The Greater Depression, Part II / The Daily Reckoning

verfasst von - Elli -, 02.07.2003, 18:48

-->The Greater Depression, Part II

The Daily Reckoning

Paris, France

Wednesday, 2 July 2003

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*** Contradictions...and negative interest rates...what
would a drunken Irish economist say?

*** At least the big brokers are honest! High-risk
speculators get what they deserve, says da judge.

*** GM's pensions...the housing bubble...gold...London
property...and more!

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

"Things cannot go wrong in contradictory directions," wrote
my friend Lord Rees-Mogg recently."The world cannot
simultaneously have an inflationary and a deflationary
problem."

But that is just what the world seems to have.

For the last 30 years, under the shining sun of the Dollar
Standard System, the U.S. has exported not only dollars -
but jobs, profits, and entire industries. Now, the rest of
the world has plenty of all of them. Maybe too much. When
it comes to 'things,' it is hard to think of any that
aren't being made cheaper today than they were a couple of
years ago, thanks to this boom in overseas capacity.

The homeland, meanwhile, has gone in a different direction.
Shipping trillions of dollars abroad, the U.S. was then
obliged to borrow them back. A huge gap had opened between
what Americans earned and what they spent; the foreigners'
money filled it.

And now the U.S. is stuck in a contradiction...with things
going wrong in both ways. The economy softens under the
deflationary pressures of debt and excess world
capacity...à la Japan...while the Feds do all they can to
lower the value of the dollar and stir up inflation.
American policymakers show signs of not merely
inconsistency, but schizophrenia, for they tell us on the
one hand that the economy is recovering nicely and that
there is nothing to fear from deflation...even while they
cut interest rates, just in case. They must also reassure
foreign investors that the dollar is still sound - for they
need more of the foreigners' money than ever before -
while, to domestic investors worried about deflation, they
practically guarantee to destroy it.

A drunken Irish economist, lurching into a bar, might offer
the following remark:

"This is all a load of malarkey y're handing us. And y'know
it. For everything y'say...y'say just the opposite a minute
later. Y'don't know what y're doin'. And now all the saints
in heaven can't save you. You'll roast in hell, all of you.
And y'deserve it, y'do."

We bring the Irish inebriate into the conversation only for
dramatic purposes. He changes nothing. What will be, will
be. But when he opens the barroom door, he brings in a
little fresh air to a stale discussion.

The world of economics has gotten so dizzy that it scarcely
makes any sense to a sober man. Or one who cannot tolerate
contradictions. The U.S. is now more dependent on foreign
lending than any nation ever was. And yet, it offers
lenders a rate of interest that is less than the current
inflation rate. And still the foreigners lend!

"Interest rates are intended to compensate lenders not only
for the use of the money but for the risk of loss,"
observed a French colleague this morning."As rates go
down, it signals that lenders see less risk on the horizon.
But what does it mean when interest rates are negative?
They must believe that the future will turn out even better
than their wildest dreams!"

The real rate of inflation in the U.S., calculates Sung Won
Sohn at Wells Fargo Bank, is about 2.7%...which puts the
real interest rate on Fed Funds at about minus 1.7%, the
lowest in twenty years. In effect, the Fed is paying people
to borrow.

Well,"what's wrong with this?" asks the Mercury News.

"For one thing," begins the answer,"negative interest
rates tempt unsophisticated investors to violate prudent
investment guidelines and transfer money from safe, short-
term investments to more speculative investments with
higher yields, such as junk bonds.

"If the economy sours, risky investments are hardest hit."

We don't wonder why people borrow at negative interest
rates. We wonder why they lend. But both groups are likely
to suffer...when things go wrong in contrary directions.
When the lenders stop lending, yields will rise. Lenders
will find they've lost money. And the borrowers will stop
borrowing...and discover that they owe more than they
thought and more than they can afford.

But let us turn to Eric Fry for the latest contradictory
update:

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

Eric Fry, down on the corner of Wall & Broad...

- Whew!...What a relief! Wall Street brokerage firms aren't
biased and dishonest after all!

-"Merrill Lynch & Co., Goldman Sachs Group Inc., Morgan
Stanley, and Credit Suisse Group won dismissal of lawsuits
accusing them of misleading investors with biased research
tailored to win investment banking business," reports
Bloomberg News."The rulings by two judges in Manhattan
federal court were the first to address the banks'
liability for research since 10 of the largest Wall Street
firms agreed in April to pay $1.4 billion to settle similar
charges by regulators. U.S. District Judge Milton Pollack
said investors who sued Merrill and Henry Blodget, its
former top technology analyst, were 'high-risk speculators'
who 'now hope to twist the federal securities laws into a
scheme of cost-free speculators' insurance.'"

- The surprising ruling triggered a brokerage stock rally.
Shares of the freshly exonerated and certifiably unbiased
brokerage firms jumped briskly, lifting the major averages
from morning losses to afternoon gains. The Dow Jones
Industrial Average gained 55 points to 9,041 and the Nasdaq
Composite Index rose 1.1 percent, to 1,640.

- The ruling seems to support the idea that Wall Street has
quietly championed for years: There's nothing wrong with
issuing 'buy' recommendations on almost every stock almost
all the time, as long as you're receiving lush investment
banking commissions for doing so...

- General Motors would welcome a few 'buy' recommendations
these days...for its cars. The struggling automaker keeps
slipping behind its Asian rivals, no matter how much money
it pays folks to buy its cars.

- General Motors' incentive spending jumped 1.4% to $3,969
last month. But still, its sales only increased 1.4%. By
comparison, Toyota spent only $2,238, while its sales
jumped 11% on the month. Nissan,which spent only $1,531
per vehicle in sales incentives, saw its sales jump 22
percent.

- Is there a housing bubble? We put the question yesterday
to Robert Tracy of Apogee Research. Robert replied,"It
stands to reason that the double-digit price increases in
U.S. housing in a time of negative economic growth and
rising unemployment levels is an imbalance that is not only
unsustainable, but due for a correction. Furthermore,
history reveals that all asset bubbles, whether tulips,
railroads or telecommunications, are all underpinned with a
common assumption that prices will always go up, therefore
you had better buy today. Clearly, if there is one comment
about the U.S. housing market that we have heard over and
over again, it is that real estate prices always appreciate
because God isn't making any more of them. That house you
want today will be more expensive tomorrow. So the
classical psychology that fuels asset bubbles is alive and
well."

- Ok, so who's standing in the line of fire, we asked
Tracy?"The list of causalities from a busting housing
bubble will be long, as the entire economy will feel the
jolt," Tracy predicts."Via cash-out home equity and
refinancing mortgages, consumer spending has remained
relatively strong despite declining payrolls and incomes. A
crash in housing prices will not only eliminate the rising
equity values that consumers have converted into cash, but
many consumers will find they owe more on the mortgage than
the worth of their homes. In such circumstances, some
consumers may be tempted to just walk away from their
obligations.

-"As for specific companies that will feel the pain of a
bursting housing bubble," Tracy continues,"the best
candidates are those who have ridden the housing bubble for
the past few years. Any company that underwrites, services,
holds or insures mortgages is vulnerable. Vulnerable
mortgage originators and those who service mortgage
include: Countrywide (CFC), Washington Mutual (WM), and
Greenpoint (GPT). Mortgage insurers who will be hit hard
from a housing bust include Radian (RDN) and PMI Group
(PMI). Homebuilders like D.R. Horton Inc. (DHI), Lennar
Corp. Cl A (LEN) and Centex Corp. (CTX) will feel the pain
form a housing bust."

- [Ed note: While 37 Wall Street firms were saying"buy,"
Apogee counseled"sell!" The difference? A 152% gain. Who
got it right? Read this to get the whole story:
http://www.agora-inc.com/reports/APG/YourMoney/ ]

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

Bill Bonner, back in Paris...

*** Chain stores' sales fell last month, reports Reuters.
Car sales were flat.

*** Germany is in"crisis," says the Financial Times,
following the collapse of a large life insurer, Mannheimer.

*** The lumps are still buying; the insiders are still
selling. Last month, insiders dumped 6.45 shares for every
one they bought.

*** Gold rose $5.40 yesterday, to $351.70. One share of the
30 Dow stocks would cost you 25.7 ounces of gold. Twenty-
three years ago, a single ounce of gold would have bought
the entire Dow. It will again, is our guess. We remind
readers...the 'Trade of the Decade' is to sell the Dow and
buy gold.

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

*** London real estate prices are coming down."Wait 6
months," we were advised - by practically everyone we
talked to. So universal was this point of view that we
began to have doubts. Either property prices will rise...or
fall much more than people think.

***"Our power is so great, and so unlikely to be
challenged for many, many years," said Admiral Stansfield
Turner, former head of the CIA to a British reporter,"that
you have to go back to Rome for any kind of parallel. It's
a misnomer to speak of the United States as being merely a
super-power. We're a super-duper power, and I don't know
that the world has seen one of those before."

"Western Europe is literally a dying continent,
demographically and spiritually," added Father Richard
Neuhaus, a neo-conservative theologian with friends in the
White House,"whereas in America, people are energetic,
vibrant, filled with technical expertise, whistles and
bells."

Can you remind us, dear reader? What was it that cometh
before a fall?

See:"Sorry Mr. Franklin, We Are All Democrats Now!"
http://www.agora-inc.com/reports/RCKN/RonPaul

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

The Daily Reckoning PRESENTS: The real test of whether the
United States is following in Argentina's footsteps, says
James Davidson, is whether we are undertaking reckless
efforts at income redistribution to try to shore up the
middle class, just as the demagogues in Argentina attempted
five or six decades ago.


THE GREATER DEPRESSION, Part II
By James Davidson

The increasing bitterness and polarization of politics in
the United States today is partly a consequence of soaring
economic inequality. With the advent of the Information
Economy, income for persons with high skills in every field
of endeavor has increased dramatically, while wages for
unskilled workers have fallen. In 1998, for example, 47.3%
of 'net financial assets' of all American households were
owned by the top 1% of Americans.

The holding of wealth in the U.S. is even more concentrated
than it was in Argentina in the first half of the 20th
century. But it does not follow that the U.S. will
necessarily go the way of Argentina.

If you recall in yesterday's Daily Reckoning, we pointed
out that the initial downturn in Argentina's fortunes
corresponded with an enlargement of the franchise around
the time of World War I. This brought the Radical Party to
power, with a policy of consciously cultivating a larger
middle class. The Radical policies tended to punish the
rich and inhibit investment. Consequently, Argentina was
one of the countries that failed to enjoy a postwar boom in
the Roaring '20s.

When the Great Depression began after 1929, Argentina was a
deeply polarized country. It was evident to most of the
educated elite that President Hipolito Yrigoyen was old,
senile and incapable. It was widely known that public
offices were being sold, and that Yrigoyen was creating
new, unnecessary offices"to have a steady supply of
product to sell."

Although he had been re-elected in a landslide in 1928,
Yrigoyen lacked public support. No one seemed to care
deeply about what he was doing. There were no thundering
editorials in support of Yrigoyen's government, no mass of
impassioned demonstrators prepared to go to the barricades
for their belief in Yrigoyen. Certainly he did not command
the devotion, even among a few, of the suicide bombers who
now so unpleasantly remind us of the depth of their support
for the cause of Hamas or al Qaeda.

On Sept. 5, 1930, the respected dean of the law school in
Buenos Aires called for Yrigoyen's resignation. The next
day, cadets from the military academy led a coup that
overthrew his government. In short order, the Argentine
Supreme Court ratified the overthrow of Yrigoyen. This set
the stage for more disasters to come, although the
conservative governments that ruled Argentina in the 1930s
coped with the Depression well. The '30s were one of the
few decades after World War I during which Argentina
outperformed other rich economies.

The trouble was that the relatively strong economic
performance was achieved by governments widely believed to
have won election by fraud. Given that the expansion of the
franchise had created an apparently permanent majority for
income redistribution, many among the rich felt that the
only way to maintain sound government was to fudge election
results.

In particular, it was widely known that tenant farmers in
Buenos Aires province were bribed or intimidated into
casting their ballots for conservative candidates supported
by the large landholders. The fact that conservatives
repeatedly won what were thought to be rigged elections
caused bitterness and polarization, not just against the
rich, but against the courts that certified the rigged
elections. The Supreme Court, in particular, was considered
to be nothing but a mouthpiece for the interests of the
rich.

For a sense of how this can poison politics, consider some
of the more exaggerated blather about the presidency of
George W. Bush from diehard Democrats who believe the 2000
presidential election was"stolen" from Al Gore by the
Supreme Court's ruling in the Florida recount case.

In any event, resentments simmered until 1943, when another
military coup seized control of the Argentine government.
One of the leaders of the 1943 coup was Juan Peron, who was
eager to be seen as a leader who could punish the upper
class. A centerpiece of the counterproductive policies
instituted at the time was rent control on tenant farming.
Rents were rolled back and frozen at 1940 levels, minus
20%. Not surprisingly, this was popular among tenant
farmers, but not with the large landholders. Popularity
aside, it had a devastating impact on Argentine grain
exports at a time when Argentina could have garnered a
larger share of world markets. But rather than expanding
production and increasing export earnings, the policies
cost Argentina dearly. Before long, large areas of cereal
production previously worked by tenant farmers were
converted to pastoral use because raising cattle was more
profitable under the new rules. Growth was retarded to
prevent the rich from becoming richer.

Peron compounded this perverse policy when he became
president by requiring that grain for export had to be sold
to the state. He paid farmers a pittance and used the
profits from foreign sale of mostly stolen grain to build
nationalized industries to"create middle class jobs" for
urban workers. Peron also began a tradition of impeaching
Supreme Court justices in order to prevent his attacks on
property rights from being overturned in the courts. All
but one of the sitting justices on the Argentine Supreme
Court was thrown out after Peron's first election.

The de-legitimization of the Argentine judiciary has had
continuing ill effects to this day. The lack of a juridical
defense for property rights and contract enforcement
facilitated the chronic hyperinflation from 1960 through
1994. In their continuing attempts to enlarge the middle
class, governments pressured Argentine companies to
overstaff and to borrow vast sums to meet payroll
obligations.

In return, Argentine firms were protected from foreign
competition. When, as frequently happened, these companies
could not repay their loans, the central bank printed money
to retire the loans and cover up holes in balance sheets.
Thus, hyperinflation.

When President Carlos Menem finally restored sound money in
1994, monetary reform was undertaken in conjunction with
widespread privatization of industries and the reduction of
barriers to imports. Consequently, with Argentine firms
suddenly exposed to competition, they had no choice but to
become more productive. They did. Large numbers of make-
work jobs in formerly nationalized firms were eliminated.
Argentine industry quickly became competitive again.
Indeed, Argentina was second only to China in economic
growth through 1997.

However, as unemployment rose due to improved productivity,
the elimination of make-work jobs and the consolidation or
bankruptcy of uncompetitive firms, politicians once again
attempted to artificially enlarge the middle class.
Government spending grew like wild. Attempts to raise taxes
to finance the new spending met stout resistance.
Argentines simply refused to pay.

The only way to finance new spending was through borrowing
rather than by the printing press. President Fernando de la
Rua lacked the conviction to cut spending. And other
players in the political process catered only to the
demands of their constituents for more spending. Under the
circumstances, default and devaluation changed the economy
for the worse, but reopened scope for the politicians to
redistribute income. President Eduardo Duhalde began a
giveaway program to 20% of the work force, which continues
under his successor, Nestor Kirchner.

You might think that my reflections on the misgovernment of
Argentina have little bearing on investment today in North
America. But Martha Stewart probably wouldn't agree with
you. She is just one of the many scapegoats among the rich
now being persecuted as part of a general recrimination
following the bursting of the 1990s bubble. Ms. Stewart has
been forced out of her company, Martha Stewart Limited
Omnimedia, under the weight of Security and Exchange
Commission charges, which remarkably claim she conspired to
lie about an activity that itself was not a crime. The
alleged kernel of her wrongdoing is that she sold her
ImClone stock after hearing a rumor that ImClone founder
Sam Waksal was dumping his. An entirely rational reaction,
if you ask me. But one which may not have been"proper"
given the vague and stylized securities regulations
promulgated by the SEC in the attempt to quarantine
investment information.

In any event, bureaucracies such as the SEC tend to
undertake reckless enforcement efforts when there is a
public demand for blood. There is such a demand today.
Those who appeared to succeed in the 1990s are under
suspicion, and large numbers of people appear to believe,
for no good reason that I can grasp, that the incarceration
and financial ruin of highfliers from the 1990s would be
bullish for the economy. What rubbish.

Over 100 corporate executives in the United States, I have
heard, are negotiating plea bargains with the Justice
Department over various supposed infractions of securities
law. It is a negative omen for U.S. economic growth when
vague and possibly bad laws that impose staggering
liabilities are aggressively enforced against business
leaders. This is a recipe for timidity and mediocre
performance, like promising to make success a tort
punishable by class action lawyers.

Another worrying suggestion from Argentina's tribulations
is that the negative effects of income redistribution
intensify when there is a larger percentage of rich people
in a given country. The larger percentage may polarize the
electorate and lead to destabilization and delegitimization
of the government. Certainly, political discourse in the
United States has recently highlighted a number of themes
redolent of politics in the last century in Argentina.
Widespread resentment of day traders and dot-com
millionaires, as well as billionaire celebrities such as
Martha Stewart, augurs ill. When an electorate is so
polarized that election results tend to fall within the
margin of error in counting, as Florida's 'hanging chad'
election underscored, politicization of the courts could
follow leading to seriously perverse economic results.

Other negative signs abound. Congress and President Bush
are about to enact a massive new entitlement to
prescription drugs. And neither the White House nor the
Republican majorities in Congress appear able to resist the
blandishments of demagogues on the issue of extending
income tax reductions, in the form of child care credits,
to low-income families who do not pay income taxes. The
Republicans wilted in the face of charges that they were
"giving money to the rich" at the expense of poor children.
All of which bodes ill for the future capacity of the U.S.
government to maintain economic stability and resist the
siren call for destructive income redistribution.

The United States and other governments are not above
imitating Argentina in other respects. They are certainly
all keen to devalue their currencies. This makes holding
gold more attractive. It is also likely that the world's
major currency blocs will continue lowering interest rates
until economies unequivocally rebound in a robust way. With
Germany and much of Europe facing the specter of deflation,
euro interest rates will come down sharply.

Argentina's"Greater Depression" reflects the bankruptcy
and debt default - the ultimate outcomes of malinvestment -
of the Argentine state. Though the monetary history of the
U.S. does not share quite the same degree of turbulence as
Argentina's, it is not inconceivable that Argentina's
example will prove an ominous harbinger of U.S. troubles to
come. The United States is slowly suffocating in a mire of
debt, both on the federal and consumer ends...and like
Argentina before it, it has channeled much of that debt
into investments that should never have been made in the
first place.

The unhappy marriage of easy credit and malinvestment in
the U.S. has created excess capacity in many industries
that are now being painfully restructured. Whether such
'restructuring' will allow the U.S. to circumvent a fate
like Argentina's remains to be seen.


Regards,

James Davidson,
for the Daily Reckoning

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gesamter Thread:

• The Greater Depression, Part II / The Daily Reckoning - - Elli -, 02.07.2003, 18:48