-->Globalization And Its Discontents

The Daily Reckoning

Paris, France

Friday, 16 May 2003

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*** Sakakibara's face...

*** Big drop in wholesale prices...bankruptcies
up...industrial production down...New York is
okay...Philadelphia still suffers...

*** New bull market...or"giant sideways"? Insiders
selling...buy euro bonds, says Gross...Argentina...Hong
Kong...and more!

Heh...heh...we can almost see the small, satisfied smile on
Eisuke Sakakibara's face when the news came out yesterday.

Sakakibara, for the benefit of readers who haven't been
paying attention or couldn't care less, was Japan's finance
minister for many years, during which time he was the
leading figure in the war against deflation, fighting on
the losing side, of course.

You often gain more from failure than from success, we
point out from time to time, just to be contrary, and you
learn more from defeat than from victory. Usually, what you
learn is"not to do that again." No exception, Sakakibara
now says that the fight against deflation was a hopeless
cause from the get-go.

Deflation is not a monetary phenomenon after all, he says;
monetary policy will not stop it. Instead it is a
structural problem...one that America and Europe will have
to learn to live with, too. (More on this subject...
below...)

"No way," say America's can-do economists and monetary
authorities."We'll target a positive inflation number,"
say they.

But yesterday, the producer price number that came out for
April was the most negative one ever seen, since record-
keeping commenced in '47. Most of the decrease in prices
was blamed on lower energy prices. But even if you take out
food and energy, and get down to what is called the"core"
number, it is still negative. Core Producer Prices dropped
0.9% in April, its sharpest decline in 10 years.

The"weak inflation number" now disturbs economists nearly
as much as a"strong" PSA reading. There was a time, of
course, when men lost as little sleep worrying about low
inflation as they did about their prostate glands. But
those days are over. Now, we all know, they are both a
source of trouble.

And Eisuke Sakakibara knows, more than most mortals, how
many sleepless nights a weak inflation reading can cause.
The latest figures from America sound as though they might
have been rehearsed in Japan. Car prices fell 2.6% in
April. Light trucks were down 4.6% - the biggest decline in
20 years. Cigarettes fell 9.6%. Gasoline cheapened up by
22.3% and heating oil by 29.3%.

Meanwhile, factory orders declined for the 3rd month in a
row in the Philadelphia area. Industrial production fell
0.5% in April. And last week, for the 13th week in a row,
more than 400,000 people lined up to file initial
unemployment claims.

And to top it all off, personal bankruptcies hit a new
record in the first quarter - up 9.5% from the year before.

We know the economy is on the mend...and stocks are
definitely going up this year - everybody says
so...analysts, economists, fund managers, investors,
Treasury Secretaries, central bankers, TV presenters,
newsletter gurus, lumpeninvestors...

On the other hand...there is Eisuke Sakakibara, in Tokyo,
with his little schadenfreudian, I-told-you-so smile...

And there is Eric Fry, too...with his little Eric Fry smile
in New York:

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Eric Fry in the wilds of Wall Street...

- Hopeful investors resumed paying hopeful prices for
stocks yesterday. The Dow climbed 65 points to 8,713, while
the Nasdaq added 1.1% to 1,551. Meanwhile, both gold and
bonds - unlikely bedfellows though they may be - continued
their synchronous rallies.

- Gold, traditionally considered an inflation hedge, gained
30 cents to $352.80. At the same time, Treasury bonds,
traditionally considered a deflation hedge, advanced for
the 8th day out of the last nine - pushing yields to fresh
44-year lows. Investors, it seems, are so confused that
they are buying everything.

- To be fair, confusion is a perfectly understandable
response to the ambiguous data issuing from our economy. On
the plus side, initial jobless claims fell for a third
straight week. Three-in-a-row may not seem like much of an
achievement, but it's the longest streak in a year.
Additionally, the New York Fed's Empire State business
sentiment index recovered dramatically this month - surging
to 10.6 in May from minus 20.2 in April. The 30.8-point
jump was the largest in the touchy-feely index's brief two-
year history.

- Despite these nascent signs of economic revival, however,
evidence of economic weakness remains abundant. Industrial
production dropped 0.5 percent in April - its sixth drop in
nine months. Capacity utilization tumbled to a two-decade
low. April's auto production dropped 2% as GM and Ford each
announced plans to slash production by more than 10%.

- Meanwhile, deflation-mania picked up a fresh tailwind
yesterday, as the producer price index dropped an eye-
popping 1.9%. Prices excluding food and energy, or the
"core rate," fell 0.9 percent - the largest one-month
decline in a decade.

- Despite the economy's uncertain health, stock market
investors seem all too eager to give it the benefit of the
doubt. They seem to find the favorable - albeit sparse -
economic data more persuasive than the abundant, negative
economic data.

-"A new multiyear bull market has begun!" The bulls
proclaim. To which the bears counter,"But we have not
finished correcting the excesses of the bubble. Stocks are
still very richly priced in an historical context. Dow 5000
is a likely target."

- We suspect that neither the bulls nor the bears will get
exactly what they expect, at least not WHEN they expect
it...That said, we're kind of partial to the bearish middle
road - i.e., a lengthy, go-nowhere market that frustrates
bulls and bears alike. John Bollinger of Bollinger Capital
Management calls this"the giant sideways."

- Morgan Stanley's Barton Biggs imagines what this"giant
sideways" might look like."The usual pattern following a
massive, encompassing bubble that has sucked in and then
destroyed the multitudes is for a sharp, initial break of
50-75% over a period of two to three years," Biggs says.
"Then the afflicted market tends to take a breather and
drift sidewise for several years. Almost invariably during
this period, at least one major rally of 30-50% (and often
as many as three) retraces as much as half the fall from
the peaks. Some market historians classify these rallies as
mini, cyclical bull markets...

-"What is interesting is that usually in the past, these
upward thrusts originated from valuation levels that were
not cheap by any means. The most prominent examples are the
two cyclical bull markets in the U.S. in the 1930s
following the Crash, and the three big rallies in Japan in
the 1990s...According to the basic thesis of the bears, the
history of world-class bubbles shows that they take
decades, not a few years, to heal, and that the U.S. in the
1930s and Japan in the 1990s are the models to study."

- One such bear is Charles Minter of Comstock Partners. In
a recent interview with BusinessWeek, Minter predicts,"We
suspect that we won't start a new bull market until we get
to stock valuation levels that established major market
bottoms, like in 1932, 1949, 1974, and 1982. The Standard &
Poor's 500 index is trading at around 30 times earnings
right now. For 80 years, its price-to-earnings multiple has
typically ranged from approximately 10 to 20 times
earnings. It's 10 at the end of bear markets and 20 at the
end of bull markets...We think the S&P 500 is going to
decline below 600, probably below 585."

- Hmmm... sounds about right.

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Back in Paris...

*** Gold rose slightly yesterday, even as the dollar rose,
too.

*** Seven out of ten insiders are selling, reports Richard
Russell. While the dumb money buys into this bear market
rally, the smart money is still getting out.

*** Bonds were up again; 10-year notes yield just 3.52%.
Depending upon the inflation number you use, real yields
are barely positive.

*** Bill Gross, who runs the giant PIMCO bond fund, has
taken up the longstanding Daily Reckoning guess: euro bonds
will outperform U.S. dollar bonds. Euro bonds offer higher
yields, notes Gross. What's more, the European Central
Bank's key rate, at 2.5%, is twice the Fed rate - which
gives them more room to make cuts, and drive up bond
prices. Germany, Italy, and Spain are all nearing
recession, reports the BBC. The ECB will almost certainly
cut rates.

*** Gross did not even mention the additional threat of a
falling dollar - which would further flatten euro bonds. We
bring up the subject...more below.

*** Old friends came into town yesterday with updates from
their around-the-world travels.

"What has happened in Argentina is unbelievable," came a
report that might as well be from the future as from the
pampas."When I first moved down there in '81, about the
same percentage of people were said to be living in poverty
as in America - about 10%. And the country was run by a
junta of generals. It was a military dictatorship. Then
came democracy....and everyone started looking to the next
election for solutions to economic problems.

"Now something like 60% of the population lives in poverty.
There are still rich people and still poor people. But most
of the middle class has been wiped out in a single
generation.

"And now nobody cares about elections anymore. The
political parties couldn't agree on how to hold a primary,
so they never did. The candidates just presented
themselves. Nobody seemed to care. They barely reported it
in the papers. And then Menem dropped out. So this guy
Kirchner was elected without anyone ever voting for him."

Meanwhile...a report from the Far East...

"It is not as bad as the international press makes out,"
says a friend from Hong Kong."Sure we all wear masks, but
the disease seems to be under control. The number of new
cases has dropped to single digits. And it never actually
made it to the good parts of town. If you look at a map of
where the cases were concentrated, you see that they were
all in these housing estates - where people are crowded in
together. But in the good parts of town, there were almost
no cases.

"Besides, SARS is supposed to be a cold-weather disease,
like the common cold. It could be eliminated this summer."

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The Daily Reckoning PRESENTS: Bill Bonner, ruminating on
empty containers in New Jersey...


GLOBALIZATION AND ITS DISCONTENTS
By Bill Bonner

The dollar is dropping in Paris. Is it dropping in New
York? It depends on whom you talk to.

"New York city residents are turning their pockets inside
out to pay higher income taxes, property taxes, subway
fares, rents and (if the cabbies get their way) taxi
rates," wrote Jim Grant recently. Grant is skeptical of
deflation. Almost everywhere he looks, prices are rising.

And yet, bond buyers - generally regarded as the shrewdest
of investors - drive bond prices higher almost every day.
They see no inflation.

People hardly know what to think. Today, we offer a
suggestion.

We begin, like a good democrat, with larceny. Here is a
passage purloined from Bill Gross:

"In any case, let me attempt to outline as simply as
possible the global economy's primary problem: It suffers
from a lack of aggregate demand and too much supply.
Because of globalization and Chinese overproduction;
because of high debt levels and its suffocating impact on
business investment and personal spending; because of a
creeping, almost imperceptible demographic muting of
consumption in aging societies such as Japan, Germany, and
Italy; because of market bubble popping and the negatives
of receding wealth; because of the dragnet of post 9/11 and
now SARS, because of all of that and more we live in a
world where we have too much relative to what we can afford
to, or want to spend."

Bill Gross did not say so, but what the world lacks is not
dollars, but spending power. There is an important
difference. A man who is deeply in debt may still have a
functioning credit card or two. But that doesn't mean he is
willing or able to go further into debt. And if he does not
borrow in order to spend...two important things never
happen. The supply of dollars does not increase - for they
have not been created"out of thin air" to satisfy his lust
for credit - and the spending that might have happened does
not.

The world in which these things don't happen is not the
world of Alan Greenspan - it is the world of Eisuke
Sakakibara...a world slowing down, not one that is picking
up speed.

If you accept this outlook, continues Gross,"then certain
private sector behavior becomes more understandable. In
order to get out from under the 16-ton sledgehammer of
debt, companies use cash flow to build reserves or retire
bonds - they don't invest. Consumers begin to put away
money instead of spend, which was the pattern of the late
90s. And the combination induces a negative spiral or
vicious cycle of even more conservative behavior, including
job layoffs, which leads to muted growth in personal
income. In combination, this private sector response to a
high-debt, reduced-wealth, increased-risk-laden economic
environment can produce a slowdown or even a recession -
Japan off and on for years now, the U.S. in 2001/2002,
Europe in 2003."

"Then there is the problem of our growing current account
deficit..." Gross points out.

The magnitude of the current account deficit is about a
half a trillion dollars. On that point, there is little
disagreement. It is the nature of it that stirs debate.

"At the current level of the current account deficit, I'm
not particularly troubled by it," said America's Treasury
Secretary recently."It is really a small part of the size
of total U.S. GDP and is certainly manageable."

At 6% of GDP, the U.S. current account deficit may not be
completely unique in economic history. But no nation ever
had a deficit of such size and managed it successfully.
Instead, huge imbalances have a way of causing trouble, no
matter which central banker is on watch when the problem
comes up.

The real problem is not what appears in the international
flow-of-funds reports, but what barely appears anywhere.
"The crucial internal effect," explains Dr. Kurt
Richebächer,"is that the spending for the import surplus
essentially diverts revenue and profit to foreign
producers. On the other hand, the money being spent abroad
comes largely from income that has been earned from
domestic producers. The end result: these have the cost,
while foreign producers have the revenue and the profit.
This is the widely unrecognized big problem implicit to the
monstrous trade deficit."

How will it end?

Either Americans will have to pay an"inflationary tax" as
the prices of imports rise, says Bill Gross, or they will
suffer a"negative wealth effect" as they are forced to cut
back their expenditures and save their money. One way or
another, he continues, there must be a piper around
somewhere...and he will have to be paid.

In this regard, America is no Japan. Japan was already a
large net creditor to the rest of the world. Instead,
America is more like Argentina, as described above, where
the"negative wealth tax" wiped out nearly the entire
middle class in a single generation.

As in Argentina a few years ago, for every dollar's worth
of goods and services America sells overseas, nearly two
dollars of imports come into the nation's ports. So great
is the imbalance that thousands of empty containers pile up
in New Jersey; (they came full, but there is nothing to
ship back in them) and trillions of dollars pile up in
overseas bank accounts.

One tries to imagine the stacks of containers and money in
awe and wonder. How could a system of globalized free trade
- in which one must presumably give as much as one gets -
get so out of whack?

Earlier this week, Joseph E. Stiglitz, Nobel prize-winning
economist was in town. His biography explains that he"has
helped explain the circumstances in which markets do not
work well, and how selective government intervention can
improve their performance." He might as well have hung a
sign around his neck saying"humbug," for the message could
not be clearer. Everybody knows that markets do not work
well...they just work as they work, giving fools a way to
lose their money that doesn't require heavy drinking or
trips to Las Vegas.

Nevertheless, Stiglitz wrote a book entitled"Globalization
and Its Discontents," which we didn't want to read, but we
still thought the man might have some entertaining thoughts
on the process that has lead to America's huge pile of
empty containers. So we dispatched one of our ace reporters
to the scene of his speech.

"He said he expected deflation in the U.S.," began the
resulting report.

"Why?"

"He didn't say."

What Stiglitz did say is that politicians have to carefully
control the process of globalization, or it might get out
of hand. He had in mind third-world countries, where
standards of living have fallen after the IMF gave bum
advice. He was thinking of Argentina over the last 5 years.

We couldn't help but think of America over the next 5.


Bill Bonner