What a great time to be an economist!

Yesterday was another dull day in the markets. The Dow was steady. Oil rose a buck. Gold went up $3.

But there’s nothing dull about the economic news. Already, we’ve been able to see things we never thought we’d see. It’s as if our strange neighbours had invited friends, and even some animals, over for a night of fun – and left their curtains open.

So far, we’ve seen a stock market crash and what looks like the beginning of another depression, already marked by the biggest bailouts and nationalizations in history. We’re getting an eyeful! And with a little luck, we’ll probably see a bout of hyperinflation too. Crash, Depression, Hyperinflation – this is the Triple Crown of Financial Catastrophes!

It is remarkable enough that we have been able to witness a genuine market crash. The crash of ’87 barely counts. It sent prices down as much as a third all around the world. But it was a very short-lived affair. Bread put in the oven at the beginning of it was still doughy when it was over. Then, it kept rising for the next 20 years.

The last real crash in America occurred 80 years ago. We never thought we’d have the privilege of seeing another one. Especially since nearly three generations of economists and financial authorities have been working to prevent them. They set up their safety nets and perfected their formulae… Fed monetary policy was thought to be such a finely tooled instrument that it was widely believed that the feds had mastered the business cycle – thereby eliminating the need for crashes or recessions. When the economy heated up, the feds turned on the air-conditioning – higher rates, stricter credit standards, and even higher taxes. When it cooled down, the switches were thrown in the opposite direction and on came the heat. The economy was supposed to maintain a constant temperature all year round.

With such perfect climate control systems in place, many thought the cold shivers and hot sweats were over. But something seems to have gone wrong…

And now we’re enjoying the show. From one spectacle to the next – you can’t say it isn’t entertaining. But what might keep us from realizing our goal and seeing all three major catastrophes that give economists the willies?

Uh oh… what’s this?

“US banks to repay $68 billion to Treasury,” says the lead headline in today’s Financial Times. “Move marks turning point in economic crisis.”

The banks are now feeling healthy enough to give the feds back their money. All is well, we guess.

And what’s this… ?

“OECD says statistics point to recovery,” begins an item in the Financial Times. The organization says most advanced economies are indeed past the worst part of the downturn. The “possible trough” was reached in April, it says.

OECD is looking at the same data as everyone else. They say it points to growth and prosperity. We wonder; how could that be? What about all those investments that still haven’t been written off… written down… and restructured? What about all that debt that is still carried on tired shoulders? What about all those homeowners still yearning to sell – as soon as they can catch a break? What about all that debt that the feds are adding to the system? What about the credit contraction? What about the de-leveraging? What about all those balance sheets – household and corporate – that need to be cleaned up? What about those falling corporate earnings? What about… what about…

Richard Russell tells us that the Transport Index has still not confirmed a new bull market – well, that’s a good sign – but that the usually reliable Coppock Index is signaling an end to the recession and rising stock prices ahead.

Oh my… what if we’re dead wrong? What if something is going on that we don’t understand at all? What if there is no depression… no hyper-inflation… no Triple Crown of Catastrophes that we were yearning to see?

“There’s more under heaven and earth than is contained in your philosophy,” wrote Shakespeare. No matter you think, things are always more complex than you imagine… with interpretations very different from those you impose.

Will we go to our graves without ever having seen a real depression or a real hyper-inflation?

What if we are wrong?

For example, we believe stocks are getting ready for another big fall. As we wrote yesterday, the smart money is short the stock market.

“If you think that, how come you’re not 100% short the stock market,” asked a friend.

In fact, we’ve still got about a quarter of our family wealth in stocks. How come?

Well, the simple answer is: we may be opinionated, but we’re not crazy. It’s one thing to have an idea about what will happen. It’s another thing to stake your whole financial future on it. Also, we treat our family money differently from our own, personal money.

Why do we own stocks, even though we think the stock market will probably go down?

1) We know someone who is at least as smart as we are who believes that buying stocks – at bargain prices – is the safest, surest way to wealth over the long term. He and his team spend all day, every day looking for extremely undervalued companies. He operates a private, family office… not available to the public… and only buys when they’re priced so cheap that even if they had to be broken up and sold off in parts, the shareholders would still come out ahead. We figure our children’s money is at least as safe with him as it is with us.

2) While we expect a downturn in stocks, we’re not sure how this downturn will be expressed. A big increase in inflation could send stocks’ nominal prices up.

As we explained yesterday, you can de-leverage in one of two ways – the old-fashioned honest way which is repaying your debts. Or, you can inflate your debts away. If the feds succeed in causing substantially higher rates of inflation, stocks could go up as investors buy them in order to escape inflation.

Of course, the best defense against inflation is gold. But gold doesn’t pay dividends. And gold has no earnings. And gold doesn’t send you quarterly reports that you can use to light a fire.

We think there will be no recovery… that the feds WON’T succeed in causing inflation soon… and that stock prices will fall. Still… we hedge our bets in some very cheap stocks… just in case.

*** While the private sector deflates and de-leverages… the public sector is building the biggest debt bomb the world has ever seen. Here are the numbers we promised yesterday:

US private debt is at a record high, about $44 trillion.

Compared to that, the federal government’s $11 trillion of official national debt doesn’t seem so bad.

And, the states have about $2 trillion more – which, in round numbers, doesn’t seem like a cause for worry.

But last week, Gov. Schwarzenegger said California’s ‘day of reckoning’ had come. He’s looking at a $24 billion hole in the Golden State’s finances. And at least he’s proposing to close the gap honestly – by cutting back on services and raising taxes.

What else can he do?

The federal government has options… and “a little technology called a printing press,” as Ben Bernanke famously put it. But California can’t counterfeit the money to pay its expenses; instead, it has to borrow it from willing lenders or steal it from unwilling taxpayers… there’s no other way.

The feds are convinced that they can spend as much as they want. This week alone, for example, they’re selling $65 billion in Treasury bonds. And this year, a total of about $2 trillion are to be auctioned off. Who’s going to buy these things? Beats us.

And consider this: in addition to the fed’s ‘official’ debt, there’s some $100 trillion more of unfunded liabilities, commitments and obligations. Those are mostly things such as Social Security and health care commitments which the government has sworn to honor. If all those “debts” are put together… .well, it comes to one helluva number – about $157 trillion of debt in America, or more than 10 times total annual GDP.

*** “Mmmm… .this lamb is very good,” we said at a dinner party in France the last time we were there.

“Oh… yes… it is good,” said our old friend, Pierre. “It’s from New Zealand. And it almost got me arrested.

“Back in the ‘80s, I was raising sheep. Even then it wasn’t a great business. Sheep are a pain in the neck. You can never turn your back on them. They are either getting stuck in the fence or coming down with a terrible illness. You have to be on the job 24 hours a day… 7 days a week. No vacations. No holidays. Never a day off.

“And to make it worse, you don’t earn any money. At least not in France.

“Anyway… as poor as the sheep business was, it got poorer in the ‘80s. The British exported lamb to the French market… and they undercut our prices. Because they were part of the European Union, we couldn’t do anything about it. It’s a free trade zone. But the British couldn’t produce lamb that cheap either. What they did was import it from New Zealand and then sell it all over Europe as ‘British lamb.’ It was outrageous. And I was very mad about it.

“So about a dozen of us decided to take political action. We found out where the British lamb was shipped from… a place in Poitiers… and we decided to block the roads.

“Well, it didn’t go so well. We drove up and waited for one of their trucks to come along… and then we put our cars in the middle of the road. But we left a little gap… actually, a fairly big gap between a couple of the cars… Then, when the truck came up, the driver stopped… and he yelled… ‘What the Hell are you guys doing.’ Or something like that. We explained that we were blocking the road so he couldn’t distribute British lamb. Well, he got back into his truck, put the big rig in gear… and smashed through our cars… .

“The next time, we did stop one of the trucks… and we decided that we were going at least to let them know in Paris that we were upset about these lamb shipments… So we took the truck to the train station… dumped the lamb out onto the tracks and set fire to it. It was a huge fire, so hot the rails glowed red. We had the police, fire department, news media. But it was night time… and we just pretended to be spectators when the police arrived.

“Then, we really decided to go big time. We planned a commando raid on the British embassy in Paris. I was supposed to distract the guards… while one of our trucks got through the gates. It was all planned out to the second. And we even had an insider – someone who had a pass to the embassy… I don’t know how he got it…

“But that went bad when there was a terrorist attack in Britain… and all the embassies were on alert… so we called it off. Instead, we decided to target the French minister of Agriculture. What a waste of time. The media didn’t even cover it. They were used to it. The chicken farmers had been there the week before. And the dairy farmers tried to demonstrate the same day we did. You practically had to get in line and take a number if you planned to do a demonstration at the Agricultural ministry…

“Later, we tried one last thing at home. This time we stopped one of the trucks with British lamb and set the whole truck on fire. This time the gendarmes were really mad. They came and surrounded us. They took our names and addresses and let us go. They were planning to arrest us later. But that just shows how the police operate in France. We knew someone in the police headquarters. He went on the computer and erased our names… So I was never charged with anything… ”

Source: The Triple Crown of Financial Catastrophes

• Agricultural Bank of China raised 50 billion yuan ($7.3 billion) in the nation’s biggest corporate bond sale. The goal of the bond sale was to raise capital and help set up an initial public offering, Bloomberg reported.

• A handful of banks have applied to repay the billions they borrowed from the U.S. government’s Troubled Asset Relief Program (TARP). Sources told Reuters that Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) are two of the banks eager to begin repaying the government.

• Fiat SpA (OTC ADR: FIATY) Chief Executive Sergio Marchionne said in a Bloomberg interview that an offer he plans to make for General Motors Corp.’s (NYSE: GM) Opel unit will include assets that are “better than cash.” Today (Wednesda) is the deadline the German government set for Opel bids.

• World Bank President Robert Zoellick said that a global economic recovery could begin at the end of this year, Reuters reported. “I’m neither an optimist nor a pessimist, I am uncertain, a realist. Clearly the fall has been interrupted. I think there’s a good chance that while we face declines, they will be smaller in size. The majority expect a recovery at the end of this year, at the beginning of next year,” Zoellick said on Spanish television.

• The Bank for International Settlements said the derivatives market declined for the first time in the second half of 2008 as the global financial crisis curbed trading, Bloomberg reported. The Switzerland-based bank said yesterday (Tuesday) the amount of outstanding contracts linked to bonds, currencies, commodities, stocks and interest rates dropped 13.4% to $592 trillion, the first decline in 10 years of compiling the data. The amount of credit-default swaps insuring investors against losses on bonds and loans fell 27% to cover $41.9 trillion of debt.

• General Electric Co (NYSE: GE) Chief Executive Officer Jeff Immelt said yesterday (Tuesday) has already borrowed all the money it planned to raise on debt markets for 2009 and may reach funding goals for 2010 before the year is out.  “From a funding standpoint, 2009 is already done,” the head of the largest U.S. conglomerate told an investor conference in Florida, Reuters reported. “We’re going to pre-fund a lot of 2010 in 2009, maybe the whole thing.”

• The United Auto Workers and General Motors Corp (NYSE: GM) still have a “long way to go” to reach an agreement that local labor leaders could vote on, UAW President Ron Gettelfinger said after a union-sponsored forum at the U.S. Capitol, according to Bloomberg. GM’s decision to shut 16 U.S. plants and boost the number of cars it imports to 7% of North American sales has emerged as a sticking point in talks on a new UAW contract.  GM has a June 1 deadline to complete a restructuring plan or enter bankruptcy.

• Home Depot Inc. (NYSE: HD), the world’s largest home improvement chain reported higher-than-expected quarterly earnings as massive cost cuts offset weak sales. But investors found the results disappointing in comparison with those of smaller rival Lowe’s Cos Inc. (NYSE: LOW) and shares fell.  On Monday, Lowe’s reported better-than-expected quarterly earnings.  Home Depot affirmed its fiscal-year outlook, Reuters reported.

Investment News Briefs Wednesday, May 20, 2009