Ruined by Good Luck

Not much action in the markets on Friday. The Dow was off 34 points. Oil slipped to $69. Bonds rose a bit. Gold and the dollar remained pretty much where they were.

The thought we kept having this weekend was an old one: that nothing is more dangerous than good luck.

As Bret Harte said, “The only sure thing about luck is that it will change.” And it certainly has a way of kicking you in the derriere.

If you’re lucky enough to win the lottery, you should watch your back. Almost all lottery winners are broke within a year or two. Many are broker than they were before they won the lottery. Because their good luck causes them to miscalculate.

There was a story about one lottery winner in the press here in London last week. He had won millions of pounds. Feeling lucky, he invested in a number of enterprises suggested by friends, relatives and total strangers – all failed. He married a much younger woman – who later left him (taking with her the house he bought for her). He invested on the advice of analysts and advisors – who naturally turned out to be idiots. And he lent money to people who, naturally, couldn’t pay it back. He was in the news because he had been arrested for attacking one of his old friends while trying to collect a debt (he needed the money to pay his rent!)

Evelyn Adams won the New Jersey lottery twice – in 1985 and 1986. Talk about luck! She won $5.4 million in total. But don’t go looking for Evelyn in a Beverly Hills or Palm Beach mansion. She lives in a trailer.

“Everybody wanted my money. Everybody had their hand out,” she says.

Or take the case of William “Bud” Post. He won $16.2 million in the Pennsylvania lottery in 1988. Think he’s fixed for life?

“I wish it never happened. It was totally a nightmare,” says Post.

Within a year he was $1 million in debt and had to declare bankruptcy. Now, he is said to live on food stamps.

Niall Ferguson explains, in his book, The Ascent of Money, that it was good luck that ruined the Spanish economy of the 16th century. Indeed, we passed along the same basic facts here in the pages of these daily reckonings. Ferdinand and Isabella kicked the last of the moors out of Spain in the same year they sent Christopher Columbus across the ocean blue. Getting rid of the Muslims was a net loss to the Spanish; the moors took with them money…and more important…valuable commercial skills. But when the conquistadors arrived in the new world, they hit the jackpot.

One mountain, Mt. Potosi, yielded 45,000 tons of pure silver between 1556 and 1783. ‘Valer un potosi’ is a saying that is still used in Spanish to describe something that is worth a fortune. Even before the mining began, the Spaniards had helped themselves to billions worth of Aztec and Inca gold. Gold and silver were real money back then. The precious metals entered the Spanish economy and quickly inflated the money supply…first in Spain and then throughout Europe. The cost of living in England, for which there are some price records, went up 700% during the “price revolution” between the 1540s and the 1640s.

The “free” money coming from the colonies financed about 40% of the Spanish government’s budget. But even with ships still bringing more and more gold and silver to Spanish ports, the crown still ran short of money. In 1557 it defaulted. And again in 1560, 1575, 1596, 1607, 1627, 1647, 1652 and 1662.

The US government now finances half its expenses with borrowed money. This is similar to the Spanish financing system, in that much of the money comes from outside the economy itself. But the difference is that the United States still has to settle up on its financing. Spanish gold was real money. It didn’t have to be paid back. It was “monetized” from the very moment it arrived.

US financing is more subtle, and more complicated. But it is made possible by an extraordinary luck. The United States has the world’s reserve currency…and the largest, most liquid economy. People put their money in US Treasuries because they are sure the money will be there for them when they need it. And they are used to a world of disinflation; interest rates and inflation rates have been falling for the last 25 years. And, inasmuch as the world economy is now in a deflationary correction, the risk of inflation seems very, very remote. So, for the time being, the United States seems to be able to borrow almost unlimited amounts of money at very low interest rates.

Though the fear of inflation is minimal right now, government’s deficit spending on this scale is bound to result in higher consumer price levels sometime. How long will it be before this good luck ends up kicking us in the derriere? How? We don’t know, but look at this chart that appeared in The Wall Street Journal. The United States has found its Mt. Potosi.

The US money supply growth was fairly constant for the last 45 years. Then, under pressure from the stimulus/bailout programs, it exploded. Art Laffer says it is meaningless to compare it to anything in our history; nothing like this has ever happened before. He argues that inflation this time could be much worse than the inflation of the ’70s, when the prime rate hit 21.5%. This is a new era!

“More Americans see sunny skies ahead,” says a headline in USA Today. Elsewhere, Bloomberg reports that consumer spending is rising.

The Wall Street Journal, however, reports that savings rates are going up.

How can consumers increase spending and saving at the same time? We don’t know. But the statistics are so jiggled and jived we have little faith in them.

The Richebächer Letter’s Rob Parenteau is scratching his head at this contradiction in trends. “Oddly,” he writes to his subscribers, “along with flat consumer spending, the gross personal saving rate has surged to nearly 7%, yet the unemployment rate has kept climbing. How is that combination possible? Specifically, where is the household sector getting the income growth to both increase saving and stabilize spending levels when job cuts remain alarmingly high?”

“If households try to hike their gross saving rate and the business sector does not increase its investment, then simple junior high algebra tells us that nominal incomes, especially profit incomes, will decline,” continues Rob.

“The only way to avoid this outcome is for the trade deficit to improve or fiscal deficit spending to increase. The trade deficit has come a long way, but it is starting to stall again as consumer spending stabilizes and the pace of inventory reduction slows. The existing fiscal stimulus will have to do the trick until the household saving rate stabilizes and residential and nonresidential investment gets some traction.”

In any case, be wary of statistics – they are furnished by government. And government has its own axes to grind and its own heads to cut off. For example, inflation numbers tend to be held down – in order to avoid costly adjustments to social security benefits. Unemployment statistics, too, tend to be understated. If joblessness was reported in the same way it was during the ’30s, the figures would be much higher. More on this in an upcoming Daily Reckoning.

Until tomorrow,

Bill Bonner
The Daily Reckoning