Free Money

Hate thy neighbor? Giveth his children money; that will fix them all.

Few things are as costly as free money.

When the Spanish Galleons came back from the New World with cargoes of gold and silver coins, the Spaniards thought they'd hit the jackpot. All of a sudden, Iberia had plenty of money. Historians report that the Spanish neglected their fields and their manufactures; now they had easy money to spend. Prices rose quickly. Then, when the treasure ships stopped coming, the Spanish were broke. Spain - and Portugal too - went into a decline that lasted four centuries.

In the late 1990s, America got in the habit of getting shiploads of stuff from Asia - and paying for it only with pieces of green paper. Pretty soon, Americans too neglected their own factories - though not their fields. Let the Asians sweat, they said. We'll think!

Not much serious thinking has taken place in the United States of America for the last 20 years. Instead, people preferred comforting illusions and conceited claptrap. We have the 'strongest, most dynamic economy the world had ever seen,' they congratulated themselves.

Of course, you don't need to think - not when you ship is coming in. But now that the ship is sinking you'd expect people would put on their life jackets and their thinking caps. Nope. Now they look to the government for the free money. Yesterday's news told us that Congress is now spending away $1 billion per hour.

We'll come back to that in a minute...

First, some treacherously good news: the Dow rose again yesterday...up 239 points. We're still withholding judgment, but it looks as though this might finally be the long-awaited rally. Stocks worldwide lost more than half their value without a single major rebound. We're overdue for one. Maybe this is it.

Oil rose too - to $47. It seems to be getting ready to slide back over the $50 mark.

And the dollar may have topped out. The euro rose yesterday to $1.28...while gold recovered $13 to close at $924.

As near as we can tell there is no good reason for stocks to rally. Unemployment is still rising and sales are still falling. Until those trends flatten out, there is no reason to think business will improve.

Au contraire, business conditions are worsening and companies are cutting dividends faster than any time since the Great Depression. How can stocks go up in price...when sales and earnings are falling? The only possibility would be an increase in P/E ratios. But who wants to pay more for corporate earnings now?

No one we know. Instead, investors are becoming more and more wary. Why? Because even the biggest, strongest companies in the world are reporting problems. The agencies knocked down GE's rating the other day. "What's it worth now?" asks a headline. But the same question could be posed to almost any company on the planet - conditions have changed; what's it worth now?

Last autumn, Warren Buffett commented on the solidity of his own company: "If Berkshire [Hathaway] isn't Triple A, I'm not sure which company would be."

But yesterday, Fitch took Berkshire down a notch...noting that the company had financial exposure in its insurance division that could be troublesome. Berkshire is no longer Triple A. And investors have to ask themselves: if you can't trust the best companies, run by the best CEOs, who can you trust?

We won't wait around for an answer, because there is none. The fact is the crisis has put a question mark behind all asset values.

Again, you'd expect these question marks to inspire a little serious thinking. If assets aren't worth what we thought they were worth...well, what are they worth? And what is happening in the economy that makes things so uncertain?

House prices show no sign of reaching a bottom; foreclosures are running 30% ahead of last year. And the press reports that there are 14 million empty houses in the United States. What happened to all the people who lived in them? Below...a partial answer...

Meanwhile, the free money is flowing. Taxpayers got rebate checks from the government last year - even if they hadn't paid any taxes. According to recent tallies, the feds have committed $12 trillion to freebies, bailouts, and boondoggles.

GM got a few billion. But the banks and Wall Street have been the biggest freeloaders so far. AIG has gotten four bailouts. Freddie Mac took a big bailout from the government too. But boo hoo...Freddie lost $50 billion last year, says the Washington Post, so it will need a little more help.

Freddie Mac "to tap $30.8 billion in aid as losses deepen," says the Bloomberg report.

When will the losses stop? Who knows? But chances are...not any time soon. You're going to have to protect yourself - and your assets - from these bailouts.

*** Where have all the homeowners gone...Long time passing
Where have all the homeowners gone...Long time before
Where have all the homeowners gone...Gone to motels everyone...
When will they ever learn? Oh when will they ev-ev-er learn?

There are said to be 14 million empty houses in America. Where did the former tenants go, we wondered?

The New York Times has part of the answer: they've moved into motel rooms:

"Greg Hayworth, 44, graduated from Syracuse University and made a good living in his home state, California, from real estate and mortgage finance. Then that business crashed, and early last year the bank foreclosed on the house his family was renting, forcing their eviction.

"Local officials estimate that 1,000 families who live in motels in Orange County, Calif., go uncounted in federal homeless data.

"Paris Andre Navarro, 47, and her daughter, Crystal, 11, have been living at the El Dorado Inn in Anaheim, Calif., for three years. Ms. Navarro said the $241 weekly rent makes it hard to save.

"Now the Hayworths and their three children represent a new face of homelessness in Orange County: formerly middle income, living week to week in a cramped motel room."

*** Finally, a Dear Reader with a comment:

"I have been reading your comments regularly for a past few years, during which I was a Managing Director at at a major US and, thereafter, major European financial institution. I am now semi-retired, living in the English countryside and watching the meltdown from afar. In my youth I was drawn to Austrian and Libertarian thinking and, as I progressed in the financial industry, never forgot these roots. Now I feel fortunate to have that grounding as it helps me to better understand what is really going on.

"During 2004-07 I saw the financial industry stacking up the powder kegs that would eventually blow up. I tried on occasion to warn people. But my warnings fell on deaf ears at Lehman and elsewhere, but not for the reasons you might think.

"I recall numerous conversations with senior people at various global financial firms on topics ranging from Fed policy, to the US/UK housing markets, securitisation and its potential pitfalls, the CDS tangle, and so on. One thing that is clear to me is that key people at these firms were aware for the most part what risks they were taking. They knew that it was all going to blow up someday, if not so spectacularly as it now has done. But they all believed that somehow they would be quicker and cleverer than rival firms, that they would effectively hedge themselves and they would get out first, before things got really ugly. As you well know, that sort of collective "greater fool theory" mindset is characteristic of bubbles and, if widely held, almost ensures that liquidity will dry up suddenly as markets turn for the worse.

"Believe me, they knew they were playing with fire to a much greater extent than is currently acknowledged. They blame 'animal spirits' and 'market forces' when they were, in fact, the most important market participants. No wonder a hedge didn't work if most major global financial institutions held the exact same hedge! If you are curious I can fill you in on some of the details although I suspect you know much of this already.

"In any event, I admire you and those few who are tirelessly pointing out that it was most emphatically not the free-market, but rather central banking and misguided regulation, that got us into this mess. You are doing the next generation a great service. Sadly, the current generation is probably beyond help at this point. I hope and pray that, like a phoenix, a form of proper, free-market capitalism rises from the ashes of the current conflagration."

Bill Bonner
for The Daily Reckoning Australia

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:

• Major Premise That Government Economists Can Improve Workings of a Free Economy
• Stocks in a Free-Fall
• Can Government Bureaucrats do a Better Job of Allocating Capital than Free Markets?
• Fed is Trying to Keep the Money and Credit Moving: Commodities, Food, Oil and Gold
• Ranting Against Free markets and Wall Street