-->A Bullish Mirage

The Daily Reckoning

Ouzilly, France

Wednesday, 31 December 2003

New Year's Eve

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

*** Our So-Called Recovery... über-optimism among investors

*** Dow slips, housing starts up, Japan fights rising
yen...

*** Unemployment is higher than you think... fur
coats... socializing... and more!

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

We have nothing in particular to say this morning; nothing
we haven't already said.

The 'recovery' is a fraud... or as Paul Krugman refers to it
in his New York Times column,"Our So-Called Recovery...."

The consumer economy is a humbug. Debt-driven growth is a
trap.

The feds believe they can stimulate the economy - with
additional debt - to such a pitch of growth that the debts
themselves will be no problem. Give the economy a shot of
that old time medicine - lower rates, more credit, more
borrowing and spending by consumers and government!

In a normal recovery cycle, people begin to spend... which
creates business investment and new jobs. The jobs lead to
more spending... profits... and a genuine boom.

But in a normal recovery, they have money to spend, money
they saved during the downturn. This is no normal recovery.
The processes of consumerism, debt, dollarization and
globalization have gone too far. Americans owe too much
money to too many people. When they get an extra dollar -
even on credit - they already have too many debts to pay.
They never stopped spending during the recession... now they
have nothing to recover from - except debt. When the feds
offer more credit - at the lowest interest rates in 45
years - consumers are only able to continue keeping up
appearances; they can make no headway. And when they do
buy, chances are the THINGS they purchase are no longer
made in America - but overseas. So the stimulating effect
of debt ends up among foreigners... while the crushing
burden of it remains right here at home.

But we have said this all many times before.

And it is the end of the year....we bow our heads and
apologize. We were surprised that the year went as it did.
We expected a bright éclat of revelation; instead, we got
more darkness, debt and dumbness. The huge burst of
government spending and additional debt did manage to hold
off the day of reckoning... at least for a while. George W.
Bush still has a shot at another term. Alan Greenspan is
not yet regarded as the mountebank he really is. Americans
are deeper in debt than ever... and going bankrupt at the
fastest rate ever in history... but seem perfectly happy to
do so!

So, it worked! The bubble was successfully reloaded.
Investors can now buy stocks for more they are worth... and
ruin themselves by borrowing for less than the real cost of
money.

And now millions of Americans can look on their end-of-the-
year statements with satisfaction. They will think
themselves heroes and geniuses. While Soros was getting out
of the dollar - the patriots stuck with it, like Daughters
of Dixie with their confederate bonds. While Grantham,
Rogers, Templeton and all the other great investors urged
them to get out of stocks and the dollar - they held their
ground like Custer's men at Little Big Horn. While Buffett
could find no stocks worth buying - they stepped up and
bought Amazon.com! And the great big River-of-no Returns
stock paid off.

The trouble with these stock market gains is that in terms
of real money - gold - or less-bad paper money - euros -
they amount to little of anything... and could disappear in
a trice."I made all my money by selling too soon,"
explained J.P. Morgan. At any time in the past year... and
at any time in the next... too soon might not be soon
enough. For, unlike the gains in euros or gold, profits in
stocks rest upon nothing but an illusion - that the Feds'
debt bubble can last forever.

When it will all come to an end, we don't know. But that it
will come to an end we have no doubt. Nothing lasts forever
- least of all a debt bubble. Already, even with the lowest
interest rates in 4 decades, Americans' debt-service ratio
is at historic highs. And, at least in Silicon Valley, as
many as 68% of all mortgages are adjustable rate. The
average mortgage rate currently is only 5.8%. Even a slight
upward movement will squeeze homeowners and bring an end to
their spending. As recently as the early '80s, mortgage
rates were above 18%. Hard to believe... but not hard to
imagine that they could bounce back to, say, 7% before the
end of 2004.

Hardly anyone expects this to happen before the November
elections. The dollar is expected to drift lower. Stocks
are expected to rise gently. George W. Bush is supposed to
float into Washington like the bloated body of a Capital
Hill staffer drowned on the upper Potomac.

It might happen that way. Then again, it might not.
Tomorrow, we bring you our own predictions for 2004.

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

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

Eric Fry in the wilds of Manhattan...

- The stock market paused to catch its breath yesterday, as
the Dow slipped 25 points to 10,425 and the Nasdaq added 3
points to 2,010. Consumer confidence also retreated a bit,
as did manufacturing activity in the Chicago area. But make
no mistake, investors are bullish, consumers are confident
and manufacturers are optimistic. America is a very
different place today than it was on December 31, 2002.

- One year ago, stocks were in a deep freeze and bonds were
as sexy and sizzling as Rio de Janeiro. Stock market
investors were gripped with fear, worried that three years
of falling stock prices would become four and fretful that
the imminent invasion of Iraq would snuff out our nation's
budding economic recovery. Only die-hard bulls, intrepid
speculators and faithful Abby Joseph Cohen disciples dared
to load up on stocks... You know what happened next: bonds
tumbled and stocks soared.

- Today, investors find themselves in precisely the
opposite situation. Stocks are sizzling and bonds are room
temperature, at best. Accordingly, almost everyone expects
stocks to rise and bonds to fall. That's because almost
everyone expects the economy to continue growing in 2004,
while almost no one worries that the dollar's decline will
become a freefall. We hope that"everyone" is right. But we
wouldn't be surprised to be surprised.

-"Everybody seems upbeat," observes Paul Farrell of
CBSMarketwatch."Economists, politicians, securities
analysts and pollsters are falling all over themselves
forecasting a rising market that may blow through 11,000 in
early 2004 and predicting a growth economy that will
bolster the President's reelection bid. This euphoria
smells like 1999 all over again to me, a renewed irrational
exuberance negating common sense as the lemmings blindly
rush over the cliff.

-"The biggest enemy of every investor," Farrell continues,
"is their bias toward über-optimism. It sabotages more
innocent investors and wastes more of their money than any
other brain function."

- Farrell cites a number of reasons why the optimism for
2004 is overblown."Analyst sentiment is extremely
bullish," he says,"which is a contrarian signal." At the
same time, corporate insiders are dumping stocks. For the
past seven months, corporate insiders have been dumping
stock at a rate exceeding a 20-to-1 ratio. Another
negative, he says, is the likelihood that interest rates
will rise in response to a strengthening economy and/or
weakening dollar.

- Farrell did not bother to mention that stocks are pricey.
Investors have become so accustomed to paying 20, 30 or 100
times earnings for stocks, that rich valuations seem
utterly unremarkable. Nevertheless, at 17 times estimate
2004 earnings, the stock market is not cheap.

- That said, 17 times earnings poses no problem without a
crisis. Perhaps the falling dollar is the sort of crisis
that could make expensive stocks seem expensive. A dollar
crisis - like a light switch at an orgy - could expose the
market's obscene overvaluation for what it is.

- The dollar has been falling nearly every day, despite the
fact that the Japanese and Chinese are continuously
intervening in the foreign exchange markets to support its
value.

-"Purchases of U.S. debt from offshore central banks
surged to the second record in as many weeks," Reuters
reports. The Federal Reserve's total holdings of Treasuries
and agency debt for foreign central banks in the week ended
Dec. 24 jumped above $1 trillion for the first time ever.

-"Japan's central bank committed around 10 trillion yen
($93 billion) this year to currency intervention
operations," observes Strategic Investments editor Dan
Denning," [and still] the dollar fell 10% against the yen
in 2003. $93 billion is a lot of cash to start throwing
around in your currency fight. Consider this, though: the
Federal government ran up a $374 billion deficit in 2003.
It's budgeted to be around $450 for 2004 - and that's if
receipts don't fall and outlays don't rise more than
budgeted.

-"Let's say Japan and China together buy up 40% of the NEW
U.S. debt (about what they own now)," Dan continues."That
still leaves US$270 billion in new bonds the U.S.
government would like the rest of the world to buy at
between 4% and 5% interest. Will the government sell US$270
worth of new bonds next year? Probably. But you have to
wonder how 'safe' a 4% yield is when you're losing 10% a
year on the currency conversion alone.

-"Meanwhile, the dollar is falling faster in euro terms
than yen terms. That kills European investors and firms
who've seen the euro gain 19% on the dollar this year. The
Europeans are going to start asking for a stronger dollar -
and soon. Kind of makes you wonder... if EVERYONE in the
world (except American manufacturers) wants a stronger
dollar....why is it still falling? Well, you don't have to
wonder that much. It's the debt..."

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

Bill Bonner, back in France...

*** The economy is said to be adding 82,000 jobs a month
since August. But manufacturing alone lost 1.4 million jobs
since the recession ended. And this week's Los Angeles
Times estimates that if you added in the number of people
who have given up looking for work... and those who have
taken marginal jobs rather than serious ones... the real
unemployment rate would be nearly 10%, not 6%.

*** It was another GUDD day yesterday. Yawn. Gold hit a new
14-year high of $417 an ounce. The euro rose over $1.25.

*** A note on fur coats from our friend Byron:

"As much as any other woman who walks upright on the
planet, [my wife] Barbara likes the idea of possessing a
fine fur coat. 'You are an old geology-major,' she said to
me. 'You must understand the primal human instinct to
protect yourself from the elements, wrapped in a full-
length shaved mink with a chinchilla fur collar.' I replied
that, yes, I majored in geology, but that is a different
subject from anthropology, which encompasses the study of
the ancient human craving for full-length fur coats.
Barbara looked at me in a certain way, indicative of 'Keep
it up, wise guy.'

"To her credit, Barbara has also hedged her bets by owning
and running her own business. If Barbara were typical of
some of the hired hands and hacks who run at least some
publicly-listed corporations, she might just have the brass
to get the company to buy her a fur coat. 'Business
expense,' and all that. But a fur coat so-procured is
nothing more than a hide bought from a poacher, an illicit
souvenir essentially pinched from the business till, a
meaningless nouveau riche-girl's bauble, and as gauche a
statement as using the corporate jet to fly the family to
Aspen for a weekend of skiing. Barbara lacks completely the
arrogance to think, let alone to say, 'The shareholders
paid for it, and screw 'em,' if you know what I mean and I
think you do.

"So it falls to her husband to do his manly duty, visit
Saks, and have a talk with the manager of the fur coat
department. Speaking as the husband, I think that reaching
deep down and buying your wife a fur coat, using your own
hard-earned currency, falling like a stone against gold and
the euro though it may be, can create an elevated sense of
harmony in the home. Post-fur coat, you are more productive
and therefore better able to earn more dollars and thereby
acquire more gold. Win-Win. P.S. - Barb to Elizabeth: 'You
go, girl!'"

***"I don't see why you want to invite the Delamères,"
said your annoyed editor."He is a pompous windbag who is
always trying to pick a fight. I know just what he is going
to do. He's going to begin by asking a question about what
the Bush Administration is doing in Iraq... hoping to start
an argument."

"Yes, but I like him..." came the reply from the distaff,
"besides his wife is very nice."

"But she never says a word."

"It doesn't matter. If you want to socialize, you have to
spend time with people you don't particularly like. It's
just part of what it takes. And if you don't do it, you
don't get invited to parties and you don't meet people and
you spend your whole life holed up in your own little
world."

"But we've already met the Delamères... and I don't like
them. Besides, I don't want to meet people. I know enough
people already."

"Oh stop being such a crank. It's good for your character."

***"It is time to remember the family," said Père Canta at
church on Sunday. The service was dedicated to family life,
as near as we could tell. Père Canta, never married, no
children, preached on the subject:

"Now, I know I have little personal experience. But I keep
my eyes open. And I have never seen a family that did not
have some problems. Sometimes the problems and tensions of
family life are so sharp that people cannot stand them;
they simply go away and have nothing more to do with their
families. But this Christmas season is a time to
rediscover, rebuild and reintegrate family life. Families
reassemble to celebrate the birth of Christ.

"Heh, heh... and you think you have problems. Think of how
Joseph must have felt. Mary was pregnant before they were
even married. And it wasn't his child. Sure, an angel came
to explain it to him. But imagine the thoughts that must
have crossed his mind!"

Our family did come together for Christmas. All six
children... plus your editor's mother... plus one fiancée.
Fires were stoked throughout the house. Music, laughter -
even an occasional argument - were heard in rooms all over
the maison.

But now the holidays are wearing out. Airline tickets have
been checked. Trains booked. The happy flood that filled up
the house is now ebbing away. Our oldest son and his
fiancée have headed back to Florida already. The two girls
left for Paris this morning. Soon, it will be time to pack
the car and leave. Except for the noise of the dishwasher,
and Edward's occasional outbursts, the place is almost
silent.

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The Daily Reckoning PRESENTS: The widely heralded sharp
upturn in business fixed investment - and the advent of
self-sustaining economic growth in the U.S. - is merely so
much statistical smoke and mirrors, reports the good doctor
below...


A BULLISH MIRAGE
By Kurt Richebächer

Good news about the U.S. economy is proliferating. The
international media is littered with articles stating that
the U.S. economy is forging ahead with rapidly rising
profits. Yet neither the stock markets nor the currency
market have taken any notice. Asking traders, nobody could
offer a plausible reason. Yet there are two very simple
tentative explanations: first, the economic news is good,
but not good enough to meet the high-riding expectations;
and second, the bulls are fully invested, and short-
covering by the bears is finished.

Better-than-expected economic news, actually, is coming
from all parts of the world. Asia, accounting for 24% of
global GDP, is hitting 7.7% growth this year. Ex Japan, the
economies are firing on all cylinders, with growth rates
vastly outpacing current and expected U.S. GDP growth. The
tiger in the group is China, with expected 11.5% growth
this year. Common to all these countries are high levels of
gross national saving, including depreciations (averaging
almost 30% of GDP), and also high levels of gross
investment (averaging between 22-23% of GDP).

The U.S. economy, accounting for a quarter of the world's
GDP, is likely to finish 2003 with GDP growth of 2.9%.
Gross national saving is hitting a low of 13.5%, while
gross investments in the past few years have been hovering
around 18% of GDP.

The euro area, accounting for 18% of global GDP, will exit
the current year with barely 0.5% GDP growth. Both gross
domestic savings and gross domestic investment equal on
average between 20-21% of GDP.

While U.S. economic growth is increasingly lagging Asian
growth, the global focus remains primarily on the U.S.
economy as the world's supposed predestined locomotive, for
the apparent reason that America's consumer is the world's
greatest spender. Implicitly, the U.S. current-account
deficit of about $560 billion per year reflects what
Americans spend in excess of their current production and
income.

Yet the Asian countries, ex Japan, have a second reason to
run a surplus with the United States. It is the main source
of the high-powered money of their banking systems. As their
central banks are buying gargantuan amounts of surplus
dollars, they create liquid reserves for their banks that
foster the lending boom to their domestic producers. Vastly
excessive reserve growth is creating vastly excessive money
and credit growth, stimulating and financing an unprecedented
investment boom, similar to that in Japan in the late 1980s.

Global activity data has kept surprising on the upside for
months, and there has even developed speculation that
unexpectedly strong global economic growth may fuel
considerably higher inflation rates. Commodity prices, in
the past generally an early indicator in this respect, have
soared spectacularly. Given, moreover, years of extremely
rampant money and credit growth around the world,
accelerating inflation will be the next great surprise for
many people.

All this raises many questions. It seems quite feasible
that the Asian tigers, with their record-high savings and
investment ratios, will continue to power ahead with
runaway credit creation. Yet our fear rather is that some
of them, in particular China, may derail into Japan-style
bubble economies.

For us the greatest uncertainties are about the U.S.
economy, its financial system and its currency. The great
issue not only for America but also for the global economy
is whether the U.S. economy has definitely reached the
stage where economic growth has become self-sustaining. Or
whether it may relapse into sluggish growth next year, if
not recession. Looking at the markets, we have the
impression that many people are struggling with this
question.

On the surface, the report of real U.S. growth of 7.2% in
the third quarter, later revised to 8.2%, was most
impressive. Many commentators hailed it as the highest
growth rate since 1984.

To us, the exciting growth number raised more questions
than it answered. Yes, it was the U.S. economy's fastest
sprint in 19 years. At the time, it was actually 7.3%, but
this rate referred to GDP growth over the whole year. This
time, it was an annualized quarterly growth rate of 2%,
which is not always meaningful.

Considering that the U.S. economy's long-term growth
potential is around 3%, it should be clear that after three
years, during which annual real GDP growth has averaged
1.8%, it will still take a lot more demand and growth
acceleration to remove the output gap that has accumulated
in these years.

It is also generally agreed that a sustained and
sufficiently strong recovery of the economy is only
possible with a prompt, brisk rebound of business fixed
investment. The bullish consensus is satisfied that this is
happening.

As reported, nonresidential business investment rose in the
third quarter of 2003 by 11%, after 7.3% in the second
quarter. For sure, these are impressive numbers, but the
only thing that gives them this strength is the fact that
the actual quarterly numbers have been annualized. The true
non-annualized growth rates of 2.75% and 1.8% for the two
quarters would have caused nothing but yawns.

But there is a second big snag in the reported investment
numbers. As usual, it arises from the familiar statistical
spin concerning the measurement of business investment in
computers.

In real terms, or"chained" dollars, it increased over the
full year until the third quarter of 2003 from $297.6
billion to $390.3 billion, that is, by $92.7 billion, of
which $35.4 billion occurred in the third quarter. That is
the statistical fiction; actual business spending in
current dollars on computers increased over the same time
by just $11.5 billion, from $76.8 billion to $88.3 billion,
of which $5.9 billion was in the third quarter.
In reality, measured in current dollars, nonresidential
investment over the year increased overall by $46.2
billion. Among this total, computer investment soared by
$93.1 billion, of which $81.6 billion came from the hedonic
spin.

Each additional dollar spent on computers in the real GDP
accounts during the year translated into eight additional
"chained" dollars, accounting, by the way, for 26% of real
GDP in this time. The difference between the two measures
of business computer investments is exploding. So much for
the trumpeted investment recovery.

As we have explained many times, these particular dollars
are fictitious dollars that nobody has paid and nobody
received. Obviously, such dollars inherently add nothing to
profits.

Putting it briefly and bluntly: The trumpeted brisk rebound
in U.S. business capital investment is another bullish
mirage lacking any serious substance.

Given this reality, it seems likely that the coming year
will find the U.S."recovery" neither sufficiently robust
nor constant enough to foster true self-sustaining economic
growth in the U.S economy.


Regards,

Kurt Richebächer,
for the Daily Reckoning