Puttin' on the Ritz

Have you seen the well-to-do up and down Park Avenue On that famous thoroughfare with their noses in the air High hats, and arrow collars, white spats and lots of dollars Spending every dime for a wonderful time…

A middle aged man sat in the tea-room at the Ritz. Dressed in a business suit, he might have been a retired Enron executive… or maybe a Russian Mafioso. With him was a young woman, dressed in jeans, and a very décolleté shirt. When she stood up… I had to look twice. For this was no ordinary woman, but one who looked as though she might have walked out of a video game. Everything about her was exaggerated – in the way you might expect of a pimply game designer. For a moment, I wasn’t sure she was real.

The couple left the tea room, leaving only Elizabeth and me and an very strange Arab trio. The two men were also middle aged. Both wore white robes with gilded ropes around their heads. They were unremarkable, save for the odd way one had dyed his beard. The first 6 inches of it, beginning at his chin, were gray. But the rest of it was a bright orange. It looked so much as though someone had set it on fire… we expected the waiter to rush over with a pitcher of water.

With them was what I believe to be a woman. All that it could say about her is that it would be hard to find a greater contrast between her and the creature who just walked out of the room. For the first, imagination was unnecessary… for the later, it was everything. She was dressed head to toe in black. No part of her was visible, for even the eye slit was covered by a pair of thick, black-rimmed glasses that tapered at each end. It was as if someone had put a pair of spectacles on a coal sack.

"I’m sure she thinks that black bag is the height of fashion," said Elizabeth, "But I hope they don’t ask her to take her gown off when she goes through airport security stations."

Why do people wear black bags and stay at the Ritz, when they could get a room just as nice at the Hyatt or the Marriott – with all the same conveniences and comforts – for $200 instead of $500?

Why do people seem to want to buy stocks only when they can pay too much for them?

Why has government spending risen so dramatically in the 20th century… and continued rising even after all the "reasons" for why it should have disappeared?

On this last question – a little elaboration: Government taxes the rich, it is argued, so that the poor don’t starve. But America’s poor now die prematurely – because they eat too much! Poor people are fatter than rich people – and suffer from bad health because of it.

Likewise, taxes are also necessary, it is said, to protect us from foreign enemies. Khruschev’s famous 1960 speech at the UN raised tax rates throughout the western world. "We will bury you," he predicted, pounding the podium with his shoe. Citizens didn’t mind paying a little more in order to see things turn out differently. As it happened, 29 years later, the Soviet Union collapsed and even renounced communism. Then, America had no capable foreign enemies. And, by 1989, it was obvious that every domestic program – from the War on Drugs to the wars on poverty, crime and illiteracy – had become an expensive farce.

But between 1989 and 2001, government still grew… even after all the ‘reasons’ had been eliminated.

How can you explain these things, dear reader?

Today’s letter – to come right to the point – makes an effort.

It was an article in Scientific American that suggested an answer. An experiment had shown that even with small sums of money and modest logic, people often act in ways that make little sense.

"Imagine that somebody offers you $100," begins the article. "All you have to do is to agree with some other anonymous person on how to share the sum."

In the experiment, people were paired together. They were offered the money – but only on the condition that they could agree – in a single transaction – how to split it up. So, the safest and easiest thing to do was for one to the turn to the other and say, "Let’s split it 50/50." If the other agreed, they each got $50. If the other failed to agree, they each got nothing.

Simple.

But a man could get greedy. He could say to his opposite number: "Look, let’s split it – $90 to me… $10 to you. Remember, if you don’t agree, you get nothing. $10 is better than nothing, right?"

What would the other person say? Would he agree? He has only one chance. No negotiation is possible. So, the logical thing to do is to take the 10 bucks; it’s free money, after all.

And yet, many people reject the offer.

And thank God! What a dull world it would be if man really worked the way economists think he does! What would I write about each day, if markets were as perfectly rational as Nobel prize winners think they are? And what kind of drab history would the world have if people acted as reasonably as they are supposed to?

Man’s charm is that he is infinitely complex… and takes as readily to absurdity as a gypsy to petty larceny. Were it not so, novelists and market moralists would be out of business.

Why would a man reject an offer of a free $10?

"We are not interested solely in our own payoff," says the Scientific Americans, "but compare ourselves with the other party and demand fair play."

Why? This desire for "fair play," say the authors, guessing, "must originate in biological needs… We feel better… "

Why do we feel better? Longtime Daily Reckoning sufferers know already. Once we have a roof over our heads… and sufficient calories to warm and nourish our bodies… what else is there? Only the desire to "feel better" by distinguishing ourselves from those around us. We try to know more… to make more money… to dress better… look better… work harder (or less)… and so on.

On the streets of Madrid, street vendors sell Louis Vuitton handbags for $10. At least, your editor couldn’t tell the difference between them and the real thing. Why bother to spend 10 times as much for a real one? The same question might be posed about stocks? An investor will turn up his nose at a stock at $10 a share… but will buy the very same company when the share reaches $100. Why? Because it makes him feel better.

He buys neither the stock nor the handbag to get richer – but only to feel better about himself. Both are marks of distinction that will cost him money – not make him money. But it’s not the money that counts.

The room in the Ritz was not materially better than the one in the Emperatriz, where we stayed on Monday night. But the style was different. The Emperatriz is sophisticated, but in a modern, spare, business-like fashion. It is stylish, but with a feeling of practicality. A man like Warren Buffett might stay there, enjoying the convenience – and the rates, about $120 per night – and feel good about himself. In fact, he would feel superior to the people staying at the Ritz. In his mind, the Ritz must be an extravagance… and a waste of money.

By any objective measure, of course, the Ritz is a waste of money. The hotel has an old-world, 19th century decadence about it. Our room was so richly decorated, it was gaudy… theatrical even. Standing in the lobby, I expected Greta Garbo to come through the door… followed by a half-dozen porters with her luggage.

Why spend the money? Only to get a different feeling about yourself – the feeling of superiority over the poor sods staying at the Emperatriz!

So great is the desire to feel superior that people put up only a token resistance to it… they invent ‘reasons’ why it makes sense to stay at the Ritz… or buy a share of Cisco or IBM. The logic helps them maintain their dignity and confuses economists. But, it merely disguises their unconditional surrender to fashion and envy. For not only are people willing to spend money to raise themselves up… they’ll also spend money to knock the other fellow down.

"Are People Willing to Pay to Reduce Others’ Income?" asks a headline in the February issue of the Annales d’Economie et de Statistique. The answer is, of course, yes.

Two English economists "crafted a series of experiments in which groups of four people were given nearly equal sums of money," says the report. The four had to gamble with their new wealth in random, computerized bets; each time, two came out with more cash, and two with less." But then the researchers did something perverse… they allowed the gamblers to spend some of their money to reduce the winnings of their fellow players. "There was no prospect that this would make him any richer. Indeed, it would cost him anywhere from two to 25 cents for every dollar destroyed that belonged to his fellow players."

The professors were shocked to discover that 62% of the participants "paid for the privilege of impoverishing their peers."

Man is a "social animal," the report concludes, "more concerned with relative rank and status than with absolute well-being."

Government spending is money down the drain. Everybody knows that. But that’s what many voters want – to destroy the wealth of those who have more of it than they do… even if it costs them money.

Why do people wait to buy stocks until everyone else is buying them? Because they fear relative underperformance more than absolute losses. If stocks rise when everyone else owns them, they will be left behind if they don’t own them. On the other hand, if they buy them and they fall in price… well, so what – everyone else will lose money too.

Except for us… of course. You and I, dear reader, are above that sort of thing.

Your editor,
Bill Bonner
March 28, 2002 — Madrid, Spain

American consumer confidence!

New homes sales rose 5.3% in February. And existing home sales hit their second highest level ever. And a popular measure clocked consumer confidence rising by 15 points in March – the biggest increase in more than 10 years.

We didn’t need the poll results. There is no doubt Americans are confident. Who but a man of great confidence would buy stocks at today’s prices? Who, in the midst of what was supposed to be a recession, would dare to mortgage his home… or increase his spending?

Here at the Daily Reckoning, we don’t worry about a shortage of confidence… but a surplus of it – confidence so dense an ordinary man can get lost in it, and end up in places he didn’t intend to go. Corporate profits worldwide fell for the 5th quarter in a row, which, according to Bloomberg, constitutes the largest drop in three decades. But not to worry, everyone is counting on the American consumer to lead the world back to prosperity. The current account deficit, a measure of how much more Americans buy than sell from overseas hit $417 billion in 2001. It "could easily rise to $500 billion in the next 2 years," asserts the Financial Times.

But the current account deficit will not rise forever. The Financial Times mentions a study of previous episodes of current account imbalance. The upper limit seemed to be reached when the deficit hit 5% of GDP. Then, the debtor nation’s currency typically fell by about 20%, bringing exports and imports back in balance. For reference, the current account deficit is currently about 5% of U.S. GDP.

Eric, how did the bet go in New York?

********

Eric Fry on Wall Street…

– The Blue Chips rallied a bit yesterday, but the gold stocks absolutely skyrocketed. There’s just no stopping these things.

– The Dow gained 73 points to 10,426, while the Nasdaq tacked on 2 points to 1,826. Meanwhile, thanks to a sparkling $5.60 jump in the gold price, the XAU Index of gold stocks soared nearly 6%, bringing its gains over the last four months to a stunning 45%.

– Gold, the increasingly precious metal, broke through $300 per ounce to finish the New York trading session at $303, and gold stocks amply reflected the metal’s advance.

– Like a long-dormant volcano, the recent eruption in the gold sector is as surprising as it is awe-inspiring. Even many veteran gold-stock investors aren’t quite sure what to make of all the pyrotechnics… but they will happily take whatever they can get.

– And if John Myers’ Resource Trader Alert is any indication, gold and silver investors are taking some pretty hefty profits these days.

– The call options on the South African gold fund ASA Ltd. that the Resource Trader recommended in January have soared 140%. Meanwhile, John’s recent recommended option trade in silver, gold, soybeans and wheat have all racked up large double-digit gains. Losers, you ask? John’s had some, of course. But so far, 2002 has been an excellent year to invest in the resource sector.

– Now that the "easy money" has been made in the precious metals sector, gold bugs must grapple with the ultimate question: Sell or buy more?

– Do you sell into this rally? Or do you "back up the truck" to buy more gold stocks in advance of the long- prophesied apocalyptic rally to $1,000 per ounce? After all, if a piddling $40 rally from $260 to $300 can cause numerous gold stocks to double and triple, what in the world would happen if the yellow metal were to climb to $400 per ounce?

– Like Moses yearning for the Promised Land, all gold bugs pray to see the day when the yellow metal returns to the "Land of $400 Per Ounce." Maybe it’ll be heading there soon. Or maybe gold is destined to wander around in the desert for another 20 years.

– As noted in yesterday’s Daily Reckoning, many well-heeled CEOs of colossal corporate failures like Global Crossing, Level 3 Communications and Metromedia Fiber Networks already inhabit private Promised Lands of their own. One owns a vintage mansion in Mill Neck, NY, another owns a $92 million spread in the posh Bel-Air section of Los Angeles and another owns a 30,000 ranch in Colorado. Not one of them, we presume, struggles to pay his mortgage.

– Unfortunately, few are the beneficiaries of the bubble economy and many are its victims. For every dot.com billionaire who pays his mortgage on time (assuming he has a mortgage), there are probably one million folks who do not.

– "The number of low- and moderate-income families in the New York metropolitan region who are seriously behind on the mortgage payments is soaring," the New York Times reports. "A new analysis by a New York City economic development group shows that in the last six months, the number of foreclosures… on all types of homes in Brooklyn and Queens [has] increased sharply."

– "It looks to me like the American dream is, for some people, becoming the American nightmare," says Delores Martin, a home ownership counselor for Jamaica Housing Improvement Inc.

– In the past, banks were quite hesitant to lend to sub- prime borrowers, except for extremely large sub-prime borrowers like the continent of Latin America in the 1980s or the entire global telecom sector in the late 1990s.

– If you were just an average Joe with a spotty credit history, you could pretty much forget about getting a mortgage. Then came the 1990s when banks suddenly started dispensing mortgages like candy to trick-or- treaters.

– "The sub-prime mortgage industry, which serves people with bad or blemished credit histories, has burgeoned in the economic boom of the last 10 years," the Times continues, "allowing people previously deemed un- creditworthy to buy a home or to raise funds by refinancing their mortgage… [But] as sub-prime loans have increased, so, too, have foreclosures." What a shock.

– For good reason, banks used to avoid lending money to people who were not likely to repay them. But many of the ancient lending practices – like prudence, for example – fell by the wayside during the boom of the 1990s. The results have been as predictable as the sunrise.

– "Between 1993 and 1999, according to federal statistics, sub-prime lending jumped from one percent to 6 percent of the national home-purchase mortgage market. In the refinance segment… sub-prime lending bounded to 19 percent of the market in 1999 from only one percent six years earlier. Over the same period, foreclosures rose by 42 percent."

– Ironically, all the while that delinquencies and defaults are rising, so is consumer confidence and so is the stock market. But the troubling mortgage delinquency trend suggests that the indefatigable consumer does indeed get a little winded from time to time. And it’s looking like he might be getting a little winded right now – at the very moment that Alan Greenspan and a nation of hopeful investors expect him to start doing some heavy lifting. Investors might be asking too much.

********

Back in Paris…

*** Now that the euro is in use everywhere in Europe, it’s easier than ever to travel and spend money. The trip from Paris to Madrid involves no passport control and no currency exchanges.

Americans refer to the European Union contemptuously – "what kind of union can you have with so many different languages and cultures," they ask. But in a way, Europe has become what America was supposed to be – a huge free-trade zone made up of sovereign states, each one jealously guarding its right to shake down its own citizens.

*** Madrid is booming. At least, there is plenty of traffic… both automobile and foot. "In the last 5 to 10 years," explained my friend Juan Carlos, "Madrid has seen a lot of construction… the economy has been good. There’s a lot of money around." And a lot of ways to be separated from it.

We spent a night at the Ritz… an elegant old hotel near the Prado museum. I do not normally stay at hotels this expensive. Writing the Daily Reckoning does not pay that well. But it was Elizabeth’s birthday and she has some sentimental attachment to the Ritz from having stayed there many years ago.

"A few years ago," Juan Carlos had told me, "it was hard to get into the Ritz. They had a policy against taking in people they considered disreputable. American actors – for example – weren’t allowed to stay there. I think it was Gary Cooper or maybe Cary Grant… who was turned away. But if you were a colonel in the army – you were okay."

Times have changed everywhere. Now the Ritz in Madrid even lets your editor stay – at $572 per night!

From the hotel we went out to dinner at one of the oldest restaurants in the oldest part of the city. Walking back, we made our way along the crowded Calle de Plaza Mayor… and then took a dark, nearly-deserted street towards the hotel. Elizabeth suddenly felt a slight tug on her purse. She turned around and there was a group of gypsies… one, a short young man with greasy black curls had his hand on her purse. He retreated quickly, as I wheeled around.

There were no police around – just the two of us and a half-dozen gypsies. But even before I had fully realized what was going on the gypsies had drifted off across the road and were finding a new target…

If there is one group in Europe that finds few friends, it is the gypsies. They don’t vote; besides, there are not enough of them concentrated in any one area to turn an election. Nor have they moved into professions such as banking or share mongering. So, they have to get their hands on other people’s money by other means… taking it directly from their pockets.

Often, for example, you hear this announcement in the subways of Paris: "Attention, there are pickpockets in the station." People on the train know what it means. "Dirty gypsies… ," they mutter to one another.

Gypsies have created a special place for themselves in the economic jungle… and use a special logic to justify it. They are widely detested because they beg and steal. So, they feel entitled to take advantage of people – because they are despised by them!

"Hitler is supposed to have tried to exterminate the gypsies along with the Jews," explained my friend Michel recently. "But his views were as lunatic on gypsies as they were on everything else. He thought pure-blood gypsies were a form of ‘Aryan’… so he tried to exterminate only those who were of mixed heritage!"

There are plenty of gypsies left in Europe, generally making a nuisance of themselves. But at least they are not psychologists or rap singers…