Trouble is Here - And He's Brought Friends

How our spirits soared over the weekend. “Gold at $898,” said one headline. “Hillary Dies,” said another.

We allowed ourselves a brief daydream. What if some strange virus attacked presidential contenders…and laid them out like dead rats in front of a terrier? Huckabee, Romney, Obama, Giuliani – the whole lot of them!

And then we read on. It was Sir Edmund Hillary who croaked, not the leading contender for the Democratic nomination.

But gold’s rise was real. It came, better than we predicted, along with a big drop in the Dow. Gold up; Dow down. That has been our mantra for the past eight years. But, for most of the time, we have been only half right – only right about gold, that is. On a floodtide of new money and credit, the Dow has floated, like an empty beer can in bilge water.

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But now Mr. Market seems to have punched a hole in the stock market’s boat. While the feds desperately pump more money into the system, stocks sink anyway. Friday, the Dow fell 246 points.

What’s going on?

The force of inflation may be unstoppable – that’s why gold is reaching towards $900. But deflation will not go away. And it keeps sucking the juice out of the financial system.

“This is not merely a subprime crisis,” writes Wolfgang Munchau in the Financial Times.

It if were just a subprime crisis it would be over already, he says. Nor is it going away anytime soon. Because “other pockets of the credit market are also vulnerable,” namely credit cards and credit default swaps.

And now we turn to that great economist from the Sovereign State of Massachusetts, Barney Frank, for an update.

The FT gave him space to tell us that what America needs now is a little more of what he and other members of Congress have to offer – more meddling! As expected, the politicians are pointing their fingers at Mr. Market. “He’s a failure,” they say. “What we need is more government.”

Mr. Frank bemoans “income inequality.” He must think it is a bad thing that some people earn more than others. Because now that some people earn even more than they did before, while most people earn less, he says we should do something about it. Ever confident in the wisdom of the same yahoos who elected him, he thinks, “the American people will decide that we should enact policies that seek to curb growing inequality.”

We only bring it up to point out that even Frank has noticed what we have been saying for years – that in the last six years, when the United States was supposed to be enjoying a boom, “average earnings for the vast majority of workers have fallen in real terms.”

The boom was a fraud, we say. Pass a law, says Frank,

Since the lumpen American earned no more income, and since his consumption spending went up…he had to get money from somewhere. That was no problem as long as house prices were rising. But when they stopped rising, he turned to credit cards. And now, with unemployment rising, the credit card companies are bound to discover what the subprime mortgage holders discovered – that their credits aren’t worth quite as much as they thought.

Meanwhile, credit default swaps are a $45 trillion industry. People buy swaps to protect against bond defaults. But, as we’ve pointed out, when credit is expanding, bonds rarely default. If a company gets into trouble and can’t pay its obligations, lenders rush to the rescue with more money. It’s when you come to the end of a credit expansion that the troubles arise.

Bill Gross, who runs the largest bond investment fund in the world, PIMCO, estimates the size of the coming crisis in swaps at about $250 billion – or about the same size as the subprime problem. His estimates, however, assume that a recession would not cut too deep or last too long. It could be much worse. Bond defaults could cause a global financial meltdown, Munchau points out. When credit was expanding, offering default protection seemed like a no-brainer; the insurer got bad for offering insurance against something that never happened. Naturally, a lot of no-brain investors came to the wrong conclusion – that they would NEVER have to pay off on their insurance obligations. But now the credit cycle has turned; credit is contracting, not expanding. And now, bonds are beginning to go bad. And so, the investor who bought a swap to protect himself turns to his insurer. Uh-oh. Here’s where it really starts to go bad. Because, real trouble rarely comes in the door alone. Typically, he comes with his drinking buddies and low-life friends.

If the economy softens substantially, or stays soft for a long time, many companies will default on their bonds. When that happens, not only will the defaulter default, but so might the insurer…and then, the insured too. In other words, all three could go broke.

A trillion here…a trillion there…pretty soon you’re talking about real money.

And a real credit crisis…

*** The weekend edition of the International Herald Tribune was full of remarkable things. On the front page is an article explaining how the United States fleet – the most powerful, sophisticated and lethal naval force ever assembled – could fall victim to swarms of Persians in speedboats. In a supposedly “classified” war game, the little Davids sank 16 American Goliath warships.

What to make of this report? If it were true, why would the U.S. military tell its enemies about it, revealing its own vulnerability to the entire world? It must not be true…comes the answer. Perhaps it is some sort of feint…or some bait, designed to lure the foreigners to battle?

We don’t know…but Caesar never advertised how his legions could be defeated…nor did the Duke of Wellington tell Bonaparte how to get around the ridge at Waterloo.

*** Elsewhere in the paper, David Brooks takes up the issue of how Republicans can pander to the masses and still be different from the Democrats.

The poor Republicans are giving up on the principles of the Reagan Era. Might as well; they began giving up their principles a long time ago. Now, “Republicans are adjusting their priorities to win back the anxious middle class.”

Yeah, say whatever you have to say to win. That’s the idea of modern democracy, isn’t it?

This is the same middle class, by the way, that has been nearly ruined by seven years of the Bush administration. But at least Bush cut taxes. And now, even that saving grace is gone from the new Republican scheme. There will be no more broad-based, Reagan-like tax cuts, says Brooks, not with so many voters getting older and depending on previous government promises. Instead, the GOP should focus on targeted cuts – like credits for people who do what the pols want them to do.

*** Autos, houses, stocks – they’re all getting cheaper. Or, to put it another way, in terms of these items, the dollar is going up!

Not only is Tata Motors (NYSE:TTM) selling a 4-door sedan for $2,500; China’s Chery Automobile Co. has one for about $4,000; And Geely – also in China – offers a model at about $5,000. French automaker Citroen (EPA:UG) has a deal in China, selling a ZX model from the ’80s for about $8,000.

And now comes another French company – Renault-Nissan – with an announcement that it will make a car in India, in cooperation with the Indian firm, Bajaj that will sell for only $2,000.

*** A note from Energy & Scarcity Investor’s Byron King:

“Gold is selling for over $890 per ounce this past weekend. Kevin Kerr and I expect gold to go to $900 any day now, and to break $1,000 per ounce this year – sooner, rather than later.

“Silver is selling at over $16 per ounce, with $20 not that far away. So silver and gold are moving quite a bit in tandem. Up. Up. Up. Why? Because – not to put too fine a point on it – the U.S. Federal Reserve is signaling that its long-term goal is to put the dollar into the tank. Politically, the Fed needs to satisfy a bunch of spendaholic politicians who cannot prioritize spending or say no to special interests. And the Fed wants to bail out some big banks and a few hundred thousand ‘favored’ members of a politicized class – people with economic and political clout. So the Fed is pursuing policies that will directly wreck the savings and work of hundreds of millions of people, both U.S. citizens and foreign dollar holders.

“For decades, people have put their trust in the dollar as a store of wealth. In effect, people put those dollars in trust. Remember when a local merchant would put the first dollar he ever earned in a frame above the counter? People admired the dollar. People trusted the dollar for the long run. The work you performed today – for which you were paid – would come back to you years down the line when you pulled those dollars out of savings. People were going to save those dollars and invest them later or use them to pay tuition so the kids could go to college – if not retire on those dollars.

“Not any more. Now investors everywhere are watching the Fed and bailing out of dollars into precious metals. Just the other day, the Financial Times referred to gold as the new global currency.

“I am discussing all of this because one of the best silver plays in the world is also one of our Energy & Scarcity recommendations.”

*** Downsizing, downsizing downsizing…

“We should downsize, too,” we began a conversation with Elizabeth. “We spend too much money. Our lives are too complicated. We have too many things…too many places…too much to keep track of.”

“Yes, you’re right…we need to simplify.”

“Maybe we should get rid of this apartment in Paris. We’ve moving to London anyway.”

“Oh no…I love this apartment. And it’s where we live when we’re in the city. And when we move, I’ll rent it out. “

“Well, maybe we could get rid of the country house.”

“Oh no…we couldn’t get rid of that…that’s our home. It’s where we have all our things…and where we spend Christmas…and it’s where we have our friends…and where your aunt is buried….

“…besides, where else would I keep my horses?”

“Well, maybe you should get rid of your horses? They’re very expensive…especially that one you keep in Paris…”

“Don’t be silly. I like riding. Downsizing is one thing, but you don’t downsize yourself out of the things you really like to do. What would be the point? You downsize so you can focus on the things that really matter to you…so you can get the clutter out of the way. And riding really matters to me…”

“Well, maybe we could at least get rid of the gardener and the cleaning lady at the country house…we’re almost never there.”

“We can’t do that…who’d take care of the horses? And the cleaning lady only comes for an hour or two…just to check on things…

“…but it sounds like you only want to downsize the things I care about…why don’t you downsize that ranch in Argentina. It takes days to get there…and every time we go you get hurt or something awful happens…”

“But I like the ranch…and it may turn out to be a good investment. At least it pays for itself.”

“You say that, but you end up investing more money every year…in new reservoirs…in the house…in planting more grapevines…

“Now there’s a place you can cut back. Why go into the wine business? You know you don’t know anything about it…you’ll end up spending a fortune and get nothing for it. Last year, they even forgot to pick the grapes…but what do you expect? You’ve got cowboys tending your vines…”

“Hold on…it’s just an experiment…not a serious investment…I’d just like to get a few bottles out of it and see what they taste like…”

“It will be the most expensive wine in history…and I will also bring up that electrical system you put in at the ranch. It was supposed to be simple. It was supposed to be cheap. But it looks like one of the power plants in northern New Jersey, with pipes running all over the place. And it never works properly…the water was ice cold when we were there and you had to bring in a technician from five hours away just to get it running again…

“And, since we’re on the subject of downsizing, why don’t you get rid of that apartment in London?”

“You know I can’t do that. The girls need a place to live.”

“Let them rent their own place. They’re both women now…they’re not your little girls anymore.”

“Well, I need somewhere to live in London too. I work in London. Besides, it’s just a rented apartment and it’s tiny. If it were downsized any more I’d have to sleep standing up…”

“But why do you go there anyway…because you have to work. But why do you have to work so much? Why don’t you downsize that? You’ve been working 12 hour days for the last 35 years…and now you’re traveling all over the world trying to keep up with your publishing business. It’s gotten out-of-hand. You’re not running it any more; you’re a slave to it. Isn’t it time to cut back?”

“I can’t do that…it’s my life. And what’s more, I can’t afford to…we need the money to support all these houses…travel…and your horses…”

“Oh no…we’re back to the horses…”

“Well, you seem so reluctant to downsize anything…that’s why I’m forced to work so hard. All my life…just trying to keep up with your spending…”

“Oh, now you’re losing it completely…”

“Okay…okay…I’m not blaming you…”

“Yes, you are. And you can stop right now…I’m not the one who moved us to Europe, or bought a house in France…or a ranch in Argentina…I’m not the extravagant one in this household. We were living very simply on our farm in Maryland and you decided to globalize.”

“Well, I’m certainly not extravagant. I live simply. I don’t even have a cell phone.”

“Oh…you are so frugal…aren’t you? A real emblem of simplicity and frugality. A genuine inspiration for all those people who want to downsize their lives. You have two houses and two apartments – on different continents, naturally. You have offices all over the world – to which you have to travel constantly. You work 12 hours a day…you’re never at home…

“…but you don’t have a cell phone. That’s simplicity? That’s downsizing?”

“Yes…”

Until tomorrow,

Bill Bonner
The Daily Reckoning
London, England
Monday, January 14, 2008

The Daily Reckoning PRESENTS: This week, The Mogambo goes on Live with Regis and Kelly and shouts about how much he loves gold – right before he’s escorted from the set for harassing Kelly Ripa. Read on…

FREE MONEY TO THE RESCUE
by The Mogambo Guru

Alan Abelson in his “Up and Down Wall Street” column in Barron’s writes, “Talk about great entrances! For investors, anyway, they don’t make them any better than the memorable one staged by that precocious calendrical infant, 2008. That is, if you’re an investor who happens to have a portfolio chock full of gold and overflowing with oil.”

And if you have your investments aligned with the Fabulous Mogambo Portfolio (FMP), then he is talking about you! Gold! That’s all you have! Gold! Lovely, lovely gold! And for the seventh year in a row, the FMP has beaten the piddly results of almost every other money manager in the world, but does The Mogambo get any credit, or even get somebody to make him up a lousy plate of nachos, like I’m asking so much of worthless kids laying around the house all the time? No!

I have to be content with making lots and lots of money as gold rises, instead of being given meaningless awards or being invited to appear on the television show with Regis Philbin and Kelly Ripa, so that they can tell me what an honor it is for them to meet me because what a freaking genius I am to have come up with creating the Fabulous Mogambo Portfolio Theory (FMPT) that has been kicking investing butt for seven years in a row now, the underlying theory of which is to own gold, gold mining stocks, gold ETFs, and marry someone who has a lot of gold fillings, gold crowns and gold dental bridgework, as a sort of portable store of gold, “on the hoof” in a manner of speaking, just in case you need to, you know, get out of town in a hurry again.

And after the introductions, I will look into the camera and say, “Thank you very much, Regis and Kelly! But to be truthful, in developing the Fabulous Mogambo Portfolio Theory (FMPT), I merely looked at the last 4,000 years or so of watching governments want to spend more than they could get out of the people, and finding out what happened when such governments got the bright idea of a way to create more money was to increase the money supply by making gold and silver coins smaller, or mix cheap metals in with the gold and silver in the coins, or to use paper money, or, in the ultimate example, make money the mere electronic storage of computer blips.”

Then I will say, “And I will tell you, and the audience, and all the viewers at home who want me to sweep Kelly up in my arms and start kissing her all over, the Big Freaking Lesson (BFL) that is thus gleaned from those 4,000 years of economic history!” Then I will lean forward, all confidential and secretive, and say, “Come closer! Closer!” while lowering my voice to draw them in, lower and lower and closer and closer, until I suddenly and unexpectedly explode, “Buy gold! Buy as much gold as you freaking can! Buy gold when the government is creating too much fiat money, spending too much money, which is made possible because the banks are creating too much money and too much credit for someone to borrow, with which to buy the debt, which gives the government the money to spend!”

And then I will walk right up to the camera until my face is right in it, getting Little Droplets Of Spittle (LDOS) all over the lens as I hysterically shout, “We’re freaking doomed! Don’t you understand that, you stupid people? The Federal Reserve has doomed the dollar, and that means that you are doomed! It’s Klaatu barada nikto all over again!

To allay the fears of the audience at home, watching all of this on their TVs, I will soothingly say, “Not Regis, of course, because he is smart and witty, and he can always get another job. And Kelly is not only smart and witty, but really hot, too, and I think I can turn her into a terrific porn star! We’ll make millions!”

The worst part is that nobody will ever believe me when I say that I was on the Live with Regis and Kelly TV show because the episode will not be aired, and Kelly will never even return my calls about any of my great ideas for a whole series of terrific adult-themed films we could make in her backyard.

And it’s too bad, too, although soon, nobody will need the money, as I am certain that there will be a massive fiscal stimulus very soon, which will probably be a replay of the “tax rebate” checks that Bush sent out to taxpayers right after being elected in 2000. I figure that $1,000 per taxpayer has just the right amount of desperation and panic, and gold will soar as a result of such blatant deficit-spending stimulus.

And Ambrose Evans-Pritchard of The Telegraph writes that I may be onto something here, and he says, “Bears beware. The New Deal of 2008 is in the works. The US Treasury is about to shower households with rebate cheques to head off a full-blown slump and save the Bush presidency.”

The problem is the same one. Will it work? The answer is “no.” Mr. Evans-Pritchard correctly says, “Not even a Bush New Deal can hold back the post-bubble tide that is drawing in across the globe”.

The part that baffled me is when he figures that, “Fortunately for America – and the world – the US budget deficit is a healthy 1.2 percent of GDP ($163 billion). Washington has the wherewithal to fund a fiscal blitz.”

This is where I laughed out loud, “Hahaha! The budget deficit is a ‘healthy’ 1.2 percent of GDP? Who told you that? I laugh a laugh, ‘hahaha’, of scorn that you forgot to check!”

I was hoping he would ask me what I meant by that rude remark so that I could tell him, “What in the hell has the budget got to do with how much the federal government spends? The actual spending deficit, from the government’s own report of the Treasury Gross Public Debt, is up over $600 billion dollars from a year ago! There’s your real deficit, dude! The budget itself is over $3 trillion freaking dollars, including the laughable budget deficit estimate of only 1.2% of GDP for the ‘deficit’? Hahaha! Try 4% instead!”

Mr. Evans-Pritchard ignores me, and says, “Britain has no such luxury. Our deficit is 3 percent of GDP at the top of the cycle”, to which I rudely say maybe it is just a matter of measurement, too! Again ignoring me, he says, even more provocatively, “Gordon Brown has shut the Keynesian door”, to which I again say, “Hahahaha! I don’t know who you have been talking to, but they are wrong, wrong, wrong!”

And I say this not because I love to hear the sound of my own voice, which I do, or how I have the power to charm with my Musical Mogambo Laughter (MML), which I don’t, but because having a fiat currency and allowing insane levels of fractional-reserve banking in the slavering service of a huge, expensive, desperate, idiotic, bankrupt, corrupt government means that there is no such thing as “shutting the Keynesian door”, as nothing could be simpler than to flood a country with government deficit-spending (“stimulating aggregate demand”).

And when that government check hits my mailbox, brother, I’ll show you exactly how giving people free money stimulates spending! Whee! Insanity in economics is fun! And it will be ironically profitable if you use the money to buy gold! Whee!

Until next time,

The Mogambo Guru
for The Daily Reckoning

Mogambo sez: It’s pretty astonishing how gold has risen to a new, all-time nominal high, but the sense of urgency it implies is missing from the news media, when if they were REALLY news reporters, they would be finding out the truth about gold and why it is rising, and then they would be in here with me, hunkered in the bunker, finger on the trigger, scared out of their freaking minds.

Editor’s Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.