-->The Blessings Of Deflation
The Daily Reckoning
Paris, France
Tuesday, 15 July 2003
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*** Fret... fret... fret... we fret more than Chet Atkins...
*** A flashback... déjà vu all over again in the Nasdaq...
*** Bond yields rising... insincere pessimism... losing your
head... an inferno... and more!
What can we tell you about this market that you don't
already know, dear reader?
U.S. bonds are so expensive; it is as if investors thought
they were a no-lose proposition. So confident are they in
the dollar, they are willing to lend at yields not seen
since the Eisenhower administration.
There was a time, your editor recalls it, when investors
thought lending to the government was a no-win situation.
U.S. Treasury bonds were called"certificates of guaranteed
confiscation" - an insight that might have come 20 years
too early. Back then, inflation flared up so brightly,
investors thought they would be consumed by it. The CPI was
already rising at double-digit rates and investors saw no
relief in sight. Had they looked around, they might have
seen the towering figure of Paul Volcker with a cigar in
his mouth and a firehose in his hands.
Now, by contrast, after 20 years of falling inflation, they
see no danger. They should look around; now, instead of the
firefighter Volcker, we have the pyromaniac Greenspan on
the job, with a pack of matches! In the latest 3-week
period, $100 billion has been added to M3. Greenspan adds
dry tinder faster than anyone ever did... to a world stacked
high with it already.
U.S. stocks, meanwhile, are almost as expensive as ever.
The hundred largest Nasdaq companies are once again in the
Land of Wishful Thinking. Putting them all together, they
sell for 40 times the P/Es recorded at bear market lows.
What could justify such prices?
[Short answer:"not much"...
See:"Rate Cuts and Profitability'
http://www.dailyreckoning.com/body_headline.cfm?id=3296 ]
But the Arizona Republic reports that even the tech sector,
where most of those Nasdaq firms reside, is expected to
shift more of its work overseas. It is one thing to export
jobs from declining industries, but losing jobs from the
nation's leading growth industries has to provoke a fret or
two.
Fretting is our business here at the Daily Reckoning. We
fret that the present echo-bubble in the Nasdaq is going to
end badly, like the last one. We fret that bonds are near a
top - and about to be ruined by a conflagration of falling
dollar and/or rising inflation. We fret that somewhere,
somehow, sometime, someone is going to have to pay for all
this debt Americans so happily built up. And we fret that
the U.S. economy has been weakened by too much credit... too
many dollars... too little savings... and too much foreign
competition, at much lower labor rates, which our own free-
spending ways have helped create.
Of course, many readers mistake this fretting for
pessimism. But if we seem pessimistic, at least we have a
saving grace: we are insincere about it. Sincere pessimism
is a curse and a bore. Our pessimism is merely superficial,
like too much make-up on a pretty girl. Hose us down and we
are as fetching as any other market kibitzer.
Deep down, as we try to explain, we are profoundly
optimistic.
Yes, the world is going to Hell in a handcart - but that is
where it deserves to go. And were people not to get what
they have coming, it would be a far, far darker world than
the gloomy place we see.
Over to Eric Fry, our very cheerful, optimistic man-on-the-
scene in Manhattan:
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Eric Fry in New York...
- Will the indefatigable Mr. Market ever break a sweat?
Will he ever pause to catch his breath? Or will he just
keep racing tirelessly higher... until he races off a cliff?
- Yesterday, the fit and trim financial marvel scaled to
new multi-month highs. The Nasdaq Composite rallied 1.2% to
1,755 - a fresh 15-month high. The Dow climbed 57 points to
9,177. What's more, six of the Dow's 30 components breached
52-week highs, including Intel, Citigroup, American Express
and J.P. Morgan Chase.
- Curiously, Wall Street's most severely earnings-
challenged companies continue to lead the way."The monster
stock rally that has been underway for nine months is
starting to take on a familiar look - maybe too familiar,"
the Wall Street journal observes."In a flashback to the
days of Internet mania, stocks in money-losing companies
again are doing better than those of profitable
companies... Of 1,500 large, medium and small stocks tracked
by Standard & Poor's, the 195 that lost money over the past
year are up 101% on average since October 9, while the
1,305 that made money are up an average of 42%... The entire
Nasdaq 100 Index, which groups 100 of the biggest Nasdaq
stocks, now sells for more than 240 times its companies'
earnings for the past year, according to market-research
firm Byrini Associates. It trades for 38 times forecasts
for its companies' earnings next year."
- Helpfully, the English language furnishes a word that
aptly describes the stock market's recent trading action.
The word is"speculation." The bullish contingent on Wall
Street - which includes just about everyone - might scoff
at the notion that speculation is driving share prices
higher. But how else could one describe a stock market
rally that propels the market's least worthy stocks to
triple-digit gains?
-"Sure, the Nasdaq 100 is selling for 240 times earnings,"
the bulls would admit,"but that's because the market is
'looking forward' to a robust earnings recovery."
- We doubt that the market ever looks forward... or
backwards or sideways. And we doubt it can anticipate the
future any more reliably than a slice of rye toast. But
just for kicks, let's imagine that the market does gaze
into the future and that it does know the unknowable well
before any mere mortal can ascertain it. How far into the
future can the market see? One day? One month? One year?
- If we did believe in the market's ability to peer into
the future, we might be comfortable with the notion that it
could"see" into August or September. And on a clear day,
perhaps, that the market could make out the faint financial
profile of 2004. But a market selling for more than 200
times earnings is not merely peeking into next year, it
must be looking ahead to the next decade. At 240 times
earnings, the Nasdaq 100 is not clairvoyant; it's
delusional.
- Yesterday, the legions of speculating stock-buyers
received a bit of hopeful news: a couple of big banks -
Citigroup and Bank of America - earned more money last
quarter than most folks, thanks to robust consumer lending.
Citigroup's earnings from consumer lending jumped 18% as
its mortgage originations doubled to $23.5 billion. At Bank
of America, the bank made a record $40 billion in new
mortgage loans. Credit card income increased 23% to $762
million.
- Thanks to the lowest interest rates since the 1950s,
financial companies from coast to coast have been enjoying
boom-time conditions. Citigroup and Bank of America are
merely two high-profile examples. Many of the lesser lights
in the consumer-finance constellation are also basking in
the warm glow of low interest rates.
- Unfortunately, the falling interest rate trend that
enabled Citigroup and BAC to post some shareholder-pleasing
earnings has been reversing with a vengeance. Yesterday,
the 10-year Treasury note plummeted once again to drive its
yield from 3.63% to 3.72%. That's a quite a distance from
the 3.08% yield it hit in early June.
- The new rising rate trend is driving a stake through the
heart of the mortgage-refi boom - a phenomenon that has
single-handedly supported the consumer spending that has
single-handedly supported the U.S. economy. Mortgage
originations have been tumbling for four straight weeks.
- As the refi boom dies, what new fuel will power the
massive, consumer-dependent U.S. economy?
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Bill Bonner, back in Paris...
*** Your editor's 82-year old mother is a real optimist.
Taking the train down to the country on Saturday, she got
out her passport in case she was asked to prove that she
was entitled to a Senior Discount.
*** Addison is back on the job. The French government
decided that it was in the best interest of La Patrie for
his wife to spend 6 days resting up at the hospital
following the birth of his son, August.
Government knows best, of course... on both sides of the
Atlantic. But on this side, people get much more rest. Your
editor took yesterday off; he always stops his work to
honor those who lose their heads in a moment of hysteria.
For the headless aristocrats of the French Revolution, it
may have been a far, far better place they went to than the
one they left behind, but they were probably in no more
hurry to get there than the rest of us.
*** America is, as everyone knows, the best place in the
world to live... except for the food, the weather, the
architecture, the traffic, and so on...
It is the richest country in the world, depending on how
you measure it. And now that socialist materialism has
triumphed everywhere, money is what seems to make the
planet turn.
We note that Californians produce $26,570 of GDP per
capita. Here in France, the total is just $22,700. But when
you divide these totals by the number of hours worked, a
strange thing happens; it is the French who begin to look
wealthy.
The average salaryman in Frogland works only about 1500
hours per year. In America, the latest total we've seen is
1862. Unless we did the math wrong, the average Frenchman
is more productive than the average Californian, by nearly
a dollar an hour.
*** Speaking of the weather... Paris has become dreadfully
hot. The temperature is supposed to shoot up to 100 today.
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The Daily Reckoning PRESENTS: Who says deflation is a bad
thing, anyway? Besides the inflationistas at the Fed, that
is.
THE BLESSINGS OF DEFLATION
by Llewellyn H. Rockwell, Jr.
Let's say you set out on a Saturday shopping trip, drive up
to the mall, and see a sign that says"50% off everything!"
That's great news, right?
Or let's say you are in the market for a new car, and the
sticker shock you experience is that cars are cheaper than
they used to be. Amazing and wonderful!
Or let's say you are paying for your daughter's college
education and find that you have set aside more money than
is necessary because the price of tuition and books is
lower than you expected. Glory be!
Or let's look at it from the point of view of business. You
are a manufacturer and your main expense is steel parts.
After many years, even decades, of rising prices for ball
bearings and other machine parts, your costs suddenly
decline. The cost of replacing assets is dramatically
reduced. That leaves more for investment, marketing, paying
employees, and enticing investors with dividends. It is a
win-win situation for everyone.
So far,"deflation" seems like a glorious thing. But wait,
says conventional wisdom. Consumers and businesses may
benefit, sure, but what about sellers? They always desire
the highest price possible for their products. If Dell had
its way, every computer would cost $1 million, and they
would certainly charge that if they could sell the same
number of computers at this price as versus $1 thousand. By
the same token, consumers want to pay exactly $0 for what
they buy. It is the interplay between these two ideal
worlds that yields the market price.
If businesses have been required by virtue of competitive
pressure to sell at ever lower prices, how can they make a
buck? By becoming more efficient. Anyone who has ever
worked in a business knows that efficiency is something
that businesses do when they have to. A monopolist is
facing no competition (think of a government toll road) and
so can charge high prices and maintain awful inefficiencies
year after year. A business in a competitive environment
cannot.
The computer industry itself provides the best
illustration. Prices have plummeted even as sales have
soared. Computer makers and retailers have profited
handsomely. And this is not a unique case. The same has
happened to appliances, which have gone down in price
dramatically over the years even as sales have risen higher
and higher. Why? Because the companies have gotten better
and better at doing what they do, and have thereby been
able to make profits even in the face of continual price
declines.
Thus we see that there is no radical disconnect between the
interest of consumers (who always want lower prices) and
overall economic health. What's good for consumers is good
for everyone. You can only marvel at the many economists
and commentators who try to convince the public that
deflation is a very scary thing. In doing so, they enjoy
the cachet associated with generating a counterintuitive
conclusion, but in this case, it is simply wrong. The first
intuition that bargains are a great thing is precisely the
right one. In discerning economic theory, sometimes common
sense turns out to be all you need.
And yet, many experts still say we should"worry about
falling prices" because they represent a"destructive
force" (according to Martin Wolk at MSNBC, for example). He
explains as follows:"As prices keep going down, money
grows more valuable." So far so good!
But he goes on to say that this is actually a bad thing
because it creates"an enormous disincentive for consumers
and businesses to spend money. Economic activity slows,
unemployment rises and demand continues to decline." Well,
but that presumes that consumers have something to gain by
forever stocking up on dollars and never buying anything,
which is absurd. It's true that falling prices create
incentives to save, but so long as the preference of
consumers is to save instead of spend, that can only
prepare the way for a future of economic growth. Consumers
save for a reason, namely, to spend later.
Wolk's next point concerns the implications of deflation
for debt. Deflation makes it"far more difficult to pay
back existing loans." It's true that loans are paid back in
dollars that are more valuable than the ones borrowed. But
that is part of the risk one takes when deciding to borrow
in the first place. If we all had perfect foresight, our
behavior would change substantially. But that is no case
for pressing the pause button on economic affairs. What
deflation does is provide a disincentive to borrow and an
incentive to use current savings for purposes of
investment. It means a reward for well-capitalized
companies and individuals - a good thing all around.
Now we get to the crux of the matter: the Great Depression.
The assumption is that falling prices somehow caused the
economy to crumble. In fact, it was the after-effects of
the boom combined with massive government intervention that
caused the depression. The only silver lining in the entire
period of the 1930s was precisely the falling prices that
made the dollar count for more. Falling prices (a falling
cost of living) are what Murray Rothbard has described as
the"great advantage" of recessions. If you can imagine the
Great Depression without falling prices, you have conjured
up an image that is far worse than the reality.
Ask yourself whether during economic downturns, you want
your money to grow or shrink in value? If your future job
security is in doubt, do you want to pay more or less for
goods? If your savings are meager, do you want them to have
more or less purchasing power in the future? If you answer
these questions rationally, you can see that deflation is
wonderful for everyone, and the saving grace of a period of
economic contraction. Throughout the 19th century, prices
fell in periods of economic growth, which is precisely what
one might expect. This is all to the good.
As Rothbard has said,"rather than a problem to be dreaded
and combatted, falling prices through increased production
is a wonderful long-run tendency of untrammelled
capitalism. The trend of the Industrial Revolution in the
West was falling prices, which spread an increased standard
of living to every person; falling costs, which maintained
general profitability of business; and stable monetary wage
rates - which reflected steadily increasing real wages in
terms of purchasing power. This is a process to be hailed
and welcomed rather than to be stamped out."
If we must have recessions, make them deflationary
recessions. What's far worse is the phenomenon of the
inflationary recession that Keynesians are always trying to
foist upon us. For the same reason that deflation is a good
thing, rising prices during a recession are the worst
possible thing, because they provide a disincentive to save
and invest for the future. They encourage present
consumption and thereby gut the capital base necessary for
future growth. They prolong suffering in every way.
Thus can we see that the widely-approved prescription to
prevent deflation, namely inflation, is the worst possible
path. But this is precisely what the Fed has endorsed as a
matter of policy. It is hardly surprising that the central
planners managing our lives would adopt the exact policy
that will make us so much worse off.
Fortunately, the free market contains mechanisms that can
work around attempts by the Fed to inflate. It could be
that the banks have a hard time foisting new money on
people and instead work to protect their balance sheets.
Businesses too, stung by economic contraction, might avoid
going further into debt, no matter how cheaply they may be
able to borrow. In this case, prices could fall whether the
Fed wants them to or not.
In economics, it is a good rule that what is good for
individuals and families is also good for the economy.
Everyone wants a bargain, which is to say a low price.
Sadly, in our present age of inflation, lower prices mostly
affect specific products and sectors. May the joy we take
in falling prices for electronics be expanded to anything
and everything we buy. Let the commentators fret and worry
about what their fallacious macroeconomic models tell them.
The rest of us can sit back and watch our standard of
living rise and rise.
Sadly, I doubt we will see any deflation. Even based on the
last ten years of data, overall price increases are still
the norm.
In fact, since 1913 and the founding of the Fed, the dollar
has lost 95 percent of its value. It is far more likely
that this robbery will continue rather than for our lost
purchasing power to be restored to its rightful owners: you
and me.
Regards,
Lew Rockwell,
for The Daily Reckoning
Ed note: Llewellyn H. Rockwell, Jr. (Rockwell@mises.org) is
president of the Ludwig von Mises Institute in Auburn,
Alabama, and editor of LewRockwell.com. A version of this
essay was published in Marc Faber's Gloom, Boom, & Doom
Report.
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