Mr. Market Ignores Me

Pride goeth before a fall.

“Why doesn’t the dollar falter?” asks a DR reader, reminding me that I’ve been expecting it for more than a year.

So far at least, Mr. Market has been unwilling to go along with my forecast of a lower dollar and a higher price for gold. Instead, as reported above, gold has fallen $12 since January 1st…and the dollar has gone up 6%.

There are two sides to every argument, of course. To the extent that reason, logic, and facts are at play – they are almost all on my side. The dollar is overvalued by almost any measure you can think of. The U.S. is running huge trade deficits. Equities are falling. The economy may be on the verge of a recession. The Fed is cutting rates. And the money supply is growing at a rate that should scare investors away, not attract them.

But arguing with Mr. Market is like arguing with your wife. Once his mind is made up, it is pointless to dispute the issue. You won’t convince him of anything, and you will get nothing but misery for your trouble.

Still, “the strong dollar,” pleaded Philip Bowring in Tuesday’s International Herald Tribune, “is the latest ‘irrational exuberance’ produced by the market. It is perverse and dangerous. It will prolong U.S. problems and hurt the rest of the world just when it needs stimulus to offset the slowdown…”

The high U.S. dollar makes no sense, Bowring believes: “The yen has fallen 15% from a year ago, the Korean won and Thai baht by 17% and the Australian dollar by a stunning 23%. The story is the same whether or not economies are technology dependent, have trade surpluses or are politically stable.

“This is perverse. U.S. interest rates are falling and will probably continue to fall at least as fast as those elsewhere, even though U.S. inflation is almost the highest among member countries of the OECD and is well above that in most of Asia. The U.S. current account deficit, at more than $300 billion, is unlikely to decline significantly without a sustained U.S. slowdown.”

Also, the U.S. is increasing its money supply faster than almost anywhere else – at about 3 or 4 times the rate of GDP increase. Back in the 1980s, this sort of increase would have panicked investors out of dollars. But today, faith in managed currencies is so strong that instead of tarring and feathering Mr. Greenspan for destroying the currency, investors have praised him – and placed their bids for more U.S. dollar assets. In fact, in the last few weeks, Mr. Greenspan has been criticized for not cutting rates fast enough. The great fear among economists and columnists – such as Mr. Dionne, whom I quoted here yesterday – is that people begin to consider their dollars worthy of saving, rather than trying to unload them immediately.

Compare the yen to the dollar: Japan has a zero interest rate, but the yen is sold. Private debt has been going down, and the growth of the money supply is negligible. The country has huge savings, low inflation, and very favorable trade surpluses. This is not the case only in Japan – but throughout Asia. Still, Mr. Market chooses the dollar.

The strong dollar helps boost up stock prices in the U.S., but it hurts U.S. businesses in the long run by making American products more expensive on foreign markets. U.S. corporate profits fall as foreign imports rise – hurting domestic suppliers in the U.S. as well as exporters. American manufacturers – the source of the ‘things’ in which real wealth is actually measured – suffer.

This is part of the explanation for the extraordinary figures I reported to you yesterday. Despite the biggest boom in U.S. history, the mean income of Massachusetts residents declined 10% since 1989.

And, as reported earlier, last year the net worth of the average U.S. household declined for the first time since 1955.

How is this possible? An overvalued dollar encouraged a run-up in debt and asset prices – while actually undermining the ability of U.S. workers to earn money. Throughout the ’90s, people borrowed money, spent much of it on foreign-made products…and comforted themselves with the knowledge that their stocks and real estate were going up. Now that stocks are going down, they find themselves poorer, not richer.

A fall in the dollar would be a good thing. It would discourage consumption of imported items. It would knock down stock and bond prices. It would give U.S. manufacturers a boost on world markets. And it would probably bring about a renewed interest in savings on the part of American households.

But Mr. Market may not care.

Why?

“The answer is quite simple,” says the aforementioned DR reader. “Perception. The US economy is [seen as] the world’s most outstanding economy: the most efficient, the most flexible, and the most dynamic. What’s more, it is led by Monsieur Greenspan…

“THE FORCE is with the US economy…”

For now, dear reader, but not necessarily forever. Mr. Market – resistant to logic, the facts, special pleading, and abject begging – nevertheless sometimes changes his mind.

Your reporter, sometimes right, sometimes wrong, and always in doubt…

Bill Bonner Paris, France March 29, 2001

*** Rally? What rally? Hardly had investors picked up the phone to place their orders – eager to get even (and perhaps get out) in the developing rally – when the big techs stepped up to the microphones and delivered more bad news.

*** Cisco dropped down to $15.75 – a loss of 80% from its high, and the biggest single stock disaster in history. Nortel lost $2.76 to end the day at $14.

*** Chris Matthai of The Fleet Street Letter: “What a difference a year makes! One year-ago this week, on March 27, 2000, Cisco Systems, became the most valuable company in the world, achieving a market capitalization of $555.44 billion after only 10 years as a publicly traded company. At the time Cisco had a P/E ratio of 194.23. A month earlier, an analyst at Credit Suisse First Boston had forecast that Cisco would become the world’s first company worth $1 trillion. The sky was the limit.

*** “Today Cisco can’t find the floor. As of the close March 27, 2001, Cisco has a market cap of $131.9 billion….$423.5 billion worth of market cap has disappeared in one year. That’s quite a haircut – and the market still isn’t satisfied that Cisco has reached a fair value yet. Cisco’s P/E is 44.21 and it is still overvalued relative to its earnings growth.”

*** Consumer sentiment might be brightening, but the outlook for the big techs is as dark as a dungeon. “Dot.com equipment floods the market” says a headline from the Rocky Mountain Times. The San Diego Union describes the former tech millionaires as “Paper Paupers.” “Stock options used to be the coin of the realm,” says the article. Now they are mostly worthless.

*** But employees can call a lawyer as fast as a shareholder. Qualcomm’s option holders have a launched a class-action lawsuit against the company, charging that they were unfairly treated when their options declined.

*** The Dow fell 162 points yesterday – with almost twice as many stocks declining as advancing. The Nasdaq suffered a 118-point drop.

*** But “Count on the Fed” says a report from Morgan Stanley. “Don’t Fight the Fed” say the pros. And yet, fighting the Fed may be paying off. The Fed has cut rates by 150 basis points so far this year. But the stock market is down, nevertheless, about 13% (as measured by the Wilshire 5,000).

*** As Ed Yardeni notes, that leaves 500 basis points for the Fed to work with. Look for more rate cuts – and further declines in the stock market.

*** “The greatest stock mania of all time will be fully retraced,” writes Robert Prechter, “probably by 2004. The question is whether that move will continue immediately or whether the Dow will make a new high first. We shouldn’t have to wait long for an answer.”

*** Mr. Market did not answer the question conclusively yesterday, but his body language suggested he was not intending to register a new high anytime soon.

*** “How deep could the fall of the world economy turn out to be?” asks Martin Wolf in the Financial Times. He responds by noting that 1) stocks are still overvalued, and 2) private sector debt has never been greater. Each of these conditions is unstable. And, together, they could resolve themselves in a very unpleasant way. First, stocks may go down further. “Because of overshooting,” writes Wolf, “a loss of 2/3rds from valuations would be within the bounds of experience.”

*** A 2/3rd drop in the stock market would mean a loss of about…uh…$6 trillion more, or more than $10 trillion in total. This would certainly make the consumer debt burden impossible to sustain. In the United States, the private sector runs a financial deficit (spending more than it takes in) of 6%. Normally, the figure is a positive 2%. In Japan, to make an odious comparison, people run a surplus of 10% to 13%. In the last 3 years, the savings rate in Japan has been an astounding 19% of GDP.

*** How will Americans react to a declining stock market? “Over the past half-century,” continues the Financial Times article, “there have been only 2 previous examples of significant declines, the most recent being in 1974. It is probable that households will respond to this by cutting borrowing and spending.”

*** What would this mean? If people merely went back to their habits from the early 90s – before the Great Bubble years – it would cut 10% from net demand in the U.S. “The impact would be devastating,” says Wolf.

*** Despite Monday’s boost in consumer confidence readings, evidence is mounting that consumers are cutting back. For example, “Americans Scale Back Spending on Vacations” says a Bloomberg headline. Only 41% of U.S. households plan to take a vacation in the next 6 months – the lowest number since 1980.

*** Coal traded at $22 a ton a year ago. Today, a ton of coal will cost you more than $40. Arch Coal, an ugly company a year ago, rose 4% yesterday – to $29.

*** Gold lost $1.50 yesterday. It is down $12 for the year. The dollar is up 6%. The euro dropped below 89 cents yesterday. What gives with the dollar? More below…

*** “Fifty years ago, the United States was producing half the world’s oil… now we can’t even produce half our own,” writes John Myers. “America, with only 4% of the world’s population, consumes 25% of the world’s oil. Almost half of that comes from OPEC countries. Each day, the average American consumes more than a gallon of Arab oil. Yet, the Mid-East is no more stable than it was a decade ago.”

*** Whatever happened to Susan Travers, I wondered? The remarkable woman was the only female ever to become a member of the French Foreign legion.

More than a year ago, I wrote about the battle of Bir Hakeim. It was not a huge encounter – but it was important. In May of 1942, Rommel was in North Africa – rolling up all the British troops in his way. But at Bir Hakeim, in the desert, a small force of French troops under the command of Colonel Pierre Koenig blocked Rommel’s route.

France was an occupied, defeated country. It was not completely clear that the French would fight at all. What’s more, the French foreign legion had French officers, but most of the soldiers – and especially non-commissioned officers – were German!

And Susan Travers? She was a young English woman who had joined the Red Cross and was sent for duty with DeGaulle’s forces in North Africa. As things developed, she became Col. Koenig’s driver…and, in the way the French do things, his mistress.

The later detail I learned just yesterday, in Le Figaro, which interviewed Ms. Travers – now 90 years old and living in a nursing home near Paris.

The Germans attacked with planes, artillery, infantry, tanks – everything they could bring to bear. But Koenig and his 5,500 troops held their ground. Surrounded, pounded day and night, the French situation looked hopeless.

But when the Germans demanded a capitulation, Koenig replied: “We are not here to surrender.” His troops never gave up an inch of ground.

Finally, after 15 days, their food, water and ammunition was exhausted. The British radioed orders to Koenig to retreat. But they were surrounded…Still, during the night, Koenig organized a surprise withdrawal – racing through German lines while getting shot at from all sides. More than 4,000 of his troops and most of his vital equipment managed to escape. When the dust finally settled the Germans had lost 3 times as many men as the French.

The battle greatly lifted the morale of the French…and it held up the Germans for two weeks – giving the British 8th Army the time it needed to prepare for the critical battle of El Alamein.

Ms. Travers and Col. Koenig continued their relationship until Madame Koenig arrived in North Africa. Later, Travers was inducted into the Legion, in recognition of her extraordinary contributions during the battle.