La Bubble Epoque

All over the world, prices are falling. Inflation is no longer a sure thing. For the first time since the 1930s America, and many other nations, run the risk that inflation rates will turn negative. Bill Bonner explores…

“It was horrible! Horrible! Like lightning had struck. No one was prepared.

“You cannot imagine the rapidity with which the whole thing happened. The shelves in the grocery store were empty. There was nothing you could buy with your paper money.”

In 1993, Friedrich Kessler, law professor at Harvard, described an event from his past – Weimar Republic’s hyperinflation. He might have been describing the future too.

All over the world, the inflation pumps are running hot. In Australia, the government recently announced a stimulus program. Checks of $1,000 per child will be sent to deserving parents. Senior citizens will get $1,400.

The Japanese have a 5 trillion yen program, while Europeans are in for $1.8 trillion. But it in the United States the pumps are practically burning up. The Americans have put up $8.5 trillion, including $120 billion to bail out a group of foreign countries, as well as the homeland. A trillion here…a trillion there…pretty soon you’re broke. But who’s worrying?

“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States,” Ben Bernanke assured Congress, adding that “a determined government can always generate higher spending and hence positive inflation.”

So determined was the U.S. Fed since 1970 that the dollar lost more than 3/4s of its purchasing power. But now, all over the world, prices are falling. Inflation is no longer a sure thing. For the first time since the 1930s America, and many other nations, run the risk that inflation rates will turn negative.

Ben Bernanke has been wrong about many things; but as to the Fed’s ability and determination to destroy the dollar, he is almost certainly right. The burden of today’s column is that we share his confidence. Having inflated so many bubbles – including the monster in private debt that has just blown up – the Fed chief should have little trouble inflating another one in public debt.

History will record that the Bubble Epoque began soon after the Plaza Accords in 1985. The immediate problem confronting the finance ministers and central bankers at the Plaza Hotel in New York was what to do about the dollar. After having gone down in the late ’70s, it went up so much in the early ’80s that there seemed no stopping it. The strong dollar had its advantages of course. American tourists visiting London in the early ’80s could leave their calculators at home. A dollar was a pound. A pound was a dollar. But the strong dollar was a threat to America’s commercial interests. Japanese imports, in particular, were undermining America’s competitive position.

So the assembled economists came up with a solution. It was decided that the yen should be revalued, upwards, so as to tilt the playing field a little more in the Yankees’ advantage. With a higher yen and a lower dollar, products from Japan would have to roll uphill if they were to reach U.S. markets.

Since Richard Nixon had closed the gold window at the U.S. Treasury, in 1971 dollar, not gold, was the bedrock of the new financial system. But the dollar was hardly granite. It was more like gas. Foreign nations bought dollars from their local merchants and exporters, and paid for them with their own currencies. The more greenbacks America emitted, the more money of all shades and colors expanded all over the planet. If central banks failed to keep up with rising supplies of dollars, their local currencies would rise against the greenback, hurting sales to everyone’s favorite customer, the USA. The banks also used dollars as reserves; as their capital increased, so did their lending.

The system was absurd; but it wasn’t unpopular. The more Americans spent, the more money foreigners had available to lend them

Readers should be grateful; if this column were not so short we would give you more of the details. But there is no need. The facts are not in dispute. The Plaza Accords was followed by the first major bubble of the bubble era – in Japan. The Nikkei Dow, rose from 12,000 in 1985 to over 39,000 in 1990. Property prices in Tokyo soared.

The Japanese bubble found its pin in January of 1990. It brought about a bust that has lasted longer than marriages and refrigerators. The Bubble Epoque was only beginning. A few years later came bubbles in Asia, Russia, and an oft-rehearsed one in LongTerm Capital Management. LTCM was the blow-up not heard around the world. Investors should have listened more carefully. The fund had two Nobel prize winners on its payroll. Their theories of risk management and mark-to-model pricing were clearly wrong. Pity no one noticed.

Instead, the authorities learned exactly the wrong lessons. When one bubble blew up…the feds pumped in more hot air – inflating a new bubble somewhere else. When the bubble exploded, they pumped overtime. Pretty soon, they had inflated huge bubbles – in emerging markets, housing, consumer credit, the financial industry, commodities, food, and even art. Private debt – used to fund the asset bubbles – was the biggest bubble of all. And now, with all those bubbles flattening, along comes another one. A bubble in public debt.

It’s inflation they want. And inflation they shall have. Of course, Mr. Bernanke is as keen to avoid the “hyper” modifier. “Just a little bit” would be plenty, he says to himself. He aims for 2%…maybe 5%. And if inflation rises to 10%…20%…or more…he won’t be the first central banker to miss the mark.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning
December 12, 2008

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, written with co-author Lila Rajiva, is available now.

Washington to Detroit: Drop Dead!

Not a headline you’re like to see – more below…

Yesterday brought another almost 200 point drop in the Dow. Gold rose $17.

What’s going on?

Reuters reports:

“The ‘nasty’ U.S. recession will tighten its grip next year as unemployment rises and weak home and stock prices imperil consumers, finance firms and debt-laden businesses, a UCLA Anderson Forecast report released on Thursday said.

“Additionally, a sustained retreat in prices for goods and services is a very real possibility that would further drag on the economy, according to the forecasting unit’s report.

“‘Where only last quarter we were worried about inflation, we are now worried about its very rare opposite: deflation,’ the report said. Falling prices would cut demand and discourage employers from hiring.

“‘The record collapse in oil prices has brought with it welcome relief to motorists throughout the country and an effective tax cut of $440 billion in the form of a lower oil import bill,’ the closely-watched report said. ‘Nevertheless the swift fall in oil prices is now lowering the absolute level of consumer prices and bringing with it likely declines in nominal GDP over the next three quarters.’

“The news from the economy is bad,” the report said. “The recession that we had previously hoped to avoid is now with us in full gale force.”

“The UCLA Anderson Forecast unit expects real GDP to shrink by 4.1 percent this quarter and by another 3.4 percent and 0.8 percent in the first and second quarters of next year, respectively, as consumer and business spending weaken and as the foreign trade that had propped up growth much of this year sags.

“Because Europe and Japan are already in recession and China and India are suffering from a significant slowdown in growth, the export boom of the past few years will wane,” the report said. “Make no mistake the global economy is in its first synchronized recession since the early 1990s.”

“By late 2009 the U.S. unemployment rate will hit 8.5 percent, compared with 6.7 percent in November, as employers shed an additional two million jobs over the next year.”

This is now the mainstream view: the downturn is bad…and getting worse.

The front page of today’s USA Today adds, “Home values may take decades to recover.” Finally, the press is catching on!

Of course, economists’ and analysts’ guesses are rarely worthwhile. How many foresaw the market collapse coming? Very, very few. How many saw the price of oil below $50? Who guessed that Japanese stocks would fall 50%? Or that Warren Buffett would lose $25 billion? Practically no one.

Analysts lack imagination. Instead, they merely read the day’s news…and extrapolate. They imagine that tomorrow will be like today. Often, it is. But sometimes, it is not. And that’s where you get big profits…or big losses – when things happen that are unexpected.

Right now, the analysts and economists are spreading gloom and doom. But Mr. Market likes to surprise us. What will the surprise be? Here is our guess: things will be better than expectations…and much worse too.

Remember, these guesses are worth what you paid for them: but despite yesterday’s setback, we wouldn’t be surprised if this rally continued for several more months. No particular reason. It’s just the way Mr. Market works. Investors have gotten scared…they’re taking precautions. They’re closing their wallets…they’re asking questions and reading prospectuses carefully. Mr. Market will want to loosen them up a bit…get them to relax, let down their guard and come out into the open – so he can destroy them.

He’ll be aided and abetted in this mischief by the feds. A headline in yesterday’s paper tells us that more and more of the economy is directed by the government. As private spenders grow reticent, public spenders become more bold. They’re talking about a massive public health system…new roads, bridges, trains.

Mr. Market surprised us in 2008. He hit harder than almost anyone expected. What’s his surprise for 2009?

Investors are expecting a slump. They’re afraid of bankruptcies, defaults and deflation. Trying to avoid losses, they’re buying Treasury paper. Treasury bonds, notes and bills are said to be the safest investments they can make.

What if they turned out to be the most dangerous investments you could make?

There are two ways in which Treasuries could lose value. Most obvious, the Treasury market could go down. The law of supply and demand has not been repealed…at least, not as far as we know. It requires that when supplies increase, ceteris paribus, prices will go down. Of course, ceteris is not always paribus. And right now, people seem desperate to buy Treasuries in order to protect themselves from the bear market in all other asset classes. But the supply of Treasuries is set to soar as government borrows more and more money for its spending plans. And with spreads between corporate paper and government paper at record lows already, it seems very unlikely that investors’ will become even more desperate in the months ahead. That is, it seems unlikely that they’ll favor Treasuries even more than they do now.

According to the latest estimates, the U.S. Treasury is expected to borrow $1.5 trillion nest year – in addition to the existing debt it rolls over. This puts a huge supply of new debt on the market. Will there be new demand to meet it? Not likely. In fact, the demand is probably going to drop. One reason: the foreigners are borrowing too – hugely – for the same reason. They want to bail out their own economies. Another reason: Americans are spending less on foreign goods – putting less money in the foreigners’ hands that they could lend back to us.

Of course, the feds are ready with a solution…and as usual, the fix will make things worse. Fearing a loss of private demand, the feds are already talking about selling Treasury debt directly to the Fed. But that brings us right to the other way Treasury values can go down – the dollar can lose value too. Not only are bonds themselves subject to the law of supply and demand, so is the currency in which they are calibrated. The more dollars; the less each one is worth.

Normally, it is a no-no for central banks to buy Treasury bonds directly. “Monetizing the debt” is what it is called. It inflates the money supply directly and immediately. So, while Fed buying of Treasuries would help support the market for treasuries, it would undermine the value of the dollar itself.

Either way…Treasuries – thought to be the safest investment you can make – could turn toxic quickly.

*** A headline we’d like to see: “Washington to Detroit: Drop Dead!”

A dear reader criticizes our comments on Detroit:

“Perhaps you should stick to your financial moorings, and not drift to [sic] far into uncharted waters.

“With the exception of Chrysler in the ’70s, the US auto industry has never appeared before Congress asking for loans. In fact, the America auto industry, unlike its foreign competition, has never been supported by government subsidies.

“But the recent brutality of our monstrous US financial system has created – in a very short period of time – a dirth [sic] of sales for ALL car companies, not just the Big 3. This has nothing to do with being nimble; all are feeling the impact. In fact, the Big 3 are now producing cars with comparable quality to the best foreign competition, if you haven’t had time to see the data lately. They’re far cry from the ‘dinosaurs’ you assert they are.

“No this is the direct effect of the disastrous policies of the Fed, Big Banks and their Congressional supporters. There is nothing the auto industry could do to offset this. Yet, what does the Congress do? It blames the car industry for not keeping up – a complete fabrication by the Hill Mob, as you might call them. It’s OK to funnel trillions of $ to banks (non-producers), with little publicity. But when asked to provide a meager (relatively speaking ) $34 billion in loans to keep the Big 3 (producers) producing, they turn it into a circus and require the CEO’s to beg. Unfortunately, the general public, including, it seems, you have swallowed the bait.

“Don’t get me wrong. I’m opposed to any bail outs. If I had to let any industry fail it would have been the non-producing Big Banks. But given that did not happen, there is now no reasonable choice but to help the Big 3, in my view.

“Please recognize that when you downgrade the Big 3 without sufficient data, you are just pandering to the very hacks you rail against. It’s very un-Bonner-like of you. And I’m one of your best fans. Keep up the good writing.”

He has a point: Detroit is largely a victim of Washington. But our point is a little broader. Detroit is a dinosaur and so is the whole system…Washington, Wall Street and the consumer economy too.

Drop dead, all of them!

*** Poor Rod Blogojevich. Voters like to see a politician with convictions, but they get snippy when a politician gets convicted. The Illinois governor is alleged to have been trying to sell the Senate seat vacated by Obama to the highest bidder. Word got out and the federales nabbed him. They think they have a real desperado on their hands.

But what is Blogojevich’s crime? Why shouldn’t the seat go to the highest bidder? People are horrified by the idea. The press wants to lynch him. But the governor has the right to appoint a senator…he has to use some selection criteria, no? The market process works perfectly well for art and whiskey, why not for U.S. Senators?

You probably think we are joking, don’t you, dear reader? But we wouldn’t joke about something as serious as whiskey. Bourbon gets to where it should go thanks to the old ‘bid and ask’ system. No one complains about it. Whiskey is limited in supply; the market allocates it to the top bidder.

Senate seats are limited too. Why not allocate them the same way?

The trouble is that selling a Senate seat makes it look like the game is unfairly rigged. People won’t stand for it. They want the game rigged, of course…but in the old-fashioned way. They believe the Senate seat should go to a hack whose vote the Democrats can count on. Or maybe to someone who will help them raise money. Or, perhaps to a crowd pleaser who will help them win elections…so they can skim more of the taxpayer’s money. Once in power, they’ll take advantage of it, naturally. We would too, if we had the chance. They’ll give their friends jobs, contracts and bailout…and spend billions on their favorite crackpot ideas about how to improve the world.

And in Illinois, they’re just a little more honest about their corruption.

Here’s a story that illustrates how it works:

An ambitious young man from Chicago once went to New York to visit a local councilmember. He was surprised to find the man’s office decorated with genuine Picassos and Rembrandts…and authentic Louis XV furniture.

“How can you afford this luxury on a town councilman’s salary?” the Chicago boy wanted to know.

“Look out that window,” said the New Yorker. “See that bridge? Ten percent…” he explained, winking at the young man.

Years later, the New Yorker returned the visit. This time it was he who was impressed. The Chicago politician wore a fine Italian suit…a Philippe Patek watch…and his office was paneled in oak…with famous paintings by Manet and Cezanne.

“Wow, how’d you manage all this?” asked the Manhattanite.

“Look out the window,” replied the guy from the Windy City. “See that bridge?”

“What bridge? I don’t see any bridge?”

“Yeah…100%” said the Chicago guy.

The Daily Reckoning