A Different World

“It is a different world now, but not a better one.”

Jim Davidson

People still cue up to buy expensive coffee, Eric reports. Restaurants in the New York area are “packed to the rafters,” he observes. Will they continue spending as before? Or is it really a different world…where people have suddenly become more cautious, less confident of the future?

“As far as I am concerned,” writes Stephen Roach, economic strategist for Morgan Stanley, “this shock seals the fate of the American consumer, who was already beginning to labor under the pressures of depleted saving, record debt burdens, negative wealth effects, and rising unemployment…And now a devastating shock hits…a lethal combination for the American consumer. Any residue of consumer support for the U.S. and global economy – both for discretionary spending as well as for housing-related activities – is likely to be a victim of the staggering events of 11 September.”

God still does not share his plans with me, I remind myself and you. But nor does he forbid a guess. My guess is that the consumer, who was being forced to cut back his spending a week ago, will now cut back willingly.

Earlier this week, a gang of men armed only with knives and carton cutters inflicted more casualties than Japan’s entire Pacific Fleet at Pearl Harbor. Lacking long-range bombers, they improvised. They made bombers out of commercial airliners – and drove one of them straight into the Pentagon.

Even at the Defense Department, the promises of new technology have turned out to be hollow. Despite billions spent on information technology, and a team of thousands of highly paid specialists on the job – no one seemed to know anything. At least, they did not know what they needed to know.

Americans are gradually coming to realize that their confidence was misplaced.

“What was built up in the Unites States during the past few years was grossly unreasonable confidence in non- existing ‘new paradigm’ miracles,” wrote Dr. Kurt Richebacher last month.

It was upon this pad of “new paradigm” mush that consumers constructed their hopes for the future. The U.S. was the only world superpower – and thus faced no serious threat. Stocks would rise, over the long term, because that’s what stocks always seem to do, they reasoned. Real estate, too, was destined to go up – for who, except in isolated instances, had ever seen it go down? Incomes would rise year after year in an economy that – thanks to leadership from the Fed – never suffered a serious setback.

As confidence grew, dangers grew too. Defense experts came to rely more and more on high-tech gadgetry – like spy satellites – rather than on the dirty and dangerous work of traditional espionage. Financial institutions placed more and more faith in sophisticated derivative contracts, which they used to replace actual financial reserves as a source of security. And consumers turned away from savings, putting more and more trust in credit, which was eagerly supplied by credit card mongers and mortgage lenders.

Could it be that – when push comes to shove – derivatives offer little more protection than spy satellites?

And might not credit prove to be a less reliable source of financial security than savings? The answers should be forthcoming. In the meantime, the Fed is doing all it can to keep the money flowing and keep consumers buying. On Wednesday alone the Fed purchased $38.25 billion of securities – a sum of money equal to the entire estimated income tax rebate.

But, “this time, it is very different,” writes Dr. Richebacher. It was different even before the terrorists launched their attack. It is even more different now.

“Between 1995-2000, broad money increased $2,470 billion, or a 10.6% rate,” explains Dr. Richebacher. “During the first half of 2001, M3 has grown $400 billion, or a 13.7% annual rate.”

Growth in the money supply in the last six months equals the entire growth in M3 for the five year period 1990- 95.

Where is all the money going?

The Fed has been doing what it does best – increasing the money supply. But, for the first time since WWII, it isn’t working. “Six months of big rate cuts [and big increases in the money supply] have completely failed to reinvigorate the financial markets…” Dr. Richebacher continues, “It means that the key components of the transmission mechanism between monetary policy and the economy are flatly paralyzed. It should alarm [economists] by now that such runaway money and credit creation displays zero effects not only on the economy but also on the markets.”

Why no reaction? What’s different?

What is different is that consumers, businessmen and investors have changed what economists call their “liquidity preference.”

“Expressing it in popular technical jargon,” writes Dr. Richebacher, “the soaring money supply evaporates in sharply declining money velocity, more than offsetting the exploding credit and money expansion, thereby robbing them of their regular economic and financial effects. Collapsing money velocity is, in actual fact, the outstanding typical feature of every severe economic crisis, just as its sharp acceleration is typical of every runaway boom.”

In a boom, people spend. In a bust, they spend less readily; cash, which passed through their hands so quickly in the boom phase, begins to hang around a little longer.

And, suddenly, it is a different world.

Bill Bonner
September 14, 2001

P.S. I’ve asked Dan Denning, of the Daily Reckoning investment team, to prepare an analysis of the markets before they open on Monday… I’ll send it to you later today.

“I’m telling all my friends to buy a stock as a patriotic symbol,” Money.com quotes a man who just might, possibly, be long.

What a week.

Yesterday, European markets bounced off their lows. In Japan, stocks rose 4%…after hitting lows that brought the Nikkei September futures to 9620…just 16 points above the Dow.

The bond market was open in New York yesterday and the yield on the 10-year T-note fell to its lowest level since it was introduced in 1972. Yields on 2-year notes traded as low as 2.98% – its lowest point since 1958.

All eyes that are not on the terrorist attack and its aftermath are, still, watching the consumer.

Reports of people backing out of deals…of empty shopping centers…of silent malls…are beginning to make their way into the press.

“The negative shock to consumer confidence could well be the transforming event of this business cycle,” writes Stephen Roach from his hotel room in Milan. “It takes the fundamentals of an already weakened U.S. economy from bad to worse. Before the shock of 11 September, America had moved to the very brink of [recession]. This tragedy could well be the tipping point for the recession of 2001.” More below…

(I was relieved to hear from Roach…many of the best-known analysts and commentators have their offices in the World Trade Center. How many of them are still alive?)

“It’s tempting to model the current set of circumstances after those that prevailed a decade ago – before, during, and after the Gulf War,” Roach continues. “That shock, of course, toppled an already weakening U.S. economy into brief recession. For Americans, the Gulf War was an external shock halfway around the World. The tragedy of 11 September is an internal shock that shatters a sense of security at home.”

Eric, your report?


Eric Fry in New York:

– World stock markets seemed to stabilize yesterday. Most Asian markets advanced a little, while most European bourses gained 1% or so. The UK’s FTSE 100 has reclaimed nearly all of the ground it had lost since the attack.

– Here in the U.S., the stock market remains closed while the individual tragic tales are surfacing of lives lost and of the devastation inflicted upon the victims’ families. Their pain is extreme and will be long-lived.

– The rest of us should be contributing assistance and prayers on their behalf, as my colleague Christoph Amberger has urged:

– For us surviving New Yorkers, shock is the word which best describes our emotional state. But from an economic point of view, losing the World Trade Center and several surrounding buildings may be no worse than a pinprick.

– It does not trivialize the excruciating bereavement that thousands of American families now endure to observe that “life goes on.” And our economic life goes on whether we like it or not.

– Those of us who invest for a living will continue to assess risk and reward, and respond accordingly. As Bill and I discussed yesterday, maintaining a disciplined, long-term focus will serve investors well amidst these turbulent times and volatile markets. And yet, handicapping the stock market’s near-term prospects can be a helpful exercise.

– In an attempt to figure out how stocks might respond to our current crisis, Gibbons Burke, editor of MarketHistory.com, examined “six major surprise acts of war-like aggression or terror on U.S. property, territories, or citizens which led to declarations of war.”

– In each of the instances that Burke examined, the stock market had gained ground within two years. For example, two years after Germany torpedoed the Lusitania in 1915 the Dow Jones Industrial Average had advanced more than 40%. Perhaps more surprisingly, two years after the Pearl Harbor attack in 1941, America was still heavily engaged in WWII. Yet the stock market had gained more than 13% since the attack.

– To summarize his findings, Burke quotes H. L. Mencken saying, “In no other country known to me is life as safe and agreeable, taking one day with another, as in these states. Even in a Great Depression, few if any starve, and even in a great war, the number who suffer is vastly surpassed by the number who fatten on it and enjoy it.”

– In the midst of the current crisis, Mencken’s observation seems rather callous. But it might just be true.

– So much for precedent. What about our richly valued stock market? What about falling corporate earnings? What about an increasingly cautious U.S. consumer who might start reining in his consumption? Won’t Tuesday’s disaster plunge consumer confidence and spending into a deep freeze, as Bill suggests? Won’t Americans in general become more conservative, both in their consuming and in their investing?

– Expecting a slowdown seems reasonable. It would be hard to expect otherwise. But then again, I did not expect the line of people waiting to order espresso drinks at the neighborhood Starbucks this morning to be snaking out the door.

– Nor did I expect a friend of mine to tell me that life on Manhattan’s Upper East Side and Upper West Side appears outwardly unchanged. “Expensive restaurants are packed to the rafters,” he reports. The sidewalk cafes are crowded with people sipping iced teas, while taking in the spectacular weather.

– Central Park is filled with the usual bustle of rollerbladers, cyclists, and nannies pushing baby strollers. But for the occasional fighter-jet rocketing across the sky, everything seems “normal.”

Life goes on.

– The economic challenges besetting the American economy have not gone away. But that does not mean that Tuesday’s terrorist attack will push us into an abyss. Could it be that the American economy will just muddle along? Come what may, good stocks tend to go up and bad stocks tend to go down. We’ll keep looking for the former, while trying to avoid the latter.


Bill in Paris:

*** The bells of St. Merry’s and all of the churches of Paris are ringing. I will cease typing…while France observes 3 minutes of silence.

*** Silence is unsettling. I looked out the window at the rue des Lombards as the city came to a halt. There is a new chill on the city. Wet leaves compete with sodden trash for space on the sidewalk, and a cold wind blows.

*** But, life goes on.

The Daily Reckoning