The Long Road to Ruin

 The stock market seems to be rolling over. Investors read the news. It’s probably
becoming clear to them that the economy is not going back to normal any time soon.
 
Yesterday, the Dow lost another 131 points. Another big day down and it will be in the
7,000-range. Oil sank too – down to $62. The dollar, bonds, and gold stayed about where
they were.
 
Economists are still talking about an “exit strategy.” But in view of what is actually going
on in the economy, they’ll probably want to stay on this highway a lot longer. This is the
long road to ruin, of course. It may be fatal, but it is not – yet – unpopular.
Broadly, what is happening is exactly what should be happening.
 
The stock market rally is getting old…and may have already peaked out. The consumer is
running out of time, money and credit. He has no choice but to cut back. Savings rates are
rising fast – from zero to about 5% of disposable income.
 
Naturally, businesses are finding it hard to make sales. Earnings are collapsing…stock
dividends are down sharply…
 
…and of course, businesses try to cut expenses by lightening up on their payroll.
When the correction began, it was led by losses in the financial sector. Those losses led to
cutbacks throughout the economy. Now, it’s the cutbacks that are leading to financial
losses. The economy followed the markets; now the markets follow the economy.
Investors are realizing that their favorite companies will find it hard to prosper in this
new economic environment.
 
“US consumers fall behind on loans at record pace,” says a Reuters headline.
Delinquencies are going up on a wide range of household debt. Debtors have never had
such a hard time keeping up with payments. Credit card delinquencies, for example, are
running at 6.6%.
 
Well…duh.
 
And no wonder “banks get stingy on credit,” as reported in the USA Today. “Despite
massive government efforts to bolster the credit market, banks are pulling back severely
on card lending,” begins the front-page article.
 
Once again, we see the feds’ plans failing. They give trillions to the bankers; the
bankers cut back on consumer credit. And why shouldn’t they? They can see what the
rest of us see – the consumer can’t keep up with the debt he’s got already.
 
“Consumers aren’t going to be able to save the U.S. economy this time,” The
Richebacher Letter‘s Rob Parenteau reminds us.
 
“Total U.S. retail sales have rolled back to levels we haven’t seen since 2005. Imagine if
every single retail shop opened in the last three years shut down overnight. It’s already
that bad.
 
“A lot of people, from Wall Street to Washington, have a great deal invested in you
believing we can reverse that trend. But, in actuality, the freeze in consumer spending
and the consumer economy could actually take many more years to thaw.”
 
At least, the consumer has wised up. He’s sick of debt. He’s seen where that road leads.
What he wants is to get out of debt…to be free…to be safe.
 
It’s the government that remains stuck in deep illusion… The feds know that it was too
much credit that got consumers into trouble. Their solution? Give them more credit!
The banks are issuing fewer credit cards than they did last year – 38% fewer. They’re
pushing credit limits down too – the average limit on a new card is down 3% so far this
year.
 
Instead of passing money on to customers, the banks are using the feds’ free cash to build
up their own reserves…raise their salaries…and pass out bonuses. Makes sense. What else
could they do with it?
 
“Uighurs are beasts” shout crowds of Han Chinese in the remote northwest of the
country. Uighurs are the Moslem minority. Han Chinese are the majority. And, judging
from the photos, the Han want to kill the Uighurs.
 
One thing smart people always do is to underestimate the power of foolishness. It is
wild and reckless to stir up a race war. But that doesn’t stop people from doing it. Any
kind of war is a blow to reason and civilization. But that hasn’t made war unpopular,
even among the most reasonable and civilized people on the planet.
 
It was within the lifetimes of many people reading this Daily Reckoning that the most
advanced countries on earth began a war of annihilation. At the beginning of the 20th
century, high culture and science were dominated by Germans. German musicians and
composers…German poets and writers…German mathematicians, physicists, painters,
philosophers – even the German economy was a world leader, second in output only to
the United States of America.
 
Then, the Germans went off their heads – along with the Italians, the Russians, the
Japanese…and many others.
 
But the Han have it right. The Uighurs are beasts from time to time. So are the Han…the
Teutons…the Anglo-Saxons…and all the tribes on earth. Occasionally, for no apparent
reason, the masks and restraints of civilization give way to mobs…and the old beast starts
howling at the moon.
 
It happens in markets too. What is a bubble, if not a wild and reckless thing? A kind
of madness? A mass illusion…a foolishness, in which people leave reason and civilization
behind?
 
What if the United States had to pay its debt in gold?
 
In the old days, before the monetary reforms of the 20th century…notably, Richard
Nixon’s unilateral decision to renege on America’s promise to pay its bills in
gold…countries had to settle up with each other in the yellow metal. The system worked
well; it was reliable; it prevented bubbles. Edward Chancellor explains:
 
“A country had to pay for its imports or foreign investments with money gained from a
surplus on trade. If more money was sent abroad than had been earned through exports,
then gold would be packed onto ships to discharge foreign creditors. A declining stock of
bullion would induce the central bank to raise interest rates in order to attract gold from
abroad. Rising rates would produce a credit contraction, unemployment and general
economic misery. The typical nineteenth century was severe, but short-lived.”
 
Then came the improvements. And the Great Depression. And now we are faced with
another one.
 
Governments are fighting this one…just as they did the last one…but with much more
money. The cost is in the trillions – most of it in the form of public debt. How will
these debts be paid? We all expect that they will ultimately be eased by inflation – in
full or in part. But suppose the feds had to pay up in real money?
 
Colleague Simone Wapler compared government debt to government gold. The United
States has gold worth about $241 billion, she reports. Its official national debt is $11.5
trillion. That gives it a debt/gold ratio of 48 – meaning; the feds have 48 times as much
debt as gold.
 
Britain is even worse. Prime Minister, then Chancellor, Gordon Brown sold much of
England’s gold at the worse possible moment – about 10 years ago. This leaves the island
with only $9 billion worth of gold compared to $1,274 billion of government debt – a
ratio of 1 to 139. But Japan is the worst of all. It has $23 billion worth of gold and $7.3
trillion of government debt, for a ratio of 1 to 323. (Of course, Japan has vast holdings of
dollars too!)
 
What nation has the best gold/debt ratio? Switzerland. It has only twice as much in
government debt as it has in gold.
 
Until tomorrow,
 
Bill Bonner
The Daily Reckoning