07/15/09 Waterford, Ireland Our faith is weakening. That is, our faith that the government will be able to cause inflation, sooner or later.
Let’s review our own narrative: deflation now, inflation later.
It’s very simple. Maybe too simple. After a half a century of credit expansion, we now have a credit contraction. In this sense, everything is happening as it should.
There was a crash and credit crunch at the end of last year. Then, the feds panicked. They fought back with monetary and fiscal stimulus. Rates were cut to nearly zero. The Fed flooded the system with cash and easy credit – buying up Wall Street’s bad investments…propping up bad banks…and guaranteeing trillions worth of bad debt. And the federal government passed a stimulus program that authorized more than $700 billion in spending.
Beginning on March 9th, we also got a big bounce in the world’s stock markets – just as we should. US stocks are up about 40% since then. Some foreign markets are up even more. Russian stocks, for example, have more than doubled. Chinese stocks are up more than 60%.
As the bounce continued, people began to get the wrong idea. They thought they saw ‘green shoots’ and the ‘light at the end of the tunnel.’ But if the economy is really improving, we haven’t seen much evidence of it here at The Daily Reckoning headquarters. As near as we can tell, housing prices are still going down and unemployment is still going up…and most important…people are still acting as though we were on the downward slope of the credit cycle. The latest numbers we’ve seen show that they saved more money in the first half of the year than the total in extra ‘stimulus’ that they received. Savings – last reported at 5% in this space – are now close to 7%. This is a just what you’d expect. But it is a huge turnaround, too.
As to housing prices, there are a million option ARMs still to be reset over the next four years. They won’t peak out until 2011…with average increases of about 80%. That will cause hundreds of thousands more houses to be dumped onto the market…and probably push the bottom of the housing decline to 2012.
As long as housing prices are falling, jobs are declining, and consumers are inclined to save rather than spend, there will be no real recovery.
In our book, recovery is impossible anyway. Because the pre-crisis economy had reached the terminal stages of the credit cycle. It was like someone in the terminal stages of a fatal illness. After they have died, you don’t wish that they could recover…and be just like they were before they died. They were sick and dying then! No, you sign the book of memories and condolences and turn the page. You let new life take the place of the dead. You move on.
But the feds have their ghoulish agenda. They have the poor thing on life-support. One tube feeds the oxygen of easy credit. Another drips in more ‘stimulus.’ The economy rattles every time it breathes. Dead companies, such as GM, say they are reborn. But take away the tubes…and they collapse. Dead-in-the-water households learn to live submerged in debt …with special tubes provided by the feds – such as the underwater mortgage refinancing offered by Fannie and Freddie, where homeowners can get up to 125% of the value of their houses. And the brain dead economists at the Fed and the Treasury department continue to offer their elixirs and panaceas – even though they have never worked.
Everything is happening as it should, in other words. But what happens next?
Ah…this is where it gets tough. Because we’re losing our faith. We figured the economy would continue to worsen (after all, you can’t correct a half-century credit expansion in a few months)…and that the feds would continue to fight it. As more and more people lose their jobs, the feds would become more and more desperate. Gradually, they’d come to see that they needed to use stronger, more experimental techniques. This would lead them to be a bit bolder with their ‘quantitative easing,’ otherwise known as “a little technology called the printing press,” to quote Ben Bernanke.
We figured that sooner or later, the feds would get the hang of causing inflation. So, we could just buy gold and wait.
But now we see; we are trapped…just like the feds themselves. Do we hedge against further economic deterioration…deflation…and falling asset prices? Or do we hedge against inflation…a falling dollar…and a collapsing bond market? What if we hold our big position in gold…and feds NEVER are able to cause inflation? What if the pain of the depression is never severe enough to make them go whole hog on quantitative easing? What if the Chinese put it to them straight: if M2 goes up more than 10% a year…we stop financing your deficits? Gold could sink…or go nowhere…for the next 10 years.
Are we prepared to sit it out…? It’s time to go back to the pub…
This morning our thoughts turn to Goldman.
The news yesterday told us that Goldman execs paid themselves $700 million in bonuses – while receiving bailout money. This morning, stocks in Asia are rising; they say it’s because Goldman had a good quarter – wiping out its loss from the last quarter of last year…
The news:
“Goldman Sachs reported second quarter earnings of $2.72 billion, up on last year’s $2.05 billion, and easily surpassing forecasts thanks to big gains in trading and underwriting.”
The New York Times offers more details:
“Analysts estimate that the bank will set aside enough money to pay a total of $18 billion in compensation and benefits this year to its 28,000 employees, or more than $600,000 an employee. Top producers stand to earn millions.
“Goldman Sachs is betting on the markets, but the markets are also betting on Goldman: Its share price has soared 68 percent this year, closing at $141.87 on Friday. The stock is still well off its record high of $250.70, reached in 2007.
“In essence, Goldman has managed to do again what it has always done so well: embrace risks that its rivals feared to take and, for the most part, manage those risks better than its rivals dreamed possible. “For all its success, Goldman is not impregnable. In addition to the federal money it took last fall, it benefited from the government’s bailout of the American International Group, being paid 100 cents on the dollar for its $13 billion counterparty exposure to the insurer, and it has $28 billion in outstanding debt issued cheaply with the backing of the Federal Deposit Insurance Corporation.”
Not everybody likes a winner. There are some who think there is something underhanded and un-American about how Goldman does business. Making billions trading bonds? It is almost as if they knew better than anyone else what the feds would do next. Maybe they do.
The DR Australia’s Dan Denning offers his two cents on the subject:
“We’d suggest that whatever Goldman did to goose earnings is probably not going to be possible for the rest of corporate America.” Furthermore, Denning points out, most other American financial institutions are continuing to play “hide the bad asset.”
“A New York Times story suggests that government capital injections and loan guarantees, along with new equity offerings, have allowed banks to evade the inevitable consequences of the popped credit bubble.
“‘The capital provided by the government through TARP, etc. has allowed the banks to continue holding deteriorated assets at values far in excess of their true market value,’ says Daniel Alpert of Westwood Capital in a note to clients, according to the Times. ‘It is unrealistic to believe that home or commercial real estate values are destined to recover any meaningful portion of bubble-era pricing.’
“This means all the new equity raised by banks after the stress-tests has merely papered over capital adequacy and solvency issues for now,” Denning continues. “The banks have simply refused to revalue loans on their books and continue to carry them at unrealistically high valuations. If they sold them, they’d get a lot less for them, forcing them to raise more capital (or wiping out their capital and revealing them to be insolvent)…
“The default and foreclosure data coming out of the US housing market suggest the banks are kidding themselves, or misleading shareholders, or both!” says Denning. “It’s the sort of calculated mistruth that can cause a short-term crisis to last years and years. The correction is postponed through phony accounting. It leads to an ‘Ushinawareta Junene,’ or ‘lost decade,’ as the Japanese say.”
Until tomorrow,
Bill Bonner
The Daily Reckoning
Sign Up for The Daily Reckoning e-letter and receive a copy of Bill Bonner's The Trade of The Decade report… at NO CHARGE.
We Value Your Privacy.
You give the best analysis of anyone as to what’s going on. So, be straight with us, Bonner, are we ditching the gold trade?
Thanks.
Yeah, Bon Bon, what’s the word? Yea or nay to el goldo? You’ve been el toro on el oro for so long… is this an about face? It’s OK, you’re allowed to change your mind – just own up to it fair and square!
I’ve been commenting here for a few days on why gold is a bad bet. The economy is getting stronger. Please, just look at the latest indicators, you really can’t argue that point. Also, we are seeing stronger earnings across the board now. INTC anyone?
If you had been buying AAPL as I have been suggesting for some time here, you’d be doing quite well. Read between the lines. Companies like Apple are doing brisk business in what is mostly a discretionary arena and they continue to grow.
The sky didn’t fall – and it isn’t going to. Don’t miss a big run up again in the markets by clinging to such a doomsday scenario.
The economy is getting stronger? Just like a dying cancer patient given some amphetamine. The bottom is in! Yipee! Beeeeeeeeeeeeeeeeeeeeeeeee….. FED CRASH CART, STAT!!
Never say die… Harry. For a lot of people the sky did fall and is still falling. Mr. Market goes up and goes down. The trend for the S@P for the last 10 years is down. We are and have been in a Bear market. We all want to see a recovery. But what country has ever borrowed their way to prosperity?
Gold needs to be set free to cover all of the excess in the system. Inflation doesn’t need to occur(which it will) for Gold to rise to astronomical levels. The system is broken and can only be made viable once Gold is able to rise to cover all bets.
It’s not an “if” it’s a “when” would you continue to give up real wealth and man hours for an eroding paper promise?
Bloomer you can borrow your way to prosperity. That works if you invest the money in projects that increase economic output down the road. Unfortunately, not a penny of the money today is being spent on investments – so it won’t have a payoff. It will just make the situation that much more dire down the road.
In Canada, housing took a fall of about 8-10% in 2008. When interest rates were brought down to 0% and variable rate mortgages went to 2%, home buyers flocked back to the markets. Up here we insure all mortgages nationally – works out to $42,000 per worker. So the banks are happy to lend. This spring we have entered into a new paradigm of home shopping. In the midst of a recession, home prices reached an all time high and sales/inventory ratio is the highest it has ever been since records have been kept.
It’s amazing how badly this will end. Canadian average home prices are $342,000 (currently about $300K US). Average household income is about $65,000 (currently about $60K US). A $120K household income will fetch first time buyers a $5-600K mortgage. All insured by my tax dollars.
Interesting eh. This downturn brought way too much stimulus to the Canadian banking. Any thoughts on how badly this will end?
http://www.americacanada.blogspot.com
Here’s what happened to Bill…
Coincidentally, I had come across old and more recent Hugh Hendry videos on YouTube. The guy is brilliant with a scintillating intelligence and a flair for the dramatic. He reminds me of Bill because of his breadth of knowledge and understanding of markets. He ties in history, philosophy and an encyclopedic knowledge of stats to buttress his case which is that that the environment is profoundly deflationary at this point. Why? Because the asset losses (home prices, 401K losses etc.) are far in excess of monetary expansion by the Fed. Dollars have simply ‘disappeared’ across the economy and there is in effect a “shortage” at current. He also feels that there are too many people buying into the inflation narrative and he likens it to people buying fire insurance when there is a flood. He has decided to underwrite the contrarian, deflationary narrative.
After three days of watching Hugh over and over again and pondering… I found myself swayed to his viewpoint and cancelled a series of trades I was about to make into commodities and foriegn currencies. Which were up today incidentally….
Hugh was so persuasive that I could not deny his reasoning. Then yesterday I pop in on the DR and find Bill in a financial existential crisis of the EXACT type I went through.
Hugh MADE 30% last year.
Go check out Hugh on YouTube and let’s hear your thoughts…
Maybe the feds don’t really know what they’re doing, we give them too much credit. They want to inflate but don’t want to crash the currency, and have to respond to threats from the ChiComs. For what it’s worth, I think they will try on and off little bouts of inflation, and each time back off when it heats up to the point where the public starts to whine and moan about shrinking food packaging and rising gas prices…
It reminds me of when I was a teenager learning to drive, accelerating and breaking, not sure yet how to make a smooth ride…
Personally, I don’t know for a fact whether there will be hyperinflation. However, I think gold continues to look good just by virtue of who’s in the white house and congress. At the very least, it can’t be taxed and you don’t have to worry about having to be made whole by the fdic.
I understand why Bill is concerned over whether Gold is still a viable investment. It’s because investing using careful analysis and research has been usurped by investing by careful analysis and research AND trying to figure out just how bad governments and policy makers can screw everything up. We should all be looking at gold as a possible waste of dollars and question every investment based on pre-depression concepts. Personally, I’m not sure what Obama, Bernanke, and Geithner are planning because I don’t think they know what to do either. The scope and breadth of this depression is unprecedented. You need look no further than the shadowed, off the balance sheet, not marked to market, $600 Trillion derivative market ($1.6 Quadrillion globally), to realize that Alice’s rabbit hole is infinite in depth. I own gold now and will increase my exposure if it falls a bit. Gold is a hedge for now that everyone must own. From my perspective, I just don’t see any way that we can pay for pensions, FDIC backing for about 3,000 bank failures, social security, Medicare, the new Healthcare plan, increasing defense expenditures, and a monstrous deficit, without inflation. We desperately need inflation, now. It’s much too late in the game for a plan or sound fiscal policy. Inflation is the only answer, and the gold is one way to play that future.
If you’ve played Gold & Silver over the past couple of years, you’ve done more than OK and have certainly pounded the performance of the market…
If not, it’ll will be a matter of the right timing…the deflationary story is indeed Real and inflation is made up of more than just increased paper notes, it’s about velocity and multiplier effect that make it happen…the Fed tried to prime the bank pump, but the banks haven’t turned it on – yet. The Fed’s charter is about low inflation and low unemployment. When will larger political forces break that public pledge.
It’s like we’re in Hooverville of the depression – deflationary. When will they come out of hiding and repudiate some of their public and personal debt? Who knows but we’ve always known this to be a matter of timing.
I’m currently hedged a little towards deflation but watchful, it’s sometimes darkest before the light.
If you have any debt, why would you buy gold? First get out of debt. American’s aren’t saving. They are simply borrowing less than they earn. How can you save anything if you have debt? The interest on the debt will eat the interest on the savings as well as the savings principal. That’s not saving, that’s dumb. Pay all of the debts, as it says in one’s will.
As long as you have debt and continue to borrow, you will eventually bankrupt. That isn’t the result of saving. Stop borrowing, repay the debt, then start saving. Then invest. Perhaps in gold!