As for the stock market, it has already hit my bogey i.e. 1998 and 2002 lows. Any downside from here will be entirely due to policy errors lengthening and deepening the downturn. In my view, stocks are undervalued here. That doesn’t mean they can’t go lower still. It will be interesting to see if we are seeing another bear market rally here.

FIRE is not production and is barely a service. Finance is capital allocation and it should be forced to do this with as low a cost as the economy can achieve. The idea that finance itself is a major profit center for a growing economic system creates a huge misallocation and waste of capital and credit. We starve the real economy while rewarding the stewards of capital allocation with 40% of its benefits. Is it any wonder the system is collapsing? It is standing on legs of sand.

Michael Hudson has a very good bit on this ridiculous notion that FIRE is production and growth. The concept is nothing new. The fallacy was seen for what it is back in the days of Sumer and Akkad. Those that do not understand history are doomed to repeat it, over and over again it seems. Hudson did an interview recently with the Renegade Economist on YouTube found here that highlights what our distant ancestors understood so well – http://www.youtube.com/watch?v=3pwAFohWBL4.

As to the idea that monetary expansion can re-inflate the economy to pull us out of this near depression I have two points. One is that the real economy (meaning actual production of goods and to a lesser extent services based on those goods) must be healthy and growing or you are simply re-inflating the empty FIRE sector, which will lead to a *larger* depression. Prices will continue to deflate until the real economy has reached price levels where it is profitable to produce again.

The second point relates to the real economy (again non-FIRE) and the velocity of money. Money is an exchange medium. It is nothing else. If it is not exchanged it is not money. It is static, unused paper, bits in a computer database. If it is not allocated and reallocated there is no turnover hence no velocity. When the real economy is stagnant you can try to re-inflate as much as you like. The result is a larger and larger pile of static funds. There is no effect on exchange hence no effect on the velocity of money and efficient allocation of capital.

The current downturn, in my opinion, will be a depression of staggering magnitude. Team Obama’s plan is to re-inflate the unproductive FIRE sector, since that is where they come from and they hold a shared fallacious view of its importance, not the real economy. China, Japan, and the Middle East sovereign wealth funds appear increasingly unable to loan them money to do this. Without an outside source of capital and with little internal capital available (or at least not enough to kickstart money exchange and real production) the TARP, TALF, et al programs are exhausting what hope we might have had to support a real goods and services restart that would eventually led to re-flation and a bottom of this downturn – with a foothold toward an eventual recovery.

In light of the above I consider the recent bump in the DOW and S&P a true suckers’ rally. Watch out below. Catching falling knives is costly and painful. I see pain and severed digits ahead.

I am sure at the end of this American experiment this theory will be proven false.