The most misguided analysis in history

The more I read and study the current economic situation, the more amazed I am that the people with the platforms to speak haven't a clue what happened and what is going to happen in the world economy. In the news media, there is too much talk about the level of consumer spending and too much begging for consumer spending to pick up. This is going to be the great shock of so many, as we have seen the real peak per capita in consumer spending for the forseeable future, maybe 20 to 50 years forward. The banking industry, the consumer goods industry and the capital goods industry are going into a long flat spell worldwide. First the growth will turn negative, then it will flatten out to zero and there will be no growth along with sizable cuts in dividends, as companies struggle to survive. Without growth, the dividend rate has to reflect either the deflationary loss in future income or the real risk of holding stock. In either case, we are looking at dividends in the 6% to 8% range for most stocks and figuring the market in general is about half that, we have another 50% decline in the market at a minimum. This will combine with a 50%decline in dividends, meaning we probably have a 75% decline at a minimum, taking the SPX into the 200 range and the Dow to the 2000 level.

There is a tendency to credit groups and blame groups. I am writing this in response to the blaming of Greenspan and Bernanke in a article I just read. I think Paul Volker has as much to do with this mess as either of these 2, with his death grip monetary policy in the 1980's, but the role of all these 3 guys in all areas of their field is much less than thought. I know this idea will generate an argument 1000 miles long in print.

I have also been reading nonsense about the Chinese and their lending back to the US helping to perpetuate this mess. The money machine was in the US and when combined with the Chinese central bank, only the skids were greased a little more. The nature of a reserve currency is it runs deficits and ends right back in the country of origin, as other countries use it for monetary collateral and long term income. If the Chinese created this money cycle, how did they get the dollars in the first place?

If I were to point a finger at anyone, it would be Robert Rubin. But, much of this ball was rolling when Rubin took office in 1994. Rubin taught Greenie about the non-existance of bubbles, if Greenspans book is to be believed. The 2000 Nasdaq peak was by a factor of 2 or 3, the biggest major market bubble in history. That market alone was 100% of GDP at the peak and I believe the 1929 market peak was only 80%. The then valuations of CSCO, INTC, MSFT, ORCL and WCOM was near the valuation of the entire Nasdaq at the present. Those 5 stocks combined wouldn't buy CSCO at its peak at the present and they were nowhere near being the overvalued portion of the Nasdaq. I believe the Shiller housing index would have had to reach a level double or triple where it peaked in order to mirror such excess. The Nasdaq bottomed at 1300 on October 8, 1998 and peaked in March (I believe the 10th) in the neighborhood of 5200 for a 300% gain in 17 months. Though Greenie helped in this matter, it was the enabling acts of Rubin (collateralizing the issuance of money is what is important in money, not the interest rate, the gold or how much money the Fed says you can have) that produced this bubble. The Clinton administration put more slugs in the fusebox once this market bubble got started than Greenie could have ever managed. There was no 10% margin in this market, aka 1929 and was more a factor of continued support of cash flow through government activity. Rubin, the US treasury secretary, had at least some power over the activities of the IMF. Even so, I can only point a broken finger at Rubin.

Getting back to blame, I mentioned Volker. Volker did the US a favor by shocking it into the idea that borrowed money could get expensive, but he didn't stop inflation. Ronald Reagan stopped inflation. I know the Democrats out there are going to have a fit over this one, especially since Volker is one of your darlings today, but this in fact true. Inflation had become institutionalized and like it or not, Reagan put an end to it, either intentionally or by accident. The biggest factor in inflation was income tax bracket creep. People that are making $30,000 a year today weren't intended to have a tax bracket when the brackets were drawn out or if they were, it was to be 10% or so, maybe 14%. But, if Reagan hadn't have done what he did to taxes, the $30,000 a year guy would be paying taxes like he was a $200,000 year guy. In fact, I don't think the $200,000 a year guy pays taxes like the $30,000 a year guy did in that code. Those of us old enough to remember, recall that $30,000 a year was a magic income around 1970, the dividing line between whether you were doing okay or had arrived. Today, it is a secretarys salary in corporate America. Cutting the taxes and forcing government to cut its rate of growth of expenditures changed the institutional makeup of the US.

In short, what Volker did with interest rates, probably doubled the Reagan deficits after 1984 and created the sudden asset appreciation that produced the trend of the early 1990's that created the bubble mania. Even so, the link I propose here could be weakened by argument and I am not prepared to go at length to crucify or defend Volker. I think the ease out of the interest rate squeeze was 5 years too late at least and should have been done by 1985. Instead of easing in 1984, Volker tightened and that in itself produced a financial crisis of its own. In any case, the move from Volker to normal was an extreme shift in financial valuation and the fuel that created the real ogre of the 1990's to 2007 bubble, home finance.

I was selling real estate when I graduated from college in 1978. At the time, interest rates were a high 9% and the Iranian revolution threw a real bomb into the gearing of the US economy. As I pointed out, the structural composition of the US was such that in order to stay even with inflation, you had to outrun inflation, which produced a spiral. Higher income produced higher taxes which produced a decline in living standards which produced a need for higher prices and the spiral was on. What else this procedure did was produce an automatic tax increase for the government through the progressive income tax, which wasn't indexed to inflation in those days (Reagan could have done nothing more than reverse taxes to inflation adjusted 1976 levels and inflation adjusted the tax rates to 1976 and left them unchanged and done the same thing but left more upper income in the future for the government), so government spending went out of control in the 1970's. The spending and income trends of the 1970's projected on trend from 1960 to 1975 would have produced deficits in the $900 billion range by 1990. I have generated these figures out of actual numbers on spread sheets, so I am not making this one up. In any case, what I am trying to propose here is the shock that interest rates on mortgages going from the 8% to 9% range to almost permanently for 11 years to above 10% and many years above 13%. After moving to mortgage lending, I recall the first refinance boom was a move to under 12% on 30 year fixed money.

There was another psychology created out of this rate structure, the psychology of the CD holder. Conservative people that had cash were able to put their cash in CD's and earn significant income. My father accumulated cash through his own endeavors, inheritance and through a lawsuit for extensive injuries he sustained in a fall and during the 1980's was able to earn more money retired out of CD interest than he made working some years. Of course I am leaving out inflation, but I am also leaving out his travel expenses. It was a shock to a lot of these older people when their income out of their $200,000, $300,000 or $500,000 in cash dropped from $30,000, $45,000 or $75,000 to something like $6000 or $9000 or $15,000 in the first Greenspan thaw around 1991. These people had adapted their lifestyles to high interest rates giving them income and they needed to speculate to support their lifestyles. The stock market had already benefitted for several years from the marginal declines in interest rates along with the gradual restoration of value lost in the 1970's to inflation and the trend drew interest. Remember, the Dow in the early 1980's was in the 800's and despite the 1987 crash, the market was well into the 2000's and rising come 1990. The passing of 3000 together with the decline in the Fed funds rate to 3% from some amazingly high number was a combination that made a mass move into stocks a no brainer. Since very few Americans, including many on Wall Street, had no clue as to financial valuation of stocks, the sky was the limit. (More and more is coming out about the education of those on Wall Street quite often being something besides financial and more connected to what school they went to or who their daddy is than what they know about valuations).

The other side of this coin was real estate. My complaints about Volker are massive and for much of his early term, Greenspan continued Volkers actions. I believe these actions created one of the worst financial recessions in history, the 1990-1992 mess that cost Bush I his office. There were housing crashes around the US and the affordability of homes had been pushed down to lower levels. When the built up decade of high interest rate mortgages suddenly were refinanciable at single digit levels, the gates opened for a housing boom. FNMA and FHLMC became major players in the financial world and the paper machine of the US. Complicit in this matter were the efforts of HUD and the congressional panels that oversaw housing matters. Stemming from an act in the mid 1970's designed to encourage lending to low income people, a 1995 act dictated to these GSE's they find a way to lend more money to these lower income buyers. But, I don't believe this was the real impact behind the housing boom or the stock boom. I do believe that the shift in rates and rising activity in equity extraction created the 1990's stock bubble. It doesn't take a lot of fire to clear a crowded arena, nor does it take much additional money to push a crowded stock market into a mania.

My contention is that the securitization of mortgages and the effects of lower rates going into the early 1990's and beyond unleashed an amount of equity and spending power out of housing that was totally financed under the guise of government guarantees and Wall Street hype that created this entire world economy. The Chinese buying mortgages and government bonds only explains a part of this mess. Something had to generate the extreme levels of cash in the first place to have moved that much money to China and I believe the above described mechanism was it. China itself is part of this bubble and thus will not escape its effects, not because they are going to lose their money they put back in the US, but because their business model is built on being financed by this Wall Street/GSE machine. So are the earning of the US corporations as well as the European and Asian ones as well, as we are seeing at the present. Toyota has fallen on hard times along with Ford and GM.

Michael Koo, of the Japanese Central bank, is the closest I have seen in coming to grips with what is going on. The populace is spent out and the corporations of which they are customers is over capacity and overleveraged. In some ways, Koo says that the current direction of stimulous packages is the right path to avoiding depression, but that it won't get us back to where we were on the peak or anywhere near it. That will take time. Some speak of the great shape the balance sheets of corporate America are in, but I beg to differ. If they were so cash rich, there wouldn't be a credit crunch would there? Also, some speak of cash on the balance sheet, but I doubt a lot of it is real cash. By this I mean there are current liabilities and current assets and in a lot of cases, I doubt the reliability of the current assets, which exposes the cash to the current liabilities and the company to bankruptcy. Instead of being highly solvent, many of these companies are going to be liable to the full extent of their cash balances.

I have seen some mention brokerage firms as having $X of cash per share and I highly doubt that money actually belongs in whole to the firms involved. In fact, I would be highly watchful of the solvency of any Wall Street firm or its ability to meet withdrawals. I see a lot of cash in the minerals and oil and gas business, but I know enough people that were in the oil business before to have doubts about their receivables. Few people realize the deflationary pull that has set in and how fast cash can evaporate.

My point in all of this is that the roots of this mess go way back. I am not sure that Greenspan, then Rubin, then Bernanke weren't all doing all they could to forstall a collapse that was caused by the interest rate and generational structure of the US in the 1970's and 1980's. I believe from my own experience that Volker kept rates too high for a lot longer than Greenspan and Bernanke kept them too low. I also believe the perceived government guarantees of the GSE's contributed to excessive securitized debt and thus the monetization of consumption in the US and therefore the world. The size of this bubble doesn't meet a a border,nor was it caused by a single asset class like subprime mortgages. It was caused by a series of bubbles that were caused by a shift of perception by a group of people worldwide without the experience and knowledge to intelligently invest in such assets.

Now, the last bubble is bonds. Bonds aren't a bubble, but an asset class. The financial bubble has broken and it isn't possible for there to be another bubble. I think people are going to be surprised, unless the entire mess collapses, how long treasuries stay below 3%. I believe the minimum will be 2020 before we see a sustained rise of treasury bonds above 3%. Aren't we all shocked that Japanese 10 years have spent more than a decade below 2%? Remember, the dollar is the reserve currency.

So many people keep thinking this is a housing problem, but it isn't a housing problem, but a problem with financing and raising more cash. The source of new cash for the US for 2 decades or longer was home equity and to some extent, commercial real estate equity and stock equity. This became the source of cash for the world. The entire world will need to deleverage out of this mess and any attempt to become the US by another country will lead to its immediate collapse. I believe that most mortgages will be under water before this mess is done and that all markets will be affected. I am in the housing business at this time and due to the current condition of the local market, DFW, I have to resist the temptation to buy more all the time. It would be a good idea to see what summer looks like.

You never get even over the long run

I want to comment on the stock market as it is a financial instrument. Shiller has adjusted this data in a good way I believe. I did a huge study on this data and what I figured out was that inflation from 1926 to 2003 was a compound 3%, that the beginning dividend rate in 1926 was 4.8% and if you bought stocks on that date in the form of the SPX or its equivalent, you would have made 4.8% plus 3% inflation plus about another 1% in real terms. If you take the dividend yield out of the data for 1/26, you get .61/12.65 or 4.822%. The CPI adjusted price for 1/26 is 157.72. The last data on this was for 6/08 where dividends were 28.71. If you adjusted the 6/08 data to a 4.822% dividend, the price would be 595.38, which is a factor of 3.77 over a period of 82 years. This demonstrates a real growth factor of about 1.5%(this would be accurate at 89 years).

Here is the rub of this data though. There are a couple of factors here, what was the price at the peak of the last debt bubble and the 10 year average trailing PE. The factor for 1/26 was 11.34 and the factor for 6/08 was 22.39. This is a rough factor of 2 and if you divide 1341.25 by 2, you get about 670, in the region of the 595 that I mentioned. If you move back to 1929, you get a trailing PE/10 of 32.56. Though much more expensive than 6/08, the 1929 PE paled compared to 43.22 at the peak of the SPX in 3/00. But, at the summer 07 peak the rate hit 27.40, not quite there, but in the region of 1929. This factor peaked in the 1960's, a sweetspot of all time economy in the US at 24.06 and going forward dropped to 6.64 in August 1982. It also dropped to 5.57 in June 1932. This supports real values in the 25% range of the top, maybe lower.

The other factor is if you look at dividend growth between 9/24 and 9/29, you get a growth from .55 to .94, a factor of 1.709 times. This is a little over 11% compound. Dividends peaked between June and December of 1930, another time when corporations failed to conserve capital in time. If you take the same time frame, 10/02 to 10/07, dividends went from 15.88 to 27.22 for a factor of 1.714, almost identical to 1929. There was one difference in the fact that the dividend rate actually went up in 2002-2007 where as it went down in 1929. The other difference was the nature of the credit system. The bubble that pushed stocks higher in the 2002-2007 period was much bigger.

There is one more point. The price in 1929, adjusted for CPI, is 403.79. The dividend yield for 9/29 was 3.003%. If you took the 10/07 peak and adjusted it to a 3.003% dividend, you would get 27.22/.03003 or 906.36. The CPI factor for 10/07 in this demonstration is 1.0681772898 to give a price of 968.15. The factor for peak to peak is 2.39766 for a period of 78 years. This is about 1.15% real growth in price(1.011 divided 78 times into this factor reduces it to 1.0214, meaning it is within .1%). If you took this 79 year period, you would find stocks returned 3% plus 1.1% plus inflation.

Let me say that again: If you took this 79 year period, you would find stocks returned 3% plus 1.1% plus inflation. Do you know what 4.1% over inflation is? It is damn short of what staying in a corporate bond fund would return you. It is about 7%, but this is if you hold from peak to peak. If you take the price of the SPX for November 1985, you get 404.39. What is this? It is when you got back to even for the second time for owning the SPX from the 1929 peak. The first time was 11/58.

People think stocks change form, but buying a basket of stocks is not that much different than buying a basket of bonds. Your yield to maturity is what you get when you buy. There isn't some kind of magic that comes in over night like the tooth fairy and give you a bonus for you losses. These are solid facts about something that mirrors the SPX.

Why my fixation on dividends? Because that is all a stock every pays its holder passively. If a stock is acquired by another company or the company buys back stock to reduce the float, it never pays a dime of dividends, the holder eventually ends up with zero. The return on a stock is its dividend rate plus its growth rate. Thus if you hold the SPX as a stock, which for the great unwashed is the only way to hold stocks (there is too much money for everyone to be buying the few prime stocks or for that matter, move into dividend stocks), you can't do any better long run than what long run is. Markets that pay low dividends as this one has for most of the last 20 years (current dividends are declining and not high and the worst time to hold stocks is when dividends are declining as the growth rate is negative and stocks have to adjust their prices to take into account the declining payout). My point is you get your long run at the price you buy and there are only deep bears and bubbles that present opportunities to buy or sell. I venture a regular non bubble, non bear market is probably in the SPX 500 range or lower.

I had written something I intended to post here on another site and the internet didn't feed and lost it. It was in response to a challenge about the stock market moving back to the mean and overcorrecting and going even lower. The mean revision that was being discussed was the PE ratio, but I choose to focus on the dividend rate. In any case, if there wasn't a mean, there couldn't be a return associated with stocks and that is what I propose to show.

Back in 2003, I was going to write a book, but I chickened out. The name of it was going to be, "Is it Safe to Get Back in the Water", meaning, is it safe to get back into stocks. During that period, I did my own personal study on long term data posted by Robert Shiller of the housing index fame, dealing with stocks. The famous return on stocks that is quoted uses 2 years, 1926 and 1950. 1926 was the last year prior to the great run up in stocks prior to the Great Depression and 1950 was the peak in dividends, so either would be a likely year to choose to mark stock returns from. 1926 because it would impress upon people that a depression couldn't stop the market and 1950 because dividends were at all time highs and it would clearly be a year to produce a great return.

In any case, Shiller had everything from earnings to dividends and the CPI number for every year from 1870 on and through this I was able to construct a model of how stocks were valued. I had been taught a formula in college about the value of a stock and the market would be valued in the same fashion. In fact, the data could actually verify what the simple model was. The formula, P=d/(k-g) is a simple discount formula where dividends are discounted the required rate of return minus the rate fo growth. Like all financial formulas, it is actually pretty simple, but finding the components was not. Through this, I made assumptions as to why the market itself was so absurdly high, as dividends were only in the 1.6% range after a sizable adjustment down from a price where dividends on the SPX were as low as 1.08%.
I decided I would use 1926 as a base year as well and what I found was that from 1926 to that time, which I believe was 2003, the long term rate of inflation was 3%, the starting dividend rate was 4.8% and the growth rate was in the 1% range, giving a long term return of about 9%. This would confirm a risk free rate of return plus 2.8% to 3% as being about normal for stocks, as treasuries would generally yield inflation plus 3% over the long haul and BBB long term debt about 5% above inflation. Bonds are safer than stocks because they at least recapture some of their value in what is certain eventual default and bankruptcy of a company.

Contrary to the bullish side of the equation, I didn't focus on the price of stocks, but rather the growth of dividends and the starting rate of dividends. A bull might say that 4.8% is too high of a dividend, but if I had used something like 3%, the rate of return would have been much slower. In fact, I could have moved to the 1929 peak and did just that.

This is where I can draw the parallel to reversion to the mean and what the return on a stock really is. If one is going to compare 1926 and 2003, they need to compare based on the dividend rate and not the price of the market, as they are 2 different things. Maybe 4.8% is too high, but then you have to adjust downward what stocks yield. I do know that 1% was too low and 2% was too low and likely 3% was too low because prior to the 1990's every time the yield hit 3%, the market failed to go higher. The best it could do was move higher with growth. There was 125 years of data lying there and suddenly history didn't apply. Anyone with a brain knows better.

To move forward, I must clarify something. This is something no one has ever mentioned in the public arena of buying stocks or an SPX fund, but there is no averaging in on the market. If you buy a stock and hold it forever, you get what you bought and nothing else. Thus, the mistake of buying a bond with too low of a yield can be made up by the end of the term of the bond, but that can't be done with stock. Thus if the historical yield of the stock market is inflation plus 5.8%, you can't pay inflation plus 4% and ever get back to inflation plus 5.8% without the market making a huge mistake. You can only make inflation plus 4% and that is if you hold the portfolio forever. You could hope for a bigger fool to come along and pay a price sufficient to produce a yield lower than 4% then you could make more than 4% by selling, but not holding. Thus the long term success of buy and hold for a market fund is predicated on whether the return in the future is lower or higher and the lower the acceptable return, the higher sales price that can be achieved. But, the forever return is always going to be where you bought in.

Why can't the growth be higher? There may be times when it is higher, but in truth there is only so much money in the system, so many resources and real growth is quite likely to not involve more money, but lower prices. Another thing is the differential in compound returns. If you take 3% for instance and compound it for 24 years, it doubles. 6% takes 12 years to double, but in 24 years it is 4 times its original size. In 48 years it is 16 times its original size while the 3% is only 4 times. Thus over the 48 years that the typical person would accumulate and live off stocks, the economy would have to support something that could be 4 times its size when it started. The factors don't work and the value of the stock market cannot grow at any appreciable pace greater than the economy as a whole. If you took the more extreme numbers of 9% and we were looking at 6% nominal in the economy, we would have a double in 12 years for the economy and 8 years for the stocks, meaning stocks would have to relatively double the economy over 24 years, as 9% produces an 8X while 6% produces a 4X. The compounds cannot be sustained on any real basis. This is actually true whether you pay dividends or buy back stock.

So, there is only 1 way that you can get an after inflation return on stocks of 6% and that is to price them that way. Stocks haven't been priced in that fashion for 25 years. The question is, why? Growth hasn't been that fantastic, actually pretty normal and below historical for a long period of prosperity. I can only offer 2 reasons, one being the natural, debt bubble that produces excessive money in search of a return and the other being an adoption of a fiction in investing. I believe today that the first reason is the primary reason, but the stock bubble couldn't be so persistent and defended without the fiction.

Here is the fiction. When I went to college, they were teaching something called portfolio theory. What portfolio theory actually meant was you could take several properly correllated risky assets and put them in a portfolio and the portfolio would over time produce the return expected out of the assets. To invest in any one of the assets would produce a return that ranged from either a total loss to a huge bonanza in excess of anything planned. Thus, you could take history and buy it and it would work as long as the assets themselves were priced reasonably going in. Nothing could be done if the assets were bought at yields much lower than necessary.

In seeing this, I wrote a paper years ago called "Who destroyed Portfolio Theory"? My contention was and still is that Wall Street took statistics and came up with this idea that stocks returned X% over time and that all you had to do was buy a portfolio and you would get the return. With the adoption of that attitude along with the credit bubble (money bubble)people started pouring money blindly into S&P funds. Over a period of 10 years or so they drove the yields down on stocks to near 1% before the bubble sprung a leak that was repaired 3 years later. Thus the assumption that all you had to do was pour money into a mutual fund and the fund would make you rich. There is really little chance that once this procedure started that Wall Street set out to take full advantage selling stocks at as high of prices as they could.

Which is the return for stocks? Is it inflation plus 2% or inflation plus 6%? I have seen about everything inbetween adopted in my lifetime. I believe that in 1982 the dividend yield on the SPX topped 6%. Thus from that time on, you could expect a real rate of return of almost 7% plus inflation. IN 2000, you could only expect a return of about 2% plus inflation. This is one reason the market could only make a double top in 2007 against its value 7 years earlier and have only dividends to show for it.

This is what mean reversion is all about. I don't know if the reader has been able to follow what I have written, but figure this one. There is a lot of talk about the 10 year bond being below the dividend rate. They talk about this like it has never happened when in fact the entire period between 1900 and 1950 the dividend rate on the broad market was higher than the yield on treasuries. I would venture that most of the following 15 years were also a period when bond yields were lower than stock dividends. This is in part because inflation wasn't certain and growth was even less certain.

If we return to normal money in a normal growth market, we will again see t-bills priced at inflation plus 3% over any given time frame. We will see long term growth on stocks of between 1/2% and 1% above inflation and we will see risk premiums above 4% again. In fact, the 1966 and 1929 tops were met with 3% dividend rates and the latest dividend I have on the SPX is 28.71 which gives a 957 price on the SPX for a historical top. As dividends fall and stocks fall out of favor and the bubble deflates, we have a long way to go down. We aren't talking about getting 10% on stocks when inflation might be zero and dividend and profit growth negative.

The Return of Bretton Woods

I believe it might be escaping all of us why the US cannot deflate without deflating the world. There is a lot more than trade deficits, bonds, interest rates and connects or disconnects involved here. There is the existence of currency worldwide at stake, something that could be possibly eluding all involved in speculation as to what each country might do. It appears to me that the nature of Bretton Woods is not only intact, but in full force.

For all those that are confused, what would make a dominant power like the United States totally lose its productive industry, especially when looking at the power of its financial structure and its domestic resources? One couldn't point to the behavior of the people, as the US gained economic prominence in the early 1900's with 8 million drug adicts and an alcohol problem so bad that it was banned in the 1910's. At the same time, what causes the world to bend over backwards to finance their exports to the United States and when these exports fall, their economies come to a screeching halt? The entire game defies logic.

What is going on when an economy like Russia goes from claiming over $1 trillion in foreign reserves to sweating default in a matter of a few months? The entire world has been made flush in cash only to suddenly be short of it. The whole idea of the matter makes one sit up and wonder what is going on.

Because none of us are educated in the international creation of money, it may be something that needs to be figured out by observation. I am sure someone in this world knows what is happening here or the system wouldn't be set up the way it is set up, but then again are the people that know the people that are running the game?

Here is what I propose is happening and has happened since 1944. Bretton Woods was set up to allow for the fixed exchange of currencies around the world with the reserve currency, the dollar, being exchangable at $35 an ounce in gold. What this did is put the onus on the United States after the world had recovered from the war, to keep producing money for the world. Once the French decided they would be better off making a run on the gold behind the dollar than holding dollars, that system fell apart and was replaced with a floating system. What wasn't replaced was what collateralized the money around the world, the dollar. Thus the game switched from hard money to strictly bank credit. The dollar had been exchangable on an international trade basis at $35 an ounce since FDR effected devaluation in 1933. Prior, the dollar was gold and silver and only represented by currencies. For those that don't understand, the gold was the money, the currency the receipt or note.

I believe it is beyond theory that once all money in circulation becomes bank credit, the only real purchasing power in the economy comes from new money being created and the failure to create new money greatly diminished purchasing power for goods and services. The old money is used to collateralize what collateralizes it, assets. Thus the more money piles up, the greater the asset base. But this game comes with a penalty, that the supply of money and the weight of interest grow faster than the economy as a whole and eventually the engine that supplies the power becomes too small to propel itself forward. In the old days, it was never the money supply that imploded, but the credit system that was representative of the money supply. In the current sense, there is no money supply, as the real property of the world is now the money and the credit the recepits for it. This gives the dollar more credence because the US is one of the places around the world where real property is property and can be owned outright subject only to taxes and liens and in some cases use restrictions.

Here is my theory and it explains why the talk of the Chinese or Japanese are going to sell their US Treasuries, that the dollar is going to zero and all the other crap is not only wrong, but so far in error that nothing could be farther from the truth. It is far from the truth because the world set sail on the dollar back in 1944 and there isn't a lifeboat sufficient to get off the dollar. The European market would like to believe they could do it with their new currency, but truth be known, this currency needs the flow of dollars for collateral and should they attempt an exit, they would find money to back their exit lacking. In short, the world money supply is created by the Federal Reserve of the United States.

You might note how many emerging markets tied their currencies to the dollar in an effort to ride the game. The ones that weren't in shape to attract export business, like Argentina, ran into deep trouble, but those that succeeded in attraction export business like China, prospered. The stability allowed them to mirror the US without the liabiity of being the US. This game works as long as a country can continue to attract dollars in sufficient amounts to allow their own banking system to work.

There are 2 examples of what happens when the amounts aren't sufficient that come to mind, Japan and Argentina. In the case of Argentina, the export business never developed and they used their anchor as so many consumers in the US use it, as an advantage to consume. In the case of Japan, they used inflows to develop internal bubbles in real estate and banking and when the US slowed down after 1990, their bubbles broke. The inflows of dollars haven't been sufficient since for the reflation of the system, as their own system can't reflate what is not actually based on its own value. The Japanese banking system, to the surprise of many of you, may be totally supported by their supply of American dollars. Its bank credit is supported by domestic collateral, but the yen itself is not. Thus the capacity of the domestic central bank has to be able to expand at an exponential rate or the system runs into trouble. In this case, the US cannot slow down or the rest of the world collapses.

This is why they never sell the bonds. The dollar and its collateral are the only chairs available for other currencies. It is also why the US is stuck in an ever ending system of expanding debt and diminishing output. The US can't quit consuming because there is really no exchange that can be made to create the currencies the rest of the world need. In fact, not a country in the world is really interested in collateralizing their own currencies because it would expose them to the same financial looting that has wiped out the US. Most of them would have to give up their industrial growth and face the prospect that their major industries take on the look of General Motors. Plus, few could stand the continued drain that goes with supporting their money with their own assets.

Here is the rub of it. The world is addicted to US trade deficits in the $500 billion range and the US consumer has finally run out of its capacity to take on more debt. No more than the rest of the world can get off its credit collateral, neither can the US. We are stuck in an end game situation and the result of this end game is clearly the shrinking value of assets we are seeing around the world. Remember, the existing money isn't here to spend so much as it is to value the assets in the market place. So we have 3 problems to support, debt devaluation, economic growth and asset return support. In order to keep the game going, more than enough money has to be borrowed into existence to keep the majority of debt being serviced, so the system can at least claim current solvency. The assets have to have enough return to justify their prices and allow for the support of the collateral values attached to them.

If you take China, for instance, in order that their economy expand 5%, they need to expand the monetary base by 5%, plus they need enough extra money to pay the return on the money already in existance along with the stream of income to the investments made around the country. Some of this money recycles back through the economy, but most of it accumulates. If they need to encourage loan solvency as well, they will need even more money. This means they need to attract enough dollars to expand their monetary reserves by maybe as much as 15% or more in order to run in place. To do less would expose the economy to deflationary forces that threatened the value of the asset base of the country and the capacity of the system to pay its debts. I am sure this is behind them not wanting to let the yuan appreciate, as this would lessen the number of new yuan they could issue.

One might recall what occurred in Japan in the late 1980's. For one, the yen apprecited to the point that I believe they could only issue about 90 new yen for every dollar they got in trade. This was down from 200 earlier in the decade and 300 in the 1970's. The yen was definitely deflating and their asset bubble was inflating as money flowed to Japan to take advantage of appreciating currency and rising asset prices in stocks and real estate. Japan started buying sizable investments in the US as well, when the US caught cold from its own financial problems and its incapacity to generate enough new credit to pay the high interest rates of the Volker Federal Reserve regime.

As strange as this may seem, the trade deficit of the US cannot be balanced and the US cannot be treated as a normal debtor nation. People over and over again differentiate Japan from the US by saying Japan was a creditor nation but not the US. What they miss is that the US owes Japan its entire monetary base, which means that if the US paid Japan off, Japan would need to find something else to use as money. Thus the Japanese economy would literally cease to exist.

Truthfully the only way the US can solve this problem is to allow consumers to pay down their debt load, if this actually could be accomplished. The problem with this is that to do so would deflate every country in the world, as the US consumer would have to earn back what the rest of the world is using as money. This would of course cause the collapse of banks around the world.

I am going to develop this idea forward, but I do know enough to know that the outline of the system is as I described it, that there is little chance the Chinese or any other outfit sells off their US bonds and for that matter, that the oil producers leave the dollar, as to do so would immediately collapse their business and the world economy. Of course, if they should wish to bring down the west, this would go a long way to doing it.

Should they bail out GM?

The Bush administration has balked at bailing out GM and now GM hopes to make it to Santa Claus' administration. This is going to be one of the great economic debates of all time and if GM makes it after a bailout, it will be used as proof that it should have been done. But, if you put your life savings on a roulette wheel number and win, is that proof you should have done it or is it merely the fact that luck separated a fool from a genius?

I know I don't understand what is going on when the statement prevails that if GM falls to $12 billion in cash they are out of business? That really doesn't make sense to me, but maybe I have lived on the edge for too long. If a company with $12 billion in cash is broke, then what is a family with $200 to make it until a week from now? This isn't the primary problem though.

The primary problem is that the figure of $25 billion that has been tossed around appears to not amount to much in this case. It is true that the loss of GM would be devastating, but a bankruptchy might work as well as a bailout from where I sit. It would force some changes in a company that is clearly broken. It isn't like they were blindsided with this economy, as they have known for the past 50 years that auto sales at the level we have witnessed for the past 15 years are an abnomoly and not the norm and that eventually something bad was going to happen, like a real recession.

My first instinct is to save GM. Mom, apple pie and Chevrolet, the symbol of American power and the backbone of many a local economy to boot. Then, the question moves to, what do you do with Ford? Do you save them as well? I don't see why not. It is clear that over the short term losing these operations would devastate the US and most likely roil the financial system more than anything that has gone down so far. Who has the CDS's on GM? Are we up for another bailout if they go down? It might be a good idea to walk them pst the window these swaps cover, if for no other reason than to disarm a devastating situation.

But, can you blindly save a company that has seen the handwriting on the wall if they continued to operate as they are? What are they going to do different than they have done over the past 20 years? It is clear they can't stand around and boast we are GM, get out of the way, can they? This company has not only made obligations they couldn't keep, but it appears they are run so purely inefficiently that it is a wonder they ever made a dime. I remember when they were the first company in the world to net a billion in profit. That has been a long time ago.

Here is what concerns me. They burned through $6 or $7 billion in cash last quarter. They supposedly have $20 billion right now. If I had that company, I think I could figure out how to get to January before I burned up $8 billion, but that is beside the point. The economy isn't going to get any better next year than it is now, as it has just recently gotten bad. This means that come January 2010, they are going to need another $25 billion if they don't do something. We are faced with 2 problems if they do get the money. One is that the current management of GM is incompetent. The second is that I doubt there is a group of managers that could be brought in to manage an auto company the next year that would be any better. And, heaven forbid you let the government bring in their people, as their people move on to companies like Fannie Mae and Freddie Mac and Wall Street firms where the pickings are easy, not to truly competitive situations. So, you put in $25 billion and hope a group of idiots can figure out how to be geniuses over the next year?

Does anyone have a clue how much money $25 billion is? It will pay 1 million people $25,000. GM is going to need another $25 billion next year if simple math means anything. Remember this group has been a deer in the headlights for a long time. In any case, the typical American probably pays no more than $5,000 a year in income taxes, so GM swallows the income taxes of 5 million working class Americans every year it is on life support.

This wasn't a sudden event. Back in 2003, GM borrowed a large chunk of money and its stock rallied. Anyone with a brain who noticed what GM paid on that money had to realize their credit rating at the time was a joke, as investment grade companies don't pay 9% on money. It also goes to show you how stupid the American investor has been. I will leave that for another writing, but GM is just one example of how poorly Americans have done investing their money. But, this example might also shed light onto what the same group of people might do in backing GM again.

Had you asked me a week ago if we should bail out GM, I would have said, do we have any choice. In fact, I thought guys like Dennis Kneale on CNBC were flat stupid saying it needed to go bust. I still believe we are looking at a disaster should they go under, but do we have any choice? Remember, this company knew it needed to pull its act together in 2003. Its labor force knew it needed to pull it together in 2003. They had 4 banner years of auto sales to allow them to get it together and now we have a company that is burning $20 billion a year in cash? This is like giving an alcoholic another case of whiskey and $5000 so he can get over a rough spell.

I can't begin to know all the details of GM's operations, but I believe I can spot a losing proposition when I see one. Ford is going to need a bailout to, especially if they bail out GM and it might only be because GM was bailed out that Ford will need help. Ford is in better shape than GM and it has fixed most of its quality problems to the point that the last I read, they were making cars on par with Toyota. Chrysler is also on life support and it appears to me that GM attempted an end run to merge with Chrysler so it would have more ammunition to get bailed out. Why does GM need Chrysler? Don't they already have the horizon covered with Buick, Pontiac, Chevrolet, Cadillac and GMC trucks, not to mention Saab and whatever else they own? Not only did that seem to be a political ploy, but I wouldnt be surprised if it wasn't to get Cerebus, their partner in GMAC some free money?

It is clear that Ovomit is coming to the rescue after the evil Bush has failed to respond. Bail out banks, but not union jobs? There is a difference between attempting to prevent trillions in systematic losses and saving a few hundred thousand union jobs. I am sure that Obama is going to attempt to reunionize the US and force the Japanese automakers to pay union wages as well, thereby polluting the entire US labor force. This will only be the death knell for the entire American auto industry as the jobs move to Korea.

So, for me, the question revolves around whether $25 billion will do the job? I don't believe it will and I believe the US consumer will begin to get very inferior automobiles out of GM should this occur. There will be no incentive to make GM work as long as Uncle Sam is standing there with all the money they could ever need. It is clear that American management has to change and the relationship between shareholders and management has to move more toward taking care of the investment made in the companies. I can't blame labor in this matter, as management negotiated these contracts. I blame Wall Street and the shareholders for not taking care of American business. It is clear that Ford is in better shape than GM, if for no other reason than a major shareholder, the Ford family is still involved with the company. Fail to bail out GM and Ford might not need a bailout.

How do you fix a paradox?

This is a paradox built out of a paradox. I think it might be the end result of charging interest. My mother most likely correctly puts it at the feet of wiping out usuary laws back around 1980. That was maybe the start.

The problem with the financial system is multifaceted, but the primary problem is that assets are liabilities and liabilities are assets and the assets that are liabilities cannot pay the liabilities that are assets. If this confuses you, then you have to learn something before you can even start to talk about this or understand that the banking system is based on fraud or at least misconception of the participants, quite often even the ones intentionally engaged in fraud or better yet a game with no mathematical solution. Who can pay switches from one side to the other, but when a particular group,the banks can't pay, we are at end game.

I would quit discussing the dollar as for what it is worth. The Dollar is the collateral for the world financial system and you can't use the dollar and Argentina in the same breath unless you talk about Argentina not being able to pay off its dollars. The dollar could really care less about the Euro, Pound, Franc, yen, yuan or peso. The values are reversed, those currencies against dollars, weighed by bankers, not by the man on the street or by the governments around the world. Let the flow of dollars get interrupted and the rest of the world becomes insolvent. We saw that happen almost overnight last month.

There isn't a solution because there isn't a solution to a math problem that presents no solution. A potential solution would be for the governments of the world to seize all the gold, lets say at $1000 an ounce and coin money, lets say at $5000 an ounce. If you took this to mean 1/2 the gold in the world, it would amount to about $12 trillion and a profit of $9.6 trillion. In any case, this would maybe produce enough spare money to pick up the debts and rebalance the banks around the world for another 25 to 50 years if we were careful. It would be a way of creating debt free money maybe to the extent necessary to bail out the insolvency. The debt would have to shrink by means of an interest rate so low that money supply would shrink along with debt. This would mean we would have to give up the growth formula for a few years in order to get out of the abyss.

Here is the problem. When banks create money, they do it through lending, usually against assets. The assets might be the credit of a business or the home of a consumer or the future earnings of either. This includes the central banks, who originally created currency off of gold and commercial paper. The problem with this method is they lend the principal and never the interest, so the amount of money created is never enough to pay the loan. There is probably a way to do banking, keep the money supply relatively extinguished and compensate the banker reasonably, but man hasn't agreed yet on how to do that yet.

Here is the problem in a nutshell. The rich get richer and the poor go along with this system. That isnt' so bad because it is very likely that both would be much poorer without it and the depression would probably be better than prosperity without this system. This is only speculation and it is clear that the trauma associated with depression is probably worse than anyone could stand and no one would choose it intentionally. But going forward, all rich don't get richer and all poor don't get poorer. In fact, Wall Street and the hedge funds are loaded with men and women for moderate and even lower middle class backgrounds that are now filthy rich. The only difference is there are well to dos that are there in some cases only because they had someone set it on the tee for them. I don't intend this to be a philosophical argument, but to say the successes and failure come from all directions, which is one reason our system, even with its collapses and depressions works better than the alternative.

In any case, most of this revolves around the seasonal need for cash and the need for one person to have access to his cash and for another to have access as well. It would be real difficult to keep a system liquid where you might have to find 100 people with $1000 to borrow $100,000 and keep them all happy as well, so banking makes it possible for those 100 people to put in their $1000 and for even 5 or 6 people to have access to the entire sum, as long as the $100,000 doesn't leave the bank and go into a wall safe or under the bed. In that case, the central bank is there to create liquidity, as the banker should also have matching funds or somewhat close to the original deposit. This works very well as long as the sum of public liabilities in the system are kept relatively close to the bank liabilities. Thus, the first thing to know about this is the liabilities and assets and to realize that one is the other and the other is the one. This means that the banks credits are the publics debits and the banks debits are the publics credits. For those that need an accounting lesson, as all money really is, even if it is gold is who has it and who owes it or who has it that owes it and who owes it that has it and so forth. In any case a banks ledger is made up of loans and other assets on the debit side and deposit liabilities and shareholders equity including paid in capital and retained earnings on the other side. Basically all deposits are owed back to the bank.

I put that in bold because in a nutshell, this is the problem that has to be solved. It is the root of all growth from the start in an interest bearing, return earning system and it becomes the problem at the end. There is more, because we have seen non-banks get involved and securitize money to the moon, but they really have no power to create money without using the banking system for something. I theorized long ago that it would be the non-banking part of the equation that became illiquid and the system would lack close to the bone money to liquidate it. Thus the assets of these non-banking organizations would fail and their liabilities would have to be liquidated. We are seeing this in the SIV's and the commercial paper money market accounts around the world, along with the securitization of credit cards and the mortgage messes of FNM and FRE. It could have just as well happened inside the banking system, but this corporate financial structure outside of banking was the trigger now and I believe it probably was in the 1930's as well. Wall street firms and companies like GE and AIG dominated finance more so than most of the commercial banks.

As long as the banks operate in a sense where the flow of loans go to those that can gain access to cash to pay them back and the cash banks owe to depositors is owed to those that generally use it to transact trade and have the intent of paying it back to those that took out the loans the system works fairly well. I have believed for a long time and this is coming true that once the assets of the financial system become loans that bear little link to those that own the liabilities of the banking system, the game is up. As long as the pile of money owed by banks is quite likely to flow in a direction where it can be used to service the assets of the banking system, the system works okay. Bank profits are moderate and their need to get their deposits back is not so great that they have to pay the checking accounts interest. Those that can't pay the banks back, what are usually a marginal few, can file bankruptcy and the system remains in relative balance.

I am going to venture that if you throw your house out of the equation, that most people on this board have more near cash assets than they owe for the rest of their debt. I would venture that those of you that day trade likely have 6 or 7 digits of cash in accounts in excess of what you owe to credit cards, on auto loans and other secured and unsecured debt. Most of you didn't get that money by running up your credit card balances and in some cases taking the equity out of your homes, though I would venture that a great deal of middle class cash balances did come out of the equity of their last home and indirectly borrowed out of the loan balance of their next home. In any case, if you cashed in your chips and put it on the table, the banking system wouldn't have near all your cash outside of your mortgage and your personal property and even your stocks. I am merely talking about what your net position is with the banks.

Now you could go out and pay cash for 10 cars if you had that much and that would extinguish your net position with the bank to the extent of what 10 cars are worth and maybe help extinguish GM's or their autoworkers or the dealers net negative position with the bank. This is known as a reduction in the money supply. There are problems with it, because the money supply is needed to service debts and create demand. At least it is believe to be so.

But, in any case where we are is the people that owe the financial institutions are not the people that the financial institutions owe. We aren't talking now about what used to be commerical banking, where a business borrowed $2 million for liquidity purposes and their account balances floated between lets say $1 million and $4 million, depending on the inventory cycle and the bank could call the note if they wanted. No we are talking now about credit cards that created cash to do commerce that are now owed by someone with 25 cents in his account or a home mortgage financed through some leveraged fund and the money market, that is on a house of declining value where the equity is insufficient to pay the loans off and the tenant (you don't call people that owe their entire equity to the loan company homeowners)can't pay the difference. There are trillions of financial assets that can't be collected to pay the financial liabilities. Technically the system is always marginally in this shape, but it is managable. Not when the financial system becomes insolvent, where the collectable assets of the banking system fall well short of their liabilities.

Here is why the solution is next to impossible. If you are a person with lets say $1 million in near cash assets (if your stock holdings are $500K and you are a speculator who goes from cash to stock, back to cash, you are playing in the street, but you could count the $500K as cash because there is likely someone on the other end doing the same thing, but both of you can only account for $500K together and not the $1 million combined you would think you have, so maybe you count half of it and the other guy counts half of it, but money cannot come out without another putting it in and extinguishing their cash balance) and you don't owe anyone, are you going to give up your $1 million to fix the problem? We could dissolve the banks, require the depositors to take only 80% of their money and take the other 20% in stock and for the time being it would be fixed. But, the money supply would drop 20% immdediately. Hopefully the non-cash assets of the bank would then make up the shareholders equity and you might have a chance. In some fashion, the depositors have to be the ones that recapitalize the banks because they are the only ones with the bank liabilities that can't otherwise be extinguished.

Now, who wants to go first? There is talk that the government put money into the banks. I don't believe this. I think they put good assets into the banks in order to have something to liquidate to satisfy deposit liabilities. If they loan money, they create more deposit liabilities. Money is a liability in the sense that if it had been put in the banks, it would be owed back to the Fed. This game was created in the fashion the injection was somewhat equivalent to normal capital and not owed back in a classical sense, meaning it wasn't a bank liability. Only the preferred dividend is a bank liability and it can be suspended if needed. A Federal Reserve note ia a liability of the people to the Fed, one more backwards instance of banking. The Fed owes us nothing for a FRN, but we owe the Fed the debt they acquire in return for the cash plus the interest,meaning more than they put out. As long as the Fed's assets are good collateral, the dollar can't go to nothing.

In any case, who goes first? If we reduced the money supply to the point that this entire game could be serviced, then we get into international debt problems. But, in a no inflation situation, the interest on a trillion dollars is reduced to $20 billion or $30 billion if you want to use the real rate of interest game. A $20 billion trade surplus fixes that problem, so that might not be impossible. In any case, for a long time the world would be looking at a reduced level of economic activity and people would be forced to build better mouse traps, rather than just put it on their credit cards. I don't know that this solves anything or not,but it moves toward the solution of an imbalance between financial assets and liabilities.

The problem is that the assets and liabilities in the financial system don't match and the problems cannot be fixed in typical fashion by the normal actions of the system over the short term. The New Deal solutions were merely band-aids, the FDIC to prevent runs on the banks, the removal of gold, the devaluation against gold, the social spending (this solution, as they are going to rudely find out has already been used up, as putting more uncollectable debts out there isn't going to fix anything). We need a world bankruptcy re-organization, where the acting bankers are forced to give up their seats, illiquid institutions are liquidated and new capital derived out of existing bank liabilities used to recapitalize, not government debt. The US could technically pay their debt to the Chinese by minting a big $2 trillion coin because the government can mint dollars and we owe dollars, not yuan. That is what separates the US from China, but we would probably see WW III against them and our other creditors if we pulled that trick. Plus, the dollar is the collaeral for the Yuan, the yen, the Franc, the Euro, the Pound, and all assortments of pesos and dollars around the world so it can't be abandoned.

The problem with even trying to deal with deleveraging is that it means paying down the debts, which would leave the unpayable debts and the unencumbered liabilities of the banking system, meaning the insolvency grows and the money supply shrinks and we deflate. All you are doing is wiping out the bank assets than can be paid and leaving the ones that can't be paid. All that is left in deposits are those owed to those that don't owe anything. Deleveraging cannot be done, which is why I laugh every time I hear about it, like the problem will be solved. It is like the often stated notion of money coming out of bonds into stocks. How?

What Causes Deflation

There is a blog called hypertiger wisdom that talks about the bottom being sucked dry by the top, which isn't entirely true, but it hints on what the real problem is once we reach the point of deflation. I have known for years that what causes a deflation is a lack of credit going forward. There is more. I believe the Keynesians thought that it was one group of people having too much money and the other side having not enough. This goes deeper than this simple equation, as there seems to be a troubling idea that giving money to people to spend hasn't solved this in the past. Some think public works or war should be employed to create this new demand, but in the form of public works, it is clear that this hasn't solved anything in Japan.

This is my theory and I believe it is a good one. Time goes on and more and more money becomes concentrated in fewer hands and the debts of those that don't have money get larger and larger. As a result, the capacity to profit from doing businuess suddenly becomes difficult as there are fewer and fewer customers among the lower side of the income scale. Since the upper income people are usually either employed or own the businesses, they are left with being their own customers. I know I am going to have to work on this idea because the entire game is complicated and the fact is that recovery could never take place if this theory is true. But, then again, this might explain the societal collapses we have seen over history, that commerce eventually gets to where it can no longer function and the leaders run out of solutions.

There is something to be said for business as a whole that employs a group of employees and makes money. This implies that business has to make more than it pays its employees. But the problem is the employees and the other business owners are the customers of the businesses as a group and their expenditures have to be greater than their pay for something to be left over. This would be true whether we are talking about a single country or the world, as something would have to give.

What we are really saying here is that the upper class can't pay the lower class and make a living off itself. We have reached the point of maximum profit potential and now moving to a lower level of profits and probably to no profits at all. There cannot be profits greater than the sum of payments for ever. We can only have them for a time.

An example might be drawn out of the California housing bubble, where the cost of owning a home so far exceeded the rent the home would provide that the bubble collapsed in on itself. Also, there wasn't another sucker with enough money to buy out the last sucker, thus no one to sell to for a profit. Since this was all financed, it went on as long as the financing was being provided to someone. Once the cost of providing financing exceeds the income from providing financing, the financing leaves. At some point, those that owe money reach a point they either cannot pay it back or cannot keep up the payments and common sense prevails.

I am going to do a post on how the Dow is going to finish this mess, most likely under 1000. This is something that few believe possible, but I believe it is going to happen. The reason I believe it is going to happen is the government is out of real tricks. The debasing of the money and allowing banks what was almost infinite credit has already been done and the banks are now at a point where they cannot collect their assets to service their liabilities. The under class and in a lot of cases, even richer people are going to be forced to either pay or declare bankruptcy. If they pay, they won't be spending. If they declare bankruptcy, the bank incurs a reduction in capital which reduces its capacity to lend more money. In either case, the amount of money available for creating demand and profits for business has declined. This is even more severe when the businesses themselves are in the position of the prior mentioned consumer.

We have reached a point where legitimate demand cannot support prior profits and the value of business declines. Unlike hte typical middle class person, most well to do people know that they need to match income with outgo and thus they don't let money slip through their hands. Their enterprises depend on them having money to operate. If they spent all the money, there wouldn't be any capital spending and if they spent all the money on capital spending, there wouldn't be the demand for the finished product, as demand is already insufficient.

The current government efforts are being concentrated on the ends of this problem, the capitalization of banks and the demand from the lower end of the income scale. This is clearly a right now solution, but it doesn't fix the math problem that has been present since the beginning. At best it provides government debt in return for consumer debt. If the consumer spends the money, the banks probably need more bailout funds and if they pay the debts, the level of business activity declines.

The American public isn't ready for what will be necessary for government to put out in order to reverse this problem. The real problem is collateral has either been used up as is the case with home equity or the value of assets have imploded to the point that they no longer merit more money being loaned against them. Or course, there is only one place to get the money to pull off such a series of transactions and that is business and its owners. Thus we are looking at a solution to prevent collaspe that will eventually lead to a collapse.

We are quite probably going to the bottom on this one and this will require the total reconstruction of the economy as we know it. I cannot see government morons running the business of the world, as they would lose sight of what was needed and lead the human race down roads that would lead to starvation and war. Profit motive and having the door open to the masses for success is probably key to the survival of mankind. Otherwise, genocide is going to be used as a solution as it always has in totalitarian economies. So, capitalists and mild socialists are going to need to get together on this one or we are all in a mess.

I am going to suspect that the government is going to end up with the banks. They will also end up with the bad loans and the liabilities of the banks. I don't believe they can keep rolling the banks and expect them to stay in business this time. We have reached the point where debts probably can't be paid without government help and what eventually happens here is the government eventually becomes the debt. I am not sure they will allow this to occur.

The point here is that enough people in society have to hock their future in order ot have a present in business. This is probably a perpetual flaw in capitalism. Hypertiger calls it an I want to be a rich guy tax, but I suspect it is just as much I want it now tax and neither side of the equation wants to give. The point about the US is the American consumer and worker have taken both sides of the equation to the extreme. The other point is that the US had been the demand for the world or the financier of the world for the past 60 or so years, which means the rest of the world goes with us.

If the government would come up with a ways to start this game over and exacty when to do so, we could probably go on and on with it. It is clear that the value of all assets are probably in shrink mode, but it is also clear that the bank liabilities are going to have to be liquidated at some point. The other effort, to keep the bubble inflated isn't going to work and is going to destroy the US for once and for all.

Obama Market gains? I think not

I was just watching a soundbite interview between a guy named Seigal and another guy. I don't know who either of them are, other than to say that Seigal was an older guy and the other guy was younger. It appeared Seigal was less prejudiced against political comparisons. Seigal hit a lot of the disparity between returns under Democrats and Republicans in the markets being more on timing than actual performance of the administrations. I don't know where the market was January 20, 1969, but I bet the prior 8 years didn't come close to the 8 years that preceeded it. Nixon-Ford was a disaster, but it was only minimally Nixon-Ford, except the Watergate mess. That was more a case of the dollar being bankrupted by the 1960's Viet Nam war and War on Poverty than anything else. Nixon should have stopped this crap, but he let it go on instead. Carter was a disaster and Reagan had a huge bull. Bush I was sideways and Clinton created a bubble with his henchmen Rubin and Greenspan. Bush inherited the biggest bubble in US history, at least a double of the 1929 market, so it was impossible to make a return. FDR got the market near its all time bottom and inflated, so he had the market set on a tee for him. Clearly Clinton had the best return, but he left a massive bubble that actually bore no relationship to the economy and was in fact the economy, the bubble economy that is finishing its collapse now.
So we had 2 Republicans walk into cyclical bear markets, Nixon and Bush II, Bush I walked into the Japan bust and the S&L refunding on the negative and Reagan and Eisnehour walking into new markets on the Republican side and Clinton and FDR walking into recoveries of some sort already under way. The comparisons are idiotic.
Now they think Obama has it set on the tee. I think he has an impossible task provided the market is above 7500 when he goes in. The 50% point is going to define the top of this market once it settles. The US bubble has broken and there isn't one to replace it. Keep chanting this, the US bubble has broken and there isn't one to replace it. The dividends, cash flows, PE's, consumption and capital spending was all financed by credit from the bottom and to the top. The bottom got subprime crap financing and the top borrowed money to leverage these subprime loans and expand their returns. The results on financial assets was great on the up and devastating on the way down, with the financing and the capital related to this financing wiped out. We are now seeing it liquidated and there isn't going to be any left to do the game over again. In the meantime, those in the middle ran their debts up or put their windfalls in the stock market depending on who they were, or they put it in their homes. The outliers were pumping the insides and now they are all suckikng each other dry.
I have often thought about how stock markets go down to levels that seem impossible to start. It is clear to me that once a credit bubble gets going, the bubble becomes the source of earnings and growth, which it stands to reason that cash disappears and so do earnings and growth. Thus a zero growth scenario needs a 5% dividend instead of maybe a 3% dividend in a normal market, or as we have seen, a 1.75% or lower dividend in a bubble market. Freely flowing cash disappears.
I still don't understand the Japanese market because I haven't seen the inside numbers of corporations. i would venture that Japan probably was valued in line with the Nasdaq at the peak and cash flow out of a real estate bubble stopped. Domestic demand dropped, profits dropped and fundementals adjusted from bubble levels to below trend. This has resulted in a steady decline, especially since export margins in Japan have been cut by cheap China labor. Capital assets have had to be scrapped and the result has been nearly 20 years below the half way point.
The Dow in the Depression market never made it past the halfway point. Halfway back then was actually a pretty healthy market, as the market had difficulty getting past the 100 point level for a long time. A rally to near 200 was a pretty good rebound, but the market really never put 100 in the rearview until around 1950. Relative, the current market had trouble with 1000 for a long time and that is the extreme view, that we would actually move that low. Since the entire move out of 1000 was created by a non-gold backed credit boom, it is entirely possible the unwinding of this bubble could take the market that low. We have already seen 7000 on 40000 in rough numbers in Japan, which would transpire to 2100 on 12,000 and 2450 on 14,000. Most people wouldn't believe below 3000 even though we have already seen it in a competitive major market in recent years.
My point is where does the market start and at what point in the cycle are we in? I believe the fact the Nasdaq failed to recover much past the 1/2 way point shows we are well into a bear market that has yet to break down totally. Remember the Nasdaq went down to interday 1000, an 80% decline. Dow 2800 isn't out of the question in light of this one item.
As I type, Seidman uses the term deleveraging as if the money is magically going to appear to effect that. what deleveraging is, for any of you that are confused is a $1 billion pile of assets that have $900 million borrowed against them are sold for cash and the loan is paid off. This is the optimistic delevraging, but the point is that $900 million in cash is destroyed unless the new borrower also leverages with a $900 million loan, which in effect is no deleveraging at all. The pessimistic side is the asset will only bring $800 million, the bank loses $100 mllion or the seller has to sell even more assets to make up the $100 million shortfall. If the first happens, then the bank loses the capacity to create $1 billion in credit and has to pull in more cash. Thus we are now talking about $1.8 billion being needed to fill the hole.
The credit bubble was just the reverse, the using of credit to replace what should have been done with capital. Thus we are actually transitioning from a credit economy to a capital economy and being the amount of capital in the system is an inverse multiple of the leverage, the supply of money becomes lacking and the flow of cash through the system slows as well.
No one can fix this, as the government can't create capital. I would venture they could leverage their public lands, but I would also venture they have already done this. Eventually the government is going to have its credit rating threatened and this game will end.
Debt has benefitted a lot of corporations in the US and in the world. It is the enemy of corporations and business as we go forward in this kind of economy. Over the past year there has been a lot of loans drawn to be sure the drawers had credit that is now going to weigh on these businesses. But, they are currently in better shape than those that failed to draw their credit lines before they lost them. Servicing these loans is going to not be easy.
This is a long unwind. If the Fed and government are successful in their recent ventures, then the banks will start lending and rescue the bubble. But, they will still have the bubble and it will need tons of new credit to keep intact. Thus it will continue to deflate at a slower pace or it will expand only to burst again in a few years. This is an epic bear market and it is just starting

Recession, what recession

How many deck chairs are on the deck of this sinking ship? It seems the Wall Street bulls are spending a lot of time rearranging these chairs while the boat they are on is sinking. Almost daily I see articles and interviews where they speak of how long recession are, when the stock market comes back in relation to the end of a recession, how much money bulls make during Democratic administrations and all kinds of other stuff that doesn't address the current situation. I heard one today say stock hadn't been this cheap in 30 years. I don't know what he was doing 30 years ago, but I doubt he was buying stocks.

3 months ago, the talk was avoiding a recession. Who would even speak of such an idea other than an economic idiot or someone who had something to sell? Clearly these people went through much of the same socialist economics instruction I did and failed to educate themselves as to the real causes of massive economic downturns. In any case, the idea one can spot the end of the recession or even guage when the stock market makes money from the current price level based on the past is absurd. This isn't a past type economy unless y0u want to go back to the 1930's or over to Japan in 1990 for a comparison.

Back in the 1980's, there was much insolvency in financials, mainly out of bad loans in the oil patch and the devastating effect on interest rates and fraud in the S&L industry. When these institutions were closed and recapitalized, save a couple of large banks that went down during the mid 1980's, it had been known for a few years that this problem was going to need to be addressed. When action was finally taken around 1990, most of the damage had been known since 1987. The entire landscape of that bailout was different. They didn't rush a bailout through Congress just prior to recess for the elections, but instead had a long term debate and discussion on what they were doing. There wasn't an emergency, just loose ends in debt to address. Not this time.

This time we had a situation blast upon the scene. For those that have been watching this mess in process for several years, this emergency wasn't unexpected. I think for myself, I was surprised at the force at which it hit, as what we just witnessed was a stock market crash that wasn't a panic, but a financial collapse. Just 2 years ago, bank profits were records, the financial industry made up 40% of the profits in the US and most thought the industry was bullet proof. The whole idea of a $700 billion bailout being needed in September 2008 on January 1, 2007 was next to impossible to envision. There wasn't any planning allowed as there was in 1990, just a sudden demand for money or the entire world was going to belly up.

Now we are being told that stocks are cheap at 14 PE's, if you believe looking back is better than looking forward, with dividends at 3% on the SPX and a busted financial system with no plans to restore the past. The analyst that said they hadn't been cheaper at any time in 30 years must forget that the SPX paid over 6% at one point in the early 1980's and clearly doesn't know how financial values are determined. They are cheap because this is the cheapest most of these 30 somethings and early 40 somethings have seen them, forgetting on which side of the peak we are on. I would be at a minimum, 60 years old to have worked through the 1966-1982 bear market at this stage. You can bet stock at the start of 1970 or whenever that recession was hadn't been cheaper since the early 1950's, but they got cheaper for over 10 years.

The last bear market lasted 3 years if you count the bottom in 2003 as the real bottom. This one is a year old and the problems surrounding this one are much more dire than anything we saw in 2000-2003. I believe at that point, we were coming out of a raging bull and needed some time to adjust, but we also had a raging housing market that benefitted from dirt cheap mortgage rates not seen for 40 years and a financial mania crazed public. Mortgage money floated us out of that otherwise market crash. In fact, I believe mortgage credit around the world floated the entire world economy and that the 1990's stock bubble was also created out of mortgage money.

This started out as something that was going to be contained to the subprime market, mainly in California, Arizona, Nevada and Florida. The bulls had this problem over before it started, in August 2006. They have yet to acknowledge the truth here, that we built an excess of 6 to 8 million single family homes between 1995 and 2007. This is a potential 10 year supply under boom conditions and the special financing to have these homes owner occupied isn't there now. Real estate prices have a long way to fall and they will start falling in areas of the country that have not been affected yet.

The other thing was the disconnect idea, that fast growing areas in Asia and Europe would skip this recession. Either we are being led by economic idiots or liars, but we aren't be led by ethical and educated people in this matter. Maybe one or the other, but not both. These are the people pushing the stocks on Wall Street and selling the investment banking products around the world and their business depends on moving these products. Never forget Wall Street isn't in the business of buying stocks, but in the business of selling stocks. They are like Walmart. You don't bring your stuff to sell to Walmart unless you want to sell wholesale. When the market turns bad, Wall Street is like a pawn shop. This is why we are seeing such big down days.

In any case, the disconnect game is now being played out to be the biggest lie ever told. What is totally misunderstood in bear and bull circles is that American home equity got the whole world game going, that Japan would have deflated off the face of the earth without it, as would have Europe and the 1990's would have been a very dismal economy for the US as well. Instead of dismal, we got the biggest stock bubble in US history and world prosperity and a group of politicians that conspired to create the biggest financial mess in history, mainly unelected ones. Their names, Rubin and Greenspan.

This won't be about Rubin and Greenspan, only about what this is about. What this is about is the end of what Rubin and Greenspan created, though Paulson continues the Rubin creed of bailing out bubbles. What they created was a system that allowed for the derivative system to get established through out the financial arena. Home equity securitization provided the fuel and cheap interest rates along with Greenspans refusal to remove the punch bowl then having to leave it there or face collapse, which allowed for the carry trade to take place. The cheap money policy in Japan also didn't hurt.

In any case, the Wall Street alchemy which has now failed was the economy. It wasn't only the US economy, but it was the process in which money flowed around the world, as it financed a huge spending boom in the US to be spread around the world. American spending became world capital spending and all kinds of bubbles were created. In fact, most other countries around the world started their own securitization bubbles. This will be blamed on the US only because it was the elephant in the room. It won't matter there were plenty of holes kicked in the walls by the Donkeys present at the time. It was the elephant everyone saw.

Maybe one can see where I am going with this and I will be as brief as I can. Bulls are planning a recovery, but I don't know what they are planning a recovery on? This is a worldwide systematic collapse of the financial and spending structure of the world. This is a fall apart and put it back together event, not an economic slowdown. There are difficulties here that haven't ever successfully been addressed in history and what was addressed in the 1930's cannot be addressed this time, because there is no gold standard to abandon to inflate out of a collapse. There is also a much worse public financial standing than there was in the 1930's and the impact of something old won't be the same as something new.

One reason the recession has had such a hard time getting started is the amount of cash created by the bubble hadn't finished its trip around the world. It has now and the sudden end of the impact of that last dose of credit has been met with astounding force. The Chinese have been bailing out their banks as they have been going along, but they won't have a solution for this collapse. The talk of 5% to 10% growth in Asian countries is a joke, as the capacity being built will never be used. Also, the idea we have recovery around the corner in the US when in fact we haven't even felt the credit contraction yet is absurd.

I recall the slowdowns of the 1968 to 1990 period. In every case, the Fed forced a recession. Not this time, as it walked rates up 1/4% at a time. This time, the housing market collapsed under its own weight. The auto industry collapsed under its own weight. We used to have layoffs then slowdowns in auto sales and housing. Not this time. The Fed cut before the recession started, not because the recession was coming or had gotten deep, but because the system was collapsing. Remember, Greenspan kept talking about how well capitalized the financial system was, yet it starts collapsing before the recession hits.

There are several things that are of great importance that have to be overlooked if one is to justify buying stock. For one, we haven't seen the financial damage to the entire economy yet. Second, I don't believe we have seen the last of the big bank failures or bailouts and I believe at least one of the 2 major NY banks and maybe one of WFC or BAC will go under or need a rescue. Also, it appears to me that all the Wall Street brokerages left are there in name only. I am astounded that GS is going to pay out billions in bonuses in their financial shape. This is like taking a luxury vacation on your credit card, knowing you just lost your job and maybe won't get one for a long time. There isnt' a plan to get through this downturn by those in business, only downsize, but keep spending.

The biggest thing they are missing is the bubble wasn't housing, autos or stocks. It was the entire world economy. The earnings in the stock market are part of the bubble and earnings, dividends and cash flow won't look like 2007 for a long time and on a relative basis, not in the lifetime of anyone over 40 years old ever again. Thus, the 14 PE is likely a 40 PE, maybe even 50 sans the bubble and the dividend rate is at best 1.5% to 2% and more likely 1%. This means that to get to a 5% dividend level, which is needed in a no growth economy, we may need to decline 80%. I could be on the conservative side here as well.

Not only can no one tell me how we are going to get the debt level of the economy back to one that encourages long term growth, but there isnt' a way to get back to where we were other than to go back to subprime financing and recreate home equity. That is the biggest problem, the no recovery in a nutshell, declining home equity. Home equity was the bubble of all bubbles and mortgage lending was the key that unlocked it. Both are either gone or on the rocks. There won't be a recovery for a long time that will warrant stocks at current prices.

What about the stock bubble?

I am having a hard time no opening this post with an obscenity, as they keep talking about the housing bubble. We have a stock bubble, which I define as any market where the dividend yield is under 3%. We have left that area recently, but for 13 years we sat in the below 3% range on the SPX and Dow and the Nasdaq doesn't have a dividend save a few large stocks. The stock bubble has been so ridiculous that they quote long term statistics now that only encompass the bubble that began somewhere between 1993 and 1995.
Long term the top of the SPX was defined as a 3% dividend. That is the top, not the bottom. Also, a downturn wasn't conducive to 3% dividends, but more like 5% dividends, the return necessary to hold stocks while the economy wasn't growing. This has happened for long periods of time in the past when the system could not produce its own inflation, a period we may be headed into now. Being that stocks use inflation to appreciate, running in place isn't conducive and you can get 3.6% or so on a 10 year treasury, so why hold stocks. But, we have a generation X that knows stocks always go up and a boomer generation that has to have stocks work or they are poor geezers who have bills that will consume their entire savings.
Another measure has been the percentage of GDP the market equates. The closing value of the SPX yesterday was 908 for a cap value of $7.949 trillion. This indicates the entire US market is worth about $11 trillion which is 80% of $13.75 trillion. I don't believe the US economy is any larger than that, but the point of this contention is that 1929 was capped at 80% of GDP and no prior market had ever traded higher, yet this one is [B]DOWN TO A BOTTOM IF YOU LISTEN TO THESE IDIOTS. [/B] We are at bubble valuations no matter how you slice the history of the market. The housing market could remedy a bubble by a 50% decline, but the stock market is still roughly in a bubble even 50% down. In fact we are as high today as we were in 1929 when dividends were headed upward.
The only difference between the stock bubble and the housing bubble is the housing bubble provided the cash for both and for the bubbles in automobiles. The market would have gone to 400 in 2002 had we not had AAA rated and evidently government backed FRE and FNM pumping triliions into the markets, spilling money all over the world to launch a boom in China and a huge jump in demand for commodities around the world. What the housing bubble floated were bubbles themselves, but I believe the stock market bubble actually got the whole poison punch party going.

The inflation side is missing it

Santelli has to sell something and now it is the idea that there is actually money going somewhere. The Fed stuff is replacing missing cash from the system to hide the insolvency of the big banks. The government bailout is going to be a swap of marketable securities for unmarketable securities and for interest bearing equity positions. The banks are taking on liabilities in this situation and really not getting interest bearing assets in return. Banks don't have a cash account and one of the reasons t-bill are so low in yield is that all this money is circling the drain back into t-bills, which are in short supply.

The other thing they are missing is that the economy hasn't slowed to the point we are going to see it slow. The government hasn't admitted to a recession, yet the public has been screaming for a year now. I read in Bloomberg that SPX earnings have declined 27% from last year on the 147 companies that have reported so far, but the CNBC crew was advertising -10%. Wait until we see 8% to 10% unemployment. The Fed is pushing on a string.

They are now saying the Fed started agressive action in early October. Which October? The Fed has been agressive for a year, letting commodity inflation rage. There is revisionist history going on over and over again. The Fed has really not had to wage a fight against inflation for 20 years now, only the rise of China creating inflation through excessive flow of dollars to lower production cost areas. One could say the dollar and the US inflation rate has benefitted from this action, but it was the dollars that put the jobs and demand in place in Asia.

There is an absurdity being revealed, whether you listen to one of the CNBC idiots or Warren Buffet. Buffet has been waiting on a time like this, except he buys into the Socialist idea that the central bank can do anything. Well, I don't see anyone cancelling debts because they can't make their own books balance if they cancel them and if that becomes the norm, then there isn't any use being in business because all money becomes an IOU nothing because no one is going to pay.

The CNBC crew, the idiot Dennis Kneale, brought up the revised 110-age (used to be 100-age) model for being in the market. I don't know too many people rich enough to have half their assets in an asset class at age 60 that goes nowhere but sideways down for 10 years and promises to do the same for the next 10 years. People don't live to 110 except on rare occasions, so rare that hardly anyone on this board has ever personally known a person that did. Second, the price idea, which is where Buffet is piling in doesn't support a long term market return. Stocks are cheap when the dividend for the market is around 5%, not 2.8% or 3.7%, which is the stated returns on the SPX and Dow, inflated by a credit bubble.

Going forward, lets see who is stupid enough to plunge into debt, which is about the only way all this smoke (replacing lost funds with IOU's to the Central bank and government isn't printing money) or how willing the banks are to lend more money to those that couldn't pay the interest on it for 3 weeks? I believe we are going to see an amazing backwards roll in the emerging markets. I have been making this argument for a long time, but they try to spin it out as a disconnect. It is clear there isn't a disconnect, that the debt bubble isn't a US subprime problem, but a global speculative credit bubble. The losses on US subprime were minimal in light of the total debt structure in the world and is a CNBC coined excuse for the entire worldwide investment banking scheme. We are going to find the corporate takeover bubble is going to dwarf the subprime mess.

Now they are talking about the gasoline decline boost. If the price of gasoline had the effect Dennis and company pretended it did, the economy would have collapsed in 2005 when we first saw $3 gasoline. My contention is that gasoline was going on the credit card and we are now in need of more borrowing to keep the credit bubble inflated. Also, every penny of decline comes out of GDP, as it is measured as production at some point. Every $1 is $82 million per day, which means $10 is $820 million. It isn't necessarily money that is going to be spent and it will have devastating consequences in countries that depend on oil production. I expect a massive downturn here in the DFW area if this phenomenon continues as the largest oil field in the country is being developed here by XTO, Devon, Chesepeak and others. I believe these companies could very well go broke in a deep recession, as the cost of producing this gas is only marginally below current prices.

The price of gasoline is actually below the price of oil when you do the 42 times gas price. The energy argument is one the bulls can't win because a rebound means we move back to $144 or higher and if we don't, we are probably going to get cheaper gas prices, it will be because we have a depression.

The deflation argument is centered around what is going on. Oil is declining because of a drop in demand, not because to dollar got more valuable. But, the dollar got more valuable because the market can't supply the cheap extra dollars it was providing in the past. Forget the Fed funds rate, as that is either income or expense for a bank and a wash for the banking system. The impact is going to be if the economy demands more or less money to operate. There is a difference between that idea and what is going on with the banking system, which is central bank and government injections, not for lending but to stop total collapse. The gasoline example is one comparison. For the consumer that doesn't have a credit card, the spendable income is going to go up, but the guy who is living around credit will merely not put extra cost on his card. All people are going to attempt to lay in some kind of cash cushion, something many wouldn't have thought about a few years ago.

Now Dennis is calling a bottom of the California housing crisis. He has no clue how long this will take to reconstruct. Neither do the stock bulls, who look at the credit bubble reflated 2002 market and how it got even in 5 years. The bubble that made the 1990's market and picked up the 2002 market has burst. A couple of people on this housing nonsense are telling the truth after 2 years of studying this mess. More than anything in the US, the amount of home equity left is as deflationary an indicator as anything.

The other inflationary power in the world is the emerging markets, the BRIC countries. They are the canaries in the coalmine, as most of them have been on spending binges. China has been literally built into a modern economy in 20 years, most of it happening in the past 10 years. Almost half the people in the world live in China and India and a slight move upward or downward in per capita demand for anything in these 2 countries has a massive world effect. Consumer demand for automobiles in these 2 countries has been the demand push for oil, as much as anything. But there is another demand push, capital expansion. If the demand for goods shrinks in a recession, I am afraid the capital goods industry rolls so far backwards (read Von Mises business cycle) that major chunks of the economy just goes idle.

Look at how strong the battle has been against something they say isn't likely, deflation. It isn't likely, but we watched it occur in the second largest economy in the world while the rest of the world was actually pumping up a bubble. How could Japan go in the tank while the rest of the world was pushing the game upward? This happened in Japan while the rest of the world was having an inflation party. What happens now that the demand for the world, the US, undergoes a massive economic restructuring and financial re-organization?

What is true for the US is also going on for Europe and will be going on in the emerging markets as well. I believe Brazil and China are massive bubbles and Russia and India really have such poor and socialist supported economic models that they have huge black holes to fall into. China claims to be growing at a significant pace, but I suspect it is expansion that will not be utilized. When it runs its course, the demand for commodities worldwide are going to fall into collapse and the resulting hit on world demand for everything is going to be mindboggling.

The CNBC guys are again talking about the bottom being in based on the speed of the decline. One guy says wait and the other guy says plunge, but neither is really arguing we go lower. Erin Burnett brings up the decline and they all measure this market against 1974 and 2002. I don't believe any of them can honestly compare this market with those 2 markets, though 2002 has a few simularities. The market in 1973 was paying a 3% dividend on the SPX and by the bottom, the market was paying enough yield to make a bottom. Also, the financial system hadn't collapsed. The financial system has collapsed across the board and what is left that hasn't collapsed is going to collapse, mainly in the discussed emerging markets. What is actually a series of props, is being sold as stimulous and printing money. Deleveraging is being done with no recogition that leverage isn't coming back and that deleveraging means destruction of credit.

We are off about 45%, give or take a few percentage points. This looks like a buying opportunity, but in real markets, the SPX would pay 3% at peak. It pays about 2.8% after this decline, so we are above peak, not below it. The financial situation supports the idea of dividend cut instead of dividend increases, with declines of 50% before this bear is done, not out of the question. It hasn't occurred to most companies and consumers yet that they are going to need to conserve capital and cash, as has been shown by the busted industries. It amazes me that banks are still paying dividends while panhandling money under smoke screens from the government and Warren Buffett at high rates. They won't be paying anything by this time next year and bank dividends are a huge part of what is paid on the market. Also, the stock buybacks are going to end, as they find out it is harder to raise capital than it is to spend it.

The point I am moving to is that the market is probably going to fall 80% or more before we find a tradable bottom. This market isn't a 1974 or a 2002 market, but a Japan market or a 1930 market. This is the difference between a slowdown and a bursted bubble and this is a worldwide bursted bubble. Remember, the disconnect story was still playing 3 months ago and some of it is still playing for China now. The downturn in Europe and the burst bubble is worse than the US and the bubble permeates all areas. My point is that the investor that has ridden this market down and gets out now is going to lose the 45% or so. The guy that takes the plunge here could lose 60% to 70% based on other bubble models, namely Japan and the great depression.

I believe Wall Street has been trained to depend on the allmighty Fed. It amazes me that they threw rocks at Japan, but in reality we aren't doing anything different other than the pre-emptive bank bailout. One problem is the traders are too young to have lived through a real bear market in everything. Remember, though the 2000-2002 market was hard on tech, housing and commodities actually did pretty well during that period of time and there were carry trades to be had that were like stealing money. Today all this stuff is unwinding and the Fed can't cut to zero.

The idea of how the banking system works has been confused. The Fed is a liquidity provider and a lender of last resort, not a loan maker. In theory, the Fed could buy treasuries and leave the money in the system, but it is more likely in a tough market that the banks would take the money and buy treasuries, thus putting it back into the Fed. Fed liabilities don't make for lending and we are about to find this out. They keep the banking system liquid, but not necessarily solvent.

The banking system has literally been allowed to operate in a position of insolvency. The Treasury smoke screen that has allowed so many insolvent banks to get capital injections in the form of government 5% preferred stocks is almost criminal. Injections from the Fed and capital injections hardly make for a lending boom. Especially when the limits of the last boom have been permanently pulled in, no subprime and soon no high risk credit cards. What is also missing is the previously mentioned home equity, which will threaten the credit card, mortgage, real estate and other consumer related industries. Its effects will be felt from mainstreet to Bejing.