An Embarrassment of Riches, Part I

As Bill pointed out above, our economy is in much worse shape than many are willing to admit. In Part I of a two-part essay, Dr. Marc Faber tells us that the signs of the U.S.’s economic weakness are all around us – you just need to know where to look. Read on…

An Embarrassment of Riches, Part I

I have to admit that while I have a lot of sympathy for some excellent economic analysts who think that the US economy is growing at between 2% and 3% per annum, I increasingly believe that there is a disconnect between official government statistics and private surveys, which has, in my opinion, to do with how price increases are measured.

As an example, the September 0.6% increase in retail sales simply doesn’t rhyme with data such as truck tonnage, railroad car loadings, state sales tax receipts, and the shrinking trade deficit. The American Trucking Association’s truck tonnage index is

2.7% lower than a year ago, and railcar loadings were down 2.8% year-on-year. (Also, in October, Ryder System – “R” – revised its earnings forecast, primarily due to lower expected results in its US Fleet Management Solutions business segment.)

The decline in volume of freight shipped is also confirmed by the Cass

Freight Index, which peaked out in June 2006. According to, Cass Freight Systems is a “freight payable processor” that deals with 1,200 divisions of 400 individual companies representing a broad spectrum of industries; therefore, the company has a very good feel for the flow and character of the US freight industry. (Part of the decline in the Cass Freight Index since June 2006 may have been due to the decline in energy prices in the second half of last year, but with energy prices now back to peak levels the index has failed to approach its 2006 high. Shipments by Canada’s largest railway, Canadian National Railways, which derives 33% of its revenues from the US, are down 12% year-on-year.)

In theory, it could be that trucks and railroads are suddenly carrying fewer but higher-value goods, but a more likely explanation is that volumes are down but prices in retail stores are up, which explains the surprisingly strong September retail sales. But even if this were the case, it doesn’t tally entirely with the declining trend in states’ sales tax receipts. In California, September’s sales tax receipts were down 7%, compared to the previous year. One possibility we shouldn’t exclude is that the economic condition of US households has deteriorated to the point where they are curtailing the purchase of discretionary items, which are subject to sales taxes, but increasing the dollar sales of groceries, due to price increases (not because of an increase in volume).

Since a large number of groceries are sales tax exempt, their price increases can boost retail sales while at the same time – due to the deficiency of demand for discretionary consumer goods – sales tax receipts decline.

I should just like to emphasize once again what I have said before, which is that cost-of-living increases for households bear no resemblance to “core inflation”. I recently asked a level-headed friend of mine who lives in London (the UK should have a lower inflation rate than the US, given its strong currency) to estimate his cost-of-living expenses increase (in short, his inflation rate). After checking with his wife, he told me it was 8.6%. Then, over a drink in Hong Kong, a rather intelligent woman told me that her grocery expenditures had recently increased by 15%. (Since Hong Kong’s currency is pegged to the US dollar, its inflation rate should be similar to that of the US.) Also, if in the Euro Zone, whose currency has appreciated by more than 40% against the US dollar since 2001, price increases seem to be higher than in the United States, one has to wonder about the reliability of the Bureau of Labor Statistics’ data.

Other signs of economic weakness in the United States include car sales, which are down year-on-year, and imports, which have slowed. In August, inbound containers at US ports were down year-on-year by more than 1%. (At Los Angeles-Long Beach, inbound containers were down 7% in August.) Fred Hickey notes that the North American semiconductor equipment book-to-bill ratio collapsed between June and August. The same seems to have happened in Japan, where the semiconductor equipment industry reported “a free fall” in its book-to-bill ratio, from 1.02 in June to 0.88 in July. (Another indicator that all is not well in tech land is that Taiwanese direct exports to the United States were down year-on-year both in August and September.) According to Fred Hickey, “the declines in these forward-looking indicators are warning that industry revenues and earnings are about to fall off sharply worldwide. It fits with all the other data we have. The memory markets are glutted with capacity and prices are falling.”

According to Fred, “bulls have been hanging on to their semiconductor equipment stocks all year despite deteriorating market conditions”. Not surprisingly, Fred holds several put options on tech related stocks, including Apple (NASDAQ:AAPL), Research in Motion (NASDAQ:RIMM), Amazon (NASDAQ:AMZN), Applied Material (NASDAQ:AMAT), and Texas Instruments (NYSE:TXN). I might add that, despite all the bullish comments about high-tech stocks, the Philadelphia Semiconductor Index (SOX) is down 11% from its June 2007 peak, while the NASDAQ 100, driven by a few stocks such as Apple, Google (NASDAQ:GOOG), Research in Motion, Garmin (NASDAQ:GRMN), Wynn Resorts (NASDAQ:WYNN), and Amazon, whose combined weight in the index accounts for more than 23%, has risen by 20% since the August 16 low. It would seem to me that the performance of semiconductor stocks is a better leading economic indicator than a few momentum-driven concept stocks.

Another indicator of an economy that has slowed to a crawl, or is already, as I believe, in recession, is the shrinking trade deficit. But, not to worry! With Mr. Bernanke at the Fed and Mr. Paulson at the Treasury, both of whom are well-advised by the Wall Street elite, “there have been extraordinary rises in the quotations for all shares, the chief cause being the catastrophic change in the economic situation”. More to the point, the recent strength in the stock market has been due, as Bill King pointed out, to “the Fed creating credit at banana republic-like rates”. Since August, the compound annual rate of change of MZM of the average four weeks is 24.3% and for the third quarter it is 18.7%.

I should like to add one more thought. It is, of course, “slightly” embarrassing for a government that the stock market is at an all-time high while the median household is struggling with illiquidity. According to Greg Ip, writing for the Wall Street Journal, the wealthiest 1% of Americans earned a record 21.2% of all income in 2005 (it is likely to be even higher today), while the bottom 50% earned just 12.8% of all income (lower than at the peak of the stock market in 2000). Greg Ip also quotes a study by University of Chicago academics Steven Kaplan and Joshua Rauh, which “concludes that in 2004 there were more than twice as many such Wall Street professionals in the top 0.5% of all earners as there are executives from nonfinancial companies.

Mr. Rauh said ‘it’s hard to escape the notion’ that the rising share of income going to the very richest is, in part, ‘a Wall Street, financial industry-based story.’ The study shows that the highest-earning hedge-fund manager earned double in 2005 what the top earner made in 2003, and the top 25 hedge-fund managers earned more in 2004 than the chief executives of all the companies in the Standard & Poor’s 500-stock index, combined.” (According to Ip, “IRS data show that the median tax filer’s income – half earn less than the median, half earn more – fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881.”)

Because of this “embarrassment of riches” in the financial sector while the middle class and the workers struggle, one can safely assume that the US government and Wall Street will have the tendency to paint the economic picture for the average American household in a favorable light.

Following the August 16 low, the recent rally in equities led to new highs in several indexes and individual stocks. The S&P 500 is, as of this writing, up 10% year-to-day, but in Euros it is up just 2.44%. From the August low the S&P 500 is up 11% and 5.9% in Euros. However, it is down in Euro terms by 4% from its June high (high in Euros was in June). Gold has appreciated by 21% since the beginning of the year, and by 14.7% since the August 16 low. (Since the beginning of 2001, gold is up by 194%.)

Money has three principal functions. It is a convenient “medium of exchange”, “a unit of account”, and a “store of value”. The “store of value” function requires that money can be reliably saved, stored, and retrieved, and that it is predictably useful when it is retrieved. (Purchasing power should have been maintained.) As a “unit of account”, money is a standard unit of measurement for the market value of goods, services, and assets. It is also a measure or a standard of relative value and deferred payment, which is necessary for the formulation of commercial agreements involving debt.

In last month’s report I described the hyperinflation in Zimbabwe and how the Zimbabwe dollar had entirely lost its “store of value” function and had also become largely useless as a “unit of account”. I might add that in all the hyperinflation economies I have looked at, sooner or later goods, services, and assets were valued in a strong foreign currency or in gold. Has the time now come where we should consider gradually presenting US economic statistics such as GDP, and assets such as bonds, stocks, and real estate, in a strong currency such as the Euro or in gold? This would bring to light a totally different economic performance of the United States, and of its asset markets, since the expansion began back in November 2001. In both Euro and gold terms, the economy wouldn’t have expanded, but contracted. Bonds and cash, as well as most equities (but not resource, material, and oil stocks), would have provided a negative return.

I am fully aware that my economist friends will shake their heads at this heretic thought and doubt my sanity. They will argue that employment is up since the expansion began, and that this is a good indicator of an economic expansion. To this I shall respond, “Yes, employment is up, but far less so than in previous expansions since the Second World War.” Moreover, I shall also point out what kind of employment is up. For September

2007, healthcare employment is up year-on-year by 494,300, to a record high of 15.4 million. Restaurants and hotel employment rose year-on-year by 367,000, to a record of 11.6 million. Professional and business service payrolls added year-on-year

314,000 jobs, to a record of 17.9 million. Retail employment fell moderately to 15.3 million.

Manufacturing employment continued to slide to 13.9 million (year-on-year, manufacturing has lost 223,000 jobs). In construction, residential specialty trade, contractors cut 15,000 jobs in September and more than 160,000 since February 2006. Moreover, as Bill King reported, the Bureau of Labor Statistics announced that the next benchmark revision will show that March 2007 payrolls were overstated by roughly 297,000 jobs.

King: “Please take a minute and think about the absurdity of suddenly producing better than expected NFP [non-farm payroll] growth with upward revisions of the past few months and at the same time admitting that prior NPF growth was overstated by 297,000!!!!” King then quotes John Williams, who believes that “these data from the BLS are nearly worthless as economic indicators and are highly suspect, given the global financial markets in ongoing crisis and given the positive ratings of U.S. President and Congress hitting historic nadirs. The reported numbers continue to run counter to better quality employment indicators such as new claims for unemployment and the collapsing help-wanted advertising index.”

I find the BLS data more useful than John Williams, for the simple reason that they reveal what kind of a consumer-oriented economy the United States really is. Sure there are numerous productive jobs among the healthcare, retail, hospitality, and business service payrolls, but the majority is geared towards consumption, which raises another question about the economic growth of the United States. Is consumption equivalent to economic growth, or rather, is a consuming economy contracting?


Dr. Marc Faber
for The Daily Reckoning
November 20, 2007

P.S. Tune in tomorrow for the conclusion of this essay…

“Radioactive Paper” is how Forbes describes it.

Forbes referred to various forms of securitized debt, of which subprime CDOs have probably gotten the most media attention.

You’ll remember how we got to into this mess, dear reader. The whole thing was chronicled in these Daily Reckoning pages. Thanks to a mixture of good luck and bad management, the United States was able to heat up the entire world economy. But now, it’s in hot water itself. Americans are up to their necks in boiling debt while Wall Street has its vaults stuffed with the kind of debt that sets off Geiger counters.

The warnings began earlier in the year. But it was only this summer that the indicators flashed a “Meltdown” signal. Since then, the papers have been announcing one calamity after another. We’re going to skip the details and go right to the big picture…

The big picture is this:

  • The United States has a consumer economy…70% of GDP is consumer spending
  • 20% of the entire world’s spending is done by Americans
  • Americans counted on house price increases…not only for current spending but for future spending; they expected to retire on them
  • Now that house prices aren’t rising…something has to give

A pause: Here’s Money Magazine’s Myth #13 about retirement from their recent “Retire Rich” issue:

“Treating your house as the ultimate retirement insurance is an easy trap to fall into. Even with the housing market in the doldrums, the five-year real estate bull market has likely left you feeling house-rich. According to a 2004 study by the National Economic Bureau, upper-income boomers ages 51 to 56 have a third of their net worth invested in their principal residence.

“As recently as May, a survey of affluent boomers by financial adviser Bell Investments Advisors found that nearly 70% were relying on their homes as a retirement asset. Question is, will the strategy work? The answer is, not that well.

“Why? Because it’s hard to eat out on your home equity. You have to live somewhere. To turn your equity into cash, you can sell and then rent, move to a cheaper area or downsize. Most retirees prefer to stay put. Yes, you can do what a small but growing number of retirees are doing: Get a reverse mortgage, which is a loan against the value of your house that you don’t have to pay back. (When you die or move out, the loan is paid off by the sale of the house, which means you may not be able to pass the home on to your children.)

“But these loans give you much less than the value of your house. For homeowners ages 62 to 69, lenders will typically let you borrow just 49% of your home equity, says Wharton finance professor Nicholas Souleles.

“The best way to look at your house is as a place to live, not a retirement account. So in the years leading up to retirement, don’t over-invest in it with the idea that you can get that money out later. Keep your mortgage and other housing expenses to no more than 28% of your income, and don’t prepay your mortgage instead of saving for retirement.”

Back to our discussion:

All this has been obvious to us for a long time. Still, until this summer, nothing gave. Consumer spending continued to rise!

But now, the latest news is that consumers are finally slacking off. Auto sales are plummeting, for example.

Of course, the first thing to go was spending on houses itself. The builders got nailed. And then, the people who financed the builders…and who lent mortgage money to borrowers who couldn’t pay it back. But nobody seemed to care…until the ‘radioactive paper’ – derivatives based on mortgage debt – started to melt down. All of a sudden, a ‘Credit Crunch’ was in the headlines…and Wall Street was on the phone to central bankers.

At first, hardly anyone knew what a credit crunch was. People thought it was a new breakfast cereal. The newspapers had a problem with the story from the get-go. They didn’t know whether it should run in the finance section…or the Police Blotter. Subprime lending could have been a crime story…or a financial accident; they didn’t know.

Then, the banks began to announce losses…and the numbers grew. A hundred billion here…a hundred billion there…pretty soon, we were talking about real money.

The latest estimate comes from Goldman Sachs (NYSE:GS). Goldman says total losses from subprime lending will hit $400 billion. But the golden boys go on to say that the losses to the economy will rise to $2 trillion.

Ah, yes, dear reader. That is how a credit crunch works. When credit is expanding, a relatively small amount of money is leveraged into a big amount of money. A borrower might use $100 million deposit, for example, to anchor a loan for $1 billion. But when credit contracts, leverage works in the opposite direction. A hundred million of capital disappears…and the $1 billion of loans are withdrawn. Altogether, Goldman expects $2 trillion in cash and credit to evaporate.

This is bad news for the U.S. consumer…and for the people who sell him things. Already, there is “alarm at rising U.S. car loan defaults,” says the Financial Times. And gasoline in the United States rose 13 cents in the last 2 weeks.

And, remember…the consumer has to eat! Food prices have been going up five times faster than the reported CPI.

Give them enough time and even economists can put two and two together. Now, more and more of them are predicting a recession. And everyone has his eyes on the holiday sales figures.

But…and here is a fairly big but…a Texas-sized but, in fact: so far, the stock market has edged down…but it has not crashed. Our ‘Crash Alert’ flag is still flying. And we’ve had some exciting 300+ point declines. Just yesterday, the Dow went down more than 200 points. But no crash.

You’d think investors would want to get out. You’d think they’d at least want to watch what happened from the sidelines for a few weeks. But so far, we’ve seen only a steady retreat…no panic. No crash. No collapse.

The old market hands are wondering…what does the market see? How come it doesn’t correct in a major way? Do investors really think that the declining dollar will save them…? Are they expecting another big rate cut from the Fed (Bloomberg says another 3/4 point is coming…)? Do they think it will all blow over…instead of blowing up?

More tomorrow…and the day after…and the day after…

Here, we stroll…perambulating and cogitating…with reflections that bounce back on one another.

The subject is contrarianism. We know it works in the investing world. “Buy when blood is running in the streets,” was how Jacob Rothschild put it.

But if it works in investing, how about the rest of life? “You are either a contrarian…or you are a victim,” says our old friend Rick Rule. Crowd followers are the victims of the financial markets. Last week, we saw how ordinary soldiers are the victims of wars. Today, we walk a little further down this hall of mirrors…hoping to see something new.

We watched a little television while we were in Ireland. A group of grown Englishmen caught our eye. They were jumping up and down like children…whooping and clapping… What were they so happy about? Their team had won. They had won. They were winners. They stood taller. They were prouder. There was real joy in Mudville.

The men didn’t look like winners. They looked like losers. They were out-of-shape…poorly dressed in tee-shirts and jeans…with stupid expressions on their faces. And yet, as if by a miracle akin to transubstantiation, they were made winners… What had they done? Nothing. What merit or skill had they revealed? None. And yet, they felt like winners, simply because the home team had scored more points than its opponents. They were fans caught up in sports…emotionally and intellectually. Far more mental energy goes into second-guessing coaches at sporting events than went into the Brandenburg Concertos or War and Peace.

“You know,” said Elizabeth, “you risk becoming so alienated you can’t take part in these things…and you can’t enjoy them. You risk putting yourself so far away from everyone else that you are like a man with his nose against a pane of glass…like Frankenstein’s monster…looking in at the human race. It will be very lonely…

“You might also think of Rhett Butler in Gone with the Wind. Now, there was a real contrarian. He knew the war was a lost cause. He urged his fellow southerners not to go to war in the first place. Then, instead of joining up himself, he profited from the war…he was a blockade runner, remember? But even he couldn’t stay out of it for long. Near the end, when the Great Cause was almost lost, he joined the Confederate Army. He didn’t have to. He knew it was hopeless. But he did it.

“It is all very well to be a contrarian…but we are human too. And humans operate on instinct…what’s more, many of those instincts are noble and good. You don’t want to put yourself at too great a distance from those instincts…or you will cease being human at all.”

A Greek philosopher – we can’t remember which one – argued that the greatest curse a man can suffer is to be married to a smart woman. She will laugh at his pretensions and find the flaws in his arguments. No, what a man needs is a good woman…he said, one who makes cookies and looks adoringly at her husband, as she would at a cocker spaniel.

But the Greeks were wrong about a lot of things. A smart wife is a man’s greatest protection from his own absurd logic and his own preposterous vanity. She will point out that he is a fool…and he will see that she is right.

Contrarianism, as a philosophy, only takes us so far. (We are not contrarians…long term Daily Reckoning sufferers will remember. We are Essentialists. Distill the transaction down to its bare essentials, we say. Then, find the rule that governs it. More on that when we have nothing better to do…)

Getting back to our subject…modern wars, often, are like sporting events. There is a logic to them. But we are often as bamboozled by own logic as we are misled by our instincts. Take the American Revolution, for example.

The history books tell us that it was a war of liberation. ‘No taxation without representation,’ was the War Party’s cry. And yet, an Englishman lays out the facts:

“One of the great ironies of the American Revolution,” writes Martin Hutchinson, “is that the colonists, who rebelled against British-imposed taxes lower than those of the mother country, were in reality living in the lowest tax polity in the history of civilized mankind. Needless to say, once the United States had achieved independence, the taxation on its people was never as low again, even though for the country’s first century and a half most U.S. governments pursued admirably frugal policies.”

The Founding Fathers were driven by their own instincts and deceived by their own logic. It happens to the best of us.

More to come…

Bill Bonner
The Daily Reckoning

The Daily Reckoning