Mission Creeps

“Buy when blood is running in the streets,” goes the old adage. Many people believe that time is now…and Bill Bonner can’t help but wonder: What accident is so bloody and so menacing, that it has the world’s three most powerful central banks racing across town, scattering crowds and ignoring traffic signals?

“Credit crisis…foreclosures…market crash…recession…falling dollar…bankruptcy…inflation: Why the Smart Money is Buying,” says this week’s Forbes cover. Forbes thinks it is being bravely contrarian. “Buy when blood is running in the streets,” it quotes a Rothschild. After the traffic accidents of the last 9 months, it thinks it sees an opportunity – similar to the one in 2002. Of course, everyone wants to go against the crowd, provided everyone else is doing it too.

Today, the markets are as crowded with people who believe that central bankers will save the day. Blood may be running in the streets, they say. But the ambulances are on the way. The whole mess will be cleaned up quickly. And with dividend yields near 2% and earnings ratios near 20, a ‘contrarian’ might feel a little hemmed in, like a passenger on a cheap airline.

What follows is a truly contrarian look at our modern ambulance squads…and a modest prediction: there will be more blood on the streets when they get finished.

This week, the sirens squealed in London. The Bank of England announced a new bailout plan, known as the “Special Liquidity Scheme.” The figure of 50 billion pounds was thrown about in the press, but Mervyn King said it was only an estimate. Amid the confusion and complexity of the financial crisis, the BoE’s bailout scheme is as simple and naked as Eve…and as full of mischief. Troubled banks can go to the nation’s central bank and trade their dodgy credits for good ones – government bonds. The plan is very similar to the U.S. Fed’s bailout gesture, known as the Term Auction Facility. The U.S. central bank, also in rapid response mode, exchanges U.S. Treasury bonds, thought to be the world’s safest credits, for a hodge-podge of “alternative assets,” that is, alternative to good ones. Of course, the U.S. Fed didn’t begin or end there. It also cut its rates 300 basis points.

Even the European Central Bank, with its sniffy continental sangfroid is on the scene. While it maintains its key rate at pre-emergency levels to combat inflation, its assets have been growing at a breathtaking rate – nearly 20% per year. The BCE, it turns out, is eagerly providing billions of euros to slippery borrowers, based on collateral which it admits is “less liquid” than before. It has added $115 billion of this sausage stuffing to its balance sheet in the last 12 months.

The initial question a contrarian might ask is: what, exactly, is the emergency that caused these emergency responses? What accident is so bloody and so menacing, that it has the world’s three most powerful central banks racing across town, scattering crowds and ignoring traffic signals?

On the surface, there is none. What does it matter to us if a few over-stretched banks and bankers lose money? Last time we looked, there was still full employment in Britain and America. And in Europe, where full employment is less of an issue, those who put their shoulder to the wheel last year still do so. World GDP is still going up – though not quite as fast as before. Inflation is still almost under control. As near as we can tell, God is still in his heaven. The queen is still on her throne. In the United States, stock prices are moving up…and house prices are down only about 15% from their all-time high. And U.K. property prices had barely begun to decline at all. The emergency, as near as we can tell, is only that some people are getting what they’ve got coming; central banks – essentially, a bankers’ guild – are trying to prevent it.

Rescue missions used to be rare. Between the day BoE governor Lancelot Holland administered a 4 million pound transfusion to Overend, Gurney & Co. in 1866, and the day the medics appeared at Northern Rock, 141 years elapsed. But rescues are becoming much more common, largely – we contend – because central bankers are causing more accidents. Central bankers have allowed what business analysts call “mission creep.” They used to be concerned only with protecting the value of the currency itself. As for the rest, it was up to businessmen, investors and bankers to look after themselves. But now, there’s a central banker directing traffic on every street corner. Full employment, re-election, trade balances – soon, they will be helping kittens down from the trees…while the currency goes to hell.

The last big pile up came in 2001-2002. That was such an emergency that Alan Greenspan felt the need to cut the signal lending rate in the United States down to 1% – far below the level of consumer price inflation as well as the real cost of money. This ’emergency rate’ was left in place for far too long; it is what led to an explosion of borrowing and spending…the bubble in residential real estate…the subsequent blow-up in subprime…and today’s on-going emergency.

“Contrarian” investors, then as now, might have figured that the bottom was in by the autumn of 2002. They would have been right – to an extent. But the smartest move in 2002 was to buy neither stocks nor property. The smart money bet against central banking itself. The smart money bet that the Fed’s easy money policies would do more harm than good…and that the central bankers’ own paper currency would pay the price. The smart money bet on gold, which has more than doubled subsequently. Our guess is that gold will be the ultimate winner this time too.

Until next week,

Bill Bonner
The Daily Reckoning

April 25, 2008 — Rome, Italy

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

“Bill, you’re wrong about two things,” begins a helpful Dear Reader. “First, you’re wrong about emerging markets. You say they are going up, along with gold and commodities…while U.S. stocks and U.S. property goes down. But so far, emerging markets have been the biggest losers in this financial ‘adjustment’ we are suffering.

“More importantly, you’re wrong about Diocletian. Not about his economic policies, but about the Piazza di Navona. It was not Diocletian who built a stadium there; it was Domitian. Big difference.”

Our reader is wrong and right, in that order. That is, he is wrong about emerging markets and right about the Piazza di Navona. As to the latter, we were misinformed…and realized it when we were having a cup of café latte out in the square and looked over and saw the “Ristorante Domiziano” on the opposite side. Why would they name a restaurant after Domitian in Diocletian’s square, we wondered. Turned out, it was Domitian’s square, not Diocletian’s.

About Domitian, we knew nothing. So we looked him up.

As to emerging markets, our Dear Reader has noticed that they have taken a beating. Shanghai was in a bubble – as we pointed out a year ago; it is down now 50%. Vietnam is down 53%. Many others have been hit hard too – although, the Latin American market has held up well.

Emerging markets are among the many things we know little about. But that doesn’t stop us from having opinions. And our opinion is that the world is turning. That will come as no shock to you, Dear Reader. You get up in the morning and see the sun rise. In the evening you see it go down. You took science classes. You know how it works. The planet spins on its axis.

You’ve read the poets too. “Gather ye rosebuds while ye may…” they warn us. Because “this same flower that smiles to-day To-morrow will be dying…”

You know what we’re getting at, in other words: things change. “You’re riding high in April…you’re knocked down in June…”

Well, that’s our point. This is April. June is coming soon. And that bright light that shined so beautifully, warmly, wonderfully on the West …is now headed East – to the emerging markets. Those markets are having a correction…which could turn out to be a buying opportunity.

Speaking of corrections – the price of gold dropped below $900 yesterday, coming to rest at $889. The last time this happened – just a few weeks ago – we opined that it was a buying opportunity…and that it “may be the last opportunity in our lifetimes to buy gold below $900.” Well…now we have another opportunity. Will this be the last one? We don’t know. But it never hurts to take advantage of an opportunity such as this one…especially when you can pad your portfolio with the yellow metal for a penny per ounce. No joke.

Long time Daily Reckoning sufferers know we don’t know…that our ‘big picture’ analysis is just guesswork. We breathe. We eat. We are mortal. And like all mortals, we live in darkness…with only an occasional flicker of light to shine upon our path.

Looking ahead, what we think we see – through the dense fog of news and opinion – is a world of ‘flation.’ That is the fundamental condition of the world economy ever since 1971, when the golden shackles were taken off and the world’s money supply was allowed to run wild. The U.S. money supply is said (the government no longer gives out the numbers) to be increasing at 20% per year. Interest rates are being pushed down by the Fed. The U.S. federal government is running a record deficit…and financing the most expensive war in history with borrowed money.

Rome got itself into a similar bind. It couldn’t support the empire from its own resources. It had the reserve currency of the day…but it was a metal-based money. All emperors could do was to send more slaves to the mines to try to dig out more silver and gold…levy more taxes…and squeeze more money and resources from Rome’s far-flung tributary nations.

The population of Rome itself rose to over 1 million people – far more than could be supported by the local economy. What resulted was the equivalent of a huge trade deficit – with shiploads of wheat, marble, wood, wine and other products arriving at the port of Ostia, near the capital, and then shipped up to Rome itself.

By the time of Domitian, this trade deficit – combined with almost constant warfare – had already brought a substantial inflation to the empire. Domitian’s father, Vespasian, had devalued the currency. But Domitian was the Paul Volcker of Emperors. He actually restored the value of the denarius to Augustine levels, increased tax collections, and managed to leave the government with a surplus.

*** Let us return to the news and to our look at the essential picture. From the Financial Times comes the view from the sunny side of the street:

“The optimistic view is based on two distinct elements. First, that the deleveraging process is reaching its natural end as valuations stabilise and institutions come clean about their losses and raise capital; second, that a series of previously unthinkable policy responses have been effective in restoring liquidity to the financial system.

“Both views have merit. Financial institutions, particularly in the US, have recognised the scale of the problem and are taking remedial steps. Just witness the recent round of capital raising by Citigroup, Merrill Lynch, JPMorgan and Wachovia . At the same time central banks in Europe and the US have opened up their financing windows, expanding the size of the financing, the range of institutions that can access it and the list of eligible collateral.”

The report goes on to suggest the alternative…that policy reactions (by the Fed and other central banks) may be “too little, too late.”

And here, we think the writer is wrong on both scores. That is, the real problem is not one that can be fixed by putting more money into the banking system. It’s more basic than that. When a bubble pops, it’s almost impossible to pump it up again. You pump and pump…but the air goes somewhere else. The consequence of the dot.com bubble, for example, was that expectations for the new age of computerized communications were over-bought. New money could be put into the system. But the new money didn’t go into dot.coms. It went into housing and finance. Now, those bubbles have popped too. The authorities are pumping new money into the banking system…but where is it going? We already have plenty of houses in America – more than enough. Don’t expect a boom in the housing industry anytime soon. And take all those leveraged, sophisticated CDOs, MBSs, SIVs, and the rest – please! Who’s going to put more money into those?

No, dear reader, that’s not the way it works. New money looks for a new home…a new bubble to inflate…not one with a hole in it.

Our guess…and again, we warn readers that we are just guessing…is that this inflation is going into gold, commodities, oil…and, yes, emerging markets. Our guess is that the setback for emerging markets is just a correction, not a fundamental shift of direction.

Our guess is that the setback for gold – down below $900 – is also just a correction, not the end of the bull market. Indian stocks…the Vietnamese economy…commodities…gold – all still have a lot of room on the upside.

Our resident commodities guru, Kevin Kerr, couldn’t agree more. “A nasty rumor has been going around that the commodity markets are old hat and will soon go the way of the dinosaur,” says Kevin.

“‘They’ have been saying that since I started on the floor almost 20 years ago. I’m here to tell you that not only are these markets stronger and more modern than ever, but there’s never been a better time than right now for investors like you to make lifestyle-changing profits, and probably more quickly than you ever thought possible. I know, because I’ve done it myself!”

Kevin is offering an incredible deal for his commodities options trading service: 3 months completely free of charge for Resource Trader Alert. Don’t miss out. This offer it too good to pass up, and will only be offered for a limited time.

*** But let’s go back to the Financial Times for a look at the dark side of the street:

“Pity the US consumers. Their ability to sustain spending is already challenged by the declining availability of credit, a negative wealth effect triggered by declining house values, and a lower standard of living as the result of higher energy and food prices and a depreciating dollar. Job losses will accentuate the pressures on consumers, leading to income declines and a further loss of confidence.

“While the financial system has taken steps to enhance balance sheets, they speak essentially to addressing the consequences of excessive leveraging and imprudent financial alchemy. As such, the nasty turn in the real economy may fuel another wave of disruptions that, this time around, would also have an impact on mid-size and smaller banks.”

*** “Did you see Berlusconi?” asked Elizabeth. “He was just out in the square. That’s what all that noise was about…it was a political rally of some sort. I was just walking through and I stopped to listen to this guy. He was really haranguing the crowd…he looked like the newsreels of Mussolini…making dramatic gestures. A real windbag, as near as I could figure…

“But he was just warming up the crowd. Then, a big black car drove up and Berlusconi got out… There were no security guards, just a couple of aides carrying umbrellas. I guess it is only in America that we think people are going to kill the president. Maybe it is only in America that they are…or only in America that we think the president is worth protecting.

“Berlusconi was smooth. Of course, I don’t know what he said…but he said it so smoothly…so suavely…so confidently that I was charmed. He smiled. He made jokes. He seemed completely in control.”

*** Domitian was the younger son of Vespasian – who founded the Flavian dynasty of emperors, after the Julians petered out. He, Domitian, succeeded his older brother, Titus, as emperor after the later died in 81 AD. Domitian married well – he wed the daughter of Corbulo, a great general whom Nero had forced to kill himself. Then, as emperor, he apparently did a good job of micro-managing the empire’s finances…and wrote a book on baldness.

Domitian is not considered a great military leader, but the business of Rome was war and he was no stranger to it. Soon after he took the reigns of government he was whipping up the warhorses – into Gaul…then Britain…and then into the Dacian Wars and then the two Pannonian wars (the second one against both the Suebi and the Sarmatians). He was said to be planning a third Pannonian war when, in September, 96 A.D., his good friend Cocceius Nerva stabbed him dead and proclaimed himself emperor.

The Daily Reckoning