The Worst Possible Way

Rumors are circulating.

It is said that Alan Greenspan would like to retire in 2 years. Naturally, the Fed chairman would not like to leave office in a recession or immediately after one. Greenspan has more name recognition than any public servant since Pontius Pilate. And he got it by nurturing the idea that he can keep an economy growing and resurrect a fallen stock market.

It might have been different, of course. The Fed chairman seemed to spot the beginnings of a bubble economy several years ago, when he made his “irrational exuberance” remark. But rather than fight it, Greenspan decided to join it – adding even more exuberance by ballyhooing a ‘productivity miracle’ and the wonders of information technology.

“Greenspan wants to avoid a recession in the worst way possible,” said one commentator.

What would be the ‘worst way possible?’ In answer to that question, I offer the following reflection.

“Consumers are still hanging in there,” said one Fed governor recently. ‘Buy, buy, buy’ says another regional Fed governor. ‘Lend, lend, lend,’ says the chairman to member banks. As long as consumers are willing and able to increase their spending, they reason, there can be no recession.

But consumers’ household debt is now equal to 100% of disposable income. It was only about 70% when Alan Greenspan became Fed chief.

And consumers just suffered the worst hit to their ready cash since the 1930’s… as Eric points out above… with households’ liquid financial assets falling 12.5% from the previous year. Yet, they continued to increase spending more than twice as fast as the increase in their incomes. (Those salaries – like the Fed funds rate – are increasing barely more than the inflation rate.)

The only way consumers can continue borrowing and spending is by going further into debt.

What is the worst thing a person who is deeply in debt can do? Borrow more money, of course. And when would be the worst time for a debtor to borrow more? Just before a period of major deflation. And there we have our answer: the worst possible way for Greenspan to try to avoid recession would be by tempting American consumers to borrow in advance of a serious decline in prices.

Thus, we have an answer to a number of mysteries:

Why has the dollar failed to fall – even as the Fed cuts rates and the current account deficit rises?

Why does the price of gold go nowhere – even when the world’s central bankers attempt to destroy their currencies?

Why have long-term bond yields failed to decline – even when the Fed was pushing down on the short rates?

Why does the gap between inflation-adjusted TIPS and regular 10-year notes remain stubbornly near 2% – even when the inflation rate has only been at such a low level once in the last 30 years…and even now is nearly twice that number?

Why, why, why.

And why are we not already in recession?

“In May,” writes James Grant, “for the 8th consecutive month, industrial production declined…and factories operated at 77.4% of capacity, down from 79.2% in April, the lowest level of utilization since August 1983. High- tech production fell by 1.2 percentage points, to 70.3%, the lowest rate in a quarter-century.”

A chart in Grants’ newsletter puts the figures into perspective. Every period in which industrial production fell by 5 or more months – since WWII – was accompanied by recession. We are already at 8 months. The record is only 3 months away – at 11 consecutive months of declining industrial production, set in 1960, coincident with the recession of ’60-’61.

“Given that the indicators that define a recession – industrial production, employment, manufacturing and trade sales – are going down in a way seen only during recessions,” says Anirvan Banerji, an economist at the Economic Cycle Research Institute, “either we are in a recession, or this is the worst non-recession ever.”

Is it only a matter of time before a non-recession becomes a recession…and the debts, so light and portable on the carefree backs of consumers in the last decade of the 20th century, become almost impossible burdens in the 21st?

In a moment of philosophical weakness, we are tempted to ask another question: what kind of God would invent such a pernicious world…where ordinary people are lured into imprudence and insolvency by the very person who is supposed to be the custodian of the national accounts?

“There is always some leveling circumstance that puts down the overbearing, the strong, the rich, the fortunate, substantially on the same ground with all others,” wrote Ralph Waldo Emerson in his “Compensation” essay. Americans have enjoyed nearly twenty years of falling interest rates, low inflation, rising equity prices, and full employment. Debt has been no problem.

Thanks to the strength of the dollar and easy money policies of the Federal reserve, American consumers have become the freest spenders and most indebted consumers in the world.

And now, Mr. Greenspan brings his ‘leveling circumstance’ – setting up consumers so they can be knocked down hard by the coming deflation.

Your correspondent,

Bill Bonner
Baltimore, Maryland
July 6, 2001

Let’s begin by going directly to Eric’s report from New York…


Eric Fry on Wall Street:

– “Why would anyone care what James Cramer thinks?” Bill asked rhetorically in yesterday’s column. “Because knowing what Cramer thinks can be very rewarding…but only if you remember to do the opposite.”

– How true that is. Contrary indicator enthusiasts, your ship has come in – and its name is the “S.S. James Cramer.” About 3 months ago, Cramer began posting his “personal stock portfolio” on So how’s he doing so far? Not too well, I’m afraid. Through the end of trading yesterday, Cramer’s portfolio had slipped a little more than 1% since he first posted it on April 1st. Over the same span, the S&P 500 and the Nasdaq Composite advanced more than 6% and 16%, respectively.

– Of course, the time frame in question is too brief to be conclusive. Still, I recalled my 10th-grade geometry teacher, who’d surely be telling Mr. Cramer what he so often told his struggling students, “Mr. Cramer, a blind monkey selecting at random would have fared better than you did on this test.” Pity the monkey.

– Cramer’s not-so-model portfolio was not the only one to suffer large losses yesterday. Stocks fell across the board – rebounding energy stocks being among the few standout winners of the session. The Dow fell 91 points, while the Nasdaq dropped a more disquieting 61 points, or almost 3%. Despite the rate cuts and all the blather that “the bottom is in,” the Nasadaq flirts with 2,000 once again.

– “Are markets headed for a Summer Rally?” the Wall Street Journal asked hopefully yesterday. Strictly speaking, a summer rally is inevitable, the question is from what level. The Journal might not, for example, exult in a rally from Dow 5000 to Dow 6000.

– At the current levels, the S&P 500 sells for about 28 times its earnings for the past 12 months, which as hedge fund manager Michael Lewitt points out, is “far greater than the post-World War II average of 15.3 and previous bear market low of 7 times earnings in 1974…”

– Over in the currency markets, Europe’s beleaguered single currency – you know the one – slid to a new eight-month low against the dollar. At 83.6 US cents, the euro stands less than a penny away from its all-time low of 82.7 pennies.

– European auto manufacturers aren’t complaining. The June sales numbers are in and the American car companies lost market share to the foreign competition…again. This time the Big 3’s combined market share fell to 63.9% in June.

– “In 2001’s first quarter, the household-sector’s liquid financial assets [i.e. assets readily convertible into cash] fell by 12.5% from a year earlier,” Moody’s John Lonski observes. “Perhaps not since the Great Depression have the liquid financial assets of households plummeted so deeply year-to-year. Yet,” Lonski marvels, “household expenditures still grow.”

– Lonski: “First-quarter 2001’s yearly drop by the liquid financial assets (LFAs) broke under the former plunge of record depth – the 8.0% year-to-year decline from 1974’s recession-bound third quarter.”

– muses, “Maybe the current mood among those who watched their wealth balloon in the bubble market is one of ‘easy come, easy go.’ Of course, should the downturn in the stock market and the economy as a whole continue to siphon off liquid financial assets in the months ahead, American consumers may at last be forced to abandon their jaunty brand of devil- may-care complacency. Only time will tell.”

– Intriguingly, yesterday’s notable stock market losers included Federated Department Stores – owner of Macy’s and the high-brow Bloomingdale’s – which lowered both its quarterly and annual earnings forecasts. Federated shares fell almost 6%. “The consumer” is still spending, but he seems to be spending less.

– At “Gray’s Papaya” – a hot dog stand on Manhattan’s Upper West Side famous for its “Recession Special” – a papaya drink and two all-beef franks retails for $2.45. The special cost $1.95 when proprietor Nicholas Gray cooked up the idea back in the 1990 recession. But as memories of the 1990 recession faded, Gray altered his sign to read: “The Recession Special: For the one that was and the one that is to come.” Gray doesn’t know if the recession “to come” is here yet, but he says that hot dogs sell well in a recession, and that business is booming. You figure it out.


Back to Bill in Baltimore:

*** “Silicon Valley Becomes a Ghost Town for a Week,” says a headline on the SF Gate website. The tech world is suffering. Tech funds, reports Lipper, are down 22.4% this year. To save money, the firms are requesting that employees take off this week – which an estimated 25,000 workers are doing.

*** And the bust in technology shows no signs of being over anytime soon. A British telecom maker, Marconi, announced yesterday that it saw no ‘second half recovery’ coming. Instead, it admitted that earnings for the year would be only half of what was expected and said that perhaps, maybe, things might be better in 2002.

*** Meanwhile, “Over the past 40 years,” writes IL’s Kathie Peddicord from the ‘Valley of Flowers and Eternal Spring’ – Boquete, Panama – “this country’s inflation rate has averaged less than 2% – that’s simply unheard of south of the United States. This country is an anomaly in Central America. And right now… it’s still very cheap. A full-time, live in maid costs $120 a month… first-run movies cost $1.50.”

*** Plus, Panama boasts the most attractive “pensionado” program in the world, Kathie says, “giving you discounts of up to 50% off everything from public transportation to movies and sporting events…from doctor’s visits to your electric bill…from restaurant dining to airfares…”

*** Here in Charm City things go on in their own quirky way. There was no boom in the city of formstone and beehive hairdos… but neither is there a bust.

*** “But have you seen the prices houses are selling for down near the harbor,” asked a colleague. “I bought my house for $62,000 just 8 years ago. Now, the house across the street is selling for $350,000.” Even in Baltimore, it seems, easy money finds an outlet. Stocks are not moving – but, in many parts of the country, property prices are still rising.

*** A hard rain storm drove through Baltimore last evening. It came just as a band was warming up in the park in front of my office. Dark clouds rolled over, the wind picked up, there was a crack of lightening…and suddenly it poured.

*** The musicians, standing up on stage, clutching their microphones and electric guitars – wires running everywhere – must have felt the crack of doom approaching. They unplugged themselves in seconds and ran for cover.