Fair Warnings

One of the hazards of having the world’s most celebrated economy is that you will puff out your chest and pontificate. Economists, politicians and journalists – that is, people who had no hand in creating the wealth and no clue as to how the economy really works – find the bait irresistible.

Thus it is that Reuven Brenner, who “holds the Repap Chair of Business” at McGill University, put down his chair long enough to offer advice in the current issue of Forbes Global magazine.

What causes one country to prosper and another to flop around like a dying fish? “Contrary to popular belief,” Brenner advises, “democracy – that is giving the people the right to vote – does not by itself bring about prosperity. Mexicans have had the right to vote for seven decades, yet Mexico remains a poor country. Meanwhile, people in Hong Kong had no right to vote, yet that city has prospered.”

Nor is access to natural wealth the key to developing the unnatural kind. “In spite of their abundant natural riches,” he notices, “these countries [Mexico, Argentina, Venezuela, Brazil, Zaire, Romania…even Canada ‘in a sense’] either stayed poor or fell behind. At the same time, such crowded resource poor and disaster-rich places as Hong Kong, Singapore, South Korea, Taiwan, Japan, Israel and even Ireland have thrived…”

What burden is it that both Canada and Zaire carry – a burden so heavy that it prevents them from making economic progress? I am about to tell you, dear reader. But I do so only for the purpose of entertainment.

“Put simply,” says chairholder Brenner, promisingly, “prosperity is the consequence of one thing only: matching talent with capital and holding both sides accountable.”

Forget savings, forget hard work, entrepreneurial spirit, attitudes, customs, money supply, tax rates – just make sure that the risk-taker and the money- lender connect with one another, and you’re on your way to wealth.

How come entrepreneurs and capital providers don’t get together in poor countries? Well, says Professor Brenner, it’s because the powers-that-be don’t want them to do so.

“Making capital markets open to all diffuses power and threatens the privileges of ruling establishments.”

So now you know why sub-Saharan Africa lagged behind Europe in the Industrial Revolution. The Zulus and Hottentots refused to open their capital markets! And so did the Mayans, Iroquois, Canooks and Incans. The silly things. If only they had been able to stop sacrificing maidens long enough to allow people to securitize assets and derivativize investments.

And now we see their descendants making the same mistake – despite the fact that they have Professor Brenner telling them what to do.

So, let me get this straight, Professor. The Powhatan tribesmen, doing their toilette on the banks of the Potomac…and the Dayaks on the shores of the Straits of Singapore had the same problem: closed capital markets. Why were they closed? Because the chiefs wanted them closed – so they could protect their privileged positions.

But in Europe, capital markets were less closed, because…? At this point, the customary thing to say is that “In fairness, I have not read Professor Brenner’s book, only the article in Forbes…” But we rarely use the word ‘fairness’ here at the Daily Reckoning. We don’t use words such as ‘dyscrasia’ or ‘inosculate’ either, but only because we don’t know what they mean.

We know what ‘fairness’ means. We just don’t trust it. So let us try ‘ridicule.’

Certain groups do far better than others, even with the same access to capital markets. American Blacks, for example, seem unable to take full advantage of U.S. capital markets, while immigrants from East Asia and Jews do spectacularly well. In fact, some groups seem to do pretty well for themselves no matter where they find themselves – the overseas Chinese, for example.

Who knows, maybe Professor Brenner has answers to these questions.

But if the key to prosperity is merely open capital markets, what is the key to opening capital markets? Surely, European powers-that-used-to-be were no less desirous of protecting their status as the privileged elite on other continents. Surely they sat around too, and said to one another: ‘we have to keep these capital markets closed.’

And now we have the U.S. economy as the #1 example of what open capital markets can do for a country. Even after a $6 trillion setback – it is still the envy of the world.

So why not puff and blow about it?

“If the developed countries want to sustain and even increase the prosperity of the past two decades, while also helping the rest of the world to prosper, they must turn the new century into a financial one,” urges Brenner. “They must use their negotiating powers and impose narrowly defined mandates on the IMF and the World Bank. People should first be given a stake in their own society…”

I love the grandiose talk of presciptivist economists, don’t you? It is so quaintly dirigiste…so charmingly 20th century… “Give people a stake in their own society.” It sounds so good, so wholesome, so fair – but you can’t trust it. What could it possibly mean? Who could possibly give what to whom? According to Brenner, the reason people do not have open markets is because the powers-that-be don’t want them open. These same powers must be the ones who would do the giving, wouldn’t they?

The idea must be that under the cudgel of the World Bank or IMF, the elites will be forced to permit Merrill Lynch to sell junk bonds to Borneo savages. Won’t that get things moving!

Maybe it is a typo. Maybe he meant people should be given a ‘steak’ in their own society. Now there’s something that should appeal to the carnivores.

But the most remarkable thing about Professor Brenner’s hypothesis is the way he credits America with not only fairer and more efficient capital markets, but fairer hearts, too.

“From ancient times,” he remarks, “through a wide variety of regulations, rationalized by a wide variety of theories, those in power have maintained a stranglehold on capital markets.”

But somehow, the powers-that-are in the U.S. government, the World Bank and the IMF are supposed to be immune from the desire to protect themselves from competition.

“Let’s hope that the leaders of America will learn to leverage this strength,” Brenner concludes.

Perhaps it is a new world after all.

Writing to you from Paris, France, the City of Light…

Bill Bonner
Paris, France
April 11, 2001

*** The rally we’ve been expecting finally seems to be underway. The Dow rose 257 points; the Nasdaq jumped 108 points for a 6% rise.

*** The Dow is back over 10,000. Two times as many stocks rose on the NYSE as fell. AMZN floated above $12.

*** “Technology stocks climbed smartly,” says a New York Times report. May we suggest another adverb? How about ‘stupidly?’ Or ‘naively’…’foolishly’… ‘recklessly’…A lot of words come to mind to describe the rise in Techs yesterday, but ‘smartly’ is not among them.

*** “Fundamentally, most of these stocks have discounted the depth of the slowdown that we expect,” a fund manager told Reuters. “These stocks are beginning to stabilize.”

*** Stabilize? At 23 times earnings? A chart in Grant’s Interest Rate Observer provides a point of reference. The chart tracks the price-earning ratio of the S&P 500 from 1872 to the present. In the late 19th century, the ratio hit 25 – a high. Thence, it fell back down to the average – 14.5 – and kept falling until it at last hit bottom in the early 20th century at about 5.

Then, we see the line bounce up and down, finally hitting the 25 mark again – just before the ’29 crash. Again, it fell – this time to a low of about 7 in the ’40s. Then, in 1992, the S&P 500 P/E ratio hit the 25 mark again, but this time it did something it had never done before – after a brief dip, it rose even higher – reaching 35 in the late ’90s. The chart shows the average P/E today at 22.6…and apparently on the way down. Will it go all the way to 7 or even 5? I know you can do the math as easily as I, but this suggests a possible drop of 75% or so from current levels.

*** An essentialist investor, John Boland, is quoted in a recent issue of Grant’s. Boland, once a writer for Barron’s, settled in Baltimore and makes a living finding decent companies in distress. He is the general manager of Remnant Partners, LP, and estimates that 30% of his current holdings sell for less than the value of the current assets. Grant’s must have posed the question: ‘is it time to be a buyer?’ Boland’s answer:

“To get to a reasonable valuation level on the real companies that got over-inflated – never mind the ones that shouldn’t exist – you could still go down 75%.”

*** An article called Optimist’s Dilemma on page 60 of the May 2001 issue of Worth magazine names the following as “stocks to avoid”…









Probably good advice. But it would have been more useful a year ago.

*** “Bulls are bold because the market is in the eye of the storm,” writes Bill King this morning. “There are no impact economic releases for a while; earnings reports will soon commence; and observant operators note Greenspan has increased credit creation. It’s hard to stay short when M3 explodes a mind-numbing $65.9 billion in one week; and many believe the PCG bankruptcy is the denouement… coupled with Al’s even more aggressive credit creation, it’s a replay of the bailouts on the Asian Contagion, Russia, Mexico, etc.”

*** Trouble is, says King, Easy Al has been following the market. “Greenspan never contracted the money supply, or restrained credit like previous Fed-induced economic downturns for inventory/inflation. This downturn is due to over-investment, which is due to over-promiscuous credit creation. These downturns take much longer to correct than ‘inventory adjustments’.”

*** The quarter just ended saw $31.8 billion in corporate defaults – more than ever before. “Debt Default to Peak in 2002,” declares the headline in the Financial Times, referring to a Moody’s report.

*** My friend, John Mauldin, believes bonds may be the “heads I win, tails you lose” investment of the year. “If the economy goes into the tank,” he writes, “Greenspan will keep lowering rates and bring long term rates down with them, thus increasing the price of long-term bonds. If the economy recovers, surpluses are likely to be larger than forecast and therefore mean a reduction in the supply of bonds, forcing down rates and increasing the price of bonds.”

*** But bonds fell sharply yesterday. Yields on 10- year Treasury notes rose above 5%. Greenspan may be cutting rates, but Mr. Market seems to be headed in the opposite direction – increasing the cost of borrowed funds.

*** Not only is Mr. Greenspan unable to find the perfect fed funds rate…when he pushes in one direction, the market goes in another. Advice to Mr. Greenspan: announce that you have a rare disease and are forced to retire. Later on, you can announce that you are cured.

*** Sticking to the essentials here at the Daily Reckoning, we’re always on the lookout for inexpensive investments. The essential rule is ‘buy low, sell high.’ We have little control over the second half of the formula, but at least we can get the first half right. What’s cheap today? Well, the Chilean airline, Lan Chile, is selling for 7 times earnings. Other bargains in Latin America: Telephonos de Mexico at 9 times earnings, and the Brazilian bank, Unibanco, at 8 times earnings.

*** Gold is getting cheaper, too. It dropped a dollar yesterday. Is it cheap enough? I don’t know. “Gold is classically a hedge against inflation – and a protection against severe political upheaval,” observes the Fleet Street Letter’s Brian Durrant from our team in London. “But, it is not particularly well suited as a ‘safe haven’ in a recession where low inflation or falling prices are the norm.” (see: href=”http://www.dailyreckoning.com/body_headline.cfm?id=1077″>Shine OnYouBarbarous Relic)

*** “…even as the ‘new economy’ falters,” says an article in IHT, “the NUDE economy keeps going strong” (emphasis added)… “There are not many industries that can call themselves recession-proof, but pornography companies can make the argument more credibly than most.” According to the article, the number of visitors to pornography sites grew more than 27% from December 1999 to February 2001. In the same period, general retail sites grew less than half that rate. “And the adult-content companies have profit margins that their owners cheerfully acknowledge are obscene.”

*** Feeling guilty about turning up the thermostat? Thinking about moving to higher ground? Relax. Los Angeles Times reporter Robert Lee Holz: “Global warming is far from an established phenomenon. Ground-based and atmospheric measurements have yielded conflicting results. While Earth’s northern hemisphere has warmed about 2 degrees Fahrenheit since the Industrial Revolution began, there is equally compelling satellite data suggesting that the rest of the world is actually cooling.”

“The case is non-proven, as even a moderately close reading of the IPCC’s ‘Summary for Policy Makers’ makes clear,” adds journalist Alexander Cockburn.

*** I’ve come back to Paris. There are too many distractions out in the country. Mr. Deshais wanders around talking to himself. And Pierre was working down in the shop – making an iron gate. I went in and found him cranking on a noisy handle in front of an antique forge. Sweat dripping from his arms, he was pumping air into the coals – while holding a metal bar in the fire. When the metal turned white hot, he took it over the anvil and pounded it into a circular shape. It was a lot more fun watching Pierre than working on my laptop computer.