09/28/09 London, England
It is a gray morning here in London. We sit in the building with the golden balls, look out the window, and wonder…
…how does it all work? We’re doing some serious thinking this week. What is it that actually causes a depression? A stock market collapse? Or too much debt? How come government can appear to cure the problem sometimes – 2001-2007 – but not other times? How come the Japanese were not able to increase consumer prices? Even now…Japan’s inflation rate is negative. And why is it, despite the most massive effort at monetary inflation ever undertaken, the US bond market still forecasts an inflation rate of less than 2%?
An interview with Richard Koo, author of The Balance Sheet Recession, and a new book by Ken Rogoff and Carmen Reinhart are helping us understand what it going on. More to come…
In the meantime, the Dow went down 42 points on Friday. Gold dropped $7. Still no sign of the Chinese coming to the rescue in the gold market.
“Global rally shows signs of running out of steam,” says The Financial Times.
Reuters says the job data will “test the rally.” The New York Times says the ratio between job seekers and jobs available has never been worse.
The Wall Street Journal, on the other hand, tells us that greater than expected profits will support the rally. So far, the increase in stock prices has not come from increased earnings. It’s come from increased P/Es…based on the hope of higher earnings. In terms of forecast earnings, the Dow is selling at a P/E ratio of 27. But in terms of actual, reported earnings…the ratio if 180.
A friend made the mistake of asking us what to expect from the economy. We said it would go do down.
“You mean, you expect a W-shaped recovery,” he said… “A double-dip recession?”
“No…we expect no recovery at all. It’s a ‘W’ without the last stroke…”
Of course, we were exaggerating. But not much. We do not think that the economy of the Bubble Era can ever be revived. It will never recover…because it is dead.
But that’s doesn’t mean we will march backward forever. The economy may lose 10% of GDP…maybe 20%. But we do not expect to be slithering in the mud of the Middle Ages, with each man is planting his own wheat and brewing his own beer. No, not at all. It only means that the depression must continue until it comes to an end.
“But when will it come to an end?” you ask.
“When it is over.”
A depression ends when it has done its work. It must correct mistakes. It must punish errors. It must destroy the bubble economy…and the mindset of the Bubble Era. Only then can new real, sustainable growth begin again.
So far, in 2009, 95 banks have gone broke. How many more need to go broke before the depression is over? We don’t know. This is where is gets complicated. Because the feds are determined to keep us from finding out!
Here’s how it works. The Fed lends the bankers money. Then, the bankers turn around and lend it back to the feds. The banks are happy; they’re making money on a risk-free trade. The regulators are happy; what could be safer in a bank’s vault than US Treasury bonds? Investors are happy; it looks like the financial sector is making money again. And the feds are happy; they’re able to finance their deficits.
Who’s not happy? So far, so good. But hold on…
“This is not a sustainable recovery,” says fund manager Crispin Odey in The Financial Times.
What a spoilsport! You mean you can’t build a lasting recovery on debt and shell-game finance?
Nope. Apparently not. Just look at what has happened to the auto industry. The feds borrowed money to help Americans pimp their rides. And this Thursday, when September sales figures come out, we find out how sustainable that boost was. Many Americans got new wheels. But now they don’t need new wheels. And now the feds are out of the auto-incentive business. So now we get to see what happens next.
Stay tuned…
Across the river is the great “City” of London…where finance is the #1 industry…
…where earnest men and women toil long hours in glass towers. What are they doing?
‘Look at this chart,’ they tell clients. ‘It shows how much you can expect to make at different risk levels. And see this curve? It is what we call the ‘efficient frontier,’ where the risk/reward relationship is optimized by proper asset allocation.’
‘Wow,’ you say. ‘You must have some pretty smart cookies working for you.’
‘Well, we do our best,’ says the young man, modestly.
In a normal economy, ‘finance’ performs a useful function – helping to match up people who have capital with people who need it. But even when it is on the level, the profession is full of bombast and flimflam.
Those numbers, presented so confidently to customers, were 9/10ths smoke and 1/10th mirror. The new book by Rogoff and Reinhart confirms a point made by our friend Nassim Taleb: both the theory and practice of modern portfolio analysis were flawed. The theory was flawed because people are not reliable. They don’t always react in the way their models predict. What they did in the past may or may not be what they do in the future. And the practice was flawed because the past that the number crunchers looked at was limited to the last 25 years; it was the period since 1980, for which they had the figures! In other words, their models were based on numbers only from the boom years.
The US dollar is getting trashed, Strategic Short Report’s Dan Amoss tells us.
The greenback “is increasingly being viewed as a ‘funding’ currency in the carry trade,” Dan continues.
“In other words, leveraged speculators are borrowing US dollars in the short-term money markets at near-zero rates to buy bonds in higher-yielding currencies like the Australian dollar or the euro. If this trend remains in place, it will continue to drive down the exchange rate of the US dollar, and drive demand for gold up.
“This trashing of the dollar is not bullish for America as a whole. It’s dangerous for the viability of the middle class. It’s good for exporters of agricultural products, specialized manufactured products, and energy producers, but bad for everyone who pays for lots of imported products, or imports that are incorporated into the supply chains of businesses that sell to US consumers.
“I think this claim that ‘a weak dollar is good for exports’ is narrow-minded and misleading. It ignores the fact that a weak dollar would drive capital out of the US, into economies that are paying a real return on their currencies.”
Until tomorrow,
Bill Bonner
The Daily Reckoning
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“Still no sign of the Chinese coming to the rescue in the gold market.” Do you mean that the gold market is going to need rescuing now that it is overbought and its bubble could burst at any moment unless a commie country comes to its rescue? Hmm.
The truth is, banks are still hemorrhaging money. Most world’s big banks and financial institutions are broke. They can’t be saved and you are correct there is no way out from it for a long time.
Recession: Over. Depression: Only existed and still does for some unknown reason, in your mind and others out there on the fringe.
Harry, I don’t know what planet you are from. But here on earth all signs point to a long an unprecedented depression.
Must be nice to live in la-la land.
It´s impossible that people stare how things come worse, US society will implode if fundamentals don´t turn. We can´t think that society moves like computer models predict, it can´t with economy, less with how people moves, think or act, Beware!!
I can imagine that the US will do everything they can do to stay a super power. Since the 1970’s OPEC agreed to price oil in dollars around the world. If the $ continues to lose value, more OPEC countries will follow Iraq’s suit (they switched over to the Euro). Venezuela may be next. Afterall who wants to trade something of value for something that will lose value? Oil is the lifeblood of industrialization and we get it for free. Afterall, we print the very dollars that buys oil. So check out Sept 22nd article from Bloomberg.com. The Fed now talking aout doing reverse repo’s to remove liquidity from banking system – why? To increase value of dollar. This will help stave off the imminent and growing sentiment to move away from the dollar as a world currency. But if they take liquidity out of the banking system, that’s like taking the patient off life support. And then we will see the end game. Great Reflation turns into Depression part 2.
CommonCents said
Harry, I don’t know what planet you are from. But here on earth all signs point to a long an unprecedented depression.
Must be nice to live in la-la land.
———————-
It is easy for my brother.
He sold all his topped out stocks and is taking the cash and non=perishables to the bunker tucked away in gubmint property in New Mexico.
Bill, may I call you Bill?
Please stop drinking in the mornings when you are penning your opus.
Too much reliance on finance, government and consumer related industries. Finance allows companies to take on too much debt and also puts too much pressure on publicly traded companies and those that are not to maximize profits, which causes damage to the local economy in a variety of ways. Government industries are totally unproductive, wasteful and corrupt taking large amounts of resources away from productive industries putting an enormous strain on local communites and economies that are forced to support them. Necessary and descretionary, of course is not all negative, but an economy that doesn’t produce enough of what is being consumed and the jobs producing this consumption are based in other locals cannot be sustained for long. I watched a World Economic Forum a few years back and a Chinese economist was trying to tell developing countries how to build a sound economy. His advice was to start from within your own country, then figure out what you can export to other economies. A John Hopkins economist abruptly cut him off and advised the reverse. China’s economy grows – ours shrinks. Whose advice would you take?
Despite the danger of sounding too scholar and hermetic, i`ll quote a great philosopher of our times, whose finely crafted phrase captures in great subtlety the intrincacies of modern economics:
“We are freaking doomed!” …where the words freaking and doomed are to be highlighted and underlined for better appreciation of its phrasal importance.
And Harry is, no doubt, Mr. bonner teasing us. No one can actually be that narrowminded.