Just Like In The Movies
“How can wealth actually be destroyed during a bubble?” asks Doug Noland. “Well, through massive overspending in projects of little economic value – either through over investment or malinvestment. ”
As I have observed with tedious regularity, no one can predict the future. But sometimes if you look hard enough at the present, the future seems to come into focus.
For example, there are occasional reports in the newspapers of people who do exceptionally dumb things. Every year, the “Darwin Awards,” for example, pay homage to these people – recognizing their selfless contributions towards cleansing the human gene pool.
One posthumous award recipient pulled the trigger on a handgun while simultaneously peaking down the barrel – in order to see what might be going wrong…another leaped from a tall building convinced that he could fly. In either case, you did not have to be a clairvoyant to guess what might happen next. All you needed was a rudimentary knowledge of physics…an awareness of gravity…and perhaps an appreciation of the law of perverse outcomes.
Likewise, guessing about what might happen next in the stock market and the economy may not require a glance into a crystal ball. A glance at what is happening now may be enough.
“Historic overspending in technology manufacturing capacity – from PCs, to routers, to semiconductor chips – has created a situation of debilitating over-capacity,” continues Mr. Noland. “And while the boom was fun and games while it lasted, now that enormous capacity has come on- line and growth has inevitably slowed, there is the sudden and harsh reality that there is too much competition and profits for no one. ”
Staring at the situation, as though down the barrel of a gun, the U.S. investor and consumer are looking at trouble. As reported above, financial debt increased from $3 trillion to $8 trillion from ’92 to present. Where did that money go? Did it get invested in new plant and equipment? In new, profitable businesses? In new activities that add to America’s wealth and quality of life?
Some of it did. But much – probably most – did not. Instead, consumers used debt to increase their standards of living beyond what they could afford from higher earnings. Businesses invested fortunes on mergers, stock buybacks, and Information Technology. Of the three, only the information technology has the potential to increase output – and the evidence suggests that it will not.
Even where investment was put to fairly direct expansion of existing successful business models – excess credit produces grotesque consequences.
“The U.S. movie cinema industry provides a much more straightforward example,” Noland explains. “For too many years, unlimited credit was available to many operators who, not surprisingly, were more than happy to take the money and build with reckless abandon in communities throughout the country. Think of this example: if a small community has, let’s say, two cinemas, then both will likely operate profitably and service the debt burdens from business cash flows. If, however, a speculative financing environment allows four new (megaplex) cinemas to be built, it is quite likely that not one of the six cinema operators will operate profitably. So, not only will the debt taken on to build the four new megaplexes be unserviceable, the ill-advised lending will also make the once sound debt of the original two operators unmanageable as well. The costs of credit excess are clear in this realistic example: wasted resources and problematic credit losses for the lending community.”
“In an unfortunate situation that is all too commonplace in our economy, the inevitable costs are now to be paid for what has been nothing short of an absolute lending fiasco in the movie cinema sector. Thus far, seven cinema companies have filed for bankruptcy – Carmike Cinemas, General Cinemas, United Artists, Edwards Cinemas, Silver Cinemas, Resort Cinemas and Mann Theaters. Regal Cinemas, the country’s largest operator, stated last week that it was considering filing for bankruptcy protection. Last month, the 3,000-screen Loews Cineplex announced, `if the company is unable to arrive at a longer-term plan to address its liquidity issue, it faces the prospect of a restructuring under bankruptcy proceedings.’ Loews is currently negotiating with bankers over a $1 billion loan due next week, attempting to forestall bankruptcy filings.”
We have no crystal ball. Nor even a ball of common glass. But it would not surprise us here at the Daily Reckoning if what was true in the movies was also true in many other parts of the economy.
The dot.coms are disappearing leaving barely a chemical trace of the billions of dollars spent. More than $3 trillion has already evaporated from the capital markets. Like morning dew, it has been taken up into the heavens and won’t be seen again until the next spin in the credit cycle rains down liquidity once again.
How soon will that be?
Wall Street will be unusually quiet tomorrow, as the Street turns its ear in Mr. Greenspan’s direction. If the economic news is bad – high unemployment, falling sales, fewer new homes – the Street will take it as good news, and count on the Fed chairman to his duty and cut rates.
But will lower interest rates fill the over-built cinemas… and send businesses and consumers scurrying to borrow, buy, and invest again?
More on this tomorrow – why Greenspan’s lower rates will not work…and why the falling U.S. dollar means The End of The World As We Have Known It.
Your humble correspondent,
Bill Bonner London, England December 4, 2000
P.S. In today’s Financial Times a headline informs us that the “Japanese Fail to Kick Start Economy.” For ten years, the Japanese have been trying `kick start’ their economy. If it were so easy to start the motor of economic expansion, you’d think they would have figured out how to do it in the country that produces so many millions of Hondas, Toyotas and Mitsubishis.
*** Friday was not a bad day for Wall Street. The Dow fell off a bit. Still, more than twice as many stocks rose as fell on the NYSE…and there were more highs than lows, 101 against 93. The Nasdaq even managed to rise a little – 47 points.
*** But November was the worst single month for the Nasdaq in 13 years. And last week alone took the index down nearly 9%.
*** For the year, the Nasdaq is down 35% – and it is almost 50% below its March high. Many Nasdaq stocks are down even more, of course, especially the dot.coms, which seem to be facing not merely a cyclical downturn in technology – but a mass extinction.
*** Since October 1st, 4th quarter earnings growth estimates for techs have fallen from 29% to 14%. Altera said it expects no growth.
*** The Dow, meanwhile, has held up reasonably well. It dropped less than 1% last week – and has lost only about 9% for the year.
*** Probably a better measure of what ordinary investors are experiencing is Investors Business Daily’s Mutual Fund Index. It’s off 17% for the year.
*** Hope springs eternal: The Nasdaq decline “does not come close to the ’29 crash,” notes a Reuters report, “which took stock down nearly 90% over a 3 year period.”
*** Of course, there’s nothing to stop the Nasdaq from falling for the next 3 years either. But investors have faith in the master magician of the Fed, Alan Greenspan. If unemployment numbers become significantly higher…and other signs point to a slowing economy…it is believed that the Fed will come to the rescue. Greenspan is scheduled to speak tomorrow.
*** But what can the Fed do? They can make more money available. Will that do the trick? Maybe not… more below…
*** “With over $80 trillion in derivatives out there,” says Gary North “and hot-shot managers who have never seen a major recession, the risk of collapse is there. In any case, all talk about `Dow 15,000,’ let alone 20,000+, is whistling in the dark. These whistlers did not tell investors to get out of the dot.coms last February or early March. They did not foresee a fall of 50% in the Nasdaq index. They do not foresee falls. They only foresee increases.” (see: The Return of the Politics of Plunder http://www.dailyreckoning.com/body_headline.cfm?id=804)
*** The American Association of Individual Investors’ has released a poll showing that investors are actually becoming more bullish – with 60% expecting rising prices…against only 17% bearish. Investor’s Intelligence reports that 55% of newsletter advisors are bullish while only 29% are bearish. And another Reuters reporter noticed that “there is a growing conviction that a bottom is not far away.”
*** But Big Bottoms don’t usually appear until people stop looking for them. Prices don’t stop falling, that is, until investors begin to think they will never stop falling. Just as the top arrived just at the time investors began to think that there was no limit to how high stocks might go, the Big Bottom will not make its appearance until investors begin to believe that there is no limit to how far they will fall.
*** “We don’t see the capitulation or the give-up that’s necessary to create a real bottom,” writes William Fleckenstein. “Believe me, after a rout like this, when it’s the bottom no one will know it for sure and folks will be scared to death – at least that’s what I’m expecting.”. (see: Are we there yet? Don’t bet on it. http://www.dailyreckoning.com/body_headline.cfm?id=802)
*** And before the Big Bottom arrives investors will shift from worrying about the return ON their money to the return OF their money. That’s right, we will have another Big B to endure first – Big Bankruptcies. Personal filings are expected to rise 15% per year. But that figure assumes the economy and the stock market do not get much worse. If stock prices and the economy continue to deteriorate – as I think they will – the number of bankruptcies could rise by more than 20%.
*** Junk bonds are going bad at a 5% rate already. 3.3% of syndicated loans are in trouble. According to Bloomberg, Janus is dropping $1 billion a day in assets. But there’s a lot more to come. Between ’92 and 2000, financial sector debt rose from $3 trillion to $8 trillion. How much of this debt was applied to profitable activity? How much of it will go bad? We will find out soon enough.
*** Ominously, as the amount of debt rose, so did foreign holdings of U.S. assets – rising from $3 trillion in ’92 to almost $7 trillion today. This figure didn’t matter as long as the dollar was rising and the U.S. was thought to have the `miracle’ economy.
*** But the euro rose for the fifth straight session on Friday. It began the week at 83.80 cents and ended it as 87.90 cents. The dollar, like tech stocks, has entered a cyclical bear market. This, dear reader, marks the end of the world as we have known it. About which…again, more below.
*** The Swiss franc rose 5% against the dollar last week.
*** Gold fell on Friday. So did oil. More signs of deflation…
*** From DR reader LA: “The Bible is way ahead of all of us. King Solomon says in Ecclesiastes 1:18, “For with much wisdom comes much sorrow; the MORE KNOWLEDGE, THE MORE GRIEF.” In the New Testament the Apostle Paul writes: “…We know that we all possess knowledge. KNOWLEDGE PUFFS UP, BUT LOVE BUILDS UP. The man who thinks that he knows something does not yet know as he ought to know…” (First Corinthians 8:1-2)
*** My daughter, Sophia, and I took the train last night from Paris to London. The train was packed. And London’s hotels are packed too. London is booming. Even late at night on a Sunday, Leicester Square is mobbed with people. They’ve even set up a few circus attractions – including a ride that looks lethal, called the Chaos. A notice warns that it is not for people with heart trouble. Sophia, of course, wanted to try it. I was happy to watch as the lights flashed and she whirled overhead.
*** I’m pleased to see that that staple of the British press – the Naughty Vicar – is back in the news. Page 5 of the The Times tells readers of the Rev. Carol Stone, formerly the Rev. Peter Stone, making a comeback to St. Philips Church in Swindon. This story edged out Gore’s election battle by 7 pages and includes a loud observation by one of the Rev. Stone’s parishioners. An elderly woman interrupted the service with this remark: “You are the work of the devil. Go to hell.”