Yet here at Notes we remain cautiously bearish. Why? Because it is our humble opinion that this remains a bear market rally, impressive as it is. Gluskin Sheff’s David Rosenberg says the rally lacks three key ingredients:

1. Leadership
2. Quality
3. Volume

History is littered with such bursts of euphoria. Probably the most infamous is the bear market rally of 1930. Stocks recovered strongly following the November 13, 1929 low. Wall Street became wildly confident that the worst of the crash was over. And for a time the bulls were dead on. From a low at 199 on November 13 the Dow rallied to a high of 294 in April 1930 – up 48%. By the end of the year, the Dow was down to 158. And by July 1932 it had plunged another 41 points.

Believe it or not, this rally occurred in the absence of an economic recession. Although it is largely overlooked today, the U.S. economy held up following the October crash. The rout in stocks was at the time considered to be an isolated incident – a direct consequence of excessive speculation and nothing more.

It is sobering to consider that few thought during the first half of 1930 – when the business curve of the Harvard barometer was almost horizontal and therefore did not signal a recession – that a devastating depression lay ahead.

The lesson from history is that depressions – or bear market rallies – aren’t avoided simply because they are not predicted. Nor are stocks always a bargain because they are “cheap.” At its November low, the Dow sold for only 10-times earnings; it had peaked at 15-times earnings in early 1929. But try telling investors who bought into the Dow in November 1929 that they’d got a bargain!

We bring this up not because we believe that history is destined to be repeated, but because we believe it often rhymes. And it would be foolish not to revisit the lessons of 1930 at this juncture – one year after our own “great crash.”

The casualties of the bear market rally of 1930 included some of the best investing minds of the era. Legendary investor Jesse Livermore lost all his money in the 1930-32 decline and eventually ended his own life. And a reclusive John D Rockefeller issued a statement that contained these fateful remarks:

In the ninety years of my life, depressions have come and gone. Prosperity has always returned, and will come again… Believing that the fundamental conditions of the country are sound, my son and I have been purchasing sound common stocks for some days.

Call us old fashioned, but we simply don’t believe that a secular bull market can last in a recessionary environment. And we firmly believe that the recovery drum has been banged a little too hard by the mainstream media.

To wit, we strongly recommend that Notes readers spend some time familiarizing themselves with the recent “fact finding” study on the depths of the current recession by two of our favorite underground sources, Tyler Durden of Zero Hedge and David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates.

What follows is a very quick-and-dirty rundown of Durden and Rosenberg’s case.

1. The US consumer makes up 70% of US GDP, yet retail sales and wage-based income are steadily declining. And consumer deleveraging continues despite efforts by the Fed and the Obama administration to stem the tide.
2. The business outlook remains bleak. May business sales decline a hefty 18% year-on-year. This is clearly a recessionary signal. Other key business outlook indicators, such as the Philly Fed’s Business Outlook Index and the MAPI Business Outlook Index, are pointing down.
3. There is no reason to believe that an inventory bounce is in the works. In fact, the decline in UPS package volumes (-4.7 year-on-year in June) show that inventory weakness is accelerating.
4. The recent falloff in jobless claims is due to seasonal factors, not an improvement in the economy. “Official” unemployment is under 10%. But the U-6 data (which includes the so-called “underemployed”) is 16.8% – 6.5% higher than a year ago. A consumer driven recovery in this environment is highly unlikely.
5. Housing is still in the ditch. It will take at least five years to mop up excess inventory. This means house price deflation will be a secular trend. This will continue to act as a drag on the banking sector and impair credit quality.
6. There is no top-line business growth. Better-than-expected earnings in the second quarter were achieved by cost cutting, which will have a negative, not a positive, impact on the economy. Stock holders will eventually want to see revenue growth. When this fails to happen, stock prices will come under pressure.
7. State revenues are imploding. The Rockefeller Institute of Government predicts a slide of 20% in the second quarter. California is the first state to go bust. It won’t be the last.
8. President Reagan’s low-tax lesson has been forgotten. There are no fewer than three tax increases planned for upper-income households by the Obama administration. We are looking at a top marginal rate jump of 10 percentage points by 2011. This will bring the top rate to 45%.
9. Although credit spreads are tightening, S&P downgrades of corporate bonds hit records in June. And credit conditions for small companies remains incredibly tight.
10. The overall inflation rate is currently running at -1.4% year-on-year. This is the lowest rate since 1950. There is no threat of real inflation until the excess slack in the economy is absorbed. [Note: We disagree with Rosenberg and Durden here: we see a clear-and-present threat of inflation down the road.]

Last weekend, we journeyed to Boston to attend a college graduation. Thousands of callow scholars were on display. Each was handed his papers…and then marched out of the hockey stadium. To the tune of ‘Pomp & Circumstance,’ wearing a long, red robe, he entered the outside world solemnly…like a patsy joining a poker game.

So far, not a single major university has asked us to make the commencement address. Nor a minor college. Not even a school of cosmetology or taxidermy. But here on the back page, protected by a broad ocean and a narrow reading of the First Amendment, we will give them – and UK graduates too — advice no one asked for:

“Plastics,” was the advice given to college graduates in Mike Nichols’ ’67 film. But that was when there was still hope for America’s manufacturing sector. Even then, it was too late. The percentage of GDP from the manufacturing sector fell for the next 4 decades, from over 20% in the last ‘60s to barely 12% last year. Better advice would have been ‘derivatives.’ They stank just as bad, but they were on the upswing. While only 8% of GDP, finance accounted for 40% of corporate profits in 2007. And derivatives grew from nothing to a face value of 16 times the GDP of the entire planet.

But your elders are always giving you bum advice.

“You cannot decline the burdens of empire and still expect to share its honors,” said Pericles to the class of 430BC. He lived during a time not unlike your parents in the USA – when Athens was on top of the world. But vanity got the better of him. He launched an attack on Sparta, which backfired badly. He soon died of plague and Athens was not only ruined, but enslaved. Athens’ ‘golden age’ turned to lead. Young Athenians should have shrugged off the burden rather than accept it. You should do the same.

When you were born 20-some years ago, the nation’s total debt per person was less than $90,000 – adjusted to ’09 dollars, of course. While that was a lot of money, it was nothing compared to what was coming. Now it’s $186,717 per person – more than twice as much, in real terms. Fortunately, private debt is not inheritable. But it comes to you as a lien against property. Instead of paying off their mortgages and leaving you a house, free and clear, the baby boomer generation spent the ‘equity’ in their houses even faster than they got it. House prices rose. But mortgage debt rose faster. While your grandparents owned 80% of their houses, by 2007, the typical homeowner only really owned 4 rooms of an 8-room house. And then, when house prices fell, so did his remaining equity…to the point where one out of six homeowners in America is now underwater. You could still eventually inherit a house, but you may to scrape the barnacles off the front porch.

But that’s not even the half of it. While your parents had control of the US government they allowed themselves a little larceny. Add the unfunded retirement and healthcare benefits they voted themselves to the official national debt and together they are scheduled to cost your generation 4 times the total annual output of the US. This is over and above the private debt they accumulated.

Some of this debt can be carried. Some will have to paid down. But as it stands, as much as $77 trillion of post-’09 earnings must be stolen from the future in order to pay for the liquor your parents drank…the bombs they dropped on god-forsaken foreigners…and the interest on their debts. So, forget about saving for a European vacation or a house of your own. Even if every penny of your savings – and every other American’s savings — are put to the task you will still be paying for your parents’ expenses all your life.

But wait, there’s more! The burden is getting heavier. Federal budget projections show an additional $7 trillion in deficits over the next 10 years. Described as the cost of fighting recession, the present generation buries its own mistakes under cash that the next generation hasn’t even earned yet. Today’s bankers, businessmen and speculators are being bankrolled by you – tomorrow’s bankers, businessmen and speculators. Today’s homeowners get a helping hand…from whom? Tomorrow’s homeowners – you. Today’s employees get a boost too. Same story. Where do you think the money came from to pay Wall Street bonuses this year? How do you think GM stays in business…and Fannie Mae..and AIG… Who pays those salaries? Who pays to keep troops all over the world and keep old people supplied with new drugs? Who pays for hundreds of billions’ worth of ‘shovel ready’ boondoggles? You will. At least, that’s the plan.

Like Pericles, your lucky parents inherited a dollar; they leave you a peso. They took over the strongest, richest, most competitive nation in the world. And like Pericles they minded everyone’s business but their own. Now, not only does the US owe money all over town, its government puts out trillions more in IOUs every year – each one with your name on it. You’re not even out in the real world yet, and you’re getting the bill for 50 cents of every dollar the feds spend – almost none of it earmarked for you. But that is the thing about the real world your teachers probably forgot to tell you about. It is more unreal and fantastical than anything you studied.

Here’s what’s real: You’ve been dealt a bad hand. From the bottom of the deck….your parents have slipped you some nasty cards. My advice? Fold ‘em. Get up from the table before they clean you out.

To Wall Street booking stupendous profits by laundering “risk” out of bad loans with new issues of tranche-o-matic securitized paper? This I doubt, since there isn’t a pension fund left from San Jose to Bratislava that would touch this stuff with a stick, even if it could be turned out in collector’s editions of boxed sets.

Does it mean that American “consumers” (so-called) are awaited momentarily in the flat-screen TV sales parlors with their credit cards fanned-out like poker hands, ready for “action?” Not too likely with massive non-performance out in cardholder-land, and half the nation’s electronics inventory wending its way onto Craig’s List. Are we expecting more asteroid belts of new suburbs carved in the loamy outlands of Dallas and Minneapolis, complete with new highway strips of Big Box shopping and Chuck E. Cheeses? Go to banking’s intensive care unit and inquire (if you can) among the flat-lining production home-builders and the real estate investment trusts on life support when they expect to rev up the heavy equipment.

The idea that we’re about to resume the insane behavior that induced the current epochal malaise of economy is so absurd it will only be heard in the faculty dining halls of the Ivy League. And if America is not picking up where it left off eighteen months ago – the orgy of spending future claims on wealth unlikely to accrue – then what is our destiny? Based on what’s out there in the organs of public thinking, it seems that we don’t want to think about it.

So many forces are arrayed against a return to the previous “normal” that we will be lucky, in another eighteen months, to still find ourselves speaking English and celebrating Christmas. What’s “out there” is a panorama of mutually reinforcing critical problems pertaining to how we live on this continent. Like the obesity, heart disease, and diabetes that plague the public, these problems are disorders of lifestyle habits and the only possible “cure” is a comprehensive revision of lifestyle. With the onset of spring weather and the cheez doodles and monster truck rallies and NASCAR tailgate barbeques and the drive-in beer emporiums all beckoning, can the public shift its attention from these infantile preoccupations to saving its own ass?

So far, the most striking piece of the economic fiasco is the absence of any galvanizing spirit among the millions getting crushed in the tragic unwind of our relations with money. It will be interesting to see, for instance, if there is any uproar over the evolving story of Goldman Sachs’ latest raid on the U.S. Treasury, after booking billions in taxpayer-funded payouts funneled through AIG, based on double-hedged credit default swaps. Such magic tricks are understandably hard to follow, but a dozen-or-so federal attorneys with a middling background in differential calculus might suss out the trail that leads from Ben Bernanke’s work station to Lloyd Blankfein’s cappuccino machine.

Something similar may be said in regard to revelations last week of White House economic advisor Larry Summers’ connection with a number of hedge funds shoveling millions into his deep pockets for showing up once a week to cheerlead their “innovations” – not to mention his shadowy visits to the Goldman Sachs gravy train even after he signed onto the Obama campaign. As long as the stock markets seem to rally – no matter what else is really going on in America – nobody will pay much attention to these disgusting irregularities.

Since it is that time of year, and I am haunting the gardening shop, one can’t fail to notice the many styles of pitchforks for sale. My guess is that the current mood of public paralysis will dissolve in a blur of blood and spittle sometime between Memorial Day and July Fourth, even with NASCAR in full swing, and the mushrooming ranks of the unemployed lost in raptures of engine noise and fried cornmeal. It doesn’t take too many determined, pissed-off people to create a lot of mischief in a complex society.

On the agenda in the second quarter of ’09 are ominous rumblings in the oil and food sectors. Half a year of cratered oil prices have decimated the oil industry and we’re driving at 100-miles-an-hour straight off a cliff into a new kind of supply crisis – even if industrial production and global exports remain moribund. So many drilling rigs are being decommissioned that the oil industry itself looks like it’s preparing for its own death, investment in exploration and discovery has withered with the credit markets, and the world may never recover from the year long hiccup in oil industry activity – translation: peak oil is biting back now with a vengeance. Its peakness will look peakier and the yawning arc of depletion beyond will look steeper and pose a threat to every globalized and continental-scale enterprise in the known world.

So many dire elements are ranging around our food production system (i.e. farming), from widespread drought and water table depletion to “input” shortages (especially fertilizers) to sickness in credit availability, that we’re all one bad harvest away from something that will make Pieter Bruegel-the-elder’s “Triumph of Death” look like Vanity Fair’s annual Oscar Party in comparison.

Barack Obama, charming as he is, had better drop his pretensions about kick-starting the old consumer economy, fire the Wall Street clowns and parasites who are running that futile exercise, and start preparing a US Lifeboat Economy aimed at reducing the scale and scope of our outlays so we can survive the coming siege of austerity. Meanwhile, I’m glad that he finally got a dog for the White House, because the President knows full well where to turn in Washington if you want some genuine love and affection.

Source: The Coming Siege of Austerity

We’re in the “anger” stage, writes John Authers in the Financial Times. No more denial…now, people want blood.

After the South Sea Bubble blew up, in the 18th century, the Walpole government was faced with similar anger. It seized the property of the company’s directors and used it to pay off the victims. Then, a resolution was proposed in Parliament by which the bankers involved in the scandal would be tied up in sacks filled with snakes and tipped into the Thames River.

So far, Congress has not proposed stoning Fannie Mae or sending AIG directors to the bottom of the Potomac. But it must be warming to the idea.

“Congress is looking for heads to cut off,” says the French press.

One member of Congress – Senator Grassley – retreated from his call for AIG executives to commit suicide. It would be all right with him if they just showed a little contrition, he says now.

But all over the world – and especially in Washington DC – the mobs are out in the streets with liquor on their breath and ropes in their hands.

The proximate cause of this anger is the bonuses paid out by AIG – after the company got a taxpayer bailout of $170 billion. According to the New York Attorney General, 73 AIG execs got $1 million + bonus checks.

“Livid Democrats demand AIG return bailout bonuses,” says a headline in today’s financial press.

We hope you realize, dear reader, that all of this, of course, is just a cynical sideshow. It’s a distraction…a self-indulgent tantrum; the real story lies elsewhere…which we’ll come to in a minute.

First, the rally is still going on. Stocks have recovered about 10% of their losses so far. And yesterday, the Dow rose another 178 points.

Don’t forget, this is not a new bull market. It is a bear trap…a rebound in an on-going bear market. After this phase of anger passes…people will probably feel that the worst is behind us. They’ll squint and see a “light at the end of the tunnel.” Later on, they’ll realize that the light is an on-coming freight train!

Yesterday’s up-move was traced to a surprising report from the housing industry.

“Housing starts unexpectedly increase on condos,” explains a Bloomberg headline.

And today, the Fed meets. Analysts are betting that the Fed will begin more “massive buying” of assets – especially U.S. Treasury bonds – in order to get more money into the system.

All the news is not favorable, of course. Auto loan delinquency rates are running 9% ahead of last year. Thornburg Mortgage is apparently headed towards Chapter 11. Caterpillar says it will lay off more than 2,000 workers; less construction means less need for heavy equipment. And AMEX says even its best customers are falling behind on their bills.

But let’s go back to into the theatre and take our seats: The politicians give money to their pet projects…and then pretend to be outraged when the companies use it to pay their bills. Among their bills were billions in payments to other companies –notably Goldman Sachs, former employer and major source of wealth for the man who designed the bailout, Hank Paulson – and thousands of employment contracts with AIG’s salarymen.

What did the feds think when they gave AIG the money? That they were donating to charity?

No, dear reader…the fix was in. And it’s still in. And while the press and politicians huff about a few million in bonuses to AIG’s hacks, billions more is being paid out to AIG’s counterparties.

It’s not only a waste of money, says our old friend Jim Rogers, the bailouts actually retard a recovery. How so? In the obvious way. Like any kind of subsidy or welfare payment, they invite people to keep doing what they’ve been doing – no matter how unproductive it is. Instead of letting AIG and its bosses and counterparties go broke, the feds give the whole brain-dead system a transfusion of taxpayers’ money. So the executives don’t have to go out and find other work. And AIG can continue peddling its mortgage insurance. And its counterparties, too, are protected from their mistakes.

Of course, the government doesn’t want to raise taxes in order to keep these incompetents in business, so it bleeds the money from the next generation of taxpayers – who aren’t around to protest. Instead of letting the debt be reduced by the natural process of deflationary default, in other words, the government adds more debt.

Already, as we pointed out yesterday, there’s about $20 trillion worth of debt debris that must be brushed aside before the economy can begin rebuilding on a solid foundation. At the present rate of savings, it will take about 45 years to do the job. Which suggests to us that it ain’t gonna happen. We don’t think the feds can sit still that long. And they’re not sitting still now. In fact, they’re adding to the public debt faster than the private debt is getting paid down.

By our calculations, the private economy is paying off about $420 billion – net – per year. (Just based on higher rates of saving…not counting write-downs, and defaults.) But the federal deficit is expected to run to $2 trillion! In other words, the feds are adding debt 4 times faster than the private sector is paying it down.

This is not a formula for putting this problem behind us. Instead, it just pushes it ahead.

Now, we turn to Baltimore, to see what Addison has for us…

“‘We do want foreign capital to come in here and we want private capital,’ our favorite stammering Rep, Barney Frank said yesterday.

“After emerging from a House Financial Services Committee meeting,” writes Addison in today’s issue of The 5 Min. Forecast, “Frank found a few mics to spit into… and the off the cuff pontifications proffered fourth. This was our favorite:

“‘We just had the Chinese raising the specter of not buying our Treasuries. Well, that would be troubling. I think they’re bluffing, personally.’

“Ha!

“Bluffing? We thought bluffing meant you were acting strong despite a lousy hand… like this:

“This game is played with the cards up…and China’s holding all aces.”

Addison 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.

Back to Bill, in the land of wine and cheese…

Newsweek magazine offers bad advice: “Stop Saving Now!”

We didn’t read the magazine’s account; giving the editors the benefit of the doubt, we will guess they were being ironic.

All over the nation – and perhaps the world – people are cutting back, making do, and doing without. “Frugal families doing own chores,” says one headline. “Beat the recession by growing your own vegetables,” says another. And a popular new website, called Mint.com, is a runaway success; it helps people plan their budgets and find ways to spend less money.

All of this financial rectitude is having a deleterious effect on the economy. The old economists called it the ‘paradox of thrift.’ The man who plants his own vegetables spends less with the green grocer. Then, the grocer spends less with his suppliers. Then the suppliers spend less with their suppliers. And so forth. Soon, everyone is spending less money…and you have a depression.

So, a civic-minded reader might think he should step up his shopping – if he were an idiot. He might think we’d all be better off if he spent more money…and everyone else did the same.

But that’s not how it works. We’re not all better off when we all do something stupid. We’re only better off when we all do something smart. And when people have spent too much money – and gone too far into debt – the smart thing to do is to spend less, not more.

*** Income-on-Demand’s Wayne Burritt on last week’s market bounce:

“As you can see from this chart of the S&P 500 – a good gauge of the broader U.S. stock market – last week’s bounce has ignited a mini-rally that is just plain joy to see. In fact, from a low last Monday, the S&P 500 has surged a mind-blowing 15%. Wow!”

“Even better: The market’s latest action snapped a series of down days that had just about everyone running ragged, me included.

“The market also bounced on higher volume, another big plus for a straightforward reason: When up-market moves are accompanied by higher-than-average volume, it’s a clear sign that bullish investors are attracted by the positive market action and are willing to buy shares to prove it.

“But that’s not all. Last week’s bounce was not just a big volume day: It was the highest-volume day out of the previous seven trading days. I have to go all the way back to the bounce of late November to find a similar surge in buying volume.

“Significant? You bet. When the market bounced late last November, it immediately began a run that didn’t end until the S&P 500 hit 944 on Jan. 6 of this year. From the November low of 741, that run marked a massive 203-point surge.

“Translation: A bounce similar to last week’s ushered in a whopping 27% upside bullish run on the S&P 500 just a few months ago. Given that we’ve moved 15% in just a matter of days, this run could best last November’s by a long shot.

“Now, I’m not about to say that it’s time to pop open the champagne. But facts are facts, and current market action is certainly a step in the right direction.”

That’s going to do it for us today. Keep reading for today’s guest essay from Bill Jenkins who will explain how he sees signs of socialism more and more in today’s headlines.

Source: The Fix Is in at AIG

In secret talks, Gono has agreed to replace the out-going Ben Bernanke, who is said to be going to work as a helicopter pilot. Gono will take over the Fed. And a new bill has already been designed – our source was able to sneak out a copy of the new note – for 1 million US dollars.

That’s Gideon Gono’s picture on it. According to reports, Gono insisted on getting his face on the bill as part of the deal. “Dead presidents are a dime a dozen,” he is said to have remarked. “And this is just the beginning; we can add zeros later.” Gono was in the news yesterday for other reasons too.

Zimbabwe has taken a couple of bold steps recently. First, it announced that henceforth citizens would be allowed to use currency other than the stuff produced by its own central bank. This came as a great relief to the people of the nation – who were already using US dollars to replace the Zimbabwean brand. With 230 million percent inflation, the Zimbabwe dollar has not been so much a store of value but an incinerator of it. Second, Gono announced that he was taking 12 zeros off the Zimbabwean currency. Twelve seems like a lot. And it seems like only yesterday that Gono introduced the first note with 12 zeros on it – the 1 trillion Zim dollar note.

But that’s the problem with zeros. They’ve got holes in them. You add nothin’ to nothin’ and you still got nothin’. Easy come. Easy go. You can as easily add zeros as take them off. At the end of the day, the extra zero gets you zilch.

Still, dear reader….

In Gono We Trust. Our economy is in a terrible mess. We need inflation; only Gono seems to know how to get it.

Yesterday, the report card on the economy came in. It showed growth in the last quarter of last year at MINUS 3.8%. “Could have been worse,” say economists. It WILL be worse, we reply. This Depression is just getting started.

The Dow fell 40 points yesterday. We’re in February already. Investors look back and see that stocks have lost more than 8% so far this year – the worst on record. In 87% of cases, what goes down in January goes down all year long. Last year, we had the worst stock market performance on record. But what the heck… records are made to be broken. This year will probably be worse still.

Macy’s said it laid off 7,000 people. California says it is kiting checks. And Republicans say they are digging in their heels about Obama’s Bailout Boondogglization program. They favour boondoggles of their own.

Consumer spending fell last month – for the 6th month in a row. Consumers are exhibiting the quality that economists fear… “the propensity to save.” Until last year, of course, they had a propensity to spend. Now, all the news tells us that what ought to happen is happening now; consumers are closing their pocketbooks.

According to mainstream economists, this “propensity to save” thing is as welcome as halitosis. It’s a conversation stopper, for sure. One man’s expiration is another’s inspiration. One’s spending is another’s income, in other words. So when he stops spending, the whole system of consumer spending comes to a halt. Sales plummet. Incomes fall. Jobs are lost.

Hey… welcome to the Depression of 2008-201?

And get ready to welcome Gideon Gono to the Fed. We need him.

*** Yesterday, we promised to take up a theme… hmmmm…. what was it…? Oh yes, the critical issue… when.

When? When what?

Oh yes… when will deflation turn into inflation?

You want a date, don’t you dear reader? You want to know exactly when you should switch out of Treasury bonds and into stocks, gold and freeze-dried food. Alas, that we can’t give you. Not even an approximate date.

This past weekend, we sat down in the Dr. Richebacher chair that we keep next to the fireplace. It’s the chair where Kurt Richebacher used to do his heavy thinking. We inherited it from the family after he died.

We sat and we tried to channel Kurt. What would he think… we wondered.

“Imagine you are in a small town,” we thought we heard him say. “Imagine that the banker printed up the town’s money in his basement. One day, he went a little crazy and started making huge loans, even to unqualified borrowers, at very low rates of interest. You would soon have a boom on your hands, with everyone paying for everything with IOUs, all derived from the bank’s easy credit policy. But, eventually, when it was discovered that people couldn’t repay their loans, there would be a terrible bust.

“That is where you are now. (I say ‘you,’ because I am no longer among the living… but I have to say, heaven is not a bad place to be… There is almost a total absence of economists, lawyers… and not a politician anywhere.) It is a period of price discovery in the credit market… because no one knows who can pay his bills and who can’t. The IOUs are being marked down.

Unemployment is rising, too, as the local economy slows down. Consumer demand has been greatly reduced as every has gotten poorer.

“Now, the banker sees what a mess the place has become. Naturally, he wants to do what he can. He tries to lend more money, but people have been down that road; they are reluctant to borrow. Then, he undertakes to build a new ballpark… you know, for playing baseball. And he decides to upgrade the town hall too… printing up the money to pay for it, as necessary, and to pay for a variety of projects to keep his friends and relatives employed.

“But while he is trying to get the boom going again, the bust is still going on. For every dollar he puts back into the town economy, $2 or $3 is taken out. Instead, of spending money like they used to… citizens stuff it in mattresses and bank accounts (much of it comes back to the bank where it started!)

“This process can go on for much longer than you think. Because the banker is, in effect, standing in the way of what needs to happen. He is blocking the process of price discovery… by lending money to deadbeat debtors and propping up businesses that are no longer profitable. The baker, for example, had built a fancy oven to produce 200 pastries every day. When the boom was in full swing, he sold every one of them. But now that people are cutting back, he sells only half as many. His investment in the new oven is now a losing proposition. But it takes the market a long time to find out; because the banker gives him enough money to carry on… when he should have declared bankruptcy months ago. And so with the tailor and the hat-maker and all the rest.

“Eventually, the banker realizes that his efforts to restart the boom have failed. Instead of spending money, people use it to pay down their debts. They cut their expenses; they reduce their output; and they’ll continue to use their cash surpluses to pay their debts until they are back down to where they usually are, he reasons. Even then, people are likely to save because they’ve gotten in the habit of saving; this could go on for a long time, he figures.

“And then, he realizes that the only way to prevent people from falling into the ‘propensity to save’ trap is to make them realize that the currency is not worth saving… that it is losing value. That is when he will turn to Gonoism. He will go down into the basement; print up stacks of $100 bills… and begin passing them out on street-corners.”

Inflation is needed. Not just more credit from the bank. But money… cash… free cash… piles of it.

The US currently has about $1 trillion worth of spare output capacity. It has about $6 trillion worth of private debt – above and beyond what is traditionally considered ‘normal.’ And unemployment is rising. As long as those things persist, prices are not likely to go up. First, because business has no pricing power – not when there is excess capacity. In our example above, for instance, the baker can double his output of pastries with no further investment nor additional costs. He cannot raise prices; instead, he’ll probably lower them in order to compete with the baker down the street who also has excess capacity. Nor are labour rates going to go up – not when workers are still being laid off. The proletariat has no more pricing power than the bourgeoisie. And as for consumers… they won’t go back to consuming until they’ve lightened their debt burden. With $6 trillion, more or less, to unload it will be a long time before they’re ready to spend again.

So don’t expect miracles from the Boondogglization programs. Prices won’t rise until central bankers Go Gono. And once they’ve gone Gono… things will really start to pop! Stay tuned.

*** Our friend, Nassim Taleb, author of the “The Black Swan,” told the Davos crew that “we should not trust these bankers. Look at their track record. The only way to stop the process is for the government to own those banks.”

Yes, dear reader, everyone is jumping all over the bankers. As we pointed out two weeks ago, there are two schools of thought. Either the bankers are evil. Or they are just very, very stupid.

Jamie Dimon, chief of JPMorgan Chase, joined the ‘they are stupid’ camp.

“God knows, some really stupid things were done by American banks and by American investment banks,” he said. But he went on to suggest that maybe the bankers weren’t the only morons. “To policy makers, I say: ‘Where were they?’”

The grammar suggests he really is stupid enough to be a politician. He probably meant to say: “To policy makers, I say: “Where were YOU?”

But the thought seems correct to us. Where were the regulators… the policy makers… the economists… the commentators… the media… the analysts… the rating agencies? And where were the investors? Of course, they were all in the same place as the bankers – fantasy land.

And now, guess what? They’re still in fantasy land… imagining that these trillion-dollar boondoggles will erase the mistakes caused by their earlier fantasy.

Oh, Mr. Gono, wherefore art thou?

Source: In Gono We Trust

“I think it’s very important for us to try to put out the fire. I think it’s good advice in general, that if there’s a fire burning, you try to put it out first, and then you think about the fire code.”

What if it’s not a fire, but more like a hard rain? It may be disagreeable… but without the monsoon rains, crops won’t grow. An economy can’t function properly without an occasional downpour; somehow, mistakes have to be washed away.

But Terry didn’t get a chance to argue metaphors. The speech was soon over and the feds could get back to work – piling up dry tinder!

Every emergency triggers a response… and every response adds to the burden of regulation and debt. In the United States of America, we are still paying for fire-fighting equipment bought by our grandfathers in WWII. And we are still taking orders from bureaucracies set up by the Roosevelt administration to solve problems that disappeared 50 years ago.

Eventually the weight of all these saving graces crush the whole society. But for the moment… there’s a fire to put out. Everyone agrees. Conservative, liberal, Episcopalian, Holy Roller… blue eyed, brown eyed… almost every silly joker on the planet thinks the feds need to do more to rescue the economy.

Yesterday, the Dow fell another 248 points. Still no sign of the long-awaited Obama Bounce. Maybe it won’t happen.

Oil held steady yesterday and gold dropped $11. Gold looks like it is ready to slip below $800 again.

The real question for an investor is one of faith. How much faith do you have in your top officials? Can they pull it off? Can they stop deflation?

The bartender bent down real close to my face so that I could not miss him, and since that is never a good sign, I decided that I would let him get a good whiff of my breath to show him the folly of his ways.

So I brightly said, “Hi!”

He immediately backed up a couple of feet and said to me, “This is the last time I am going to tell you about keeping your voice down, and to stop insulting the customers and Democrats by calling them idiots. The idiots who are not customers or Democrats are complaining about being insulted by the association.”

I instantly laughed out loud at the joke, although being funny is very uncharacteristic of him, as he is mostly “all business”, throwing me out of the bar long, long before I am so sloppy drunk that other bartenders finally throw me out, too.

So I said, “My apologies to the idiots for lumping them with Democrats, who are so stupid and corrupt that they actually think that government exists to ‘help’ people by giving them money or services!! Hahaha! And don’t get me started on the stupidity and corruption that has bid up the prices of short-term Treasury debt so that it yields exactly zero! Zero! Hahaha!”

At this, the bartender walks away, muttering something under his breath that sounded like “Oh, hell. Here he goes with that economic crap again.”

Turning to the other customers, I say, my words slurring slightly, “Putting words into the mouth of Bill Bonner at The Daily Reckoning, he says ‘The Mogambo is right; you’re all morons!’ Hahaha!!”

The bartender started walking towards me with his eyes narrowing to slits and his hands clenching into fists, so I hurriedly say, “Okay, okay! Sorry about that! Obviously, Mr., Bonner did not say that, but he almost did when he wrote that ‘investors imagine that U.S. government debt, and the currency in which it is denominated, will be good forever. At the present nominal rate of return on T-notes, an investor would have to wait 50 years to earn back his investment. At the real rate – adjusted for the current rate of consumer price inflation – people will ice skate in Hell first. The real rate of return on T-notes is negative.’”

Apparently, the horrifying news of negative interest rates does not register with these morons; the bartender went back to talking to the pretty girl at the end of the bar, and the other barfly customers were flipping those little beer-stained cardboard coasters at me saying, “Shut up!”

So I shout back, “No, YOU shut up” and they shout back at me “No, YOU shut up!”, and then I shout back at them, louder than before “No, YOU shut up, shut up, shut up!”

It was about the tenth time that they screamed “No, YOU shut up!” at me that I decided to, you know, shut up, and I said, “Okay, I’ll shut up, but only so that you can listen to Mr. Bonner, who has generously gone on to inform you that bond prices are going to fall into the toilet because bond prices are so insanely high right now, and that it makes the imputed yield insanely low, and if you think that the nation’s houses losing value at 18% a year is bad, wait until a few zillions of dollars of debt loses half its value in a few months, weeks, days, hours or even minutes!”

Working backward through time like that made me dizzy and dreading impact, so I calmed myself down by reading to them directly from Mr. Bonner’s piece. “The supply of U.S. government debt,” he writes, “is soaring; surely, you might imagine that it would go down in price. Sometime in the future, interest rates are bound to go up. When they do, investors in Treasury bonds are going to be disappointed. But when that disappointment will come, we don’t know.”

Disappointment! I marvel at his cool understatement! But at least he is trying to be helpful by alerting you to get the hell out of government bonds at your earliest opportunity, and you would think that Barron’s, if they truly were trying to be likewise helpful, would have used the front of their magazine to use the quote from their own “Gold Performance” chart, which is that “February Comex gold finished at $897.50 last week, up 5.5% for the year – its eighth consecutive annual gain”, whereas bullion itself gained, too, according to Doug Noland at PrudentBear.com, who writes that “Gold added 0.7% this week to $875 (’08 gain 5.7%)”.

And then Barron’s could tidily sum things up with, “Gold went up versus stocks, non-government bonds, housing and damned near everything else, which all took a clobbering! Go gold!”

Or they could have quoted their own Alan Abelson, in his Up & Down Wall Street column, who noted that, while most everything is down, “The lucky quartet that bucked this sorry tend to post gains included cocoa, sugar, gold and, most interestingly, hogs.”

Or they could have even quoted The Mogambo, who said, “Buy gold, or you’re a freaking moron who is ignorant of history, and who doesn’t understand economics even basic math, and I hate you all for your stupidity and treachery!”

At which my daughter says, “You forgot to mention to also buy silver and oil! So who’s the moron now, old man?”

Okay, you take care of buying the gold, silver and oil, and I’ll take care of the smart-aleck kid.

Source: Interest Rates Have “One Too Many”