The Daily Reckoning - The Grand Illusion (Sean Corrigan)

verfasst von Firmian, 02.01.2004, 21:16

-->The Grand Illusion

The Daily Reckoning

Ouzilly, France

Tuesday, 30 December 2003

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

*** Dow up 125 points... clear sailing ahead, say investors.
Don't forget your life jacket, says the Daily Reckoning.

*** Best year for real estate in history - if you ignore
the currency... Bipolar problems...

*** Why middle-class moms and pops are going broke... orgy
of spending... dollar crisis... and more!

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

We see today's headlines... and maybe tomorrow's.

The Dow rose 125 points yesterday. Stocks are speeding to
the finish line this year - after a fine run.

Can so many millions of investors be wrong?"Clear sailing
ahead," they say.

"Don't forget to put on your life-jacket," we counter.

It has been a great year for stocks - if you ignore the
currency in which they are calibrated.

It has been a great year for real estate, too... subject to
the same objection. In fact, it has been the best year ever
for real estate - ever in history.

* A record 6.1 million homes were sold... up from 5.56
million in 2002.
* A record 1.1 million new houses were sold.
* A record $3.4 trillion in new mortgages were taken out -
equal to a third of the entire U.S. GDP.
* And the median house sold rose 9.1% in price during the
last 12 months.

Of course, adjusted for the drop in the dollar, the median
house is actually worth less now than it was at the
beginning of the year.

But who's in the mood for quibbles? The voters are having
their say; they want stocks and real estate to rise, while
they spend, spend, spend their way wealth. Hold the
kvetching... stop fretting about China or gold... who cares
about the deficits, debts, or the dollar?

The dollar fell again yesterday. It dropped to nearly $1.25
to the euro. The rent on our Paris apartment has risen
nearly 50% in the last 2 years. How low will the dollar go?
$1.50 is our near-term guess.

Gold rose to $415. How high will it go? $500 is our near-
term guess.

The big surprise, we continue to warn, may be a sudden
collapse of the dollar - beyond what anyone expects. Then,
like an unexpected eclipse of the sun... the world's economy
would see a darkness at noon that would astonish and alarm
almost everyone. Stocks, bonds, and real estate would all
crash. The U.S. economy would go into deep recession. The
whole world economy might follow. One way or another,
Americans will be forced to adjust to lower living
standards. Normally, we would expect a long, disagreeable
period of bear market, a falling dollar, and on-again, off-
again recession. But a short, vicious shock might be able
compress the pain into a few short years.

Yesterday, we also saw a headline that we thought we might
need to get used to."Grocery workers agree to slash pay,"
reported the Detroit paper. Elsewhere, the news came out
that few people got large holiday bonuses this year.

Americans are going to have to adjust to a smaller share of
the world's pie. They gobble up 86% of the entire world's
savings, but only create a third of its output. Year after
year, they consume more than they produce, spend more than
they can afford, and borrow more than they should.

Meanwhile, the foreign competition grows stronger day by
day. Chinese peasants - who, a few months ago, had never
even seen a computer - migrate to the cities and take up
jobs putting them together. Thanks to Americans' reckless
spending... they find a ready market for nearly everything
they make. And the more they make, the more they CAN
make... and fewer areas are left where Americans have a
clear and decisive advantage. In a globalized economy, how
can Americans hope to continue earning 10 times more than
their competitors?

We've already noticed the effect of competition at the low
end of the scale. Factory workers in America have seen
almost no increase in their real hourly earnings in the
last 30 years. Now, the competition is moving up the socio-
economic ladder. Even the middle class are finding
themselves on slippery rungs...

But so far, few notice...

Here's Eric with more news:

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

Eric Fry in the City that Never Sleeps...

- Yesterday, Eli Lilly won FDA approval for Symbyax, a new
drug to treat"bipolar disorder," also called manic
depression... Mr. Market could use a prescription. The drug
is a combination of two older Eli Lilly drugs:
antidepressant Prozac and anti-psychotic Zyprexa.

- Imagine, a pharmaceutical cure for bear markets!... A
regularly medicated Mr. Market might not subject investors
to the mood swings they've come to expect and to fear. By
taking Symbyax, Mr. Market could advance, point-by-point,
in carefully measured steps toward Abby Joseph Cohen's 2004
S&P 500 price target of 1,300.

- But what fun would that be? Without a bit of psychotic
behavior, the stock market would become as tedious as a
presidential debate. What's more, for the last several
months, the stock market has been far more manic than
depressive... and what investor doesn't love a good, old-
fashion mania?

- Stocks have been advancing so steadily for so many months
that most investors have forgotten all about the pain of
three-year bear markets. Once again, they are enjoying the
delirium that share prices will rise forever. Yesterday,
the Dow added to its gains for 2003 by jumping 125 points
to 10,450, while the Nasdaq vaulted 33 points to 2,006 -
its first close above 2,000 in nearly two years.

- Meanwhile, gold and the dollar continue waging their epic
monetary battle. Day-by-day, the forces of good - a.k.a.
gold - gain ground against the forces of evil - a.k.a. the
dollar. Gold jumped $2.50 to $415.30 - its highest close in
nearly eight years. The dollar slipped another half a
percent against the euro to a new record low of $1.248 per
euro.

- Curiously, the lumps don't seem to care about the
crumbling dollar. As long as American stocks are rising,
the withering value of America's currency is no big deal.
Net-net, the stock market bulls are firmly in command, and
there seems to be enough pent-up bullishness and irrational
exuberance floating around to buoy share prices into the
first part of next year.

-"It's hard to see what might prevent the market from
retaining its upside bias at the start of the year,"
Barron's remarks."Economic numbers have improved and
investors are happy to extrapolate them into a continuing
upward arc. Market technicians report that the index charts
lack serious vulnerability." The bulls also have the
presidential election cycle on their side. Election years
often produce stock market gains.

- Fundamentals aside, the stock market's greatest asset may
be the sheer momentum of rising share prices and giddy
bullish sentiment. Stocks are rising, simply because stocks
are rising... and the most speculative stocks are rising the
most of all.

- Perhaps stocks will rally throughout 2004, or perhaps
they will crash on January 2nd... We have not seen the
script. But we did come across a scenario that seems
plausible to us: Smith Barney's chief U.S. equity
strategist, Tobias Levkovich, expects the market to
continue higher early in the year, then slide lower
thereafter. Rising interest rates, he predicts, will halt
the market's rally and drive share prices lower.

- 2004 could resemble 1994, says the cautious strategist.
Stocks fell that year, even though GDP grew 4.2% and
corporate earnings surged 20%."In that mournful year,"
Barron's recalls,"benchmark Treasury yields rallied three
percentage points, as the Fed tightened credit."

- Luvkovich does not anticipate disaster, merely a decline.
Noting that the average P/E on S&P operating earnings since
1960 is 15.6, Luvkovich applies a 15.3 multiple to 2005
estimates of $67 to arrive at an S&P target of 1025 for
year-end '04.

- The Smith Barney strategist is alone among prominent Wall
Street pooh-bahs in calling for stocks to fall in 2004. The
stock market's lengthy rally has driven the bears close to
extinction once again, which, from a contrarian
perspective, is one of the very best reasons to distrust
this market. The widespread bullish sentiment on Wall
Street is one of the best reasons to trust that Luvkovich's
cautious forecast will prove correct... or too optimistic.

- More reasons tomorrow....

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

Bill Bonner, back in Ouzilly...

***"We're seeing another holiday orgy of spending by U.S.
consumers," reports the Detroit Free Press."Everywhere we
look, we're encouraged to spend, spend, spend. Budgets are
being squeezed by mounting credit card debt, student loans,
mortgage borrowing and, increasingly, by rising out-of-
pocket health care costs.

"The big question is: How much longer can we keep this up?

"Experts have mixed views. But a few things are clear. 'A
lot of people are dangerously close to the edge and any
minor setback could push them over,' said Amelia Warren
Tygai, co-author of 'The Two-Income Trap: Why Middle-Class
Mothers and Fathers are Going Broke,' ($26, Basic Books).
'And everyone should reassess his or her financial
condition for the new year and cut back wherever possible.'

"Unlike in past recessions, consumers kept borrowing during
the last downturn, which began in March 2001 and officially
ended in November 2001. The recession would have been far
worse if consumers didn't opt for zero-percent financing
deals and didn't keep pulling out credit cards.

"But all that spending - on top of a three-year downturn
for stock prices - hurt household balance sheets. We only
started seeing stock gains in spring of 2003.

"That was after the ratio of household liabilities to net
worth hit an all-time high of 22.6 percent in the first
quarter of 2003. Outstanding consumer credit, mortgage debt
and other debt hit $9.3 trillion by April 2003, up from $7
trillion in January 2000."

Ah, stop your worrying... it will all turn out okay.
Millions of Americans will go broke. But so what? Look on
the bright side. More may get through the eye of the needle
and into heaven.

***"Will there be a dollar crisis?" asks our friend Martin
Spring.

"The most astonishing figure I've seen reported in recent
weeks is the Japanese provision for currency intervention,
essentially to support the dollar. It's Y100 trillion -
about $930 billion at the current yen/dollar exchange rate.

"That's the amount of yen the Japanese central bank has
been authorized to borrow in a year to spend on buying
foreign currencies to hold down the yen's exchange rate.

"The mind-boggling size of the provision - about 50 per
cent greater than America's forecast foreign trade deficit
next year - alerts us to two conclusions:

* The Japanese authorities see a significant risk of a
major dollar crisis which would send money flooding into
alternative major currencies.

* If that happens, they are determined to keep a lid on the
yen - which would both help the dollar to resist decline
and divert most of the money flood into the euro.

[For more from Mr. Spring's, see his article on the DR
website:"A Dollar Crisis?"
http://www.dailyreckoning.com/body_headline.cfm?id=3651 ]

*** Has the"Era of REALLY Big Government" now arrived?"
asks the Independent Institute.

"Over the past three years, with inflation at record lows,
U.S. government spending has increased by a massive 28.3% -
with non-defense discretionary growth of 30.5% - producing
the largest deficit in U.S. history and the highest rate of
government growth since LBJ's"Guns-and-Butter" combination
of the Vietnam War and"Great Society."

"This explosion of government power has only been possible
in the aftermath of 9/11 as politicians take full advantage
of a frightened American public.

"During this time, President Bush has become the first U.S.
president since James Garfield (serving only in 1881 until
he was assassinated) and Millard Fillmore (1850-1853) NOT
to have vetoed a SINGLE bill, with the result that we now
have record pork spending and corporate welfare in
agriculture, education, Medicare, energy, defense,
transportation, foreign aid, homeland security, and more.
U.S. government agencies have furthermore been given new
powers to arrest and detain people indefinitely without
charge, legal counsel, or trial; to secretly search
anyone's property; and to intercept phone, Internet, and
other communications, as well as access health, financial,
and other private records."

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

The Daily Reckoning PRESENTS: Through the magic of the
printing press, the Fed has convinced investors that the
healing balm of"gentle" inflation will soothe away our
economic troubles...


THE GRAND ILLUSION
By Sean Corrigan

"Inflation tends not only to pressure, but to increase, the
maldistribution of labor between industries, which must
produce unemployment as soon as the inflation ceases."

- F.A. Hayek, Open or Repressed Inflation, 1969.


The failings of the Macromancers who dominate contemporary
economic reasoning can be encapsulated as follows: if you
can't leave the house because the trousers Granny has
bought for you are too long for your legs, you can solve
the lack of fit by trying them on while standing on a
chair.

To explain what we mean by this, let us start by conceding
that both Keynesians and Friedmanites - as well as the
majority of their derivative sub-cults - realize that if
there is a seeming surplus of labor, it is because it must
be priced too high in relation to the value to which it
will give rise.

Being politically cynical enough to presume that reducing
labor rates in money terms is more problematic than making
the money in which they are paid worth less, the recipe for
any business setback is thus the application of a little
judicious inflation. This doctrine is now so well ingrained
that the Norges Bank of Norway recently stated proudly that
its policy aim was"higher inflation" because the
prevailing rate was"too low."

This simplistic, aggregate approach overlooks at least one
critical fact: a general rise in prices carries no
guarantee that a struggling firm - which, presumably, is
struggling only because it has misjudged the relationship
prevailing between resource costs and consumer preferences
- will right itself, any more than the act of flooding a
lock can be reckoned to right the capsized dinghy
floundering inside it.

While we know a new inflation will build its usual
distortions under the veneer of a temporary prosperity
(mostly localized among those favored to receive the first
use of the new means of payment), we must remember also
Hayek's point that those dependent on the artificial
stimulus of inflation for their continuance will become so
addicted to it that they will sicken and die if that
inflation slows or is redirected.

To date in this so-called"jobless recovery," U.S.-driven
inflation has, in fact, succeeded in leading to more labor
being hired. However, to the collectivists' dismay, the new
labor is largely in China, where the labor distribution is
better adapted to U.S. spenders' needs and where total
relative labor costs are substantially lower than they are
in the U.S..

In this, U.S. consumers - sustaining their lifestyles not
from sufficient production of exchange value, but by using
borrowed money they have not earned - have been exhausting
the fruits of others' labor via the consumption of present
capital and the alienation of future income. Neither of
these trends can be maintained indefinitely in real terms,
though they can be monetarily disguised for long enough
that the damage can become severe before it is fully
recognized.

When their Chinese suppliers were saving a goodly
proportion of these proceeds and buying U.S. securities
with them, the secondary beneficiaries of the inflation,
thanks to this act of misguided largesse, worked in the
U.S. housing market and in what Robert Higgs calls the
Military-Industrial-Congressional Complex. Thus, America's
homebuilders, realtors, mortgage lenders, government
contractors, etc. all did well at home.

Further, the inflation made service providers such as banks
and insurance carriers, with their less open markets, all
the more lucrative, while poor old manufacturers were made
simultaneously to bear increased costs at home and
heightened competition from abroad.

Now, however, there has been a subtle shift. China, at
least, is saving much less and spending much more of the
money. Hence, commodity prices are up while the dollar is
down sharply.

Those businesses serving Asia's new retail clientele and
its emergent yuppies - as well, some allege, as those
serving China's own MICC hierarchy and its members' desire
for strategic stockpiles - are now the redirected
inflation's main beneficiaries, rather than the importunate
U.S. householder.

For China's booming industrial concerns - and, by
extension, for their Asian suppliers and investors - a
triple threat may emerge from this transformation:

* A policy of deliberate central bank restrictionism,
instituted in addition to the likely slower acquisition of
those dollar foreign exchange reserves that have so boosted
domestic money supply this far

* The burden of higher import costs due to the renminbi's
link to the sagging dollar (though a partial subsidy is
being granted by the currency interventions of such players
as the Bank of Japan)

* Greater competition for labor and capital resources from
domestic consumer industries whose customers' requirements
may, furthermore, be widely misaligned with the tastes of
their international counterparts who have been so well
served until now.

The corollary to all this is that, as the dollar falls,
there will be an initial boost to some - though not all -
U.S. industries. The greenback's decline should be
particularly beneficial to those firms that are relatively
sparing of energy use and that do not include a high degree
of import content (whether raw materials or components)
into their own final products.

With the effects of U.S. inflation having the potential no
longer to be so disguised and indirect as when it formerly
underwent an interim Asian transformation, housing and
finance may both suffer - at least, in the absence of a
more concerted effort on the part of the Fed to take up the
slack (more below). Conversely, makers and sellers of
manufactured goods might find the cost-price balance tilted
a little less heavily against them from here onward.
Indeed, manufacturing has shown tentative signs of
stabilization of late: sales, hours, and head count have
begun a slow ascent, and even inventory registered an
uptick last month.

Whichever industries best represent the various categories,
certainly there would now be scope for the creation of a
marginal extra incentive for employing capital and/or labor
in the U.S., as opposed to sending it all to the coastal
entrepots of the South China Sea.

But these tenuous"benefits" of inflationist policy in the
U.S. are illusionary at best. They will almost certainly
falter should the Fed step down its monetary efforts. The
Fed's actions are, in fact, analogous to wrapping a corpse
in an electric blanket, and then expecting that delaying
rigor mortis will also bring about a resurrection.

Before too long, the Fed may well find itself faced with
the dilemma compelling it to yield to the necessary
correction of recent monetary excesses - or else to fully
monetize every price increase in order to ensure that its
"grand illusion" of increasing prosperity continues.

Yet a continued resort by Western central banks to running
the printing presses at full speed will prove less and less
successful at distracting attention from the hole at the
heart of the Western - and above all the U.S. - economies.
The descent of both the internal and external value of the
dollar might begin to accelerate, threatening more upheaval
and potentially triggering inherently unpredictable
cascades of loss in the murky and highly nonlinear world of
international financial speculation.


Regards,

Sean Corrigan
For the Daily Reckoning

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• The Daily Reckoning - The Grand Illusion (Sean Corrigan) - Firmian, 02.01.2004, 21:16