Hayek, The Fed and The Double Dip / The Daily Reckoning

verfasst von - Elli -, 16.04.2003, 20:49

-->Hayek, The Fed and The Double Dip

The Daily Reckoning

Rome, Italy

Wednesday, 16 April 2003

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

*** Stocks up...bonds up...gold up...but the dollar?
Down...

*** Abby's advice...industrial production falls...

*** Rumble in the jungle...the decline of
capitalism...inside the city of the dead...and more!

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No clear trend has emerged - neither in the stock market,
nor in the economy - since the war ended.

Yesterday, stocks rose slightly...gold rose
slightly...bonds rose slightly...and the dollar fell
slightly.

We cannot predict the future and cannot say what trend will
emerge. But we have no reason to think that stocks will be
more expensive tomorrow than they are today. Typically, the
third of the year ending in April is the best for stocks.
That may or may not be the case this year...stocks may go
up, but with a dividend yield of less than 2%, we can't
think of any reason to own them.

Nor do we have any reason to want to own the dollar - or
dollar-based investments. U.S. bonds yield less than euro
bonds...and may be undermined by a falling dollar. Bonds
might rise, of course, as the Fed cuts rates again. As Eric
explains, below, the only thing that would bring lower
rates...another round of refinancings...and higher bond
prices...is a slumping economy, which is not exactly good
news for the dollar.

And sooner or later, paper money always declines against
gold. We don't know if this is sooner or if it is
later...but sooner or later it is bound to be.

With nothing further to say about it, we turn to Eric Fry
for the latest news:

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

Eric Fry in New York City...

- Lately, Abby Joseph Cohen has been as difficult to track
down as Saddam Hussein. But the Goldman strategist finally
emerged from her bunker yesterday to reiterate her bullish
prognostications. The economy will improve, she predicts,
and share prices will move higher. For one day, at least,
she was correct. The Dow gained 51 points to 8,402 and the
Nasdaq added half a percent to 1,391.

- But even congenitally bullish folks like Cohen would
admit that the economy isn't looking shipshape. Not to
worry, however; conditions will improve later this year,
they promise. According to Cohen's prophetic vision, the
economy will recover, consumers will begin to"dissave",
coporations will begin to"dislose" money and the stock
market will begin to"disfall".

- Cohen's optimism may well prove to be correct. But in the
here and now, economic conditions leave much to be desired.
Industrial production fell 0.5% in March and manufacturing
output declined 0.2%. Even more troubling, capacity
utilization tumbled 0.5 percentage points to 74.8% - a
whopping 6.5 percentage points below its 1972-2002 average.

- Corporations are responding to the sluggish conditions by
conserving their cash and shoring up their balance sheets.
Poor Richard would be pleased. But the very same thrift,
which seems prudent at the individual level, is very
unhelpful for the economy as a whole. When everyone saves
money at the same time, no one is left to consume and
invest.

-"Growth in overall debt owed by nonfinancial corporations
in the last two quarters of 2002 slowed to just 0.7%
annualized," observes Morgan Stanley's Richard Berner,"the
slowest pace in a decade."

-"A trip to the Betty Ford Center for Balance Sheet Repair
can make sense from a bottom-up perspective," says Paul
McCulley of the PIMCO funds."But it's just not good if you
have the entirety of corporate America at the Betty Ford
Center for Balance Sheet Repair. And that's what we have in
the economy right now...Everyone wonders why businesses are
not investing. Well, for God's sake, they had a bubble in
investment and financed it with a bubble in debt - and they
blew up. You've got capacity utilization way down here
because there is excess capacity out the wazoo...Why would
any logical person in this environment go into the boss and
say, 'Let's ramp up the capital budget?'"

- Consumers are becoming equally thrifty."Consumers are
already feeling the pressure of a low savings rate and
record debt," says Comstock Partners,"and are no longer
spending freely without steep discounts and financial
incentives that are squeezing corporate profit margins and
causing them to cut employment and delay capital spending.
This, in turn, leads to further decreases in employment
and, therefore, lower growth in personal income. The
benefits of continuous mortgage refinancing depend on even
lower mortgage rates, and that can happen only if the
economy continues to weaken. Since it is this negative
feedback loop rather than the war that is causing the
economic malaise, the end of the war will not automatically
lead to an economic revival."

- But let's assume that the perma-bears at Comstock
Partners are out to lunch and that the perma-bulls like
Cohen are on target. Let's assume that the economy recovers
smartly, thereby boosting corporate profits. Even so, the
stock market still ain't cheap.

-"The continuing bubble is evident in the stubbornly high
valuations still being accorded the technology stocks,"
says Comstock."We examined the 16 technology stocks that
are part of the top 50 capitalizations in Nasdaq, and found
that they are selling at an average of 41 times estimated
fiscal 2003 earnings. Nine of those stocks were in
existence and had positive earnings in 1991. During that
year their average P/E ratio was only 19, compared to 35
today when their prospects for rapid growth are much less
than they were at that time. In our view the bear market is
far from over."

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William Bonner, back in Rome...

***"It's just a rumble in the jungle," for now, says our
South African correspondent, Evan Pickworth, but from
Nigeria comes news that Muslims are urging one another to
dump the dollar in favor of the euro.

"European countries," preached Sheik Ibrahim Umar Kabo, the
head of Nigeria's Council of Muslim Scholars,"have refused
to be fooled by America...we should therefore encourage
transactions with the euro and stop patronizing the
American dollar."

"It would be a great mistake not to treat the threat
seriously," said Nobel prizing-winning economist Robert
Mundell.

Iraq began selling its oil in euros about 4 years ago. We
haven't heard the latest news, but it seems likely that the
entire economy will become the first country to be
dollarized at the point of a gun. Too bad the dollar's
value can't be guaranteed by Abrams tanks too.

***"After a year of scandal and fraud allegations at
Merrill Lynch & Co., not to mention a battered stock,
investors might reasonably have expected the Wall Street
giant's top brass to feel some pain in their paychecks,"
begins an article in the Boston Globe."Instead, the
chairman and chief executive of the nation's largest
brokerage each took home a $7 million cash bonus - seven
times the sum each had received in the prior year. At EMC
Corp., the state's largest technology company, chief
executive Joseph Tucci failed to meet the profit goals his
board of directors had set for him. But that didn't stop
the board from awarding him $7.1 million last year, even as
shareholders saw the stock price plunge 76 percent. Tucci's
cash bonus suffered a mere scratch, falling $25,000, to
$675,000. In January, he received 75,000 options to buy
shares at just a penny each."

We keep noticing...and now we remember why...that American
capitalism no longer rewards capitalists. Instead, they
wait at the end of a long line - behind tort lawyers, tax
collectors, and employees, both current and retired. But in
the '80s and '90s while this was happening - that is to
say, while more and more hands were slipping into the
corporate till - the prices capitalists were willing to pay
for corporate earnings rose. It made no sense. The golden
age of capitalism had not arrived, as they thought; it had
departed.

And even today, three years after the bear market in stocks
began, stocks are still valued as if a dollar's worth of
corporate earnings in 2003 were worth as much as 5 times
more than it was worth in 20 years before.

*** Yesterday, your editor and his entourage journeyed to
the city of the dead - the necropole deep beneath the
Vatican. The visits are by appointment only and carefully
guided. No English guide was available, so we joined a
small group of French people, led by a nun with calluses on
her hands from years of smacking children with a ruler.

We descended a narrow stairway and passed through the main
brick wall, about 6-ft. thick, built perhaps in Nero's
reign. There, we halted and received the first part of our
lecture. We were in a graveyard of sorts...where people
built their own family mausoleums. The whole place had been
out in the open....but was filled with dirt in about 320
A.D. in order to build St. Peter's basilica on top.

We could read the inscriptions above the doors, explaining
a little about the family and the gods it worshipped. There
were elaborately carved sarcophagi for the bodies...and
urns for ashes. Some of the burial houses had more than one
floor...with stone staircases leading to the second level.
Among the cult of the Etruscans, the nun explained, it was
customary for the family to visit the mausoleum often and
to eat meals there...while paying homage to the dead.

We recalled why we like the French. The Sister of
Everlasting Severity reminded us of the qualities we like
so much - excess rationalism, authoritarianism and a
pathological inability to follow the rules. Hardly had she
begun her discourse then she turned it into a dialectical
exercise.

"Look now, then I will give you the synthesis and a
conclusion," she ordered.

Later, after peeking at the tomb of St. Peter, the small
group followed her down a further narrow defile...

"We're not supposed to come in here...it's off limits to
the public...but I like to see it myself...

We thought we might be sneaking a look at some Vatican
secret...its hoard of gold...the arc of the covenant...or
the holy grail...

But there before us was the marble sarcophagus of Pope Pius
12th...with his image carved on the top. Why it was out-of-
bounds we never found out.

At the end of our tour, we stopped again near where we
began. The nun led us in the Lord's Prayer...and ended with
a final plea to St. Peter himself...

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

The Daily Reckoning PRESENTS: What would the late, great
economist F.A. Hayek have to say about the economic mess
we're in? If he were inclined to gloat, suggests Apogee
Research's Andrew Kashdan, he'd have good reason to say,"I
told you so."


HAYEK, THE FED and THE DOUBLE DIP
By Andrew Kashdan

To even the most casual observer of the stock market and
economy over the past 3 years, the failure of the Keynesian
"print-and-spend" approach to curing a business cycle
downturn has become glaringly evident.

Regardless, most people will continue to believe in it, of
course, but a few are groping for a better explanation of
how we got into our current rut, and why we're having so
much trouble getting out of it.

Today we offer an explanation put forth more than 70 years
ago by F.A. Hayek, because for the most part, his basic
insights hold up as well in today's market as they did
following the Great Crash. Building on the monetary theory
of Ludwig von Mises, Hayek would later receive the Nobel
Prize. Reason enough, we think, to look for guidance in one
of his perhaps forgotten tomes like"Prices and
Production," which Hayek wrote in the depression year of
1931.

Attempts to cope with the Great Depression caused Hayek's
contemporaries to ask: Doesn't the existence of unused
resources in the economy justify the expansion of the money
supply? To which Hayek responded"no", explaining that all
monetary expansion distorts the structure of production.
Similarly, today, Hayek's response explains why Fed easing
and seemingly strong consumer spending hasn't gotten us out
of the slump.

Far from being the answer to our problems, Hayek argued:
"[I]t should be fairly clear that the granting of credit to
consumers, which has recently been so strongly advocated as
a cure for depression, would in fact have quite the
contrary effect; a relative increase of the demand for
consumers' goods could only make matters worse." The
reason, in brief, is that the structure of production -
that is, the economy's particular use of capital goods -
must be adapted to the true savings preferences of
consumers, as opposed to the distorted consumption and
investment decisions prompted by monetary expansion. In
other words, notwithstanding the sage advice of Dallas Fed
President Robert McTeer, our economy would not be better
off if every American rushed out to buy an SUV.

For those who consider Hayek's stance too dogmatic, it is
interesting to note that he actually acknowledged the
theoretical possibility of a beneficial monetary expansion
that favored producers (as opposed to consumers), if it
occurred at the beginning of a downturn. But the emphasis
is on"theoretical", for such an expansion would have to be
so carefully regulated and then withdrawn that Hayek
admitted,"Frankly, I do not see how the banks can ever be
in a position to keep credit within these limits." He
concluded by arguing against"the well-meaning but
dangerous proposals to fight depression by 'a little
inflation.'" Sound familiar?

Furthermore, while Mr. Greenspan tells us that nothing
could have been done during the boom to prevent the bust,
and now all he can do is address its after-effects, Hayek
held the exact opposite view:"[W]e arrive at results which
only confirm the old truth that we may perhaps prevent a
crisis by checking expansion in time, but that we can do
nothing to get out of it before its natural end, once it
has come."

Yet, not all the blame for post-boom economic distress
should be put on the regulators of the monetary system.
Capitol Hill deserves its proper share of blame as well.
"[C]ertain kinds of State action," Hayek said at the end of
his book,"by causing a shift in demand from producers'
goods to consumers' goods, may cause...prolonged
stagnation. This may be true of increased public
expenditure in general or of particular forms of taxation
or particular forms of public expenditure."

So where does all this leave us? In short, with many
investments that still need to be liquidated before a
healthy and sustainable expansion can begin. Such a process
is difficult in the best of times, and unfortunately war
and vastly expanded government spending will only divert
resources away from economically productive uses, no matter
how much"stimulus" it appears to bring.

The symptoms of the continuing post-bubble adjustment are
all around us. There is weakness in retail sales, consumer
confidence, business investment and employment, to name but
a few areas of malaise. The eternal optimists among us are
quick to blame"temporary" factors like oil prices,
"geopolitics" and cold weather as the culprits. We would
point out, however, that this is merely what happens when
growth is weak and the economy is vulnerable to an external
shock. It hardly matters which particular event triggers
another downturn.

The good news so far is that oil prices have not spiked
further - a sustained increase would certainly send us back
into recession. But a tour of recent economic indicators
makes it clear that we have indeed hit another"soft patch"
(to use the soothing words favored by the Fed chairman).
First, let's consider the labor market. As everyone has
heard repeatedly, the employment situation is a lagging
indicator. But what was a convenient excuse at the
beginning of the recession has now become evidence that the
recovery never quite got on track after all.

As the Fed's Beige Book for the first few months of the
year puts it:"Business spending remained very soft as
geopolitical concerns and uncertainty over the strength of
demand continued to constrain spending and hiring plans."

Stephen Roach, crack Morgan Stanley economist, goes
straight for the jugular when he blames the deterioration
in the labor market for the"high and rising" odds of
recession. Other indicators also bring into sharp relief
the recent setback in the economy. For instance, although
industrial production growth has rebounded from negative
territory, it hardly compares to previous recovery periods,
and already appears to be leveling off.

The manufacturing industry will certainly not find it any
more comforting to hear that GDP growth is still positive.
The Institute for Supply Management's index tumbled to 46.2
in March, below the expansion level, and down from 50.5 in
February and 53.9 in January - now the lowest since right
after September 11. ISM survey chairman Norbert Ore was
correct last month when he observed that the drop seemed to
be more than a temporary blip.

The ISM survey also showed that jobs in the manufacturing
sector continue to disappear. And after it looked like they
might finally be moving in the right direction, jobless
claims are heading higher once again.

Indicative of the investment overhang, non-residential
private construction remains very weak, down 15% from a
year ago, and 30% from its peak in 2000. How long will low
interest rates continue to boost the residential market?
Not forever is our unhelpful guess. Housing starts are
already declining, and the inventory of unsold homes has
risen sharply since the beginning of the year.

Of course, all this could change if the removal of Saddam
Hussein really is the answer to all of our economic
problems. We're just not betting on it. If there is one
benefit to all the troubles we find ourselves in, perhaps
it is the learning of some very old lessons.

War is never good for the economy, and when it comes to
monetary policy, there still ain't no free lunch.

Regards,


Andrew Kashdan
for The Daily Reckoning

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gesamter Thread:

• Hayek, The Fed and The Double Dip / The Daily Reckoning - - Elli -, 16.04.2003, 20:49