Money itself is up for correction

Sep 29, 2010

Baltimore, Maryland

Epithet for a doomed economy...

What will they say? How will they describe the '00s and '10s?

Irish Prime Minister Brian Cowen was accused of being drunk when he gave a "croaky" radio interview two weeks ago.

---------------------- User Speak! ----------------------
"Loved the mobile version of equitymaster. Great to be able to access it on my blackberry." - Atul Kumar, an Equitymaster Subscriber
"I liked very much equitymaster website on mobile. I can keep myself updated while I am travelling. Thank you very much." - Prakash Gudnavar, an Equitymaster Subscriber
What's your say? Check our new mobile website now!

He denied it.

But we'd be tempted to turn to the bottle too if we were in the fix Ireland is in. Ireland's banks got into trouble. So the government threw them a lifeline...forgetting that the line was tied to its own neck. It guaranteed bank liabilities equal to four times Irish GDP. But isn't that going to be the story of the whole period? Private sector banks and speculators got in trouble. Then, the public sector went down with them.

Irish bond yields hit a new record high yesterday - over 6.7%. Investors are afraid Ireland will default. If it does, its bonds will fall even more.

This is either a great opportunity or a trap. Investors could realize a huge windfall. If Ireland is bailed out...yields could fall in half. Then bond prices would double.

On the other hand, the Emerald Isle could actually default. Bonds could take a big hit.

Which will it be? We don't know.

But we've been thinking a lot about the big picture. If you had been in the 1930s, the big picture would have been as difficult to see as ours is today. You would have had a lot of the same questions. Are stock prices rising or falling? Is the economy recovering or falling apart? Is it inflation we should worry about, or deflation?

But now we have a narrative. We know how it turned out.

There was a huge rally following the crash of '29. Stocks rose up more than 50% in the "suckers rally." There were several "recoveries" too. And there were 6 separate quarterly bounces between '29 and '33. They averaged 8% each.

Investors were entitled to think that the economy 'had turned a corner.' Or, that the worst was behind them. Or, that they were 'on the road to real recovery.'

But they would have missed the big picture. Looking back at it, the US economy was in a Great Depression. Investors would have been better off just staying away...from '29 to '49. Yes, dear reader, a 20-year period of abstinence would have made the heart grow fonder of equities - even though there were several good years as well as several bad years during that period.

What about now? Are investors kidding themselves by trying to make money in this market? Would they be better off taking a leave of absence for the next two decades?

We have to wonder about the big picture. What will people say about this period 30...50...years from now? How will they describe it? What will be the standard narrative?

Will they say it was a recession followed by a recovery? Nope. That story has gone with the wind. What then?

Maybe they will say it was a credit cycle correction... a balance sheet recession...much like the '30s. "Investors should have taken a long sabbatical," they might say. "They should have sold in 2000....and come back in 2020..."

Maybe...but this time there is more to the story than there was in 1930. Back in the '30s, the equity market turned sour...but the bond market was still safe and sound. The dollar was still as good as gold. Hundreds of local governments went broke, but there was never any question that the US government would default...or inflate...or ditch its own currency. Investors could take a break from stocks. All they had to do was to sell out...and hold onto their cash. They could buy the same stocks 20 years later for more or less the same prices. Why bother with risk? Why bother with the headaches?

But don't try that this time, dear reader. We'll tell you why...below...

*** Why can't you just hunker down...hold cash...and wait until this Great Correction is over? Because this time money itself is up for correction. Yes, that's right. The dollar is no longer good as gold. Not even close. It was cut loose back in '71. Ever since it's been floating on a sea of debt, inflation, and hallucination. The feds imagine that they can create as many dollars as they want. They think inflation is good for the economy.

The US money supply has increased 1,300% since 1970. And now that the economy is correcting, the feds think they can fix the problem with the same thing that caused much of the problem in the first place - more notional dollars.

According to the Financial Times, Ben Bernanke is asking himself: should I, or shouldn't I.

"Bernanke mulls launching QE2 to keep America afloat," says the headline.

That's it! That's the solution! Flood the economy with dollars!

So, that's what we're wondering. When they tell the story of the '00s and '10s, they'll probably omit the ups and downs...the 'recovery' sightings...the inflation and deflation fears...

The story will probably go something like this:

"The private sector took on too much debt. It hit the wall. Then, the public sector took on too much debt. It hit the wall a few years later."

Or, a slightly more detailed version:

"The stock market peaked out in real terms in Jan. 2000. The feds responded with huge inputs of fiscal and monetary stimulus, causing bubbles in housing, finance, oil and other sectors. But the credit expansion had reached its end by 2007. Then, the stock market, real estate market, and the economy all turned down. Despite several futile 'recoveries,' the correction continued for the next 10 years. Investors should have gotten out in 2000...and stayed out.

"But not in dollars. Governments pumped trillions into the economy, beginning in 2008 - first borrowed money...and then printed 'quantitative easing' money. In the two years following the crisis, for example, only one out of every two dollars spent by the federal government came from tax receipts. The rest was borrowed. Or printed. For a few years, the gravity of private sector de-leveraging kept these additions to the money supply in check. But the feds just kept printing more and more money. And as they printed more paper money, the price of real money - gold - rose.

"And then, all hell broke loose. All of sudden, people lost faith in the dollar. They fell over one another trying to get rid of it. They bought houses, cars, stocks, toilet paper - anything. Most of all, they bought gold. When they could get it. The price rose to $5,000 an ounce...

"...and then it was over. The debt had been washed away. Savings, pensions, insurance plans... They announced a new currency, backed by gold, at $5,000 an ounce. It was over."

*** A new movie, "The Social Network," is getting a lot of attention. We haven't seen it yet. But we will. Daughter Maria has a small part in it. You gotta start somewhere... Look for her. She's the waitress.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Recent Articles

A New Infrastructure Boom March 26, 2019
Selva Freigedo talks about the potential in 5G network and how it could transform the way we communicate.
A 40 Somethings Guide to YouTube Hits March 20, 2019
Vivek dwells into a new YouTube phenomenon.
As the Economy Slows Down, Maruti and Two-Wheeler Companies Cut Production March 19, 2019
The country's largest car maker has cut production by more than a fourth.
In Supporting Demonetisation, RBI Behaved Like an Old Uncle Not Willing to Take a Stand March 13, 2019
The minutes of the meeting of the RBI Board which happened before demonetisation have been released.

Equitymaster requests your view! Post a comment on "Money itself is up for correction". Click here!

1 Responses to "Money itself is up for correction"


Sep 29, 2010

The man is a manic deppressive. Can you please spare us his daily rant on how the world is coming to an end. We get it by now. No real need to remind us day in day out.
I am on the hunt for a nuclear shelter with a board outside which says keep Bill Bonner out !!!

Equitymaster requests your view! Post a comment on "Money itself is up for correction". Click here!