-->The Post-War Period

The Daily Reckoning

Paris, France

Thursday, 19 December 2002

-------------------

*** Mr. Market may be wearing gold knuckles...

*** Dollar down...as investors look for alternatives...3rd
biggest bankruptcy in history...

*** No tech recovery...oil over $30 a barrel...


Watch out, Bernanke; Mr. Market fights dirty.

Stocks went down - led by the techs. And the dollar
"drifted lower." The British pound, for example, rose to
over $1.60, its highest level since 2000.

We can't prove it, but we think Mr. Market may be wearing
gold knuckles.

The Canadian dollar, the 'loonie', rose to.6456 cents. The
Australian and New Zealand dollars have risen nicely
against the U.S. brand, with the Kiwi buck at a 3-year
high. But the biggest change has come from South Africa,
where the rand has gained 37.7% since the beginning of the
year.

Why are all these currencies doing so well against the
greenback? They are all natural resource exporters...and
most are major gold producers, especially South Africa.

Gold itself shot up $4.20 (Feb. contracts) yesterday.

"People are exiting U.S. dollars and looking at alternative
investments," said an economist at Westpac to a Reuters
reporter.

Bernanke & Co. can destroy the dollar. But it will cost
them. Investors would go elsewhere...taking their money
with them. Wall Street would collapse. Americans' standard
of living - which depends heavily on foreign investment -
would fall.

Bernanke hopes he can destroy the dollar just a little and
avoid these problems while still holding off deflation. And
we are the first to admit; anything's possible. But so far,
in this opening phase of America's long, soft, slow slump,
Mr. Market's gold has been a better investment than Wall
Street's stocks or Bernanke's dollar. This trend may have
years more to go before it runs its course.

And now, over to Eric, just returned from Latin America:

------------

Eric Fry, back in Manhattan...

- While it's true that my body has returned from Nicaragua,
my mind is still drifting somewhere around the 12th
parallel north of the equator...It's difficult to forget
the soothing combination of sun, sand, stunning views and
superb food, all of which Rancho Santana offers in
abundance...More about that unique refuge in a moment.

- Meanwhile, just north of the 41st parallel, near the
corner of Wall and Broad, investors found no refuge
whatsoever. Stocks fell for the second straight day, as the
Dow lost 88 points to 8,447 and the Nasdaq slipped more
than 2% to 1,361. The shares of semi-conductor maker Micron
headed up a long list of losers by tumbling 23%. It seems
that the erstwhile tech-stock icon will lose even more
money than previously forecast, which means that the
"impressionable" investors who bought into the
semiconductor-recovery story will also lose more money than
forecast.

- The"semiconductor recovery" has to be one of the most
enduring myths on Wall Street. About once a year, the myth
emerges from hibernation, mauls a few investors and then
returns to its den until the following year.

- Back in the early fall, many Wall Street analysts
predicted a recovery in the semiconductor sector. But, as
usual, no recovery has materialized. Quite the contrary, as
Apogee Research recently observed:"Novellus Systems Inc.
(NVLS) is hearing increasingly glum news from the
semiconductor industry, but you'd hardly know it from
watching NVLS shares trade. Last week, the Semiconductor
Equipment and Materials trade group (SEMI) said that total
equipment sales this year will plummet 32.4% below last
year's level of $28 billion.

- The group forecasts a 'recovery' in demand during 2003,
but the so-called recovery is for industry sales of $21.8
billion, which would still be 22% below the 2001 level. In
fact, expectations for $26.4 billion of sales in 2004 and
$27.5 billion in 2005 still wouldn't match the 2001 level.
Yet NVLS trades at over five times trailing 12-month sales
and at 3.3 times its peak fiscal-year 2001 sales. How can
that be, we wonder, when the industry is not expected to
revisit such levels for at least three more years?

-"Since October, the shares of nearly every company
remotely related to the chip industry have risen to
valuations that suggest the boom-time party is about to
resume. Trouble is, the punch bowl remains depressingly
empty." Little wonder that Apogee has taken a very dim view
toward the shares of Novellus.

- While many stock market investors are licking their
wounds, commodity investors are licking their chops. Life
is sweet in the commodity sector these days. Gold and oil
both soared to new multi-month highs yesterday. Crude oil
for January delivery climbed as high as $30.44 a barrel, a
new two-year high. Over on the Mercantile Exchange, gold
put on another sparkling performance by jumping $4.70 to
$342.70 an ounce.

- Two years ago, only gold bulls under the age of twenty
dared to imagine that the yellow metal would clear $340 per
ounce within their lifetimes. In the opinion of most market
"experts", this was not supposed to happen. According to
the official Wall Street script, gold was supposed to
shrivel up and die while stocks soared ever higher.
Instead, gold, oil and numerous other commodities are
soaring, while stocks are struggling. Apparently, Mr.
Market likes to ad lib...

- If Rancho Santana had been equipped with an Internet
connection, you would have needed a crowbar to pry me out
of the place. I could have been,"Eric Fry, our man in
Nicaragua," instead of"...our man in New York."
Unfortunately, Rancho Santana is currently without a
connection to cyberspace. However, an Internet connection
is coming soon to this remote refuge...I'm happy to be back
in New York with my family, but staying in Nicaragua for a
few more days wouldn't have been a BAD thing.

- On my way down to Nicaragua, via last week's Supper Club
meeting in Orlando, I met Larry Holmes, one of the very
first residents of Rancho Santana. Larry spends several
months a year in his beautiful home overlooking Rosada
Beach. He also owns 11 other lots inside Rancho Santana. So
Larry is something of an expert about the place. When I
asked him how he liked it down there, he replied,"It's
heaven on earth."

- I was skeptical. But after seeing it firsthand, I've been
converted. Even if Rancho Santana is not quite heaven on
earth, it is at least a spectacular purgatory...More
tomorrow.

------------

Back in Paris...

*** We are back at our respective desks - Eric in New York
and Bill in Paris - but it is as if we never left.
Refinancings rose in the latest reported week...vacation
homes are selling well...and Wall Street is as bullish as
ever.

*** Conseco went Chapter 11 - the 3rd biggest bankruptcy in
U.S. history.

*** China announced that its entry into the car business is
going faster than expected - with production at the 1
million/year mark. The first few million cars will be sold
to the domestic market, while the Chinese improve the
quality of the cars and the their own marketing. But how
long will it be before these cheap China-made automobiles
reach California?

*** California faces a $35 billion budget deficit.
Washington State is looking at a $2 billion shortfall. Over
on the other side of the continent, New York City ran
budget surpluses in the last 2 years. This year, it has a
$1 billion deficit to deal with. And next year, the deficit
is expected to rise to $6 billion.

In writing our new book, we realized that never before has
government displayed such a keen interest in markets and
the economy. The politicians, of course, have to face the
voters of Shareholder Nation every couple of years. What's
more, their budgets depend directly on how much revenue
they get in income and capital gains taxes, and indirectly
on how much they can squeeze out of the economy.

No wonder Bernanke, Greenspan, Bush et al are so unwilling
to let the economy take a rest; they need the money...and
the votes! No wonder government is so ready to intervene in
the economy, promising voters gain with no pain, progress
without savings...economic resurrection without
recessionary crucifixion. But what a pity, too - their
meddling only makes things worse.

*** Booms and busts during the 19th century came and went
quickly; hardly anyone noticed. Capitalists were rich and
few. Who cared if they went broke? But then, the
democratization of media, government and the capital
markets brought more and more voters and small
shareholders. Soon, both government and markets came under
the control of crowds...and began to act like all mobs -
reckless, stupid and desperate.

The little guys were perfectly happy to join the real
capitalists in the profits. But they couldn't stand losses
and demanded that government 'do something' to protect
them. Creative destruction is all very well, provided no
one gets hurt! So, now we have the SEC, the FED, safety
nets, bureaucrats by the thousands and laws no one reads or
understands. And now we have a new kind of capitalism
without real capitalists. Today's big investors are
collectives - mutual funds, pension funds, endowment funds.
And now the bubbles are bigger than ever...and the
corrections take longer!

***"We heard from Pierre the other day," Elizabeth
reported last night."Mr. Laporte died."

***"And I got a letter from my friend Joan," added your
editor's mother, with more bad news."She went to a funeral
for her sister's father in law. They were all standing
around at the funeral waiting for the sister and her
husband. But they never showed up. It turned out that the
sister's husband was so distraught over the death of his
father, at least we imagine that that's what it was, that
he killed his wife and then shot himself."

"Joan is so nice," she continued."What a shame things like
that happen..."

*** What a shame, we repeat. But maybe Bernanke and his
band of miracle workers can bring them all back to life?

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---------------------

The Daily Reckoning PRESENTS: On occasion, we're tempted to
ask: is this time really different? You bet! answers Ray
DeVoe, but not in any way"New Era" dreamers would like to
hear...


THE POST-WAR PERIOD
by Raymond DeVoe, Jr.

I have been keeping a list of the stupidest things said on
CNBC. The list is lengthening. But the one that gets into
my mind the way those"Golden Oldies" do are the comments
that start with something like:"In the postwar period, the
economy (or stock market) has always (or almost always...)"
...and then they go into what either always, or almost
always, was done in the period since 1945.

To fill in some of the blanks following those"postwar
period" lead-ins:"[The economy]...responded to Federal
Reserve interest rate cuts and was recovering 6-9 months
later";"[The market] anticipated the recovery and was
substantially higher when the economy bottomed";"[The
stock market] was X% higher on average six months after the
economy turned Y% higher a year into recovery)";"bear
markets average about 11 months, so we should be..." etc.

My reaction to this is the same as when the people on TV
state something like,"The stock market has been higher 65%
of the time on the Friday following Thanksgiving, so there
is a 2-to-1 probability that it will rise on November 29,
2002." This goes into my"Rule (or, Misrule) of History",
which goes,"If the stock market regularly repeated past
patterns, the richest people on Wall Street would be
librarians and historians - and that's just not true."

My reaction to those"postwar period"-citing analysts and
strategists is: what is so special about the postwar
period? Why should the period since World War II ended in
1945 mean that everything will follow those economic and
stock market patterns?? How do they summarily dismiss
everything that happened prior to 1945??? Could it be that
what is going on now is quite different from"postwar
period" conditions, that it really is different now????"
For the latter - think theme music from"The Twilight Zone"
- all is not what it appears to be.

Recently, I did an interview for the December issue of a
financial magazine profiling"The 30 Smartest Investors on
Wall Street." I don't know how they got my name, since I
have done very little personal investing - and my attempts
at bottom-fishing have not been particularly successful. I
asked who the other 29 were - I couldn't imagine that many
brilliant people this year, since"Genius is a strong bull
market", and the opposite is true of a bear market. The
interviewer wouldn't name the others. Since the article was
for the December issue, I told her that the Annual Wall
Street Christmas Pageant had already been cancelled - they
couldn't find three wise men, or a virgin.

I was asked who the smartest person was I had met in the
investment world. That was easy: my professor and guidance
counselor at Columbia Business School, Prof. David Dodd of
Graham and Dodd's Security Analysis. Then she asked what I
thought was the best book about investing, and why. I
thought about it, and answered the question somewhat
differently - if there was one book that every novice
investor should read, my nomination would be Manias,
Panics, and Crashes - A History of Financial Crises by
Charles P. Kindleberger.

Why? Behind my reason was the fact that before you can
drive a car or fly a plane, you have to have a certain
amount of training with an experienced instructor. Then you
have to take an examination and a test drive or flight,
where you can fail, before you get your driver's or pilot's
license. For the latter, you also have to keep up with
continuing education. To qualify for night, instrument, or
non-visual flying, you have to take additional instruction.

Yet neophyte investors, some unable to articulate the
difference between a stock and a bond, are allowed to
"pilot" their life savings and/or intended retirement
portfolios without any form of instruction or training. All
they have to do is open a brokerage or mutual fund account
and give some (frequently confused) indications about their
financial resources and investment objectives. Since this
neophyte investing is almost always started in favorable
weather, a bull market, they are totally unprepared for
what might happen when a storm arrives.

Worse, they have been conditioned (brainwashed?) into
believing the mantras of"buy on the dips","hold for the
longer term", and that"there is no long-term risk in
stocks, only short-term volatility".

Mr. Kindleberger's book may not prevent people from making
financial fools of themselves, or losing a lot of money.
But it will give a new investor a warning and a sense of
history. Manias are nothing new and have occurred
regularly. However, the one that popped on March 10, 2000
(Nasdaq Composite 5048), others that may be hssssing now,
and the housing bubble to deflate some time in the future,
in combination, may constitute the largest financial mania
in history. A new investor reading Manias, Panics, and
Crashes would be alerted to the fact that no mania goes on
forever - that some have panics, some have crashes - and
others can be followed by years, sometimes decades of
stocks going nowhere. I always point out that in the 18
years prior to this bull market (1964-1982), the Dow
Industrials sold in the 800-900 area at some point during
the year.

This may not prevent a new investor from being caught up in
a mania, but at least they would be aware of what always
happens (i.e. there is never a"New Era") and possibly get
out in time or limit their losses."The market always comes
back," another mantra, has been true - but it took 25 years
to do that after the 1929 peak. Still, many stocks do not
come back. I knew a man who bought Radio Corporation of
America (now part of GE-$25.28) in 1928 when it was the
cutting-edge technology growth stock of the time. It
tripled to the 1929 peak. He held it for over 40 years,
until the color TV mania of 1968, so that he could break
even. Others were not so fortunate, since thousands of
stocks were wipeouts.

Overstaying a mania, particularly"holding for the longer
term" has approached an ominous point now. Today's Wall
Street Journal has an article by Ken Brown titled
"Investors Seem No Longer To Be Big Dippers" that indicates
investors no longer"buy on the dips" - but rather, could
be poised to sell if the market declines further. James
Bianco of Bianco Research tracks the profits and losses of
equity mutual fund investors since the final stage of the
bull market began in 1990."When the market hit bottom
earlier this month, falling to five-year lows, mutual fund
investors, in the aggregate, had a slight loss on all the
money they put into domestic stock funds since October
1990", Mr. Bianco reports.

The low point that month in 1990 on the Dow Industrials was
2365.10, vs. 8443.99 now. The reason for the near break-
even condition of equity mutual fund investments, with the
Dow Industrials 257% higher than 1990, is that very little
money was invested in the earlier stages of the bull
market, when values were more reasonable. Most investments
were made near the top - in 1998 and 1999. In addition,
large amounts were switched into previously"hot" mutual
funds just as they peaked. Mr. Bianco cited his"casino
theory": that investors are much more aggressive with
stocks when they have large profits ("playing with the
house's money") and are more likely to become very
conservative when their own capital is at risk.

Following my magazine interview, I decided to take my own
advice and re-read Mr. Kindleberger's book. It's not long,
just 197 pages before appendixes and footnotes. My first
edition copy (1978) is looking rather dog-eared, marked-up,
and the paper has turned orange - so I bought the 1996
third edition. It has an ominous quotation from Prof. Paul
A. Samuelson of Massachusetts Institute of Technology (MIT)
on the paperback's cover:"Some time in the next five
years, you may kick yourself for not reading and re-reading
Kindleberger's Manias, Panics and Crashes." It took only
about four years from 1996 to March 10, 2000 for people to
start kicking themselves about Nasdaq. The first three
chapters, entitled"Financial Crisis: A Hardy Perennial",
"Anatomy of a Typical Crisis" and"Speculative Manias",
document almost four centuries of boom-and-bust financial
cycles.

The main difference in the third edition is that it
includes the rise and fall of the Japanese stock market and
property boom in the 1980's - and the bust that followed-up
to 1996. In his"Introduction to the Third Edition", Mr.
Kindleberger warned"....and what looks, in the fall of
1995, suspiciously like a bubble in technology stocks." In
the book he lays out the classic pattern of boom-and-bust
cycles. 1) a fundamental change, such as war or new
technology occurs - which creates new investment
opportunities, 2) investment expands, often fueled by easy
bank credit, 3) investment becomes more speculative, based
on overoptimistic expectations of potential growth and
earnings, 4) in the latter stage, investment is totally
detached from reality and becomes a mania, frequently
spreading globally, 5) the excessive borrowing to finance
overinvestment brings about excess capacity - and a
collapse in prices, 6) eventually the mania ends in a
crash, with widespread investor revulsion as investors flee
falling markets, and 7) authorites are then left with the
problem of how to stabilize and then fix the financial
system, with the discovery of extensive corruption and
financial manipulation.

Sound familiar? Appendix 'B' at the back of the book is
entitled"A Stylized Outline of Financial Crises, 1618-
1990" and lists 42"crises" that occurred during that
period. Only four of them are in the"postwar period,"
including the Japanese speculative peak of late 1989. These
"crises," not necessarily recessions or bear markets,
include the OPEC-induced recession caused by the embargo
and quadrupling of crude oil prices in 1973, the Federal
Reserve-induced recession of the early 1980's to bring
double-digit inflation under control, and the"panic" of
October 19, 1987, also related to the Fed's raising
interest rates to suppress inflation.

Raising interest rates is what started the decline from the
peak of 2722 in the Dow during August 1987. The 508 point
decline of October 19th was brought about by a combination
of other factors - including the estimated $90 billion in
stocks that was"protected" by portfolio insurance. When
the triggers were hit on this huge amount of stock, massive
dumping occurred, and it overloaded the system. Actually,
the one-day decline could have been worse, in my opinion,
if the options and futures' traders had continued to make a
market. Instead they disappeared - removing the other side
of the"insurance", - and stocks that should have been sold
were removed from the market. He labels that a"crisis",
which was a one-day bear market, but no recession followed.
Thus, two of the three U.S. postwar"crises" were
attributable to exogenous variables.

In any case, almost every one of the pre-1945"crises"
listed in the Appendix to Mr. Kindleberger's book are of
the"boom-and-bust" variety. And virtually every recession
since 1945 in this country has been brought about by the
Fed's raising interest rates to suppress inflation.
Question: how many major stock market bubbles have occurred
in"the postwar period?" Only one, during the 1990's.

There have been other speculative manias, but they were
confined to individual sectors - I can list at least four
in technology (or, in"The Great Garbage Market of 1968,"
anything that appeared to be technology, or had a name that
suggested it. That was similar to the"dot-com" mania when
companies added".com" to their names and the stock prices
soared.) There were others in bowling stocks, uranium,
airlines, color TV - but they were confined to those
sectors. When the bubbles burst, the major damage was
generally limited to the participating stocks, with some
fallout. There is always some spillover, since when a
bubble bursts, many of those former high-flyers are
virtually un-sellable. The liquidity disappears, and large-
capitalization stocks with good markets are sold instead.

This time, it really is different. This is not a"postwar
period" type situation - it is a"post-stock-market bubble
period." The London Economist in a 28-page pullout ("The
Unfinished Recession - A Survey of the World Economy,
September 28, 2002") points out about Central Bankers:
"They do not seem to grasp that this economic cycle is
different from its predecessors". As they state,"postwar
recessions have been principally the result of increasing
inflation. Last year's recession and current economic
stagnation are not the result of inflation, but the result
of burst economic and stock market bubbles." This is the
first of that type in the entire"postwar period" - and why
the economy has not responded to 11 interest rate cuts -
which has always stimulated traditional Fed-induced
"postwar" recessions and brought about economic recovery.

Thus, this is not a normal,"garden variety" postwar
recession. This is more comparable to the traditional boom-
and-bust"crises" Mr. Kindleberger has documented for about
400 years. The late Rudi Dornbusch, another MIT economist,
once remarked that"none of the postwar expansions died of
old age; they were all murdered by the Fed". With the
exception of 1973-74, which was due to exogenous variables
(OPEC's embargo and the quadrupling of oil prices) - and
the current ongoing experience, every recession since 1945
was preceded by a sharp rise in inflation that forced the
Fed to raise interest rates to cool off the economy. There
were always two policy errors - allowing the economy to
overheat in the first place, then hitting the brakes too
hard.

That Economist pullout"The Unfinished Recession" is
another suggested reading, not only for a post-mortem of
the 1990's bubble, but for a sober assessment of the
current state of the U.S. and world economies. As they
state in the introduction,"This is no traditional business
cycle, but the bursting of the biggest bubble in America's
history. Never before have shares been so overvalued. Never
before have so many people owned shares. And never before
has every part of the economy invested (indeed,
overinvested) in new technology with such gusto. All this
makes it likely that the hangover from the binge will last
longer and be more widespread than is generally expected."

This"post-postwar period" is different from the other
recessions and recoveries since 1945. This is the only time
that a bubble in both the stock market and economy has
occurred in 73 years, and burst. As pointed out previously
in other reports, investment has fallen for seven
consecutive quarters. That's the longest in the entire
"postwar period". Stocks haven't fallen for this long in
that same span. Household net worth rose every year in the
"postwar period", until 2000 - and is likely to shrink this
year for the third year running. But most significantly,
never during the"postwar period" have we had the unwinding
of a massive speculative bubble.


Regards,

Ray DeVoe,
for The Daily Reckoning

P.S. Those limiting their analysis to the last 57 years are
arbitrarily ignoring all previous history of financial
crises - as documented by Mr. Kindleberger's analysis of
almost 400 years of"crises". This is an economic"Twilight
Zone" fluctuating between recession and recovery - with
very poor visibility. It will be different - not
necessarily better, or worse, just different - and will
take longer to recover from than is generally expected.