Thursday, July 30, 2009

Why Green Shoots Are Just Compost in The Greater Depression

In this week's installment of Conversations With Casey, Doug's doing a little yardwork...moving down those pesky green shoots!

The stock market may be up, but are economic conditions really improving? Also - who the heck is going to buy all the debt the US Treasury is issuing?

Enjoy this week's bearish rant, courtesy of the legendary Doug Casey...

Doug Casey on Mowing Down Green Shoots

(Interviewed by Louis James, International Speculator)

L: So, Doug, we're sitting here in Vancouver, epicenter of many of our investments, thinking about the future. Meanwhile, the U.S. Treasury has announced some mind-boggling debt auctions for next week. Any comments?

Doug: Yes, the size of this auction coming up, $235 billion, is really rather shocking - especially when you consider that that's roughly the cost of the entire Viet Nam war. That was considered off the scale and lasted ten years. This action is just in one week. It's an amount that annualizes to $12 trillion - and it's still just starting.

They are going to have to borrow even more money to bail out all of the other banks that are going to fail (which is going to completely bankrupt the FDIC) and all the pension funds that are going to fail (which are insured by the Pension Benefit Guarantee Corporation). And there are lots of other financial catastrophes still on the runway.

This $235 billion is just a drop in the bucket - and I'm not entirely sure where they're going to get this money. If I were a foreigner and I already owned massive amounts of U.S. debt, would I want to buy that much more? That's especially questionable when any intelligent person can see that interest rates are being artificially suppressed. That makes buying this debt a guaranteed loss. It just doesn't make any sense to me.

The Chinese have, say, $2 trillion in foreign-denominated reserves, of which they say about $1.4 trillion is U.S. paper. They realize they're holding a burning match; they want to get rid of what they have, not buy more. But here's the scary thing: even if the Chinese lent the U.S. all their $2 trillion of FX, it would only cover this year's U.S. borrowing. Where is the U.S. going to get next year's? Because next year, it's going to need even more.

Let me be as clear as possible. There's no way out of this without major structural changes. It's not going to be just a disaster. Catastrophe is a better word.

L: Well, we heard today that the government of Dubai did a public offering of debt, and it had to be rescued by Abu Dhabi, because no one else would take it. We've heard other, similar stories. You'd think that at some point, these people would begin to worry that there might be a limit to how much debt they can peddle.

Doug: It seems to me that it's almost the endgame for this financial system. Since the depression of 1929 to 1946, we've had a worldwide economic boom; in its early stages it was quite real, since it was based on the savings that were accumulated during the depression. But over the last generation, starting in the 1980s, we've had a phony boom, driven entirely by debt.

The whole world is awash in debt. Individual consumers are head over heels in debt. State and local governments are head over heels in debt and going bankrupt. National governments all over the world are deeply in debt. And businesses that are catering to old patterns of consumption are going to find they have no earnings to service their debt with, and their assets are unsalable at acceptable prices.

One of the problems we've got here is that people confuse paper money with real capital. This is an important distinction that's being overlooked. Capital is actually just another word for "savings" - the excess of production over consumption. I can't emphasize that enough.

Unfortunately, people are used to thinking of capital as being the same as the dollar bills or other paper money in their wallets - and that can be created out of thin air. But capital can't be created out of thin air.

So, I'm very concerned that all these governments are going to destroy the world's monetary system in tandem. I don't know exactly how it will end up, but it's going to be really ugly. This is compounded by the fact everybody is looking to the governments to solve these problems. Government is the cause of these problems. And the people it employs are not the best and the brightest (how that ridiculous canard ever got traction astounds me) but the poorest and worst part of humanity.

Boobus americanus is looking to the type of people employed by their DMV or the TSA - albeit sporting prestigious degrees and expensive suits - to solve a millennial economic crisis. Good luck, suckers.

There are lots of reasons I say that the Greater Depression is going to be even worse than I think it's going to be.

L: That's a pretty negative view, Doug. What about all these green shoots we keep hearing about? Improved housing numbers, improved unemployment figures, the Dow up over 9,000 again... There are all these signs of recovery, but you say you don't see any green shoots. Are you myopic, or is everyone else in the world wrong?

Doug: I don't want to be seen as a perma-bear who's negative on the economy no matter what happens, but this is a time when I'm very happy to be a contrarian. In fact, I'm not negative. The future should be, and can be, better than all but what the most optimistic science fiction proposes.

So let me put it this way: I've believed for many years that the Greater Depression was in the cards, simply because I believe that cause has effect, and actions have consequences. All the distortions and misallocations of capital caused by government interventions in the economy have to be liquidated. So, no, I don't see any green shoots.

The talk of green shoots is all PR, because the morons running the government actually believe the economy is based on psychology. In fact, psychology has zero to do with it. If it did, then all the Zimbabwe government would have to do to solve their depression would be to slip everyone a Prozac tablet every day. But maybe we've already tried that here, since something like 50 million Americans are already on antidepressants....

There may seem to be green shoots in the same way it seemed that way for a while in 1930. After the stock market went down for six or eight months, it reached a temporary plateau and bounced back up. People thought it was just another recession, that they'd pull through as they did after World War I.

L: Safe to get back in the water.

Doug: Safe to get back in the water. But that's not the way it is this time. For example, people are now saying that housing is looking up because the rate of collapse has slowed. Of course, nothing goes straight down - or up - without retracements. The fact is that there's been immense overbuilding in housing for a long, long time. It's been the epicenter of speculation in the U.S. and many other places around the world.

There's a huge supply of square footage that people simply can't afford to live in. Even if Obama were to freeze people's mortgages, so they don't have to move out of their houses and into tent cities - who's going to pay the real estate taxes on those houses? The local governments are bankrupt, so, if anything, they'll want to raise real estate taxes.

And even if the federal government pays the local taxes - who's going to pay the utilities? Right now, oil and natural gas are at relatively low levels. When you see oil going back up over $100 - which I think you will in the next few years - and when you see natural gas doubling, or even tripling, in the next few years, people aren't going to be able to pay their utility bills.

Besides, all these McMansions are going to have a lot of deferred maintenance. The fact is that people have been living way above their means in terms of housing.

The same thing is true of cars. People have bigger, newer, more expensive cars than they did during the last recession, and they have lots more of them. Cars are on average of much higher quality now, unlike those of the 1970s - which you might call the first federal period of auto manufacturing; those were perhaps the worst cars ever made. During the 1980 - 1982 recession, the average car in the U.S. fleet was something like seven years old, and the average family didn't have more than one or two cars. Today, most cars are way above those of past years in quality. They basically last forever, the car fleet is almost brand new, and Americans have lots of cars.

What makes that even more troubling is that cars are no longer minor assets on most people's balance sheets. Back in those days, if they didn't buy them for cash, most people bought cars with a two- or maybe three-year financing. Now, everyone finances cars for five years or even leases them for that long. They've gone from being a minor asset to a major liability on families' balance sheets.

So, forget about the auto industry recovering. That's not going to happen. No green shoots there. In addition to the fact the cars that will be made by a nationalized and bankrupt GM and Chrysler will be politically correct crap. Nobody but people like Barney Frank and Nancy Pelosi will want to be caught dead in them.

Forget about housing, forget about autos, forget about almost anything you hear about on the news. For years, the whole world has overconsumed and lived above its means. It was great fun while it lasted, but now the party's over - and for a long time. You won't see any green shoots.

What you are going to see is lots more corporate bankruptcy and lots more unemployment.

All those people giving $150 massages and $40 haircuts are going to find that people can no longer afford them. Professions like personal trainers are going down the toilet. There are going to be lots of unemployed carpenters, financial planners, mortgage brokers, department store clerks, and car salesmen.

On the bright side, there will be legions of unemployed lawyers - unless they're bankruptcy specialists.

There are so many businesses - almost everything you look at, from restaurants to car washes - that are still catering to old patterns of production and consumption.

Many people are simply not going to be able to afford these things anymore, so lots more people who have been hanging on by their fingernails are going to fall off the cliff. What are they going to do to provide goods and services in a new world? I think the world is going to change more radically in the next ten years than it did from 1929 to 1945.

So, forget about green shoots. If you believe in them, you're going to be in for a sucker punch.

L: What about the companies that are rebounding, like Goldman Sachs?

Doug: Goldman is a special situation. Much of their competition has gone out of business, so a lot of what business there is, is going to Goldman. And they're very politically connected, so they'll be handling lots of state-sponsored deals. It's so brazen as to be shameless. I wouldn't be surprised if the American hoi polloi - with no jobs, no houses, no money, and no prospects - react in a most unpleasant manner against people who appear to be profiting from their distress.

L: Do you even believe Goldman's numbers, or is it all a function of them being able to change the rules that govern how they book things?

Doug: That's a good question. What can you believe today? The government has a vested interest in casting everything in the most favorable light possible. And the newspapers, magazines, and TV more or less parrot what they're told. I prefer not to clutter my mind with what official sources say but make my own observations and interpretations of what others put together. And my view is that the Greater Depression has barely even started.

L: What about recent reports that Americans actually have started saving again?

Doug: I believe that. That's definitely a major part of the cure, a very favorable thing. It's a sine qua non - critically important. Naturally, and stupidly, the government and mainstream economists are all against it. I say stupidly not as a pejorative, but in the sense that "stupid" means "an unwitting tendency towards self-destruction." They don't want to see people saving (the only cure), they want to see people consuming and spending. They're trying to prolong the totally unsustainable patterns of production and consumption the Long Boom engendered.

Fortunately, the average person is watching out for his or her own welfare, despite that being the opposite of what conventional economists are telling them to do. Saving is the only solution to the depression. In addition to massive deregulation, huge tax cuts, and the institution of a sound currency. But since those things are totally in the hands of the government, you can forget about them happening.

Look, you can't solve the problems created by decades of building debt with a few months of higher savings. It has to go on for years to rebuild the capital base.

L: Okay then, for the person who's expecting the sucker punch you mentioned, what's the best way to play it? Shorting masseuses and restaurants? Wall Street? What?

Doug: I want to go for the low-hanging fruit. What the stock market does and what the economy does are really two different things. Stocks could actually skyrocket because of all the dollars the government is creating. People might want to buy stocks because they actually are equity; they represent real wealth. I suspect that in this depression, the stock market isn't going to bottom until we're looking at dividends in the ten percent range across the board, after being cut from present levels, which implies a much lower stock market.

But do I want to make a bet that way?

Not particularly. All that money creation could drive the stock market up in spite of much lower earnings and a bad economic situation.

It seems to me that the sure bet is to be short bonds. Interest rates are going way up. Why? There will be tremendous demand for capital, of which there's a limited supply. Interest rates are the price of capital. So they're going up for that reason - and because of the trillions of paper dollars the government is creating, inflation is going to skyrocket. High inflation will itself guarantee high interest rates.

So, the trade of the decade is going to be to short long-term bonds and to go long precious metals (which are the only financial assets that are not also simultaneously someone else's liability). These are two excellent investment plays, but there are many others. We go into a lot of detail on the best ways to play them in The Casey Report and the International Speculator.

However, just as important is political diversification. The main risk you have is your own government. You have to diversify your assets out of the control of your government. This is even more important than picking the right investment today.

L: Great advice - thanks Doug.

Doug: Till next time.

To the editors of The Casey Report, shorting interest rates is one of their favorite investments of 2009... and there are different ways to do it. Learn all about how you can participate in the huge gains this investment promises in Chief Economist Bud Conrad's new report - just click here.

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