The Daily Reckoning - Ponzi Economy

verfasst von Firmian, 09.09.2003, 20:40

-->Ponzi Economy

The Daily Reckoning

Paris, France

Tuesday, 9 September 2003

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

*** How we got into this mess... how we'll get out...

*** Deficit explodes... stocks rise... but 'devoid of
value'...

*** Globalization... 'No comment' from the chocolate making
countries... and more!

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

We now understand, more or less, how we got into this mess.
We are waiting to find out how we get out.

Or, maybe we should say 'messes': one economic... the other
political. One tragic... the other pathetic.

Debt and war start off with high expectations. But, like
love affairs and camping trips, things usually begin to go
wrong almost from the get-go. Finally, the campers return,
looking as though it must have rained all weekend, and are
almost always happy to be back home.

Sunday, the American president delivered some depressing
news: we will be in Iraq for a very long time, and it will
cost much more money than we thought. According to today's
Figaro, the U.S. deficit will rise even higher than we
projected - to $600 billion.

What historians will make of the war, we cannot know.
Perhaps it will be written off as an errant folly
perpetrated by a pack of imbeciles - Bush, Rice, Rumsfeld,
Rove, Perle and the rest of them. Or, maybe the adventure
will have an unexpected twist, which miraculously
transforms the neo-cons into geniuses and heros. More
below...

But what of the economic mess? You understand how it
developed. Once the U.S. no longer had to settle its
accounts in gold... it could spend, spend, spend...

.. which lit a fire under foreign producers, who realized
they could sell, sell, sell...

While protesters railed against 'globalization' and
deregulation... worrying on the one hand that they were
stealing jobs from the developed world, and on the other
that they were exploiting people in poor countries... they
missed the cause: Nixon's Dollar Standard system.

But now we see even the 'anti-globablization' intellectuals
catching on:

"[G]lobalization was triggered by elected politicians, and
central bankers, in both the U.S. and the U.K.," says a
report from the New Economic Foundation."In the post-
Vietnam war era, led by Richard Nixon and later Ronald
Reagan, these politicians sought ways to avoid making the
'structural adjustments' necessary to the American economy
if debts incurred by foreign wars were to be repaid by U.S.
taxpayers. Rather, these politicians preferred to disband
the existing system of paying off debts by exchanging gold,
and opening up capital markets, so that the U.S. could
borrow to pay off its debts.

"This new arrangement also allowed them to print the money
in which they paid off those debts (unlike poor countries
which have to repay debts in foreign currencies like
dollars or sterling). British politicians and central
bankers were only too happy to act as U.S. intermediaries
in the capital markets. Together they constructed a new
financial architecture that effectively obliges central
banks of both rich and poor countries to lend to the U.S. -
by buying U.S. Treasury bills (debt).

"It is US treasury bills that have now effectively become
the world's reserve currency - where once that reserve
currency was neutral (gold)... It is this international
financial system that makes the U.S. administration so
arrogant in its refusal to 'adjust' its economy by cutting
spending and paying its way... It is this financial system
which makes U.S. financiers so confident that the rest of
the world will continue to finance their nation's
extravagant spending binge. In the words of David Goldman,
head of debt research at Bank of America Securities:
'America is at little risk for the foreseeable future,
simply because the world's capital has nowhere else to
go'(Wall Street Journal, 13 August 2003).

"The Real World Economic Outlook challenges that view.
There is now a growing consensus that the vast build-up of
household, corporate, state and foreign debts of the U.S.
is not sustainable. Some central banks are already
switching out of U.S. dollars and into euros. When capital
flows shift away from the U.S., and there are recent signs
of this happening, Alan Greenspan may have to raise
interest rates to attract capital back into the U.S. to
fund the growing federal, state and foreign deficits.
Indeed, the bond markets seem to be signalling that they
expect this to happen quite soon.

"When interest rates begin to rise again, when debt costs
soar both for corporates and households, when defaults and
bankruptcies increase more rapidly than now - then the
'tipping point' will be reached."

When that happens... Americans will go bankrupt, their
standards of living will be reduced... they will have to
save, save, save... and the greatest credit bubble in
history will deflate.

Eric?

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

Eric Fry in the city that never sleeps...

- So many, many wonderful things are happening in the world
today that it is impossible to determine precisely which
wonderful thing is responsible for making stocks go up. Is
it the fact that President Bush would like to ship another
$87 billion dollars over to Iraq for immediate disposal? Or
is it the fact that our economic recovery is producing
steady job losses instead of steady job gains? Or is it,
maybe, the fact that bond yields are climbing faster than
they did during the months leading up to the 1987 crash?

- Whatever the reason, investors keep showing up every day
to buy stocks, especially tech stocks. Yesterday, tech and
biotech stocks powered the Nasdaq to an 18-month high. The
'techy' index jumped 1.5% to 1,887. The Dow advanced 90
points to 9,593, as it continued trudging toward 10,000.
But the Dow is merely a follower; it is the Nasdaq that
leads the way. The marvelous Nasdaq Composite has racked up
an astounding 41% gain year-to-date.

- One distinguishing trait of the Nasdaq's 'echo bubble' of
2003 is that investors, once again, are heeding the advice
of Wall Street analysts, as if the analysts really knew
something. When the analysts say"Buy," the lumps buy, just
like they used to do in 1999. And when the analysts say
"Sell"... Gotcha! Analysts don't ever say"sell."

- Interestingly, Wall Street analysts are much more
confident about the U.S. technology sector's 'recovery'
than are the tech industry insiders themselves. Yesterday,
CS First Boston upgraded IBM to an 'outperform' rating from
a 'neutral,' and also raised its 2004 earnings forecast for
Big Blue.

- Smith Barney also did some cheerleading by raising its
rating on the semiconductor equipment group to 'overweight'
from 'market weight' on the hope that an improving economic
will trigger a revival in the sector. Smith Barney expects
industry sales to grow 20 percent in 2004 and 30 percent in
2005. But if the sales fail to materialize, the brokerage
firm may be forced to change its rating on the industry
group to 'lead weight.'

- Merrill Lynch's Richard Bernstein offered a bold contrary
call on the tech sector yesterday - calling it"devoid of
value by any reasonable valuation method." In the current
market environment, however, 'devoid of value' is another
way of saying 'great-performing stock.'

- We are happy that our stock-buying brethren are enjoying
this best of all possible worlds, and that buying richly
priced stocks is once again a fruitful activity... assuming
that one does not forget to sell them before they become
cheaply priced stocks. We would not know when to sell an
overpriced stock if we owned one, because we would not know
when to buy it in the first place. So, instead, we will
stand aside while the intrepid stock-buying
lumpeninvestoriat becomes rich together... and then poor
together.

- The dollar attempted to rally yesterday morning, but
squandered its early gains. Ditto the bond market. Treasury
bonds broke a three-day winning streak yesterday, as the
10-year Treasury note's yield jumped to 4.41 percent from
4.35 percent at the previous close.

- Maybe a few of the folks out in Investorland are
beginning to wonder where the United States will find all
of the billions of dollars required to pay for the Iraqi
occupation, while still paying for all the other swell
stuff that our tax dollars support, like maintaining
Yellowstone Park, paving roads, dispensing welfare checks
and bankrolling the New York Attorney General's posse.

- Where will the U.S. government (and the state
governments) find the money for all of these things? Will
it print the stuff, borrow money from foreigners, or both?

- Even before President Bush declared the need to spend an
additional $87 billion in Iraq and Afghanistan, the
Congressional Budget Office was projecting a record $455
billion budget shortfall this year. A $480 billion funding
gap is expected to follow next fiscal year.

- Treasury-bond holders and dollar holders are becoming
understandably antsy about America's soaring federal
deficit... and understandably reluctant to continue holding
dollars and bonds. But stock holders don't care about such
matters. Let bond investors worry about such things. They
know that all is well, as long as Cisco's earnings will be
higher next quarter and as long as consumers continue
spending money they don't have on things they don't need.

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

Bill Bonner, back in Paris...

*** The news is all over the frog papers; the French love
it. We mean, the spectacle of George W. Bush asking for
their help.

Who was it... Rumsfeld? Perle? You remember, dear reader, we
quoted him here."Why would anyone bother going to lobby
Jacques Chirac," he asked,"except if you wanted to change
the cheese or something."

Well, now the American president is asking the 'chocolate-
making countries' to help bail him out in Iraq. Well,
that's how the French press is reporting it. Columnists are
wallowing in a delicious schadenfreude; headlines
practically smirk: 'I told you so.'

"We might ask a few questions," before coming to America's
aid, suggests Renaud Girard on the front page of the
Figaro.

Such as why America refused to give us air support when our
troops were surrounded by communists at Dien Bien Phu in
1954?

Or, why America failed to support a joint Anglo-French
campaign, in 1956, against an Arab dictator, Nasser, who
had clearly violated international law, by seizing the Suez
Canal?

Or, why the U.S. continuously harassed and criticized the
French for the way they tried to hold onto Algeria between
1954 and 1962?

On this last point, the French claim superior experience.
They too tried to hold onto to a predominantly Moslem
country, futilely as it turned out.

But the Pentagon is not above trying to learn from the
experience of others. Recently, the Defense Department
showed a 1965 film, The Battle of Algiers. The movie was
made by Gillo Portecorvo, who was then a member of the
communist party, and banned from visiting America. But now,
38 years later, his flick has made it to the Pentagon
theatre where military leaders are studying it to try to
understand what the French did wrong.

Of course, no one asked our advice - then or now. But had
we been asked, we would have given the same counsel to
DeGaulle as to Bush... as to Gustavos Adoplhus, Bonaparte or
Hitler... as to stock market investors... bond
buyers... debtors... campers and lovers everywhere: watch
out... the beginning is always more fun than the end.

*** Along the way, of course, many interesting investment
opportunities will arise. That's what we - with Richard
Russell, Jim Rogers, Bob Prechter, Eric Fry, Addison Wiggin
- and host of other luminaries will be discussing when we
meet in New Orleans October 29th-November 2nd this year for:

The Investment Event Of The Decade!
http://www.oxfordclub.com/conferences/neworleans2003/home.cfm?id=2

I suspect it will be a bit more turbulent and outrageous
than last year's event. Hope you can make it.

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

The Daily Reckoning PRESENTS: Bullish sentiment is riding
at 1987 levels; tech stocks are leading the way in the
reflation rally. What can we say, dear reader, but"oh là
là... look out below!"


PONZI ECONOMY
By Kurt Richebächer

Hope and hype are again triumphing over reality.

The primary preoccupation in economics worldwide is the
U.S. economy's 'recovery', presently hyping the markets. We
note three different views. First, a cocksure bullish
consensus; second, doubtful voices, among them the Federal
Reserve, stressing the lack of conclusive evidence; and
third, a few lonely voices, ours among them, who flatly
repudiate the possibility of a full-scale, self-sustaining
economic recovery in the United States.

We see years of Japanese-style sluggish growth for America,
if not worse.

Yet, the latest American Association of Individual
Investors poll showed 71.4% bulls and a miniscule 8.6%
bears. The gap between the two is the highest since August
1987, just weeks before the crash. Merrill Lynch surveys
show institutional investors more fully invested than at
any time in the past two years, and heavily overweight high
tech.

The case of the bullish community rests crucially on the
assumption that the U.S. economy is basically in excellent
shape. Fed Chairman Alan Greenspan, and with him the large
bullish community, have actually never seen anything
seriously wrong with it.

In their view, its failure to return to normal economic
growth is mainly due to a series of exogenous shocks
inflicted one after the other on the economy: the stock
market crash, the September 11 terrorist attack, the
corporate governance scandals and the Iraq war. Rather,
they consider it a sign of health that the economy has not
weakened more in the face of this unusual sequence of
shocks.

Yet compared to the extraordinary exuberance prevailing in
the markets, the Fed has been remarkably hesitant in
declaring the economy's impending recovery. In his
testimony to Congress, Greenspan acknowledged that the
"economy is not yet showing convincing signs of a sustained
pickup in growth." In the same vein, Richmond Fed President
Alfred Broaddus said a bit later in an interview,"We still
don't have a critical mass of hard evidence that the
economy is accelerating," defining"hard evidence" as
increases in employment, production and capital spending.

Now to our own opinion: after careful analysis both of
recent economic data and also of basic micro- and
macroeconomic conditions for the resumption of strong
economic growth, we have come to two conclusions:

* First, the U.S. economy neither improved nor accelerated
in the second quarter. The reported GDP growth of 2.4% is
grossly misleading. From the perspective of quality, it has
distinctly deteriorated.

* Second, as we shall explain in detail, the crucial macro-
and microeconomic conditions for a self-sustaining and
self-reinforcing economic recovery remain flatly missing.
Necessary economic and financial adjustments of past
economic and financial excesses implicitly involve pain.
But pain is not accepted in the United States. In essence,
policymakers are trying to cure past borrowing excesses by
more of the same and new excesses.

Trying to assess the U.S. economy's prospects, the first
thing to realize is that past cyclical experience offers no
guidance to the present downturn because it has completely
different causes and also a completely different pattern.

All past recessions had their main cause in monetary
tightening. As soon as the Federal Reserve loosened its
shackles, the economy promptly took off again, propelled by
pent-up demand. For the first time in history, the U.S.
economy went into recession against the backdrop of most
rampant money and credit growth.

Manifestly, the forces depressing the economy this time are
radically different from past experience. The typical,
major imbalance in post-war business cycles has usually
been in inventories. To correct it, retailers and
manufacturers temporarily sold from stock, depressing
production. Once the stocks were down to desired levels,
production came into its right again. At the heart of the
regular V-shaped business cycles was the inventory cycle.

In contrast, the present downturn has its brunt in the
combination of a profit and capital-spending crisis. At the
same time, there has accumulated an array of economic and
financial dislocations that tend to depress the economy in
many ways, such as extremely poor profits, badly ravaged
balance sheets, a variety of asset bubbles in different
stages of development, excessive leverage in the whole
financial system and shrinking cash flow. There is nothing
normal anymore in the U.S. economy and its financial
system.

For the old economists, investment in tangible assets -
factories, commercial buildings and machinery - was paramount
in creating both economic growth and wealth. It creates
demand, employment and income as the capital goods are
produced. And with their installment, all these new
buildings, plant and equipment create increased supply
along with increasing employment and income with increased
productivity.

The United States has always been a low-savings and low-
investment economy. Putting it in reverse: a high-
consumption economy. But all three went to unprecedented
extremes over the past several years. Savings and
investment have been run down to atrociously low levels
that are typical for underdeveloped countries.

To repeat: Investment in tangible assets is paramount in
creating everything that is decisive in generating our
wealth and raising our living standards. Given the low
levels of saving and investment in the United States,
American policymakers and economists in recent years have
elevated productivity growth to the single most important
achievement of an economy. But just by itself, productivity
growth creates only unemployment. It is the normally
associated capital spending that makes for the necessary,
simultaneous demand and employment growth.

This simple recognition - gross lack of saving and capital
formation - is really at the root of our controversial and
highly critical view of the U.S. economy's sanity and
vitality. True, its growth rate has been the highest among
the industrial countries for years. But it has all the time
been economic growth of the most miserable quality. The
striking hallmarks of this extremely poor quality were
collapsing savings, low rates of business fixed investment,
a profit carnage that began at the height of the boom,
exploding consumer and business debts and an exploding
trade deficit.

Today's economists have at their disposal information in
quantity and speed as never before. But reading numerous
reports, we have the impression that very few are making
use of it.

Particularly shocking in this respect were the immediate
euphoric reports about growth acceleration in the second
quarter.

During the 1960-70s, by the way, the U.S. accumulated on
average about 1.5 dollars of additional debt for each
dollar of additional GDP. Just extrapolate this escalating
relationship between the use of debt and economic activity.
And think of it: the GDP growth of today is tomorrow a
thing of the past, while the debts incurred remain.

Plainly, Greenspan's policy has collapsed into uncontrolled
money and debt creation that has rapidly diminishing
returns on economic activity. The late economist Hyman P.
Mynsky would call this a Ponzi economy, where debt payments
on outstanding and soaring indebtedness are no longer met
out of current income, but through new borrowing. Soaring
unpaid interests become capitalized.


Regards,

Kurt Richebächer
For The Daily Reckoning

P.S. We keep asking the question of the American
economists: Are they providing deliberate misinformation or
simply performing slipshod work? In our view, as usual, the
latter rings true.

The whole economic discussion today is fixated on the next
economic data with one single question in mind: is it
better than expected? Careful, more detailed analysis with
a longer-term perspective is completely missing. Obviously,
most economists and journalists read no more than the brief
summaries provided by agencies, like Bloomberg and Reuters,
that only rehash the summaries preceding the official
releases.

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• The Daily Reckoning - Ponzi Economy - Firmian, 09.09.2003, 20:40