I, Greenspan... Part One
“The primary mission of Fed policy this spring,” says a column in the Financial Times, “is to prevent the capital spending slump from having serious spillover effects on personal consumption through job losses and wealth destruction in the equity market.”
The world’s financial press has realized what you and I saw months ago (thanks to Dr. Kurt Richebacher): This is no ordinary inventory correction. It is more like the busts of the 19th century…or maybe even the period leading up to the Great Depression of the 1930s. It is caused by a collapse of capital spending and cannot be readily reversed by interest rate cuts…
“The severe and protracted recessions that regularly defy monetary easing for a prolonged period,” observes Dr. Richebacher, “are invariably the upshot of a prior, pervasive ‘bubble economy’ – the age-old phenomenon in which soaring asset prices stoke borrowing and spending binges in investment and consumption that burst once asset prices decline.
“It has been labeled a ‘post-bubble recession,’ in contrast to the garden variety inventory recession. The distinction is vital. There is no question that the current U.S. economic downturn belongs to the ‘post-bubble’ type. Measured by the phenomenal extent of the prior borrowing and spending excesses, it has been the greatest bubble in history.”
The type of downturn we are looking at, Dr. Richebacher explains, is “by nature akin to the U.S. Depression of the 1930s and Japan’s current prolonged recession…the official data do not allow any doubt that the present U.S. downturn belongs to the latter, very dangerous type.”
Spending on new technology soared in the last half of the last decade of the last century. At the beginning of the decade, each year saw about only about $3 billion per year of tech IPOs. But by the end of the ten years, this number had increased 1200%. Both individuals and businesses were sure that the new technology would pay off big.
This was not a new phenomenon. It happened several times in the 19th century – when investors became excited about the possibilities offered by the railroads and the industrial revolution. Then, again, in the late 1920s, it was electrical appliances and automobiles that caught investors’ fancy. In both cases, the technology proved hugely successful, but it took years of booms and busts in the capital markets before accounts were settled and investors (or, often, their heirs) finally got what they deserved.
Markets eventually sort things out. In the free give and take of the marketplace, people get, more or less, what they’ve got coming. Fear, greed, stupidity, patience, self- discipline, hard work, independent thinking – human strengths and weaknesses are rewarded or punished as the case may be. And if the results seem unfair, who are we to argue with them?
But the world of politics is different. The operating principle is different – free give and take is replaced with assault and battery. And the results are different too. Nothing quite works out as promised…and almost no one gets what he deserves. Scalawags and mountebanks get public adulation, while honest citizens are robbed, bossed around, and from time to time, killed.
Governments promise voters the sun, the moon and the stars – that is, things that are out of reach…such as gain without pain…progress without savings…boom without bust. What they actually deliver up is something different. For even they are subject to the laws of nature…and nature always gets her price. (More about this tomorrow…)
But today’s letter is not written to complain about politics. Instead, it merely offers a modest prediction: the sun, moon and stars will stay where they are. Even the most revered bureaucrat since Dwight Eisenhower will not be able to lure them from the heavens.
Have the tech investors of ’98 – ’01 gotten what they deserve? Certainly, some have. Investors in the dot.com sector have been nearly wiped out. For example, anyone foolish enough to invest in Microstrategy, the “data mining” firm, near its peak, now has little more than a hole in the ground. The stock traded above $300 a share for a brief period.
Today, shares are approaching zero.
But most investors seem to be in relatively good shape. The stock market, worth 180% of GDP at its peak, is still worth 140% of GDP – far above its long term average. The Dow remains only a few hundred points below an all-time high. Dow investors have, so far, enjoyed nearly two decades of gain, with very little pain. Until recently, they have realized annual profit growth of 18% per year…a level more than twice the average. And the ‘greatest bubble in history’ has, so far, been followed by one of the least impressive economic downturns.
Is that all there is?
Investors hope so. And they are pinning their hopes on Alan Greenspan. Armed with the powers given to him by the Federal government, Greenspan – it is hoped – will make sure investors never get what they’ve got coming… Using some magic that has yet to be explained, he is supposed to guarantee that their return on investment will remain far above what markets typically allow, not just for 20 years, but forever.
While capital spending has collapsed, consumer spending has fallen off gently. “In light of the relentless carnage in the stock market and virtual stagnation in real disposable personal income, consumer spending has held up amazingly well,” reports Dr. Richebacher. “A resilient consumer is the great hope of those who are still venturing that a U.S. recession may be avoided.”
Two-thirds of the economy is consumer spending. To succeed, Mr. Greenspan must prevent the illness in the capital spending from infecting the consumer. Can he?
May 28, 2001
Your man on the scene in sunny Paris…across from the Le Paradis cafe…where you always get what you deserve…even if you didn’t order it.
To remind you, this section of the Daily Reckoning is written by Eric Fry, editor of Grantsinvestor.com. Eric will also be the guest host on CNN-FN next week, 9:30 – 11 E.S.T. My notes and letter follow, as usual.
*** The promising economic shoots of the last few weeks now find themselves surrounded by the tares of a stubborn slowdown.
*** Weekly jobless claims jumped back above the 400,000 mark, new home sales fell for the first time in three months, factory orders declined 5% and orders for semiconductors dropped an astonishing 31%.
*** Capping off the week’s news, the government ratcheted down its first-quarter GDP estimate from 2% growth to a more-subdued 1.2%. In short, the US economy seems unlikely to produce the kind of earnings growth that Wall Street of late has begun to expect.
*** Maybe that’s why the stock market sagged a bit last week. The Dow lost 117 points on Friday and 296 points for the week. This may be the year to follow the old adage: “sell in May, go away.”
*** The hottest American export these days seems to be recession. Last week, the German Ifo business sentiment index fell to its lowest level in two years. “The news will heighten concern that the German economy is being affected by the US slowdown,” the Financial Times surmised.
*** Not even a dismal US GDP report or a sell off on Wall Street seems to help the beleaguered euro these days. Europe’s currency-by-committee fell -2.5% against the dollar last week amid reports of slowing German and French economic growth. The euro plunged to new lows for the year against all major currencies and trades very close to its all-time lows.
*** The euro is fast becoming the Chicago Cubs of currencies – often in the news, but never in the World Series. It’s a dollar dynasty in this league, and everybody seems to want greenbacks.
*** The US dollar is another hot export. We can’t seem to print greenbacks fast enough to meet demand. Other countries send us stuff to buy – wicker chairs, pinatas, Land Rovers and the like – we send them dollar bills. Before you know it, we’ve got a record trade deficit. A large and growing trade deficit, like a large and growing tree, is not the kind of thing that seems to bother too many people…unless it falls on their house. Why should the trade deficit bother anybody? It’s been putting down roots and growing at a healthy clip for many years, and still, the sun rises and sets every day on a prosperous nation.
The deficit is no problem, of course, as long as foreigners are happy to trade the stuff that they’ve got for the currency that we’ve got. If they change their minds, the dollar falls, probably the stock market falls and a Parisian vacation becomes tres cher. Don’t lose any sleep over it, folks, but pay attention.
And a few notes from Bill:
*** Not only is the euro down, so is the dollar’s other major competitor – gold. The yellow metal gave up $8 last week. Gold stocks declined an average of 8%.
*** But TIPS (inflation adjusted treasury notes) are doing well. They’ve returned 6% so far this year.
*** Can the dollar stay up forever? Or will it fall up to 30% as I [continue to] predict? I don’t know, dear reader, but it would be a good idea to have some insurance – just in case.
*** “I’d like to see a copy of your son’s senior thesis,” wrote a DeaR reader. “I want to see what you got for your $100,000.” I have not read Will’s paper, but I suspect that investing in education is no different from other investments. You begin with money and no knowledge. You end up with knowledge and no money.
*** It was a warm, sunny weekend out at Ouzilly. Taking a stroll around the pond, we enjoyed the sweet perfume of chestnut and locust trees in full bloom. But along the shore of the pond we counted at least 20 dead fish. A heron is apparently diving in the water and killing them…only to discover that they are too big to carry off.