After all, the S&P finished up for a second straight week, higher by around 2.5% since Monday’s open. The markets are 60% above the 12-year low set back in March, and within a whisper of recouping half the losses since they fell from their 2007 records.

“What’s not to be confident about?” the Feds wonder – incredulous that foreclosed families are not whistling the same recovery tune. They point out that the banks are back to lavishing record-level bonuses on their top brass…trading desks are wheeling and dealing again…everything under the sun is worth more (in dollar terms) than it was a few months ago…AND, unemployment is still a few percent lower than Estonia’s record high…

And yet, despite all this “good” news, those consumers are trying to pay down their debt. Why, they’re just spoiling the party! We can almost hear those disgruntled DC goons now…

“Just because those ungrateful saps don’t have jobs, doesn’t mean they shouldn’t be pulling their weight to aid the recovery. Why aren’t they out there buying more stuff from the department stores? Don’t they know we’re broke? This is the time to spend, spend, spend! And don’t give me that ‘tapped out credit line’ hogwash either. Why, look at our national credit card. It’s in a despicable state…but has that stopped us from doing our bit to spend our way out of trouble? I should think not!”

If only our unemployed brothers and sisters read the paper they would know that true economic recovery – the sustainable, nation inspiring kind – only comes from plasma television lay-aways and gratuitous Visa purchases at the individual level. Well, at least that’s what their government expects of them.

But the individual is not like his government. He cannot, for example, amass exorbitant debts to his neighbor and then simply print off the money in his basement to repay them. If the Feds catch him in the act, he is charged with counterfeiting and sent to the slammer. The Feds don’t like competition, you see, and currency debasement is their racket. To them, the smell of freshly-inked bills is an anodyne for the inconvenient pains of real world economics.

But such naïve thinking is truly dangerous, and dangerously untrue. It leads arrogant politicians to think that “deficits don’t matter,” as one ineloquent politician infamously remarked.

Take, for example, just one of the mounting debt problems facing the United States: the trade deficit. According to figures released Friday by the Commerce Department, that deficit – which measures the difference between US imports and exports – jumped 18.2% in September, the largest margin in a decade, to $36.5 billion. The shortfall to China alone jumped 9.2% to $22.1 billion for the month, the highest imbalance in almost a year. No prizes for guessing which country owns the most US debt overall…

But that’s okay, the Feds say. We’ll just auction off more bills to finance it. This week alone, The US Treasury auctioned off $81 billion in new debt ($40 billion in three-year notes on Monday, $25 billion 10-year notes and $16 billion in 30-year bonds). By any measure you care to use, that is a large number.

Sure, its lunacy…but that usually only guarantees that it’s also policy. Dan Denning had a great piece during the week about US sovereign debt with a rather foreboding chart you might want to check out. Long story short: Debt eventually comes due. And, if you haven’t treated your creditors with respect, they might not be so willing to continuously finance your shopping sprees.

That the citizens of Bailout Nation express some trepidation about their financial future is no surprise. In fact, given the spendthrift nature of their government, any skepticism must be viewed in a complimentary light. Contrary to popular political opinion, Chinese people don’t make the world’s toys for free. One day, perhaps very soon, those workers are going to start demanding what they’re owed.

So yes…we’d be worried too.

Thrift Spoils Everything in a Consumer Economy originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

But by Friday, investors were scratching their heads with one hand…and hitting the “sell” button with the other. Apparently the “man on the street” is not doing so well…despite news that the economy around him is improving. Consumer spending was down 0.5% for the month of September, according to the Commerce Department, and the housing market is still floundering.

“[N]ew home construction is 74% below the peak it reached in January 2006,” reports Forbes. “The drop is far more dramatic than the 46% decline in 1981 and well ahead of the 60% fall between 1986 and 1991.”

There are now almost 20 million vacant homes in the United States. That’s a lot of inventory to move.

By close of trading Friday, investors had given back all of Thursday’s gains…and then some. How could this be?

“Don’t believe the GDP hype,” Dan Denning cautions from his post here in Melbourne. “The big problems in the economy – too much debt, too much leverage, too much government – are still there. They didn’t go anywhere overnight. We’d suggest that getting sucked back into stocks now because of the US GDP figure is a very bad idea.

“Of course, we could be wrong,” Dan continues. “Maybe stocks will go up another 20% from here. Or 30%. Or 50%. But it’s not likely. It’s more likely that the recession is over, but that the Depression has just begun.

“It’s begun because what the US GDP numbers actually show is a private sector in full retreat as its income shrinks, its assets fall in value and the cost of servicing debt rises. Into that terrible breach the public sector has stepped, armed with an arsenal of inefficient and stupid programs that give the illusion of economic activity, but actually prevent the economy from liquidating excess capacity and bad debt (the two conditions required for a real recovery).”

The Fiscal Plight of the “Man on the Street” originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

The short answer to these questions is that the GDP calculation is a fraud…or perhaps it’s a fraud wrapped in a deception.

To understand why the GDP numbers could be so good when the economy all around looks so bad, it is necessary to understand a few pertinent details of the GDP calculation. It is necessary to see just what meat and meat by-products go into this economic sausage. For one thing, GDP includes government spending…but does not SUBTRACT any of the borrowing the government does to fund its spending. And obviously, government spending is in no way a reflection of private sector economic activity.

Therefore, as Frank Shostak, an adjunct scholar of the Mises Institute, observes, “The GDP framework gives the impression that it is not the activities of individuals that produce goods and services, but something else outside these activities called the ‘economy.’ However, at no stage does the so-called ‘economy’ have a life of its own, independent of individuals. The so-called economy is a metaphor – it doesn’t exist.”

Convention tells us that the GDP framework is, more or less, a tool used to measure the size and health of this “metaphor”…ahem, the “economy.” Most often, we hear it expressed as a rate of growth – either positive or negative. And it is this widely followed number that determines when economic expansions end and recessions begin (two consecutive quarters of “negative growth.”). But GDP as a measurement is really just hogwash. It can no more calculate the health of an economy than it can tell you the time or give you a back massage.

Let us consider briefly the computation of the GDP measure. There are three main ways to calculate GDP:

1) The expenditure method
2) The income method and
3) The value-added method.

Theoretically, all three methods should produce the same result although, in practice, this almost never happens. For instance, when there is a large surge in public spending, as we have seen recently with the torrent of stimulus packages from governments around the world, the GDP “growth” registers most prominently in the expenditure method.

Roughly speaking, this method calculates the “size” of an economy by totaling its expenditures, minus imports. It is also the most common method employed to determine GDP. The equation looks like this:

GDP = private consumption + gross investment + government spending + (exports − imports).

To understand just how misleading the expenditure method can be, let us consider briefly the case of the Australian economy. It is widely accepted that the Aussies, under the deft stewardship of Prime Minister Kevin Rudd, had avoided entering a technical recession during the crisis from which we are now said to be “recovering.” It’s a nice story…except that it is a lie or, at best, a “one-third truth.”

Australia DID unquestionably fall into recession. It’s just a matter of definitions.

Like their American counterparts, Australian politicians pushed through a series of emergency stimulus packages, now credited with having helped the country avoid recession. Dr. Steven Kates, who lectures on economics at RMIT University in Melbourne, provided a rare dose of clarity in a recent article, published in The Australian. Dr. Kates concludes that by both the income and value-added measures, Australia comfortably satisfied the criteria for a technical recession.

“The income series… indicates a pretty minimal year all round,” Dr. Kates explains. “Both the September and December 2008 quarters showed an actual fall in the level of output, the very definition of a technical recession. Over the year, the level of GDP has fallen 0.4 per cent, by no means as bad as elsewhere, but more in keeping with the general experience across the economy.

“The third measure shows the changes in GDP according to the production-based data,” Kates continues. “Here, too, [in the value added, or, production series] we have the ingredients for a technical recession, with an actual reduction in the level of output in both December 2008 and March 2009. Across the year, GDP has fallen by 0.7 per cent.

“While the stimulus package appears to have been able to distort one of the three sets of national accounting measures we use,” Dr. Kates concluded, “beneath it all the Australian economy, in keeping with the rest of the developed world, has gone through a recessionary phase from which it is only now beginning to emerge.”

Therefore, the only way the Australian government could claim that it had “avoided” a recession was by utilizing the expenditure method, or by averaging all three measures of GDP together. Here we see that unprecedented government stimulus spending propped up the expenditure metric, much like a steroid injection might help prop up a cheating athlete. Not only is stimulus spending an unsustainable and deceptive scam, measuring it as a “+” under the expenditure GDP calculation separates further the reality individuals experience from the fantasy their governments serve up to them.

As the Australian example shows, this methodology simply ignores the fact that government spending is not true production at all because it is debt financed. Government spending, therefore, should really only be government spending, LESS government borrowing.

You see how misleading this measurement can be, especially when huge sums of debt-financed stimulus must be taken into account. Sound familiar?

Murray Rothbard, the legendary Austrian economist, elaborated further when he proposed his alternative measures: Gross Private Product (GPP) and Private Product Remaining (PPR).

Rothbard defines the former as “gross national product less income originating in government and government enterprises.” PPR is GPP less the higher of government expenditures and tax revenues plus interest received. Rothbard argues that because government output is “financed coercively” (i.e., by taxation), it is unclear what – if any – market value may be ascribed to the end product. Simply put, both measures place government “production” where it belongs: in the “opportunity cost” pile.

If free market participants did not deem it worth their while to buy something in the first place, why should it be considered a net positive when the government uses their money (or China’s) to buy it on their behalf? This case may be brought against the “cash for clunkers” program, the $8,000 credit for homebuyers and impending “cash for anything” programs currently finding their way through the special-interest-greased halls of Congress as we write. Indeed, the entire bailout and stimulus programs fall squarely into the opportunity cost pile. But that’s not how those trillions are calculated using conventional GDP metrics.

Measure it how you will, dear reader; true economic progress is forged not in the crucibles of debt or coercion, but from the honest toil of individuals seeking to better their own lot, unhindered from the government’s long, strangulating reach. No nation can spend its way out of recession…no matter what the official GDP numbers may imply.

Regards,

Joel Bowman,
for The Daily Reckoning

The “GDP Fraud” originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Almost everything is some shade of a rusted auburn…from the corrugated iron roofs of the old Queenslander homes to the railroad spikes to the doors on the old Holden automobiles and, of course, the shoulders of the outdoor, sports-loving people. The “Sunburned Country,” they call it.

Your editor arrived on Friday, a day after the Aussie stock market shed $30 billion dollars, or about 2.7%. It was the forth consecutive day the index ended in the red. The Aussie dollar, after having outpaced gold’s meteoric rise over the past few months, also fell against the greenback. We hadn’t seen Friday’s numbers when we jotted these few notes on the train but, all in all, it wasn’t a great week for the Aussie markets.

Nevertheless, most businesses here are of the mind that the worst of the economic crisis is long gone. Eighty-five percent of businesses said as much, according to the Veda Advantage Business Sentiment survey, released to The Australian this week. Moreover, over half of respondents said Prime Minister Kevin Rudd’s record-breaking $42 billion stimulus did not improve business prospects in any meaningful way. We’ll see how they do when the taps run dry, as they soon will.

Appetite for risk, you see, is eroding. Investors around the globe are beginning to ask themselves exactly what this “recovery” is founded on and whether it can last. The IMF warns that growth in the Asian region is set to fall again. They caution that poor economic data from the US will continue to dampen export-reliant Asian economies…especially once government gifts and stopgaps expire.

We’ll “see how she goes,” as they say, during the week and, between barbeques and beers with friends, we’ll bring you a few notes from our temporary post.

A Bad Week for the Australian Economy originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

In part due to this shift, these economies – China, India, Brazil, etc. – command an increasingly important role in the geopolitical arena. In addition, these New Economies on the Block are forging important trade ties with each other and inking deals to secure their mutually beneficial future, ex-US.

The United States, meanwhile, is up to its ears in ever-mounting debt…both to its creditor nations in the Middle and Far East and, to an even larger extent, to its own citizens.

And so we ask ourselves, will the young Johnnie and Jenny Smiths of the West be able to bluff their way through the next round of negotiations with a pair of twos? Or will the Changs, Patels and Ahmeds of the world call their bluff and take them to the cleaners?

Unfortunately, the trouble started for Generation iPod before they even had a chance to cause it for themselves. “Like America itself,” observes Bill Bonner, “[Young Americans] are in danger of finding themselves slipping downhill. Instead of expecting things to get better, they may find it hard even to hold onto what they’ve got. Instead of the ‘Morning in America’ that Ronald Reagan promised, they may find that it seems more like evening, both in their personal as well as their national lives.”

Much of America’s international influence was acquired during a time when the dollar roamed free and easy as the world’s reserve currency. French President Charles De Gaulle called it an “extraordinary privilege.”

At its height, the greenback commanded a magisterial awe and its position was largely considered unchallengeable. But no challenge is too great for the mighty US government…especially the challenge to debase its own currency.

It is true that extraordinary privileges carry extraordinary responsibilities. Within a single generation, the irresponsible goons in charge of preserving the dollar’s integrity had destroyed almost all of its purchasing power. Measured against gold, it has slumped some 97% since Nixon closed the gold window in ’71. And now, when the Treasury Secretary of the United States of America tells a classroom of Chinese university students that his nation’s currency is trustworthy and reliable, they laugh in his face.

Then, on top of an increasingly worthless currency, Generation iPod also inherits about a quarter of a million dollars each in unfunded Social Security and healthcare obligations, the overdue infrastructure bills of a crumbling nation, a couple of distant wars to fight and die in and a world full of disgruntled foreign creditors.

Is there any hope?

Opined John Mauldin on the subject in Tuesday’s issue: “It is not the times which dictate the man (or daughter!), but the response of the man which dictates his own time. Today has a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it…”

Echoes Bill, “The real advantage in life is having the gumption to get on with it; no one knows where that comes from.”

Indeed, history provides us with countless examples of individuals triumphing over adversity. A hard working American student has every chance to succeed in life, as does a hard working Asian student. It’s just that, on the whole, graduating classes of Asian engineers and computer programmers are far more diligent than graduating classes of Western feminist film studies students.

Taiwanese university graduates, for example, would happily take on the workload of most western jobs as a vacation, never mind as a vocation. The forty-hour workweek (35 for our French readers) is something students here manage between classes…and cram sessions…and helping run the family business…and music lessons…and English school in the afternoons and evenings. Not only have the Asian countries already outworked the west over the past generation – by a measure significant enough to now own virtually all of the western countries’ debts – but they continue to up the ante even now. They have raised the bar, in other words, and they are raising it still.

A generation ago, Mao Tse-Tung did his people a huge favor and finally died. His successor, Deng Xiaoping then told the Chinese masses not to fear wealth and that, in fact, to get rich was “glorious.” It was a stark contrast to the self-immolating edicts spewed forth from Mao. The people rejoiced…and got to work. Last year, China created millionaires at the second fastest rate of any nation on the planet. Only India outpaced her. Meanwhile, America “demoted” millionaires quicker than any other country could manage. England was next on that dubious accolade.

US Financial Future Rests on a Bluff originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

One day does not a trend make, dear reader, but it does us give pause for thought. What if we dollar bears are wrong about the greenback’s fate? What if all these column inches spent bashing the buck – and the frauds at the Fed in charge of protecting it – all come to naught?

“Nonsense!” we say.

Mankind will eventually bury the greenback in the cold, hard ground, alongside every fiat currency that ever went before it. The only question, it seems to us, is when the first shovel of dirt will be thrown. Traders from New York to New Delhi are gathered around the open pit, but they may have to wait, at least for a while. Just to be on the safe side, we’ve bought (and urged readers to buy) a golden shovel, but for now we’re content just leaning on it.

Here in the Far East, the dollar is a particularly curious entity. Once upon a time, the mighty greenback was the best show in town, the “must have” ticket for the rocking Asian economies. China, Korea and Japan all amassed gargantuan stockpiles. The three hold about US$4 trillion (with a “T”) in foreign reserves, much of it in US Treasuries. Even Taiwan – an island one-third this size of Tasmania but with a population equal to Australia – has stashed away the equivalent of US$332 billion in foreign reserves.

But that was then. This is now. And now everyone knows what all those dollars – and the men who stand behind them – are really made of…paper and promises, promises and paper. And now that the game is up, everyone is betting on a dollar collapse. But that presents a problem, and an opportunity, in itself…

“Whenever you find yourself on the side of the majority,” Mark Twain once observed, “it is time to pause and reflect.”

Right now, every necktie on television is betting against the dollar. The Powershares DB US Dollar Index Bullish and Bearish Funds – which measure the sentiment for and against the greenback versus a basket of six major currencies – are showing dollar bearishness in the extreme. But what if this “recovery” is not all it’s cracked up to be? What if equity markets suddenly start resembling reality – even for a short while? If risk appetite contracts, even marginally, might we see a rally in short term Treasuries…just like we did last time? And just how quickly will currency traders be able to cover their short dollar positions if such a scenario unfolds?

We don’t know the answers, dear reader. We only observe that the larger the mob, the more likely it is to be galloping in the wrong direction.

So are we dollar bears, or bulls? The answer, dear reader, is both – the former over the long haul…but the latter before then.

Dan Denning, our friend and colleague on our Australian DR desk, puts it thus: “Though we are confirmed US dollar bears, the dollar is looking oversold. Stocks are looking overbought. And frankly the reflation of all asset markets (bonds, stocks, commodities, and real estate) is looking over cooked… Watch out!”

Asian and European markets largely floundered overnight after Wall Street’s lackluster session yesterday.

Here in the Far East, Japan’s Nikkei 225 dipped 1.35% by the close while Hong Kong’s Hang Seng and the Aussie All Ords ended down by 1.85 and 1.45% respectively. China’s CSI index was the only major measure to buck the trend. It finished higher by 0.45%.

Back to the European measures and London’s FTSE, Germany’s DAX and France’s CAC 40 all finished lower by around 1.3% for the day.

In the commodity pits, crude had slipped back a bit last we checked. A barrel of the world’s goo was down about 60 cents to just shy of $79. Gold was hanging on around $1,036 per ounce…but looking a little punch drunk.

Until next time…

Cheers,

Joel Bowman
for The Daily Reckoning

The US Dollar – Then and Now originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Even the intra-day activity was difficult to pin down. After a huge spike following their earnings announcement on Wednesday morning, Wells Fargo slipped 7% for the day, “a classic ‘outside day’ reversal,” as Eric Fry pointed out in Thursday’s issue. Indeed, the Dow Jones Industrial Average itself collapsed 165 points, top to bottom, on Wednesday, with a triple digit haircut in the last couple of hours alone.

http://dailyreckoning.com/falling-down-the-wells/

That’s not the kind of “confidence” you want to see confirming a “recovery.”

But markets don’t move in straight lines, dear reader…neither up nor down. After all, a sucker’s rally is nothing without the suckers. Ergo, Mr. Market must lure in as many victims as he can with promises of better sunsets and fatter cigars for all. For his part, the sucker is ready and willing to believe anything that confirms his delusion. He was ready to buy a house he couldn’t afford…ready to believe stocks would always go up…ready to believe he could always get something for nothing. And if he’ll believe all that, he’ll surely believe a jobless recovery with contracting earnings and ballooning deficits is all but a sure thing.

But he’s living on borrowed time, as Dan Amoss explains.

“A rational, disciplined investor would be fearful about buying today, after prices have been jacked up by an unprecedented seven-month rally,” warns Dan, the mind behind the Strategic Short Report. “Nearly every economic and corporate development over the past few months has been translated into a reason to buy stocks. But underneath the elation over Dow 10,000 lies the palpable feeling that this rally is to be ‘rented,’ not ‘owned.’”

Every day the rally persists, in other words, the probability that it will perform a “black swan dive” off the cliff increases. Stocks are rapidly approaching – and in some cases have eclipsed – valuations that presuppose a robust, multi-year recovery is well underway. The S&P 500 index sells for over 19x FALLING earnings…earnings that are unlikely to improve in any meaningful, sustainable way.

Companies, meanwhile, are slashing employees like a bad horror flick. Initial jobless applications rose by 11,000 to 531,000 in the week ended October 17, according to the Labor Department. Economists fret that people working fewer hours and earning less money might tighten their belts a bit going into the Christmas season. They worry about what might happen to their consumer economy when the consumers economize.

We could take a guess…but we wouldn’t want to spoil the ending. Besides, thoughtful, reasonable individuals have already read the book. They have a pretty good idea how it all shakes out…and they’re running for the hills.

A Rented Rally originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Yesterday, while enjoying a leisurely brunch at a little café down in the Soho district, your editor noticed a group of strangely dressed twenty-somethings strutting along the sidewalk. A few New Yorkers even did double takes as they passed by. One member of the group, possibly their spiritual leader, sported a large “afro-style” hairdo. Nothing strange about that…except that it was only half a hairdo; he had decided to shave the other half off. The remaining “do” was, of course, bleached blonde. The rest of the posse had some variation of the same style with “flat-tops” and assorted right angles protruding from every head.

One member carried a retro-style “ghetto-blaster” and they all wore baggy pants with colorful graffiti markings. They looked like the cast of a mediocre Spike Lee movie.

“It’s the next look,” our fashion-astute friend remarked. “People are starting to re-embrace the whole ‘M.C. Hammer’ thing.”

M.C. Hammer, for those who missed his brief act, was a late-80s- early-90s rap star most famous for squandering a huge fortune. “Hammer” had amassed a booty of some $33 million at peak popularity thanks to a few hit songs and some catchy dance moves. With or without the advice of his manager, the rap star dumped $12 of that million into a Californian mega-mansion, complete with two gold- plated “Hammer Time” gates at the entrance to the property and a 17- car garage, which he filled with luxury vehicles. Not one to shy away from his own reflection, Hammer had $75,000 worth of mirrors installed throughout the house. A couple of helicopters were on standby out back in case Hammer needed to be anywhere faster than his Lamborghinis could take him.

Alas, as we all know, “Hammer Time” can’t last forever. And, after his entourage of 300 helped the poor rapper blow his loot, Hammer filed for bankruptcy and spent the final years of the millennium as a comical footnote in the book of one-hit wonders.

It was therefore interesting to learn that Hammer Time is back in New York, especially as the city’s chart –topping singles (remember the Mortgage Backed Security remix featuring Biggie Bear Stearns and L.L. Lehman Bros.?) are, like, so five minutes ago.

Posse leader (and Federal Reserve chairman), Ben Bernanke, appeared in Kansas over the weekend to defend his group’s flailing reputation.

“I was not going to be the Federal Reserve chairman who presided over the second Great Depression.”

Bernanke hit back at allegations from the crowd that he had acted irresponsibly by spending billions of taxpayer dollars to prop up Wall Street “beheamoths” instead of allowing them to fail and “making room for the small business.”

“It wasn’t to help the big firms that we intervened,” M.C. Bernanke pleaded. Small business must have wondered why the Fed didn’t NOT help them by funneling hundreds of billions of dollars their way.

It would seem too that Wall Street insiders, those with the word on the next big thing, are rapidly losing confidence in the Bernanke economy’s ability to churn out another chart-topping single.

Since the start of May, there’s been “massive selling” by insiders, to the tune of $3.9 billion vs. just $350 million of insider buying.

Banks too are lacking for confidence. The front page of this morning’s Wall Street journal reports that “The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter,” What’s more, over half of the loan volume in April came from “refinancing mortgages and renewing credit to businesses,” not new loans.

Whether it is in the hip-hopping world of entertainment or the entertaining world of global finance, crowd approval can be equally as fleeting. One need only write a few poorly received songs or send an entire economy into the depths of depression and, “bang” just like that you’re yesterday’s news.

“Hammer Time” Hits New York City originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

We encountered our fellow adventurers in Japan last week, while dining at one of Fukuoka’s famous Yatai (traditional street side food stalls). We were in Japan on a kind of reconnaissance mission. Deflation is on a global rampage and we wanted to see what it looks like up close, taken to a multi-decade extreme. If price collapse is on the rise in the west, we reasoned, it might be useful to see how those in the Land of the Setting Sun deal with it. And so, hoping to preview one possible economic future for the U.S., we caught a glimpse into an Orient-fused version of it’s cultural past.

“Jobs are not easy for us,” one of the travelers told us. A college graduate, the young lady has been “on the road” for almost two years, mostly in Japan but also in India and South America. Now she makes jewelry along her journey, living off the funds and friends’ couches while she figures out her next step.

“It’s not like when our parents got rich,” she says. “We don’t know where we will go from here.”

Indeed, Japan itself has been wandering in a desert of deflation for the better part of two decades now (incidentally, their horse may or may not have a name). After the now-infamous market implosion, which we touched on in last week’s notes, their meanderings have been painfully punctuated by many a mirage of recovery. Alas, their parched tongue met with nothing but sand and dry heat. The stock market finally “bottomed” last year…for now, that is.

Then, to rub salt in the wounds, Japan’s most faithfully consuming customers became victim to a crisis of overconfidence. Americans are tightening their belts. So while savings rates there marched toward a 14-year high, Japan’s exports dropped off a cliff. May recorded a year-over-year decline of above 40% (not a typo).

Unsurprisingly, government tax receipts are coming in well below expectations too. Overall tax revenues slid by record 13.2% for fiscal year 2008, The Japan Times reported last Friday. Even more worrying, corporate receipts sunk by almost a third (32.1%) as earnings deteriorated.

So is the United States doomed to repeat the mistakes they warned the Japanese about two decades ago? Are we headed toward terminal deflation, a negative feedback loop of earnings destruction and job layoffs? In many ways, we’re already there. You saw the jobs numbers last week – 365,000 more people worth of “slack” in demand ought to exert significant downward pressure of prices for a while yet. Home values are still falling, for example, while foreclosed inventory levels pile up each and every day.

America’s assets have only been hissing for two years, mind you; Japan’s have lost two decades worth of hot air. And, with such a delusional runnup in prices, who’s to say when enough air has been let out? As one blogger recently quipped, “What is the natural price when everyone wants to sell?”

The natural correction for low prices, of course, is low prices. But, in a world where prices must seek government approval to fall below a certain level, it is increasingly difficult to ascertain where that watermark is. That said, the longer prices refuse to obey the will of our elected and unelected officials, the farther they are likely to overshoot the mark in the opposite direction when they are “allowed” to snap back.

Meanwhile, the cries to “do something” were loud and desperate enough in the corridors of Capitol Hill that unprecedented intervention was not only allowed, but encouraged. The Federal Reserve balance sheet, for instance, has exploded like a Hiroshima mushroom cloud.

With $45 billion in capital and $2.1 trillion in assets, the central bank would not withstand the scrutiny normally afforded other institutions, James Grant, editor of Grant’s Interest Rate Observer said recently in a television interview.

“If the Fed examiners were set upon the Fed’s own documents— unlabeled documents—to pass judgment on the Fed’s capacity to survive the difficulties it faces in credit, it would shut this institution down,” he said. “The Fed is undercapitalized in a way that Citicorp is undercapitalized.”

So what happens now? We must rely on the people who got us into the most indebted position in the nation’s history to turn the hoses off at the precise time. If they fail, the deserts will flood and all the creatures in it (including horses with and without names) will drown. Guard against deflation for now, in other words, but prepare for the rains.

An Undercapitalized Fed originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.

Now, one hundred thousand might not seem like much these days, especially when so many numbers with so many zeros are so regularly bandied about. It might seem a bit distant, almost unreal in a way. Well, it’s certainly very, very real for that many people who weren’t expecting to lose their jobs last month…then did. It will feel very real to the restaurant owner when those people don’t call to make reservations. The struggling car dealer/maker will certainly feel it when they don’t come to test drive any new vehicles. Banks too will get the reality check when that many people can’t pay their loans back. The same goes for the banks’ banks and their banks too.

Gee whizz, one hundred thousand people sure do add up quickly. But the world’s largest consumer didn’t lose one hundred thousand jobs last month…that was only the difference between Economist Land predictions and hometown reality. The real figure, as by now you have surely committed to memory, was much worse.

Before the jobs report shocked green-shoot enthusiasts (into deeper denial, no doubt), Bloomberg had gathered 79 of the brightest economists in the land to hear their forecast. Predictions ranged from 150,000 at the low end to 500,000 at the other. Now, what does this massive discrepancy tell us if not that these guys had no clue in the first place? Does the guy whose math led him to stand up and say “150,000” still have a job? Will he chance on a closer guess next time and, if so, will we be listening to his expert opinion on television later that day because of it?

It’s no use wondering how these guys get it so wrong so often. Let us not forget, Rude reader, these are the same guys, from the same schools, who stood at the peak of Dow 14,000, cast their view toward the horizon and pronounced in clear, confident tones, “Calm waters ahead captain…nothing to report but prices rising to infinity for the rest of eternity.”

What the thoughtful investor might ask himself instead is why he still pays these neckties any mind at all. He may also wish to bear in mind that terminal incompetence is not safely confined to small time financial prestidigitators. The biggest and the loudest are all too often also the… eh, “wrongest.”

Before taking office, Ben Shalom Bernanke himself spoke of the “Great Moderation.” In his address to Eastern Economic Association in the nation’s capital, Bernanke acknowledged three possible explanations for the long calm, which he called “structural change, improved macroeconomic policies, and good luck.”

Mr. Bernanke didn’t see much reason to praise Lady Fortuna’s handywork, of course, preferring instead to congratulate his own profession for its pivotal role in everlasting financial tranquility and blissful economic calm. So confident was he, in fact, that he even thought it prudent to tempt fate…

“…if the Great Moderation was largely the result of good luck rather than a more stable economy or better policies, then we have no particular reason to expect the relatively benign economic environment of the past twenty years to continue.”

“Indeed,” Bernanke challenged, “if the good-luck hypothesis is true, it is entirely possible that the variability of output growth and inflation in the United States may, at some point, return to the levels of the 1970s.”

We imagine Mr. Bernanke would gladly take the tumult of the ’70s over what he has on his hands today. For some reason, the Princeton graduate mistakenly equates complexity with strength and resilience. The reader may wish to employ a Jenga visualization to understand how this is not always the case. [Tip: You can even write “MBS,” “CDO” and other complex derivative acronyms on the little Jenga blocks for added effect.]

Poor Economist Land Predictions originally appeared in the Daily Reckoning. The Daily Reckoning, a FREE daily e-letter, offers a "uniquely refreshing" perspective on the global economy, investing, and today's markets.