Give Liquidation a Chance!

Bill Bonner snippet
Provided as a courtesy of Agora Publishing & The Daily Reckoning
written Feb 25, 2009
posted Feb 27, 2009

A plea to lawmakers... give liquidation a chance!

U.S. stockowners got a break yesterday [Tue 24th Feb] the Dow rose 236 points. News reports tell us that investors were listening to Ben Bernanke. He's speaking to Congress... intending to boost investor confidence. But we can't find anything in Bernanke's remarks that would give us much confidence.

In fact, consumer confidence is at a record low. And investors couldn't have taken much comfort from the Fed chief. Bernanke said the economy would start to grow again in 2010... and then, only if the banking system is stabilized. Of course, Bernanke is talking nonsense. He doesn't know when the economy will begin to grow in earnest again, and if it does begin to grow it won't be because the banking system is stabilized. You can stabilize a comatose person. You can stabilize a battlefield. You can stabilize a ladder. But stabilizing a crummy bank won't help the economy grow. For that you need a healthy bank. And the only way a bank can be a healthy bank is if it holds healthy assets and can earn decent money when it makes a loan.

Banks aren't making loans now because they don't know who will be able to pay them back... and don't know what the collateral is worth. They'll have to wait until this period of price discovery settles down. And that won't happen until deflation has done its work... until prices have been knocked down to their lowest level. That could happen quickly... or it could take years.

AIG now says it is facing a $60 billion loss. How much is its stock worth? Citigroup is nearing bankruptcy, with the U.S. government getting ready to up its stake to 40%. What will the shares be worth when the operation is over? GE finance says it will get by - maybe. Micro Tech is laying off 2,000 more people in Idaho. And Italy is officially in recession.

One by one, company by company, country by country... the whole world slips into depression.

Oil traded at $39 yesterday. And gold lost $25.

What's ahead?

We'll give it to you straight - darned if we know. Stocks could rally from here... or collapse. We have our 'Crash Alert' flag up... just in case. The Dow will probably get down to the 3,000 - 5,000 range before this crisis is over. If we're right, it's got to lose another 2,000 plus points. You don't want to be holding stocks when that happens. Might as well get rid of them now - even at the risk of losing out on a rally.

As for gold...

Chris Wood says it will reach $3,500 by next year. Chris is more right than most analysts. In his newsletter, Greed and Fear, he warned that the bubble in sub-prime lending was going to blow up... The Wall Street Journal says he's the "man who saw it coming."

Why will gold soar? "It's the only form of money or credit not contaminated by the credit system," says Chris. Which explains why it has risen - even while inflation expectations are so low. Investors are not buying gold as a protection against inflation; they're buying it to protect themselves from deflation. Yesterday, as deflation expectations subsided, so did the price of gold.

Wood is primarily an Asian analyst. Which is to say, he spends most of his time trying to figure out what it going on in the Far East. He's watched Japan for decades. And now he sees the threat of the entire world entering a Japan-like slump. How to avoid it?

Nationalize the banks, says Wood. And create a 'bad bank' where you can dump all the toxic assets. That's what is already underway... more or less.

Wood believes nationalization is the only way to get the rottenness out of the banking system - quickly. He's not the only one. Nouriel Roubini is for it. So is Nobel Prize winner Paul Krugman. They believe, as we do, that the banking system is still resting on the sand of trillions in bad loans and radioactive investments. Taken as a whole, the entire banking industry in America is insolvent. That's another reason banks aren't making loans - they don't have any money. And deflation continues to wash out the loose sand and expose the weak foundations of the banks' assets. It will also undermine their collateral. Until this process is over... the system cannot begin to put itself right.

The banks mustn't be stabilized as they are, in other words. They need to be cleaned out first.

We don't disagree. But if it were up to us, we'd give nature a chance. The market seems to be doing a decent job, as near as we can tell. The value of everything on earth put together is about $100 trillion. In the space of less than two years it has wiped out about a third of the entire capital value of the planet.

If our hotline rings and Mr. Obama is on the phone, we know what advice we will give: Let the banks fail. Let them go broke. Let them be liquidated. Then, the surviving banks could buy up the decent assets and emerge stronger than ever.

Bill Bonner
Source: http://www.dailyreckoning.com.au/give-liquidation-a-chance/2009/02/26/
email: DR@dailyreckoning.com
website: The Daily Reckoning

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