Tag Archives: depression

Trading sardines vs. eating sardines

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I have no strong opinion on near term market direction. I was prepared for this little downward correction, as for the larger bounce off 666 on the S&P500, but am highly ambivalent about where we go from this juncture.

Has this been a four month flat correction?

A case can be made that the entirety of market action since November has been one giant zig-zag correction that terminated last week, in which case we are now about to plunge to 550 among the kind of panic conditions that were so lacking at the latest lows. In support of this scenario we have the death-defying performance of a great number of tech and consumer stocks that have failed to even re-approach their November lows, as well as some of the most extreme readings on retail bullishness since the start of the bear market (Rydex bull/bear fund assets, put/call ratio, NYSE Tick). Remember, the ’29-’32 market corrected from its initial crash with a 48% rally from November ’29 to April ’30. If this is the Greater Depression (and by the looks of the latest trade and manufacturing numbers, let alone the scale of the debt saturation that caused this situation, it is), perhaps a big zig-zag is all the enthusiasm society can muster this time.

Or was it actually a washout?

That said, more likely in my mind is a protracted rally extending to 900 or higher by summer, then rolling over to meet a date with 400 next winter. Look at last year’s rallies from March to May and July to August for an idea of what this might look like, though on a larger percentage and time scale because we are correcting a larger sell-off. The case for such a move is bolstered when you hear major investment banks’ strategists calling this a dead cat bounce. Too many people are still afraid to call a bottom, and they need to be suckered into long positions before this is over (along the same lines, too many traders are embracing the dead cat bounce and need to be shaken out before it can get back to leading the buy-and-holders to slaughter).

I am highly skeptical, though respectful, of calls for a the mother of all bear market rallies. Robert Prechter and some other Elliott Wavers, as well as Tim Knight (slopeofhope.com) seem to be anticipating a 6-month or longer rally to as high as 1050. I simply don’t see why that is necessary in this environment. This is a depression, and the last one was accompanied by bear market that, after the first 6 months, maintained the momentum of a cruising supertanker. Rallies of 20 percent and 2 months were about all you got from April 1930 to July 1932 as the Dow dropped from about 295 to 41. That deflation-driven event was a much more orderly bear market than the jagged trajectory of the dot-com crash, which occured while the credit bubble continued to expand. Interestingly, the 1966-1982 secular bear (a brutal 75% loss in real terms) also traced out such a series of steep plunges and rallies as the bubble kept inflating thanks to a compliant Fed and the abandonment of the last trace of the gold standard. Employment was down, but animal spirits were still running high with the computing boom, the advent of securitization, and new innovations in consumer credit.

Feel like a depression yet?

Though the current bear market is half over in terms of price (three weeks ago we hit -57% and you can’t lose more than 100%), we are still early in the game as far as the economy goes. Official (read: bullshit) unemployment is still just a tad over 8%, and while the old measure (U-6) is reading 14%, we are headed for 25% in a hurry. Baring a catalyzing event, Obama’s approval rating has nowhere to go but down — in terms of historical context his term is positioned like that of Hoover, not FDR, who took office after the market had bottomed and already doubled.

This all spells a continuing deterioration in mood, possibly even at an accelerated pace, but because the market is not efficient and couldn’t care less about the economic fundamentals, an aggressively bearish trading stance is still only warranted when the market is highly overbought in multiple time-frames. Right now, we are only mildly overbought on a week-by-week scale (on Friday we were very overbought on this scale), while of course oversold on a daily scale and still somewhat oversold to neutral on a monthly scale (picture a 1-year chart). It is the 3-10 year chart that makes me nervous about being too quick to load up on shorts again. All things being equal, does this look like a good spot to go short?

3-year view here from bigcharts.com:

To deal with this situation I have lately been slowly accumulating December 2011 OTM puts on the S&P, scaling up purchases as the market rises. These positions are for keeps. I do not intend to part with them until the market has fallen well below 600 if not 500 (32 months should be more than enough time for that to happen, no matter how things girate in the interim). For trading the twists and turns along the way, December 2010 and even 2009 puts do very nicely. They are highly liquid and responsive to the market’s daily moves.

I am still bearish on the precious metals from a trading standpoint, and exercise this opinion mainly through the silver futures market and various equity puts (that said, if you don’t already have a nice pile of physical gold, get some and you’ll sleep better). Here and there investors are still losing their minds over certain stocks (ahem, Best Buy), and I always stand ready to short such silliness.

Quick opinions:

S&P earnings: Analysts still have their heads in the clouds and the I-banks are still getting away with talking about “expected operating earnings.” NET NET NET trailing report earnings are all that matters, and those will fall under $20 and stay there for many months before they start to grow again. Put a PE of 8 on that Jackson for your stock market bottom.

US bonds: bearish but not shorting

US dollar: bullish

Euro and Swiss Franc: bearish

Yen: neutral

Oil: neutral but prepared to start shorting at 60

Base metals: neutral to bearish (will short again if higher)

Grains: still waiting to buy

US real estate: wait until 2012 and figure on a cash market, but maybe buy in late 2010 if you can still get a low fixed rate loan.

NYC real estate: wait a year longer than the rest of the US — amazingly, denial still runs deeper there.

Guns ‘n ammo: good to own, but worthless if you don’t learn how to use them intelligently.

Obama: To appease and distract the masses, will he be crucified like Nixon?

So, where are we now?

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When I started this blog in early August, I was living near the equator in a city overlooking the Pacific, having packed up and shipped out of New York just after Bear Stearns blew up.  18 weeks ago, the Dow was solidly over 11,000, the 30-year bond was 4.6%, gold was $900, oil was $120 and the latest CPI figures were showing double-digit annualized inflation. I was holding a huge array of LEAPS and ETFs that put me massively short equities (including mining and energy), net short gold, and long Treasuries.

I was then constantly emailing friends and family with my latest reasons to get out of stocks, miners included, and to buy into Treasury MMFs and index puts. For the previous nine months I had been endlessly explaining the logic of deflation and its implications, having been dissuaded of Schiff-esque conclusions by the likes of Mish and Prechter, and I wanted to go on the record more publicly with my calls. Besides bragging rights, I wanted the pressure to dig deeper and get the details right.

I called for a depression worse than the 1930s. I said that the Dow was on its way to below 3500 (under 9500 by Christmas, I suspected), that commodities would tank, that gold would fall well under $700, that there would be huge bailouts for the crooks who blew the bubble (though I never thought we’d see anything like $9 trillion by the end of ’08), that Obama would win and back a “new New Deal” and that the long bond would yield less than 3% anyway.

Let it be known…

I believe that the only market call that I got wrong was my early preference for the Swiss Franc over the dollar, but I switched out of that on the first real signs of dollar strength. Please call me out if you know of any others. I also sold my Proshares inverse ETFs very early in the crash (over the week or two following the late September shorting ban), and of course they did not proceed to fail from a swaps default, but given the lack of disclosure regarding counterparties and collateral, that was the right call, especially for a portfolio stuffed to the gills with puts anyway.

Living history.

And so this is Christmas, and where are we now? Well, I’ve ditched the volatility of Latin America for frosty and gorgeous Zurich, and the world is falling apart more or less on schedule.

I haven’t traded much since November, other than to close some more shorts on dips. I’m not a short-term trader. Starting in mid-2007, I recognized a rare opportunity to catch a tidal wave, and positioned myself for the big move. I wound down my business by early ’08. I got out of all long positions. I put most of my eggs in one basket, and I watched that basket!

By August I was glued to the computer, tracking dozens of data streams. At times this fall I was sleeping 4 hours a day, waking up at 3AM to watch the crash wash around the globe and plan out the day’s orders for several different accounts. Naturally, this blog was a big part of that routine, as it helped me to organize my thoughts. It was also fun to see all of the traffic come in, 600 visitors a day at times.

Man, the action was fantastic, wasn’t it? What thrills! The weekend that Lehman was thrown to the dogs; the desperation and collapse of Wachovia; the ETF scare when AIG folded (swaps mayhem!); the 4% TED spread; even worries that the Options Clearing Corporation might default. This was uncharted territory. Nobody knew exactly how fragile the system was — clearly, it had been built by schmucks who hadn’t read history and wouldn’t give a damn anyway, and we didn’t know how much stress each component could take.

So for now “the system” still stands, though I have a few more gray hairs.

Politics is (really) theater.

Team Obama is of course the same Team America that has been running this show for time immemorial, the face change being a tried and true steam release for public discontent. But this time around, with the internet allowing any inquiring mind to look behind the curtain, it is still astounding to me how even intelligent people are relieved to see a ‘change’ in the White House, even as well known made men line up for posts at Treasury and such.

The Who knew this game:

We’ll be fighting in the streets
With our children at our feet
And the morals that they worship will be gone
And the men who spurred us on
Sit in judgement of all wrong

They decide and the shotgun sings the song
I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again

The change, it had to come
We knew it all along
We were liberated from the foe, that’s all
And the world looks just the same
And history ain’t changed
‘Cause the banners, they all flown in the last war

I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again
No, no!

I’ll move myself and my family aside
If we happen to be left half alive
I’ll get all my papers and smile at the sky
For I know that the hypnotized never lie

Do ya?

YAAAAAH!

There’s nothing in the street
Looks any different to me
And the slogans are replaced, by-the-bye
And the parting on the left
Is now the parting on the right
And the beards have all grown longer overnight

I’ll tip my hat to the new constitution
Take a bow for the new revolution
Smile and grin at the change all around me
Pick up my guitar and play
Just like yesterday
Then I’ll get on my knees and pray
We don’t get fooled again
Don’t get fooled again
No, no!

YAAAAAAAAAAH!

Meet the new boss
Same as the old boss

Travel, sleep, extracurriculars.

I apologize again to those of you who miss the active posting. Everything is fine. I’ve just been away from the markets (relatively speaking) since November, since I’ve been on a lot of airplanes and have lately been taking some time out to attend a German course.

Besides, I never really intended for this to be a news blog. I don’t have much new to say on each bailout measure or report of economic distress, since they are all just color at this point. They shouldn’t surprise anyone now, nor should they change anyone’s expectations. This is a depression and the government is only making it worse. It will last for years, and the US will become much less free in the meantime. At some point in the next few years, the Treasury market will buckle. Things will get very interesting when the government has to default on its promises. In the process, the global paper money system may change dramatically, from a fracturing of the EMU to unprecedented inflation in the US. We don’t know how or when these things will happen, but we do know that holders of all kinds of government paper will get stiffed, so we just have to keep buying gold at a measured pace — less now, more later, much more under $600.

So here are some new predictions for the next 24 months:

Unemployment as reported will hit 12%. Real unemployment (U6 — see shadowstats) will be 25%, as in the ’30s.

GDP will fall at least 15% from peak 2007-2008 levels. GDP is a bogus stat (why are consumption and government expenditures included?), but I’ll defer to convention.

The Dow will have breached 3000, with a few 20% rallies along the way, a couple of which lasting a few months.

Home prices will continue to drop, and Case-Schiller will register a 40% decline from peak by the end of 2010.

Trading notes

As far as trading goes, nothing is very compelling to me at the moment. I’m still holding a large, though much smaller, basket of 2010 puts on the S&P and various and sundry industrials, retailers, REITs and miners. I’m still holding real money of course, though I still have some hedges on it via GLD, and I have put the bulk of my shorting profits in T-bills, where they will sit until I am compelled to go more heavily short by a more heartfelt equities rally or heavier into the heavy metal at the right price.

Agriculture, as I have mentioned, is interesting. Grains never go out of style, depression or not, and prices are not in bubble territory anymore. Except for the last couple of years, farming has not been very profitable for decades, so the sector could be in need of investment. Also, a less free global market and greater political tensions (both a consequence of government responses to depressions) could mean shortages.

Energy is also getting tempting. Crude production peaked in the first half of 2005 — we will never again get as much out of the ground as we did then. The stuff is really, really, cheap. It was also cheap at $147, but I still shorted Suncor. $25 is not out of the question, but really, waiting for the bottom of the bottom is a fool’s game. I’ll be looking for ways to scale into oil and uranium slowly over the next couple of years.

No final bottoms.

I don’t think we have seen bottoms in anything yet: neither grains, nor metals, energies, foreign currencies, corporate bonds, munis nor equities (other than those at zero already). We have only seen the first move, but this move tipped the market’s hand.

All the same, I don’t like to be in the way of such a compressed market. Make no mistake — a rally and general improvement in mood could last a year! At all points in this bear market, consider what would happen to your portfolio if prices were higher 12 months out. Being right but early is being wrong if you lose so much that you compromise your ability to trade within the limits of prudence. Look for the layups and buy yourself as much time as possible. If you are going to short, find far-out LEAPS and buy them cheaply. Be a miser. The profits (and losses) are all in the buy.

Impatient Treasury shorts toasted.

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The 30-year yield closed at 3.91% today, in a massive compression of the yield curve, a movement that has a lot of room left to run. Way back on August 8th (day 4 of this blog), I wrote the following in “That crazy, crazy bond market: a call for sub-3% long bonds”:

I predict that the dollar rally will strengthen the compression of Treasury yields at all ends of the curb, as the market perceives a lower currency risk. This is a sign of deflation: an increasing preference for cash. With the banking system on the verge of a collapse worse than the ’30s, people will have no choice but to buy Treasuries. These promises of an insolvent and unrepentant debtor are safer than cash in the bank (because its not really in the bank!).

This flight to safety will send short-term yields back under 1% (as they were in March), and traders will move out the yield curve to get ahead of the compression, driving long bonds to historic lows, likely well under 3%. …

So it may seem crazy, but it is entirely possible (and given the banking crisis, likely) that long Treasury yields will fall to 60 year records in the face of horrible fundamentals. But once they get there, I expect them to turn up and keep going, as the government starts to default by Fed printing.

To all those who feel that the US debt just DESERVES to be shorted, I say wait. It will get more deserving.

That post is worth another look, if only for the charts of the last top in Treasuries, the 1940s, when long yields hovered under 3% while inflation breached 10%.

There has been a lot of talk of a widening yield curve lately, and more than a couple of people have mentioned to me that they were thinking of shorting TLT or buying a short Treasury ETF. This actually furthered my conviction that despite the HUGE deficits that the US gov’t has started to run, that bonds were still a buy, or at least not yet a short, as no market tops out in room full of bears. Well, the premature shorts had another rough day, as we all were reminded again that this is a deflationary panic, and that Treasuries are the only things that go up in these little episodes.

Markets don’t have to make fundamental sense. They only sometimes do, in the sense that a stopped clock is right twice a day.

The end of the crash is nigh (but not the bear market).

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If this is ’29, we’ll dip down to new lows in the next few days (tomorrow?) and then rally for five months before getting back to business for two more years of a crushing bear market. The analogous endpoint would be summer 2010 and Dow 1400.

We should be so lucky this time, since we have no productive industry anymore and debt levels are off the charts. That includes the government, so the end game here is either a Treasury and entitlement default or currency failure (de facto default). This is French Revolution stuff.

Right now, prepare for a return to the panic conditions that we saw breifly at the open on Black Friday, October 10. This time everyone will throw in the towel. Dow 7000 will feel like the bottom has fallen out. Then you go long.

Real credit vs. fake credit.

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The essence of why bailouts will only deepen our problems is that real credit cannot be created out of thin air. This counterfeit operation is what caused the bubble to begin with, and by trying to put out a fire with gasoline, Bernanke, Congress and Obama are going to burn down the whole city.

Frank Shostak, the Chief Economist at M.F. Global, knows a thing or two about economics, which is not something you can say about many of today’s economists. The Mises Institute website publishes this essay of his on credit, which illustrates the critical identity between savings and investment, and the proper role of banks in an honest system.

Central-bank policy makers have said that the key for economic growth is a smooth flow of credit. For them (in particular, for Bernanke) it is credit that provides the foundation for economic growth and raises individuals’ living standards. From this perspective, it makes a lot of sense for the central bank to make sure that credit flows again.

Following the teachings of Friedman and Keynes, it is an almost-unanimous view among experts that if lenders are unwilling to lend, then it is the duty of the government and the central bank to keep the flow of lending going. …

It is true that credit is the key for economic growth. However, one must make a distinction between good credit and bad credit. It is good credit that makes real economic growth possible and thus improves people’s lives and well-being. False credit, however, is an agent of economic destruction and leads to economic impoverishment.

Good Credit versus Bad Credit

There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit); and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (bad credit).

Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers. To understand why, we must first understand how good credit comes to be and the function it serves.

Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one week’s time. Note that credit here is the transfer of “real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.

Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.

Note that the saved loaves of bread provide support to the shoemaker, i.e., they sustain him while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is a path to real economic growth.

Money and Credit

The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend those dollars to the shoemaker. With eight dollars, the shoemaker can secure either eight loaves of bread (or other goods) to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things includes eight loaves of bread that the baker has produced. Note that without real savings, the lending of money is an exercise in futility. …

The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. …

Despite the apparent complexity that the banking system introduces, the act of credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.

Now, when the baker lends his eight dollars, we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully “backed-up” dollars so to speak.

False Credit Is an Agent of Economic Destruction

Trouble emerges however if, instead of lending fully backed-up money, a bank engages in fractional-reserve banking, the issuing of empty money, backed up by nothing.

When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality, however, nothing has been saved. So when such money is issued, it cannot help the shoemaker, since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. But, since the printed money masquerades as proper money, it can be used to “steal” bread from some other activities and thereby weaken those activities.

This is what the diversion of real wealth by means of money “out of thin air” is all about. If the extra eight loaves of bread aren’t produced and saved, it is not possible to have more shoes without hurting some other activities — activities that are much higher on the priority lists of consumers as far as life and well-being are concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.

Rather than facilitating the transfer of savings across the economy to wealth-generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation. It has to be realized that banks cannot relentlessly pursue unbacked lending without the existence of the central bank, which, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn’t cause banks to bankrupt each other.

We can thus conclude that, as long as the increase in lending is fully backed up by real savings, it must be regarded as good news, since it promotes the formation of real wealth. False credit, which is generated “out of thin air,” is bad news: credit which is unbacked by real savings is an agent of economic destruction.

Fed and Treasury Actions Only Make Things Worse

Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings. …

If the pool of real savings is still growing, then doing nothing (and allowing the interest rate to reflect reality) will allow the recession to be short lived and economic recovery to emerge as fast as possible. (At a higher interest rate, various bubble activities will go belly up. As a result, more real savings will become available to wealth generators. This in turn will work towards the lowering of interest rates.)

We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.

By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.

If Princeton and the rest weren’t run by fools and knaves, this is the kind of thing they would be teaching, not Bernanke’s brand of institutionalized theft.

I recommend reading Shostak’s whole essay. Click around the Mises site while you’re there. It is a wonderful resource for real economics, the kind that can make you money. The Rothhbard and Mises files would be good places to start.

Listen to the people who predicted this: No bailouts, no New Deal, no serfdom.

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Here is a list of popular personages who predicted this credit implosion and depression while the bubble was still being blown:

  • Robert Prechter. In 2002, he published Conquer the Crash, How to survive and prosper in a deflationary depression. So far right on the money except gold hasn’t fallen hard (yet).
  • Jim Rogers. The man has good timing when it counts. He bought a NYC townhouse for 107k in 1977 and sold it for 16 million last year and got the heck out of Dodge. He moved his family, business and money to Singapore and shorted the US market. Missed the turn in commodities, though, and refused to sell China out of some kind of principle.
  • Peter Schiff. Published Crash Proof in 2006, which has been pretty accurate other than Schiff’s missing the deflation stage and holding commodities and foreign stocks too long. The results of the New Deal and bailouts are likely end with the currency failure he predicts.
  • Mish Shedlock. Publisher of a popular blog, Mish has been warning of a deflationary depression since 2005 or 2006, and now has the best record of predicting its course (deflation, bailouts, gold and the dollar doing well).
  • David Tice. Manager of the Prudent Bear Fund, BEARX, which is performing spectacularly.
  • Doug Casey, the original international speculator, and publisher of the Casey Research newsletters. Missed the deflation part, also burned by commodities, but spot on about fascism.

There are countless others who saw this coming, including Congressman Ron Paul, who’s own studies of monetary policy inspired him to first run for office.

What do all of these men have in common that allowed them to see around the corner? They understand money and the credit cycle. How did they learn it? Not in college, that’s for sure, because colleges teach perverse Keynesian claptrap. They have all read the Austrian economists, in particular Ludwig von Mises and his American pupil Murray Rothbard. Their explanation of the business cycle as the credit cycle is both elegant and extremely powerful.

And what do all of these followers of the Austrian School think we (meaning our governments) should do, now that their worst fears are coming true? In a word, to a man, nothing.

Don’t fear the crash. Fear fascism.

You see, the very worst fear of Austrians is not a crash or a depression, which is actually the healthy restoration of sanity after a credit-fueled mania, but the expansion of government that seems to follow these events like day follows night. Frederic Hayek laid out these fears in The Road to Serfdom, and that is exactly where we are going: utter economic collapse. The government is going to hamstring the markets and drain our resources for its pet projects and wars, all for our own good. Their aim is to stave off a proper accounting of the losses that have already taken place, and to preserve the power of those who inflated our way into this mess.

The damage from the bubble is already done. Government adds new damage.

What not one person in 10,000 understands is that the losses have already taken place. The losses were the waste of resources and labor for doomed endeavors that never made sense: think McMansions in the desert, and the roads, power plants and strip malls that served them. The price declines that we are now experiencing are necessary to restore valuations that reflect true values, because proper pricing clears markets — it allows people to accurately assess the worth of certain items against that of others.

A 5000 sqaure foot house on a dry hillside 20 miles outside of Phoenix is a money pit, not a million dollars. It was never properly valued in terms of the labor and raw materials that went into it. But because bankers, backed up by the Fed and various government programs and guarantees, would lend $1 million to buy it, those resources were drawn out into the desert instead of to sustainable productive uses.

An honest, gold-backed monetary system and a free-market banking system with no government support would never have allowed bankers to misprice assets so greatly. Any that did would face severe difficulties inducing the public to trust them with deposits. But with FDIC, who cares what your bank does with your money? And bankers say, “with the Fed to bail me out, who cares if all my loans blow up?”

What will happen if government doesn’t lift a finger?

The owners of McMansions will lose them to the banks or other mortgage holders, and those mortgage holders, if they bought the paper with loans of their own, will lose them to others, and so on. Almost every bank in the world will fail. They have all come to depend on deposit insurance and central banks to cover for the fact that they have been reckless and insolvent from nearly day one. There will be no bank lending at all.

What will happen to the depositors? Well, almost all of their money will be lost.

So, that is what we are looking at: every bank failing, zero bank lending, almost all the money in the world going to heaven. How is that not the end of the world? Simple: It is a reverse split. In 2006, let’s say, there was a million dollars in total bank deposits. Then in 2008 all the banks go under. All that is left is the cold cash in people’s pockets, let’s say $100,000 in all.

That remaining cash becomes extremely valuable. It has to work where one million did before. If you had $10 in your pocket and $90 in the bank, you now treat each dollar as if it were ten. The key is that so does everyone else. The world still has its unit of account and medium of exchange, we have just moved the decimal point over on all prices. (Note: gold and silver would rapidly re-enter circulation and quickly become the preferred money, as they always do until government outlaws them).

Of course, deflation on this scale makes debts unpayable, so essentially all debt is defaulted upon, but of course most creditors are bankrupt too. Contracts have to be renegotiated or annulled. No big deal, really. The assets are all still there, just the same as before. Nothing has burned down. A car bought on credit still gets the same mileage as before its loan went bad, a house keeps you just as dry.

Trust the prudent and smart, not bankers and politicians.

Such an event brings about a massive transfer of wealth from the reckless to the prudent and farsighted, who are exactly the people you want making the decisions about what to do with money and assets after the crash. They are statistically and philosophically the best equipped to decide what will generate the highest returns with the lowest risk. Life goes on. There is nothing to rebuild because nothing was destroyed. It is all just reordered in a more sensible fashion. The house in the desert is scrapped for materials. The Lehman mortgage traders find something productive to do, like drive cabs.

But that outcome is so quaint, so 1800s, so gold standard. We’re more scientific today. Bernanke is a wise economist. Congress is benevolent. War is peace, and lies are truth.

The bailout blackmail bluff.

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The bluff is not that nothing will happen to the economy if the bailout doesn’t pass, but that the bailout will do nothing to stop the depression (but lots to deepen it).

—-

Scare tactics.

All of a sudden, the economy is in dire danger of unknown horrors, we are hearing from Bernanke, Paulson, Bush, and the US press, especially the financial press. Unless the bailout passes, and RIGHT NOW, stocks will crash, your bank will fail, your home will keep losing value, and your employer will go broke and fire you. All of the bankers’ stooges who were trying to get us to look the other way since the credit markets started to freeze up 13 months ago are trying to scare the daylights out of the US public. How to avert the crisis? Give the con men who created it a blank check drawn on the US Treasury, of course.

This campaign reminded me of a spot-on comedy skit by the British Comics, Bird and Fortune, that popped up on YouTube 12 months ago, back when nearly all of my acquaintances all thought I was nuts for stocking up on put options and gold.

I recommend the whole thing, but the end (jump to 7:20 if you’re in a hurry) was particularly prescient. I transcribed it below, but it’s more fun to watch:

These are the lines was I reminded of today:

Interviewer: “But now, you see, the people are saying that now the crisis is going to turn into financial meltdown. I mean can that be avoided?”

Investment banker: “It can be avoided, provided that governments and central banks give us, the financial speculators, back the money that we’ve lost.”

Interviewer: “But isn’t that rewarding greed and stupidity?

Investment banker: “No, no. It’s rewarding what the Prime Minister, Gordon Brown, called “the ingenuity of the markets.”"

Interviewer: “I see…and, and …

Investment banker: “We don’t want this money to spend on ourselves. We want this money just to go into the markets so that we can go on borrowing and lending money as if nothing had happened without thinking too much about it.”

Interviewer: “Yes, but, if the worst came to the worst, and you didn’t get this money, what then?”

Investment banker: “Well then, there would be another market crash, and then I would say to you what people like me always say, that it’s not us that would suffer, it’s your pension fund.”

Interviewer: “Thank you very much.”

_____

George Bush, tonight: “The stock market could drop even more, which would reduce the value of your retirement account.”

Call the bluff.

I have zero hope for a sensible outcome from the US government. Politicians are not debating the concept of bailouts and moral hazard; they are debating which irresponsible parties get how much. ‘Compromises’ will be reached that allow for grandstanding all around, but the core of the bill will give bankers what they want.

The executive salary cap for bailout recipients is a red herring. Manhattanites will figure out other ways to get their hands on these trillions, ways that don’t involve holding executive titles at big banks. Those banks are dead in the water anyway — it wouldn’t surprise me if they were completely nationalized over time. Another dispute is over equity — the government will get its equity position, sure, but the equity is worthless. And of course, everyone wants to throw in money for the idiots who are underwater on their mortgages — they’ll get theirs, if not in this round, the next.

By the way, anyone else notice the tactical similarity to how seven Septembers ago we were subjected to the same kind of scare tactics and rhetorical bombardment while another huge and unconstitutional bill was being rushed through Congress?

All over but the shouting.

We will get a depression. We’ve got it already. If US still had any character, this would be a short and relatively painless lesson in giving government too much power, which really means giving power to bankers. I say painless not because nobody will go broke — they will, in spades — but the pain will be like the first weeks in fat camp or reform school, not the gulags.

There will be no reformation this time. Americans of all intelligences are confused and ethically bankrupt after 100 years of saturation in nationalist and socialist propaganda by schools and media. This lack of a moral compass or common sense assures us that this will be the worst depression in our history, and maybe the last.

As the depression deepens, a terrified populace will allow the government to grab more and more power, until society is completely transformed. Remember those emergency powers that the executive granted itself last year? You better believe they are being readied. This stuff happens, folks. This is what human beings do to themselves, with great consistency. Freedom and prosperity are the exceptions to the rule as far as history is concerned.

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PS — Buy the bailout rumor, sell the news? If I had to pick a date for the start of the Crash, it would be the day after Congress passes this bill.

Disclosure: I’m short the equity markets with put options and inverse ETFs. See disclaimer.

Why bailouts will not stop the depression

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The market is a force of nature, like gravity. To use it is prosperity. To fight it is misery.

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By bankers, for bankers.

This is a bailout of bankers. The Fed was created by bankers, and the Treasury is run by a banker, so there are no surprises here.

The plan is to have the government take banks’ bad mortgage debt (will they add credit card, auto, student and corporate debt?), so that they are no longer insolvent. Solvency has always been the issue, not liquidity — that is a red herring. By no means will all of the bad debt (out of $50 trillion in total domestic financial and non-financial sector private debt) be absorbed by this program, which is going to move $700 billion at a time.

The fact that the government still relies on a market for its bonds puts limits on the pace at which debt can be socialized. There has been a great demand for Treasuries of late as safe havens, so the first tranche or two should be absorbed easily. Bonds may even rally more as assets prices continue to plunge.

Later, after the bulk of the deflation has passed and the bond market is saturated, this demand will ease and the Fed will have to buy greater and greater amounts of bonds with newly created dollars. The government’s spending needs are infinite, but the tax base and bond market are finite, so this phase of inflation can lead to currency failure. That can be chaotic, because contracts become meaningless when currencies are worthless. Out of such episodes arose Napoleon and Hitler.

Econ 101: Savings = Investment.  Lesson: reward savers with deflation.

We should embrace deflation, not fight it, because it restores sanity. The irresponsible go broke, and the prudent are rewarded. When money is tight, prices need to come down, and this encourages the savings that will turn to investment after the dust settles. Those who were smart enough to go into this crisis with savings are the ones you want allocating the capital for rebuilding, not the swindlers who beg for newly printed ‘stimulus’ money for their pet projects.

Your neighborhood, a government housing project.

Let’s assume the program actually removes all bad debt from bank’s balance sheets. Once again, they are fully capitalized and ready to issue loans, with assistance of course from an accommodating Fed. That will ‘fix’ one side of the reflation machine. On the other side, borrowers will still be choking on their existing debt and in no condition to take on more.

So the next step on the road back to inflation city will have to be debt relief for borrowers. As the owner of huge amounts of mortgages, the government is likely to be a very accommodating creditor. Can’t handle $2000 a month? Well, just pay $1000, but promise to spend the rest, ok! Or it could offer a quickie default: we take the house, but you can rent from us for cheap. In either case, the government has title to an enormous amount of housing stock, so all of America takes on the air of an inner city housing project.

(A side note: Once government becomes your landlord, it has a lot more leverage to force the installation of whatever it wants in your home, from ugly fluorescent lighting and those ‘efficient’ toilets that clog, to monitoring devices for your ‘safety’.)

The Crash is the Market, and It cannot be stopped.

Crashes are the market’s way of correcting the perversions of bubbles blown by bankers and governments. They are not market failures. The Market never fails. It is a force of nature. Bankers and politicians can shackle us with their guns and laws, but they cannot change the way the universe organizes itself. Any scheme but freedom, the absence of force (such as theft, a form of which is inflation), will be thwarted by the Market. Tax cheats, corrupt politicians, crooked brokers, smugglers and prostitutes are as plentiful as the laws that create them. In the absence of force (as George Washington said, “government is not reason; it is not eloquent; it is force”), the Market will reward honesty and industry above all else. When force is used liberally, society rewards George Bush Jr and Angelo Mozillo.

The government has tried to thwart the Market for so long, from the New Deal to the S&L crisis and beyond, that the distortions have become too big to support, and this time the Market is taking its revenge. Saving some big banks and some borrowers is certainly possible with bailout programs (rent seekers should call their lobbyists ASAP to get on that list!). But $50 trillion is way, way beyond anything the government can handle, so there will still be massive debt deflation left and right, and asset prices will continue to crash.

Debt revulsion is the fly in the reflation ointment.

To reflate, we need willing and able borrowers and lenders (inflation is the net increase of money and credit, deflation is their net decrease). Even if all bad debt is taken off the books of both borrowers and lenders, can the Feds rekindle America’s affair with debt? The answer is yes, eventually, but it won’t be any fun this time.

If the government forces the issue before the Market has cleared the way for growth, people will only be willing to borrow again to protect against the decline in the value of currency. During the crash, currency will continue to gain in value, so for at least the next couple of years, borrowers are going to be very wary of debt. They don’t want to repeat this nightmare, and besides, with asset prices crashing, the economy in a tailspin, and new regulations restricting commerce, where on earth can investors profitably deploy this capital? China? Not so fast — investing abroad may be restricted. Even with a 0% loan, can borrowers generate any return at all in this environment? With poor investment prospects and no need to protect against inflation, few will be willing to borrow.

This is why the traditional reflation machine will stay broken. This is the machine that Greenspan operated for the bankers with such mastery. But try as Bernanke might, this machine will not start up again until money or credit is somehow flooded into the economy through other means.

¡Chavismo!

In Hugo Chavez’s Venezuela, people borrow not for productive uses, but to speculate in any kind of asset that will lose value at a slower rate than inflation plus interest. It is a sickening thought, because it totally perverts all economic decisions and leads to staggering waste. We have just experienced a milder version of this in the US, but at least we built a few useful things with the credit, though most will go to waste.

In Venezuela, people invest in new automobiles, sometimes fleets of them, because the sum of interest and depreciation on the vehicles is less than the rate of general price increases. Hence, cars bought new appreciate in Bolivars as they rust in driveways. Venezuelan society is in a later stage decay than the US, but it may resemble our future.

The new New Deal, and the Neverending War

So how do you get that stubborn price level (the rearward looking indicator, CPI, was negative in August — expect more and bigger negative numbers for many months to come) to start ticking up again with gusto? After a general asset price crash, which I emphasize cannot be prevented at this point, the government can spend and spend and spend.

If you think the bridge to nowhere was ridiculous, you haven’t seen anything yet. Our sociopathic leaders, with hearty encouragement by esteemed professors, seem to have no problem with the old Keynesian theory of burying bottles stuffed with cash and letting people dig them up. Hey, it puts people to work and raises the price level! Let’s all pray for more hurricanes while we’re at it. Think of the boost to GDP!

Expect lots of pork for ‘green’ energy projects, and expect those projects to cost more than they produce and have all kinds of perverse effects. Expect national ‘service’ programs (if mandatory, they are national enslavement programs) such as have been touted by Obama, Hillary and the media wing of the Fascist party (now the only party in power in the US).

We were all taught in school that although FDR’s valiant efforts helped put Americans back to work, what really saved the US from sinking into a big hole the earth was War, glorious War. How lucky of us to already have two of them going and plenty more enemies lined up just in case!

SEC intends to ban short selling. Government boxcars reported in Greenwich.

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Hedge fund managers said to pack dirt under fingernails, roughen hands on bricks to avoid suspicion and possible shipment to North Dakota re-education camps.

These days it seems like we are living in an Onion article (1 , 2). It would be funny if it were not the end of the world as we know it.

I’ve been a bear since spring of 2006, preparing for a depression since early 2007, and have had no illusions about the death of the idea that was America. I saw these events coming a mile away, but the speed with which they have arrived is shocking.

By edict of the Duma…

I figured that the shorting ban (WSJ article) would pop up somewhere near the midpoint of the bear market, maybe Dow 8000, but this train to Animal Farm is an express. When will they ban international money transfers? Unapproved foreign travel? Gold?

The speed with which our leaders are dropping any pretense of respect for markets just makes me that much more bearish. 8000 could be next month, not next year as I had figured. And I have to rethink my bottom target of 3500. Really, that would not be the end of the world — this market started at 800 back in 1982, and you have to remember that equity values go POOF after an economy gets as leveraged as ours is. 75% stock market drops are not black swans. They follow credit bubbles like day follows night.

Markets are so bourgeois, anyway.

The possibility of Dow zero just ticked up a standard deviation or two. What happened to the Moscow stock exchange after 1917 anyway?

The end of the stock market? Impossible, right? Well, if our Bolsheviks enact their desires to use government funds to buy all manner of securities (as the Russians are now doing), they could eventually own everything, not just the mortgage market and a huge insurer.

Buyout mania, with a twist.

If a security’s market price is $10 and the government offers $20, that is not ‘market support’, that is a buyout. Of course, there are limits to this sort of nationalization, namely the difference in scale between the Fed’s $900 billion balance sheet and the many tens of trillions of dollars in US private equity and debt instruments, so at first they will be very selective (ahem), but they do have two tools to help them work around those limits: printing presses and guns. In a few short years, when the former lose their potency, the latter can be brought to the fore.

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PS — Of course, my opinion is that this rally (futures are up 2% on top of today’s dramatic close) is just a short squeeze and dead cat bounce. The air pocket under stocks just got a whole lot bigger. 90-day T-bills last traded at 0.07%. The stall warning light is still on.