- The Daily Reckoning - Pilgrim, Prepare Thyself - Firmian, 18.08.2003, 16:46
The Daily Reckoning - Pilgrim, Prepare Thyself
-->Pilgrim, Prepare Thyself
The Daily Reckoning
Ouzilly, France
Monday, 18 August 2003
---------------------
*** The bubbles continue - big one forming in China!
*** Money supply up big time... Dow steady... bonds
stabilize...
*** Vacations... and more... including - Mogambo on Monday!
---------------------
"Unsustainable," say economists.
"Bubble," say the sourpusses.
"Buy," say the lumpeninvestoriat.
The average investor cannot bear an opportunity to lose
money. He looks at a bubble like a starving cannibal at a
fat tourist. The rest of us look on, too, not knowing
whether to be appalled or amused.
"Housing prices hit a record in July," reports the LA
Times.
"House sales hit record in July," comes the news from
Toronto's Globe & Mail.
"Shanghai property prices soar," says a source from China.
Apartments rose 18% during the first 7 months of the year,
with their sharpest increase in July, our source continues.
In the best neighborhoods, the annual rate of increase is
running at 172%.
Bu... bu... bu... bubble!?
The Dollar Standard has had its effect all over the world.
The flood of dollars first blew up the bubble in Japan in
the 1980s... and then bubbles in Thailand... and Malaysia in
the early '90s... and then in the U.S. stock market in the
late '90s... and now in real estate... and especially,
Chinese real estate.
These events seemed almost unrelated at first. But now, the
pattern is becoming more obvious. The Dollar Standard
allows Americans to spend more than they can afford.
Foreign nations, seeing their opportunity, hustle to get a
piece of the action. Before long, they are selling more to
the U.S. than they buy from her. They are left with dollars
in their pockets. What can they do with them? Build more
factories! Buy more stocks! Lend, borrow, spend!
The resulting boom attracts more and more capital from
overseas and gathers momentum until it has turned into a
bulging bubble... which, sooner or later, blows up.
Why don't the bubbles stop? Because the source of them is
still gushing up more and more dollars. And now the world
economy depends on them. China, for example, has gotten in
the habit of selling to Americans... who pay in
dollars... which it then uses to build more factories, pay
more workers... and buy more U.S. Treasury bonds. And when
this peculiar economic arrangement comes to an end, most of
the world will go into a gloomy secular
recession/depression - much like what Japan has been
through over the last 13 years. No politician or central
banker wants that to happen... so they fight it with
everything they've got. And all they really have is - guess
what? - more dollars. To a world suffering from too many
dollars and too much credit, they come with more!
In the week of August 4th, the U.S. money supply, as
measured by M3, went up by $50 billion dollars. We had to
rub our eyes when we saw the figure - we could scarcely
believe it. But there it was... more evidence that if the
world economy does sink into deflation, it won't be for
lack of effort on the Fed's part.
Which is not to say that the Fed will avoid deflation.
Inflation begets deflation, we remind you. By inflating the
world economy with dollars, the Fed has created huge debt
and huge capacity. Sooner or later, prices fall... for there
is just so much stuff people can afford to buy.
The Fed, aided and abetted by the credit industry, tries to
keep people buying with lower interest rates... and ever-
looser credit policies (we read in the paper that interest-
only mortgages are becoming common... and that the average
automobile is financed for more than 4 years) but this too
begets its own perverse reward. The debt bubble must
deflate, just like all the rest of the Fed's bubbles. When
interest rates rise - as they have begun to do - the burden
of debt becomes heavier and consumers must cut back their
spending and pay down their debt. Many people will not be
able to pay their debts; they will default, causing further
default and bankruptcies up and down the credit chain.
As we said, this pattern is now becoming unmistakable -
even to economists. But inside this Devil's Brew is the
wild and mysterious dollar itself. How long will people
accept these pieces of paper as though they were real
money? How far down will it go? What will happen to the
world financial system when its reserve currency collapses?
If anyone knows, he is not working here at the worldwide
headquarters of the Daily Reckoning.
Over to you, Eric...
--------------
Eric Fry, freshly returned from the Agora Wealth
Symposium...
- The Dow added 130 points last week to 9,322, while the
Nasdaq jumped 3.5% to 1,702. The gold price also continued
its sparkling advance by gaining $6.90 to $363.80 an ounce.
But woe is the bond market, as Treasury prices resumed
their stunning two-month collapse and bond yields soared to
fresh one-year highs - the 10-year Treasury note yield
rocketed to 4.52% last Friday from 4.19% the prior Friday.
- Last week, while one half of the Daily Reckoning's Paris
brain trust built sand castles in Brittany and the other
half retreated to his castle in Ouzilly, the New York
contingent eschewed such regal pastimes... opting instead to
mingle with his fellow commoners in San Francisco.
Together, the commoners convened at the Agora Wealth
Symposium to study and debate how they might extract an
extra sou or two from the grudging financial markets.
- In response to the all-important question:"Where is the
stock market heading next?", a large percentage of those
assembled responded,"Up." An equally large percentage
answered,"Down." The remainder believed that the market
would either go up first, then down... or down first, then
up.
- Happily, very few of the symposium's speakers bothered
with such fruitless financial Gnosticism, although some of
them tossed out predictions just for the fun of it. The
always-controversial Dan Denning, editor of Strategic
Investment, predicted that the Dow would hit 7,825 -
"Exactly," he joked - within the next six months.
- Dan also predicted the"end of the world as we know
it"... timing uncertain. Dan admitted that he had provided a
similarly apocalyptic forecast last year, and allowed that
he might do so next year. In other words, his doom and
gloom outlook is more a philosophical framework for
investing than a Nostradamus-style prediction.
- Helpfully, Dan provided a series of trades by which to
prosper from our imminent collective demise. He advocated
bearish positions on long-dated Treasury bonds, as well as
on various stock market sectors that are sensitive to
rising interest rates - homebuilders and mortgage lenders
being prominent examples.
- Dan suggested to the audience, as he has been suggesting
to his readers, that they establish such positions via
exchange-traded funds, a.k.a., ETFs."For example," said
Dan,"one way to play the upcoming collapse of the housing
market would be to buy put options on the Housing Sector
Index (HGX)."
- Denning also expressed a fondness for bearish positions
on"IEF," which is the Lehman Brothers 7-10 year Treasury
note fund. [For more on how to conduct these trades, see:
Strategic Options Alert
http://www.agora-inc.com/reports/STA/WiseGains/ ]
- Denning concluded his remarks with his most titillating
prediction:"Later this year, Hillary Clinton will declare
her candidacy for President. She will run against George
Bush and defeat him in the 2004 elections, after which 25%
of the people who are sitting in this room will pack up
their possessions and join Bill Bonner in France as
exiles."
- Despite his flair for the bizarre - like wearing a green
sarong in Paris - Dan Denning is actually a very reasonable
fellow. One evening, over a glass of wine (Dan's third,
your New York editor's first) in the elegant lobby of the
Fairmont Hotel, Dan volunteered,"You know what would help
people to become much more intelligent investors?... If they
imagined that they were on the hook personally for a
company's losses, and not just in line to share in its
prosperity."
-"Hmmm... nice idea," came the response.
-"I just got this idea," Dan continued,"by reading Robert
J. Shiller's book, 'The New Financial Order.' Here, take a
look at this passage about the origins of limited liability
companies in America." Writes Shiller:"Before the passage
of this law, investors could in principle lose their homes,
life savings, and everything else, and even conceivably end
up in debtors' prison, simply by owning a few shares in a
company that later fails."
-"Wow, you're right about this, Dan," said your New York
editor."If all investors were to adopt this mindset, the
stock market would be a very different place... So let's
bring back debtors' prisons and restore order in the stock
market. What do you say?"
-"I'm in!" said Dan.
------------
Bill Bonner, back in Ouzilly...
*** We are on vacation.
We have gathered the family here in rural France and are
enjoying life. At least, that was the idea. It was why we
bought the place. Each summer, we said to ourselves, we
would follow the French example. We would take the month of
August off... and invite all the family to come and stay.
Then, we imagined the happy sun-lit days... gaily scraping
the paint off rusty shutters or collecting green beans from
the garden... and the long evening meals... outside on
trestle tables... with all the family in one place... and
plenty of red wine.
What is the point of it, otherwise? Why bother with all
this 'getting and spending' if you have no time left to
spend time with the people that matter to you most?
And so they came... all six children... mother-in-
laws... nieces... nephews... brothers and
sisters... friends... friends of friends... and a few people
of whom no one seemed able to identify the provenance. And
the children brought their boyfriends... and
girlfriends... who then had friends... and relatives of their
own..
Oh... it was almost too glorious...
But this year, the weather turned vile. The temperature
rose to nearly 40 degrees centigrade... which was over 100.
Every day, we closed all the windows, and shutters, and
curtains, trying to keep out the hot midday air. There, in
the dark, the parents lay about as though they had come
down with consumption and been sent to the tropics for a
cure. The children didn't know quite what to do with
themselves. They would have normally gone down to the pond
to catch frogs... or played badminton or croquet on the
lawn... or taken a ride on the bicycles. But it was too hot,
so they stayed indoors and played board games, or chess, or
just got on everyone's nerves...
And there was Donovan in the kitchen. He too came as the
friend of a friend, and showed himself particularly at ease
in the kitchen... and so he was hired to help keep this vast
menagerie fed. Donovan is Swiss (his parents were fond of a
certain Anglo-Irish balladeer in the '60s). He speaks a few
words of English. But French is his mother tongue. And
there he was, sweat dripping from his nose... a cigarette in
his mouth... ashes and perspiration falling into the
soup... children running about underfoot... and finally
Donovan seemed to lose his temper. He had been trying to
listen to Verdi on the radio, but Henry was strumming a
guitar... Annabelle was chattering to no one in
particular... and Edward seemed to be doing skateboard
stunts next to the porcelaine de Limoges.
All of this activity in the kitchen just seemed like too
much for him. He is an artist, after all. He picked up a
meat cleaver and began cleaving it in the children's
direction. They had noticed this tendency towards violence
in Donovan before... and all decided to beat a quick retreat
out the kitchen door.
But all of that is behind us now. The Feast of the
Assumption came on Friday... and, as everyone in rural
France knows, it brought a dramatic change in the weather.
The days are suddenly cool and cloudy.
Edward shifted his stunts to the veranda, where he has
already sustained a gash over his left eye when the
skateboard attacked him. Henry is still hacking away at the
guitar... but outside. Sophia's boyfriend and Jules are
trying to fix an old motorbike. And a whole group has gone
off to visit the chateaux of the Loire valley.
Everyone is outside except your editor. Loyal to his post,
he continues to write to you, dear reader... and from time
to time (and here he lets you in on a secret) - he longs
for September.
***"I've never seen it like this," said Pierre on
Saturday.
He was referring to the way the hot weather and drought had
dried out the trees. The grass has turned brown and is now
covered with gold leaves that crackle underfoot. It is
strangely beautiful, especially in the evening, when the
low sun passes through dried-out leaves and sends a
yellowish light out over everything.
The Daily Reckoning PRESENTS: The Mogambo Guru applies the
rule of 72 to the expanding supply of US dollars... and
tumbles into a catatonic stupor.
PILGRIM, PREPARE THYSELF
by The Mogambo Guru
Last week in Zimbabwe, their currency, the Zimbabwe dollar,
fell to 6,000 to the U.S. dollar. Back a few years ago, it
was trading almost to a par with the U.S. dollar.
I know that you think I am going to work myself into a fit
of hysterical outrage about the situation in Zimbabwe, but
I am not. It's been going on for years already, and we have
the pretty exact same thing happening right here in the
USA, so what's new, eh?
Rather, what I am going to do is to use it as an object
lesson in the power of gold. When the Z$ was selling at par
with the US$, gold was, let's say, three hundred bucks an
ounce, give or take. Suppose you, being the genius
Zimbabwean dude or dudette that you are, correctly foresaw
the coming collapse of the Z$, and you cleverly converted
all your Zimbabwe money into ounces of gold. You paid Z$300
per ounce. Of course, by being a"gold bug," you had to
endure the taunts and ridicule of your neighbors and family
members.
Fast forward to today. What is that ounce of gold worth?
The answer is Z$1,800,000 per ounce. Now, to the ordinary
man on the street, an investment that turns 300 currency
units into 1,800,000 currency units is a home run! A hands-
down winner of any investing competition you can name!
Compounding that over twenty freaking years, it comes out
to an annual return of 54.5%! Even compounding that over
forty years, forty freaking years, it STILL comes out to
24.3% per year!
Jeez, Louise! What more can you ASK from a damn investment?
But, as you are aware, it is just another example of money
illusion. A loaf of bread that used to cost one Z$ now
costs, one must assume, somewhere around Z$6,000, and that
is why most Zimbabweans are starving and grumpy. So in
terms of sheer wealth, you, as a clear-thinking Zimbabwean
of genius and foresight, are not really any richer when
wealth is computed in loaves of bread. But gold sure kept
you from being poorer! Unlike the persons who trusted the
fiat currency known as the Zimbabwean dollar, who ARE
poorer, and are now desperately and literally starving and
on the verge of revolution, you circumvented the whole
disaster. How special.
Now, you spend your days thinking about how you suffered
when everyone made fun of you as a 'gold bug,' and now you
now get to ridicule them for being 'fiat currency bugs,'
and you are dissatisfied how that just doesn't seem to have
the requisite biting acid sound that you were looking for,
and it sounds kinda stupid, too.
Where is the justice, eh?
Leaving Zimbabwe, which is probably good advice, we
traverse the cold Atlantic Ocean back to the good old USA,
and we turn our attention to the U.S. dollar, and see how
THAT currency unit is faring. It's going down. And now we
note how the price of gold is faring against the dollar.
It's going up.
Why? Here's a pot-shot at the answer: Doug Noland, that
brilliant dude who makes his living over at The Prudent
Bear unearthing economic factoids that turn the blood of
thinking humans into stone, has looked at the numbers and
concluded, and I quote,"The money supply has now doubled
since May 1995."
Just like that.
In a little over eight years, the money supply has, let me
check that quote again, doubled. So how does that famous
Rule of 72 go? The one financial planners use to figure out
how quickly their clients will go broke? Oh yeah, divide 8
into 72 to see what that figures out to as some annual
percentage. Ok, grabbing the calculator and the instruction
book we look up"How to divide one number by another" and,
over the next half hour or so we manage to successfully
divide 72 by 8 and get, let me check that number again,
ummm, 9%.
So the money supply, by the Rule of 72, has been increasing
at 9% per year. Not content with that, we seek a second
opinion, and use 2 as our future value, 1 as the present
value, the period equal to 8, and solving for the exact
compounding interest rate, it is also about 9%, maybe a
little more.
Or, in a different way, we nervously note that the class is
almost over, and so I cleverly sum up by picking up a piece
of chalk and writing numbers at random all over the
blackboard, at the same time as I say, in a ridiculous
clipped Austrian accent as my pathetic way of showing
solidarity with Arnold Schwarzenegger, an Austrian who is
running for the governor of California,"Zee money supply
ist compounding at der 9%, und der GDP ist expanding by
less dann 2%, ja? Und zo der prices, vitch vee will call
'Der price X at time T sub-N,' MUSSEN be rising at, over
der geshlugginer long term, der price inflation at 7%,
nicht wahr?"
Students later recalled that my face suddenly went ashen at
the prospect of a few years of 7% price inflation. As they
left the room, it seemed as if I had slipped into a
catatonic state, and I stood there transfixed by the horror
of what I had just written.
The night janitor would later make the statement that he
repeatedly saw me bent over my desk as he went about his
janitorial duties in the otherwise-deserted building,
working with a calculator through the night, the desk and
the floor covered with a layer of coffee cups and cigarette
butts and reams of discarded scraps of paper with scribbled
numbers all over them, looking more and more haggard and
depressed, endlessly calculating and re-calculating the
price of Oreo cookies at the end of each period of
retirement at a constant 7% inflation. To see me moaning
and groaning at the results would have broken your heart.
So, since incomes are not sufficient to live on anymore,
and destined to get worse, I can only say"Pilgrim, prepare
thyself." Brace yourself for calls for a higher minimum
wage, 'living wages,' more protectionist legislation, more
tax rebates, more taxes and fees, more deficits, etc. It is
that 'etc.' that is so scary, as it is an umbrella term for
any and every way that the government can intervene in the
workings of the economy. I shall assume that you are aware
of the results of a government intervening in an economy,
and I will wait for your hands to stop shaking in fear.
Feeling better now? Actually, that's the GOOD news.
The bad news is that, after all these decades of the
government getting bigger and bigger, the government IS the
economy.
Regards,
The Mogambo Guru
for The Daily Reckoning
P.S."Counties, cities, towns and villages across the
country will continue to have little choice but to borrow
to meet essential project needs," Mr. Noland notes,"even
if they do cut back on other spending."
To be sure, long-term municipal issuance is, and I quote,
"on target for yet another record-breaking year." The
record of $357.1 billion was set just last year. About
three thousand dollars in new debt, increasing the debt
burden for every private-sector worker in the country by
over $3,000 each.
Mogambo Sez: The Chinese have placed an order for a billion
chip-implanted ID cards for the citizens. This is truly the
beginning of the ascendancy of the Chinese economy, as all
they needed was a way to get credit extended to enable the
gigantic pent-up demand. And now they have it. Americans,
ask not for whom the bell tolls, for it tolls for thee.

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