What will be the impact of the Great Correction?

Nov 9, 2011

London, England

Yesterday, Silvio Berlusconi said he will leave government...once the legislature has agreed on an austerity program.

Too bad. We'll miss "The Cavalier."

Once in Rome, we heard him speak to a crowd. We didn't understand a word of what he was saying. But he said it well. He was at ease...friendly...joking...enjoying himself.

And now what? The poor man will be out of politics. No more will he get to work with the great men of finance, trying to solve the historic problems of the day. He'll have only his bunga-bunga parties with plenty of alcohol, music and beautiful young women. Poor fellow.

Our guess is that the great men of finance won't be able to solve Europe's debt problems. At least, not without a few blow-ups. And the European Union will probably end up less united than ever. (Gold is trading over $1,800 this morning...looks like investors are worried too.)

Until recently, both economics and politics argued in favor of a more centralized Europe. Now they are pulling it apart.

But we've made so many guesses over the past few months and years...we've lost tract of them. Herewith a review:

First, back in the mid '00s, we guessed that the housing market, stock market, and the financial industry would all blow up. They did.

Then, we guessed that this would not be followed by the typical recession/recovery pattern of the post-war period. It wasn't.

Instead, we had a hunch that the economy had entered a Great Correction...from which it would not emerge for many years. So far, that appears to be what is happening.

As to what gets corrected, when and how...we admit ignorance. But ignorance never stops us here at the Daily Reckoning; it is like red meat to a hungry dog. We thrive on it.

We guessed that the main thing to be corrected was the credit bubble. Debt levels are too high. They need to be reduced. That's why the feds have been unable to turn the situation around. In a recession, they can make credit cheaper and more abundant. That usually does the trick. At lower financing costs more projects make sense. People begin to invest and spend again. But it doesn't work that way in a debt correction. It's not a question of the price of credit...but of there being too much debt. Debt levels need to be reduced.

The price of credit has been reduced to zero (the fed funds rate)...and the US government is running trillion-dollar deficits. Neither monetary nor fiscal stimulus has worked. Both add debt; instead, debt needs to disappear.

We also guess that this correction will end with the end of the dollar-based monetary system that was set up in 1971. No paper money has ever survived a complete credit cycle. The dollar won't be the first.

De-leveraging will keep prices low while cutting profits and sales. As it develops, stocks, real estate and other assets will eventually be marked down to real bottom-of-the-bust levels. You should be able to get a 5% yield on your stocks...about twice what is available today. That will mean prices at about half what they are today.

The slumpy economy...combined with periodic liquidity crises (such as is now happening in Europe)...along with falling asset prices will drive investors to the safety of US bonds. This will keep US government financing costs low - despite huge deficits. It will also convince the feds that they can pump large amounts of cash into the system without fear of inflation. This they will do...

The price of gold may fall in the early de-leveraging phase. Then, it will rise as the late de-leveraging stage begins. This is when the feds' money-printing will move into high gear. Sophisticated investors - including foreign central banks - will be wary. They will buy gold.

The price of gold will rise. The Dow will fall. They will intersect at about $5,000.

But our guesses don't stop there. We also guess that...

...the developed countries will find it very difficult to grow. First, because of the weight of debt. Second, because much of their capital is "invested" in unproductive, zombie industries. Third, because their populations are stagnant. Fourth, because they have already gotten most of the above-trend growth resulting from increased use of cheap fossil fuels.

...since the developed economies cannot grow...and since they are up to their chins in debt...they cannot fulfill the promises made to their citizens. The grand bargain of the modern, social welfare state will begin to look more and more like a bad deal. Young, unemployed men will become increasingly fed up. They will look for radical solutions...and more radical leaders with jingo answers.

...governments, which are inherently reactionary even in the best of circumstances, will respond with repression. They will not adapt peaceably. They will not throw their zombie clients under the bus. Instead, like the Ancien Regime, they will dig in their heels and protect them. The defense industry, for example, will try - probably successfully - to direct the citizens' rage against imaginary foreign enemies...and thereby increase its own power and wealth...

...the real economy will weaken. Revolution will begin...probably coincident with hyperinflation. Finally, the middle class will be broke (the poor are already broke) and the country will be ruined.

There, that pretty much sums it up. Any more questions?

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*** Two important events happened in 1971. One was the creation of America's centrally-managed paper money system on the 15th of August. The other happened on the 8th of March at Madison Square Garden. Frank Sinatra was there. So was Hubert Humphrey. And so was Bernadette Devlin, an Irish political activist. They had all come to see the fight.

Center stage were Mohammed Ali, a charismatic, quick-witted, sure-footed boxer, who had joined the Black Muslims and changed his name from Cassius Clay. And "Smokin' Joe" Frazier, one of the toughest sluggers of all time.

Neither fighter had ever lost a fight.

We remember it as though it were 40 years ago. Which is to say, we hardly remember it at all. But turning to press reports to refresh our memory, we recall that it was the 'fight of the century.' Not merely because they were two of the best boxers to ever practice the sport, but because it was a showdown that pitted two different styles...characters...and politics against each other. Frazier was direct, simple, and sans complexe. He advanced on his enemies like a Greek phalanx...relentlessly, unstoppably, without flinching.

"Joe Frazier would come out smokin'," said George Foreman. "If you hit him, he liked it. If you knocked him down, you only made him mad."

Frazier described it himself:

The way I fight, it's not me beatin' the man: I make the man whip himself. Because I stay close to him. He can't get out of the way. Before he knows it - whew! - he's tired. And he can't pick up his second wind because I'm right back on him again."

Ali, on the other hand, could be light on his feet...hard to hit...and hard to beat, too. He said of his style: "Float like a butterfly; sting like a bee." Ali could spout poetry...he was handsome and clever. And he had political ideas. As to America's imperial adventure of the time, he said:

"I got no quarrel with them Vietcong."

As a consequence of this forthright insight, he was convicted of draft evasion and stripped of his heavyweight champ title, which was subsequently restored after a court fight.

And so the stage was set. The fight of the century. The hero of the anti-war movement, of students, of the Left and the liberal intelligentsia...against the Great White Hope of the conservatives and blue collar patriots... "Smokin' Joe" Frazier.

Why do we care? Because our day to day work is so full of humbug, nonsense and claptrap...it is comfort to see a solid blow. You can argue any side of the stimulus program. You can argue about what caused the slump and what to do about it. You can argue that Bernanke is a fool...or Summers is an even bigger fool...or about how high a banker will bounce when you throw him out of a 21st storey window. But it is all idle. Vain. Useless. You might as well have an argument with your wife!

But you couldn't argue with Joe Frazier's left hook. It was real. It staggered 21 boxers in a row...before the 1971 fight with Ali.

The betting was going 6-to-5 in favor of Frazier. He was shorter. He had 7 inches less reach. But Ali moved around the ring fast. Frazier came at him, as he always did...but Ali managed to keep him away. The fight went on...round after round. But Ali was getting tired. Finally, in the 15th round, out came the left hook. Ali took it on the jaw and fell to the mat.

That would have been enough for most fighters. But Ali rallied. He got up and was able to finish the match. Frazier won by unanimous decision.

In a rematch in 1974, known as the "Thrilla in Manila" Ali finally subdued Frazier. The long battle left Frazier so beaten up that he was unable to come out for the 15th round.

But Monday night, Frazier fought his last fight - with cancer. Again, the decision was unanimous. "Smokin' Joe" died. RIP.

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.

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2 Responses to "What will be the impact of the Great Correction?"

Fred Morse

Nov 11, 2011

Hi Bill,

Makes sense. Isn't the problem a little more specific than too MUCH debt? Isn't more too much STUPID debt? Bad underwriting? Debt is great if it produces more value? Its stupid if it is waisted on stuff that does not produce more value.

It seems the solution is to require skin in the game at least. Originating lenders should be hit with some of the losses. Borrowers should have to demonstrate an ability to repay from current cash flow.




Nov 9, 2011

Very well written the Death of the World-a HopeLess world we live in....and death of Frazier very touching indeed RIP. Great we can be cynical of everything in this world and believe there is nothing positive to look for or live for...living dead? So we all go bankrupt and begging?

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