Bells Ringing

“Dr. Greenspan’s medicine may be starting to work,” says a Washington Post editorial. “And if not, the Fed can always cut again.”

No need to roll your eyes. What follows is not another polemic about the ineffectiveness of rate cuts. Instead, today’s reverie begins where others have ended: suppose the Fed does cut again…and again…and again…and things don’t get better. What then?

You will recall that an interlocking system of military alliances in Europe seemed reassuring a century ago. Today, it is a cross-rigged web of financial alliances that offers the mirage of safety.

In 1914, all of Europe was trussed up together, like climbers roped one to another on a dangerous rockslide. Tethered to the line, each felt safer. But, if any of them lost his footing, all would be pulled down.

That is, of course, what happened:

“The mobilization began with bells and drums,” according to a book by Pierre Miquel, Les Poilus. “In the villages, where half of the French lived, the sound of bells ringing seemed to announce a cataclysm.”

Farmers came in from the fields, merchants from their shops… Mothers, wives and children looked out at the town squares all over France with a mixture of fascination and dread.

The bells rang as they did when the Vikings approached in the middle ages, or when the Cossacks attacked in 1814. But ever since 1870 – when the Prussians invaded France – the bells of war had been silent. For nearly half a century, France had enjoyed peace.

And what an extraordinary time it had been! Trains, electricity, automobiles and tractors, Mr. Eiffel’s tower – never before had France enjoyed such prosperity. And Paris, what a spectacularly beautiful city it had become. Baron Haussmann had knocked down what must have seemed like half the city in order to build it up again – grander and more beautiful than any city ever was. The rows and rows of apartment buildings you see all over the city – including the one in which I live – were constructed during this period.

In the Belle Epoque, it seemed as though things just couldn’t be better. New technology was transforming every aspect of commercial life – making things faster, more efficient, and more productive.

These new innovations were supposed to guarantee prosperity – perhaps forever.

And peace? Would the proletariat of one nation ever again be willing to take up arms against their fellow workers in other nations? Or, would not the new bourgeois ideals – democracy, compulsory public schooling, support for the arts, a free press, and liberal trade policies – make war a thing of the past? Was not war a creature of ignorance, envy and retrograde aristocracy

And yet, in August of 1914, the bells tolled, summoning the French to arms. After 44 years of peace, Europe began a very mean regression.

Soldiers rushed to their assembly points, fearful that they would miss the action. French troops might already be on the other side of the Rhine before they got there, they worried. Almost everyone was sure that the war would be over by Christmas. Whatever the outcome, they were confident of a ‘second half recovery.’

The peace of the world’s financial systems has been threatened many times in the late ’80s and 90s. Paul Kasriel lists a few of the archdukes who have fallen: “Mexico/the oil patch/Continental Bank, the U.S. stock market, banks and S&Ls, Mexico again, Asia, Russia, Brazil, Long-Term Capital [Mis]management, the US stock market, Turkey, Argentina.”

Each time, financial analysts held their breath as the web of financial connections stretched. But, each time, it held. And Greenspan and other central bankers added more threads of easy money and credit, which seemed to reduce the risk of loss still further.

American consumers did their part too. Throughout the entire post-war period, Americans tended to be the world’s consumers of last resort. But as Greenspan made more cash available, American consumerism shifted into overdrive. Overseas nations found that they were able to ‘export their deflation’ as U.S. shoppers stepped up to the cash register to buy excess production – on credit, of course.

By the first quarter of 2000, Americans were running a current account deficit equal to about 4.5% of GDP, which Kasriel notes, is “the highest absolute and relative borrowing from the rest of the world in over 40 years.”

What would happen if U.S. consumers ever took their foot off the gas pedal? As late as early this year, it was still believed that the slowdown in the U.S. would be offset by strong growth in Europe and Asia.

Instead, one by one, the world’s economies are being drawn towards recession as they were drawn to war 100 years ago.

“What Happened to Economic Growth?” asked last week’s headline in the Figaro in Paris, where unemployment is rising again and GDP growth and consumer confidence figures are falling.

To the east, economist Anirvan Banerji reports that “Germany may also be headed toward a recession. German Economics Minister Werner Muller warned last week that the German economy could see zero growth in the current quarter. You can read between the lines.. If Germany goes into recession, which now appears to be a serious possibility, it would be the first time since the first oil shock a quarter of a century ago that the world’s three largest economies would be in synchronous recessions.”

All over the world, economies are slowing down: “Australia, Korea, Taiwan and Mexico are clearly in recession and getting worse,” writes my friend John Mauldin. “The US is in a global economy. If the rest of the world slows down, it will affect us. We have only seen the beginnings of woes on the international front.”

What’s next?

“They left as though on a crusade,” writes Pierre Miquel of WWI French draftees. But each man knew, deep down in his heart, that the days of plenty were over…and that the hour had come to pay tribute to death.”

Bill Bonner
July 3, 2001
Baltimore, Maryland

Consumers are ‘still hanging in there.’ Personal spending rose in May by 0.5%, more than twice the 0.2% increase in incomes.

How can you spend more than you make? You have to dip into savings. If only there were some savings in which to dip! The savings rate, a pathetic negative 1% in April, fell to a negative 1.3% in May. Lacking savings…and expenses exceeding income…Americans made up the difference with more debt.

“Bankers more careful on all but mortgage loans,” notes a headline at The Prudent Bear. Why? Because, as the article explains, mortgage loans are easily securitized – allowing banks to pass risk on to investors, often foreign investors. And Fannie Mae and Freddie Mac, chartered by the federal government, have effectively turned private debt (mortgage loans) into government bonds. Lenders and investors can’t lose, can they?

From the dark mist of the above facts, one obvious question emerges: how long can this go on? And then, another: if markets give people what they deserve, rather than what they want or expect, what will befall such a nation of debtors?

Ah, the sun is beginning to burn off the fog. And what do we see? Deflation…what debtors deserve but least desire.

Eric Fry reports from Wall Street:


– Yesterday’s report from the National Association of Purchasing Management (NAPM) reminded me of my grandmother’s cheese souffle – bad, but not as bad her well done pot-roast. And if it’s the pot-roast you’re expecting, the cheese souffle is a pleasant surprise.

– “The manufacturing sector continued to decline in June,” the NAPM reported. But, “the rate of decline slowed somewhat during the month.” Specifically, US manufacturing declined for the 11th month in a row. But the good news is that the Purchasing Managers’ Index improved to 44.7 in June from May’s 42.1. Any reading under 50 is bad…but at least it wasn’t as bad as in May.

– Trouble is, “less bad” is a long way from “getting better.” And until orders pick up – something that isn’t happening – “getting better” is still a ways off. The NAPM’s Backlog of Orders Index shows that order backlogs have declined 14 months straight.

– No matter, thanks to the okay NAPM report, the giant industrial stocks inside the Dow grabbed the baton from the Nasdaq and raced ahead 91 points. An apparently fatigued Nasdaq took the day off – falling 12.

– “The Economist [cited] various studies suggesting that the decline in the U.S. household saving rate is the result of a faulty definition of saving,” writes Paul Kasriel, head of economic research at Northern Trust Co. “The message of the article is: ‘Cheer up. Things could be worse.’ [But] My message is the punch-line to an old joke: ‘So, I cheered up. And sure enough, things got worse’… [A]ll you have to do is look at the behavior of the current account deficit in recent years to know that Americans are spending more than they are producing.”

– Kasriel notes that between 1952 and 1982, total debt as a percent of the nation’s total capital “ranged from approximately 42% to 51 1/2%. But national leverage started on an uninterrupted upward trend in 1983. Debt as a percent of the capital stock has moved up from about 48 1/2% in 1982 to 92% in 1999.”

– Given our rising indebtedness, Kasriel expects the Fed to err on the side of inflation, rather than risk deflation. “There are more voters who are debtors than who are creditors. As a result, it’s politically correct now to inflate.”

– Debtors might love inflation, but the US dollar does not. The greenback has been weakening lately against the Canadian dollar. Does the Canuck buck “know” something? Weldon’s Money Monitor traces the Canadian dollar’s recent strength to Canada’s “high and rising trade surpluses with United States.” Helping to boost Canadian exports, Weldon notes, are exports of electricity andnatural gas into the U.S. Northwest and California.


*** “You can forget the Nasdaq,” Fleet Street Letter contributor, John Mauldin wrote recently. “That was a bubble and that 50% drop had nothing to do with a recession. It was mass insanity or momentum investing gone amok. It will drop another 20%-40% if we do, in fact, go into recession.”

*** “What worries me are non-tech stocks…” Mauldin continues, “They have not fallen by anywhere close to 20%, let alone 40%. If you measure just non-tech stocks, you could make a strong case that we have yet to enter a bear market. Will we see a drop in the market [from here]? History tells us yes.”