Return to Magic Mountain

The mountain is still there...but where's the magic?

"This year the politicians are the real stars," says a commentary in the International Herald Tribune this morning. Which gives you a hint about how bad the show is...

"It's worse, quite frankly...than everyone thought it was...and it's getting worse every day," says America's new Vice President, Joe Biden.

Mr. Biden is talking about something he knows nothing about - the worldwide financial crisis. And this week, a large group of people who know nothing about it are going to travel to Davos, Switzerland, to talk about the financial crisis.

Davos was once made famous by Thomas Mann's book, The Magic Mountain. Now it is made famous by the movers and shakers who gather at the place each year to move and shake. Recent years have seen an explosion of glitz and glamour at Davos - led by Hollywood celebrities and big-spending financial firms. Goldman Sachs, for example, provided the money, hosting a party that was always the talk of the town. Brad Pitt and Angelina Jolie brought the intellectual gravitas. And politicians provided a comic element.

But no one is laughing at the politicos now. The whole world is making a shift...from the "innocent fraud" of the free market to the armed robbery of politics. People are taking politicians seriously again.

"The pendulum has swung and power has moved back to governments," says Davos organizer Klaus Schwab.

All over the world, capitalism is out...politics is in. Obama is a hero. Fuld is a schmuck. Politicians are taking control of banks. They - not investors - are deciding which firms survive and which perish.

For example, this morning brings news that the auto parts sector needs a bailout too. If it doesn't get $10 billion of somebody else's money, it will be in big trouble, it says. And there's Larry Flynt, over in the porno business. He says the bump and grind industry has fallen on soft times too. Will the feds rise to the occasion and pump in a little cash, he wants to know? We will see.

The problem is, practically every industry needs cash.

Leverage is a two-way street. When the going was good, a small addition to the financial sector's capital would be multiplied many times. The limit for Wall Street's investment firms was 12 to 1...until it was increased to 33 to 1 in 2004. Thereafter, if you put $100 into an investment bank...counterparties would soon have about $3,300 worth of credits.

Easy come...easy go! When the financial system rolled over last year, the banks lost money. Suddenly, $100 less in bank capital forced the banks to reduce outstanding credit by as much as $3,300. Cash disappears and everyone is forced to cut back.

The guy who was going to buy a new car decides he should wait a year or two...and then Detroit is hurting. And then, the assembly-line worker is laid off...so he cuts back on his porno purchases... Pretty soon, no one has any money.

Even the best companies - such as Microsoft - say that the days of easy-spending customers are over. (See below...)

So Obama is trying to come up with a global solution - tax cuts, infrastructure spending, rebates, handouts, bailouts, stimulus spending...a little of this...a little of that...anything that will get cash back into peoples' hands again.

The logic of it is so simple we can't understand it. People spent too much. Now the feds want them to spend some more. The crowd at Davos ought to put down their champagne classes and think about that. Instead, they will learn the latest claptrap theories and return home inspired by the latest self-serving hokum.

"Governments need to take a more aggressive stance," they will say. "We need to regulate morewe need to control more...we need to spend more! We need a worldwide, coordinated program of economic stimulus."

But when Republicans saw the details of Obama's big spending project - $825 billion worth - they weren't stimulated at all. Instead, they lost interest. Not that they mind throwing cash around wantonly...nor does it seem to bother them that the U.S. government doesn't have any cash to throw around...instead, they just thought they could do a better job of chucking it out.

"At the end of the day, we want him to succeed," said the Republican minority leader. "Because America needs him to succeed."

Will Obama's plan get the economy going again? Even one of his aides says it "may not be enough."

Here at The Daily Reckoning, however, we take a different view: to us, it is not too little; it is too much. It is bad money after good. Mistakes need to be corrected, not hidden behind the new furniture. Bad investments need to be reckoned with...not propped up with someone else's money. The mountain of debt is still there; there's no magic that will make it disappear.

*** Gold got a big boost on Friday - up to nearly $900. What does the gold market see? Inflation? Bankruptcies? Monetary chaos?

We don't know. But gold is what you buy when you fear that the financial authorities are making a mistake. And right now, central bankers worldwide are trying an experiment program called "quantitative easing." As we have explained, you can't slide a knife between "quantitative easing" and printing money. They're so close, you can't tell where one stops and the other begins. And when the other begins, inflation begins too.

At some point, inflation is likely to appear suddenly. In the space of a few days, prices could rise so sharply it will take our breath away. That is not likely to happen as long as the financial sector and the real economy are both imploding. But perhaps gold is looking a year into the future. Maybe less.

No matter when gold skyrockets, we will be prepared...and so can you. Find out the easiest way to pad your portfolio with gold by clicking here.

*** Our Pittsburgh correspondent, Byron King, former classmate of Steve Ballmer, passes along a letter sent to Microsoft employees.

" I wonder if Pres. Obama will send a memo like this out to the federal workforce?" he writes.

"Or will Gov. Schwarzenegger send a similar memo to the California workforce? Or Gov. Patterson to the New York workforce? Or Gov. Rendell to the Pennsylvania workforce?"

From: Steve Ballmer

To: All Microsoft FTE

Subject: Realigning Resources and Reducing Costs In response to the realities of a deteriorating economy, we're taking important steps to realign Microsoft's business. I want to tell you about what we're doing and why.

Today we announced second quarter revenue of $16.6 billion. This number is an increase of just 2 percent compared with the second quarter of last year and it is approximately $900 million below our earlier expectations.

The fact that we are growing at all during the worst recession in two generations reflects our strong business fundamentals and is a testament to your hard work. Our products provide great value to our customers. Our financial position is solid. We have made long-term investments that continue to pay off.

But it is also clear that we are not immune to the effects of the economy. Consumers and businesses have reined in spending, which is affecting PC shipments and IT expenditures.

Our response to this environment must combine a commitment to long-term investments in innovation with prompt action to reduce our costs.

During the second quarter we started down the right path. As the economy deteriorated, we acted quickly. As a result, we reduced operating expenses during the quarter by $600 million. I appreciate the agility you have shown in enabling us to achieve this result.

Now we need to do more. We must make adjustments to ensure that our investments are tightly aligned with current and future revenue opportunities. The current environment requires that we continue to increase our efficiency.

As part of the process of adjustments, we will eliminate up to 5,000 positions in R&D, marketing, sales, finance, LCA, HR, and IT over the next 18 months, of which 1,400 will occur today. We'll also open new positions to support key investment areas during this same period of time. Our net headcount in these functions will decline by 2,000 to 3,000 over the next 18 months. In addition, our workforce in support, consulting, operations, billing, manufacturing, and data center operations will continue to change in direct response to customer needs.

Our leaders all have specific goals to manage costs prudently and thoughtfully. They have the flexibility to adjust the size of their teams so they are appropriately matched to revenue potential, to add headcount where they need to increase investments in order to ensure future success, and to drive efficiency.

To increase efficiency, we're taking a series of aggressive steps. We'll cut travel expenditures 20 percent and make significant reductions in spending on vendors and contingent staff. We've scaled back Puget Sound campus expansion and reduced marketing budgets. We'll also reduce costs by eliminating merit increases for FY10 that would have taken effect in September of this calendar year.

Each of these steps will be difficult. Our priority remains doing right by our customers and our employees. For employees who are directly affected, I know this will be a difficult time for you and I want to assure you that we will provide help and support during this transition. We have established an outplacement center in the Puget Sound region and we'll provide outplacement services in many other locations to help you find new jobs. Some of you may find jobs internally. For those who don't, we will also offer severance pay and other benefits.

The decision to eliminate jobs is a very difficult one. Our people are the foundation of everything we have achieved and we place the highest value on the commitment and hard work that you have dedicated to building this company. But we believe these job eliminations are crucial to our ability to adjust the company's cost structure so that we have the resources to drive future profitable growth.

I encourage you to attend tomorrow's Town Hall at 9am PST in Cafe 34 or watch the webcast.

While this is the most challenging economic climate we have ever faced, I want to reiterate my confidence in the strength of our competitive position and soundness of our approach.

With these changes in place, I feel confident that we will have the resources we need to continue to invest in long-term computing trends that offer the greatest opportunity to deliver value to our customers and shareholders, benefit to society, and growth for Microsoft.

With our approach to investing for the long term and managing our expenses, I know Microsoft will emerge an even stronger industry leader than it is today.

Thank you for your continued commitment and hard work.

Steve

And on that note...we will sign off for the day,

Bill Bonner

for The Daily Reckoning Australia

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