The Daily Reckoning - Flight To Imbecility

verfasst von Firmian, 12.09.2003, 21:42

-->Flight To Imbecility

The Daily Reckoning

Paris, France

Friday, 12 September 2003

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

*** Chinese under pressure... what will happen if they
revalue the yuan?

*** New Yorkers edgy... jobless claims edging up... mortgage
delinquencies edging up... foreign holdings of Treasuries
edging up... life insurance premiums for Swedish politicians
edging up...

*** Flypaper Strategy... and another good man down...

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

Today's news is scarcely worth reporting. The Dow went down
slightly. Gold dipped slightly, too. The dollar stayed
about where it was.

None of it means much.

So we cast our new eyes around the world and wonder what is
going on. And nowhere is more going on than in China, where
GDP has been growing 4 times as fast as in the U.S.. And it
is real GDP - not phony numbers puffed up by debt and
military spending. By all measures, the Chinese are
actually producing more goods and services at a remarkable
rate.

Still, the Chinese economy is nearly as dependent on U.S.
debt as the American economy; don't forget, the former is
just the latest bubble created by the Dollar Standard
system. American households now borrow 11 cents of every
dollar they spend. Much of that money finds its way to Wal-
Mart... and then to China, where factories work overtime
trying to keep up with U.S. demand.

"Fears grow that China is overheating," say the worrywarts
at the Financial Times.

"China on High Alert on Influx of Speculative Capital," a
headline from the People's Daily tells us.

And all over the world, political leaders are beginning to
gang up on China."Unfair," say they of China's policy of
fixing its money to the world's reserve currency, the
dollar. The Chinese have faithfully maintained the yuan at
8.3 to the dollar for nearly 10 years. Now that their own
economies are having trouble competing, the Finance
ministers of other countries - notably the U.S. and France
- think they spot an injustice... or an opportunity.

Pressure, both political and economic, is growing for a
revaluation of the yuan. It may happen. But would it be the
end of China's incipient bubble?

Not necessarily. As we pointed out yesterday, even a big
increase in the yuan would not eliminate China's advantage
in cheap labor. In fact, a more expensive yuan may actually
help stretch out the bubble.

In the mid-'80s, Japan was the world's fastest-growing
economy. Like China today, Japan attracted the rest of the
world's envy... and disapproval. In 1985, at the Plaza Hotel
in N.Y., Japan was the center of attention of the world's
finance ministers, who demanded that Japan let its currency
rise against the dollar.

The effects were as unexpected as they were dramatic. At
first, Japan's economy was knocked off its feet; suddenly,
its products were nearly 50% more expensive on world
markets. Fighting back, the Japanese did what Greenspan
does - they cut rates and eased banking rules. In a few
months, the whole country was booming again... and
attracting billions in speculative money from abroad. The
result was a bubble as absurd as America's tech bubble of
the late '90s. Japan's bubble finally blew up in January of
1990; America's bubble popped almost exactly 10 years
later.

Now it is China's turn.

Chinese stocks, and Asian stocks generally, are still
relatively cheap... and still under-represented in
international investment portfolios. Typically, portfolio
managers assign about half their global assets to U.S.
markets. Only 11% is given to investments in Asia, which,
as Marc Faber points out, is"already the world's largest
economic bloc with 3.6 billion people and the world's most
favorable growth prospects.

"I believe that investors should allocate at least 50% of
the money they invest in equities to Asia," Faber
concludes,"where... valuations are far lower and growth
prospects more favorable than in the U.S."

So, go ahead. Buy China. Just don't forget to sell too
soon... while the exits are still clear.

Eric, what say ye?

-----------

Eric Fry, checking in from the Big Apple...

- As if anyone needed reminding, yesterday was September
11th. We New Yorkers tried to behave as though it were an
ordinary day. But a vague sense of paranoia was difficult
to suppress.

-"Are you worried about riding the subway today, Eric?" an
acquaintance asked your New York editor yesterday morning.

-"Nah, I don't think so," came the reply, immediately
before your New York editor walked out of Grand Central
Station to Lexington Avenue and hailed a cab to Lower
Manhattan. He would ride a subway later in the day, but not
without a bit of unease.

- Happily, September 11, 2003 came and went without
incident, which allowed New Yorkers to serenely remember
the wretched tragedy of September 11, 2001, and to pay
homage to the victims. The NYSE's opening bell was rung by
family members of stock exchange employees who perished on
Sept. 11th. The bell-ringers were escorted to the podium by
the NYSE's multi-million dollar bell-ringer himself, Dick
Grasso.

- Additionally, the U.S. financial markets observed four
separate moments of silence yesterday: 8:46 a.m., when the
first hijacked plane struck the North Tower; 9:03 a.m., the
time the second plane hit the South Tower; 9:59 a.m., when
the South Tower fell; and 10:29 a.m., the time of the North
Tower's fall.

- Except for these four brief moments of silence, the NYSE
was the same old raucous casino that it always is. Indeed,
investment activity on the stock exchange was rather
festive. The Dow Jones Industrial Average climbed 39 points
to 9,460, while the Nasdaq Composite rallied 1.2%, to
1,846. America's patriotic investors buoyed share prices
with a flood of buy orders, just like they did in the weeks
following 9/11.

- Remember when short-selling was an act of treason and all
red-blooded Americans were expected to buy overpriced
stocks, even if they didn't really want them? Well, we are
pleased to report that the patriotic buyers of stocks in
September of 2001 are finally back to break-even, assuming
that the gut-wrenching declines that occurred between then
and now did not spook them out of their holdings with steep
losses. The Dow is down 1.5% from its closing level on
Sept. 10, 2001, while the Nasdaq is up almost 9% from its
pre-attack reading.

- We here at the Daily Reckoning have been remarking about
the perils of September. James Stack of Investech Research
provides a few more historical details...

-"Let's face it, September is a BAD month for the stock
market," writes Stack."Last year saw an 11% decline in the
S&P 500 Index - the largest decline for any month of the
entire 3-year bear market. The previous September in 2001
experienced an 8.2% loss - making it only the third largest
monthly decline of the bear. Neither the S&P 500
Index... nor the DJIA... nor the Nasdaq has seen a positive
September gain since 1998."

- But September 2003 is gamely bucking the trend... so far.
This particular September has been kind to stock investors,
but it has been brutal to the nation's laborers. The
economy is shedding jobs faster than the Dow is adding
points.

- Weekly jobless claims jumped again last week to 422,000 -
the second consecutive claims figure above 400,000 and the
highest reading in two months. September's dismal jobless
claims reports are merely a continuation of a months-long
trend. The economy unexpectedly lost 93,000 jobs in August,
the most since March, according to the Labor Department.

- Not surprisingly, the mounting job losses are
contributing to rising credit delinquencies."More
homeowners were behind on their mortgage payments in the
last quarter as job losses put a strain on some households'
budgets," the Associated Press reports."The seasonally
adjusted percentage of mortgage payments 30 or more days
past due for all home loans rose to 4.62 percent in the
April to June quarter, up sharply from 4.52 percent in the
first three months of this year, the Mortgage Bankers
Association of America reported."

- Apparently, consumers without jobs don't pay their
mortgages on time. But not to worry, they will always find
a way to buy a couple hundred shares of Fannie Mae, or
Cisco Systems.

-----------

Bill Bonner, back in Paris...

***"Foreign holdings of U.S. Treasuries Hit Record 46%,"
says a headline in the Financial Times. Who are the major
buyers? Asian banks. Foreigners are expected to buy $775.4
billion of U.S. bonds this year.

"Should the day come when Asians have more confidence in
their own economic bloc (which I think will happen in the
next few years)," writes Marc Faber,"we could see a
massive shift of assets from the U.S. to Asia, with Asian
financial assets and Asian currencies raising very strongly
against the dollar."

*** Elsewhere in the news, Europeans are wringing their
hands over the death of the Swedish foreign affairs
minister, an attractive woman who seemed likely to become
Prime Minister.

Anna Lindh was stabbed as she did her grocery shopping,
unprotected by security guards. You see, in Europe -
especially in the Scandinavian countries - politicians do
not have praetorian guards protecting them. They often live
like ordinary people and take their chances. A friend
reported, for example, that he saw France's Prime Minister,
Jean-Pierre Raffarin, on the same train we normally take,
headed out to the country for the weekend, like everyone
else.

"It's unfortunate, but this 'open society' can't continue,"
say various European pundits, recalling the killing of a
popular politician in Holland earlier this year, and the
murder of Olaf Palme, Sweden's Prime Minister, 17 years
ago.

And yet, what is charming about Europe is that it is so
relaxed and normal. Ministers, congressmen, and presidents
say outrageous things, but often go grocery shopping along
with everyone else. Losing a few politicians to homicidal
voters every once in a while seems like a small price to
pay for such a civilized society.

*** What the Pentagon sought, it seems to have wrought. The
Flypaper Strategy may be brilliant or it may be moronic,
but it seems to be attracting (or creating) terrorists.
Terrorists are said to grouping in Iraq, forming new
organizations, developing new tactics, devising new ways to
attack the Great Satan.

"Bin Laden's network is rallying new recruits to battle
U.S. forces in Iraq," says an account from yesterday's
news.

*** And this from our correspondent in South Africa,
entitled 'Another good man down':

"Just a short note to say I'm taking the plunge on
Saturday, finally getting married to Sabine, the German
girl I met at our offices last year.

"We're really looking forward to it, only problem is I'm in
a cast (torn ankle ligaments) after my bachelor's party and
my best man went to hospital for 9 stitches... As you can
guess, the party was a resounding success..."

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

The Daily Reckoning PRESENTS: Investors are up and
running... but whither do they go? Bill Bonner weighs in
with his judgment, below.


FLIGHT TO IMBECILITY
by Bill Bonner


"Just because every fiber of society and government wants
bond and housing price inflation to continue without
consequence does not mean that this will happen."

- Michael J. Burry


In a crisis, investors fly to safety; all of a sudden,
their attention shifts from return ON investment to return
OF investment. Bond buyers, typically headed down the yield
curve, will give up the gray skies of high-yielding debt in
favor of the more reliable weather offered by Treasuries.
'We'll at least get our money back,' they tell themselves.
Whatever else may happen, the U.S. government will pay...

.. even if it has to print the money.

Stock buyers, meanwhile, fly to quality by moving from
growth and momentum stocks towards those that offer value
and yield. Thus out of harm's way, they prepare to wait out
the crisis... cashing dividend checks.

But what about today's investor? He looks around him and
sees no menace, neither from the highest debt levels in
history, nor from the trillions in derivatives, nor from
rising unemployment, nor from falling profits, nor from
high stock prices, nor from the largest deficits in history
- both in government and trade. What should he do?

Get another pair of eyes, is our answer.

Instead, he has boarded a cheap flight to mediocrity... and
taken the entire market with him.

In the bond market, investors have favored junk over
quality."C-rated paper in aggregate has outperformed B-
rated paper by more than 3000 basis points since the market
low on October 10, 2002," writes Dr. Michael J. Burry of
Scion Capital (courtesy of Marc Faber).

And in the stock market, the most speculative tech stocks
have been the best performers - by far - so far this year.

"Just as the lowest-rated of junk bonds led the bond rally
during the first half of the year," Burry continues,"the
best stocks in terms of performance were the worst in terms
of quality."

There is the smart money and the dumb money. In normal
times, they are like Republicans and Democrats, not so
different from one another that you can tell them apart. A
stock trading at 10 times earnings, for example, may be too
expensive. Or it may be too cheap. Only time will tell.

Worse, for long periods of time, the dumb money actually
looks smart. Nothing raises the I.Q. of an investor faster
than seeing his shares go up; until a crisis changes
attitudes, even the dumbest investors think they are
geniuses.

As investors reach for higher-yielding bonds, for example,
they drive the junk up in price. Stock market investors,
meanwhile, rushing to buy shares of bad companies, push up
prices... making both the companies and themselves look like
winners.

But at extremes, the smart money and the dumb money part
company. We read in yesterday's news that insiders, usually
the smart money, sold $44 of stock for every $1 they
bought. Insiders are generally net sellers. But this ratio
is the highest ever. The smart money is taking advantage of
this opportunity to get out.

Looking back on the bubble years - 1997-2000 - we see who
was who. The smart money sold stocks. The dumb money bought
them. Smarter money sold stocks it didn't own. But the real
geniuses created the stocks investors wanted to buy.

Not all the money lost in the initial phase of the bear
market, 2000-2003, disappeared. Many companies - notably
Amazon.com - took advantage of investors' fearlessness to
create and sell stocks. Investors offered money with no
strings attached. The companies needed neither collateral
assets, profits, dividends, nor even a reasonable business
plan. Effectively, the money was free. Amazon and other
companies raised billions of dollars this way... which gave
them a cushion of cash, on which many fat derrières rest
even now.

On the other side, the dumb money bought Amazon at the
peak. Dumber money borrowed to buy the shares. And the
dumbest money of all was in the hands of corporate
managers, who borrowed money to buy back their own inflated
shares! The object of the game was to run up your share
price, issue millions of shares, and sell them to yokels
without a clue. But these corporate finance wizards
completely misunderstood what they were doing. Instead of
taking advantage of the dumb money, they bought the dumb
money's shares back - at higher prices. In this case, the
money was not merely dumb, but so severely retarded that
you would be doing it a favor by holding a pillow over its
head.

Where then is the dumb money now... and how can we take
advantage of it?

We don't know; we're just asking. But in the stock market,
it seems obvious; buyers of Krispy Kreme, financial stocks,
or builders are probably cruisin' for a bruisin'. The
stocks are expensive. As a general principle, the smart
money buys cheap and sells dear; the dumb money does the
opposite.

But how about people who are lending money at the lowest
yields in 40 years? Are they not providing capital at
astonishingly low rates? Shouldn't we borrow it... before
lenders look around and notice a possible crisis or two?
Foreign lenders, for example, won't they soon realize that
they have little to gain from a bond paying 5%... if the
dollar goes down 10%?

And there is the spectacle of people mortgaging their
houses for more than they are worth; what do we make of
that? Who is the greater fool... the borrower, or the
lender? It is hard to say; both seem to be headed towards a
disaster.

Theoretically, the lender is the expert; the borrower is
the rube. But, in their flight to mediocrity, mortgage
lenders have reached further and further for yield - going
after more and more marginal credit risks. Haven't they
created a situation in which both sides could be losers?

The lender stands to lose from a boost in inflation rates.
Inflation would collapse the value of a fixed-rate
mortgage.

But inflation is no sure thing. The homeowner stands to
lose, too. Jobs are disappearing. Pay levels are
stagnating. Deflation would make it harder for him to make
his mortgage payments. And if his house fell in value,
maybe he wouldn't want to.

An adjustable rate mechanism would protect the lender from
inflation... but then again, not if the borrower can't pay.

In a real crisis, over-stretched homeowners couldn't
continue servicing their mortgages. Already going bankrupt
at the highest rates in recent history, millions more could
go down if a genuine recession were to begin. Most likely,
Fannie Mae, Freddie Mac and other mortgage lenders would
soon be insolvent, too.

What about gold? Who is the chump? The buyer or the seller?
We don't know, of course, but trading the Dow stocks for 26
ounces of it seems almost like a giveaway; you get 26 times
more for your money than you would have 23 years ago. Back
then, the dumbest thing you could do was to trade the Dow
for a single ounce of gold. Over the next 20 years, the Dow
went up 1,100%, while the gold price got cut in half. Of
course, that was a period of crisis - when investors took
flight for quality. The Dow may have been cheap, they
reasoned, but gold was sure.

They were wrong. And now they probably are wrong again -
but in the opposite direction. Now there are crises waiting
for them everywhere, but they don't see them. Instead of
flying to quality... they scoot off towards mediocrity, and
imbecility. They take up the worst deals on Wall Street,
and leave gold untouched.


Bill Bonner

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• The Daily Reckoning - Flight To Imbecility - Firmian, 12.09.2003, 21:42