Darkness without a dawn... - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 13 December 2011
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Baltimore, Maryland

The Dow down 167 yesterday. Gold down $48. Nothing to get excited about.

The excitement is still ahead. When the Dow cuts through the 10,000 mark and heads to 6,000. Stay tuned...

In the meantime, yesterday's Financial Times told us that the industrialized nations will borrow $10 trillion this year. Next year, the figure should be higher.

Where does all that money come from? It's more than the world's total savings. Not that we know exactly, but total world GDP is about $50 to $60 trillion. Savings should be about 10% of that - or only about $5 to $6 trillion.

So how are the developed nations able to borrow so much?

With so much debt turning over, it makes the world financial system extremely vulnerable to inflation...or just a change of sentiment in the bond market. Which makes us wonder. What would happen if the lenders balk?

We are, as all Dear Readers know, in a Great Correction. And in a great correction asset prices fall...along with a general fall-off in employment, consumer spending, investment, GDP growth and all the other things that make a robust economy. Demand drops...which typically causes prices to fall (or at least not to rise as quickly as before). There is less demand for credit as for everything else. So, the pool of available bonds falls...forcing up bond prices and forcing down bond yields.

Got that?

Well, don't worry if you don't. Because there's at least a 50/50 chance it won't happen that way.

So far, the Great Correction has followed the usual script. Bond yields have fallen. Price inflation has generally come down. But demand for credit - as evidenced by the aforementioned $10 trillion government financing costs - is running hot. 'Typically' may not matter. Because this is no typical downturn. And it wouldn't be too surprising if all this demand for credit pushed up bond yields.

Wouldn't that be a drag?

And here we find ourselves with a grim, but philosophically amusing, insight. Typically, every cloud has a silver lining. Every glass that is half empty is also half full. And dawn follows even the darkest night. That's just the way the world works. But what if the cloud has no lining, neither of silver nor of anything else that reflects light? And what if the glass is completely empty?

In the normal economic world, low interest rates are the half-full part of the correction glass. A correction comes. Asset prices go down...along with all the other things mentioned above. But interest rates go down too...which make it easier for new projects to clear the "hurdle rate." At 6% interest, for example, a new project has to return at least 6% to breakeven. Any new investment that won't produce more than a 6% minimum gain is quickly abandoned. But as the correction drives down yields, to say 3%, all of a sudden a lot more investments begin to make sense. Dawn comes.

Lower inflation rates...and lower asset prices...help too. As prices fall, shrewd investor and careful businessmen can put their money to work again. Employees are re-hired. Household earnings recover. Soon, the downturn is over.

Both booms and busts are, normally, self-correcting.

But leave it to the feds to stop the sunrise. This huge demand for credit from the industrialized governments could drive up interest rates. Imagine what that will do. Already in a slump, households, businesses and investors could find their borrowing costs going up, not down. They could find prices rising, too, especially the prices of energy and food. What a world...a major slump, but with rising prices and rising interest rates!

And then, consider what happens next. The feds will err again. They will feel obliged to finance government borrowing themselves. Here's the Bank of International Settlements, giving us the heads up:

The Bank for International Settlements Sunday issued an oblique endorsement of coordinated action by the world's largest central banks to ease funding conditions for banks. "A freezing of interbank markets in major funding currencies, as during the recent crisis, may require the ability to supply official liquidity in major currencies in an elastic manner," the BIS wrote in its regular quarterly report." - MarketWatch

It was only a week ago that 6 major central banks announced a coordinated rate cut - expected to juice up the markets. And now all major central banks seem ready and willing to sacrifice the integrity of their currencies in order to protect their bond speculators.

This is what we expected all along. But we didn't expect it so soon. It causes us to revisit our "long, dark road to Tokyo" forecast. You remember our prediction: the US has already followed Japan through one "lost decade." We figured it will lose another one as the Great Correction drags on.

But things could happen faster...and worser. Japan financed its own deficits with its own money. Now, everybody is running deficits. And the amounts to be refinanced are staggering. Bond buyers may balk...or simply be unable to swallow so much debt.

Which will cause the central banks to come into the picture - with coordinated money-printing. Instead of going down, bond yields and consumer prices could go up.

Think things are bad now? Wait until the economy has to deal with a Great Correction and inflation.

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*** "The Divine Right of Kings" was a theory of government that held water. But you had to put the water in the right container. You had to believe in God. You had to believe that He gave out job assignments. You also had to believe that He didn't mind when His employees and agents made a mess of things...or even when they contradicted His own orders. Looking the history of the monarchs who were thought to have been given this divine authority, you would have to conclude that God was either a very tolerant task-master, or a very negligent one. Adultery, murder, thieving, lying - there was hardly one of God's commandments they obeyed.

As a theory of government, the 'divine right of kings' would have been okay had it not been for the kings themselves. Some were reasonable men. Others were tyrants. Many were incompetent, largely irrelevant and silly. Taken all together, it was very difficult to believe that they had been selected by God, without also believing that God was just choosing His most important managers at random. Kings were not especially smart. Not especially bold or especially timid. Not especially wise or stupid. For all intents and purposes, they were just like everyone else. Sometimes smart. Sometimes dumb. Sometimes good. Sometimes evil. And always subject to influence.

Towards the end of the 18th century, the 'divine right of kings' lost its following. The church, the monarch and the feudal system all seemed to lose market share. The Enlightenment had made people begin to wonder. Then, the beginning of the "Industrial Revolution" or the "energy revolution" made them stir.

In 1776, Adam Smith published his "Wealth of Nations," arguing that commerce and production were the source of wealth. Government began to seem like an obstruction and a largely unnecessary cost. Its beneficial role was limited, said Smith, to enforcing contracts and protecting property.

The school of laissez-faire economics maintained that government was a "necessary evil," to be restrained as much as possible. The "government that governs best," as Jefferson put it, "is the one that governs least."

Government was supposed to get out of the way so that the 'invisible hand' would guide men to productive, fruitful lives. Smith thought the arm attached to the invisible hand was the arm of God. Others believed that not even God was necessary. Men, without central planning or God to guide them, would create a 'spontaneous order,' which would be a lot nicer than the one created by kings, dictators or popular assemblies.

This theory of government, such as it is, leads to what we know of today as "libertarianism." Libertarians argue about how much authority the government should have. They scrap among themselves over what the government should do and how big it should be allowed to get. But all libertarians agree with Jefferson. And all agree that the governments in the world circa 2011 are much too big.

Here at the Daily Reckoning we are sympathetic to this point of view. Not that we are libertarians. We just don't like anyone telling us what to do.

But libertarianism is hardly a theory of government. It makes little attempt to explain why government is what it actually is. In fact, it is purely prescriptivist day-dreaming, focused on what government ought to be. In theory, a government ought to be small, say the libertarians.

Government ought to mind its own business, they say. It ought to sort out disagreements between members of the public...and protect the public from wrongdoing. It ought to have not to drain the resources and productive output of one part of the population for the benefit of another. But so what? Who cares what the libertarians want?

Throughout history, government has operated in pretty much the opposite fashion. The insiders who get control over the police power of the state use it to promote their own agenda. Sometimes it is an apparently selfless agenda. Adolf Hitler, for example, took little wealth for himself. Nor did Stalin raid the public treasury for his own benefit. Instead, each worked long and hard in the interests of his people. ( It would have been better if they had been on the make for money. It might have distracted them.)

Whether the insiders want money or power hardly matters. If they seek money, they take it from the outsiders - those, by definition, who do neither control nor are favored by the insiders. If they seek power, that too must be taken from someone. The outsiders pay, every time.

While the proto-libertarians focused on how much harm an activist government could do, the utilitarians, positivists, and collectivists turned their attentions to how much good it could do. According to John Stuart Mill and Jeremy Bentham, a government should provide the "greatest good to the greatest number."

Again, this was not a theory of government, it was merely an idea about what government should do. And a dumb idea, at that. Who knows what is 'good' and what is not? Only God...or people themselves. Since God keeps his own counsel, only the people can decide. But how? They can only decide if they are allowed to choose for themselves - how they will spend their time and their money. And the only way they can spend their time and money as they wish is if they are given the liberty to do so, which takes us back to libertarianism, the very creed to which the utilitarians, positivists and collectivists opposed themselves. They wanted an elite to decide what was 'good' for the masses.

Which, of course, is what really happens. The elite insiders decide what they want. They call it 'good.'

More to come...

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

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