Stocks are up 20% from their November lows. And they could go much higher. But don’t be fooled by this “sucker’s rally”. The Dow is on its way to 5,000. The Fed is trying to stop it. But remember, the Fed caused this crash. And it was government ‘rescues’ that made the 1930s Depression so Great…

Here is another excerpt from Bill Bonner and James Davidson’s crisis report, How to Survive and Prosper in the Coming Global Depression.

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One of the most important things to grasp right now is that this is no ordinary market correction.

The problem is much deeper and more complex than that…and probably not even one investor in one thousand truly understands it.

You see, what’s actually happening is the bear market that began in January 2000 is finally getting down to work.

Stocks have been going down. And they will probably keep going down until they finally hit rock bottom — probably at about 5,000 points on the Dow.

Maybe we’ll even see a correction to the entire bull market run that began in 1982. If so, you can expect the Dow to sink down to about 3,000 (adjusting the 1982 level to inflation).

Of course, we are likely in for a big “sucker’s rally” first — just like the one that lured in doomed investors back in 1929.

From September 1929 through November 1929, the Dow plunged 47 percent from its high of 381. It then started its famous sucker’s rally of the spring of 1930, before plunging to 41 in July 1932.

Japan also had plenty of sucker’s rallies during the country’s economic slump in the 1990s.

In fact, stocks there rallied at least 30 percent higher five times after 1992. They then found new lows again…and again…and again.

Why do we believe the Dow will drop to 5,000 points?

We don’t have any inside information, nor do we have a crystal ball. But if you study a long-term chart of the Dow, you will notice something very peculiar. It tends to go way down after it has been way up – in 15- to 20-year waves.

The top of this wave washed over us in January 2000. Since then, the index has been higher…but not when you adjust it for inflation.

It probably would have corrected to the 5,000-point range already. But the feds intervened.

This is critical to understanding the current crisis.

It’s not an insight you’re likely to pick up on CNN. Nor is it something Barack Obama or George Bush or Ben Bernanke wants to admit.

But in trying to head off a bear market back in 2001, the Federal Reserve actually provoked a housing bubble, a financial bubble a commodities bubble and a worldwide credit bubble.

As Bill wrote in his 2006 best-seller, Empire of Debt: The Rise of an Epic Financial Crisis:

What the Greenspan Fed had accomplished was to put off a natural cyclical correction and transmogrify an entire economy into a monstrous economic bubble. A bubble in stock prices may do little real economic damage. Eventually, the bubble pops and the phony money people thought they had disappears like a puff of marijuana smoke. There are winners and losers. But in the end, the economy is about where it began — unharmed and unhelped. The households are still there and still spending money as they did before. Only those who leveraged themselves too highly in the bubble years are in any trouble.

But in Greenspan’s bubble economy, something awful happened. Householders were lured to take out the equity in their homes. They believed that the bubble in real estate prices created wealth that they could spend. Many did not hesitate. Mortgage debt ballooned in the early years of the twenty-first century — from about $6 trillion in 1999 to nearly $9 trillion at the end of 2004 — increasing the average household’s debt by $30,000.

The US economy faced a major recession in 2001 and had a minor one. The newborn slump was strangled in its crib by one of the most central planners who ever lived. Alan Greenspan cut lending rates. George W. Bush boosted spending. The resultant shock of the renewed, ersatz demand not only postponed the recession, it pushed consumers, investors and businesspeople to make even more egregious errors. Investors bought stocks with low earnings yields. Consumers went further into debt. On the other side of the globe, foreign businessman worked overtime to meet the phony demand.

Post-1929 Rescue Didn’t Work Either

Uncle Sam didn’t do much better in ‘fixing’ the Great Depression.

Why?

It’s simple, really: Presidents Hoover and Roosevelt lacked faith in the marketplace.

In this respect, they were no different to President Bush or President-elect Barack Obama.

Just like their 21st century successors, Hoover and Roosevelt acted as though government management of the economy was the only solution the country’s economic problems.

But the real problem was, and still is, government intervention.

Hoover’s introduction of international trade tariffs under the Smoot-Hawley Tariff Act is an obvious example.

Rather than helping protect the wounded US economy, as Hoover had hoped, it cut American imports and exports in half and is widely recognized as a catalyst for the Great Depression.

Roosevelt’s government programs were also to blame for drawing out America’s economic woes.

That’s not to say all were a disaster. Some, like the establishing of the Securities Exchange Commission, had a stabilizing effect at the time.

But as Bloomberg columnist Amity Shlaes points out in her history of the Great Depression, The Forgotten Man, “Other institutions, such as the National Recovery Administration, did damage.”

The NRA … sought to solve the monetary challenge through price setting. NRA rules were so stringent they perversely hurt businesses. They frightened away capital, and they discouraged employers from hiring workers. Another problem was that laws like that which created the NRA — and Roosevelt signed a number of them — were so broad that no one knew how they would be interpreted. The resulting hesitation in itself arrested growth.

Sprawling government programs designed to fix the economy. Laws “so broad that nobody knew how they would be interpreted.”

Ring a bell?

As Roosevelt put it in his second inaugural address, he “sought unimagined power” to turn the economy around.

But Roosevelt wasn’t a patch on Henry “Hank” Paulson Jr…

On October 3, 2008, Public Law 110-343 bestowed upon Paulson perhaps the most incredible powers ever bestowed on one person over the economic and financial life of the nation.

The 451-page law created not only created the $700 billion Troubled Assets Relief Program, it also gave the US Treasury Secretary almost dictatorial powers.

Consider this passage from the first draft of the bill.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Or these two humdingers…

The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this act without regard to any other provision of law regarding public contracts.

Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure.

Roosevelt may have sought “unimagined power,” but he was never brave enough to try to sign such powers into law.

You see, Bush, Paulson, Bernanke and Obama really do believe the best path to calming the current crisis is to throw huge amounts of taxpayers’ money at banks, credit card companies, automakers and anyone else with a lobbyist with deep enough pockets to get his foot in the door of the Treasury Department.

But they’re all missing a fundamental point.

As Shlaes puts it:

The big question about the American depression is not whether Germany and Japan ended it. It is why the Depression lasted until the war. From 1929 to 1940, from Hoover to Roosevelt, government intervention helped to make the Depression Great.

Austrian School economist and father of modern Libertarianism Murray Rothbard reviewed the record of the post-1929 rescue team and came to the following conclusion.

The Hoover and Roosevelt administrations met the challenge of the Great Depression by acting quickly and decisively, indeed almost continuously … putting into effect the greatest program of offense and defense against depression ever attempted in America [using] every tool, every device of progressive and enlightened economics, every facet of government planning to combat the depression.

Yet the depression didn’t go away. It intensified. Real wage increases and higher government spending smothered an expected recovery in 1931.

The guilt for the Great Depression must, at long last, be lifted from the shoulders of the free-market economy and placed where it properly belongs: at the doors of politicians, bureaucrats and the mass of ‘enlightened’ economists. And in any other depression, past of future, the story will be the same.

A Titanic Rescue

Yet on the announcement of the US government’s $700 billion bailout plan, stock markets all over the world breathed a sigh of relief…albeit brief.

This is not unusual.

As we’ve already pointed out, after the October crash in 1929, stocks rallied until April. Then they started to slide again and did not fully recover until the 1950s – more than 20 years later.

Investors can always find reasons for optimism…when they’re in the mood. After so many years of rising prices, the momentum of a bull market keeps them hoping.

It was as though the passengers on the Titanic had seen in the distance what looked like a flotilla of rescue boats on the horizon.

Hats were tossed in the air. Life preservers were cast off. Investors cried “Hosanna!” and shouted “Yippee!” The band broke off playing Nearer Thy God to Thee and picked up a soaked version of Laissez les Bon Temps Roulez!

A couple of days later, the rescue boats drew closer…and passengers jaws dropped when they realized they were just more icebergs! Stocks sold off again.

At roughly $8 trillion, the credit crisis already clocks in as the most expensive endeavor in American history. It’s more than the country spent fighting Hitler and his allies in World War II.

And banks still aren’t lending!

Washington simply doesn’t get it.

As Rothbard puts it:

The depression is the ‘recovery’ process, and the end to the depression heralds the return to normal and to optimum efficiency.

The depression, then, far from being and evil scourge, is the necessary and beneficial return of the economy to normal after the distortions imposed by the boom. The boom, then, requires a ‘bust.’

But after sinking the Titanic of Wall Street and the dinghies of homeowners by giving away too much easy credit, our modern-day rescuers have come to the scene with life preservers of lead: more easy credit.

About the authors:

Contrarian Profits readers are probably familiar will Bill’s commentary from his Daily Reckoning column. But here is some information about James Davidson:

Davidson is a self-made multi-millionaire, venture capitalist and best-selling author.

His books include Blood in the Streets, Financial Reckoning Day and The Sovereign Individual.

As an author and editor of private financial advisory service Strategic Investment, Davidson has made a number of bull’s-eye crisis predictions.

He is the founder and chairman of the National Tax Payers Union, the largest and oldest grassroots taxpayer organization in US.

His forecasts and his war against taxes and deficits have earned him frequent invitations on programs such as Good Morning America, The Tonight Show and MacNeil-Lehrer.

Once again, sign up below to join the thousands of Contrarian Profits readers that have already read this report. Your free e-mail updates will arrive shortly…

One of Obama’s prime campaign planks has been his promise to mercilessly raise taxes on the “rich,” a group initially defined as those making more than $250,000 per year. This was later dropped to $200,000 per year, and more recently has been defined as those Americans making more than $150,000 annually.

Setting aside the precipitous downward slide in the definition of “rich,” there is ample reason to suspect that Obama’s tax changes portend much higher, if not confiscatory, taxes on the most productive Americans. Obama has strongly argued for higher taxes as a way of employing government to alter the pre-tax distribution of income, which he believes has concentrated too much of the gains from productivity in recent years in the hands of the very rich.

He seems to think that the “very rich” are a closed caste of more or less fixed membership, which changes little from year-to-year. This figures in his concept of “fairness,” which supposes that it is perfectly just to burden a small fraction of the population with a majority of the costs of running the Federal government. This was detailed in a New York Times article on “spreading the wealth” by David Leonhardt. He wrote of Obama:

“He would then pay for the cuts, at least in part, by raising taxes on the affluent to a point where they would eventually be slightly higher than they were under Clinton. For these upper-income families, the Tax Policy Center’s comparisons with McCain are even starker. McCain, by continuing the basic thrust of Bush’s tax policies and adding a few new wrinkles, would cut taxes for the top 0.1 percent of earners – those making an average of $9.1 million – by another $190,000 a year, on top of the Bush reductions. Obama would raise taxes on this top 0.1 percent by an average of $800,000 a year. ‘It’s hard not to look at that figure and be a little stunned. It would represent a huge tax increase on the wealthy families. But it’s also worth putting the number in some context. The bulk of Obama’s tax increases on the wealthy – about $500,000 of that $800,000 – would simply take away Bush’s tax cuts. The remaining $300,000 wouldn’t nearly reverse their pretax income gains in recent years. Since the mid-1990s, their inflation-adjusted pretax income has roughly doubled.’

“To put it another way, the wealthy have done so well over the past few decades, with their incomes soaring and tax rates plummeting, that Obama’s plan would not come close to erasing their gains. The same would be true of households making a few hundred thousand dollars a year (who have gotten smaller raises than the very rich but would also face smaller tax increases). As ambitious as Obama’s proposals might be, they would still leave the gap between the rich and everyone else far wider than it burdensome on the young entrepreneur who was making his first millions as it would on the aging plutocrat who actually had enjoyed the prosperity of the past-quarter century since Reagan cut marginal tax rates.”

An October 13 editorial in The Wall Street Journal clarifies the mysterious arithmetic of Obama’s sweeping claims to cut income taxes for millions who currently have no income tax liability and pay no taxes:

“For the Obama Democrats, a tax cut is no longer letting you keep more of what you earn. In their lexicon, a tax cut includes tens of billions of dollars in government handouts that are disguised by the phrase ‘tax credit.’ Mr. Obama is proposing to create or expand no fewer than seven such credits for individuals:

“- A $500 tax credit ($1,000 a couple) to ‘make work pay’ that phases out at income of $75,000 for individuals and $150,000 per couple.

“- A $4,000 tax credit for college tuition.

“- A 10% mortgage interest tax credit (on top of the existing mortgage interest deduction and other housing subsidies).

“- A ’savings’ tax credit of 50% up to $1,000.

“- An expansion of the earned-income tax credit that would allow single workers to receive as much as $555 a year, up from $175 now, and give these workers up to $1,110 if they are paying child support.

“- A child care credit of 50% up to $6,000 of expenses a year.

“- A ‘clean car’ tax credit of up to $7,000 on the purchase of certain vehicles.

“Here’s the political catch. All but the clean car credit would be ‘refundable,’ which is Washington-speak for the fact that you can receive these checks even if you have no income-tax liability. In other words, they are an income transfer – a federal check – from taxpayers to nontaxpayers. Once upon a time we called this ‘welfare,’ or in George McGovern’s 1972 campaign a ‘Demogrant.’ Mr. Obama’s genius is to call it a tax cut.

“The Tax Foundation estimates that under the Obama plan 63 million Americans, or 44% of all tax filers, would have no income tax liability and most of those would get a check from the IRS each year. The Heritage Foundation’s Center for Data Analysis estimates that by 2011, under the Obama plan, an additional 10 million filers would pay zero taxes while cashing checks from the IRS.

“The total annual expenditures on refundable ‘tax credits’ would rise over the next 10 years by $647 billion to $1.054 trillion, according to the Tax Policy Center. This means that the tax-credit welfare state would soon cost four times actual cash welfare. By redefining such income payments as ‘tax credits,’ the Obama campaign also redefines them away as a tax share of GDP. Presto, the federal tax burden looks much smaller than it really is.”

After all the sloppy definitions are parsed, one point remains clear. The top 5% of U.S. income earners, who presently pay 60.14% (2006 figures) of all income tax, are destined for a huge federal tax increase under Obama.

One of Obama’s specific proposals is to raise the capital gains and dividend taxes to 25%, which will sharply increase capital confiscation as increasing percentages of “gains” will reflect inflationary depreciation of the currency. In the U.S., an investor must pay tax on the difference between the sales price of an asset and it purchase price, with no adjustment for inflation. Consequently, when the tax rate and inflation are high, a large portion of the “capital gain” is illusory. Any asset that appreciates by less than the rate of inflation will result in its owner losing purchasing power and having to pay taxes on the illusory gains. At Obama’s higher tax rates, (he has suggested that capital gains and dividend taxes should be hiked to as much as 25%,) capital confiscation would result from modest levels of inflation.

And the Great Credit Crunch implies that inflation will be far higher than in recent experience.

Setting aside whether it is moral or equitable to force a small fraction of the population to essentially pay for the whole cost of government, much of which entails the shuffling of checks to purchase votes of various aggrieved groups, there is a bigger question. Can it be wise for the whole fiscal regime to stand on the shoulders of a small group, like a pyramid tottering on its point, so that any tribulation which undermines the prosperity of those who pay would promise to bankrupt the state?

It is a worthwhile question to ask if you have considerable assets. In light of the worldwide credit crunch, which has deflated assets of all kinds, the prospect of burgeoning prosperity at the magnitude required to enable one-in-20 Americans to become “Super Rich” benefactors of Big Government is vanishingly small. There won’t be enough rich people to fill the role assigned to them in Obama’s scheme. The result to be expected, in addition to confiscatory taxation, is a dramatic shortfall of revenues. This, in turn, implies surging deficits and deficit financing requirements that will rapidly swamp the capacity of the Treasury to borrow.

Source: Playing the Tax Credit Card