-->Policy Traction

The Daily Reckoning

London, England

Wednesday, 24 March 2004

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*** Gold reaches $420... but what do we know?

*** Slow news day... gas hits record prices... jobs... jobs...
jobs...

*** Invest in collection agencies! And more!

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Nothing happened yesterday.

The Dow went nowhere. The S&P went nowhere. The dollar stayed
put. Only the price of gold showed any life; it rose up $2.40 --
to $420.

Maybe we were right about gold after all... but just a few days
early. Maybe the world has seen $400 gold for the last time.

But what do we know? If we knew anything at all we wouldn't be
writing this daily letter. We'd be in some different world
altogether.

That is our conclusion after much observation and reflection:
nobody knows anything. We all depend on illusion. The key
decision you make -- and you are probably better off if you never
actually realize you've made it -- is which illusion you care to
believe.

Here at The Daily Reckoning we choose to believe the dusty old
illusions... the venerable Old Truths that our fathers,
grandfathers, remote cousins and monkey ancestors handed down to
us... after ruining their lives and burning in Hell for them.

"Do not kill," they said,"or you'll regret it."

We don't know if we'd regret it or not. And there are some people
we'd like to kill so much it would almost be worth finding out.
But the old timers must have known something. We take their word
for it.

Likewise, when they tell us to save our money, not to go to far
into debt, not to buy stocks when they are expensive, and not to
believe a word that comes out of the mouth of a public office --
we cannot argue with them. We don't know any better or any
worse.

The alternative is to pick up some trendy illusion-du-jour. Such
as the idea that you can kill people as long as you think they've
got it coming. Then, heck, you can send a missile chasing a guy
in a wheelchair... blow the fellow to kingdom come... and feel
good about it.

Or, you can -- conveniently -- cling to the illusion that you can
spend all you want... borrow as much as you can get... and live
as far beyond your means as you can get away with -- and somehow
it will all work out. You can believe that Alan 'Bubbles'
Greenspan has some special skill or magic that over-rides the
experience of centuries... and that George W. Bush is such a
genius that he'll figure out a way the whole nation can live at
the expense of foreigners -- forever.

People learned -- over the course of 50 generations -- that the
illusion of gold-as-money was a helpful one. Gold -- number 79 in
the periodic table -- is just another commodity... with no
inherent 'value' of its own. It is found in the earth's crust
along with iron ore and peat. You might as well use it to line
the public latrines, as Lenin suggested, as to worship it as
something of real worth. It earned no profits. It paid no
dividends. It kept its mouth shut.

But gold is rare... and takes time and effort to pull out of the
ground. What's more, it is never destroyed... over the course of
history the supply increases, roughly in keeping with the
supplies of everything else. Nor could it be artificially
replicated... counterfeited... or easily controlled. Thus, it
made a perfect medium of exchange... a marvelous store of
value... an almost heaven-sent, natural money... a currency you
could actually trust.

But in one of the crowning illusions of our time people think
they are much smarter than all the generations who came before
them. Now, they no longer have any use for the yellow metal. They
believe they can hedge their bets with derivatives... and control
their money with enlightened central bankers and modern monetary
policies. They believe that America's central bankers can
actually create 'money' by printing pieces of paper... and that
they will create exactly as much as the economy needs to grow and
prosper. They imagine Greenspan, Bernanke, McTeer and the whole
troop of geniuses... carefully adjusting the knobs and levers of
the Great Machine. They do not err. They do not falter. They do
not waiver in their duty; they never get sick and never go mad.
And like the Starship Enterprise... they imagine that this
marvelous new engine -- this post-modern, debt-fed consumer
economy -- defies the laws of gravity and economics....and takes
them wherever they want to go.

For the last several years, this illusion has proved useful.
Those who believed it have lived well... and even made money in
junk bonds and junk stocks. Will it prove durable as well as
useful?

We will see, dear reader, we will see.

In the meantime, here's Addison Wiggin with some thoughts,
ideas... conundrums...

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Addison Wiggin in Paris...

- While sitting in the waiting room of the Necker children's
hospital yesterday, we read a series of daily newspapers intended
for children. They were riveting. We noticed one item we thought
the average abused reader of the Daily Reckoning might find
mildly astonishing.

- A survey of 10 year old French kids, taken in January, revealed
Beyoncé Knowles as their favorite female singer, Justin
Timberlake their favorite male performer and... are you ready
for this?... George W. Bush was their choice for 'Man of the
Year 2003'. Who would of thunk it, huh? Perhaps the president's
fiscal habits remind them of their late Socialist president
Francois Mitterand.

- Larry Summers, successor to Robert Rubin at the Treasury, under
the Clinton presidency, was in the news yesterday. We didn't
think all that much of him when he was on the job in Washington.
And now that he's the president of Harvard, we're even more
suspicious. But, by gum, yesterday the words he was speaking
seemed to actually make sense."There is surely something odd
about the world's greatest power," Summers told a group of number
crunchers at the officious sounding International Institute of
Economics,"being [at the same time] the world's greatest
debtor."

- Sounding a little like the gloomy contingent, who take their
wine at the Paradis café, on the rue de la Verrerie in Paris,
Summer continued:"There is surely a question that must be asked
when, in order to finance prevailing levels of consumption,
prevailing levels of investment, it is necessary for the United
States to be as dependent as it is on the discretionary acts of
what are inevitably political entities in other countries."

- Summer's beef? According to paraphrased remarks produced by the
Reuters news organization:"The United States briefly ran
surpluses in the late 1990s, but now relies upon borrowing from
abroad through the sale of U.S. Treasury securities to meet
day-to-day spending needs. Much of that money comes from Chinese
and Japanese purchases of U.S. Treasuries, or Government IOUs,
using dollars acquired by exporting consumer goods, electronics
and cars to America." Would you get a load of this guy? Where
does he get off saying such disparaging remarks about America?

-"It can be argued," Summers admitted [sheepishly, we're dying
to add],"that the incentive for Japan or China to dump Treasury
bills at a rapid rate is not very strong given the consequences
it could have for their own economies... But it surely cannot be
prudent for us as a country to rely on a kind of balance of
financial terror to hold back reserve sales that would threaten
our stability."

- Did you get that? As if it's not complicated enough to keep our
eye on the balance of trade... in today's environment, suggests
the sitting president of Harvard, we've got to maintain a
"balance of financial terror"! Shocking as it is, we can't say we
didn't see this coming.

- Summers also suggested that the Bush administration, which has
on cutting taxes - without cutting spending - is simply delaying
the inevitable"day of reckoning" for America. Any delay in
addressing the fiscal crisis will only make the process more
"painful and expensive."

- The markets, like politicians surely will, simply ignored the
aging elitist academic. In fact, the Dow was so bored by the end
of the day it barely registered a pulse. Following a late session
sell-off the Dow finished down a solitary point, closing at
10,063. The S&P 500 lost equally as much finishing its day at
1093. The Nasdaq lost 8 points, coming to rest at 1901.

- The dollar rose a penny against the euro to $1.22... but not
on its own strength. Rather the euro fell on the numbskull
remarks of Jean-Claude Trichet, president of the European Central
Bank. After launching a PR campaign to get the likes of French
president Jacques Chirac to keep his yap shut regarding a rate
cut when the ECB meets April 1st, Trichet indicated he was open
to idea yesterday. Currency traders apparently aren't too keen on
the idea...

- And what's this? Ooh, la, la... another sign financial
reckoning day is on the way. The American Bankers Association
released a report yesterday showing credit card delinquencies
jumped to another record high for the year 2003."The improving
economy [sic] has not yet touched all individuals," said the
ABA's chief economist,"particularly those who continue to look
for work and may be relying on credit cards to meet their daily
living expenses."

- Where are the jobs, Mr. Greenspan?"Perhaps," suggests the good
doctor Richebacher in a guest essay below,"the Fed's current
policy lacks the necessary 'traction'." More below...

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Bill Bonner, back in London...

*** Jobs, jobs, jobs... From the Seattle Times comes word that
Silicon Valley is hiring again, but the new talent is being taken
on in India. In February, only 21,000 new jobs were added in the
U.S. -- barely more than 1/10th as many as economists believe
'normal' for this period.

A few whiny unemployed people are taking a bus across the country
to try to draw a little press attention, says the other Seattle
paper. They are willing to be retrained, notes the article, but
for what? The economy is simply not adding jobs in any sector.
Something should be done, say the travelers.

Both Democrats and Republicans have proposals to do something --
all of them, naturally, are moronic.

*** Americans have $6.82 trillion of mortgage debt. Even a small
decrease in house prices would leave many of them 'upside down.'

*** Gas prices at the pump have hit a new high, says Triple A.
Too bad, we were planning a long car trip this summer. But
wait... here in Europe, we're used to gas two or three times as
expensive. It costs nearly $100 to fill the tank of our new
gas-guzzling Nissan Patrol, which Elizabeth uses to pull her
horse van. What are Americans complaining about?

***"I know everybody worries about the price of oil," began a
note from our friend, Gregor,"I saw a statistic
yesterday saying that increases in the price of oil gobbled
up 1/2 of the Bush tax refunds... but in the oil crisis of the
early 80s, oil went to about $32 are barrel. Predictions were,
that by the end of the century, oil would hit one hundred dollars
a barrel.

"One 1981 dollar is now worth $2.08. So in constant dollars,
today's oil price, at 38 dollar a barrel, is actually about $19!.
So instead of tripling, as predicted, even by the oil companies,
oil actually dropped by a third. I know this is a small
consolation for the consumer. But as you well know, compared to
European prices, gasoline in America is dirt cheap."

***"The Washington Post reports that the IRS just walked away
from $16 billion in delinquent taxes," reports colleague Dan
Ferris."The IRS says it doesn't have enough personnel to make
the 30-second phone calls necessary to get people to pay up (in
most cases).

"So it wants to use private collection agencies...

"Collection agencies are becoming one of the great growth
industries of the early 21st century in the United States."

*** And this from our unpaid correspondent in Pittsburgh... on
building democracies...

"For all the worthy criticism of the 'neocon' theory behind the
US invasion of Iraq, not everybody outside of the E-Ring of the
Pentagon thought it was a bad idea.

"Case in point, Daniel, the Iraqi-exile bus driver at the Alamo
car rental place at the Detroit airport. Yesterday (Sunday, 21
March) I was somewhat late in getting away from my Navy Reserve
duties at Selfridge, Michigan, north of Detroit. I did not have
time to change clothes, and I wore my green BDUs ("battle dress
uniform") off base, as I drove like a bat out of hell down I-94
to the airport to catch my plane back to Pittsburgh. I turned in
the car at Alamo and walked to the shuttle bus to the air
terminal, in my greens. Daniel, the driver, walked out and
grabbed my bag:

Daniel (noting the obvious):"You are wearing your uniform."
Me:"Yes, I didn't have time to change."
Daniel:"That is a very beautiful uniform. You should be proud to
wear it. It is the uniform of a liberator."
Me:"You are too kind. Thank you."
Daniel:"No, thank you. Thank you to all the soldiers who
destroyed Saddam and brought freedom to Iraq. Thank you to all
the families of America who gave their children to the cause of
freedom, and to the brave people who have suffered such losses
for people they do not know."
Me:"I appreciate your sentiments and your gratitude. But other
people deserve your thanks far more than I. And it is not over."
Daniel:"It is over enough. Saddam is gone. The Iraqi people will
build a new future. America has made the world a better place."

"Daniel and I proceeded to talk as we made our way to the
terminal. He is a Christian, born and raised in Baghdad, who left
Iraq in the 1980s.

"A number of his family were imprisoned by Saddam. He is very
optimistic about the future of Iraq. He thinks that there is a
relatively small cadre of militant Islamists who want to wreak
havoc, and"We will just have to kill them."
Me:"Who do you think should do the killing?"
Daniel:"Americans cannot tell the difference between Iraqis who
mean well and those who harbor ill. You will need to hire Iraqis
who can tell the difference. They will work with you and do the
job. I volunteered to help, but the U.S. government never got
back to me."
Me:"That's too bad."

"Memo to Mr. Rumsfeld -- Please call Daniel."

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The Daily Reckoning PRESENTS: The good doctor on what's in vogue
among wonks in Washington.

POLICY TRACTION
By Kurt Richebacher

"Policy traction" is an expression that lately has come into
fashion. In essence, it is about the relationship between the
size of the monetary and fiscal stimulus injected into an
economy... and their effect on economic growth and employment.

In the past three years America has experienced an interest rate
collapse, a record fiscal stimulus and the loosest monetary
policy imaginable fueling money and credit creation at a scale
that has no precedent in history. Has it really worked?

Well, in one way it had fabulous traction. It engendered the
greatest credit and debt bubble in history. Total outstanding
debt, financial and non-financial, in the United States has
ballooned by almost $6,500 billion since 2000, as against GDP
growth of $1,238 billion. For each dollar added to GDP, there
were about six dollars added to indebtedness.

And it had fabulous traction in a second way: The runaway money
and credit creation went with a vengeance into asset markets --
stocks, bonds and housing. When the equity bubble popped in early
2000, the consumer simply moved on to the housing bubble that had
been waiting in the wings, helped by the Fed-inspired bond bubble
driving mortgage rates sharply downward.

Their joint result was the unprecedented mortgage finance excess.
While businesses were slashing the consumer's income growth, he
offset this income loss largely by stepping up his borrowing.

Yet in the course of 2002 it became clear that the lowest
short-term interest rates in nearly half a century were failing
to create the customary strong economic recovery. In June, the
Fed cut its interest rate for the 13th time, to 1%, a 45-year
low. In the following month, it admitted in its report to
Congress the fact that the economic performance during the first
half of the year had remained sub-par.

On the other hand, however, the Fed stressed the success of its
easing by mentioning the recent rise in stock prices, the sharp
narrowing of credit spreads on corporate debt, the strong housing
and mortgage refinancing market and rising consumer sentiment.

What, in fact, had emerged was an unprecedented dichotomy in the
effects of the Fed's most aggressive monetary easing between
economy and financial markets. Instead of jump-starting consumer
and business spending, the extreme monetary looseness and
rock-bottom short-term interest rates generated multiple, price
bubbles in the stock, bond, mortgage and housing market.

Without great discussion, the U.S. economy has been shifting to a
growth model that radically differs from past experience. In the
old model that has ruled for centuries, monetary easing was
conceived to work directly on the real economy, and it could be
counted on to promptly do so. But it was a world with low debts
and strong employment and income growth.

Most importantly, it was a world in which financial systems of
very limited size principally served as mere conduits for
channeling savings into capital investment, creating national
wealth in the form of productive plant and equipment, and
commercial and residential buildings.

Faced with an economy that responded poorly to its aggressive
monetary easing, and with very little scope for further cuts in
short-term interest rates, a desperate Fed reacted in an
unconventional way. Internally, it was obviously considering an
attempt to increase policy traction by bringing long-term rates
down as well.

Wanting to avoid direct intervention, it apparently decided to
put America's highly vigilant, huge, financial and speculative
community before the cart, by using nothing more than simple
opportune rhetoric. Repeated public talk by Mr. Greenspan and
other Fed members of looming deflation in the economy was one bit
of bait. Simultaneous talk of two new policy considerations was
the other.

The first idea, was to repeat in public an explicit commitment to
maintain the existing rock-bottom short-term rate peg of 1% as
far"as the eye can see"; and the other one, was public hints
that"unconventional" measures, like direct purchases in the
market, were being considered to push long-term rates further
down as well.

It was really an unreserved invitation to investors and
speculators around the world for greater engagement in playing
America's yield curve with heavily leveraged carry trade. Many
heard and acted promptly. In just six weeks, U.S. 10-year yields
fell from 3.9% to 3.1%.

It should, by the way, be clear that this manipulated indirect
intervention vastly outdid what the Fed could have possibly done
with direct purchases. We have no idea about the scale of the
purchases that suddenly flooded the U.S. bond market, but it was
without question in the range of several hundred billion dollars.


What followed is well known: A frenzied stampede of the financial
community into the highly leveraged bond carry trade sent bond
yields plummeting, pulling in their wake highly correlated
mortgage rates sharply downward with them. In the same vein, the
loose money helped to boost house prices.

Given in addition extremely aggressive mortgage lending
institutions, eager to lend prodigiously against rising house
prices, consumer borrowing just went parabolic.

All in all, four interrelated bubbles have kept the U.S. economy
going after the bursting of the stock market bubble in 2000:
rising house prices, falling bond yields and mortgage rates, and
soaring mortgage loans feeding the consumer spending binge. Yet
the key role fell manifestly to the bond bubble. By pulling
mortgage rates precipitously down, it provided the big bait that
lured house owners to capture the offered big savings in current
interest rate service by refinancing and increasing their
mortgage.

U.S. economic growth, therefore, is no longer based on saving and
investment. Its essence is that credit excess provides soaring
collateral for still more credit excess creating still more asset
inflation for still more borrowing and spending excess. It seems
like a perpetual motion machine that just goes on cranking out
wealth and spending.

The traction that these policies have so far achieved, and its
probable economic and financial effects in the longer run, have
therefore become the most important issue in the current
development in the United States.

The true name of this game is bubble-driven growth... and all
bubbles end by bursting.

Regards,


Kurt Richebacher,
for The Daily Reckoning