Clamor for a Cure
How the melody of commerce went out of tune…and the surest way to reinstate financial harmony.
In a truly free market, where business concerns are free to compete, replace, and improve each other, profits made by the foresighted and fortunate will, on balance, outweigh the losses made by the foolish and foredoomed. And so the seed corn for future progress is sown.
In such a market, the music of commerce would be harmonious and evenly paced, its dynamics restrained; there would be no swelling crescendo into a Boom, no cacophonous accelerando to its climax and no minor key diminuendo thereafter into a Bust.
But alas, such has not been the melody of Western economies. Once the government takes over from the free market as musical director – and certainly after it appoints the central bank to conduct the orchestra – things are never quite so euphonious.
Too many brass players are hired, while there are empty seats left in the woodwind section. The timpani play too fast, the strings too slowly. The piano fails to arrive in time for the performance, since the instrument maker has been too busy churning out penny whistles, and ultimately, what the band plays, the public no longer wants to hear – certainly not at the ticket prices being charged.
At last, then, the reaction sets in.
Economic Rationing: What Was Hidden Is Revealed
Investment projects are revealed as hopelessly optimistic, or simply wrongly conceived. Wages turn out to be too high for the ultimate value workers can generate. Certain vital inputs become too scarce and hence too costly to use to complete entrained production processes and to bring goods profitably to market.
Denied those current or prospective profits, capital investment dries up, unemployment rises and general business expenditures are reduced. Sub-marginal and overstretched businesses are squeezed…and previously hidden deceits and defalcations, cultivated amid that erosion of personal morality and professional integrity which always accompanies the fever of seemingly instant prosperity of inflation, are finally revealed.
At this point, the clamor goes up for a cure – a cry all the more plaintive because so many have been rudely disabused of the mirage to which they have succumbed.
Fearing for their jobs, seeing their pensions and college funds slashed in value as inflated asset prices come into closer coincidence with the much lesser real wealth to which these ultimately lay claim; feeling at first rueful, then vengeful, that they have been gullible enough to participate in the madness, people everywhere awaken to the shocking truth: the Boom has not enriched them, but impoverished them.
So, having imbibed too much at the previous night’s wild Bacchanalia, which prescription would most swiftly relieve the distress of our thunderous hangover?
Economic Rationing: Nothing, Nil, Nada
Actually, we need do nothing more than to follow the advice of the tactful, but mildly skeptical doctor, who tells us, "Take two aspirin and call me in the morning." We need no deficit spending, no unfinanced tax cuts, no protectionism, no lowered interest rates or expanded credit, no vendettas against short sellers or ‘speculators’, no extra unemployment benefits or increased minimum wages. Nothing. Nil. Nada.
True, if an earthquake in the unsound credit structure threatens to topple too many of our intrinsically insolvent banks at once – and so bury more innocents in the rubble than is necessary – emergency finance might be temporarily provided to the most urgent supplicants…but only at such a swinging cost that this particular avenue is unattractive to all but the truly desperate.
In fact, once this liquidity crisis abates, ’emergency finance’ must categorically not be perpetuated as a support mechanism for banks and companies among the living dead…no matter how illustrious their pedigree, or how many presidents, prime ministers, princes and pontiffs they have owned in the past.
Rather, we must hold unflinchingly to the practice of ‘financial selection.’ If the monetary value of our liabilities has grown disproportionately large in relation to the income and real assets underpinning them, it is much better, far more equitable, and vastly less threatening to liberty to bring the debts down to the assets through bankruptcy and write-downs…rather than artificially engineering the upward matching of assets to the debt through the insidious mechanism of inflation.
Further, if, as might well happen in the throes of the Boom, a nation has become drastically uncompetitive on the world stage, a one-off currency devaluation might just be seen as a more politically certain address than a protracted domestic deflation. But any resort to the lesser evil of devaluation should be sternly reinforced with credit restriction at home. Otherwise, the ‘need’ for it will surely recur, to the disruption of world trade and to the detriment of the international division of labor that so enriches world commerce.
Economic Rationing: Tighten Your Belts
Above all, recognizing that much capital has been lost and that our wealth has been greatly diminished, all sectors of society – householders, corporations and, above all, governments – should tighten their belts and attempt to live within their sadly reduced circumstances. Saving – not newly elevated spending – will be what ultimately rebuilds peoples’ fortunes. The sooner we grasp that there are no shortcuts by which penitents may recover the grace from which they have fallen, the more readily the right course of action will be followed.
After all, if Robinson Crusoe loses the roof off his hut and sees his maize crop flattened and his goat herds scattered by a passing hurricane, the last thing he should do is pour all his remaining food stock into his cooking pot, use what’s left of his thatch and his stockades to set a fire under it and sit back and smoke a pipe while his last great feast is simmering.
And yet, this is exactly what the powers-that-be are recommending to us today – in the vain hope that, once we Crusoe’s have consumed our goods and chattels and have expressed a wish to have some more, the necessary replacements will magically reappear. No, if Crusoe doesn’t want to starve, he needs to ration his residual provisions as closely as possible to see him through. In the meantime, he must set to work, with redoubled effort, in order to make repairs and to replenish what has been lost, paying particular attention to the timeliest possible replacement of his capital assets.
Make no mistake: what works for Crusoe on his island – and what doesn’t – will also hold true for us out in the big, scary global economy.
for the Daily Reckoning
October 28, 2003
Sean Corrigan, the Daily Reckoning’s "man- on-the-scene" in London’s financial district, is a graduate of Cambridge University and a veteran bond and derivatives trader. Corrigan is the founder of Capital Insight, a London-based consultancy firm which provides key technical analysis of stock, bond and commodities markets to major US, UK and European banks. He is also a co-manager of the Bermuda-based Edelweiss Fund.
A version of this essay was delivered as part of a speech before the Ludwig von Mises Institute last Thursday. During the conference, "War, Prosperity and Depression," the Honorable Ron Paul was given the Schlarbaum Prize in service of freedom. Sean has promised an eyewitness account.
We check the calendar. Is it 2003? Or 1999?
We ask because we have that same feeling of waiting for something to happen that we had 4 years ago. Then, as now, it was fairly clear that the trends currently in motion couldn’t last forever. But then, as now, they seemed to have been going on for so long that they had begun to look eternal.
Still, by mid-’99 most market indexes were topping out…and the price of gold bottomed at $292 per ounce. Since then, the price of gold has risen nearly a hundred dollars…while stocks fell, then bounced back approximately half way to where they had been.
The bigger trend, however, continued – American consumers kept going deeper and deeper into debt for the benefit of American policy makers and foreign industries. For what does it really accomplish when a man borrows against his house to buy a home entertainment system? The GDP goes up. Greenspan is relieved; maybe he will be able to hold off the day of reckoning until after he is out of office. Bush is hopeful; maybe he will be re-elected.
But it is the foreigners who actually benefit. The American borrows so that he may buy foreign-made goods; fifty cents of every dollar spent on manufactured items ends up overseas. Factories in China boom. Workers are hired overseas. New technologies are introduced in foreign nations. Pretty soon, the foreigners are no longer supplying cheap gee-gaws, but precision tools and high- technology products, rivaling…and surpassing…those of American manufacturers.
The foreigner is no fool. He then lends his profits back to Americans…so they can borrow and spend more.
Eventually, of course, the trend will come to an end. The dollar will fall and the foreigners will take a loss on their investments. But Americans will take the bigger loss; Asian companies will turn their backs on Americans and their dollars…and begin selling their wares to people with real money. Like the Spanish after the discovery of New World gold…Americans will fall into poverty, victims of their own good fortune.
What could have been more agreeable than having a printing press in your basement…and being able to print up dollar bills that the rest of the world accepted as though they were worth something? Who could have imagined that the Dollar Standard system would be the kiss of death to the U.S. economy and its martyred consumer?
We think we see the end coming…but what date the calendar shows when these things come to pass, we don’t know.
Over to Eric Fry with the latest market developments…
Eric Fry in New York…
– The urge to merge swept through Wall Street yesterday, as a flurry of billion-dollar mergers sparked a brief buying panic in the morning. But exuberance soon yielded to ennui, and the major averages finished the day with only slim gains. The Dow added 26 points to 9,608, while the Nasdaq climbed nearly 1% to 1,883. The dollar also gained slightly, while bonds and gold both dipped slightly.
– Bank of America led yesterday’s mega-merger parade – the busiest day for corporate acquisitions in almost four years – by agreeing to pay $47 billion for FleetBoston. Monday’s other multibillion-dollar deals included Anthem’s $16.4 billion bid for WellPoint Health Networks and UnitedHealth Group’s agreement to buy Mid Atlantic Medical Services for $2.95 billion.
– "The $156 billion of takeovers this month represents a 66 percent jump from September and is the most since July 2001, when acquisitions totaled $200 billion," Bloomberg News reports. And yesterday was the busiest day for mergers since January 17, 2000, the first business day after the epic bull market of the 1990s reached its peak. On January 14th, the DJIA topped out at 11,723.
– Will history repeat itself…or maybe rhyme just a bit?…Let’s take a look at some of the spooky anecdotal evidence.
– For starters, the FleetBoston takeover is the classic sort of overpriced, ego-driven, trophy acquisition that always seems to cap a bull market. As bull markets age, share prices soar, investors become increasingly exuberant, and American CEOs redouble their efforts to squander shareholder cash. This is simply the way the world works. We may not like it, but it is the natural financial order.
– One thing is certain: frenzied merger activity does not occur at the BEGINNING of a bull market rally. The FleetBoston takeover seems like a near-perfect bull-market- ender. The deal is big – it would create the nation’s second-largest bank, and it would be the largest takeover in any industry since Pfizer Inc.’s $64 billion purchase of Pharmacia Corp. in July 2002. It’s also very pricey: B of A’s purchase price represents a hefty 42% premium above Fleet’s share price prior to the deal, which is more than double the average of 16 percent for the 10 biggest bank deals since 1998, according to Bloomberg data.
– "They are overpaying for Fleet," one portfolio manager bluntly remarked to Bloomberg News. We suspect the portfolio manager is correct, even though we possess no particular insight about bank stocks or mergers. But we can plainly see that bank and brokerage stocks have been rallying briskly all year, and have continued sizzling throughout the summer and fall, despite the fact that interest rates are rising and mortgage refi activity is drying up.
– Countrywide Financial shares have more than doubled year- to-date, and have jumped 35% since interest rates bottomed on June 13th. Indeed, most major bank stocks have been advancing, even though rates are rising.
– Last time we checked, rising interest rates were not a good thing for finance companies. But investors aren’t worrying about such nettlesome details. They aren’t worrying about much of anything, except about being under- invested.
– "There’s never been such a long period of bullish sentiment readings," says your New York editor’s friend, Jay Shartsis. "We are getting accustomed to a fat contingent of bulls from Investors Intelligence every week. Last week was the 25th straight report of greater than 50% bulls from this venerable survey. Well, it turns out that never in the 40-year history of the survey has there ever been a string of 25 weeks of 50%-plus bulls.
– The extreme bullish readings are very bearish in Shartsis’ view, and points out that the Investors Intelligence survey is not the only sentiment survey producing extreme readings.
– "Barron’s sees five bulls for every bear, (which is a new record)," Shartsis notes. "The recent Barron’s Big Money poll reflected five times as many bulls as bears among their professional managers surveyed. The 64.6% bulls number broke the old record, according to market-timer Chris Cadbury."
– Mergers are on the rise and bulls are everywhere. Hmmmm…we may not yet be at the top of the current bull market, but we are far, far away from the bottom.
Bill Bonner back in Ouzilly…
*** Gold fell $1 yesterday…coming to rest at $388, far above our $370 target price.
*** A record 6.69 million houses were sold in September. The bubble continues!
*** The American consumer has nailed himself to a cross of debt, so that other people in other countries should have life…and have it more abundantly. We wrote that yesterday, but like it so much, we repeat it. The poor consumer…Greenspan, Bush, Bernanke and the lot have pressed down upon his brow a crown of prickly bills that he will wear for the rest of his life. His martyrdom will take the form of a lower standard of living…and a work life that may never end.
"Many people won’t retire because they haven’t saved enough," says a Houston Chronicle headline.
How could they save, when they were busy borrowing and spending to support foreign industries?
According to the Baltimore Sun, 29% of workers have not even begun to save.
And now comes the sad news from the Dallas Morning News: "Boomers may not get the inheritances they expect." Why not? Because the older generation has mortgaged and spent them on THEIR retirements.
*** "You mention CountryWide as a proxy for the U.S. mortgage market," writes colleague Dan Ferris, editor of Extreme Value. "You’re right to do so, as it accounts for about 13% of it. As CW goes, so goes the rest of the country’s mortgage sellers.
"Insiders dumped $19.3 million of CW in the third quarter, after dumping $40.9 mil in the second quarter. In early Sept., CW’s COO sold 91,000 shares and a senior managing director sold 113,000 shares. Sounds like management has some good inside info, except that it’s no secret that CW is hedging its bets.
"As a hedge against the refi bust, which by the way is here now, CW has bought a bank, a securities firm and two insurance companies. It expects big revenue from its loan portfolio, and it also thinks it’s going to sell adjustable rate mortgages when interest rates rise…to whom, I don’t know. Then again, their customers are probably the same people who’ve run consumer debt up over $1.7 trillion – no kidding.
"And hedge they must. CW’s mortgage pipeline fell 30% in Sept. to $54 billion, after dropping 17% in August. CW handed out 565 pink slips to unproductive mortgage production employees in August, and more in Sept., though I don’t have the latter number. This probably isn’t perceived as significant for a company with 35,700 employees.
"The Mortgage Bankers Association recently adjusted its forecast for mortgage originations downward to $1.5 trillion in 2004, from $1.9 tril. All of that $400 billion difference is refi that won’t be there. Nationwide, 2004 refinancings are now expected to be about $430 bil, versus the previous estimate of $830 bil.
"I don’t know about CountryWide’s future, but I wouldn’t bet on it with real money. It’s on the ugly side of a refi boom. All of its numbers look stellar, except for its debt- to-equity ratio of 5 and its negative $15 billion cash flow. With that kind of leverage, anybody can make big returns on equity, so I’m not really impressed. It sells for 7 times earnings…but its earnings, as you just noted, are through the roof. Trees don’t grow to the sky."
*** Now readers are really getting into the spirit of the thing. "Dear Mr. Bonner and Mr. Wiggin," writes Patrick Duley of Alexandria, Virginia, "Here is great idea for your readers to assist you in the marketing of Financial Reckoning Day – simply have each DR reader request that their local library order a copy! That’s what I did and as a result 8 copies were ordered by the Fairfax County Public Library as evidenced below:
Local Dewey call num ORDERED 0310
Personal Author BONNER, ORDERED.
Title Financial reckoning day.
Publication info John Wiley, 2003.
Physical descrip. 8 copies
General Note NF / I
Held by ZTECHOPS
"Sorry, I would not afford my own copy (so I indirectly ordered 8!)."
Addison’s mother is donating a copy to her local library in New Hampshire.
*** Another reader had a bit more seditious approach: "I visited my local Barnes and Noble brick and mortar store in Eau Claire, Wisconsin in search of your book, Financial Reckoning Day. "I began by scouring the new releases and best-seller sections, turning up only Bill O’Reilly and Dr. Phil. An inquiry at the Services desk led me to the second to the last row in the back of the store. On the bottom shelf in the business section there was one copy of your book. "In protest, I took your book to the front of the store and put it on the Best Seller table. Hope this helps," Dave Dejno Faithful DR reader
*** Bravo, Dave! Any other thoughts, suggestions or covert operations would be much appreciated. The book managed to land at #6 at bn.com, which includes brick and mortar Barnes & Noble store sales as well.