It's More Than Half Full.

Ok, Bill, let's review those wonderful days from whence we sprang, so fraught with the advantages of having nothing. So potent with opportunity. It was the middle of the '70s when we started our careers. Inflation was high and rising. The Soviets were seen as a major threat. Japan was beating our brains out and buying everything, even if nailed down (like Pebble Beach and New York skyscrapers). I had to borrow money at 15% (or more) to buy paper in order to meet customer demands for printing. And guess what? The banks got into trouble and called loans willy-nilly. (My bank even called my mother and threatened her to pay my loan - against written agreements - and she did. Evil sons of bitches. The more things change... And they delightedly did fail! Not that I hold a grudge.)

There were multiple successive and deeper recessions. Gold was rising as the dollar was seen as a joke. Howard Ruff (a good friend to both of us when we were starting out!) and almost every newsletter writer were telling people to buy gold and freeze-dried food to protect themselves against a near certain economic, if not apocalyptic, catastrophe. Unemployment was high and rising for a decade.

The correct answer to the question, "Where will the jobs come from?" back then was "I don't know, but they will." And it is the correct answer today.

In 20 years, no one will want to come back to the halcyon days of 2005. Our kids (all 13 of them) are getting ready to live through what will be the most exciting period in human history. There will be a century's worth of change, measured by the standard of the 20th century, just in the next ten years, and then we will double that pace in the next ten after that. Medical miracles that will mean our kids and grandkids will live a lot longer than their dads, although I intend to be writing well into my 80s, like our mutual hero Richard Russell.

There will be whole new industries developed in the US. How do I know that? Follow the money. The rest of the world spends a fraction on research and development that we do. Where do you go if you are looking for venture capital?

Do I care if the Chinese and the "developing" worlds are far better off, relatively speaking, than the US in 20 years? Not a whit. Good on them. I hope they make discoveries and inventions and new businesses that benefit us all. But we are not going into some long dark night. We, and our kids, get to choose how we respond to what is the reality of the day.

Our nation had to almost hit the wall in 1980 before a Volker could come along and force us to take the pain of recessions to beat back inflation. And we will have to come perilously close to the wall this time before we take action as a nation. Way to close for comfort. Maybe you are right, and we have a soft depression. I hope not, but even so, the world will be better, far better, in 20 years, with far more opportunities than today.

It was not fun starting new businesses in the '70s and early '80s. But we did. I remember coming to Baltimore and being (literally) afraid to get out of the car to visit your offices in the slums. But that was what you could afford. A far cry from the chateau in Ouzilly.

I lived in a small mobile home. Tiffani was born there, and we converted part of the kitchen to be her bedroom. (Yes, I was white "trailer trash.") But I got up every morning just like you did and killed as many alligators as I could. The rest had to wait till the next day.

And that is the legacy our kids have. They know what it is to wade into the swamp every morning. Never quitting. In thinking about this, you may be the father I respect the most. You have raised your kids to be multi-lingual children of the world. What a work ethic. How did you get them to scrape window shutters at your chateaus? (I actually saw this, and my kids marveled.

Thereafter I threatened to make them go live with you when they did not act right!)

You have given your kids the opportunity to follow their dreams, even demanded that they do so. And such dreams they (and mine) have. Will they succeed? Who knows? But they will go at it with gusto, in a world with more opportunities than you and I ever imagined 40 years ago. And, oh boy, were we optimists back then. How else could we have done what we did? If we believed the rhetoric that the world was coming to an end, would we have dared to venture out?

You cannot have raised your kids to be such bold adventurers without instilling in them a certain high level of optimism. I am going to out you, Mr. Bonner. You present yourself to your readers as a bona fide end of the world pessimist. But you are a really and truly a closet optimist. Your whole business empire (and what an empire it has become!) is based on finding people who are optimists, in the sense that they think they can actually get people to send them money for what they write. Which they do! Even if it is to read why the world will come to an end, which it thankfully never does.

You are right in this: it is personal gumption that makes or breaks us. There are those who started out with less than we did (hard to imagine but true) and made a lot more. And there are those who started out with far more and made less. But there are very few who are happier than either of us. Or luckier.

Our kids? It is not the times which dictate the man (or daughter!), but the response of the man which dictates his own time. Today has a brighter future for someone young than any other time in history, whether they are in the US or Brazil or China. They just have to seize it.

And as our kids do just that, and as the millions of kids of those who read us do so, and the billions of kids who are just now getting ready to bust loose all work to achieve their dreams, the world is going to be a far more fantastic place. Smooth ride? Not a chance. We didn't get one, and in thinking through history, there have not been many smooth rides. Why should we think we will get any better? Our kids will just have to live with our generational (and individual) iniquities, government debt and all, and figure out how to master their own fates. But if I had a choice to take the '70s or today? In less than a heart's beat I choose today. And I bet you would too!

Regards,

Bill Bonner and John Mauldin
for The Daily Reckoning Australia

• Baby Boomers Figure They Will Have to Work Longer than Expected
• Children Growing Up in a Different World
• Baby Boomers Are Ill-Prepared for Retirement
• Rare Coins as an Informal Way of Estate Planning
• Jules Begins His Last Year of School in Boston

What's a little odd about this story is that this woman has three grown children...six grandchildren...and even a great grandchild. Now, what's going on here? Are all those kids so heartless that they won't take in grandma? Or is grandma so insufferable that no one can stand her?

We always take the 'glass half full' approach here at The Daily Reckoning. So this reminds us of what is so nice about depression: it brings families together. It also improves manners. Grandmothers know they need to watch their behavior, or they'll be sent to a homeless shelter.

Once you knock them down it is harder than ever for grandmothers to get back on their feet. Why? They're not as flexible as they used to be. Besides, they have no way to earn money.

Mortimer Zuckerman, editor of US News & World Report, provides the figures:

Of people who are out of work, more have been jobless for longer than at any time since 1948. More exhaust their unemployment benefits before finding a new job than ever before. And if they are lucky enough to find work, they'll work the shortest workweeks since 1951.

In other words, the baby boomers have never seen times so rough...for themselves as well as for their children. One American in nine depends on the government for his daily bread. There are 6.2 million more people on food stamps than when the recession began. And there are 6 people waiting in line for each job opening, up from 1.7 when the recession started.

The baby boomers meanwhile figure they will have to keep working longer than expected. Sixty-three percent of them say they expect to delay retirement in order to build up more retirement savings.

This is bad news for younger workers, who were hoping the boomers would get out of the way to free up some jobs. Among young Americans, unemployment hasn't been so high since 1945.

If that weren't bad enough, the government has made things worse by increasing the minimum wage; that alone cost the young an estimated 300,000 jobs. In a depression, prices fall. The price of labor falls too...but not easily. That's why inflation usually helps increase employment - it lowers the real cost of labor. But people do not accept wage cuts readily. And then, along come the feds with a crackpot scheme to INCREASE wages...making the situation worse.

Naturally, Zuckerman looks at these facts and comes to the wrong conclusion. The headline:

"The free market is not up to the job of creating work."

"Only massive programs are equal to the challenge of restoring stable growth to our economy," he writes, in The Financial Times. What kind of massive projects? He mentions an "infrastructure bank." He might have said a war. WWII worked wonders for unemployment. All of sudden, anybody who wanted a job could find one.

But it's all hokum and claptrap. The Soviet Union put everyone to work. You can see where that got them. It's not the fact that people are sweating on a job site that makes a society prosper; they also have to be doing things that add to their wealth. Infrastructure, like any other capital investment, makes sense only when it pays off. The Japanese poured more concrete per square inch than anyone before or since. They proved that you can put up all the bridges and canals you want; it still won't restart the economy.

The free market is the only thing that can create worthwhile work. Because it is the only thing that knows - by sales and earnings - which projects make sense.

But we're facing a losing battle. People much prefer soothing lies.

Heck, we like them too.

Mundus vult decipi et decipiatur!

Bill Bonner
for The Daily Reckoning Australia

• Baby Boomers Are Ill-Prepared for Retirement
• Baby Boomers Face Early Retirement With No Money Saved
• Chartwell Enterprises – Pyramid or Ponzi?
• Consumer Economy Not Going to Return to Robust Growth Anytime Soon
• Americans Aren’t Borrowing Or Buying

Yesterday, the Dow soared over they 10,000 mark. If it keeps going at this rate - up 144 points yesterday - it will soon equal the post-'29 bounce. All we need is two more days and we're there.

Oil rose over $75. Gold closed the day at $1,064, after a big move to the upside over the last few days. And the dollar fell - to just $1.49 per euro.

The reason for yesterday's big move is announced on the front page of almost every financial rag this morning:

"JPMorgan profits lift the Dow."

JPMorgan, the Wall Street firm that was bailed out by the feds a year ago, reported income of $3.6 billion in the 3rd quarter. With that kind of profit in the financial sector, it won't be long before the whole economy is running red hot, right?

That's what the papers seem to think. The International Herald Tribune says the bank's profits are just another sign that a major recovery is underway. Investors seem to believe it, too. "Earnings optimism," is behind the buying, says a broker.

But is it true? Is the real economy growing, expanding, and making money? Let's look:

"Still on the job, at half the pay," is a headline in The New York Times. It tells the story of an airline pilot whose position has been downgraded and whose pay has been cut in half. The fellow is now earning $30,000 a year rather than $60,000. He is not counted in the unemployment statistics but he has much less spending power than he had a year ago. Practically all his discretionary spending power has been wiped out.

The NYT:

"The Bureau of Labor Statistics does not track pay cuts, but it suggests they are reflected in the steep decline of another statistic: total weekly pay for production workers, pilots among them, representing 80 percent of the work force. That index has fallen for nine consecutive months, an unprecedented string over the 44 years the bureau has calculated weekly pay, capturing the large number of people out of work, those working fewer hours and those whose wages have been cut. The old record was a two-month decline, during the 1981-1982 recession.

"What this means," said Thomas J. Nardone, an assistant commissioner at the bureau, "is that the amount of money people are paid has taken a big hit; not just those who have lost their jobs, but those who are still employed."

All over the country incomes are falling. Officially, about 15 million people have no jobs. Many others have given up looking for jobs. And now, for the first time ever, more than half of those who lose their jobs run out of unemployment benefits before they find another one. Many others never get any benefits at all, because their jobs are not eliminated, they are merely cut back...either in the number of hours they can work or in the compensation itself.

Yesterday, we reported that Baby Boomers are actually working longer hours...but earning less. The boomers are in an especially tight spot. They've got only a few years to save money for their retirements...and it won't be easy in this slumpy economy.

And we reported the plight of the callow youths...whom BusinessWeek has called the "Lost Generation." Their unemployment rate is twice the national average. They're at the bottom of the labor pool, and unless the economy begins to expand they'll have a very hard time finding the bottom rung of the ladder.

Take all the people who are unemployed...who are working fewer hours...who have given up looking for work...whose positions have been downgraded...and add the family members who depend on them for their daily bread...and you have nearly a quarter of the population. How can companies expect to increase sales and profits with a quarter of the population forced to cut back severely?

They can't. The earnings numbers are misleading. Most of the earnings that we've seen come from cost cutting, not growing top-line sales. How do businesses cut costs? By trimming employees! In other words, the earnings figures we're seeing are contributing to the slump...not alleviating it.

You can see how, in the short run this can lead to increased profits. But it can't go on for long. The more businesses cut costs the more their sales go down, because consumers (who are also their employees) have less money to spend.

And according to a Wall Street Journal report, with too much capacity...and falling sales, businesses "are hesitant to reinvest such profits into their businesses."

That's why business investment, as we reported two days ago, is falling even faster than sales. And it's why people who are looking for a job are going to have a hard time finding one.

How did JPMorgan earn so much money in such a bad economy?

We begin with a bit of skepticism. After all, we know consumers aren't borrowing. Consumer credit is going down. So they can't be making money there. And we know businesses aren't expanding, so they can't be making money by lending to corporations either.

Wait a minute. JPMorgan is a bank, right? Don't banks make money by lending money? Yes...that's what we thought. Then who is JPMorgan lending to?

The only net borrower is the government.

The Financial Times confirms that Morgan's "US consumer businesses continued to bleed, with its credit card unit losing $700 million in the quarter and its retail bank...barely breaking even." It wrote off $7 billion in uncollectible consumer loans - more than twice as much as last year.

Its mortgage group lost money too. And it surely didn't make any money helping US business build new factories and expand payrolls.

So what does that leave? All the components of the business that have to do with the real economy are losing money or barely breaking even. What's left?

The news reports attribute the huge profits to "trading." But trading is a broad category. And our guess is that if you look more closely you will find that JPMorgan made its money the old fashioned way - by ripping off the government.

'You mean, JPMorgan took the feds' money and now is showing huge profits because it is just lending money back to the people they got it from?'

Yes. But not only that. They're also probably speculating on gold, oil and stocks...along with everyone else. The feds' money has pushed all these speculative trades into profit.

'And now, they're going to pay themselves big bonuses, aren't they?'

Yes. The papers tell us, "bonuses explode on Wall Street to a new record."

'So, then...when the next crisis comes...they won't have any money in the banks, will they?'

Nope.

'So they'll have to get bailed out again.'

Yep.

'But maybe the next time the feds will wise up and just let them go broke.'

Not a chance. Wall Street has plenty of friends in the highest places in Washington. A report in today's media tells us that "Geithner Aides Reaped Millions Working for Banks, Hedge Funds." The aides earn about $150,000 for their government work. On the side, they advise the financial firms they're supposed to be regulating, and get paid millions.

Such a nice relationship. They make sure Wall Street prospers - even when it does stupid things. Wall Street makes sure they prosper - even when they advise the government to do stupid things. And when their gig is over in Washington they go back to Wall Street where they earn millions more. America's centers of political and financial power have a cozy little game going. It won't end any time soon. It's too profitable for both of them.

Until next time,

Bill Bonner
for The Daily Reckoning Australia

• JPMorgan and Goldman Sachs Making Billions in Profits
• Federal Government is Sabotaging a Genuine Recovery
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Should You Buy Stocks Now to Take Advantage of Bull Market?
• Can a Consumer Economy Boom If Consumers Have Less Money?

Know what that means? It means the "Age of Thrift" is here...and that consumers really are cutting back - just like we said they would.

And it means that the consumer economy is not going to return to robust growth anytime soon. And it means, too, that people will find it hard to find jobs for a very long time.

Another thing it means is that housing prices are not likely to recover - not in our lifetimes. That was a once-a-century bubble and it has blown up.

Mortgage lenders say they expect the peak in foreclosures to come about a year from now. As for the bottom of price declines, you can expect that in 2013 or beyond. A housing bubble typically takes prices down for six years, says a study by professors Reinhart and Rogoff. But this was not a typical bubble; it was an extraordinary bubble. Seems logical that the correction will be extraordinarily deep and long too.

And it also means that this stock market rally is very vulnerable. The stock market and the economy seem to be reading different newspapers!

The Dow fell 14 points yesterday. It could begin a major drop any day. That's why our 'Crash Alert' flag is flying from our London headquarters.

Yesterday, we reported the curious fact that consumer spending as a percentage of the GDP had increased. But it only increased because the other parts of the GDP - notably business spending and investment - fell off even faster.

With output falling...sales falling...and investment (in new plant and equipment) falling even faster...who's going to hire new workers? Not many companies. And which companies are going to invest in young workers...who will have to be trained - sometimes over a period of many years - before they are really productive? Not many.

It's the "Lost Generation," says BusinessWeek. Unemployment nationwide is officially 9.8%. But for young people the rate is nearly twice that level - at 18%.

Their elders aren't doing so well either.

"Baby boomers working longer hours, for less," says a Financial Times headline. What do you expect? Their currency is going down in value. Their customers are disappearing. Their retirement savings disappeared with housing prices. They can't even borrow money anymore.

David Rosenberg:

"Now that lenders have started to respond to their record-high delinquency rates by rationing credit, a mad scramble for cash is occurring to replace the loans - food stamp usage is up 22% year-over- year, pawn shop business is up nearly 40%, and there is a tidal wave of applications for Social Security disability benefits that are not explained alone by workplace mishaps."

Boomers have no choice. They need money. So they work harder, and longer. And they get paid less. Why? Because prices are falling. Even the price of labor. It's a deflationary world.

Meanwhile, The New York Times reports, "China consolidates its lead in global trade."

This headline is a little like the announcement that consumer spending is a bigger part of the economy. It might lead you to think that global trade is growing - or, at least that the Chinese part of global trade is growing. Not at all! Global trade is still shrinking. Chinese exports too. It's just that China's part of the global marketplace is increasing...because America and Europe are losing market share. China is gaining market share because it competes on price. And price competition is what is driving this market.

No discount? No sale!

Power and wealth are shifting east. No doubt about it. The Chinese took over the Hummer this week. And they are even building a 'big plane' - the C919 - to compete against Boeing and Airbus.

Is there any business they can't compete in? We don't know...but we're counting on them to stay out of financial publishing at least until we retire!

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
• Bear Markets Do Not End With Stocks Still Trading at Nearly 20 Times Earnings
• Stock Prices Down Signals Bears to Hold onto Cash, Treasuries and Gold
• Economy Has to Grow at 1% to Stay Even With Population Growth
• We Expect No Recovery from the Economy

Interesting huh? Consumer credit has fallen off a cliff.

What does that mean exactly? It means Americans aren't borrowing...and they aren't buying either.

This weekend, The New York Times noticed:

"Americans stop buying; trade deficit declines" begins the headline.

This is the story we've been telling here at The Daily Reckoning for two years. Americans have to cut back. They are out of time and out of money. Ten years closer to retirement than they were in before the tech stock crash, Baby Boomers are not a penny richer. Now, they're facing a funky economy where housing prices are in decline, jobs are hard to find and lenders are reticent to lend them more money. Daddy has finally taken the T-bird away.

But wait...if the Baby Boomers stop spending won't it have, like, repercussions?

The NYT continues:

"For the first eight months of the year, the United States trade deficit with China is down by about 14 percent or $20 billion, compared with one year ago. The nation's trade deficit with Japan has shrunk by almost 20 percent, and its deficits with Mexico, Canada and the European Union are down more than 40 percent.

"The huge shift stems mainly from the staggering collapse in trade. With credit markets frozen and Americans facing the highest unemployment in more than 30 years, the United States suddenly stopped shopping overseas at anywhere near the volumes that had become normal."

Americans were the world's champion consumers. Just lend them money; they'd spend it. But when they stop spending it brings a hush to the entire planet. The malls go quiet...trucks slow down...ships are idled...and finally factories are shut down. Clerks, drivers, stevedores and assembly line workers all go home. That is what a depression is all about.

The feds are trying to get consumers to spend again. They've given them tax rebates, incentives, loans, and bribes. They've run a federal deficit three times higher than the previous record. They promise $1 trillion deficits "as far as the eye can see." And they put at risk a sum of money equal almost to the entire US GDP.

Still those hardheaded consumers won't consume like they're supposed to.

Suddenly, it's the 'Age of Thrift.'

But if it's really the age of thrift, the stock market doesn't seem to have gotten the message. The Dow rose 78 points on Friday, to a new post-crash high. Oil held at over $72. And gold lost $7 to close at $1,049.

What are stock market investors thinking? Are they thinking at all?

If the consumer credit party is over...and the Baby Boomers are on the wagon...is it really possible for US businesses to grow...and prosper?

Yes, it is. America has great businesses with great brands. As the dollar falls it should be able for them to gain global market share in some sectors. But 70% of the economy is consumer spending. Until that changes, the US economy is hostage to US consumer spending. When consumers stop consuming, the US economy's wheels stop turning.

Okay, so you're thinking: "Well...maybe Americans have to cut back, but there are plenty of other people in the world. Let them do the buying for a while!"

And you are right. America has less than 5% of the world's population. But it consumes more than 20% of the total world's output - as measured by GDP. Clearly, Americans have been doing more than their fair share. It's time to let the foreigners belly up to the bar. Heck, they're skinny. They could use a good drink.

In time, foreigners will spend more. We don't doubt it. But rebalancing the world's economies won't happen overnight. Nor even in a couple years. It will take a long, long time. And a lot of investment in new tools, new training, and new techniques. Until that happens, when US consumers stop buying it slows wheels all over the world.

Every time finance ministers and heads of state get together they talk about "rebalancing" the world economy. They promise to take steps to make it happen. But so far, the market is doing all the rebalancing work on its own.

And instead of letting nature take her course...allowing the invisible hand of capitalism to direct capital to where it is actually needed...the heavy hand of government blocks the process of correction.

Credit is still contracting. And Reuters reports that "small US firms face credit squeeze."

In theory, a genuine recovery in the United States could be led by exports. A cheaper dollar...and a cheaper workforce (in global terms)...would make the United States a better competitor.

But even a cheaper dollar is not guaranteed. Consumers may have stopped borrowing, but the US government borrows more than ever. This borrowing - in dollars - increases demand for greenbacks and may actually sustain the dollar at a higher level than it should be. The feds' appetite for borrowing could also force up interest rates - further restricting small businesses' access to easy credit.

There is a big difference between selling a few more Harley Davidsons overseas and real export-led economic growth for the US economy. The latter would require hundreds...thousands...of Harley Davidson enterprises, selling billions worth of goods and services to foreigners. And right now, those enterprises don't exist. They have no lobbyists trying to get TARP funds. They have no pet Congressmen slipping tax breaks for them into defense bills. They have no unions backing them. How could they; they haven't even gotten off the ground yet. And they may never get off the ground if they can't get financing.

The boomers are saving. They put their money into the safest possible place - US bonds! That is, they lend it to the government. They're the feds' biggest single source of financing - even bigger than the Chinese.

Meanwhile, the feds pump billions into the banking system. They supply the banks with capital for expansion and consumption. But instead of making loans to the private sector, the banks take the feds' money and lend it right back to them. They can borrow at a negligible rate...and then use the money to buy long-dated T-bonds yielding over 4%. Result: banks make money; the private sector has no money to create new businesses.

This weekend, we had a conversation with an English carpenter.

"It's rough. I remember just a couple of years ago, I could get work anywhere. Now it's off and on. I still find work, but I have a lot of free time too.

"It's not easy. Not with four children. We don't have any choice. We don't get any public benefits, you know...because I'm working. But I'm not working as much as I used to. And I'm not getting paid as much. So what can we do? We have to tighten our belts. We get by. But we're definitely not spending money they way we used to. In fact, I wish we hadn't spent so much back then. I'd like to have some of that money now."

A report in the Telegraph predicts British property prices - which have been in an upward trend for several months - are headed down again...with a 17% decline expected.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Is Gold at $1000 a Bargain…Or a Trap?
• Until This Debt is Reduced, Americans Will Be Reluctant to Borrow or Spend
• Baby Boomers Face Early Retirement With No Money Saved
• Americans Have No Money to Spend Because They Already Spent It!
• The Country is Going into a Recession with its Finances in the Worst Shape Ever

Now, to the markets. You may remember that yesterday we asked chartist Gabriel Andre to confirm or deny the claim by Chart Partners Group that the S&P ASX/200 could rise by another one percent-and then fall by 19%. It turns out Lord Swarm had published his own forecast yesterday in our sister letter, Money Morning.

"What is the target then for this current rally," he asked. " Well, as we anticipated a few months ago (see Money Morning dated May 14), it is likely that the next significant objective will be around 4,550 points. That is 300 points ahead, or 7% higher [than yesterday's open]. The Bollinger bands are widening, the volatility is up. The target could be reached soon.

"Two key points argue for an exhaust at this level of 4,550 points. First, the Relative Strength Index (RSI) clearly shows that the index is already overbought. You may know that a stock or index or any other asset can remain overbought (or oversold) for some time. However a high valued RSI usually means that the countdown has started for the trend in place. Here the RSI is valued at 74, above the overbought level of 70.

"Second, the level of 4,550 points corresponds to the 38.2% Fibonacci retracement ratio of the decline occurred between November 2007 (point A) and March 2009 (point D). It is likely to be a resistance area where investors and traders will take profits."

There you have it. Expect a rally to 4,550 then profit taking. You heard it here first. Or second, if you read Money Morning yesterday.

Sometimes technical analysis sounds like a foreign language. In many ways, it IS a foreign language. It makes the claim that the best way to understand and trade the market is to be fluent in the vocabulary of technical variables and chart patterns. It's a big claim.

Your editor does not pick up foreign languages easily. But just for grins, we asked Gabriel to try his technical speak on the CRB commodities index. It's been up, then way down, then back up. We wondered-all the fundamentals of supply, demand, growth, and recession aside - what the index looks like to trader with an eye for patterns and mind full of oscillators. We showed him the chart below, on to which he put the lines you now see.

Click to enlarge

His commentary was to the point: "23.6% Fibo (the very first retracement level) hit on last June 11 (point C), is likely to be the immediate target, around 265 points. A correction had followed then a rebound on a support level (green horizontal line) valid since last March. I expect the resistance at 265 points to trigger profit-taking. It should hold, as many commodities are a bit overbought on short-term basis."

Speaking of commodity prices, the RBA published its commodity price index yesterday. It was, in the spirit of the season, less bad than expected. The RBA said the index was flat in July after being down 3.8% in June. Coal and wheat were down, but beef, veal, and iron ore were up.

Like all other investable asset classes, commodities are trying to find a natural price floor. That floor would be based on the long-term demand in the real economy for tangible assets. And with commodities, you at least get predictable cycles where overcapacity in production leads to falling prices. Or, as we saw in 1999, years of underinvestment in productive capacity coincided with a surge in demand, creating a huge gap that led to spiking prices.

Now things are levelling off at a higher equilibrium. But what about other asset classes? Specifically, returning to the question we began today's letter with, can asset prices make new highs without new leverage in the system? And exactly who is willing to take on leverage now anyway?

This is the question that we think the markets are working through right now. You get the sense that people feel better about the economy. And they feel like the worse of the financial crisis is over. At the very least, investors feel that systemic risk-the chance of a total meltdown-has been averted. There are still risks, but perhaps not as grave as the risks faced once Lehman Brothers collapsed in September of last year.

One reason investors feel better is that governments have now stepped in and made clear they won't let any systemically important firms collapse. That's been a messy process. But it seems to have reassured people that the worst case scenario is impossible.

We're not so sure. If anyone has learned anything in the last two years, it's that the improbable is still possible. It only has to happen once, and it only has to happen to you for an event to derail a lifetime of planning. We reckon investors will bear the lessons of the last two years in mind as they approach markets today.

But it sure doesn't look like that's happening now, does it? So what, really, is happening? We reckon one explanation is that the financial system has simply doubled down on itself. Banks and institutions have partly shored up their balance sheets by selling new shares or, increasingly in Australia, bonds. They've taken the rest and made financial bets which generated paper profits and the false dawn of an earnings recovery, which has been priced into stocks.

You wonder though, how much of the liquidity made possible by central bank policies and government fiscal stimulus has simply found its way right back into speculating on higher asset prices. Is this a recovery in asset prices that simply duplicates the speculative excesses of the credit bubble peak last year? Hmmn.

If the entire financial world-institutions and retail investors alike - reverts back to the bubble era thinking, then you can almost guarantee further losses. This is the debt-deflation scenario. But it's a scenario where the losses are taking grudgingly, drip by drip, in the face of furious attempts to releverage the system.

We were going to say that recommitting to the bubble could guarantee a retesting of the 2003 lows on stock markets. But this time, it may be a bit different. Because the monetary authorities will not allow a large firm (or sovereign state?) to fail-and because people believe there are no firms whose failure is big enough to take down the system-you'll get a very different kind of crisis in phase two.

The credit bubble cannot be reflated. But the rate at which asset markets grind lower (in real terms) can be drawn out if there are no catalysts to cause a panic and if liquidity efforts by central banks remain in place. For example, we reckon that Aussie banks and fund are carrying hundreds of billions of dollars in unlisted assets on the balance sheet that are probably worth a lot less. But those assets don't have to be re-valued continuously (marked to market). We reckon there are serious problems with those assets.

For one, there is the composition of them. Are they infrastructure funds? Listed property trusts? Commercial real estate loans? And then, don't forget, there are the listed assets, which also include commercial and residential property.

Our main point is that asset values are probably much lower than investors would like to admit. But because of changes to accounting rules, no one has to realise any losses on these assets which would require more capital or, in some cases, force a firm into solvency once the value of the asset was written down.

So the zombie assets slumber on the corporate balance sheets in the hopes that everything recovers, the bubble is reflated, or excess bank reserves make their way into the economy to inflate asset prices (although in real terms, investors will lose ground).

In any event, you can be sure the "authorities" would like you to believe that a gradual reflation of housing and stock prices means there is nothing to fear any longer. But they may be underestimating one major change in investor psychology over the last two years: fear.

It is all well and good for the financial industry to turn Fed credit into asset price speculation. But at the household level, how are investors going to behave? We reckon most investors who expect to retire in the next ten years cannot afford to have another year like last year. The entire investor class that has seen stock and house prices rise for most of their adult life is counting on those assets to live off of in retirement.

Now they have a choice: stay in the game to make back some of what you lost and benefit from government reflation policies. Or cash out, hope you have enough to get by with, and adjust your expectations for a less lavish retirement than you had hoped for.

No one likes downsizing his expectations, of course. But as was discussed last Friday at our Debt Summit, attitudes towards wealth and debt may also move in cycles. Those cycles are informed by the unique experience of each generation. If you've experienced nothing but prosperity and rising stock and house prices, you're happy to take on debt and you tend to discount risk.

But one good wealth-destroying recession is the kind of thing to temper both your expectations and your attitudes toward risk. We would not be surprised at all to see investors begin with holding liquidity from the stock and property markets. They are eighteen months closer to needing that money than they were when the crisis began. We suspect this will modify some behaviour.

Maybe it's not all that complicated. We'll see. But it could be that a permanent feature of this recession-and of globalisation for that matter-is lower real wages and income for Western workers. For Western workers to become retirees, then asset prices will have to bridge the income gap. However, as Glenn Stevens himself admitted a few weeks ago, the credit bubble created an exaggerated expectation about the rate of return you can expect from stocks and houses.

We reckon those investors who are first to realise this new reality of expectations will profit best. That is, they will modify their asset allocation plans accordingly. They won't liquidate entirely. But they will probably (and prudently) risk much less of their capital, while putting the rest to work buying tangible assets at a good valuation. More on this subject tomorrow!

Dan Denning
for The Daily Reckoning Australia

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Let's look at a specific example. This is for my own parents, who turned 65 last year. (That puts them just before the Baby Boomers.) They live in a nice suburb outside of New York City, on the coast of Connecticut. Like many older people, they would like to stay in the house they have owned for about 20 years now, in the community they are accustomed to, and near the friends they have. It's not so easy to start over when you're over 65.

Even people who have been able to accumulate significant assets, pensions etc., might be a little nervous. Trying to depend, for the next 20 or even 30 years perhaps, on financial abstractions and government promises would be a little scary. I usually tell them that they should be scared! Or, at least don't put too much faith in various Wall Street promises (and pensions are ultimately Wall Street promises too). You aren't going to make a smooth 8% per year in your 401(k) just because some financial advisor told you so. But, I guess you've figured that out now. Anything can happen. Particularly as we are sort of in a depression right now. Owning a big house in a nice neighborhood is not cheap, even if it is 100% owned with no mortgage. The annual costs of a house look something like this:

Property tax: $8000 (and that could go up)

Insurance: $2000 (could be higher)

Maintenance: $2000 (could be higher)

Utilities (phone, internet, cable, electric, trash collection) per month: $200 or $2400/year.

Heating oil: $2000 per year (could be higher).

Total: $16,400. That is probably on the low side. So, let's just budget it at $18,000.

Then, you've got a car and all the other expenses of living. And what happens when you get a little frail, and want living assistance?

Have you seen the prices for nursing homes?

It's not that these burdens are unbearable. It's rather that they are burdensome. Just house-related costs could chew up most of your Social Security check right there. And, if things really go to hell in the future, they might become unbearable. Who knows what things will look like in 20 years? Only your financal advisor knows for sure.

Let's look at it from the financial side. Maybe you can get 3% of cashflow from a "safe" muni bond portfolio, or dividends from stocks. And, you have to take into account inflation ... over the next twenty years. How do we "take into account" the unknowable? What happens if there's not enough fifteen years from now, and I'm still alive? To get $18,000 of income would take $600,000 of muni bonds. And, muni bonds are looking kinda risky these days. Dividends from stocks might take more than $600,000, because you have to pay taxes on dividends. Stocks go up and down a lot too. Sickening.

Now, like I said, they've been living in the area for a while and have some good friends, who are about the same age and in similar circumstances.

So, here's the plan:

You get together with your friends. You say: "We're all retired now. I've got a big empty house. You do too I suppose. Maybe we can think of living together. That would help reduce our living expenses. Plus, it might be fun, and it would be a good way to keep an eye on each other. That can be important when you're getting older."

Everyone is repulsed at first, because we Americans are all taught that we have to live as far away from each other as possible. But, they remember that, when they were in college, they used to share houses, and it was kind of fun. Also, everyone is older now and a lot better behaved than when they were in college. And, it is true that it might be good to have someone keeping an eye on you.

So, everyone decides to move into one house, owned by the Owner. The people who move in, two other retired couples, are the Renters. The Renters pay the Owner $800 a month to rent a bedroom, and agree to pay 1/3 of the utility and heating bills. The Renters' cost of living looks something like this:

Rent: $800 * 12 = $9600

Utilities: $100/month = $1200

Heat: $700

Total annual costs: $11,500.

Now, indeed renting turns out to be cheaper than owning the big house, even when the big house is fully paid for. They could sell their big houses if they wanted to. But, they are nervous about just selling the house they have owned for twenty years, and moving in with someone else. It might not work out. Let's not burn any bridges. So, instead of selling their now-empty houses, they rent them out.

Rent: $3500 per month = $42,000 per year (typical, actually a little low). Heckuva lot cheaper than paying the mortgage on a million-dollar house. Just the thing for a Wall Streeter with a family that needs to downsize quickly. Real quickly. Utilities are paid for by the renters.

Costs:

Property tax: $8000

Maintenance: $3000 (higher with renters)

Insurance: $2000

Total: $13,000

Net cashflow: $42,000 - $13,000 = $29,000.

Now, they're getting $29,000 in rent net of property expenses. Then, they pay their $11,500 it costs to live in the shared house.

$29,000 - $11,500 = $17,500.

Now, look at the renters:

Before: $18,000 per year of housing costs.

After: Housing and utilities are paid for, and an extra $17,500 per year of free cashflow, plus probably some tax benefits.

Wow, all of a sudden, you're living for free, and getting paid too! You just created, out of thin air, the equivalent of a $1,200,000 muni bond portfolio. Maybe more, if you consider tax benefits (rental properties can charge depreciation.) And, you still own your house.

For the Owner, it looks like this:

House costs: $13,000

Utilities: $1200 (1/3)

Heat: $700 (1/3)

Total: $14,900

Rental Income: $800 * 2 * 12 = $19,200

Net cashflow: $19,200 - $14,900 = $4,300.

So, the Owner is also living for free! However, their cashflow is not as high as the Renters. That's probably the way it should be, because the Renters will probably want a little extra incentive to move out of their house into someone else's.

So, now where are we? All three couples are now living for free, and getting some extra cash on top of that. And, there are things you can do in a shared house, like splitting cooking duties. Instead of cooking every night for two, the cook can cook twice a week for six. That's a lot easier, and would probably result in a more ambitious menu, and would resolve the question of how three people can cook in one kitchen. If the men are smart, they will encourage a little friendly competition among their wives, to "keep up the pace" for their two dinners a week. You can finally use that formal dining room every day. Then, everyone has a house's worth of furnishings. The antiques, boutiquey stuff, art and heirlooms, and the grand piano, all goes into the house where everyone is living. The more generic, replaceable stuff can go into the houses that are being rented out. Maybe you can charge an extra $500 a month for a furnished house. $500 a month is $6000 per year. That's another $200,000 muni bond portfolio-equivalent, that you created out of some used furniture. You would have had to save $400,000 before income taxes, to get a $200,000 portfolio after taxes.

After a while, in a shared house, there is always the issue of who does what house chores, and do they do it adequately, and so forth. The easy way to solve this problem is to get a housekeeper to come in one day a week, and do the vacuuming, laundry, bathrooms and all that. It's $100 a week, or $5,200 a year, or $1,735 per couple per year. Covered by their extra cashflow. Over time, people are over 70 and a little frail. Maybe they would like a little more help with shopping or even cooking, or they are no longer able to drive safely by themselves.

So, they get a live-in full-time housekeeper. The housekeeper lives in the fourth bedroom. The housekeeper gets room and board and use of a car, plus $1,000 a month in salary. Not a bad deal for a housekeeper. That's $12,000 per year or $4,000 per couple. That is also within their net cashflow. So, now everyone has their housing and utilities and a live-in housekeeper paid for. Make it $2,000 a month and you could get a registered nurse, probably. Now you've got a private nursing home.

Being older with lots of free time, it would probably be good to get outside for some light exercise. The house sits on two acres, of which perhaps there is one full acre of lawn. Instead of growing grass, let's grow some vegetables. This is prime farm country, or it was in the colonial days. You can grow a lot of vegetables on a full acre. Heck, you can grow a lot of vegetables on a tenth of an acre. A tenth of an acre is 4,356 square feet, or 43 feet by 100 feet. Not a small garden, that. So, you drop some seeds in the ground, and have fresh vegetables all summer. You even do some canning and put some away for winter. It's all organic, you get some exercise, and no more big-ticket trips to Whole Foods.

So, now, instead of paying out $18,000 a year in housing expenses, you're living for free, with your friends, with a live-in housekeeper, with some extra cashflow on top of that, and a lot of your food costs are covered as well. What is there to be worried about? Pass the 401(k) on to your kids. Don't worry about the corporate pension. Consider the Social Security check to be your entertainment budget. If there's inflation, just raise your rents.

And all it took was a little cooperation among friends, to make better use of what they already own.

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Retirement financing is going to be a big issue for many, many people - even those who thought they had it in the bag.

Altogether, trillions of dollars' worth of retirement funds have been lost already. Trillions more are still at risk. After such a long period of growth and credit expansion, baby boomers came to believe that their stocks and their houses were as a good as "money in the bank." And as recently as 2007, even counting the value of their stock portfolios and their houses, experts found that a high percentage of baby boomers were woefully ill-prepared for retirement. And now their stocks are worth, most likely, about 40% less than they were in 2007...and their houses about 20% less.

And the boomers already have it hard enough without their retirement funds being at risk. The Social Security crisis, as outlined in the companion book to I.O.U.S.A., is projected to only get worse as the years go on. Here's an excerpt from the book:

"On October 15, 2007, Reuters reported, 'The latest report by the program's trustees said by 2017, Social Security will begin to pay more in benefits than it receives in taxes. By 2041, the trust fund is projected to be exhausted.'

"The Federal balance sheet is already unsustainable. And the baby boomers have only begun to retire this year. 'The baby boomers are not a projection,' says Senator Conrad. 'They were born, they're out there, they're going to be eligible for social security and Medicare...and yet we can't pay our bills now.'

"Judd Gregg, the Republican leader in the Senate Budget Committee, puts the looming problems of these unfunded liabilities this way: 'The only issue more severe than this is the idea that an Islamic fundamentalist would get his or her hands on a nuclear weapon and use it against us. Beyond that there's nothing more severe than this.'

"Gregg goes on to state that the retirement of the baby boomers represents 'the potential fiscal meltdown of this nation...and absolutely guarantees, if it's not addressed, that our children will have less of a quality of life then we've had...that they will have a government they can't afford...and that we will be demanding so much of them in taxes that they will not have the money to send their kids to college or buy a home or just live good quality of life.'

"These grave warnings from leaders in both political parties have largely fallen on deaf ears, but we believe Americans can no longer hide from them. Simple economics dictate that you may be able to spend more than you take in for a long time, but you cannot do it forever."

*** Making the situation worse - possibly much worse - for the baby boomers is the increase in unemployment. Whirlpool just announced 5,000 job cuts. We typed, "job cuts, October 2008" into Google. We got 3,350,000 hits.

The International Herald Tribune tells us that wealthy Americans are cutting back on eating out...and household help. Our two daughters - both of whom work as waitresses, while going to school or trying to become movie stars - report that getting a job in a bar or restaurant is not as easy as it used to be.

"You used to be able to walk into almost any pub in London and get a job," said one. "They were happy to take anyone who could speak English. But now, you put your name on a list...and they never call you."

If there was one thing the baby boomers were sure of, it was that if they didn't get their retirement financing together in time, they could always just keep working for a few more years. But already, the percentage of 'seniors' in the workforce - 16.4% - is higher than ever. And what if the jobs disappear?

Bill Bonner
for The Daily Reckoning Australia

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A correction is always deflationary too. Delusions and hopes push up asset prices. Reality and despair pull them back down. The latest figures show M2 – a measure of the money supply – no longer growing. True, the feds are desperately trying to increase the money supply with bailouts and tax rebates. But the bankers are running scared. They get their hands on some hard cash...and they want to hold onto it as long as possible. They figure they might need it.

This is the phenomenon that Keynes described as “pushing on a string.” The feds push. But the string bends.

Of course, it’s not just the bankers. Remember, bankers act like retail investors – and householders. And right now, they’re all feeling a bit under stress and looking for stray coins under the seat cushions.

Unemployment is rising. It is projected to hit more than 6% before the end of the year. In the last major recession – of the early ’90s – unemployment hit 7.8%. It could well reach up to 7% or 8%...or higher...this time too.

The combination of falling employment (including overtime and so forth) and falling house prices makes it almost impossible for the consumer to continue consuming in the manner to which he has become accustomed. We are watching the retail sales figures closely for proof. Broadly, from our great distance, the figures show little sign of a let-up in consumer spending. But when you look more closely, the picture is more interesting.

Consumer spending continued to rise in the last quarter, for example. But there were three important nuances:

First, most of the growth in consumption spending is no longer coming from the consumer. It is the government that is doing the spending. The feds are stepping up to the plate to try to compensate for weakening consumer spending (they don’t know they are doing this...they are just doing what comes naturally). Federal government spending rose at a real rate of 6.7% in the last quarter, while personal consumption rose only 1.5%.

Second, consumer spending is not even keeping up with consumer incomes. The feds handed out billions in tax rebates, which boosted incomes by 4% – more than twice the level of consumer spending increases. This tells us that consumers are trying to cut back.

But third, they’re finding it especially hard to cut back because prices are still rising. Ah, here’s the real complication. It’s a deflationary correction – we see that clearly, through our binoculars. But consumer prices are still going up. In June, consumer prices rose 0.8%. Doesn’t seem like much, but multiply that times twelve and you have an annual rate of nearly 10%. Prices for the essentials – food and fuel – have risen so much that the consumer has to spend all his money just to keep up. The broad figures show consumer spending rising...but the consumer is actually consuming less. He’s eating out less – so the restaurants are failing. He’s buying less – so the retailers are hurting. And he’s driving less – so gasoline sales, in gallons, are actually going down.

And pity the poor baby boomers! They’ve lived their whole lives with a pot of honey in their hands. Save money? Why bother? Na na na na live for today! The economy was always expanding...they were always getting richer...jobs were always plentiful...and so were credit cards. Now though, the tables are turning against the boomers. When companies lay off employees – they get rid of the middle-aged, expensive workers – the baby boomers. And since the poor boomers never bothered to save money – and since their houses are losing value – they now face retirement with no money in their pockets and no way to get more.

And now, even when they save money, they get kicked in the derriere. Interest rates are so low, they make almost nothing.

What are the poor baby boomers to do? D-O-W-N-S-I-Z-E in a hurry...

Bill Bonner
for The Daily Reckoning Australia

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There has been an extraordinary shift in the age group which dominates political life, in Europe as well as the United States. Those of us who are older than the baby boomers, saw them take over from our generation and now see our children’s generation taking over from them. Technically, I think that Barack Obama is himself a baby boom child, if one extends the birth dates of the baby boom generation from 1947 to 1965, but he relates to the generation born between 1965 and 1990. To them Hillary Clinton, aged 62, seems to be on the cusp between the middle aged and the elderly. Every time she refers to her greater experience, she reminds the generation now in its thirties that she belongs to an earlier generation.

My generation, now in our seventies, is the one to which Senator John McCain belongs. We find it easy to empathise with him. We were at school during the Second World War, lived out adult lives under the threat of the Cold War, and were contemporary with the Vietnam War, whether we were involved in it or not. It affected the lives, and the political attitudes of most American students. It had less impact on European students, but still had enough impact to cause the events of 1968 in Paris. To us the student experience of Bill Clinton himself is still a contemporary event. For the post baby boomers, it is quite distant in history.

The trouble with the baby boomers is that they have become too familiar. They have been around too long and there have been too many of them. They are boring to the next generation, who became students in the Eighties, but they are also boring to he pre-baby boom generation, who were students in the Fifties. I was never sure what triangulation meant. It sounded like poor geometry as well as poor politics. But Hillary Clinton is exposed to the double difficulty of having lost the younger generation without creating enthusiasm among the older – she makes good speeches, but her speeches do not relate to the hopes of either generation. She does, however, retain her identification with the women of her own age group.

In Britain, the young are having quite a tough time. They now have to pay high tuition fees if they go to College; the average debt at graduation is £20,000. They have to incur an even bigger debt to get into the housing market. The cost of rearing children is phenomenal. The norm, by the age of thirty, is a debt of between £100,000 and £200,000. There are far fewer lifetime jobs outside the civil service. The companies, like ICI and GEC, or British Leyland, which offered training and lifetime jobs in the 1960s and 1970s no longer exist.

I do not know what the ideals of this generation will prove to be, but I do know that they are responding to Barack Obama’s rhetoric or hope, just as my father’s generation in England responded to Franklin Roosevelt’s message of hope in 1933. “The only thing we have to fear is fear itself.” Hope may be an illusion, but it has powerful political appeal. If there were primaries in the European Union, I think Barack Obama would win them comfortably. I might vote for Senator John McCain, who is my contemporary, but the thirty year olds would vote for Senator Obama.

William Rees-Mogg
for the Daily Reckoning Australia

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