Fighting the Correction in the Worst Possible Way

Want to know what is really going on?

Investors are waking up. They are wiping the sleep from their eyes. Behold! No recovery.

Analysts and the commentariat are struggling to make sense of it. With record low mortgage rates, and after eight programs designed to boost up housing, for example, sales are still plummeting. July saw the biggest monthly drop in existing house sales since the Johnson Administration.

The supply of houses for sales is growing - thanks to record foreclosures. The demand is falling. Prices will come down too.

It's a Great Recession, say some.

It's not a recession, it's a depression, says David Rosenberg.

It's a "Contained Depression," says one headline at Seeking Alpha.

The recession never ended, says another headline.

Stocks will sink to 5,000, says a headline at CNBC.

Bloomberg takes a more moderate tone:

"Durables, Housing Signal Recession Risk."

But you, dear reader, you want to know what is really going on. So we will tell you.

We begin with a detail from yesterday's news: credit card debt has dropped to its lowest level in eight years. This tells us that the de- leveraging of the private sector is real...and on-going. And as long as it lasts, you can forget about a "recovery."

Instead, you should expect more on-again, off-again recession...with high unemployment, falling asset prices (stocks and real estate), weak sales and declining incomes.

This correction is a good thing. Consumers have too much debt. They'll be better off when they get rid of half of it. But the feds want to fight this correction in the worst possible way. What's the worst possible way? Adding more debt!

While the private sector de-leverages, the public sector leverages up. Eventually, this will have the result that everyone expects...bonds will crash, and the dollar will collapse...BUT PROBABLY ONLY AFTER PEOPLE STOP EXPECTING IT.

In the near term, the stock market is probably going down...it seems to be rolling over now. Yesterday, the Dow rose 19 points - a very weak bounce after so many down days.

When stocks go down, they will drag inflationary expectations. It will probably bring down stock markets in the emerging economies...possibly causing the Chinese economy to blow up...and bring falling commodities prices and deflation too. The idea of a "bond bubble" will disappear. People will see the "depression/Great Recession" as real...and permanent. They will try to protect themselves by buying US Treasury bonds. This will permit the feds to go further and further into debt.

Thus begins the world's long day's journey into night.

The US economy will become a Zombie Economy, with more and more activity dependent on government spending and government support. Banks are already Zombie Investors. Rather than lend to viable businesses that expand the world's wealth, they borrow from the feds and lend the money back to them. We'll see private investors become Zombie Investors too - putting nearly all their savings into US Treasury paper, just as the Japanese did.

The Dow will sink down towards 5,000. The feds will announce program after program to boost up the economy. Household savings rates will head to 10%. Unemployment will go to 12%...maybe 15%. Bond yields will collapse to new record lows. Ben Bernanke will threaten to drop money from helicopters...but as long as the US remains in an orderly decline, he will not dare to do it.

Eventually, the whole system will blow up in a spectacular fireball. But not until America's investors are fully committed to US paper. Then, after having suffered huge losses in stocks and real estate, they can be finally ruined in what they thought were the safest investments in the world - dollar-based US Treasury bonds.

And more thoughts...

No discussion of the upcoming collapse of the bond market would be complete without a mention of Social Security.

At least, after they've lost their money in stocks, real estate and bonds, Americans will at least have Social Security to live on, right? Wrong!

You know all that money you pay in Social Security taxes? Where do you think it goes? Into current expenses and US bonds!

That's right, the feds just use the money to finance whatever fool scheme they've got going at the moment...and give the Social Security Administration a bond in return. In theory, the SSA has assets. In practice, all they've got is the hope that the feds can squeeze enough money out of taxpayers to meet their obligations.

Can they?

Professor Laurence Kotlikoff:

Social Security has also played a central role in the massive, six- decade Ponzi scheme known as US fiscal policy, which transfers ever- larger sums from the young to the old.

In so doing, Uncle Sam has assured successive young contributors that they would have their turn, in retirement, to get back much more than they put in. But all chain letters end, and the US's is now collapsing.

The letter's last purchasers - today's and tomorrow's youngsters - face enormous increases in taxes and cuts in benefits. This fiscal child abuse, which will turn the American dream into a nightmare, is best summarized by the $202 trillion fiscal gap discussed in my last column.

The gap is the present value difference between future federal spending and revenue. Closing this gap via taxes requires doubling every tax we pay, starting now. Such a policy would hurt younger people much more than older ones because wages constitute most of the tax base.

What about cutting defense instead? Sadly, there's no room there. The defense budget's 5 percent share of gross domestic product is historically low and is projected to decline to 3 percent by 2020. And the $202 trillion figure already incorporates this huge defense cut.

Reducing current benefits, most of which go to the elderly, is another option. But such a policy is highly unlikely. The elderly vote and are well-organized, whereas 3-year-olds can neither vote, nor buy Congressmen.

In contrast, cutting future benefits is politically feasible because it hits the young. And that's where Congress is heading, starting with Social Security. The president's fiscal commission will probably recommend raising Social Security's full retirement age to 70 from 67, for those who are now younger than 45. This won't change the ages at which future retirees can start collecting benefits. It will simply cut by one-fifth what they get.

In other words, there is no question about whether the US government will default or not. It will default. The only question is how. Will it manage to slip out of its obligations by raising the inflation rate enough to slough them off? Or will it have to officially renounce them? Will it refuse to pay retirees? Or bondholders?

Any way you look at it, the situation is interesting. Retirees, employees, loafers and chiselers - all are stakeholders in the US government. They have something to lose and will fight to hold onto what they've been promised. Bondholders have something to lose too.

So far, the bondholders have been largely protected - even enriched. Stakeholders in Greece, Ireland and other countries have begun to feel the pain. In America, the class of stakeholders is actually increasing, as the public sector spends more and the private sector spends less.

Best guess: stakeholders, bondholders, placeholders, cupholders, napkin holders - they'll all take a loss.

Regards,

Bill Bonner
for The Daily Reckoning Australia

Fighting the Correction in the Worst Possible Way , 9.6 out of 10 based on 12 ratings

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• What’s Really in the Social Security Trust Fund?
• The More Money in a Financial System the Less Each Unit is Worth
• The Country is Going into a Recession with its Finances in the Worst Shape Ever
• Opt Out of Social Security
• Can the U.S. Central Bank Really Begin Fighting Inflation in a Serious Way?