“Bad economic booms tend to produce bad results…like runaway indebtedness and a plummeting currency. Do you happen to know of any large Western economy with these characteristics?
“Sometimes, the difference between a good boom and a bad boom is very subtle and subjective. A ‘bad boom,’ for example, might simply be a good boom that you failed to participate in. But usually, key fundamental differences differentiate the good from the bad. Bad booms tend to rely upon credit, for example, rather than earnings and savings. Therefore, when the inevitable bust occurs, credit becomes a four-letter word: Debt.
“When a nation of debtors finally exhausts all its sources of additional credit, it chokes on debt. The nation of debtors can no longer sell a house to repay its creditors. Instead, the debtors must simply work to satisfy their creditors. And that’s not all. Sometimes the debtors must work for cheapened money, but repay their creditors with expensive money.”
September 21, 2007
Keep reading today’s guest essay here:
And for the news from Short Fuse, reporting from Los Angeles…
Views from the Fuse:
Despite the Fed’s attempt to cushion the blow of a hard landing for the economy, Robert Shiller has recently pointed out that falling home prices could “prove to be the Achilles’ heel of this resilient economy.”
The Yale University economist told the Senate joint economic committee “the collapse of home prices might turn out to be the most severe since the Great Depression.
“The decline in house prices stands to create future dislocations, like the credit crisis we have just seen.”
A survey released today showed that a record 26% of Americans say that the value of their homes has fallen during the past year…and that’s just the percentage of Americans who actually know the value of their home has declined. There are countless others who have no idea how much their home is worth, or haven’t realized that their home may not be worth as much as they think.
Greenspan, who has been famously tight-lipped and cryptic in his comments pertaining to, well, just about anything, has been gabbing away about the economy this week. And what he has to say about the housing market is less than optimistic:
“So far, prices have dropped only slightly. But it was enough to cause alarm around the world,” he said in an interview with Austrian magazine Format. “Prices are going to fall much lower yet.”
“Thanks for telling us what you really think, Mr. Magoo,” writes Addison in today’s issue of The 5 Min. Forecast. “Too bad you waited until you had a book on the shelves before dispelling the myth of Fed supremacy you helped foment as its chairman.
“Wait, did we say that out loud?
Greenspan continues, “The Federal Reserve began a series of interest rate increases in 2004. We were hoping to bring the speculative excesses in the real estate sector under control. We failed. We tried again in 2005. Failure.”
“To his credit, Greenspan told USAToday earlier this week that Bernanke has a more difficult environment in which to make decisions,” says Addison. “Bernanke doesn’t have the luxury of cutting rates during every global crisis he will face…because if he does, the dollar will burn. Thanks again, Magoo.”
Keep reading today’s issue of The 5 Min.
While not much has been happening in the U.S. stock market after the initial buying spree immediately following the rate cut, over in the Far East, there seems to be a party going on…Free Market Investor’s Christopher Hancock reports:
“The Hang Seng index jumped 26% in just over 26 days. The reason: Beijing now grants Chinese citizens access to the Hong Kong stock market.
“Twenty-six percent in just over a month… They call this move the ‘train to HK stocks.’
“This market has room to run. Here’s why.
“The Federal Reserve: The Fed cut the interest rates 50 basis points this week.
“Remember, the Hong Kong dollar remains pegged to the greenback. This means Hong Kong dollar interest rates are closely tied to U.S. rates. A rate cut here should bode well for Hong Kong property stocks.
“Asian Development: The bank reports that Asia can now weather a slowdown in the [United States]. U.S. recession coupled with a 10% slide in the dollar would cut growth by only 2 percentage points.”
“It seems so obvious.”
Elizabeth was looking at the headlines from yesterday’s International Herald Tribune, and today’s.
Yesterday came the announcement: “Fed cuts key rate by half a point…”
Today’s news brings the follow-up: “Dollar pays price for Fed’s rate cut”
“It says the Fed is trying to save the economy from the housing problem…but I wonder how much of this rescue we can afford.”
An economic explorer…arriving, like Columbus, on the shores of our New World Financial Order…would be amazed, puzzled, impressed…and completely lost. He would see before him the most astonishing things…things he never before imagined or thought possible.
A whole civilization – the most advanced economic civilization of all time – resting on an almost miraculous money system. Everyone, everywhere uses the U.S. dollar as a reference, and a substitute, for wealth. It is taken by plumbers as well as by military contractors, drug merchants and oil drillers. It fills the coffers of Asian central banks and the mattresses of Ukrainian grandmothers. But what are these dollars really worth? And if you don’t know what they are worth…how do you know what anything else is worth?
Our economic Magellan is mystified. He is accustomed to looking at the stars. The stars may move about in the heavens, but their movements are known, reliable, and always the same. He only has to crane his neck and refer to his charts; thus does he get his bearings and plot his course. But what course can a modern investor plot out, when all he has to guide him is a piece of shifty paper?
The paper dollar was caught by a gust of wind yesterday…it blew down to its lowest level ever. Measured against the euro (EUR) it hit a new record low – worth less than $1.40. Measured against crude oil, it hit another new record low – worth only 1/83rd of a barrel. As for commodities generally, the dollar also registered a new record low – at 441 on the CRB index.
Gold, too, hit a new record high against the dollar – at $739.
[Incidentally, there’s a way that you can get gold out of the ground for a penny an ounce…and you can make four times your money even if gold doesn’t budge – although, the way the yellow metal has been soaring lately, the odds are pretty good in your favor.
It was not a new record…but still worth mentioning: the dollar fell to a 31-year low against its closest neighbor, the Canadian “loonie” (CAD).
This morning, we went to a neighborhood café…we had a croissant and a cup of coffee. Shortly after the euro was introduced, this breakfast would have cost us about $4. Today, it was $7. The euro traded as low as 88 cents to the dollar during the last years of the Clinton administration. Now, it is worth nearly twice as much.
(A few years ago, we guessed that the dollar would slip to $1.50/euro. We are now not far away.)
Cutting the fed funds rate, Ben Bernanke, former head of the economics department at Princeton and now head of the U.S. central bank, hopes to avoid a recession. Central bankers do not like recessions because politicians do not like recessions. Politicians do not like recessions because voters do not like recessions. But why don’t voters like recessions? Because recessions – which, by definition, are declines in national output – make people feel poorer.
But wait, says the Sebastian Cabot of the economic trade, isn’t everything Americans own measured in dollars? And if the dollar goes down, doesn’t that mean that all their assets and their earnings are going down in value? And if their assets and earnings go down in value…aren’t they, well, poorer?
“The world dumped the dollar Thursday,” begins the IHT account. “The day left little doubt that attitudes toward the dollar were evolving faster than most analysts had expected.”
Yes, dear reader, the dollar seemed to go into freefall yesterday. Ben Bernanke did nothing to slow it down; it was he who had kicked it out of the airplane! And with the falling dollar went down Americans’ real wealth. Today, they can buy fewer things with their money; they are poorer. Just how poor are they? From the time the dollar traded for 88 cents against the euro until today, an American has lost nearly 60% of his purchasing power in Europe. In the gold market, he has lost even more; his dollars from ’99 will buy only one-third as much of the metal. Even his house didn’t keep up – it is only up about 100%. At the gas station…his purchasing power is similarly reduced. And now, the foreigners are buying up his assets at cut-rate prices. (More below…)
Ben Bernanke’s bold rescue effort is a curious thing. The intrepid team of Lewis & Clark economists conclude: It seems intended to bail out the speculators on Wall Street…and the imprudent borrowers in the housing market…but it merely redistributes the losses onto the people who don’t deserve them – the general population of dollar holders, dollar earners, and dollar savers all over the world.
“What will the foreigners do with all those dollars?” we’ve asked ourselves on more than one occasion. China alone has about a trillion of them. And it is getting more at the rate of about $1 billion per day. The oil exporters, too, are piling up dollars. And now that the dollar is in the news (it has been falling for 70 years…while few noticed), the foreigners are probably getting edgy. “What to do with all those green pieces of paper?” they must ask themselves.
Well, along comes a headline with the obvious answer:
“Mideast states seize an opportunity,” it says in the International Herald Tribune.
As the dollar goes down, Americans become poorer…and their assets become cheaper. You can pick up things cheaply in the banana republics. People just don’t have much money. So too can you pick up things cheaply in the huge republic north of the Rio Grande, where they don’t even have bananas. Americans have plenty of debt; but they don’t have plenty of money. Ergo, their assets are becoming cheaper and cheaper.
Let’s put two and two together. The foreigners have huge piles of dollars, which are losing value. American industries and businesses are relatively cheap…and getting cheaper and cheaper (in foreign currency terms). Doesn’t it make sense for them to use the dollars to buy American assets?
The Arabs must think so. Few Americans can find Detroit on a map, let alone Dubai, Qatar and Abu Dhabi. Neither geography nor economy are required subjects in U.S. public schools. Not to worry. We have a feeling that they are about to learn a lesson about both. Now, the desert-dwelling moneybags are invading the United States. They are making offers on the NASDAQ…the London Stock Exchange…and the Carlyle Group, a U.S. buyout firm.
China, meanwhile, recently took a big stake in Blackstone (NYSE:BX), another big corporate chop shop. Buying up the buyout firms is a particularly important omen, we think. It allows the foreigners to take up more and more U.S. (and U.K.) assets without getting their name in the paper. And it allows Anglo-Saxons the soothing flattery of thinking that their assets are becoming more and more sought after…it takes their minds off the sour news, that foreigners are using their mountains of trashy dollars to get control over genuinely valuable assets…and that Americans will increasingly be working for foreigners…
Not that we have anything against foreigners. We love foreigners. We live among them. We have learned their languages and their ways. We can now report this from experience as well as from theory: they are every bit as dumb as Americans.
But we never thought they were dumb enough to sit on their Everests of green paper forever. If the dollar’s keepers won’t protect its value, why should they?
China…ah yes…China… is there anything so stupid that the Chinese will not give it a try? These were the people who put up with Mao, after all – and his Great Leaps…his backyard steel ovens…his agricultural policy…his Cultural Revolution. What will they fall for next?
Yes, the latest news from the middle kingdom tells us that the Chinese want to deal with rising inflation in the worst possible way. What would be the worst way you could possibly try to stop inflation? Price controls, of course. They have been proven…on many occasions…to do more harm than good. Therefore, it seems obvious that the Chinese would want to give them a whirl.
Emperor Diocletian used them to help screw up the Roman economy two millennia ago. Of course, Mao used them in China – to disastrous effect. More recently, Richard Nixon used them to whack the U.S. economy in the ’70s.
Price controls don’t work. It is obvious why they don’t work. They provide distorted information. Prices tell you something. They give you an idea of how much resources go into producing a thing…and how much people want it. If the difference between the cost of producing it…and the price for which it sells…is higher than the cost of capital, you know you should produce more (ceteris paribus…and keep your fingers crossed).
Impose price controls…and suddenly, you are the driving without GPS…without lights…at night…after attending the opening of a distillery.
You will make a wrong turn. You will run into something. In economic terms, you will become poorer.
Why then, do central bankers control the price of the one thing that is most important for economic decision-making? The Fed imposed a new price control on short-term credit on Tuesday. Tighten your seat belts, dear reader.
Enjoy your weekend,
The Daily Reckoning