-->Vindication For The Fed?

The Daily Reckoning

Rancho Santana, Nicaragua

Tuesday, 24 February 2004

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

*** Gold under $400... what does it mean?

*** Counsel from the dead, or the living? Fibonacci's
numbers...

*** Speculating in Nicaragua... kidnapping, capitalism and
Sandinista-sympathizers' dreamy slogans... and more.

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

The answer is"No."

The question is the one we posed a week ago: has the world
seen $400 gold for the last time?

Which leads to this week's question: will it seen $300 gold
again, too?

What we are questioning is our whole economic
worldview... or our Weltanshauung, as we like to say around
the office.

We think we know what is going on. But there is more under
heaven and earth than is contained even in our philosophy.
God does not share his plans with us. Instead, he merely
whispers in our ear... when we are half-asleep or half-
drunk... 'just do the right thing!'

Then, when we sober up, we ask... 'but what's the right
thing?'

We do not know.

But everywhere around us, we see people doing things that
couldn't possibly be right. Yesterday's news brought word
that home sales and mortgages"may beat records," according
to Bloomberg. Americans can't pay their bills already. How
could it make sense for them to be buying new houses and
taking out new mortgages?

Elsewhere, we discover that people are still buying stocks
at prices near their highest levels in history... We say no
more about this. We know no better than anyone else what
stock prices will do, but buying at these prices can't be
the 'right thing' to do.

And in the current Economist, we discover that it is not
only the lumps that are erring on the side of recklessness.
Apparently the banks, too, have been taking bigger and
bigger positions in their trading rooms in a manner that is
"not dissimilar" to the geniuses at Long Term Capital
Management... before that hedge fund blew up.

Even foreigners can't resist upping the ante; they continue
to invest in U.S. assets, the Fed reported last week.
"Depending upon where you get the statistic," writes our
friend John Mauldin,"foreign central banks own between 39-
45% of our government debt. Throw in private investors and
it is even larger. At current trade deficit levels, this
would grow to 65% within five years.

"The U.S. has accounted for 96% of the growth in world
trade for the last few years. Thus, foreign nations have to
be willing to either not take depreciating U.S. dollars and
suffer the inevitable slowdown in their economies, or take
less for their products in order to be able to keep their
work forces producing and economies bumping along..."

We don't know exactly what is going on, but hardly a day
goes by that we don't notice more evidence of it. We see it
in the world economy... in its money system... and in
politics, too. It is the top of a credit cycle, we think.
People seem far too confident... far too complacent... far
too sure that they will get what they want, rather than
what they deserve.

We don't know how this confidence will be undone. But our
Weltanshauung... or is it our Erfahrung... tells us that it
will be undone sometime, somehow, somewhere. Otherwise, it
would be an even stranger world than we think. Things would
go up without coming down. We would have summer... but no
winter. There would be good, but no evil. You could borrow
without having to pay back. You could drink all you wanted
without getting a hangover... and whiskey would run from
public fountains all over the republic.

We have been in the paradise world of Nicaragua for the
last few days. Perhaps everything has changed. But that is
not the world we remember.

In the world we remember, gold rises... because the smart
money knows there is something wrong. It buys gold as
protection... and is happy to get it at a lower price.

Over to Eric Fry, with the dream-spinners in New York City:

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

Eric Fry on Wall Street...

-"The dead cannot talk," your Paris-based editor often
laments. Therefore, most investors seek the counsel of the
living. Too often, however, investors seek the counsel of
the living who make their livings on Wall Street providing
misguided counsel to investors.

- However, an obscure minority of investors seeks the
counsel of the deceased - men like Benjamin Graham and
Leonardo Pisano Fibonacci. Mr. Fibonacci shed his mortal
coil about 800 years ago. But his insightful mathematical
observations have gained a kind of immortality among
"technical" investors... If forced to choose, we'd rather
"listen" to the deceased Italian mathematician than the
living Wall Street strategists.

- But before we turn our attention to Mr. Fibonacci's
latest insights, let's recap yesterday's trading action. In
the stock market, the Dow slipped 9 points to 10,610, while
the Nasdaq tumbled 1.5% to 2,008 - only four points above
its starting point for 2004.

- Gold managed to stop falling for one day, as the yellow
metal climbed $1.30 to $399.30 an ounce. But gold stocks
continued sliding anyway. Since topping out in early
January, gold stocks have showered abuse on gold stock
investors. Nevertheless, gold stock investors - like the
boyfriend of a beautiful, but mean-spirited girl - are
trying very hard to keep the flame alive. (After all, look
how beautiful she is!) But the daily abuse is making it
easier and easier to turn away from gold and seek a kinder,
gentler (and more profitable) investment elsewhere...

- Re-enter Mr. Fibonacci. The insightful mathematician
determined that life on this orb often unfolds along
predictable numerical patterns. He also had a penchant for
illustrating profound mathematical principals with
commonplace metaphors. He wrote, for example,"A certain
man put a pair of rabbits in a place surrounded on all
sides by a wall. How many pairs of rabbits can be produced
from that pair in a year if it is supposed that every month
each pair begets a new pair which from the second month on
becomes productive?"

- We do not know the answer to Fibonacci's hypothetical
question. Biology is not our beat. But we have observed the
following predictable pattern:"A certain man put a pair of
Wall Street investment bankers in a room, along with a pair
of investment banking clients. After several months, and
despite multiple attempts by the investment bankers to
procreate with the investment banking clients, the
investment banking clients do not ever beget a new pair.
But they do lose whatever money they possessed upon
entering the room."

- Today's technical analysts have seized upon Fibonacci's
work to find - they believe - somewhat predictable patterns
in the direction of financial markets. Broadly speaking, of
course, financial markets are extremely predictable... they
go up, then they go down, then they go up again.

- But predicting the precise moment when a given market
that is going up will begin to go down is a bit more
problematic... even for Fibonacci scholars. That said, a lot
of technical analysts pay close attention to what they
think the dead man's special numbers are telling them.

- Relying on a few"classic" Fibonacci numbers,
Elliotwave.com deduces that the S&P 500 will hit an
important peak on or about Feb. 25, 2004."The all-time
high for the S&P 500 was recorded on March 23, 2000,"
explains options pro Jay Shartsis."Adding a Fibonacci 987
days to that date points to Feb. 25, 2004. Then, taking the
post-Sept. 11, 2001, panic lows seen on Sept. 21, 2001, and
adding a Fibonacci 610 days, we also get Feb. 25, 2004, as
a top target for the S&P 500."

- Are you still with us?

-"Last Thursday was close enough to qualify as a near
bull's-eye by my thinking," says Shartsis."It would seem
to me that this targeting is further affirmation that an
important top is at hand, as suggested by the very wild and
negative divergence presented by the Nasdaq and transports
vs. the Dow."

- Not to be outdone by the dead mathematician, Shartsis
points out a few numbers of his own:"On Dec. 1, the Dow
was at 9899 and there were 627 new daily highs on the NYSE.
Yesterday saw the Dow hit 10,688 but there were only 233
new daily highs. That is a striking negative divergence on
a Dow gain of 740 points."

- Fibonacci also has something important to say about the
gold market, according to Greg Weldon, editor of Weldon's
Metal Monitor."Gold mining shares are 'rolling over,'"
says Weldon."So how low can gold go? The long-term, weekly
charts offer several possible DOWNSIDE targets." Weldon
presents an array of"Fibonacci retracement" numbers to
pinpoint possible downside targets at $387, $362 and $342.

- Certainly, the"downside" seems to be the path of least
resistance for the gold market right now. But in a world of
leveraged financial markets and half-a-trillion dollar
current account deficits, the path of least resistance has
a way of changing rather abruptly. Based on our work - and
on the Fibonacci numbers WE use - gold will either go
lower, or it will go higher. If it goes higher, we will be
delighted. If it goes lower, we will trade a few more of
our dollar bills for ounces of gold.

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

Bill Bonner, back in Nicaragua...

***"We should have bought property down here when we first
got here," said Elizabeth as we were surveying the Pacific
Coast from a fishing boat yesterday.

"But how could we know it was going to go up so fast," your
editor wanted to know.

"It seems pretty obvious in retrospect," his wife
continued."It's beautiful country... and more and more
Americans want to find something like this."

"Sounds like that would have been the smart thing to do.
But, remember dear, we don't try to do the smart thing. We
try to do the right thing. And we don't know what that
is..."

"Please don't start that..."

***"It was terrible. I went to my sister's house with my
two little children. Sylvio was just a baby, only two years
old. And when I got there a man with a hood over his head
put a machine gun in my back."

A Nicaraguan friend was describing what the country was
like in the late '70s. (Missing out on rising real estate
prices is not the worse thing that can happen to a family.)

"The Sandinistas were kidnapping people and holding them
for ransom. And when that happened, you didn't want to go
to the police because they would just come in and kill
everyone - including you. So, I called my brother-in-
law... and he negotiated with these guys. There were six of
them. They all wore hoods. They were very rough. And they
told us that if they didn't get the money they asked for
they would kill the children first.

"But it was Sunday. The banks weren't open. So, my brother-
in-law had to go around to everybody he knew... and still he
couldn't come up with enough money. So we thought they were
going to kill us all.

"But my brother-in-law, he negotiated a deal... somehow he
paid them off. The next day, we left Nicaragua with all the
family."

*** In the mid-1900s, almost all problems seemed to have a
political solution. Nicaragua was not the first to fall
into the trap. But unlike Russia, which took 70 years to
get out, Nicaragua was back on the bumpy capitalist road
within a single decade. Now, groups of Sandinista
sympathizers still occasionally gather to chant their
dreamy slogans... even while speculators conclude multi-
million-dollar real estate deals.

*** A reader correction:"For the record, the Dow-to-gold
ratio peaked at almost 45-to-1 (not 30-to-1) on August 25,
1999... the Dow closed at 11,326.04 and gold closed at
252.55."

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

The Daily Reckoning PRESENTS: Sir Alan applauds himself for
his success in preventing all but"an exceptionally mild
recession." But what exactly was"exceptionally mild" about
the recession - and is it a good thing? The good doctor has
his doubts.


VINDICATION FOR THE FED?
by Kurt Richebächer

Manifestly, there is general overwhelming optimism about
the U.S. economy. Positive arguments abound:

Thirteen rate cuts and the lowest interest rates in
decades; runaway money and credit creation; rampant fiscal
stimulus; the long and strong rally in the stock market;
persistent, massive wealth creation through rising house
and stock prices; an impending, powerful boost to output
from a widespread need to replenish run-down inventories;
reported strong profit gains promising an additional strong
boost to business investment, returning job growth; surging
commodity prices; and the strong stimulus to exports from
the slide in the dollar.

To be sure, a more impressive list of growth-boosting
influences is hard to imagine. More and more economic news-
beating expectations seem to have carried away many people.
Late in 2003, there was even widespread talk that strong
economic growth in the New Year would soon force the Fed to
start pre-empting inflation by tightening monetary policy.

It did not carry us away. Much of what we read and hear
reminds us of a book by Paul Krugman, published in 1990:
"The Age of Diminished Expectations." The main subject of
the book was the observation that"relative to what
everybody had expected twenty years ago, our economy has
done terribly." Krugman expresses his amazement"how
readily Americans have scaled down their expectations in
line with their performance, to such an extent that from a
political point of view our economic management appears to
be a huge success."

It seems to us that in particular, there is a general
perception that the anti-recession policies pursued by the
government and the Federal Reserve during the last few
years have been a great success, considering above all the
rapid sequence of severe shocks imparted to the economy
through the bursting of the stock market bubble, Sept. 11,
corporate scandals and the Iraq war.

Yet, according to this mantra, America experienced its
mildest ever recession. For many people, even outside the
United States, all this is just further proof of the U.S.
economy's wonderful flexibility and resilience.

In a recent speech to the American Economic Association in
San Diego, Fed Chairman Alan Greenspan applauded himself
once more for his successful policy with the following
words:

"There appears to be enough evidence, at least tentatively,
to conclude that our strategy of addressing the bubble's
consequences rather than the bubble itself has been
successful. Despite the stock market plunge, terrorist
attacks, corporate scandals, and wars in Afghanistan and
Iraq, we experienced an exceptionally mild recession - even
milder than that of a decade earlier."

He offered mainly two explanations -"notably improved
structural flexibility" and"highly aggressive monetary
ease."

We are tempted to say that we disagree with every single
word.

In the first place, we reject the general perception of
America's"exceptionally mild recession." Measured by real
GDP growth, that certainly appears true. But that is a very
arbitrary measure. The officially declared end of the
recession in November 2001 was by no means the end of the
bubble's painful aftermath.

That painful aftermath has continued for more than two
years, and not only in terms of protracted, sluggish GDP
growth, but above all in America's worst by far postwar
performance in employment and associated growth in wage and
salary income.

Consider: While real GDP surged in the third quarter at an
annual rate of 8.2%, wage and salary income adjusted for
inflation edged up at an annual rate of 0.8%. Citing Paul
Krugman:"In the six months that ended in November 2003,
income from wages and salaries rose only 0.65% after
inflation." For most workers real wages are flat or falling
even as the economy expands. For America's employees and
workers, numbering almost 150 million people, there has been
no recovery.

In light of these facts, all talk of America's mildest
recession in the whole postwar period is outright absurd.
It plainly serves to delude people. GDP numbers are an
abstract statistical aggregate. What truly counts for
people is what happens to their employment and their
income. By these two measures, the U.S. economy is
experiencing its longest and deepest recession since the
Great Depression of the 1930s.

For the bullish consensus, this tremendous, unprecedented
discrepancy between real GDP and employment growth in the
United States finds its ready and also most convenient
explanation in the simultaneously reported record-high,
unprecedented productivity growth, accruing from
corporations that are becoming marvelously efficient
through cutting labor costs.

We do not buy this explanation. It does not make any sense
to us. Investigating the relevant statistics, the first
thing to note is that the U.S. economy's growth pattern
since the early 1980s has become increasingly geared toward
consumption. Its share of GDP during these years has
steadily risen from barely 63% to recently 70%. For most
other industrialized countries this share is between 50-60%
of their GDP. Since end-2000, the U.S. recession's start,
consumer spending has accounted for 101.6% of real GDP
growth.

To us, an economy in which consumption has been taking a
steeply rising share of GDP for years is in essence an
economy ravaging its savings and investments, both being
normally the key source of productivity growth.

In consideration of these and other facts, we feel flatly
unable to buy America's trumpeted productivity miracle.
There is one obvious statistical source: artificially low
inflation rates.

We can make a simple test by comparing both real and
nominal GDP growth between the United States and the
eurozone over the period from end-2000 to the third quarter
of 2003. Measured by real GDP, the U.S. economy grew
overall by 6.9%, compared with 4.5% for the eurozone. But
measuring by nominal GDP growth, the difference contracts
sharply - a U.S. growth rate of 13.1% over the whole period
compares with 12.2% for the eurozone.

As we have repeatedly pointed out, the U.S. economy's
superior growth performance during the past few years,
measured after inflation, had its source largely, though
not solely, in the application of lower inflation rates.
For the United States, the price deflator for GDP in the
third quarter of 2003 since end-2000 had risen a mere 5.8%,
as against a reported 7.5% for the eurozone.

Considering the U.S. economy's parabolic credit excesses,
the relationship between inflation rates should be the
opposite. But pressured by politicians and in particular by
Mr. Greenspan to produce the lowest possible inflation
rates, America's government statisticians have worked hard
to comply, in particular by counting quality improvements
as price reductions. Understating inflation rates, in turn,
overstates real GDP. A more accurate GDP deflator would
lower real GDP growth to a rate that would certainly
correlate better to the poor employment performance.

In our view, the prevailing perception that the U.S.
economy experienced but an"exceptionally mild" recession -
and now continues to perform exceedingly better than the
eurozone economy - needs drastic revision.


Regards,

Kurt Richebächer,
for The Daily Reckoning

P.S. This particularly applies to the job market. For
decades, all through the postwar period, job creation has
been the U.S. economy's outstanding superior feature among
the industrialized nations. But that has radically changed.
Since 2000, America is by far the worst performer in this
respect. Following past postwar recessions, payroll
employment was on average up 4% after two years. This time,
it is down almost 1%. Something very ominous is going on.