Only an Economist Can Think This Way

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Published on Thursday, 19 July 2012 15:57

Written by Bill Bonner, Founder and President, Agora Inc.

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What's so bad about stable prices? Economists across the globe are sounding the alarm about deflation. Their misguided "science" will hurt us all.

Dow up 103 points. Gold down $18/oz.

"Parece normal, pero no es," said Juan Carlos, who is hosting us here in Madrid.

It looks normal, but it's not.

The jobless rate here is nearly 25%. Youth unemployment is twice that. The banks hold billions of euro worth of loans that will never be repaid. The government borrows to make ends meet. But if lenders become just a little more demanding, the jig will be up.

The yield on the Spanish 10-year note is just a shade under 7% as I type. Greece lasted 17 days after its 10-year borrowing costs hit the same level. Ireland held out a couple of months. Then caved. Ditto Portugal.

Spain's El País newspaper reports that Spanish real estate prices suffered their biggest decline since the crisis began. In Madrid, the price per square meter fell 10% last year. Nationwide, the loss was 8.3%. That puts Spain almost even with the U.S. Since 2008, prices are down about 24% on average... but as much as 30% in some areas.

This is probably just the start. Prices are still not cheap in Madrid; there is plenty of room on the downside.

And yet, on the hot streets of Madrid last night, people walked around as they always do in summer. Girls in provocative outfits walked two by two... or three by three.

When did those short shorts become acceptable as everyday, urban walking around attire? This is the first time we've noticed. But they look like the new style... at least here in Madrid. Occasionally, by herself, a prostitute in an even more provocative outfit called out.

Madrileños drink in bars... eat in restaurants... and smoke in sidewalk cafes. What has changed?

"The ban on smoking in bars and restaurants changed the entire city," Juan Carlos explained. "That's why we have so many people at these sidewalk cafes. Because they can't smoke inside. It's changed the whole look of the city. In my opinion, it's made it better. There's more street life now. It's more fun to walk around.

"I know a guy who has a restaurant here, in the center of the city, at the Plaza Mayor. He tells me that people who used to spend €40 now only spend €32. And where he had 100% of his tables filled four years ago, now he might have 75% of them filled. It's not terrible. But it's not the same. All this activity is misleading. It looks like everything is normal. But it's not."

The same could be said for the Spanish economy... for all of Europe... and perhaps for the entire world's financial system. It looks normal. But it's not.

There's nothing normal about printing money to cover bad loans from the past or expenses from the present. In normal times only desperate, raggedy edged countries -- like Zimbabwe or Argentina -- will resort to the printing money. But now the IMF is calling on the U.S. and the EU to turn on the presses.

El País reports that the IMF wants the ECB to "do more" to help avoid deflation in Europe. Consumer prices have risen about 7% since 2008. But IMF projections show the inflation rate falling to 1% next year.

What is so bad about 1% inflation? What is so bad about prices that are almost stable?

The economists at the IMF -- and almost everywhere else -- think higher rates of inflation are necessary for growth. Of course, you have to be an economist to think such a thing. And during the second half of the nineteenth century, America experienced China-like growth rates with falling consumer prices.

That's what should happen. Prices should normally go down -- deflating -- as an economy gets better at producing things. Deflation is normal. It's inflation that is weird. But economists have convinced themselves that deflation is bad. They're ready to put Europe's money in jeopardy to try to avoid it.

And that's the world we live in...

Central banks and the governments they work for have consistently boosted the supply of money and credit above and beyond the increase in the supply of goods and services. This causes prices to rise.

After so many years of this, rising prices seem normal. But they're not. And now the world economy is so swamped with cash and credit it cannot seem to find a patch of firm ground to stand upon.

A owes B. And B owes C. We don't know if A can pay. And if he can't, B is broke. So the central bankers give A more credit so he can continue making payments.

If B goes broke, they say, it will lead to deflation... and maybe even depression.

A's debt to B is backed by collateral: say, office building D. On the books, D looks OK. But it is rented by a company E that gets 100% of its revenues from the government (G)... which can only continue paying the rent by borrowing. And it can only continue borrowing if the central bank lends money to the local banks. So they will buy G's bonds.

But what's this? El País says now Spain can use bailout funds to buy its own bonds. In other words, it can borrow money from other EU nations and the IMF directly... and then lend it to itself. Hmmm....

Which credits are good? What's this funny money worth? Who's broke? Who's not? How long can this grotesque system continue?

Nobody knows. And nobody wants to find out.

Editor's Note: I have a very dire warning for you. My economic research team has uncovered a string of events that could bring down the stock market. Our research shows a high likelihood that an "economic terrorist attack" will take place on or around Oct. 1, 2012.

Two more attacks will quickly follow. The result will cripple the stock market and potentially kick off another depression. This is not a conspiracy theory or hoax. This is a very real threat.

Here's the truly shocking part: This attack is coming from within our own borders. The attack won't be carried out by Muslim fanatics or Chinese hackers. This will be done by Americans.

You need to get up to speed quickly on this threat... and find out where to park your money outside the stock market. You can find all the details here.