His whole presidency rests on getting this bailout thing right. If he does, he’ll be a hero. If he doesn’t, the economy will go into a Japan-like slump and he’ll spend his entire time in office dealing with people looking for handouts – zombie banks, comatose corporations, and desperate households.
Tim Geithner unveiled his new bank resuscitation machinery on Tuesday. He said it cost $2 trillion. Investors looked on…and saw the same old second-hand, worn-out rescue equipment the Bush team had used. The key tool is a pump that injects money into the banks, in the hope that if the bankers have a little more change lying around, they’ll be emboldened to lend it to someone.
But the banks aren’t going to lend…and neither is anyone else…as long as the value of the collateral is a) falling and/or b) unknown. This is a panic…at least that’s what it would have been called until 1929.
Yesterday, the Dow rose 50 points…a weak bounce, after such a big drop on Tuesday. Gold rose $30 (with a ways to go). And oil slipped to only $35. Who would have thought? No one working at Markets and Money! We knew oil had gotten ahead of itself…but we imagined that that price would fall only to $70-$90 a barrel. It would be a correction, we reasoned, in a bull market. Instead, oil seems to have repudiated the whole ‘Peak Oil’ argument.
News this morning is that “US lawmakers agree on $789 billion stimulus plan,” according to Bloomberg. But that doesn’t seem to have reassured investors very much.
It’s a panic because people fear that the money they sent out to work for them may not be coming home again. As soon as the panic hit, they immediately got on the phone and tried to find it…trace its footsteps…wondering…worrying. Much of it will never come home. And even when it does make it home, it comes in the door with its clothes torn and bruises on its face.
“What happened to you?” the owners ask.
“Credit meltdown,” it replies. “Everyone’s getting beaten up.”
Naturally, the owners don’t want to send out any more of their cash until things settle down.
When will that be? When debt is down to a more tolerable level. That means one of two things: either debt goes down…or incomes go up.
This is a depression, not a recession (we know you are getting tired of hearing it; but it’s an important distinction). Private debt rose from only about 2% of disposable income in 1945 to about 15% in 2006. That huge, long trend has come to an end. People realize that went too far. They haven’t enough income…or collateral…to support that kind of debt. What’s more, incomes are falling…and so is the value of the collateral. This puts almost all businesses in danger…and millions of households too. And it threatens all credits that depended on incomes and collateral at boom-time levels too – almost the last five years’ worth of loans, private equity buyouts, house sales, credit card debt, home equity lines, stock prices, property prices – you name it. Smart money. Dumb money. All kinds of money. Like those geniuses who bought Sam Zell’s real estate empire at the top of the market. Practically every one of them is now in trouble. Rents are down – not enough to cover the operating costs and debt service. And what about Sam himself? He put a big chunk of his money into publishing. And now his flagship newspapers are going broke too. Ad revenue is down and shows no sign of recovering – ever.
The problem in a panic is that no one is quite sure who’s solvent and who isn’t. Can GM survive? Starbucks? The LA Times? The local mall? The family next door?
No one knows. So, few lenders or investors are eager to let their money out of the house.
What should be done? So glad you asked: The cure for a depression is a depression. The situation won’t return to “normal” until this crisis has been able to do its work…and this period of price discovery has been allowed to follow its course.
Back in the ’90s, when Americans still believed in capitalism, they sent a steady stream of advisors and kibitzers to Japan. The world’s second largest economy was in a stall and seemed in no hurry to get out of it. Its largest banks were “zombies,” said the Americans; they were propped up by the Japanese government in order to avoid losses and embarrassment. If the Japanese wanted to get things moving again they should let those banks fail…let the free market do its work…let the chips fall where they may. Then, capitalists, entrepreneurs and scrappy businessmen could pick them up and build with them.
The Japanese didn’t take the advice. To this day, 19 years after the beginning of Japan’s long, soft, on-again, off-again depression, the economy is still in a slump…and expecting negative growth again this year. All together, Japanese investors are said to have lost a sum equal to 300% of the nation’s annual GDP…the equivalent to a loss of about $45 trillion in the United States.
Years ago, we predicted – in these daily reckonings – that when the crisis came in the United States, Americans wouldn’t take their own advice. Alas, we were right. Instead, they are keeping the zombies alive, just like the Japanese did. And the zombies are sucking the blood out of the economy.
And poor Barack. Our guess is that Paul Volker has spelled the nuts and bolts of the situation out for him. But Obama, surrounded by a fluff of advisors with their dog-eared copies of Keynes’ General Theory of Employment, Interest and Money, doesn’t know who to believe…or who to trust. So, he goes with the flow. It would take a strong man, with strong convictions about economics to resist a gaggle of Ph.D. economists and experts telling him that he risks ‘catastrophe’ if he doesn’t act quickly. Poor Barack may be a decent fellow…but he is a decent fellow in a bad trade. He doesn’t know it, but the flow leads nowhere.
*** The bankers got our sympathy this week.
‘Tramps and thieves,’ is what everyone says of them. ‘Stupid banker’ is said to be redundant.
“Do you have a different moral compass?” asked John Mann, member of Parliament, of Sir Fred Goodwin, recently retired from banking. It was a low question. “Different to what?” Sir Fred should have answered. But there was no fight in any of them. The poor bankers are playing along, of course. They’re apologizing to politicians for all the harm they’ve done.
‘Yes, we wrecked Western civilization, but we’ve said were sorry, all right? Now, can we have the money?’
The banks are essential to our economy; at least, that’s what everyone says. So the politicians are giving them money – as much as $2 trillion more, according to the Geithner plan – so they’ll stay in business.
“Son of TARP,” the Financial Times calls it.
Why do the banks need money? Because they don’t have any. If you add up their assets and subtract their liabilities, you end up with a hole. Maybe that hole is only $200 billion debt. Maybe it is trillions deep. Nobody really knows.
But nobody seems to want to find out, either.
At this stage in a financial crisis, the markets should be doing some serious price discovery. Values have been put in doubt. Everyone wants to know what things are worth before they lend, invest or buy. But instead of allowing the price system to work, the feds are on the case…jiggling one price…squeezing another…propping up one zombie company…running an extension cord out from the Fed to a local bank so it can keep the lights on.
*** ‘Son of TARP’? Wait a minute. What did original TARP produce? We recall its inventor Hank Paulson promising that it would be a good deal for the taxpayer. He was buying bank assets at such low prices the taxpayers were going to make a profit, remember that? We got a laugh out of it then. Now we get another laugh. Comes word last week from the Congressional Oversight Panel that assets bought by TARP are now worth $78 billion less than they paid for them.
*** Joblessness… For every company that is adding to payrolls, three are cutting them. In manufacturing, according to David Rosenberg of Merrill Lynch, there are 14 people laid off for every one that is hired. And a total of 3.6 million people have lost their jobs since Dec. ’07…half of them in the last three months.
*** Smoot & Hawley are back in business all over the world. Smoot was spotted in France early this week, when Sarkozy gave its automakers $12 billion…but on condition they shut their plants in OTHER countries, not in France.
Then, the U.S. trade deficit fell to its lowest level in six years – reflecting Americans’ inability to continue living in the style to which they had become accustomed. Meanwhile, at the other end of the shipping lane, China’s exports plunged 17.5% in January.
And now Mr. Hawley is writing from Alaska, asking federal regulators to kick Virgin America out of its airspace. Alaska Airlines says Virgin has no right to fly in the United States because it is not a U.S.-owned company.
*** Unemployment in the United States is pushing 8%. But that’s nothing; in Zimbabwe it’s said to be 94%. If that’s true, practically no one is working. Must be more to the story. What about all the people who are preparing Robert Mugabe’s 85th birthday bash? He’s ordered 2000 bottles of Moet & Chandon champagne…8,000 lobsters…500 bottles of Johnny Walker whiskey…3,000 ducks. Hey, why not? Have a little fun. Someone has to have a little fun in Zimbabwe. The rest of the population is starving…or so it says in the paper.
*** Gold is sparkling…maybe too much. “Bullion sales hit record in rush to safety,” says a headline from Tuesday’s Financial Times:
“Investors are buying record amounts of gold bars and coins, shunning risky assets for the relative safety of bullion amid renewed fears about the health of the global financial system.”
Health of the global financial system? Don’t worry about it; that system is dying. And word is beginning to get out. There’s no other reason for them to be buying gold. Oil is going down. Deflation is taking hold. Jewelry sales are off. Why would anyone want gold? Only if they thought the system was in trouble. They fear there may be more bubbles…more blow-ups…and more panic. But when the dust clears, the last things still standing will be gold.
The U.S. Mint, for example sold 92,000 ounces of its American Eagle coins last month. That’s four times as much as it sold a year ago…and more than it sold in the whole first half of 2008.
It bothers us contrarians – a bit. We don’t like to see a crowd gathered around…admiring our favorite refuge. Still, the crowds are pretty thin, compared to what they will be when the bull market in gold really takes over. Then, your neighbors will be talking about gold…and telling you how much money they made in gold. That’s still ahead…when gold goes over $1,000…over $1,500…over $2,000.
Everyone ought to own gold coins. Few people do. Most people never even think about it. Sure, some people are talking about the yellow metal. People are buying coins in record quantities. But gold is still regarded as a little kooky…a little marginal.
What is interesting now is the movement in the gold shares; they’re going up. And this week, we got a recommendation for a gold share from colleague Chris Mayer. We liked the idea so much, we bought some of the stock for the children’s account. Probably not too much downside in the stock, we reasoned. And if the price of gold goes above $1,000 again, this share could really fly.
“The economics of gold stocks have never looked better to me,” writes Chris. “Gold trades for around $900 an ounce and the average cost to produce it is around $450 an ounce or so. You don’t have to know much about economics to know that’s a nice combination.”
Chris continues, “A gold stock you can warm up to even if you don’t think gold will go to the moon. And it has one of the stronger balance sheets in the business. Shares go for just under $7 per hare as I write. They are worth nearly twice the price at current gold prices…trades at 7 times cash flow…should trade for at least $12 per share.”
for Markets and Money