Agora Financial’s Rude Awakening

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Paris, France

• When the mighty say it’s over, the crisis is just beginning,
• Real unemployment levels beyond 20% plus,
• Japanese hippies, trans-Pacific deflation (for now) and more…

Joel Bowman, reporting from Taipei, Taiwan…

“We head west,” our new friends exclaimed, “like hippy people from America do.”

We encountered our fellow adventurers in Japan last week, while dining at one of Fukuoka’s famous Yatai (traditional street side food stalls). We were in Japan on a kind of reconnaissance mission. Deflation is on a global rampage and we wanted to see what it looks like up close, taken to a multi-decade extreme. If price collapse is on the rise in the west, we reasoned, it might be useful to see how those in the Land of the Setting Sun deal with it. And so, hoping to preview one possible economic future for the U.S., we caught a glimpse into an Orient-fused version of it’s cultural past.

“Jobs are not easy for us,” one of the travelers told us. A college graduate, the young lady has been “on the road” for almost two years, mostly in Japan but also in India and South America. Now she makes jewelry along her journey, living off the funds and friends’ couches while she figures out her next step.

“It’s not like when our parents got rich,” she says. “We don’t know where we will go from here.”

Indeed, Japan itself has been wandering in a desert of deflation for the better part of two decades now (incidentally, their horse may or may not have a name). After the now-infamous market implosion, which we touched on in last week’s notes, their meanderings have been painfully punctuated by many a mirage of recovery. Alas, their parched tongue met with nothing but sand and dry heat. The stock market finally “bottomed” last year…for now, that is.

Then, to rub salt in the wounds, Japan’s most faithfully consuming customers became victim to a crisis of overconfidence. Americans are tightening their belts. So while savings rates there marched toward a 14-year high, Japan’s exports dropped off a cliff. May recorded a year-over-year decline of above 40% (not a typo).

Unsurprisingly, government tax receipts are coming in well below expectations too. Overall tax revenues slid by record 13.2% for fiscal year 2008, The Japan Times reported last Friday. Even more worrying, corporate receipts sunk by almost a third (32.1%) as earnings deteriorated.

So is the United States doomed to repeat the mistakes they warned the Japanese about two decades ago? Are we headed toward terminal deflation, a negative feedback loop of earnings destruction and job layoffs? In many ways, we’re already there. You saw the jobs numbers last week – 365,000 more people worth of “slack” in demand ought to exert significant downward pressure of prices for a while yet. Home values are still falling, for example, while foreclosed inventory levels pile up each and every day.

America’s assets have only been hissing for two years, mind you; Japan’s have lost two decades worth of hot air. And, with such a delusional runnup in prices, who’s to say when enough air has been let out? As one blogger recently quipped, “What is the natural price when everyone wants to sell?”

The natural correction for low prices, of course, is low prices. But, in a world where prices must seek government approval to fall below a certain level, it is increasingly difficult to ascertain where that watermark is. That said, the longer prices refuse to obey the will of our elected and unelected officials, the farther they are likely to overshoot the mark in the opposite direction when they are “allowed” to snap back.

Meanwhile, the cries to “do something” were loud and desperate enough in the corridors of Capitol Hill that unprecedented intervention was not only allowed, but encouraged. The Federal Reserve balance sheet, for instance, has exploded like a Hiroshima mushroom cloud.

With $45 billion in capital and $2.1 trillion in assets, the central bank would not withstand the scrutiny normally afforded other institutions, James Grant, editor of Grant’s Interest Rate Observer said recently in a television interview.

“If the Fed examiners were set upon the Fed’s own documents—unlabeled documents—to pass judgment on the Fed’s capacity to survive the difficulties it faces in credit, it would shut this institution down,” he said. “The Fed is undercapitalized in a way that Citicorp is undercapitalized.”

So what happens now? We must rely on the people who got us into the most indebted position in the nation’s history to turn the hoses off at the precise time. If they fail, the deserts will flood and all the creatures in it (including horses with and without names) will drown. Guard against deflation for now, in other words, but prepare for the rains.

In the column below, Bill Bonner asks the question every investor wants to know…then gives an answer few may wish to hear. Please enjoy and send any comments to the address below…

— Breaking Research from The Strategic Short Report —

Introducing The Fear Factor Strategy:

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While the S&P 500 crashed 43.3%… this strategy has bagged average 102.9% returns

It’s proven to turn $1,000 into $2,619… $3,383… even $5,718

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Stay Out of the Water
By Bill Bonner

This week began with shrieks of joy. First, a federal court came down on Bernie Madoff like a brick on a baldhead. Madoff, convicted of lying to investors, drew a sentence that only a sea turtle or a swamp oak could complete. Then, like children playing in the sea, investors were teased by one wave of good news…and tickled by the next.

Bloomberg reported that “Wall Street’s largest bond-trading firms say the worst may be over for investors…” Then, General Electric’s CEO, Jeffrey Immelt and famous investor George Soros both said that the crisis is “behind us” and that growth will begin again next year. Finally, analyst John Dorfman opined that the stock market would be a safe place for their money at least through the end of the year.

And now comes the big American holiday – July 4th. Investors pack their suntan lotions and head off to the beach for Independence Day. With Jaws in a cage, they had judged it safe to go into the water. But then came Thursday’s news. Instead of going down as predicted, the number of job losses for June went up. Another 467,000 people became unemployed last month. The figure even surprised us; we didn’t think there were that many people who still had jobs.

And so…this weekend, investors walk along the beach deep in thought. Is it safe to go back into the water…or not? They should listen carefully. That gurgling sound they hear is not mermaids singing, it is the world economy, drowning.

As we reported in this space, the feds’ bailouts, boondoggles and bankers’ bonus plans aren’t working. At the end of last year, they predicted unemployment over 8% in 2009 – if the stimulus plan were not enacted. But it was enacted. Unemployment is at 9.5% already and it is still rising. It will be over 10% before the end of the year. Global trade is collapsing; exports from Germany and Japan are down about 40% from a year before. Prices are going down too – with a report this Wednesday that the entire Eurozone has slipped into negative inflation. And from Britain came data showing a contraction of 2.4% in the first quarter, bringing the year-to-year decline to nearly 5%. “Economy shrinks at 1930s rates,” said the headline in Wednesday’s Telegraph.

When we look at America’s employment numbers, we feel like a school doctor. We would call the authorities, except that it was the authorities who should be arrested. After the feds got finished with them, the numbers told of a better-than-expected drop in May U.S. payrolls. The key to this uplifting news was not a genuine improvement, but new and improved techniques in torture. Water-boarded with seasonal adjustments and birth/death models, the numbers began to see jobs everywhere. As for “discouraged workers”, meaning those who gave up looking because they couldn’t find a job, these unfortunate souls disappeared from the jobless figures altogether.

John William’s Shadow Government Statistics reports that without these twists, the numbers tell the same story they’ve been telling all year – unemployment is still getting worse, at about the same pace as earlier in the year. “The unadjusted annual decline in May payrolls was the worst since May 1958,” says Williams. And if they were allowed to speak freely – as they did in the ’30s – the figures would show real unemployment at over 20% of the workforce…or about 30 million people. That approaches Great Depression levels…and we’re still only in 1930, not 1932. As for those still working, an additional 1.5 million U.S. workers have been “forced into part time work” according to the Financial Times.

Analysts compare these sharp drops in trade, prices and employment to what happened after WWII. Come 1946 and the world had little use for so many soldiers, machine guns and artillery shells. Millions of young men were ‘de-mobed’ and joined the unemployed. And smokestacks suddenly stopped smoking. But that was at the very beginning of 62-year period of credit expansion. Consumers had pent up demand for houses, cars, and other goods and services…and they had the wartime savings to buy them with. Even so, it took three years of adjustment after the war before the stock market began to turn up.

Now, we are at the other end of the cycle – the beginning of a major credit contraction, with no pent-up demand, no savings, and too much capacity to turn out too much stuff that too many people don’t have the money to buy.

Meanwhile, housing prices are still going down in America…and with housing goes the lenders’ collateral. U.S. residential property prices have fallen 33 months in a row. So many houses are “underwater” that the United States is beginning to look like the lost continent of Atlantis.

More foreclosures are coming. U.S. mortgage loans typically call for “down the road modifications” that lead homeowners into a kind of financial cul de sac with no way out except foreclosure. According to a study by T2 Partners, there are three more big waves of foreclosures still ahead – including those in ‘prime” loans, home equity lines of credit, and in commercial real estate.

“When [these mortgage loans] start adjusting upward it will turn millions of homeowners into over-levered, underwater renters, and ensure housing is a dead asset class for years to come,” says Mark Hanson of the Field Check Group.

With incomes falling and house prices weak, consumers will miss payments, default, and cut back spending. Business earnings will decline; bankruptcies will increase. This economic undertow is treacherous. Investors should stay out of the water.

Joel’s Note: Our annual Agora Financial Investment Symposium in Vancouver, British Columbia is rapidly approaching…and this year marks the 10th anniversary of The Daily Reckoning. So, this July, the Symposium will be focused around a “Decade of Reckoning”…four days that will help you to gain greater insight on how to turn investment ideas into the profit opportunities of the next decade.

So, will we be seeing you there? This event is already 70% sold out, so you’ll want to be nimble. Click below for all the info:

The Agora Financial Investment Symposium: July 21-24

—- The Richebacher Society Breaking Report —-

Secretive Society of economists, market players, and world-class researchers and analysts reveal…

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Elite alliance of experts warn: don’t hold your breath waiting for a recovery this year or even in 2010. The three toxic timebombs they name below make a quick rebound next to impossible.

Yet, they also name seven “Super Shields” you can use to safeguard against further losses… plus at least five surprising “long” plays you can still use — even now — to get very rich. Read On Here.

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[Rude Endnote: We’re off to Indonesia tomorrow for some rest and relaxation with the family. If you’re in that neck of the woods, drop us a line.

We’ll check in again from transit before we leave.

Until then…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com