Land of the Rising Sun... Has Officially Sunk

When the sun rose on 2008, the typical Japanese was still in a fetal position, with his head down and his wallet closed up tightly. But along came the sell-off of 2008 – and he got the boot again. The Nikkei fell another 50%.

As if the poor Japanese investor hadn’t had misery enough! He’s been beaten up for the last 18 years. He was whacked when Japan, Inc. went bust in 1990. He was smacked when stocks fell 70%- 90% during the ’90s. He was racked with pain when property collapsed to as little as one-tenth its late ’80s value. He was starved for yield when the Japanese Central Bank dropped its policy rate to zero and kept it there for six years. He was tortured over an entire decade as his government wasted $1 trillion trying to force him to spend and invest. And he was hung by his thumbs in four separate recessions. You’d think Mr. Market would have the grace not to kick him when he was down.

When the sun rose on 2008, the typical Japanese was still in a fetal position, with his head down and his wallet closed up tightly. But along came the sell-off of 2008 – and he got the boot again. The Nikkei fell another 50%. The Japanese investor who bought stocks in 1982 when he was 35 years old is now 61…and his stocks are not worth a penny more! And this week he got the news that the Japanese economy is once again in recession. Today, we feel his pain – not so much because we sympathize with the Nipponese themselves, but because now we are Japanese too.

The G20 nations met in Washington last weekend, hoping to get a little preview of the future. They thought they might do a little editing before the film was released to the public. But while the Japanese example was available for all to see, no wanted to look. And so, the meeting came to an end and the heads of state left town with a clear conscience; while they had done no good, at least they had done no harm.

Even seasoned hacks seem to have no idea what is going on. "Barron’s" has been putting out a financial weekly since 1921. You’d think in all that time they’d get a little idea of how things worked. Nope. The best advice they could give to President-Elect Obama was the same program that didn’t work in Japan: protect the dinosaurs…and spend more public money. Curiously, the paper wants to bail out Ford and GM but let "Chrysler go under." (What does Barron’s have against Chrysler? Maybe the publisher owns one of its cars….)

Since neither pundits, ministers plenipotentiary nor Wall Street pros pre-penitentiary have yet explained the crisis, it falls to us to do so. We will pass over what went wrong; everyone now knows. But we offer an important nuance: this is not a typical business cycle recession. The idealized business cycle downturn came about after an economy "overheated." Labor rates rose and the cost of living went up. This consumer price inflation forced the central bank to raise rates, causing the economy to "cool off" again.

Today’s recession in America and Britain is a credit cycle recession; it is different. For proof, we offer exhibit A: a corporate bond from International Paper Company with a yield of nearly 10%. Compare that to the yield on U.S. Treasury paper – barely one tenth of one percent on 91-day T-bills. Even the 10-year Treasury notes pay less than the official rate of consumer price inflation. The "spreads" between corporate bonds and U.S. government bonds are wider than at any time since America’s Great Depression. Why?

Investors all over the planet are taking a beating. Mr. Market has taken a cudgel to stocks, property, consumer spending and the economy – just as he did in Japan during the "Lost Decade." People are afraid to lend and afraid to borrow; they worry that the money will be knocked senseless before it finds its way home.

This time, the economy did not overheat…nor did labor rates go up. And when the bubble popped, the pin was not higher lending rates. This bust was caused by too much credit, not by too little. It is what economist Richard Koo calls a "balance sheet recession" a la Japan in the ’90s. That is, it is a time when businesses, investors and householders realize that if they don’t cut back they could go broke.

And unlike the more typical recession, this is a slump the feds can’t control and can’t cure. They can offer easier credit; but more debt is just what both lenders and borrowers are most afraid of. The feds can offer more props, more handouts, and more public spending too, just like Japan. But all they are doing is retarding the correction. Mistakes of the bubble era need to be fixed. Balance sheets need to be brought back into balance. There’s no way around it. Japan proved it.

Just a few months ago, investors reached for the highest yields they could get. Now, they fold their arms, clutching to their breasts the lowest-yielding paper on the planet. Once they believed in capitalism and its bonds. Now, they want nothing that does not have the seal of the US government on it. A few months ago, they saw no danger. Now, they see nothing else.

Years ago, driving out of Paris for a long weekend, we tried a diversion:

"What do you want to be when you grow up?" we asked the children. To our surprise, among tomorrow’s pilots and ballerinas was one little 6-year-old with a strange itch: "I want to be Japanese," said Henry.

That was 12 years ago. What seemed impossible then seems inevitable today.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

November 21, 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.

What a week! It’s Friday…thank God.

We walked along the Seine last night, on the left bank, making our way to a romantic restaurant rendezvous. It was a lovely night. Paris is the world’s most beautiful city…and along the river, near the Pont Neuf and Notre Dame, we watched the lights on the water…and the outlines of the buildings on the Isle de la Cite…and the Rive Droite. A gentle mist fell on the scene like an impressionist’s brush.

But as pretty as it was…and as much as we looked forward to our dinner…we walked along with our head down. It’s the end of the world as we know it…and we don’t feel so good.

Why? Because this correction is beginning to hurt.

On Monday, we put out the word that the Morgan Stanley index showed a worldwide loss of equity value of some $30 trillion. By Wednesday, we got an update: another $2 trillion had been lost. And yesterday, once again, the Dow went down hard – another 445 points were lost. This brings the index down to 7,552…another day like that and it will have wiped out all the gains of the last six years. The low for 2002 was 7,286. It looks like we’ll get there soon.

That will mean that Mr. Market will have corrected the entire 21st century rally. You’ll remember, we thought the bear market began in January 2000. Stocks fell. Then, in October 2002 began a uptrend that most people took for a new bull market. We figured it was just a bear market rally – a trap for unwary investors. But it lasted so long and took stock prices so high that even we had trouble sticking to our story.

Now we see we were right. Almost all the gains made by investors in this century have now been corrected.

But what next? Will Mr. Market stop there? It doesn’t look like it. We’ve never seen him so angry…and never seen him so determined to do damage. It looks to us as though he wants to correct a lot more than just the bear market rally…

….maybe he’s going to correct the entire bull market run that began in 1982. If so, you can expect the Dow to sink down to about 3,000 (adjusting the ’82 level to inflation).

…maybe he’s going to spank the baby boomers. They didn’t save. They were reckless and spendthrift. They’ve lived such charmed lives; they were born just after the last Great Calamity – the period of 1914-1945. But now it looks like they are in for a correction…correcting their foolish habits and silly ideas. In other words, it looks like the boomers are going to sweat – for the first time in their lives.

…maybe he’s going to correct the entire post-’71 funny money system, taking the dollar down a peg so it’s no longer the world’s only reserve currency.

…or maybe he’s going to correct something even bigger. A "correction" is an episode – inevitable, but rare – in which mistakes are identified and put right. But there’s another way of looking at it…it’s a period when things regress to the mean…when they go back to normal…when they return to where they ‘ought’ to be.

Well, it’s not ‘normal’ for the price of oil, for example, to shoot up from barely $30 to nearly $150 in the space of a couple years. Now, we’re seeing the oil price come down to more normal levels. Yesterday, oil dropped below $50. This morning, in Asian trading, it is below $49. It is regressing to the mean. It might even "overshoot" to get there.

It may not be ‘normal’ either for a man in Detroit to earn $35 an hour while a man in Shanghai earns only $1.50. Both men’s work should be worth about the same thing. And for most of human history, there was probably little difference. In the 18th century, for example, economists believe that a fellow had about the same standard of living, whether he lived in Delhi, Detroit or Dongguan. Then began an anomaly. Detroit took off. Thereafter, people in Europe…or of European descent…earned far more than the ‘wogs.’

Naturally, the Europeans developed a certain sense of superiority.

"What separates civilized men from barbarians?" the French have been known to jest. "The Mediterranean!"

*** Now, it’s the Europeans and Americans who are on the wrong side of the Mediterranean. They have a big disadvantage: their costs are too high. Just look at Detroit. Its labor is too expensive. It has too many legacy costs. It operates with too much overhead…too many lawyers and bureaucrats…too much staff…too many expenses and impediments that its competitors in China don’t have.

And so now, the Chinese are proposing to buy GM! Can you believe it? What was good for GM was supposed to be good for America – at least, it was in GM’s heyday. But now they’re talking about selling the whole U.S. auto industry to communists. Here at The Daily Reckoning we’re having a serious case of irony overload… We read the headline news…and we just don’t know what to make of it.

But yesterday evening…walking along the quai…we had a thought. What if Mr. Market intends to correct the entire European advantage? What if he intends to correct the entire Industrial Revolution…bringing the developed world’s GDP/person more into line with those in China and India? Maybe he intends to unhinge the sky again? Maybe we will see all five stages of collapse – financial, economic, political, social and cultural…and maybe some hurricanes and a major epidemic too!

But we’re not going to worry about it. That is all in the future…perhaps the distant future. Let’s get back to what is happening right now.

The feds are now in full inflation mode. They’re cranking out as much cash as they can. But as much as they create new money – Mr. Market destroys it faster.

And what will happen today? Who knows…? But yesterday probably took another $1 trillion out of the financial world’s stuffing…

A Reuters report tells us that it will take a lot more than Paulson has left to fix what it wrong with Wall Street. Financial institutions need between $1 trillion and $1.2 trillion to repair their balance sheets, says an analyst.

Remember, it’s a "balance sheet recession," not a standard business cycle recession. Companies, governments, consumers, investors – we’re all desperate for cash to rebuild our balance sheets. We need to pay down debt and build up savings.

And given the size of the holes we have to fill, you can expect some big loads of sand, rocks and gravel coming from the world’s central banks. In fact, one report we got this week tells us that the size of the campaign – in dollar terms – is already over $4 trillion…or more than the cost of WWII.

*** Joblessness is near a 26-year high, says a Bloomberg report. Lost your job on Wall Street? Need retraining for a new career? Learn to say, "Would you like fries with that?"

Yes, it’s the "New Frugality," says the Associated Press:

"It is a whole reassessment of values," said Candace Corlett, president of the consulting firm WSL Strategic Retail. "We’ve just been shopping until we drop and consuming and buying it all, and replenishing before things wear out. People are learning again to say ‘No, not today.’"

"The trend is evident in where cash registers are ringing, and where they are not."

*** A federal judge has just ordered the Pentagon to release two of its Guantanamo prisoners. The conservative judge was supposed to be friendly to the Bush administration, but even he could find no justification for holding the two men.

Which sounds to us like another charge that will eventually be brought against Dubyah and his Hole in the Head gang – unlawful imprisonment.

More below…but in the meantime, be sure and sign up for the second installment of our Emergency Retirement Recovery Series of webinars. This time, Chris Mayer tackles this market, and tells you exactly where to look for long-term profit opportunities.

The Daily Reckoning