Voodoo Economics Hit Top Stocks Market

Finally...we're back in London. We left at the beginning of April...went to San Diego and Los Angeles...then to Buenos Aires and Salta...then to Paris for a few days.. and now we're back. London is cold and rainy...just like we left it. Not exactly home...but it will do.

But what's this?

The City seems to be winding down. All those hot shots in the financial sector aren't so hot any more. In the space of just ten years, the percentage of GDP generated by the financial sector almost doubled - from 5.5% in 1996 to 10.8% a decade later. But now the whole sector is shrinking...along with bonuses...payrolls...and expense accounts.

And since Britain counted so heavily on the financial high fliers and their money...the whole country seems to have gone into a funk.

Tax revenues are collapsing. Deficits are soaring. The U.K.'s national budget deficit is already at 12%...about even with the United States. But if current trends continue, she'll soon have the largest deficit in the developed world.

But here comes the bad news. Your editor didn't mind when investor and speculators lost trillions. He barely noticed when the U.S. government practically nationalized the largest banks, insurance and automobile companies. He hardly blinked when $13 trillion of the nation's treasure was committed to a foolhardy effort to combat capitalism. But now they are going too far.

In an effort to raise money, the British government is raising your editor's taxes! Yes...your poor editor pays taxes in several countries. And now the Brits are raising their rates to levels that rival those of the highest tax jurisdictions in the world - Sweden, Norway and the Netherlands.

The trouble with this strategy is that your editor just bought a pair of Argentine boots. And these boots are made for walking. If these news taxes pinch too hard he - and thousands of other people working, vaguely, in the financial sector - is likely to walk right out of here.

But to where? Ah...there's the rub. All over the world, governments are desperate to get out of the mess they've gotten themselves in. Argentina and Ireland just got handouts from the IMF. Other countries are getting in line. Having spent far too much in the past, they now spend more - hoping that spending will miraculously bring about economic growth. We say "miraculously" because there is no other way to explain it. When economic growth results from saving, investing and hard work you can describe it in terms of 'cause and effect.' But if you ever get economic growth simply by spending money, you can only refer to it as an act of God...or the devil. Black magic, maybe. Voodoo economics.

Hardly a day goes by without some abracadabra or hocus pocus announcement. The feds bail out the banks on Monday. On Tuesday, they take over the auto industry. By Wednesday, they're passing out money on Wall Street. If any of these tactics result in greater wealth or more output - it will be a miracle.

One question that has so far been avoided by practically all the commentators and well-wishers is this: where's the money come from? In the popular mind, if you can call it that, the government's pockets are infinitely deep. Reach down far enough and you will pull up whatever resources you need. But the fact of the matter is a bit different. In time of war, a government can marshal the resources of an entire nation. People believe they must buy war bonds, collect old metal, use rationing coupons, forego salary increases, pay higher taxes, and sign up for the Home Guard. Every back bends to the job; better that than bending to the lash, people say to themselves.

But the war against capitalism is not getting the same level of popular support. People are not buying "war bonds" so the feds can bail out Wall Street or the City. They're not likely to eat margarine so the bankers can slather real butter on both sides of their bread. And they're not willing to spend less just so the government can spend more.

So instead of asking the whole population to suffer, the feds - both in Britain and back at home in America - have chosen an easy target...the rich!

In the public mind, 'rich' and 'banker' are inseparable. Like 'corrupt' and 'politician.' What's more, the rich were at the scene of the crime when the financial crisis began. The rich were caught red-handed. It doesn't matter if the 'rich' man earned his money from doing heart operations or selling vegetables. Every rich person is presumed guilty of the crime of the century. "Tax them!" screams the mob. Tax them! Tax them! Eat them.

And so, it will come to pass that 'the rich' are taxed. The money will be taken from them and given to...well...the rich. But these will be different rich people - bondholders...bankers...insiders...hustlers and anglers.

This is why we've been urging you, dear reader, to build your own 'personal bailout' - it's doable. All the resources you need to get started are here.

Now, we turn to Addison, who is busy deciphering the GDP numbers:

"Well, 'less awful' it is: The Commerce Department says first-quarter GDP dropped an annualized 6.1%," writes Addison in today's issue of The 5 Min. Forecast.

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"That's a tough number. Wonks, quants and analysts on Wall Street expected an annualized 4.6% decline. But the 'official' number is still a minuscule improvement over the 6.3% rate for the fourth quarter of last year.

"But lest you should strive to breathe easy, put the two quarters together and you have the weakest six months in the U.S economy since 1957-58. One more quarter of contraction and we'll officially have the longest recession since the Great Depression.

"One caveat: Commerce issues three estimates of quarterly GDP growth, and this is just the first. Expect revisions.

"The GDP numbers form an interesting backdrop for today's meeting of the Federal Reserve's Open Market Committee. The Fed's "deflation boogeyman" is retreating, for one. Personal consumption grew 2.2% in the first quarter... much better than the 4.9% decline in the previous quarter.

"So what will the Fed do? Predictions in mainstream financial media run all over the map. One says the Fed will hold off on any more purchases of Treasuries and mortgage securities as long as 'green shoots' (like the housing and consumer confidence numbers yesterday) keep showing up in the economic data.

"Another speculates some sort of loose-money measures are in the offing to fight the economic effects of the swine flu outbreak.

"We're not going to venture a guess. We'll only remind you that in the Fed's fantasy world, interest rates right now would be at minus 5%. And go from there."

Each weekday, Addison brings readers The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less.

The 5 is free to subscribers of our paid publications, including the newly revamped Richebächer Letter. Dr. Kurt Richebächer could often be found in the pages of the DR, or his newsletter, The Richebächer Letter, calling for the demise of the dollar...along with the collapse of the housing market and the end of the over-extended American consumer, as far back as 2000.

Many of you felt the void left by Dr. Kurt Richebächer when he passed away in 2007, so in his honor we've formed a brand new 'wealth protection' society. Join this elite group of investors by clicking here.

And back to Bill with more thoughts:

The Dow fell 8 points yesterday. Oil slipped below $50. Gold slipped too - below $900.

What gives? As far as we can tell, the rally that began in March continues.

While it might peter out any day, we continue to believe that this market intends bloody mayhem...and that it won't stop until it has killed both the bulls and the bears.

The bulls will be killed in the classic way. A strong rally on Wall Street...or a series of minor ones... will lead them to believe that "the worst is over." They'll get back into top stocks after a 20% or 30% advance - hoping to recover what they lost last year.

Then, the stock market will make a new dramatic move to the downside. This will probably happen several times...each time leaving bullish investors with more losses. Finally, the bulls will give up. They will sell hot stocks...driving prices down and dividend yields up. By the time the bottom is reached, former investors will neither know nor care. P/Es will be scarcely more than 5. Dividend yields will rise above 5%. The Dow will sink to 3,000 - 5,000.

Then, it will be the bears' turn. When stock prices go down, they'll sit smugly with their cash, Treasuries and gold. But gold will not resist the deflationary whirlpool. It could get sucked down violently...or might just float down gently, remaining low for a long time. Either way, the gold bulls will give up. Only the gold bugs will hold on. Cash and Treasuries, meanwhile, will look smart - for a while. Then, suddenly, they will look like the stupidest investment on the planet. In a matter of days...maybe weeks...the dollar could lose half or more of its value. Savers will suffer staggering losses.

No, dear reader, the months ahead will be a challenge. The world economy is telling a story no one has ever read before. Every day we turn the page just to see what happens. We have no idea how the story might develop. It's all guesswork.

Still, when the final chapter is read out...the moral of the story will probably be familiar to us. It always is.

China has increased their gold holdings 75% in the last six years. They recently announced that the gold holdings have been transferred from the State Administration of Foreign Exchange (SAFE) books to the People's Bank of China. PBOC. Our intrepid correspondent, Byron King explains what this really means:

"China is monetizing its gold!

"This SAFE-to-PBOC transfer marks a profound decision by Chinese government leaders. Obviously, the Chinese government has bought gold over the past six years. But in keeping with a nation where youngsters get their Sun Tzu with their mother's milk, the Chinese went through an internal debate over whether to add the gold holdings to the official Chinese monetary reserves. That is, if the gold was not "monetary," then it was just another nonmonetary investment commodity like iron ore or copper or petroleum.

"But now, with the announcement by the Chinese Central Bank, it appears that the debate is resolved. The gold has been added to Chinese monetary reserves.

"This action by China is part and parcel of an under-the-radar global effort to rehabilitate gold as a monetary reserve asset. Gold has not been a factor in global trade and currency exchange since the late 1960s. But there's a powerful movement afoot in the world to reestablish gold as part of an international monetary system. It's because the U.S. dollar has been so badly mismanaged over the decades. No, you won't read about it in your local newspaper, or even in the standard, mainstream business media. But that movement is out there. It's happening.

"So now the Chinese are primed to begin using gold as a monetary asset. What's the practical impact? I expect to see central banks worldwide start to add gold to their monetary reserves. The floodgates are opening. The PBOC and other central banks from here to Timbuktu are going to become net purchasers of gold in the years ahead. In the future, only central bank suckers and losers will be net sellers of gold. (Take note, IMF.)

"And people who own physical gold, as well as shares in well-managed mining companies, will benefit greatly. Need I say more?"

For ideas of how to integrate gold with your portfolio.

We'll have more from Byron in today's guest essay, below.

The plane coming back from Buenos Aires wasn't full. Air traffic is down 11% from a year earlier.

And this was before people began worrying about swine flu.

Today, commentators are fretting about how a serious epidemic would affect the "recovery." They needn't worry. First, because there is no genuine recovery to worry about. Second, because if a serious epidemic were to hit the world, economic growth would be the least of our problems.

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