- The First Panacea / The Daily Reckoning - - Elli -, 25.06.2003, 19:49
The First Panacea / The Daily Reckoning
-->The First Panacea
The Daily Reckoning
Paris, France
Wednesday, 25 June 2003
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*** What kind of world would it be, dear reader? $5
trillion of new money in the Greenspan years!
*** Stocks barely higher. Gold down $6.70!
*** Oh Fannie, we can't believe you would lie to us!
Mountain mama...President Hillary...Shania Twain...and
more!
---------------------
The Fed prepares another rate cut pronunciamento. Will the
13th succeed where the other 12 failed?
But what kind of world would it be, dear reader, if you
really could create money out of thin air?"You can't get
something for nothing," we keep saying. But what if you
could? Would there be any eternal verities left? Would
there be any laws, any principles, or any rules you could
still count on? Would there be a single moral rock solid
enough to lean against...or any natural dirt hard enough to
hold your weight...or any God left in heaven to press his
thumb upon the scale of divine justice?
If the hacks at the Fed really can make us all wealthier
simply by lowering the Fed Funds rate, what can't they do?
Why don't they make our women all look like Hollywood
starlets and our kitchen faucets run with good Scotch!
The Fed has added $5 trillion in new dollars since Alan
Greenspan became chairman. Is there no price to pay for
this new wealth? Or is the Fed chairman divine...bringing
manna down from the skies as if he were an air traffic
controller landing DC-7s full of bon-bons on an island of
weight-watchers?
It is all just too absurd to take seriously. But here at
the Daily Reckoning, as we explained in a final note
yesterday, we are optimists: we think the Fed will fail.
Eventually, somehow, the heavens will have their way...
All over the world, the authorities are trying the same
monetary and fiscal claptrap. Rates have been cut
everywhere. In Japan, there are no rates left to cut. In
the U.S., there remain only 125 basis points; in Europe,
there are only 200.
All the major countries of Europe are spending more than
they can afford, in violation of the 3% deficit limit
established by the Maastricht Treaty. In America, the
deficit has reached 4% of GDP. In Japan, the government
deficit is up to 7%.
But for all this easy money - out of thin air it comes -
there is no evidence that anyone actually gets richer. In
Japan, for example, the monetary base has increased by 84%
since '97. But GDP went down 6%.
And now the whole world seems to be slouching towards
deflation - despite officials' best efforts to create
inflation. Today's news brings word that even in Latin
America, prices are falling. In May, CPI figures for
Mexico, Argentina, and Chile all declined. And in Israel,
the cost of living dropped at a 5% rate in the last 3
months. What's more, with prices falling in Germany...2 out
of 3 of the world's biggest economies are either in
deflation or close to it.
We remain optimistic, however. We have no doubt that
central banks will eventually destroy the currencies they
are supposed to protect. But maybe not when or how they
choose.
Over to you, Eric:
-------------
Eric Fry in New York...
- The Dow Jones Industrial Average climbed 36 points
yesterday to 9,109, while the Nasdaq Composite slipped 5
points to 1,605. In the commodity markets, gold for August
delivery plunged $6.70 to $346.70 amid strength in the U.S.
dollar, which hit a five-week high against the euro of
$1.152.
- The stock market rally since March 11 has been a
delightful interlude - a delicious respite from the sturm
and drang of our painful three-year bear market. But all
pleasures end...especially the fleeting pleasure of bear
market rallies...
- From its intraday low of 1,108 last October 10th to its
intraday high of 1,677 on June 18th, the Nasdaq gained a
breathtaking 51%."That's as good as it gets," insists Jay
Shartsis, a professional options trader with R. F. Lafferty
in New York."Sometimes you get rallies of 40% or 50% after
a bubble bursts - and you have to still believe that we are
in a post-bubble environment - but that's it...And guess
what, from bottom to top, the Nasdaq has gained about 50%."
- The funny thing about the Nasdaq's 50% rally is how
little business has improved for tech companies since the
rally began. Semiconductor companies are still struggling
to sell computer chips, as AMD's revenue-shortfall
announcement yesterday testifies, and consumers are still
hesitant to buy PCs, even though they do not hesitate to
buy the richly priced shares of PC vendors...
- Et tu, Fannie Mae? First comes the news that fellow
mortgage-lender Freddie Mac has been"massaging its
numbers" to produce steady, cosmetically-pleasing earnings
results. Then comes the shocking allegation that Fannie Mae
"hid" a few billion dollars of losses. We all know that bad
news comes in threes...What's next? Is Microsoft about to
file for bankruptcy?
- The unnerving disclosure of corporate malfeasance at
Freddie Mac alarmed the legions of gullible investors who
trusted in this government-sponsored enterprise's (GSE)
"predictable" earnings growth. Scarcely had the
disillusioned masses regained their composure when the
rumor mill kicked out a shocking story about Fannie Mae,
the other mortgage-lending GSE.
- According to the New York Times, a bevy of accounting
experts and money managers believe that Fannie Mae's assets
- when shown at fair value - suffered a loss of several
billion dollars last year due to a drop in interest rates.
But thanks to some handy accounting rules, the company
managed to divert these hefty losses away from its income
statement.
- Is it a mere fluke that these two massive, but still
rapidly expanding, GSEs are both pushing the accounting
envelope in the pursuit of impeccably manicured - and
therefore, share-price-boosting - earnings results?
"Unlikely," scoffs Apogee Research's lead analyst, Robert
Tracy."I smell a rat...or at least something that smells
very much like a rat...We're digging into this thing right
now. So I'll keep you posted.
-"Ya know," Tracy continued,"I've done a lot of digging
into Sallie Mae's financials (that's the student-lending
GSE) and I've found a number of suspicious accounting
practices. And I've expressed my suspicions about the
company's accounting in print, as part of Apogee's
skeptical analysis of Sallie Mae.
-"As you might guess, the company's CFO has called me and
provided some very reasonable-sounding explanations for
their bizarre accounting practices. But I just can't buy
it. Net-net, Eric, my guess is that aggressive accounting,
the type that skirts the edge of legality, is simply part
of the GSE's corporate culture...To be clear, I'm not
accusing any of them of illegality. But their accounting
practices definitely mask the huge volatility that is part
of today's mortgage and lending market. So the effect of
this game - whether intended or not - is to deceive
investors about the massive risks that these GSEs are
dealing with day in and day out.
-"The mortgage market can be a volatile marketplace, and
it is becoming an increasingly dangerous place for big
lenders like Fannie and Freddie. So, best case, honest
earnings reporting will likely lead to lower share prices
for these companies. Worst case, I shudder to think...maybe
some sort of derivatives debacle.
-"But to repeat, I'm looking into this now and will be
issuing a report shortly."
- We suspect that the Freddie Mac affair is more than just
a financial fender-bender. So far, investors are shrugging
off the twin scandals at Freddie Mac and Fannie Mae, just
like they shrugged off the initial reports of scandal at
Enron, WorldCom and Tyco. Unfortunately, in each of these
instances, the"First sale was the best sale!"
- What's more, anything that causes difficulties for Fannie
and Freddie, by definition, causes a problem for the
housing market. Could the Freddie-Mac-cum-Sallie-Mae
scandal be the pin that finally bursts the bubble that some
people say has become the nation's housing market?
-"Questions about Freddie Mac's finances could spark
investor concerns about its mortgage-backed securities,
which are crucial to providing funds for banks and other
mortgage lenders," says CNN/Money."If Freddie Mac's
problems mount, that could drive up mortgage rates, which
could hurt the housing market and possibly lead to a sharp
drop in home prices."
-...or maybe not."But," says Apogee's Tracy,"I suspect
that more shoes are yet to drop from the GSE's financial
statements."
- [Ed note: for more investment advice consistent with the
ideas you read in Eric's commentary, please subscribe to:
Apogee Research
http://www.agora-inc.com/reports/APG/YourMoney/ ]
-------------
Bill Bonner, back in Paris...
*** Readers continue to send interesting mail from the
world over:"Hillary Clinton will succeed George W Bush as
U.S. President," writes our old friend Martin Spring, from
England,"and probably as early as next year.
"The universal expectation in the States is that Hillary
Clinton won't run for the presidency next year as Bush will
be unbeatable - she's planning to succeed Dubya after he
completes his second term. However, they said that the
little-known governor of Arkansas couldn't beat Bush
Senior. Could another Clinton be about to repeat history?
"Hillary has repositioned herself as a centrist - so much
so that her voting record and public statements on hot-
button issues such as the invasion of Iraq and
homosexuality have severely strained her relationship with
the Left. When elected to the Senate she made a point of
focusing her attention on the armed services (which mainly
interests Rightist males) rather than on health and welfare
(seen as female, Leftist issues)...
"Many commentators believe the recent launch of her book
was the opening salvo of her presidential campaign in 2008.
But she is making such progress in preparing for her bid
that the Clintons could well blindside everyone, as they
did in 1996, and run next year."
Here at the Daily Reckoning, we remain steadfast in our
optimism. Perhaps Hillary will run against George. But as
Henry Kissinger said of the Iran-Iraq war, it is too bad
they both can't lose.
*** Another friend, staying out at our country house south
of Paris, sends an amusing memoir in which he recites the
lyrics of a mega-hit by Shania Twain:"...climaxing with
her own version of Greenspanian economics:
When you're broke go and get a loan
Take out another mortgage on your home
Consolidate so you can afford
To go and spend some more when you get bored.
..[it's] a guttural, instinctual premonition that, for the
gilded calf of American consumerism...the gig is up. Even
our sex symbols are in on the secret. Everyone knows except
Messrs. Greenspan, Bernanke, and McTeer. Although, I
suspect even this trio senses the sea change - late at
night when it's just them and their MTV. Everyone knows it.
It's just that nobody wants the music to stop."
The rest of the letter is on the DR web site. See:
Ka-ching!
http://www.dailyreckoning.com/body_headline.cfm?id=3279
*** A Canadian reader comments on the beautiful state of
West Virginia and the people who call it home:
Dear Mr. Bonner,
Having suffered with the Daily Reckoning
Affliction/Addiction for some time now - and, thankfully,
no end in sight for this condition yet - I will try to get
some relief by sending this e-mail.
While reading your travel-log about West Virginia some time
ago, I thought: Surely, he must be exaggerating.
My jaw dropped however, as I stared in disbelief at the
photos put out by the US Ministry of Propaganda, showing
the home of Private Lynch after the first airing of that
made-for-TV movie:"The rescue of Private Lynch".
This young woman made the right, and smart choice! Good for
her!
Anything, including sandstorms, sandfleas, broken bones,
and a hospital bed in Iraq is preferable to the place she
came from. Even if it means going to a foreign land
fighting people who talk funny, who eat strange food, and
probably smell bad (or at least different). Imagine,
actually getting paid for getting away from that place,
called home.
After seeing those, and subsequent photos, I now know where
some of the 'Boobus Americanus' reside.
*** And Mr. Fry shares this letter from a friend in Japan:
Hi Eric,
This is Paula in Tokyo. The deflation here continues...
Three-bedroom apartment rentals are down from $20,000 a
month to just $10,000 a month. Restaurant dinners costing
$400 a person 5 years ago are now just $200 (if you order
cheap wine).
Kelly Bags which were bought new at $5,000.00 are now being
sold at thrift stores for just $3,000.00. Ditto for gold
Rolex watches which were $20.000 and are now at prices of
just $16,000.
Sales of two-bedroom apartments are down from $5 million to
unheard of levels of $2 million. Where all of this will end
we don't know...
---------------------
The Daily Reckoning PRESENTS: A mismanaged economy and its
unintended consequences.
THE FIRST PANACEA
by John Myers
"The first panacea for a mismanaged nation is inflation of
the currency; the second is war. Both bring a temporary
prosperity; both bring a permanent ruin. But both are the
refuge of political and economic opportunists."
- Ernest Hemmingway
America's total debt load is already so big that the nation
must spend more than $1.7 trillion a year, or about 15
percent of the nation's GDP, on debt service. But it's
starting to grow rapidly once again.
The price tag on invading and occupying Iraq, for example,
will likely soar to more than $700 billion. Meanwhile, the
Pentagon is asking for a $380-billion budget next year to
upgrade the military's intelligence corps and rapid-
response teams.
That is more defense money than the combined spending of
Russia, China and all of Europe.
Given all of its commitments, plus President Bush's tax
cut, the federal government is adding half a trillion
dollars in additional debt each year. By 2005, the federal
deficit will be about $8 trillion, or roughly two-thirds of
the nation's GDP. Given these rapidly growing federal
liabilities, it's no wonder the Fed is hell-bent on
reflating. Uncle Sam would love to repay today's debts with
tomorrow's cheaper dollars, especially because it would be
paying much of it to foreigners.
Foreign central banks own $749 billion in U.S. Treasuries,
or more than 20% of the entire market. Holdings of U.S.
assets by foreign central banks have risen by $163 billion
in just the past year, with the Bank of Japan buying a
record $34 billion in Treasuries this past May.
Foreigners now own more and more of America - about"$8
trillion of U.S. financial assets, including 13% of all
stocks and 24% of corporate bonds", according to
Bridgewater Associates.
Given America's growing reliance on the"kindness of
strangers," the United States would not dare to renege on
its debt in any way, shape or form. But that doesn't mean
it has any qualms about repaying its debt with devalued
dollars.
The deflationists [present company included - Addison]
argue that that federal government hasn't the wherewithal
to devalue the currency; that if Washington tried, the bond
markets would react immediately and severely. What those
deflationists fail to take into account [ahem] is that most
of the world has too much wrapped up in U.S. financial
instruments to do anything that would contribute to their
demise. [What some deflationists argue is that the Fed
doesn't have the wherewithal to correct historic levels of
consumer debt...but they appear to be hell-bent on
destroying the currency while trying - Addison]
The massive eight trillion dollars of U.S. financial assets
held by foreigners means that all foreign central banks and
foreign institutions have good reason not to liquidate
stocks and bonds, even if the U.S. were to systematically
debase its currency. Liquidating U.S. assets could create a
vicious cycle of dollar weakness, leading to additional
asset sales that would lead to additional dollar weakness,
on so on it would go. What Washington really has then, is
tacit permission from foreign investors to devalue the
dollar; albeit slowly.
And this is precisely the path that the Fed is pursuing. In
my advisory service, Outstanding Investments, I am
predicting the Fed will succeed in rekindling inflation.
After all, history shows that central banks have an
unblemished record of currency destruction. Central banks
can destroy any currency, if they set their minds to
it...even the U.S. dollar.
Let's examine the historical record. Between 1970 and 1981,
M2 money supply tripled! For 11 straight years, a record
amount of liquidity was injected into the economy.
Yet as the 1970s proved, money is not wealth. From the
beginning of 1971 to the end of 1979, GDP growth was
extremely sluggish, rising by about 2 percent per year.
Meanwhile, consumer prices during the same span rose by a
staggering 6.5 percent per year. By 1980, the greenback had
lost half the purchasing power that it had just 10 years
earlier!
Reflation is no friend of the stock market. In the summer
of 1971, when President Nixon severed the Gold Standard,
the Dow was trading at 900.
In hindsight, 1971 was an excellent time to get out of
blue-chip stocks and to load up on hard assets. But hardly
anyone realized it. In the spring of 1980, the Dow was
trading at 759. Not too severe a loss from the highs of
about 1,000 that the Dow reached in 1966...unless you
factor in inflation. The 1980 Dow, measured in 1966 terms,
was trading at 404. In real terms then, the stock market
had lost nearly half its value during the 1970s and two-
thirds of its value from its 1966 high.
It was the opposite situation for hard assets. Excess
dollar-creation and fiscal irresponsibility led investors
into real assets and the companies that produced them. The
first wave of investors was simply looking for something to
shelter their investments from inflation. But as more and
more money moved into real-asset stocks, their value began
to climb at a rate that more than compensated for the
declining value of their investment dollar.
While most Americans were absorbing big losses in the stock
and bond markets, a few forward-looking investors were
racking up incredible gains in real assets. The stocks of
companies that explored and produced base metals, precious
metals, lumber and petroleum saw their stock price
appreciate throughout the decade. Some junior gold
companies rose by a factor of 10 or more, while even major
petroleum companies saw their stock price double or even
triple.
Thirty years later, the cycle has come full circle.
Mountains of debt can only be repaid in devalued dollars.
Monetary growth is rampant, and the dollar has begun to
weaken. Meanwhile, commodity prices are beginning to stir,
even though with a weak economy, they should be falling.
This tells me that the financial markets have already heard
the hooves of approaching inflation. It's time to saddle
up!
Regards,
John Myers
for the Daily Reckoning

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