The Daily Reckoning - Doctor Disinflation (Gary Shilling)

verfasst von Firmian, 16.07.2004, 20:31

-->Doctor Disinflation

The Daily Reckoning

Baltimore, Maryland

Thursday, July 15, 2004

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

*** Britney Spears...FBI...Indian Villagers...

*** Oil surges to $40.97, Nasdaq sinks...

*** The bravery of farm boys...'Vive La Revolution!'...and
more!

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Where are we now?

Oh yes...Baltimore...2004 AD...the 4th year of the great
bear market...the 17th year in the reign of Alan
Greenspan...

What is going on?

In the stock market - nothing. But in the real estate
market - oh la là!

More below...

First, the news from Eric Fry in New York City:

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

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

-"Oops! We did it again!" Britney Spears might have said,
yesterday, if she were a pinstriped oil analyst rather than
a bare-midriffed pop diva.

- Once again, Americans burned through more oil than they
stockpiled. The Energy Department reported a 2.1 million-
barrel draw down in crude supplies for the week ended July
9, to a total of 302.9 million barrels. The American
Petroleum Institute estimated an even larger draw down of
5.1 million barrels. Either way, we consumed a lot more oil
than we stored.

- The large inventory decline occurred in the face of
massive crude oil imports. For the eighth straight week,
U.S. imports topped 10 million barrels -"the longest such
streak ever," according to the Government's report. The
shockingly large drop in inventories sparked an explosive
rally in crude oil. Over in the energy trading pits of the
New York Mercantile Exchange, the price of crude jumped
$1.53 to $40.97 a barrel - a new six-week high.

- Despite record-high oil and gasoline prices, Americans
continue to guzzle the stuff...but the nation's ever-rising
energy bill is starting to take a big bite out of
discretionary spending. Retail sales plummeted 1.1% in June
- the biggest decline in 16 months - thanks largely to a
4.3% fall in auto sales. Apparently, we Americans are not
buying quite as many things we don't need with the money we
don't have. We've even curtailed our once-robust
consumption of common stocks.

- The major equity averages fell again yesterday, as the
Dow lost 39 points to 10,209 and the Nasdaq slipped nearly
1% to 1,915. As stocks slipped, the dollar also weakened,
falling half a percent to $1.238 per euro. The gold market
made the most of the dollar's weakness by jumping $3.80 to
$405.45 an ounce.

- The stock market bulls say stocks should be higher. We
say they SHOULD be lower, especially if $40-a-barrel crude
oil keeps hanging around like an annoying party guest. The
balance between supply and demand in the energy markets is
delicate at best. As the world's developed countries
continue to find new and ingenious ways to exhaust the
earth's finite energy supplies, Chinese and Indian demand
for fossil fuels is booming.

-"Indian villagers, who account for more than 70 percent
of the nation's 1 billion population, are spending on
televisions, refrigerators and other goods at more than
twice the pace of their urban counterparts," Bloomberg News
report."Demand for consumer products in India's 627,000
villages is expanding by 25% a year compared with growth of
10 percent in cities and towns, according to a survey by
the Federation of Indian Chambers of Commerce and
Industry."

- All these new gadgets mean lots more demand for
energy...and all the while that demand booms, the global
oil supply struggles against the forces of inevitable
depletion. What's more, the global balance between supply
could become quickly imbalanced if terrorist attacks
disrupt supplies.

- Time Magazine reports that the FBI sent a classified
intelligence bulletin to local law enforcement agencies
last week warning of a potential terrorist threat to the
U.S. energy infrastructure. Meanwhile, half a world away,
Islamic militants continuously plot to disrupt the oil
infrastructure within Saudi Arabia.

-"An increasing number of Saudis who crossed the border
into Iraq are returning home to plot attacks against the
Saudi government and Western targets in the desert
kingdom," the Washington Post Foreign Service reports.
"Other Saudis are returning after spending time in newly
established training camps across the Red Sea in remote
parts of Sudan where central government influence is
weak...some Western officials express fear that the
homecoming will grow if Iraq stabilizes."

- After the Iraq insurgency is over, 'there will be people
who are freshly trained in the art of guerrilla warfare,'
said a Western diplomat who spoke to the Post on condition
of anonymity. 'It's a real concern.'

- We could certainly imagine the oil price falling from
current levels. But it's so much easier to imagine it
rising. Hmmm...what would Britney say?

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

Bill Bonner, back in Baltimore...

***"They are jealous!"

"I couldn't believe it. But I keep hearing it. Americans
think that the rest of the world is jealous of them. They
tell each other what a great country they have...they fly
the flag all over the place...and they think that when
another country causes problems or doesn't agree with them,
it is because they are jealous."

The person speaking was a young Belgian woman who lives in
Baltimore. We had gotten together a small group of French
speakers to celebrate Bastille Day. Not that we have any
sentimental attachment to the French Revolution. We do not
approve of revolution - even the American one. But we never
forgo an opportunity to drink too much.

"Even after September 11, I heard on the news," she
continued,"that the reason bin Laden had attacked the U.S.
was because he was jealous. They seem to think that the
reason people in other countries are the way they are is
because they have failed in their efforts to be like
Americans."

It is a fatal conceit. It leads Americans to believe the
most absurd things - that if they offer American-style
institutions to foreigners, even at the point of a gun,
they will take them up readily and then say 'thank you.'
And that they will live indefinitely on foreigners'
savings; the Huns and Frogs and Japs are so eager to put
their money into the world's most dynamic country, they'll
never ask questions.

But the conversation veered from money to war...and back
again.

"Belgium is a strange, unnatural country. It is meant to be
a buffer state between France and Germany. We are always
getting invaded. Half the country - well, really, a third -
feels they are French. Another third feels it is German. So
that when the Germans invaded in WWII, the people in the
East of the country welcomed them, and collaborated. The
French speakers resisted. At least, that's what the
Walloons (the French speakers) like to believe. My
grandfather got sent to a slave labor camp during the war.
My grandmother lived in a cave for two years. It was
horrible.

"And even now, two or three generations later, and I was
talking to a woman from Holland. She asked me what I
thought of the Germans. I said, frankly, I didn't trust
them. Of course, I don't know them at all. It's just a
reflex.

"The Germans are not likely to go to war anymore. They've
had enough of it...but here in the U.S.A., I'm a little
shocked by how eager Americans are to go to war..."

*** From Alexis de Tocqueville's 'Democracy in America':

"The Americans have no neighbors and consequently they have
no great wars, or financial crises, or inroads, or
conquests to dread; they require neither great taxes, nor
large armies, nor great generals; and they have nothing to
fear from a scourge which is more formidable to republics
than all these evils combined: namely, military glory. It
is impossible to deny the inconceivable influence that
military glory exercises upon the spirit of a nation.

"General Jackson, whom the Americans have twice elected to
be the head of their government, is a man of violent temper
and very moderate talents; nothing in his whole career ever
proved him qualified to govern a free people; and, indeed,
the majority of the enlightened classes of the Union has
always opposed him. But he was raised to the Presidency,
and has been maintained there, solely by the recollection
of a victory which he gained, twenty years ago, under the
walls of New Orleans; a victory which was, however, a very
ordinary achievement and which could only be remembered in
a country where battles are rare. Now the people who are
thus carried away by the illusions of glory are
unquestionably the most cold and calculating, the most
unmilitary, if I may so speak, and the most prosaic of all
the nations of the earth..."

For most of their history, Americans were mostly inept at
war. They were no good at it because they had better things
to think about and better things to do. And, except for
Lincoln's intramural war against the southern states, there
was no need. While France faced danger from either side -
Britain and Germany...and Germany faced danger from France
and Russia...America stood only against Canada and Mexico,
neither of which could inflict any real harm.

This is not to say that the average grunt lacked courage or
discipline; on the contrary, he almost had too much. Farm
boys went to war thinking they were the greatest soldiers
on earth. The illusion of invincibility went to their
heads; they forgot to duck.

We say that after reading more of Thomas Fleming's history
of Woodrow Wilson and WWI. The poor doughboys got killed in
appalling numbers. It was as if their officers had learned
nothing from the slaughter of the French and British over
the preceding two years. They sent their men across open
ground to attack machine guns. At the end of the battle,
American bodies were spread out like a carpet. The German
machine guns were still in place.

"Private First Class James Rose of the First Division later
told of advancing across an open field to within fifty
yards of the German Line," writes Fleming."Suddenly, the
air around the men 'became a solid sheet of machine-gun and
artillery fire. No words could possibly describe the horror
of it. Body stacked upon body in waves and piles...our boys
never faltered, they came, wave upon wave, climbing over
the bodies of their fallen comrades with one obsession in
mind, to reach and destroy every machine gun that was
mowing down our advance.' These brave men were obeying the
orders of the division commander, Major General Charles
Summerall, who summed up his tactical thinking on how to
deal with machine guns in two brutal words: 'Charge 'em!'"

'Charge 'em' brings to mind an entirely different kind of
recklessness today: the credit bubble has reached
practically every Middlesex village and farm.

"I was flabbergasted by what is going on in the real estate
market - even here in Baltimore," said another member of
our Bastille Day party.

"I remember when I left here 4 years ago, there was a
townhouse for sale across the street in Fell's Point. It
was advertised at $87,000 and probably sold for less. Well,
it's back on the market - this time for $380,000."

"Vive la revolution!"

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

The Daily Reckoning PRESENTS: Economist Gary Shilling is a
legend. The July 7, 1997 edition of the Wall Street Journal
stated that"Mr. Shilling...had the best overall forecasts"
of the economy, interest rates, exchange rates and
inflation"among the...57 economists polled in the latest
survey." Today, he talks to us about...lead balloons.

DOCTOR DISINFLATION
by Gary Shilling


A huge worldwide speculative balloon is now deflating. The
economic outlook for the U.S. and, indeed, around the globe
depends on how the hot air is expelled.

To see how we arrived at this point, go back to late 1996,
when Fed Chairman Alan Greenspan made his"irrational
exuberance" speech amidst a stock rally that was then 14
years old and had lasted long enough that investors were
convinced it would last forever. But instead of tamping
down some of the exuberance and potentially risking a bear
market and a recession, the Fed sat on its hands. As a
result, rampant dot.com speculation unfolded and spilled
over, hyping up the overall economy in the late 1990s.

When the Fed finally got serious about tightening credit,
five years ago, overblown stock speculation was already
doomed. Then, as stocks collapsed in 2000, the credit
authorities shifted to a massive easing cycle, starting in
January 2001, in an effort to avert a major recession and
to fight deflation. With record low interest rates, tax
cuts, hikes in government spending and easy mortgage
financing terms, housing and consumer spending sailed
through, propping up the U.S. economy through the 2001
recession and the shaky recovery that followed in the years
after.

The Fed had another motive for easing credit in the 2001-
2003 years: a fear of deflation, which it publicly admitted
in May 2003, a month before it lowered the Fed funds rate
to its 1% floor.

Meanwhile, a new speculative cycle was unfolding, a cycle
engineered specifically by the Fed and other central banks
to stimulate growth. The generators of the hot air -
propelling this new speculative balloon to stratospheric
heights - were very low short-term interest rates and a
steep yield curve.

As a result, hedge funds, brokers, banks, private equity
pools, pension funds and insurance companies all took
advantage of the wide yield-spread granted with the Fed's
seal of approval, and borrowed short-term low-interest debt
in order to finance purchases of longer-term Treasurys,
commodities, currencies, emerging country stocks and bonds,
convertible securities and junk bonds. They gave no thought
as to what might happen tomorrow.

Individuals, encouraged by low mortgage rates and easy
financing terms, switched their focus of speculation from
stocks to owner-occupied houses and used cash-out mortgage
refinancing to pay for their consumerist habits. As a
result, household real estate mushroomed from $8.7 trillion
in the fourth quarter of 1997 to $15.2 in the first quarter
of 2004.

These seemed to be profitable ventures at the time. As long
as the curve didn't flatten, the profits rolled in.

Now, however, with short-term interest rates beginning to
rise, the yield curve is starting to flatten, and the
massive extent of this reckless speculation is being
revealed. Bond-yield volatility clearly shows this...

Inflation-sensitive Treasury bond yields jumped 100 basis
points from mid-March to mid-June as traders anticipated a
massive reversal of the carry trade. Junk bonds, emerging
market stocks and bonds, commodities and foreign currencies
all reversed gears and nose-dived. Copper prices dropped
15% from their March 1 peak. While U.S. stocks haven't been
hit as hard as bonds, junk and commodities, they haven't
moved much from their January 1 levels and continue to look
vulnerable.

One troubling thought: few speculative trades have been
unwound so far. This is worrisome since market-leverage is
much greater than it was 10 years ago when Fed rate
increases last caught speculators off guard. In 1994, the
Fed managed not only to kill Kidder Peabody, but also the
finances of Orange County, California as well as the
Mexican economy.

For one, overnight borrowing to finance fixed-income
investments, in relation to the total size of the fixed-
income market, has doubled since 1994. Which major
financial institutions might succumb this time around?

House prices are vulnerable to rising interest rates and
less-diligent lenders. They normally move in step with the
CPI, but since September 2001, median existing house prices
are up 20% while the CPI gained only 5.2%. A nationwide
fall in house prices would be devastating to the 69% of
American households that own their own homes. And big
mortgage financers like Fannie Mae and Freddie Mac, with
$1.7 trillion in debts, could require government bailouts.

So the Fed finds itself in a tight spot. It raised rates at
the end of June, but now it must adhere to market
anticipations with further hikes or run the risk of
appearing impotent. That could prove to be deadly for the
leveraged speculators who have been encouraged by Fed
actions — and inactions — since 1996.

And higher rates may also burst the housing bubble, and
unleash numerous problems for government-sponsored mortgage
lenders, as well as for young, low-income and minority
families who became homeowners in recent years via low
down-payments and low mortgage rates.

Delinquency rates have been rising in recent years and the
concern is that, since most of these low-income families
have negative net-worths outside their homes, continuing
layoffs will squeeze them out of the housing market. And as
that lack of demand ripples up the move-up market, housing
prices from top to bottom will fall in what could be a
self-feeding and serious decline leading to the first
nationwide drop in housing prices in the post-World War II
era.

This hot-air balloon is a lead balloon; watch out below...


Regards,

Gary Shilling
for The Daily Reckoning

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gesamter Thread:

• The Daily Reckoning - Doctor Disinflation (Gary Shilling) - Firmian, 16.07.2004, 20:31
  • The Daily Reckoning -"Britney Spears und der Ã-lpreis" - Sorrento, 16.07.2004, 23:50