Imagination

“No one can draw more out of things, books included, than he already knows. A man has no ears for that to which experience has given him no access.”

Friedrich Nietzsche

So, where are we? Are the Internets really coming back? Should you prepare for a new boom? Or will things just drift along without much change?

No one knows. But it is the things you don’t expect that do you most damage. And what people least expect is what they cannot imagine.

We only know things by reference to experience, analogy and metaphor. But our experience with market conditions similar to those of today is limited, and largely historical.

Dr. Kurt Richebacher recently compared market conditions today with those of 62 years ago: In September 1929, the price-to-earnings ratio of listed corporate stock stood at 13.5. Sixty-two years later, this week, the S&P 500’s P/E is around 24. The Dow has a P/E of 29, and the Nasdaq’s P/E is still near 100.

Between 1925 and 1929, the money supply rose 10%. But during the last five year, to the end of 2000, M3 mushroomed 55%, or more than 5 times as much as the economy itself.

Dr. Richebacher reports that the U.S. added $500 billion to its GDP during the five years since 1995. But the volume of credit available to consumers and business rose $1.4 trillion in 1997, $2.1 trillion in ’98, $2.25 trillion in ’99, and an estimated $1.8 trillion in 2000.

And this credit explosion happened while savings were collapsing and the trade deficit was growing bigger than any trade deficit in the history of the world.

We know the ’29 crash and Great Depression only by reputation. Things were tough. But very few people now active in financial markets have had any direct experience with it. And we lack the imagination necessary to apply the information we have. Surely a credit bubble that is bigger than the ’29 bubble ought to produce at least as much debris when it finally explodes. But what sort? How? We cannot even imagine it.

Close your eyes and try to picture a financial calamity on a scale with the Great Depression. A quarter of all men without jobs…soup kitchens…10,000 banks close their doors. All that comes to my mind are black and white Depression-era photos. Well, it won’t be like that. People do not dress as well today. And they drive better cars. And banks can’t go bankrupt, or can they? But what difference would it make? No one has any money in banks anymore.

My own grandfather was wiped out when his bank in downtown Baltimore failed in 1931. I can’t imagine that happening to me. I put my money in mutual funds, stocks, real estate, and federally-insured CD’s!

I’m so much smarter than my grandfather. And the Fed is so much smarter than the Fed six decades ago. And the new Bush administration is so much smarter than the old Hoover gang. And investors are so much smarter, too. Rather than panic and sell out – they hold their stocks for the long term…and even buy the dips. Gosh…I can’t even imagine how dumb people were back then – as dumb as the Japanese since 1989. But I can’t imagine that either.

In fact, with today’s investors, today’s Fed, today’s enlightened economists, I can’t even imagine a financial catastrophe of any sort. Whatever else you can say about it, this time, it will be different.

But “every market will eventually find a reason to regress to the mean,” says veteran Merrill Lynch analyst Bob Farrell, interviewed in the L.A. Times. The stock market may be a wealth machine, but it is one that produces wealth, going all the way back to ’26, at the rate of about 11.3% per year. That number is fattened by the last 20 years stocks spent in the Wall Street feed lots. During that period – from ’82 to ’99 – the S&P 500 gained 19% per year, dividends included. In the more recent period – ’94 to ’99 – stocks did even better. The S&P 500 rose at 20% per year.

These recent figures distort the picture for stocks in the 20th century. Adjusting the numbers in various ways, Andrew Smithers and Stephen Wright, in their book “Valuing Wall Street”, estimated that the real return on stocks over the first 97 years of the 20th century was less than 5% annually.

Clearly, the performance of the period ’82 to ’99 was extraordinary.

“After 18 fat years with returns averaging 18% to 20%,” continued Bob Farrell, “we are likely to have a stretch of lean years with returns less than 10%.”

But that’s not what investors expect. A recent survey showed that investors expected to earn 11.8% on their stocks over the next 12 months. That’s much less than the 18% they expected a year ago…but still more than twice what Smithers and Wright consider the long term, real rate of return on stocks…and not nearly low enough to skim the grease off this blubbery market.

“The very quality that makes the stock market such a good place to invest most of the time,” I reprise a familiar Smithers and Wright passage, “means that it has to be a lousy place occasionally. One of these occasions is now.”

There have been other lousy periods. U.S. stocks rose 27% per year from June ’49 to April ’56. Then, for the next 6 years, investors got only 5.6% per year from their stocks.

In June ’62, a new bull market developed, giving investors 14.8% annual gains for the next 4 years. But the following dozen years were grim – with minus 4% gains each year.

Last year, for the first time since 1982, investors lost 9.1% on their S&P 500 stocks. Does this mark the beginning of a trend, or the end of one?

We will see, dear reader, we will see.

Your reporter,

Bill Bonner Paris, France January 16, 2001

The landing approach has begun. The flaps are down. A moderate slowdown has hit the U.S. economy. Investors are still optimistic. But consumer spending is way off.

Still…it seems that everyone believes that Alan Greenspan has engineered a soft landing for the formerly high-flying tech bubble. But according to one of the world’s leading economists, it’s worse than blind faith. It’s high-octane ‘new paradigm’ propaganda.

Here’s what you need to do – right now – to prepare yourself for:

The Coming Economic Crisis

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*** Wall Street was closed yesterday. So, maybe this is a good opportunity to take stock.

*** A Financial Times article outlines the articles of faith of New Economy believers: 1) the business cycle is dead; 2) capital markets now work in a new way; 3) current technological progress is unprecedented; 4) an information technology economy works differently from a machine-age economy.

*** So where does the New Economy stand? In just the last few months we have seen evidence that the business cycle is not dead…for we have entered a cyclical slump of unknown dimensions. Capital markets are bigger, and more global, than ever before. Developments in securitization and derivatization have served to amplify cyclical trends – but we still don’t know to what ultimate effect. The technological progress of the last 10 years was unique…but not unprecedented.

*** Any of the 5 decades before 1940 may have actually seen more revolutionary progress – with the advent of internal combustion engines, electricity, radio, automobiles, penicillin and so forth. And the info tech economy doesn’t seem to work any differently from any other economy. For all the blather about the value of information and knowledge – it turns out that neither are worth anything unless put to the service of an otherwise valuable, profitable undertaking. And then, what is needed is not abstract “information” or “knowledge” but very specific skills and know-how that can only be learned at great expense and considerable investment of time.

*** My friend, Brian Smith, reports – for example – that after numerous efforts he discovered that this intellectual capital was not sufficient to the task of “dry stacking” stonewalls in Western Virginia. Use cement, Brian, lots of cement.

*** Marc Andreessen, founder of Netscape, believes the U.S. is suffering from a “massive champagne hangover.” Interviewed by the Financial Times, Andreessen said “The era when everything will be free [on the Internet] is over.”

*** A year ago, Byron Wien, Morgan Stanley’s U.S. economic strategist, predicted “10 Surprises” for the year ahead. He was remarkably accurate – 7 came true, including a prediction that oil would go over $20 a barrel and that the Japanese stock market would fall below 15,000.

*** Now, Wien says he thinks the dollar will go up, not down, in 2001 – with the euro falling as low as 75 cents. Well, who knows?

*** Only three weeks ago, Merrill Lynch predicted 5% growth in S&P 500 earnings. Now, the forecast has fallen to zero – with declines of 3.4% in the first quarter of this year and a decline of 5.2% in the second quarter, compared to the year before.

*** Meanwhile, Richard Berner, chief U.S. economic strategist at Morgan Stanley Dean Witter, says that a recession has already begun. He believes the U.S. economy went into recession in the last quarter of last year.

*** And Robert J. Barbera, chief economist at Hoenig & Co. expects S&P profits to fall 7% to 10% in the first half of 2001.

*** A year ago, the AOL/Time Warner deal was worth $160 billion. Now, it’s worth only $105 billion. Still, that’s better than Yahoo! which lost 90% of its value in that same time.

*** A Salomon Smith Barney report shows Bank of America to be most exposed to bad loans. BOA could suffer $4.24 billion worth of defaults this year, says the report. Other banks with big loan default risks (in order): Bank One, J.P. Morgan Chase, First Union, Fleet Boston, Bank of New York, KeyCorp, Wachovia, U.S. Bancorp, Commercia.

*** But “there is cause for optimism,” said Harry Davis, a professor of the dismal science, “the Federal Reserve’s decision to cut interest rates earlier this month should make it easier for corporate borrowers to pay off their debts.” Is that so? See below…

*** While U.S. retail sales slumped in December, and U.S. automakers have trouble selling cars – even with zero percent financing – Germany, France and Italy enjoyed record sales during the holiday season. Royal Ahold, a huge Dutch retailer, said sales had jumped 50% over a year ago. And German automakers, Volkswagen, Porsche and BMW, report record sales and profits.

*** Europeans have very low debt levels and only 5% of their wealth in stocks, compared with a 25% exposure to stocks in the U.S. They are much less vulnerable to the negative wealth effect of falling stock prices and debt defaults. Euroland is expected to grow by 3.2% in 2001 – faster than the U.S.

*** Euroland – 15 countries…13 languages…one big happy family. One of the major achievements of the last half of the 20th century is that the European wars seem to have been put behind us. Now, tensions between European governments tend to be comic rather than tragic.

*** Even at the scout meeting in far Poitou, the organizers could not resist singing a song which must have been a relic of the 100 Years War. “Hooray for the King of France,” the scouts sang, in French of course, “and the King of England can drop dead!” The two English parents in the audience did not find it very funny.

*** And a little news on the tax front… “This week the OECD’s attack on tax havens suffered a major setback.” writes the Sovereign Society’s Bob Bauman, “As that notorious G-7 front group was forced to back down from its high handed demands at a meeting Barbados. OECD minions were forced to accept creation of new a joint task force including both OECD and tax haven nations, giving blacklisted nations ‘a seat at the table’ and a forum for their complaints and defense.”

*** “It does not surprise people when I tell them that the most important tax haven in the world is an island,” writes tax lawyer Marshall Langer. “They are surprised, however, when I tell them that the name of the island is Manhattan, in the United States. The world’s second most important tax haven is also located on an island. It is a city called London in the United Kingdom.”