Separating Fools from Their Money

Cut expenses. Go broke. Be happy.

Everybody is convinced the market is going up. So what does the market do? It goes down - 72 points yesterday.

What do you call it when the market goes down 72 points? A beginning!

Well, we don't know if it's really the beginning of the end or not. We've seen more beginnings than we can count. Still, no sign of the end. But there must be an end out there somewhere. Always is.

And look at what is happening in the gold market. While everyone has been watching health care...and top stocks for 2011...and bonds, gold has been moving up. It rose another $17 yesterday to bring the price up to $1,151.

Why is gold moving up? Because it anticipates higher inflation? Because it is afraid of government defaults?

Most likely, it has no more idea than we do. It doesn't know what's going to happen...but with the feds borrowing more than 10% of GDP each year, it ain't going to be pretty.

The S&P is now trading at a P/E over 23, according to the most recent Barron's report. Dave Rosenberg:

"No matter how we slice it, whether on a Shiller P/E, Tobin Q or historical profit basis, the US market is anywhere between 20% and 30% overvalued."

Emerging markets are soaring. Oil is over $85. And the temperature here in Baltimore is 83 degrees.

The heat is on. Something's gonna blow.

But Goldman Sachs is as cool as a cucumber. Goldman released its annual report earlier this week. The firm said it hadn't done anything wrong. It hadn't bet against its own clients. Nor had it expected any help from the government.

Here at The Daily Reckoning, we've always taken Goldman's side. We've always had a weak spot for cripples, lamebrains and predatory lenders. Besides, Goldman stole the money fair and square.

Critics charge that Goldman 'perverted' capitalism. But they just don't understand how kinky capitalism can be on its own.

You see, dear reader, when it comes to putting meat on the table, nothing beats capitalism. But it only succeeds so well because it is allows foolish hunters to blow their own heads off. In his book FIASCO, Frank Partnoy recalled his days on Wall Street:

"The way you made money from derivatives was by trying to blow up your clients," he writes.

He described how Wall Street regularly sold extravagantly complicated derivative instruments to institutional buyers who were either too dim or too lazy to figure out what they were buying. If they had known what was in them, they wouldn't have bought them.

Then, of course, the instruments blew up...along with the pension funds, endowments and insurers who bought them.

But that's just the way it should work. Capitalism doesn't like it when idiots have too much money. So it uses people like Goldman to help take it away from them. That's what Lloyd Blankfein meant when he said Goldman was doing "God's work."

We don't know if God wanted Goldman to blow up the world economy...but capitalism seemed to be calling for it. And it looked like capitalism was going to blow up the bomb tosser, too. Unfortunately, the feds stepped in. They bailed out AIG...and the whole financial industry - including Goldman. Now, they lend the big banks money for practically nothing...which the banks lend back to the feds at 4%. The banks make money. They restock their reserves with US Treasury debt. And the feds get to finance their gigantic deficits. It's great for everyone - until it blows up too.

It's true, of course, that capitalism had already been twisted long before the feds bailed out the banks. Individual investors believed they could make money just by buying mutual funds or a house. Institutional buyers thought they could make money by buying collections of mortgages, any one of which they knew was likely to be garbage. But these crackpot ideas are just part of what makes capitalism so much fun to watch. And don't worry, just leave it alone...it will correct those mistakes in a jiffy.

Here we are barely 24 months after the correction began. Who thinks he can make money by buying a house now? Only people standing on the courthouse steps and hoping for an extreme bargain. Who thinks he can finance his retirement by buying top stocks for 2011? Only the young and the dreamers.

And who thinks you can make an economy richer by consuming more? Or cure a problem of too much private sector debt by adding more debt in the public sector?

Only economists! And that's a whole 'nuther subject.

And more thoughts...

While the markets are hot, the economy is cool.

Nearly 7,000 people go bankrupt every day - a record number. And in March, M3, the broadest measure of the money supply, recorded its biggest drop ever.

And get this. Peak to trough, December '07 to February '10, 8.3 million jobs were lost. As we reported yesterday, take away the statistical tricks and the number of people with real jobs actually fell last month - despite reports of an additional 163,000 new jobs in March.

Consumer credit fell again in February - down $11 billion. To put this number in perspective, the US government has run about $2.5 trillion in deficits since the correction began. So, in spite of pumping monthly deficits on the order of $120 billion...consumer credit still sank by $11 billion.

What can we say? It's a Great Correction, after all.

Greece is going broke after all. Yields on Greek debt rose over 7% yesterday. So let's look at how this works. Investors worry about a default. They push up yields (they need higher interest payments to justify the risk). This causes Greece to go further into debt (the cost of paying the extra interest), which causes even more worry among lenders.

Why doesn't Greece just cut expenses?

Ah...glad you asked. This just goes to show what a dead-end debt can be. The government has already proposed substantial cuts. But it has to answer to the voters - who are on the verge of rioting in the street. And its own cabinet ministers are calling the Germans 'racist' because they refuse to give the Greeks money.

It's hard for a popular democracy to cut spending. And then when it does, it discovers that it is in another trap. So much of the private sector depends on government spending that, take it away, and the whole economy shrinks. This causes tax revenues to fall by more than the budget cuts. In other words, a multiplier works in the other direction - causing the budget deficit to widen when cuts are made!

And guess what? Greece is not the only government that is falling into this hole. Latvia. Iceland. Maybe Ireland, England, California...and even the US...

Where, exactly, the point of no return lies, we don't know. But it's out there somewhere...

What's the solution? Well, just to bite the bullet. Make the cuts. Default. Be happy.