Marking to Madness


That’s the sound of chopper blades. Yes, Fed Chairman “Helicopter Ben” Bernanke is getting his squadron warmed up…preparing to drop dollars all over the nation.

You’ll recall, dear reader, that Ben Bernanke, former head of the economics department at Princeton, is also a leading student of the Sushi Slump – Japan’s long on-again, off-again recession that began in 1990. He wants to stop it from reaching the United States in the worst possible way – that is, by dumping paper money, “even from helicopters, if necessary.”

He tried soothing words. Then, he tried cutting rates. And he tried colluding with central banks all over the world to inject liquidity into the system (not since 9/11 has the word seen such a cascade). Finally, it looks like it is time to rev up the helicopters.

And so our theory got a test yesterday.

Our theory is simple: Mr. Market wants to correct. He wants to bring down asset prices…put the United States in recession…and reduce debt levels. And Mr. Bernanke wants to stop him, fearing that – with so much debt outstanding and consumer balance sheets so fragile – any correction is likely to end up in a Sushi Slump. Or worse!

But all the feds can do is to give Mr. Market more of the same medicine that made him queasy in the first place – more cash and credit. And whenever they force-feed the patient more cash and credit it causes a kind of gold fever…sending the price of gold up and driving down the dollar.

If the medicine fails to work…that is, if they fail to head off a major recession, stocks come tumbling down.

If they succeed in stopping recession (and/or preventing a bear market in stocks) it will be at a ghastly price – inflation, which will drive up gold prices.

Either way, in theory, the best thing for dear readers to do is probably to do what we’ve been doing for the last eight years – sell stocks on rallies…buy gold on dips.

And yesterday, we got to see how it works in practice. The Fed chief said he was “ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks.”

Translation: whoosh…whoosh…whoosh…

Investors didn’t even have to wait for the news analysis. They saw a 50 basis point cut coming in the Fed’s key rate later this month. And so, they bought stocks. The Dow rose…nearly 1%.

But if our theory were right, we’d see a pop in the price of gold too. And a lower dollar. And yes, that’s what happened – gold hit a new all-time high of $894…and the euro spiked back up to $1.48.

What next? More of the same. As long as the economy keeps softening, the Fed has to keep its vault doors open. And as long as the vault doors are open, the dollar is bound to lose value and gold, what the Financial Times calls the “new global currency,” is bound to go up.

The Fed is already lending money at real rates near zero. Subtract the inflation rate from the Fed funds rate and there is nothing left. If they cut the rate again, they will be lending substantially below zero.

The Fed is also running the loosest regime in the Western world. Real lending rates in both the Eurozone and Britain are higher than they are in the United States, and inflation rates in both areas are lower than those in the United States.

Still, just listen for the helicopters…the noise will get louder and louder.

It may be madness…but it is fun to watch.

*** A note from our energy guru, Byron King:

“Oil also has reached historic high-price levels in the past couple of weeks, at one point breaking the psychologically important barrier of $100 per barrel. Gee, do you think people might start to wake up to what is going on with oil? The fact is that worldwide demand for oil has outstripped the ability of the oil industry to lift crude and other liquids to the surface. In the richer developed world, most people just mutter a few words and pay the higher prices. But in the less developed nations of the world, each increase in the price of oil causes more and more people to exit from the Oil Age.

“In this world, those who cannot pay the higher prices simply do without oil, and the product gets shipped elsewhere. You can see desperation and panic reactions in some niches of the world markets. Truck drivers wait for days to buy diesel fuel in China. Pakistan has just a few days of petrol in reserve. In parts of Africa, entire nations have been shut off due to the lack of foreign exchange to pay for fuel imports. We have not felt these kinds of impacts in the U.S. – well, not yet. But the U.S. energy chain is really held together by threads. We are one hurricane, pipeline leak or offshore platform catastrophe away from regional shortages.

“It is starting to sink in that high oil prices are here to stay. The world’s high-price oil environment is paving the way for massive new investments in secondary, tertiary and other forms of ‘enhanced’ oil recovery. New thinking is welcome, because the old thinking has reached the limits of the intellectual envelope. This is exactly the scenario in which one company that I am recommending to my Energy & Scarcity subscribers can profit. There are opportunities here – you just need to know where to look.”

You can profit along with Byron’s Energy & Scarcity subscribers…until midnight, January 14, we are offering his newest service free of charge for three months.

*** Here in Ireland, house prices are going down.

One owner in Dublin has dropped his offer price five times – by 100,000 euros. In Waterford, a typical price has come down 90,000 euros. And in County Wicklow, there’s a photo of a house that has come down 65,000 euros. The Irish Independent says, “Prices have come down consistently, all through 2007.”

What is still shocking to the foreigner is how little you get for your money in Ireland. The house that sold for nearly $1 million in Dublin looks like a very modest semi-suburban house…worth maybe $200,000 in Houston. And the house in Co. Wicklow that is now on offer for $300,000 is a “semi-detached” three-bedroom model of the sort you’d expect to get for, say, $150,000 in Florida.

*** As predicted, politicians are taking up an anti-business, anti-greed, anti-globalization line of guff.

Huckabee, for example, is whining about corporate bonuses and losing American jobs to offshore competitors. Hillary, too, is kvetching that the middle class is getting a bad deal. And Edwards has been pandering to the rabble from the get-go.

Now the Chamber of Commerce is fighting back, vowing to spend $60 million to “punish anti-business candidates.”

“We plan to build a grass-roots business organization so strong that when it bites you in the butt, you bleed,” chamber President Tom Donohue said.

Our guess is that ‘you ain’t seen nothing yet.’ Once the middle class really comes to understand how it has been ruined, populist scoundrels are going to sound almost reasonable.

*** We were sitting by the side of the road, in a remote part of Argentina. Time passed. And then, more time passed. An hour. Two hours. Three hours.

What were we waiting for? We didn’t know. But when people with guns tell you to wait, you tend to listen.

The tale of our recent vacation has no particular financial point…or lesson…to it. We pass it along as it happened in the same spirit with which we take a trip with no particular destination in mind – knowing that we don’t necessarily end up where we expected to go…but always arrive where we ought to be.

Eventually, the forces of law and order had had enough themselves. We awoke from a brief nap and found they had gone.

“What happened to the police?” we asked.

“They left.”

“Did they say anything?”

“No, they just left.”

We figured we might as well leave too. Along with the fellow from the other car, we crowded into our one still-operative truck and drove to the local police headquarters to give ourselves up.

The young policewoman smiled. She was hoping that she had seen the last of us.

“Look, you have to settle this on your own,” she said. “Otherwise, we have to fill out a lot of reports…then, you’ll have to go to court in Salta…and then, you’ll have to get lawyers.”

This seemed perfectly reasonable to your editor. He was prepared to pay the damages – which didn’t look like much anyway.

“I recognize that it was mostly our fault,” we explained. “I’m happy to pay for it.”

“No…no…” protested the other driver. “I don’t have any way to get my car fixed. And I’m stuck up here…it’s 1,600 kilometers from Buenos Aires. What am I supposed to do?”

“Why don’t you just change the tire and drive off…get an estimate for the damage…and I’ll pay it?”

“No…no…you’re a foreigner. You might just go back to Europe. And I don’t know if my car is drivable. Besides, my wife was injured…this is a serious matter.”

“Okay, then…we’ll start the process for a formal accident report,” said the woman, throwing up her hands. “Juan…please type up a report for us. Get statements from both of these men…and then type up the report from the recriminalistas.”

Juan was already at the typewriter. He seemed like an earnest young man, with a serious look on his face. But the machine he was working on was not a computer. Not even an electric typewriter. It was an antique worthy of a flea market – a Remington manual typewriter, of the sort that disappeared from newsrooms in America 50 years ago. And Juan appeared to have just begun taking typing lessons that very morning. Kachunk…he pressed one key. A few second later, down came another…kachunk. At his present rate, it would take him approximately until dinnertime to type our names. For a full report, we could see ourselves waiting until Easter.

Kachunk…ay Chihuahua…Juan made a mistake. The paper came out of the typewriter. A white goo was applied. Then, Juan blew on the goo for a minute or two and put the paper back in the typewriter.

“Maybe we better settle this between us,” we suggested.

“Well, the only way I can think of to settle up would be for you to buy my car…for what it was worth before you ran into it.”

We thought about that for a moment. The logic of it seemed correct.

“Okay, that seems fair.”

“It was worth about 26,000 pesos.”

We took him at his word. It seemed believable. But it was 4 PM on New Year’s Eve. And we were in a tiny town in the middle of nowhere, in the foothills of the Andes. Even in the best of circumstances, it is almost impossible to get your hands on a substantial sum of money in Argentina. The ATM machines allow you only take out 300 pesos at a go. That’s only about $100. And when you try to transfer large amounts of money into the country, you have to go through a “money broker” in Buenos Aires, who undertakes a complicated transaction involving buying bonds in Miami in order to sell them in Buenos Aires. You show up in his office and he hands you a large wad of cash.

In fact, when we left for Salta in the first place, your editor carried 35,000 pesos. He had a lump in his pocket worthy of a handgun. But it was the simplest way to pay the salaries on the ranch; we just carried cash from the money broker. People tend to keep cash on hand, because the banking system is unreliable. During the crisis in 2002, for example, dollar deposits were forcibly converted to pesos and then the peso was allowed to fall to a third of its previous value. And even if you had money in the bank, it did you no good, because the government forbade the banks from giving it back to you.

Your poor editor had already handed over the 35,000 pesos to Francisco. He had no cash to buy the car. What to do?

A deal was struck…we would meet in the town square of Cafayate two days hence (after the banks had reopened)…we would deliver him the 26,000 pesos. He would deliver title to the car.

But as they used to say in the foothills of the Appalachians…

…that is, ‘God willing and the creeks don’t rise.’

And the creeks did rise.

More to come…and keep reading for today’s essay…

The Daily Reckoning PRESENTS: Today’s financial world may be a mess, but we financial journalists couldn’t ask for a better one. Bill Bonner explains…

by Bill Bonner

A foreclosure hotline has been “overwhelmed” with desperate pleas for help, moans a report from the United States. One of America’s largest builders reports a record loss…and, in the last quarter, house prices across America took their biggest fall in 21 years. U.S. Treasury Secretary Paulson says he’s run out of “easy answers” for the credit crunch problem. And the U.S. stock market registered its worst first five days in history.

The BBC passes along a Merrill Lynch (NYSE:MER) report, warning that a recession “has arrived” already in the United States of America. And colleague John Stepek, Deputy Editor of MoneyWeek, says, “Britain will not be far behind.”

The news headlines whine and squeal. But here at The Daily Reckoning, we are as happy as a loafer and tranquil as a corpse. We neither add to your worries nor take away from them. Instead, we count our own blessings: we have the devil’s own subprime debt and a credit crunch from Hell; we have dollars, pounds and euros – none of them worth much of anything in particular; we have Ben Bernanke, Mervyn King, and a whole caste of characters that seem to have escaped from a circus; we have economic theories that would make an alchemist blush…and financial opinions that would embarrass a plumber; and we have a bull market in our favorite metal, gold.

The Canutes at central banks in all time zones are determined to put the market out of business. If they put enough new money and credit in circulation, they believe, the mistakes of the past will disappear and the markets will behave themselves. They seem not to notice that the mistakes were caused by too much money and credit in the first place! Prices of real things – oil, gold, food and farmland – are soaring. Oil rose over $100 last week – for the first time ever. And gold punched into entirely new territory – almost reaching $900. The Financial Times says that gold is the “new global currency,” hinting that the old currencies – notably the dollar – are yesterday’s news.

But who has gold? Only a few speculators and grumpy old-timers. If it really were the world’s new currency, most of the world’s people would be flat broke. Most people have paper money. And they have no idea what it is really worth.

It was only a few years ago that low-cost communications and computer technology seemed so promising. Access to the Internet was said to have changed everything. Former Fed Chairman Alan Greenspan said 10 years ago that a new era of faster productivity growth had arrived – thanks largely to the power of the Internet. But now the pudding has been tasted and digested; we make a face and pronounce judgment on it: with infinite knowledge at our fingertips we have turned into a race of morons. Ten years after the dawn of the Information Age nobody knows anything. Is it inflation or deflation? Are we getting richer or poorer? Nobody can tell you.

What is a derivative contract really worth? Who knows? Not the people who put it together, the people who sold it, the people who gave it a AAA rating, or the people who own it. The alarums sounded back in the summer; it was clear then that the ‘mark to model’ valuations of these investments were as flawed as a TV preacher. Remarkably, months went by without anyone really knowing anything more – except that many people were losing money, including some of the smartest financial institutions in the world. Buying, selling, trading, investing – the transactions kept happening; trillions of dollars changed hands. And financial firms tote up many of their positions based on Enron-style “mark to market” calculations. They guess not only on the value of the trades six months, one year…five years into the future…but on what the dollar will be worth too. And who even knows what a buck is worth today? Circa 2008, the whole world’s financial structure is built of sugar bricks. It is all so sweet, until it starts raining.

And the builders – they seemed to know not nothing – but less than nothing. How complicated was it to build a house at a profit? Levitt and Sons – inventors of modern American suburban development – had been doing it for more than 50 years. And yet, with computers on every desk…with access to Black Scholes Option Pricing Model… the Lev and Thiagarajan indicators, the Edwards-Bell-Ohlsen analysis…with a staff of trained economists and mathematicians ready to figure thousands of financial scenarios…and Internet connections drawing forth every possible bit of information at the speed of light, they still went bust. With all the wonders of the new era in communications at their disposal, Levitt’s sons couldn’t figure out what the old man had been able to calculate on the back of an envelope – whether they were making money or losing it.

The financial world is essentially a war of wits. But in the 21st century the combatants laid down their arms. We recall the people who made “mark to market” accounting notorious – the Enron desperados. Ken Lay’s defense was a jewel; he argued that he had so much information he didn’t know what to do with it all. He couldn’t be guilty of intentionally misleading investors, he told the court, because he didn’t know what was going on himself. The same line of talk was used on reluctant investors: Enron’s business model was too sophisticated for ordinary investors to understand. Like the New Era of dotcoms…subprime mortgage debt and derivatives…the current account deficit…the dollar…and all the financial subterfuges that are so clever we will never understand them…you just ‘got it’ or you didn’t.

But that is the great glory of the financial markets. What the people who ‘get it’ get, sooner or later, is usually what they deserve. Who could ask for more?

Until next week,

Bill Bonner
The Daily Reckoning
Waterford, Ireland
Friday, January 11, 2008

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics is available now by clicking here:

Mobs, Messiahs and Markets