Hangover Nation

Yesterday, the Dow fell 38 points. But the real action is in the gold market – the price rose to $908 per ounce. Even the gold miners are finally going up. What does it mean? Is inflation closer than we thought?

Copper is up. Yields are up. Silver is up. The dollar is down to $1.31 per euro. Why?

We don’t know. But everyone seems to have a cure for what ails the world economy. All the treatments are dangerous. But only one is effective; unfortunately, it also – most likely – fatal. The only sure protection? You guessed it, gold.

For nearly 10 years, we kept a lonely vigil. We watched…we waited…we guffawed…

What were we waiting for? The bubble economy of 2002-2007 had all the appearance of a happy, healthy financial system. Trouble was, it was having far too much fun. People can’t party that hard without getting sick. We waited for them to start throwing up.

Now, there are so many sick people around you have to watch where you step…

Today brings news of more illness.

“More woe as 72,500 jobs axed in one day,” is the lead line in the Financial Times.

As expected, the New Year is brought the collywobbles. The financial crisis of 2008 is becoming the economic crisis of 2009.

The euro area is in its deepest slump ever in its 10-year history… The economy of Europe is expected to decline 1.9% this year.

The woe is most acute on the periphery. Spain, Ireland, Portugal, Greece – the countries that most benefited from low euro-land interest rates are those that suffer most from tightening credit. At the center, France and Germany are still in relatively good shape. But the periphery states are finding it harder to finance their deficits…and, with the limits on deficit spending imposed by the Maastricht Treaty, they have no way to spend their way out of recession (assuming that would actually work).

And out in the North Atlantic, problems caused by the financial crisis have become so severe that mobs are forming in the streets…inducing the president of the country, Geir Haarde, to resign.

Back in the USA, the government is still at work, but the working stiffs are rapidly running out of work to do. Caterpillar said it was cutting 20,000 jobs. Pfizer said it could do without 19,000. Sprint Nextel lopped off 8,000 people from its payroll. And Home Depot said sales were so slow it sent 7,000 of its employees home.

And this headline from the Wall Street Journal:

“IBM payroll cuts may be deeper than anticipated.”

Bloomberg reports that last year saw the biggest drop in house prices in the United States since they began keeping records…and probably since the Great Depression. The typical house lost 15% of its value in 2008.

Oh woe…oh woe…

But, fear not… every sentient meddler on the planet is offering advice…and solutions. More below…

*** Over in the Financial Times, the editorial staff tells the Obama Administration what it should do: “stop fretting over currency and press China to spend more.”

On the facing page, a pair of economists insist that government must recapitalize the banks, but must do it in a smarter way:

“The most politically robust solution is for the government to acquire not voting stock, but warrants – the option to buy such stock. These warrants would convert to commons stock when sold, and a Resolution Trust Corporation-type structure could manage the disposal of these controlling stakes into the hands of private equity investors.”

Even commentators who are usually sensible have given in to the urge to public service. Can you blame them? They see a problem…they want to fix it. Many of the leading fixers, of course, are either on the Obama payroll already…or angling for a job.

Other improvers are taking the mountain air at Davos… Maybe the altitude will help them think more clearly…and help them come up with solutions to the problem they clearly don’t understand.

Aside from a couple of economists – Roubini and Shiller – who are trying to explain to the group how market cycles work, none of the movers and shakers now jiggling the Alps or helping Team Obama saw the problem coming. None has any idea how an economy actually functions. None has a clue how to make it work better. In fact, almost all of them played some role – great or small – in CAUSING the crisis…either by omission or commission. Some were regulators who misled the public into thinking there were cops on the beat. Others worked on Wall Street. (Only recently, when they heard the police sirens, did they take the stockings off their faces and dump their pistols in the trash bins.)

Jonathan Weil:

“Almost half the people on Obama’s economic advisory board have held fiduciary positions at companies that, to one degree or another, either fried their financial statements, helped send the world into an economic tailspin, or both.”

But that doesn’t stop them from wanting to put things right. And the only fix they can imagine just happens to be a fix which, by pure coincidence of course, gives more power and money to the fixers. Yes, dear, dear reader…

…now, people are retching all over the place. We’re no longer waiting for them to get sick. We’re not on Bubble Watch any more. Now, we’re on Quack Watch…waiting to see how the quacks put them out of their misery.

At every level, the politicians are getting out their black bags and taking command of the situation. In California, for example, two cities aren’t waiting for the Obama ambulance to arrive on the scene. They’re giving mouth-to-mouth themselves. The WSJ reports:

“Victorville, a desert town on the main highway between Las Vegas and Los Angeles, recently approved a $200,000 loan to Victorville Motors, a 40-year-old family-owned dealer in the town’s auto park.”

So you see, dear reader, you don’t need bankers or capitalists to allocate capital. Any city councilman can do it. Yes, of course, the hacks will err…they will allocate capital stupidly and counterproductively. But not necessarily worse than the bankers have done recently…

What they won’t be able to do is to take a year off the calendar. We will never party like it was 2006, again. At least, not in our lifetimes…

Included in the Wall Street Journal this morning is an editorial, commenting on the Obama resuscitation plan. The emergency plan includes hundreds of billions for various projects designed to get the economy’s heart beating again. Trouble is, most of these projects don’t begin until after 2010. Infrastructure spending, for example, takes time. You don’t begin building a bridge tomorrow. First, you have to draw up plans…have engineering studies…and so forth. In other words, the patient is going to be a dried up corpse before the medicine takes effect.

The British newspaper, The Guardian, is also catching on to why the quacks won’t be able to cure what ails the world economy:

“In the 1960s and 1970s, total debt [in the US] was rising at roughly the same rate as nominal GDP. By 2000-2007, total debt was rising almost twice as fast as output, with the rapid issuance all coming from the private sector, as well as state and local governments.

“This created a dangerous interdependence between GDP growth (which could only be sustained by massive borrowing and rapid increases in the volume of debt) and the debt stock (which could only be serviced if the economy continued its swift and uninterrupted expansion).

“The resulting debt was only sustainable so long as economic conditions remained extremely favourable. The sheer volume of private-sector obligations the economy was carrying implied an increasing vulnerability to any shock that changed the terms on which financing was available, or altered the underlying GDP cash flows…

“From this perspective, it is clear many of the existing policies being pursued in the United States and the United Kingdom will not resolve the crisis because they do not lower the debt ratio.

“In particular, having governments buy distressed assets from the banks, or provide loan guarantees, is not an effective solution. It does not reduce the volume of debt, or force recognition of losses. It merely re-denominates private sector obligations to be met by households and firms as public ones to be met by the taxpayer. “

We have suggested another way to look at this, several times. The WSJ further explains:

“…the money from this spending boom has to come from somewhere, which means it is removed from the private sector as higher taxes or borrowing. For every $1 the government ‘injects,’ it must take $1 away from someone else – either in taxes or by issuing a bond.”

The Journal, not to be left out of the orgy of civic spirit, favors a different kind of medicine: tax cuts. Permanent cuts in marginal rates, it says, are the best solution.

We never met a tax cut we didn’t like. But we don’t see how it solves the essential problem: whether the feds spend the dollar, or the taxpayers…it’s still just a dollar.

But everybody’s got some patent medicine he wants to try. The most potent elixir is the one from the central bank of the US, the Fed. In fact, it’s the only one that works. The Fed has cut rates to the lowest level in 95 years…

“What will the Fed do next?” asks CNBC.

“Since it can’t lower rates any more,” answers the WSJ, “it has begun effectively to print money in an attempt to bolster the economy.”

This is where it gets interesting. We’re not on Bubble Watch now…we’re on Quack Watch…looking to see how much damage the fixers do. We bring the binoculars up to our eyes…and look at the printing presses. And what do we see? Gold.

*** Have you noticed? Bernie Madoff bears a striking resemblance to George Washington. And so goes the nation…from the man who couldn’t tell a lie, to the man who couldn’t tell the truth.

*** Gold is moving again. It’s up 15% in the last 2 weeks and 34% from its October low. What’s going on? While almost every analyst expects a deflationary slump…gold is acting as if inflation were in the headlines.

What has bothered us is that so many people expect inflation…and a rising gold price. Where’s the surprise, we wondered.

We could only think of two. One – that deflation goes deeper and remains longer than expected…pushing the gold price down and discouraging the gold speculators. Two – that inflation arrives quickly…and violently – before investors have a chance to unload their government bonds, or buy gold.

Which will it be?

Until tomorrow,

Bill Bonner
The Daily Reckoning