Are We Following in Japan's Footsteps?
London, England
Friday, February 29, 2008 --------------------- *** This is gonna get ugly…the United States is entering a recession - and is probably already in one now… *** Is the United States going the way of Japan?…does anyone really understand CDOs? *** Gold hits another record high…is it possible that Bernanke will wake up as Volcker?…and more questions, thoughts and insights to take you into the weekend! --- Special Offer --- Your Chance at a Ground-Floor Opportunity for Sky-High Profits India's economy is growing by leaps and bounds. Consider this: - By 2020, its economy will be larger than Great Britain's
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That's why the dollar is falling…about which, more in a minute. But in the battle between the feds and deflation…it appears that the feds are getting their derrieres kicked. And they're losing the non-battle against inflation too. The cannon to the left of us and the cannon to the right of us volley and thunder no matter what the Fed does. Yes, dear reader, as you sow…so shall ye reap. The feds sowed inflation - and now they've got a bumper yield of it. They planted a good crop of deflation too - by encouraging so many bubbles and so much debt. They're going to fill the silos with that too. And what can they do about it? "The Fed is not really in control of the situation," says Paul Volcker, former Fed chairman and the last man at America's central bank to protect the dollar. In trying to fight deflation rather than inflation, the Fed chose the wrong enemy, in our opinion. At least it could win the fight with inflation. Paul Volcker proved it was possible. The fight against deflation, on the other hand, is a losing proposition. When Mr. Market wants to deflate, there is not much a central bank to do to stop it; Paul Volcker's Japanese counterparts proved that. Has it come to that? Are we finally come to the grim harvest we predicted in this spot eight years ago? Are we now, at long last, faced with a long, slow slump a la Japan? The United States "risks a lost decade like Japan," says a headline in the London Telegraph. "Is America heading for a Japan-style crisis?" asks a headline in our own MoneyWeek magazine. The answer to this question is yes…and no. Yes, there are definitely parallels. Yes, the U.S. central bank is fighting the downturn just as Japan's authorities fought its slump. And yes, they will probably make the situation worse, just as Japan's policymakers did. We mentioned yesterday that Western kibitzers blamed Japan's authorities for not allowing the banks to fail. Japan's big bank had lent hundreds of billions to Japanese industry in the boom years. Then, when the boom was over, the loans went bad. But the banks were 'too big to fail,' so the bad debt couldn't be marked to market and the financial sector couldn't move on. In America, the big financial firms have plenty of debt too. Much of it is certainly bad. So far, many Wall Street lenders have fessed up to losses - totaling more than $100 billion. But there is much more…still waiting to be discovered. What's more, America's debt is not only broader and deeper than its Japanese equivalent…it is also more inscrutable. It's not only the big players who have a lot of debt in the United States, in other words; the little guy has his share. And right now, U.S. authorities are looking for ways to keep the little guy from getting what he deserves - and, incidentally, protect the big lenders from further losses at taxpayer expense. For example, there's a proposal - originating with Goldman Sachs (NYSE:GS)…and put on the Congressional agenda by Rep. Barney Frank - for the government to buy up mortgage contracts. This would permit homeowners to hold onto their digs - even though they can't really afford them. Nobody mentions it, but this proposal would also get Wall Street off the hook, putting the government in as a buyer of last resort, rather than allowing the mortgage contracts to be marked to market properly. Meanwhile, there are trillions of dollars worth of derivative contracts outstanding. Here, the problem is not so much that the banks are hiding their losses…but that they don't know what their losses are. Even Robert Rubin, formerly the head man at Goldman and the U.S. Treasury, says he didn't really know much about CDOs either, until they began to blow up last summer. And then, two weeks ago, the world's leading insurance company, with a trillion dollar balance sheet, and net income greater than the GDP of some sovereign nations, announced that it had made a mistake. It had "discovered a material weakness in its internal control over financial reporting and oversight relating to the fair value valuation of the super senior credit default swap portfolio." Anybody can make a mistake, of course. And whether AIG (NYSE:AIG) made a mistake when it first analyzed its swaps…or a mistake when it reconsidered its swaps…or will make another mistake when it rethinks them again…is anyone's guess. Our guess is that there are more "mistakes" to be uncovered…because, as we will explain in some future Daily Reckoning ramble, the whole proud tower of modern financial business is based on a compounded series of frauds, subterfuges and mistakes-waiting-to-be-discovered. In retrospect, the $15 billion investors wiped from AIG's market cap may turn out to be wishful thinking. The losses could go much, much higher…and take many years to be discovered. Nevertheless, there's a whole ocean of difference between an island nation with huge savings, a thrifty population and an enormously positive trade balance, and a stretched-out empire, possibly in decline, running record deficits in its external trade and internal government finances, with an aging, over-paid, over-indebted workforce. The former can tolerate deflation. The latter hasn't got the stomach for it. *** The big news yesterday came from the currency markets…and gold. "Ben talks, dollar falls," was the NY Post's take on it. "Another day, another crisis for the dollar," was how the Financial Times described it. The crisis in the dollar is simple enough. Ben Bernanke has made it plain that the Fed has its guns trained on deflation. While it fires away, it takes incoming from inflation behind it. The currency markets expect another rate cut in Washington…while in Brussels, the European Central Bank turns its hard face to inflation. What's a currency speculator to do? He trades his dollars for euros (EUR). Yesterday, the euro hit another record high against the dollar, at over $1.52 cents. But it's not just the euro that is rising. Our Latin American correspondent, Horacio Pozzo, says you only have to look at the dollar index to see that the buck is falling against ALL major currencies. Your poor editor is out of luck. Whether he spends his money in pounds or euros or pesos…he gets less for it practically every day. His lonely exile not only separates him from the land of his birth…but the purchasing power he once enjoyed. When he was born, the dollar was not only a respectable currency…it was a desirable one. By 1948, it was already down to about half what it was worth at the turn of the century. But the worst was still ahead. Since then, it's lost nearly another 90% of its value. Not only is the buck retreating against other currencies, take a look at the commodities market and you see it losing ground against practically everything else. The CRB index is up to 566 - a new record. And gold? What is happening with our old, yellow friend? How fare's thee? Not too badly, it turns out. Gold, too, is reacting…spectacularly. Yesterday, the price of an ounce of gold shot up more than $11…to bring the price to $973. Yes, you guessed it, a new record high. And this happened just days after an announcement that the IMF will sell some of its gold reserves in order to fund its operations. Soon, the price of gold will hit the $1,000 mark. Then, you will see something unusual…something exciting…something remarkable. You will see the bull market in gold enter a third stage. At first, only the goldbugs bought the stuff. At $300 an ounce…gold was a no-brainer. Then, a few savvy investors and sovereign governments began accumulating gold…gradually bidding it up. But now, as it heads over $1,000 - the bull market in gold is going public. It's going to make headlines. People will start talking about it. Soon, ordinary people are going to start buying gold…and then speculating on gold. Yes, dear reader…gold fever is about to hit…the third stage of a bull market. How high will this fever take the gold price? We don't know…$2,500 maybe. It could go into bubble territory too - perhaps up to $5,000. Anything could happen…and probably will. Make sure you're prepared… But as we said yesterday, there's only one thing that bothers us with this prediction - it's too obvious. What could go wrong? Could Ben Bernanke suddenly wake up as Paul Volcker? Or could deflation strike so hard it sucks inflation out of the system so fast the feds can't put it back? Could gold stagnate around $1,000…or lower…as the economy enters a deep, dark downturn…perhaps followed by a desperate push to get money into circulation, including dropping it from helicopters, as Bernanke once promised? Could the resulting hyperinflation render the dollar completely worthless? We're thinking…we're thinking… More below… --- Special Offer --- You Can Get Option Sized Gains… Without the Risk Get the hottest info on "orphan stocks" before the opening bell. Imagine getting 1,567%, 3,685%, 8,500% EVEN 31,875% in just a matter of hours. You could add up hundreds of times your normal investment. Don't delay; there are a limited number of seats available. Click here to read more. --------------------- The Daily Reckoning PRESENTS: With the steady decline of the financial industry, the public perception of those who deal with money is turning negative. The rich are under attack. But as Bill Bonner points out, maybe putting up with the rich is not such a bad idea. Read on… THE PIPS SQEAK BACK
by Bill Bonner Not since the fall of the dotcom impresarios has a group seen its stock marked down so fast. A few months ago, the masters of the universe were the masters of the universe. Here in England, the British thanked the financial industry for the island's remarkably puissant economy and inclined its neck towards the City (Britain's equivalent of Wall Street) as though to the passing of the True Cross. Never had so many owed so much to so few, as Churchill might have described it, followed by a malicious chuckle. Now, it seems the financial geniuses are blamed for everything…from the losses at AIG to the decline in housing prices to the lack of parking places. What has happened? It was the "biggest failure of ratings and risk management ever" said analysts at UBS. As the tide of cash and credit subsided, in Warren Buffett's beautiful metaphor, we got to see "who's been swimming naked." Not a pretty sight. Prevailing opinion is that the financial engineers made 'mistakes;' they forgot to put on their bathing suits. Now, everyone is pointing at them and laughing. As the price of subprime debt plummeted, so did the reputation of an entire profession. All of a sudden, everyone who touches money for a living is suspected of being a rascal. And every one who has a lot of it is thought to be a scoundrel. Week after week, the press targets another victim - bankers…mortgage lenders…German tax evaders…hedge fund managers; first one, then the other, they are singled out for abuse, ridicule and reprisal. The whole moneyed class has been downgraded from a triple A credit to junk debt - especially those rich, privileged few, the 'non-doms,'(people who live in Britain but are not British citizens) who don't have to pay rack rate U.K. taxes. Of course, even when they are making money, the scheming rich have few real friends. And when they lose money they are as unwelcome as smokers. Even the editor of our own MoneyWeek magazine, Merryn Somerset Webb, and one of our leading columnists, Simon Nixon, have argued in favor of squeezing their own London-based publisher…yours truly. "Why are people who have been based here for 20 years allowed to claim that the U.K. is not their domicile in the first place?" Merryn wants to know. "And having done so, why are they allowed to pay practically no tax and then pretend that this situation is good news for the rest of us?" There are matters of principle. And matters of practicality. Merryn is arguing the principle of the thing. "It's not fair," she might have said. Simon is concerned with the practical issues. If the non-doms leave, won't they pack up Britain's miracle money machine in their luggage and take it with them? Don't worry, says Simon, they're not going anywhere: "The only places in Europe where non-doms can expect better treatment are traditional tax havens, such as Monaco and the Channel Islands, or Ireland, which operates a similar non-dom regime to the United Kingdom. These aren't serious rivals to London." But here on this little page of The Daily Reckoning, at least, we always take the side of the underdog, even a mangy one. We rise to defend this whole class of econopaths and lucred loners - especially the non-doms - neither for reasons of fairness nor practicality, but for the simple reason that we are, statistically and legally, among them. No, it's not a matter of principle. It's the money. There is nothing new…and nothing local…about this phenomenon. Instead, it is cyclical. Labor minister Denis Healey got some mileage out of attacking the rich in the '60s. He promised to squeeze them "until the pips squeak." Britain sank into a dreadful slump largely as a result. And in the United States today, the desire to punish the rich is growing. "I'm not against the hedge fund manager," said Mike Huckabee; he might have added that some of his best friends were hedgies. "Unfettered capitalism is not something I support," added Republican contender John McCain. As for the democrats, they are ready to attack the rich, excluding campaign donors, of course, as soon as they see the whites of their eyes. All of which just goes to show that the whole boom was based on false pretenses from the get-go. In Britain, for example, we are faced with having to pay the British government an additional 30,000 pounds (we already pay tax in Britain on our U.K.-source revenue…and taxes elsewhere, wherever the money is generated). The extra charge might not cause us to leave the country. But we will be getting our bags together, just in case. Most likely London's major industry - finance - is in decline. And most likely, the departure of a few non-doms is not going to make much difference. But, at the margin, who knows? If the financial industry is in a slump and, on top of that, a substantial number of non-doms take their credit cards and leave, London could suffer. A logical analyst might conclude that the city has more to lose than to gain by taxing the non-doms now. But one of the foundation delusions of the whole Reagan/Thatcher boom era was that people always respond directly and logically to financial incentives. "Homo Economicus" was said to always make rational, wealth-maximizing decisions. In fact, he's an imposter. Real man is often more driven by envy than the desire for absolute wealth. And we can prove it. Behavioral economists conducted an experiment in which people were offered $100, on the condition that they share it with someone else. If they couldn't strike a deal as to how to divvy up the money, quickly, they got nothing. Logically, the second person should agree to anything, because it was free money. But researchers found that if they were offered anything less than 30%…they refused; it just wasn't considered fair. Likewise, Britain is probably better off offering shelter to the footloose exiles, no matter how little of their wealth they choose to share. But envy pushes the politicians and its citizens to insist on a fair deal. Americans, too, would be better off just putting up with the rich…no matter how loathsome they appear. Enjoy your weekend, Bill Bonner
The Daily Reckoning Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis. Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now by clicking here: Mobs, Messiahs and Markets Back to Top | 
