BIS warns of Great Depression dangers from credit spree

Some global elites DID give advanced warning prior to the 2008 financial crisis.


http://www.telegraph.co.uk/finance/economics/2811081/BIS-warns-of-Great-Depression-dangers-from-credit-spree.html

Greenspan: "The Stock Market Is Great", But The Economy Feels Like In "The Late Stages Of The Great Depression"

I'm taking the over/under wager proposition on when former Fed Chairman Alan Greenspan-turned-truthsayer is demonized by the mainstream financial press.  Another side bet could be made on when current Fed Chairperson Janet Yellen will accuse Greenspan of being a turncoat.

http://www.zerohedge.com/news/2015-02-26/stock-market-great-economy-not-alan-greenspan-warns-great-depression-global-demand

Key Metric Hits Same Level As Prior To The Great Depression

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2014/6/1_Key_Metric_Hits_Same_Level_As_Prior_To_The_Great_Depression.html

Paul Craig Roberts: By Winter Unemployment Explodes, More Foreclosures-Worse than Great Depression

http://youtu.be/buqJP7y115s

Gerald Celente - The Frightening Trends For 2013 & 2014

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/2/13_Gerald_Celente_-_The_Frightening_Trends_For_2013_%26_2014.html

How Bad Was The Great Depression?

http://www.zerohedge.com/news/2012-09-29/how-bad-was-great-depression

US house price fall 'beats Great Depression slide'

Where were all the green shoots from 2009 and 2010?  Didn't government statistics and the mainstream media declare the Great Recession ended in June 2009?  Why are all the "experts" surprised by the latest grim economic news?

http://www.independent.co.uk/news/business/news/us-house-price-fall-beats-great-depression-slide-2291491.html

The ailing US housing market passed a grim milestone in the first quarter of this year, posting a further deterioration that means the fall in house prices is now greater than that suffered during the Great Depression.

The brief recovery in prices in 2009, spurred by government aid to first-time buyers, has now been entirely snuffed out, and the average American home now costs 33 per cent less than it did at the peak of the housing bubble in 2007. The peak-to-trough fall in house prices in the 1930s Depression was 31 per cent – and prices took 19 years to recover after that downturn.

Home price drops exceed Great Depression: Zillow

http://www.reuters.com/article/idUSTRE70961E20110111

Depression within a depression

Again, the myths of FDR and his role in the Great Depression are dissected, coming up with different conclusions from what Keynesian economists want to admit.

http://theburningplatform.com/blog/2010/10/23/depression-within-a-depression-featured-article/

Trichet warns of "beggar thy neighbor" policies

He knows competitive currency devaluation wars lead to trade wars, protectionism and plummeting global trade. This was the exact scenario which triggered the Great Depression.

http://imarketnews.com/?q=node/20665

The First Great Depression vs. today's Second Great Depression

http://www.zerohedge.com/article/first-great-depression-blow-blow-bis

US just PO'd China--again

China, the US' largest creditor, is livid about US arms sales to Taiwan. Expect more trade sanctions. One of the few lessons learned from the Great Depression was the erection of trade barriers among countries caused commerce and economic output to plummet. Apparently, that lesson is lost among government leaders worldwide.

http://www.presstv.ir/detail.aspx?id=117442§ionid=351020404

Unemployment

You thought the US had unemployment problems. The official unemployment rate in the US is 10.2%, but according to shadowstats.com, the unofficial rate is 17.5%, if you include people who stopped looking for work, and no longer receiving unemployment benefits (i.e. they are still unemployed) and workers at an undesirable position earning less than what they previously earned. These numbers are admittedly horrible by everyone, the worst since the early 1980's by some measures, or the worst since the Great Depression by others.

But Spain has it even worse. Their official unemployment rate is 19.3%, but their unofficial rate is 34%! Latvia's official unemployment rate is 19.7%. Folks, that's no recession--that is an outright depression.

The alleged silver lining is unemployment figures are a lagging indicator, meaning the economy recovers before employment does. This is true, but this Great Recession has been so deep, and the economy has been so severely impaired, that it may take much longer before cash-strapped and credit-starved companies start hiring again.

If the American consumer is broke and jobless, they won't be consuming.

Hence, the "jobless recovery" may not be a recovery at all.

Lessons from the Great Depression

They are not the lessons many would surmise. Art Laffer, the creator of the Laffer Curve, theorizes that increasing tax rates do not necessarily increase tax revenues. He's been proven wrong on a few issues, especially after his infamous debate against Peter Schiff on CNBC in 2006. In the live debate, Laffer insisted that the economy and the mortgage industry specifically, were doing fine. Schiff took the opposite side of the debate--that the US economy was headed towards the mother lode of collapses due to unsustainable consumption fueled by debt and false prosperity. Schiff, of course, won that debate--and bet, handily.



In other words, Laffer totally missed the call on the impending financial meltdown.

But Laffer does bring up some good historical points on the Great Depression:

http://online.wsj.com/article/SB10001424052970203440104574402822202944230.html?mod=googlenews_wsj

Dead cat bounce?

Due to my increasing anxiety with every rally in equities, I gathered some charts of the S & P 500 Index. It recorded a low of 666 in early March 2009, down from the October 2007 high of 1565. This represents a decline of 57.5% from the peak. What came next has been this powerful 50% retracement to approximately the 1000 level. A Fibonacci 61.8% retracement yields a value of 1078 as an intermediate peak for the SP 500. I would be a net seller if and when we approach that level.

For comparison's sake, between the 1929 peak of the Dow Jones Industrials Average to the low in 1932 (see first chart above), the market had a handful of double-digit gains. But in that duration, the market declined by 90%! In other words, for every 1 step up, the market took 3 steps down.

From the 1932 low to the 1937 peak, the DJIA had 3 triple-digit gains, including one for almost 300%--almost a quadruple. But none of these powerful rallies prevented the Great Depression. And investors holding since 1929 weren't whole again until 1953.

The harder a market falls, the higher the market rebounds, but the more difficult it is to get back to even--despite multiple powerful rallies. With the 2007-2009 decline "only" measuring 57.5%, this retracement rally should not have been surprising.

To the trained eye of an electronics engineer, the SP 500 chart between 2007 and 2009 looks like a waveform transitioning between logic "1" to logic "0" (see second chart above). However, instead of being an ideal waveform with uniform horizontal and vertical lines, the signal is distorted with undershoot and high-frequency ringing.

In layman's terms, this market is a dead cat bounce. And gravity will eventually cause it to fall back down before finding a steady-state equilibrium. The hope is that the SP 500 secular low of 666 will not be revisited, and that the index will find a trading range of consolidation above that low until a recovery is well-established.

I still posit this is a bear market rally--and not the beginning of a secular bull market. The world economy is still undergoing a delevering process as corporations, individuals and governments are still awash in debt. Banks haven't honestly accounted for toxic assets on their balance sheets. With unemployment climbing, tight credit conditions, and the American consumer tapped out, any economic recovery will remain muted. Equities may still rise from here, but at some point (soon), the market will become over-extended.

(In)Famous quotes

Should we still trust our elected and non-elected government officials? Or Wall Street? Here's a who's who of respected economists from a previous era (see list below). The parallels to today's constant pumping by CNBC are stunning and haunting, considering there is a consensus among government economists--and a foregone conclusion that Obama is pursuing Keynesian Economics policies. I may be in the extreme minority on this, but our country is headed down the wrong path towards recovery. When I hear "the worst is over" or "this time it's different", I'm running for the exits. To quote a former Los Angeles morning DJ, "Sorry--too hip, gotta go".

Will we be able to avert another Great Depression? Perhaps, but the unintended consequences of our government's exploding balance sheet will come back to haunt us for years--if not decades, to come.

And the last quote is particularly stunning considering FDR confiscated private US citizens' gold holdings two days after taking office in 1933. How do we know this? It's called Ft. Knox.

Here's a compilation by Colin Seymour:

1. "We will not have any more crashes in our time."
- John Maynard Keynes in 1927

2. "I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future."
- E. H. H. Simmons, President, New York Stock Exchange, January 12, 1928

"There will be no interruption of our permanent prosperity."
- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928

3. "No Congress of the United States ever assembled, on surveying the state of the Union, has met with a more pleasing prospect than that which appears at the present time. In the domestic field there is tranquility and contentment...and the highest record of years of prosperity. In the foreign field there is peace, the goodwill which comes from mutual understanding."
- Calvin Coolidge December 4, 1928

4. "There may be a recession in stock prices, but not anything in the nature of a crash."
- Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929

5. "Stock prices have reached what looks like a permanently high plateau. I do not feel there will be soon if ever a 50 or 60 point break from present levels, such as (bears) have predicted. I expect to see the stock market a good deal higher within a few months."
- Irving Fisher, Ph.D. in economics, Oct. 17, 1929

"This crash is not going to have much effect on business."
- Arthur Reynolds, Chairman of Continental Illinois Bank of Chicago, October 24, 1929

"There will be no repetition of the break of yesterday... I have no fear of another comparable decline."
- Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929

"We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices."
- Goodbody and Company market-letter quoted in The New York Times, Friday, October 25, 1929

6. "This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan... that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years."
- R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929

"Buying of sound, seasoned issues now will not be regretted"
- E. A. Pearce market letter quoted in the New York Herald Tribune, October 30, 1929

"Some pretty intelligent people are now buying stocks... Unless we are to have a panic -- which no one seriously believes, stocks have hit bottom."
- R. W. McNeal, financial analyst in October 1929

7. "The decline is in paper values, not in tangible goods and services...America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin."
- Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929

"Hysteria has now disappeared from Wall Street."
- The Times of London, November 2, 1929

"The Wall Street crash doesn't mean that there will be any general or serious business depression... For six years American business has been diverting a substantial part of its attention, its energies and its resources on the speculative game... Now that irrelevant, alien and hazardous adventure is over. Business has come home again, back to its job, providentially unscathed, sound in wind and limb, financially stronger than ever before."
- Business Week, November 2, 1929

"...despite its severity, we believe that the slump in stock prices will prove an intermediate movement and not the precursor of a business depression such as would entail prolonged further liquidation..."
- Harvard Economic Society (HES), November 2, 1929

8. "... a serious depression seems improbable; [we expect] recovery of business next spring, with further improvement in the fall."
- HES, November 10, 1929

"The end of the decline of the Stock Market will probably not be long, only a few more days at most."
- Irving Fisher, Professor of Economics at Yale University, November 14, 1929

"In most of the cities and towns of this country, this Wall Street panic will have no effect."
- Paul Block (President of the Block newspaper chain), editorial, November 15, 1929

"Financial storm definitely passed."
- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929

9. "I see nothing in the present situation that is either menacing or warrants pessimism... I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress."
- Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929

"I am convinced that through these measures we have reestablished confidence."
- Herbert Hoover, December 1929

"[1930 will be] a splendid employment year."
- U.S. Dept. of Labor, New Year's Forecast, December 1929

10. "For the immediate future, at least, the outlook (stocks) is bright."
- Irving Fisher, Ph.D. in Economics, in early 1930

11. "...there are indications that the severest phase of the recession is over..."
- Harvard Economic Society (HES) Jan 18, 1930

12. "There is nothing in the situation to be disturbed about."
- Secretary of the Treasury Andrew Mellon, Feb 1930

13. "The spring of 1930 marks the end of a period of grave concern...American business is steadily coming back to a normal level of prosperity."
- Julius Barnes, head of Hoover's National Business Survey Conference, Mar 16, 1930

"... the outlook continues favorable..."
- HES Mar 29, 1930

14. "... the outlook is favorable..."
- HES Apr 19, 1930

15. "While the crash only took place six months ago, I am convinced we have now passed through the worst -- and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us."
- Herbert Hoover, President of the United States, May 1, 1930

"...by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent..."
- HES May 17, 1930

"Gentleman, you have come sixty days too late. The depression is over."
- Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930

16. "... irregular and conflicting movements of business should soon give way to a sustained recovery..."
- HES June 28, 1930

17. "... the present depression has about spent its force..."
- HES, Aug 30, 1930

18. "We are now near the end of the declining phase of the depression."
- HES Nov 15, 1930

19. "Stabilization at [present] levels is clearly possible."
- HES Oct 31, 1931

20. "All safe deposit boxes in banks or financial institutions have been sealed... and may only be opened in the presence of an agent of the I.R.S."
- President F.D. Roosevelt, 1933

Colin J. Seymour, June 2001

Deflation or Inflation?

I've posed this question before, but if you own gold, the answer is it doesn't matter.

According to Porter Stansberry:

"This is really shaping up as the Great Depression Part II, with Obama's nearly $900 billion bailout package as the first episode of the New New Deal. Protectionism was one of the highly destructive ideas that helped keep the U.S. economy down during the 1930s. The bailout includes "Buy American" language, requiring bailout money to be spent on U.S. goods, something U.S. trading partners like China, India, Russia, and other signers of trade treaties with the U.S. aren't crazy about.


I bet you some day soon we get something very much like the New Deal's Committee on Continuity of Business and Employment, which put out a report in 1931 stating: "A freedom of action which might have been justified in the relatively simple life of the last century cannot be tolerated today... We have left the period of extreme individualism and are living in a period in which national economy must be recognized as a controlling factor."


Where do you invest if the Great Depression II is in our future? Believe it or not, gold stocks. Homestake Mining shares rose sixfold from October 1929 to December 1935, during which time the Dow Jones Industrials Average lost 64% of its value. A huge run up in Homestake's share price came after FDR stole everyone's gold. It's foolish to think you can impair gold's value by making it illegal. Prohibition usually increases the price of the outlawed commodity."

Forecast for 2009 and beyond

Equities will bottom this year, while housing may bottom 2010--best-case. The dollar will break down further, and when the market realizes that, gold will rise. When the market recovers with a false rally, inflation will kick in, prompting gold's rise. Gold is not like most commodities--it is a currency of real value--a hedge against inflation. There is usually a year lag before inflationary fiscal and monetary policies kick in. In other words, money supply M is in place for inflation, but inflation will remain subdued until banks start lending (increasing money velocity V). And banks can't lend right now, despite huge capital injections because they are hoarding cash to strengthen their crippled balance sheets. Not sure when that will happen (banks lending to each other, to businesses, to individuals, etc.), but it's gotta happen at some point. Either that, or the whole banking system collapses, and we go back to barter....maybe the muslims are right. Even in that worst-case scenario, gold will hold its value--what other paper currency will hold its value in an Armageddon scenario--the USDollar?

Either way, gold will rise--it's not a matter of if, it's a matter of when. This downturn will be worse than the 1973-74 deep recession, when gold increased 2325%. I don't think it will be as bad as the Great Depression of the 30's, when we had almost 25% unemployment. Even in that deflationary environment, gold went up 69%. So if we are closer to a repeat of the Great Depression, you are right, gold may languish around the $500/oz to $1000 range , up from its 1999 low of $253. But if a full-fledged recovery occurs, a 2325% spike translates to a price of $5882. Realistically, the 1980 $850 peak, deflated in today's dollar indicates a $2400 price.

But with the accelerated debasing of the dollar in concert with other currencies, inflation is already in place. The definition of inflation is an increase in money supply, not necessarily the Consumer Price Indicator, the official government statistic. An increase in CPI is a symptom of inflation, not the source. It is a combined result of an increase of money supply flowing into the economy. Prices increase when more money supply chases scarcer assets. Having said that, the CPI is notoriously underreported as money supply growth is in the double digits, while CPI remains under 4%. The reason why it is underreported is another topic, but it does not match money supply growth.

So the targets above will trend higher if we take into account money supply growth--the very definition of inflation. Gold has increased almost 4-fold since 2001--another way to interpret the data is that the USDollar has been devaluated by almost 75% during that period. If that trend continues (and it looks like it will accelerate as the Fed and Treasury continue to print dollars ad nauseum to the tune of trillions of dollars), the current deflation of asset values will eventually yield to inflation--perhaps even hyperinflation.

The result will be higher taxes to pay for these government-sanction bail outs, and the debasing of the USDollar. Despite rhetoric that the government is interested in a strong USDollar, their actions speak otherwise. It makes sense because inflation is a form of taxation without legislation (Milton Friedman). It is more politically expedient to slowly, stealthily tax the population than to let unemployment increase and recessions deepen. Congressmen and the Administration aim to get re-elected. Hence the bailouts. Inflation allows the government to slowly tax the population under the radar, while at the same time, lower their massive debt obligations with deflated dollars (a $10 trillion debt becomes smaller as inflation eats into the principal). If I owe someone $10, but if 10% inflation kicks in, that debt is only $90 in today's dollars a year from now--and declines going forward. Propping up failing businesses is politically populist, but ultimately detrimental to the overall economy--it lengthened the Great Depression, and it's kept Japan's economy in decline for 19 years. It's a form of rewarding bad businesses, while taxing its productive businesses--it's misallocation of financial resources. Would you rather have GM manage your investments, or Google? Well, the government is investing in the GM's of the world--or any other industry that is insolvent, and in the process, taxing its citizens and profitable industries.

The problem is that hyperinflation reduces the purchasing power of consumers and invisibly reduces corporate profits. Our standards of living decline. These bailouts just defer and exacerbate our huge debt problems, but politically, Keynesian economics is the government's only option. We are past the point of no return, as we sink into a death debt spiral. Our financial crisis was caused by overleveraged debts gone bad, by consumers, businesses, local and state governments. Now the federal government is compounding that billion dollar problem into a trillion dollar problem (their own, in this case). That solution has never worked. When interest rates rise (they are at all-time lows), that trillion dollar debt only accelerates, forcing the government to accelerate money supply again, further debasing our currency. US Treasury bondholders, bidding up prices in a flight to safety, will get crushed when interest rates rise. The biggest buyers of said bonds--Chinese and Japanese sovereign banks and funds, will be net sellers, no longer willing to prop up our deficits, while earning 0% for the privilege. Besides, they will need to prop up their own economies. The US Treasuries market will be the last bubble to burst, and this time there will be no backstop, as the US government itself will be insolvent. The Fed can control the short end of the curve, but the long-term bond market dwarfs any government reserves, and is more influenced by market expectations of inflation, not government central bank intervention. The Fed and Treasury can only prop up 30-year T-bonds for so long, before the dam breaks. We are at the mercy of China, Japan, and the Arabic petrodollars. All 3 entities have explicitly warned the US government that they will no longer be buyers of US Treasuries. The Saudis are already in the process of creating their own exchange, creating their own currency for trading oil, as they realize their reserves denominated in USDollars have been a losing proposition. The Chinese and Japanese are also retreating in US Bond purchases. Interest rates will have to rise to attract new demand.

To look at our future, see Iceland--the country imploded, their banks froze up, as their debt exploded in a massive unwinding of leverage. The US Treasury will lose its AAA credit rating, driving up interest rates further. Eventually, the government will default, unable to meet its debt obligations. Guns and gold--if you think I am joking, ammo prices have doubled in the last year. The gold market is pausing, yet holding up while equities re-test their November lows. But once reality hits, it will rise. Not sure what the trigger event will be--another big bank failure, WWIII (Israel is discussing bombing Iran), Pakistan/India posturing, California insolvency (all State employees will start receiving IOU's next month, as California has run out of cash). Arnie has been unsuccessful with the state legislature on resolving a budget expected to be $42 billion short, and if unable to receive a Federal bailout, state employees will be unpaid).

http://www.sco.ca.gov/eo/...2008/12/pr08069letter.pdf

The 1991 riots will be like a walk in the park when cities and counties cut back on basic services like law enforcement and fire protection. I know one city in LA county has lost 60% of their detectives already--even as crime is soaring. Rape case samples are already extended out to 10 years for DNA results. I visited a coin dealer who had exactly one $20 St. Gaudens double eagle to sell. Gold bullion buyers are demanding physical delivery instead of cash settlement, causing spot prices to carry a premium above forward futures delivery contracts--the first time this has ever happened on the Comex gold futures exchange. Sure, the downside is a 30% temporary drop in price, but the upside is 100 - 800% potential upside. Not one stock mutual fund gained in 2008. Gold was the only asset class that gained last year--up 6%--and that was a bad year for gold. It was also the 8th consecutive year of gains. The Nasdaq plunged 80% after the tech bubble. The S & P lost 40% again last year. Treasury bondholders did well in a false flight to quality, but once they figure out tying up your money for 30 years yielding 2.6% is a losing proposition, they will flee that market as well. T Bills yielding 0% will prove problematic as an inflation hedge. Stocks have retreated to 1998 levels, and are headed lower. What else is left? Meanwhile, gold has already quadrupled in this decade.

The reason why financial planners and brokers (gee, they've given good advice over the years) don't advocate gold is because clients purchasing gold don't generate fees for them. Gold ETF's generate some commissions, but overall, there is no incentive for investment and commercial banks to pimp gold. Having said that, many conservative advisors do recommend clients keep 10% of their portfolio in gold bullion, preferable over paper securities (ETF's, futures contracts, gold mining shares). Storing bullion is inconvenient, but it's part of a diversification strategy. Once more people realize this, some sideline cash will be deployed to purchase precious metals, base metals, soft commodities, and dividend-yielding equities. Companies with leading market share, moat-like pricing power, strong balance sheets (loads of cash, no debt), high profit margins, and increasing dividend payouts on cash flow, will thrive in a market where access to debt is increasingly difficult.

Who is shorting gold?

Regarding the gold shorts, I've read JP Morgan, HSBC, and Goldman Sachs were shorting gold futures, artificially driving the price down, while at the same time hoarding the physical bullion on the spot market at a lower price. Ironically, JPMorgan Chase and Citigroup analysts are forecasting $2000/oz gold. Looks like manipulation, especially when you factor in a ten-fold increase in short positions. Someone on the inside knew what was going on with Fed easing and tightening.

I'm not sure if it was just big money centers--I think some of the commercial shorts were mining companies themselves. If they short it and the price plummets, they've locked in a profit as the short contracts increase in value when gold declines in price. That's why gold producers use it as a hedge in the case of falling gold prices. If they sell short the futures contracts, and prices rise against them, they are forced to cover at a higher price, but then their gold inventory also increases in value, negating the loss from short sale. In other words, they profit either way--as long as they have the gold in inventory. Without said inventory, they are "naked" and must realize the losses within 5 days--or until they deliver the physical product.

If indeed manipulation is going on, it is not only illegal, it will not be sustainable. Eventually, the Fed won't be able to save the shorts, as physical bullion becomes even scarcer, and buyers insist on delivery, instead of some "shadow" paper delivery against some vault. Gold experienced backwardation for the first time ever in December--the spot price was higher than the forward contracts. In other words, buyers wanted delivery NOW--and would not sell at ANY price, as fear has gripped the markets. Under normal conditions, a contango exists, where forward contracts command higher prices. I think this backwardation is very bullish for gold, and the fact that mints are out of inventory is indicative of that.

Also, I've read statistics where central banks, especially in Europe, are no longer selling their gold inventory. If the Chinese government steps up and purchases tons of gold like they have threatened (their ratios are much lower than the US's and Europe's), that will absorb inventory and drive prices higher also. And India is already the world's largest buyer of gold, up to 20%. With the Pakistan thing going on, I can't imagine them wanting more rupees, instead of gold, which has become the de facto currency.

Bottom line: MV = GDP, and as long as the Fed provides easy credit (interest rates can't get much lower than 0%), and as long as the Treasury prints trillions of dollars, the money supply M will be poised to catalyze inflation. But once the velocity V of capital flows thru the economy, it will provide the stimulus our economy needs, but potentially kicking off hyperinflation. In other words, once bank balance sheets have been restored, they will start lending again. We would have avoided another Great Depression, but God helps us when we get runaway inflation a la the 70's. Having an extra $8 trillion floating around in our economy will prove inflationary, and interest rates will soar. Treasury bondholders with longer maturities will get crushed, as the Fed can only influence short-term maturities (T bills). With higher interest rates, the government won't be able to pay off its huge debt obligations, and we'll have stagnant growth for years. We are experiencing a credit crisis because investment and commercial banks are insolvent. When the markets realize the US government is also insolvent, all hell will break loose. The government has compounded a multi-billion-dollar debt crisis into a multi-trillion debt crisis.

I hope I'm wrong in this logic chain, but this playbook has been repeated many times before when fiat currencies are under attack by central banks. I just don't see any other outcome when your debt is almost as large as the size of your economy.

Lehman and Merill Lynch this morning....

I wrote this in response to a concerned client:

XXXXX, on the contrary. These firms (investment banks, commercial banks, and insurance companies) invested in mortgage-backed securities, thinking they were safe. Little did they know it was just another asset bubble bursting.

Life insurance companies are more conservative by nature, investing premium payments in short- and long-term bonds, and in the case of indexed products, are linked to stock indexes like the S & P 500. With your contracts, if the S & P tanks, you are still guaranteed a 1% floor--which isn't much, but it's better than losing 15% or more, which is what your current stock portfolio is doing. They are able to guarantee the 1% due to options trading, much like they cap you at 15%.

Expect a big loss in the stock market this morning, as this is really, really bad news, but not something I didn't warn you all about several months and years ago. I predicted the real estate bubble, and it's coming to fruition as well. While the more expensive neighborhoods of the bay area are holding up, expect high-end prices to start declining. Manhattanites continue to brag their real estate market has held up, but do you really think that will continue, now that hundreds of billions of dollars are vanishing? Not only are Wall Street bonuses going to disappear at the end of this year, but many investment bankers will be lucky to have jobs. Having a consortium of banks to band together to raise money to prevent the next disaster is akin to gathering 10 cancer victims into a leaky boat--a few will get tossed over the side. First Bear Stearns, Countrywide, now Lehman and Merrill Lynch. Don't forget insolvent Freddie Mac and Fannie Mae, who only hold trillions of dollars of mortgages (70% of all US mortgages). Check out their share prices--they've lost over 90% of their market cap, which makes the tech bubble look like Disneyland.

Expect more big losses and layoffs--it is going to be a bloodbath--the biggest since the Great Depression. Insurance companies were the only ones standing in the aftermath of the Depression, as thousands of banks failed. They set premiums based on actuarial data, not based on speculative lending practices. Banks use 10:1 leverage, which works great in a growing economy, but is terrible in a downturn, as bad loans mount. Expect Washington Mutual to fold, too--unless they get bailed out. It amazes me that people still think banks are safe, despite pervasive evidence to the contrary. How many more banks have to fail before people get it? In any case, insurance companies are forbidden by law to implement that type of leverage.

The VC market has dried up as well--last quarter was the first time ever that there were no IPOs. The liquidity crisis is spreading up and down the food chain--couples with high FICO scores and sizeable assets are having trouble getting financing. Cash is more important than ever, so curb your spending and hoard it. Don't mess around this time, this ride is going to be hell.

In summary, this is EXACTLY what should be doing in a severe downturn, where every asset you turn to is dropping like a Thai thunderstorm downpour. The next 2 (or more years) will be very difficult, and when the last bulls finally turn bearish, basically giving up all hope and expecting the world to end. hopefully we will reach a bottom. Real estate agents and stock brokers have been preaching to me their respective markets will turn around for the last two years, and given their polyannish outlook, I know this hellstorm is going to last longer. They're like Colonel Klink in Hogan's Heroes--whatever they say will happen, do the exact opposite.

If you had to pin me down, the meltdown recovers in 2010, which means you can expect a climactic abyss in stock markets late 2009. THAT will be the time to nibble at good companies who got thrown out with the baby wash--the companies themselves are solid, but the financial hurricane took them down unfairly Pick the winners of each struggling group: Goldman Sachs will be a screaming buy in a couple years, but don't try to catch a falling knife--it'lll cut you. Wait till they bottom and bounce off the bottom a couple times. It's better to be late when bottom-fishing (buying), and it's better to be early when selling.

Of course, I could be wrong and too optimistic on the recovery time, at which point, all bets are off. Just to give you an idea of how bad it is, Warren Buffett of Berkshire Hathaway just sent a directive to one of his portfolio companies, a reinsurer who guarantees funds above the FDIC limit of $100,000 for banks. They lost a mint in guaranteeing losses when IndyMac went under recently, so the reinsurer just notified thousands of banks they are no longer guaranteeing accounts above $100,000! Do you think wealthy depositors are going to react to that?

As an aside, the formerly venerable Lehman firm was the preemiment fixed-income (bond) banker who got themselves in trouble with junk offerings years ago. Buffett actually stepped in and helped bail them out at the time. Obviously, he's not bailing them out this time. These subprime mortgages are the latest cyanide, only this time the Kool-Aid is a lot more toxic. You thought I was a doom and gloomer earlier, and it turns out I understated the magnitude. And unfortunately, it's going to get even worse.