Washington to Detroit: Drop Dead!

Not a headline you’re like to see – more below...

Yesterday brought another almost 200 point drop in the Dow. Gold rose $17.

What’s going on?

Reuters reports:

“The ‘nasty’ U.S. recession will tighten its grip next year as unemployment rises and weak home and stock prices imperil consumers, finance firms and debt-laden businesses, a UCLA Anderson Forecast report released on Thursday said.

“Additionally, a sustained retreat in prices for goods and services is a very real possibility that would further drag on the economy, according to the forecasting unit’s report.

“‘Where only last quarter we were worried about inflation, we are now worried about its very rare opposite: deflation,’ the report said. Falling prices would cut demand and discourage employers from hiring.

“‘The record collapse in oil prices has brought with it welcome relief to motorists throughout the country and an effective tax cut of $440 billion in the form of a lower oil import bill,’ the closely-watched report said. ‘Nevertheless the swift fall in oil prices is now lowering the absolute level of consumer prices and bringing with it likely declines in nominal GDP over the next three quarters.’

“The news from the economy is bad,” the report said. “The recession that we had previously hoped to avoid is now with us in full gale force.”

“The UCLA Anderson Forecast unit expects real GDP to shrink by 4.1 percent this quarter and by another 3.4 percent and 0.8 percent in the first and second quarters of next year, respectively, as consumer and business spending weaken and as the foreign trade that had propped up growth much of this year sags.

“Because Europe and Japan are already in recession and China and India are suffering from a significant slowdown in growth, the export boom of the past few years will wane,” the report said. “Make no mistake the global economy is in its first synchronized recession since the early 1990s.”

“By late 2009 the U.S. unemployment rate will hit 8.5 percent, compared with 6.7 percent in November, as employers shed an additional two million jobs over the next year.”

This is now the mainstream view: the downturn is bad...and getting worse.

The front page of today’s USA Today adds, “Home values may take decades to recover.” Finally, the press is catching on!

Of course, economists’ and analysts’ guesses are rarely worthwhile. How many foresaw the market collapse coming? Very, very few. How many saw the price of oil below $50? Who guessed that Japanese stocks would fall 50%? Or that Warren Buffett would lose $25 billion? Practically no one.

Analysts lack imagination. Instead, they merely read the day’s news...and extrapolate. They imagine that tomorrow will be like today. Often, it is. But sometimes, it is not. And that’s where you get big profits...or big losses – when things happen that are unexpected.

Right now, the analysts and economists are spreading gloom and doom. But Mr. Market likes to surprise us. What will the surprise be? Here is our guess: things will be better than expectations...and much worse too.

Remember, these guesses are worth what you paid for them: but despite yesterday’s setback, we wouldn’t be surprised if this rally continued for several more months. No particular reason. It’s just the way Mr. Market works. Investors have gotten scared...they’re taking precautions. They’re closing their wallets...they’re asking questions and reading prospectuses carefully. Mr. Market will want to loosen them up a bit...get them to relax, let down their guard and come out into the open – so he can destroy them.

He’ll be aided and abetted in this mischief by the feds. A headline in yesterday’s paper tells us that more and more of the economy is directed by the government. As private spenders grow reticent, public spenders become more bold. They’re talking about a massive public health system...new roads, bridges, trains.

Mr. Market surprised us in 2008. He hit harder than almost anyone expected. What’s his surprise for 2009?

Investors are expecting a slump. They’re afraid of bankruptcies, defaults and deflation. Trying to avoid losses, they’re buying Treasury paper. Treasury bonds, notes and bills are said to be the safest investments they can make.

What if they turned out to be the most dangerous investments you could make?

There are two ways in which Treasuries could lose value. Most obvious, the Treasury market could go down. The law of supply and demand has not been repealed...at least, not as far as we know. It requires that when supplies increase, ceteris paribus, prices will go down. Of course, ceteris is not always paribus. And right now, people seem desperate to buy Treasuries in order to protect themselves from the bear market in all other asset classes. But the supply of Treasuries is set to soar as government borrows more and more money for its spending plans. And with spreads between corporate paper and government paper at record lows already, it seems very unlikely that investors’ will become even more desperate in the months ahead. That is, it seems unlikely that they’ll favor Treasuries even more than they do now.

According to the latest estimates, the U.S. Treasury is expected to borrow $1.5 trillion nest year – in addition to the existing debt it rolls over. This puts a huge supply of new debt on the market. Will there be new demand to meet it? Not likely. In fact, the demand is probably going to drop. One reason: the foreigners are borrowing too – hugely – for the same reason. They want to bail out their own economies. Another reason: Americans are spending less on foreign goods – putting less money in the foreigners’ hands that they could lend back to us.

Of course, the feds are ready with a solution...and as usual, the fix will make things worse. Fearing a loss of private demand, the feds are already talking about selling Treasury debt directly to the Fed. But that brings us right to the other way Treasury values can go down – the dollar can lose value too. Not only are bonds themselves subject to the law of supply and demand, so is the currency in which they are calibrated. The more dollars; the less each one is worth.

Normally, it is a no-no for central banks to buy Treasury bonds directly. “Monetizing the debt” is what it is called. It inflates the money supply directly and immediately. So, while Fed buying of Treasuries would help support the market for treasuries, it would undermine the value of the dollar itself.

Either way...Treasuries – thought to be the safest investment you can make – could turn toxic quickly.

*** A headline we’d like to see: “Washington to Detroit: Drop Dead!”

A dear reader criticizes our comments on Detroit:

“Perhaps you should stick to your financial moorings, and not drift to [sic] far into uncharted waters.

“With the exception of Chrysler in the ’70s, the US auto industry has never appeared before Congress asking for loans. In fact, the America auto industry, unlike its foreign competition, has never been supported by government subsidies.

“But the recent brutality of our monstrous US financial system has created – in a very short period of time – a dirth [sic] of sales for ALL car companies, not just the Big 3. This has nothing to do with being nimble; all are feeling the impact. In fact, the Big 3 are now producing cars with comparable quality to the best foreign competition, if you haven’t had time to see the data lately. They’re far cry from the ‘dinosaurs’ you assert they are.

“No this is the direct effect of the disastrous policies of the Fed, Big Banks and their Congressional supporters. There is nothing the auto industry could do to offset this. Yet, what does the Congress do? It blames the car industry for not keeping up – a complete fabrication by the Hill Mob, as you might call them. It’s OK to funnel trillions of $ to banks (non-producers), with little publicity. But when asked to provide a meager (relatively speaking ) $34 billion in loans to keep the Big 3 (producers) producing, they turn it into a circus and require the CEO’s to beg. Unfortunately, the general public, including, it seems, you have swallowed the bait.

“Don’t get me wrong. I’m opposed to any bail outs. If I had to let any industry fail it would have been the non-producing Big Banks. But given that did not happen, there is now no reasonable choice but to help the Big 3, in my view.

“Please recognize that when you downgrade the Big 3 without sufficient data, you are just pandering to the very hacks you rail against. It’s very un-Bonner-like of you. And I’m one of your best fans. Keep up the good writing.”

He has a point: Detroit is largely a victim of Washington. But our point is a little broader. Detroit is a dinosaur and so is the whole system...Washington, Wall Street and the consumer economy too.

Drop dead, all of them!

*** Poor Rod Blogojevich. Voters like to see a politician with convictions, but they get snippy when a politician gets convicted. The Illinois governor is alleged to have been trying to sell the Senate seat vacated by Obama to the highest bidder. Word got out and the federales nabbed him. They think they have a real desperado on their hands.

But what is Blogojevich’s crime? Why shouldn’t the seat go to the highest bidder? People are horrified by the idea. The press wants to lynch him. But the governor has the right to appoint a senator...he has to use some selection criteria, no? The market process works perfectly well for art and whiskey, why not for U.S. Senators?

You probably think we are joking, don’t you, dear reader? But we wouldn’t joke about something as serious as whiskey. Bourbon gets to where it should go thanks to the old ‘bid and ask’ system. No one complains about it. Whiskey is limited in supply; the market allocates it to the top bidder.

Senate seats are limited too. Why not allocate them the same way?

The trouble is that selling a Senate seat makes it look like the game is unfairly rigged. People won’t stand for it. They want the game rigged, of course...but in the old-fashioned way. They believe the Senate seat should go to a hack whose vote the Democrats can count on. Or maybe to someone who will help them raise money. Or, perhaps to a crowd pleaser who will help them win elections...so they can skim more of the taxpayer’s money. Once in power, they’ll take advantage of it, naturally. We would too, if we had the chance. They’ll give their friends jobs, contracts and bailout...and spend billions on their favorite crackpot ideas about how to improve the world.

And in Illinois, they’re just a little more honest about their corruption.

Here’s a story that illustrates how it works:

An ambitious young man from Chicago once went to New York to visit a local councilmember. He was surprised to find the man’s office decorated with genuine Picassos and Rembrandts...and authentic Louis XV furniture.

“How can you afford this luxury on a town councilman’s salary?” the Chicago boy wanted to know.

“Look out that window,” said the New Yorker . “See that bridge? Ten percent...” he explained, winking at the young man.

Years later, the New Yorker returned the visit. This time it was he who was impressed. The Chicago politician wore a fine Italian suit...a Philippe Patek watch...and his office was paneled in oak...with famous paintings by Manet and Cezanne.

“Wow, how’d you manage all this?” asked the Manhattanite.

“Look out the window,” replied the guy from the Windy City. “See that bridge?”

“What bridge? I don’t see any bridge?”

“Yeah...100%” said the Chicago guy.

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