Monday, August 24, 2009

The Calm Before the Storm?; The Mogambo on the Golden Eggs in Your Market Basket

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The Daily Reckoning
Monday, August 24, 2009

  • Bounces don't last forever...and this one is running out of time...
  • One of the greatest mysteries: where will the money come from?
  • If the Asians don't finance US debts, who will?
  • The Mogambo on the golden eggs in your market basket...and more!

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    The Calm Before the Storm?
    by Bill Bonner
    Ouzilly, France

    Is the rally over?

    Not at all! The world's bankers say the economy is recovering. Investors believe them; they're bidding up stocks.

    The Dow rose 155 points on Friday. And today, stocks are rising in Asia. Oil is over $74. Gold rose $13 on close at $954. And the dollar is killing us softly...sinking to $1.43 per euro on Friday.

    Stocks and oil are at their highest levels so far this year. With such profits at hand people figure they don't need the dollar. Investors run to the safety of the greenback when financial storms approach. But now...they think it will be clear sailing.

    "Worlds bankers suggest rebound may be under way," says a headline at The New York Times.

    Is the world economy really recovering? Should you buy stocks now to take advantage of this new bull market?

    You already know the answer, dear reader.

    After a fall comes a bounce. And along with the bounce come a lot of silly ideas. You see how it works? "Markets make opinions," say the old timers on Wall Street. When stocks are going up investors find reasons why they are going up. Pretty soon, they've convinced themselves that they'll go up forever.

    But bounces do not last forever. They aren't giant turtles...they're moths. After a few months of flitting around bright lights, they dry up. When exactly this summer of winged love will end, we don't know. September or October is our guess. But we have little doubt it will come to an end soon.

    Ultimately, stock prices depend on earnings. People compare the rate of return they can get from stocks to what they can get from other investments. Rising earnings signal higher rates of return, so investors pay more.

    During the great credit expansion of 1945-2007, businesses could anticipate, generally, rising earnings. People were buying more and more things on credit. In a national economy, businesses pay wages and then the employees use the wages to buy products. The wages are a 'cost' to the business...but they are also the source of business revenue. When sales come from credit, on the other hand, businesses have the revenue but no wage cost. Profits go up.

    Now, the cycle has turned. Businesses still have the wage cost. But instead of using the money to buy things, the employee uses it to repay loans for purchases made last year or the year before. Now the business has the cost but not the revenue.

    As they say in the economic textbooks: bummer.

    The process of de-leveraging will be slow. Maybe five years. Maybe 15. Maybe 25. It will go up and down...with high unemployment (businesses will cut their wage costs as sales fail to recover)...low prices (at least in real terms)...low profits...and slow growth, or none at all.

    Is that bad? No, not at all. It's good. Economies need to adjust to the new realities of the post-credit bubble world. It will take time. And with the world's financial authorities fighting it every step of the could take a LONG time. As we've explained in these daily reckonings, government is a profoundly conservative, parasite- protecting enterprise. It cannot draw forth the future - it has no idea what the future will be. Instead, all it can do is to try to recover the past. That's the idea of the 'recovery' try to coddle, protect and pay-off yesterday's success stories. From Wall Street to welfare...governments attempt to prevent correction.

    Of course, it makes sense. Government's only real function is providing protection and order. What can it protect? Only what is...not what is to be.

    And so the feds try to forestall and prevent the future from ever happening. Will they succeed? Of course not. The future will happen whether they like it or not. They can't stop it. The future will come.

    But they can still make a mess of it.

    [You don't have to be a part of that mess. Take the necessary steps now to protect yourself from these government shenanigans...and turn a nice profit while you are at it. See how here.]

    More news from The 5 Min. Forecast:

    "The bank failure scene in the US turned a shade uglier over the weekend. By this time tomorrow, it'll probably be even worse," writes Ian Mathias in today's issue of The 5 Min. Forecast.

    "For starters, Guaranty Financial of Texas went belly up late Friday and secured a spot in the history books. With $13 billion in 'assets,' the bank is the third largest to fail this year and tied for the 11th biggest bank failure in US history.

    "Even more interestingly, the FDIC brokered Guaranty's assets to Banco Bilbao Vizcaya Argentaria, a bank from northern Spain. We're surprised on two fronts here: 1) That a bank from Spain - strapped with double digit unemployment and a wretched housing bust - wants to bring their euros to I.O.U.S.A. 2) That BVVA already has a huge presence in Texas. With this acquisition, they will be the fourth largest banking chain in the Lone Star State. That could be an interesting trend to watch.

    "Three other banks failed along side Guaranty: CaptialSouth, First Coweta and Ebank. That brings the yearly total to 81.

    "This should put the FDIC's deposit insurance fund on its last legs. At the beginning of 2008, the FDIC's bank failure war chest had over $52 billion. At the end of the March 2009, the last time the FDIC has given us a look into the DIF, they had $13 billion left. 60 banks have failed since, including Guaranty and Colonial, which by themselves took out half of that remaining $13 billion. Only the FDIC can say with accuracy if there is any money left, but this chart gives you a pretty good idea of how the trend is shaping up:

    FDIC vs. DIF

    "The DIF does have a source of income - it taxes member banks a significant 'insurance fee.' But we have to think that the DIF is still in bad shape, perhaps even empty...and that the FDIC will soon be hitting up someone (Tim Geithner, Joe Taxpayer, and/or US banks) to refill their coffer.

    "The FDIC will provide their second quarter report tomorrow, which among other things will include a look into the DIF and their infamous bank 'problem list'...could get ugly. We'll keep you up to speed."

    Ian writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. It's a free service available only to subscribers of Agora Financial's paid publications, such as Resource Trader Alert. RTA's latest report details a trading strategy that will help you rake in some nice gains in a short period of time...without having to touch stocks. Get the full report here.
    And back to Bill, with more thoughts:

    The Obama administration announced that it expects $9 trillion in deficits over the next 10 years. One of the great mysteries of our time is: where will the money come from? As we pointed out last week, even if every dollar of US savings is applied to the task, the feds will still be short. And if they make up the difference with funny money - from their quantitative easing scam - the Chinese vigilantes are likely to get cheesed off and dump their US Treasury bonds.

    The evidence shows that the Chinese...and other Asians...are already trying to lighten up on their US debt holdings. This from The New York Times:

    "Figures released by the Treasury Department this week indicated that China reduced its holdings of Treasury securities by $25 billion in June, the most China had ever sold in a month.

    "Monthly figures can be volatile, and can be revised, so it is risky to draw conclusions from one month's data. In May, China increased its holdings by $38 billion, according to the Treasury figures.

    "Nonetheless, the decline highlighted a fact...Asia's appetite for Treasury securities is not growing as fast as it once did. That means the United States will have to turn to other buyers, including American citizens, who are now saving as they did not do during the boom years, to finance the deficits... In the first half of 2009, China and Hong Kong acquired only 9 percent of the more than $800 billion worth of Treasuries that were sold.

    "Japan, which was replaced by China as the largest foreign holder of Treasuries last year, has been a larger buyer this year, taking up 11 percent of the new supply of Treasuries.

    "Ownership of US Treasuries by China, Hong Kong, Japan, South Korea, Singapore, Taiwan and Thailand - since 1994 - rose to 25 percent, from less than 8 percent. Since then, as budget deficits in the United States grew, the share has fluctuated within a narrow range. In June, it was 24.7 percent."

    If Asians don't finance US debts, who will? We don't know... But the fewer bonds Asians buy...the more they are bought with funny money by the Fed. And the more the Fed buys with funny money the fewer Asians want to buy with real money.

    How will this end? Badly...we keep saying. There is no way out. Either the feds cease spending more than they can raise honestly, by taxation and reasonable borrowing. Or, the system runs into chronic, mega the chronic deficits in the private sector during the bubble years. Then, it blows up.

    That is why we caution readers against the dollar and against Treasuries. Most likely, they will both go up this investors flee to safety from the next market downturn. But the chances of them blowing up completely are too great. That's why we stick with gold - even though we would not at all be surprised by a period of weakness in the gold market.

    [Gold and other precious metals may have their ups and downs, but in the end, they and the people who are holding them, will certainly come out on top. Get yourself - and your portfolio - ready for the surge precious metals are going to here.]

    On Friday night, we went to a 'dinner in white' at a nearby chateau. It was a jolly affair, at an ancient chateau entirely surrounded by a moat.

    We set up our table, alongside the others. We gathered for drinks. We saw old friends. And then we prepared for dinner.

    Why "white?" The dinner marks the occasion of the Assumption of the Virgin. It's held each year in this rural area of France. Everyone brings a full dinner service - table, chairs, candles, etc. etc. Then, after setting up outside, under the stars...there's a twist. Couples switch around so that your editor ends up having dinner with a woman to whom he is not married.

    Having dinner with someone else's wife can be a delight. At least, you have nothing to argue about. But how much of a delight it is depends entirely - or perhaps mostly - on chance.

    In our case, we were terribly lucky. In front of us was a charming woman who turned out to be a relative of many people we already knew. So we kept up a lively conversation about cousins, uncles, tragedies...and upcoming marriages. On our right, was a cute woman with a bright smile and a friendly manner. On our left, was another charming woman with a shrewd, fast wit.

    Time passed quickly. We crossed swords with the woman on our left - over education policies. We chatted with the woman in front of us - about family, the weather, local trends, food and whatever. We flirted with the woman on our right:

    "Do you come to these dinners often?" we asked.

    "About as often as you do," came the reply, "once a year."

    "Well, the dinners suit you. You look very nice in white."

    "Thanks...but I really don't have any choice. It's a 'dinner in white,' after all. If I had a choice, I'd wear black."

    "Why...because you have a black, cruel heart? Or is it because you are in a sad mood? I hope not. And if so, perhaps I can cheer you up by telling you joke. How many Belgians does it take to change a lightbulb?"

    "I've heard that one."

    "Then why does the guy from Belgium go to sleep with one full glass of water next to his bed and one empty glass?"

    "I don't know...why?"

    "Because he never knows if he'll be thirsty or not when he wakes up in the night."


    Until tomorrow,

    Bill Bonner
    The Daily Reckoning

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    The Daily Reckoning PRESENTS: This week, we're graced with a Mogambo Economic Fable (MEF) about putting all your eggs in one basket. As you might imagine, things get a little out of hand. But amid the chaos of quarreling townspeople and the entrance of a Big Bad Wolf, there is a clear moral that should definitely be heeded. Read on to see what happens...

    Golden Eggs in the Most Valuable Market Basket
    by The Mogambo Guru
    Tampa Bay, Florida

    My skin went clammy and cold when I read that over 140,000 people suddenly disappeared from the "continuing claims" rolls of those receiving unemployment checks at the same time as we see rising unemployment. It made me wonder when I was going to be among them, either as a guy who got fired and could never again find a job and so he collected unemployment checks until his benefits ran out, or as the guy who just literally disappears one day and everyone thinks that the CIA finally "took him out", or a mother ship finally got here from another galaxy to rescue me and take me back to my home planet where the people are a lot smarter in that they have a currency made of gold so that the government cannot increase the money supply, so that there are no monetary booms and thus no devastating busts, and everybody is happy and living happily ever after, and the beer gives you a really nice sustained buzz, but you can never drink so much that you throw up all over yourself.

    But even the unemployed have a stake in the recent bull run of the stock markets, and is one of those good news/bad news jokes, in that the bad news is that it is rising stupidly in defiance of reality and common sense, whereas it is seemingly good news for all of the people who have all their entire financial future invested in paper assets that are already showing losses and for the unemployed who hope to get a job with some of those same companies or companies catering to them.

    I can't remember if there is an Aesop's Fable about the folly of putting all of one's eggs in one basket, but there is, fortunately, a Mogambo Economic Fable (MEF) about it.

    It seems that, once upon a time, there was this egg rancher who incorporated his operation and sold a lot of the stock to some investors, keeping enough shares to still give him majority control plus a lot of money which was (as they say), "Mostly spent on liquor, horses and women, and the rest I spent foolishly."

    For a while, things were fine, but the rancher soon found himself paying blackmail money to suppress some embarrassing, and probably incriminating, photographs of him and several members of a visiting Albanian folk-dancing troupe who said they were women, and who looked like women, too, but were really men.
    "But now he could sell the golden egg and buy some baskets! The news was, of course, so exciting that the rancher stumbled and fell, and all the real eggs broke, turning the day into a total loss..."

    Anyway, by the time the rancher discovered the deception, it was too late to stop, and it turned out to be the episode that launched years of intense psychotherapy, during which time he discovered to his horror that this folk-dancer fiasco thing was just the tip of a really big cesspool of some really weird psycho crap.

    To pay the hush-money and the psychiatrist, the rancher finally had to sell his egg-gathering baskets. Then, one day, the baskets were all gone except for one last basket. So he used the one remaining basket to gather all the eggs.

    As fate would have it, one day he found an egg made of pure gold! Upon leaving the chicken coop, he was thinking that he needed to buy some more egg baskets, but the price of the baskets was too high because the loathsome Federal Reserve was creating so staggeringly much money and credit to keep inflation roaring in the inflated stock market, the inflated bond market, the inflated housing market, the inflated derivatives market, the inflated basket market, the inflated food and energy markets and the cancerous growth of government so that these markets would not collapse and hand a huge, crippling, crippling, catastrophic loss to everyone who owns the paper assets comprising those markets, the result of which will be even MORE inflation in prices, which had already, to the rancher's initial dismay, affected the price of egg-gathering baskets.

    But now he could sell the golden egg and buy some baskets! The news was, of course, so exciting that the rancher stumbled and fell, and all the real eggs broke, turning the day into a total loss, which just happened to be the "straw that broke the camel's back", profit-wise as a result of mismanagement by the rancher, an accountant that was a cricket, farm laborers that were ants, and the bankrupting burden of constantly-increasing government regulations and taxes.

    The rancher was, alas, bankrupt, and all the stock went to zero value.

    Of course, the stockholders all ran down to yell at the rancher with their little Munchkin-like voices and waving their little arms comically in the air that that they were now broke and ruined because they had put all their retirement money into the one stock.

    And the rancher yelled back that he is broke, too, as all his controlling interest in the business is now worthless, too, and he had long ago spent all the money he received from the initial stock offering on, for instance, partying with visiting Albanian folk dancers and psychiatrists.

    Then they all started screaming and yelling at each other, and there was a big fight, whereupon they all started killing each other, attracting the attention of a big, bad wolf that was nearby, huffing and puffing trying to blow down the brick house of three cowering pigs, but he couldn't blow the house down.

    So the wolf came over and ate the rancher, all investors, all the broken eggs and most of the chickens, too, before then using the golden egg as a mighty hammer to beat down the door of the pigs' brick house and eat them, too.

    The End.

    Until next time,

    The Mogambo Guru
    for The Daily Reckoning

    P.S. The moral of the story is that knowing that the majority of investors must lose money so that a minority of investors can make money, plus pay the added costs of the required financial services and taxes, then they are complete and utter idiots if they are investing money for the long haul in the one basket called "paper assets", especially when the government is acting so irresponsibly as to allow such sustained creation of money and credit by the Federal Reserve, instead of putting money into the one basket called "gold", which has existed, unchanged in purchasing power, for thousands of years.

    And that is probably why neither Aesop or they, unlike I, never say, "Whee! This investing stuff is easy!"

    Editor's Note: Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter - an avocational exercise to heap disrespect on those who desperately deserve it.

    The Mogambo Guru is quoted frequently in Barron's, The Daily Reckoning and other fine publications. Click here to visit the Mogambo archive page.

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