The World He Lives In

Today we approach a serious and disturbing paradox: how could it be possible for an economy to slow down just when its central bankers and its central government push harder than ever on the accelerator?

If you would prefer something more lighthearted, you could read Alan Greenspan’s address to Congress on Tuesday. More and more, we find we share the sentiments of Rep. Bernie Sanders, who remarked following a previous testimony by the Fed chairman:

“Mr. Greenspan, I always enjoy your presentation because, frankly, I wonder what world you live in.”

We wonder too.

As near as we can tell, it is a strange one. For in Mr. Greenspan’s world, there are no paradoxes. It is a world as clean and dull as an actuarial table with only whole numbers. The Fed chairman is surrounded by such positive thinkers, the poor man must not get a chance to voice a doubt or doubt a voice. Ben Bernanke thinks he can make the dollar worth as much or as little as he wants, just by controlling the speed of the printing press. Robert McTeer says he can hardly wait to fight deflation; he thinks it will be fun. Alfred Broadus is probably the most cautious of the bunch…but still delusional. He says the Fed has proven that it can fight inflation, and now it has to prove it can fight deflation.

Deflation: Do They Take Us for Morons?

It is to this last point that we are drawn…as if to a crime scene. The Fed claims it came along just in time and chased off the miscreant. We look at Al Broadus and the rest of his gang and wonder: who do they take us for, complete morons?

And yet, Americans’ can-do optimism seems to depend on the ability of its central bankers to do what the Japanese could not – successfully wage war on deflation. All right, so the war on inflation was not the great success that Broadus thinks it was. (The dollar ended the year 1913 about where it was 100 years before. In that year, the Fed took up its mission – to protect the value of the nation’s currency. Over the next 90 years, the dollar lost 95% of its value.) What the Fed has proven is not that it is a good inflation fighter, but that it is good at stabbing the dollar in the back. And since destroying the dollar is just what the times seem to call for, what are we worrying about?

If only there were not so many paradoxes, dear reader. Wouldn’t life be much better if women meant what they said? Wouldn’t it be nice if you could be happy by thinking of yourself and only doing what makes you happy? Wouldn’t it be grand if the investments that made people rich last year would make you rich this year?

Or, more to the point, wouldn’t it be just peachy if the Fed really could control the money supply…so that people would have money to spend when the Fed wanted them to spend? But therein hangs a tale, which is the subject of today’s letter.

But here, hardly having moved forward a single inch, we must arrest our progress. Alert readers may already be looking ahead, with an objection:

Deflation: The Dollar Had Better Collapse

“Hey, I know where you’re going with this. You’re going to say that the Fed will be as incompetent at destroying the dollar’s value as they were at protecting it. But haven’t you been saying that the dollar was going to collapse? (And sotto voce: I’ve been buying gold and euros thanks to you…the dollar damned well better collapse!)”

Ah…but you expect too much, dear reader. If you want consistency or simplicity, you will have to pay for it. Dearly.

Many, if not most, of our friends have taken the Fed at its word, and on its record. If there is one thing the Fed can do, they say, it is inflate the currency.

“Buy gold,” they say. Consumer price inflation is on the way…with higher interest rates and falling bond prices. But an odd thing: even as the dollar lost value…and the trade deficit hit 5% of GDP…and federal deficits soared…long T bonds, recently, went up. Why would people lend money for 30 years, at paltry rates of interest, to a government openly declaring that it intends to inflate?

We don’t know. Perhaps people need the income, as small as it is. But, whatever the reason, the bond market is unconcerned about inflation. Not only did long T bonds go up, the differential between regular treasury bonds and those whose return is adjusted for inflation narrowed. (We would give you the figures, but we don’t have them at hand; you will have to take our word for it.) [Editor’s note: Bill is lost in the wilds of his château in Ouzilly, taking advantage of the long May-Day weekend in France.]

The bond market seems to anticipate not a rerun of the inflationary ’70s…but something else; perhaps America will follow in Japan’s footsteps after all. For the last 8 years or so, the U.S. economy and its stock market have done a fair imitation of the Japanese trendsetter…with a 10-year time lag. When the Japanese economy boomed, so did the U.S. economy – 10 years later. Then, Japan entered its bubble phase, followed by the U.S., 10 years later. Then came the bear market in Japan, again trailed a decade later by a bear market in America.

Deflation: The Japanese “Blip”

At first, no one paid any attention to the Japanese situation. It was just a blip, said economists; Japan will come back fast.

That was 14 years ago. And last week, the Nikkei Dow sank to new lows – down 80% from a high set back in the final year of the Reagan Administration. After Reagan, Bush the Elder took over in America, up-chucked on Japan’s Prime Minister…and it has been downhill for the Japanese ever since.

But the Japanese did not go gently into that good night. They fought the dying light just as the Greenspan Fed would do – 10 years later. Rates were cut…and cut…and cut some more, until they reached zero. Nor did the Japanese shirk from government spending…public works projects of all manner and description were begun. Never before has so much concrete been mixed and poured in such a small place.

But it didn’t work. The money supply fell anyway…and Japan became the first major nation to experience outright consumer price deflation since the Great Depression. Twenty years of stock market gains have been wiped out. Unemployment edges up as the economy experiences multiple recessions. Consumers seem unwilling to spend – guessing that they will get more for their money next week than they would this one.

How could it be, we ask ourselves? How could a central bank be unable to do what central banks do best?

We remind readers that when the Fed creates money ‘out of thin air’ it does not create any corresponding wealth. The world’s supply of services or swimming pools does not magically increase when Ben Bernanke turns up the dial on the printing press. What it does create is an illusion of wealth; people with more ‘dollars’ imagine that they are richer…and begin to act the part.

Kurt Richebächer describes this as “pseudo or phantom wealth”, whose effect is, paradoxically, to make people poorer. In the boom phase of an economy, the phony money goes into stocks, or real estate, or some other asset.

“What the rising asset values effectively create,” Richebächer explains, “is a corresponding rise in claims on the economy at the expense of those who do not own such assets. But this is wealth redistribution, not wealth creation. More importantly, this kind of wealth creation involves no gain in current incomes and productive capacity. To the extent that it actually boosts consumption at the expense of investment and foreign trade balance, the net result from a macro perspective is overall impoverishment.”

Deflation: Less Money

Poor people have less money to spend…and less money to repay their debts. Unless the central bank delivers the new cash along with the daily paper, money creation takes place through credit. The new money is lent out. If the borrower cannot repay, the cash disappears.

Curiously, money ‘created out of thin air’ tends to disappear even when the loans are paid back. As explained in a recent issue of the Mogambo Guru’s, which we would quote if we could find it, when a man lends out his savings, he can expect to get paid back, with interest, and all is well. No change to the money supply.

When money is created ‘out of thin air’, on the other hand, the money supply is enlarged when it is lent out. It didn’t exist before it was borrowed. Then, when it is paid back, naturally enough, the money supply shrinks! The money goes back to its maker; it exists no more. Thus, the more new credit the Fed has created…the greater the measure by which the money supply will eventually fall.

The only way to avoid this inevitable deflation would be to either to give the cash away on the streets…or to keep the supply of credit expanding forever. The first solution would be worse than the problem it was meant to solve; the second is impossible.

Meanwhile, the world’s apparent wealth – and implied spending power – expands and contracts as the assets, bought on credit, go up and down in value. About 7 trillion dollars were wiped out so far in the stock market decline of the last 3 years. If U.S. stocks follow the Japanese plan – falling 80% over 14 years – another $8 trillion or so, in America alone, will disappear.

Is it any wonder that cash and ‘wealth’ created ‘out of thin air’ returns whence it came – no matter what its creators would like? There is some elegant justice to it, we think, reminding us once again that we do not get what we want from life, nor what we expect…but what we deserve.

Bill Bonner
May 2, 2003


The U.S. dollar is stuck in a “doomsday cycle”, says, offering as evidence all the many things we’ve discussed.

“U.S. economy continues to struggle,” observes the Financial Times, citing the usual reasons.

“Gold up $3,” reports no one in particular, and giving no reasons nor apologies. Gold does what it wants to do, regardless of what anyone says. Right now, it seems to want to go up.

“Where does one look for satisfactory returns in a world of 1.25% money market rates and 5% long-term bonds?” asks Dogs-of-the-Dow inventor, Michael O’Higgins. In one word, gold! “Because it is undervalued, under-owned and in a strong uptrend after 20 years in the doghouse. Not only that, but gold has historically served as a great hedge against the kind of falling stock market and weak economy that we are likely to experience going forward.”

Gold has been in the doghouse for so long that most investors are afraid to touch it; they think it has fleas. In the last two decades of the 20th century gold fell 70% in price, while the Dow stocks skyrocketed 1200%.

This was such an extraordinary event that it made us feel like soothsayers. Looking into the future, we guessed that the world would have to veer back towards the mean sometime soon. We suggested what we called the Trade of the Decade: sell stocks and buy gold.

Since then stocks have fallen about 50% on average, and gold has risen about 40%. But it still takes 22 ounces of gold to buy the Dow, which is twice as many as it has, on average, for the last 100 years. Which makes us think this trend has a long way to go.

“In other words,” explains O’Higgins, “the price of gold could more than double and it would still be reasonably valued relative to stocks. Of course, if it went back to the levels of 1980, 1932, or 1896, it could go up by 1,000% to 2,000%.

And here’s Eric Fry with the latest news from Wall Street:


Eric Fry in the Big Apple…

– Stocks muddled along yesterday…just like the U.S. economy. The Dow dipped 26 points to 8,454, while the Nasdaq edged half a percent higher to 1,473… muddle…muddle…muddle. Meanwhile, the dollar continued sinking like a brontosaurus in a tar pit. The U.S. currency traded down half a percent to $1.124 per euro, a new four- year low. Yesterday’s drop brings the dollar’s three-day decline to more than 2%.

– Government bean-counters released another cluster of gloomy economic reports yesterday. The steady stream of downbeat economic reports is forcing the glass-half-full contingent to recalibrate its assessment…Perhaps the glass is only 45.4% full. That would appear to be the message from the Institute for Supply Management (ISM), which reported yesterday that its index of manufacturing activity fell to 45.4 from 46.2 in March and 50.2 in February. Sub-50 readings indicate that more manufacturers feel business is getting worse rather than better. In other words, a reading below 50 means the glass is more than half-empty.

– Separately, construction spending tumbled and jobless claims remained close to a one-year high. In all, not a very comforting collection of data. Construction spending fell 1% in March on weakness for public projects. Over in the job market, 448,000 folks filed for unemployment insurance last week, down slightly from the 461,000 initial claims filed during the prior week. The four-week moving average of weekly unemployment claims is a not- insignificant 442,000 – that’s 60,000 more than the 4-week average of just three months ago…Just imagine how bad off we’d be if Greenspan hadn’t cut interest rates so many times!

– No question about it; America’s job-growth engine is sputtering badly. Despite a theoretically recovering economy – as evidenced be a string of positive quarterly GDP numbers – jobs have become almost as scare as Iraqi chemical weapons.

– And, as we have oft-observed, consumers without jobs don’t consume quite as much as those with jobs. To wit: Ford’s car sales tumbled 6.7% on April, despite hefty rebates and low-interest-rate incentives. Apparently, there’s a limit to the number of times you can dope a racehorse before it collapses.

– GM car sales fell a similar amount, while Daimler Chrysler finished several lengths behind with a 10% sales drop. Sluggish car sales are but one of the many indicators of economic stasis we’re seeing these days.

– And now, a few more bullish musings from the oil patch…or more properly, the natural gas patch, which we presume is located somewhere nearby. The US Energy Department’s weekly natural gas report showed a slightly larger-than-expected increase in gas inventories, but one week does not a trend make. Natural gas inventories are still a stunning 54% below year-ago levels.

– “Last week marked the official start of the annual six- month push to fill up the [nation’s] natural-gas storage tanks,” the Wall Street Journal notes. “With gas inventories at their lowest levels in a decade, the effort takes on increased urgency this year.” And as T. Boone Pickens stressed at Wednesday’s Grant’s Spring Investment Conference, the urgency to replenish badly depleted natural gas inventories is likely to lead to rising gas prices sometime over the next few months.

– If high, and rising, natural gas prices seem so probable, why aren’t the exploration and production companies working feverishly to increase their drilling activity? The answer, according to Pickens, is that “there’s nuthin’ to drill”. Natural gas companies have stepped up their drilling activity somewhat, but not nearly as much as one might expect, given today’s elevated gas prices.

– “One year ago, 613 gas rigs were toiling away on American soil and in contiguous waters,” James Grant observes. “Now, following a propitiously cold winter and a backward spring (we write from the New York perspective), there are 805. However, as recently as July 2001, there were 1,068.

– “As high corn prices elicit more corn, other things being the same, so do high gas prices elicit more gas, other things being the same. But exploration activity presupposes a belief on the part of the explorers that there’s gas to be found. Among U.S. drillers, the faith seems to be waning, the current high gas price notwithstanding…Over the long run, exploration will become less and less fruitful in the lower 48 states.”

– The economy may continue muddling along, but the natural gas market promises to offer many chills and thrills over the rest of the year.


Back in Ouzilly…

*** Factory orders fell again.

*** Bethlehem Steel is no more. The company had been in bankruptcy. Its assets have now been sold off. Old Bessie is no more.

Your editor’s father and many of his uncles worked in steel mills. For much of their lives, they worked in rhythm with the mills. Three shifts a day in the ’50s and ’60s…and then layoffs, payoffs, and early retirement…

An uncle recently recalled what life was like at the Sparrow’s Point Bethlehem Steel plant in Baltimore:

“I got a job there in the late thirties. I don’t remember how much I was paid; it wasn’t much. But I was lucky to get any job at all.

“Those were the days…all along the waterfront, everyone was hustling and bustling…you could hear the factory whistles all over town. And you knew that the bars around Highland Town would fill up a few minutes after the whistle blew. Everybody worked for the mill. And our whole lives revolved around it. Other things might change, but we thought the mill was permanent. People would always need steel, and nobody made it better than we did.

“People think working steel was a science, but it seemed more like an art to me. I remember my boss…a big Irishman named Milligan…he would mix up a batch of steel like he was baking a cake. He’d add a pinch of this and a dab of that…and then, he’d know just what kind of steel would come out of it…and somehow, he would know just what customer it was good for. You had to get the temperature…the timing and the mix just right. And each mix was different. One might have more strength…or more flexibility…than another. But Milligan knew just what kind of batch he had and he marked it down for the right customer…steel bridge girders…or auto steel…or whatever.

“Every time we poured a batch…I don’t know…there was something exciting about it. It was if we were working right in the heart of this great, pulsating machine. Each batch of steel was like the lifeblood of the entire system…hot…full of life. We were proud, happy and tired when we came home from work.

“Of course, those days are gone. Now, they’ve mechanized and computerized everything. And besides, the factories don’t seem to work they way they used to. The energy and excitement seems to have gone out of them. And I guess those kind of jobs have all gone to China or Korea. But it’s too bad.

“I loved the work, but then the war came along and we all shipped out. After the war, I came back to get my job back. But I had gotten malaria in Iwo Jima or somewhere…and it came back. I spent months in a military hospital, by then, they had given my job to someone else.”