O! Bama! Where is thy bounce!

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Yesterday, stocks got whacked again – the Dow was down 411 points, bringing the loss for the year to more than 4,000 points.

Oil fell to $56 a barrel; investors feared that the world’s drivers would leave their cars in the garage and the world’s teenagers would begin turning off the lights when they left their rooms.

And they seem to be right.

“Buying binge slams to a halt,” reports the New York Times. It is a “crisis of confidence” among consumers, the paper explains.

Crisis of confidence? No… it is more like an attack of good sense… a bout of sanity… a brush with sobriety. This is a ‘balance sheet recession,’ remember. Consumers, businesses and speculators are all acting perfectly reasonably. They haven’t lost their senses, in other words, they’ve come back to them. They finally realize that they need cash… savings… money in the bank “for a rainy day.”

The weather forecasters on Wall Street and in the press said it would never rain again. But here it is – pouring down!

Even gold is running for shelter. The price of an ounce of gold fell $22 yesterday.

A hard rain is gonna fall. No doubt about it, it’s falling already.

And now, the whole world turns its weary eyes to America’s president-elect – Barack Hussein Obama:

“Mr. Obama, please… do something!” they beg. “Save me! Spare me! I promise I will never do stupid things with my money again. “

Will Obama be able to restore consumers’ confidence? Will consumers recover from their bout of sobriety? Will the feds be able to lure them off the wagon with more cheap booze?

And so… those questions before us… the world moves closer to its first trillion-dollar deficit. Wait… did we say ‘trillion dollar?’ Make that $2 trillion.

There is now no doubt about the general direction of the markets and the economy – they’re going down. That’s not to say we can’t have a nice rally. We’d be disappointed if we don’t get one. Following the crash of ’29, for example, the Dow rallied back to within 60 points of its all time high. The rally took 6 months and gave investors plenty of time to get out.

Instead, many concluded that the good times were rolling again. Alas, it wasn’t so. The good times were over… and wouldn’t really come back until the 1950s – 20 years later.

What we had in the ’30s… in Japan in the ’90s… and now worldwide… was a massive destruction of wealth. Well, wealth… such as it was. In all three cases, a huge, credit-led boom led to a huge build-up in speculative debt. Then, when asset prices fell… balance sheets looked terrible. People had to pay down debt and build up savings. That takes many years. And while it is going on, spending, investing and living it up are depressed. Obviously; people need the money for other things. Just look at Starbucks – the stock is down 75%. And Coach (maker of expensive leather handbags) – down two thirds. Tiffany has been cut in half.

Yes… the hard rain is falling on everyone, rich and poor alike.

*** Central banks lower interest rates to try to gin up some activity. They set up another round of drinks, hoping the party will get going again. The Fed cut rates decisively (if a bit slowly) in the ’30s. Japan’s central bank went further – taking rates down to near-zero and leaving them at that level for years. The U.S. Fed, meanwhile, has already hacked its key rate down to 1%. It’s ready to cut more… if need be.

But the central bankers are missing the point. They’re like a liquor salesman at an AA meeting. Everyone is desperately trying to sober up – not go on another bender. Of course, the feds will get a few people to take up the bottle again… but these poor saps will be even worse off.

In this type of correction, people need to correct the mistakes of the late bubble. That means getting balance sheets back in balance. And that means spending less and saving more.

Economists describe this problem as “pushing on a string”… or a “liquidity trap.” The central bank can make more credit more readily available, but it can’t force people to borrow.

Yesterday’s news headlines included one that went to the heart of the matter; “Government to force banks to lend.” But the problem is not so much the banks – it’s the economy itself. Banks would be happy to lend – if they could be reasonably assured of getting their money back. But in a crumbling economy… who knows?

This is the tough financial situation that President Obama will face.

While monetary policy won’t do much good, fiscal policy might. At least, there’s plenty of temptation in fiscal policy… so much that powerful, ambitious and/or corrupt politicians – forgive us for repeating ourselves – always find it irresistible.

The principle is simple. If businesses won’t spend… and consumers won’t spend… the government will do the spending. This is the idea made popular by Keynes and known today as “Keynesian” economics.

“We are all Keynesians now,” said Richard Nixon back in the ’70s. As we said, the idea was irresistible.

Keynesian spending doesn’t really make people better off, but it has three things going for it:

1) It gives politicians an excuse to spend more money

2) It looks like things are getting better… and at least government is “doing something”

3) It tends to keep the lights on

In the coming U.S. downturn, (we say “coming” because the worst of it is still in the future) consumers are likely to pull hard on their belts and send the rate of saving soaring. Maybe not the 20%-30% you see in Japan and China, but at least back to the 10% we saw before the 1990s. That will remove more than $1 trillion from the economy. Directly. Indirectly, it will remove a lot more.

And here we bring bad tidings of Christmas.

“Balloon bursts on festive parties in tough times,” is a headline at the Financial Times. Companies are cutting back sharply on their holiday celebrations. We know that from personal experience. A memo just received from corporate headquarters in Baltimore tells us that the annual Christmas party will be greatly scaled down. “Employees only,” is the word.

Well, the grinches in our own little company are generous compared to those in other firms. The big Wall Street firms “have scrapped extravagant parties,” comes the word from the street. “What’s there to celebrate?” asked one executive. “It’s the year from Hell.”

Certainly a “glass is half empty” way of looking at it. It’s a correction. And in corrections, spending goes down as people correct the errors of the past.

In Detroit, GM and Chrysler have cancelled their big holiday bashes, too. Oh, the poor caterers! It’s not as if there were a lot of upper-end work in Detroit these days. The caterers probably waited all year to put on a big do at Christmas for the carmakers. Then, wham, they cut off the juice… the party lights go out… and it’s a cold, cold winter in Detroit. As if it weren’t cold enough already!

The automakers are trying to cut costs as rapidly as they can. But revenues fall faster. Vehicle sales fell again in October – for the 12th straight month. This is the longest losing stretch in 17 years.

A writer for Britain’s Spectator Business took a drive to Detroit to check on the state of things. Spotting a live human being in a huge parking lot… apparently guarding an abandoned factory… he stopped to chat.

“Ten years ago, this place was booming,” said the guard. “Hard to believe isn’t it? Back in ’85 I used to work for General Motors fitting radios and cruise-control switches to the dashboards of cars. But they moved the factory somewhere else and that was that. Now I do security. Although what they’re guarding this for, I do not know. There’s nothing here.”

Behind him was the apocalyptic scene we associate with Detroit. Then, referring to the American Dream, the guard took up his reflection:

“I thought it was the auto industry… with jobs and pension and health insurance and what not, but that went pop. Now they say they are building condos everywhere down here, but I don’t know who they think is going to buy them. I guess that’s another type of dream.”

“It’s time to wake up, America,” continues the reporter, “this dream has become a nightmare.”

So, in addition to the $1 trillion taken out by the savers… there’s also the effect of less spending magnified all through the economy. The caterer doesn’t get to serve up a holiday party… the baker doesn’t get to bake… the liquor bottles begin to collect dust… from the guys who park cars to the babysitters to the hairdresser… the whole economy spins fewer dollars… people earn less… and they pay less tax. Then, at the far back of the income bus, the most marginal workers fall off altogether. The jobs they could get anytime before can’t be gotten at all now. McDonald’s begins to get choosey. It wants someone with a master’s degree in fluid mechanics doing its deep-frying. And over at the Bright Nails shop, heck, they’re looking for someone who used to be a chemist!

So the guys with few skills and spotty employment records can’t get jobs at all. They should do like those fellows in Latin America and South Africa. They stand out on the roadsides, waiting for anyone to pick them up and put them to work… a day at a time… one hour after the other. They get paid at the end of the day – in cash. They should reduce the cost of their labor to the point where they’re worth hiring, in other words. But this is the United States of America we’re talking about. This is a democracy. And there are a lot of votes in the greater Detroit area… and a lot of Democrats who are going to be really cheesed off if their man in the White House doesn’t do something to protect the voters from reality.

So what’s Obama going to do? Simple, he’s going to do what his most persuasive advisors tell him to do… he’s going to borrow all those savings and put them to work. Everyone wants the safety of Treasury paper. Fortunately, the Obama Administration is going to give them plenty of it. They’ll absorb the trillion or so in U.S. savings… and then everything else they can get their hands on – including much of the rest of the world’s savings too. The U.S. deficit will soar – along with the national debt. Rates will rise.

And then… maybe 18 months from now… maybe 10 years from now… it will get really interesting…

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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  1. The Obama Bounce to follow JFK Bounce?

    “The Dow had risen steadily in the first half of 1959, but there was a sell-off in the fall, after which the market recovered to close at a new all-time high of 697. But there were indications that a new recession was developing… More than three decades had passed since the Great Crash, but its specter haunted Wall Street whenever the economy gave indications of a downturn or the market sold off…

    “Stocks declined sharply in January [1960], recovered somewhat, and then plunged again, not stopping before cracking the 600 level in March. Richard Russell, a leading technician, wrote that the long-awaited collapse was imminent. But [George] Schaefer [of Indianapolis, the somewhat eccentric publisher of the Dow Theory Trader, [who] had a large following among market theoreticians in the late 1950] disagreed; he remained convinced that one last upward spurt was needed before the house came tumbling down. Hamilton Bolton, a proponent of the Elliottwave Theory, told subscribers that “we are well-entered in the fifth and final upwave – the last in the bull market, and so seemed to agree with Schaefer.

    “There was a mood of Armageddon on Wall Street in 1960. Although stocks see-sawed for the first half year, the Eisenhower bull market clearly had ended.

    “The recession deepened… The automobile companies closed down assembly lines and the housing industry was dormant… the third Eisenhower recession was the most crippling of all.

    “By then the economy was close to bottom, and a sluggish recover would commence in October and November, though this was not realized at the time, of course. The turnabout came too late and too faint to help the fading presidential candidacy of Richard Nixon. “In October, usually a month of rising employment, the jobless rolls increased by 452,000,” Nixon would write in his memoirs [cp. the 240,000 jobs lost in October 2008]. “All the speeches, television broadcasts, and precinct work in the world could not counteract that one hard fact”…

    [“… for “Maverick” McCain, the collateral damage from the October market meltdown torpedoed his long-shot bid for the presidency… a late October to Nov 4th rally, boosting the market by 15%, was too-little, too-late…” (Gary Dorsch, After Shocks from the October Meltdown, 321gold.com, November 7, 2008)].

    “Eisenhower’s successor, John Kennedy, had based a good deal of his campaign upon the need to “get the country moving again,” and he spoke of his willingness to “seek new directions”…” (Robert Sobel, The Last Bull Market, pp.67-69).

    “On the last day of 1960 Wall Street was in a euphoric New Year’s Eve mood… the last Eisenhower administration was expiring amid general stagnation and a mild business recession, and the market, then as nearly always reflected hope or fear about the future rather than current facts, was clearly reacting to the go-ahead spirit created through both instinct and intention by a young President-Elect, John F. Kennedy. People felt that now there would be action, movement, indeed forward movement; good things, never mind what, were bound to be ahead…” (John Brooks, The Go-Go years, p.26).

    “The Cult of Obama” – Sydney Morning Herald headline, November 6, 2008

    “The new mood persisted and grew; very soon, in fact, it grew ominously from cheerfulness to something near mania…

    “By mid-February the stock averages were up some 15 percent from their October lows, and there began to be talk of a “Kennedy boom.” Not even the Cuban Bay of Pigs disaster in mid-April could stem the tide…” (John Brooks, The Go-Go years, pp.26-27).

    “…there were unmistakable signs in March that the recession was ending, and although Kennedy had done nothing to make this possible, he enjoyed the political benefits therefrom.

    “The combination of fresh attractive leadership and the kind of moderation in practice the American people appeared to prefer at the time helped boost Kennedy’s popularity…

    “The Dow closed at 686 on April 12 [1962], giving what Dow theorists considered a “sell signal,” which would mark the beginning of a bearish phase…

    “As it happened, the signal had not been false…

    “The Kennedy Crash had begun…” (Robert Sobel, The Last Bull Market, pp.70-89).

    [In a reversal of The Cuban [Soviet] missile crisis of 1962 we have:

    “President Dmitri A. Medvedev of Russia greeted his future American counterpart, Senator Barack Obama, with bristling language on Wednesday, promising to place short-range missiles on Russia’s western border if Washington proceeded with its planned missile defense system in Eastern Europe” (Ellen Barry and Sophia Kishkovsky, Russia Warns of Missile Deployment, nytimes.com, November 5, 2008)].

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  2. Obama has indicated he will attempt to fix the severe healthcare crisis in the US. If Obama can lower healthcare costs in the US, that would free up money for US citizens (consumers) to spend on other goods and services, thereby, providing some real long-term stimulus to the economy. As it stands now, a tremendous amount of money is wasted on exorbitant health care costs. I’m hopeful, but not optimistic.

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  3. Obama can try but there are not enough medical doctors in many area of the country to treat the aging population. it takes months in my area to get into see a specialist, about 6 weeks to see a family doc, and if you have multiple problems, they seem to hurt you more than help b/c in 8 minutes they can’t take in the entire problem. in addition, most providers are overworked and make mistakes left & right (my experience).

    Obama has not made any effort yet to my knowledge to address the shortage of docs.

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