-->Bazookas and Teddy Bears

The Daily Reckoning

Paris, France

Monday, June 28, 2004

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*** The big week...interest rate policy about to reverse...

***"Frenzy" in the housing market...

*** Cossack dancers...Bush...and more!

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This is the big week. This is the week that the Great
Enabler, Alan Greenspan, begins to undo what he did so
well.

At least, that is what people expect.

Faced with the threat of a deflationary slump, the
Greenspan Fed took emergency measures. It cut the key
lending rate and cut it again...and kept cutting until
there was not much left to cut. At 1%, the rate had never
been so low - except in response to the Great Depression
and World War II!

But it seemed to work. Along with tax cuts, spending
increases, and EZ credit terms, 1% seemed to be just what
the market wanted. The slump was postponed. Stocks rallied.
Employment stabilized. Prices didn't fall. The economy
seemed to revive...the latest figures for the first quarter
of this year show GDP growth of 3.9%. And yet, the Fed's
lending rate remains at 1%. What is the emergency, people
ask.

On the surface, there is none. Quite the contrary. Judging
from almost every indicator, investors and consumers have
never, ever been so un-alarmed. Never before have they
bought and sold so many houses. Never before have they
taken out so many mortgages...and never before have so many
selected variable rate mortgages. Never before have they
been comfortable owing so much money to so many people.

Now, these same people who jumped to take advantage of the
Fed's ultra-low, 'emergency' rates...are sure the maestro
can pull off the same trick in the other direction.

For, just a week or two ago, Greenspan announced that the
vigil against deflation was over. Deflation concerns, he
said, were now"safely behind us." What lie ahead are
inflation concerns.

"Inflation returns, worldwide," announced last week's
Economist."Once again the specter of inflation is haunting
the financial markets."

Can we count on the Fed to put these ghosts safely behind
us too?

When you give money away for less than the inflation rate
you have to expect someone to take it. After two years, so
many people have taken up the Fed's offer that the world's
entire economy has come to depend on it. Without cheap
credit, Americans will be unable to continue spending.
Without American buying, China's factories will not have
enough customers. Without anyone to buy up the output from
existing factories, China will have to stop building new
ones...and stop buying such vast quantities of oil, copper,
steel, and other primary commodities.

This week, Greenspan is supposed to begin the long, slow
process of getting the fed funds rate back where it is
supposed to be. The smart money is betting that the key
rate will rise by a quarter of a percent - enough to show
the Fed is responding to inflation concerns, but not enough
to put the kibosh on America's credit-dependent economy.
After all, if you think your house will rise 10% again next
year, what difference does it make if short-term mortgage
rates rise by.25%? Still, anticipating higher rates has
apparently sent house speculators into a"buying frenzy,"
says CNN/Money. People are panicking into houses the way
they once panicked into tech stocks.

A few months ago, America's central bankers worried that
the rate of inflation was becoming too low. Now they worry
that it may soon be too high. For those people with nothing
better to do than watch central bankers, the dramatic
tension is rising. Will the Fed be as effective against
high inflation as it was against low inflation, they
wonder? Optimists say yes. Pessimists say no. We will not
say. We do not presume to know whether inflation will be
too high or too low. 'Both,' is our guess.

What we know is that the Greenspan Fed has been giving away
money for a long time; it has not dealt with an emergency
...it has created one. By enforcing a phony stability with
a phony lending rate...it has destabilized the planet's
financial system. Its fastest-growing economy gobbles up
resources in order to make things for people who can't
really afford them. Its poorest people save a quarter of
their incomes so they can lend to its richest, who save
almost nothing. Its biggest economy is also its most
indebted. And its biggest debtors buy and sell each other's
houses - and think they are getting richer.

Inflation? Deflation? Yes, most likely.

And now, for more up-to-date data...news...and
opinion...here's Eric:

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Eric Fry, from Downtown Manhattan...

- The stock market offered a little something for everyone
last week. The Dow delighted the bears by dropping 44
points to 10,371 and the Nasdaq dazzled the bulls by
gaining 2% to 2,025. Bond prices rallied, pushing the 10-
year Treasury yield down to 4.64%, the lowest yield since
the first week of May, while the dollar fell and gold
jumped.

-"No one ever lived through a complete cycle of paper
money without wishing they had bought gold," your Paris-
based editor declared to the attendees of last month's Gold
Show here in Manhattan. Your New York editor seconds that
thought, but would promptly add that no one ever bought
gold during a complete cycle of paper money without wishing
- at various times - that they owned the paper money
instead...or better yet, that they owned overpriced"growth
stocks" denominated in the paper money.

- Owning gold is a long-term relationship, dear reader, not
a one-night stand. And like any long-term relationship, a
complete and unwavering commitment is essential if one is
to derive the maximum benefit.

- Fortunately, for those of us who hold a flame for the
yellow metal, she still knows how to set our hearts
aflutter on occasion. Last week, our precious little metal
gained $7.50 to $403.20 an ounce. Gold will continue giving
to those who hold her precious, we believe, because Uncle
Sam and Uncle Alan keep taking from the rest of America.

-"We are facing a horrendously serious problem," says
Robert Rubin, the Treasury chief under Bill Clinton from
1995 to 1999."I think that the probability is high, though
not certain, that at some point the kinds of deficits we
see will have very serious effects on our markets and our
economy.

-"This has no timing one can predict," says the former
Treasury Secretary and Goldman Sachs partner."It has no
way to quantify it. It doesn't fit into the model people
use for forecasts. For all those reasons, people tend to
pay much less attention to it than is warranted."

- In stark contrast to Rubin's view, the CURRENT Treasury
Secretary, John Snow, along with the current Federal
Reserve chairman, insists that America's outsized deficits
pose little risk to either the financial markets or the
economy at large.

- But the bond market and the gold market both seem to side
with Rubin. Despite Greenspan's insistence that the
deficits are no big deal, and that they will not contribute
to inflation, the prices of long-dated Treasury bonds have
been tumbling for the last 12 months, pushing the yield on
10-year notes up from 3.11% to 4.64%. Meanwhile, the price
of gold has been climbing ever since the George W. Bush
moved into the White House.

-"Without changes to taxes or spending, we may reach a
point where ever-larger amounts of debt must be issued to
pay ever-larger interest charges," warns Federal Reserve
Governor Edward Gramlich.

-"While the current deficits may not be terribly harmful
in the short run," says Gramlich,"The list of 'wrenching
changes' might include those imposed upon us by the
financial markets" - changes like a plummeting dollar and
soaring interest rates...and that's when we'll be happy we
spurned the allure of paper money and remained faithful to
the one true money we call gold.

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Bill Bonner, back in Paris...

***"Aggh...les Americains...!"

Our taxi driver was listening to the news. Something seemed
to bother him.

"I like Americans. But not Bush," said he.

"We hear that quite a bit," we explained to him."People
say they like Americans - probably, they're just being
polite - but they don't like Bush...or America itself, for
that matter. It's just the opposite in America. People tend
to like France, but not the French..."

"Heh, heh...you must be an American...what do you think of
your president?"

"Yes, Bush is a disappointment," we sympathized."People
who voted for him thought they were getting another Reagan
- a man not too concerned with policy details, but a decent
man with good instincts. Turns out, his instincts seem as
defective as everything else. He's a national disgrace."

"Oh, I guess you're supporting what's his name, Kerry?"

"Are you kidding? He's even worse..."

*** It is the season for recitals. 'Fur Elise' comes up at
every piano recital - often several times in one evening.
We have nothing against it. Still, we are beginning to
detest the piece. Perhaps if we ever heard it played
correctly, we would like it. But banged out by a 10-year-
old, it is painful to listen to it.

Henry's piano recital was last week. We sat through 2 hours
of it before finally getting to Henry, 14, Madame Vermier's
star pupil. But by this time, Henry had heard so many
mistakes; he must have thought that you were supposed to
hit the wrong notes at the wrong times.

Then, last night, was Edward's dance recital. For reasons
never made clear to his father, Edward, 10, was signed up
for ballet this year. The poor boy had to hide his ballet
shoes in order to keep his friends from finding out, but he
seemed to enjoy hopping around on stage.

He takes lessons with Madame Slowona, or something like
that. The woman has become the Martha Stewart of dance in
Paris. Her students' performance was held at the Palais des
Congres with a cast of what seems like thousands of
snowflakes, mice, fairies, gypsies...and other dancers.

The little girls came out...line after line of them...all
dressed in cute little outfits, bumping into each other on
the vast stage. Then, as the dancers grew older, so grew
their ambitions. One chubby girl of about 11 was working up
a sweat as she jogged around. The poor girl couldn't seem
to keep up the pace. So the girl behind her tried to prod
her forward. After a couple of prods, the chubby girl
turned about and took a swing at her pursuer. No harm was
done; in the immense panorama of dancers, hardly anyone
noticed.

One thing we admire about the French - they don't take
restrictions, rules, and laws too seriously. Notices all
over the theatre told spectators to stay in their seats
until the end of the performance and not to take photos.
All evening, flash bulbs went off from all over the
theatre...while people walked up and down the corridors.

"The funniest example I've ever seen of French scofflaws,"
Elizabeth volunteered,"was in the video made by Henry's
class from their trip to Rome. You know, every time they
take a class trip, they make a film of it and show the film
to parents. Well, you must have been out of town, but I
went and saw the trip to Rome. They visited the Vatican.
And there on the wall was a sign that said using cameras or
video equipment was strictly forbidden. Well, they paid no
attention, of course. They not only filmed the entire
thing...you could see the sign telling them not to take
pictures on the film. And this is the film they made to
show the parents!"

Finally, after hours of whirling fairies, Edward's group of
dancing Cossacks came out. The boys carried scimitars and
whacked at each other as they jumped around. In school,
Edward often has a hard time sitting still and
concentrating. He would be better off as a Cossack; he
seemed to enjoy trying to cut someone's head off while
dancing a steppe jig.

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The Daily Reckoning PRESENTS: How do you raise your net
worth? You read Mogambo. Unless you are Mogambo, in which
case you go and search the couch for coins, and maybe the
neighbors' cars too.

BAZOOKAS AND TEDDY BEARS
by The Mogambo Guru

I was recently urged to read"A People's History of the
United States" by Howard Zinn, probably as a result of the
utter contempt I have for the whole Bush
administration...(someone out there must have whiffed my
secret Leftist leanings).

So, as my wife was going to the library, I asked her to
pick up a copy for me. Naturally, I thumbed through it
quickly, looking for pictures of pretty girls in swimsuits.
I quickly determined that 1) there weren't any such
pictures, and 2) it is the history of how Americans, mostly
us white Americans, routinely raped and murdered and
pillaged our way through everything and everybody. Just
like everybody else in history. But let's not get into all
that.

It is the last entry on the last page of the book that drew
my attention. It tells a tale, a tale of the future. It is
a verse by Shelley, the poet, which underscores the
quintessential weakness of democracy: that the majority
will always tyrannize the minority.

"Rise like lions after slumber
In unvanquishable number!
Shake your chains to earth, like dew
Which in sleep had fallen on you -
Ye are many; they are few!"

But on the other side of Shelley's coin, there are those
anxious people who say"They are many; we are few!"

Now, let me just flash my credentials - I am a guy who has
experienced many episodes of"They are many, and I are
few!" and I note, for the record, that it never really
worked out for me.

I bring this up because the recent news is that one out of
every 129 Americans now has a net worth in excess of one
million bucks. Well, all that money that the Fed has been
creating for all these decades had to go somewhere, I
guess. But at the same time, you will notice that there is
a hell of a lot of people, and I bandy the figure 25% of
the working population to mean"A hell of a lot of people,"
who make less than $18,000 per year. Average household
income is now less than forty thousand bucks a year, which
used to be a hell of a lot of money, but now can hardly buy
you a pot to peer in. This is because prices have risen so
high.

These are people whose net worth is actually negative; it
rises and falls with the number of coins that are behind
their couch cushions and the few bucks you can glean by
sending the kids to search the neighbors' cars for coins
carelessly left in the ashtray. If they didn't even take
the common-sense precaution of locking their damn cars,
it's their own damn fault. And yet, here they come,
predictably whining and crying that it is somehow MY fault
that their cars are ransacked and now reek of some peculiar
odor of some sort.

And pretty soon, as the income level rises, you find
yourself in the minority, the ones we heretofore refer to
as"the few." These people have a high net worth, and about
$50,000 in their retirement plans. Of course, this may not
seem like a lot to you, dear reader, because you are so
brilliant and wonderful and you haul down the Big Money.
But just a paragraph ago, didn't I tell you that prices
have inflated so much that a $40,000 gross income is
insufficient! Exactly, so how far do you think that
$50,000-retirement plan, in terms of buying power, is going
to get you? About as far as you can throw me, I'd say...

And most of that 'high net worth' is due to the
appreciation in real estate. Anecdotally, buyers here in
Florida were shocked to discover that, when they paid an
astronomical price for their house, the assessed value of
the house instantly went to a new, higher valuation, based
on the price they actually paid. Thus, their property tax
bills are several thousand dollars higher than the bill
paid by the former owner. Bummer!

I notice that Richard Russell, he of the Dow Theory
Letters, is getting more somber in tone these days, too. He
doesn't actually mention, in black and white, how his hand
reflexively clutches the handle of a powerful handgun and
how his trigger finger occasionally spasms and how he is
drinking bourbon straight from the bottle to try and drown
his fears, like I do, but you can be sure he sits there
like that from the way he writes. But anyway, he says that
houses are not a good buy because they don't pass,what he
calls,"The acid test." If you can't buy a house, rent it
out, and cover your costs, then it fails the acid test. As
you already know, today, there aren't many houses out there
that pass this test. In other words, it's far cheaper to
rent a home than it is to buy one. This situation has
always indicated that house prices are over-valued.

So either houses have to 1) go up in value to make them
MORE overvalued, or 2) hold steady while rents increase, or
3) both, or 4) none of the above, or 5) one or two of the
above, one more than the other, depending, maybe. As you
have guessed, I have no idea either, as it depends on a lot
of other things, like fiscal things, for instance. All I
can do is look at what has happened in history, and when I
do, I quickly chug the last swig out of the bottle and
scurry back into my little rat's nest of a hiding place
under the stairs like the gutless little coward that I am
and spend the next few hours whimpering pitifully with a
bazooka in one hand and a teddy bear in the other.

Meanwhile, the PRNewswire says that only one in five
Californians can afford to buy a median-priced house. The
median, in case it has been a week or more since you took
statistics class, is that point where half the houses cost
more, and half cost less. In this particular case, the
median-priced house in California costs $453,590. So, half
the houses in California cost less than that. And half of
them cost, gulp, more.

The report says"The minimum household income needed to
purchase a median-priced home in California in April was
$102,550." And this is a low-ball estimate, based on"a
typical 30-year, fixed-rate mortgage at 5.42% and assuming
a 20% down payment."

Last year, the minimum household income needed to purchase
a median-priced home was $84,510. Now it takes $102,550.
God knows what it will be NEXT year! And the year after
that! And the year after that! No wonder people are buying
houses with such abandon!

And what, dear reader, happens if 'minimum household income
needed to purchase a median-priced home' doesn't rise as
fast as prices or maybe even falls because of unemployment
and low-wage competition from Asia?

I recommend a bazooka...and a teddy bear,

Regards,

The Mogambo Guru
for The Daily Reckoning

---Mogambo Sez: Although the Fed raising Fed Funds rates by
a quarter of a point isn't much to a high roller like you,
but moving from 1% to 1.25% still represents a 25% jump in
the rate! And to raise it to 1.5% would entail a jump of
50%! Increasing rates by 50% is damn significant stuff!