Money Matters that Matter to Money
The Daily Reckoning PRESENTS: As yesterday’s events show, money is like a perpetual child. It needs to be cared for and worried about; otherwise it can get out of control. This week, Bill Bonner reminds us of a time when people still worried about things like trade deficits and money supplies, and how a current carefree attitude toward these things might lead to our downfall. Read on…
MONEY MATTERS THAT MATTER TO MONEY
From care-worn, to carefree, to careless…sic transit gloria money.
With spring right around the corner, we’ve been in as dewy-eyed and sentimental a state of mind as we ever get these days.
We remembered happier times – when we walked arm-in-arm along the banks of the Thames, when a pound and a dollar were almost the same price, and when we could buy shares at five times earnings.
We were younger then, but far from carefree. In fact, a young man frets a lot more than an older one. He has more to fret about. As a man ages, he realizes that the fretting is largely a waste of time; that most things don’t really matter…and that he can’t do much about those that do matter, anyway.
But money is a special case. As the years go by, most of the cares people once had about financial matters cease to matter to them. Then, all of a sudden, they start to matter again.
In the early 1980s, you could buy a nice apartment in central London for $200,000. That’s dollars, dear reader – American dollars! That was before the dollar headed down against sterling…and before London property took flight.
When the dollar fell after 1985, investors were alarmed…then resigned. After the initial panic at the falling greenback, Americans got used to it. Now, with the dollar worth only about half as many pounds as it was a quarter of a century ago, no one worries about it. It doesn’t seem to matter.
But mattering matters. Worrying is under-valued.
On Monday of this week came news that the U.S. trade deficit hit a new record last year – $763.6 billion. But did it matter? It didn’t seem to. People have become accustomed to record trade deficits. Each year brings another one, like a new calendar. Nobody thinks anything of it.
It used to be that the trade deficit numbers would set off alarms – like the buildup of carbon monoxide in a mine shaft. Investors would have heard the whistle and rushed up for fresh air. They would have sold off the high-deficit currency in favor of one that was safer, the one with a trade surplus. The result? The trade imbalance would right itself automatically. But now, people pay no attention. All the carbon monoxide in the air simply makes them drowsy. And the deficits keep mounting up.
But the less we care about things, the more we will eventually have to care about. Had investors panicked on news of last year’s trade deficit, they wouldn’t have so much to panic about this year. Today, the trade deficit is $47 billion higher. And still they don’t panic.
Among the many panic-free things are the money supply figures. A little blip up used to send the bond market into fits of hysteria. Investors (the so-called ‘bond vigilantes’) would dump their bonds, sending yields upwards. Higher yields chilled economic activity, which had the effect of reducing both money supply increases and consumer price inflation. Problem solved.
But who pays any attention to money supply numbers any more? No one. They’re as irrelevant as a monk at a mobster’s convention. But simply because they don’t seem to matter anymore, they matter more than ever. All over the world, the traditional measures of money are increasing two to three times faster than the economies they feed. New forms of money – supplied by the financial intermediaries – are increasing even faster. All this unchecked new money makes each unit of old money just a little shakier.
Take family finances, for instance. We learned recently that the average person in Britain had debt equal to 1.4 times his income – or a total of 1.3 trillion pounds worth. Last year, there were 17,000 repossessions in the country…and currently 400 people go broke every day. One estimate told us that more than half the nation would be out of cash less than three weeks after losing a job. These figures are even worse in America, where private debt to private income just reached a new record high of 1.75 times.
It wasn’t always so. As recently as the 1980s, people still cared about how much debt they carried. As the bills mounted up, bill-payers reacted. They cut back spending and increased savings. As if by magic, the problem corrected itself. Less spending led to less debt.
What people took for absurd in a more levelheaded era, they now take for assured. They go from being care-worn, to being carefree, to becoming careless. Last week, we reported on the latest U.S. government budget. We remember when Republican politicians could hardly show their mugs in public after allowing a budget deficit. They felt personally responsible for it. They looked upon it as a stain on the national credit record…a blemish on the nation’s escutcheon. Deficits were a burden on the taxpayers…a threat to the dollar.
Now, a Republican president proposes the most insouciant spending in history and who objects? ‘Deficits don’t matter,’ is the accepted math. You might as well howl up a rainspout in Azerbaijan as deny that solemn truth.
In the old days, when deficits still mattered, the old knees jerked up against them. Senators railed. Congressmen ranted. Every dime of deficit spending was yielded up as if it were a foot of no-man’s land; every conservative imagined himself Petain holding Verdun against the Huns. And as long as they still had a little deficit-fighting fire in their bellies, deficits weren’t allowed to sprout, let alone grow.
People used to worry about paying too much for stocks, too. A quarter century ago, you could have bought almost any stock listed in New York or London for less than 10 times earnings. Now, you struggle to find one that is less than 20 times earnings. When the price of shares still mattered, investors bucked and bridled as shares rose. They had seen what had happened to stocks in the 1970s. They didn’t want to be saddled with over-priced shares again. But the longer shares rose without serious interruption, the less high prices bothered them. They stopped thinking that stocks might fall; instead, they couldn’t stop thinking about how much they would rise. And now there’s only more to think about. The Dow represents much more capital at 12,000 than it did at 1,200.
We see the same spirit in the property market. Just this week, the Gherkin Building – a landmark architectural masterpiece, shaped like a bullet – set a new record for London, selling for $1.2 billion.
As recently as seven years ago, people still bought REIT’s for yield. Sam Zell’s empire, Equity Office Properties, for example, sold at only half its current price. At that price, investors could get a yield over 7%. But in the great real estate boom of the 2000-2007 period, even a 7% yield began to seem paltry. Property itself was going up by 20% per year…even more in many areas. London and New York – the two big rock candy mountains of the financial industry – hit record after record.
As prices rose, worries receded. People do not pay to worry. And if they’re going to worry they’re not going to pay. Just look at the prices; property investors must be more carefree than ever.
EOP enjoyed a net operating income of $2.04 billion in 2006. If the final deal cost Blackstone $40 billion, the ‘cap rate’ of the business would be very near to 5% – or the equivalent of 20 times earnings. But however good it is in 2007, it was twice as good in 2000. EOP was twice as expensive in ’07 as it was in ’00. Its yield today is barely a third of what it was back then.
If investors still fretted, they’d worry that paying twice as much would cut the returns in half. Or worse. Then again, if they still fretted…they never would have done the deal; and they wouldn’t have so much more to fret about in the future.
The Daily Reckoning
February 28, 2007
Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).
In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount – just click on the link below:
Our ‘Crash Alert’ flag is still fluttering outside.
You’ll recall that it was hoisted up there about three months ago. For a long time, it looked silly. Who needs a ‘Crash Alert’ when the world is booming?
But just yesterday, as we were writing about the threat posed by collapsing Chinese stock prices, it turned out that Chinese stock prices were…in the process of collapsing. Some stocks were down to the limit in Shanghai and Shenzhen. The markets ended the day down almost 10% – the biggest drop in 10 years.
Other emerging markets fell too, emulating the Chinese example. And then, when the tsunami got to New York, U.S. stocks were soaked too. The Dow was down more than 500 points at one time during the trading day – the biggest hit since 9/11.
And look at what is happening to the financial stocks. Yes, even Goldman seems to have topped out – a company run by the smartest financiers in the business…perched on the biggest financial bubble of all time.
Does this mean the Chinese bubble is finally popping? And if so, does that mean that the whole enchilada…the whole worldwide liquidity bubble…is finally going to blow up?
We’ll have to wait and see.
But we remind readers that the many lurking threats to their money are not all equal: Some are unpredictable…and others are unavoidable. Among those that are unforeseeable are war and natural disasters. Among those that are ineluctable are the popping of the credit bubble…and the destruction of the U.S. dollar.
The first challenge for investors is merely to recognize the difference, for different sorts of threats require different responses. The second challenge for investors is to recognize the different ways the market can do damage to them: While they might lose a lot of money ignoring inevitable threats…they could also lose a lot of money chasing inevitable opportunities.
On the good side, when you speculate on the inevitable, at least you are on the right side of the trade. But, on the bad side, whether you make money or lose will depend on your timing. “The market can stay irrational longer than you can stay solvent,” said Lord Keynes. So, sometimes, it is better not to try to trade a trend – even if it is inevitable. Just get in position so it won’t do you any harm. You may not get rich, but you’ll still be better off than most investors.
On the other hand, there are some who say you should just ignore inevitable threats in order to take advantage of the inevitable opportunities that usually go along with them.
“Yes, I agree, the Chinese market is going to take a tumble. It’s inevitable,” said our friend last weekend. “But over the long term – and I’m talking about 10 years or more – China is going to boom. I want to be a part of that boom. I want to be in it. So, I’m willing to take some discomfort in the short term in order to participate in the longer-term gains.”
We think our friend is an optimist. By way of rebutting him, we call two witnesses. Our first is the Ghost of ’29. No economy was more successful in the 20th century than the United States. And never was it more successful than in the ’20s. America…and America alone…emerged from World War I as the clear winner. The rest of the world owed it money. Its industries were booming. Its stocks were soaring. Its young and inventive hard-working people were creating new technologies and building new factories and skyscrapers. Europeans returned from visits to New York in the ’20s like Americans now return from Shanghai. The pace…the excitement…the commercial activity…the liveliness…the energy – it was overwhelming. They could scarcely believe their eyes. Many wanted a piece of it.
Over the long run, a European investing on Wall Street might do fairly well. But what if he had invested in the late ’20s, when America’s promise and success seemed most inevitable? Just ask the Ghost of ’29. If he had invested his money just before the crash, he would have had to wait until ’56 to break even! That is, he would have had to hold on through a Great Depression…another major world war…and practically until the end of the Eisenhower administration – a period of 27 years! After that, he would have enjoyed a good 10 years of capital growth – and then another setback.
Our other witness is still living; he can speak for himself:
We started by asking him, “Isn’t it true that Japan was the greatest success story of the post-war period?”
“Yes…I believe that is correct.”
“Isn’t it also true that the Japanese made their money by selling goods and services to Americans? Isn’t it true that they realized huge foreign trade surpluses in this manner – similar to what the Chinese are doing now? And didn’t they build up huge foreign currency reserves? And didn’t the Japanese economy boom…especially after the Louvre agreement, when they tried to keep their currency low by reducing interest rates and increasing liquidity – very similar to the Chinese example now, in fact? And weren’t investors so excited by the prospect of getting rich in Japanese stocks – and I think this includes you – that they rushed into the Tokyo market? And didn’t Japanese stocks and real estate reach an epic, zany high in January of 1989?”
“Yes, all that is true.”
“Then would you mind telling us, in your own words, what happened after you bought Japanese stocks in January of 1989?”
“Not at all. It is very simple. The Nikkei index was over 39,000 when I bought. Shortly thereafter it crashed. I didn’t worry about it, because I was investing for the long term. And over the long term I believed Japan would do well. It was, well, inevitable. I had read the papers. I also read a few of those books about how smart the Japanese were and how their management techniques were superior to those of Americans.
So, it seemed to me that betting on Japan was a no-brainer. But that was in ’89. Then, when the Nikkei got down to 8,000, I began to have second thoughts. And then, when it didn’t bounce back I had third thoughts…and fourth thoughts. Japanese stocks stayed down for the next 15 years. They’re only starting to come back now. The Nikkei is now back to almost 20,000. It’s in all the papers that Japanese stocks are at a 15-year high. But wait a minute, I’m still out half my money. Let’s face it. I may be dead before I get my money back.”
“Thank you…no more questions.”
Look up, dear reader. The ‘Crash Alert’ flag still flies. Oh, long may it waver…
Now, more news:
Chris Gaffney, reporting from the EverBank world currency trading desk in St. Louis…
“Apparently the sell off in the Chinese markets started with a rumor that the Chinese government was looking to start taxing capital gains. This has been denied by Chinese officials, who came out in support of stability in their financial markets.”
For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig
And more views:
*** Oh…and what’s this? Alan Greenspan (remember him?) says the U.S. economy might go into recession before the end of 2007.
He may be right. The subprime mortgage market is getting whacked hard. And when people can’t buy at the bottom, it weakens the whole market structure. Prices fall. Jobs are lost. Spending declines. What we’re seeing so far is that people who can afford to do so are taking their houses off the market. This creates an invisible inventory of empty houses that will probably hold down prices for many months to come. Steadily, but surely, the millwheel of a correction will grind away.
*** A friend of ours from our old neighborhood in Baltimore is visiting us at the beach. She brings a strange and sad story:
“Do you remember that black kid who used to work for you? His name was Shawn, but they called him Pookie. He was a good kid in a bad situation. Our neighbors Kathie and George liked him so much they practically adopted him. He had a very good attitude. He liked to work…and learn. I remember you had him helping you scrape wallpaper off the walls. That seems like so long ago. Well, it was a long time ago – 25 years.
“But we were all pioneers in that neighborhood, weren’t we? Because the houses were so big and beautiful. But you remember, what the neighborhood was like. Drug dealers. Prostitutes. Layabouts. Bums. It was just a typical inner-city slum. Maybe worse than most because people were always shooting at one another. And most of the people were incorrigible.
“But Pookie was nice. We all tried to help him. His father was in prison, remember? He had a brother; I can’t remember his name. And I don’t know about the rest of the family, but I think he had a very hard time of it. So, we liked him and tried to help him. I think Kathie and George even helped him with his homework and that sort of thing.
“And then, when he grew up, you probably don’t even remember this, but you gave him a job in the business. It was a great opportunity for him. Well, you know how your business is. Nobody really cares where you went to school or what your background is. So, we were all hoping that this would be a good career path for Pookie.
“But then he was fired. We heard he had stolen credit card numbers or something. He wasn’t prosecuted. Nothing was ever proven, but naturally you couldn’t have someone around the credit card numbers you weren’t 100% sure of…so he had to go. I remember, Kathie and George were heartbroken. They treated him like their own son.
“And then one thing kind of led to another. Time went by. He never did seem to find any work that he liked. And then we heard that he had a lot of lifestyle issues…or problems. And then both he and his brother were in various treatment programs. They were suicidal, we heard.
“And then, last week…Pookie hanged himself. The next day, his brother – who was already in a mental hospital, I believe – hanged himself too.”
*** In that mordant vein, we read that Vice President Dick Cheney was almost blown up on Monday. He said attackers were trying, “to find ways to question the authority of the central government.”
Predictably, our Veep is wrong. If the assassins had wanted to question the authority of the central government they could have sent a letter to the newspaper. What they were trying to do was to kill him. But they were as incompetent as he is; instead of offing him, they only managed to kill 23 other people who didn’t deserve to die.