A Financial World Gone Mad

08/06/09 Ouzilly, France

The Dow slipped a bit yesterday – only 39 points. Everyone is watching. They want to see how far this rally carries on. Many think it is more than a bear market bounce; they think it is for real.

The prevailing opinion is that quick action by the feds avoided a more serious meltdown. Ben Bernanke says he was working to prevent a “second Great Depression.”

And now that the crisis is past, the economy is slowly climbing out of its hole. The second quarter showed GDP falling at 1% per year in the United States…rather than the 6.4% rate recorded earlier in the year. Housing sales have perked up. Oil is trading above $71 – a sign of renewed economic activity. And gold seems to be getting ready for another assault on the $1,000 mark – a sign of growing inflation pressures.

At least…that’s the way the world sees it.

Here at The Daily Reckoning, we look…we squint…we wipe the fog off our glasses and try to tear the scales off our eyes. What do we see? We see a financial world gone mad.

Or, perhaps we should say…a financial world that has still not recovered from the Bubble Madness of 2002-2007.

One bubble begat another. We have previously reported that the Bubble Era was over. Because the machinery that made it possible – the bubblelized financial industry – was broken. Well, we were only half right. The finance sector has exploded. Bear Stearns was sold for peanuts. Lehman Bros. went broke. Merrill was forced into a shotgun wedding with the Bank of America; with Hank Paulson holding the firearm. JPMorgan is still in business. So is Goldman. But now we know that even Goldman might have gone under if Paulson – ex-Goldman man – had not engineered a stealth bailout. He brought the feds in to save AIG, and in the process he saved his old alma mater too…AIG’s biggest trading partner, Goldman Sachs.

And now Goldman is in the news almost every day. It reported spectacular trading results for the quarter, lifting the entire world stock market. What’s good for Goldman must be good for the whole world economy, investors reasoned.

Then it was reported that Goldman made its money in a variety of ways – none of which had anything to do with providing genuine service to the economy. Goldman made a fortune on the feds’ own money raising, it came out. And then it came out …Goldman was making billions by trading at lightning speed – clipping investors for fractions of pennies each time a transaction passed through the markets.

Goldman… Goldman… Goldman… The Italians think Goldman runs their country. They’ve got the top three posts in Rome…Premier Romano Prodi is an ex-Goldman guy. So is the headman at the Treasury. And the chief of the central bank, too.

They think Goldman is like a cult…a semi-secret society of insiders with the power to rule the country – surreptitiously. Like the free masons…the Jesuits…or the Illuminati.

Goldman has its boys in important posts in the United States too – but not at the same level as in Italy. Tim Geithner is not a Goldman graduate. Neither is Ben Bernanke. But both have plenty of input from ex-Goldman associates, colleagues and handlers.

We confess an interest – we have relatives working at Goldman. But we doubt that Goldman rules the world. Just look what they said and did over the last couple of years; they had no more idea of what was going on than anyone else. No, they don’t rule the world…but they do manage to persuade it in their direction from time to time…

During the bubble years, they urged consumers, bankers, and investors to borrow…to speculate…and to ruin themselves. Naturally, Goldman made out like…well…like a bandit.

And now Goldman guys urge the government to ruin itself too. Yes, dear reader, the Bubble Era is not quite over. Now, there’s a bubble in government debt. Here as well, Goldman makes money…like a bandit. The more the feds borrow…the more debt there is to buy and sell. And the more the feds stimulate…the more acts of reckless speculation there are to finance.

And the more money Goldman makes…the more politicians the firm is able to buy. Of course, they welcome campaign contributions.

And of course, Wall Street is spending record amounts in lobbying. But the real appeal is the lure of being able to join Goldman itself…of being able to spend some time in Washington…pushing business Goldman’s way…and then cash in big by joining the firm and getting a piece of the action…

There are two big bubbles now. There is the familiar one in federal government debt. The other is the Peoples’ Republic of China.

Andy Xie says China is a ‘giant Ponzi scheme’ fed by new investors hoping to get rich. Of course, the China story is an attractive one. China’s growth rate is spectacular. Even in a worldwide financial meltdown…and the biggest depression since the ’30s…China is still growing at greater than 8% per year – or so the figures tell us. New cities are still being built…at a breathtaking pace. Stocks on the Shanghai exchange are up 80% so far this year. China has the biggest pile of cash on the planet – $2 trillion worth. And it has more bright, well-educated engineers, accountants and economists than anywhere else… In fact, it has so many economists trained at Western universities, it is almost sure to blow itself up…

Maybe this is the Chinese Century. Maybe it is not. Either way, it seems inevitable to us that the Chinese bubble economy is going to pop. Banks are lending three times as much as they lent last year. You can’t increase lending at that rate and still maintain credit quality – if there was any in the first place. A lot of buildings are going up that won’t find tenants. A lot of factories are expanding that won’t find customers. A lot of speculations are going on that investors will later regret. That’s just how a bubble works!

Mr. Xie says, for example, that the cost of property in China is about the same as in the United States. But wait, the average income in China is only 1/7th what it is in the USA. How can the Chinese afford American prices? Well, they can’t. They’re all betting on the ‘greater fool theory’ – that they can pay any price, because some greater fool will come along and pay more. Trouble with that is that the Greatest Fool of All finally shows up…and then the whole structure collapses.

Barron’s says that “The Greenback is Broken.” True, the dollar has been losing ground as the stock market gains it. Yesterday, it took $1.44 to buy a euro.

“I was amazed at how expensive everything is in Paris,” said son Will. “You go into a shop to buy a few groceries… You expect to pay about $12. Instead, the bill comes to $40. Or, you stop to have a cup of coffee and a croissant. It costs you $10. I don’t know how you can afford to live in Paris.”

Will lives in Buenos Aires…with frequent visits to in-laws in Florida…

“You know, it used to be so much cheaper to live in Buenos Aires than just about anywhere. But now, I think the prices are about the same as in Florida. Everything seems so cheap in Florida. And you can make some very good deals on property…

“Remember that house that I bought in 2006? You warned me not to do it. But right after I bought it people were coming to my door asking if they could buy it. One guy offered to write a check for $600,000. Then another guy offered $675,000. I began to think I really had something hot.

“Of course, then the market crashed. Now, I’m thinking of selling it for $300,000 – if I could find a buyer.

“But that’s in South Florida…only about an hour up the coast from Miami. There are places in the US where things are really, really cheap. In Iowa, maybe, or Arkansas…or Michigan. You can get a nice house for less than you’d pay for a garage in Paris. From that standpoint…the US seems like the place to be. You can live so cheaply. And fairly well, but quality of life is another thing…”

The dollar is low…America is cheap. Barron’s is probably wrong about the buck. It’s not broken – not yet. Our guess is that it will rise when stocks crash this fall.

We’ve thought a lot about quality of life. It is not a constant, fixed thing we conclude….

There are only three main decisions you make in life – what you do; who you do it with; and where you do it. Typically, these decisions are made without much real thinking – which is probably the best way. They are not things that lend themselves to thought…but to feeling. Pity the more man who marries a woman after a prolonged and logical thought process. The poor sap is doomed. His head may be in the game, but his heart will drop the ball. The next thing you know, he will be in divorce court or therapy. Likewise, the decision about where you live is not one that is readily subject to logical analysis. You like a place because you like it… And you may like it for a variety of reasons that defy analysis. There’s no accounting for taste, as they say.

Living in rural Iowa probably wouldn’t suit us. We don’t have the stomach for it. We couldn’t draw enough nourishment out of such lean meat. We need more stimulation.

We like Paris for the street scenes. Everywhere we look, we see something we like to look at – people, buildings, shop windows, streets, bridges, and river boats. Same thing out here at our summer place. We work in an octagonal office that sits in the park. No matter what window we look out of, we see something that pleases us. A stone barn with a red barrel tile roof. Those big limousine cattle grazing in the field. And there’s the house itself…a conglomeration of a fortified farm house from the middle ages with a Renaissance-style faux-chateau cobbled onto it in the 19th century. And there is our grandson…16 months old…playing in the gravel…

Wait – what’s he doing? Uh-oh…he’s eating the gravel.

Gotta run…

Until tomorrow,

Bill Bonner
The Daily Reckoning

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. 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 a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010. 

 

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