From Tandil, Argentina, comes an arresting story.
A man walked into a bank armed with a hand-grenade. He meant to leave the bank with more money than he entered with. In that sense, he was no different from any other man pulling a bank job. In fact, he could have been any one of us, couldn’t he? Who hasn’t tried to rob a bank at least once in his life?
What made him unusual – and of interest to us here at the Daily Reckoning – was that the money with which he intended to leave was his own.
Such is the state of things on the pampas that bank depositors are forced to resort to extreme and controversial methods to make withdrawals. That is what happens in a real slump, dear reader: Forget about making a profit on your money…you’re lucky if you can just get it back.
Argentina is in the midst of a financial crisis. So many people want to get their money out of banks…out of pesos…and out of Argentina…that the government has imposed a ban, limiting the amount a person can withdraw. The bank tellers in Tandil tried to hue to the law, even with a grenade in front of them. They dutifully called the head office in Buenos Aires and asked permission to give the poor man his money. Finally, the clerks gave him his cash (which he needed to pay for medicine)…but also called the cops, who collared him soon after.
Markets are like electric fences, we think.
But are investors sheep? Certainly, for many investors, calling them dumb as sheep slanders the mutton. But on the whole, men, like sheep, get along and go along with whatever wishful thinking is popular at the time. Like sheep, they tend to roam around haphazardly most of the time…and eventually go too far, needing a good jolt to bring them back where they belong.
You may protest that men are not sheep…because men have the power of reason. Thus do we flatter ourselves, dear reader. What process of reason would lead a man to buy a stock such as Webvan? Or to attack Russia? Or declare war on the U.S. while already conducting a war against both Russia and Great Britain? Or go to a Britney Spears concert? What reason could produce parachute pants, Michael Jackson, Survivor, P. Diddy, the anti-globalization movement, Marmite, Rosicrucianism, and andouillette sausage?
I could go on. But you get the idea. Most of the things that most people value in life has nothing to do with reason.
Even the U.S. dollar is a stranger to reason. It is nothing but a piece of paper, an "I.O.U. Nothing" from an issuer who retains both the right and the power to renege at any time. As General DeGaulle noticed back in the early ’60s, the U.S. can pay off its debts in dollars. Who determines how much those dollars are worth? Americans do…up to a point. Why do people accept them? Indeed, why have they favored them, over gold, for more than two decades?
Because, because, because, because, because…We humans think. But our thoughts are little more than arrieres pensees – after the fact justifications, excuses, simplifications and bowdlerizations of reality. The explanations work – until we make the fence.
South of the Rio Plata, Argentines have already run into the electric fence. They are shocked to discover that their currency has lost 40% of its value in the last 3 months.
We Americans are still smug.
Of course the Argentines are in trouble, says U.S. Treasury Secretary Paul O’Neill, because they tried to operate an economy without producing anything for export. No one seems to notice or care that America’s number one export is dollars – with which we pay for the growing list of things we don’t produce.
The difference between what we export and what we import grows almost daily. It is nearing half a trillion dollars a year. This is the amount by which America’s net debt to the rest of the world grows.
One of the most remarkable features of the recent recession (it is over now, isn’t it?) was that U.S. indebtedness continued to expand…even as the economy shrank.
"Looking back," writes Dr. Kurt Richebacher, "1998 stands out as the great inflection point in the U.S. economic and financial development under Mr. Greenspan. From then on, everything went to new extreme excess, particularly the financial system. Over just three years, from mid-1998 to mid-2001, financial and nonfinancial borrowing erupted $6.5 trillion, or 36%…
"Leaving the New Economy propaganda aside, what was the most momentous change in the U.S. economy after [the LTCM bailout in] 1998? One thing: the literal collapse of personal saving from $311 billion, at an annual rate, in the 3rd quarter to virtually zero in 2001, reflecting the wildest consumer borrowing and spending binge in history.
"What we are witnessing since then is unprecedented in history: an economic slide into recession with exploding credit."
But no matter which side of the equator you stand on, you cannot get rich by borrowing and spending. You get rich by saving and capital investing. Honest businessmen use savings to build new plant and equipment and thus produce profits. With these profits, they hire new workers, build new productive capacity and add to the world’s wealth.
You need look no further than America’s corporate profit picture to see that the problem in the U.S. is not going away any time soon. According to the Economist, U.S. profit margins are at their lowest levels since the Depression. As a percentage of GDP, corporate profits through the 3rd quarter of last year were down 26% from a year earlier, to a level of 7.5% of GDP. Five years ago, they were at 12.5%.
"The Fed has, through swift interest-rate cuts," says The Economist, "succeeded in saving the economy from deep recession – so far. Lower interest rates reduce debt service and so allow a more gradual adjustment, but they cannot stop the pressure to reduce excess debt. That could imply several years of sub-par growth…But for many American consumers, and for investors, who have been living thoughtlessly on the never-never, the next couple of years could deliver a rude shock."
Reducing saving, flooding the world with credit, and creating a "get rich quick" atmosphere in the capital markets typically leads to Buenos Aires, not to wealth. But even on the pampas, there are electric fences. Eventually, a shocking limit is reached.
Even in the vast expanses of the dollar-based economy, there are limits. The dollar itself, the world’s biggest credit, is not worth an infinite amount of goods and services. And, as anyone who remembers the mid-’80s can attest, it is not necessarily worth tomorrow what it was worth yesterday. Argentines are worried not so much about the quantity of cash available to them, but the quality of it. Dollar holders will one day have the same soucis.
Your editor, still predicting a decline in the dollar,
January 31, 2002 — Paris, France
"Bush promises to defeat recession" is how the BBC headlined its coverage of George W. Bush’s speech last night.
Bush’s tactic is simple – cluster bombs of government spending along with a few new laser-guided entitlements. How this will actually defeat an economic slump was not explained.
But Bush didn’t have to worry about it. On the very day of his State of the Union address came news that the recession is over. Brain-damaged consumers bought so many cars…and the Pentagon ordered so much equipment for Bush’s other war…that GDP actually grew in the 4th quarter, by 0.2%.
Consumer confidence rose smartly (or dumbly) in December. And the Conference Board’s leading indicators turned up. So what’s the problem?
Bush managed to avoid mentioning the word. But with the sincerity of a village idiot, every hack in medialand writes out the name a hundred times a day. "Reform!" they insist. William Greider, writing in the New York Times…or was it the Washington Post…worries about the "insidious corruption of democracy by political money" and thinks Enron gives us "a strong new brief for enacting campaign finance reform that is real."
Here at the Daily Reckoning, we worry more about the corruption of money by politics. Most of the time the world’s businessmen go about their work in an upstanding and laudable manner. Their motives are clear and pure – to make money. Good businessmen scarcely notice their company’s stock price…and hardly have time to cook the books. The best they can do is season them a little bit for the benefit of bankers, investors, and tax collectors. And even that is generally a timid effort, understating the real value of the business as often as inflating it.
But every once in a while, the lure of easy money distracts them. Like ghetto teenagers passing a convertible with the keys still in the ignition, the temptation to creative accounting becomes so great it is almost irresistible. Better men than Ken Lay have fallen for it in the past and better men will in the future, no matter how many auditors are on the job. The best an investor can do is to try to find a safe place to park his money and give the security guard a good tip…
At least, corporate chicanery is cyclical. Political chicanery, on the other hand, is permanent.
Eric…what do you think…?
Eric Fry in New York City, biggest and brightest in the land of milk and honey…
– Another wild and woolly day on Wall Street. Steep early morning losses gave way to late afternoon gains as investors decided, "Accounting, schmaccounting! Let’s buy some stocks!"
– Some of the day’s strongest performing stocks were the very ones that investors lately have been going out of their way to avoid. Shares of J.P. Morgan reversed a 5% loss in the morning to chalk up a 3% advance. More remarkable still, Tyco’s star-crossed stock rebounded from an 18% drop early in the day to gain more than 3%.
– Investors did buy some perfectly ordinary stocks as well, helping to drive all the major indices higher. The Dow soared 145 points to 9,762, while the Nasdaq bounced 20 points to 1,913. The S&P 500 tacked on more than 1% to 1,113.
– But one day’s respite does not mean that the witch-hunt for companies involved in accounting shenanigans has been called off. Indeed, shenanigans is exactly what the Irish drug maker Elan might be up to, according to a front-page story in yesterday’s Wall Street Journal. Investors responded to the allegations by vaporizing one third of the company’s market value shortly after the opening bell.
– And who can muse about accounting shenanigans without remembering those hooligans overseeing Enron?
– During the bubble years, $300 million probably seemed like a perfectly reasonable amount of money to pay former Enron CEO Kenneth Lay for three years on the job, even if he’d actually been working to advance the shareholders’ interests. Evidently, this princely remuneration seemed reasonable to somebody because, as the New York Times reports, "From 1989 through 2001, the total of his salary, bonus and profits from stock options topped $300 million."
– Even so, rumor has it that Lay faces financial problems. No doubt. Trying to figure out what to do with all that money can be a real problem.
– The inimitable Christopher Byron framed the "problem" as follows: "Scarcely had the rubble stopped smoking at Ground Zero than a fifth column of evildoers struck at America all over again, this time on the floor of the New York Stock Exchange. We begin with the men at the top, as embodied by Enron’s departed CEO, Jeffrey Skilling, conveniently cashing in his stock and fleeing the scene as if Enron were the Twin Towers and he knew what would be hitting them any minute. Then, climbing through the rubble afterward, we find the bodies of the workers at the bottom, obliterated financially as the company came crashing down around them, even as circumstances had arranged themselves so that they couldn’t sell their stock and escape like the men in the corner offices had just done."
– Ironically, Enron’s corporate "ethics" are still for sale to the highest bidder…literally. That’s right, for only $355 you too could have purchased the "Enron Code of Ethics" manual on eBay.
– "Dated July, 2000, 64 pages, paperback," the eBay description reads. "Perfect condition, like new. Sections include: Principles of Human Rights; Securities Trades by Company Personnel; Business Ethics; Confidential Information and Trade Secrets; Governmental Affairs and Political Contributions; Consulting Fees, Commissions and Other Payments; Conflicts of Interest, Investments and Outside Business Interests of Officers and Employees, etc." Almost reads like a rap sheet, doesn’t it?
– "American companies must be made more accountable and held to the highest standards of conduct," proclaimed President George W. Bush in his State of the Union Address. NOW he tells us! It would have been nice if someone had mentioned that about a decade ago.
– "Confidence in the stock market rests on several basic beliefs," MarketWatch.com observes, "that corporate managers will be truthful, that auditors will be able to judge companies’ financial positions and that stock analysts and bond rating agencies will be able to analyze how sound or promising companies are. The fall of Enron has shattered all these fundamental beliefs. As a result, many investors perceive greater risk in almost every publicly traded stock. ‘If I own a lot of stocks, now I have to wonder about whether much of the data on which I have based my judgments is accurate or phony,’ said Stan Jonas, managing director at Fimat USA, a broker-dealer in New York. ‘If I don’t know whether a company is honest or its accountants are honest, I have to act as though it is dishonest. That means I have to discount the price I will pay for it to adjust for that risk.’"
– Just maybe, 35 times earnings is not the right price.
Back in Paris…
*** What else? Well, the International Herald Tribune reports that the Bush administration thinks the Geneva Convention may be out of date. It is not suitable to this "New Era" of terrorist warfare, say officials.
*** Meanwhile, Jim Davidson thinks he sees a New Era too. Quoting Ray Kurzweil: "The economy really wants to grow at 5% or 6%, and that rate will continue to…The model the Fed is using is obsolete. It’s based on Old Economy principles…
"The upsurge in the secular trend of growth could surprise almost everyone," Davidson concludes. "Part of that surprise could be a much more rapid recovery from the downturn than would be expected in a standard business cycle."
*** "The Americans, the Brits and the Australians are the most ardent disciples of the destructive nonsense of the New Era…" writes Sean Corrigan, the Daily Reckoning’s man on the scene in London. "All run large external deficits because their consumption, financed on ever increasing levels of credit, outstrips their domestic ability to meet it. As a result, the UK and Australia struggle to finance domestic investment needs out of its scanty savings pool. And the U.S. falls woefully short of achieving that same needed balance."
*** We don’t have any idea how fast the economy wants to grow. It doesn’t speak to us. But we’d be surprised if it grows by more than 1% this year. One rarely loses betting against a New Era – either in international politics or in markets.