list.
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How to Survive and Prosper in the Coming Global Depression
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