Bonner of Daily Reckoning

A Deflation Story
by Bill Bonner
London, England

"It was at Rome, on the 15th of October, 1764, as I sat musing amidst
the ruins of the Capitol, while the barefooted friars were singing
vespers in the Temple of Jupiter, that the idea of writing the decline
and fall of the city first started to my mind."

- Edward Gibbon

Warren Buffett famously says that people do not make money by betting
against the US economy. But two years ago we decided to take a chance.

"We are short the United States of America," we announced from the
comfort and safety of our headquarters in London. "Sell its stocks.
Sell its bonds. Sell its money. Sell its real estate. Sell the equity.
Sell the debt. Sell everything."

What we saw was an over-stretched empire getting ready to snap. But we
were also allowing ourselves to be lazy. Rather than deconstruct the
capital structure of the world's largest economy, we decided to sell
the whole damned thing.

All Hell broke loose in September 2008. Since then, US stocks have gone
down about a third. Real estate too. Unemployment has doubled. Consumer
prices are going down at the fastest rate since the '50s. And the
economy is in the worse recession since WWII.

Meanwhile, Americans' per capita wealth has fallen from $172,000 in
September from $212,000 two years earlier. And the UN reports that the
quality of life in America has gone down too...from #5 on its list in
2000, it fell to #13 in 2007. No doubt it is below #20 now.

Buffett has lost billions betting on the US economy while our gold
positions are handily up; gold was the most profitable major asset over
the last ten years.

So you see, we were right; America was a sell two years ago. 

And now it is the dollar that is falling. It's gone down 12% in the
last six months - a huge move for a major currency. 

"Asia tries to slow dollar fall," is the lead story in today's
Financial Times. 

Today, a buck and forty-seven cents will buy you only 1 euro. Ten years
ago, you could have gotten a euro for less than a single dollar. A
falling dollar makes imports more expensive, say analysts...raising the
cost of living in the homeland. But you wouldn't know it from walking
around on the streets of Miami or Las Vegas. You can get a house at 50%
off its price three years ago. As for the breakfast special - for less
than 3 euros you can get enough food to kill a Pakistani.

By European standards, America is cheap.

"Europeans again interested in Florida houses," says a headline in The
New York Times. 

House prices are down 30% to 50%. The dollar is down about a third too.
That makes the United States a bargain.

But is the United States of America about to become even cheaper?

One thing we were wrong about when we issued our 'sell America' call
two years ago was US debt. Treasury bonds have resisted the general
downward trend of things with the stars and stripes on them. Bonds have
not gone down; they've gone up. 

Private households are buying them for their retirements. Banks are
buying them for risk-free profits. Speculators are buying them in
anticipation of deflation. 

David Rosenberg:

"The big story yesterday was the further massive $12 billion decline in
outstanding consumer debt in August - the consensus was looking for an
$8 billion contraction. This was the seventh month of debt retrenchment
in a row. In other words, the tidal wave of the credit collapse
continues unabated, and this is the primary reason why bond yields are
still in a fundamental downtrend. 

"Over the past year, consumers have run down their debt by a record
$113 billion (and this does not include mortgages). This is an
absolutely epic shift in household attitudes towards credit and
discretionary spending."

Americans are saving. And they're buying US Treasury bonds. (More
below...) But how safe is their money? Is it a good idea to buy US debt
now? 

On Wednesday, Latvia tried to raise a trivial amount of money. It
offered $17 million worth of 6-month bonds. How likely is it that
Latvia will default before Easter? We don't know, but investors judged
it not worth the risk. Not only did the bond auction failed, it failed
with no bids.

That's what happens when lenders lose faith in a government. They
refuse to lend it money - except at high rates of interest. But the
high rates of interest work like a noose on the neck of a cattle
rustler. They block the vital flow of oxygen - not to mention breaking
his neck.

Note that the US federal government is still functioning like an empire
at the peak of its power. The Pentagon is still rustling up trouble all
over the world - at a cost of trillions. US government employees are
growing more numerous and richer - with twice the annual incomes of the
private sector. And the Obama Administration - apparently unaware that
the total unfunded debts and obligations of the federal government have
soared to nearly $120 trillion - is considering new ways to get rid of
cash. 

Remarkably, investors still lend the US government money - asking only
4% annual yield on a 30-year loan. As for 91-day money, they
practically give that to the feds for free; it sports only a yield of
0.066%.

This will surely be a point of puzzlement for the financial historian
of the next century. It is certainly a point of puzzlement for us. 

[We wrote a book with Addison Wiggin, Empire of Debt that looked at the
similarities between the United States and the Roman empire - right
before its fall. We recently updated this New York Times
bestseller...and you can get your copy here.]

http://clicks.dailyreckoning.com//t/AQ/gqI/iBE/z8g/AQ/AYivIA/LD1K

More below, after the news, from The 5 Min. Forecast:

"Thirteen months ago, the government took over Fannie Mae and Freddie
Mac, both on the verge of failure," writes Ian Mathias in today's issue
of The 5. "What have we learned since then? Jack...

"The Federal Housing Administration, 'appears destined for a taxpayer
bailout in the next 24 to 36 months,' Edward Pinto said at a
Congressional hearing yesterday. As the former chief credit officer for
Fannie Mae, he should know.

"But it doesn't even take an industry insider to figure this one out.
Just a year after bailing out the overleveraged Fannie and Freddie, the
FHA has managed to paint itself into the exact same corner. When the
free market - in its infinite ignorance - stopped issuing easy money
home loans last year, the FHA stepped in and became a huge player in
the mortgage loan biz. They went from insuring 6% of new mortgages in
2007 to over 21% last year, and even more in 2009.

"Now the FHA insures 5.4 million single-family home mortgages - most of
which require only a 3.5% down payment - at a value of $675 billion.
Their cash cushion? Oops... Must have forgotten to beef that up too...
It's just $30 billion. That's the same 20-1 leverage our government's
been pooh-poohing on Wall Street. Funny how that works.

"And since the FHA has become the insurer of last resort, famous for
their crazy-low down payments, the loans they cover are souring at an
accelerating pace. The more recent the loan, the worse it's
performing... Can you hear the wind sucking out of this one?

http://dailyreckoning.com/files/2009/10/DRUS10-09-09-1.GIF

"So what happens if the FHA goes belly up? Hey, don't call us
alarmists: 'Let's be clear,' said Congresswoman Maxine Walters at the
hearing, 'without the FHA, there would be no mortgage market right
now.' As we've forecast before, look for the FHA to be the next multi-
billion dollar bailout."

You can get The 5 in your inbox 5 days a week, free of charge. It's one
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And back to Bill, with more views:

Yesterday, gold hit a new record at $1057. Doesn't gold go up when
inflation rates rise? And don't bonds go down when inflation goes up?

So why are people buying bonds with such puny yields?

There is a lot of whispering in this market. Gold is trying to tell us
something. Bonds are trying to tell us something. The dollar seems to
have something on its mind too. Stocks are just babbling. 

If gold is trying to signal that inflation is coming, the bond market
is not paying attention. Bonds seem to be saying that it is deflation
we should be worried about; but the stock market doesn't seem to hear.

And there's the dollar. The greenback is in the same choir with stocks
and gold, as near as we can tell. They all seem to be chanting about
inflation coming back.

But what if they're all wrong?

Just look at what is going on in Washington, if you can bear it. 

The feds have a budget that anticipates inflation and growth. Spending
is supposed to remain flat until 2013. Tax receipts, which are no
higher today than they were 10 years ago, are supposed to rise,
gradually filling in the Grand Canyon of deficits. The number crunchers
think we're headed back to the Reagan years - when the tough-love
policies of the Volcker Fed squeezed out inflation and created a real
boom. Then, tax revenues rose 9% per year between 1984 and 1989. 

How likely is that today? Not very. Instead, what is likely to unfold
is a deflation story. Instead of staying flat, federal expenses are
likely to rise as one failed stimulus gives way to another failed
stimulus. Then, instead of going up, tax revenues will go
down...digging an even grander canyon between out-go and income. 

Then, or long before, there will be a panic out of bonds, the dollar,
stocks - practically everything. Everything goes down!

At this point, the US will be in about the same situation as the Roman
Empire as it approached retirement. Expenses kept rising. Rome had to
pay the Blackwater-type military contractors of the era...in addition
to keeping Roman mobs supplied with food stamps and unemployment
benefits...while its tax base fell. Gradually, the empire lost the
ability to defend itself. 

When Edward Gibbon began his history of Rome's decline and fall, Roman
real estate had probably been in a bear market for at least 1300 years.
Rome's population fell from over a million to under 20,000.
Politically, Italy had broken apart more than 1,000 years before Gibbon
was born, and it wouldn't be put back together again until nearly 100
years after he was dead. 

It's far too early to write the story of America's decline and fall.
That job will fall to some future historian, perhaps seated on the
ruins of the Lincoln Memorial, wondering how people made such a mess of
things.

Our guess is that he will come to the same conclusion we have: Stocks?
Bonds? The dollar? Investors should have sold them all!

[But we'll hang onto our gold...and you should do the same. Don't be
turned off by the high price of the precious metal...there's a way you
can get gold at just a penny per ounce. See how here.]

http://clicks.dailyreckoning.com//t/AQ/gqI/iBE/DSg/AQ/AYivIA/dj3g

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---------------------------------------------------------------

The Daily Reckoning PRESENTS: The maestro himself, Sir Alan Greenspan,
has declared a recovery underway in the United States. The same man who
didn't see the world's biggest financial bubble until it exploded in
his face. This revelation seals the deal for Bill Bonner: the country
is clearly not recovering. Keep reading...

Chronic Depression
by Bill Bonner
London, England

This week, the Australian central bank became the first to declare
victory. It raised its key lending rate 0.25% and gave a
whoop...signaling an end to the slump. The European Central Bank
fidgeted and vaguely threatened to raise rates too. But the Americans
stayed in their trenches. New York Fed governor Bill Dudley said that
even though the economy is recovering, any rate hikes in the United
States would be over his dead body.

Then, word came that even Alan Greenspan thinks a recovery is underway. 

"This is what a recovery looks like," said the maestro. That settled
the matter as far as we are concerned. Alan Greenspan didn't see
history's biggest financial bubble until it exploded in his face. In
the following few words we undertake to show that Greenspan is as blind
as ever. 

"Great time for US consumers, America is on sale," says an item at
YahooFinance. The "discounts are unbelievable," adds a blogger known as
Frugal Rhode Island Momma. All across the nation, merchants are no
longer selling the merits of their products; they're selling price.
McDonald's advertises its "dollar meals." Hotels have cut room prices
by 20% in the last year. House prices are down about 30% since 2006.
Sellers are offering bargains and they want buyers to know it. "Sold
for $365,000 in 2006. Now $195,000," says a typical house ad. 

Foreigners have noticed too. Colleagues in London say they are thinking
of moving to Florida where they will get far more for their money. The
dollar falls; foreign purchases go up. Stocks, for example. In the
first quarter, foreigners were unloading US shares. Now they're buying
more than $100 billion worth per month. 

It is a deflationary world, at least that part of the world between the
Rio Grande and the 49th parallel. The CPI in the United States is
negative and falling faster than at any time in 59 years. Households
can only be induced to spend money by cutting prices. "Cash for
Clunkers" cut prices on new cars by about 20%. As soon as it ended, so
did auto sales. Most new house sales could be traced to a tax credit -
which reduced the down payment by at least 20%. That program is
scheduled to end in November.

And now, the White House frets about jobs. Unemployment is supposed to
be a lagging indicator, but this time it seems to have dropped out of
the race all together. Still, Congressional elections are coming up.
Unemployed voters are surly and unreliable. So, the Obama
administration is considering a $3,000 tax credit to bribe businesses
to hire them. If the typical employee costs his firm about $40,000,
this effectively reduces the cost of labor by 7.5%. 

It's beginning to look more and more like the Roosevelt years. By the
end of this year, all the jobs created during the bubble era - 2002-
2007 - will have been eliminated, making it the first decade with no
job growth since the '30s. We're expecting a fireside chat any day. 

Typically big businesses cut workers in a recession. Then, when the
economy recovers, small businesses are quick to take them back. But
this is unlike the typical post-war recession. This time, deprived of
capital as well as customers, small businesses don't have a chance.
Neither does a genuine recovery. 

The authorities still do not understand what is going on. They are used
to fooling most of the people most of the time. They think they can
dupe them again - with bailouts and boondoggles. But real demand has
vanished as households try to pay down their debt. That is not going to
change anytime soon. Not while the federal government is sabotaging a
genuine recovery. It's savings - capital - the US economy needs. A
capitalist economy in which the capitalist have no capital won't work.
Why is there no capital? Because the feds take it.

Supplying cash-for-this and cash-for-that is an expensive proposition,
especially when tax receipts are falling. The money has to come from
somewhere. As it turns out, the feds borrow it from the very people who
are trying to rebuild their personal balance sheets. Of the $1.6
trillion the US government will borrow this year, the biggest single
lender is the private sector, chipping in $700 billion. But instead of
being put to use in a way that might stimulate a real recovery -
providing credit for small business and consumers - it is taken up by
the US government and then frittered away. 

The banks are happy to play the government's game too. They can borrow
overnight money from the Fed at only one quarter of 1%, annualized. But
lending to small business is hard work. And it is risky. Why bother?
The US Treasury will pay them 4 % for lending back to the government,
long term. This is practically free money to the banks. Both the
bankers and politicians end up ahead - with a bigger piece of the
economy under their control. 

Meanwhile, the real economy staggers. "Drought of credit hampers
recovery," summarizes The Wall Street Journal. The United States needs
to create a million and a half new jobs each year just to keep up with
population growth. Currently there are 15 million people without jobs
already...and a couple hundred thousand more unemployed every month.
And if this recovery continues long enough there won't be a single
person left in America who still has a job. 

Even if the economy could be stabilized, it will leave millions without
jobs - more or less permanently. Add the people working reduced hours,
and those who have been looking for work so long they are no longer
counted, and their families, and you have a quarter of the population
without money to spend. That's why this slump is not going away any
time soon. As in Japan in the '90s, we may have to live with this
depression for the rest of our lives. 

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

Editor's Note: Bill Bonner is the founder and editor of The Daily
Reckoning. He is also the author, with Addison Wiggin, of the national
best sellers Financial Reckoning Day: Surviving the Soft Depression of
the 21st Century and Empire of Debt: The Rise of an Epic Financial
Crisis. He is also the author of, along with Lila Rajiva, Mobs,
Messiahs and Markets: Surviving the Public Spectacle in Finance and
Politics.

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