Benefits of Recession
What a strange recession!
Instead of cutting back on debt, Americans have added to
it. Instead of cutting back on major purchases – they’ve
bought cars and homes at near record rates.
And stocks – instead of sinking to recession levels,
where you can buy a dollar’s worth of earnings for 8 to
12 bucks, a dollar’s worth of earnings today, after 10
months of recession, will cost you about $40. Stocks are
so high that earnings could double this year – as most
analysts are predicting – and P/E ratios would still be
at the top of the bull market range…even if stock
prices went nowhere.
What kind of recession is this? Perhaps it is the
perfect one – as phony as the boom that preceded it.
We remind readers that the boom was built on a lie: that
thanks to a cluster of ‘New Era’ stars, the earth would
never again sleep in darkness. Things would get better
and better, forever and ever, amen. So brightly did
these stars sparkle that investors went mad looking at
them – sure that they were going to get rich without
Suffused with the confidence of a rich man’s spoiled
son, they bid up stock prices and thought they saw their
wealth go up. And thus they thought the promises of the
stars were coming true.
It was a phony wealth. "It was new wealth, yes…"
writes Dr. Kurt Richebacher, but "the burst in stock
prices created wealth for the stock owners, for them
only, not for the economy as a whole…Generations of
economists would never have thought of rising stock and
house prices as ‘wealth creation.’ They would have
derided it as pseudo or paper prosperity."
Real wealth, Dr. Richebacher goes on to explain, only
comes from real savings and investment in industries
that produce profits. But instead of investing real
savings in real businesses with real profits…consumers
stopped saving altogether, and invested whatever money
they had in information technology, an industry that has
so-far failed to produce a single net dollar of profits,
and which – according to a McKinsey study – has added
neither a jot nor a tiddle to the nation’s productivity.
As stock prices rose, Americans were not shy about
spending their new-found ‘wealth.’ Spending rose at
twice the rate of incomes during the entire bubble
period. But then, the Nasdaq bubble burst. All of a
sudden the stars that had lit up the "New Era" went out.
But some habits are hard to break. Americans had gotten
in the habit of anticipating paper prosperity and
spending money they didn’t really have. Stocks were no
longer going up at double digit rates, but people still
had faith that the bull market would continue. Polls
show investors still expect 15% per year from their
stocks…after this "recession" is over.
But at the present rate, today’s recession may never be
over. Because there is barely enough recession in it to
do any good. Where once Americans thought they could get
richer without the discipline and forbearance of saving
money and investing it carefully in serious
businesses…now they think they can have a recession
without real suffering. They spend as though they were
still in a boom – and postpone the lessons of hardship.
For the last two years, stocks have gone down but real
estate has continued to go up. Aided by lower rates from
the Fed, Americans have eagerly ‘unlocked’ the equity in
their own homes. Home mortgage debt has increased by
$1.2 trillion over the last 3 years – money that has
been fed back into the economy as though it were real
Easier credit has helped "soften the downturn" notes the
Wall Street Journal, allowing "Americans to continue
borrowing to pay for homes, cars and other big-ticket
items, bolstering the weakened economy. But the
resulting growth in consumer credit – to a record $7.5
trillion at the end of the third quarter of 2001 – also
has exposed a potential new economic fault line."
"Economists worry ," the WSJ continues, "that by buying
now what they would otherwise be buying tomorrow,
consumers are dulling one of the few major benefits of a
recession. Though painful, recessions usually purge the
economy, as lenders reduce the availability of credit to
compensate for the higher risk that their loans will go
So far, the recession of ’01 has produced little
purging. A few companies – Enron, Cisco, Amazon, Global
Crossing – have turned out to be such flaming losers
that even this market couldn’t ignore them. But most
companies still sell for reckless multiples of
earnings…while the earnings themselves rapidly
disappear. "Dividends Show Biggest Drop Since 1951,"
reports the PRNewswire.
Enron alone wiped out $61 billion of supposed wealth.
Cisco knocked off $168 billion. But against the tide of
debt that swamps the nation, even these huge amounts
seem trivial. Consumers’ assets fell 4% over the last 2
years. Their debts, however, rose 15%.
"During the first two quarters of the early 1990s
recession," the WSJ cites Mark Zandi at Economy.com,
"the average American household reacted to those tighter
credit conditions by paring its debt by an inflation-
adjusted $410…That helped leave consumers in shape to
borrow anew when the economy ultimately turned the
corner. By contrast, during the first two quarters of
the current recession, which began in March, the average
U.S. household took on $1,420 of new debt."
At the corporate level, the situation is little
different. Since 1994, corporate debt has increased
twice as much as the nation’s GDP – 85% compared to just
42%. In the last year alone, corporate debt increased 7%
– even as 3 times as many corporations had their credit
downgraded as upgraded. In fact, "Credit Quality Falls
Worldwide," observes the Financial Times.
That is the trouble with cutting rates to try to avoid a
recession. They dull the main benefit of an economic
downturn. People get older and poorer but no wiser.
Useful instruction is lost in a swamp of easy money.
Why bother to settle old accounts, people ask
themselves, when new ones are so easy to open? Thus do
marginal borrowers – in need of cash to keep up
appearances – sink in liquidity, like primitive
amphibians, rather than learn to walk upright on dry
ground…Credit quantity increases, while its quality
Here at the Daily Reckoning, we do not forecast what
will happen. We forecast what should happen. And even if
it doesn’t happen, we don’t worry. We are right no
matter what. For even if it doesn’t happen, it should
have. God may be wrong from time to time, but never us!
"Should" and "will" rarely meet in politics. But in the
markets, they regularly cross paths. Consumers and
businesses, deeper in debt than anytime in history,
should want to pay off some of their obligations. Will
they do so anytime soon? We don’t know. But sooner or
later, we feel confident, "should" and "will" are bound
to bump into one another.
Your correspondent, on the job in the year 2002…
January 03, 2002
P.S. My friend, Jim Davidson, informs me that 2002 is
the last palindromic year for 110 years. "Palindromic"
is such a rare word, even my computer doesn’t know what
it means, putting a red line beneath it as though it
were a mistake. But it refers to anything that reads the
same back to front as in the normal direction. "Madam,
I’m Adam," for example.
Just thought you’d like to know what kind of year we’re
going to have: one whose ending is likely to be the same
as its beginning.
Well, so far the euro is doing what it should do
– rising against the dollar. It was up a penny in its
first day of trading since appearing in tangible form.
Until January 1st, euros existed only in theory. But on
the 1st, cash machines and banks began distributing
Now that they’re a little more real…perhaps
people will have more confidence in them.
The world has never seen anything like the euro.
Previously, money might be backed by gold. Or it was
backed by the power of a sovereign state. The euro is
backed by neither. Only a convention between European
nations gives it life.
But couldn’t France or Italy decide it no longer
wants the euro? Suppose inflation began to endanger
savings? Or, suppose the euro rose so high that it hurt
exports? Wouldn’t the Italians say, "thanks, but we’ll
go back to the lire…at least we could inflate that
currency as much as we wanted"?
The euro is a grand experiment. It should be fun
Just a guess: the threat of nations abandoning
the euro in favor of their own currencies will force
European central bankers to be very careful to keep the
currency stable. By contrast, Americans are stuck with
the dollar, like it or not.
Americans have much more debt than Europeans.
Debtors favor inflation…and a falling currency. On
these factors alone, we expect the dollar to drop
against the euro – eventually. And even if it doesn’t…
well, it should.
Eric, what’s new on Wall Street?
Mr. Eric Fry…
– David Copperfield may be the "Master of Illusion," but
Mr. Market is at least a master’s apprentice. He can
make rallies appear out of thin air, without any visible
valuation support. He can cause vast crowds of people to
imagine they see an economic recovery right before their
eyes. And for the grand finale, he can make paying 85
times earnings for Cisco Systems look exactly like a
"great investment". Yes indeed, no minor illusionist is
– Yesterday, he performed a very nifty trick by halting
a falling stock market in mid-descent and then causing
it to levitate. The Dow fell about 50 points early in
the day, before reversing course and climbing 52 points
to 10,073. The Nasdaq floated 29 points higher to 1,979.
– But Mr. Market will need to call upon the complete
scope of his magical powers to maintain the illusion of
economic recovery throughout the entire 12 months of
2002. More than likely, investors will begin to spot the
smoke, mirrors, and other tricks of the trade sometime
early this year.
– Try as we might, it’s hard for us to see how consumer
spending can carry the economy much longer – unless
there is a pronounced rebound in employment or dollar
bills start falling from the sky.
– Employment, as we all know, continues to fall; savings
are something only rich people have; and the mortgage-
refinance boom has run into a brick wall. The economic
results might be gruesome. "No rubber-necking folks!
Keep it movin’! Keep it movin’!"
– Despite massive mortgage-refinance activity in 2001 –
five times greater than in 2000 – the consumer finds
himself more indebted than ever. In other words,
household debt outstanding has actually INCREASED. This
is a rather astonishing fact.
– How does surging refi activity cause mortgage debt to
RISE? Shouldn’t indebtedness be heading in the opposite
direction when mortgage rates fall? Yes, is the obvious
answer, unless folks are sucking equity out of their
houses, thereby increasing the size of their mortgages.
– The consumer has been trading in his home equity for
some extra pocket change, which helps the economy short-
term. But longer-term, his rising debt load will weigh
on consumer spending, and therefore, on economic growth.
– Furthermore, soaring 10-year interest rates have put
an end to the refi boom’s heart. The Mortgage Bankers
Association’s data show that applications for mortgage
refinancings have plunged about 54% during the four
weeks ended December 21st, compared to the prior four
weeks. My well-placed contact in the mortgage industry
told me yesterday that January volumes would be even
worse. No more "free money" for homeowners.
– The National Association of Purchasing Management
(NAPM) has rechristened itself the very New-Age-sounding
"Institute for Supply Management." To commemorate the
momentous event yesterday, the Institute-formerly-known-
as-the-NAPM issued a "surprisingly" strong reading on
the economy’s health.
– Notably, the new orders index popped to 54.9 from 48.8
the prior month – the strongest reading in 20 months.
Even a skeptical bear would have to acknowledge that the
report is in fact "surprising."
– However, a skeptical bear would quickly add, "But
let’s see what happens next month!"
– But the financial markets took the news at face value
and reacted immediately: stocks jumped, bonds fell. The
10-year Treasury yield soared to 5.16%. The refi boom
that recently died is even "deader" now.
– Nevertheless, says Ventana Capital’s Charlie Peabody,
"Investors appear to be ‘hanging their hats’ on the
belief that the Federal Reserve’s interest rate cuts
will finally have an impact on the consumer in 2002."
– The rate cuts may be causing consumer confidence to
pick up a bit, but rising consumer spending is not
– Most of the recent surge in confidence, Peabody
observes, was due to an improvement in the expectations
for the future, while the ‘present situation’ index
remained virtually unchanged.
– He concludes: "We do not believe the [surge in
confidence] indicates that more consumers will pay their
bills on time, or that consumers will be reinvigorated
to pile on more debt…It is interesting to note that
collapses of bubbles are often preceded by surges in
consumer confidence. Investors buying shares on this
latest news are buying on shaky ground."
Back in rural France…
*** We continue to think that the only real problem with
this recession is that it hasn’t happened yet.
*** Recessions straighten things out…like rain, they
remind you to fix the roof. In recession, default rates
and bankruptcies go up…and lenders are reminded that
not all credit is good credit. They tend to tighten up
on their loan requirements.
*** But "this time around," reports the Wall Street
Journal, "lenders, who were quick to reduce the flow of
credit during past recessions, have left the tap wide
*** What a strange recession! More below.
*** The mayor of a nearby town is getting ready to
retire soon. Who will replace him? This was the subject
of conversation last night when some neighbors dropped
"Mr. Leopald is the most likely winner," said Francoise.
"He’s a socialist and he’s stupid as a pig, but people
seem to like him."
"And there’s no real competition," added Henri, "the
other candidate is a guy who has been the tax inspector
for years. Can you imagine anything so ridiculous. Who
would vote for a tax inspector? As soon as you mention
‘tax inspector’ people want to kill him, not vote for