Counterfeit Expansion

Bill Bonner - Wed 03 Mar, 2010

How does an economy expand when the banks are lending less money?

There’s good news and bad news… and a lot of news in between.

Consumers spent a little more than was expected of them. And manufacturing did a little better than expected, too.

On the other hand, the federal government’s tax receipts plunged in the month of February… and bank lending is still contracting. Last week it shrank $33 billion – the 7th week in a row it has contracted.

How does an economy expand when the banks are lending less money? Beats us.

We believe the “expansion” reported in the GDP figures is mostly counterfeit. It’s government spending and hot money filtering into the economy. Still, it’s amazing that the GDP figures are positive…

The Dow was flat yesterday. The euro rose a little – on expectations of a settlement of the Greek affair. Greece is still in the news. It only had a month to sort out its problems. That was two weeks ago. The “clock is ticking,” say news reports. Most likely, the Hellenes can’t really sort their problems on their own. Greece will need some sort of bailout – even if it is limited and tentative – from Germany. Stay tuned.

It will be interesting to see what happens when Britain runs into trouble financing its deficits. It won’t have the Germans to help. Britain never took up the euro. It will be on its own.

But the big news from yesterday was the $19 boost in gold. Why did gold suddenly shoot up?

We don’t know. But our guess is that gold will suddenly shoot up a lot more. We’re in a deflationary period. That means everything is going down in price. But against what? Well, against money. Against real money that is – gold.

So gold should continue to go up until this deflationary period is over. That doesn’t mean there won’t be more hiccups and reverses in the gold bull market. But one of the surest trends of our time is the crack-up of the paper money system. And that is bound to be good for gold.

Chris Wood of CSLA says he gives the dollar standard 5 more years. Maybe it will be a bit more… maybe a bit less. But one thing is sure. Governments cannot continue to run such huge deficits forever. There will come a day of reckoning…

The feds are hoping it comes at a time and place of their own choosing. They all want to ease their way out of their troubles… with the help of consumer price inflation. You heard central bankers talking last week about increasing the inflation target from 2% to 4%. If they can actually control inflation so precisely, it will be a miracle. But that is what they hope to do.

A few years of 4% inflation would do wonders. In ten years, they would have cut a third of the national debt – in real terms, of course (supposing that they don’t add to it even faster). Not only that, the debts of the private sector would be eased too. At 6%… debts would be cut in half in a decade. With half the debt burden – the private sector might be ready to begin a new period of growth. That is the feds’ real strategy… to de-leverage the private sector enough that it can grow… and increase tax receipts.

By the way, that was what happened in the Reagan administration. The inflation of the ‘70s forced up interest rates and caused the worst recession since the Great Depression. But it also lightened debt loads – so much that the economy was ready for another big growth spurt.

This growth really paid off in the ‘90s… and the very early years of the Bush junior administration. Thanks to growing tax revenues, both Clinton and Bush were able to pay down the huge debts of the Reagan years… and still increase spending. The economy was able to “grow its way” out of debt.

Then, with the war on terror and the micro-recession of 2001, the budget magic of the ‘90s was lost. Bush apparently never met a spending bill that he didn’t like. Spending exploded… especially time-bomb spending for health care, which increases automatically year after year.

Then came the depression… known popularly as the Great Recession of 2007-2009. Tax revenues fell. Spending increased even more. And now the deficits come hard and fast. And there seems to be no way to “grow our way out” of them. All of the conditions that made for a boom in the early ‘80s are making for a bust in the early 2010s. Interest rates are at record lows, not record highs. Stocks are high, not low. Bonds are high, not low. The government is the solution, not the problem.

More below, after Riccardo Marzi, with this report from our London office…

Looking for a way to play the bust-up in Europe? Here’s a lead for you to follow… and a trade idea in the making. Riccardo sets the scene…

“Here is an incredible fact. Last year, in the midst of the most severe recession in the last 60 years, more than 14.5 million cars were purchased in Western Europe. That was just 1.6% lower than the year before.

“And last month in Spain, car sales jumped 47%. Europeans – seemingly oblivious to economic meltdown – are crawling over each other to get into car showrooms. At a time when Toyota is recalling cars with faulty brakes from across the world and North American car sales have collapsed from 16m to 10m cars a year, European car manufacturers are enjoying bumper sales.”

What? How can that be – isn’t the Eurozone in serious economic trouble? Yes, but there’s a reason for this bonanza in car sales… and it’s one that cannot last, as Riccardo explains…

“There is only one reason why Western Europeans are trading in their ageing bangers – their governments are paying them to. The scrappage schemes introduced last year to prevent a collapse of the car industry have hugely distorted the European car market. And as I’ll explain today, they may just have ruined it.

“The thing about a scrappage scheme is that it does not increase total demand in the market. It merely pushes forward demand that might have been expected this year.

“But what happens when that doesn’t materialise later this year? Because governments can’t continue to pay consumers to trade in their cars forever. Car scrappage schemes cost a lot of money. And they are very obvious cost-cutting targets for anxious governments that want to reduce the budget deficit. When these schemes are removed in the coming months, demand will disappear with them.

“But here is the real problem with the European car industry – it has far too much capacity. While the industry sold 14.5 million vehicles last year, European car makers had the capacity to produce around 20 million.

“It is a very expensive business keeping so much labour and machinery idle. Because car assembly lines are a high capital and high fixed cost business, they need to be operated near full capacity before they make money. This is called the operational gearing: a typical plant needs to operate at 80-85% capacity before it cover its costs, after that it’s almost all pure profit.

“Last week Renault and Peugeot warned that the Western European car market could fall another 10% from last year’s levels, while Moody’s is more pessimistic and is forecasting a contraction of 15%…

“…Excess capacity and the end of scrappage schemes in my view are an explosive combination for the profitability of the whole sector. This is going to be a brutal year for European car stocks.

“There are already signs of trouble this week for major European car groups. German new car registrations declined 30 percent in February, to about 195,000, the VDIK industry group said in an e-mailed statement today. And this could just be the start of a steady stream of bad news on these stocks.

“As soon as I see a good opportunity arise, I will alert you to what stock to short or spread bet.”

To get in on Riccardo’s idea for making money from the blow-up in the European car industry, be sure to add your name to his list of readers of his Events Trader service. You’ll find details of the service here.

Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600

And more thoughts…

*** Since the feds can’t grow their way out of debt… they’ll have to try to inflate their way out.

Trouble is, first… central bankers don’t have that good a grasp of inflation. They can control the amount of money in the monetary base at the Fed. But they don’t really control what happens to it next. For a long time, prices don’t necessarily react… because, in a depression, the velocity of money slows down to a crawl. The banks don’t lend; the money doesn’t get around… and it doesn’t feed into consumer prices. Then, all of a sudden, people realize that their dollars are losing value… suddenly, they are eager to send them on their way. Velocity increases – fast. It is as if they had put cash in a particle accelerator. Instead of 6% inflation, the CPI goes to 12%… or 25%… or 100%.

The other problem is the ‘bond vigilantes.’ You remember them. They’re the ones who so impressed Bill Clinton that he said that if he died, he wanted to be reincarnated as a bond trader. Because those guys are the ones with the real power, he noticed.

America is going to need to borrow an additional $1.6 trillion this year. And then keep borrowing $1 trillion-plus for years and year to come. There are no surpluses – ever again – in any plausible budget forecasts.

But what will the bond vigilantes make of this? What if they see inflation increasing? What if they no longer want to lend? What if yields on the 10-year notes (which go up when bond prices go down) rise to 5%, or to more than 15%, as they did in the early ‘80s?

Then, instead of a deflationary depression we will have an inflationary depression. How it will play out exactly is beyond the scope of today’s Daily Reckoning. Besides, we don’t know. But one thing is almost certain – that gold will go up.

Gold is what people buy when they fear a crack-up in the monetary system. As the day of reckoning draws near, gold will shift from being a means of storing wealth… to a hedge against inflation and/or a monetary crisis… to a speculative play.

Currently, you see ads for companies that offer to buy your gold – in exchange for paper dollars. The public still has no idea; if they knew what was coming they’d want to hold onto every piece of gold they own.

Sometime in the future you’ll see ads with the opposite message. Companies will want to sell you gold – at prices far higher than those today. Then, cab drivers will give you tips on which is the best penny mining share to own… and hair dressers will opine on their favourite gold coins.

When that happens, we will have to remember to sell. But that is still way in the future…

*** We took the train up to New York on the weekend. It has been at least 10 years since we took that ride. In the intervening years, you’d think something might have changed.

Nope.

Same abandoned factories and warehouses. Same derelict houses. Same broken windows. Same trash. Same abandoned cars.

Same miserable cities – Trenton, Newark, Philadelphia, Baltimore.

And these aren’t even the worst cities in the nation. None of them even made the top ten:

Top 10 Most Miserable U.S. Cities

Jobs are hard to find. Taxes are high. The weather stinks. And even the pro sports teams are losers. Welcome to Cleveland, Ohio, the most miserable city in the United States, according to Forbes magazine. For many, it lives up to its nickname: The Mistake by the Lake.

Cleveland isn’t alone in its misery, although it was the only city to fall in the bottom half of the rankings in all categories. Stockton, California came in second because of high unemployment, high violent crime, long commutes and onerous taxes. Memphis is in third place due to the second-worst rate of violent crime in the United States and an alarming rate of convicted public officials.

To measure cities’ misery, Forbes used the following metrics: income taxes, sales taxes, commute times, violent crime and the win-loss record of the professional sports teams over the past two years. Also included in the mix were the weather, the number of Superfund pollution sites and corruption of public officials.

The top 10 most miserable U.S. cities:

1. Cleveland, Ohio
2. Stockton, California
3. Memphis, Tennessee
4. Detroit, Michigan
5. Flint, Michigan
6. Miami, Florida
7. St. Louis, Missouri
8. Buffalo, New York
9. Canton, Ohio
10. Chicago, Illinois

*** Same false advertising too: Trenton Makes; the World Takes. Trenton doesn’t make anything at all. At least, there is no evidence of it from the train. All we saw were the bombed out remains of a city that was once very productive… but now lives on federal handouts and government jobs.

You want to see the future, dear reader? Take a look at the places where government runs the economy. Take a look at Trenton.

Until tomorrow,

Bill Bonner
For The Daily Reckoning

post a comment

	BlinkList
	Del.icio.us
	Digg
	Facebook
	Google Bookmarks
	linkedIn
	Livejournal
	Newsvine
	Reddit
	StumbleUpon
	twitter
	Yahoo! My Web