Cursing the Loss of Purchasing Power

The Mogambo has a problem with the government’s Plunge Protection Team: either it exists and is massively operating to intervene in the markets, or that people are truly idiots. Or maybe delightful little fairies guard our dreams and protect us in life!

Thomas G. Donlan’s new essay in Barron’s is titled "Lands of Waste and Debt" with the subhead "The states send signals that it will not be a happy Spring", which makes me ask the obvious question "It won’t be happy for who?", as I am all in gold, silver and oil, and I am dead-bang sure that I will be VERY happy for a long, long time because I know what happens to those particular items when a moronic, corrupt government teams up with a central bank, especially one utilizing some bizarre computer models to determine monetary policy; inflation that screams your death knell!

So maybe it won’t be a happy time for some working people having their death knells screamed at them, or their families screaming at them because things cost so much and they whine, whine, whine about it all the damned time until you want to scream a death knell of your own, as the latest employment report showed that 80,000 jobs were lost in March, which does not even account for the fact that the two previous month’s job losses were each revised upward by 76,000! In two months, 152,000 more jobs were lost? Yow!

And these are only the reported job losses, and I’ve even seen estimates as high as 400,000 jobs lost!

And people with houses to sell are not going to be too happy, either, as Bill Bonner here at The Daily Reckoning reports, "So far, U.S. homeowners have lost probably about 12% of the wealth they thought they had in their houses. The total capital value of the residential housing market is about $20 trillion. So, a 12% loss is equal to about $2.4 trillion."

Apparently, Mr. Bonner recognizes the look of horror on my face and the way I am gasping for breath at the prospect of a country with a GDP of $15 trillion losing $2.4 trillion in wealth. To make me feel better, perhaps, he added, "A few foreign housing markets have been hit harder – Ireland, Spain and Iceland, for example." Yikes!

Back here in America, the National Association of REALTORS reports, "the median price of an existing single-family home dropped 8.7 percent in February from a year earlier, the most in four decades of record keeping."

And it is not just first mortgages that are in trouble, as Ed Steer of GATA sent the International Herald Tribune article "U.S. Equity Loans Are Next Round In Credit Crisis", which contains the chilling statistic "Americans owe a staggering $1.1 trillion on home equity loans – and banks are increasingly worried they may not get some of that money back."

And they should worry, as, "In December, 5.7 percent of home equity lines of credit were delinquent or in default, up from 4.5 percent in 2006, according to Moody’s", and "In places like California, Nevada, Arizona and Florida, where home prices have fallen significantly, second-lien holders can be left with little or nothing once first mortgages are paid."

To make sure that they get their money back, "many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first." What makes this all the more worrisome is that "In the past, when home prices were not falling, lenders did not resort to these measures." Cue ominous soundtrack, with wolves howling and banshees wailing.

And it won’t be happy for those guys holding stocks of the S&P500, as that index had earnings sliding again, this time to $66.18. In case you were wondering, less than 6 months ago, the earnings of the S&P500 were almost $86.00! It’s amazing that the stock market HASN’T collapsed in the face of an earnings slowdown of 23%!! Earnings are slashed by almost a quarter, but the underlying stocks haven’t sold off, but actually seem to rise? Wow!

This amazing phenomenon proves either that the government’s Plunge Protection Team exists and is massively operating to intervene in the markets, or that people are truly idiots. Or maybe delightful little fairies guard our dreams and protect us in life! Something.

Either way, the earnings yield of the S&P500 is a miniscule 4.83%, which is the lowest since sometime in ’04. Nice "growth" there, dudes!

And it won’t be happy for many shareholders at all, as Jack Willoughby in Barron’s reports, "The average U.S. diversified stock fund lost 10.11% in the opening quarter, slightly more than the Standard and Poor’s 500 index’s drop of 9.44% over the same span."

It also looks like all the other stock funds, (big cap, low cap, high growth, blue chip) had losses, too, ranging 7% to 15% in the first quarter, with the exception of everybody’s favorite, the gold funds, which gained 5.22%, and some short funds that were up 11.93%.

And the news is not any better in bonds, and Ty Andros of has been looking at the gigantic bubble in bonds. He says that bond prices "have been this high, and rates this low, ONLY one other time in over 50 years, and that was the 2nd quarter 2003."

Wow! 50 years! Then, since he knows what a drudge I am about inflation, innocently asks, "How about purchasing power? Let’s use the rule of 72 to figure out what type of purchasing power losses these holders are about to face. 72 divided by inflation of (I will be kind) 9 percent."

The results are that, "In the case of the 10-year note, it will lose half its value over the next 8 years, and in terms of the 5-year, a 31% loss of purchasing power will be seen between now and redemption time." My God! These are staggering losses, considering the sheer tonnage of bonds that are already extant in the freaking world!

And why will bond investors face purchasing power losses? Easy! Mr. Andros says, "MZM (money with zero maturity) is expanding at 30 percent, and reconstructed M3 is running at over a 17% growth rate." I am stunned! In short, the Federal Reserve is creating money seemingly as fast as it possibly can, which devalues all the existing currency by just that little bit more!

On the other hand, he says, "As long as they create fiat currency and credit as they are, stocks can NEVER be expected to decline for long. They will just rise to reflect their re-pricing in the currency in which they are denominated (currencies don’t float they just decline at different rates) with nominal gains to reflect the loss of purchasing power, not to be confused with REAL gains as measured in gold."

And to prove it, look at Zimbabwe, where a single cigarette now costs over Zim$750,000; their stock market shows the biggest gains of all the stock markets in the world!

Too bad the entire capitalization of the Zimbabwe stock market is roughly equal to a used Chevrolet with bald tires! Ugh.

Until next week,

The Mogambo Guru
for The Daily Reckoning
April 14, 2008

The Mogambo Sez: If I was ever a bull on gold, silver and oil, I was but a novice, as I am much, much more so now.

And so should you be.

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.

The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning and other fine publications.

It was here in Manchester, England, that Europeans stole a march on the rest of the world. The Industrial Revolution made it possible for people to produce more wealth, more quickly.

But now, two things are happening:

First, the planet seems to be running low on easily obtainable energy. Cheap oil fired the furnaces, filled the pistons, and greased the gears of the whole machine. Now, oil is not so cheap… In fact, it hit a new record high last week.

Second, the non-Europeans have caught on to the magic of the Industrial Revolution. They’re building newer and better factories – and staffing them with cheaper, harder working labor. What’s more, they’re competing with the West for the raw materials to feed their factories. And, perhaps most important, they’ve got money – mountains of it. While Europeans – led by Anglo-Saxons – squandered their wealth on pointless wars and frivolous spending, the non-Europeans have been saving and investing. The Chinese, for example, are said to save more than 25% of their incomes.

And now, a kind of financial war seems to have broken out. We have opined that this is not merely a war between inflation and deflation…but a war of Total Liquidation…in which the huge debts built up during the expansion phase of the credit cycle – roughly, 1980-2007 – mostly in the West, especially in America and Britain, will be written down, written off, and inflated away.

Neither inflation nor deflation will be a clear winner, in other words. Instead, like WWI, both will do damage…and in the end, very few people will be better off. Some possible exceptions – gold miners, commodity producers, and emerging markets.

No one will benefit much from deflation. But commodities and gold will reap some gain from inflation.

On Friday, for example, we saw both in action. The Dow tumbled 256 points – after GE (NYSE:GE) proved that it could was vulnerable too. Its shares lost 13% of their value in a single day. What provoked the run on GE was disappointing earnings – particularly, you guessed it, in its finance division.

Finance was the big winner in the expansion of 2002-2007; it will be the big loser in the contraction phase.

While deflation was battering investors’ wealth…inflation was aiming its wallops at consumers’ budgets. Rice and oil hit record highs. Corn and tin too.

Interestingly, $6 corn is too much for the ethanol business. The industry was a fraud from the get-go, requiring taxpayers’ money to justify turning corn into fuel. But now, even with subsidies, corn is too expensive and the ethanol producers are going bust.

They deserved it. But pity the poor people who have to eat. A handy chart on this weekend’s edition of El Pais shows what has happened to basic food prices. In the last two years, corn, wheat and rice have all more than doubled. And get this, in 2007, stockpiles of these grains fell to their lowest level in 25 years.

No wonder there are food riots breaking out all over the place.

But let’s return to our big picture view.

Inflation and deflation only appear to be "at war" with one another. Sometimes inflation has the upper hand. Sometimes, deflation. But over the next few years they will make common cause in the destruction of wealth in America, Britain and a few other economies.

Why do we single out the Anglo-Saxon economies? Because they were the ones that most feverishly embraced what became known as the "Anglo-Saxon model" of economic growth, what our friend Kurt Richebächer used to call "late, degenerate capitalism," marked by a freewheeling financial industry, widespread securitization of debt, and overall debt at breathtaking levels.

One awkward feature of this model was the fact that the rich got a lot richer…while the poor stayed about where they were.

The Financial Times explains:

"After decades of ‘financialisation’ in the US and other Anglophone economies, whereby financial services have increased their share of gross domestic product, banks are being bailed out – using public money…

"From a political perspective the notable feature of the inegalitarian, free-market era that began in the 1980s is how little backlash there has been against the stagnation of ordinary people’s earnings in such a large portion of the developed world economy. …This is potentially dangerous territory…

"Between 1979 and 2005 the pre-tax income for the poorest households grew by 1.3 per cent a year, middle incomes before tax grew by less than 1 per cent a year, while those of households in the top 1 per cent grew by 200 per cent pre-tax and, more strikingly, 228 per cent post-tax.

"The result of this lopsided distribution of income growth was that by 2005 the average after-tax income for the bottom fifth of households was $15,300, for the middle fifth $50,200 and for the top 1 per cent just over $1m.

"Looked at from another perspective, in 1979 the post-tax income of the top 1 per cent was 8 times higher than that of middle income families and 23 times higher than the lowest fifth. By 2005 those ratios grew respectively to 21 and 70. The process reached its extreme point with US President George W. Bush’s tax cuts. Emmanuel Saez of the University of California at Berkeley estimates that in the economic expansion of 2002-06 the plutocratic top 1 per cent captured almost three-quarters of income growth.

"Figures for wealth, derived from the Federal Reserve Board’s Survey of Consumer Finances, are less up-to-date but the picture is similar. The share of US wealth owned by the top 1 per cent of households rose steadily from 20 per cent in 1976 to 38 per cent in 1998."

The backlash has already begun – just listen to America’s presidential candidates. They’re all bidding for the resentful voter – complaining about high executive salaries, kvetching about the Bush Administration’s bail out of the banks, and whining about tax cuts for the rich. They all want to soak the rich…and bailout the ‘little guy.’

But they can stop worrying. Wealth is self-correcting. Economic success is self-healing. In this new downturn, the rich will lose more than the poor – simply because they have more to lose. They were the big gainers from the Industrial Revolution…and then the late, degenerate financialization stage of capitalism. They will probably be its biggest losers too.

*** Talk about the rich getting poorer! Just look what’s happening to those million-dollar McMansions out in the desert.

"Pity the poor homeowner in Las Vegas," writes our colleague Byron King, "with 12-inch tiles on the floor instead of the de rigueur 20-inch tiles. Or thin granite veneer near the bathtub instead of granite slab. These manses are now obsolete, and perhaps unsaleable to any but the least hip. Really, can you spell ‘Loser?’ Dude, where’s your seeing-eye dog?"

Byron is referring to the speed with which a rich man’s house in Las Vegas becomes a not-so-rich man’s house… The hot desert sun seems to do to housing fashions about the same thing it does to lettuce. Crisp new places wilt after only a few years. Then, you can barely give them away. The rich don’t want them because they’re no longer cool And the poor can’t afford them. What can you do? Blow them up?

The LA Times ads details:

"They blow up aging casinos in this town. Now, some are wondering what to do about yesterday’s desert dream homes.

"Take the foreclosed million-dollar house realty agent Michael Antos recently showed. Please.

"To the untrained eye, the four-bedroom, five-bath retreat may appear top-drawer, shimmering with granite and marble throughout, and with posh touches like a pool with a sandy beach entry.

"But Antos pointed out that the house was showing its age. After all, it was built in 2000. In Vegas, that makes it as dated as a coin-operated slot machine.

"The chandelier? Plastic. The granite surrounding the upstairs bathtub is tile, not slab. And those polished travertine tiles in the entryway may look luxurious, but at 12 inches by 12 inches, they just won’t cut it today.

"Now you’ve gotta have at least 20 by 20 to sell something at this price," Antos explained.

"The housing slump has fattened the inventory of unsold homes throughout the country, and a staggering 51% of them in Las Vegas are vacant. But there’s another twist to the story here: a glut of glitzy homes.

"About 1,000 houses are listed for sale in Las Vegas for $1 million or higher, more than 600 of them built since 2004. But unless they’ve been constructed in the last year or two, the properties are considered out-of-date, making them all that more difficult to sell, real estate agents say."

*** The Olympic torch went through Buenos Aires on Friday. People began assembling on the sidewalk about 3PM…small groups at first. Then the crowds grew. By 3:30 the crowds and the traffic were so thick we wondered how the torch would get through.

And then the police showed up – dozens of motorcycles and squad cars…then, whole phalanxes…each one driving the crowds back further…and directing the cars onto side streets. It seemed disorganized. Kids played in the streets. Police didn’t seem to know which direction to push back the crowds.

About 5 minutes later, we heard the honking of horns…and went back out on the balcony. The parade took place on the Ave. 9 de Julio – the widest street in the world, which happens to be right outside our South American office. From down the street came a group of runners dressed in red…flanked by what appeared to be volunteers of all sorts, running along with them. Then came buses – many of them flying Chinese flags…and a few Chinese on bicycles… And an open bus full of people with cameras. And then, finally, came a group of runners with a young girl in the middle of them; she was carrying the Olympic torch. The crowd cheered. More red flags. And then more buses, more runners, more police motorcycles, and more Chinese people.

Then, gradually, the crowds dispersed like a bad smell. And then it started raining.

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Be sure to check out Byron King’s latest report in Energy & Scarcity Investor. In it, he details a company that has the technology to "microwave" any item made out of oil…and actually extract and reuse the oil. This company could deliver in-the-know investors a gain of 1,310%.

The Daily Reckoning