A Grand Illusion
"It turns out that the self-interest that Vauban has called the ‘father of war’ becomes, according to Wayne Angell, the principal rampart of peace."
John U. Nef
"In 1910, a book that had already had great success in England was translated and distributed in 11 different countries," writes a French economist, Philippe Simonnot. The author was Norman Angell, an economist with a worldwide reputation and a hot idea.
War, wrote Angell, was nothing more than a "great illusion." The illusion, according to Angell, was the "belief that steel and firepower alone protect people, whereas it is the force of Universal Credit that really muzzles the canon."
Much good has been attributed to credit. Recently, it is said to have saved the republic…indeed the entire world economy…from getting what it deserved. But nearly a century ago, Angell believed it could do what no balance of power, technology, nor treaty had ever been able to do – maintain peace.
Angell had a bestseller. He was, as subsequent events were to show, either at least 100 years ahead of his time…or out to lunch forever.
His argument was logical, reasonable…and preposterous. People made war, he thought, for economic reasons. They sought to get richer by taking something away from somebody else. But modern economies had become too complex and interdependent, he said; that strategy would no longer pay off.
"Wealth in the civilized world," he wrote, "rests on a base of credit and commercial contracts. If these are confiscated by a victor, the wealth, which depends on credit, not merely evaporates, leaving the victor nothing in exchange for his efforts, but it also pulls him down.
"It is impossible for a nation to enrich itself by subjugating another country," Angell explained. In fact, the only way he could avoid being dragged into an economic decline along with his defeated enemy would be "by scrupulously respecting the enemy’s property." Why then risk war?
Mr. Angell was an exception – even for an economist; he was such a good thinker he was dangerous.
Peek into the average brain and what you find is a collection of empty phrases and hollow ideas – strung together as though they were Christmas lights… illuminating about as much. A man may say that he is "for free trade", or that he is "against political correctness", or that he believes in democracy or value investing.
Polls show, for example, that nearly 100% of the population favors "education" and almost as many want to see more money spent on it. But few people actually take the time to learn anything. Instead, given a choice between watching television and studying…99.9% of the American population will choose TV.
Nobody believes that you can get rich by borrowing money…but almost everyone with an opinion on the subject seems to agree that low interest rates from the Fed boost the national economy and make people wealthier. And even staunch supporters of "free trade" can find dozens of reasons to make an exception – when the loot finds its way to their own pockets.
Put a man behind the wheel of an automobile – even a Democrat or a Gypsy – and you can usually trust his judgment. His miscalculations are few…and self- limiting. On the A-10 headed out of Paris on Friday night, for example – where the average speed is probably about 90 miles an hour in bumper-to-bumper traffic – drivers never make the same mistake twice.
But pluck him from his auto, put him in the State Department, on the Editorial Page desk or an internet chat-line, or at the Fed, and he is almost immediately transformed into a menacing idiot. He can go on for many, many years…rising in prestige and rank…based on the silliest and most puerile claptrap.
Which doesn’t mean he stops thinking. But it’s a different kind of thinking…about things he knows nothing about. Instead of thinking about how he’s going to get to work, how he’s going to balance his checkbook, or what he’s going to have for lunch…he begins to gab about foreign policy, credit patterns, military strategy, housing bubbles and the designated hitter rule…
Take Tuesday’s issue of the International Herald Tribune, for example (I always turn to the editorial page for a dose of absurdity): "Israel’s error: settlements, but no settlement" says Gershom Gorenberg. "Palestinians deserve peace but won’t get it this way" adds Jim Hoagland. "Sharon’s offensive must stop" and "Two takes on Enron" declare two other headlines. "Killing innocent people is not Islamic" writes the prime minister of Malaysia. The news and opinion is as entertaining as television…and just as valuable.
Of course, that’s what we do here everyday, too – kibitz about things we cannot see and cannot really know. At least we learned a long time ago that we do so with modest expectations. We cannot command, nor even predict, future events. But we must admit that it is fun to try.
Surely it was fun for Mr. Angell too. He gained an international reputation for providing a valuable service – he gave people a reason to believe what they wanted to believe. According to his logic there was no further reason to spend money on national defense. "Modern wealth has no need to be defended," he wrote, "since it can’t be confiscated."
He pointed out that even if Germany took over Holland intact, "not a single German citizen – except for the bureaucrats – would be enriched by a single pfennig." In fact, they’d be worse off, since they’d then have to compete with the Dutch merchant!
And what about getting tribute from the vanquished nation? Angell recalled that after the war of 1870, France had to pay huge penalties to Germany. What was the effect? The money could practically only be used to buy goods from France. So, "the war indemnities permitted the French to increase her exports to Germany…to the detriment of German industries," Simonnot elaborates. "Bismarck himself had commented on it and was publicly mortified."
What was the root cause of this astounding transformation? People had always made war; what was new? "The incredible progress of communications," Angell answered. And globalization! Only very recently, he explained, rapid mail delivery, as well as the instantaneous diffusion of financial and commercial information by telegraph, had changed the world. All of a sudden, people were manufacturing, buying and selling all over the world…with all sorts of different people. From the Hottentots of the Cape to the far away tribes in Borneo. Tea, tobacco, textiles, railroads – products were coming from nearly everywhere and nearly everybody seemed to be getting richer.
Who would want to disturb this peace and prosperity?
The German general, Bernhardi, complained about it. Pacifism was growing. People seemed unwilling to go to war…or even to think of it. "Growing wealth," he wrote, "causes us to live in the present; we no longer have the courage to sacrifice our pleasure for the realization of grand ideas."
Angell predicted peace. There was no longer any reason for war, he noted. But war, like love and markets, has a logic of its own. "War needs no particular motive," wrote Kant on the subject. "It seems to have its roots deep in human nature, appearing as a noble undertaking which brings both love and glory, but without any special benefit for anyone."
Four years after Angell’s book appeared the worst war in human history began.
Your editor…who promises an important distinction tomorrow: 2 different kinds of thinking…
April 04, 2002 — Paris, France
Addison was right. Yesterday was a good day to sit in the sun and meditate. Stocks fell. Gold fell. The only thing that didn’t fall was the confidence of consumeris americana termitanicus. As long as his house keeps rising in price, he’ll continue eating away at its value…mortgaging more and more of it in order to spend the money on things he doesn’t need. ("Auto sales continue to hold up," notes the LA TIMES.)
"The Houses That Saved the World," proclaims a headline in the Economist, "have helped to shelter the whole world economy from deep recession." Last year, the corporate sector suffered the deepest recession since the ’30s, but consumers hardly noticed. Why? Because in that same period house prices rose at their fastest-ever rate in real terms.
What a strange recession! Nothing seemed to go as it should. Typically, house prices fall – or at least go flat – in recession years. This is because recessions are usually brought about by higher interest rates, which are needed to fight rising inflation. But this time, inflation was not a problem. And interest rates fell. Instead of cutting off a housing boom – which is the ordinary way things work in recession – the 475 basis points dropped by the Fed acted like miracle grow. The tender, pullulating shoots of a housing boom grew like kudzu in a tomato patch.
And now that the recession is over, the whole world economy peers over the fence to see what will happen next. The kudzu has taken over the garden…
"To maintain the current pace of growth in spending," says the Economist, "consumers will need to pile up even bigger debts." But, as Eric notes below, it is getting harder and harder to pay the debts they’ve already got. Mortgage refinancing allowed consumers to spend, opines the Economist, "but such spending has literally been borrowed from the future."
So, Eric…what’s shakin’?
Eric Fry in New York…
– Oy Vey! What’s happening to the stock market? Yesterday, the Dow tumbled for the fourth straight session…and most folks are blaming the turmoil in Israel for the turmoil on Wall Street.
– There are probably a couple other, less sensational explanations for the sell-off – like rich valuations and poor earnings growth prospects, to name a few. But whatever the actual reasons, the Dow fell 115 points to 10,198, while the Nasdaq shed a little more than 1% to 1,784.
– Certainly, the nightmare unfolding in Israel is not helping the stock market. But when stocks trade for 40 times earnings, almost any reason to sell will suffice. Despite the escalating problems "over there," most investors think things are looking pretty good "over here." The stock-buying masses eagerly anticipate a new economic springtime in America.
– Unfortunately, we have not yet finished clearing away the dead wood of winter from many parts of the economy…and there’s a lot more of it than most investors care to admit.
– The dead wood takes on various forms: from excess industrial capacity to excess debt to excess beautifying of earnings.
– Excess capacity continues to plague the tech industry, in particular. Recalling the boom that sired today’s excesses, Jim Grant writes, "Under the influence of towering P/E multiples, all things seemed possible, including, a couple of years ago, the seductive idea that the demand for unlit fiber-optical cable would forever match the fast-growing supply. Such misbegotten investments founder when the cost of capital rises. Laymen call them ‘white elephants.’ The economists’ term is ‘malinvestments.’"
– The market price of fiber-optic white elephants continues to plummet. "In its fourth-quarter 2001 financial statement, Level 3 took an asset impairment charge of $3.2 billion," observes the Net Economy magazine. "[Telecom company] Level 3 devalued its fiber network by nearly $1.3 billion."
– "[M]etro and long-haul fiber networks are selling for 5 cents to 20 cents on the dollar, says Sean Doherty, a managing partner of Venture Asset Group, which finds strategic buyers for the telecom assets of distress companies."
– "’There are fewer and fewer buyers because of the spiral down in the telecom market,’ Doherty says, adding that the biggest problem is the lack of potential bidders. ‘It’s not a great situation,’ he says."
– There appears to be a bit of excess capacity in the airline sector as well.
– "Business travel, a major factor in a return to profitability for the airline industry, is recovering, but at the pace of a New York City traffic jam," the New York Times reports. "While overall passenger traffic has picked up and the industry appears to be slowly recovering, the weak economy…continues to depress business travel."
– "Demand is out there," Robert Baker, vice chairman of AMR Corp. tells the Times, "but at tragically low prices. No one can make money at these prices."
– And what about our excess debt – an issue that we may have raised once or twice in the Daily Reckoning? Surely the rebounding economy is helping to reduce our national debt burden. Think again.
– The household debt service burden continues to rise, says Charles Peabody of Ventana Capital. The Fed’s recently released numbers for the household debt service burden ratio show a distinct upward shift. The ratio of debt payments to disposable personal income now stands at 14.3%. Although not quite a record, it is the highest level in this indebtedness measure since 1986.
– What is somewhat more worrisome is that the ratio of mortgage payments to disposable personal income just reached a new high. "Despite the refi boom and falling rate environment," says Peabody, "the mortgage debt service component of the household debt service ratio hit a new all-time high and is still headed higher.
– "The consumer continues to leverage his/her balance sheet against inflating asset (i.e., rising residential real estate prices)," says Peabody. "This increasing debt burden and leverage puts the consumer in a precarious position should we experience any sort of economic downturn and/or deflation in housing prices." Rising interest rates certainly would not help.
– Ah, but why worry about such things? "Like fire and sex, credit is almost too wonderful," Jim Grant observes. "Producing wealth by work is hard. Conjuring up credit is easy."
Back in Paris…
*** Investor Business Daily’s Mutual Fund Index is down 4.3% for the year. That’s probably close to what most investors are getting. Unless things change, they’re headed for their 3rd losing year in a row.
*** But not all investors are doing poorly. Our own Lynn Carpenter reports that her "Core" portfolio is up 11.89%. And all her equity picks are up an average of 9.15% – nearly 3 times the Dow.
*** The poor Gypsies! Europeans think all Gypsies steal. "And not without reason," says the Economist. "…60% of the male inmates in Hungarian prisons are Gypsies, 12 times the national average. In Spain, where Gypsies account for 1.5% of the population, Gypsy women make up more than a quarter of the female inmates."
*** "I was almost pick-pocketed too…right here in Paris," said my friend Paul over drinks at the Paradis. "So, I went to a police office and filled out a report. I asked who was doing all the pick-pocketing. They said it was the gypsies. And you know what – the word for pickpocket in French is ‘voleur de roulotte’ – or a thief in a gypsy wagon."
*** "Across Europe," says the Economist, "Gypsy is another word for thief."
*** "They rent them, you know," said my friend Michel, my source for all manner of arcane information…"the gypsy children…you see the gypsies on the subway or on the streets all over Paris. They sit there holding a child in their arms, begging for money. Well, there’s a depot in the north of town where they have a whole bunch of these kids. The parents rent them out to the beggars. No…I’m not making this up…it was in the news."
*** All this talk about gypsies must be feeding prejudices, Stuart warns. He’s right about that. But a man who says he has no prejudices is a liar or a fool. He might just as well say he has no liver or no intestines. He may not want to talk about the work of these vital organs in polite conversation…but without them he could not function.
*** Likewise, a man would not last long without being able to guess and generalize about other people. You do not go to a black ghetto to find a won ton chef, nor to a Jewish ghetto to find a running back. Not that you couldn’t find them…but it would be a costly way to run a recruiting program.
*** "The first time I met a Gypsy was when I was in high school," recalls Doug Casey, "when a member of that tribe defrauded me in a car repair contract…" Gypsies, Tramps and Thieves…