-->Waiting For Godot

The Daily Reckoning

Paris, France

Thursday, 21 August 2003

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*** Gold rises $4... will we ever see $350 gold again in our
lifetimes?

*** This turtle don't sprint... the U.S. economy muddles
along...

*** Housing's last hurrah... Tomorrow's
headlines... Iraq... and more!


Anyone who is watching the stock market carefully is
wasting his time, in our opinion.

The important action is taking place elsewhere. The price
of gold rose $4 yesterday, to $367. Gold has been in a bull
market for the past two years. It has risen more than 40%
already.

Yesterday, we were hoping it would go down. Our own target
for buying gold is below $350. Each time it drops below
$350, we tell ourselves we should buy. And each time, we
forget to buy. Then, when it rises again, we wonder if we
will ever see $350 again.

At $350, gold is a bargain. It is a bargain at $400 too.
Recently, on the back of an envelope, we calculated that
since Alan Greenspan became Fed chief, $6,125 had been
added to the money supply for every ounce of gold brought
out of the ground in that period. Even if we were off by a
decimal point, gold is still a bargain; it should at least
double in price in order to stay even with paper dollars.

Of course, it is not really the price of gold that is out
of order, but the purchasing power of the dollar.
Dollars... and assets quoted in them... are more expensive
than they ought to be. U.S. stocks, for example, trade
hands at 33 times earnings. Who would want to wait 33 years
to get his money back? The only way to justify the price is
by assuming that earnings will rise sharply. But why would
they?

Corporate earnings, as a share of GDP, have been going down
ever since the Dollar Standard system came into being in
1971. No coincidence. Every extra dollar manufactured by
the Bureau of Printing and Engraving encourages someone to
lust after it. The pattern of the last 30 years has been
for the luster to set up a factory in Japan, or Malaysia or
China... and thereby offer something to trade for the money,
giving the spender a better bargain for his money than he
could get at home. And so, U.S. corporations found their
profit margins squeezed by greater worldwide capacity,
generally, and low-cost manufacturing from Asia in
particular.

The Fed encourages the illusion of an economic
recovery... goosed along by more credit from the Fed and
more dollars from the Bureau of Printing and Engraving.
Investors count on a recovery of corporate profits, too.
But each additional dollar only incites the
competition... and hastens the day when the dollar finally
gets marked to a wicked market. To a point, the Fed can
stimulate consumer buying... luring the lumpen deeper into
debt. But it does so at the expense of the very profits
investors are counting on.

"The outlook for the global economy is profoundly
disturbing," writes Richard Duncan in his book,"The Dollar
Crisis.""Until the dollar adjusts sharply lower, asset
price bubbles and deflation will continue to undermine
corporate profitability, banking systems and government
finances. When the dollar does fall, as it inevitably must,
the global economic slump will intensify as the major
exporting nations fall deeper into recession and the
overheated U.S. economy deflates."

More on the coming dollar crisis... and Richard Duncan's
excellent book... tomorrow...

But today, here's Eric Fry with the latest news and
entertainment from Wall Street:

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

Eric Fry in Long Island...

- The stock market muddled through another late-summer
trading day. The Dow stumbled 31 points to 9,397, while the
Nasdaq dipped half a point to 1,760.

- But the stock market has done very little muddling in
2003 - all the major indices have scaled to fresh one-year
highs. Unfortunately, the economy stubbornly refuses to
follow the stock market's lead. The acrophobic U.S. economy
prefers, instead, to keep its feet firmly planted on level
ground, and simply muddle along.

- So desperately do investors hope for economic growth,
that Wall Street's economists and strategists - like
gamblers at a turtle race - verily cheer, holler and cajole
the economy to pick up the pace and sprint toward the
finish line.

- But this turtle don't sprint... The proof may be found in
Hewlett Packard's just-released third-quarter earnings
report. The diversified tech giant, like the economy
itself, is merely plodding along, despite constant
sycophantic cheering from Wall Street's analyst-fans. H-P's
latest report offers a very telling, ground-level snapshot
of our economy... and the picture isn't pretty.

- Many of H-P's main business units posted losses once
again. Personal-systems sales, for example, which include
desktop and notebook computers, chalked up an operating
loss of $56 million in the quarter, compared to a profit of
$21 million in this year's second quarter.

- Enterprise-system sales, which include storage devices
and servers, reported an operating loss of $70 million.
That's an improvement over the $252 million it lost last
year, but far worse than the $7 million it lost in the
second quarter.

- Hewlett's imaging and printing group, the company's most
profitable division, managed to grind out operating income
of $739 million. But that result pales alongside the $918
million it earned a year ago and also compared to the
second quarter's $851 million profit. H-P's lackluster
result does not bode well for the tech sector, or for the
economy at large.

- Elsewhere in the Great American Turtle Race, many
consumers are shifting from consumption to conservation. In
other words, the nation's spenders are becoming
savers... and that's not a helpful trend for an economy that
subsists on consumerism.

- Saving money - like abstaining from alcohol - is a
healthy trend... unless you happen to be a bar owner. And
it's no secret that the U.S. economy, if it is to grow,
needs folks to continually 'belly-up' to the consumer-
spending bar and buy stuff. Unfortunately, the American
consumer is learning temperance.

- For example, nearly half of all Americans who have
received their tax rebate checks said the funds went to pay
bills. Another 29% said they've saved or invested the
rebate money, while only 18% said they'd spent it."The
results are at odds with the Bush administration's - and
certainly retailers' - hope that Americans would quickly
spend the windfall and stimulate economic recovery," the
Financial Times notes.

- Meanwhile, demand for credit-card debt and other forms of
revolving credit fell more than 2% in June. It's possible,
of course, that the last gasps of the mortgage refi boom
have skewed the consumer credit numbers somewhat, as
borrowers have been applying part of their refi proceeds to
paying down credit-card debt.

- However, the Cambridge Consumer Credit Index, which
measures credit-card use, fell from a reading of 60 in July
to 55 in August. What's more, the percentage of respondents
in the Cambridge survey who said that they have taken on
more debt declined from 30% in July to 25% in August.

- It looks like the nation's new frugality fad is for real.
But unfortunately, this new debt conservatism is heavily
focused on the"haves." The"have-nots" are still borrowing
money at a rapid clip in order to make ends meet.

-"The so-called sub-prime market is a different ball
game," one analyst correctly observed."What we have seen
there is significant collateral deterioration, because the
borrowers in that segment have been much harder hit by the
downturn in the economy in terms of losing their jobs."

- This is not a healthy trend for the sub-prime lenders.
Then, too, we would not be surprised if a growing percentage
of the nation's prime borrowers were to begin resembling
their sub-prime counterparts... There's a lot of risk out
there in"Lending Land."

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Bill Bonner, back in Paris...

***"Housing's last hurrah," says a CNN headline. Consumers
fear rising mortgage rates; if they were thinking of buying
a new house, they are making their move now rather than
later.

"Mortgage applications drop further," is another CNN
headline.

*** We love the new-born, fresh-faced innocence of the
financial press."Credit binge faulted for rising
bankruptcies, loan defaults and repos," remarks a headline
from yesterday's Bremerton SUN. What a delight it must be
to discover the entire world as though it had been created
yesterday; it is all so new and fascinating. 'Who would
have imagined that borrowing so much money would lead to
trouble?' this journalist must have said to himself.

What can we expect next? We can almost guess at tomorrow's
headlines:

"Housing glut blamed for price collapse.."

"High prices on Wall Street seen as cause of bear
market..."

"Too many dollars led to decline, say economists..."

"Record debt levels caused recession..."

***"Service Industries Go Global: Skilled white-collar
jobs are starting to migrate to lower cost centers
overseas," says one Financial Times headline.

"U.S. banks transfer analysts' work to India," says
another.

But don't worry about this trend, dear reader. The Fed can
always cut rates!

***"Errors always come along when you need them." We quote
a line from our forthcoming book, Financial Reckoning Day.
In it, we describe how you can always count on people to do
the wrong thing, sooner or later. We cite, for example, the
Japanese in 1941. They were masters of the entire Asian
side of the Pacific Rim. The only potential competition
they faced was remote and reluctant: the U.S. So, what do
they do? The one thing... and perhaps the only thing... that
could ruin them - they bombed Pearl Harbor. Tojo
immediately recognized his mistake."I fear," said he,"we
have awakened a sleeping tiger."

Nature hates monopolies; every niche is balanced by
competition. Every hero has his nemesis. Death stalks every
bull and every bear market... and there are sleeping tigers
everywhere.

And yet, at the debut of the 3rd millennium, it appeared
that the American military had no rival.

A visitor from Mars or West Virginia might have looked at
the world and wondered: what could stop the U.S.?

And then came the War on Terrorism. It was a popular
project for the Bush Administration, but there was just one
problem: a shortage of terrorists. If you're going to have
a war against someone, you must have someone against whom
to make war. The American people had all been marshaled to
fight terrorism... but, after the 9/11 strike, the
terrorists disappeared. They did not take out bridges, or
buildings, or even blow up tin cans in municipal dumps.
Logical inference: there were very few terrorists.

But then, the Bush Administration may have found the
mistake it was looking for: it invaded Iraq. There were no
terrorists there either, it turned out. (Nor any weapons of
mass destruction.) But the occupation of Iraq may still
provide the competition a great power needs. Recent news
accounts suggest that the U.S. presence in Iraq is creating
terrorists. Arab fighters, says the BBC, are leaking into
Iraq, starting new groups, sabotaging pipes and blowing up
things. The U.S. military is creating a bull market in
terror; every crackpot with a grudge seems to be setting
himself up in the business.

Has the U.S. awakened its sleeping tiger? We don't know.
But it has certainly rousted more than a few muslims out of
their hot slumber. Now they have a cause... and a target
close at hand.

The American military machine may work well against
conventional armies, but it has no advantage against
determined guerrillas.

"The lesson of Algeria," said a French friend,"is that if
they want you out... you should leave sooner rather than
later."

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The Daily Reckoning PRESENTS: It's nearing Fall 2003... and
economic indicators are promising. Will this year usher in
the fabled second-half recovery, after all? Alas, the devil
is in the detail.


WAITING FOR GODOT
by Kurt Richebacher

"There is no means of avoiding the final collapse of a boom
brought about by credit expansion. The alternative is only
whether the crisis should come sooner as a result of the
voluntary abandonment of further credit expansion, or later
as a final and total catastrophe of the currency system
involved."

Ludwig von Mises,
Human Action, A Treatise of Economics,
Yale University Press, 1949


Once again, we are treated to the vaunted"second-half
recovery" mantra from the mainstream financial press. Could
it be that this year we will finally have our cake and eat
it, too? For the benefit of long-time Daily Reckoning
readers, we will cut to the chase and dispense with all
illusions of suspense: in reality, the U.S. economy is in
recession, as reflected in the dismal employment
performance.

Pointing to the various statistical adjustments in the
price indices that substantially boost America's real GDP
growth, we have argued ad nauseum that the reported U.S.
growth rates grossly overstate the reality in comparison to
other countries.

Of course, it is nevertheless always possible that the
economy is embarking on a strong, solid recovery, as
predicted and widely expected. The bullish consensus draws
its optimistic assessment largely from the belief that a
sufficiently strong policy stimulus is now in place and
partly from some better-looking indicators.

As to the first assumption about policy stimulus, we can
only express our utter amazement. It flatly ignores the
extremely poor economic effects of the even more prodigious
monetary and fiscal stimulus of the past two-and-a-half
years. To us, this recent experience really forbids any
optimism in this respect about the future.

Assessing the U.S. economy's prospects essentially begins
with two crucial questions: first, will businesses start
hiring and investing again pretty soon? And second, will the
consumer be willing and able to keep up his borrowing and
spending binge? Please consider that one month of the second
half of the year is already behind us.

Looking for the recovery, it strikes us in the first place
that the second quarter was no better than the first
quarter, if not weaker. Production posted gains of 0.1% in
May and June. But it decreased at an annual rate of 3.2% in
comparison to the first quarter.

The central assumption behind the consensus' U.S. recovery
forecasts is an incipient, strong revival in business capital
spending. In actual fact, it is absolutely indispensable that
it materialize very quickly.

Since any sign of higher investment spending or even of
higher production is so far completely missing, we have to
look for early indicators. There are modest improvements in
survey indexes, generally considered as leading indicators,
but there is no trace of it in the hard data, reflecting
current facts.

Capital goods orders and shipments, in our view the best
proxy for investment spending, remain stuck in virtual
stagnation. In fact, 'core' orders for capital goods
excluding defense and aircraft dropped 0.4% in May,
following a 2.8% decline in the month before. New orders for
machinery were 4.3% below their level a year ago, and among
those, orders for computers and electronic products were down by
9.6%.

However, the bullish consensus argues that the necessary
conditions for the investment revival - above all, higher
profits, higher cash flow and stronger balance sheets - are
developing.

It is generally agreed that a strong rebound in profits is
the key condition for a solid and sustained investment
recovery. Aggregate after-tax profits of nonfinancial
corporate business, as measured by NIPA, were $197 billion
in 2002, even lower than the $205.3 billion in the
recession year before. Yet they improved in the course of
the year. But as it is so often, the devil is in the
detail.

The fact is that profits have been and continue to be
heavily inflated by special factors. We note: first, big
'inventory profits' deriving from rising oil and commodity
prices; second, big gains from financial activity and
speculation; third, big currency gains by foreign
subsidiaries of U.S. firms; fourth, an unusually large rise
in the profits of foreign firms in the United States; and
fifth, continuous, heavy underfunding of pension fund
obligations.

If the poor profit performance needs any further proof, it
is in the unfaltering 'earnings-management game.' Despite
the condemnation of past accounting tricks, the familiar
tricks to make profit numbers look better than they are
have remained in rampant use. A common ploy is to report
fictive 'pro forma' profits; another is to measure them
against deliberately reduced 'expected' profit. For
example: the reported profits of Apple Computer topped
expected profits by a whopping 67%. In actual fact, they
had fallen 41%.

Whenever we read of better-than-expected profits, we
presume cheating. Such reports often lead to the systematic
delusion of investors. Yet no one protests; instead, they
follow after the delusion in the hope that it will mean
higher stock prices. Economic reality is too unpleasant to
be faced with open eyes. But for people with a bit of
common sense, this method of comparison is completely
arbitrary and meaningless.

It seems, of course, a fair assumption that a solid second-
half economic recovery will not fail to buoy profits. But
first of all, we do not believe in this recovery, and
second, we fail to see the micro and macro adjustments that
are necessary to improve profits.

As we have stressed many times, our own assessment of
profit prospects is strictly determined by focusing on the
particular flows of business revenues and expenses that
generate business profits. Based on this analysis, we see
nothing that speaks for substantially higher profits. There
is a great risk to profits in a probable, prolonged rise in
personal saving from current income. A possible boost may
come from the rising budget deficit.


Regards,

Kurt Richebacher,
for The Daily Reckoning

P.S. Poor profit prospects are not the only reason we are
unable to see a solid, sustained investment recovery in the
United States. General financial viability, measured by
various financial indicators, is another indispensable
condition.

How robust are American company finances? The short answer
is that balance sheets are not a picture of health. What's
more, whether they are improving or deteriorating remains
an open question. We believe in the latter eventuality; at
best, there has been very little recent improvement.

In the frantic pursuit of higher stock prices, American
managers in the past few years have systematically
devastated the balance sheets of their companies. Financial
damage that took several years to build up cannot be
corrected in several quarters.


Editor's note: Former Fed Chairman Paul Volcker once said:
"Sometimes I think that the job of central bankers is to
prove Kurt Richebächer wrong." A regular contributor to The
Wall Street Journal, Strategic Investment and several other
respected financial publications, Dr. Richebächer's
insightful analysis stems from the Austrian School of
economics. France's Le Figaro magazine has done a feature
story on him as"the man who predicted the Asian crisis."