-->The World He Lives In
The Daily Reckoning
Ouzilly, France
Friday, 2 May 2003
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*** Dollar's 'doomsday cycle'...gold up $3...
*** Factory orders, construction spending - down...Dow down
too, more gloomy news...
*** More on natural gas...and the night they drove old
Bessie down...
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The U.S. dollar is stuck in a"doomsday cycle", says
TheStreet.com, offering as evidence all the many things
we've discussed.
"U.S. economy continues to struggle," observes the
Financial Times, citing the usual reasons.
"Gold up $3," reports no one in particular, and giving no
reasons nor apologies. Gold does what it wants to do,
regardless of what anyone says. Right now, it seems to want
to go up.
"Where does one look for satisfactory returns in a world of
1.25% money market rates and 5% long-term bonds?" asks
Dogs-of-the-Dow inventor, Michael O'Higgins. In one word,
gold!"Because it is undervalued, under-owned and in a
strong uptrend after 20 years in the doghouse. Not only
that, but gold has historically served as a great hedge
against the kind of falling stock market and weak economy
that we are likely to experience going forward."
Gold has been in the doghouse for so long that most
investors are afraid to touch it; they think it has fleas.
In the last two decades of the 20th century gold fell 70%
in price, while the Dow stocks skyrocketed 1200%.
This was such an extraordinary event that it made us feel
like soothsayers. Looking into the future, we guessed that
the world would have to veer back towards the mean sometime
soon. We suggested what we called the Trade of the Decade:
sell stocks and buy gold.
Since then stocks have fallen about 50% on average, and
gold has risen about 40%. But it still takes 22 ounces of
gold to buy the Dow, which is twice as many as it has, on
average, for the last 100 years. Which makes us think this
trend has a long way to go.
"In other words," explains O'Higgins,"the price of gold
could more than double and it would still be reasonably
valued relative to stocks. Of course, if it went back to
the levels of 1980, 1932, or 1896, it could go up by 1,000%
to 2,000%.
And here's Eric Fry with the latest news from Wall Street:
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Eric Fry in the Big Apple...
- Stocks muddled along yesterday...just like the U.S.
economy. The Dow dipped 26 points to 8,454, while the
Nasdaq edged half a percent higher to 1,473...
muddle...muddle...muddle. Meanwhile, the dollar continued
sinking like a brontosaurus in a tar pit. The U.S. currency
traded down half a percent to $1.124 per euro, a new four-
year low. Yesterday's drop brings the dollar's three-day
decline to more than 2%.
- Government bean-counters released another cluster of
gloomy economic reports yesterday. The steady stream of
downbeat economic reports is forcing the glass-half-full
contingent to recalibrate its assessment...Perhaps the
glass is only 45.4% full. That would appear to be the
message from the Institute for Supply Management (ISM),
which reported yesterday that its index of manufacturing
activity fell to 45.4 from 46.2 in March and 50.2 in
February. Sub-50 readings indicate that more manufacturers
feel business is getting worse rather than better. In other
words, a reading below 50 means the glass is more than
half-empty.
- Separately, construction spending tumbled and jobless
claims remained close to a one-year high. In all, not a
very comforting collection of data. Construction spending
fell 1% in March on weakness for public projects. Over in
the job market, 448,000 folks filed for unemployment
insurance last week, down slightly from the 461,000 initial
claims filed during the prior week. The four-week moving
average of weekly unemployment claims is a not-
insignificant 442,000 - that's 60,000 more than the 4-week
average of just three months ago...Just imagine how bad off
we'd be if Greenspan hadn't cut interest rates so many
times!
- No question about it; America's job-growth engine is
sputtering badly. Despite a theoretically recovering
economy - as evidenced be a string of positive quarterly
GDP numbers - jobs have become almost as scare as Iraqi
chemical weapons.
- And, as we have oft-observed, consumers without jobs
don't consume quite as much as those with jobs. To wit:
Ford's car sales tumbled 6.7% on April, despite hefty
rebates and low-interest-rate incentives. Apparently,
there's a limit to the number of times you can dope a
racehorse before it collapses.
- GM car sales fell a similar amount, while Daimler
Chrysler finished several lengths behind with a 10% sales
drop. Sluggish car sales are but one of the many indicators
of economic stasis we're seeing these days.
- And now, a few more bullish musings from the oil
patch...or more properly, the natural gas patch, which we
presume is located somewhere nearby. The US Energy
Department's weekly natural gas report showed a slightly
larger-than-expected increase in gas inventories, but one
week does not a trend make. Natural gas inventories are
still a stunning 54% below year-ago levels.
-"Last week marked the official start of the annual six-
month push to fill up the [nation's] natural-gas storage
tanks," the Wall Street Journal notes."With gas
inventories at their lowest levels in a decade, the effort
takes on increased urgency this year." And as T. Boone
Pickens stressed at Wednesday's Grant's Spring Investment
Conference, the urgency to replenish badly depleted natural
gas inventories is likely to lead to rising gas prices
sometime over the next few months.
- If high, and rising, natural gas prices seem so probable,
why aren't the exploration and production companies working
feverishly to increase their drilling activity? The answer,
according to Pickens, is that"there's nuthin' to drill".
Natural gas companies have stepped up their drilling
activity somewhat, but not nearly as much as one might
expect, given today's elevated gas prices.
-"One year ago, 613 gas rigs were toiling away on American
soil and in contiguous waters," James Grant observes."Now,
following a propitiously cold winter and a backward spring
(we write from the New York perspective), there are 805.
However, as recently as July 2001, there were 1,068.
-"As high corn prices elicit more corn, other things being
the same, so do high gas prices elicit more gas, other
things being the same. But exploration activity presupposes
a belief on the part of the explorers that there's gas to
be found. Among U.S. drillers, the faith seems to be
waning, the current high gas price notwithstanding...Over
the long run, exploration will become less and less
fruitful in the lower 48 states."
- The economy may continue muddling along, but the natural
gas market promises to offer many chills and thrills over
the rest of the year.
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Back in Ouzilly...
*** Factory orders fell again.
*** Bethlehem Steel is no more. The company had been in
bankruptcy. Its assets have now been sold off. Old Bessie
is no more.
Your editor's father and many of his uncles worked in steel
mills. For much of their lives, they worked in rhythm with
the mills. Three shifts a day in the '50s and '60s...and
then layoffs, payoffs, and early retirement...
An uncle recently recalled what life was like at the
Sparrow's Point Bethlehem Steel plant in Baltimore:
"I got a job there in the late thirties. I don't remember
how much I was paid; it wasn't much. But I was lucky to get
any job at all.
"Those were the days...all along the waterfront, everyone
was hustling and bustling...you could hear the factory
whistles all over town. And you knew that the bars around
Highland Town would fill up a few minutes after the whistle
blew. Everybody worked for the mill. And our whole lives
revolved around it. Other things might change, but we
thought the mill was permanent. People would always need
steel, and nobody made it better than we did.
"People think working steel was a science, but it seemed
more like an art to me. I remember my boss...a big Irishman
named Milligan...he would mix up a batch of steel like he
was baking a cake. He'd add a pinch of this and a dab of
that...and then, he'd know just what kind of steel would
come out of it...and somehow, he would know just what
customer it was good for. You had to get the
temperature...the timing and the mix just right. And each
mix was different. One might have more strength...or more
flexibility...than another. But Milligan knew just what
kind of batch he had and he marked it down for the right
customer...steel bridge girders...or auto steel...or
whatever.
"Every time we poured a batch...I don't know...there was
something exciting about it. It was if we were working
right in the heart of this great, pulsating machine. Each
batch of steel was like the lifeblood of the entire
system...hot...full of life. We were proud, happy and tired
when we came home from work.
"Of course, those days are gone. Now, they've mechanized
and computerized everything. And besides, the factories
don't seem to work they way they used to. The energy and
excitement seems to have gone out of them. And I guess
those kind of jobs have all gone to China or Korea. But
it's too bad.
"I loved the work, but then the war came along and we all
shipped out. After the war, I came back to get my job back.
But I had gotten malaria in Iwo Jima or somewhere...and it
came back. I spent months in a military hospital, by then,
they had given my job to someone else."
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The Daily Reckoning PRESENTS: The road to a long, soft,
slow depression is paved with the illusion of wealth...
THE WORLD HE LIVES IN
By Bill Bonner
Today we approach a serious and disturbing paradox: how
could it be possible for an economy to slow down just when
its central bankers and its central government push harder
than ever on the accelerator?
If you would prefer something more lighthearted, you could
read Alan Greenspan's address to Congress on Tuesday. More
and more, we find we share the sentiments of Rep. Bernie
Sanders, who remarked following a previous testimony by the
Fed chairman:
"Mr. Greenspan, I always enjoy your presentation because,
frankly, I wonder what world you live in."
We wonder too.
As near as we can tell, it is a strange one. For in Mr.
Greenspan's world, there are no paradoxes. It is a world as
clean and dull as an actuarial table with only whole
numbers. The Fed chairman is surrounded by such positive
thinkers, the poor man must not get a chance to voice a
doubt or doubt a voice. Ben Bernanke thinks he can make the
dollar worth as much or as little as he wants, just by
controlling the speed of the printing press. Robert McTeer
says he can hardly wait to fight deflation; he thinks it
will be fun. Alfred Broadus is probably the most cautious
of the bunch...but still delusional. He says the Fed has
proven that it can fight inflation, and now it has to prove
it can fight deflation.
It is to this last point that we are drawn...as if to a
crime scene. The Fed claims it came along just in time and
chased off the miscreant. We look at Al Broadus and the
rest of his gang and wonder: who do they take us for,
complete morons?
And yet, Americans' can-do optimism seems to depend on the
ability of its central bankers to do what the Japanese
could not - successfully wage war on deflation. All right,
so the war on inflation was not the great success that
Broadus thinks it was. (The dollar ended the year 1913
about where it was 100 years before. In that year, the Fed
took up its mission - to protect the value of the nation's
currency. Over the next 90 years, the dollar lost 95% of
its value.) What the Fed has proven is not that it is a
good inflation fighter, but that it is good at stabbing the
dollar in the back. And since destroying the dollar is just
what the times seem to call for, what are we worrying
about?
If only there were not so many paradoxes, dear reader.
Wouldn't life be much better if women meant what they said?
Wouldn't it be nice if you could be happy by thinking of
yourself and only doing what makes you happy? Wouldn't it
be grand if the investments that made people rich last year
would make you rich this year?
Or, more to the point, wouldn't it be just peachy if the
Fed really could control the money supply...so that people
would have money to spend when the Fed wanted them to
spend? But therein hangs a tale, which is the subject of
today's letter.
But here, hardly having moved forward a single inch, we
must arrest our progress. Alert readers may already be
looking ahead, with an objection:
"Hey, I know where you're going with this. You're going to
say that the Fed will be as incompetent at destroying the
dollar's value as they were at protecting it. But haven't
you been saying that the dollar was going to collapse? (And
sotto voce: I've been buying gold and euros thanks to
you...the dollar damned well better collapse!)"
Ah...but you expect too much, dear reader. If you want
consistency or simplicity, you will have to pay for it.
Dearly.
Many, if not most, of our friends have taken the Fed at its
word, and on its record. If there is one thing the Fed can
do, they say, it is inflate the currency.
"Buy gold," they say. Consumer price inflation is on the
way...with higher interest rates and falling bond prices.
But an odd thing: even as the dollar lost value...and the
trade deficit hit 5% of GDP...and federal deficits
soared...long T bonds, recently, went up. Why would people
lend money for 30 years, at paltry rates of interest, to a
government openly declaring that it intends to inflate?
We don't know. Perhaps people need the income, as small as
it is. But, whatever the reason, the bond market is
unconcerned about inflation. Not only did long T bonds go
up, the differential between regular treasury bonds and
those whose return is adjusted for inflation narrowed. (We
would give you the figures, but we don't have them at hand;
you will have to take our word for it.) [Editor's note:
Bill is lost in the wilds of his château in Ouzilly, taking
advantage of the long May-Day weekend in France.]
The bond market seems to anticipate not a rerun of the
inflationary '70s...but something else; perhaps America
will follow in Japan's footsteps after all. For the last 8
years or so, the U.S. economy and its stock market have
done a fair imitation of the Japanese trendsetter...with a
10-year time lag. When the Japanese economy boomed, so did
the U.S. economy - 10 years later. Then, Japan entered its
bubble phase, followed by the U.S., 10 years later. Then
came the bear market in Japan, again trailed a decade later
by a bear market in America.
At first, no one paid any attention to the Japanese
situation. It was just a blip, said economists; Japan will
come back fast.
That was 14 years ago. And last week, the Nikkei Dow sank
to new lows - down 80% from a high set back in the final
year of the Reagan Administration. After Reagan, Bush the
Elder took over in America, up-chucked on Japan's Prime
Minister...and it has been downhill for the Japanese ever
since.
But the Japanese did not go gently into that good night.
They fought the dying light just as the Greenspan Fed would
do - 10 years later. Rates were cut...and cut...and cut
some more, until they reached zero. Nor did the Japanese
shirk from government spending...public works projects of
all manner and description were begun. Never before has so
much concrete been mixed and poured in such a small place.
But it didn't work. The money supply fell anyway...and
Japan became the first major nation to experience outright
consumer price deflation since the Great Depression. Twenty
years of stock market gains have been wiped out.
Unemployment edges up as the economy experiences multiple
recessions. Consumers seem unwilling to spend - guessing
that they will get more for their money next week than they
would this one.
How could it be, we ask ourselves? How could a central bank
be unable to do what central banks do best?
We remind readers that when the Fed creates money 'out of
thin air' it does not create any corresponding wealth. The
world's supply of services or swimming pools does not
magically increase when Ben Bernanke turns up the dial on
the printing press. What it does create is an illusion of
wealth; people with more 'dollars' imagine that they are
richer...and begin to act the part.
Kurt Richebächer describes this as"pseudo or phantom
wealth", whose effect is, paradoxically, to make people
poorer. In the boom phase of an economy, the phony money
goes into stocks, or real estate, or some other asset.
"What the rising asset values effectively create,"
Richebächer explains,"is a corresponding rise in claims on
the economy at the expense of those who do not own such
assets. But this is wealth redistribution, not wealth
creation. More importantly, this kind of wealth creation
involves no gain in current incomes and productive
capacity. To the extent that it actually boosts consumption
at the expense of investment and foreign trade balance, the
net result from a macro perspective is overall
impoverishment."
[See:"Phantom Wealth", a DR essay from 1 April 2003.
http://www.dailyreckoning.com/body_index3.cfm?id=5334 ]
Poor people have less money to spend...and less money to
repay their debts. Unless the central bank delivers the new
cash along with the daily paper, money creation takes place
through credit. The new money is lent out. If the borrower
cannot repay, the cash disappears.
Curiously, money 'created out of thin air' tends to
disappear even when the loans are paid back. As explained
in a recent issue of the Mogambo Guru's, which we would
quote if we could find it, when a man lends out his
savings, he can expect to get paid back, with interest, and
all is well. No change to the money supply.
When money is created 'out of thin air', on the other hand,
the money supply is enlarged when it is lent out. It didn't
exist before it was borrowed. Then, when it is paid back,
naturally enough, the money supply shrinks! The money goes
back to its maker; it exists no more. Thus, the more new
credit the Fed has created...the greater the measure by
which the money supply will eventually fall.
The only way to avoid this inevitable deflation would be to
either to give the cash away on the streets...or to keep
the supply of credit expanding forever. The first solution
would be worse than the problem it was meant to solve; the
second is impossible.
Meanwhile, the world's apparent wealth - and implied
spending power - expands and contracts as the assets,
bought on credit, go up and down in value. About 7 trillion
dollars were wiped out so far in the stock market decline
of the last 3 years. If U.S. stocks follow the Japanese
plan - falling 80% over 14 years - another $8 trillion or
so, in America alone, will disappear.
Is it any wonder that cash and 'wealth' created 'out of
thin air' returns whence it came - no matter what its
creators would like? There is some elegant justice to it,
we think, reminding us once again that we do not get what
we want from life, nor what we expect...but what we
deserve.
Bill Bonner
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