This market is based on hype and hallucination

Dec 8, 2010

Melbourne, Australia

"It was a debt of honour, so-called, which I had to pay, and I used money which was not my own to do it, in the certainty that I could replace it before there could be any possibility of its being missed. But the most dreadful ill-luck pursued me. The money which I had reckoned upon never came to hand, and a premature examination of accounts exposed my deficits."

"The case might have been dealt leniently with, but the laws were more harshly administered thirty years ago than now, and on my twenty-third birthday I found myself chained as a felon with thirty-seven others convicts in the 'tween decks of the barque Gloria Scott, bound for Australia."

- The Adventures of Sherlock Holmes

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Imagine going from England to Australia on a sailing ship, shackled 'tween the decks. The convicts must have been happy to finally get here.

Imagine getting sent to Australia for failing to pay a debt (even one that was never intended by the creditor)! That would discourage you from spending money that is not your own!

It was a tougher world back in 1855. The 'laws were more harshly administered' then.

Now, the laws aren't administered at all. The culprits are in so tight with the feds you'd need some WD40 to get them loose. The banks seem to have taxpayer money on tap. As much as they want. 24/7. On/Off. And the feds spend money that is not their own...and promise to replace it. That replacement money will never come to hand. And an examination of the feds' accounts exposes immense deficits - about 20 times the entire annual output of America's private sector.

And along comes Washington with word of a deal. The bargain was struck yesterday. The rich get to hold onto their money for another two years. And the poor get another 13 months of unemployment benefits.

Win/Win, right?

Are you kidding? The feds' accounts show a deficit of $1.3 trillion. Tax cuts and further spending? Lose, lose, lose...

Well, why not? Give everyone a Christmas present - whether you can afford it or not. Stocks will probably go up today. The papers are reporting that the extension of the Bush tax cuts may be all the economy needs. No further stimulus may be necessary. Because if rich people can look forward to the same tax rates next year...

...what exactly is it they will do? Invest more money? India! And China! And commodities! And even gold!

Yes, that's where the stimulus has gone so far.

We don't like the looks of it. This market. This economy. Or this political situation.

We don't like any part of it. It's all based on hype, fraud and hallucination.

So, we've got our "Crash Alert" flag out.

Most likely, of course, it won't be necessary. Things usually muddle forward.

And most likely, they'll muddle forward like they did in Japan in the 1990-2010 period...or in Britain from the end of WWII to the Thatcher years. Sluggish economy...high unemployment...falling house prices...and foolish government intervention.

We should see falling stock prices too. Investors have made no money in stocks in a dozen years...but stocks are still pretty pricey. We'd like to see them fall to about half to a third today's level. Then, maybe we could get excited about buying them. As it is, we presume they still face their rendezvous with the bottom. Until it is behind us, it is still ahead of us.

Giving good financial advice is really very easy.

Buy investments that are going up.

"But what if they don't continue to go up?" you ask.

Then don't buy them.

See how easy it is?

*** While stocks have been going nowhere, guess what's been going up. You know. Gold! That's right, gold has been in a bull market for the last 10 years. And this year, gold is up 28%.

That's a trend we like. Because it is long. Solid. And it shows no sign of stopping anytime soon.


Because the world monetary system has a rendezvous ahead of it too...a rendezvous with destruction. Until that's behind us, it's still ahead of us.

'Wait a minute, do you know the monetary system is going to crack up? You admit that you don't get to read tomorrow's headlines before everyone else.'

Good point.

Of course, we don't KNOW anything. We're just guessing. But it seems like a good guess. Let's put it this way, it's an extrapolation of current trends in which we have great confidence.

Ben Bernanke admitted this week that he didn't see the problem coming. Which confirms what we knew all along - the people running US monetary policy have no idea what they are doing.

Gold is a bet against Ben Bernanke. It's a bet against the feds. It's a bet against a system that is corrupt and reckless. It's a bet that the managers of a managed currency will sooner or later manage to mess it up.

*** Mr. Bernanke went on to assure the world this week that there was no way inflation would get over 2%. If they headed in that direction, he'd raise rates immediately, he said.

We want to see that! Once consumer price inflation begins to leak into the system, people begin to expect it. They buy and invest - in order to get rid of paper currencies. The velocity of money increases. Prices go up. Raising rates a little doesn't help. You can't follow the rise in inflation. As Paul Volcker found, you have to get ahead of it. You have to raise rates MORE than the current CPI rate in order to squeeze out inflationary expectations. People have to believe you're serious, in other words; you actually have to cause pain and contribute to de-leveraging.. It's not enough to talk tough. You have to be tough. Otherwise, they'll continue dumping currency and pushing up prices.

Now let's try to imagine ol' Helicopter Ben raising rates in an economy with 10% unemployment, a 10% budget deficit, total debt equal to 380% of GDP and falling house prices. We can't picture it. We squeeze our eyes...we wrinkle our brow...but as hard as we try...

...we can't imagine it.

*** Here's the Telegraph with a report on one of the big bombs that could explode any day:

"The Royal Bank of Scotland has advised clients to take out protection against the risk of a sovereign default by China as one of its top trade trades for 2011. This is a new twist."

"It warns that the Communist Party will have to puncture the credit bubble before inflation reaches levels that threaten social stability. This in turn may open a can of worms.

"Officially, inflation was 4.4pc in October, and may reach 5pc in November, but it is to hard find anybody in China who believes it is that low. Vegetables have risen 20pc in a month."

"The Communist Party learned from Tiananmen in 1989 how surging prices can seed dissent. "Inflation is a redistributive mechanism in favour of the few that can protect living standards, against the large majority who cannot. The political leadership cannot, will not, take risks in that regard," said Mr Ash."

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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