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Generational Dynamics Web Log for 4-Oct-2008
The $700 billion bailout bill becomes law. Now what happens?

Web Log - October, 2008

The $700 billion bailout bill becomes law. Now what happens?

We can learn some lessons from China.

The political pressure to pass the Emergency Economic Stabilization Act, which I call the Bailout of the World (BOTW), was enormous, even though nobody could clearly state what the BOTW would do.

However, the tone of the statements from pundits and politicians has changed a bit since a week ago. A week ago, they were always saying something like, "The bailout will prevent the entire financial system from melting down."

Now what they're saying is, "The bailout will make the recession less bad."

And the recession is getting real. There's bad news every day, such as plummeting manufacturing numbers and plummeting employment numbers in just the last couple of days.

We have some good indicators of how much the world economy is slowing down.

Baltic Dry Index and price of oil for 2004 to 3-Oct-2008 <font size=-2>(Source: InvestmentTools.com)</font>

Baltic Dry Index and price of oil for 2004 to 3-Oct-2008 (Source: InvestmentTools.com)

We hear talk about the real estate bubble and the credit bubble collapsing, but this graph shows that lots of other bubbles are collapsing as well.

Collapse of Chinese economy bubble

What it probably shows most clearly is that the Chinese economic bubble is collapsing.

China's economy has been growing at over 10% a year since the early 1980s, and by the 2000s decade it's been clear that China's entire economy was in a bubble. As I began discussing in 2004 ( here, and in "China approaches Civil War"), China itself agreed that the economy was overheating and had to be slowed down.

Starting in 2003, the Chinese tried to slow their economy down from 10% growth to 7% growth. They failed to do so in 2003, 2004, 2005, 2006 or 2007. I and a lot of other people speculated that the continuing bubble was being caused by the frenzy leading up to the Beijing Olympics, and that the Chinese economy would finally begin to slow down once the Olympics games ended.

Actually, the slowdown began occurring earlier this year, and I discussed it in June, in "Shanghai China stock market and Baltic Dry Index are crashing sharply."

I've frequently stated my belief that a major cause of the huge spike in commodities prices in the last four years -- wheat, iron ore, oil, and many others -- was caused by the accelerating bubble in the Chinese economy. The prices of many of these "dry" goods is reflected by the Baltic Dry Index.

Now the commodities bubble is leaking rapidly, and the graph above shows that the BDI and the price of oil have fallen sharply, and in unison. What I actually believe is that, with the excitement of the Olympics over, the entire Chinese economy is in free fall. We'll see in the next few weeks whether this last turns out to be true.

But now let's get back to the Bailout of the World plan.

The point I want to make is that the Chinese have totally failed, over a period of many years, to slow down their overheated economy.

The Chinese Communist Party (CCP) had the power to do anything they wanted. They could manipulate any macroeconomy variable they wanted. They could manipulate interest rates, manipulate regulations, manipulate import or export controls, manipulate business laws, manipulate many import and export prices, and so forth. The CCP has all the powers that the American government has, and many more. And they don't have to go through Congress to get something changed; they just do it.

And yet, they've totally lost control of their economy. They couldn't slow it down when it was overheated, and now they can't prevent it from slowing down much faster than they want.

So here's the question I want to ask:

If the CCP, with all the power that it has to regulate and control the macroeconomics of the Chinese economy, could not control the Chinese economy,

then how could anyone CONCEIVABLY think that the Bailout of the World plan is going to do anything to control the American economy?

The answer is that, as usual, the people in Washington are dreaming. The BOTW plan will not have the desired consequences. In fact, the American and Chinese economies are closely interlocked, and I believe that both are plummeting quickly now.

Incidentally, a lot of people are making a mistake when they say, "China is going to do well, because the Chinese people are savers, while Americans are borrowers, and are deeply in debt."

Actually, the collapse of the Chinese economy's bubble is just as disastrous as the collapse of America's real estate and credit bubbles. The easiest way to see that is that the 1930s Great Depression was disastrous to Americans, even though Americans had been savers in the 1920s. Read "The bubble that broke the world" to understand how that happened.

The world waits

The bailout bill vote in the House of Representatives has been worldwide news. People around the world have been following the vote with rapt attention, as their economies run down. The concept is: "The Americans did this to us with their worthless mortgage-based securities, so now we expect American money to help us out."

That's going to be a good trick. The Fed and other central banks have already injected a trillion dollars of liquidity, and things have continually gotten worse, so it's hard to see how a few hundred billion more is going to turn things around.

I hear comments from pundits and politicians like, "I feel people have a positive view of the future," and "The economy is biased toward growth." That's sort of true, but when they give examples, the examples are always from the 1990s (the dot-com bubble) or 2003 (the credit and real estate bubbles).

What they refuse to understand is how drastically people have changed. The massive fraud and deception that was commonplace up till the beginning of 2007 -- thanks to the lethal combination of the stupidity of the Boomers and nihilism of the Generation-Xers -- has now been reversed. Mutual trust has been replaced by mutual suspicion. Mutual tolerance has been replaced by mutual condemnation.

These are massive attitude and behavioral changes of generational behavior. Everyone seems to expect that the Bailout of the World bill will cause these massive attitude and behavioral changes to reverse. Why would they believe that? Because they're thinking of the Unraveling era, the 1990s, when the motto still was, "Whatever feels good, do it."

Buy on the rumor, sell on the news

Market summary, 3-Oct-2008

Market summary, 3-Oct-2008

I've heard this phrase, "Buy on the rumor, sell on the news," but I've never been entirely sure what it means. It's something like this: If there's a big event coming, then everyone buys. Then, when the event actually occurs, the day traders sell, taking a profit, leaving behind the poor schmucks who thought that buying was actually a good idea.

Anyway, that's what happened on Friday.

The Dow went up 300 points as the House of Representatives vote approached. Once the vote was completed, around 1:30 pm, the Dow fell 300 points quickly, and continued to fall.

Friday's stock market fall was a disaster all by itself. The Dow index is now 28% below its peak last year in October, and is at the lowest point since October, 2005.

Pundits and analysts had very long faces on Friday afternoon. I heard words like "disappointing" and "disconcerting." The given causes included Friday's disastrous employment report, and other poor economic indicators.

The pundits have a new hope: A Fed interest rate cut on Monday or Tuesday.

It seems that the only thing preventing a big plunge is for the Fed to keep throwing things at the market. If $700 billion doesn't do the trick, then it's hard for me, at least, to see how an interest rate reduction is going to help much.

The deflationary spiral continues to accelerate. The amount of money in the world is decreasing rapidly, fast enough so that the $700 billion can't keep up with it. Credit is becoming tighter, and commercial interest rates continue to be at historically high levels. It'll be interesting to see whether the $700 billion has even a TEMPORARY effect.

The next that the pundits will be watching for is the reaction of the Asian markets, as they open at around around 7 pm ET on Sunday evening.

Comments from web site readers

I strongly urge everyone who wants more frequent commentary and discussion to visit the new Generational Dynamics forum, especially the Financial Topics thread. I've been posting frequent commentary in that thread, and others have been posting their own comments.

In fact, if you're wondering what to do with your money, I recommend reading the entire thread, for lots of good ideas.

Here are some recent comments from visitors to the forum:

"I read your blog about the reader who can only choose 1 money market for his 401K. [See: "Are your 401K funds safe?"]

First of all, he has been informed of what is in it. These companies are required to send a prospectus periodically stating what is in each money market fund and they do. If he threw it away, that is his problem. I read mine and pulled my money out of the fund in 2005 when there was still plenty of time to do it.

Ignorance is no excuse. If someone is too stupid to understand the prospectus or too lazy to read it, then that person deserves to lose their money, and frankly, I don't feel sorry for any of these people."

This is a very hard opinion, but it's typical of how the attitudes of the great mass of Americans are changing. As we've said, mutual trust has been replaced by mutual suspicion, and mutual tolerance has been replaced by mutual condemnation. This change will accelerate.

Another person had an idea for the person who can't get money out of his 401K:

"There is one way out of the 401K debacle if you think you are about to get screwed. 401Ks typically have a loan option. You can take out perhaps up to 50% (the amount equal to the IRS penalty) and hide that somewhere else. Of course you will have to repay that loan... I wonder what the IRS will do if people all of a sudden lost their entire 401K yet still had a loan out (and then lost their job, too). Gives me a headache... Oh well, if the crash happens I will find out. I took out a loan to provide a downpayment on a house (saved me from mortgage insurance, heh heh).

Actually, when I tried to find out about my money market fund it was over a year ago, before all of this stuff started headlining the news. They had no answers then and I'm sure if anything is wrong they will certainly stonewall me now."

I honestly don't know if this idea will work for most people. If you borrow money against your 401K, and then your 401K loses value, then you still have to repay the loan, and your 401K has still lost its value. But the situation may be different for each individual, so check with your lawyer or financial adviser.

I've frequently mentioned the Principle of Maximum Ruin -- the principle that, as in 1929, the coming crash will ruin the maximum number of people to the maximum extent possible. Here's one person's posting on this subject:

"I have to laugh when I think about recent developments. The Principle of Maximum Ruin has to happen because people will believe what they want to... because they have to believe in it. They are so invested (emotionally and financially) in their Pollyannaish outlook that they can't admit that a freight train is about to hit them. I never thought in my wildest dreams that I would witness such collective insanity. It's REALLY mind-boggling."

The "panic crash" or "capitulation event" that we're headed for will only accelerate the Principle of Maximum Ruin. Don't expect the pundits, politicians, analysts and bloggers to start saying, "Ohmigod! I've been wrong all these years, and I now realize that we're the in the midst of a big crash."

Instead they'll say, "It's everybody's fault but mine, because the Congress and Administration didn't take my advice. But now the worst is over, and the market will go up again, especially if they take my advice now."

So ordinary people will listen to this crap, will invest further in the market, and will get further screwed, since the market is going to continue to fall for several years. As the months go by, the maximum number of people will be ruined to the maximum extent possible -- the Principle of Maximum Ruin.

Incidentally, if you'd like to post something on the Generational Dynamics forum, but you don't want to do it yourself, then send it to me as a comment, and I'll post it for you.

(Comments: For reader comments, as well as more frequent updates on this subject, see the Financial Topics thread of the Generational Dynamics forum. Read the entire thread for discussions on how to protect your money.) (4-Oct-2008) Permanent Link
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