As I see support level after support level taken out in the popular US equity indices I am amused at the endless parade of experts who are trotted out to appear on the financial programs:  "Buy when there is blood in the streets."  "It's always darkest before the dawn."  "A bet against America has been a bad bet."  "You need to be a long term investor in US stocks."  These are among the dumbest and most dangerous investment clichés that you could attach your investments decisions to.  These so-called experts remind me of the Mayan villagers who were massacred in Mel Gibson's Apocalypto...only it will be your investments that will be massacred in this case if you listen to them.

The theme of this commentary is "resistance is futile."  The sooner we relent, the better off we will all be.

1. Private Equity and VCs should give their money back and investors should abandon their tech investments (really it's not too late).  Private equity should accept that there is no "next new thing" to pour their billions of dollars into.  Investors have already sniffed out that the addressable market for web 2.0 is just not that big and have tired of the hype.  The Consumer Electronic Show (CES) was a bust and Mac World is a yawner.  Industry participants should consider a career change and investors should pull out while they still can.  I have to laugh at the pundits who were giddy yesterday after the pitiful one-day tech rally we witnessed.  The real money, however, will be lost on "green technologies" and "renewables."  The venture capital and private equity flowing into this sector is now dwarfing the amount being wasted on web 2.0 as investors are foolishly betting that the gains experienced in tech in the 1990s can be replicated.  This sector is wrought with ideological drivers and emotional sentimentality with the commensurate hype to keep the money flowing.  This is anathema to sound investing.  The VCs in Boston and Silicon Valley are becoming much more astute in marketing than in technological prowess.  It is a virtual certainty that more money will be wasted chasing "green dreams" than was blown during the great misallocation of telecom capital in the 1990s which saw over $500 billion evaporate.  Responsible managers should return the funds to the investors, but they will remain hopeful and resist this reality.

2.  Members of The Federal Reserve should ditch their desire to present the perception that they are inflation fighters.  The Fed is still resisting, being "reflationary."  This is the strongest example of futility among all others mentioned in this commentary. We could be days away from experiencing one of the biggest investment reversals in the history of US financial markets.  I am referring to a reversal in the continued decline in long-term US Treasury rates.  Yields are likely to abruptly reverse upwards, ending the 25-year bull market in the US 10-yr and 30-yr bond.  It will soon become clear to all that they Fed is buckling to the demands of the population and will no longer be fighting inflation.  We have had inflation for years, but due to statistical machinations, it has not shown itself in official numbers.  This could continue.  I expect that, now that the prices of homes are declining, rather than "owner's equivalent rent," we will actually see the delta in home values used and as the house price variable and it will probably receive a higher weighting in the overall calculation.  But expectations for inflation (the extent to which officials can convince the population that inflation is contained) will soar.  The safe haven status of treasuries will rapidly transform into the bastard child of investment options.  Money will flow to new safe haven investments which benefit from a confirmed inflationary environment. 

The US dollar and most US equities will fall as a result in nominal terms.  They have already been falling in real terms over the last decade.  Given the deflationary outcome many debt bubbles have had in the past, you might wonder why this will be different.  A Legg Mason report issued back in 2003 titled, "War, Legacy Debts, and Social Costs as Catalysts For a US Inflation Cycle" correctly responds:

"Debt may seem to be a catalyst for deflation, but when most of the debt is backed by government guarantees (actual or implicit), and the government owns the printing press, debt may warrant an inflationary response.  It is a question of timing and national choice." We will choose inflation in large doses and the Fed will accommodate.  The days for responsible government with controlled spending and honest money have long since passed.  We are simply too indebted to pay the bill.  The result would be a wholesale slaughter of defaults.  At this point, we will absolutely have a deflationary depression if the Fed does not act aggressively.  I have been surprised that the Fed has appeared slow to grasp this, but I am now confident that they are on the brink of massive monetary accommodation (see my recent commentary [1] on this subject).

Due to our credit binge and excess money creation since we abandoned the gold standard in 1971, we have amassed unpayable debts and unserviceable debt-to-equity ratios for the government and the consumers.  Corporations will be next.  Get ready for a government fiscal spending and tax reduction package coupled with an ultra-expansionary monetary loose Fed policy that would make the officials of the Weimer Republic blush.  The fiscal and financial fireworks will be spectacular.  That is what the US population is demanding.   

 We are increasingly becoming a society reliant on government intervention.  We continue to stress consumption and demand-side Keynesian economics at the expense of the more sound and sustaining economics of encouraging savings and investment for capital formation in productive assets, the real source of jobs and wealth creation.  We have long since abandoned this model to our detriment.  John Maynard Keynes said that "we are all dead in the long run" when responding to a critique over the longer term harmful consequences of his "tinkering" fiscal policy recommendations.  Well, he might be dead, but we are not...the long-term has arrived and we must deal with its consequences.  Libertarians promote this view and think that they can persuade the population and policy makers to reject their Keynesian ways or be forced to deal with the aftermath which will soon be upon us.  They think that where the first Great Depression created the programs associated with the New Deal, the second will result in the dismantling of them.  They are hopelessly waiting for vindication.  This country will become more and more of a welfare state.  Those who fight the good fight to restore this country to the constitutional intent of the framers are doomed for disappointment.  The US is already on a trajectory for government spending to surpass the private sector.  This crossover will be accelerated during the impending downturn.

The existing cycle goes something like this:  financial services and engineering couple with globalization has led to a temporary boom in the macroeconomic factors used to measure the US economy.  The benefits of these trends have principally flowed to the money shufflers--hedge fund managers, institutional and commercial bankers and those in involved in capital equipment financing/leasing, the most profitable arms of what exists of US industry and manufacturing-to the expense of the laborers who are the losers of global labor arbitrage.  Owners of capital and financial intermediaries benefit while laborers lose.  This accounts for the disconnect between the satisfaction of the average American worker and the more positive economic indicators which have been used to show a robust US economy now, even these indicators are beginning to fail.   In order to compensate for lack of wage gains in the past, workers have been able to rely on a combination of asset gains in the 401(k)'s/stock portfolios and housing price appreciation and government handouts for those who have only marginally benefitted from either.  This is a result of a multi-year inflationary Fed policy where the people and the government demand money and the Fed accommodates by monetizing the debt by buying bonds on the open market which the government issues, thereby injecting liquidity and inflating the entire system.  Now that financial firms' black box shadow instruments--securitized debt and other such mispriced derivative instruments-- have been revealed as shams, you can expect to see the macro numbers drop along with the asset markets which Americans have come to rely on to partially offset their paltry wage gains.

By inflating the money supply, the plan is to pay government debts in with tomorrow's inflated dollars.  On the fiscal side, voters will demand more government bailouts to pay for their debts.  Inflating the money supply should also limit the nominal declines in the stock and housing markets.

If you think this is impossible, this was the fate of a nation three hundred years ago in France when John Law convinced the Bank of France to jettison gold and adopt a paper money standard.  France experienced economic nirvana for a decade before their entire economy and financial markets collapsed.  Marc Faber, in drawing parallels to that period the current environment writes in "Tomorrow's Gold: Asia's Age of Discovery" that "following a January 2002 meeting of the FOMC, a Fed official mentioned and an "unconventional measure" in case monetary policy became ineffective the "buying of US equities' and later indicated that the Fed ‘could theoretically buy anything to pump money into the system', including "state and local debt, real estate, and gold mines-any asset'".  Law was hailed as a hero for years until he met his ultimate forced to flee the country.  Hyper-stimulative Fed easing and other measures are a virtual certainty.  Its only choice is to print money and to hope that it does not result in hyper-inflation, and that the US can ride the coattails of the growth of the rest of the world.

*Come back for Part II Tomorrow...