The Daily Reckoning - The Poet of Finance (Chris Mayer)

verfasst von Firmian, 22.07.2004, 19:50

-->The Poet of Finance

The Daily Reckoning

Baltimore, Maryland

Wednesday, July 21, 2004

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

*** Man who saved NY from bankruptcy: we're headed for
trouble!

*** The little guy gets screwed again...Greenspan speaks...

*** Part-time bartender becomes leveraged speculator...and
much more!

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

God is in his heaven. Bush is on his throne. Gold is over
$400. And the economy is recovering; everybody says so. So
why worry?

But what's this...?

"The fact that at this point our economy is delivering a
satisfactory level of growth is, I believe, the temporary
result of an overlong Federal Reserve policy of 'free
money' and a falling dollar, coupled with unsustainable
deficits."

Felix Rohatyn, the man who once rescued New York City from
eminent bankruptcy, was explaining to Wall Street Journal
readers why he was fed up with the Bush administration.
Despite the war on terror, he said, Americans were no
safer. And financially, they were headed for trouble.

Of course, this is the trouble we've been writing about for
years. People do not get rich by spending money they don't
have. As long as America's 'recovery' is led by consumer
borrowing...it is no recovery at all - it is a hoax, a
fraud, a flim-flam.

We have looked at the figures. They tell us that Americans
are getting poorer, by going deeper and deeper into debt.
But we are, what is known in the profession, derisively, as
'literary economists.' We believe more in words, ideas,
metaphors - and what we see with our own eyes - than in the
numbers themselves. Below, we continue looking around...

First, here's Tom with the news:

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

Tom Dyson, from the wrong side of Blackfriars Bridge...

-"It's always the little guy who gets robbed," said a
friend over a pint or three last night."It really gets my
goat."

-"Last night," explained our friend,"I was listening to
the Money Program on the radio. An elderly consumer was
complaining about being ripped off, again, by the insurance
industry. They had refused to honor a claim. Then the host
said: 'Sir, what you need to realize is that it's all-out
war. It's them against us. They will do whatever they can
to earn a buck at your expense. Underhand tactics, false
marketing, biased small-print...I'm not just talking about
one insurance company, I'm talking about all big business
in general.'"

-"I couldn't believe the host of the radio show had said
it, but he was absolutely right. We always knew that it was
like that in the States, but here in Britain, this is a new
corporate ethos...perhaps only twenty years old. In the old
days, pensions, banks, insurance, brokers, all those type
of people, they provided a service. And it was provided at
fair cost. And the consumer trusted them to provide this
service at fair cost." Now, everyone's out to screw money
from the hard-put middle-class, he added - and particularly
those older folk stupid enough to try and save a little for
their retirement.

-"I know this one guy...he is an idiot," said our friend.
"No education and no depth of character, but he is a good
and ready liar and he always does well in job interviews.
Last I heard, he'd been hired by a commodity futures broker
which targets retail investors. They encourage ordinary
people to give them control of their nest eggs, and then
trade with the capital. Often they lose the lot. Well, this
guy's job, I mean, his specific job and sole function in
the company, is to phone up the old ladies after they have
lost their life's savings, and apologize, and smooze and
charm them, and convince them to deposit some more cash.
'We'll win it all back for you,' says the shyster."

- News of another shyster - this time playing double or
quits with the whole world’s credit rating. Alan Greenspan
testified before the U.S. Senate yesterday. Care to guess
what the Maestro had to say? Here’s a clue: bonds went
down, stocks went up...

-"Economic developments have generally been quite
favorable in 2004, lending increasing support to the view
that the expansion is self-sustaining," said the Grease
Pan. He said that June's slow down in consumer spending was
nothing but a blip and July's numbers were already shaping
up to be much stronger.

- Moreover, growth was likely to regain its momentum over
the remainder of the year, he said, while inflation would
remain subdued."The little bulge in inflationary pressures
seems to have created a soft patch here," Greenspan said.
"And, it is something, obviously, we are watching very
closely."

- Stock market gains have been scarcer than a Microsoft
dividend of late, but thanks to Greenspan and Gates,
yesterday, we got both. The Nasdaq leapt 33 points or 1.76%
to 1,917, while both the Dow and the S&P, though more
subdued, did some leaping of their own. The Dow gained 55
points, half a percent, to 10,149 and the S&P ended the
session at 1,109, up 8 points on the day.

- Meanwhile, Microsoft finally announced that it would pay
out $75 billion to shareholders, over the next four years
in dividends and share buy-backs. The stock rallied
5%...while U.S. bonds were sold off hard. By the New York
close, the 10-year T-bond yielded 8 basis points higher at
4.44%.

- But were the lumpen really listening to Greenspan, we
wonder, or was this just an overdue bounce following three
weeks of one-way traffic? We get the distinct feeling that
Easy Al's speeches are designed to appease Mr. Market. But
Mr. Market's not stupid. He's heard this rhetoric before.
If July was going to be so strong, how come the Dow is on
course to record its worst monthly performance since Jan
2003?

- The market is giving the distinct impression that it is
quietly rolling over. The Nasdaq shed over 8% in the first
two weeks of July. While this stealth plunge hasn't escaped
your editors' attention, here at the Daily Reckoning, it
may have escaped the mainstream press...they've barely
mentioned the fact. And volatility remains glued to 97-
month lows. Yesterday the VIX closed at 14.17. It's not a
new 8-year low; it hit 13.34 five days ago, but it's not
far off.

- We get the feeling that the little guy is about to get
squashed again...

- And this just in...a big guy getting crushed...by an even
bigger government: Russian Bailiffs said, last night, that
they would sell off the main operating arm of Yukos, the
Russian oil giant, in order to recoup back taxes."It's the
worst-case scenario," said one analyst."Frankly, it's
similar to performing a heart transplant on a man with a
cough."

- Yesterday we published an essay by Dr. Steve Sjuggerud in
which he recommended Yukos as a risky, but potentially
profitable, speculation. Today, Dr. Sjuggerud has
recommended to his subscribers that they sell their stake,
immediately, after his recommended stop-loss was breached.

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

Bill Bonner, back in Baltimore...

***"My daughter is only 25, but she just bought a house in
Northern Virginia. Of course, she mortgaged most of it. But
can you believe that they lent her $275,000? Is that crazy,
or what? She works as a bartender, part time. She's very
responsible and is good for the money, I'm sure. But I
can't believe they would lend her that much money. How do
they think she will pay it back?"

Are Americans really the heavily indebted spendthrifts the
world's press makes them out to be? On the evidence, yes!

The Bureau of Labor Statistics figures that the average
hourly worker earned $521.73 per week in 2003, (the 12
months ending in June). During the same period a year
later, he earned an average of $524.37. Immediately, we
notice that there is not a lot of difference between the
two numbers. In fact, BLS tells us that the latter is only
0.5% greater than the former. Which is too bad for the poor
schlep who works by the hour. Because the cost of living -
the CPI - rose by more than 3% during the same period; he
actually has less spendable income this year than he did
the last.

How then, is a consumer-led recovery possible? How can he
spend more in 2004 than he did in 2003?

The answer, dear friend, is blowing in the wispy wind of
America's housing bubble.

"How much do places like these go for?"

We posed the question to our lawyer as we drove through a
section of Baltimore known as Federal Hill - near where the
British lobbed cannon balls in the War of 1812...and
Francis Scott Key, looking on, composed the national
anthem.

The houses are hardly fancy. Instead, they are neat, modest
places...which would be more familiar in Britain as 'mews'
houses. They were meant for factory workers in the 19th
century - tiny, cheap, and simple.

Twenty-five years ago, so many of these houses had been
abandoned that the mayor started giving them away for $1
each.

But the area has changed...and so has the nation. Twenty-
five years ago, America was at the bottom of a confidence
cycle. Nothing seemed to go right. Interest rates were high
and stocks were low - selling for 6 to 8 times earnings.
Gold was twice as high - even in nominal terms - as it is
today. And Federal Hill was a derelict, abandoned,
forgotten, trashy slum.

Today, America has never been more sure of herself.
Everything seems to go her way. The Dow is more than 10
times higher than it was at the end of the '70s; many
sectors sell for 50 times earnings - and more. Interest
rates, by contrast, are low - the Fed's key lending rate is
barely a tenth of what it was back then. Gold sells at a
humble $400 per ounce. And Federal Hill is booming. There
are bars, cafes, restaurants, even restaurants good enough
to entertain a group of expensive Washington lawyers.

And the houses?

"Well, I just sold one," said our own consignee,"so I know
what the market is doing. You can buy them for about
$300,000. Two-fifty to three-fifty, I'd say."

We have pointed out on more than one occasion - often
enough so you must be getting tired of hearing us say so -
that rising house prices do not make people rich. A house
can sell for $1 or for $300,000; it provides exactly the
same yield either way: you can live in it.

But rising house prices are not neutral. A man buys a house
for $1 and then sells it for $300,000. He then buys another
house for $500,000 - with a $200,000 mortgage. He feels
much richer. He is now consuming a house worth half a
million dollars. But while he was previously debt-
free...now he is $200,000 in debt.

And what about the first-time house buyer, like our
colleague's daughter? She puts down $25,000...and borrows
$275,000 to buy the $300,000 house. The same place she
could have gotten for a buck in the year she was born.

Are they richer? Not really. Instead, without realizing it,
they have become speculators - leveraged ones - betting
heavily that interest rates don't rise and house prices
don't fall. Woe to them if they're wrong.

*** Pittsburgh correspondent, Byron King, with more
thoughts about prosperity in America, 2004:

I think that you could have written the paragraphs on
"prosperity" from Volume II of"Democracy In America", or
something close to them, but Mr. de Tocqueville beat you to
it by about 165 years.

When Mr. de Tocqueville discusses"prosperity," he does not
define the term. He is discussing a conclusion, and only
describing the foundations of the premise in a roundabout
way. Perhaps the foundations and constructs of the term
"prosperity" in the 1830s were so obvious and self-evident,
that they needed no description to readers in that age.

Everyone knew, back then, that prosperity came from work
and saving, from transforming one's local resources into
saleable capital.

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

The Daily Reckoning PRESENTS: Lessons from the past: Chris
Mayer examines the ideas of Jacques Rueff, the eminent
French economist and former minister of finance to Charles
de Gaulle.

The Poet of Finance
by Chris Mayer


Jacques Rueff was accused of being a perennial prophet of
doom - a doom that never seemed to arrive.

Rueff first began to voice his concerns in 1961, alerting
the world to the dangers inherent in the world’s monetary
system, then operating under the Bretton Woods agreement.
It would take ten years before Rueff’s view was fully
vindicated.

The international community must have shivered as Reuff
evoked the haunting memories of the Great Depression. He
compared the years 1958-61 to the years 1926-29, which many
could still chillingly recall as the prelude to an economic
disaster none wished to see again. As Rueff notes, “there
was the same accumulation of Anglo-Saxon currencies in the
monetary reserves of European countries, in particular
France, and the same inflation in creditor countries.”

In the 1920s we had the gold-exchange standard; in the
1960s we had Bretton Woods. Both systems were monetary
jalopies, jerry-rigged Rube Goldberg-like contraptions that
could not hold together for long. The two convertible
currencies, dollars and pounds, became reserve currencies,
effectively held by European banks as reserves instead of
gold.

Rueff uses the example of the years after WWI, when a large
influx of U.S. and British capital flowed to Germany and
France. The new liquid funds entered these recipient
countries and were held as reserves, since they could
theoretically be converted to gold. In the older gold
standard days, these dollars and pounds would find their
way back to the banks of issue and be redeemed for gold. In
this way the debt was settled. Gold was the world’s money
accepted as final payment; not dollars or pounds, which
were essentially notes - promises to pay the holder in
gold, which was real, as opposed to printed paper, which
was not.

In the booming twenties this was not the case. So, France
and Germany held dollars and pounds and issued more of
their currency and credit against these dollars and pounds.
In the gold-exchange standard of the twenties, only dollars
and pounds were redeemable in gold - all other currencies
were redeemable in pounds, which were in turn redeemable in
dollars. Very confusing, I know. Why the Genoa experts
recommended this is another sorry episode of political
expediency, compromise and historical accident, which we
will skip here or I may never get to my conclusion.

Such a system, only loosely tethered to gold, allowed
considerable inflation. As Rueff noted, it was “probably
one cause for the long duration of the substantial credit
inflation that preceded the 1929 crisis in the United
States.”

The ensuing collapse of this pyramid scheme was to figure
prominently, in Rueff’s estimation, in explaining the birth
of the Great Depression.

Anyway, the point of the comparison with the 1920s was that
Rueff thought that, mutatis mutandis, the same thing was
happening again in 1960. He noted how the international
community held tremendous reserves of dollars against an
ever-smaller base of gold reserves. As in the 1920s, the
U.S. was able to expand its supply of dollars skirting the
old discipline that would have shackled it under a gold
standard. No final payment was required; dollars - lots and
lots of printed dollars - were accepted as final payment.
Again, this allowed considerable inflation of dollars.

Here Rueff gives us one of his most famous sayings, when he
called this situation circa 1960 and the situation in the
1920s as creating a “deficit without tears.” He wrote that,
“it allowed the countries in possession of a currency
benefiting from international prestige to give without
taking, to lend without borrowing, and to acquire without
paying.” Rueff does not lay all this at the feet of the
U.S. After all, these other creditor countries willingly
accepted U.S. notes in lieu of gold. Rather, Rueff calls it
an “unbelievable collective mistake.”

The holding of vast dollar reserves by foreign creditors
puts the credit structure of the U.S. on notice. In the
days of the gold standard, and even in the gold-exchange
and Bretton Woods eras, this was more acutely felt because
the gold stock of a country was visible, could be counted
and was routinely reported. In the sixties, Rueff noted
that an uncomfortable gap was growing between the dollars
outstanding and gold in stock that backed it.

Writing in 1960, Rueff felt that if foreigners “requested
payment in gold for a substantial part of their dollar
holdings, they could really bring about a collapse of the
credit structure in the U.S.” Rueff called for a return to
the old gold standard.

The Le Monde article caused a stir, and a rash of criticism
followed, in which Rueff was chided as an old-timer,
applying a quaint antique analysis to a modern problem. The
gold standard was a thing of the past, one author noted at
the time, like sailing ships and oil lamps.

The new iterations of money, though, did not represent an
advance in man’s understanding of money. On the contrary,
each new monetary wrinkle, each new invention, each
creative expedient only cheapened it.

We will skip ahead a bit in Rueff’s chronology to 1965.
By this time, Rueff had continued his attempts to persuade
the monetary authorities to alter their course. On February
4, 1965, Rueff would gain something of a public victory
when General de Gaulle made his now famous speech on the
need for gold as a basis for international monetary
cooperation. Rueff finally had the ear of an important head
of state; he had the ear of de Gaulle, who would eventually
refer to Rueff as the"poet of finance."

After giving a brief history of the international monetary
scene beginning with the Genoa Conference, de Gaulle noted
how the acceptance of dollars to offset balance of payments
deficits with the U.S. lead to a situation where the U.S.
was heavily in debt without having to pay. He correctly
observed how the dollar was a credit instrument and
recommended that the system be changed.

“We consider that international exchanges must be
established," proclaimed de Gaulle,"as was the case before
the great worldwide disasters, on an unquestionable
monetary basis that does not bear the mark of any
individual country."

"What basis?" continued the French head of state,
"Actually, it is difficult to envision, in this regard, any
other criterion or any other standard than gold. Yes, gold,
which does not change in nature, which can be made either
into bars, ingots, or coins, which has no nationality,
which is considered, in all places and at all times, the
immutable and fiduciary value par excellence.”

Rueff pressed on with renewed vigor and the U.S. monetary
situation continued to deteriorate with accelerating gold
losses. Yet, negotiations continued, as Rueff says, “at a
snail’s pace on a volcano, which may erupt all of the
sudden.” While the experts dallied, the volcano belched and
smoked all around them. That a crisis was brewing was now
obvious even to the skeptics.

European nations that had been accumulating dollars at a
pace of $1-2 billion per year began liquidating them - more
than $2 billion were liquidated inside the twelve months of
1965 alone. By 1970, there was $45 billion in dollars held
by foreigners against only $11 billion in gold stock.

At this point, the ending was inevitable. Though there were
some changes made to the monetary structure in the waning
days of dollar convertibility, it would finally expire in
the summer of 1971 when Nixon brought the Bretton Woods
agreement to an end by taking the U.S. entirely off the
gold standard.

I think there are many ways in which Rueff’s criticisms to
the monetary systems of the 20s and the 60s apply to the
monetary world of today. There are many observations that
we can take from this tale and apply to our current
situation.

For one thing, note that the inflation of money and credit
was able to continue for a long time after Rueff’s initial
diagnosis that a crisis was brewing. Like any bubble, the
pin is hard to find. Though he could not point to when the
crisis would break, he thought that any number of events
could trigger it - a continued weakening of the balance of
payments deficit, some banking or financial incident, some
political event, a mere shift in opinion.

Any of these could effect the “subservience of dollar
holders and induce them to request conversion of their
dollar holdings in whole or in part, even at the risk of
antagonizing the Washington authorities.”

In the end, the math simply became too stark to ignore.


Regards,

Chris Mayer
for The Daily Reckoning

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