All Fall Down

A cascading collapse of international finance is underway. While many fixers may jump heroically into the tumbling wreckage hoping to rescue this-and-that, James Kunstler believes that the outcome by Friday is liable to be an unrecognizable smoldering landscape of the G-7’s hopes and dreams.

God knows what manner of deals went down this past weekend in the Hamptons’ wine cellars and below-decks among the Chesapeake Bay sailboat fleet. All these hidey-holes must have been dank and fetid with the sweat of mortal fear. Will the U.S. government declare itself a subsidiary of General Electric? Will Vlad Putin be roped in to save Goldman Sachs? Meanwhile, the whole noisome rat maze of international counter-party deals was taking on sewer water and rodents of every nationality were seen leaping for daylight all over the fusty old motherlands of Europe. A cascading collapse of international finance is underway. While many fixers may jump heroically into the tumbling wreckage hoping to rescue this-and-that, the outcome by Friday is liable to be an unrecognizable smoldering landscape of the G-7’s hopes and dreams.

Some big questions for the week: will the Euro survive as a currency? Will the rush into the U.S. dollar continue even as the U.S. financial system dematerializes in a Fibonacci fever of accelerating de-leveraged infinitude? Will the remaining Big Boyz, Goldman Sachs and JP Morgan succumb to the counter-party hemorrhagic fever? Will great rows of lesser banking dominoes now start clacking onto their faces? Will all fifty states follow the leads of California and Massachusetts and line up at the U.S. Treasury’s hand-out window. Will the entity that calls itself the civilized world be left at week’s end with anything resembling money?

Your guess is as good as mine. We’ve entered the realm of phase change, where everything is slipping and nothing has settled. The final result, when the dust settles – and that may not be for weeks to come – will certainly be a poorer western world. Will it be so poor that it can no longer afford to import anything? Including oil from the land of the date palm? If so, we are really in for a rough ride, poised as we are at the edge of the heating season here in the temperate regions. Notice, by the way, that the $700 billion just approved by congress to bail out Wall Street is exactly the same sum of money that we send to the oil exporting nations this year.

Will millions stop receiving paychecks due to the turmoil in banking? It’s certainly possible, starting with the poor drones in Mr. Schwarzenegger’s motor vehicle bureau and eventually ranging to every payroll office in the land. Will Sarah Palin’s fellow Six-packers line up around the parking lagoons of the suburban banks trying desperately to withdraw the last seventy bucks in their checking accounts? (And will their thoughts in the event be: this economy is fundamentally sound….) Will the supermarket shelves of chipotle-flavored crunchy snacks and power drinks go empty as truckers refuse to deliver their loads without up-front payment? And how long does it take a hungry public to turn mean?

We could see a parallel problem in the motor fuel supply sector. So far, gasoline shortages have only appeared in parts of the Southeast USA, due to interruptions caused by two hurricanes. If the oil tankers quit offloading now for lack of credible payment, then the whole nation will get an interesting lesson in the shortcomings of the suburban development pattern.

The candidates’ debate Tuesday night should be interesting. I don’t expect too much give-and-take on the subject of East Ossetia this time around.

Even at this point, the current crack-up in world finance makes the 1929 crash and the events of the 1930s look in comparison like an orderly small town auction of somebody’s grandmother’s effects. Back in that sepia day, America had plenty of everything except ready cash. We had, especially, plenty of our own oil, and – you’re not going to believe this but it’s true – the stuff was selling for as little as ten cents a barrel, it was so abundant. And yet still, America in the 1930s plunged into a dark depression of inactivity, loss of confidence, and impoverishment.

This time around, things could get more disorderly. Personally, I think we may be beyond the reach even of fascist authoritarianism, because unlike the programmed industrial masses of the 1930s, we are unused to regimentation, to lining up at the factory gates and the movie theaters. Back then, society was so regimented that everybody wore uniforms in-and-out of the military. Look at movies from the 1930s. Every man-jack wore either a necktie and hat or overalls. The industrial masses behaved like termites. Once unemployment hit, they were waiting to be told what to do, to line up for something. It worked fabulously for Hitler, who took every advantage of this mentality. Luckily, the US went for Roosevelt (both FDR and Hitler entered office the same winter of 1933, by the way). FDR was more like everybody’s kindly Uncle Frank, and his reassuring persona enabled Americans to suck up their bad luck and altered circumstances. Many of them retreated to the family farm (which still existed then) and waited things out – and, anyway, the melodrama of the Great Depression soon resolved in the Second World War when Hitler’s love of regimentation led him into military misadventure. He shouldn’t have picked a fight with someone who had so much petroleum – end-of-story.

Okay, what happens here and now? To this point (9 AM Monday October 6, 2008) events have been proceeding under a veneer of still-just-barely-credible authority. We (as represented by Congress) have allowed Mr. Paulson to advance and activate his remedies. As things unspool further, he will be out of credibility, perhaps in a few days, and it’s unlikely that his successor will have any either. Mr. Bernanke has simply gone AWOL. Notice, he has vanished from the media landscape. We may soon be hearing the declaration of various "emergency" measures involving the allocation of food and the rationing of oil products. The Big Bailout of last week may be partially rescinded as it becomes obvious that it has had no effect – I believe about half the $700 billion has already been allocated, which is to say: lost.

I realize these things sound pretty extreme. But forces have been set in motion and momentum rules. One thing for sure: the American public is about to undergo a severe mood adjustment. There will be fewer American Idol fans and worshippers of Donald Trump by the close of business on Friday.


James Howard Kunstler
for The Daily Reckoning
October 07, 2008

James Kunstler has worked as a reporter and feature writer for a number of newspapers, and finally as a staff writer for Rolling Stone Magazine. In 1975, he dropped out to write books on a full-time basis.

His latest nonfiction book, The Long Emergency describes the changes that American society faces in the 21st century. Discerning an imminent future of protracted socioeconomic crisis, Kunstler foresees the progressive dilapidation of subdivisions and strip malls, the depopulation of the American Southwest, and, amid a world at war over oil, military invasions of the West Coast; when the convulsion subsides, Americans will live in smaller places and eat locally grown food.

"It’s pretty much all out war," said the chief financial economist at a large Japanese bank.

Yesterday, the battle was hot and heavy. By 8 PM last evening, the financial media was in a panic. An attack of stock market panics was rolling over the world. Japan was down 5%. India was down 4%. In Russia, they stopped trading twice. In Iceland, they stopped trading in financial shares all together.

By the time the battle reached Manhattan, the London press expected the whole island to be pulverized. And for a while, it did look as though U.S. stocks would be hammered to dust. The Dow fell 600 points at one point.

But by the end of the day, stocks were down…but not out. The Dow lost 363 points, to below 10,000. And this morning, there are signs of new life coming from Asia. One investor thought he saw a dove with a green twig in its beak.

What is going on?

The long-awaited sell-off seems to be here… Suppressed, denied, and delayed – Mr. Market is finally having his say. And he’s speaking so loudly, even the clowns are listening. This from Jim Cramer:

"Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.

"I don’t care where stocks have been, I care where they’re going, and I don’t want people to get hurt in the market… I’m worried about unemployment, I’m worried about purchases that you may need. I can’t have you at risk in the stock market."

"I think what you have to do, if you can withstand it, is just ride it out."

It could be a long ride. By our reckoning, the bear market began in January 2000. Then it was held off by a huge barrage of cash and credit – which sent property prices soaring…and caused stock prices to rally. The Dow surpassed its January 2000 high – but only in nominal terms. Adjusted for inflation, stocks were still going down.

You remember our Trade of the Decade? Sell stocks on rallies; buy gold on dips. The second half of that trade has done very well. Gold rose from under $300 to over $900. Yesterday, it went up $25 – to $858. But lucky for you, it’s still available at a penny per ounce.

But the first half of the trade has never looked very good. We kept our "Crash Alert" flag on the mast and wondered – when will stocks fall?

It looks like they are falling now. Half the stocks on the NYSE hit new lows yesterday. Worldwide, stocks lost $2.2 trillion in value. The Russian stock market lost 22% in the last five days. Here in London, yesterday brought the biggest drop in FTSE history. And if this is the continuation of the major bear market that began in January 2000, it still has a long way to go. Typically, bear markets run for many years. After stocks peaked out in ’66, for example, it wasn’t until ’82 – 16 years later – that they finally hit bottom.

They have a long way to go in terms of price too. At major bottoms, stocks sell for 5-10 times earnings. This implies a Dow of less than half today’s level. Dow 5,000 – remember, you heard it here first!

But the war goes on. The forces of inflation (led by field marshals Hank Paulson and Ben Bernanke) are clearly on the defensive – desperately pumping cash and credit into the market to offset Mr. Market’s campaign of value destruction. The Treasury is blasting Wall Street’s bad debts – at a cost of about $700 billion. And the Fed itself seems to be firing all its ammunition at once. Bernanke told Barney Frank a couple of weeks ago that he had $800 billion to fight the war. And yet, here’s today’s headline from Bloomberg:

"Fed boosts cash auctions to $900 billion."

The Financial Times adds that the Fed is planning, for the first time, to make unsecured loans. Bloomberg goes on to note that the Fed’s balance sheet swelled more in the last week than ever before – to a record $1.498 trillion of ‘assets.’ What are these ‘assets?’ They used to be U.S. Treasury bonds. But the Fed is selling that relatively good paper to buy up the kind of paper that caused Bear Stearns and Lehman Bros. to go broke. It is bad enough – from a banking point of view – to be selling Treasuries in order to buy trashy credits and make loans against them. But now the Fed is going even further, making loans with no collateral at all. If the Fed were a publicly traded bank, we would rate it a sell. It isn’t public. But its money is. Be wary of it.

*** "Shoppers cut spending," says the New York Times. Analysts think we will see the first quarterly drop in consumer spending in nearly 2 decades.

"Crisis hits home," adds the Boston Globe.

Elsewhere in the financial news is collaborating evidence.

"Big discounts fail to lure shoppers," reports the Wall Street Journal. Restaurants are empty. Shopping malls are not even attracting strollers and gawkers – let alone people with money to spend. Auto lots are so quiet the salesmen take turns pretending to be customers – just to keep their skills at-the-ready. Even the private jet business is in a tailspin.

But don’t worry, dear reader. It’s not the end of the world. That’s just the way the world works.

Economist Irving Fisher described the process in 1933. When people get too far in debt, there typically comes a moment of panic when they rush to sell assets in order to pay it down. They know debt is a killer – especially when there is a danger they may lose their source of revenue. Then, as more and more people – and here we may as well be talking about big financial institutions – dump assets, prices collapse. This causes even more dumping. There’s a "stampeded to liquidity," said Fisher, as people try to raise cash and get rid of dodgy ‘assets.’

In other words, what is happening is just what you’d expect to happen. After a bubble, comes the crash. After a credit expansion comes a credit contraction. After life comes death.

So relax. It’s all a part of the plan…a part of the way things are supposed to work.

And of course, the authorities are supposed to do foolish and counterproductive things too. Misters Smoot and Hawley are always on call – ready, willing, and eager to make a bigger mess. Mr. Hoover is always in office too…with Mr. Roosevelt right behind him. They’re all more than happy to let the ‘up’ phase of a free economy take place. Heck, they’ll even claim credit for it. But come the ‘down’ phase – and they swing into gear trying to prevent it from happening.

*** Hedge funds are back in the news. Years ago, we explained how they were a "heads I win; tails you lose" business. The managers take big bets, because they are rewarded with a large part of the gains – typically 20% – if they win the bets. And if they lose, it’s not their money!

Sooner or later, the fund is bound to take a loss…and the customer is bound to pay for it. Sooner or later seems to be here now. Tontine Partners have lost 66% of their money so far this year. Copper River is down 55%. Maverick Levered is 35% in the hole. Tremblant is off 28%.

Hedge fund investors are going to regret giving all that money to the managers; they’re going to need it.

Until tomorrow,

Bill Bonner
The Daily Reckoning