-->Japanese Phantom Growth

The Daily Reckoning

Baltimore, Maryland

Thursday, 11 December 2003


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*** Debt increases... but the debt machine hesitates...

*** Layoffs continue... but 'restaurant hiring' continues
too...

*** Prepare for big, long drop in the dollar... gold takes a
hit... California is dreaming... and more gratuitous
insults...

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The tax cuts and rate cuts have done their work. Americans
have gone deeper into debt... while believing they were
getting richer.

Since the beginning of the Dollar Standard era in 1971,
debt has increased about twice as fast as GDP. That is, for
every new dollar of output... $2 of new debt were added. But
as liabilities increase, it takes more debt to move the
economy forward, while still covering previous borrowings.
Last year, for example, debt increased 7 times faster than
GDP.

But now, the whole debt machine seems to hesitate...

Mortgage demand is near an 18-month low, says CNN.

The money supply, M3, is ominously - and a bit mysteriously
- falling.

The dollar is falling; foreign dollar holders are getting
sick of being chumps. But despite a large drop against the
euro and gold, the trade deficit continues. Foreigners
scarcely seem more eager to buy American goods than they
were a year ago. Nor has Americans' appetite for foreign-
made products declined. The dollar is linked to the Chinese
yuan by decree; as the dollar falls, Chinese-made goods
become even cheaper.

The dollar is America's I.O.U. If the U.S. economy could
stage a real recovery... the dollar might recover, too. But
what could it recover from? The economy is in such a
strange slump... it is any wonder the 'recovery' is just as
odd? Jobs are supposed to be finally increasing - but last
week's number came in at less than half of what was
expected. People are waiting longer to find new jobs, too -
up to almost 20 weeks. And while layoffs from serious jobs
continue, the NY Times refers to the new jobs as
"restaurant hiring." If someone can explain how busboys and
waitresses are supposed to lead the world's largest and
most-indebted economy... he has not explained it to us.

The dollar bounced a little yesterday, after 8 straight
days of losses against the euro. Still, the surest bet
around seems to be that the dollar will fall more. Even
TIME magazine is talking about 'hedging' against the
dollar's fall. Meanwhile, the smart money - Soros, Buffett,
Templeton, Rogers - is betting against the dollar, hoping
to make epic profits as the dollar declines.

Our friend, David Galland, sends this note from his new
publication, What We Know Now:"When the U.S. dollar
historically begins to weaken, it stays weak for a very
long time. To be more specific, we turn to Everbank's head
trader, Chuck Butler.

"The first weak dollar trend of the period began in 1971
and ended in 1978, 7 years in duration. During that period,
the Swiss franc gained +186% versus the dollar. The
Deutsche mark gained 53% during the same period.

"The next weak dollar trend began in 1985 and ended in
1996, 11 years in duration. During that time, the Swiss
franc gained +138% versus the dollar. The Deutsche mark
gained 53%.

"As we are still not even two years into the current dollar
weakness (the current downturn began in February 2002)... we
have a rare opportunity to get in early into what could be
a very long trend. While you have the luxury of waiting a
week or so to see if the dollar manages a short rally -
because it is almost certainly getting ahead of itself just
now - but even if you don't feel like waiting, don't be
overly concerned - based on all the evidence, the U.S.
dollar has a long way to fall. Which means other currencies
will continue to gain.

"The easiest way to invest in other currencies is not
through some fly-by-night commodity scheme, but through
Everbank, which offers FDIC insured deposit accounts
denominated in any of the major currencies." [For an update
on Everbank's current recommendations and 6 other ways to
sell the dollar, watch this space for our Special Reckoning
Report: Bonfire of the Currencies.]

Until then, here's Eric with today's scoops:

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

Eric Fry in New York...

- The Japanese bought themselves a nice little dollar rally
yesterday. According to the scuttlebutt from the London
trading pits, the Japanese central bank scooped up about 10
billion dollars in the open market yesterday, in an effort
to prop up the ailing greenback. The dollar purchases,
while large, were not out of the ordinary for the Japanese
central bank. The Bank of Japan has sold a record 17.8
trillion yen ($164 billion) this year in order to weaken
the yen against the dollar. We suspect these massive dollar
purchases will go down in history as one of the worst
Japanese investments since buying Pebble Beach.

- Yesterday's contrived dollar rally produced a swift sell-
off in gold and gold shares, while helping to support the
struggling stock market. The Nasdaq recovered from early
losses to post a modest drop of only 4 points at 1,904. The
Dow slipped 2 points to 9,922. Treasury prices bounced a
little yesterday, pushing the 10-year bond yield down to
4.32% from 4.35% on Monday. According to the newswires, the
bond market rallied because investors expect the Japanese
to spend most of the 10 billion dollar bills they purchased
yesterday buying Treasury bonds.

-"Speculation that the BOJ will invest the dollar proceeds
of its yen sales in the U.S. Government bond market boosted
Treasury prices in early trading," Bloomberg News reports.
"Fed holdings of Treasuries on behalf of foreign central
banks have risen to record levels in each of the last three
weeks, most recently $826.8 billion the week ending
December 9." How many bonds can the bank of Japan buy, we
wonder? And what would happen if and when they reduce their
purchases?

- Gold shares struggled all day and finished the session on
their lows, as gold for February delivery fell $1.90 to
$407.00 an ounce. Gold's modest decline would not have
seemed so bad, except that the yellow metal touched $413.30
an ounce earlier in the session, the highest price since
February 1996. But gold's downward reversal during the
afternoon seemed to break the spirit of gold bugs, who
unceremoniously dumped gold shares of all shapes and sizes.
Bellwether Newmont Mining tumbled more than $2 to $45.70,
while The AMEX Gold Bugs Index collapsed more than 6%.

- One reason the gold shares may have suffered such a steep
drop relative to the modest sell-off in gold itself is that
there's a new kid in town. As Addison mentioned yesterday,
Gold Bullion Securities Ltd. started trading on the London
Stock Exchange on Tuesday. The new security is a kind of
"paper gold" that trades just like a share of Newmont
Mining - maybe too much like a share of Newmont Mining -
but represents a claim on actual gold bullion. Presumably,
some large percentage of the gold-stock-buying public would
prefer to own the thing itself, rather than the shares of a
company that mines gold.

-"Gold Bullion Securities won't act exactly like an
exchange-traded fund," explains Dan Denning, editor of
Strategic Investment,"but in principle, it's the same
thing. That is, it's a proxy for physical gold, a way for
you to profit from the rise of spot gold prices without
having to buy, take delivery, or store the physical asset."

-"GBS is backed by physical gold," Dan continues."It will
own physical gold, held in a vault, and then 'securitize'
it by issuing shares. Each share of GBS will trade at
1/10th the price of an ounce of spot gold. Even though it
trades in London, all the pricing will be in U.S.
dollars... As institutional and retail investment demand for
gold rises, GBS plans on adding more bullion reserves to
its trust, and issuing new shares based on the new
reserves. How many shares it ends up issuing depends on how
much demand there is for gold-backed shares."

- Gold bulls hope that the new security will create a mini-
boom for physical gold. Now that buying gold is so easy,
they say, demand for gold will soar. The bulls may have a
point.

-"If GBS becomes a real paper proxy for physical ownership
of gold, just how liquid could it become?" Denning asks.
"One possible comparison is the QQQ, the ETF for the Nasdaq
100. On a good day, the"Triple Qs" trade around 60 million
shares. That's good enough to usually place them in the top
10 of the most actively traded public shares on any given
day. For example, on Friday, volume on the Qs was 87
million...

-"There's not a gold stock among the top 50 most actively
traded shares for Friday. Newmont (NEM) rolled in at 55th,
trading just under 5 million shares. If a U.S.-listed GBS
does to gold what the Qs have done to the Nasdaq, you're
looking at daily volume of at least 50 million shares
trading hands, which raises an obvious question of how
large a U.S.-listed GBS would become. At a gold price of
$400, and with each share of GBS trading at 1/10th of an
ounce of gold, a potential volume of 50 million shares a
day implies just under $2 billion in bullion assets..."

- Thanks to the new gold security, buying gold has never
been easier. But why bother, says the Wall Street Journal.
"The stock market swoon has ended," the esteemed journal
triumphantly declared yesterday,"leaving investors freshly
attractive alternatives to buy in lieu of gold."

- Hmmm... The Wall Street Journal still scorns gold. Maybe
the gold bull market isn't over yet.

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Back in Baltimore...

*** California debt was downgraded, again, by Moody's. U.S.
debt won't be far behind.

*** When the consumer stops spending, how will you profit?

"Besides Wal-Mart, I think shorting CountryWide Financial
Corporation is a good idea right now," suggests Dan Ferris.
"It represents 13% of the nation's mortgage market. Its
mortgage business has taken huge, double-digit hits in each
of the past three months.

"And today, Washington Mutual, another big mortgage lender,
revised its outlook downward due to weakness in its
mortgage business.

"By the way, did you know that 85 million households are in
the stock market now? Low interest rates have kept stocks
and homes popular as investments, and speculations... and
foolhardy purchases.

"Where will it all end? How?

"I don't know the answers, but I'm going to sell Wal-Mart
and CFC and buy debt collection agencies, gold, commodities
and whatever dirt cheap, inflation-proof businesses I can
get my hands on. I've found one of the latter for the
current issue of Extreme Value: orthodontics!"

*** From a Daily Reckoning reader:"I remember a factual
story of years ago when either Henry Ford I or Henry II was
walking around the/a new Ford factory with Walter Reuther,
then the head of the Auto Unions. Henry was talking about
how many fewer workers this factory needed than other ones.
He continued by saying that in the future, we would have
almost NO workers building cars and trucks. Walter
responded to Henry and said, 'That's great - who is going
to buy these cars and trucks, then?'

"All this productivity is the same thing. Export jobs.
Destroy the middle class. We will have Argentina and Brazil
- where the wealthy live in gated communities, fearful to
show any wealth, while the vast lumps hate them and look
for ways to rob them.

"The difference is, now all the rest of the world hates us
as well and 'lumps,' no pun intended, all of us together as
ugly Americans."

***"Gratuitous insults..."

That is what several readers have made of our comments on
Americans."What possible difference does it make how
people dress?" asked one Daily Reckoning sufferer.

The Daily Reckoning is a free service. We feel entitled to
insult whomever we please, at no charge. But, as we
explained to Henry's priest after he read our comments
about him, the DR is also a new kind of journalism. Your
editors give their opinions, their observations, their
reflections - without malice, but also without worrying
about whose feelings might be hurt. One reader accused of
us being 'anti-American.' We deny the charge. But we admit
that we are not 'pro-American' either. Fools, knaves,
geniuses and saints are fairly well distributed across
national borders, we maintain.

But we do worry about Americans... for they are us. We look
in the mirror and wonder: Perhaps we have had it too easy
for too long? Americans have come to believe things that
can't be true... but are too comfortable, too complacent,
and too lazy to want to think too hard about it. We hate
criticism... but it is probably just what we need. Or a kick
in the pants. Americans seem so relaxed... so ready to go
along with anything... so sure that everything will work
itself out for the better.

Maybe it will. But we think we see the gods putting on
their steel-toed boots.

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The Daily Reckoning PRESENTS: Et tu, Japan? Says Dr.
Richebacher:"Japan's statisticians have learned from their
American colleagues how to conjure up the perception of an
economic recovery that does not exist."


JAPANESE PHANTOM GROWTH
by Kurt Richebacher

Lately, international investors have become enthusiastic
about Japan's economy and stock market.

Several American investment banks have trumpeted that the
turnaround of Japan's economy has arrived. Foreign
investors have been pouring money into Japanese stocks,
boosting the yen in the process. Officially, Japan's real
GDP grew in the second quarter by a sensational 3.9%,
beating America's growth rate of 3.3%.

Our knowledge about Japan's economy comes exclusively from
the monthly reports of its central bank, the Bank of Japan.
Its September report stated:

"Economic activity still continues to be virtually flat as
a whole, although signs of improvement have been observed
in such areas as the environment for exports. With regard
to final demand, business fixed investment is recovering
gradually.

"Meanwhile, private consumption continues to be weak,
housing investment remains sluggish, and public investment
is declining. Net exports are virtually flat. Industrial
production continues to be basically level in response to
these developments in final demand, and corporate profits
are on a moderate uptrend."

This hardly reads like the description of an economic
recovery. But how to reconcile this dismal description of
the economic situation with the officially reported stellar
real GDP growth rate of 3.9% for the second quarter?
Putting it bluntly: It is exactly the same statistical hoax
as the 3.3% simultaneously reported for the U.S. economy.
Japan's statisticians have learned from their American
colleagues how to conjure up the perception of an economic
recovery that does not exist.

Yet in Japan's case, there were some critical comments in
the press. A report in the Financial Times quoted an
economist as saying that"the government deliberately
manipulated statistics" using in particular an"incorrect
measure of deflation."

This, in turn, provoked a reply from the head of the
Japan's Department of National Accounts, a Cabinet Office.
In his letter to the FT, the director explained that the
"basic price statistics used in Japan's GDP deflators, such
as the consumer price index and corporate goods price
index, adopt the hedonic method to track price changes
accompanying quality improvement in it goods" - stressing
that this is common international practice.

To be precise: Just like the practice of annualizing
quarterly numbers, this is an American, not an
international, practice. Without the annualization,
reported real GDP growth would have been 1% in the quarter,
and 3% year-over-year. In today's world of sluggish growth,
that would also be impressive, if its main source was not
hedonic pricing of computers. Under its impact,
nonresidential investment grew 4.7%, or a stunning 20.2% at
annual rate.

Measured in current prices, a radically different picture
emerges: Japan's nominal GDP grew during the quarter by a
dismal 0.3%, or 1.2% at annual rate. Year-over-year, it was
up 0.5%. Repeating the first sentence of the above citation
from the Bank of Japan:"Economic activity still continues
to be virtually flat as a whole."

Assessing the Japanese economy's performance and prospects,
there is a broad choice. If you want to see an economy and
a stock market powering ahead, focus on the 3.9%, as
measured in real terms and annualized; if you want to see
an economy that remains stuck in the post-bubble aftermath,
focus on the 0.3%, as measured in nominal terms and without
annualization.

Such a vast difference in measured economic activity is, of
course, laughable. One of them must be completely out of
whack with economic reality. For us, there is no question
which one - the 3.9%. It has two main statistical sources
that we regard as outright phony: first, annualized
quarterly figures; and second, a very low GDP deflator.

Take these two statistical gimmicks away, and you end up
with the earlier mentioned mini-growth rate of 0.3% in
nominal terms for the second quarter. From the above
citations of the Bank of Japan, we conclude that it, too,
favors this measure.

But which of the two is the better measurement of economic
activity?"Real" figures attempt to measure the physical
volume of goods produced and sold in the economy by
adjusting nominal figures with calculated inflation rates.
Falling prices essentially increase real GDP growth, and
rising prices decrease it. By contrast, the nominal figures
simply add up the amount of money that has been spent on
various demand components.

We have to say that we are principally opposed to
translating falling prices into rising real GDP growth. It
corresponds, of course, with the opposite practice to
deduct inflation rates from nominal GDP growth.
Mechanically, both seem equally logical, but economically,
this equal treatment makes no sense. Consider that the
steeper the fall of prices, the higher the economy's real
GDP growth rate.

For us, the decisive consideration is that the real figures
tell us nothing about the movements of incomes and profits.
These only show in nominal figures, based on money
transactions. This may have been less important in times of
high inflation, but in our time of protracted economic
sluggishness, the money measure is far more important than
the volume measure.

Regards,

Kurt Richebacher,
for The Daily Reckoning