Depression II: The Horror

02/11/09 London, England DEPRESSION II …The Horror…coming soon to theatres near you!

“It’s gone deep. It’s gotten worse,” said the president.

We’ve seen so many shock and horror movies over the years. We recognize the dialog. But this is no Hollywood thriller. This is real life.

It is like a Netscape News story:

“WASHINGTON (AP) – On a single day filled with staggering sums, the Obama administration, Federal Reserve and Senate attacked the deepening economic crisis Tuesday with actions that could throw as much as $3 trillion more in government and private funds into the fight against frozen credit markets and rising joblessness.

“…Wall Street investors sent stocks plunging, objecting that new rescue details from the government were too sparse. The Dow Jones industrials dropped 382 points.

“…shortly after Senate passage of an $838 billion emergency economic stimulus bill cleared the way for talks with the House… Separately, Treasury Secretary Timothy Geithner outlined plans for spending much of the $350 billion in financial bailout money recently cleared by Congress, and the Federal Reserve announced it would commit up to $1 trillion to make loans more widely available to consumers.”

GM said it was cutting 10,000 jobs…and reducing executives’ pay.

Fannie and Freddie are likely to need $200 billion more to stay in business, say regulators.

And Tim Geithner’s new bank bailout program may cost $2 trillion.

Meanwhile, practically every business and every family in America is looking for ways to cut costs. Unfortunately, one person’s cost-cutting is another person’s income. So, incomes are going down too. Then, people have to cut costs even more.

“Let’s not mince words…this looks an awful lot like the beginning of the second Great Depression,” says Nobel-prize winning economist Paul Krugman.

Paul Krugman is wrong about a great many things; but he’s right about this. This is not a recession. It’s a depression.

What’s the difference? Some economists say a depression takes 10% off the GDP. Some say it is a recession that persists for more than a year. Most have no clue.

The real difference is this: a recession is a pause in an otherwise healthy economy. A depression, on the other hand, is when the economy drops dead. There’s no point in putting on the wires or strapping on the inhaler, there has been too much brain damage already. The best you could hope to do is to keep the body alive. But it would be a vegetable. Better to let it go…quickly.

But we’re not giving advice to the Obama team. So far, they haven’t asked. Instead, they’ve got the defibrillators in their hands.

“TARP II” is how the International Herald Tribune defines Geithner’s new program. Bold in scale. Vague in detail. Geithner says he hopes to bring in private money to fund the bailout. How? We can’t imagine. It’s one thing for government to try to revive a corpse with public (mostly imaginary) money. It’s quite another for private investors to waste their own time and money. ‘What’s in it for me?’ they’re likely to answer. And if there were anything in it for them, they’d already be investing in it. It’s not as if there aren’t plenty of opportunities on the Big Board. The financial sector is down 2/3rds to 3/4s from its high. Anyone who thinks there’s money to be made can take his chances.

Instead of buying, investors are selling. Just look at what happened to the Dow yesterday. They’re selling because they think there could be a lot more pain and suffering still to come in the banking sector – and in the economy at large. And they’re right.

Nouriel Roubini, who has become a celebrity thanks to his Daily Reckoning-style warnings, says the losses will reach $3.6 trillion. We don’t know what the ultimate figure will be, but it is bound to be a big number. This depression is just beginning. So far, we have only had the shock in the financial industry. The real damage will come in the economy…which is only now reacting to the financial losses.

Just wait until we get deeper into this film…that’s when the real blood and gore will come.

*** “This strategy will not work,” writes Haag Sherman in Barrons. “Asset values will continue to decline, regardless of how much money the government borrows, even it if borrows printed money from the Fed. And in that case, the government risks another, more calamitous crisis – a run on US Treasury securities.”

Treasuries are going down. Everyone wonders why. Is it because fear is easing…or increasing? On the one hand, spreads between private debt and federal debt are narrowing. This signals an increase in confidence. Investors are less panicky than they were a few weeks ago. Despite Obama’s “catastrophe” talk, they seem to think we’ll muddle through somehow.

So, they figure that they can leave the safety of U.S. Treasuries and venture out where they might be able to earn some money. With 10-year yields at only 3%, investors need to look elsewhere to get any income. Now, they appear to be at least poking their heads up above the trench walls.

On the other hand, there is probably a growing fear that the feds’ efforts to create ‘positive inflation’ will blow their heads off. The feds are certainly putting a lot of cash and credit into the system. At some point, the crunch will reach its natural end and then all this unnatural cash will produce a stimulating effect. That is, people will be motivated to get rid of it. When that happens – if not before – you’ll see the ‘run on U.S. Treasury securities’ that Sherman mentions, along with a run on other forms of U.S. paper, notably the dollar.

For the time being, we are still in the process of ‘price discovery.’ Last year, investors suddenly realized that debtors couldn’t pay their bills…that assets weren’t worth what people paid for them…that collateral was declining in price, making many erstwhile valuable credits worthless…and that revenue streams were not sufficient to maintain whole sectors of industry and commerce. They panicked. That is why these episodes were called “panics” in the 19th century. Nobody knows which assets are good…and which are bad…. or who’s solvent and who’s not…or which businesses can survive and which can’t. Everyone tries to hold onto to what he’s got…trusting no one and nothing…until the market has time to discover proper prices for things in the new post-bubble era.

In the 19th century…up to the Panic of 1921…this all happened fairly quickly. And then the economy got up off the ground, dusted itself off, and went on its way.

But since the Hoover Administration, the meddlers have intervened. Now, they try to stop the process of price discovery…by keeping zombie businesses alive…by loaning money to brain-damaged industries…and nursing the cadavers and corpses with trillions in taxpayers’ money.

Mr. Sherman continues…

“…the US government’s balance sheet looks increasingly like that of a Third World country. America’s debt-to-GDP ratio is more than 100%, including the nationalized debt of the two mortgage giants Fannie Mae and Freddie Mac. Budget deficits of $1 trillion are projected for years to come. Worse yet, America’s pension and medical obligations to the baby-boom generation and those that follow are estimated to be considerably more than $50 trillion.

“As the US government prints more money to address the crises, investors will realize that are being repaid in a much diminished currency. For the moment, foreign investors have remained relatively firm. But, at some point, foreign and domestic investors will consider the US government’s terrible fiscal position, and they will start dumping debt.”

*** That may happen next week. It may happen years from now. Remember, there are always back-eddies and countercurrents – even in the biggest flood. We’ve had a rebound, but it has been very slight. In the ’30s stocks rallied six times – more than 20% each time – before finally beginning a new bull market. And several times, investors thought the crisis was over…only to see it hit again, harder.

Our advice: stay in investments that you will not want to sell in the next ten years. What kind of investments are those? They’re investments with income and/or capital that is reliable. Forests. Down-market retailers. Apartment houses with good tenants. Farms, ranches providing foodstuffs at good prices. Basic service industries with decent revenues. Nothing fancy. The world is moving away from fancy. You want to be the low-cost provider of whatever goods or services people need.

And of course, stay in gold. Our favorite yellow metal will prove to be one of the safest bets for a store of wealth in this topsy-turvy economy. Yesterday, while Wall Street was sinking on the news of Geithner’s stimulus plan, investors flocked to their safe haven: gold. After dipping a bit on Monday, gold for April delivery jumped $21.40 to settle at $914.20 an ounce.

As we’ve pointed out many times, during a period of economic turmoil, investors increasingly turn to gold as a buffer against market volatility. We don’t know about you, but we have the sneaking suspicion that this ‘volatility’ in the markets is here to stay, at least in the foreseeable future. And in turn, gold will have a lot higher to go.

*** Oh no! The greatest central banker of our time…is going…going…Gono! Reports in the Financial Times this morning tell us that Gideon Gono has been replaced in a “power sharing” move by a fellow named Tendai Biti.

Poor Mr. Biti has his work cut out for him. His predecessor made a mess of Zimbabwe’s economy. But Mr. Biti looks like just the man to correct it. He apparently has no training in economics. That’s a definite plus. The paper describes him as a “44-year old lawyer [who] was a student leader active on human rights issues.”

Good luck.

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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