Europe, de-centralized

Tuesday, Silvio Berlusconi said he will leave government?once the legislature has agreed on an austerity program.

Skip to next paragraph Bill Bonner

Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning (dailyreckoning.com).

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Too bad. We?ll miss ?The Cavalier.?

Once, in Rome, we heard him speak to a crowd. We didn?t understand a word of what he was saying. But he said it well. He was at ease?friendly?joking?enjoying himself.

And now what? The poor man will be out of politics. No more will he get to work with the great men of finance, trying to solve the historic problems of the day. He?ll have only his bunga-bunga parties with plenty of alcohol, music and beautiful young women. Poor fellow.

Our guess is that the great men of finance won?t be able to solve Europe?s debt problems. At least, not without a few blow-ups. And the European Union will probably end up less united than ever. (Gold is trading over $1,800 this morning?looks like investors are worried too.)

Until recently, both economics and politics argued in favor of a more centralized Europe. Now they are pulling it apart.

But we?ve made so many guesses over the past few months and years?we?ve lost track of them. Herewith a review:

First, back in the mid-?00s, we guessed that the housing market, stock market, and the financial industry would all blow up. They did.

Then, we guessed that this would not be followed by the typical recession/recovery pattern of the post-war period. It wasn?t.

Instead, we had a hunch that the economy had entered a Great Correction?from which it would not emerge for many years. So far, that appears to be what is happening.

As to what gets corrected, when and how?we admit ignorance. But ignorance never stops us here at?The Daily Reckoning; it is like red meat to a hungry dog. We thrive on it.

We guessed that the main thing to be corrected was the credit bubble. Debt levels are too high. They need to be reduced. That?s why the feds have been unable to turn the situation around. In a recession, they can make credit cheaper and more abundant. That usually does the trick. At lower financing costs more projects make sense. People begin to invest and spend again. But it doesn?t work that way in a debt correction. It?s not a question of the price of credit?but of there being too much debt. Debt levels need to be reduced.

The price of credit has been reduced to zero (the fed funds rate)?and the US government is running trillion-dollar deficits. Neither monetary nor fiscal stimulus has worked. Both add debt; instead, debt needs to disappear.

We also guess that this correction will end with the end of the dollar-based monetary system that was set up in 1971. No paper money has ever survived a complete credit cycle. The dollar won?t be the first.

De-leveraging will keep prices low while cutting profits and sales. As it develops, stocks, real estate and other assets will eventually be marked down to real bottom-of-the-bust levels. You should be able to get a 5% yield on your stocks?about twice what is available today. That will mean prices at about half what they are today.

The slumpy economy?combined with periodic liquidity crises (such as is now happening in Europe)?along with falling asset prices will drive investors to the safety of US bonds. This will keep US government financing costs low ? despite huge deficits. It will also convince the feds that they can pump large amounts of cash into the system without fear of inflation. This they will do?

The price of gold may fall in the early de-leveraging phase. Then, it will rise as the late de-leveraging stage begins. This is when the feds? money-printing will move into high gear. Sophisticated investors ? including foreign central banks ? will be wary. They will buy gold.

The price of gold will rise. The Dow will fall. They will intersect at about $5,000.

But our guesses don?t stop there. We also guess that?

?the developed countries will find it very difficult to grow. First, because of the weight of debt. Second, because much of their capital is ?invested? in unproductive, zombie industries. Third, because their populations are stagnant. Fourth, because they have already gotten most of the above-trend growth resulting from increased use of cheap fossil fuels.

?since the developed economies cannot grow?and since they are up to their chins in debt?they cannot fulfill the promises made to their citizens. The grand bargain of the modern, social welfare state will begin to look more and more like a bad deal. Young, unemployed men will become increasingly fed up. They will look for radical solutions?and more radical leaders with jingo answers.

?governments, which are inherently reactionary even in the best of circumstances, will respond with repression. They will not adapt peaceably. They will not throw their zombie clients under the bus. Instead, like the Ancien Regime, they will dig in their heels and protect them. The defense industry, for example, will try ? probably successfully ? to direct the citizens? rage against imaginary foreign enemies?and thereby increase its own power and wealth?

?the real economy will weaken. Revolution will begin?probably coincident with hyperinflation. Finally, the middle class will be broke (the poor are already broke) and the country will be ruined.

There, that pretty much sums it up. Any more questions?

Bill Bonner
for The Daily Reckoning

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