These Firefighters are Pyromaniacs!

Today, we take a page from the book of one of our favorite economists, Murray Rothbard, and reiterate a point we’ve been harping on since the first issue of The Daily Reckoning: a correction is equal opposite to the deception that preceded it. This financial crisis is nothing new; but if the deception continues, we could see a new record for the world’s most difficult correction. Bill Bonner explains…

This week opened with the wail of fire engines. The Europeans announced a bank rescue, variously reported to cost 1.3 trillion euros (Le Monde)…1.7 trillion (Liberation) or 1.873 trillion (Financial Times). They ought to get their story straight. But who cared…investors had a bid!

As the Great Fire burned through their capital, investors bowed their heads and said their prayers: ‘Please God, spare me…and I will be happy with what I’ve got.” And lo! A host of smoke jumpers came down from the heavens. Investors turned their faces to the sky and thought they saw angels. And there was the archangels Gordon Brown and Henry Paulson leading the flock. Suddenly, the wind died down…and the fiery furnace calmed. ‘Hallelujah,’ they said…and bought some more stocks!

In the last 100 years there have only been two fires similar to that of today. The first inferno was in 1929, centered in New York. The second was in 1989, when Tokyo went up in flames. In both instances, rescuers took extraordinary measures. And in both cases, they not only failed to save the economy, they scorched it even more. Obviously, few economists share this analysis with us. The few who do are probably either insolvent or insane, or perhaps both. So, the burden of proof is on us.

We begin by calling an expert witness; Murray Rothbard, once professor at the University of Las Vegas, now among the forgotten dead. A properly-functioning economy is balanced, he explains in his classic, America’s Great Depression. One industry enjoys an expansion, another suffers a contraction. But sometimes there is a “cluster of errors” which causes a major boom. Whence cometh these errors? Who is responsible for them? Rothbard identifies the culprit: “monetary intervention in the market, specifically bank credit expansion to business.” If Rothbard were still among the quick, he’d probably be pointing his finger at Alan Greenspan – the arsonist who lowered the key U.S. lending rate to an “emergency” level of 1% and held it there long after the emergency was over. With the Fed’s false signal before them, business, investors and consumers racked up the biggest pile of tinder in history. Then, he’d probably point at Ben Bernanke, who continues to add kindling…and to Hank Paulson, who led Goldman Sachs while it created trillions of dollars worth of asset-backed explosives and sold it to financial institutions all over the world.

“The boom…is the time when errors are made…” Rothbard continues. “The ‘depression’ is actually the process by which the economy adjusts to the wastes and errors of the boom… Far from being an evil scourge, [the depression] is the necessary and beneficial return of the economy to normal… Evidently, the longer the boom goes on the more wasteful the errors committed, and the longer and more severe will be the necessary depression readjustment.”

But here come the rescuers with yet more dry wood! After stoking the flames with easy credit…they bring more. Professor Rothbard, reviewing the record of the post-’29 rescue team came to this conclusion: The authorities “met the challenge of the Great Depression by acting quickly and decisively…[using] every tool, every device of progressive and ‘enlightened’ economics, every facet of government planning to combat the depression.”

Yet, the fire didn’t go out. It intensified. An expected recovery in 1931 went up in smoke, says Rothbard, thanks to government meddling:

“The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy and placed where it properly belongs: at the doors of politicians, bureaucrats and the mass of ‘enlightened’ economists. And in any other depression, past or future, the story will be the same.”

Six decades and half a world away, the Japanese proved him right. In January, 1990, a spark touched off the Nikkei Dow. Soon, Japan’s miracle economy was in trouble. Bankruptcies rose. Profits fell. Banks teetered. But the Japanese had their economists too. And soon, they were doing what Hoover and Roosevelt had done before them. As to monetary stimulus, the Bank of Japan’s key lending rate was cut from 5% down to “effectively zero.” And there were plenty of fiscal stimuli too. Japan’s government did just what Keynes recommended – it spent money. It went on a spree of what Alan Booth calls “state sponsored vandalism” in the 1990s, taking the budget deficit to a remarkable 5% of GDP in 2002. Roads to nowhere, concrete shorelines, bridges and dams…Japan, per square mile of available territory, covered 30 times as much surface in concrete as in America. In 1996, the Shumizu Corporation even announced plans to build a hotel on the moon using specially developed techniques for making cement on the lunar surface.

Once again, these heroic efforts produced nothing more than farcical consequences. The Japanese economy is still barely on speaking terms with prosperity. And the Nikkei Dow closed at 8,276 last week… a level last seen (except briefly in 2003) a quarter of a century ago.

America’s pyromaniacs still have a ways to go. There are 150 basis points between the Fed’s current key rate and zero…and the US budget deficit is expected to quadruple – reaching $2 trillion in 2009. In the resulting roast, we predict, even the devil will sweat.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

October 17, 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.

Good news, bad news…and new we don’t know what the heck to make of…

The good news is that the Dow rose more than 400 points yesterday. Or, maybe that’s the bad news. This market needs a good hosing, in our opinion. Best to get it over with.

Who’s afraid of a financial meltdown? Everyone. Except us. On the other hand, we’ve never seen a financial meltdown…and maybe once we have a look, we won’t like it.

What would happen if the banks were allowed to fail? What would happen if the economy were allowed to sink into a recession quickly? What would happen if stocks were allowed to fall to 5 times earnings?

We don’t know. But we guess there would be a few major bankruptcies…a quick drop in prices…and then things would begin to rebuild on a firmer foundation. That’s what happened throughout the panics, crashes and crises of the 19th century.

Things of real value don’t disappear. The houses are still there – they’re just cheaper. So are the banks…and the insurance companies…and the automobiles…and the pizzas.

“Liquidate the banks…liquidate the farmers…liquidate labor…it will purge the rottenness out of the system…” That’s what U.S. Treasury Secretary Andrew Mellon thought in ’29, before Hoover’s world improvers put a muzzle on him. Ever since, hardly anyone has been willing to accept liquidation. They all think that if they’re smart enough they can avoid it. And the public won’t stand for it.

People don’t like losing money. We don’t like it either. But heck, that’s just the way things work. We don’t think we’re going to like old age; but it’s better than the alternative. And a meltdown, at this stage, is probably better than all the efforts made to prevent it.

That’s the trouble with free enterprise. It’s like the weather; people only like it when the sun is shining. But without the rain…things would get awful dry.

Are we making this too complicated for you, dear reader? Just kidding…but you see how simple economics is. People make mistakes. When they make mistakes there’s no point in trying to duck the consequences. The mistakes don’t go away if you deny them. The costs of them doesn’t go down if you put off paying them.

“The best way through trouble is straight through,” an old friend used to say. Let the liquidations begin!

But since the ’20s, we have a more ‘enlightened’ form of economics. John Maynard Keynes maintained that governments could manage the economy so as to eliminate the boom/bust cycle. His idea was hardly original.

Asked what the problem was in the banking system Emilio Botin, head of Santander Bank, said it was simple: “In the fat years, people made mistakes…” People always make mistakes when the going is good. They pay for them when the going isn’t so good.

Keynes’ idea was more than 2,000 years old when he thought of it; it came right out of the Old Testament story of the 7 good years and the 7 bad ones. Pharaoh knew the people wouldn’t be smart enough to save any grain for themselves. They’d make a mistake – and eat it all. So he stocked up the grain in the fat years…then, released it to the people when the lean years came. Keynes said the government should do the same — run surpluses in the good years and deficits in the bad ones.

Since then, of course, governments have proven very good at running deficits – even in the fat years. It’s the surpluses they have trouble with. And now, the United States seems to be entering one of the leanest periods in its economic history. But when Pharaoh George II goes to the granary what does he find? It’s empty! Worse than that…he has a budget deficit of $455 billion – a record – even before the recession starts.

What the heck, he just orders bigger deficits! Cometh a report in today’s press that more and more analysts are projecting a $1 trillion US budget deficit for 2009. (We’re sticking with our $2 trillion estimate…)

But can you really run a sensible ‘Keynesian’ program without surpluses in the fat years? Can you really help your people survive a famine without stocking any grain? Can you really have the hope of Heaven without also having the threat of Hell?

We don’t know, dear reader. We doubt it. Everything seems to work in balance. Give and take. Yin and Yang. To and fro. If you don’t bother to save…you have no savings to fall back on, do you?

*** Here’s some more good news: the price of gold fell $30 yesterday. This is good news for everyone, as near as we can tell. It’s good for the world rescuers because it means investors have more faith in the dollar – and are less concerned with inflation. In fact, the latest report shows the CPI in the U.S.A. holding steady – just as you’d expect at this stage in a deflationary meltdown.

With no inflation to fear…and the threat of a widespread banking collapse averted…investors feel they have less need for gold.

This is good news for us, too, because it gives us a chance to buy the yellow metal at a lower price. At $808 an ounce, gold looks like a good deal to us. Buy gold on dips; sell stocks on rallies.

Of course, we could be wrong. We are frequently wrong. But so far…this financial crisis seems to doing what it’s supposed to do. Deflation now…inflation ahead. How far ahead? How low will gold go before it heads up again? If only we knew!

*** The bad news is that the economy continues to soften. It’s already a little like mashed potatoes. Pretty soon, it will be like potato soup.

The Philadelphia Fed, for example, has an indicator of general economic health. Yesterday’s report put it at its lowest level in 18 years. And the New York Times says house prices could continue to fall through 2009.

Houses, remember, are not an investment. They are a consumer item…a long-term consumable. They’re an expense, in other words, not a profit generator. Since they’re an expense item – like an automobile or Aunt Jemima’s pancake mix – they have to be affordable to consumers. Which is to say, the average house has to be within range of the average house buyer’s budget. By our calculation, that meant that prices would probably have to come down about 30%-40% from their 2007 peak. So far, we’re only about half way there.

*** Household incomes are falling too. Why? Last week put the fear of God in employers. They’re cutting back as fast as they can. From a conference call of business executives:

“Look, we’ve all had it pretty easy for the last few years,” explained one of the participants. “Most businesses had big profit margins. So there was no pressure to cut marginal projects or marginal employees. All that changed last week. Now we have to do what we should have done all along. Now, running a business is not easy. It’s hard.”

“I don’t know…I look at my business and wonder what all these people do,” came another opinion. “And I look at the parking lot at 5:05 PM and it’s almost empty. That tells me that my people aren’t working hard enough. I could probably get rid of half my staff and wouldn’t even notice it. My revenues would probably be the same. They might even go up.”

Not many employers like firing people. It’s like taking out the trash; you only do it when you have to. Now, profits are falling fast. Employers are getting squeezed. Their banks are no longer eager to lend. And the stock market is no longer eager to give them more capital on agreeable terms.

So, what do they do?

“Cut your ‘C players’,” was the advice.

How many “C players” are out there? Millions of them….

*** We’re on our way to Buenos Aires, where we’re going to grow cabbages.

That’s just a figure of speech. Historians of the Roman Empire will catch the reference quickly and congratulate themselves. The rest of our dear readers will wonder what the heck we’re talking about.

By the middle of the 2nd century AD, the Roman Empire had become a remarkable meritocracy. Anyone could join the army, rise through the ranks and even become emperor. This is what Diocletian did.

Most of these emperors – practically all of them – ended badly. Usually, they were murdered by their rivals. But Diocletian was smart. In 305, he gave the empire to a group of successors and resigned. He left Rome for his house on the Dalmatian coast, where he grew cabbages.

No, we’re not really ready to resign…and we hope we’re not a “C player”…but we thought we ought to check on the cabbages – just in case.

*** Also, we promised a Special Emergency Report. We’re working on it…putting together a coherent explanation of what is going on…and a reasonable plan of action for our Dear Readers. We’ve even got a special guest appearance by Lord Rees-Mogg, who was born just before the ’29 crash. When he was little, his American grandfather told him about the Panic of 1907. William says he has financial crises “in his blood.” Stay tuned.

Colleague Dan Amoss has put together a report of his own, in the form of a ‘webinar’ – a downloadable video. The video is only 20 minutes, but in that time Dan packs in the information, explaining how the United States got themselves into this mess, and more importantly, how to still manage to profit…while the rest of Wall Street is losing its shirt.

The video will be ready for your viewing pleasure on this coming Tuesday, October 21, so sign up now. The link below will explain exactly how this will work.

The Daily Reckoning