The Muddle Through Middle

Now, we come to the third scenario and -- no surprise to long-time readers -- the one I think is most likely. I think that after we climb out of recession, we Muddle Through for an extended period of time. Follow my reasoning, and remember that I am often wrong but seldom in doubt! And please allow me some room to speculate. I can guarantee that I have some (or most) of the particulars wrong. But I think I have the general direction we are heading in.

We are in a serious recession. We have to allow time for both the housing market and the credit markets to heal. This will take at least two years. I think we have permanently seared the psyche of the American consumer. Consumer spending is likely to drop at least 6-7% over the next two years, and maybe more. The combination of all three bubbles (consumer spending, credit, and housing), which were made possible by increasing leverage and poor lending standards, is by definition deflationary. (I know, I keep repeating, but most readers do not really get the rather disturbing implications.)

The US government in general and the Fed in particular will react to the problem. Most of the government stimulus, other than that used to reliquefy the banking system, build useful infrastructure, and encourage small business to expand, will be wasted or have little short-term effect. The Fed (and central banks around the world), on the other hand, do have the potential to succeed with a "shock and awe" type of stimulus program.

Pension plans, endowments, insurance companies, and individual investors who are counting on 8% long-term compound returns from their stock portfolios are as likely to be disappointed in the next five years as they were in the last ten. The environment I am describing is one of compressing price to earnings ratios, much like the period from 1974 to 1982.

This environment is going to force the creation of new investment programs and products based on income generation. And that is one of the forces that will bring about a real recovery in the middle of the next decade. Investment capital will be made available to businesses that can generate low double-digit or high single-digit returns, as well as new technologies with the promise to deliver new paths to profits.

The second major force will be the arrival of new waves of technological change. We will see a biotech revolution beyond our current comprehension. It has the real potential for solving a great deal of the Medicare entitlement program problems. For instance, it is likely we will have a real cure for Alzheimer's within five years. Since that is as much as 7% of US medical costs, that can create a real cost reduction. The same for heart disease, obesity, cancer, and a host of other medical conditions that will start to be dealt with by a new generation of therapies. That is going to create a new, very real bull market in biotech.

I expect to see a new generation of wireless broadband that powers whole new industries. And it will not just be green tech, but entirely new forms of energy generation that drive the cost of energy down and, combined with other new technologies, make electric cars practical. And along about the end of the decade, the nanotech world begins to really get into gear.

And just as the tightly wound, low P/E ratios of the early '80s gave way to a spring-loaded major bull market as new technologies became the driver for a whole new set of public companies, we could (and should!) see a repeat of that performance. There is a new bull market in our future.

The problem is getting from where we are today to that next dawn. The definition of insanity is to keep repeating what you have done in the past and expect a different result. We are in a long-term secular bear market. P/E ratios are going to decline over time to low double digits. Hoping that stocks somehow rebound to new highs and that the economy is going to go back to what we saw in 1982-1999 or 2003-2006 is not a strategy. You need to be proactive and take charge of your portfolio, looking for absolute-return types of investments for the next 4-5 years. Simply using a traditional 60-40 split of stocks and bonds is not going to get you to retirement nirvana. It will lead to retirement hell.

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Is America Broke Part II -- The Debt God

* Federal Reserve Notes circulate as the currency
* The currency is secured by Treasury Bonds
* Fractional Reserves are money required to be held by the bank
* The reserve requirements go from zero, to 3%, to 10% * Federal Reserve notes (cash) are the main reserve deposit
* The U.S. Treasury has an account at the Fed
* The Fed holds U.S. government securities in its accounts
* The Fed conducts open market operation by buying or selling Treasury securities Where the Money Comes FromTrillions of dollars are on deposit around the world. I remember as a kid that a million dollars was a big deal. Today, billions of dollars are tossed around without the blink of any eye. Trillions are now the topic de jour.

 Where does all this money come from?

There are a couple of parts to the answer.The process begins with the Treasury Department creating a bond, which is now done electronically. Treasury bonds are debt obligations of the Federal government to repay a loan, which includes both the principle amount of the loan and the interest on the loan.

The Treasury sells bonds to the public and other buyers - Japan and China being the largest players, accounting for over 40% of our debt issue. The bonds not purchased by these buyers are deposited by the Treasury with the Federal Reserve. When the Fed accepts the bonds from the Treasury, it lists the bonds on its books as an asset.

The Fed assumes the government will make good on its promise to pay back the loan. This is based on the belief that the government's power to tax the people is sufficient collateral.Because the Fed now has an assetthat it didn't have before receiving the Treasury bond, the Fed can create a liability that is offset by its new asset. The liability that the Fed creates is a Federal Reserve check. It gives the Treasury the check in payment or in exchange for the Treasury Bonds.

The Fed loans the government money by purchasing Treasury Bonds.However, where did the Fed get the money to have deposited on account to cover this check, especially if one goes back to the beginning of the Federal Reserve and the creation of the first Federal Reserve Notes?Also, recall that Federal Reserve Notes are secured by Treasury Bonds - bonds that the Fed buys with the same Federal Reserve Notes the bonds secure. It sounds a bit circuitous to say the least.

The money was created by the very act of the Fed offering the Treasury a loan, and the Treasury accepting the loan. The Federal Reserve's check is endorsed by the Treasury and is deposited in one of the government's accounts. The government can then use the deposits to write checks against, to pay for government expenses.

Safe Haven | Is America Broke Part II -- The Debt God

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Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

Will these market and economic anomalies diminish, the markets recover, and the economy return to normal within the timescale of the 50 or 60 year old buy-and-hold stock investor? Perhaps, but more likely a transformation of the entire structure of the global markets and economy is starting that will take decades to resolve.In my view, these historic events will next year be complicated by political responses to high unemployment globally, and it is reasonable to expect that some of these responses will not be entirely constructive.

The stock market buy-and-hold era ended in 1998. In a world where the so-called business cycle is dominated by bubbles, inflation, crashes, deflation, recession, and reflations and all manner of government interference, stock market timing, and sector analysis, will continue to be the key to making money. In fact, across the broad stroke of American history, there is never a period when markets are not either largely or entirely influenced by the actions of government. For hundreds of years the US has either been at war, recovering from war, growing asset bubbles, crashing asset bubbles, recovering from asset bubbles, or mucking around with the monetary system–entering the gold standard, leaving the gold standard, entering into a new global monetary regime, leaving that regime– endlessly. How can markets possibly be efficient if they are perpetually driven by large-scale events produced by government policies? The idea is profoundly naive.

Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

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Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

That forecast back in 2001 was complicated by the housing bubble, the most idiotic and irresponsible act of government economic manipulation in world history and completely beyond me to predict. Not even in my darkest dreams did I think our Federal Reserve and banking regulators could be so stupid: bursting real estate bubbles bring down banking systems and economies. They did in the US in the 1870s and 1930s, in Japan since the 1990s, and many other nations as well. The US 2002 to 2006 housing bubble extended the tax cut, rate cut, dollar devaluation reflation boom by two of years longer than the 1930s version sans housing bubble. As you can see, that extension made the collapse we are seeing today considerably more severe.

Now we have a post bubble reflation boom crashing around the fake boom created by the technology stock bubble- two crashes nested one within the other– thus the terrific cascading financial and economic collapse we see today.We wrote dozens of occasionally over-the-top, but always factual and data driven, warnings on iTulip.com since March 2006 to try to scare readers out of the stock market. As it turns out, we were able to determine and notify subscribers on Dec. 27, 2007 when the DJIA was trading at 13,365 that, if they were for some crazy reason still in the market, that was it: the last chance to get out.

Debt Deflation Bear Market Update Part I: 2009 Windup - Eric Janszen - iTulip.com

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Past Financial Crises

Broadly speaking, financial crises are protracted affairs. More often than not, the aftermath of severe financial crises share three characteristics. First, asset market collapses are deep and prolonged. Real housing price declines average 35 percent stretched out over six years, while equity price collapses average 55 percent over a downturn of about three and a half years. Second, the aftermath of banking crises is associated with profound declines in output and employment. The unemployment rate rises an average of 7 percentage points over the down phase of the cycle, which lasts on average over four years. Output falls (from peak to trough) an average of over 9 percent, although the duration of the downturn, averaging roughly two years, is considerably shorter than for unemployment. Third, the real value of government debt tends to explode, rising an average of 86 percent in the major post-World War II episodes.

Thoughts from the Frontline

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JimRogers

Embedded Video

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The 10 Laws of Lifetime Growth

THE LAWSof Lifetime Growth:

LAW ONE: Always make your future bigger than your past. Find out more

LAW TWO: Always make your learning greater than your experience. Find out more

LAW THREE: Always make your contribution bigger than your reward. Find out more

LAW FOUR: Always make your performance greater than your applause. Find out more

LAW FIVE: Always make your gratitude greater than your success. Find out more

LAW SIX: Always make your enjoyment greater than your effort. Find out more

LAW SEVEN: Always make your cooperation greater than your status. Find out more

LAW EIGHT: Always make your confidence greater than your comfort. Find out more

LAW NINE: Always make your purpose greater than your money. Find out more

LAW TEN: Always make your questions bigger than your answers. Find out more

The 10 Laws of Lifetime Growth

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"Official" US Unemployment Rate circled in red below

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Oil

Russia will need $70 oil. These countries are going to need to produce and sell what they can, which is in conflict with the need to control production and move prices higher.So far, the OPEC nations are not cutting back any significant amount of production compared with the destruction in demand. Oil is backing up in the system. Energy economist Philip Verleger suggests that OPEC should execute an "astounding 7.7 million barrels per day" just to restore market balance today. Global demand is down by over 5 million barrels a day to 81.6 million barrels a day. Non-OPEC countries produce almost 50 million barrels of oil. OPEC produces roughly 31 million, plus there are some other OPEC sources of about 5 million barrels equivalent in natural gas liquids. Thus, Verleger says OPEC oil production needs to drop by almost 25%, to somewhere under 24 million barrels a day. Think Iran or Venezuela will cut that much, given their need for cash to fund their regimes? Will Russia join OPEC and cut production? It will be interesting to watch Iran and Venezuela in the coming year scramble to maintain power.

Thoughts from the Frontline

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Value ?

One year ago Royal Bank of Scotland (RBS) paid $100bn for ABN Amro. For this amount it could now buy:- Citibank $22.5bn- Morgan Stanley $10.5bn- Goldman Sachs $21bn- Merrill Lynch $12.3bn- Deutsche Bank $13bn- Barclays $12.7bnAnd still have $8bn change which would allow you to pick up:- GM- Ford- Chrysler and- The Honda F1 Team

Michael Covel: Trend Following

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