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Looking Like Bulls in a Bullfight
By Bill Bonner | Published  01/18/2008 | Stocks , Options , Futures , Currency | Unrated
Looking Like Bulls in a Bullfight

Now the bear is starting to sink in his claws. The Dow fell 306 points yesterday. There were only 12 stocks hitting new highs, against 397 hitting news lows.

The fight between the inflation and deflation is beginning to resemble the Corrida de Toros we saw in Madrid . That is to say, it does not look like a battle between equal and opposite opponents. It almost looks like the fix is in.

The inflationary bull comes out snorting and pawing the ground. He charges at full speed and looks like he is going to knock down the stadium walls. He looks unstoppable. But the picador stands his ground and drives his spear into the bull’s back. Then, the banderilleros go to work, jabbing him with their little spikes. The bull weakens. The life bleeds out of him.

The bull can’t win. Not in a bullfight. Occasionally, he’ll gore one of the banderilleros. But the smart money goes on the matador.

Yesterday, news came out that Merrill Lynch had lost twice as much money as forecast, Lehman Bros. laid off 1,300 people in its mortgage unit, and housing starts hit their lowest level since ’91.

This last item is really good news, but investors didn’t seem to see it that way. The bear market in housing can’t end until new building slows. Until now, builders have been putting up houses that they had in the works before the crisis hit. These houses merely added to the inventory that needs to be sold off before prices can stabilize.

It’s going to be a long process. There are two million homeowners who face mortgage increases in the next two years. Their houses are already down 5% to 10% and more. The Bureau of Labor Statistics added that, once discounted for rising prices, the wages of American workers fell 0.9% between December 2006 and December 2007. Now, with unemployment rising, many of them are not going to be able to keep going.

The ratio of unsold, vacant houses to the houses on the rental market is 50% higher than it was 20 years ago. And from the Bay Area of California comes word that sales are at a 20-year low.

It gets worse. Business Week warns of a “home equity crisis ahead.” People not only borrowed to buy houses; they borrowed against their houses to buy other things too. Now there is $14.7 billion of home equity line credit said to be delinquent. Bad home equity loans are up 130% at some lenders, from ’06 to ’07. It’s an $850 billion business, and much of it is going to go bad .

Even “rich” homeowners are having trouble, adds a Reuters article. Elite neighborhoods, of $1 million plus houses, are beginning to look a little gaunt, says the report. The influx of marginal new buyers and the rise in house prices teased middle-class homeowners into houses they couldn’t really afford. They stretched their finances in order to enjoy a bigger, more prestigious house, hoping that the rise in prices would pay off big. It didn’t. Now, they’re really stretched and, for many, the elastic is beginning to snap.

None of this is bullish, not for housing prices, and not for stocks either.

What has gone wrong? Weren’t the feds taking action? Wasn’t Ben Bernanke warming up his helicopters, so they could drop cash onto the people who need it?

Yesterday, Ben Bernanke, former head of the Princeton Economics Department and now head of the biggest central bank in the world – the U.S. Federal Reserve – explained that monetary policy wasn’t enough. Already, as we pointed out here in The Daily Reckoning, the yield on 10-year Treasury notes is lower than the rate of consumer price inflation (or close to it). This means that the most qualified borrowers can get money on very favorable terms; it is practically free. But who wants to borrow? What would they do with the money? Buy stocks? The average stock market portfolio is down about 5% so far this year. Who wants a piece of that? Or maybe they could buy property? Forget it; not many speculators are eager to buy now. Or, maybe they could use the money to expand their business? But who expands before a recession? Only pawn shops.

*** The Fed has cut rates. Central banks all over the world have “injected liquidity” into the system. But stocks and houses are still falling and so is employment. The bull is bleeding to death.

“Tall Paul” Volcker spoke to the press and explained the problem. The Fed had permitted “too many bubbles,” he said. The bubbles encouraged too many people to borrow and spend too much money. Now, they have too much debt and no good way to pay it off.

Asset prices are falling. The carry trades are unwinding (the yen and the Swiss franc are rising, causing serious losses for those who borrowed at low yen and swissy rates in order to buy stocks!) So, who would want to borrow more money? Only someone who was unlikely to pay it back, which is why lenders are looking for more guarantees.

The bubbles could have been prevented by the Fed, simply by making credit a little harder to come by. That’s the way you protect the quality of a currency and the stability of an economy. But who wants to do that? “It’s no fun raising interest rates,” said Volcker.

And now, with a major bear market and major recession staring him the face, the former economist from Princeton, Ben Bernanke, is in a tough spot. His bull is getting killed. His reputation is on the line. And his lower rates seem to be too little and too late.

Yesterday, oil barely held above $90. The commodity index held above 490, and gold dropped $1.50. The day before, gold lost $20. Where is inflation when you need it?

“Fiscal action could be helpful in principle, as fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone,” said Ben Bernanke, appearing before the House Budget Committee. ‘Give us more helicopters,’ he might have said. He endorsed a plan for “fiscal stimulus” of $150 billion to be added to his monetary stimulus. Not only are they going to cut rates and make it easier to borrow, in other words; the government is also going to step in and spend money it doesn’t have – probably by giving tax rebates.

Here at The Daily Reckoning we’ve never met a tax cut we didn’t like. But we smell sushi . No country ever tried as much fiscal stimulus as Japan. After cutting rates down to “effectively zero,” the Japanese embarked on the biggest program of unnecessary government spending in history. With no military to waste money, it had to turn to public works. New highways to nowhere, new bridges, new rail lines; by the late ’90s, the little island of Japan was pouring more concrete than all the fifty states. It was very stimulating to cement sellers. But as to the economy, it did nothing. Here we are, 18 years later and the Nikkei index is still down by two thirds.

*** “But wait...you said the price of gold went down 20 bucks, yesterday. And now you say the unstoppable force of inflation is being stopped dead in its tracks. Doesn’t the bull market in gold depend on rising inflation? And isn’t your Trade of the Decade going to look like it should have been abandoned three years early if the U.S. economy goes the way of Japan?”

A very good question, dear reader. We wish we had a very good answer.

Instead, we take a guess. Japan is a nation of savers, with a very positive trade balance. Japan has no armed forces to speak of. Nor does it have the world’s reserve currency. We got word yesterday, for example, that the Gulf States now have more than $2 trillion in foreign assets – most of it in dollars. The United States, by contrast, has only about $80 billion worth of foreign reserves.

It may be that a global recession takes the air out of the gold market. Maybe the price stops going up. Maybe it falls back some. But when it comes to the feds’ efforts to sink the dollar, in order to avoid a Japan-like slump, you ain’t seen nothin’ yet. Tax rebates. Rate cuts. Federal spending. Perhaps even direct intervention in the credit and equity markets. (What’s a Plunge Protection Team for, anyway?) Crank up the presses. Put the choppers on full alert. It will be interesting to see what happens. We don’t know. But our guess is that, at some point, gold is going to soar as investors seek safety from a disappearing greenback.

Meanwhile, imagine what happens to stocks in a major recession. Even if gold were to hold steady, or even decline, our guess is that the decline in stocks will be worse. The Trade of the Decade still looks good to us.

Bill Bonner is the President of Agora Publishing. For more on Bill Bonner, visit The Daily Reckoning.