-->Cracked / The Daily Reckoning

Paris, France

Friday, 25 July 2003

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*** U.S. stimulates... China is stimulated...

*** Rosy outlook excites stocks... don't worry about rising
yields...

*** TIPS/10-year note spread passes 2%... unemployment
claims down, but mortgage rates up... fewer hours being
worked... last tangos... how they see us... and more!

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Oh là là... What a wicked, wonderful, wacky world it is.

We don't have any specific reason for saying that. It's
just that it's Friday morning... we're in a light-hearted
mood... and we've been so impressed lately by the elegant
perversity of it. No sooner does someone think he's got the
world by the tail than it turns around and bites him on the
derrière.

Next to exterminating male members of the Hussein line, the
Bush administration has made economic recovery a top
priority. To that end, it has given the nation a tax cut,
expected to provide an economic stimulus equivalent to 1.6%
of GDP.

Too bad so much of the stimulating is done overseas,
particularly in China.

For if an American consumer has an extra dollar in his
pocket, about 2 and a half cents of it will end up in
Chinese hands. That may not seem like a lot of money, but
it is more than the return from money market funds, more
than the inflation rate, more than twice the Fed funds
rate... and more than $200 billion dollars a year.

And the Chinese know how to get even more money; they just
have to build more factories, hire more people and produce
more and better goods - all the things that the tax cut was
supposed to stimulate in America.

Likewise, lower interest rates were supposed to stimulate a
recovery in America. What they have actually stimulated is
mortgage refinancing... which permitted Americans to spend
more... which allowed them to buy more goods from
China... which put more money in Chinese hands, stimulating
their businessmen to compete even more with U.S.
enterprises...!

Oh là là, dear reader... what have we come to? We don't
know... but we'll find out together. More below...

Here's Eric's news:

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

Eric Fry in New York...

-"Rosy Outlook Excites U.S. Stocks," a CBSMarketwatch
headline cheerily observed yesterday morning. But the rosy
outlook did not excite stocks for long. It's true that
stocks surged higher immediately after the opening bell.
But by the close of trading, the market was looking a
little downcast, as the Dow drooped 82 points to 9,113 and
the Nasdaq slumped 1% to 1,701.

- Nor did the"rosy outlook" thrill the bond market. The
Treasury's 10-year note fell about half a point, driving
its yield up to 4.18% from 4.11% on Wednesday. Nothing
excites the bond market these days, except the closing
bell. Nearly every day, bond prices fall and yields
rise... and that's not very thrilling for bond investors.
The 10-year note has tumbled about 10% since hitting its
peak on June 16th.

- Before too much longer, we suspect, the manic stock
market will find it very difficult to cohabitate happily
with the depressive bond market. Soon stock investors will
begin to share the bond investors' pain. For the moment,
however, denial prevails in the stock market.

-"Don't worry about rising bond yields!" say the stock
market bulls."Interest rates ALWAYS rise when the economy
is recovering. The recent spike in long-term interest
rates, while painful for our bond market buddies, is a good
sign - a hopeful omen." We are dubious, mostly because the
U.S. economy has been relying almost entirely upon consumer
spending, which has been relying almost entirely upon
generational low interest rates.

- The millennial U.S. economy differs markedly from its
20th century counterpart in a couple of very important
respects. For one thing, 21st-century consumer demand is
opportunistic and"want based" rather than"need based." In
other words, the consumer's mind-set is approximately,"If
you are giving it to me, I will take it."

- Secondly, Americans have learned to neither expect nor
tolerate recessions. We may thank chairman Greenspan for
nurturing both of these socio-economic phenomena. Remember,
the 20th century economy struggled through 87 arduous years
WITHOUT the visionary, new-age guidance of Alan Greenspan
as chairman of the Federal Reserve. Greenspan became the
Fed chairman in 1987, which means that the 20th century
economy benefited from Greenspan's stewardship for only 13%
of its existence.

- By contrast, fully 100% of the 21st century U.S. economy
has operated under Greenspan's stewardship... Vive la
difference: the 20th century included the Great Depression,
while the 21st century, so far, has seen only one itty-
bitty pathetic-excuse-for-a-recession. During this
statistical slow-down, housing prices soared, expensive
restaurants never lacked for customers and the share price
of Porsche AG hit a new all-time high.

- Is it any wonder that with Greenspan at the helm,
Americans have learned to expect nothing but full-time
prosperity? Bear markets, recessions and rainy weather are
thought to be fleeting aberrations, which can be eliminated
swiftly by lowering the fed funds rate by just the right
amount at just the right time - that's Greenspan's job.

- Under Greenspan, Americans have also learned that stocks
always go up in the long run, and that interest rates will
forever remain low enough to facilitate home-buying. As a
by-product of the Greenspan era's"new economics," most
folks have come to believe in a corresponding"new
geopolitics." America may flex its military might whenever
and wherever it pleases. And if any country dares to stand
in its way, America will exact revenge by seeing to it that
an American citizen cycles to victory in the offending
country's most prestigious national sport...

- Net-net, the legacy of the Greenspan years has been to
convince an entire generation of Americans that, yes, there
is a free lunch, and if you hang around long enough, there
will be a free dinner and dessert as well.

- But one downside of a recession-free economy is that it
is also a recovery-free economy. And that's why rising
rates may inflict a great deal of pain during this
particular recovery attempt. Since low interest rates alone
have been sustaining the U.S. economy, there is no pent-up
demand for goods and services, merely"opportunistic
demand." When interest rates rise, the opportunistic, debt-
financed buying will vanish.

- Hence, GM has managed to sell cars only because it pays
its customers more than $3,000 each to drive them off the
lot, or because it offers 0% financing for five years... or
both. But the task of enticing buyers to borrow money and
buy things they don't need is becoming ever more difficult.

- Now that interest rates are rising briskly, thereby
increasing the cost of debt-financed consumption, we
suspect that Opportunistic Demand will take a seat on the
front-porch rocking chair, right next to Pent-up
Demand... and while these two consumption-drivers while away
the days, America's economy will drift off into a deep
sleep.

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Bill Bonner, back in Paris...

*** The U.S. economy may still retain the odor of sushi,
but bond buyers believe they smell inflation. For the first
time in a long while, the spread between inflation-adjusted
TIPS and regular 10-year Treasury bonds has risen over 2%.

*** Mortgage rates are rising, too. Last week's increase
was the 5th in a row.

*** But new unemployment claims dropped below 400,000 for
the first time in a long while, too. The major trend may
still be negative, however. A chart of weekly hours worked
shows a decline that has been going on for 32 months. Never
before has there been such a decline. The closest thing to
it was a 17-month fall-off in the recession of '74-'75.

*** Our last tango in Paris passed without bodily injury.
"Thanks for taking the lessons with me," your editor said
to his daughter as we left the studio. The"tango-in-5-
easy-lessons" program has come to an end. We are not quite
ready for competitions, but at least we can do a salida or
two.

"It was kind of fun," she replied. But she had not acted as
though it was fun, especially after our little group was
joined by an Adonis-like young man, with slicked-back,
blond hair and a pleasant smile; he looked like a poster
figure of the master race, but tangoed like a Fred Astaire
of the pampas.

"What's the matter?"

"Well, I feel like such a dork, dancing with Dad."

*** What have we become, dear reader? Non-Americans don't
seem to mind telling us. Here is a short sample of emails
recently received at the Daily Reckoning headquarters:

From the Far East:

"Another thing that I have noticed is that in all my
travels abroad you can always spot an American from a mile
away. So typical of the Far Side comic strip these tourist
families stick out like a sore thumb. Chubby flubby mom and
pop and ill behaved children wear their t-shirts and shorts
like little school children ready for the day at the beach.

"Bitchin' and moaning how they have to walk so much and
comparing everything to America and why no one speaks
English and why do these people do this and that and how
strange this is etc. How disgusting I can't possibly eat
that... Why can't I get proper service bla bla bla. All the
while dressed like and acting like children. All the while
not knowing the local custom would dictate that any self
respecting local person would at least attempt
to dress proper when going out to eat and a night on the
town.

"Oh yes we are Americans big fat naive slobs with no social
grace and yes my ears are broken cause I never listen to
what other people say, just like to hear myself talk about
whatever opinionated American centric b.s. I parrot from
CNN and CNBC and yes what I say is right and I don't listen
to you cause like I said my ears are broken."

And another, from Australia:

"Very amusing your notes on US tourists. I work for a small
airline in Oz flying 36 seater Dash 8's, and yep you can
spot 'em a mile away as they trundle along the tarmac with
not only their shirts, their weight, their kids & their
noise, but their 5 freakin' items of massive hand
luggage... each!!

"What do they keep in there? McFood I suspect."Oh but I
just caaammme oorrrff the 7-forty-7 and it was all OK on
there, why you gotta take it oorrff us now?" A very typical
question we deal with on a very regular basis when it comes
to our US friends."

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The Daily Reckoning PRESENTS: Bonner cogitating on
differences, without declaring a winner...


CRACKED
By Bill Bonner

"There is a crack in everything God made..."

- Ralph Waldo Emerson


"No man ever had a point of pride that wasn't injurious to
him," was another of Emerson's remarks. And by the end of
the 20th century, Americans had discovered enough points of
pride to practically annihilate themselves. They had the
most magnificent military machine the world had ever seen.
They had the world's most dynamic and resilient economy.
They had Microsoft and Hollywood. And Howard Stern. And
Will & Grace.

For the last couple of weeks, we have been comparing
America and France. Our point has been that the two nations
are not nearly as far apart as they think:

In France, a much larger percentage of the GDP is spent by
the government than in the U.S. - 53% compared to 32%. But
the difference is smaller than it appears, because in
France, health and education are almost exclusively run by
the government, and workers in these industries are on the
government payroll. Government also has a big position in
the transportation industry in France. The trains, the
metro... even some trucking business is done by state
employees.

And here we run into one of those delicious little
confusions that keep life interesting. The average person
in France would say that health and schooling are 'free' in
France, but expensive in America. Whereas the average
intellectual in America would say that they are 'free' in
America but state-monopolies in France. In both cases, the
word 'free' makes them sound like a good thing. But in both
usages, it would be a complete lie. For in France, the
services are hardly free; they are paid for by taxpayers.
Nor are they free in America, in the American sense; both
health and education have so many government strings
attached that they resemble state-run industries. Just talk
to a doctor or to a school teacher. You will find few
differences between one in Paris, France and one in Paris,
Texas. Both take the guff of centralized bureaucrats and do
as they are told.

And which system is better? Your editors have tried both.
We have sent our children to French schools and American
ones."The hospital here was much better than the one in
Baltimore," says Addison, whose wife just had a baby in
Paris."But it was the American Hospital."

We see differences, but no clear winners. Maybe the U.S.
health system is more advanced, but the French live longer.

When the costs of health care and education are added to
government spending in America, the resulting percentage of
GDP is within a few percentage points of the French total.
Americans spend about 14% of their GDP on health. They
spend nearly another 3% or so on post-secondary education.
They don't spend much on train tickets, because the trains
in America don't trundle anywhere Americans want to go.

Government debt in America is 70% of GDP. In France, it is
60%. Private debt, by contrast, is 162% of GDP in America.
We don't know how much it is in France, the number seems
impossible to find, but we'll bet it's a lot lower. The
French don't even have credit cards; they use debit cards.
And the idea of refinancing a mortgage in France is almost
absurd.

On one side of the Atlantic, the newspapers rant about the
'ruthlessness' of American capitalism. On the other, the
papers rag about the 'rigidity' of French socialism. But on
both sides of the great oceans, throughout the entire 20th
century, the high tides of central planning, paper money,
debt and social-welfare promises slapped the shore in the
same corrosive way. The maligned ideas of German
intellectuals and French philosophers drifted across the
North Atlantic in a matter of weeks. Soon, both continents
were drenched in politics... until every sod in the nation
depended on the runoff of money from Paris or Washington,
and was ready to vote for whichever clod promised more.

Almost no matter where you are in the modern world, for
every transaction, there is a tax. For every act, there is
a regulation. And for every idea held by the masses, there
is a massive fraud.

"It's the whole system of social protection put in place by
Bismarck at the end of the 19th century that we have to
take a look at," professor Peter Losche of the University
of Göttingen was quoted in Le Monde, explaining why the
whole shebang is doomed.

"If we change nothing, it will be necessary to pay 2/3rds
of our salaries in order to support the [government's]
health, retirement and unemployment systems."

And thus we come back to the printing press in Washington's
basement and America's unique situation at the debut of the
21st century. It is the Dollar Standard that separates the
U.S. from France, and gives Americans an immeasurable boost
towards ruination. While California and France are being
forced to come to terms - honestly or dishonestly - with
their predicaments, the U.S. still has the world's reserve
currency.

Americans have had the rest of the planet bamboozled; the
foreigners sent them nearly $2 billion worth of goods and
services, every day, even though Americans couldn't afford
them and had nothing to give in return except little pieces
of green paper. The poor huns, frogs and wogs... it cost the
U.S. Bureau of Printing and Engraving less than a penny to
produce a dollar bill, but the foreigners took it as though
it were worth a hundred of them.

The dollar undergirded all of America's good fortune. Upon
it rested the whole hullabaloo - the lopsided trade, its
effervescent markets, its national and private debt. An
entire generation of Americans had come of age with the
strong dollar. They took it for granted that the strong
dollar, like the Rolling Stones, was neither cyclical nor
circumstantial, but eternal.

The American dollar broke records. There was nothing else
like it in the world. There was nothing like it in history.
It seemed even to defy God Himself. For God had planted his
own 'money' in the Earth, scattering a bit on the surface
and more deep down, where it was hard to get out. For
thousands of years, ever since there was money, gold had
served as money. And who complained about it? The yellow
metal couldn't be bribed, flattered, seduced, or
flimflammed. Nor did it interrupt dinner with moronic,
self-serving announcements. It said nothing. It went
nowhere. It held no press conferences and no opinions. For
centuries, it just sat there, as quiet and serviceable as a
graveyard.

But since 1971, Americans seemed to have no use for it;
they had invented something better.

Men had previously appreciated gold because it was hard to
come by - in fact, the world's supply of it increased
almost in exact proportion to the growth in the world's
other goods and services. In the time of Christ, a Roman
could buy a respectable suit of clothes for about an ounce
of gold coin. So could an American 2000 years later.

But the dollar was an improvement on gold, they believed,
for precisely the opposite reason: because they could
create an infinite quantity of them. In effect, Americans
thought the dollar gave them a line of credit that was
inexhaustible... and a credit card that never had to be paid
off.

America has become"the world's mouth," said a source
quoted by James Grant - the ultimate consumer, ready to eat
up the world's excess production like a fat man going to
work on a pile of cream puffs.

"We can pay off anybody by running a printing press," said
Thomas Gale Moore, a member of the president's Council of
Economic Advisers. He was speaking in the late '80s, just
about the time the U.S. net international investment
position slipped below the waterline separating debtor from
creditor. In the beginning of the great boom in 1980, the
U.S. enjoyed a net positive investment position of about 7%
of GDP. By the end of the century, the nation was soaked in
debt, with a net negative position equal to 25% of GDP.
"Frankly," Moore continued, with Bernanke-like candor,
"it's not clear to me how bad that is."

Here at the Daily Reckoning, it is not clear to us either.
But give us time. Our hunch is that the cracks in this
Dollar Standard system are spreading. Within another 10
years or so, the whole thing may fall apart.

Already, dollars spent by Americans end up stimulating
economic development - not in the homeland, but abroad.
Overseas competitors, with much lower labor costs, little
debt and few of Bismarck's promises to keep, become more
and more able competitors with every dollar spent.
Meanwhile, Americans sink deeper and deeper into the debts
they thought they'd never have to pay.

But every bill gets paid somehow. If not by the
borrower... then by the lender.


Bill Bonner