Back To Japan

Are they digging the foundations of a recovery? Or
are they digging their own financial graves?

I refer to the people who are buying cars and
refinancing their homes. Auto sales hit a record in
October – thanks to zero interest financing. Household
mortgage credit jumped 11.4%.

“Lock me in” say homeowners, as 30-year mortgage
rates fell to 6.46%. Refinancings are running 40% ahead
of the level a year ago. The volume of business is so
heavy that the industry can barely keep up.

Two generations of Americans have dreamed of 6%
mortgages. When inflation rates were at 4% or 8%, a 6%
mortgage was a bargain. But what if inflation goes
negative? Who wants to be “locked in” to a mortgage at
6% when deflation is knocking prices down 2% per year?

While people were standing in line to get
mortgages at 6.46% yesterday, few noticed that the
Producer Price Index fell by 1.6% in October – the
biggest drop ever.

More widely reported was the fact that corporate
profits are also deflating – by 72% in the 3rd quarter,
compared to the same period a year ago.

Wall Street deflated a bit too, right Eric?

*****

Eric Fry in Manhattan…

– Fearing a fresh terrorist onslaught, investors dumped
stocks nearly from the opening bell.

– “Too fast!” exclaimed Options Underground’s Bryan
Botterelli, “In the morning we were trading solidly up,
which should have given us an hour or two before our
expected bottom move kicked in. Instead, we saw a
violent spasm downward, which cleared out the bears –
exactly as predicted – but in about five minutes instead
of two hours.”

– But then, the early news reports coming across the
wires indicated that the tragedy was an honest-to-
goodness accident – and not the work of al Queda. So
investors regained their nerve and resumed buying
overpriced stocks. The Dow recovered from a nearly 200-
point drop to finish the day 54 points lower at 9,554.
The Nasdaq recovered from negative territory to gain 12
points to 1,840.

– Put simply: Terrorist attacks are bearish.
Malfunctioning General Electric aircraft engines are
bullish. (See: Options Underground)

– Tourism stocks struggled all day, however. AMR,
American Airlines parent, led the airline sector lower –
no surprise there. But many hotel company shares dropped
even more than the airline stocks. Four Seasons, for
example, dropped 8%.

– Times were tough enough for the tourism industry, even
before yesterday’s plane crash. Nobody I know is
searching for additional reasons to avoid traveling.

– “At Club Med, the water is turning chilly,” the Wall
Street Journal reports. The global travel company is
shutting or mothballing several resorts from Tunisia to
Tahiti. All told, Club Med is taking 15 of its 120
resorts out of commission. The problem of course is soft
demand. I’m guessing that airplane crashes, whether
accidental or the work of terrorists, will not boost it.

– If it’s any comfort, Club Med has some illustrious
company. The Walt Disney Company announced a dispiriting
68% drop in earnings for its latest quarter. Worse,
nearly every facet of its business is suffering: theme
park attendance is down; hotel occupancy rates are soft;
and its ABC broadcast network’s fall season is suffering
from poor ratings.

– Disney’s core theme park operations are suffering an
especially severe slowdown. Recently, attendance at
Disney World in Florida has fallen 25% below last
year’s. Per capita spending is also lower. That’s not a
good combination.

– From the looks of things, many Americans now prefer to
“cocoon” in front of their TV sets and watch CNN, rather
than to fly to some far-flung vacation destination.
The stay-at-home trend, together with the rising
unemployment trend, together with cautious corporate
spending trend, all add up to falling demand for crude
oil. And as demand drops, so do prices.

– Crude oil fell almost one dollar per barrel yesterday
to $21.83. Heating oil, unleaded gasoline and natural
gas all suffered steep price declines as well.

– Oil and gasoline prices have been relatively cheap for
so many years now that most of us think very little
about where our next barrel is coming from. But maybe we
should. According to John Myers, of Outstanding
Investments fame, our oil supplies from the Middle East
are far less reliable than most folks have come to
believe. “Remember, beneath the Saudi desert sands lie
one-third of the world’s oil reserves,” says Myers.

– Unfortunately, the ruling royal family is in a very
precarious position. “They are walking a tightrope
between satisfying the United States and appeasing the
radical elements inside their country.” Myers fears that
growing Islamic extremism within Saudi Arabia
jeopardizes our access to the world’s most bountiful
supply of oil.

– “Nobody puts the words ‘oil’ and ‘national security’
together anymore,” writes the New York Observer’s Terry
Golway. “After all, Jimmy Carter tried that, and what do
we remember about Jimmy Carter? He was the guy who gave
a speech in a cardigan sweater.” Nevertheless, Golway
thinks it’s high time we begin preparing for the day
when we lose access to Saudi oil. The time has come, he
says, for Americans to forfeit “their inalienable right
to burn obscene amounts of gasoline.”

– Golway concludes: “There has been talk about the need
to empanel a new Manhattan Project to outthink and
destroy terrorism. Getting the country’s best scientists
together to replace the internal-combustion engine would
be just as important.”

-“Buy a small car if you like,” says Myers. “But I
suggest buying Canadian oil and gas stocks, along with
the occasional call option on crude oil.”

(see: Maniacs In The Desert)

*****

Back in Paris:

*** More deflation news from my friend, John Mauldin:

“So far this year, inflation at the wholesale level has
been declining at an annual rate of .8% (WSJ). The
Commerce Department said last week that its favored
measure of inflation – the price index for gross
domestic purchases, or prices paid by U.S. residents –
fell by 0.3% in the third quarter, a sharp reversal from
the 1.3% increase in the second quarter and the first
quarterly decline in 40 years.

“Bank loans are down. Many readers ask where is all the
money going that the Fed is creating? Part of the answer
is that banks are taking money out of the system. Growth
in commercial and industrial loans, which reflects bank
lending to small businesses, has contracted for the last
three consecutive months.

“Large firms, which issue ‘commercial paper’, have seen
these markets dry up, as non-financial commercial paper
(non-financial institutions like banks or insurance) is
down almost 40% if I read the chart correctly. Either
they can’t get the money or don’t want it. Either way,
that is neutralizing the money creation activity of the
Fed.

“That is deflationary, any way you read it. It is also
called pushing on a string.” (http://www.2000wave.com)

Many readers wrote last week to say they did not appreciate my analogies.

“Afghanistan is nothing like Vietnam,” said one. “The comparison is ridiculous.”

“You should stick to writing about economics,” advised another, “at least you seem to know something about finance. You know nothing about war.”

In deference to these readers, I return today to investment. In truth, I know no more about it than I do about war, but it seems to inspire fewer.

Besides, our money is at stake in the world of finance. War is merely a matter of life and death – with a little luck, someone else’s.

So, we take our leave of both Afghanistan and Vietnam…and run our little bark ashore – in Japan! “With each passing week,” begins a Wall Street Journal article, “the similarities increase. In the 1980s, Japan was considered the model capitalist economy; in the 1990s, the U.S. held that distinction. In both cases, the good times ended with the bursting of a stock market bubble, pricked, at least in part, by a nervous central bank. In both cases, predictions of a quick turnaround proved to be wrong.”

So often have we visited Japan in these letters that long-suffering Daily Reckoning readers are probably beginning to feel like frequent travelers. And the Japanese, accustomed to our visits, are beginning to check our visas carefully…wondering if it isn’t about time we have outworn our welcome.

But it is an analog world, not a digital one. We only understand what is going on in a new circumstance by comparing it to something familiar to us. And so we journey to Japan again, a country that is becoming as familiar as the kitchen sink.

“I don’t think it’s apt to make a comparison,” says U.S. Treasury Secretary Paul O’Neill.

The U.S. economy bears no resemblance to that of Japan 1990-2001…nor to itself 1930-1940. (Nor is the war in Afghanistan in any way comparable to Soviet’s effort in Afghanistan, say what could be a majority of Daily Reckoning readers…nor to the U.S. war in Vietnam.)

Why not? Because, in every respect, the outcome we can expect – say the bulls – will be better than any of the proffered examples. Let us hope so. But hope is no substitute for experience.

“They’re not an open economy,” says O’Neill of the Japanese, “One of the things that has really been beneficial to our economy is this openness and the challenge that we have permitted to come in here, from foreign suppliers from all over the world…”

Of course, no comparison is ever perfect. Every situation is different. The economy is always new. But the novelty of a situation is often less instructive than its essence – that is, the things that are not new about it. In the mid-80s Japan was enthusiastic about memory chips and automobiles. In the mid- and late-90s, it was the Internet and the telecosm that set American imaginations on fire. Japanese auto companies built 13.5 million units in 1990…a decade later, they are still below that level, at only 10 million units.

In North America, telecom companies spent billions of dollars to lay millions of miles of fiber-optic cable. “Build it and they will come” was the motto of the time.

Now it is built, but less than 3% is being used. Excess capacity, whether of chips or cable, tends to reduce prices.

Another distinction without a difference between Japan and the U.S. is the concentration of bad debt in the Japanese banking sector, for which no parallel is said to exist in America. Yet, for every dollar of bad business debt held by Japanese banks, there are probably at least one or two of bad business and consumer debt held by America’s innovative lenders.

The junk bond default rate just hit a 10-year high. American Express alone lost more than $1 billion on junk. Meanwhile, sub-prime lenders, such as Providian, are now demonstrating how hard it can be to collect a debt from a sub-prime borrower in a recession.

“The large amount of consumer debt outstanding in the U.S. is the ticking time bomb that could rival the bad loans dragging down Japanese banks,” notes a Wall Street Journal article. Unlike Japan, where the personal savings rate never fell below 12%, savings nearly disappeared in the U.S. in the late ’90s.

The illusion of wealth in Japan was gunned up by massive increases in the prices of real estate. In America, housing prices rose modestly, except in a few places such as Manhattan and Silicon Valley, where the increases were extravagant. But, in America, the illusion of wealth arrived daily in the stock price quotations. More people in America owned stocks, so that “the share of total household financial assets comprised by equities in the U.S. was 30.4%,” writes John Youngdahl, an economist at Goldman Sachs (in Grants Interest Rate Observer), “whereas in Japan this percentage stood at 16.5% in 1990 despite significant overvaluation in that market.”

The overvaluation of which Youngdahl speaks was about the same in the U.S. as in Japan. Stocks in the U.S. nearly tripled in the last 5 years of the ’90s. In Japan, they nearly tripled in the last five years of the ’80s.

While stocks rose at about 25% per year, business fixed- investment in both countries rose at less than half that rate…but still almost twice the rate of growth in private demand. In its essence, both countries were adding more capacity than consumers could use.

Each bubble subsequently burst, with each country’s’ stocks down about a third in the 18 months following the peak.

But Youngdahl, O’Neill and others focus on the response of politicians and central bankers. In the U.S., enlightened officials acted promptly. In Japan, they dithered.

The Fed has cut 4.5% from key rates in just 10 months. The Japanese central bank took 4-1/2 years to do the same work. Congress rushed out a plan to spend $100 billion to stimulate the economy. The Japanese Diet took longer.

Will the speed of U.S. official response be decisive? Can credit-fueled overcapacity be corrected faster by offering more credit, more cheaply, more quickly?

I don’t know. But we will soon find out.

Your editor, still trying to develop a taste for raw fish…

Bill Bonner
November 13, 2001

Are they digging the foundations of a recovery? Or are they digging their own financial graves?

I refer to the people who are buying cars and refinancing their homes. Auto sales hit a record in October – thanks to zero interest financing. Household mortgage credit jumped 11.4%.

“Lock me in” say homeowners, as 30-year mortgage rates fell to 6.46%. Refinancings are running 40% ahead of the level a year ago. The volume of business is so heavy that the industry can barely keep up.

Two generations of Americans have dreamed of 6% mortgages. When inflation rates were at 4% or 8%, a 6% mortgage was a bargain. But what if inflation goes negative? Who wants to be “locked in” to a mortgage at 6% when deflation is knocking prices down 2% per year?

While people were standing in line to get mortgages at 6.46% yesterday, few noticed that the Producer Price Index fell by 1.6% in October – the biggest drop ever.

More widely reported was the fact that corporate profits are also deflating – by 72% in the 3rd quarter,compared to the same period a year ago.

Wall Street deflated a bit too, right Eric?

*****

Eric Fry in Manhattan…

– Fearing a fresh terrorist onslaught, investors dumped stocks nearly from the opening bell.

– “Too fast!” exclaimed Options Underground’s Bryan Botterelli, “In the morning we were trading solidly up, which should have given us an hour or two before our expected bottom move kicked in. Instead, we saw a violent spasm downward, which cleared out the bears – exactly as predicted – but in about five minutes instead of two hours.”

– But then, the early news reports coming across the wires indicated that the tragedy was an honest-to- goodness accident – and not the work of al Queda. So investors regained their nerve and resumed buying overpriced stocks. The Dow recovered from a nearly 200- point drop to finish the day 54 points lower at 9,554. The Nasdaq recovered from negative territory to gain 12 points to 1,840.

– Put simply: Terrorist attacks are bearish. Malfunctioning General Electric aircraft engines are bullish.

– Tourism stocks struggled all day, however. AMR, American Airlines parent, led the airline sector lower – no surprise there. But many hotel company shares dropped even more than the airline stocks. Four Seasons, for example, dropped 8%.

– Times were tough enough for the tourism industry, even before yesterday’s plane crash. Nobody I know is searching for additional reasons to avoid traveling.

– “At Club Med, the water is turning chilly,” the Wall Street Journal reports. The global travel company is shutting or mothballing several resorts from Tunisia to Tahiti. All told, Club Med is taking 15 of its 120 resorts out of commission. The problem of course is soft demand. I’m guessing that airplane crashes, whether accidental or the work of terrorists, will not boost it.

– If it’s any comfort, Club Med has some illustrious company. The Walt Disney Company announced a dispiriting 68% drop in earnings for its latest quarter. Worse, nearly every facet of its business is suffering: theme park attendance is down; hotel occupancy rates are soft; and its ABC broadcast network’s fall season is suffering from poor ratings.

– Disney’s core theme park operations are suffering an especially severe slowdown. Recently, attendance at Disney World in Florida has fallen 25% below last year’s. Per capita spending is also lower. That’s not a good combination.

– From the looks of things, many Americans now prefer to “cocoon” in front of their TV sets and watch CNN, rather than to fly to some far-flung vacation destination. The stay-at-home trend, together with the rising unemployment trend, together with cautious corporate spending trend, all add up to falling demand for crude oil. And as demand drops, so do prices.

– Crude oil fell almost one dollar per barrel yesterday to $21.83. Heating oil, unleaded gasoline and natural gas all suffered steep price declines as well.

– Oil and gasoline prices have been relatively cheap for so many years now that most of us think very little about where our next barrel is coming from. But maybe we should. According to John Myers, of Outstanding Investments fame, our oil supplies from the Middle East are far less reliable than most folks have come to believe. “Remember, beneath the Saudi desert sands lie one-third of the world’s oil reserves,” says Myers.

– Unfortunately, the ruling royal family is in a very precarious position. “They are walking a tightrope between satisfying the United States and appeasing the radical elements inside their country.” Myers fears that growing Islamic extremism within Saudi Arabia jeopardizes our access to the world’s most bountiful supply of oil.

– “Nobody puts the words ‘oil’ and ‘national security’ together anymore,” writes the New York Observer’s Terry Golway. “After all, Jimmy Carter tried that, and what do we remember about Jimmy Carter? He was the guy who gave a speech in a cardigan sweater.” Nevertheless, Golway thinks it’s high time we begin preparing for the day when we lose access to Saudi oil. The time has come, he says, for Americans to forfeit “their inalienable right to burn obscene amounts of gasoline.”

– Golway concludes: “There has been talk about the need to empanel a new Manhattan Project to outthink and destroy terrorism. Getting the country’s best scientists together to replace the internal-combustion engine would be just as important.”

-“Buy a small car if you like,” says Myers. “But I suggest buying Canadian oil and gas stocks, along with the occasional call option on crude oil.”

*****

Back in Paris:

*** More deflation news from my friend, John Mauldin:

“So far this year, inflation at the wholesale level has been declining at an annual rate of .8% (WSJ). The Commerce Department said last week that its favored measure of inflation – the price index for gross domestic purchases, or prices paid by U.S. residents – fell by 0.3% in the third quarter, a sharp reversal from the 1.3% increase in the second quarter and the first quarterly decline in 40 years.

“Bank loans are down. Many readers ask where is all the money going that the Fed is creating? Part of the answer is that banks are taking money out of the system. Growth in commercial and industrial loans, which reflects bank lending to small businesses, has contracted for the last three consecutive months.

“Large firms, which issue ‘commercial paper’, have seen these markets dry up, as non-financial commercial paper (non-financial institutions like banks or insurance) is down almost 40% if I read the chart correctly. Either they can’t get the money or don’t want it. Either way, that is neutralizing the money creation activity of the Fed.

“That is deflationary, any way you read it. It is also called pushing on a string.” (http://www.2000wave.com)