MAX BEARISH II

Back in October 2007, I came out with my first MAX BEARISH posting in which I stated that the market was making an imminent major multi-year top:

..."So what can the market do now that would inflict max pain on max people? Reverse hard down and never look back..."

Exactly 10 days later (October 11th), the market topped out and started the beginning of the two year mega-collapse from 1576 (S&P 500) down to 666 i.e. a 58% decline - the worst since 1930-1932.

Here again, I am going out on a limb and saying that I am once again Maximum Bearish and believe that we are at or very near the top of this counter-trend move. Last month, I allowed that there could be one more run higher, and there was, but there are several signs now that this move has been exhausted:

1) Near unanimous belief that the economy is improving - just this past Friday, the jobs report showed "only" 250,000 job losses and the market rallied on the "good news". Two years ago, a jobs report that bad would have crashed the market, but now it is taken as an unambiguous sign that recovery is on the way. In a perverse way, I actually agree with the dolts who see this as a good jobs report, because this is likely the best jobs report we see for years.

2) Near unanimous (misguided) belief in inflation. Today I read that the gurus at PIMCO, the world's largest bond manager, said yesterday on CNBC: "...the next Fed's move has to be tighter as a tautology" (Paul McCauley). And the commentator quoting Paul (Tom McGraff at RealMoney.com), rejoins with "Which is true. But when is the real question..." i.e. everyone expects the economy to improve, to bring with it obvious inflation, and for the Fed to have to tighten. This is why I have said that the reflation trade is very crowded to say the least i.e. long commodities, short dollar etc. As I have said (too) many times, we are in a deflationary collapse, there is no sign of inflation and there will be no inflation until the majority of outstanding debt has been wiped away through defaults and bankruptcies.

3) Fibonacci 38.2% retracement it the stock market (S&P 500) - achieved last week.

4) Overwhelmingly bullish sentiment towards the stock market, both the AAII and the DSI polls registered bullish readings last seen in October 2007

5) Speculative stocks ramping - AIG doubled in two days last week; Citigroup ramped 55%. There were a number of other small junk stocks blowing off last week as well - which has been a very reliable indicator in the past that the move is over...

6) The Shanghai market which is up almost 100% since last October now looks to have left the party. Remember that was the index that led the way down last year as well...

7) Low volatility index (.VIX). I said last year several times that the .VIX would explode, well it did from 10 in 2007 up to 95 last fall ! Now the .VIX is back in the mid-20s and it looks like it could be carving out a bottom here i.e. the market has been going higher for the past several weeks, but the Vix has not made a new low since early July, signaling that risk tolerance is waning...

8) Bob Prechter from EWI now believes the rally is either over or very near over. Bob has been early on many of his other predictions, but overall he is the master who said this deflationary collapse would happen and how it would happen in scientific detail. Bob also made a great (and timely) call at the March low this year, saying we would have this huge rally - fantastic call.

Finally, in my opinion, the most damning piece of evidence is the long-term view of the market itself, because as they say, "a picture is worth a thousand words" (see below - click to enlarge). Notice the steepness of the current rally since March - what better way to suck everyone in to think the worst is over. Notice how volume has systematically tapered off since the rally started (lower pane):

Batten Down The Hatches

The biggest part of this stock market rally/economic "bounce" is now over. I don't know if we will have one more surge higher that lasts days/weeks or even months, but the initial target I cited for this rally S&P 500 (900-1000) has already been met and therefore the greatest part of prudence dictates preparing for what comes next...

400 foot Tsunami now on the horizon
Call this next phase the "recognition" phase, the panic phase or the liquidation phase - it's all the same thing. It's the point at which this economic decline accelerates into an unstoppable panic collapse. When I started this blog, the economic crisis had not yet started so there was an excuse not to believe my predictions; however, now the weight of evidence is all around us and no excuse remains. Do you honestly believe the Mainstream Media, Government bureaucrats and Wall Street hustlers when they tell you that the economy is getting better when they didn't even predict this crisis would occur in the first place? If so, ask yourself - what has changed? The same factors that precipitated last year's collapse are still in place - massive debt levels, unrelenting job losses, ongoing credit contraction, housing collapse. Now we can add to the list unprecedented government deficits, as public debt is desperately exchanged for private debt, hence shifting the burden from the financially weak to the financially strong and putting the system more at risk. There is over $50 trillion in private debt in existence, do you think the Government can possibly offset losses against all of that potentially bad debt? What if they succeed in doing so, what would that accomplish (other than obliterating the U.S. dollar) - will it create any new jobs or industries? The answer is clearly no - as there have been six million jobs lost so far since this depression started. All the government is doing at this point is maintaining the illusion of fiscal solvency, purely based on smoke and mirrors and not based on any sound economic fundamentals. This economy is Wile Coyote running in place in mid-air...

Irrational exuberance is back, as the the "reflation" trade is the most crowded trade on Wall Street. Everyone is looking down the left side of the tracks expecting hyperinflation when the deflation train will be coming from the other direction and catch everyone by surprise. Apparently these fools have no concept how the economy works. There is absolutely no sign of inflation anywhere, because the Fed is not printing cash, they are increasing credit, which assumes consumers are willing to borrow; however, all indications are that reserves are piling up at banks as lending standards have increased, shutting out the people who really need the money but are no longer solvent. Meanwhile, solvent consumers are starting to save and pay down their existing debts - i.e. the 40 year Monetary Policy ponzi scheme is officially over. The Nouveau Misian movement still doesn't get it and are openly embracing deflation. However, as I have said before, this is not going to be a gentle deflation, this will be a deflationary crash in which the value of assets and incomes fall hard while nominal debts remain intact. Some foolish observers have noted that if prices fall that will free up discretionary income, however, when prices fall fast (due to liquidation vs. productivity gains) then profit margins fall which means increased layoffs. So if I lose my job and my house loses half its value, then seeing low prices at Wal Mart is likely to be small comfort.

Prepare now or forever hold your peace
Those who fail to heed the signs of impending collapse and take immediate action will be "left behind", literally. Once the collapse begins there will be no time to move your financial assets to safer ground (short-term U.S. Government Treasuries), as it will come without warning and decimate ALL RISKY assets (stocks, corporate bonds, municipal bonds and likely even precious metals). Risk spreads will widen and stay wide, giving no one a chance to get out. There will be no buyers - only sellers, and markets will not function properly, leading to "discontinuous price discovery" aka. crashes. There will be extreme counter-party risk, meaning companies and individuals will be defaulting on their obligations causing further turmoil and illiquidity in markets.

Position your assets accordingly.

Reality Check (May 2009)

Time for another reality check as it's been over a year since the last reality check.

As I said last year, the majority of economists and commentators are clueless about the severity of the economic decline (and of course we now know for certain that they were), once again, we now find the majority of economists still totally out to lunch. Just today, AP tells us that more than 90% of economists predict that the recession will end this year ! Yes, these are the same "gurus" who were telling us last year there wouldn't even be a recession !!!

WTF?
As I often say, don't let the facts get in the way of a good story, but just for fun, let's review the factors I discussed last year to see where we stand:

1) Savings Rate: Contrary to the past several years, the savings rate has now turned positive, which is good for retirement accounts, but not so good for the economy. Clearly, there is a new shift towards frugality, that is not likely to be short-lived. After all, the Boomers are getting ready to retire and they have seen some hefty 40% declines in their overall wealth portfolios that need to be made up somehow. Economists clearly expect consumers to immediately shift back to their spendthrift ways, which is totally unfounded. As I indicated before, the consumer is roughly 70% of the U.S. economy, so each 1% increase in the savings rate shaves about .7% from GDP. Right now the savings rate is hovering around 4% whereas the long-term historical rate is closer to 8%. I know, last year I said that a negative savings rate is bad and now I am saying that a high savings rate is bad, but it's more a question of speed of adjustment. As an analogy, exercise is great, but if you weigh 400 pounds and haven't worked out in 40 years, it's not a good idea to attempt a marathon i.e. something might just stop working.

2) Housing Market: According to this week's Barron's, the next leg down in housing is right around the corner...Here are a few key snippets from the article:

"The Housing Hurricane will Howl Again"

by Mike Morgan
"We're out of the eye of the hurricane, but here comes the back half of the storm"
"Law firms for banks are once again lining up to file foreclosures"
"All of the Obama Administration's attempts to revive, resuscitate and shock the housing market into recovery have failed."
"Unfortunately, there are no signs of recovery, despite the hype and the twisting of numbers in many media reports"

3) Credit/Banking crisis:
The Fed has squandered trillions of dollars on this issue, but guess what, they only scratched the surface (subprime). As I predicted two years ago, subprime was the tip of the iceberg and now prime is starting to be the next source of problems i.e. every prime borrower who just lost his job is now the new subprime. Also, as expected, bank failures are starting to accelerate...

4) Unprecedented levels of debt: Guess what? The debt is still out there! Apparently we need to pay off all of the old useless junk we bought before we can go out and borrow to buy some new useless junk - go figure. In addition, 500k+ job losses per month, hiring freezes, salary freezes and the worst job market in 30 years haven't done anything for household balance sheets either.

5) Trade Deficit: Good news ! The trade deficit has been reduced, because...Bad News ! nobody can afford to buy anything anymore...

6) Two Never-ending Wars: Enough said...

7) Energy Crisis: Good news ! Oil has come down in price...Bad News ! Alternative energy projects have been shelved en masse and if the economy starts to recover, oil will shoot back up again ...

8) Fed out of ammo (Not!): Last year I said the Fed was out of ammo (short of printing money), so I was kind of wrong and kind of right. I was wrong, because the Fed was not out of ammo, as they invented the TARP, the TALF and twenty other new programs to give away money. I was right however, because then they did start to print money !!!
As a next step they will likely drop money out of helicopters as Ben Bernanke has promised he will do, so I correct myself to say that the Fed will NOT be out of ammo until we are all carrying our money around in wheel barrows (my apologies for being wrong about this).

In summary, more than 90% of economists do not understand all of the above basic facts, which is truly mind-boggling. This isn't Econ 101, this is Econ for Fucking Morons. I have no doubt these dolts lost a big chunk of their assets in the recent market decline and therefore believe that the coming collapse will see them duly stripped of the remainder.

Something Wicked This Way Comes

Something I mentioned in a recent post is the inherent yet unquantifiable 'event risk' which pervades the socioeconomic environment at this critical juncture. I mentioned the inevitability of a global currency crisis likely starting in Eastern Europe. However, in addition to the well known and oft discussed economic catastrophe we are facing, there is a wide array of other seemingly unrelated risks that will more than likely feed off of one another creating a lethal catastrophic firestorm of historic proportions. It turns out that the same greed, stupidity, laziness and denialism that got us into this economic catastrophe, played a starring role in several other simmering catastrophes as well - go figure...

Geopolitical/anarchic Risk:
Latent geopolitical risk has been simmering for quite some time in the usual places: Iran, North Korea, Pakistan etc. However, now other countries such as Mexico are seeing dramatic increases in violent crime as the fallout from the economic collapse causes various unforeseen dislocations. Even in my home country of Canada (British Columbia) there has been a spasmodic increase in gang-related crime the likes of which that Province has never seen. And then of course there are the myriad protests going on around the world fuelled by burgeoning unrest from the economic crisis. Expect those to become a lot more violent in the days ahead. Here in the U.S. the "tea parties" being staged as a protest against government intervention in the crisis are just the first signs of simmering anarchy and unrest in this, the most heavily armed country in the history of the world... And while we have just come through a relatively calm period from a human historical standpoint, as I have said before, expect that the ongoing explosion in economic volatility will produce a concomitant explosion in geopolitical anarchy, that we are only just now starting to witness...

Environmental Risk:
Thanks to decades wasted and billions spent on obfuscation and disinformation we of course are way behind the curve in addressing latent environmental issues. Expect that these too will find their way into the brewing catastrophic firestorm, as climatic temperature increases will bring rising sea levels, drought, earthquakes (from tectonic shifts, due to melting ice caps), tsunamis, floods and myriad other crises at a most inopportune time.

Peak Oil:
Peak oil will ultimately do more to reduce human consumption of fossil fuels than we could ever accomplish with a climate treaty. So from that standpoint, this is the one crisis that could ultimately bring great benefit to the human race, assuming that we survive the transition to viable alternatives. Expect the adjustment process from oil to renewable energy sources to be halting and turbulent to say the least. The price of oil will continue fluctuating wildly over time, accentuating the duration, severity, and frequency of economic recessions. Every time we look to be climbing out of a recession, expect the price of oil to leap ahead, thereby putting an automatic damper on economic growth. As growth slows, oil prices will eventually fall back again, thus putting the brakes on renewable energy projects that will be deemed economically unviable - just as many projects have now been shelved since oil fell below 50 (after having hit 150 only about 9 months ago). In short, it will be yet another repeating loop of short-sightedness and stupidity. Check - been there, done that.

Health and Disease:
Simply put, impoverished people can't take good care of themselves. And since the vast majority on this planet - including most in the heretofore 'wealthy' nations - will be poor, then expect preventive health maintenance to be reduced, putting us all at increased risk of sickness and disease. On top of that , health resources will be stretched and inadequate to cope with burgeoning pandemics, like the Swine Flu epidemic that is just now getting started. Suffice to say it's not a good time for the largest segment of our population (The Boomers) to be heading for retirement putting further strain on public health resources. It's also not so timely that we squandered the Medicare "trust fund" (i.e. the money coming out of your pay check every month) to pay for unaffordable tax cuts to fund conspicuous consumption and not one, but two ill conceived wars of misadventure....

Disaster Cocktail:
Put it all together and what do you have? You have a volatile cocktail of crises, each of which will accentuate and resonate off of one another in ways that policy-makers have not even begun to consider. After all, we have silos of "experts" fiddling around with the economy (rearranging deck chairs, really); health experts focusing on pandemics; scientists considering the environment; geologists considering peak oil etc. However, who is looking at the big picture? All of these crises are all coming together at the same time in both deadly and unforeseen ways. The economic connection is easy to make i.e. fewer resources to address any and all types of crises. However, how will geopolitical realignments affect the impacts of peak oil ? How will the environmental crises affect health and geopolitical stability? You get the idea.

The Complete Triumph of Laziness and Stupidity
Overwhelmed with unparalleled amounts of information, disinformation, propaganda and data in all forms, human beings have fallen back on blind faith and delusion as our standard mode of thinking and operation. Legions of "smart" people have told us that we can in no way predict the future and therefore it is a fool's errand to even try. I readily admit, there are many coincident crosscurrents that make absolute predictions virtually impossible, however understanding the general vector of human progress is not difficult in the least. So, while I can't say with absolute certainty what events will take place when, there can be little doubt to anyone with a shred of commonsense or honesty that the path we are taking on economic, environmental, energy and humanitarian related issues is spiraling downward. Yet we are constantly tempted by false prophets to believe that the laws of cause and effect have been suspended. Moreover, short-term side-effects can easily be obfuscated or rationalized away. Everyone from Nassim Taleb (Black Swan theory), Robert Prechter (EWI) - and countless others - have offered up sophisticated book-selling con jobs for why there are "unseen" forces at work (luck, social mood etc.) exerting absolute control over human destiny. Of course these theories only serve to contribute to the general sense of confusion and futility, thereby restraining our progress towards straightforward solutions to solvable problems. Worse, there are myriad others anchoring themselves to such pathetically glib fallacies as "we have been through worse before" and "the American economy always comes back". All I can offer as a fittingly glib rejoinder is "Past performance is no guarantee of future results". In short, the outcomes of cause and effect have not been permanently suspended, they have only been delayed such that the accumulated imbalances will only ensure that the inevitable devastating outcomes will be vastly magnified and uncontrollable...

Wave C Destruction
Finally, getting back to my favourite topic around the markets and economy, Prechter recently reinforced a critical observation the other day in the latest version of the "Elliot Wave Theorist", which is that 'C' waves, such as the one that we are in, are steeper and therefore far more destructive than 'A' waves. Recall under Elliot Wave Theory, the first leg down was 2000-2002, which was Wave 'A' in a 3 wave correction of the stock market (A-B-C) going back 300 years (i.e. the biggest correction we have had since the founding of the United States). Wave 'B' was a retracement rally that coincided with the George Bush fantasy years where people leveraged their homes like they were ATMs, we raided Social Security and Medicare to pay for a tax cut for the ultra wealthy, started two ill-conceived wars, and otherwise did our level best to prove that human beings are as dumb as a door knob. So, that puts us in Wave 'C', which started in October 2007 and has already brought the market lower than 'A' wave which ended in 2002. How do I know that Wave 'C' hasn't ended? Because if, Prechter is right (and I believe he is), then Wave C won't end until we retrace much of the stock market rise that has taken place since 1932 i.e. putting the Dow back below 1000. Accordingly to that theory which is by the way supported by all of the current economic data available (regardless of what your government is telling you)...then, once this little stock market rally ends (weeks, months from now - who knows?), we can expect the most devastating segment of Wave 'C' to begin in full force...

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NOTE: One may wonder why I quote Prechter's charting of the markets while I dismiss his social mood theories. He believes that prevailing social mood (which is cyclical) drives events whereas I believe events primarily drive social mood. While I can go so far as to believe that social mood is a contributing factor in human "change", I am not so fatalistic to believe in an exogenous (uncontrollable) theory of human progress/regress. That said, regardless of how we got to this pivotal juncture - events driving mood or other way around, the inevitable outcome is agreed to be the same...

ALL IN

"There is no means of avoiding the final collapse of a boom brought by credit expansion" - Ludwig Von Mises

In my post from just two days ago, I indicated that the Fed would soon start buying Federal Treasuries, which is tantamount to "printing money". It appears that soon just got here, as the Fed announced today that they are going to start buying Federal Treasuries in order to drive interest rates down across the entire credit market.

In the long-term of course, this won't do anything to derail the deflationary economic collapse, however, in the short-term this is very significant and indicates that the Fed is now "All in" in its bid to stop deflation. Essentially what the Fed is trying to do is to induce the capital markets to take on more risk by making the "risk free" yield (i.e. U.S. Treasuries) relatively low and unattractive. Of course, the stock market took off on this news and rightly so, as stocks should be one of the primary beneficiaries of this historic policy (as far as I can ascertain, the U.S. Government has never monetized its debt on a significant basis). Therefore, I think the stock market could have a significant multi-month rally back to the 200 day moving average which is an important demarcation line that stymied all of the rally attempts during the last bear market (2000-2003). We have yet to have a rally back to the 200 DMA in this bear market, so we are long overdue. In percentage points from here, based on the S&P 500 (currently 800) and depending on the trajectory of the rally, I would hazard a range between 900-1000 (~12-25%) is possible sometime between now and the summer. Bearing in mind that the market is already up 20% off of last week's lows (!), so a pullback is due any time now. As always, take all stock market predictions with a grain of salt...

As I mentioned however, in the grander scheme of things, this monetization policy will not alter the deteriorating economic fundamentals. Think of it as similar to pouring gasoline on a dying fire - yes there is a great, seemingly impressive burst of flame, but then almost as quickly as it started, the fire burns down, as there is no underlying "fuel" to keep it burning. Similarly here, stocks will rally and become more expensive, and then everyone will realize that there are no underlying fundamentals (aka. profits) to support the higher valuations. Households will still be massively in debt (and falling further behind every day), and there will be no long-term driver for economic growth. As I wrote recently, the (latest) stimulus package is a joke relative to the size of the overall economy and the magnitude of this crisis. Last year's stimulus package didn't do anything, and yet they apparently think we are stupid enough to believe that this time will be different. It's starting to feel a lot like Ground Hog Day around here...

Event Risk
There is one major risk to the near-term rally scenario, and that is event risk. The specific event I have in mind is a looming global currency crisis that will most likely begin in Eastern Europe and then spread worldwide from there. I don't think it's a question of if there is a crisis, only when. And while short-term the market typically trades off of technical supply/demand factors (moving averages, overbought/oversold indicators etc.). Should we see some sort of "black swan" (unpredicted, though far from unpredictable) currency event, then whatever "up trend" (if any) is in place, will surely be curtailed. Suffice to say a truncated rally at this juncture would be EXTREMELY bearish to this economy and the markets, as the Fed has now played its last card. This is it, as I said at the beginning, we are ALL IN now, and if the casino (market) calls the Fed's bluff, it will be panic time...

Fortunately, and contrary to Bernanke's wishes, I see this Fed program to buy Treasuries as a good thing for those who prefer to ride out this crisis in "risk free" assets. After all, basically what the Fed is doing is to put a floor underneath Treasury prices which even further reduces risk for those who want to hide out in Treasuries and leave the short-term stock market speculation to the gamblers...Imagine an asset class (Treasury bonds) that won't go down, because the Government is the buyer of last resort and yet has upside potential in the event of an "adverse event" and ensuing safe haven buying. Sounds like a great idea to me...

What of Gold?
Despite today's historic decision to monetize the debt, on top of the $7+ trillion the Government has thrown at this economic fiasco to date, gold still is lower today ($940) than it was in January 2008 (albeit not by much). Suffice to say if gold can't decisively break $1000 and stay above $1000 on this (supposedly hyperinflationary) news, then it has a long way to fall...

Position your assets accordingly...

Blind (Deaf, and Dumb) Faith

It was about a year ago that I rendered my assessment here, that the average financial "expert" (i.e. economist, financial advisor) is as dumb as a post and that just about all of the "experts" are wrong in their assessment of the economy. After the fact, it turns out they were wrong, and one can only presume (hope?) that they too were relieved of 30-50% of their wealth along with the general public who trustingly believed their advice. However, far from being contrite, many of these same "experts" are now saying "nobody saw it coming", which besides being an outright lie, conveniently avoids the question as to why didn't they see it coming? Suffice to say, no market is collapsing faster than the market for Wall Street's Ph.D "savants" and who knows, maybe one day in the distant future, common sense will come back into fashion.

Fast forward one year and now we have a new batch of "experts" to help solve our problems, however unfortunately it appears that this current batch is no more intelligent than the last crop. Sadly my only hope at this juncture is to believe that Bernanke, Geithner, Obama, Summers et al. (i.e. the current stewards of this economic debacle), are simply outright lying to the public at this point. After all, there is tremendous pressure on each of them to be as optimistic as possible and hide as much of the facts and reality as possible. The public has little stomach for more truth than is already being crammed down their throats by their own economic realities; meanwhile the infotainers across the Mainstream Media came down on Obama recently for being too negative (i.e. realistic) about his views on the economy, so he recanted and has been pushing "happy talk" ever since. Just last night Ben Bernanke said on "60 Minutes" that he thinks the economy will begin to recover by the end of 2009. Based on what job and business creation fundamentals, he didn't say. But he did say that recovery is conditional upon getting the banking system stabilized. Apparently his plan is to get banks to start lending once again to people who borrowed too much in the first place, then we can get on with the business of borrowing and spending our way out of this mess. That should work. And the public believes this nonsense - the media believes this nonsense - almost everyone believes this nonsense. Somehow, a 30 year borrowing and spending binge is going to resolve itself without any permanent change in our standard of living, virtually in a period of a few months - presto ! The alternative to believing that Bernanke and Co. are "obfuscating", is to simply conclude that they are as dumb as a doorknob not to realize that we can no more borrow and spend our way out of a multi-decade borrowing and spending problem than an alcoholic can drink his way out of a drinking problem.


Let the Flat Tax begin!

This week the British started their campaign of "quantitative easing" aka. monetizing the debt, wherein, one branch of the government (the Central Bank) buys the bonds of another branch of the government (The Treasury) by printing money out of thin air. Bernanke has said recently that the U.S. is going to do the same thing soon - both to drive down long term interest rates and to help liquidate this year's $1.75 trillion deficit. Meanwhile, the Chinese said recently that they "hate" (their words) having to buy U.S. government bonds, but they will likely continue to do so (as it's their best means of devaluing their currency and inducing us to buy their cheap junk). Apparently they deem nothing in the U.S. to be of more value than paper IOUs which are paid for with yet more paper IOUs! Tellingly, despite all of this obstensibly "hyper-inflationary" news, long-term U.S. Treasury bond interest rates (yields) are still near multi-decade lows. So lest you think the U.S. is becoming the new Zimbabwe, bear in mind that the bond market has already voted, and it thinks that Obama & Company don't have a snowball's chance in hell of getting this economy restarted, much less generating any inflation.


What of this nascent stock market rally?

The short answer, is I don't know and neither does anyone else. Last fall's "nascent rally" only lasted a few weeks and then rolled over like a sick turtle. Some believe this current rally has legs and could last a few months. Others even believe that last week was a multi-year low in the market. Anything is possible, but all I know is that the steepness and severity of this stock market decline is on par with the early 1930's market and there are many people just waiting for a rally so that they can sell into it. Meanwhile the economic decline appears to be accelerating with job losses for March expected to approach 1 million ! So, the only way one can believe in an enduring rally is to believe that the economic fundamentals (i.e. job and business formation) are going to improve sometime over the next 6 months. Unfortunately, just like last year's predictions and despite Government's assertions to the contrary, there are no facts upon which to base that fantasy...

As I have said many times since this fiasco started, we are in a relentless deflationary collapse of unprecedented proportions.

And to think, we haven't had any real panic...YET.

Death of a Salesman

Always the one to be positive, I think the best (only?) good thing that will come out of this economic collapse will be the end of the era of the Salesman.

Currently, and for quite some time, the most "successful" and lauded people in the U.S. have been salesmen: business salesmen, political salesmen, religious salesmen, infotainment (media) salesmen - you name it.

In the age of the Salesman, it is far more important how things look than how things are in reality. Whereas, the U.S. economy was once based on small business and then manufacturing, now in past decades, the U.S. economy has become a front-office for goods made in other countries. This means that the most powerful people in every organization are the Sales Men. People who actually get things done have been demoted to the back office, well out of sight.

There are no honest, intelligent, straight talking men to look up to anymore, because they have all been crowded out by smooth talking pretenders. We pick our politicians like we pick our apples, we look for the perfect, shiny waxed ones regardless of their intrinsic quality. It started with electing an aged, Alzheimer afflicted B-rate actor as President. Then it (hopefully) culminated with electing a draft dodging, C student, dilettante to the same office. Yet even, Obama, the "beacon of change", is turning out to just be an exceptionally smooth talking light weight with no real world experience to fall back on.

Turn on your television to any major media station and tell me that you are not being lied to almost non-stop. Obviously I am not talking about bald-faced lies, that are easily verified. The techniques are always subtle and insidious, including obfuscation, spin, bias (one-sided reporting), subjectivity and half-truths - whatever, it's still all nonsense intended to make everyone ignore facts and reality. If I can turn on CNN, Fox News or any other station and know within 30 seconds the political bias of the so-called "reporter" who is delivering the news, then that is not quality, objective journalism - that is propaganda.

When in Rome
The Baby Boomers are The Ultimate Salesman Generation. They have been trained from birth to believe that blind optimism is always the best way forward, the truth not withstanding. The same culture that gave us drug addled Hippies during the '60s, later fanned out both left and right to give us Amway salesmen, Neocons, Limousine Liberals and Born Agains. These glassy eyed sociopaths all have the same traits in common: a strong predilection towards fantasy, denial, self-delusion and hedonism - yes, even those Born Agains, who spend half their lives in Sodom and Gomorrah only to conveniently find Jesus at age 45 (after they are drugged out, sexed out, and burned out) and turn into sanctimonious hypocrites from that day forward.

Mind the Gap
Unfortunately, along with Salesman culture, comes what I call the "credibility gap" i.e. the difference between what we are led to believe will happen v.s. what actually happens. The key goal of Salesmanship of course is to push off the credibility gap discovery process as long as possible, preferably onto one's children's or grand children's generation. Unfortunately, there are times like now, when the future arrives ahead of schedule and the "gap" gets closed like a vise.

Still, in all, despite the economic carnage to date, the charade continues, as the Boomers are a lot like gerbils with a Pez dispenser - trying sadly and desperately to kick start their dying fantasy economy - wanting more stimulus, more bailouts, more government intervention, to forestall the inevitable. And yet, ironically the same salesmen are in place trying to fix this mess who got us into it in the first place. The same "captains of industry", the same "expert economists", the same politicians. And no one is more conned by this sad game than the Boomers themselves !

To most people around the world looking in at the U.S. they are just as misinformed about the current state of affairs as we are. After all, they too have been brainwashed by the U.S. media and U.S. Government to believe that the U.S. is the greatest, strongest country in the world -everything is A-Ok. Most foreigners have no idea how bad things are in this country, because the unvarnished truth and reality never see the light of day.

"You can't handle the truth"
Fortunately or unfortunately, depending upon how you look at it, the credibility gap just keeps on closing. Those Boomers with their undying faith in the market who just lost half of their retirement assets and 30% of their home value, won't possibly admit that the game is over. It's a lot like a gambler who parlays a fortune from nothing, but late in the game his streak turns cold and he loses half his money. Rather than accept his fate and cash in, he just pushes the whole stake back onto the table and doubles down. So it is with the Boomers, they can't walk away, because they can't accept less - it's just not in them to do so. As a generation, they have always gotten their way.

So, in the end they will all be relieved of their homes, their jobs and their retirement savings.

And don't worry about all of the phony salesmen who got us into this mess, because somewhere down the road there is a mob with pitch forks and torches heading in their direction...

Wall Street: Grand Masters of Ponzi

For those attempting to understand who was behind this globalized pyramid scheme, one need look no further than the corner of Broad and Wall.

Wall Street is the hand that conceived and built the global financial and economic Ponzi pyramid. Its banks, brokers, and investment funds stand alone at the top of that pyramid. No one cohort has played as large a role or benefited as much during the past decades from the carving up and selling of America than Wall Street. The billions in wealth extracted from the U.S. economy in past decades by Wall Street firms stands in sharp contrast to the trillions in wealth that has evaporated in the past year due to Wall Street's failed alchemy.

Wall Street is the ultimate wealth concentration machine. It packages and securitizes companies and sells them off to the highest bidder, taking a large slice of the profits along the way. Apologists will say that companies need Wall Street to gain access to capital, but the reality is what we really need are more accessible and open capital markets, not markets controlled by a self-nominated ultra-wealthy country club.

It's Wall Street's all-consuming drive for profits that has driven the relentless outsourcing trend over the past 30 years. It started in the '70s and '80s with blue collar jobs and in the past decade millions of white collar "knowledge worker" jobs have gone overseas as well. We were all told that knowledge-based jobs were the careers of the future, only we were not told the future would only last about 8 years. One must ask what would the country look like today if Goldman, Morgan, Merrill, Lehman and Bear had never existed? The answer is clear: American incomes would be stable and evenly distributed, unemployment would be negligible, the U.S. would still be a leader in science and engineering and this financial collapse would never have happened.


Profits Before People
Last month I said that the December jobs report was bad at 500k+ jobs lost, well as expected, January's was worst at 600k+ lost. I understand there are firms that are on the edge of insolvency that need to lay off just to survive, but how about all of these highly profitable companies laying off workers on top of that? Take Microsoft as an example; recently they laid off 5000 of their workers, because profit margins, although higher than any other company in the history of the world, apparently are not high enough to satisfy Wall Street. Not to mention that they have over $20 billion in cash and their most recent quarter's operating cash flow was a staggering $9 billion i.e. just 3 months of cash flow is enough to pay those 5,000 workers for roughly the next 12 years (assuming they make on average $150k).

And where will those 5,000 ex-Microsoft employees go to get new jobs as they are dumped into what is clearly the worst economy in the past 80 years? Obviously most of these people won't get new jobs any time soon and if they do eventually find a new job it will likely be outside their primary field of expertise and at a fraction of the pay. Not to pick on only Microsoft, because there are dozens if not hundreds of other corporations out there that are still profitable at this juncture that are taking full advantage of this downturn to "streamline" operations. In doing so collectively, they will short-sightedly turn what would have been a bad recession into a prolonged and enduring depression, simply because they are too profit-obsessed to take a temporary drawdown on their profit margins and/or are unwilling to retrain and move people around the company.

The incestuous relationship between Wall Street and Washington is lock solid. While banks and brokers received trillions of dollars in bailout funds, Detroit auto CEOs were hauled up in front of Congress like third class criminals for requesting a mere $25 billion. I will leave aside the debate as to whether either of these groups should have been bailed out at all, but the difference in treatment between these two industries was stark to say the least. The key difference is that Detroit's bailout represents hundreds of thousands of decent paying middle class jobs, while Wall Street's bailout represents billions of dollars in bonuses and payouts for ultra wealthy campaign contributors.

There are those who blame Greenspan and other government bureaucrats for this financial debacle. I am not going to say that the man wasn't absurdly ideological and short-sighted in his policies, but to believe that he was the primary sponsor of those policies is naive in the extreme. No. Behind Greenspan was the strong hand of the Wall Street firms who were far and away the greatest beneficiary of the multi-decade monetary profligacy. In short, Greenspan's role was simply as front man and stooge for moneyed interests.

And finally, under my favourite theme of "who didn't see this coming?": Suffice to say that when your "best" and "brightest" are flocking to Wall Street to trade pieces of paper back and forth in a zero sum game while extracting billions of dollars of fees in the process, then you should be honest enough to realize that as a nation your best days are behind you...

TOO LITTLE, TOO LATE

Now that Obama has formally taken office, hope springs eternal that he will be able to fix the damage wrought by 40 years of class warfare. If only he could somehow get back the millions of jobs lost to overseas outsourcing. And then maybe he could also put a floor under house prices and once again render solvent the middle class, most of whom are essentially bankrupt and are not even aware of it. As you guessed, I am more than a bit skeptical.

Many hold faith that Obama's pending $825B stimulus package will get the economy back on track with its promise to create 3-4 million jobs over the next two years. Unfortunately, last year alone the U.S. economy lost 2.6 million jobs and at the current accelerating rate, the economy is on track to lose a further several million jobs in the coming year. That means the pending stimulus package will only partially mitigate the economic effects wrought by relentless job losses. Consider that in December alone, the economy lost over 500,000 jobs and December is usually a light month for job losses, as employers are generally reluctant to cut before the holidays. The other issue is that many of the jobs being lost are high income jobs in such fields as Finance, Sales, Marketing and IT that won't be duplicated under the Obama stimulus plan. The Obama plan is expected to create jobs in the construction, renewable energy and infrastructure industries.

Further frustrating any attempts to stimulate the economy:

1) Increased savings rate: By all accounts, Americans are starting to reverse their decades long trend of over-spending by increasing their savings rate. This is largely due to growing job uncertainty and the reverse wealth effect caused by the destruction of trillions of dollars in stock market and credit market wealth. Were the savings rate to rise from recent negative levels and return to its historical average level of ~8%, that would have a massive impact on GDP, as consumer spending is roughly 70% of the economy i.e. each 1% increase in savings reduces GDP by roughly .7 %, so a return to an 8% savings level could lower GDP by over 5%.

2) Reduced access to credit: As one would fully expect during a deflationary credit collapse , (potential) borrowers can not/are not borrowing and lenders are not lending. Most borrowers have their hands full with the debts they already owe, while lenders are still reeling from the trillions in losses they took down last year. This lowered reliance on credit and debt to fuel consumption will have a substantial yet-to-be-quantified negative impact on GDP. As I wrote recently, in a cash-based economy, consumers will forgo purchasing big ticket consumer durable items as long as possible. The fact that policy-makers are still fiddling with the TARP program and other myriad schemes to induce bank lending, tells me "they" (the policy-makers) really don't get the fact that the borrowing induced debt Ponzi is over, once and for all.

3) Negative wealth effect: Over the past several years, the hyper inflation of every asset class from stocks, bonds, commodities, real estate led many people to rely on the growth in asset values to fund consumption. Whether through mortgage equity withdrawals or by cashing in on over-inflated stock/bond portfolios, this hyper-inflation of asset values has had significant impact on consumption. Now, in credit and asset deflation, that additional economic stimulus from asset values will be removed from the economy. What few people seem to realize (and what Prechter has pointed out), is that when asset values collapse, the majority of the lost value in collapsing asset class 'A' doesn't move to asset class 'B' or 'C', it simply disappears. This is because financial assets are valued by the marginal (last) sale of the asset. So for example, when Microsoft dropped from $19.50 to $17.00 per share on Thursday last week (due to its punk earnings report) that revaluation of the company eliminated $2.50 of value from ALL (9 billion) of the shares outstanding, not just the small subset of shares that traded that day. This phenomenon is especially hazardous in some of the more exotic (and illiquid) credit assets such as CDOs (Collateralized Debt Obligations) because of what I euphemistically call "discontinuous price discovery", which leads to very severe price downward price adjustments, due to the fact that these types of assets trade relatively infrequently. During 2008, just in terms of stock market losses alone, over $30 TRILLION dollars in wealth was lost, which is half of combined global GDP.

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Fortunately, one of my dire economic predictions that has not come to pass so far is a nationwide bank run. This event has been forestalled by the proactive efforts by Bernanke's Fed to support the banks during the credit crisis. As indicated, the Fed has found some very creative ways of lending trillions of dollars to the banks to maintain the illusion that the banks are still solvent. Despite these efforts, Nouriel Roubini just this week indicated that the U.S. banking system is now "effectively insolvent". Beyond the roughly $1 trillion in writedowns taken by major banks to date, he indicates that further writedowns will eventually wipeout all remaining equity in the banks. Further to this point, Citigroup and Bank of America shares sank to decades lows of $3 and $5 respectively, and the combined market capitalization of the top 24 U.S. banks is now less than the market capitalization of Exxon Mobil ! Therefore, if you still have your cash sitting in bank deposits, I would highly suggest moving it to the higher ground of a brokerage account where you can invest it in short-term Federal Treasury bonds (either directly or through ETFs such as SHY and SHV). Any money you keep in local bank deposits could eventually be subjected to a bank run at which point you will need to wait in (a very long) line to get your money back from the FDIC, assuming it's still functioning and solvent. By the way, that's an ENORMOUS 'IF', considering that the FDIC only maintains reserves amounting to 1.15% of outstanding deposits! (you read that right).

As bad as things are for the U.S. it appears that the U.K. economy and financial system are in even worse shape. Adding to anxieties in the marketplace, the Pound Sterling has fallen off a cliff of late as foreign investors dump the Pound and all things U.K. denominated. Were it not for the fact that the U.S. dollar is considered a "reserve" currency, this would surely be the fate of the U.S. at this time, and no doubt portends badly for the future. For as I have written recently, the U.S. may well be able to "print" its way out of this mess (starting now with Treasury bonds, but eventually leading to printing currency), but once foreigners start to dump dollars in earnest and the dollar loses its status as a reserve currency, then the Post-Apocalyptic cash-only economy I have been writing about will become a full fledged reality.

So while I am tempted to drink the Kool Aid along with the rest of the Obamaniacs and believe that the man is some sort of magician who can make everything right again, the facts and reality tell me that the inexorable economic collapse to lower more sustainable levels is still very much on track and poised to accelerate in the not too distant future. Not to say that he isn't a breath of fresh air after 8 years with that other guy, but let's face it he is only one man in all this madness. Meanwhile, the hardcore right wing is already working overtime to slander and subvert the poor guy literally only hours since he took office. Sadly, I expect that despite the horrendous mess he has been handed, it won't be long before the honeymoon is over and he starts to accumulate blame for not fixing what in actual fact is an irreparable situation.

WORLD'S GREATEST PONZI SCHEME

I'm back for one more post. Recent developments are just too significant to be ignored.

Take this Bernie Madoff scandal as an example. Old Bernie has been credited with creating the largest Ponzi scheme in history. Are you kidding me? How can you compare Bernie's puny $50 billion dollar pyramid scheme to the U.S. Government's pyramid scheme involving trillions of dollars?

Since I stopped blogging a few months ago, the total tally for U.S. government bailout funds has gone from roughly $500 billion to over $7 trillion !!!. Essentially the U.S. government has been using its own balance sheet to buy up all of the irresponsible loans from banks and lenders. Add that $7 trillion sum to the existing roughly $10 trillion in Federal government debt and untold trillions of Corporate and Consumer debt and the total debt figure easily climbs north of $50 trillion. Once you add in another $50 trillion for those unfunded liabilities known as Social Security and Medicare and that sum is up to a cool $100 trillion !

The All Important Question
The critical question in all of this, and one that only a few observers seem to be asking themselves, is what will come of all of this debt and how/will it ever be repaid?

The clear and obvious answer of course is that it will never be repaid, simply because the economic fundamentals of the economy are inherently unsound and therefore provide no basis for repayment via normal means (i.e. taxation).

So, that brings up the question of how will the U.S. government eventually get out of repaying all of this money? And to that question, there are only 3 possible answers:

1) Outright default - this means that the U.S. government repudiates its debts and then overnight essentially becomes a third world banana republic. This scenario is highly unlikely however the because the debt is denominated in U.S. dollars, which gives the Fed the option to print our way out of this mess, whereas other banana republics don't usually have that option (e.g. Latin American debts are usually priced in U.S. dollars).

2) Debt monetization (Printing Money) - So far the Federal Reserve has been "sterilizing" all of its bailout operations to prevent outright printing of new currency; however, should the Fed get really desperate, then they could simply credit the U.S. government account with fresh money that could be used to buy back Treasury bonds, hence "printing money".

3) Inflation - This is the most pernicious of mechanisms that can be used to get out of debt. Instead of an overt repudiation of debt, inflation is instead an indirect way of essentially devaluing the dollar such that the debt gets partially repaid but with significantly devalued dollars.

Since option (1) would be politically unthinkable, that leaves options (2) and (3) on the table, and with deflation now spreading inexorably, I believe that the Fed will eventually need to use both options in tandem to relieve the collective debt burden. Monetizing the debt will be the mechanism by which the U.S. government gets itself out of debt. It will also allow Helicoper Ben to make good on his promise of distributing "free" (devalued) money to the masses, which will ultimately generate inflation, hence relieving the consumer debt burden.

How Now Deflation?
So given this recent massive increase in the "money supply", how is it that we could still be heading towards deflation and not inflation? This is the key fundamental question, and one that seems to elude most economists and bloggers. The answer is two-fold. First, as I mentioned above, to date, the Fed has not been printing currency, they have been expanding credit and also sterilizing these operations to prevent outright inflation. The second part of the answer is that contrary to most belief, credit is not "money", credit is debt and whereas in a normally functioning economy the expansion of credit is inflationary, in an asset-impaired economy the expansion of credit has no impact i.e. lenders won't lend and borrowers won't borrow - out of lack of confidence, lack of collateral etc.

Bear in mind that Bernanke is a dedicated Monetarist. He believes in a credit (debt) based economy. He also thinks that he has learned the lessons from the Great Depression and can take steps to avoid the same deflationary spiral. Bernanke and other Monetarists believe that the Fed of the 1930s caused the Depression by allowing the money supply to contract (i.e. as banks failed). However, comparisons between then and now are completely specious, because at that time the U.S. was on the gold standard. That means that the Fed was physically limited to the extent that it could increase the money supply by the amount of gold reserves. So while yes, the Fed did less to expand credit after-the-fact in the 1930s, keep in mind that the money over-supply going into the Great Depression was likewise much more constrained than what we are facing now, due to the disciplines imposed by a Gold standard. Therefore despite Bernanke's interventions, there is no reason to believe that economic fallout from the catastrophe that we are now facing won't be as great or greater than what was faced during the Great Depression.

Careful what you wish for
And of course the Misian pollyannas are out in full force telling us that deflation is not something to be feared but something to be embraced.

Unfortunately, there are actually two types of deflation. There is the "cinderella deflation" that the Noveau Misians speak about, as characterized by responsible fiscal and monetary policy, a fixed money supply (based on the gold standard) and ever-increasing productivity.

Then, there is what I call "Frankenstein" deflation which is precipitated by 30 years' of reckless fiscal/monetary policy leading to out of control debt accumulation; characterized by widespread asset price destruction and precipitating a rapid uncontrolled economic collapse the likes of which not even an Ivory Tower Misian hiding behind 20 foot walls could embrace i.e. "are those the neighbour's kids eating out of my garbage can?".

In short, unless you are an end times Militia freak living in a bunker in Montana surrounded by crates full of M16s and 5.56mm, I don't think it's going to be a fun time...

The Deflationary C(r)ash economy
John Maynard Keynes called it "The Paradox of Thrift". If one person saves his money, he makes himself wealthy. If everyone saves their money, the economy collapses. That paradox which is occurring as we speak, combined with the deflation in the credit markets and the corresponding unwillingness to borrow and lend fully explains why we are heading towards extreme deflation and eventually a cash-based economy. Imagine a cash based economy, where individuals hoard physical cash, because they can't trust their banks and where they are unwilling to borrow to buy consumer durables such as cars, homes, appliances etc. In other words, in a cash economy, economic activity falls drastically and the circulation of money (liquidity) falls correspondingly. That gets us back to options (2) and (3) above, wherein the Fed will get desperate and unleash hyperinflation to get the economy moving again and at the same time de facto wipe out all prior debts (think Weimar Republic, circa 1923). As I indicated above Bernanke won't give up on the credit markets overnight, but once he eventually capitulates and reaches for the nuclear option (printing currency), then all financial assets (stocks, bonds etc.) will be destroyed and the 40 year Class Warfare of Monetary policy will come to its predictable end.

What of this nascent stock market rally?
As I predicted this past August, the stock market had another major leg lower. Despite the fact that I am still extremely bearish in the longer-term, one must bear in mind that markets, being discounting mechanisms, do not fall or rise in a straight line. As I have pointed out here, I believe this market decline is markedly similar in shape and form to the crash of the 1930s. So if in fact we are following a script similar to that of the early 1930s, then we are currently in the retracement rally that started in late 1929 which should see the market lurch unevenly higher back towards the downtrend line at which point it will again rollover and head inexorably down towards oblivion. If you haven't sold your stocks yet, but are looking for a chance to do so, I think you will get the opportunity in the coming weeks/months, however, be realistic about your price target (i.e. S&P 500 between 1000-1050 seems to be a reasonable target)...

And yes, as I predicted several times, volatility did eventually explode to unprecedented levels with this last stock market decline and by all accounts those hedge funds that were net sellers of volatility were in fact decimated. Ironically in this economy, it's going to be hard for these guys to just get their old jobs back at Starbucks...

Gold
Despite the fact that gold (@ ~$840) has been holding up better than most markets, it is still lower than the peak of $1000 hit last spring. As I have said many times before, gold will be the ultimate asset to own when attempting to hide from the inevitable hyperinflation, but until we get to that point, and especially as we transition through the "cash economy" phase described above (brief though it may be), then gold will not be a good place to hide. I can't predict exactly what price gold will become a "buy" but I imagine it will be closer to $200 than to $800 where gold resides currently. So, as I see it currently 2-3 year treasuries (e.g. via SHY ETF) are the only safe haven in the short-term, with a longer term eye towards migrating towards gold with a "dollar cost averaging" strategy using wide "scales" (i.e. allowing for a large decline in gold).

The Economy
What of the economy? The eight year Bush Fantasy economy is gone and it's never coming back. The reason I am not optimistic about the future is because we can't solve a problem if policy-makers can't acknowledge the root cause of it. Most economists seem to think that if we bail out the banks, give out some free stimulus checks, change some regulations and wait a few months then we will get back to normal again. Unfortunately, what everyone seems to be overlooking is that this past 30 years hasn't just been a colossal financial disaster, much more importantly it has been a phenomenal economic/industrial disaster as well. As I have pointed out, this country has (in a relatively very brief period of time), outsourced its entire manufacturing, R&D, and engineering base, and all of the associated intellectual capital that goes along with it, to foreign countries. Those millions of manufacturing jobs that went overseas took with them hundreds of years worth of accumulated industrial intellectual capital, turning this country into a front office marketing and finance agency. Once the sound and fury from all of the credit crisis starts to quiet down, then it will finally dawn on everyone that the country's industrial seed corn has been eaten. There is no long-term engine for job creation, as the temporary jobs from the Bush era (mortgage finance, construction, bar tending) will have all long evaporated. In short, decades of greed-motivated industrial arbitrage (aka. outsourcing) has permanently hollowed out and impoverished what once was (and no longer will be) the middle class.

This entire era has been a grand failed experiment in the so-called "Anglo-American" economic model, premised on wide open markets as prescribed by the Ricardian model of comparative advantage and the modern day reincarnation of Supply Side ("Let them eat cake") Economics. Apparently Ricardo didn't envision what would happen when an open trade based nation like the U.S. goes up against dedicated export mercantilists such as Japan and China; however, I am sure he was smart enough to guess the inevitable outcome...