-->Deep In Debt, Caught In A Net

The Daily Reckoning

Baltimore, Maryland

Tuesday, 4 November 2003


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*** Indian Summer on Wall Street... gold falls closer to our
buying target...

*** What if we're wrong... Buffett explains boom...

*** An unused constitution... tractors in France... packing
heat... and more!

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The Indian Summer continues. It is so warm in Baltimore we
had to turn the air conditioning on.

And in the financial markets, the warm after-glow of the
great bull market continues to brighten hearts and account
statements. The Dow rose 57 points yesterday. The dollar
went up against the euro... to $1.14.

Gold fell to $377.

"Construction surges to record in September," says a
Reuters headline.

"Manufacturing index at 3-year high," adds Bloomberg.

All over the country, people are convinced that this
recovery is real. Savings rates are falling; people are
borrowing and spending as never before.

And so, dear reader, is it time to ask:

What if we're wrong?

What if the recovery is genuine? What if this really is a
new bull market, rather than a bear market rally? What if
the trade deficit and the federal deficit don't really
matter? What if the dollar doesn't fall - no matter how
many of them we produce? What if you really can get rich by
spending, after all?

Will winter never come?

Of course, to this query, we know the answer. The answer we
lack is to the question: when."In the fullness of time,"
we reply, for lack of a better response.

"Give me a trillion dollars and I'll show you a good time,
too," was Buffett's answer. He was replying to a different
question, addressing the beginning of today's boom, rather
than its end. The source of the present excitement on Wall
Street, Buffett implied, was neither a real economic
recovery nor a genuine bull market. Instead, it was a
response to more than a trillion dollars' worth of
stimulus. The federal budget went from surplus to deficit -
a swing of more than $700 billion - in an 18-month period.
Cutting interest rates rapidly, the feds also managed to
light up the housing market - adding hundreds of billions
to the economy through mortgage refinancings and new
construction.

Will winter never come? Can you now get rich by spending
more than you can afford on things you don't really need?

We don't know. But it is unlikely, in our humble view, that
the planet earth has shifted on its axis. Winter will show
up, as it always does - sooner or later. Nor is it likely
that the laws that have ruled the world of money for so
many years have suddenly been repealed.

So, we turn the 'what if' question in a different
direction. What if the economy doesn't get another
trillion-dollar jolt of stimulus? What if the government
decides not to shell out another $700 billion... taking the
federal deficit to, say, $1.2 trillion in the hole? What if
China and Japan don't lend more money next year? What if
interest rates can't be cut further; what if the
refinancing boom has already run its course?

We don't know that answer to these questions. But we can
take a guess. One of the curiosities of the bear market of
2000-2002 was that U.S. investors never panicked. Stocks
sold off. Trillions were lost. But never was there a mad
flight for the exits.

This time may be a bit different; we may finally see a
pell-mell panic in international currency markets, debt
markets, and in the U.S. stock market. Foreign holdings of
U.S. dollar securities have bubbled up from less than 10%
of long-term public debt in 1997 to more than 50% in August
of 2003. Some future headline is likely to tell us that the
foreigners have grown a little panicky:"Foreigners Rush to
Dump U.S. Dollars," USA Today may report.

In America, investors still believe in stocks for the long
run... but few will be willing to hold them through another
short-run collapse.

Look out.

In the meantime, here's Eric, back in NY with more news:

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

Eric Fry from Wall Street...

- The stock market is soaring... and woe to anyone who tries
to stand in its way.

- Yesterday, the Dow gained 57 points to 9,858, while the
Nasdaq jumped nearly 2% to 1,967. Stocks are expensive. But
millions of investors buy them anyway. They fear only the
expense of NOT buying stocks that are going up... The
stomach-turning regret over buying too many shares of Cisco
Systems in late 1999 has yielded to the regret over buying
too few Cisco shares in late 2002. The semiconductor
giant's stock jumped another 3% yesterday on word that
global chip sales swelled by 6.5% in September to $14.4
billion, the largest monthly increase since 1990.

- The economy is recovering. Everyone knows that. So stocks
will keep rising... Everyone knows that, too. Each new
tidbit of favorable economic news is, a priori, a new
reason to buy stocks.

- Fresh on the heels of last week's booming 7.2% GDP report
came the news yesterday that the beleaguered U.S.
manufacturing sector is rebounding. The Institute for
Supply Management said factory activity in the United
States grew in October for the fourth consecutive month.

- Specifically, the ISM manufacturing index rose to 57.0
percent last month from 53.7 percent in September, the
strongest pace since January 2000. Within the report, the
new orders index rose to its highest level since June 1994.
In other signs of economic revival, the Commerce Department
said spending on construction projects rose 1.3 percent in
September after a 0.7 percent rise in August.

- The resurgent economy is great news for everyone but
pawnbrokers and bond traders. In the bond market, signs of
economic growth are as welcome as the bride-to-be at a
bachelor party. That's because strong economic growth often
coincides with rising bond yields. Yesterday, the yield on
the 10-year Treasury note popped up to 4.35% vs. 4.30%
Friday. Meanwhile, the gold price tumbled $7.50 to $377.10
an ounce.

- 2003 has been a kind year to most investors. Buyers of
gold stocks are nearly as happy as buyers of tech stocks.
But the buyers of bonds are not happy, especially foreign
bond buyers. The twin declines in the bond market and the
U.S. dollar have dealt a wicked blow to the capital
accounts of the foreigners who are graciously supplying our
capital. How long will they tolerate this sort of abuse?

- Last week, the octogenarian sages who addressed the New
Orleans Investment conference cautioned the attendees to
steer clear of the U.S. dollar. But the nation's investors
have no use for the seasoned wisdom of old folks, much less
the wisdom of the relatively sprightly Warren Buffett. The
72-year old billionaire investor stated recently,"I am
crying wolf again and this time backing it with Berkshire
Hathaway's money. Through the spring of 2002, I had lived
nearly 72 years without purchasing a foreign currency.
Since then Berkshire has made significant investments in -
and today holds - several currencies.

-"Both as an American and as an investor, I actually hope
these commitments prove to be a mistake. Any profits
Berkshire might make from currency trading would pale
against the losses the company and our shareholders, in
other aspects of their lives, would incur from a plunging
dollar.

-"But as head of Berkshire Hathaway, I am in charge of
investing its money in ways that make sense. And my reason
for finally putting my money where my mouth has been so
long is that our trade deficit has greatly worsened, to the
point that our country's 'net worth,' so to speak, is now
being transferred abroad at an alarming rate."

- Jimmy Rogers, who is more than a decade away from 80, but
who has seen more of the world than most 100-year olds,
also advises unloading greenbacks."If I could tell you all
just one thing today," said Rogers to the audience,"it
would be to sell the dollar."

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Bill Bonner, back in Baltimore...

***"I never met anyone who said to buy gold."

Your editor was chatting with a young woman on a flight
from Atlanta to New Orleans. In North America, as in
Europe, buying gold is seen as bizarre, anti-social and
barbaric. That will change, we predict.

***"It reminds me of Vietnam," said a veteran on the
flight from Paris. He was referring to the war in Iraq."I
was drafted right out of college. They told me I was going
to Vietnam to protect the free world from communism. It
took me exactly two weeks to realize that it was a load of
b.s."

This traveler was from Heston, Kansas... an engineer working
for Massey-Ferguson tractors.

"What takes you to Paris," we wanted to know.

"Well, the office is in Heston, Kansas, but we make our
tractors in Beauvais, France. We used to make them in
Coventry, England. But we found that we can make them
better in France."

Go figure.

*** A friend sends the following...

Provocative recent remarks from the host of NBC's Tonight
Show:

On the U.S. Senate:"The Senate voted 97-0 for an anti-spam
bill to stop those annoying things you get on your
computer. The senators made it very clear that when you
start misleading the American people and start taking their
money over false promises, that's our turf, buddy!"

On the effort to write a constitution for Iraq:"As you may
have heard, the U.S. is putting together a constitution for
Iraq. Why don't we just give them ours? Think about it - it
was written by very smart people, it's served us well for
over two hundred years, and... we're not using it anymore."

*** Poor little Edward. The boy has his 10th birthday this
week... and he's already got a record. He was collared at
school for packing heat - a b-b gun that he had bought from
another naughty boy. The two of them were waving it around
to impress their friends when the law showed up - a teacher
who confiscated the weapon and sent them to the principal's
office.

*** By the way, if you are free next Wednesday, November
12, you may wish to join our man in New York, Eric Fry, at
the upcoming meeting of the Supper Club. The event will be
held in at the Broadmoor Resort in Colorado Springs. Four
new investment ventures will be presented... as well as
twelve past opportunities, some of which are still open.

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The Daily Reckoning PRESENTS: Your average debt-strapped
American burger-mashers, in over their heads...


DEEP IN DEBT, CAUGHT IN A NET
By Hans Sennholz

"Deep in Debt, Caught in a Net"... This old English proverb
concisely describes the financial condition of many
Americans. Household debt is rising at an 8.8 percent
annual rate, home mortgage debt at 14.2 percent. Total debt
in the United States doubled from 1998 to 2002, from $16
trillion to $32 trillion, and may double again in the next
five years.

The Federal government, which sets the pace, reported a
$555 deficit for the 2003 fiscal year; its total debt is
given at $6.783 trillion. For the next two years the budget
deficits are estimated at $566 billion to $644 billion
each, which should increase its total debt to more than $8
trillion, or some $27,000 for every man, woman, and child.

Economists make an important distinction between
"productive" and"consumptive" debt. Although the
difference may not always be clear and exact and,
therefore, may give rise to much controversy, it is
significant as to motive and effect. A debt incurred for
productive purposes, e.g. a commercial or industrial
investment designed to earn future incomes, may cover its
interest costs and even yield entrepreneurial profits. In
contrast, new debt in the form of a second mortgage on a
home may finance the purchase of a vacation home, new
furniture or another automobile, or even a luxury cruise
around the world. The debtor may call it"productive," but
it surely does not create capital, i.e. build shops or
factories or manufacture tools and dies that enhance the
productivity of human labor.

Similarly, a debt incurred for the purpose of expanding
Medicare may improve the health and looks of many elderly
and, therefore, be deemed"productive," but it does not
create capital that makes workers more productive and
raises the levels of living of all. It actually may consume
capital and thereby depress standards of living.

Private debtors may find it difficult to pay for bread that
has been eaten. It is likely to become ever more difficult
in the future as the cost of debt is likely to double and
triple. At the present, interest rates are far below market
rates due to massive monetary and fiscal stimulation by
both the U.S. Treasury and the Federal Reserve System. The
basic Fed rate stands at one percent, three-month money
market instruments at 1.11 percent, one-year paper of 1.78
percent, and two-year government notes at 1.77 percent.

For a while, government may ignore and even outlaw market
prices, market wages, and market rates of interest and
mandate its own, but price and rate edicts invariably
disrupt the smooth functioning of the market order. They
cause business misdirection and maladjustment that lead to
ever more business losses and failures. In economic
disarray, the Fed may have no choice but to raise its rate
to market heights that enable businessmen to readjust to
the judgments and wishes of the people.

Public debtors may view their debts in a different light.
They may call them"a national bond" which, in Franklin D.
Roosevelt's words, is"owed by the nation to the nation."
In reality, it is unlikely that future generations of
taxpayers will willingly bear the bond of debt. Like so
many before them, they may choose currency depreciation,
which offers the most advantageous escape from a burden of
debt. It depreciates all debt and, in terms of purchasing
power, may even reduce debt faster than new deficits are
added. In the end, no matter how large the budget deficits
may be, debt depreciation may outpace the deficits, which
benefits all debtors, public and private, and defrauds all
creditors.

Many creditors are exposed to yet another danger. The
currency depreciation may accelerate if foreign creditors
should begin to question the quality of the American dollar
and liquidate their dollar claims, seeking refuge in other
countries and other currencies. While many domestic credit
institutions are legally barred from investing in foreign
currency claims, foreign creditors usually have no such
limitation; they are free to shed dollar investments at any
time and search for profitable opportunities elsewhere.

Every such liquidation would reduce the demand for dollars
and aggravate its depreciation. Moreover, it would cast
doubt on the special position of the American dollar as the
world's primary trade and reserve currency. For many years
this special position has allowed the Federal Reserve
System to provide the world with ever more of its notes in
exchange for ever more goods and services. If the world
should ever lose its trust in the U.S. dollar and convert
some of its holdings, more than $7 trillion of American
assets and claims, the consequences would be too calamitous
to contemplate.

Our debt generation is a sad generation misguided by false
notions and doctrines, and preoccupied with its own needs
and wants. When economic conditions begin to deteriorate it
may grow ever more egocentric and wretched, which tends to
aggravate the social tension and strife. Clinging
tenaciously to its transfer claims and rights, the unhappy
society thus may deteriorate into a militant assembly of
diverse pressure groups feuding and fighting each other.

When the political conflict finally explodes into violence,
the transfer society urgently needs a peacemaker who is
prepared to suppress violence with superior violence. In
the end, a society that can no longer work together in
peace must submit to the dictates of a strong president
armed with an array of emergency powers. In other places,
at other times, he would be called Caesar.


Regards,

Hans Sennholz
For the Daily Reckoning