“At long last,” to repeat yesterday’s quotation from Dr. Kurt Richebacher’s recent letter, “the great global bear market instocks has arrived”
But what happens next?
I ended yesterday’s letter with an interrogative that must have left you on the edge of your seat. Why did corporate profits decline after 1997? Surely, with the spread of Information Technology…and the beneficent light of the New Era sun …profits should have risen.
But they did not. Why?
You may be worried that this subject will be too narrow and dull to be worth your time. Let me assure you – you are probably right. Yes, I do explain why life as we know it on planet earth will soonend…and how. But if you have other things to do…I will understand. America has, since WWII, enthusiastically taken up its role as the consumer of last resort. Like the teenager with an infinite appetiteat the family table, America has been willing to consume just about anything and everything that the world wanted to send its way.
In economists’ terms, we provided the Keynesian demand required for global growth. “But the long-term effect of Keynesian economics,” writes Dr. Richebacher, “was dwindling capital formation and ‘stagflation,’…an unusual coexistence of economic stagnation and inflation.”
The answer to this problem of the late 70s was supposed to bea shift to the supply side – Reaganomics. Lowering taxes and reducing regulations produced new growth. But the growth was notthe investment-led growth that was expected. “The reality,” as Dr.Richebacher puts it, “was the precise opposite: an unprecedentedconsumer borrowing and spending binge, with exploding budget and trade deficits.”
Instead of increasing the amount of investment, Reaganomics actually reduced capital formation and increased consumption. Once again, America played its role well – absorbing products from all over the world (especially from Japan, which was the economic miracle of the time)…and going deeply into debt.
“Over the decade,” again, quoting Dr. Richebacher, “total outstanding debts skyrocketed from $4.1 trillion to $12.8 trillion. During the threedecades since World War II, each dollar in incremental GDP growthrequired approximately $1.40 of additional debt. At the end of the1980s, the debt-to-GDP ratio had soared to $2 with a rising trend.”
The 1990s merely continued the trend. We were getting good at it.Debt-to-equity, total debt, and debt-to-just-about- every-other-measure-under-the-sun has gone up. “The American reality of the last four years is the wildest and most reckless credit and debt binge that the world has every seen,” as Dr. Richebacher puts it.
That is the trouble with Keynsian demand-side growth. It gives the illusion of growth – the effect and essence of growth, as it were, but much of the growth is virtual, not real.
Nothing comes from nothing. Real growth still and always requires real investment of real money. It requires sacrifice – giving up current consumption in favor of capital formation. In the most primitive economy, progress requires that a man give up his leisurein order to do some work. In a more advanced economy, a person must forego additional consumption in order to devote the money to investment purposes.
But instead of saving their money and investing it…Americans spent it.And instead of making capital investments that would have boosted earnings and profits, US companies preferred to give the consumer/investors what they wanted – a fast return on their money. They preferred to substitute virtual profits (in the form of stock market increases) for actual increases in productivity and earnings.
A real return requires time. And sacrifice. But a fast return could be had by embracing the latest jingoes of American corporate management.In the 1960s, American go-go management was the envy of the world.But after in the bear market of ’73-’74, the American model was discarded.For a few years, it was the German model that the world wanted. Then, in the 80s, books on Japanese corporate management were the rage. By the 1990s, a new American model was back in style –one that was consistent with the underlying trends in the U.S. economy.
The single imperative of U.S. executives has been to “maximizeshareholder value.” And do so quickly. You do this by cost cutting, restructuring, merging, acquiring and buying back your own shares –not by investing in new plant and equipment. Each announcement of a merger, for example, produces a pop in the share price. So does a large purchase of your own shares. But these gains are virtual – they produce no additional profit.
In his 1997 book, The Synergy Trap, Mark Sirower showed thattwo thirds of all the 168 mergers and acquisitions he studied failed to produce additional shareholder value…instead, they destroyed shareholder value.
And even the gains from cost-cutting are largely an illusion. That is, companies are always trying to remove unnecessary costs. And while one company can, theoretically, boost its net earnings by eliminating costs, what really happens is that the culture of cost-cuttingproduces cuts across the entire economy. One company’s cost, it turns out, is another’s revenue. The aggregate effect is merely areduction in economic activity, not an increase in profits.
In short, corporate profits leveled off after 1997 because there wasso little real investment in the preceding years. There was not enough money going into new plant and equipment to produce new profits.
While American corporations were trying to squeeze out additional earnings by cutting costs, and goose up their share prices bybuying back their own shares…their workers were on a spending spree.This too contributed to the lack of profits. The money paid to employees did not come back in sales revenue. Instead, muchof it ended up in the hands of foreign businesses. Then, when itdid come back to America, it came back as capital investments in stocks and bonds. The dollar was boosted up…so were U.S. equities. Interest rates, on the other hand were held down. And U.S. corporate profits suffered.
Dr. Richebacher: “The U.S. current-account deficit increased to $338.9 billion in 1999, from $220.6 billion in 1998, and $143.5 billion in 1997. That is, the deficit has doubled within the two years.It is already well above $400.” In fact, the first quarter of 2000 thedeficit – which measures the difference between goods and services sold abroad and those imported from overseas – hit $100 billion for the first time ever.
“Follow the trail of debt excesses,” urges Dr. Richebacher, “Thedecisive causes of every single, serious economic and currency crisis are credit and debt excesses. Apparently, one cannot repeat it often enough: the U.S. credit and debt excesses of the past fewyears are beyond past experience…essentially leaving behind a horriblyvulnerable economy and financial system. This tells us to expect a very hard landing of the economy with a steep, steep fall of the dollar.”
Paris, France June 23, 2000
*** Al is dead…Al is dead…like the hidden lyrics in a Beatlessong…a rumor spread yesterday morning that the chief of the world’s most powerful banking cartel and price fixing organization– Alan Greenspan of the Federal Reserve – had died.
*** At first, prices fell. Then, they went up. Then, they fell again. Investors and floor traders didn’t seem to know whetherto take it as good news or bad news.
*** But by the end of the day, the rumor had been dispelled – it was revealed that ‘Easy Al’ still had his bony hand on thelevers of interest rate policy, and a cold eye on the inflation figures. The Dow lost 1.2%, or 121 points. GM fell to $60 – down from a high of $94 in April.
*** A cloud seemed to pass over the ‘summer rally’ picnic. The Nasdaq fell 3.1% – down 127, closing well below the 4,000 mark.
*** Down, down, down, down…Amazon drifted further into the heart of darkness and closed at $42. This river of no returns stock was at 113 on Dec. 9.
*** Only 49 stocks hit new highs on the NYSE yesterday.
*** Gold lost 90 cents – the day before the World Gold Conference begins here in Paris. I’m going over to the Intercontinental Hotel later to day to peek in at the events. Sure to be discussed: theglobal conspiracy to drive down the price of gold. I am surprised at the outrage this notion provokes. Large holders of gold will certainlydo all they can to manipulate its price. If they can keep the price down – so much the better. As George Soros advises, you should try to “profit from the folly of government.” Buy gold, sell dollars.
*** We are still waiting to see if the dollar has reached ‘the end of greatness.’ Yesterday, it fell sharply against yen – after Bank of Japan officials threatened to stop giving money way. Japan hashad a zero interest rate policy for years. It may be ending.
*** Lumber futures fell $6.10 – further evidence of a slowing economy. Lumber is selling for 27.63 cents/bd. foot.
*** Labor, though, remains tight. The International Herald Tribune reports that employers are turning, in desperation, to the last pool of labor available to them – people over the age of 50. Census Bureaufigures show the number of people 20-34 years old fell by 6 million in the past decade. The number of people over 50 rose by 12 million. Making these fossils work harder has become a big concern of personnel departments throughout the nation.
*** “Fear Grips Zimbabwe” says the headline in today’s Financial Times.The election is scheduled for this weekend. So far 30 voters have beenkilled – thought to be opponents of Mugabe’s ruling party.
*** Fear might be gripping the White House too, according to Bill King.The Justice Department is proposing to investigate Al Gore’s fundraising abuses. Conspiracy-minded readers might wonder why, just beforea close election, a Clinton-controlled Justice Department would take up such an explosive issue.
[If you’re interested in Bill King’s service, just call 1- 800-433-1528 and ask for code 3457 to receive a FREE one- month trial.]
*** Well…reasons Bill King…if Clinton were afraid Gore was going to lose…and also afraid that Hillary was going down…he might want to clear Gore out of the way in the hopes of a better chance with a different candidate. Maybe even Madame Clinton.
*** Hillary has been making a point of privacy lately. But her opponent, Lazio, charges that she hired a PI to investigate him as soon as he announced his candidacy.
*** Remember, I spoke about Nicuraguan beachfront property a few weeks back? Well, Kathie Peddicord writes to tell me prices are alreadyon the rise. Still, “For just $12,000 you can own a lot in a wooded enclaveset back from a private, fine-sand beach and with wonderful sunset views out over the ocean…”
*** “Now you can get the best up-to-the-minute financial news and commentary ABSOLUTELY FREE,” says the Internet message I just received from TheStreet.com. Apparently, with so much free information on the web, people were not willing to pay for what TheStreet had to offer. The trouble with free information is that it is worth what you pay for it.
*** The Daily Reckoning is an exception because it only appears to be free. In using it as a source of information and ideas, you are also forced to read various advertisements and promotions…plus my gratuitous reflections on subjects that have nothing to do with investing…