-->The Greater Depression

The Daily Reckoning

London, England

Tuesday, 1 July 2003

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*** Jobs move offshore...dollars too.

*** Dollar wobbles. Dow too. Fiscal disaster in
California...

*** Harry Potter in France...Face lift in Britain...
Dreaming in Iraq...watching the bridges...and making the
world safe for democracy...

"Tech jobs move offshore," says an indignant headline from
Atlanta.

American policymakers are perfectly content with the
division of labor in the world economy: the rest of the
world makes, America takes. Other countries create jobs,
profits, and products; the U.S. creates dollars with which
to pay for them. Foreigners export cars and big-screen TVs;
Americans export money and jobs. This is what makes America
the richest country in the world, explained a half-mad
economist recently, because wealth is measured by how much
you consume, not how much you earn!

There you have it, dear reader: the road to wealth. Just
turn left down Spendthrift Lane...then left again down
Insolvency Drive...and then a final left on the Road to
Ruin.

Live beyond your means. Spend more than you can afford.
Consume more than you produce. Those of us who have no
printing press with which to produce more dollars would
find it hard to do for very long. We would soon run out of
highway...and have to back up. We'd have to cut back on
spending and pay down our debts. But the Dollar Standard
System has allowed the U.S. to keep at it for an entire
generation. That very same generation now approaches
retirement - fat and sassy, and convinced that it can make
it all the way to the grave on the savings of foreigners.

Egged on by deviant economists, they have come to believe
that foreigners have no choice but to buy U.S. stocks and
bonds...and that the flow of foreign savings to U.S. assets
demonstrates not weakness in U.S system, but strength.
Foreigners set up factories, create jobs, produce valuable
goods, and earn profits...what else can they do but lend
the money back to their own customers? Besides, everybody
knows that the U.S. economy is the best in the world. Isn't
the current account deficit a measure of their admiration?

But something is going wrong. The central pillar of the
whole system - the dollar - wobbles. Foreigners may be
willing to buy U.S. treasury bonds, or they may not...but
nothing guarantees that they will buy them at 1.15 euros to
the dollar...or at the lowest yields in nearly 50 years.

When the foreigners figure out what Bernanke & crew aim to
do to the dollar, their admiration could turn into
contempt. They may not abandon the dollar altogether, but
they will almost certainly want an additional point or two
of interest - just in case. And that little nudge upward in
the cost of money could have a devastating effect on the
U.S. housing market...and the entire U.S. economy. All of a
sudden, a generation of big spenders will find themselves
at the end of the line...with nowhere else to go but back.

In the meantime, here's Eric Fry with the latest news:

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Eric Fry in Manhattan...

- The Dow dipped 4 points yesterday to 8,985, after rising
as much as 79 points earlier in the session. And just like
that, the final curtain fell yesterday on Wall Street's
best quarterly performance in more than four years. What a
performance it was! Year-to-date, the Dow has added 7.7%,
while the Nasdaq Composite Index has jumped a breathtaking
22%.

- How about a round of applause for the best darn bear
market rally since the bear market began? But let's also
reserve a bit of applause for the lumpeninvestoriat, whose
faithful sponsorship of the Wall Street performing arts
made it all possible. If the lumps hadn't dumped billions
of dollars into mutual funds, none of the dazzling
theatrics would have been possible. Without their blind
faith in Greenspan, their suspended disbelief in a second-
half recovery and their willingness to pay lofty prices for
companies that don't grow, the stock market averages would
have 'gotten the hook' a long time ago.

- Investors tossed about $40 billion into mutual funds
during the second quarter, according to Trim Tabs."That's
a far cry from the $93 billion inflow registered during the
first-quarter of 2000, when the stock averages peaked,"
notes CBS Marketwatch. Quite true, but $40 billion is also
a far cry from zero, which is about the amount of
investment dollars that a stock market selling for 30 times
earnings deserves to receive.

-"California [is] on the brink of a fiscal disaster,"
gloats the Washington Post."The nation's most populous
state, home to one of the world's largest economies, has
been staring in disbelief at the same dire predicament for
months: a $38 billion deficit, the largest shortfall in its
history and an extreme example of the budget woes
afflicting many states...California's $38 billion deficit
is larger than the entire annual budget of any other state
except New York. It represents about one-third of the
state's annual spending."

- The Golden State's leaden finances are but one of the
most visible after-effects of the busted stock market
bubble. When the bubble burst, so too did the co-dependent
technology-spending bubble and the capital-gains-tax-
revenue bubble.

- $38 billion is a big number, even for the richest state
in the Union. Heck, that's the same amount of money that
the entire nation of stock market investors added to mutual
funds during the last three months. Where will California
find this money? Will the Golden State"find" this money by
raising taxes, or by firing state employees...or both?

- Whatever the solution, we doubt that plugging a $38
billion budget deficit will stimulate economic growth.
Stock market investors might care - eventually - that
throughout this fair land of ours, billions of dollars
continue to pour down the rat-holes of budget deficits and
pension shortfalls.

- It is curious, is it not, that the dollar has been
rallying of late, even though the stock and bond markets
have both been falling? Oftentimes, when stock and bond
prices fall, the dollar also falls. But lately, the
greenback has been bucking the trend. From whence cometh
this curious dollar strength? Or it is really strength? Of
course, the beleaguered currency had fallen so far so fast
that it deserved a little respite from its travails. But
maybe the respite is over.

-"It's a selling opportunity," one anonymous hedge fund
manager told me yesterday. Your New York editor could not
conjure up a persuasive counter-argument. He, too, suspects
that the dollar is better sold than bought at current
levels. Perhaps it will continue to rally for a bit longer.
But the reasons to steer clear of the greenback are as
compelling as ever.

-"The dollar is hard to counterfeit and pleasing to look
at," Jim Grant observes,"but it costs next to nothing to
produce - much less, for example, than a bottle of
champagne or a Toyota Celica. Not surprisingly, therefore,
the United States consumes much more of the world's goods
than it produces - about $500 billion more...The dollar is
welcome at fine stores and restaurants worldwide. In this
sense it resembles the American Express Card. And it is
like The Card in another sense: it is a monetary medium of
no intrinsic value. Its circulation is faith-based."

- Will the dollar's value hold up for another generation,
Grant wonders?"We say no," Grant replies to his own
question. We here at the Daily Reckoning would resond to
Grant's query as we often do:"We don't know if the dollar
will succumb to the myriad pressures weighing on it...but
it should." Our ignorance, as always, leads up to gold's
doorstep, where we beseech the ancient metal for a
temporary safe-haven - just in case Ben Bernanke gets his
wish, and helicopters do, in fact, begin dropping dollar
bills from the skies.

- Turning to the ancient metal for help is only half the
remedy, however; we must also know how best to win its
favor. Steve Sjuggerud believes he's found an answer -
collectible gold coins."Coins have been in a horrendous
bear market for 14 years now. Today, 14 years after the
peak, coin prices are STILL down an astounding 69%,"
marvels Steve."Bargains abound in gold coins... The
downside is almost non-existent. The upside is triple-digit
gains." [Ed note: for Steve's full ruminations, see his
article on the DR website:

Like Gold, Only Better
http://www.dailyreckoning.com/body_headline.cfm?id=3283 ]

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Bill Bonner, back in London:

*** While Moms and Pops get back into the stock market, the
smart money continues to exit. Aren't markets wonderful,
dear reader? Such an elegant way of separating fools from
their money! So beautifully undemocratic! In May, insiders
sold $3.36 billion of stock, reports the Houston Chronicle.
In the first half of June, they sold another $1.3 billion -
- or about 10 times as much as they bought.

*** It must be a slow news day in England. The big story in
the Times today is about Lady Archer's facelift. Why it is
important, we cannot say, but it is on the front page.

*** Harry Potter has taken France by storm, comments the
Times. It is the first foreign-language book to become a
bestseller in France. L'Humanité, the communist daily,
complains that it is a product of"hypocrisy and odious
commercial behavior...a typical example of the
globalization of tastes and colors."

*** Over on page 13 is a story about internet tycoon Jay
Walker's suggestion to create a Home Guard of people who
would spend their time watching bridges via internet and
on-line cameras to protect them from terrorist attack! Good
suggestion, Jay. Sign us up to watch the ornamental bridge
in the Parc Monceau in Paris, and make sure you angle the
camera to get the topless sunbathers on the grass - they
looked dangerous.

***"I actually supported the war against Iraq," said an
American in London yesterday, after reading the English
press for the last few weeks."But it turned out to be
nothing but lies. No weapons of mass destruction. No
connection to terrorism. The Iraqis didn't seem to be any
danger to anybody but themselves."

And in yesterday's Times, General Wesley Clark described
turning Iraq into a showcase of democracy as a"grandiose
dream."

*** Today is the anniversary of the Battle of the Somme,
which began on July 1st, 1916. On this day, at dawn,
750,000 soldiers rose out of their trenches and encampments
and began to march toward the enemy lines. It was the most
catastrophic day in the history of the British Army. An
unbelievable 400,000 soldiers died over the next few days.

For what? Monuments were erected to the fallen heros, but
what was the point? Oh, if only the dead could speak!
Woodrow Wilson spun it into a war"to make the world safe
for democracy." Of course, he might just as well have gone
over the side of the Germans and had the same grandiose
dream. Both Germany and England had constitutional monarchs
- who were cousins. Neither was a particularly shining
example of democracy. Besides, why would anyone want a
democracy? After WWI, Germany was pushed towards more
democratic government - and elected Adolph Hitler!

American neo-conservatives claim to be inspired by the
ancient Greek thinkers; they want to bring Wilsonian
democracy to the entire world. But the ancients despised
democracy. And yet, the neo-cons persist in pushing
democracy on the world, like mobsters offering protection:
take it or we'll burn your house down.

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The Daily Reckoning PRESENTS: Is the U.S. following
Argentina down the dark path to the first Great Depression
of the 21st Century? James Davidson, fresh from Buenos
Aires, warns in the first of a two-part series that the
similarities between the two countries are all-too-eerie.


THE GREATER DEPRESSION
By James Davidson

With a shaky global economy, a plunging dollar and
deflation casting its dark shadow into many corners, there
are nonetheless some encouraging signs of revival in the
U.S. stock market. Yet, it cannot be denied, we are living
in one of the more challenging periods for investors in
many decades.

During the first few days of June, I spent some time trying
to get an added perspective from about as far from Wall
Street as you can get...in Buenos Aires. My journey was the
first I have taken to Argentina since it slipped into a
devaluation crisis and a 'Greater Depression' in January
2002. I wanted to see first-hand how people there were
coping with an economic collapse even more severe than the
United States suffered in the Great Depression. In 2002
alone, the average income in Argentina plunged by 40%.

The economic history of Argentina provides cautionary
evidence that wealthy countries can rapidly fall to Third
World income levels. This may be more pertinent than it
first appears because the collapse in Argentina occurred
very rapidly, within the span of one long human lifetime.
Even if you have never thought you had any interest in
Argentina, stay tuned.

If you've never been to Argentina, I recommend the trip.
Buenos Aires is a beautiful, cosmopolitan city, the most
European in South America, with lots of Belle Epoque
buildings, and broad avenues lined with cafes, trendy
boutiques and bookshops. Unless you are blinded by
'political correctness,' you are bound to notice after a
few hours that everyone you see is of European descent.

Argentina's demographic mix was frozen generations ago when
it ceased to be one of the world's more dynamic economies.
As Argentina stagnated, it became unattractive as a
destination for later waves of ambitious immigrants from
Africa, the Middle East and Asia. A common caricature of an
Argentine captures this Western European heritage:"An
Argentine is an Italian speaking Spanish who believes he is
an Englishman living in Paris."

In 1950, Argentina was more than twice as rich as Japan on
a per-capita basis. By 1970, the Japanese had caught up and
were 30% richer than Argentines. But while Argentina's
economy contracted at an almost 2% annual rate, Japan's
soared ahead. By 1990, when the Japanese bubble burst,
Japan was almost three times richer than Argentina on a
per-capita basis, reversing the situation at the eve of
World War I, when Argentines were on average almost three
times richer than the Japanese. In three quarters of a
century, Argentines failed to even double their incomes,
while the Japanese multiplied their per-capita incomes by
almost 14-fold.

Many economists believe the negligible population growth in
Argentina through most of the last half-century contributed
to its weak economic performance prior to the 1990s. Per-
capita economic growth was negative from 1970 to 1990. A
contracting economy tends not to attract immigrants, which
makes the economy weaker still.

If Argentine history is any indication, frequently voiced
worries about massive defaults on consumer credit card debt
in North America are probably overstated. Notwithstanding
the fact that poverty rates in Argentina have soared beyond
anything imaginable in North America, given last year's 40%
plunge in per-capita income, credit card debt is the only
valuable asset left in Argentina's banking system.

Business borrowing has come to a halt. Even companies that
are losing money are hoarding piles of cash. The government
has defaulted on its debt, wiping out pension programs that
held 70% of their assets in government bonds, and depriving
the banking system of what is usually one of its strongest
assets. The mortgage market has been devastated by the fall
of personal income, which means that most people who would
need a mortgage to buy a home can't qualify. Yet Visa and
MasterCard accounts are still being paid. Amazing.

A review of the confiscatory policies instituted by the
last four Argentine presidents reads like the driving
record of an alcoholic with a heavy foot. The last half-
century has witnessed one gaudy crackup after another. The
most recent, in January of last year, involved the
abandonment of the currency board, which had successfully
pegged the Argentine peso to the U.S. dollar for eight
years. Because the currency board system really made the
peso worth a dollar, it flatly prohibited the Argentine
government from printing money.

Contrary to the superficial impressions of some critics,
however, the currency board did not fail. It could have
continued to peg the peso to the dollar indefinitely. It
was abandoned because of ideological conviction. A large
number of economists - and others meddlers such as former
U.S. Treasury Secretary Paul O'Neill - loudly complained to
Argentine authorities that sound money was hampering their
economy. The local political establishment eagerly grasped
the advice to return to easy money as a tonic for weak
exports, unemployment and the unfairness of life. But
contrary to expectations, the economy did not prosper. Real
wages plunged by 40% following the devaluation. And the
official poverty rate, which had seemed high at 38.5% in
December 2001, skyrocketed to 58.5%. Ouch.

The experts were wrong. They had forgotten the history of
Argentine political dysfunction, impressed cruelly on the
Argentine population in the second half of the 20th
century. These include the most disastrous peace-time
inflation in all of modern history - an annual average
inflation rate of 127% between 1960 and 1994. Unless you
have an instinctive facility for compounding interest and
the numerical gifts of an astrophysicist, you may not
immediately grasp how devastating an annual average
inflation of 127% is over 34 years. To put it in better
perspective, consider that an Argentine with a fortune of
$1 billion in 1960 who kept his savings in pesos through
1994 would have the equivalent of 1/13th of a penny left.

Why?

How did a wealthy country careen to such a disaster? That
is an important puzzle if you have money to invest or
expect to have it in your lifetime. I can't pretend to be
more than a voyeur where the history of Argentina is
concerned. Still, I have my theories. I see the repeated
crackup of the Argentine economy and its long-term decline
from the ranks of the world's richest countries as the
unintended consequences of continuing efforts at income
redistribution.

You will note that income redistribution is hardly an
Argentine invention. The United States and all the high-
income economies have democratic political processes that
guarantee gestures at subsidizing the underachievers. The
logic is simple. Votes are equally distributed. Money and
the other good things of life are not. Hence, the vivid
appeal of income redistribution. But the question remains,
why did these policies have so much more disastrous
consequences in Argentina than apparently similar programs
elsewhere?

I suspect that the answer may lie with the peculiar fact
that there were relatively more rich people in Argentina
than in the United States or Canada, but fewer in the
middle class in the mid-19th century. Unlike the United
States or Canada, Argentina does not have a strong
tradition of yeoman farming. And not because of a lack of
fertile land. The Argentine Pampas, an area 50% larger than
France, contains some of the most marvelously fertile
farmland on earth. Even today there are places in the
Pampas where the topsoil is 10-feet deep. Little wonder
Argentina was once known as"the world's bakery." Yet
unlike North America, where land suitable for cereal
farming was divided into small plots, land tenure in the
vast Argentine Pampas was concentrated into larger holdings
that predated the Argentine Republic.

A century ago, it was not modernist irony to say that
someone was 'as rich as an Argentine.' Lots of Argentines
were rich. You can divide an area 50% larger than France
into quite a few large holdings. Consequently, by the late
19th century the rich in Argentina were a relatively
numerous group, far larger, for example, than the
percentage of Americans who became industrial tycoons like
Rockefeller or Carnegie.

I have no doubt that it is preferable in political terms to
have a larger middle class than Argentina had when the 20th
century began. In 1900, per-capita income in Argentina and
Canada were at an equal level, as they had been since 1870.
Both were not far below the United States. As you will
probably remember from your history studies, most Western
democracies initially had limited franchise, which
restricted the ballot to property owners. So long as the
franchise was limited in Argentina, the elected governments
followed sound, free-market policies, and Argentine per-
capita income rose smartly. Indeed, the growth of
Argentina's economy accelerated in the early years of the
20th century, rising 37.8% in real terms from 1900 to 1913.
Notwithstanding unequal capital holdings, free-market
policies raised Argentine per-capita income by more in the
first 13 years of the 20th century than statist policies of
income redistribution did in the 53-year period since 1950.

What can you learn from Argentina's experience? Probably
the most urgent lesson is that while a larger middle class
may be politically stabilizing and desirable, it does not
follow that efforts to artificially enlarge the middle
class through income redistribution are economically
stabilizing and desirable. Indeed, the record shows that
Argentina's economic crashes have been repeatedly
occasioned by political efforts to cultivate and subsidize
a bigger middle class.

More lessons to come, tomorrow...


Regards,

James Davidson,
for The Daily Reckoning