-->'White Elephants' And Other Monetary Ailments
The Daily Reckoning
Paris, France
Thursday, 26 June 2003
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*** 100 basis points to zero...and a hot corner of Hell!
*** Rate cut brings yawn...lower stock prices. Bonds down.
Dollar down. Gold up! Houses up. Durables down. And so on.
*** How lucky we are...a beer for $650. How inflation
overcame virginity. And more!
Do you remember Ed Yardeni, dear reader?
He was the man who popularized the Y2K scare...and then the
"Fed model" for mis-pricing stocks...and then thought he
saw an evolved race of super-humans during the Tech Bubble:
"those who get it."
That new species finally got it, good and hard, when the
bubble burst, but Yardeni was unconcerned. The Fed would
fix things, and fast.
"There are 600 basis points between here and zero," said
he. As far as we know, Yardeni has never been right about
anything. But in this remark, he managed to be wrong twice.
For it implied that that the Fed could easily reflate the
bubble, just by taking basis points off the Fed Funds
rate...and that it had only 600 of them to work with.
Yesterday, two...no three...no four...fascinating things
happened. First, in the 32nd year of the Dollar Standard,
the U.S. central bank decreed that its key lending rate
would be reduced to 1%...only 100 basis points were left on
the way to zero. Second, did the investment markets leap
for joy? Did businessmen sign up for new spending projects
in anticipation of the boom? No. Investors sold off stocks
and a poll of CFOs said they were still cutting expenses,
not adding to them. Then came word not of inflation...but
of deflation...in fact, the unkindest price cut of all:
Reuters reported that the New York Time's best-seller
lauding Alan Greenspan, albeit in simpleminded fashion, had
been marked down to just 99 cents by Amazon.com's used-book
affiliate.
Last, but not least, it turns out that the Fed has more
than 600 points to work with after all. Yesterday, the
interest rate on overnight loans in Japan fell below zero
to minus 0.001%. Meaning, borrowers paid back less than
they borrowed. Talk about something for nothing; wait until
America's auto dealers, homebuilders and mortgage brokers
hear about this!
Zero percent financing? Forget it...we'll pay you!
Ah, what a wonderful, dizzy world we live in...When people
suffer from too much debt - give them more. Lure them in
deeper with easier credit terms...keep the printing presses
turning...what could go wrong?
But what's this?? A response to our"Dead Men Talking"
column of last week...An email from the nether world...a
dead letter...from the Great Beyond:"Ha, ha, ha..." it
begins,"you puffed-up fools. You thought we had nothing to
teach you. You thought you invented the printing
press...and paper money...
"Well, we're waiting for you...there's special little
corner of Hell reserved for central bankers. We're stoking
the fires for you...so that they may scorch your fat,
arrogant derrières..."
Is the letter authentic? Here at the Daily Reckoning, we're
optimistic enough to believe it. (We will give you the full
text of this remarkable message...tomorrow...)
Meanwhile...Eric Fry, our man in the citadel of modern
capitalism:
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Eric Fry in New York City...
- The Fed trimmed interest rates again yesterday, then
investors trimmed about 100 points off of the Dow Jones
Industrial Average. The Dow, which had been hovering in
positive territory most of the trading session, plunged
after the Fed news came out and closed down 98 points at
9,011. The Nasdaq Composite fell 2 points to 1,602,
eliminating its earlier 2% gain.
- Bond prices also tumbled, as the benchmark 10-year
Treasury note fell 22/32, lifting its yield to 3.33 percent
from 3.25 percent in the previous session. Now that bond
prices are plummeting from the Olympian heights they
reached earlier this month, the bull market in bonds is
looking increasingly vulnerable. Is the seemingly immortal
bond bull merely mortal after all?
-"The bond market rally has gone too far, too fast in our
opinion," says Donald H. Straszheim of Straszheim Global
Advisors."It looks a lot like the Nasdaq run-up of the
late 1990s - early 2000...The February 2000 to June 2003
decline, from 6.76% to 2.08%, was a stunning 68%...When
investor sentiment turns against bonds, there will be a
stampede for the door and many investors will get
trampled."
- Like a bad punch line, Alan Greenspan's rate cuts can't
seem to produce the desired effect. The economy just shrugs
its shoulders and stares back vacantly at the chairman's
one-man monetary show. 13 times since January 2001,
Greenspan has reduced the Fed Funds rate. 13 times the rate
cuts have produced - ta daaa! - NOTHING...except for a
runaway housing market. Economic growth is nowhere to be
seen.
- Yesterday, Greenspan trimmed the fed funds rate from 1.25
percent to 1 percent. Short-term rates have not been this
low since 1958 and, arguably, interest rate cuts have not
been this ineffectual since 1958, or maybe not since 1858.
What good have all of these rate cuts achieved? Is the
economy any stronger? Are TV sitcoms any funnier? Are
American tourists any leaner?
- About the only thing that we can say for certain about
the 13 interest rate cuts is that the interest rates are
lower than they were 13 rate cuts ago. But the
macroeconomic results are dubious at best.
- Not that anyone needs a fresh reason to sell the
overpriced shares of companies with no earnings growth, but
the Federal Open Market Committee (FOMC) provided one solid
reason yesterday:"The economy...has yet to exhibit
sustainable growth." The FOMC then displayed its peerless
command of macro-economics by predicting,"The upside and
downside risks to the attainment of sustainable growth for
the next few quarters are roughly equal."
- The economy may lack sustainable growth, but it does not
lack for unsustainable growth. Take a look at the housing
market. New home sales rocketed 12.5% in May - the biggest
one-month jump since September 1993. It seems that folks
are still buying houses and tech stocks, even though most
American corporations still refuse to spend the money to
replenish their pencil supply.
- Government spending, too, at least appears to be in the
unsustainable category (although one never knows with those
jackals)."The lion's share of the government's budget is
spent meeting its domestic obligations. In 2003, Washington
will spend $2 trillion!" writes John Myers, the driving
force behind Resource Trader Alert."Of that, about $1.1
trillion will be spent meeting the federal government's
social agenda (Social Security, Medicare, Medicaid). That
leaves roughly $900 billion for everything else, but after
interest expenses of $300 billion, Washington spends
roughly $600 billion, or just under a third of its entire
budget on defense and foreign aid."
- Mr. Myers"fully expects [that, to meet these
obligations,] the U.S. Treasury and the Federal Reserve
will continue - like the empires before them - to grow the
number of dollars in circulation. Add that to a rapid
divestment of foreign-held Treasuries or other U.S. assets
held by foreigners, which could be catastrophic for the
dollar, as well as the U.S. stock and bond markets."
-"And, oh yes," Myers adds"it would send precious metals
and other real asset prices into the stratosphere." See:
The Decline of Pax Americana
http://www.dailyreckoning.com/body_headline.cfm?id=3271
- Shipments and orders for U.S. durable goods fell 0.3
percent in May, the third decline in the past four months.
But let's not worry too much about durable goods sales. We
must remember that Alan Greenspan had reduced rates only 12
times prior to this particular durable goods report. The
13th cut, which is the one that should really take care of
things, hadn't occurred yet.
- And if that doesn't work, wait until you see rate cut
#14!!...Eventually, Greenspan will get it right.
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Back in Paris...
*** Other market news: the price of gold rose nearly $3
yesterday. Bonds fell. The dollar fell against the euro.
*** If America really is going to go the way of
Zimbabwe...perhaps we ought to check in and see what it
will be like. Herewith, a note from that benighted land:
"Zimbabwe is becoming a really interesting place. It's the
only country in the world where your largest note - $500 -
can't buy you a beer, which is $650.
"A roll of 1-ply toilet paper costs $1000. There are about
72 sections on the average roll, so it is cheaper to take
your $1000, change it into $10's, wipe your bum on 72 of
them and get $280 change.
"How lucky are we!"
*** And here...a letter from a live reader, in Australia:
"I read with interest your essay this morning titled 'Dead
Men Talking'. An excellent essay. I cannot but wonder what
future historians will say about this crazy era, and in
particular about Bush, Greenspan and Bernanke. Will
Greenspan be compared with the German Reichbank President
Rudolf Havenstein, who was responsible for the money
printing? He and his associates should be.
"I feel that on this subject, President Bush is entirely in
the dark. Like The Fuhrer, who was convinced that
'everything' could be accomplished by an act of the will,
he seems to think that all is well so long as he declares
it so. Could he become America's Fuhrer? Or will it be some
equally power-mad Democrat?
"The following may also help bring some understanding of
what a rapidly expanding money supply can do:
"In his book, titled 'Before The Deluge', Otto Friedrich
devoted an entire chapter to the inflation in Germany
between 1919 and 1923. He called this chapter 'A Kind Of
Madness'. It is a fascinating study. It is worth repeating
a small section of his narrative in order to alert readers
to the deleterious effects inflation has upon a population:
"A seventy-five-year-old lady, previously a journalist told
him, 'Yes, the inflation was by far the most important
event of this period. It wiped out the savings of the
entire middle class, but those are just words. You have to
realize what that meant. There was not a single girl in the
entire German middle class who could get married without
her father paying a dowry. Even the maids - they never
spent a penny of their wages. They saved and saved so that
they could get married. When the money became worthless, it
destroyed the whole system for getting married, and so it
destroyed the whole idea of remaining chaste until
marriage.
"'The rich never lived up to their own standards, of
course, and the poor had different standards anyway, but
the middle class, by and large, obeyed the rules. Not every
girl was a virgin when she married, but it was generally
accepted that one should be. But what happened from the
inflation was that the girls learned that virginity didn't
matter any more. The women were liberated.
"'A visiting journalist, Louis Lockner, reported in 1923 he
got the usual first impression of cafes crowded with
stylishly garbed ladies, but soon found a different story
on the side streets off the fashionable boulevards."I
visited a typical Youth Welfare Station", he said later.
"Children who looked as though they were eight or nine
years old proved to be thirteen. I learned that there were
then 15,000 tubercular children in Berlin; that 23% of the
children examined by the city health authorities were badly
undernourished." The old were equally helpless. One elderly
writer, Maximilian Bern, withdrew all his savings, more
than 100,000 marks, and spent them on one subway ticket. He
took a ride around Berlin and then locked himself in his
apartment and starved to death.
"'"Barbarism prevailed," said another old resident, George
Grosz. The streets became dangerous....we kept ducking in
and out of doorways because restless people, unable to
remain in their houses, would go up on the roof tops and
shoot indiscriminately at anything they saw. Once when one
of these snipers was caught and faced with the man he had
shot in the arm, his only explanation was,"But I thought
it was a big pigeon".
"'The fundamental quality of the disaster was a complete
loss of faith in the functioning of society. Money is
important not just as a medium of exchange, after all, but
as a standard by which society judges our work, and thus
ourselves. If all money becomes worthless, then so does all
government, and all society, and all standards. In the
madness of 1923, a workman's work was worthless, a widow's
savings were worthless, everything was worthless.
"'English historian, Alan Bullock, wrote in his book titled
"Hitler: A Study In Tyranny","The collapse of the currency
not only meant the end of trade, bankrupt businesses, food
shortage in the big cities and unemployment: it had the
effect, which is the unique quality of economic
catastrophe, of reaching down to and touching every single
member of the community in a way which no political event
can. The savings of the middle classes and the working
classes were wiped out at a single blow with a ruthlessness
which no revolution could ever equal; at the same time the
purchasing power of wages was reduced to nothing. Even if a
man worked till he dropped it was impossible to buy enough
clothes for his family - and work, in any case, was not to
be found. The result of the inflation was to undermine the
foundations of German society in a way which neither the
war nor the revolution of November 1918, nor the Treaty of
Versailles had ever done. The real revolution in Germany
was the inflation, for it destroyed not only property and
money, but faith in property and the meaning of money".'"
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The Daily Reckoning PRESENTS: Innovation booms and a host
of investments that don't make any sense under any set of
economic circumstances.
'WHITE ELEPHANTS' AND OTHER MONETARY AILMENTS
By Marc Faber
There is a fundamental difference between a"real economy"
and a"financial economy." Understanding it could help you
navigate the stormy decade that no doubt lies ahead.
Ignoring the difference could be disastrous.
In a"real economy," the debt and equity markets as a
percentage of GDP are small and are principally designed to
channel savings into investments. In a"financial" or
"monetary-driven economy," the capital market is far larger
than GDP and not only channels savings into investments but
also continuously into colossal speculative bubbles.
This isn't to say that bubbles don't occur in a real
economy, but they are infrequent and usually small compared
to the size of the total economy. So, when these bubbles
burst, they tend to inflict only limited damage on the
economy. In a financial economy, however, investment manias
and stock market bubbles are so large that, when they
burst, considerable economic damage follows.
Every investment bubble brings with it some major economic
benefits. A bubble generally leads either to a quantum jump
in the rate of progress or to rising production capacities,
which, once the bubble bursts, drive down prices and allow
more consumers to benefit from the increased supplies. In
the 19th century, for example, the canal and railroad booms
led to far lower transportation costs, from which the
economy greatly benefited. The 1920s' and 1990s'
innovation-driven booms led to significant capacity
expansions and productivity improvements, which in the
latter boom drove down the prices of new products such as
PCs, cellular phones, servers, and so on, and made them
affordable to millions of additional consumers.
My view is that capital spending booms like these, which
inevitably lead to minor or major investment manias, are a
necessary and integral part of the capitalistic system.
They drive progress and development, lower production
costs, and increase productivity, even if there is
inevitably some pain in the bust that follows every boom.
The point is, however, that in the real economy (with a
small capital market), bubbles tend to be contained by the
availability of savings and credit...whereas in the
financial economy (with a disproportionately large capital
market, compared to the economy), the unlimited
availability of credit leads to speculative bubbles, which
get totally out of hand.
In other words, whereas every bubble will create some
"white elephant" investments - investments that don't make
any economic sense under any circumstances - in financial
economies' bubbles, the quantity and aggregate size of
"white elephant" investments is of such a colossal
magnitude that the economic benefits arising from every
investment boom can be more than offset by the money and
wealth destruction that arise during the bust.
This is so because, in a financial economy, far too much
speculative and leveraged capital becomes immobilised in
totally unproductive"white elephant" investments. In this
respect, I should like to point out that in the early
1980s, the US resembled far more a"real economy" than at
the present, which I would definitely characterise as a
"financial economy". In 1981, stock market capitalisation
as a percentage of GDP was less than 40% and total credit
market debt as a percentage of GDP was 130%. By contrast,
at present, the stock market capitalization and total
credit market debt have risen to more than 100% and 300% of
GDP, respectively.
It is not wise to base today's monetary machinations on
those performed in the early '80s. Consider the tight
monetary policies of former Fed chief Paul Volcker. In the
1970s, the rate of inflation accelerated - partly because
of easy monetary policies, partly because of genuine
shortages in a number of commodity markets, and partly
because OPEC successfully managed to squeeze up oil prices.
But by the late 1970s, the rise in commodity prices led to
additional supplies and several commodities began to
decline in price even before Paul Volcker tightened
monetary conditions.
At the same time, the U.S. consumption boom engineered by
Ronald Reagan in the early 1980s (driven by exploding
budget deficits) began to attract a growing volume of cheap
Asian imports, first from Japan, Taiwan, and South Korea,
and then, in the late 1980s, also from China.
I would argue that even if Paul Volcker hadn't pursued an
active monetary policy designed to curb inflation by
pushing up interest rates dramatically in 1980/81, the rate
of inflation around the world would have slowed down very
considerably in the course of the 1980s, as commodity
markets became glutted and highly competitive imports from
Asia and Mexico began to put pressure on consumer product
prices in the U.S.. So, with or without Paul Volcker's
tight monetary policies, disinflation in the 1980s would
have followed the highly inflationary 1970s.
Nevertheless, after the 1980 monetary experiment, many
people - especially Mr. Greenspan - began to believe that
an active monetary policy could steer economic activity on
a non-inflationary steady growth course and eliminate
inflationary pressures through tight monetary policies, and
cyclical and structural economic downturns through easing
moves! This belief in the omnipotence of central banks was
further enhanced by the easing moves in 1990/91, which were
implemented to save the banking system and the Savings &
Loan Associations, by similar policy moves in 1994 in order
to bail out Mexico and in 1998 to avoid more severe
repercussions from the LTCM crisis, by an easing move in
1999, ahead of Y2K, which proved to be totally unnecessary
but which led to another 30% rise in the Nasdaq to its
March 2000 peak, and by the most recent aggressive lowering
of interest rates, which fueled the housing refinancing
boom.
But consider for a minute what actually caused the 1990 S&L
mess, the 1994 tequila crisis, the Asian crisis, the LTCM
problems in 1998, and the current economic stagnation. In
each of these cases, the problems arose from loose monetary
policies and the excessive use of credit.
In other words, the economy - the patient - gets sick
because the virus - the downward adjustments that necessary
in a free market - develops an immunity to the medicine,
which then prompts the good doctor, who read somewhere in
the Wall Street Journal that easy monetary policies and
budget deficits stimulate economic activity, to increase
the dose of medication. The ever-larger and more potent
doses of medicine relieve the temporary symptoms of the
patient's illness, but not its fundamental causes...which,
in time, inevitably lead to a relapse and a new crisis,
which grows in severity, since the causes of the sickness
were neither identified nor treated.
Karl Marx might prove to have been right in his contention
that crises become more and more destructive as the
capitalistic system matures (and as the"financial economy"
grows like a cancer). If Marx's conjectures hold, the
ultimate breakdown will occur in a final crisis that will
be so disastrous as to set fire to the framework of our
capitalistic society.
"Not so," Bernanke & Co. will argue, since central banks
can print an unlimited amount of money and take
extraordinary measures, which would, by intervening
directly in the markets, support asset prices such as
bonds, equities and homes, and therefore avoid economic
downturns, especially deflationary ones. There is some
truth to this view. If a central bank prints a sufficient
quantity of money and is prepared to extend an unlimited
amount of credit (and to bail out troubled government-
sponsored enterprises, such as will have to happen in
future with Freddie Mac and Fannie Mae, the same way that
China keeps its money-losing state-owned enterprises
alive), then deflation in the domestic price level can
easily be avoided, but only at a considerable cost.
First, it is clear that such policies do lead to a
depreciation of the currency, either against currencies of
countries that resist following the same policies of
massive monetization and state bailouts, or against gold,
commodities, and hard assets in general. The rise in
domestic prices then leads at some point to a"scarcity of
circulating medium," which necessitates the creation of
even more credit and paper money.
If the inflationists, who are now, under the leadership of
the Fed, in control of central banks around the world, have
their way, this vicious cycle will continue and a very
dangerous economic policy course will be followed. Never-
ending credit creation will eventually result in sharply
rising inflation rates and a much lower U.S. exchange rate.
It will also bring about a disastrous global recession,
which could threaten the capitalistic system as we know it
today.
Regards,
Marc Faber
for the Daily Reckoning
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