There are two new energy technologies that may change the world, but probably not until the 2020s and after. Both are being developed in Asia, one by the Chinese and one by the Japanese. Asia needs them because it is relatively poor in petroleum supplies and relatively heavily polluted. It has been clear to the governments of the East Asian countries that the future of economic growth depends on the resolution of the problems of energy supply and pollution.

The new technology in which Japan is taking the lead is the use of hydrogen as a fuel for cars. All the major automobile companies have been spending very large sums on research into fuel cell engines. This type of engine has great advantages. Its waste product is water. It does not in itself add to the carbon dioxide influence on global warming. Although fuel cell engines still cost 10 times ordinary gasoline engines, the technology is relatively advanced. But there are difficulties, particularly in the distribution of hydrogen as a fuel. DaimlerChrysler promised to have fuel cell cars commercially available by 2004; it has not happened.

Toyota is also spending very large sums on fuel cell research, but it has made a success of a less revolutionary technology, the "hybrid" car, which combines gasoline engines with batteries. The Financial Times states that this "reduces pollution and increases fuel economy."

The five-seater Toyota Prius, the world’s first hybrid car, was launched in 2000, and production is being expanded to 200,000 a year. So Asia is already at the commercial stage, while the United States and Europe are still in the prototype stage. Nevertheless, the fuel cell car will probably prove to be a commercial proposition at some point after 2010 and will perhaps make a significant contribution to world energy conservation in the 2020s.

The Pebble Bed Reactor : First New Design in Decades

The other new technology, also reported in the Financial Times, is the "pebble bed" reactor, which is being built in China. The new reactor is a high-temperature, gas-cooled reactor; it should be producing power in about five years. It relies on hundreds of thousands of nuclear pellets the size of billiard balls, which provide safety against the possibility of meltdown. It is the first major new design of a nuclear power station for several decades. This is a Chinese "first," just as the Prius is a Japanese first.

One could argue that both automobiles and nuclear power plants are relatively old technologies. Nuclear technologies are approximately 50 years old, and the first automobiles appeared in the 1880s. The United States still has the lead in almost all the technological applications of really advanced science.

There is some truth in this, though that is not much comfort to Europe, whose strongest industries tend to belong to mature technologies. Nor is it really true. Most analysts regard Toyota as the world’s most competitive automobile producer, which gets both its commercial and technological decisions right more often than its major competitors, like General Motors. If there is a revolutionary change in the world automobile industry toward fuel cell technology sometime in the second quarter of this century, Toyota is well placed to lead it.

In the same way, safety from meltdown is a necessary condition if a new generation of nuclear reactors is to be built. The pebble bed technology apparently also makes conversion to weapons grade more difficult. It would not solve all the problems of nuclear energy, but it would solve some of them. This may be a 50-year-old technology, but it remains an advanced technology.

The Pebble Bed Reactor: Economic Growth and Technological Advance

Economic growth normally stimulates technological advance, both by providing the need to develop new technologies and by providing the capital. 18th-century Britain, 19th-century Germany, and the 20th-century United States all had both rapid growth and new technology. Asia is now the area of fastest economic growth and of new technologies.

However, we should not simply concentrate on the rise of Asian scientific capacity. The energy issue is just as important. In physical terms, oil is the real limit to the growth of the world economy. The growth of world demand, particularly the rate of growth of China’s economy, has pushed the oil price up to its current $43 a barrel. Despite a temporary relapse, demand for oil still seems to be greater than potential supply.

If one supposes that $40-60 a barrel is now the normal range of the oil price, all sorts of things become necessary or possible. Hydrogen fuel for cars, a new generation of nuclear power stations, and conversion of shale oil and tar sands all begin to look economic. Indeed, they all are economic at anything over $40 a barrel.

Yet they all take time. Perhaps in 2025 we shall all be riding around in hydrogen-fueled cars, going home to houses lit by pebble bed nuclear power, and relying on oil won from tar sands. But 2025 is a generation away. I have an uneasy feeling that there will be serious energy shortages in the period before these new technologies all come on stream. Oil at $100 a barrel would not be good for world trades.

Regards,

Lord William Rees-Mogg
for The Daily Reckoning

March 16, 2005

China’s economy has grown an average of more than 8% per year for the last ten years, and in 2005 it is expected to grow by more than 10%…it’s no wonder that their demand for oil and other resources have skyrocketed in the last decade! The rise of China will change the world oil and energy balance forever – but for those investors that are properly positioned, the opportunity to profit is enormous.

Leading political editor, William Rees-Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. Lord Rees-Mogg has been credited with accurately forecasting glasnost and the fall of the Berlin Wall – as well as the 1987 crash. His superbly perceptive, startlingly well-informed, but often controversial insights can be found in the U.K. edition of The Fleet Street Letter and Strategic Investment in the United States.

Yesterday, the dollar rose because foreigners bought U.S. assets at the "fastest pace in two years." Is this because the dollar is a good deal? Is it because the U.S. economy is so dynamic and flexible, everybody wants a piece of it? Does it mean that the U.S. economy is in a stable, long-term up-trend? Or is it merely what happens when Americans spend more money overseas – a perverse and misleading indicator of an economy that is heading for trouble at break-neck speed?

You’ll recall, dear reader, that January was another record month for the U.S. trade deficit. Americans spent $57 billion more than they earned. That left $57 billion more in foreign hands than they had the month before. What were they to do with it? For the moment, they are still buying U.S. Treasury bonds. But how much credit are Asian banks willing to give? How many U.S. dollar assets will they be willing to hold? When will poor, sleep-deprived Mr. Asakawa finally crack?

Stocks went down a bit, yesterday. Gold held in the $440 range. The dollar rose.

We have made the point many times before: Just because nothing happens today doesn’t mean nothing will happen tomorrow. But even we are beginning to wonder.

Something must happen sometime, we say to ourselves. That is, the trends that are currently underway must come to an end. Everything in life has a beginning, middle and an end. Each day that passes in which they do not come to an end brings us a day closer to the day when they will. Not only that, each day that passes when nothing happens increases both the proximity and severity of the something that will happen.

"Stability leads to instability," said economist Hyman Minsky. The longer things remain stable, the more people become convinced that they will never change. As long as the camel’s back doesn’t break, why not heap more straw upon it? And if you need not worry about something happening, the smart thing to do is to go after as much yield as you can get now. Why not? Nothing bad will happen.

That is what today’s house flippers are doing. They are taking riskier and riskier positions – because they are sure that present trends will not come to an end anytime soon. Instead of buying a house with 20% down, they buy one with 10%…or nothing…down. Instead of buying one, they buy two. Instead of buying a modest house, they buy an extravagant one. Look, if you expect house prices to rise by another 10% this year – maybe you should rush to do the same. Buy a $1 million house with $100,000 down. If it goes up by 10%, you’ve doubled your money. Better yet, buy two of them. Live in one. The other would be a pure speculation.

But as more and more people make such risky bets, it actually hastens the arrival of what all of them forgot to fear: something will happen.

At some point, houses are cut loose completely from their real value as places to live; they become too expensive to live in. How many people can afford to live in a $1,000,000 house? Even at today’s low interest rates, mortgage payments still would be in the range of $6,000 per month. How many people earn enough income to support that kind of a drain? Not many. And when they are all fully housed, where will the new buyers come from? At some point, the speculator can only sell his $1 million house to another speculator.

Now, imagine that you have two million-dollar houses. You might be paying $12,000 per month – not including taxes and maintenance. If the market really does rise 10%, you are a genius. But if it does not, you are in real trouble. Houses are unlike stocks in two critical respects: First, they have real value (as shelter); and second, it costs you money each month just to own them.

When the end comes, expect weeds.

More news, from our team at The Rude Awakening:

————–

Tom Dyson, reporting from Baltimore…

"Oil, copper and now gasoline prices are all making multi-year highs. The CRB hasn’t been this high in 24 years. But is now a good time to sell the peak or buy the trend?"

————–

Bill Bonner, with more random opinions and marginal thinking…

*** The Seattle Times guesses that oil will rise as high as $80 before backing off. We have no reason to doubt it. Oil may be the best investment you can make. But what bothers us is that everyone seems to think so. Newspapers and magazines tell us that oil will rise and the dollar will fall. And yet, Shell sells for only 11 times earnings. And you can still buy an ounce of gold for less than $450.

What we make of that is that investors don’t really buy what they think will happen. They buy what they FEEL will happen. The dollar is almost sure to go down against gold. Gold is real money; the dollar is getting phonier every day. But investors don’t yet feel gold’s pull. Many young investors don’t know what gold is. They have never seen it, except in jewelry. They don’t understand how it works as an anti-dollar. They have no feeling for it.

Nor do they yet have much of a feeling for oil. Yes, they may say to themselves, oil will probably go up. But oil there is no excitement in oil. It has been around too long. It is yesterday’s investment story. Today’s big money – they believe – is made in Google or Ebay.

Neither gold nor oil are a la mode yet. But hemlines rise and fall. So do oil stocks. We suspect they are rising

*** Each generation of world-improvers adds their own regulations. After a while, there’s so much red tape around that even the world-improvers themselves realize that they are being smothered by it.

"Civil servants find it easier to introduce new regulations to tackle problems than to do anything else," says today’s London Times, citing an official report. What to do about it? Mr. David Arculus, a private businessmen in charge of a task force on the subject, says: "My solution is to say ‘don’t just do something, stand there.’" He proposes that Britain adopt a "one in, one out" approach. If regulators want to improve the world, they would have to get rid of some previous improvement.

Dream on, Mr. Arculus, dream on.

*** Family life is settling down. Jules has completed college applications. He awaits an answer. Edward’s teeth seem to be re-attaching themselves, after he knocked them out. Henry is studying French, German, English, Spanish and Latin all at the same time; we don’t know how he keeps up with them all. Maria has gone quiet on the subject of her new boyfriend, except to say that she may be going to Greece in the summer. And Elizabeth came back from her riding competition with a black eye.

"Wow…you must have really gotten on someone’s nerves," we said, gallantly.

"Oh, don’t be silly, I hit myself with my riding helmet. I don’t know exactly how…"

"Well, it’s a good thing we’re in France. If we were to go out into public in the U.S. I’d be hauled in by the police for wife-beating."

A few minutes later…

"Your eye looks much better, what did you do?"

"I put on some great make-up. It hides everything. Must be very popular with women whose husbands beat them."

Fueling Economic Growth originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Last week, I had breakfast in London with a senior, but relatively young, Chinese official. I was strongly reminded of visits to the White House 20, perhaps even 30 or 40, years ago. He was exactly like the White House aides of the Kennedy, Nixon, or even the Carter years: friendly, polite, immensely well informed, reasonable, and able to answer with confidence any question of national policy that might be thrown at him. He is one of China’s “brightest and best.”

The picture he gave me of Chinese policy was also rather like those distant years in the White House. It combines self-interest, which every government has to follow, with recognition that other nations have their own interests, and a willingness to try to fit together the jigsaw puzzle of national interests. He might almost have been a student of Dean Rusk’s.

We discussed the issue of nuclear proliferation, which is worrying the present White House. China has been accused of helping some other nations, such as Pakistan, to create nuclear programs; so Chinese protestations should probably be treated with caution. But there is nothing but reason and reassurance in the official line.

I raised the question of China’s ugly neighbor, North Korea. He replied that China’s policy was a nuclear-free Korea, North and South. China did not want to have a nuclear neighbor herself, but also recognized that a nuclear North Korea would be a potential threat to other Asian countries, such as South Korea or Japan.

China believed that the best way to secure a nuclear-free Korea was a policy of negotiation and diplomatic pressure. It has the same attitude toward Iran. China does not want Iran to become a nuclear power and sees the problems that might cause. But it believes that negotiation is the best way to prevent that. In this respect, Chinese policy is very similar to that of Britain or the European Union.

I can see that there are people in Washington who would shout with derision at this outline of Chinese policy. I do not. My own view is that China needs another 20 years of peaceful economic development, in which the United States and Japan would be the most important economic partners. I believe this is the real basis of Chinese policy.

China’s average economic growth rate has been 9.5% for the last 25 years. That has allowed Chinese industry to absorb about 20 million new workers every year. The United States is China’s largest market, absorbing huge quantities of Chinese manufactures. The Chinese currency, the renminbi, is tied to the dollar. China has benefited hugely from American technology. Not surprisingly, the Chinese government, which is much more Chinese than it is Communist, does not want to upset this apple cart. China puts a very high priority on its good working relationship with the United States.

On Sky Television, of which I watch quite a lot, we can view CCTV, the Chinese English-language 24-hour news service. It is reassuringly old-fashioned, like the BBC used to be in the 1960s: polite to everybody and surprisingly impartial.

The young official and CCTV tell the same story. China is becoming a major power, but is still in a stage of cautious development. Those Americans who treat China as an equal partner will, I think, be rewarded. One thing is clear. The Chinese are at least as clever as the Westerners, and perhaps a little bit cleverer. So were President Kennedy’s young White House aides.

Winning Without Fighting originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

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All of the world seems to be moving at once.  There is the American election, whose outcome is not known to any of us as I write.  There is the signing of The European Constitution, which I suppose will be called the Second Rome Treaty.  There is the revolt of the European Parliament against the new European Commission.  There is the serious illness of Yasir Arafat who has dominated Palestinian politics, and has frustrated successive peace processes for forty years or more.  There is the vote in the Knesset in favour of Ariel Sharon’s proposed withdrawal of Israeli settlements from the Gaza Strip.  The cauldron of international affairs is certainly bubbling, and I have not even mentioned the situation in Iraq.  Nor have I mentioned the high price of oil, or the recovery of the gold price to something very close to the highest levels in more than a decade.

Obviously the U.S. election result is among the most important of these events.  However, we should not exaggerate the room for manoeuvre that either candidate would have, if elected.  The essential interests of the United States are what they are, and will be what they will be.  The U.S. electorate has concentrated, I think rightly, on the contrasting personalities and cultures of the two men.  The decisions they would make in the White House would be shaped much more by what sort of men they are, than by the platforms on which they might be elected.  Senator Kerry is a “Massachusetts Liberal,” to use the phrase pinned on him by his Republican opponents.  He happens to come from Yale rather than Harvard, but he might just as well be a Harvard man.  His roots go back to the early days of New England.  He has the intellectual caution of a thoughtful and careful temperament.  He is not an intellectual of the quality of Woodrow Wilson, but he would make the sort of president for whom Woodrow Wilson seems an appropriate comparison.

George Bush is not described by his opponents as a “Texas Cowboy” – though one hears the phrase used in Europe often enough – because the Republicans think that “Texas Cowboy” is a favourable brand image with Americans, particularly in the South and West.  If one were to hold a poll between the “Massachusetts Liberal” and the “Texas Cowboy,” the Texas Cowboy, as such, would probably win.

Yet the global issues themselves will not be changed.  The United States will still have to have an economic policy, and foreign policies towards the Middle East and Europe, the areas of highest tension.  Senator Kerry thinks that Europe would be easier for him to handle.  That might last for about twenty-four hours.  It has already been pointed out in Germany that his tough line on trade, and his desire to get the help of German troops in Iraq, would both be highly contentious matters.  The Germans do not want to make concessions to U.S. trade, and they certainly do not want to send German soldiers to Baghdad. That is not wildly popular even in Britain, and is not helping Tony Blair’s campaign for re-election.  No doubt the Senator would be friendlier towards European political leaders, but his kind words would not butter any European parsnips.

The claims of the European Parliament to approve the members of the new Commission, combined with the signing of the Treaty for a European Constitution, present the next administration with a greater challenge.  The United States has helped to create a monster in Europe, a jealous twin for American power.  Most Americans believe that a continental American power is a good thing – they are proud of their country’s Constitutional democracy.  They have assumed that a similar United States of Europe would be equally benign.

Unfortunately, nations define themselves by competition for power.  The separate European nations have been happy to be protected by American power against the threat of the Soviet Union.  In the absence of the Soviet Union, a United States of Europe will see the United States of America as a rival rather than a protector.  That is obvious to almost everyone in Europe, but so far, to hardly any Americans, and certainly not to Senator Kerry.  I wonder when the truth of European rivalry will be recognized by Americans.

Cowboys and Liberals originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Arnaud de Borchgrave, who is the UPI Editor-at-Large, is an extremely well connected and well-informed international journalist. When he says something, it pays to listen. His most recent dispatch follows visits he has made to intelligence sources in five European countries. These sources contradict the more positive view of Iraq that the United States, officials in Baghdad, and the British Government take for granted.

Arnaud’s bullet points are these:

• The neo-con objectives for making Iraq a functioning democracy were always overly optimistic.
• Iraqi security forces have not been trained to the level at which they can resist the insurgents.
• The insurgency has grown from about 5,000 in the early months of the occupation to about 20,000 now.
• To defeat the insurgency, the U.S. would need about 200,000 troops. “Short of that number, the insurgency will continue to gain momentum.” The U.S. will have to stay until about 2010.

Iraq has become a magnet for terrorists.

I put a good deal of confidence in Arnaud, who is a good journalist and a friend of mine. However, I put less confidence in his intelligence sources. All intelligence positions involve a good deal of guesswork, as we can now see from the original intelligence about Iraq’s “weapons of mass destruction.” It is more than possible that Arnaud has it right in correctly suggesting what his European intelligence sources are saying. It is equally possible that European intelligence is biased towards the European view of the Iraq war, and wants Europe to be proven correct. It is also likely that U.S. intelligence is overly confident. President Bush and Senator Kerry are obviously going to be at odds on this issue. They are, after all, fighting a Presidential election campaign.

However, it is prudent to base one’s expectations on the less favourable possibility.  At present, we should assume that the security situation in Iraq is continuing to deteriorate. In any case, that’s what it looks like from the current reports. What conclusion should we draw from this information?

Some Europeans believe that the alliance should pull out of Iraq. My conclusion is that there is no safe exit. If the United States and Britain withdraw, the consequences will be terrible. Islamic terrorism will have won its great victory and will be reinforced in every way. Iraq is an essential supplier of oil, at a time when the oil price has risen close to $50 a barrel.

If anti-Western insurgents regain Iraq, Saudi Arabia, an even larger supplier of oil, will be threatened. It will affect Russia and influence the policy of Iran. It will guarantee that Iran will go ahead with a nuclear weapons program.

There is no exit; and therefore, no alternative. The United States may have miscalculated, but neither the U.S., nor Britain, can afford to pull out now.

Leading Politcal Commentary and Insight

Leading political editor William Rees-Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. Lord Rees-Mogg has been credited with accurately forecasting glasnost and the fall of the Berlin Wall – as well as the 1987 crash. His superbly perceptive, startlingly well-informed, but often controversial insights can be found in the UK edition of The Fleet Street Letter and Strategic Investment in the US.

Flawed Intelligence originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

London, England: It is sometimes possible to identify terrorist risks before they occur. Indeed, I raised the issue of the vulnerability of the World Trade Centre in New York back in 1997.

The Twin Towers had been attacked already; they were obvious symbols of the United States. Jim Davidson and I had just published The Sovereign Individual, which deals in some detail with the theme of “vulnerability to violence”. I was asked to write a brief foreword to the English paperback edition, and I gave the Twin Towers as an example of the vulnerability of modern urban civilisation.

The modern world was not built as a fortress, with strong walls and narrow entries, which can be well guarded. For the terrorist, modern communications, air, rail, road and sea, combine mass use with points of maximum vulnerability.

In the mid-1930s, Stanley Baldwin, then the British Prime Minister, forecast the great danger of the coming war: “The bomber will always get through.” Unfortunately, it is equally true to say that the terrorist will always get through today.

Our main defence lies in intelligence

Before 9/11, counter-intelligence against terrorism was inadequate in all countries, as has been shown by the committees of enquiry. Since 9/11, some countries, including the United States and the United Kingdom, have reorganised their intelligence. Before 9/11, information was often in the wrong place. There has certainly been a great improvement in the transmission of intelligence inside the Washington machine, and that improvement goes right up to the President.

Unfortunately, as Spain shows, there has been no similar improvement in intelligence, or in its organisation, in most continental European countries. In physical terms, we all present soft targets. There are many thousands of high value, high vulnerability targets in all the advanced countries of the world. In intelligence terms, some of the soft targets are better protected than others.

The US and the UK form, in effect, a single intelligence area. Britain more or less invented “sigint” – the interception of communications – in the First World War, and developed it further in the Bletchley penetration of German codes in the Second World War.

UK-US co-operation proved invaluable

American investment and electronic know-how had overtaken British by 1945. Nevertheless the cooperation in sigint has been maintained. Normally, the American intelligence community is remarkably reluctant to share information. But in some areas, particularly the Middle East, Britain’s MI6 has particularly good human sources, known as “humint”.

France and Germany were penetrated by Soviet agents throughout the cold war, but the Anglo-American partnership has paid off for both countries. Unfortunately, the European nations are not in the loop, and – except France to some extent – they are not able to look after themselves at all effectively.

From the terrorists’ point of view, this makes a difficulty. Nothing would be easier than to create a major terrorist event in France itself. It has a large and radicalised Islamic population. There are internationally famous symbolic buildings and vulnerable high-speed trains. France has a sophisticated intelligence service, but it does not have the resources of the Anglo-American system.

Why bin Laden won’t attack France

Yet it would serve no political purpose for Al Qaeda to knock down the Eiffel Tower, because France was on the side of Saddam Hussein in the United Nations. Indeed, one of the factors influencing French foreign policy may have been in consciousness of French vulnerability to Islamic terrorism.

Osama bin Laden believes in spectacular terrorist events. He likes to act on a big scale. He will now have to decide things: whether he has the resources to mount a spectacular event in the US before the Presidential election, whether his system has been penetrated by US intelligence, and what the political effect of this infiltration might be.

No doubt, a spectacular attack before or during the Presidential election campaign would gratify his anger, and his vanity. That was what Al Qaeda did in Spain. But I am fairly sure it would have the opposite result if the United States had to face a major terrorist event a week before polling day. That would help to re-elect the President.

And helping to re-elect George W. Bush would be quite as counter-productive politically from Al Qaeda’s point of view as it would be to knock down the Eiffel Tower, if for very different reasons.

The Bomber Will Always Get Through originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The boom on Wall Street in 2003 was not irrational, but it could draw investors into a trap. The boom itself is a recovery from the declines of the previous three years. The market has not broken through its 1999 and 2000 highs, and it is unlikely to do so in the coming months, though I expect Wall Street to continue to be quite bullish through the election in November.

The market has been reacting to the renewed growth in the U.S. economy and the strong rise in corporate profits. In the third quarter 2003, the U.S. economy grew at around 9% annualized, an unexpected rate of growth for a mature economy. In the same quarter, corporate profits rose by 30% and broke through the $1 trillion barrier for the first time.

I find in the last few weeks that I have regularly been referring to "trillions." When I entered journalism, we counted in "millions"; the inflation of the 1970s taught us to think in "billions"; the 21st century is teaching us to think in "trillions." I wonder who the first "trillionaire" will be. So far as I know, no individual has yet reached the $100 billion mark, though Bill Gates may have done so at the top of the Internet boom.

Consumption Boom: Nervous Foreigners

I did not expect so strong a performance from the U.S. economy, and I am still uncertain about the underlying causes. We do, however, know that it was led by U.S. consumption. It was not savings or exports that did it, nor was it a higher inflow of foreign funds. Foreigners have become nervous of the dollar. I am nervous of this boom in consumption, since it has been financed by a boom in debt, based on the huge borrowings from Japan and China. The prosperity of the United States in 2003 has not been the product of U.S. earnings but of borrowing the earnings of Asian countries.

The world trade and currency relationships reflect this tension, and have been following exactly the forecasts we have been making. On this, your editors and I have the same analysis. It is not an analysis of any single currency, of the dollar, the euro, the yen, the pound, or the renminbi, but of the unsustainable relationships between them. We also treat gold as another currency and use movements of the gold price as a very significant indicator of the underlying balance of the market. Gold has broken through $400 per ounce and seems set to go much higher. Analysts regard $500 as only the next step.

In the last month, our current forecasts have all been on track. The dollar has continued to fall against all the other currencies except the Chinese renminbi, which is tied to it. This has largely corrected the overvaluation of the dollar, but has not corrected the trade deficit of the United States, which currently runs at $500 billion, or half a trillion dollars. It has also produced an acute undervaluation of the renminbi, which is reinforced by China’s extremely low labor costs.

The yen has risen closer to the 100 yen-to-the-dollar relationship. In order to maintain export competitiveness, the Japanese have continued to buy dollars on a massive scale. The U.S. trade deficit with Japan is therefore recirculated and used to finance the U.S. deficit.

Consumption Boom: Euro Rising

Britain and Europe are on the receiving end of this movement of the dollar. The euro has risen to its highest level ever. The pound, which has a different trading pattern to the euro, has fallen against the euro but risen by more than 20% against the dollar. The result is that European exports, which already had high costs, have ceased to be competitive, particularly with the exports of Asia.

Germany is sometimes referred to as "the engine of Europe," but the German economy is sick and has fallen back to zero growth. Germany is a manufacturing and exporting country, and German manufacturers are not competitive in world markets. In the whole Eurozone, youth unemployment is one- sixth, a social disaster.

Even China is not free from problems. An undervalued currency is obviously helpful as a way of undercutting one’s neighbors and promoting exports. China has tens of millions of workers to introduce into its expanding modern economy. But an undervalued currency introduces inflationary pressures, and China is beginning to suffer from them.

At some point, the renminbi will have to be revalued against the dollar, or floated. Floating would be much the better solution. The present situation, in which the dollar and the renminbi are tied together, but all the other major currencies are floating, is illogical and damaging for all of them. President Abraham Lincoln said that one cannot have "two nations – one slave and one free." It would be equally true to say that the world cannot have two sets of currencies, one floating and one fixed. That is particularly true when the fixed currency is the most competitive on Earth.

The dollar will not be able to settle down to a more stable rate so long as it is fixed to the renminbi. Nor will the euro return to a more competitive level. At present the United States and China are like two fugitives from a chain gang, tied together at the ankle. It may, however, be difficult to cut off their fetters until the U.S. presidential election is out of the way.

Regards,

William Rees-Mogg
for The Daily Reckoning
January 12, 2004

Editor’s note: Leading political editor William Rees-Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. A version of this essay originally appeared in the January edition of Strategic Investment, to which Lord Rees-Mogg is a frequent contributor.

For more, see: The Investment of a Lifetime

Erring on the side of recklessness.

Who can know how long this stock market rally will last? Or whether employment will really pick up or not? Or, when the Chinese will stop lending?

But Americans have decided to go ahead – as if everything will turn out all right, no matter what. The thought occurred to us when reading the latest employment reports.

It is still a "jobless recovery" as near as we can figure…or even a jobless non-recovery. We suspect it will soon be a jobless bust…but hold that thought for a minute; today we’re not making predictions, we’re merely marveling at the extraordinary optimism of American investors.

While investors are optimistic to the point of recklessness…people who actually know something tend to be more cautious. While the little guys buy appalling stocks at outrageous prices, the real pros – Soros, Buffett, Templeton, Rogers, Grantham et al – head for the exits. And now we find our friend Marc Faber saying that business managers are currently 4 times as likely to sell their stock as buy it.

And when managers hire new employees, again they show timidity, not temerity; they are more likely than ever before to pick up ‘temporary’ workers, rather than full- time ones.

Faber quotes Jose Rasco of Merrill Lynch:

"…The temporary worker is the marginal worker and is the first in the door. If demand remains strong, then companies can hire those workers on a full-time basis. If that’s the case, then maybe we will see a traditional recovery led by job creation and income generation. Or, conversely, the rise in temporary workers could be a sign that employers are beginning to apply accounting principles to human resource departments. Instead of hiring someone on a full- time basis, corporations may be moving their labor risks from being a fixed cost to a variable cost. Rather than bringing someone on board and paying them a full-time salary and benefits, companies can keep them as temp/flex workers whose workload can be adjusted with the vagaries in demand. With companies lacking pricing power, and input prices rising…what can a company do to expand margins? The answer is obvious. The easiest way to boost corporate profitability is by lowering its biggest fixed cost: labor!"

You may be shocked to discover this, dear reader: in America’s consumption-led economy, real wages are actually going down. The rush of money into stocks over the last 15 months has not come from increased earnings…but from increased debt. Lower rates encouraged consumers to re- mortgage their homes. Mortgage debt rose…but so did other consumer debt.

Where then did the money go?

"…It seems that only a small part of it was spent," concludes economist Gerard Minack. "Yes, the household sector is still running a cash flow deficit (spending more on consumer and capital items than it receives in cash flow), so the shortfall had to be financed. That cash shortfall was $113 billion in the year to June. But that is relatively small compared to the increase in borrowing. As it turns out, it seems that much of the Fed-facilitated borrowing has gone into Wall Street."

The household sector became the biggest buyer of stocks in the first half of last year – buying $416 billion of them, despite the fact that real incomes were falling.

Real wages have gone down over the last 10 years. But the cost of labor still goes up – because health insurance premiums and other costs have been rising at double-digit rates.

This is very bad news for the American proletariat. Even though he gets less money, his employer is still under pressure to get rid of him!

And here we have another little wrinkle in the fabric of modern, degenerate American capitalism. Corporate managers have no loyalty, neither to their shareholders nor to their workers. They pay themselves extravagantly, sell their own stocks short…and treat employees like inventory. The idea seems to be to cut costs on everything but themselves…to hire the cheapest employees possible, just in time, in order to meet short-term objectives.

Nobody holds anything in stock anymore. No excess food in the pantry. No excess products on the shelves…no excess money in the bank, no excess employees on the payroll. Inventory is an expense item. Erring on the side of recklessness, Americans live hand to mouth…paycheck to paycheck…as if nothing will ever go wrong.

"NO ONE is making long-term investments," writes Hirschel Abelson after surveying the dozens of companies in which his fund invests. Neither in equipment, nor in people. Of course, this is no way to build an economy or make people rich. In the modern, globalized economy, if an American is to continue earning 10 times as much as a Indian, he has to produce 10 times as much. Which means, the society in which he lives has to invest massive amounts of money in new equipment and training. Instead, corporate America seems to care only about cutting expenses to make the next quarter’s numbers…and its own stock options.

The approach is not only reckless…it is hopeless.

"…We are at the point where peak efficiency has begun to take hold and sources for further cost-reduction are becoming harder to recognize," Abelson continues.

Eventually, business managers run out of costs to cut. Then what?

Over to Addison for the news:

——————————————————————————–

Addison Wiggin in Paris…

- Just as we were getting used to bashing Paul O’Neill for toeing the party line, the man up and got himself fired for failing to do so. Now we’re dangerously close to becoming fans…if not for his views, then certainly for his gumption.

- Then again, Mr. O’Neill could just be trying to sell copies of his new tell-all book, "The Price Of Loyalty." In any case, O’Neill told viewers of the CBS rag 60 Minutes last night that removing Saddam Hussein was a top priority of Bush the younger upon taking possession of the White House. O’Neill saw no convincing evidence of Weapons of Mass Destruction during his tenure. Furthermore, he was told by the Vice President that Reagan proved that "deficits don’t matter."

- What a relief it must be for the president to have the docile Mr. Snow as a Treasury Secretary instead, huh? In contrast to turncoat O’Neill, Snow is still among the faithful – even going so far as to cheer on the president’s audacious new space plan. After all, every president worth his salt needs a space plan. Why not a ridiculous and completely insane one? Why Snow, rather than a NASA official, was talking up the plan to build a colony on the Moon and send Americans to Mars remains a bit of a mystery, however.

- But then again, Snow is a "can do" optimist. Exactly the guy Bush needs to get the job done. He’s just as confident the U.S. can put a man on Mars and cut the deficit in half while doing it…as he is that they can jumpstart consumer capitalism in the deserts of Iraq…that he talk the Chinese out of their desire to hollow out the American manufacturing sector and sell dirt-cheap gee-gaws…and that the American consumer, going bankrupt at an historic pace, will miraculously provide the necessary ‘stimulus’ to end the ‘jobless’ part of the Great Jobless Recovery of 2003. Ho hum…all in a day’s work.

- We here at the Daily Reckoning are fairly confident that as long as John Snow says these things in public, he will be able to keep his office at the Treasury. Heck, even if the plan doesn’t work 100%…even if the rest of it goes south…Snow will at least find himself on the short list for a luxury suite on the moon, far, far away from the toil and trouble that will undoubtedly come from cleaning up the mess they leave down here on the earth.

- Meanwhile, back to reality. Friday’s new job numbers make the mission to Mars the more plausible of Mr. Snow’s two speech subjects. Far from the 200,000 new jobs he was expecting in December, what Snow got instead was the discount version of the report. An anemic 1,000 new jobs were created in December. In fact, only 144,000 jobs were created in the whole of the fourth quarter. "That bad piece of jobs data makes me wonder," wrote Everbank’s Chuck Butler this morning, "how long the ‘exceptionally strong’ labor productivity story can continue."

- "How long" has become a familiar refrain around these parts. We ask the question so often, our wives have begun ask tune in with us.

- In the face of continued job weakness, we lamented on Friday (although admittedly a bit confused by reports on the subject), we noted that personal debt is being relied upon by as diverse organizations as the American Banking Association and the American Bankruptcy Institute to bring the economy back from the brink of recession.

- How long can that trend continue? Well here’s a disturbing and tiresome clue from our friend John Mauldin: "Consumer short-term debt…is approaching a historical turning point. Having risen at an abnormally fast rate for ten years, it must soon adjust itself to the nation’s capacity for going into hock…which is not limitless. Whether the rate of growth in consumer debt will slow down is no longer the question…it must slow down."

- Surprise: That quote was taken from the March 1956 issue of Fortune magazine. Other sources throughout the years have made similar comments, which were all obviously wrong. "How long?" Mauldin asks. "My guess is [financial reckoning day] will not be this year…there is still some room left on the credit card."

- Perhaps reserving seats now for the next shuttle to Mars is not such a bad idea.

——————————————————————————–

Bill Bonner, back in England…

*** Why bother to stockpile labor? China has millions of laborers: "Other Asian lands ran out of unemployed people as they developed and had to shift to more sophisticated output to accommodate increasingly expensive labor," writes Gary Shilling.

"China has not. Almost half of its 320 million farmers are not needed to work the land, by the reckoning of the Ministry of Agriculture. There are around 80 million redundant workers in government and government enterprises, not to mention the 100 million squatting in the coastal regions, looking for work, and also the soon-to-be- employable youth – a quarter of the Chinese are under age 15. So China has 500 million potential new workers. "How long could China maintain 8% annual economic growth before exhausting this huge pool of unemployed? About 30 years, assuming 4% annual productivity growth – no great feat for a developing country that can adopt modern technology. Also, the growing Chinese middle class promises strong domestic demand, which will reduce dependence on exports and lead to greater imports. Maybe one day each of those 1.3 billion Chinese will drink one can of Pepsi. "But if you are awed by China’s current and potential power, think twice. Recall the awe over Japan during its 1980s bubble days. Remember how we were all going to be sweeping up around Japanese computers? My contrarian forecast in 1988 was that Japan’s bubble was about to break. I feel the same way now about China." "…China’s two recent growth engines are highly vulnerable. First are exports. Official data show that from 1997 to 2001 exports averaged 21% of GDP but accounted for 48% of GDP growth. And most of those exports go directly or indirectly to the U.S.. American consumers have ended their 20-year borrowing-and-spending binge and are embarking on a saving spree…So the outlook for Chinese exports is glum…"

*** We flatter ourselves with more fan mail: "I am an active reader of the Daily Reckoning," begins one letter. "Whenever I am getting too pleased with the upward movement of the stock market and my ‘greedy’ inclinations, a dose of your column puts some reality on the picture. As a daily reader, I am quite clear on your point of view of the current situation and the dire consequences you paint for the future.

"Rather than repeating the same story on a daily basis, I would ask that you occasionally present a constructive investment strategy that could help me, a naïve investor, increase the possibility of economic survival if your prophecies come true. If the objective of your analysis is to make me want to subscriber to the various newsletter advertisements interspersed with your invective against the system then I would be most disappointed."

*** "Yup! Your critics are right!," says another. "They would have made a ton of money investing in the absolute wreck of the market! Of course you told them to buy gold (stocks coins and bullion) and instead of a ten-month run they would have celebrated two anniversaries of undeserved success by now. With a little thought they could have cake walked from March 2000 until the present but that’s another story. You guys are what you say you are; a well run, easy- to-read journal that costs nothing.

"Your contrarian view is the most powerful antidote to the moronic positivism we get in the mainstream media. The individual who wished you were more positive (06/01) and wanted you to talk up alternate energy or some such thing really needs to look more closely at himself and the world he lives in. There are very real barriers preventing the accomplishment of ‘good’ things in this world. You touch on many of them in your work and there are many many more. Your role (to me) is to shine a light on the intellectual corruption and self interest that passes for reasoning amongst the most powerful in our society. Please keep up the good work. You are a true rarity."

*** Another do-gooder gone bad. That is what we make of press accounts of Armin Meiwes’ prosecution.

Poor Meiwes thought he had a solution to the problems of poverty and overpopulation. He was no doubt discussing his program with Bernard Brandes just before the two cut off Brandes’ most private part and ate it. Then, wouldn’t you know it, Brandes died, either as a result of blood loss from the butchering or as a consequence of the fact that Meiwes slit his throat. And now the British press has made a big stink about it, branding Meiwes the ‘Cannibal of Rotenburg.’ But Meiwes is not merely a pervert; he’s an activist.

"We could solve the problem of over-population and famine at a stroke," said he, according to the testimony in The Times of London. "The third world is really ripe for eating."

But wait, a fellow omnivore thought he saw a flaw in Meiwes’ utopia: "If we make cannibalism into the norm, then everyone will start eating each other and there will be nobody left."

"That’s why I’m not keen on eating women," Meiwes replied.

It seemed never to have occurred to either of them that…just perhaps…not everyone would want to be eaten. Here at the Daily Reckoning, for example, we got through all last week without anyone being eaten…or even expressing a desire to be eaten. But of course, we’re contrarians.

The Currency Chain Gang originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Early in the 20th century there was much fashionable concern in Europe about the decline of the West. Many observers thought that the European lead in 19th century manufacturing would prove to have been a temporary advantage, that Europe was suffering from long-term social decadence, and that Asia would become the dominant continent by sheer weight of numbers.

This fear was particularly widespread in Germany, where it not only related to the massive populations of India and China, but also to Russia, the Asian country that already had a European presence. Some at least of the Kaiser’s advisors at the start of the First World War thought that they were fighting a pre-emptive campaign. If they did not destroy Russia while they could, Russia would simply become too strong for them.

Most Europeans also took a racist view of the Asian populations and, as with all racism, there was fear mixed in with the feeling of racial superiority. In 1914, everybody feared populations to the east of them. The Russians feared the "Mongol Hordes" and the Japanese, who had defeated Russia in the War of 1905, the first war in which an Asian power proved to have technological superiority over a European country. It has to be admitted that the Russian navy in 1905 was astonishingly incompetent, shooting up some British trawlers in the Dogger Bank incident before traveling around the world to be sunk by the Japanese at Port Arthur.

The Germans and the Austro-Hungarian Empire feared the Slav populations of Russia and the Balkans. That fear led the Austrians to want to take the excuse to crush Serbia in 1914. The French and British feared the Germans. Only the Americans were too far away across the Atlantic to fear anybody in particular.

We all know that Asia did not come to dominate the world of the 20th century. There was a decline of the West, in that Europe started two World Wars and was a major victim of both of them. But the rising power turned out not to be Asia but the United States, which became the leading world power during the Second World War, replacing the British Empire, and the leading technological power even earlier, from the rise of the twin giants, electricity and the automobile.

To the historian of 500 years’ time, there may well seem to have been a nearly continuous period of English speaking world leadership, which will probably be dated from the Seven Years’ War, when France lost Canada and India and failed to crush the rising power of Russia under Frederick the Great. The British period lasted from 1759 to 1914 — despite the separation from the American colonies after 1776. The baton was passed between 1914 and 1945, and the United States has carried the baton since 1945. The combined period of English speaking hegemony has been about 250 years, and all forecasts of the decline of American power have thus far proved premature.

In the first half of the 20th century, Asia notably failed to take advantage of the decline of Europe, though between 1900 and 1945 Europe manifestly did decline. Between 1945 and the present day, Europe has recovered to a certain degree, but there is absolutely no sign of Europe regaining the relative position of 1900. The European Union is a big economy but has high costs, middle-rank technology — most of Europe’s exports are of products invented before 1900 — and very limited defense capacity. Yet Asia, like Europe, has so far been developing under the ultimate security of the U.S. defense umbrella.

Russia proved that the communist model, though quite efficient at the task of fighting the Second World War, was not sufficiently variable or competitive to be economically viable in peacetime. China made the same mistake. The Japanese invasion cost China one generation of development, and the victory of Chairman Mao and the Communist Revolution cost another. China is still 50 years behind where she should have been if development had not been interrupted.

Japan’s great mistake was Pearl Harbor, and it set back Japanese development, which was well ahead of the Chinese before 1900, by a generation. For these reasons the major Asian powers, as well as India, which had adopted a relatively benign form of British Social Democracy, failed to take advantage of the opportunity that was presented by Europe’s acts of powerful self-destruction.

However, both demography and arithmetic are on Asia’s side, as they always were. The combined population of China, India, Russia and Japan, the big four of Asian powers, amount to about 2.6 billion people, close to half the world’s population. The combined population of the European Union and the United States, even if Canada and Mexico are added in, comes to less than a billion. The North Atlantic powers have a population that is not more than a third of the Asian four. The European population is relatively elderly, and birth rates in Europe are extremely low. These are factors of decline. For the next 30 years at least, the major Asian countries will have much lower costs than the North Atlantic group, though at some still-distant point, they will catch up, as Japan has already done.

The educational standards of the brightest and best students in the Asian countries are extremely high. China has always believed in educating an elite — the Mandarin class in the old China — and that policy has been followed again. These Chinese students are privileged, extremely well taught, and strongly motivated. The top 10% of Chinese high school students are probably well ahead of their U.S. or European counterparts. The same may be seen in other Asian countries, as it would most notably be in some small countries like Singapore. All four of the big countries have developed a substantial middle class that is still growing in number, and, as in Western democracy, governments have to be able to satisfy the wants of these middle class people, as consumers as well as citizens. Only China is still a directed society, and the conditions on which the Chinese Communist Party holds power are those of performance. Only so long as they satisfy the Chinese people will they be able to remain in office.

The next 50 years will see the great Asian advance, unless it is interrupted by political divisions, war, or other disasters. The Chinese economy will be generally comparable to the United States by 2050. Japan, which is a more advanced economy, is the major external investor in the development of Chinese industry. The Chinese economy will grow about twice as fast as the American. India will take longer but is already a major exporter of IT services.

Inside Asia the growth potential will probably be led by China, with India second and Russia and Japan third. In global competition, the order will be Asia first, America second, Europe third.

Unless Europe can find a way to become more competitive, which is proving very difficult on the continent, European living standards may actually decline from high costs, fixed regulations, and an ageing population. Asia is a major area of investment opportunity. The United States is likely to keep the technological and defense lead.

Best regards,

William Rees-Mogg
for The Daily Reckoning

October 22, 2003

Leading political editor William Rees-Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. He is a frequent contributor to: Strategic Investment.

It is almost like a vacation here at the Daily Reckoning headquarters. We still come to office early in the morning and leave late at time…but our work has grown easier.

Our labor consists of ridiculing the conceits and foolish ideas in the investment media. Though stocks are selling near all-time highs, pundits, economists and analysts have ceased trying to explain it with comic hypotheses. Gone are the absurdities of the late ’90s…that the Dow will go to 36,000….that the Information Age will make us all rich….that Greenspan won’t permit a bear market or a recession. All that is left is the illusion of productivity and growth….and the bedrock belief that God shines his light upon stocks, the dollar, and the American system of consumer capitalism.

Why a dollar’s worth of earnings in America should be worth more than a dollar’s worth in other countries is never explained. And why should a dollar’s worth of earnings be worth more today than it was in 1990….1980 or 1970 or 1960? No one even tries to offer an explanation. That’s just the way it is. Period.

Not that we know anything different, but we have observed that when people come to believe they bask in God’s special light, they begin to do odd things. They give away their money, for example. We recall that religious zealots gave away their farms and houses in the early 19th century, during what was called ‘the Great Awakening.’. Moved by a prophesy, they gathered on hilltops and roofs, expecting to be taken up to heaven all at once.

In today’s world’s, people are no less credulous. The prophets of CNBC have told them that a ‘recovery’ is here….and that ‘stocks always go up in the long run.’ And so they give their money away, trusting that they will soon be sunning themselves in paradise, or Florida.

Back in the late ’90s, investors gave their money away to dot.com hustlers. Today, they give it away to tech companies trading at 40 times earnings…if they have earnings at all.

"Tech companies never have free cash flow, never make any money and have competitors all over the place," explained Seth Klarman in Grant’s Interest Rate Observer. "So, I think they’ll be some carnage there…"

Foreign central banks are giving away money too — by buying Bush-era U.S. treasury bonds at Eisenhower-era rates. With the U.S. budget deficit rising to 5% of GDP….and the current account deficit approaching 6%,, who can doubt that buying T-bonds (by foreigners, especially) is a form self-sacrifice?

"A situation like this which has emerged over the past few years implies an increasing financial vulnerability of the United States," explains Antony P. Mueller. "If the busying spree by foreign central banks should stop or even reverse, the impact would affect the dollar exchange rate, the treasury market and the domestic price level with the consequences of a sinking dollar, a sharp rise of domestic interest rates and an increased inflation rate. It is highly unlikely that the American economy would prove resilient enough to withstand such a triple blow."

Who else is giving away money? Sellers of gold? Buyers of the dollar?

But what of us? Is it wrong for us to take advantage of these poor pilgrims? Is it immoral for us to take these naifs’ money….by selling them tech shares or Treasury bonds?

Au contraire, we feel we must be doing God’s own work. Bearing no false witness and holding no gun to their heads, we help separate fools from their money. Besides, only God knows who is the fool…and only in time will He tell.

Over to you, Addison, for more news:

———————-

Addison Wiggin, ridiculing the pundits from about 6 feet away…

- Nothing but good news from the great River-Of-No-Returns, Amazon.com last night. After the close of the stock market in New York, Amazon reported a ‘small’ profit for the third quarter. We quaffed the announcement with satisfaction, noting that the third was the same quarter our book Financial Reckoning Day debuted at Bezo’s store, and surely it’s brisk sales help to tip the scales from ‘minuscule’ to ‘small’ small. (As always, we’re eager to help…)

- It’s a shame, though, we had grown used to calling it the River-Of-No-Returns. Looks like we may have to knock it off, eh? Wait… what’s this? Maybe we won’t.

- Even with annual sales in the vicinity of $4 billion this year, Scott Rothbort from Lake View Asset Management, by way of USAToday, says Amazon is not likely to "post a full year’s worth of profit anytime soon." Yesterday, we Dailyreckoneers, were in awe to discover, having bothered to take a look, that Amazon’s shares had skyrocketed from a $6 low to a 52-week high of nearly $60 – a 900% gain. Yet, to the casual onlooker the still have no clear plan for profits.

- "Amazon is wildly overvalued," says Rothbort. You don’t say… "River-Of-No-Returns" it is! Amazon’s share price fell 2% on the news.

- Marketwide, the rally kept on a steamin’ forward… even if supplies of coal appear to be running low. The Nasdaq and the S&P both posted gains of 15 and 2 points, respectively. The Dow being the only exception. The grand old iron horse of Wall Street slowed… and eventually through the throttle in reverse for a 30 point loss to 9747.

- "Congratulations on the brisk sales of the book," writes a reader. "Unfortunately, if it climbs any higher in the charts, my contrarian discipline will require me to discount everything it says." We note with satisfaction that sales have been rather steady, both on Amazon (you’re welcome, Jeffrey) and at bn.com. We’re told there is a table top display at a Borders in Lower Manhattan… in fact, the book is now widely available at Borders and brick and mortar bookstores across the country.

- Another reader, who identifies himself as a private futures and stocks trader, calls attention to a fact that has made us somewhat un-easy about the book ourselves. "I have read 421 books in the last 11 years," he writes "And since 1996, I have read 59 books about economics and investing, a couple written back in the mid and late-1800s. – "Of all those books, I just completed what I view as the most important book I have ever read about economics, investing and the most likely future of the US and world economies. Important in the sense, and on a personal level, that it will likely make a big difference in my own family’s financial survival and future progress.

- "If I could change one thing about the book," [ahhh, we knew there would be a catch] "it would be the title. [Financial Reckoning Day] sounds as if it is an emotional effort to sensationalize the U.S. and world economic problems of the last 3 years. It is nothing of the kind.

- "It is a serious, thorough and thoughtful history and analysis of economic, political and military history and most importantly, human behavior since the French Revolution. It dissects and analyzes the Japanese economy since 1980, enlightens and clarifies the actions of Alan Greenspan since 1987 and specifies in detail the coming ‘deleveraging of America.’ It is well written, and even humorous at times. More importantly, Bonner and Wiggin’s effort will, in my opinion, be proved all too accurate."

- And that’s just it… "Financial Reckoning Day" is gussied up like a teenage librarian on her way to the senior prom without a date; it’s been packaged for the market as though it were sexy, but in reality it would prefer to be snuggled at home in a terry-cloth robe finishing its homework.

- One of the major themes, of course, is the deleveraging of America, our trader friend refers to above. We recall, a few weeks back, attending a luncheon in London offered by the folks at Arbor Research, with their hotshot analyst Jim Bianco. Our friend and colleague, Dan Denning put the question to Jim: "What would happen if the credit quality of US government debt were to be downgraded?" citing as possible causes, the Treasury’s exposure to derivatives risk at the behest of Fannie Mae and Freddie Mac.

- "It would never happen," came Bianco’s reply, "That would mean the end of the modern financial system." The answer was, of course, both matter-of-fact and shocking all at once. While, Bianco didn’t see the possibility, Denning got to work figuring out how he could judge the quality of US debt versus that of the banana republic kind.

- Using a calculation he calls the BED Spread, Denning notes that the Morgan Stanley Government Income Trust – a trust containing a basket of US government debt, such as Treasuries and Fannie and Freddie bonds undefined has converged with a similar basket of emerging market debt, each of the last three times he’s made the calculation. In short, the yield on debt issued by Uncle Sam is rising, meaning the market believes it’s becoming more risky, while yields on emerging market debt are falling… or becoming less risky. (More from Denning and the Bed Spread… in tomorrow’s guest essay. Look for it…)

———————-

Bill Bonner back in Paris, fresh off the Eurostar from London…

*** We quote from London’s MoneyWeek, edited by our new friend Merryn Somerset Webb:

"There will be no robust recovery, [according to Nobel-prize winning economist Joseph Stiglitz], and much of the fault lies with Alan Greenspan, the chairman of the Federal Reserve…."

"’More jobs have been lost under Bush than since Herbert Hoover and the Great Depression,’ Stiglitz told The Observer. ‘In the private sector more money has been wasted though misallocation of capital in the stockmarket bubble than the government could ever manage.’ Neither the recent tax cut, nor the increase in military spending, will give the US economy the stimulus it needs.

"The trade deficit has the underlying problem of what will happen when foreigners decide to stop funding the US deficit…"

Then, what will Mr. Greenspan do? More rate cuts? More liquidity? More talk of productivity increases and New Eras?

No, it will be time for Mr. Greenspan to express his regrets, blame the Chinese and retire….

*** ‘Royals at War!’ screams a London tabloid headline this morning. The battle rages, according to press reports, over the latest revelations brought to us from a former butler to Princess Diana. This war has been going on for a long time, we note. But the British never seem to get tired of it. In the latest news, letters from Prince Philip tell us that he thought his son was mad. Only a ‘crazy man,’ he wrote to Diana, ‘would leave you for Camilla.’

*** Here’s a sad item. "Man who survived Iraq is gunned down in LA" says a TIMES headline. "With an annual murder rate of about 653 — up 11.1% on 2001 — the sprawling slums of Los Angeles are arguably as dangerous a place to live for young Americans as Baghdad. The murder rate is 4 times the national average and double that of Bogota, the Colombian capital."

Decline of the Old Order originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

The whole of the worlds’ economies will be affected by whether this war occurs, and if it does, by its outcome. If Saddam Hussein is removed from power, either by a deal with his Arab neighbors, by assassination (which has been a common event in Iraqi and Mesopotamian history) or by the U.S., that will be good news for stock prices. If there is no war or a drawn-out campaign, markets are likely to drift lower, though oil and gold may go higher. If Saddam Hussein is still in power in three months’ time, it will mean a defeat for the United States, with serious consequences for market confidence.

Already, the imminence of war has had a very important effect on the Western alliance. NATO was held together from its formation down to the break-up of the Soviet Union by fear of the Soviet superpower. It has held together more precariously since 1990, by practical agreement on successive international issues, and by the predominance of U.S. defense technology and power. There were strains between the U.S. and Europe during the break-up of Yugoslavia, but these strains did not amount to a breach, despite clumsy policy formation on both sides. Now that unity has been broken.

Germany and France are in agreement in opposing American action against Iraq, with Chancellor Schroeder using Iraq as an issue in the German election campaign. Germany is now a temporary member of the U.N. Security Council and France is a permanent member. Both countries have coordinated their policy, which is one of hostility to American action. They believe that an attack on Saddam Hussein would be contrary to international law, despite his alleged failure to comply with a succession of U.N. resolutions.

World Financial Stability: A Crisis for NATO

This dissent is a crisis for NATO, which is still the main organization for European defense. The views of France and Germany are unlikely to deter the Americans, but do threaten the whole structure of international relations. The rift obviously threatens the United Nations, which has relied on the defense power of the United States to give the only effective backing to its resolutions. When, as in Israel, the U.S. has been unwilling to act, the U.N. has been important. The future of NATO is also under threat. The decision by Lord Robertson, the well-esteemed Secretary General of NATO, not to serve for a further year when his term expires, is not a good sign of NATO’s confidence.

Undoubtedly, this disagreement over Iraq threatens the whole future relationship between Europe and the U.S. In the two World Wars of the twentieth century, the United States saved Europe from German rule, making it less popular in Germany than in Britain, its closest European ally. After the Second World War, the U.S. saved Europe from Soviet rule, again making it less popular in Russia than in Britain. Now there is a danger that Europe will be developed as a rival rather than an ally to the U.S. There is a strong French nationalist tradition, hostile to the U.S. and to Britain. President de Gaulle refused to allow Britain membership of the old Common Market in the early 1960s. President Chirac is a Gaullist. The U.S. already regards Europe as an unreliable ally, and in the U.S., isolationism is not dead.

World Financial Stability: Depending on Cooperation

From the economic and investment point of view, this potential division between Europe and the United States threatens the international structure of trade and currencies. American post-war policy has been globalist, creating the institutions of the World Trade Organization, the International Monetary Fund and the World Bank. Anti- globalist protestors hate these institutions. But they have managed to preserve a surprisingly high degree of world financial stability in the last half-century, despite the breakdown of the Bretton Woods exchange system in the early 1970s, which was followed by global inflation.

The effectiveness of this system depends on cooperation between the U.S., which remains the world’s premier economy, the European Union, Japan and China, which are the world’s largest savers. Japan has the most efficient export industries and China the lowest export costs of major powers. The global system also requires cooperation from the main Arab oil producers, which makes the confrontation with Iraq particularly significant.

This global economic system is based on the American economy and the dollar. The U.S. is already running an external deficit, mainly financed from Asia, of 5% of gross domestic product. The dollar has been under pressure. A split between Europe and the U.S. would be very dangerous for the whole global economic structure established since 1945. It would be almost impossible for the British Government, as we have close ties with both sides. This is a big, big crisis for the world.

Regards,

William Rees-Mogg
February 19, 2003

————–

It’s déjà vu, all over again. But this time it could be worse.

A decade ago – the last time the Americans were trying to dig themselves out from a recessionary economy – much of the eastern United States got buried under snow in a late winter storm. Retail sales fell almost 1 percent, logging the biggest decline for any month from ’92-’94.

The effects from the storm were then…and are likely to be now…temporary. City governments, for example, already cash-strapped from bloated surplus-era budgets and rapidly dwindling tax receipts, are in trouble. New York’s mayor estimates that clearing roads and sidewalks could cost $20 million, doubling the amount by which the city had already exceeded its budget for snow removal this winter. News commentators are throwing around the “price tag” of this storm – “$1 million a square inch” – as if they had a clue.

“Given the dire financial straits these cities are in, this is painful,” says Economy.com’s Mark Zandi. “They’ve got a lot of cleanup to do at a time when there’s a lot of red ink.”

But, like the latest fashions in the Paris spring line, we’ll have to put up with commentary blaming the storm for the hideous appearance of the economy until the next panacea presents itself. Iraq, for example, is sure to reassert itself – drag that it is – very soon. As we noted yesterday, the IMF projects a U.S.-led war with Iraq could slow the world economy by 50%…

“This global economic system is based on the American economy and the dollar,” asserts our own William Rees-Mogg. “The U.S. is already running an external deficit, mainly financed from Asia, of 5% of gross domestic product. The dollar has been under pressure. A split between Europe and the U.S. would be very dangerous for the whole global economic structure established since 1945. It would be almost impossible for the British Government, as we have close ties with both sides. This is a big, big crisis for the world.”

Still, in our humble view, the dominant economic issue remains: the debt hangover from the 1990′s bubble.

“Retirement funds caught in a downward spiral,” reads a headline in the FT. “During the bull market companies were lured into investing more of their investment funds in each other’s success. This may haunt them for a long time,” explains an article. “The prolonged bull market became entrenched in people’s thinking, but now we must adjust to a very different world,” chimes another.

In the U.S., total household debt is at a record level – both in absolute terms and when compared with disposable personal incomes.

“Ten years ago,” points out CBSMarketWatch.com’s Irwin Keller, producing figures from the Federal Reserve board, “total consumer debt amounted to 85 percent of annual incomes, while 20 years ago this ratio was about 65 percent.”

During the last 20 years – an era widely believed to have been the largest economic expansion in U.S. history – consumer debt has risen by more than 40% of disposable income. “As a matter of fact,” says Keller, “the average household today owes more than its breadwinners bring in during an entire year.”

And there’s the rub. If the Fed were to try to raise rates now…it would squeeze the “average household” to the breaking point. “For consumers,” explains Keller, “low rates translate into debt service that is no higher today relative to take-home pay than it was back in 1986. People have to set aside only 14 percent of their disposable incomes to service their existing debt, a ratio they have handled easily in the past.”

Greenspan, Bernanke & friends are beholden to keep rates artificially low – whether it draws in undesirable borrowers or not.

So what?

“After a year of slowly moderating price increases, the cost of a home is shooting back up,” USAToday replies. “The median home price in the U.S. rose at an annual rate of 8.8% to $161,600 in the 4th quarter last year. That’s the biggest quarter-over-quarter increase reported since 1981. And the upward push on prices is widespread: 39 metro areas registered double-digit price growth for the quarter, triple the number of metros with such increases in 1999.”

“The big jump reflects the explosive mix of tight supplies of homes for sale and mortgage interest rates below 6%, the lowest in four decades,” David Lereah, chief economist at the National Association of Realtors, told McPaper.

We Daily Reckoneers have noted on occasion that throughout history, as one bubble deflates, investor fervor is often directly transferred to a new asset class…most notably real estate. With the Fed locked in low rates for a long- time, we suspect the “housing bubble” every one is so keen to talk about may have not even begun.

The Dow defied snow, slush, the odds, the gods and gravity yesterday by jumping up 132 to 8041. The S&P 500 and Nasdaq followed suit, rising 16 and 36 respectively. Gold, on the other hand, continues to attract attention. But yesterday the once-neglected metal lost $4 to $342. “Like a long-dormant volcano,” observes Andrew Kashdan, conducting a trade in the Resource Trader Alert, “the yellow metal surprised nearly everyone recently by erupting toward $400 an ounce. Gold then retreated sharply and dropped to $350 an ounce. But investors are keeping a wary eye on this ‘Pele’ of the commodity markets, as it may erupt again at any time. Every minor sell-off, so far, has been buried by another explosive rally.”

Regards,

Addison Wiggin

The Transatlantic Gulf originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

Many people do not realize that a strong historic argument for gold even exists. Put at its simplest, one can say that gold has the same exchange value as it did in 1900. That is approximately true in high inflation countries, like Germany, which had two wipe-out inflations in the 20th century; in medium inflation countries like Britain, which lost 98% of the purchasing power of the pound; and in low inflation countries, like the United States, which lost about 95% of the purchasing power of the dollar. In Britain, the gold price has moved with the cost of living index, at least over long periods. An ounce of gold will now buy about the same area of farmland as it did in 1660.

After my first book, gold responded to the global inflation of the 1970s. At one point, it rose from the official price of $35 an ounce to a peak of around $850, or by about 23 times. Provided one sold out near the top, gold was the star performer of a very difficult decade. Since then, gold has been a poor performer, particularly when compared to the Wall Street boom of the late 1990s.

Gold Bull Market: Losing Touch with Reality

However, I thought that the bull market in equities was seriously losing touch with reality rather too early – at around the time Fed Chairman Alan Greenspan started to talk about “irrational exuberance”. At its bottom three years ago, gold fell below $260 an ounce, and it came close to that low point again two years ago. An investor who switched from equities to gold in the course of the millennium year would now be more than twice as wealthy as one who stayed in equities, let alone the Nasdaq.

I have repeatedly written that gold has become a better investment than the Dow, and it has been. In 1980, at $800 an ounce, gold was a bubble. At $260, it was dirt cheap, and the dot-com shares were a bubble. Is gold still cheap? The gold market is certainly performing very well, up 30% in the last two years and outperforming most other investments. For several months, the gold price hovered around $320 an ounce and seemed to have difficulty breaking out above that level. What are the factors now?

The expectation of war in Iraq is probably the most important one. Gold certainly benefits from inflation, but it also benefits, more generally, from uncertainty. I think it is probable that the United States will go to war to overthrow the Saddam Hussein regime, and that the war will be short and successful. At least temporarily, that would be unfavorable for the gold price, because it would remove uncertainty. However, there is no certainty about any war. Gold remains a good protection against a spread of war, such as is widely predicted by Arab commentators. So long as the uncertainty exists, oil prices are likely to remain high, and Middle Eastern investors are likely to be putting some money into gold.

Gold Bull Market: Interest Rates

The second influence to consider is interest rates. They are abnormally low at present, not only in the United States, but also in Europe and Asia. That means that the cost of holding gold, which is always a first-class security, is very low. Governments remain afraid of another recession, so there seems to be little risk of a higher trend in interest rates for the time being. That is favorable to a higher gold price.

So is the general anxiety about the major world currencies. The dollar has been weak, because the United States has a high and rising external deficit to finance. It now amounts to nearly 5% of the gross domestic product. Because the dollar has been weak, the euro has been comparatively strong. But the European Union has agreed to accept 10 new members, with 20% of the existing E.U. population. These are poor countries and will be a burden on the currency. The Japanese banking system is in serious trouble, which affects the yen. It is not hard to see that gold is more attractive than any of these currencies. Every other currency relates to debt; gold has no debt, though individual gold holders, of course, may.

Central banks have been selling gold, but that has largely stopped. The main creditor countries, including China, Taiwan, and Japan, are in Asia. They have a gold tradition. I expect their central banks to prefer gold to dollars in 2003. This seems to be the view of the market. A year ago there were large bear positions, but now the speculative positions are bullish.

My own view is that the latest rise is only the start of a long-term bull market in gold. From the late 1960s, the last bull market in gold lasted for over 10 years. It is quite possible that what looks like a new bull market will run for some years, and go well above the present price. But, inevitably, there will be market reactions along the way.

Regards,

William Rees-Mogg,
for the Daily Reckoning
January 28, 2008

————

The Dow has been down triple digits in 5 of the last 6 sessions. It is the “end of the cult of equities,” says the Financial Times.

“The Bubble is over for all of us,” adds the Orange Country Register.

More than half of America’s households still own stocks. And more than half of them have no idea what they are doing; they are the lumpeninvestoriat who got lured into the stock market when everybody said it was the right thing to do. These people wouldn’t know a balance sheet from a bedpan. They just go along with the mob whichever way it is headed. Sooner or later, the mob will leave the stock market, but when?

Usually, sometime after the first stage of a bear market, the mob gets spooked and panics. But so far, the lumpen have sat as still and silent as if they had had a fatal stroke yesterday. Their stocks are down 45% (Wilshire reading) from the top. Their dollars have lost 20% of their value, or more if measured against gold. Their economy – once the crown of creation – is now beginning to prick them painfully. They’re having trouble paying their debts…their net worth is going down…and their friends are losing their jobs and having a hard time finding new ones.

Yet, the poor saps just take the abuse like smokers – they do not complain.

Still, the day may come – and come soon – when they are finally disgusted. Year after year, they get older. Year after year, they get poorer, too. How much more will they take?

We don’t know. But be warned: they could panic any day. In any direction.

Eric, what did they do yesterday?

————

Eric Fry, reporting from Wall Street…

- Well the “kangaroo” weapons inspections reached their predetermined verdict yesterday: Iraq is guilty of something…Of what, no one is exactly sure. The approximate verdict reached by chief UN sleuth Hans Blix is this: “That Hussein guy is trying to hide something, most likely weapons of mass destruction…and we don’t like it one bit.”

- Yesterday, Blix’s report called on Iraq to prove that it has disarmed itself. We’re confused; isn’t it Blix’s job to determine whether Iraq has disarmed? Since when does the mouse alert the cat to its whereabouts? In any event, Blix told the U.N. Security Council that the various inspectors need more time to verify Iraqi compliance.

- But the Bush administration has heard enough already, and it is clearly itching to pull the trigger on an Iraqi invasion. “We can’t keep kicking the can down the road,” Colin Powell said of extending the inspection deadline.

- Countering Powell’s impatience, Senate Minority Leader Tom Daschle – a man who never met a foot he didn’t want to put in his mouth – posed two very worthwhile questions yesterday: “First, does Saddam Hussein pose a threat to our national security so imminent that it justifies putting American lives at risk to get rid of him? And second, how are our efforts to deal with this threat helped by short- circuiting an inspections process we demanded in the first place?”

- We suspect that Daschle’s question will go unanswered, drowned out by the drumbeat of war. Thus, the prospect of an American invasion draws ever nearer, and with it, the prospect of a fourth straight losing year for the stock market.

- Yesterday, stocks tumbled yet again, as the Dow dropped 141 points to 7,989, closing below 8,000 for the first time since Oct. 14. The blue chips are now down more than 4% so far this year. The Nasdaq joined the Dow and S&P 500 in the minus column for 2003 by falling 17 points to 1,325. Global stock markets are also sliding lower. London’s FTSE dropped for an 11th straight day, while most European bourses fell about 3% each.

- Conditions have become so tough out there on Wall Street that even the gold stocks are falling. The yellow metal itself continued its winning ways by gaining $1 to $369.40 an ounce, but most gold stocks declined. The Philadelphia Gold & Silver Index fell 3.2% to 79.6.

- But while share prices are tumbling, home prices are soaring. Somehow – we don’t know how – despite rising unemployment, despite intensifying global geo-political turmoil and despite deteriorating U.S. economic conditions, the U.S. housing market keeps chugging along like some sort of financial Mr. Magoo. Sales of existing homes rose about 5% in December, capping a record year for the industry, according to the National Association of Realtors. Housing remains one of the very few bright spots in a very somber economy.

- The tech sector is more typical of the tough times on Main Street. At the World Economic Forum’s annual meeting in Davos, Switzerland, Microsoft founder Bill Gates said he did not expect a big pickup soon in technology spending. “This economy is fairly flat,” said Gates, “technology spending, there’s no big uptick.” Gates gets no argument from his fellow technology company executives. In fact, the outlook is fairly grim throughout techland, which is a big part of the reason that stocks are falling – with or without the Iraqi conflict.

- “The stock market has reneged on its early promise,” says Andrew Kashdan of Apogee Research. “Pretty much all the market leaders have been forced to dampen analysts’ enthusiasm for a recovery that is looking not so imminent. The list of party poops includes General Electric, Microsoft, IBM, Sun Microsystems and Intel. To take one example, Intel beat the numbers (if anyone still cares), but another machete-like cut to capital spending did not exactly inspire confidence. Sun Microsystems didn’t even bother making a forecast for its fiscal third quarter…”

- Being a long-term investor just isn’t as much fun as it used to be. In fact, Strategic Investments editor, Dan Denning, says that investing in the U.S. stock market is far more likely to be painful than profitable. “Any strategy that counts on the relative out-performance of traditional blue chips is a lot like trading futures on death row inmates,” says Denning, “hoping you’ll own the one that gets a pardon. And unless the stock market starts acting like the Governor of Illinois and gives clemency to the hundreds of blue chips which will get crushed by the bear market, its’ not going to pay to try and guess which blue chips sill ‘survive.’”

————–

Back in Paris…

*** Americans have been leveraging themselves with stocks, real estate, and credit card debt for many years. Debt totaled only 150% of GDP in 1950. Now it is twice that high. Little by little…or in a sudden panic…they will have to de-leverage themselves somehow. Not until that happens will the bubble really be over for us all.

*** De-leveraging can take a long, long time. Japan began in 1990. But yesterday’s news brought evidence that the process continues. Short-term interest rates have fallen BELOW zero, reflecting obstinate deflation…retail sales fell 3.9% in December…and the nation’s trade surplus shot up by more than 51%. The Japanese just won’t spend money.

*** Here at the Daily Reckoning, our beat is money. But long time DR sufferers have realized that money is just a cover…an alibi…a pretext for commenting on other things. We’re fascinated by the way the world works…and by this strange creature, homo sapiens sapiens, the infests the place. Watching him carefully – rather than studying statistics or econometric formulae – gives us clues to how his money works, too.

But we don’t really care about money, dear reader. We live simply and frugally. A bed, book, and candle are all we really need. In fact, as long as we have enough to pay for our office and our apartment…our 2-hour lunches…good vintage wines…our summer house…vacations…riding lessons…music lessons…French lessons…antique cars…Savile Row suits…19th century French landscape paintings…boarding school and college for our 6 children…the cleaning lady…the gardener…cement for our stone walls… heck, we can take it or leave it. After all, it’s the simple things that really matter.

*** Maria is on a modeling assignment in Mauritius, where she is staying at a resort called Touessrok.

“You wouldn’t believe it,” she said last night. “This place is so beautiful and so deluxe. Everybody who comes here must be super-rich. I came into my room last night and they had spread rose petals on my bed. Everywhere you look, it is stunning…There’s a white sand beach…a coral reef…the sea is a beautiful color of green…

“I had a free massage…and tomorrow I don’t have to work…so I’m going to sit by the pool and have one of these guys in the white uniforms bring me drinks with umbrellas in them…”

You see, dear reader, it really is the simple things that really matter.

The Case For Gold originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.

There are undoubtedly serious concerns in Britain about the prospect of war against Iraq. The Government seems to be willing, if reluctant, to join an American action against Saddam Hussein. But the majority of Labour supporters, including probably the majority of backbenchers, seem to be against joining another war.

Even among Conservatives – who are traditionally inclined to support the American alliance in almost all circumstances – there appear to be doubts. Tony Blair puts the US alliance first, for very good reasons, but even he seems fairly reluctant to commit himself to military action.

The European Union is even more skeptical. If President Bush does decide to go to war with Iraq, he will not get much support from Europe – but he will receive a lot of criticism. In the United States, there is solid support for military action, particularly at the level of public opinion. The American voter remembers September 11th and regards Saddam Hussein as a dangerous tyrant who threatens world peace in his development of weapons of mass destruction and his support for terrorism. But intellectuals and academics, particularly democrats of a liberal persuasion, are not convinced.

The American and British Governments both have intelligence information about the danger that Saddam Hussein represents, and this information has not yet been made available to the American or British public. But I am impressed by the way in which those who know most about the danger seem to be most concerned about it.

Certainly Washington is convinced that the danger is real and immediate, not merely theoretical and longer term. The administration considers that the war on terrorism cannot succeed so long as Saddam Hussein is in power in Baghdad. Tony Blair knows what the intelligence reports are and he too takes them very seriously.

If George Bush does decides to go to war in order to change the Iraqi regime, he cannot afford to lose the battle, either from the point of view of US authority, or of his own survival for a second term.

The United States has an even greater technological superiority than at the time of the Gulf War. The problem now is the lack of an alliance in any way similar to the one that supported American action to free Kuwait. Then the US was able to build up its forces using Saudi Arabian bases, and with European support. Now the US has little Arab support, apart from Kuwait, and little European support.

Even Kuwait would need guarantees against possible Iraqi reprisals. They do not want to be invaded again.

When I visited Kuwait in February, the Kuwaitis were perfectly sympathetic to the American desire to change the regime in Baghdad. The Kuwaitis have even more reason than the Americans to detest Saddam Hussein, but they are worried about the absence of a coalition of support. They agreed that the US should try to improve relations with Iran, which has reasons of her own to detest the Saddam Hussein regime. The Kuwaitis I met also hoped the US would make progress towards the establishment of a Palestinian state. That would free pro-American Arab countries – including Saudi Arabia – to help the US to deal decisively with Saddam Hussein. But neither course has been adopted.

The United States has gone out of its way to tie together Iran and Iraq as "rogue states", part of the "axis of evil". Washington has seemed to be interfering in the politics of Iran. No progress has been made in developing a peace settlement between Israel and the Palestinians, let alone creating an independent Palestinian state.

On the contrary, Washington has backed Sharon, whom all Arab leaders regard with distrust and hostility. The failure to create, or even try to create, an anti-Iraq alliance in the Middle East itself probably represents a defeat for Colin Powell, the Secretary of State, at the hands of Donald Rumsfeld, the Secretary of Defense.

Yet it leaves the US with very restricted policy options. A commando raid on Iraq would probably fail to kill or capture Saddam Hussein himself. It would be a very high-risk gamble. Yet a major campaign, like that of the Gulf War itself, would need bases, support, over flying rights, logistical preparation. Without allies that would be hard to achieve.

If one accepts the US argument that Saddam Hussein should be overthrown as an immediate threat to world peace, one may still wonder how that can be done. An unsuccessful attempt would be worse than none at all.

Regards, William Rees-Mogg,
for The Daily Reckoning
August 30, 2002

Editor’s note : Leading political editor William Rees- Mogg is the former Editor-in-Chief for The Times of London and a member of the House of Lords. Lord Rees- Mogg has been credited with accurately forecasting glasnost and the fall of the Berlin Wall – as well as the 1987 crash. His superbly perceptive, startlingly well-informed, but often controversial insights can be found in Strategic Investment.

For more, see:

Strategic Investment

The latest numbers from the Commerce Dept. show the economy growing in the last quarter at a 1.1% rate. We don’t know how much crunching was done to them, but even after tarting up by the government, the numbers show the economy barely growing.

Only two things keep them positive: autos and houses.

If the reports we read are correct, you can walk into an auto dealer and drive away in a new car – without paying a penny. Even the taxes and tags are finance – at zero percent. Of course, now you have a big liability on your balance sheet, but who cares about that? And who needs savings? Cash flow is all that counts…and as long as the cash flows, just in time to pay the bills, all is well.

Want to buy a new house? Same deal. You can get one without putting up a farthing or a fare-thee-well. Mortgages are written without points…without verifying income…without down payments…without equity. Heck, you’re even encouraged to get a bigger mortgage than you need…or to ‘take some cash out’ in order to pay down your other debts.

But the latest report from Goldman Sachs says that people don’t use the money to pay off other debt. They spend half of it.

But so what. It’s cash flow that counts. Each time they refinance they may end up with a bigger mortgage, but it’s only the monthly payments they worry about.

You see, dear reader, a consumer economy is a cash-flow economy. As long as it is expanding…and there are plenty of jobs and plenty of credit…and lower interest rates with rising asset prices – everyone is happy.

The public is still confident…it still sees the economy as benign. Cash flow is not yet a major problem.

And so durable orders keep coming in. In fact, they were up a remarkable 8.7% in July. But wait…what’s this? Those figures were seasonally adjusted, Lance Lewis points out. Without the adjustments, the raw figures were actually down 13%!

And sales at the nation’s chains stores are slowing too. Is it the heat? Or are people running out of cash flow?

Sooner or later they will – at least, that’s our guess – when house prices stop rising, and they can no longer ‘take out equity.’ Then those balance sheets – with beaucoup debt and little in assets – are likely to tilt the consumer into a different state of mind. He’s likely to discover that the economy is not so benign after all…and that rather than depend upon the cash coming in ‘just in time’ to pay his bills, he’d prefer to have some savings ‘just in case’ the cash doesn’t flow as well as he’d hoped. Then, he stops refinancing…and slows his spending. And then, the economy stops growing…and the world as we have known it comes to an end.

But let’s turn to Eric’s report from Wall Street for the latest news from the heart of capitalism:

******

Eric Fry, in Manhattan:

- Helplessly and dejectedly, the bulls are watching their summer rally fade away like the warm nights of August. The chill of autumn is in the air. Soon it will be September, when kids return to school, baseball players refuse to play baseball and the stock market often tumbles.

- It’s true; October grabs most of the headlines, but September is, on average, the worst month of the year for stocks. This year, September seems to be getting an early start. Since the Dow’s close above 9,000 on August 22, the blue chip index has slipped 4%. Yesterday, the market offered a little something for everyone. The Dow dipped 23 points to 8,671, while the Nasdaq gained 21 to 1,336.

- "Big is the death of cool," says Danny Kwok, co- founder of Quiksilver, a cool surfwear company. In other words, once a fashion brand becomes mainstream, it loses its cachundefined. "Cool" surfwear, by definition, cannot be purchased at Wal-Mart.

- What’s true of "extreme sports" fashion is also true of finance. "Big" is the death of investment performance. When stocks become a big national phenomenon, value has long since fled the marketplace. Popular stocks usually carry a big valuation, and paying a big price for a little bit of earnings is a hard way to make money (although it’s a very good way to lose money). That’s why a popular stock market is a very "uncool" stock market to own. Buying stocks when they’re out of favor – now THAT’S cool!

- From extreme sports to extreme real estate…San Francisco tops an ignominious list of "extreme" real estate markets, according to research and advisory firm, Property and Portfolio Research LLC. "An extreme office market is defined in this report as one where construction has ground to a near halt," the Wall Street Journal explains. "Construction of office buildings nationwide fell about 43% for the six months ended June, from a year earlier…But in tech-wrecked San Francisco, construction starts dropped a whopping 97%."

- Despite the construction bust, the vacancy rate in the Bay Area continues to soar. Here in Manhattan, the office property market is holding up somewhat better, but vacancy rates are rising nonetheless. The vacancy rate for prime Manhattan office space rose to 10.2% in July, according to Colliers ABR Inc., up from 6.2% one year earlier. In terrorist-stricken Lower Manhattan, the vacancy rate has soared to 14.7% in July from only 5.8% one year earlier.

- There’s no sign of a turnaround, yet. And there won’t be one until companies start hiring more folks than they’re firing. But weekly jobless claims spiked above 400,000 again last week, to the highest level in almost two months. The four-week-average of new claims rose for a third straight week to 392,750.

- "The rise in claims is in line with a survey showing the number of consumers who considered jobs hard to get this month was the highest in more than six years," Bloomberg News reports.

- Confirming the grim employment outlook, the Conference Board’s Help-Wanted Advertising Index dropped again in July.

- "The U.S. labor market is treading water," says Conference Board Economist Ken Goldstein. "With an economic recovery not yet strong enough to produce new jobs, businesses simply aren’t increasing their recruitment efforts."

- Is it any wonder that consumer confidence has plunged to its lowest levels since last November? Still, somehow, the determined American consumer finds a way to consume. The most popular means of consumption right now, of course, is to swap some of that "excess" home equity for a new car, a DVD player, a Stairmaster or whatever else consumers deem a necessity. We are smack in the middle of the fifth distinct mortgage-refinancing surge since 1997, and this current surge is by far the most spectacular. Refinancing activity is literally "soaring off the charts."

- Is this, too, a bubble about to burst?…"Yes," is the implicit answer from the home-building industry. "Executives across the US home-building industry have been selling shares in their companies at a record pace this year," the Financial Times reports, "Corporate officers and board members in publicly traded US building companies sold a record $258 million-worth of shares more than they bought in the second quarter…Of the 16 homebuilders with the largest market capitalization, seven had reduced their executive shareholdings by the largest amount seen in individual records going back two decades."

- So what’s driving this housing-bubble-cum-insider- selling-opportunity? The Financial Times provides a handy summary: "Home values may be increasingly fuelled by excess credit, a subsequent deterioration in lending standards and unsustainable expectations among prospective home buyers for more double-digit percentage gains."

- If it walks like a duck…

******

Back in Ouzilly…

*** Bloomberg reports that Alliance Capital, the 8th largest fund management company in the world, has managed to lose $7.9 billion of its clients’ money. How did it do it? It was easy; they simply turned the simplest investment rule on its head: buy high, sell low. While the smart money sells out, the dumb money rushes to take its place. For example, they bought Worldcom at $79 in November of 2000 and sold it a year later at 28 cents.

*** Despite the August rally, the Dow threatens to end down this month – for the 5th month in a row.

*** Meanwhile, the dollar is beginning to slip and the price of gold is moving up. Gold rose $3.50 yesterday.

*** All over the developed world, the zeitgeist seems be growing gloomy. Bloomberg tells us that the Swedes are feeling less confident. And the Poles are having trouble too, says the International Herald Tribune. Small businesses in Poland are going bust at an alarming rate.

*** Here in France, it is the children who are gloomiest. Long faces on short bodies tell the story: the summer is over. School starts up next week. All over the country, people are putting away the tennis rackets and warm clothes…packing up…closing shutters…and locking the doors of their country houses. Roads will be jammed this weekend – as the annual migration back to Paris begins.

*** "Are you looking forward to going back to school?" I asked Jules yesterday.

All I got in reply was a sour look.

*** More on the coming deflation, from my old friend, Rick Ackerman:

"I’ve been writing about deflation for ten years, but new manifestations of it continue to outpace my imagination. There’s the eerie rally in Treasurys, for instance – "eerie" because, as far as I can determine, there are no healthy coordinates for it in the U.S. economy. Granted, a related and seemingly positive development is that mortgage borrowers are able to reduce their monthly payments as rates in general fall. But this is not strengthening the economy; it is merely keeping it afloat – barely – to the extent that robust consumption levels can be temporarily sustained as U.S. incomes stagnate or fall. But what many observers seem to be overlooking is that consumers’ reduced borrowing costs come at the expense, in particular, of investors whose portfolios are loaded with mortgage-backed securities. They have been exchanging these securities for Treasurys by the truckload in recent weeks, since a new wave of mortgage refinancings threatens to devastate mortgage yields.

"The run on Treasurys is an unintended consequence of the Fed’s last-ditch effort to keep the housing boom alive. One could argue that lower rates all around have the potential to make everyone a winner, but this ignores a few disquieting facts. For one, there is the huge hit to savers and their institutional proxies who are weighted in mortgage-backed securities. For two, the unnaturally heavy skew of money toward housing is creating an asset bubble vastly larger in size, even, than the S&L bubble; and, three, all bets will lose if the dollar falls. On that last point we should wonder whether, merely by becoming unthinkable, so potentially catastrophic an event becomes inevitable."

Bush’s War originally appeared in the Daily Reckoning. The Daily Reckoning, published by Agora Financial provides over 400,000 global readers economic news, market analysis, and contrarian investment ideas.