The Daily Reckoning
Thursday, July 30, 2009 |
The biggest public offering in more than a year comes from China... You can't buy real prosperity on credit... The credit explosion didn't make households richer... Byron King with a Requiem for Ben Bernanke...and more!
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This Too Shall Pop, Part II
by Bill Bonner
London, England
Comes word this morning that the China State Construction Engineering Company has gone public. It's the biggest public offering - at $7.3 billion - in more than a year. It's also China's biggest homebuilder. And as soon as the shares hit the market yesterday they soared...closing 56% higher than the IPO price. At that price, it trades at about 40 times forecast 2009 earnings.
Why would you pay 40 times earnings for a homebuilder? It's a fairly easy business to enter. No barriers to entry that a little money...a few connections...and a circular saw can't overcome. With no barriers to entry, profit margins are always squeezed by competition. And growth is limited too - other builders are always starting up. If the investor paid 40 times earnings, he can only get 2.5% on his money - if the company pays out 100% in dividends! So, why pay so much?
The answer has two parts. First, China is providing stimulus to its economy on a mammoth scale. It gave the signal to its banks. The banks responded by opening the flood gates. Loans in the first half of the year measured three times those of the same period a year before. Naturally, this liquidity had an effect. The economy is booming. Everything credit can buy is being bought. But, as we at The Daily Reckoning know, you can't buy real prosperity on credit.
And the other reason for the bubble in builders' shares? Investors - especially investors in China - have learned nothing from the crash of '07-'08.
These are our little secrets, aren't they, Dear Reader? The rest of the world seems unaware of how the investment markets work...and they think credit is Miracle-Gro for the economy.
But markets are not mathematical...nor mechanical; they're moral. Their purpose is not to make people wealthy, but to make them wise. And then...only for a while.
It they were mathematical you might make people richer by adding zeros. But it's not that simple. Zimbabwe tried it; it doesn't work. A Dear Reader gave us a $10 TRILLION dollar bill - real money printed by the Zimbabwean Treasury. That - and about $5 US dollars - will buy you a cup of coffee in Harare...if they have any.
If they were purely mathematical, you might be able to anticipate price movements with computers and PhDs in math. Many have tried it. As far as we know, none has ever really succeeded.
It's not a mechanical system either. When prices go down, there are no screws you can tighten...no levers you can pull... Nor can you add more fuel or slather on more grease. It's not that simple.
Instead, markets are complex natural systems. Like mistresses, they can be jiggled and jived... but they can never really be controlled or predicted. That's what makes them so interesting, of course.
The markets are always teaching us...always correcting us...always giving us a kick in the pants. These are moral lessons...in the broad sense. That is, if you do the wrong thing you get punished for it. Step on a rake; it hits you in the face.
The purpose of a bear market is to correct the errors of the preceding boom. Most prominent among those errors is to think you can make money by speculating in the stock market. When this idea takes hold, good sense goes out the window. People will buy dotcoms with no business plans...and house builders at 40 times earnings!
But that's how we'll know when the correction is over - when people give up on the stock market...when they want nothing more to do with it. Judging by today's news...we're still a long way from there.
Get ready for another crash...the next leg down of this historic correction...the next kick in the pants...the next moral lesson.
[You can get ready by learning about 'super shields' that will protect you against the next round of market wipeouts. Get the information you need by clicking here.]
More news, from The 5 Min. Forecast:
"The US Postal Service is on track for a record $7 billion deficit this year. That's more than double last year's loss," writes Ian Mathias in today's issue of The 5 Min. Forecast.
"Postmaster General John Potter bumped up his previous projection by a billion bucks yesterday, citing the growing expenses of six-day delivery and employee retirement/health care plans. Potter and his team are scrambling to cut costs left and right - from a year-long hiring freeze to early retirement offers to branch closures. But we wonder... will it even matter?
"The Government Accountability Office recently labeled the USPS a "high risk" federal program, and while we're hard-pressed to think of any risk-free government program, we're inclined to agree.
"The Postal Service is facing a perfect storm of business risk: The business is already loaded up with debt. Minimum wage and benefit costs are rising while revenues are plummeting. For example, it is expected to handle at least 27 million fewer pieces of mail this year than in 2008. Is there any business in America that isn't looking to cut shipping costs? (There's this new technology we've heard about called 'e-mail.')
"Then there's UPS and FedEx, two worthy private-sector rivals. And what about Peak Oil? A summer of 2008 redux could cripple the whole industry. Above all, the USPS is run by the government...c'mon.
"Snail mail might not be dead, but we suspect the USPS is going the way of Amtrak, at best.
"The government can't even deliver our mail without losing money, yet the public looks to it to manage our healthcare? Oy..."
Ian writes every day for The 5 Min Forecast, an executive series e- letter that provides a quick and dirty analysis of daily economic and financial developments-in five minutes or less. It's a free service available only to subscribers to Agora Financial's paid publications, such as Resource Trader Alert. RTA's latest report details a 'no- brainer' trading strategy that will help you rake in some real gains in a short period of time...without having to touch stocks. Get the full report here. And back to Bill, with more thoughts:
If investors have learned nothing so far...neither have the feds. All over the world they're trying to solve a problem caused by too much credit by providing more credit. Trillions' worth, in fact...
We see the result of it in China...a country where the feds have money to spend...and the power to tell bankers what to do. The markets have gone wild...
In the United States and Britain, they've been less successful. But they haven't given up. On the contrary...they've put at risk an amount equal to nearly twice the GDP of the entire US economy...and now they're talking about Stimulus II...
Then Stimulus III...then Stimulus IV will probably follow...until the whole thing finally explodes in a blaze of glory...
Consumers have wised up. They seem to have learned their lesson. Savings rates have gone from zero to 7% in the past 12 months - a remarkable turnaround. Frugality is back in fashion. Thrift has been put back in the dictionary. Consumers are tired of carrying huge debt loads. They're eager to get rid of them as soon as they can.
But neither Wall Street, nor Washington, nor investors seemed to have learned much. Wall Street is still handing out billions in bonuses - leaving its firms short of capital reserves. Investors still seem ready to jump onto whatever wagon has the most other people on it. And while the private sector ran up trillions in debt in the bubble years; now, it's the public sector's turn.
In 1991, borrowing by government and the private sector put together was less than 5% of GDP. But by 1998, the private sector was on a binge. Every year for the following decade, households and businesses borrowed between 10% and 15% of GDP, while government continued to borrow modest amounts...less than 5% of GDP.
In 2008, the positions reversed dramatically. Private sector borrowing collapsed to below zero - meaning, the private sector was is paying off debt, not accumulating more of it. The public sector, on the other hand, has come to the rescue with borrowings between 10% and 15% of GDP.
Of course, this is classic counter-cyclical stimulus. What the private sector giveth up on...the public sector taketh up like an unexploded hand grenade. The politicians are now pulling the pin...
Yes, dear reader, there are still lessons to be learned.
But wait...isn't counter-cyclical stimulus a good thing? Everyone says so. Without it, said Ben Bernanke, we might have entered a Second Great Depression. And we don't know...maybe he's right. The private sector is no longer borrowing and spending like it used to; now, the feds have to do it, right?
Where have you been, dear reader? That's not the way it works. The credit explosion in the bubble years didn't really make households richer - it made them poorer. That's why they're struggling to pay their bills now. And the credit explosion in the public sector now isn't going to make people richer either; it's going to make them poorer too. Soon, the United States will be struggling to pay its debts too.
That's the moral lesson: borrowing makes you poorer. Unless you're using the money to increase output, there's no economic health it in. In other words, if a factory sees an opportunity, it might borrow to expand. The extra output should produce enough profit to allow it to repay the loan...and come out ahead. But if you borrow to consume, at the end of the day you're poorer. That's the lesson of the Bubble Years. That's the lesson consumers need to learn every couple of generations. And now, they seem to have learned it. They remember that the economy ran hot in the bubble époque, but it didn't do them any good. And while the stimulus of that era did stimulate consumption, it was not genuine wealth building.
[If you are feeling a little bitter about funding these stimulus programs, knowing that your hard-earned money is going to line the pockets of these Wall Street fat cats, we've got you covered. Learn how a legal 'loophole' will start you an extra income flow - completely backed by the US government. Get all the details here.]
And now cometh the feds. They're borrowing and spending on a scale never before seen. The federal deficit is expected to come to $2 trillion this year. Trillion-dollar deficits are foreseen for the next 10 years. There seems to be no way out.
What the private sector took away - about $1.4 trillion of debt-induced spending - the public sector puts back. But will this spending produce any more real wealth than the private sector binge? Let's see...the news reports tell us they are using it to fix toilets in national parks...cut down pine trees in rural Tennessee...and bail out the bankers on Wall Street. Is this consumption or investment? If it is investment, is it wise investment? It's not enough to invest; you have to put money into projects that pay off...that pay dividends...projects that give you the cashflow to pay back the debt! Will federal spending for the stimulus/bailout projects do that?
Don't even wait for the answer, dear reader; you already know what it is.
Tomorrow...the vigilantes are back...the real showdown...
Until then,
Bill Bonner
The Daily Reckoning
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| The Daily Reckoning PRESENTS: A few of our dear readers have written in to ask where our comments on Ben Bernanke's town hall-style meeting that happened this past Sunday are. Unfortunately, many of us were traveling back from the AF Investment Symposium in Vancouver and missed it - but luckily, Byron King tuned in. His thoughts, below...
Requiem for Ben Bernanke, and His "Second Great Depression"
by Byron W. King
Pittsburgh, Pennsylvania
"I was not going to be the Federal Reserve chairman who presided over the second Great Depression," declared Federal Reserve Chairman Ben Bernanke this past Sunday. Well, he sure had me fooled.
My gut reaction to Mr. Bernanke's statement was to recall the famous words of former President Nixon, who said of the Vietnam conflict, "I'm not going to be the first American president to lose a war." And we know how that turned out.
Poor Mr. Bernanke. Does he really not understand his fate? I'll grant that he was dealt a bad hand - a draw of pure, malevolent evil - by his incompetent predecessor at the Fed, Alan Greenspan. But when you volunteer to run the nation's central bank, you're asking for a seat at the table of history. When history deals, you play the cards that you're dealt. And sometimes history holds all the trumps, if not a few aces up its sleeve.
This past weekend Mr. Bernanke "appeared stoic at times," according to The Wall Street Journal, as he met with 190 people in a town hall-style forum at the Federal Reserve Bank of Kansas City. Over the course of an hour, at an event moderated by PBS correspondent Jim Lehrer, the Fed chairman answered 20 questions from attendees.
The unusual setting allowed the former Princeton professor to speak outside of his usual comfort zone. The give-and-take in Missouri - aka "flyover country" to many Washingtonians - was far removed from Fed chief's normal, well-scripted congressional testimony, or his occasional academic presentations to roomfuls of big shot bankers and professional economists.
Continuing the Nixonian theme, the Kansas City forum was an opportunity to find out what Mr. Bernanke knew, and when did he know it.
Mr. Bernanke defended himself and the Fed against suggestions that he was too eager to aid large financial institutions last fall and winter, while sacrificing the interests of small businesses and everyday American citizens. "It wasn't to help the big firms that we intervened," argued Mr. Bernanke as he discussed intervening to help the big firms - y'know, the financial firms that are supposedly too big to fail.
Using a Discovery Channel analogy, Mr. Bernanke said, "When the elephant falls down, all the grass gets crushed as well." Thus did he justify unprecedented levels of federal aid to the very Wall Street banking houses that contributed so mightily to the bubble economy of recent years. In essence, the Fed had to feed the beast and save the big guys to protect the little guys. But have the little guys really benefited?
Mr. Bernanke claimed that he was "disgusted" by circumstances under which the Fed rode to the rescue of several large financial firms. "Nothing made me more frustrated," he said, "more angry, than having to intervene" when big banks were "taking wild bets that had forced these companies close to bankruptcy."
Then Mr. Bernanke argued - strangely - in favor of new laws to let financial firms other than banks fail WITHOUT going into bankruptcy. Huh? What's wrong with bankruptcy? It's been around since the days of the Roman Empire.
I practiced bankruptcy law in my pre-Agora career as an attorney. (I'm a recovering attorney now.) I don't understand Mr. Bernanke's viewpoint at all. Why shouldn't big financial firms go bankrupt when they deserve it? OK, there's the usual canard: because it would be difficult or impossible for a bankruptcy court to "unwind" all the open trades in the sweatshops and boiler rooms of big outfits like AIG. I disagree.
| "Mr. Bernanke and the Fed had a clear policy choice last fall. They could do a big bailout or not. The Fed chose to open Door No. 1 and bail out Wall Street. This was at the expense of Main Street, let alone the national balance sheet." | |
Mr. Bernanke's comment makes me wonder how well he understands the intent (let alone the history and legal process) of bankruptcy. Or does the Fed boss just always default to handing out special deals to the big-money guys?
Still, I have to give Mr. Bernanke credit for showing up to speak with a couple hundred informed citizens. The Fed certainly deserves the exposure.
According to a recent Gallup poll, a mere 30% of Americans believe that the Fed is doing a "good" or "excellent" job (down from 53% as recently as 2003). About 57% of Americans believe the Fed is doing a "fair" or "poor" job.
Indeed, according to Gallup, the Fed is the least-trusted of nine government agencies. The Fed lags far behind on a list that includes agencies such as NASA and the FBI, as well as traditional bête noires such as the Central Intelligence Agency, the Internal Revenue Agency and the Food and Drug Administration.
Mr. Bernanke's tenure at the US central bank faces intense scrutiny, and not just from the serial bashing that he receives from the writers at Agora Financial. He has only six months left in his term as Fed chairman. Mr. Bernanke will soon learn whether President Obama will reappoint him to another four-year term or replace him with another Fed chairman wannabe.
Does Mr. Bernanke really want to continue at the Fed? Why? If Mr. Bernanke doesn't want to preside "over the second Great Depression," as he claims, then he should get the hell out now and try to salvage some measure of his professional reputation - if not his old job and paycheck at Princeton. Or does Mr. Bernanke want to continue on the pathway of becoming the central bank equivalent of Gen. William Westmoreland?
The questioners in Kansas City were on the right track. They certainly raised better issues than we see in the softball questions Mr. Bernanke routinely receives from members of Congress and senators.
Here's the key point. Mr. Bernanke and the Fed had a clear policy choice last fall. They could do a big bailout or not. The Fed chose to open Door No. 1 and bail out Wall Street. This was at the expense of Main Street, let alone the national balance sheet.
But the "Second Great Depression" was not going to be stopped so easily. You don't just throw money at a Great Depression, especially money that you don't have. Mr. Bernanke ought to know this, based on his studies of the first Great Depression.
Instead of the bailout last fall, Mr. Bernanke and the Fed should've let the big guys fail. The Fed should've upset the whole stinking mess on the card table and reset the US monetary system. The Fed had the chance to make a statement and choose a new path, and to cast the money-changers out of the temple, so to speak.
Mr. Bernanke and the Fed should've allowed the failed banks to go down. The Fed should've sent the bubble perps down the street to the US Bankruptcy Court in lower Manhattan, along with all their fraudulent paper such as MBSs, CDOs, SIVs, etc.
Would large-scale bankruptcies have been a shock to the US and world financial system? Of course. That's the idea. It would have been very ugly. But it would've helped to clean up the US economy for a couple of generations.
Would Mr. Bernanke be despised by many people? Yep. Burned in effigy, a la Paul Volker? Yes, and it comes with the job. The Fed chairman should not try to be Mr. Popularity.
By now, almost a year later, we'd have some semblance of financial finality. That's because bankruptcy courts have the legal power to void bad contracts and discharge unpayable debt. Instead, we still have the problem of bailed-out zombie banks with massive levels of unmarketable paper and unpayable debt on their books. Right now, the "dead banks walking" are doing little but sucking capital out of the system while the Fed tries to reinflate more bubbles.
Would finance and commerce have proceeded during a banking bankruptcy? Yes, because there's an entire economy out there, with hundreds of millions of people expressing needs and wants in the marketplace. If you believe in the basic idea of Capitalism, then you have to believe that we would have adapted, and learned new ways to meet the needs and wants absent the big, failed banks.
And it's worth pointing out that plenty of people and companies do business while they're in bankruptcy court. There's nothing quite like the stroke of the pen of a federal judge to cut through the crap.
When Ben Bernanke says that he doesn't want to preside over the second Great Depression, he's missed a critical point. He's already there.
Whether it was Pres. Nixon and his policies, mired in the rice paddies in Southeast Asia many decades past, or the current fever-swamps of the Potomac River, there are some bullets that have your name on them. You can't duck and dodge.
Right now, many years of monetary malpractice are roiling the American economy. To quote a famous Chicago preacher, "The chickens have come home to roost." The second Great Depression is happening, and it's happening on Mr. Bernanke's watch. Did he really expect to skate through a couple of terms as post-Greenspan Fed chairman and not get blown up?
Sad to say, Mr. Bernanke bailed out the big banks. Now the damage is done. We're still in for that "Second Great Depression." And Mr. Bernanke will forever be associated with it.
Ben Bernanke could have been a heroic figure. He could have refused the bailout and repudiated several generations of bad monetary ideas. He could have launched a new movement - something like monetary perestroika in the US - and moved the country ahead into a future of increased productivity and financial solvency. Instead, Mr. Bernanke is just a bit actor in a historical tragedy.
There's no armor against the arrows of fate. Mr. Bernanke has lost his chance. Perhaps he can take solace in the words of Robert Louis Stevenson from his classic "Requiem": "Home is the sailor, home from the sea."
That's all for now. Thanks for reading...
Byron W. King
for The Daily Reckoning
P.S. Many of you may be wondering: where do we go from here? Well, the US economic problems are far from over. So no matter what Mr. Bernanke decides to do, we want to be positioned to defend our purchasing power during the difficult years ahead.
In the midst of this monetary mess, I believe that things of REAL worth will hold up better than mere promises on paper, however green. For my Outstanding Investment subscribers, I'm advising them to hold on to our precious metal miners, our energy producers and the other related value-stocks in the OI portfolio.
To see the full Outstanding Investments portfolio, see here.
Editor's Note: Byron had a very interesting presentation at this last week's Agora Financial Investment Symposium - and even if you weren't able to join us this year, you can still be privy to all the investment advice that Bryon (and all the rest of this year's presenters) offered. That's because we are recording all of the main session presentations, and you can get them delivered straight to your front door.
Get these audio recordings by clicking here.
Byron received his Juris Doctor from the University of Pittsburgh School of Law, was a cum laude graduate of Harvard University, served on the staff of the Chief of Naval Operations and as a field historian with the Navy. Our resident energy and oil expert, Byron is the editor of Outstanding Investments and Energy and Scarcity Investor.
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