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How Bad Can It Get?
by David Stanowski
11 October 2008

91% of the American public are not satisfied with the way things are going, at this time, according to a Gallup poll. In fact, people are more dissatisfied than at any other time in the history of the poll. Why now?

Gallup Poll 

After many years of denial about our festering political and financial problems, when the credit markets started to melt down, the public finally noticed that something is terribly wrong. As long as easy credit was available to fund ever increasing binges of consumption, most didn't care! Partisans make the claim that this all happened over "the last eight years"; i.e. it's all George Bush's fault, but anyone who has studied the historical data knows it began long before that.

Many measures of household financial strength, as well as real household income peaked between 1965 and 1970, and have been declining ever since. One of the key reasons for the present crisis was  Nixon's decision to stop converting the U.S. Dollar into gold in 1971. This opened the door to the unprecedented creation of credit over the last two decades.

Most of the media are blaming the current financial problems on "Wall Street greed"; but that is only part of the story. It was the collapse of the residential real estate bubble that set off the avalanche. Wall Street played a roll in this by inventing ways to repackage and sell off mortgages, but they weren't building, financing, and selling houses.

The fundamental cause of this crisis is the Federal Reserve System, and the fractional reserve lending that it facilitates at commercial banks, which places little limitation on credit creation without the discipline of gold. The real estate industry has been "giving money to" politicians for decades to get more and more credit pumped into their industry through a variety of corrupt schemes.

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Wall Street certainly played a big role in the current troubles, but the worst offenders, Congress and the real estate industry, have been able to point the finger at George Bush. His administration has done a pitiful job of dealing with the crisis, but they are hardly the ones that caused it.

The Conventional Wisdom is that the government must "do something", but almost any interference in the markets, as the private sector tries to sort out this mess, will make the losses deeper, and force the resolution to take longer.

Now is one of those times when political analysis must play a prominent role in how investments are selected. Those who let wishful thinking and ideology blind them to what is really going on, and what most likely will happen, over the next few years, will suffer unnecessary losses!

The political rhetoric of the current presidential campaign makes it almost impossible to deal with the real problems we face. Ron Paul is the only national politician who has demonstrated a grasp of the underlying causes of our current woes, and a clear idea of the constructive changes that are necessary. He knows that the answer is to simply stop doing what we have been doing; borrowing and spending too much, and then let the markets do their thing to sort out this mess.

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There are very, very few people who actually want to see John McCain become president. He has  shown little evidence that he has anything approaching a coherent set of ideas and principles, and he would certainly bumble through any attempt to "solve this crisis". Most of his support is based solely on the fact that, if he is elected, he would keep Obama out of the White House. 

Those who are fully aware of Obama's past influences envision him turning America into Cuba or North Korea, especially with the strong Democratic majority that he will have in Congress. Whether we will see the Hammer & Sickle flag flying over an Obama White House, or not, one thing that is fairly certain is that we will have to endure a Second New Deal when he takes office. This is a man with many government solutions in search of real or imagined problems. There isn't a free-market bone in his body.

By the time FDR took office, in 1933, the stock market had already hit bottom in July 1932. This meant that many of his True Believers had already lost all their money and assets. When Obama takes office, in January 2009, many of his True Believers will still have something to lose, so they may lose faith when they realize that the Second New Deal will not save their wealth.

The U.S. economy was ready to start a rebound in 1933, but the New Deal programs kept taking resources from the private sector and killing off each recovery attempt, which dragged out the Depression for at least another 12 years. A Second New Deal should have the same effect.

Obama's Second New Deal will probably feature draconian anti-free-market policies, so investments must be positioned accordingly. In the New Deal, FDR declared a "bank holiday", and closed all the banks, and froze the deposits. Eventually, he raised the top income tax rate to 91%, and confiscated all the gold. Anyone who "illegally" retained their gold was subject to a fine of $10,000 (about $200,000 in today's Dollars), and/or 10 years in prison. How about that for an investment dilemma?

Investors have to be prepared for similar measures in any kind of Second New Deal including such things as currency controls; i.e. limitations on transferring money out of the U.S. Those who have the means and inclination may even want to consider taking a long "vacation" in another country if things get too repressive.

Be prepared!

Why aren't the multitude of bailout plans working?

Because wealth is being destroyed at a faster rate than the federal government is creating new credit. They are trying to re-inflate the economy, by creating credit for banks and businesses; they are not actually printing money.

Here is just one example: The Bloomberg World Market Index made its high on 31 October 2007. From that point through 13 October 2008, this index shows that there has been a loss of $26 TRILLION in stock markets around the world; that's $26,000 Billion! $7 TRILLION of that loss is in the U.S. markets. About $2 TRILLION has been lost in U.S. retirement accounts.

Stock market action this week has pushed worldwide losses to well over $30 TRILLION! When you throw a $700 Billion bailout, i.e. 0.7$ TRILLION, at a $30+ TRILLION problem, it can disappear pretty fast!

World Stock Market

World Stock Market

However, the losses on stock markets are only part of the story. The U.S. residential real estate market has lost at least $2-3 TRILLION since its top in 2005, the commercial real estate market is now following suit, the losses in the domestic credit markets are running into the TRILLIONs, and losses in commodities are catching up fast. And, don't forget the $500 TRILLION in off-exchange derivatives that have to be marked to market, and eventually closed out!

This is actually quite a lot of money that is going up in smoke!

How much further can the markets drop?

As of this week, the first year of this bear market in U.S. stocks has surpassed the first year of the 1929 bear market! In that case, the stock market lost 92% of its value before it bottomed in 1932. Those who are expecting some sort mild bear market and recession in the aftermath of the most overvalued stock and real estate markets in history, are not being realistic.

Stock Market Performace

If this bear market merely equals what happened between 1929 and 1932, the DJIA could potentially drop to about 1,200! The Stock Market: the Beginning or the End?

In addition, this country currently has 18.6 million vacant houses, with another one million under construction. This means that in a few months there should be at least 20 million vacant houses, and this is without considering how the weak economy is bound to shrink the number of households as people begin to move in with each other. There is a lot of downside potential in this market, too.

Several people have asked me whether I think we can recover from this financial crisis.

There is no question that the markets will stop declining at some point, but recovery usually implies a return to old highs, which is very doubtful for a very long time. Stock market cycles don't point to a bottom until about 2012. Until then, the main trend should be down, punctuated by some exciting rallies.

The real estate market has many years of excesses to work off, so it is not unreasonable to look for a bottom in this market near 2012, too.

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The economic health of the U.S. probably peaked between 1965 and 1970, and has been in decline ever since. There is little chance that we will ever return to these levels without a massive structural change in our government. A true Constitutional Republic with a small federal government would portend great things for the future, but anything short of some sort of revolution is unlikely to cause this to happen.

It should also be noted that our economy peaked in the days of cheap and abundant oil. With the probability that we have reached the point when cheap and abundant oil is a thing of the past, a strong economic rebound is even more unlikely.

Finally, when the economy was ready to recover in the 1930s, America had the strongest industrial infrastructure in the world, and it was ready to tool up and rebuild. Today, much of our manufacturing capacity is gone. We have mis-allocated our capital into real estate for years, and all we have to show for it is millions of vacant houses. How can we possibly use them to rebuild our economy?

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John McCain doesn't posses the common sense to trust the free markets, so any kind of last minute shift that puts him in the White House would not be a sign that we were in for a quick rebound in the economy.

Of course, a President Obama will have plenty of ideas on how the government can fix things, so this will delay any real rebound for years. The Japanese did not want to let the markets sort out their financial problems, when they started their decline in 1989, and their economy and markets have been struggling for 19 years! The most likely outcome, with a President who has a government program for every problem, is many years of little or no growth, too.

Many people will label this conclusion as pessimist or negative, but what good does it do to look at the world through rose-colored glasses when it creates a distorted image? In order to protect and grow your money, you have understand what is most likely to happen.  

If this scenario plays out as expected, the biggest losers in the coming years will be those who have most of their wealth in stocks and real estate, and who don't move into safer investments. The Conventional Wisdom is that the buy-and-hold approach always works in these markets, so just ride it out.

Many are saying that if you just hold on for a few years, all of your losses will be recouped, and you'll be making money once again. Of course, what they don't tell you is that if you bought the DJIA on 03 September 1929 at 381.17, it didn't reach this level again until 23 November 1954; a mere quarter century later! And that understates the recovery time involved, because it ignores the interest that could have been earned over this 25-year period, AND the fact that many companies in the DJIA went bankrupt and were dropped from the average.

Real estate investors may face a similar situation, as they wait many years for a declining economy to adsorb the overpriced and impractical homes that were built during the bubble.

Everything in this article may be totally wrong, but what will happen to your investments if it isn't?


Do you think that we will see these
kinds of references in the mainstream
media after Obama is elected?


The information contained in this article reflects an analysis of market trends and conditions, and nothing contained in this article, or on this website should be interpreted as, or deemed to be, a recommendation to any investor, or category of investors to purchase, sell or hold any security.

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In contrast, what you just read is simply INFORMATION, that was obtained from what are believed to be reliable sources. It is ALWAYS wise and prudent to undertake investment positions only after considering a wide variety of information and opinions, on the subject, and after consulting with those who are authorized to give INVESTMENT ADVICE, if so desired. Although consultation with "experts" may be helpful, everyone should do their own DUE DILIGENCE regarding ANYTHING that may affect their financial well being.

The author is an active participant in the markets, and may trade the securities that are discussed in this article, both before and after publication, and/or may have a long-term position in such securities. In other words, the author usually has a financial interest in the subject of the articles on this web site.

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