Debt Hangover / The Daily Reckoning

verfasst von - ELLI -, 14.01.2003, 19:27

-->Debt Hangover

The Daily Reckoning

Paris, France

Tuesday, 14 January 2003

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

*** You'd have to be crazy...

*** Sell the dollar...cab drivers aren't recommending gold
stocks...

*** Joblessness...refinancings...state deficits...and
waiting for the real recession...

"You would have to be crazy to be bullish on the U.S.
economy," Daily Reckoning contributor Marc Faber told
Barron's this week,"...you would have to be Fed
chairman...!"

"This post-bubble environment is the most exciting
environment of the past 20 years," Faber continues.

Money flows from one illusion to the next, he believes.
From oil in the '70s to Japanese stocks in the '80s to U.S.
stocks in the '90s....

"Once the bubble bursts, there is a change in leadership,"
Faber explains.

After the bubble in stocks - particularly in dreamy tech
stocks - capital turned to things it could see, touch and
feel. Home prices in England have almost doubled in the
last couple of years. In California, they've risen 20% in
the last 12 months.

Commodities, says Faber,"fell to their lowest level in the
history of capitalism" in February 2002. Now, they're
booming. Gold has risen $100 in the last 2 years.

Faber's advice:"Be long commodities, stocks that relate to
commodities and countries that relate to commodities."

"And get out of the dollar," we add from the Paris
headquarters.

"While President Bush talked this week of a stimulative
package to propel the U.S. out of its downturn," reports
the Financial Times,"Europe yesterday embarked on a
different course.

"Pedro Solbes, the European Union's monetary affairs
commissioner, yesterday told Germany, France and Italy -
the three biggest economies in the eurozone - to focus on
cutting their deficits. So while President Bush cuts taxes
and lets the U.S. deficit take the strain, the EU's
stability and growth pact requires that Germany, flirting
with deflation, has to boost taxes or reduce spending.

"Mr. Solbes smiled yesterday when asked what he made of
President Bush's approach, then launched into a staunch
defense of the fiscal discipline imposed by the pact.
'Sound public finances are a condition for durable growth
and rising employment in Europe. Sound public finances are
part of the solution, not part of the problem. We can't
spend our way out a downturn in Europe.'"

When the European Union began, American commentators
disparaged it. The frog would never be able to get along
with a hun, they said. They speak different
languages...they have different cultures...and they hate
each other. The Union would never be able to develop a
strong, centralized government, or to undertake major
programs.

"A man should thank his faults," said Emerson. Europe's
weakness turned out to be its greatest strength. For it
cannot do anything really important - neither foreign wars
nor domestic inflation.

Here at the Daily Reckoning, we recall criticizing the euro
as an"Esperanto currency." We saw the lack of a single
country backing the currency as a weakness. We were wrong.
European member countries find it hard to agree on anything
- even destroying their own currency.

Over to you, Eric...

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

Eric Fry in New York...

- The U.S. financial markets idled in neutral yesterday.
Bonds barely budged and the gold price didn't budge at all.
Over on Wall Street, the Dow gained one meager point to
8,788, while the Nasdaq slipped one point to 1,446.

- The old Wall Street saw,"Never sell a dull market
short," would seem to pertain to yesterday's sleepy market
action. In other words, markets tend to become very quiet
immediately before explosive moves. The pyrotechnics may
begin very shortly, as several high-profile companies are
due to report their earnings this week. Microsoft, IBM and
GE - to name a few - will report quarterly earnings over
the next few days.

-"We may just have rung in 2003, but Wall Street can't
seem to tear itself away from the mania of years gone by,"
writes the ever-bearish Bill Fleckenstein."Hype and hope
still trump the fundamentals that warrant neither." The
principal"fundamental" that troubles Fleckenstein is a
familiar one: stocks are too expensive."Values in the
aggregate don't exist," he says. An expensive stock market
wouldn't be so worrisome, were it not for the fact that the
economy shows little sign of improvement. Rather,
unemployment is rising and factory use is falling.

- Even so, investors do not lack for flimsy rationales to
buy stocks."Some of the reasons the bulls are touting to
predict better times ahead are mind-boggling," observes
Reuters' Pierre Belac."They cite historical market
patterns, such as years ending in '3s' and the third year
of a presidential term, which have often been good for
stocks. Then there's the famous 'January Barometer,' a
prognosticating tool that has helped investors anticipate
how the market will perform during the rest of the year."

- Belac scoffs at the idea that any of these touchy-feely
"seasonal" stock market tendencies will propel stocks
higher for long. In the absence of a genuine and
substantial economic recovery, he says, stocks are headed
for a fourth straight losing year.

-"People swear that Wall Street has been penalized enough
for its excesses in the 1990s, Belac concludes."The market
has fallen so much over the past three years, they say,
that it should turn higher, no matter how bad the economic
script. But the smart money says:"Just because the market
has racked up four straight years of losses only once from
1929 to 1932, doesn't mean it can't do it again."

- The lumpeninvestoriat will have none of Belac's
skepticism. They know that stocks excel"over the long run"
and they are understandably delighted that stocks have been
excelling over the very short run of 2003-to-date. They
know, above all else, that stocks are the preeminent asset
class and that they needn't concern themselves with
"fringy" investments like gold.

- In the eyes of the lumpeninvestoriat, the yellow metal is
a two-headed goat. An attention-grabbing curiosity to be
sure, but certainly not the sort of creature one would want
to have roaming loose in a barnyard. Most investors
continue to shun gold, dismissing its year-long rally as an
aberration. Even so, the yellow metal is on almost
everyone's lips these days. (In fact, gold is also THROUGH
almost everyone's lips these days...and through their
eyebrows, ears, tongues and navels...but maybe that's just
the style in Manhattan).

- The precious metal simply refuses to roll over and die.
Fleckenstein offers a partial explanation:"The money that
you carry around in your wallet or use via your credit card
obviously is created at warp speed by the government. The
Fed has told you in no uncertain terms that it will do
everything to fight deflation...So, while credit cards and
cash may be good mediums of exchange, they are pretty
pathetic stores of value...It's pretty tough to find a
paper currency regime that has lasted for more than 50
years, and that's giving some of them the benefit of the
doubt."

-"The dollar-centric global monetary regime is finally
starting to fray around the edges," says Fleckenstein.
"What stands behind the recent move in gold is the
recognition by many investors around the world that all
this paper - whether one is speaking of paper currencies or
paper stock certificates - is not what it was cracked up to
be."

-"Gold has a long way to go, both in time and price,
before it's time to take the other side of the gold market
in a major way. When people start bragging to you about the
gold stocks they own (the way they bragged about Internet
stocks, or stocks in general, or the way they talk about
their real-estate holdings), then it will be time, perhaps,
to leave the party. But we're certainly not there yet."

- It's true, your editors have yet to hear a New York City
cab driver say,"My buddy was telling me about a red-hot
stock called Newmont Mining..."

-----------

Back in Paris...

*** The percentage of workers who run out of jobless
benefits before they find work is at a 30-year high. What's
more, for the first time in many years, labor market
participation is dropping...people are deciding not to seek
jobs. They're going into retirement...or staying home.

*** The mortgage refinancing boom put $172 billion in
homeowners' pockets in '02, up from $44 billion in 2000.
That was the amount of cash taken out in refi transactions.

"This helps explain the miracle of consumer spending growth
amid declining income levels," says a Moody's economist.

*** It also helps explain how the U.S. economy continues to
defy gravity. It ought to fall into serious recession. But
as long as consumers are willing to spend money they don't
have...putting their homes at risk in the process...the
recession remains something to look forward to.

The purpose of a recession is to clean up the mistakes of a
boom. Businesses need to go bankrupt from time to time.
Consumers need to cut back on spending, pay off debts, save
some money and tidy up their balance sheets. The recession
of 2001 was just not up to the task. It followed the
biggest boom in history, with more mistakes to correct than
ever before. But instead of getting out the broom and
scouring pads, it merely went around with a feather duster
so soft that most people never even felt it brush their
ears.

Yes, the corporate sector got rinsed. But consumers are as
greasy as ever - and getting even more sullied, thanks to
real estate lending.

"In the 3rd quarter of '02," Marc Faber points out,
"mortgage debt was growing at an annual rate in excess of
$900 billion, in a $10.5 trillion economy."

It can't last, of course. Sooner or later, the consumer
will get scrubbed. Then, we will have the recession the
country needs. More from Dr. Faber, below...

*** California is far in the lead among in state-level
budget deficits. The Golden State faces a shortfall of $35
billion. Runners up include New York and Texas - each with
about $10 billion deficits. Where's the money going to come
from? Too bad the states cannot print money...

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

The Daily Reckoning PRESENTS: Each time retail sales in the
U.S. increase and beat the Street's estimates by a small
amount, Wall Street cheers and pushes the market higher.
Marc Faber suggests those figures do bode well for the
economy...but NOT in the U.S.!


DEBT HANGOVER
By Marc Faber

While analysts, pundits and government quants all cheer the
American consumer, rising retail sales that are not
accompanied by a rise in industrial production are highly
questionable as an indicator for the domestic economy. In
fact, they are a far better indicator for the strength of
the Chinese economy.

Consider the following. The U.S. housing industry is
booming. However, U.S. production of appliances is flat to
moderately down compared to a year ago. Or take the home
furnishings industry, which should be a prime beneficiary
of strong home-building activity. However, furniture
imports into the U.S. have jumped 71% since 1999 in three
years and now comprise between 40% and 50% of all sales as
of the second quarter of this year.

For wood and metal furniture, principally bedroom
furniture, chairs, tables, and cabinets, import penetration
has increased even faster. The imports of such items now
account for 80% of sales by domestic manufacturers,
compared to 20% a decade ago. According to an economist who
has studied how U.S. industries have been affected by
rising imports, half a million workers lost their jobs in
the furniture industry between 1979 and 1999. This is in
stark contrast to China, which has become one of the
world's largest manufacturers and exporters of furniture,
claiming 10% of the global market share.

In the first seven months of this year, furniture exports -
principally to the U.S. - rose 35% to more than US$3
billion.

Perhaps Fed governor Ben S. Bernanke should consider this
point when advocating an ultra-easy monetary policy. In his
now famous"printing press" speech at the National
Economists' Club in Washington, Bernanke suggested that:
"By increasing the number of U.S. dollars in circulation,
or even by credibly threatening to do so, the U.S.
government can also reduce the value of a dollar in terms
of goods and services. We conclude that, under a paper-
money system, a determined government can always generate
higher spending and hence positive inflation."

What Mr. Bernanke said in his speech was already evident to
market observers, since M3 has gone up almost vertically
since October 7, rising at an annual rate of 22.5%. (Please
also note that, for Mr. Bernanke, the Fed, which is
supposed to be an independent institution, and the
government are one and the same.)

I would concede that the government can generate
temporarily higher"spending" - but overseas!

If we look at the increase in U.S. retail sales over the
last three years and compare it to the increase in the U.S.
trade deficit, we note that practically all additional
retail sales originated from the import of additional
overseas products.

Mr. Bernanke's U.S. printing press seems to have an
extremely limited effect in stimulating domestic economic
activity, while being very effective in stimulating foreign
direct investments and industrial production in China and,
increasingly, Vietnam.

A similar situation to the U.S. furniture industry is
evident in its auto industry. While overall auto sales are
robust, sales of the three domestic producers are currently
lower than they were in the 1990 recession, while sales of
imported cars and light trucks are at a record. Ford
announced recently that it will boost its purchases of auto
parts in China to as much as US$1 billion annually starting
in mid-2003.

The shifting U.S. economy is reflected in the jobs picture,
too. The"goods-producing" sector lost 332,000 jobs in the
last eight months, while at the same time the service-
producing sector has added 506,000 jobs. Mortgage brokers,
most notably, were up 47,000...health services employment
was up 178,000, education up 92,000, and government up
158,000. In the meantime, the number of manufacturing jobs
is back to the 1961 level.

Rising import penetration aside, there is another reason to
be skeptical about the durability of strong U.S.
consumption growth. For one thing, it should be obvious
that there is at present no pent-up demand in the U.S., as
consumers have not yet retrenched and rebuilt their
liquidity, as was the case in previous recessions. In
addition, until recently, U.S. consumption was boosted
above the trend-line by a decline in the savings rate. In
the absence of strong stock market gains in the near
future, it is likely that the savings rate will increase
somewhat in the next 12 to 18 months and, therefore,
contain consumption growth.

Finally, and this seems to me to be the crux of the matter,
the consumer has become highly leveraged and his
consumption may finally succumb to his debt load. Now, I am
aware that many analysts and strategists will dismiss this
concern, arguing that the consumer has been highly
leveraged for a long time and has so far continued to spend
and will therefore continue to spend in the future. To my
mind, this line of argument is reminiscent of U.S.
strategists who, in the spring of 2000, predicted that the
stock market would continue to rise, based on the fact that
it had been going up for 18 years in a row.

Responding to a piece by Gene Epstein, who writes a weekly
column about economic issues for Barron's, which stated,
"Over the 56 years since 1946, consumer borrowing habits
don't appear to have changed at all," The Prudent Bear's
Doug Noland recently produced the following figures: In
1946, as a percentage of national income, total personal
sector liabilities were 31%, non-farm mortgages 13%, and
consumer credit 5%.

At the end of 2001, however, total personal sector
liabilities were 133% of national income, non-farm
mortgages 70%, and consumer credit 21%.

Non-farm corporate liabilities stood at 44% of national
income in 1946, compared to 101% at the end of 2001; total
mortgage debt was 23% compared to 93%; security credit 3%
versus 10%; state and local government debt 7% versus 17%;
and total credit market debt 192% versus 359%.

In addition, in 1946, the personal savings rate stood at
9%, compared to around 2% now.

Noland points out that, in what has become a historic
boost, it has taken less than nine years for the money
supply to double. Noland concludes:"The
service/consumption-based U.S. system is becoming only more
monetary in nature - only progressively dependent on
rampant money, credit, and speculative excess."

The economist William Ropke explained in his book Crises
and Cycles (London, 1936) that the"qualitative"
distribution of the money stream may become a factor of
instability. Referring to the 1920s and the factors which
led to the Depression, he wrote:

"This period, which has been followed by the severest
crisis in history, shows, on the whole, a price level which
was slightly sagging rather than rising. [The same as in
the 1990s - ed. note] How, then, can there have been
inflation? Owing to decreasing costs following on technical
progress, prices would have fallen if an amount of
additional credit had not been pumped into the economic
system. Hence there was inflation, even if only of the
relative kind. But it can be perfectly well argued that the
quantitative effect of the inflationary credit expansion
was considerably aggravated by an abnormal qualitative
distribution of credits. One case is the great expansion of
installment credits, which gives the impression that the
Federal System was trying to administer the heroin not only
per os but also per rectum.

"Another example is the real estate market, which was
grossly oversupplied with credits. The worst and most
conspicuous case, however, was the stock market
speculation, which was the leader on the road to disaster.
For purpose of illustration, it may be mentioned that the
volume of brokers' loans rose from 1921 to 1929 by about
900 per cent. We may conclude, then, that the last American
boom is a striking example of how the disequilibrating
effects of variations in the volume of credit may possibly
be greatly aggravated by peculiarities in the qualitative
composition of the stream."

I have reproduced Ropke's explanation of the 1920s' boom
and the following depression, because it immediately
becomes obvious that we have a very similar situation today
- only with far worse credit excesses and far more
"abnormal qualitative distributions of credit".

This time, however, the problem is not so much the
expansion of brokers' loans, but consumer and real estate
credits as well as the leverage that was built up through
government-sponsored enterprises - Fannie Mae, Freddie Mac,
etc. - the derivatives markets, and corporations' special-
purpose entities.

I hope the reader will understand that the current mortgage
financing boom and consumer credit explosion is simply not
sustainable in the long run and that, at some point, credit
expansion in the consumer and mortgage sector will slow
down, as it has in the last two years in the corporate
sector. The consequences of such a slowdown will obviously
be that consumer spending will have to slow down very
considerably, which will inevitably hurt the economy, but
hopefully will redress some of the external imbalances.

So, whereas economists who point out that the consumer is
in great shape may be correct now, sometime in the future
the consumer may wake up with a terrific"debt hangover,"
which will force him to retrench.


Regards,

Marc Faber,
for The Daily Reckoning

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• Debt Hangover / The Daily Reckoning - - ELLI -, 14.01.2003, 19:27