The Eye of the Economic Hurricane

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Yesterday was beautiful in London. We wandered along the banks of the Thames and crossed Waterloo Bridge over to Covent Garden. Everywhere, people were sitting out on the grass…standing outside pubs…walking hand in hand. Everyone had the same idea — to take advantage of the nice weather before it goes away.

Last year, London had a beautiful summer too. But we were gone that week and missed it.

Alas, many of the best things in life are fleeting. And thankfully, so are the worst things.

What put us in such a reflective mood were yesterday’s news reports. The Dow rose again — up 19 points this time. Gold edged closer to the $1,000 mark — at $984. Oil traded at $68. And the dollar fell to only $1.43 against the euro.

These trends — not to mention the broad rise in commodities and stocks worldwide — lead many investors to think that the fair weather is back, permanently. Asset prices are rising. Investors are less afraid of risk. Hallelujah — a dove with a sprig of green in its beak!

Of course, it may be true. But our advice, dear reader, is to take an umbrella with you anyway. As far as we can tell, nothing has happened to disturb the major weather pattern that began developing two years ago. Anyone could see it coming years in advance. “You gotta expect trouble when the average house is more expensive than the average person can afford,” we kept saying.

But it was only when high winds hit the housing market that the newspapers took notice. Then, for 40 days and 40 nights the rain came down.

First, the house flippers were caught off guard. They were in the middle of flipping condos when all of a sudden the wind shifted and sent their contracts aloft. Mortgage rates were rising and buyers disappeared. The flippers lost their deposits and walked away from empty buildings.

Then, resets and higher rates blew the roof off the subprime market.

Then, the whole housing sector was getting knocked down — builders, suppliers, and financers.

Next came the credit crunch…when major lenders and investment banks realized that they were in heavy seas. Their ships were swamped with mortgage-backed debt and derivatives…and their captains were morons. Lehman went down. Wall Street abandoned ship. And the feds sent out rescue planes.

By late in 2008, everyone was taking shelter. Businesses were cutting payrolls. Banks were squeezing their reserves. Consumers were staying at home. And GM was hiring bankruptcy lawyers.

Everything was falling in price — houses, office buildings, stocks, commodities…practically everything except the US dollar, US bonds, and gold… These three were seen as the only safe refuges for storm-tossed investors.

But on March 9, 2009, came a lull. Reluctantly, investors came out of their storm shelters. The skies lightened…the sun shined. Oil has gone up 53% since then. Stocks worldwide are up about 30%.

And now…people say “the worst is behind us.”

We meteorologists watch the skies like everyone else. But we also read reports from big storms of the past. And what we notice is that this doesn’t look like the passing storms of the ’80s or ’90s. It looks to us like a major change in weather patterns. To be more precise, it looks to us like the Great Storm of the ’30s. Do you remember that one, dear reader? No? Well, we don’t either, but we’ve read the histories. It was a doozy. And it began…well…just like this one.

In 1930, six months after the initial storm front passed, world output was down about 15%. Today, it is down about 15%, too. Stock markets were only down about 20% in mid-1930. Today, they’re down about 35%. And world trade slipped about 15% in the six months following the onset of the Great Crash of ’29. Today, it is down 25%.

One thing you notice is that like the Great Depression, this downturn is global. A collapse in world trade followed the Crash of ’29. It is usually blamed on two protectionist bumblers in Congress — Smoot and Hawley. But in a real depression, trade falls anyway. World commerce needs to readjust to new realities…whatever they are. That’s happening again now.

The other thing you notice is that this adjustment takes time…and takes the losses much further…much deeper…than anyone expects. The actual bottom in the ’30s didn’t come until 2 to 3 years after the crash. And it took stocks all over the planet down to about 65% below their peaks. World output eventually fell to only about 2/3rds of what it had been in the late ’20s.

It took two decades and a major world war before the world was back on its feet.

“Treasuries Tumble,” announced a cover of Barron’s recently. Oh my. Long bonds are down 20% since January.

Pity the poor Chinese. They’ve got $768 billion worth of them.

And pity poor Tim Geithner. He’s over there right now on a fool’s errand, lying to the Chinese:

“Geithner Tells Chinese its Holdings Are Safe,” says the Washington Post.

Reuters went on to report:

“His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.”

More on Geithner’s visit to China later in the week…

“Those people did not become French in the last five months,” says Mitch Daniels, Republican governor of Indiana.

He was referring to the people who re-elected him. His point was that Americans are not necessarily in favor of socialism. They may be fed up with what they see as the failures of capitalism. But they’re not ready to vote for Nicholas Sarkozy.

But the country has clearly moved towards more government intervention in the economy. In 1986, 40% of Americans thought government regulated the economy too much. Now, 40% think it doesn’t regulate enough. And get this… The Economist reports the results of a worldwide poll. When asked if “people [were] better off under free markets,” 75% of Indians say ‘yes’ and so did about 72% of Chinese. But put the question to Americans and only about 69% think so.

Even Italians are more in favor of free enterprise than Americans. Go figure.

The Economist passes along the thoughts of an American lawyer to explain it:

“The disaster in the housing and mortgage markets shows that free markets don’t always get incentives right or generate the information people need to make wise decisions. There may be times, he adds, when government is better suited to giving people the information they need.”

Ha. Ha.

Information? What information was it that people didn’t have? All the information was not only available — it was free. We reported it here — for free. Day after day…we read the headlines and passed along the statistics. What was hidden from view? What was unknown?

This information was available to the government too. Its thousands of regulators, representatives, researchers, and consumer advocates had computer terminals and newspaper subscriptions. They even had thousands of PhDs in economics whose JOB IS TO STUDY THE ECONOMY!

If government were really able to give “people the information they [needed],” you’d think that one of these earnest meddlers would have whispered to Secretary of the Treasury…or maybe to the head of the Fed: “Hey…better tell the voters to watch out…this thing is getting out of control.”

But do you remember a word from the Secretary of the Treasury…from the Fed…from the SEC…from the other busybody parasites who live on the public payroll? We don’t. All we remember is how they told us to “buy an SUV” and how derivatives “spread the risk to those who are able to bear it” and how “subprime mortgages help increase home ownership.”

The government, do a better job of running the economy? Ha. Ha.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007).

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