-->Bastille Day

The Daily Reckoning

Paris, France

Monday, 14 July 2003

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*** Your editors, hard at work...

*** The rally persists! Russell 2000 up 24%, as investors
"clamor for maximum juice"... but bonds suffer...

*** Storming the Bastille..."Vive la revolution!"... and
more...

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Your editors this side of the Atlantic are busy with
extremely pressing matters... hard at work, that is,
enjoying Bastille Day here in France. Bill and his family
have chosen to celebrate the holiday as tradition demands:
out at the chfteau d'Ouzilly, their country home. Addison
is at the hospital for the last time; he will welcome his
son home for the first time tomorrow.

Your New York editor, however, has already had his
holiday... and is still on call, bringing you the latest
news from Manhattan. Forthwith, we leave you with his
remarks.

Eric?

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Eric Fry, from the Big Apple:

- The stock market's enigmatic rally continued last week.
Every morning the stock exchange opened its doors to
swarms of eager stock-buyers, none of whom seemed to worry
about the dearth of upbeat economic news. A recovery may
be nowhere in sight, but the stock-buyers could clearly
see that share prices are rising... so why not buy a stock
or two... or ten?

- During the week, a parade of tech company executives
admitted that business conditions in the tech sector have
improved little, if at all. After carefully and
thoughtfully considering these unanimously glum reports
from the like of Intel, Cisco Systems and Dell Computer,
investors rushed in to buy tech stocks... again. Their
feverish buying powered the Nasdaq to a whopping 4.2% gain
for the week, to hit 1,733. The stodgy Dow, by comparison,
added only 49 points to reach 9,119.

- The stock market's recent trading action has been eerily
reminiscent of the waning months of the 1990s bubble
market - the riskier the stock, the greater its appeal.
Investors are clamoring for"maximum juice."

-"The Russell 2000, a widely followed barometer of small-
cap performance, is up a smashing 24%, far outdistancing
the 13% rise in the S&P 500," Barron's observes."And it's
the sizzling performance of the very smallest of the
small-caps that is sparking that index's hefty
advance... While small is certainly beautiful, it is small
and speculative that is setting investors' hearts
aflutter. High-growth, high-multiple, high-beta stocks -
especially if they are relatively illiquid - offer a
terrific bang for the buck in a sharply rising market.

-"Another sign of fervent speculation," Barron's
continues,"is that low-priced stocks are sky-rocketing.
Shares in the Russell 2000 selling under $5 soared 54.8%
in the April-June quarter, compared with a gain of 14.3%
for stocks priced at $20 or more."

- But while investors are snapping up risky, overpriced
stocks, they are also dumping risky, overpriced bonds.
"Long-term Treasury yields are significantly overvalued at
current yields and the market is displaying the
characteristic aspects of a bubble," says The Bank Credit
Analyst.

-"Buying Treasurys at current yields is a bit like
playing chicken with the Fed," continues the Analyst."The
Fed is trying to encourage investors to buy long-term
Treasurys at yields below 3.5%. Yet, the Fed is explicitly
targeting a stronger economy and increased inflation, two
events that will ensure Treasurys purchased at current
yields become a losing proposition....The challenge for
investors will be to figure out how long to play the Fed's
game, and the challenge for the Fed will be to figure out
how to eventually raise rates without causing complete
carnage in the bond market. In practice, it probably will
be impossible for the Fed to exit from its current super-
easy stance without causing a Treasury market blow-up."

- If you hate bonds, you'll love buying one of the two
mutual funds that specializes in selling short Treasury
bonds.

-"For the bond bear that does understand the inverse
correlation between yield and price, Grant's presents a
pair of ideas," notes James Grant in the latest issue of
Grant's Interest Rate Observer."They are Rydex Juno Fund
[which your New York editor owns in his 401k] and
ProFund's Rising Rates Opportunity Fund. Each is an open-
end mutual fund. Each rises or falls in value as long-
dated Treasurys fall or rise in value... [In the Juno Fund]
each 3/32 change in price of the long bond means
approximately a one-penny move in the share price."

- The Rising Rates Fund offers"a little more juice,"
according to Grant, as it uses leverage to boost its
investment performance."Negative correlation between the
Rising Rates price and the long bond's price has been
125%, as opposed to a 100% correlation for Rydex."

- So if it's maximum juice that you're looking for, you
may find it by betting against the bond market rather than
betting with the stock market.

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The Daily Reckoning Presents: An homage to the French
national holiday. This DR Classique was originally run a year
ago tomorrow.


BASTILLE DAY
By Bill Bonner

"One man has a skinny wife, and wants a fat one... another
has a fat wife and wants a skinny one."

- The Marquis de Sade explains why people join
revolutions
Marat/Sade by Peter Weir

"They've gone mad."

- George III

"Vive la revolution!"

Only an American would say such a thing at a Bastille Day
celebration. Raising our glasses at yesterday's picnic,
the Frenchmen looked puzzled, then amused, at my toast.
Everybody celebrates the 14th July in France. But no one
would want to see a return of the revolution.

"Oh... there were some good things and some bad things that
came out of it," said a friend on Sunday. Asked what the
good things were, he couldn't think of any.

We wonder from time to time how it will all turn out - we
mean the Great Bear Market and the long, soft, slow
depression that America seems to be entering. What happens
when a great people get themselves into a great mess?

The French Revolution was a terrible mess. By the 18th
century, France had become the greatest power in Europe,
the richest and most populous country in the western
world, and the clear leader in art, science, philosophy,
education, cuisine, fashion, architecture... and, of
course, viticulture. It had the richest people in the
world, the prettiest women, and the best booze.

It also had the most enlightened economists - the
physiocrats - from whom Adam Smith was boosting some of
his best ideas.

A poll taken in the early 1780s might have shown the
French to be extremely optimistic and confident. And why
shouldn't they be? The last major financial crisis -
caused by John Law's Mississippi Bubble - blew up over 60
years before. And had the world ever seen anything
approaching the splendor of Versailles?

But in 1789, Paris mobs came to the crossroads of history
and veered left. They replaced an absolute monarch who had
very limited power, with a people's republic restrained
neither by common sense nor common decency.

The uprising began on July 14th, 1789, at the old prison,
the Bastille, which was seen as an emblem of the ancien
regime. The prison was stormed by the Paris proles, who
took the guards hostage (promising they could go unharmed
if they laid down their guns) and released a handful of
lunatics and hoodlums from their cells. Then, the crowd
hacked the unarmed guards to pieces and paraded around the
city with body parts on the end of pikes. Not long after,
the"law of the lamppost" became the ruling order in
Paris: aristocrats, CEOs, government officials and army
officers were hung from streetlights. The Marquis de
Lafayette, the liberator of the American colonies, tried
to maintain order at the command of the National Guard.
Lafayette was supposed to be guarding Louis XVI when a mob
attacked the palace at Versailles on the 4th of October,
1789. A few raggedy women broke into the palace trying to
kill Marie-Antoinette, who fled to her husband's
bedchamber. There, the attackers backed off. They may have
doubted that Louis was put in his place by God
himself... maybe God wouldn't mind if they cut up the
Bourbon king; but the femmes decided not to take a chance.

Lafayette intervened, telling the crowd that he would make
sure Louis returned to Paris - where the king would be at
the mercy of the radical new government. A few years
later, Louis and his family went to the scaffold... along
with thousands of others. France was soon at war with
nearly all its neighbors, and with the Vendee, a region in
west of the country that refused to go along with the
revolution. Church property was confiscated, a new paper
currency - the assignat - was created, and then destroyed,
by inflation. Outrages to the clergy, the aristocracy, the
language, and even the calendar were perpetrated.

None of this might have happened, however, except for the
efforts of the Alan Greenspan of the late 18th century -
Jacques Necker. It was Necker who replaced laissez-faire
economist, Jacques Turgot, as French finance minister in
1776.

Turgot's free-trade policies had the fatal flaw of all
sensible rules - they benefited everybody to the advantage
of nobody in particular. Turgot dissolved the guild
system, eliminated the corvee (the forced labor of the
peasants), imposed a simple property tax and opposed all
forms of economic privilege at the expense of the common
good. He even set himself against Marie Antoinette, by
refusing to grant favors to her cronies. Since everybody
in France in the 18th century as well as every American in
the 21st wanted the privilege of picking someone else's
pocket, Turgot eventually made enemies of nearly every
class. Louis XVI, though responsible for the well-being of
the entire nation, had not the strength to stand up to the
special interests.

Turgot even had a prophetic intuition and a view of
history similar to our own. Periods of civilized progress
are followed, he noted, by periods of barbarism and
madness. Dismissed in 1776, he warned Louis XVI:"Do not
forget, Sire, that it was feebleness that placed the head
of Charles II on the block."

Necker made enemies of no one. His program was the
opposite of Turgot's; he favored particular privileges at
the expense of everybody else. Rather than tax people to
pay for state expenses, Necker borrowed - taking short-
term, high-interest loans that brought the government
close to bankruptcy. Then, Necker turned to accounting
tricks to show that the government was actually running a
surplus! The patsies loved it.

Pushed out for the first time in 1781, Necker was called
back on the eve of revolution in 1788 for another dose of
his financial magic. But it was too late. The old miracle
elixirs - heavier debt and cooked books - wouldn't work
any longer; bankruptcy was unavoidable. The aristocrats
got rid of him again - on July 14, 1789. The mob, which
still had faith, was so disappointed... it headed for the
Bastille.


Your correspondent,
Bill Bonner