The Daily Reckoning

Federal Reserve chairman Ben Bernanke answers questions following his speech as part of the Cleveland Clinic "Ideas for Tomoorrow" speakers' series, in Cleveland. (Amy Sancetta/AP)

Bernanke's plot to overthrow the US dollar

By Bill Bonner, Guest blogger / 10.03.11

Where’s the Bastille…?

The Dow got a boost yesterday — up 143 points.

Gold remained where it was — about $1,617.

Dear Readers know what we think.

The Great Correction has a lot of work to do — there are so many things that need correction. And it will take time to do it. Meanwhile, your goal as an investor is to lose less money than everyone else. He who loses least wins!

Stocks should go down. Real estate should go down. Even gold should go down…as the dollar goes up!

Cash will be king…

…until the revolution.

What kind of revolution? When?

Ah…dear reader…you’re asking a lot from a free service!

But what the heck… We’re happy to tell you what we think. We just hope it’s worth at least what you paid for it.

Here’s the way we see it. Cash is king in a de-leveraging, dis-inflationary, depressing slump. The king should reign for a long time…because it will take a long time to squeeze the excess debt out of the US economy.

But as you know, there’s a lot more going on. While the private sector reduces its debt the public sector adds debt. And the people who run the public sector are activists…determined to de-throne the king. They are plotting treacherous acts of insurrection… They are looking for the Bastille!

Here’s Ben Bernanke, stirring up the mob. Bloomberg reports:

Federal Reserve Chairman Ben S. Bernanke said the US is facing a crisis with a jobless rate at or above 9 percent since April 2009, and that fiscal discipline would help spur the economic recovery.

“This unemployment situation we have, the jobs situation, is really a national crisis,” Bernanke said in response to questions after a speech yesterday in Cleveland. “We’ve had close to 10 percent unemployment now for a number of years and, of the people who are unemployed, about 45 percent have been unemployed for six months or more. This is unheard of.”

Mr. Bernanke is preparing the crowd. He wants to take action to topple his royal highness, king dollar. He wants to bring cash down… And he figures that the way to do it is to drop him out of a helicopter.

When people see so much cash fluttering in the air they’ll want to get it…and get rid of it…as soon as possible. That will get the economy rolling again and convince people that he, Ben Bernanke, actually knows what he’s talking about…and that he, Ben Shalom Bernanke, should be in charge. He should be the real monarch…

But Mr. Bernanke’s hour has not come round yet. He is faced with opposition in Congress…and in his own central bank. He will have to wait before it is time to slouch to Bethlehem…he’ll have to wait for things to get worse…then, he’ll be able to start up the helicopters.

What might make things worse? When? Keep reading…

Here’s more bad news for the world economy. Again, Bloomberg is on the case:

China Growth Seen Less Than 5% by 2016: Poll

Most global investors predict Chinese growth will slow to less than half the pace sustained since the government began dismantling Mao Zedong’s communist economy three decades ago, a Bloomberg poll indicated.

Fifty-nine percent of respondents said China’s gross domestic product, which rose 9.5 percent last quarter, will gain less than 5 percent annually by 2016. Twelve percent see such a slowdown within a year, and 47 percent said it will occur in two to five years, the quarterly Bloomberg Global Poll of investors, analysts and traders who are Bloomberg subscribers showed.

China, which saw its exports tumble the most since at least 1979 amid the 2008-09 global crisis, may not be able to rely on trade in any prolonged demand slump in Europe and the US, now battling to avoid returning to a recession. Managing the economic downshift would fall to the Communist Party’s next leaders, as President Hu Jintao and Premier Wen Jiabao begin their transition from power late next year.

“If we’re not buying things, they’re not making them,” said Charles Doraine, Chief Executive Officer of Doraine Wealth Management in Corpus Christi, Texas, and a respondent in the poll of 1,031 investors, analysts and traders taken Sept. 26.

If Americans don’t buy, Chinese don’t make. That leaves both of them feeling a little poorer.

And here’s what happens when people get poor.

PHILADELPHIA (CBS) — Thousands of Philadelphia residents gathered in long lines, citywide, waiting hours outside of 12 County Assistance Offices, hoping to apply for relief following Hurricane Irene.

The residents, many confused and lacking official information, hoped to receive a month of food stamps for food ruined by floods and power problems caused by the hurricane.

The program, called Disaster SNAP (Supplemental Nutrition Assistance Program), was created by the federal government and is administered by the State Department of Public Welfare.

Because of unexpectedly large turnouts, the application process was moved from Disaster Recovery Centers in Philadelphia to the 12 state offices in neighborhoods citywide.

Residents, based on income, household size and proof of flood-damage can receive up to a month’s worth of food stamps.

Those already receiving food stamps are eligible for partial relief, to the extent that their prior month’s food supply was damaged.

Throughout the day Monday, and beginning early Tuesday morning, many state offices had lines stretching for blocks with confused residents, many alerted by other neighbors that relief was available.

Little if any guidance was available at offices in the early going, although later in the day, officials did permit applicants to fill out forms outside the building instead of waiting for hours in line.

A thought keeps coming to mind. This correction is bigger, meaner and longer lasting than even we imagined. It’s not just taking us through a normal recession cycle…and not even through a normal credit contraction.

Actually, we have so little experience with credit contractions that we don’t know what normal is. Like the US in the ’30s? Like Japan in the ’90s?

At least we know how, in theory, credit contractions work. People cut back spending until they have rebuilt their balance sheets. That’s why they are also called “balance sheet recessions.” We can also make some estimates about how long they will last, based on how long it should take to pay down debt. When the correction began we calculated that it would last 7 to 10 years. That’s how long it would take to pay down debt to ’80s levels, assuming savings rates went back to where they had been at the beginning of the ’80s.

Now, it looks like it will take longer. Maybe forever. At least, it will seem like forever.

This is partly because the feds interfered. They panicked when it looked like the process of de-leveraging was out of control. People were going broke — even people who made large campaign contributions! Even people who were members of that privileged fraternity — bankers! So, they came in…and locked up the economy in its depressed state, keeping zombie institutions alive indefinitely.

But that’s not all. It will also take longer because it is a more serious correction. It has a lot of work to do. What exactly?

Well, we don’t know exactly. But many of the governments of the developed countries are not likely to survive.

‘Wow, Bill, have you lost your mind?’

We don’t take anything for granted. And we know that we are sometimes right and sometimes wrong. And always in doubt. Still, the social welfare governments of the modern world are not equipped to deal with this challenge. They were designed for growing economies, not stagnant ones. They were all created in a period of growth — made possible by the widespread introduction of cheap fossil fuels. That period is over. Temporarily or permanently. And the dinosaurs of the growth era are unable to adapt to the colder climate of the new age of austerity.

Here in France, for example, they’ve already taxed the rich about as much as the rich can stand. And they’ve robbed future generations as much as they could get away with. What else can they do?

In the US, they can probably tax the rich harder…but it will yield peanuts, perhaps even reducing the feds’ take. America’s providential state is less generous and less ambitious socially than the French model. On the other hand, the US is far more ambitious militarily. For every layabout chiseler the French supports, the US supports two soldiers and one Pentagon contractor. The cost is staggering …and probably even more irreducible than Europe’s social costs…

Neither the Europeans’ social welfare states…nor the Americans’ welfare/warfare state…are likely to survive in their present forms.

Regards,

Bill Bonner,

A dollar sign drawn in sand at the beach. The value of cash is going up, making things like real estate lose value. (Michele Constantini / Altopress/Newscom/File)

Cash will get more valuable

By Bill Bonner, Guest blogger / 09.30.11

Cash is still king.

Cash is king because non-cash is a commoner and a loser…it’s losing its value. An article in yesterday’s Financial Times, for example, tells that:

“US inflation expectations at lowest point in year.”

In other words, forget inflation. Forget price increases. It’s cash…cash…cash.

Cash on the barrel…cash in hand…cash and carry. You got cash? You da king!

People expect cash to be more valuable. And if we’re right…it will be more valuable.

Stocks, for example, fell Wednesday. The Dow dropped 179 points.

And gold. It lost $34.

Another article in yesterday’s financial press told us that “it’s a great real estate market…if you’re rich.”

Why? Because the rich have cash. They’re the kings, queens and jokers too. And now they can use cash to buy other assets at a discount. They get more for their money. When inflation subsides so do prices. And nowhere have they ebbed more than in the real estate market.

A friend sent us an investment opportunity…a 12-unit apartment building in Florida, a block from the beach. What does something like that go for? Well, in the glory days of the bubble in real estate, it might have sold for $3 million. Today, it’s available for $750,000 — with owner financing at 5%.

Let’s see…if you can get $800 per unit per month…whoa…this could be a good deal. Because you can probably cover the cost of operating and maintenance and still get better than a 5% yield. If that is true, over time, you get the building for free.

But the problem with real estate is that every deal is different. Every toilet backs up in its own unique way…and every roof leaks in a different spot. If you don’t know what you’re doing…don’t do your homework…and can’t manage a property, including collecting the rent from people who don’t have much money, you probably won’t do very well.

Here at The Daily Reckoning we prefer the public markets, where the tenants don’t give you hard-luck stories and the paint doesn’t peel. But what we see in the public markets is a lot worse than what we see in the real estate market. Where can you get a yield of 5% outside of housing?

All over the investment world — except for US government debt — yields will probably go up. Cash in king. But cash is probably going to become even more powerful. In real estate, for example, the bad news is not yet fully priced-in. People assume that prices will hit a bottom and then begin going back up again. They figure they just need to buy at the right time and all will be well. But as we keep pointing out, markets are more like cats than like dogs. They play with their prey…killing them slowly while having some fun at it.

Real estate has already been whacked hard. It’s down 30% to 50% depending on where you look. But is that all there is? Is that the end of it? We don’t think so. The trends that worked so happily together to boost real estate to bubble levels have now become surly and uncooperative.

• Household income is going down, for example. It is almost back to 1990 levels, erasing 20 years of gains. Who wants to ‘move up’ the real estate ladder when his income is going down?

• And the rate of new household formation is going down. Instead of setting up new households of their own, the young…and not so young…are moving back in with mom and dad. The unemployment rate for young people is 20% — near Great Depression levels.

• Population pressure is easing. The rate of immigration, for example, is also going down. There are reports of illegal immigrants returning home in such numbers that there are now more leaving than coming. Besides, with so few jobs opening up, who wants to go to all the trouble to sneak into the country?

• Most important, the Great Correction is far from over. We’re expecting a long period of stagnation, de-leveraging and depression. Prices don’t go up in a credit contraction. They go down. What we’ve seen so far is probably just the beginning of a long trend that will probably take prices down another 50%.

But wait, we know what you’re thinking. At today’s levels, houses in America are not over-priced. They’re about in line with the very long term trend. They’re about where they should be. And at today’s ultra-low interest rates — mortgages are below 4% — housing is a good deal.

Maybe so. But Mr. Market doesn’t care. Just as he didn’t mind pushing up prices to dizzying heights he also doesn’t mind pushing them down to dreary lows. He’s an equal-opportunity deceiver. First, he made people think that housing always goes up. Now, he’ll make them think that it always goes down. And when he’s finished, you’ll be able to buy a house for about half today’s price.

Of course, then…you won’t want to. Because you will have learned an important lesson that you can pass on to your children: ‘Don’t buy a house. Rent. It’s cheaper.’ Then, perhaps house prices will begin to rise again.

In the meantime…and perhaps for a long time…cash is king.

Regards,

Bill Bonner

In a tumultuous week for the markets, the dollar held steady while almost everything else was in decline. (Rafael Ben-Ari/Newscom/File)

The US dollar is still in demand

By Bill Bonner, Guest blogger / 09.27.11

Cash is king.

Ai yi yi…

Last week was the worst for investors in 3 years. Even gold melted down, as we thought it eventually would.

The only things to go up were US Treasury debt and the dollar. As expected, the Great Correction is doing its work.

So far, the stock market has held up as well as it has. But now it seems to be selling off. And gold is selling off too.

Rich people buy gold. They can afford to. They know the end of the dollar is coming — sooner or later. They can wait.

But the middle classes need dollars. Debtors need dollars. Consumers need dollars. Almost everybody needs dollars. In a correction, cash is king. And the king of kings is the dollar. Here’s CNN confirming what Dear Readers already know:

…the data [from the census] gave the first glimpse of what happened to middle-class incomes in the first decade of the millennium. While the earnings of middle-income Americans have barely budged since the mid 1970s, the new data showed that from 2000 to 2010, they actually regressed.

For American households in the middle of the pay scale, income fell to $49,445 last year, when adjusted for inflation, a level not seen since 1996.

And over the 10-year period, their income is down 7%.

“Economists talk about the lost decade in Japan. Well, with these 2010 data, we can confirm the lost decade for the American middle class,” said Jared Bernstein, senior fellow at the Center on Budget and Policy Priorities.

Sure, it’s fair to say Americans at all levels of income, from rich to poor, were hit hard in the decade that started with the dot-com boom and bust, and ended with the Great Recession.

But according to the census data, those losses disproportionately hit the lowest 60% of Americans, while the richest 40% actually gained wealth, relative to the entire US economy.

The middle classes need dollars. They want dollars. Because it’s a currency — believe it or not — that you can still trust. No thanks to Bernanke, Obama, et al. Instead, our gratitude goes to the Great Correction itself. It’s doing the work of an honest central bank. It is making the dollar respectable again. Thanks to the Great Correction the greenback can hold its head up. Uncle Sam’s money is Number One.

How so? In a correction, almost everything goes down. And almost everyone gets scared that his investments and his savings (which he put into stocks on the advice of his financial magazine) will go down too.

Your editor says that in the long run gold will be a better place for your money than dollars. But everyone can’t wait for your editor to be proved right. Most people have bills to pay. And you don’t pay bills with gold. You pay them with dollars.

And imagine that you are a European or an Asian investor? What are you going to do with your money? Put it in a French bank or a Greek bond? Nope. You want something safer. You want a US treasury bond.

And as long as the Great Correction is allowed to continue…US Treasury debt will be a good place for your money. The trouble is, we don’t know when the feds might run in…like a bull in a china shop…and break all the teacups. So, here at The Daily Reckoning at least, we’ll stick with our gold through this correction, confident that when we come out the other side the dollar will be among the porcelain shards and gold will still be standing tall.

When we entered this Great Correction we figured the process would take a few years. We felt like a judge had just given us a prison sentence.

“Five to ten,” said your honor.

Now, it looks like it will take longer. We figured the feds wouldn’t be able to finance their deficits for very long. That would force them to hit the panic button and begin dropping dollars from helicopters. But what the market is showing us now is that this Japan-like phase can last a long, long time. Because the correction itself is making the dollar and dollar debt more attractive!

Get this: the yield on 10-year US Treasury debt is now lower than the yield on the S&P. The longer the correction goes on…the deeper it goes…the more people will want the safety of US notes and bonds. And the more they buy Treasury debt…the lower go the yields…

Meanwhile, stocks should go down…pushing up yields. That’s what happens in a correction. That’s what happened in Japan over the last 20 years.

Most likely, we’ll see yields of 5% on the S&P before this is over. That’s because prices will be cut in half.

Meanwhile, we’ll see yields on bonds go down to 1% or so on the 10-year bonds. This correction means business. It appears to be even more powerful than we imagined. It is not merely correcting a bull market and a credit bubble. We don’t know for sure, but it may be correcting an empire, modern government, the dollar-based monetary system…and who knows…maybe an entire civilization.

We’ll just have to wait to see how far it goes.

The author argues that collapse is really what the economy needs. (David Ennis/Newscom/File)

Go ahead, let the economy collapse

By Bill Bonner, Guest blogger / 09.23.11

A big sell-off Wednesday. The Dow down 283 points. The 10-year T-note yields only 1.87%. And the price of gold barely budged.

In our opinion all three should be going down. Because the world is edging towards a global depression…

…with the US consumer unable to spend…

…the Chinese economy slowing down…

…and Europe preparing for defaults…

Assets should be going down. Except for US Treasury debt…which should be going up. That’s what happens in a depression.

All of which is making our “solution” to the financial pile up of ’08-’09 look better and better all the time. You’ll recall that we promised to tell you how you could fix the problem in our last exciting installment. This must have left you on the edge of your chair. It sure left us on the edge of our chair; we had to think of a solution overnight!

But it is really very simple: give collapse a chance.

Remember how desperate officialdom was to “prevent a catastrophic collapse?” Both in Europe and America. The European banks bailed out their speculators. Then the governments bailed out their banks. Then, they bailed out the countries that had bailed out their banks.

In America, the government bailed out the banks…the insurance companies…the automakers… About the only industry that wasn’t bailed out was the financial publishing industry. Guess we didn’t send them enough campaign contributions…

Then, the Europeans and the Americans bailed out each other.

And they’re still bailing. The US is running a budget deficit so large that we’ve lost track of it…was it $1.5 trillion? $1.8 trillion?

And the Europeans are preparing another big bailout for Greece…Italy…and who knows who else.

And every bailout makes the world poorer. Because it’s clearly bad money after good. Greece does not suddenly become a good credit risk just because you lend it more money. And Americans won’t be made richer because the feds offer them more debt at an even cheaper rate!

The problem is that doing more of something that doesn’t work is not a good idea. When you lose money on every sale you can’t make it up on volume! Nor is it a good idea to put more money into an investment that isn’t paying off….or to allocate more resources to an industry that stopped producing real benefits a generation ago.

Yes, that’s when the education industry turned sour — in the 1970s. Since then, it’s gotten sourer and sourer…with more and more money spent on education but not a bit of progress to show for it. The youngsters are as dumb as ever.

And the oldsters are even dumber. They want to continue to bailout, subsidize, give credit where it isn’t due, and otherwise funnel huge amounts of money to worn out, unproductive institutions. And for what? So they can avoid “a catastrophic collapse.”

Well, here at The Daily Reckoning we say ‘bring it on.’ Let’s have that catastrophic collapse and get it over with. Better now than later. It will only be worse if it is postponed.

But seriously, how would we ‘fix’ the situation? Well…that is how we’d fix the situation. We were being serious. We’re always serious. And earnest. And trying to do our best to help.

But that’s not all we would do. The problem really has two parts to it.

One part is natural, inevitable…it can’t be fixed. When you borrow too much money, you have to pay it back. Or default. Better to do it as soon as possible.

Likewise, if your company isn’t profitable…if your industry can’t take resources and add value to them…then you should go broke. Again, the sooner the better.

In these cases, the ‘fix’ is obvious. Bite the bullet.

But there’s more. There is also the zombie factor. This is something that can be fixed easily. As institutions age — including private industries — they attract parasites. The next thing you know you’re meeting with lawyers and working with regulators. There’s an agency hounding you about one thing…and a department on your tail for another.

And there are taxes up the kazoo. And debt. And extra costs.

You pay for stamps and handicapped parking places. You pay for well-meaning kids to offer advice to hardened heroin addicts…and lobbyists can get a break in the next tax bill. You pay for goons to frisk you are airports and hit squads to take out “insurgents” in cities you never heard of.

Oh, and don’t forget the kid who takes out loans so he can get a degree in the Emotional Life of Fruit Trees…and then defaults on his student debt. And the slob who uses Medicaid and disability to avoid having to go to work.

It’s all part of the picture of a society in need of a revolution…or a kick in the pants.

We propose one or the other.

How? Easy peasy. First, allow businesses and nations to go broke. No subsidies. No bailouts. No below-market loans. Just let them crash and burn. It will be fun to watch.

Second, cut taxes to 10%. That’s all. Just 10%. Like a tithe. With no deductions. No ifs…ands…or buts. Russia already has a tax like this. And it is booming.

And prohibit borrowing. Or money printing. These measures would solve the US debt problem overnight. They would protect the dollar. They would reassure investors, businessmen and householders.

They would also reduce the total US budget from about $3.6 trillion today down to less than $1 trillion. We don’t much care what the feds do with the money. They will surely waste most of it. But so what? A flat 10% tax rate would cut out most of the zombies. Freed from the dead hand of zombidom the private sector could get back to work.

Give it a whirl. Let us know how it works out.

Regards,

Bill Bonner

Bull and bear sculptures by gold bars. The author argues that it is a good time to buy gold, even though the dollar is high. (Creativ Studio Heinemann/Westend61/Newscom/File)

Is this a good time for gold?

By Bill Bonner, Guest blogger / 09.22.11

Not much market movement Tuesday. Dow basically flat. Gold rose $30. Gold investors don’t seem to be able to decide. Is the economy good for gold…or bad?

Here’s our opinion: This is a good time to own gold. But it won’t seem like a good time. Not now. Because the Great Correction just gets worse and worse. And as the correction bites the economy, the dollar goes up against almost everything.

“Gold is not going down,” says David Rosenberg. But we’re not so sure. Gold investors bought gold to protect themselves against the dollar. But in the short and medium term, they won’t need protection against the dollar. They’ll need protection against everything else! They’re likely to be disappointed with gold and drop it as this period of de-leveraging drags on.

Yesterday, we promised to explain what was really behind what Tyler Cowen calls “The Great Stagnation.” We haven’t forgotten. We’ll come back to it. Just hold on.

First, let’s look at how this world economy is slipping into a worldwide depression.

Just check out the container shipping volumes at California ports. They’re down nearly 10% from a year ago. That’s a big drop in world trade. What happened? Did Americans finally get enough gadgets and gizmos from Asia? And what does it mean for the Asian exporters? Their economies depend on buying from overseas. They’re export economies. Of course, it is true that local demand is increasing. Eventually they’ll adjust to fewer exports and more domestic consumption. But adjustments take time…and are usually linked to major financial crises. What will happen?

Here’s an answer from Britain’s Telegraph newspaper:

China ‘faces subprime credit bubble crisis’

Monetary tightening in China threatens to pop the $1.7 trillion (£1.07 trillion) credit bubble in local government finance and expose the country’s simmering “subprime” crisis, according to the Communist Party’s economic guru.

Mr. Cheng said China is entering a “very tough period” as growth runs into the inflation buffers, threatening the sort of incipient stagflation seen in the West in the 1970s and leaving the central bank with an unpleasant choice.

“The tightening policy is creating a lot of difficulties for local governments trying to repay debt, and is causing defaults,” he told a meeting at the World Economic Forum in Dalian. “Our version of subprime in the US is lending to local authorities and the government is taking this very seriously.”

“Everybody assumes that they will be bailed out by the central government if they default, but I disagree with this. It means that the people will ultimately pay the bill for it all, at a cost to the broader welfare.”

Meanwhile, in Europe, Italy got downgraded by S&P. Angela Merkel lost a critical vote. And Greek bankruptcy is right around the corner.

And back in the US the typical American is suffering. He had equity of 61% in his house back in 2001. Now, he’s got a paltry 38%. And he’s lucky to have that. There are 11 million homeowners who have less than zero equity. They’re ‘under water’ and still sinking.

One in four young people is jobless…with sentiment among the youth at a record low. The old people may be optimistic, but not the young.

And 15% of the population — a record number — is now below the poverty line. That’s 46.2 million people living in poverty in the richest nation on earth.

But don’t worry, dear reader, president Obama is on the case. He says he has a solution to the US debt problem. He says he’ll cut expenses and raise revenue. Why didn’t we think of that!

A quarter of the cuts are supposed to come from the military budget. But they’re totally fraudulent. The feds don’t really know how much their wars will cost. So when they talk about ‘cuts’ and ‘savings’ they are talking about reductions in projected costs, not real costs. They’re made-up numbers, in other words. Even they admit that the savings are “illustrative” — rather than real. And there’s no way these illustrative savings will turn real — not as long as America stays on the imperial path.

Obama also wants the rich to pay more in taxes. Heck, Warren Buffett is on board. And so are most of the voters.

Of course, most of the voters don’t pay taxes at all! Not net. About half of the people eligible to vote get more from the feds than they pay in taxes. That leaves the “rich” shouldering an outsize burden. Already, the top 1% pays 30% of the taxes.

But if you’re rich, don’t expect any sympathy from us or anyone else. The rich have rigged the system in their favor. Everyone else has gotten poorer while they’ve gotten richer. Voters will be happy to soak the rich. Heck, they’d drown them if they could get away with it.

But let’s go back to the big picture. Tyler Cowen thinks the US enjoyed the low-hanging fruit. Fertile farmland, cheap energy, abundant water, easy credit…getting rich was a piece of cake.

He mentions too that investments in health care and education seem to have reached points of diminishing returns. The US spends far more on both than other countries…and gets no extra benefit. Our schools are not better. And Americans don’t live as long as people who spend only half as much on health care.

Can we fix this problem, asks Mr. Cowen? Wasting no time answering his own question, he responds that we just need to boost the prestige of scientists…and count on human ingenuity and innovation to come up with a solution. Heck, even Thomas Friedman could have come up with that! In other words, he thinks the system can heal itself.

But the real problem is not a ‘low hanging fruit’ problem. It’s a declining marginal utility problem. And a zombie problem.

As a society ages its institutions become brittle and inefficient. They are no longer dynamic and productive. And, they become nests for dead-head zombies. The two things go hand in hand. On the one hand, declining marginal utility undermines the productivity of future inputs. And the zombies take over…making it impossible to direct inputs elsewhere. The zombies protect their turf; they make sure they get more resources, not less.

Take education, for example. A little of it goes a long way. When a person learns to read and write, the whole world of ideas and information opens up to him. Whether more inputs of formal education actually pay off or not is open to question. Clearly, beyond some point, they don’t. Americans spend twice as much per student as they did 40 years ago. The educational attainment results are about the same. Which suggests that the marginal utility of investment in the education industry declined to zero 4 decades ago.

Most the world’s great ideas…great books…and great inventions were produced by people who spent relatively little time in formal school settings. But now, every goofball and half-wit is expected to have a college degree. What do you expect? A college degree isn’t really worth very much.

But the zombies want their children to go to college. And the zombies want cushy jobs as ‘educators’ and educational administrators. (They don’t want to teach…that’s too hard!) And children are no dopes either; they know it’s a lot more fun to spend 4 years at Party U., at someone else’s expense, than 4 years out in the real world. Especially now, when it’s hard to get a job. That’s part of the reason student loans have quadrupled since ’07.

Obama promised to bring ‘change’ to the nation. But change is the last thing the zombies want. And it’s the last thing that Obama would want to give. The voters wouldn’t stand for it.

Instead, we have a Great Stagnation…an economic deadend…where further inputs into traditional, zombie-controlled institutions no longer pay. More credit? More military spending? More Medicaid? More Social Security? More education? More consumer spending? More hiring? More capital investment? More energy consumption? More programs? More unemployment compensation? More taxes? More laws? More regulations? More lawyers? More educators? More security guards?

Will they pay off?

Not a chance.

Tune into tomorrow to find out how to really fix the problem.

Regards,

Bill Bonner

Euro coins are seen next to U.S. Dollar bills in Frankfurt, central Germany. (Michael Probst/AP/File)

The real cause of economic stagnation

By Bill Bonner, Guest blogger / 09.21.11

We think we’re onto a big story. A BIG story.

This correction is aiming high…it’s going to take down the entire capital structure of the world’s developed economies.

Stocks…bonds…real estate — watch out…they’re all going down.

The dollar…the pound…the euro — look out below!

But that’s not all. No, if we’re right, this is bigger, much bigger than just a market correction.

It’s an economic correction…a monetary correction…and a political correction.

But we’ll come back to that in a moment. First, let’s look at what happened yesterday. The Dow lost 108 points. Not much information content there…

…but look at what happened to gold. It was down $35. Could gold be finally testing its admirers? Though still in a major bull market, could it be correcting…possibly falling back to the $1,000-$1,500 range?

Yes it could. Gold’s time will come. But we don’t think it is here yet. Gold has risen in anticipation of trouble. But the trouble gold buyers foresaw hasn’t come…not yet. There’s been massive money-printing. Still, in terms of the goods and services it will buy, gold has held up pretty well.

Gold will take off — when the anticipated trouble becomes real here-and-now trouble. And that probably won’t happen for a while. And part of the reason it won’t happen is this Big Story we’re following.

You see, our whole economy…and our society…and our government…and much of what we think…all were built on truths that are no longer true.

In a word or two, our modern economy — and our government — depends on growth. And growth may be a thing of the past.

You want to make money, you invest in profit-making businesses, right? Not necessarily. On the whole, investments in stocks only go up if the economy grows. Otherwise, companies are just fighting for market share. One goes up, but another goes down. Taken all together, investors go nowhere.

Well, at least you can always put your money in bonds. You won’t earn a lot of money, but over time you’ll receive safe, sure gains. Right?

Wrong again. Practically all the world’s major debts — private, corporate and government — depend on growth. Without growth, the debtors can’t pay. And if they can’t pay the debt is worthless.

Do you hold Japanese Government Bonds, dear reader? Good luck with that!

But those points are obvious, aren’t they? How about this: if you want healthier people, you just grow your health-care institutions, right?

Wrong again. In terms of a percentage of GDP, Chile spends only a third as much on health care as the US — much less in absolute dollars. Life expectancy in the US is 77.6 years. How long do you think they live in Chile? Well, we’ll tell you — 78.6 years.

Maybe there’s something in the water in Chile. But suppose you could take a group of Americans and give them all the free health care they want. Would they live longer?

Well, guess what, the Rand Corporation tried it. And guess what it found? Except for people who were extremely poor and had no access to health care previously, giving normal people more health care did not make them healthier. The group with free health care consumed a lot more resources from the health industry — about 25-30% more. But it was no healthier.

And guess what else? When it comes to surgery, who do you think comes out ahead — people on Medicaid…or people with no health insurance? The people with no health insurance, of course.

These facts and figures come from a delightfully moronic book called The Great Stagnation, by Tyler Cowen.

He points out that the results from educational spending are similar. In 1971, the US spent a little more than $5,000 per student per year. Now, it spends more than $12,000. So guess how much reading scores have increased? Have they more than doubled too? Nope. They haven’t budged.

This is especially interesting because of something known as the “Flynn Effect.” Flynn noticed that kids were getting smarter every year. So, if IQs are going up, you’d naturally expect test scores to go up to. But they’re not. Which suggests that the quality of educational inputs is going down…so that the results end up in the same place.

In other words, the great Truth of the Modern Age — that further inputs produced further outputs — is no longer true.

What’s the connection between education and government debt? Why are we trying to compare stock market gains with gains in health care?

Here’s where The Great Stagnation falls apart. Its author completely misses the point. He thinks the “low hanging fruit” has already been picked. In a way, he’s right. The big gains in output — in education, health care, heavy industry, farming, banking, debt and many other areas — have already been made. Now, it’s hard to make any successful investment in any area…

…if you invest in more health care…it will probably be a waste of money.

…if you spend more on education (not individually, but collectively), that too will probably be money down a rathole…

…if you increase the level of credit (as the government is trying to do)…you might as well save your money.

…no point in investing in the stock market either. The glory days are over…

…and stay away from the bond market. The debtors won’t be able to pay…

Yes, we’ve entered an era of ‘Great Stagnation.’ And yes, it looks as though the low hanging fruit has been picked.

Tyler Cowen thinks this is a problem that we can fix. He thinks we just have to put our thinking caps on.

The silly goose. He doesn’t realize that the era of low-hanging fruit changed the way we look at things too. It made our arms shorter and our brains smaller. We are all dumb optimists now. That’s what 300 years of finding low-hanging fruit does to a people. We think that every downturn — even a Great Stagnation — can be reversed by, among other things, raising “the social status of scientists.”

No kidding. That’s what he recommends. As if the social status of people was determined by an act of intellectual will.

What a disappointment. We began reading The Great Stagnation thinking its author was a closet Dear Reader. Instead, he turns out to be a disciple of Thomas Friedman.

More on the real causes of the Great Stagnation…tomorrow…

Regards,

Bill Bonner

An investor reads a newspaper in front of an electrical board showing stock information at a brokerage house in Huaibei, Anhui province. The author argues that China is keeping the world economy afloat. (Stringer/Reuters)

Don't rely on China to keep the world economy going

By Bill Bonner, Guest blogger / 09.20.11

What keeps this world economy turning around?

Not the US. America’s private sector isn’t spinning at all. It’s stuck…dead in the water…out of gas…pumped out…

GDP growth is reported at 1%. But that’s almost all government transfer payments and stimulus deficits. Real growth is negative.

And all the recent reports show it is getting worse. Wall Street is cutting earnings estimates…strategists reduced their S&P 500 targets 8%.

…corporate tax receipts have decelerated sharply…

…the president’s job bill is DOA in Congress…

…retail sales are slowing…

…and prices are softening, with the core CPI headed below 2%.

As we keep saying, there is nothing unusual about this. It’s just what you’d expect in a Great Correction. And it will probably get much worse.

How about Europe, then? Maybe Europe is providing the steam to keep things moving.

Uh uh. Moody’s just downgraded French banks… It assumed they would lose 60% on their Greek debt holdings. But the banks themselves have only written off about 20%. And then there’s the Italian debt. And the Spanish debt.

They’ve got a long way to go. And it’s all down.

Merkel and Sarkozy may pledge to keep the olive countries from defaulting. But where will they get the money? France is deep in debt too. And the German economy has stopped growing all together. Not to mention that German voters are just about fed up. They won’t pay for the Greeks to take early retirements forever.

Europeans are becoming old, tired pinchpennies. Just like Americans. They’ve got a social welfare system they can’t afford — just like Americans. And they’re going broke — just like Americans.

What they don’t have is a huge, expensive, aggressive military. Americans regard their armed forces with pride. They see the Pentagon as their greatest strength. Actually, it is their biggest weakness. All told, the imperial agenda costs the US $1.2 trillion per year. Ultimately, both Europeans and Americans may be forced to tighten their social welfare belts.

But can the Americans off-load their ammunition belts? We don’t think so. There are two parts to the human character, said the ancient Greeks. There is appetite and spirit. Appetite is logical, goal-oriented, material…and sensible. But the spirit is mad. It is concerned with symbols…atavistic impulses and the length of God’s arms. The spirit sets off on the road to Hell. The appetite shows it how to get there.

But we are getting off the subject. What keeps the world economy going, we asked? Europe is stuck in the mud. The US is exhausted.

But wait. There’s China. Uh oh. The Middle Kingdom looks like it is slowing down too. Ambrose Evans Pritchard in The Telegraph:

China risks hard landing as global woes spread… China’s carefully-managed soft landing is turning harder by the day, threatening to deflate the torrid credit bubble of the past three years. Beijing is alarmed by inflation above 6pc and price-to-income ratios for property in the rich coastal cities… “There is a large potential risk,” said Zhu Min, the deputy managing director of the International Monetary Fund and a former Chinese official. Mr. Zhu said China had doubled the loan ratio from below 100pc of GDP before the Lehman crisis to roughly 200pc today. The danger is that this excess could start to unwind just as the West goes into a sharp downturn, and possibly a double-dip recession. China and emerging Asia are fundamentally in weaker shape this time, having used up their “fiscal cushions”, leaving them with little leeway to cope with a fresh global shock.

China is our last great hope. If China goes down, the world economy falls with it.

When the stock market crashed in ’29, people had no idea what it meant. They referred to it as a “break” or a “crash.” Almost everyone figured it was just a matter of time before things were back to ‘normal.’ They were more-or-less right. The Dow returned to its ’29-high 17 years later. In real terms, it was still around its ’29-high as late as the mid-’80s — 55 years later.

But in the early ’30s, it looked as though the economy was recovering; the stock market was soon to follow, they figured.

Then, after regaining about half their value, stocks fell hard again. And then banks failed. And companies went broke. Roosevelt began his Fireside Chats. And unemployment rose to 25%.

Still, people did not see it as the “Great Depression” until later.

Similarly, when the subprime crisis and the collapse of Lehman Bros hit the markets few people knew what to think. The feds were particularly dim; they thought it was just another typical post-war downturn. They thought they could fix it the way they fixed all of them — with more credit.

But more credit wasn’t the solution to this problem, it was the cause. And adding more just made it worse.

Little by little, month after month, commentators and analysts have opened their eyes. They realize that this is a balance-sheet problem…not an inventory, liquidity or interest rate problem. But that is only the immediate problem. Gradually, they are beginning to realize that there is more going on.

Our Daily Reckoning view of it was better than most — if we say so ourselves. We knew it was a Great Correction from the very outset. We knew debt was the problem.

But even we did not see the power of this correction.

Of course, we don’t have much experience with this sort of thing. There are only two examples in the last 100 years — the ’30s in the US. The ’90s and ’00s in Japan. Not enough data points to draw much of a conclusion. But at least these two have one genetic similarity — longevity. It took 2 decades to end the Great Depression. The Japanese de-leveraging episode has already lasted more than 20 years.

We should have taken it at face value. Instead, we figured the US de-leveraging would be shorter. We saw it as a battle between the forces of deflation (the markets) and the forces of inflation (the feds). We thought the feds would have won by now. After all, they’ve got a printing press. And Ben Bernanke told us that they would use it.

But it’s not that simple, is it? The feds turned on the printing press. They added trillions in cash and credit. But so what? It hasn’t had much effect. Inflation is low…and apparently going down. If the economy goes back into recession, the CPI could even turn negative.

To make a long story short, the Great Correction appears to be greater than we realized. It has frustrated the feds completely. It has sunk bond yields to their lowest levels in 6 decades. It has knocked the upper stories off every house in America. It has taken 7 million people out of the job force.

And it looks like it is just getting started.

So, what’s this correction aiming for?

…will it correct the housing bubble that began in 1997…and stop there?

…will it correct the stock market boom since ’01…or since ’82…and be done with it?

…will it correct the bull market in bonds that goes back to ’83…or the bull market in bonds that goes back to 1971?

…how about the post-1971 dollar-based monetary system?

…will it correct the credit expansion/consumer spending boom that began in ’49?

…or maybe it will correct the boom in US economic and military power that dates back to 1917?

…Who knows? Maybe it is going to take out the entire industrial revolution boom going back to the 18th century…

…or even the boom in the human species that goes back to the 17th century?

We don’t know where this correction is going…but we want to make sure we’re somewhere safe when we finally find out.

Regards,

Bill Bonner

Shoppers pass a Victoria's Secret at a mall in San Jose, Calif. Retail sales have stagnated, which the author argues shouldn't be surprising in a bad economy. (Paul Sakuma/AP/File)

Retail sales stagnate, but not unexpectedly

By Bill Bonner, Guest blogger / 09.15.11

“Retail Sales in US Unexpectedly Stagnate,” says a Bloomberg headline.

Unexpectedly? Guess they don’t read The Daily Reckoning. Stagnating sales are what you get in a Great Correction. We’ve been saying so for the last 4 years.

In an expansion, well…everything expands. Why make it complicated?

In a contraction…everything contracts. What do you expect? That’s what it’s all about. That’s how it works.

And when you have a consumer economy, what contracts most? Consumer spending, of course. Simple, huh?

And when consumer spending contracts, business sales go down. Eventually profits go down. And eventually investors realize that holding stocks is not going to be profitable. Then, stocks go down too.

And here’s another Bloomberg headline:

Wholesale Prices in US Are Little Changed as Energy, Vehicle Costs Drop

Surprise, surprise! The feds pump in trillions in cash and credit. Still, they can’t get prices to go up significantly

Contractions are deflationary.

That’s why we don’t expect the price of gold to rise.

And now that Germany and France have gotten together with China and all have agreed that they aren’t going to throw poor little Greece off the Euro-Bus…gold has nothing to do but go down. No crises on the horizon. No inflation either.

So who needs gold?

Well…. We all will. But maybe not just yet…

“Gold fulfills the functions for which money is used better than any other type of money,” wrote Lord Rees-Mogg in his introduction to “The Case for Gold” — a three volume tome rehearsing the history of the yellow metal.

But if gold is the best money, how come we don’t use it rather than dollars?

Lord Rees-Mogg explains: “The problem for gold is not that it doesn’t work, but that it works too well…it imposes limits on human behaviour, and those limits can be resented and rejected. Indeed, it can become impossible for a government to maintain the discipline of gold…”

Ah yes….

Limits. There are always limits. You can ignore limits. You can reject limits. You can pretend they don’t exist. But you can’t ignore the consequences of ignoring the limits.

Right now, the economy is in a major contraction. As long as this phase continues, you only need gold as insurance against a catastrophe. But what would cause a catastrophe? The feds, of course.

In a contraction, the market itself imposes limits. It forces asset prices down. It undermines businesses. And it drives debtors and creditors into bankruptcy.

The feds don’t like limits. And they don’t like contractions. Especially not when an election is coming up. Maybe they’ll keep their nerve. Maybe they won’t. They could do something reckless and desperate…in an effort to overcome natural limits. That’s when the merde will really hit the fan… That’s when you’ll need your gold.

Here’s an interesting item.

In July, consumer credit rose. This was much applauded and much discussed. Analysts said that the $12 billion increase proved that the credit expansion of the last 60 years was not over. They thought it meant that recovery was just around the corner. Consumers were borrowing again they said…so they must be spending too.

But it turned out it wasn’t exactly consumers who were doing the borrowing. It was students. And they weren’t borrowing to spend. They were borrowing to pay the high costs of education.

Real consumer credit went down, as expected. Credit card debt, for example, fell some $4 billion.

And guess what else. Many of them will never pay the money back.

Government-backed student loans have risen from less than $100 billion in ’08 to about $400 billion today. We don’t know why. But we smell a zombie.

The default rate is rising. And we suspect that many ‘students’ are actually people marking time in universities because they can’t find a good job in the outside world.

Speaking of which… Senate GOP leader Mitch McConnell describes Obama’s jobs plan as a “re-election plan, not a jobs plan.”

But it’s so easy to criticize! Give the prez credit. At least he’s trying.

At least, he’s trying to get re-elected, that is.

Gold bars weighing one ton are on display in a vault at the Czech Central Bank in Prague, Czech Republic. The price of gold fell $49 on Monday. (Petr David Josek/AP/File)

Time to give gold a break?

By Bill Bonner, Guest blogger / 09.14.11

First, a look at the markets. They’re becoming exciting. Yesterday, for example, stocks reversed some of the losses from Friday. The Dow ended up 68 points, keeping the index above 11,000.

Going the other way, gold lost $49.

What to make of it?

In our guess…both stocks and gold SHOULD be going down. That doesn’t mean they will go down, of course. But at least it gives us a point of reference.

They should go down because there’s a Great Correction going on. There’s no secret to it. Sometimes stocks are expensive and sometimes they’re cheap. When an economy is expanding, it makes sense for stocks to be expensive…companies’ sales are going up…profits should increase too. But when an economy is contracting…or, more precisely, when credit is contracting…stocks should be priced for shrinking sales, followed by shrinking profits. That is, they should be cheap, not expensive. Stocks are now priced for an expansion, not a correction. They should go down.

Investors are figuring that out…little by little. As they do, stocks go down. Simple as pie.

But gold is a little trickier. By our reckoning, gold is a little expensive. It buys more stuff than usual.

Of course, it should be a little expensive. Looking ahead, the whole world’s banking, credit, and monetary systems are wobbling. Gold is the only money you can trust. So smart investors, smart CEOs, smart family men, and smart central bank chiefs are all thinking the same thing – that they should lay in a supply of gold as a reserve against catastrophe. So they’re buying.

But in a Great Correction…assuming things don’t fall apart…the value of paper money goes up. Or, to put it another way, the price of assets and other stuff tends to go down as demand falls. Broadly speaking, it is a deflationary world. And paper money is good money in deflation. As long as the system holds together.

And since, according to our Daily Reckoning guesswork, the system will probably hold together a bit longer…we figure speculators will begin to sell gold to get cash.

Besides, gold has had a spectacular 11-year run. It’s time for a rest for the metal…and a test for the metal lovers. That’s just the way it works. Markets and lovers always test their admirers. Gold should be giving its fans a test…before moving in the final stage of the bull market.

Will you pass the test, Dear Reader? Will you be true?