-->The Vicious Cycle

The Daily Reckoning

Paris, France

Monday, 9 February 2004


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

*** A kids' market... sometimes you can make a lot of money
on fakes...

*** G7 disappoints media... Unemployment numbers disappoint
investors... dollar drops... gold back up above our target
price...

*** Eiffel Tower turns pink... Fed motto... at the
beach... Redback... and more!

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

Eric is back after a trip to Brazil. Addison is back after
a visit to London. As Porter Stansberry reports, below,
insanity is back on Wall Street.

Adam Smith described market conditions such as these as a
'kids' market.' It has been a good time to be a teenager
with an on-line brokerage account, with no fear, no
experience, and not much sense. If you were reckless
enough, you could have made a fortune.

"Sometimes you make more money on fake stuff than on really
valuable pieces," said an antique dealer over the weekend.
"You won't believe this, but on a recent magazine cover
from the auction house, I saw a large vase that was said to
be 14th century, Moorish, from Spain. I just looked at the
picture and I could tell that there was something wrong
with it. But it was exhibited at the Louvre... and then sold
at auction for $2 million.

"But it was a fake. Well, not an intentional forgery... I
mean, it was just a copy done on the 19th century. You
know, in the 19th century, they copied everything antique.
They had recently rediscovered some of the great art of the
past and, naturally, they admired it and reproduced it. But
these copies are not especially rare, nor very valuable.
Unless, of course, you can pass it off for the real thing.
I bet that some of the people selling that vase knew that
it was not real. But so what... as long as they could sell
it. I think the buyer was a rich Arab."

The moral of his story was that you can make a lot of money
on things that are really not supposed to be worth very
much. We don't deny it. But it takes more nerve, more
brains, and more luck than we have.

Back on Wall Street, while nervy kids were getting rich,
the so-called 'smart money' has been selling this rally.
Insider sales-to-purchase levels have been far above
normal. Templeton, Grantham, Soros, Faber, Rogers, Buffett
- almost all the sage old pros warn stock market investors
to play it safe. And now comes Bill Gross with this advice:
watch out for bonds, too.

The pros have been timid; they know there is something
wrong. Stock prices are too high; they never fully
corrected after the Dow peaked out in March of 2000. And
what is wrong with the economy? Two and a half million jobs
have been lost since the recession ended. Friday's
employment report showed no change in the pattern. The
dollar fell; gold rose over our target price of $400. (We
wonder: will we ever seen gold below $400 again?)

It's not supposed to work that way in a real recovery. Job
growth normally allows people to spend more money. Without
more jobs and real income, consumers have had to pretend.
They mortgage their homes - adding to their debts and
depressing their real wealth - in order to continue
spending at the rate to which they've become accustomed.

Woe to them all - investors, consumers, homeowners - if
current trends should ever come to an end. Higher interest
rates would put the kibosh on the whole make-believe
prosperity. But for the moment, at least, all is well in
fantasyland. Even the money supply is once again bubbling
up, after a worrisome slump in the fall. In the last 4
weeks, M3 has increased at an annual rate of $1.5 trillion
- or about 10 times faster than the increase in above-
ground gold.

"As for gold," our antique dealer friend continued,"people
my age [he is only about 30] don't know anything about it.
You have to explain. They don't understand why it doesn't
shine, for example. They think the real stuff is fake; and
the fake, glittery stuff... they think it's real. And none
of them buys gold as an investment. At least, not yet."

And now we go to our New York correspondent... tanned from
the beach at Ipanema... rested from a week-long
holiday... ready to samba on Wall Street, Eric Fry:

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

Eric Fry, back on the pavement in New York...

-"The bolsa is volatile," observed Brazil's President Lula
last week, after his country's stock market tumbled more
than 5%."But I am calm," he reassured the
lumpeninvestoreiras. Evidently, the locals believed their
president, as the Bovespa Index rebounded 4% on Friday.

- The New York stock market was also volatile last week.
But your New York editor was calm... very, very calm. He
spent the entire week sitting on a Brazilian beach - or
rather, a variety of Brazilian beaches. This sort of
extreme, sun-baked inactivity is not for everyone. But some
of us can tolerate a tropically induced torpor for brief
periods of time.

- While lying on the sand, your editor tried to think of
nothing at all... and usually succeeded. But he could not
suppress his professional inclinations entirely. He could
not help but notice, for example, that the Brazilian
currency - the real - is very, very weak, even though the
local economy seems to be quite strong. And he could not
help but imagine that the U.S. dollar could go the way of
the real, but for the grace of foreign investors.

- Five years ago, one real fetched one dollar. Today, a
Brazilian must scrape together three reals to buy one
dollar. Perhaps, your editor imagined, the dollar and the
real will again achieve parity - either because the
Brazilian national finances continue to improve or because
the U.S. national finances continue to degrade, or both.
Interestingly, almost no one can imagine that the real and
dollar would ever achieve parity again. And yet,
interestingly, the real is one of the very few currencies
in the world to have APPRECIATED against gold over the last
two years.

- Brazil's official statistics show an economy that is
improving only marginally. But anecdotal evidence is far
more compelling. The shopping malls are crowded, the bars
and restaurants are full (at least on the weekends) and the
entire state of Sao Paulo seems to be"under construction."

- New buildings and houses are going up everywhere. The
evidence of private enterprise at work is particularly
visible along the beach towns of the Sao Paulo coast. New
condominium projects dot the landscape like bougainvilleas.
The construction activity does not seem to be crazy or
bubble-like, merely steady. Meanwhile, the Sao Paulo
government is spending much of the money it doesn't really
have on infrastructure projects, like widening highways and
renovating the capital's beautiful old train station.

- One of the main trends powering the economy's resurgence
is Brazil's thriving export trade with China. Brazil
supplies the resource-hungry Asian nation with iron ore,
wood products and myriad other natural resources. Brazil's
trade surplus with China stands in stark contrast to
America's multi-billion dollar trade deficit with China.

- Meanwhile, up here in the northern hemisphere, the U.S.
stock market forged ahead, even though the economy merely
muddles along. The Dow jumped 104 points last week to
10,593, but is still 154 points below the January 27th
intra-day high of 10,748. The S&P 500 also tacked on 1% for
the week, but itself remains 13 points below its January
26th high 1155. The Nasdaq dropped a two points to 2,064.

- The Nasdaq stumbled a bit midweek, thanks to a
disappointing earnings report from Cisco Systems. But the
buy-the-dip crowd showed up in force, as they so often do,
to buy the Nasdaq's midweek dip and restore it to a very
slim loss.

-"The unabated, near-vertical sprint of the Nasdaq ranks
right up with some of the most forceful post-bear surges in
market history," writes Barron's."From the Nasdaq's low in
October 2002 through its recent high on Jan. 26 at 2153,
the index had rallied 95% over more than 15 months,
computing to an average monthly gain, or velocity, of more
than 6%.

-"Comparing the move with 22 other post-bear market
rallies in the U.S. and Japan since 1900... the monthly rate
of ascent of the present rally has been exceeded by only
three, each of them occurring in the Depression following
the 1929-32 washout. The average duration of these rallies
has been 17.3 months and the average overall gain amount
was 69%...

-"Things have been so good for so long," Barron's
concludes,"that they are bound, at least, to become less
good before too much longer."

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

Bill Bonner, back in Paris...

*** Will we see a sharp sell-off in the dollar today? As
Addison noted on Friday, currencies traders in Tokyo,
Sydney and London were planning to take their breakfast
early this morning... in case comments from the G7 meeting
in Boca Raton sparked a Soros' style rush for the exits.

"We reaffirm that exchange rates should reflect economic
fundamentals," read the press release from Florida.

"Economic reasons for dollar weakness are still there,"
added a currency strategist in London.

So far, in early trading, the dollar has lost only half a
penny against the euro.

*** Rob Peebles at PrudentBear.com has retranslated the
Fed's Latin motto as follows:"If you can't get something
for nothing, its not worth having." Rob also tells us of a
Longview, Texas woman who struck oil recently... not in her
back yard... but in her bathroom. Seems utility workers had
mistakenly hooked up an oil pipeline to the woman's sewer
line.

***"There's not much better for financial journalists to
write about than fools being parted from their money,"
comments Porter Stansberry."Such good stories...

"Consider the recent buyers of Redback Network warrants. I
won't go into the history of Redback Networks. (Short
version: Using investor's money, it tried to compete head-
to-head against Cisco.) But it finally gave up the ghost
late last year, reorganizing by converting its substantial
$400+ million in debt into new stock. Holders of the old
stock were virtually wiped out, via a massive dilution.
They drank the cool-aid, so to speak. Specifically, there
was a 1-for-73 reverse split, leaving Redback's true
believers with 1 share for each of the 73 shares they'd
bought retail. Or, in other words, what investors once paid
nearly $15,000 for would now fetch $8.75 on a good day.

"However... dumb investors are nothing if not resilient. Not
content merely to be completely wiped out once by the
managers of Redback, its true believers are drinking the
cool aid yet again...

"If you held on to your Redback stock through the
reorganization and reverse split, you got one new share for
each of the 73 old shares you owned, plus you got a
warrant. This warrant gives you the right to buy a new
share of stock at $5.00. Thus, the warrant has a current
intrinsic value of about $3.75. ($8.75 - $5.00). As any
options dealer would tell you, there's some time value here
too, because the warrant doesn't expire for seven years.
How much would you pay for this warrant...? I'd be
surprised if Redback is in business in seven years. But
even if you assume a 100% premium for the time value, that
wouldn't explain why this warrant is trading hands for
$10.50 in the OTC market. What does explain it...? The
drunks haven't woken up yet.

*** China is set to become Europe's largest trading partner
next year, reports the Wall Street Journal. We noticed a
couple of weeks ago that the Eiffel Tour had turned pink.
The edifice was lit up with red lights... through the fog,
it gave off a strange pink light, like a nuclear reactor
melting down. Now we know why. It was to honor China's
president on a recent visit. Traffic came to a halt all
over town, so the official motorcade could make its way
around town. News reports tell of one woman who was not
allowed to go back to her own home, since it was along the
route.

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

The Daily Reckoning PRESENTS: Mogambo on Monday! In this
week's episode, our fearful hero starts at the Fed and
follows credit and cash whither it goes... sloshing from
bank to bank, country to country... and back into the arms
of the almighty American consumer.


THE VICIOUS CYCLE
by The Mogambo Guru

Last week was pretty weird everywhere I looked.

The Fed was not called upon to issue any credit, and they
only dabbled in monetizing existing Treasury debt, the
usual $202 million or so, which is literally turning
government debt into money by printing up the money to buy
the debt, and then throwing the debt into the shredder.
Which is such a blatant fraud that I am embarrassed by the
ineptitude of the media who, although they like to run
their mouths about everything, cannot recognize a blatant
fraud when it is happening right in front of their eyes.

Uh-oh! It looks like I am ranting! Sorry.

But the big action was in the banks, as almost all line
items changed pretty dramatically. I was especially
enthralled by the revelation that they sucked up, like a
huge, demented vacuum cleaner, a $20 billion wad of
government and agency debt. The Treasury Department itself
only issued another $6 billion in new debt last week,
taking us, once again, to another new record, although I
have been reporting this"new record" thing for so long
that I am beginning to sound like a broken record broken
record broken record.

"The banks have buried themselves in government debt
certificates," explains Gary North."They have bought
government bonds. They have bought what economist Franz
Pick called 'certificates of guaranteed confiscation.'
Eventually, the debt will be repudiated. There is a
universal long-run law of all government debt: creditors
eventually get skinned."

And, as far as the Treasury acting like profligate children
goes, it is not their most egregious effort by a long shot.
And speaking of egregious efforts, as I write this the
national debt has bumped up to $7.043 trillion, which is up
another $29 billion, and the week is just getting started.
"2003 will enter the financial history books," wrote Marc
Faber in the Daily Reckoning last week,"as the year in
which all asset classes - including equities in developed
as well as emerging markets, government as well as any kind
of corporate bonds, industrial commodities, precious
metals, real estate, and art - increased in value."

To be fair, although he used the term"value," nothing
actually increased in intrinsic value as far as I am
concerned, because assigning value to something involves
individual judgment about"worth." And then when people
hear we are talking about"worth," then that inevitably
brings up how worthless I am as a human being, and I get so
tired of hearing that over and over, day after day. But I
gotta admit that all those things he mentions certainly
increased in price. But if that is how you measure value,
then, okay, they all increased in value according to Mr.
Faber, and increased in price according to me.

And isn't the popular definition of inflation, and I am
asking you instead of actually looking it up in the
dictionary, something about how prices go, umm, up? And so
how come this blistering inflation in prices was not enough
to get the Fed to increase interest rates? How come the
year-after-year double-digit increases in house prices, or
stock prices, or the prices of oil, or commodities, or the
rapidly rising prices of anything, is not enough to get the
Fed to try and cool down the white-hot asset sector?

The answer is obvious, once you remember that this Fed is
the most inept, corrupt, ridiculously pompous and smugly
arrogant bunch of clueless weenies in U.S. history. They
are worried about deflation, which is now defined as when
something, even things that are already so grossly
overpriced, goes down in price. Like stocks. And bonds. And
houses. You know: Everything that that is currently
waaayyyyy overpriced.

And why do they want to prevent this deflation in
preposterously overpriced things? Wouldn't the U.S.
consumer, namely you and me, be better off if things were
cheaper? Wouldn't it be a big benefit to us pathetic bozos
out here in the real world when our paltry incomes buy a
bigger basket of things on payday? Without waiting for your
answer, I answer my own question and say,"Yes, it
certainly would be a benefit!" But Greenspan does not WANT
us to be better off. Why? Because the whole U.S. economy is
now totally dependent on things NOT going down in price. In
fact, the whole U.S. economy is now dependent on overpriced
things being more and more and MORE overpriced!

Namely, stocks, bonds and real estate. Weird, huh?

Dr. Steve Sjuggerud, also writing in the Daily Reckoning,
pointed out that because of these price rises, there is a
dearth of places to put money where there was a good
possibility of making some profit, instead of having a good
probability of losing your shirt and ending up in the
gutter begging money to buy stale bread or another shirt.
Sjuggerud quotes Jeremy Grantham:"Today we have
substantially the worst prospects for long-term global
investment returns of my 35-year career when all asset
classes are considered, particularly for U.S.-centric
investors." This is because things are all so overpriced,
and this should not come as a surprise to you if you had
been paying the least bit of attention to me, and don't
feel bad if you have not, since nobody else does, either.
And when things are overpriced, there is usually not a good
chance that they will get MORE overpriced, which is where
your profit should come in.

But how and why did they all increase in price? Because the
Fed increased the amount of dollars in the system, and the
Congress borrowed and spent those dollars. And so the
system was flooded with more dollars, but the amount of
goods and services did not increase. Ergo - and don't you
just love it when I use the word"ergo?" - the value of
each dollar went down.

And don't worry if you do not understand this concept right
away. The Federal Reserve has never understood it either,
and they think they are smarter than all of us put
together. They are not. In fact they are much more stupid
than we are, QED. They just think that they are smarter.

Anyway, that flood of dollars sped hither and yon through
the economy, and ended up in somebody's pockets, who spent
the dollars on imports, which flooded foreign economies
with dollars. But those foreign exporters did not want
dollars, but instead they want their own currency, because
their wives want to spend money, and the places where they
shop do not want to go through the hassle of converting
U.S. dollars into their own currencies. So the exporters
were prone to dumping those dollars to get their own
currencies with which to fill up the pocketbooks of their
wives, and then the banks ended up with all the dollars.
But the banks do not want the dollars either. So then the
foreign central banks printed up some big wads of their own
currencies, and bought up the U.S. dollars from the banks,
who do not want, as we have seen, dollars. And then the
boss of the central bank comes to work one day and wants to
know who in the hell has been piling up all these dollars
in the lobby and making such a big mess, and issues an
order to get them out of here and get this placed cleaned
up! So all those dollars, those lovely mountains of dollars
that in the aggregate add up to more than a half a trillion
dollars a year, were used to buy U.S. debt.

Which the U.S. government spent, continuing the viciousness
of the cycle. And then they went into people buying things,
like stocks, and bonds, and houses, and imports. And prices
went up. And then, the next year, they went up some more.
And then, the next year, they went up some more. And then
the next year, they, but this is getting real boring, so to
save time, we will hop into Professor Peabody's Time
Machine and fast forward a decade or so, and when we step
out of that time transporter we notice that I am still
intoning,"And then the next year, they went up some more."

Then we are all happy that we are back in the present, and
have finally stopped that"and then next year..." crap.

And sure enough, there is Jeremy Grantham saying that
"today we have substantially the worst prospects for long-
term global investment returns of my 35-year career when
all asset classes are considered, particularly for U.S.-
centric investors," which gives me an eerie feeling of
déjà-vu, but is quickly explained by the fact that I just
cut-and-pasted his original quote, but that doesn't change
the facts.

And it is a truism that the mechanism of inflation is that
the beneficiaries of excess creation of money and credit
will be those guys who are first to get in line for it, and
who buy the things that will soon go up in price. And it is
another truism that after this initial bunch of winners
will come another bunch, who will get in the parade and do
the same thing, and prices will go up some more. And it is
another truism that more and more people will take notice
of the profits being made, and then they will get into the
swing of things, too, and then, finally, at the end of the
parade, come the guys who think that they can arrive late
at the party, and they will be buying those assets that are
so high in price that there is nobody left to take the bag
from them, and so they will be left holding the bag.

The big question (BQ) is: is anybody holding the bag yet?
Yes. Lots of them. In fact, the whole American economy is
now composed of people holding bags. Big bags (BB). Big,
BIG bags (BBB). And the Other Big Question (OBQ) is: Is
there another bunch of people who are willing to pay money
to take the bag? Ahhhh. That's the REAL question (RQ)!

And the way to entice people into buying something that is
ludicrously overpriced is to, and here we see the beauty of
Modern Fiscal Policy, give everybody their money back! Yes!
That's right! And how do we do that? Through the Tax Credit
section of the 1040! The government will pay you back if
you spend your money the Government Approved Way (GAW)!


Regards,

The Mogambo Guru,
for The Daily Reckoning

P.S. In a related vein, the IMF, given that they are as
brain-dead as our own Fed, which is understandable since
the Fed is the biggest of the creditors of the IMF, decided
to give Argentina some more loans. I left off the
exclamation point there, although normally that would rate
at least one exclamation point. But I am cleverly setting
you up for the punch line, to show you that the Mogambo has
a humorous side, which I call the Mirthful Mogambo, with
which to offset his dangerously angry and trigger-happy
side.

The IMF gave them more money even though Argentina is
pretty honest and blunt about saying that they are in
pretty bad shape, and they are going to keep defaulting on
loan payments! I put that last exclamation point in there
to indicate the fact that this is the punch line, and now
you should laugh heartily - Ho ho ho! - and say, wiping the
tears of laughter from your eyes,"No! Really? No! What is
the joke, oh Mighty Mogambo?"

The joke, and you are going to love this for all its cosmic
ramifications, is that it is no joke. That is what really,
really happened.

Now, anybody who knows me immediately deduces, correctly,
that all of this is just too, too spooky for me, and I am
grinding my teeth so hard that the friction is sending out
a radio signal that is jamming radios and government
communications for blocks around. I know this from looking
outside my window and watching the government's Super
Secret Agents spying on me as they try to talk to each
other on their cell phones over the loud static I am
producing, and I sneer at them"Chumps! This is one of
those 'unintended consequences' from your reign of terror
against me, the Magnificent Mogambo!" And, to give the
government agent credit, he was fast on his feet when he
replied,"Huh? Look, Mister, I'm just here to read the
water meter! Honest!"

Well, I think that is what he said, but my Super Duper
Central Computer System was activating a Perimeter Defense,
Repel Boarders-type action, and what with all those machine
guns cocking, and shells being loaded, and sirens blaring,
it was pretty loud, and the super-powerful Klieg lights
were illuminating the Fire Control Zone with a blistering
glare and neighborhood kids were falling to their knees
crying"My eyes! My eyes!" and he was in a hurry to leave.
But he was one of them, all right. Trust me on that one.


Mogambo Sez: I wish I weren't so lazy, and then I would
take the time to go back through precious issues of the
MoGu and identify the guy who said that buying gold was an
investment that was obvious, riskless, and a bunch of other
swell things, all of which added up to suggesting, in the
strongest of terms, that you ought to take a break from
downloading pornography off the Internet, and go out and
buy gold.

I shall merely paraphrase, and you must look deep into my
eyes to discern my utter seriousness, when I tell you to
quit trying to download pornography off the Internet and go
out and buy gold right now. If not sooner. You'll thank me
later when the investment pays off in spades, and you can
hire somebody else, who did NOT look deep into my twinkling
blue eyes and who did NOT buy gold as per my suggestion, to
do the downloading for you, and then project it onto the
giant plasma screen TV on the wall of your lovely beachside
villa.