Can The Center Hold?

Turning and turning in the widening gyre

The falcon cannot hear the falconer;

Things fall apart; the centre cannot hold;

The Second Coming, W. B. Yeats

I have been leading up to something important, dear reader. I’m sure you have sensed it too….that dull quiet before a storm hits…that leaden anticipation waiting for Alan Greenspan to speak or bars to open. Some revelation is at hand.

Some things change and some things remain the same.

I am indebted to the French newspaper, Liberation, for reminding me of this verity. Today’s edition reports that they are still cutting off people’s heads in Borneo – just as they always have.

And Daniel Cohn-Bendit, aka “Danny the Red,” a leading leftist provocateur of the ’60s has been transformed into a pudgy member of the Jospin government. But he is still as big a clown now as he was then.

And Turkey has gotten itself into a real financial mess. Short-term interest rates shot up to 6,200% and reserves of $3 billion were used as the government tried to defend the lira. Stocks dropped 30% in the first 3 days of the week…and then the lira was allowed to float freely. It is expected to lose 25% of its value in the next few days.

What stays the same in the financial markets is the cycles of greed and fear, boom and bust, expansion and contraction…love and hate…which accompany all human activity.

What changes is the landscape upon which these emotions are played out.

We have spent the last few days exploring the boom of the late 20th century…comparing it to previous booms. Today, we leave the familiar coastlines of the known world and sail into the unknown, the future…

Not that we can see it any better than anyone else. We look it from the rail of our little vessel, like Christopher Columbus looking at Hispaniola. We know there is land there…but what sort of land? How is it different from the land we have just left?

Well, for one thing, it is bigger. I will not bother to supply figures; the point is self-evident. The world economy is bigger. The U.S. stock market is far bigger…and many more features of the economy – even financing used cars – have been securitized.

The derivatives market – which barely existed prior to the advent of the latest boom – now is estimated to be worth $80 trillion…or more than 7 times the output of every tinker, cobbler, pastry-maker and everyone else in the entire U.S. economy. And private debt levels in America…and public debt levels in Japan…have reached multiples of the previous peaks.

Plus, the world has grown much more economically interdependent. The division of labor has expanded to the point where a single person with a briefcase might walk around with products from 20 different countries, and stop for lunch and eat the produce of 10 more.

And at the center of this widening gyre of securities, derivatives, debt, and globalized trade is the U.S. dollar. Can it hold?

I will give you my conclusion without forcing you to read to the end: It may not give way completely, but under the strain of capitalism’s latest crisis…it is sure to wobble.

No one – outside of government or an asylum – sets prices. They are not set, they are found…by the interaction of natural forces and collective human action. As markets have grown larger, so have the collections of humans that drive them.

Collective action requires collective thinking. But as groups get bigger, they think less and less. Derivativation, securitization, globalization – who wouldn’t rather get his teeth cleaned than have to think about such things?

As the market grows, the ideas that motivate people become fuzzier, less precise…and less grounded in real experience. The experience and intuition of the farmer has been replaced by the abstract ideas of the information age employee. A peasant in the middle ages had a very direct and tangible idea of what wealth was, for example – it was sheep, cows, and stored grain. He knew what it was worth in terms of how many people it would feed for how long.

But a software designer in the Bay Area probably measures out his wealth in terms of stock. Who knows what his stocks are really worth? And the measuring stick itself – the dollar – is also an abstraction, perhaps the biggest and most important abstraction of our time.

How much is the dollar worth? That too is a matter for the market…for the collective sentiments of millions of people…the unthinking masses.

“If group-think were not bad enough,” my friend, Mark Ford puts it, we now have a new phenomenon animating the markets, “group-feel.”

Group-feel sounds as though it could be fun. But it also sounds unstable.

So, as this crisis in capitalism gets underway, there are differences. Not only is the scale far larger than it was in the 1920s…gold has been replaced by the dollar at the center of the financial system.

Most economists believe the paper currency gives policymakers and central bankers the flexibility to deal with a crisis. But the only thing they can do is to make it less valuable.

Since WWII, the Fed has gradually reduced the value of the dollar. The declining value of the money encouraged consumers to spend, rather that save. Thus, did America become the consumer of last resort – absorbing 20% of the entire world’s imports and running a trade deficit of nearly 5% of GDP.

The division of labor took on a curious and sunny character as the 60s and 70s gave way to the 80s and 90s. Foreign countries – especially in Asia – added production capacity. America added debt. Foreigners produced. Americans consumed.

Of course, the world has not been immune to financial crises in the 2nd half of the last century. This led the U.S. government and Federal Reserve to assume another de facto role – the lender of last resort. That is why Larry Summers, Robert Rubin, and Alan Greenspan found such favor as the “Committee to Save the World.”

All of this might last forever were it not for the fact that forever is longer than a few business cycles. After a few such turns, debt levels have become difficult to carry in the U.S…and supplies of dollars overseas have become more than adequate.

Besides, the value of those dollars rests on nothing more than collective sentiment – which could (and I know I have been saying this for a long time) change at any moment. In a trice, the dollar may be no longer the world’s most sought-after currency.

Your correspondent, promising to move on to other subjects,

Bill Bonner Paris, France February 23, 2001

*** The Dow plunged 140 points yesterday but then came back to where it began. Internets fell a little. There were 1138 advancing stocks on the NYSE; 1895 fell.

*** The Nasdaq dropped back 24 points.

*** As usual, a couple Big Techs announced that things weren’t going as well as planned. Investors knocked both of them down, 7% for Brocade and 6% for EMC.

*** Cisco and Sun Microsystems recovered a tad. CSCO rose above $26. Sun managed to climb above $20.

*** Jobless claims came in lower than expected. The index of leading economic indicators turned up in January, plus 0.8%.

*** It seemed more like an old day than a new one. The media was chattering about the bombing of Iraq… inflation…recession – just like old times.

*** “Is stagflation rearing its ugly head,” wonders a headline on MSNBC. “If you step back,” writes Christopher Byron, “and look at the entire 30 years of consumer price inflation, the pattern becomes even more pronounced. Whether you’re talking about the core rate or the overall rate, prices are now rising at a sustained pace not seen in the U.S. in more than a decade.”

*** Not since the 2nd term of Ronald Reagan, in fact. And that episode of inflation lasted only a brief time. For a longer stretch of rising consumer prices you’d have to go back to the Carter administration.

*** The Cleveland Fed’s “Economic Trends” notes that higher inflation rates will make things very tough for the Fed during this ‘adjustment’ period.

*** According to Bill King: “A TechnoMetricaMarket Intelligence survey shows Americans are more bearish than bullish on the US economic outlook, but don’t think it will affect them personally. They also think their financial condition will be better six months from now.”

*** Investors’ Intelligence reports that investment advisors are 61.2% bullish – near an 8-year high.

*** But the insiders are buying less of their own company’s stock. Insider buying dropped to a 5-year low in January.

*** Nearly 51,000 dot-com and Internet workers have lost their jobs since December 1999, reports the Industry Standard, by way of this morning’s Early To Rise.

*** “Sales of $1 million homes soars to record” reports the LA Times. Real estate is still hot in California. In Pasadena you can get about 3,000 square feet on a quarter acre lot for $1 million, says the paper. In upscale Bay Area communities, such as Atheron or Hillsborough a million dollar buys only about 1,000 square feet. “It would be a fixer… if you could find it,” said one real estate agent.

*** “Most investors make their worst decisions right after they’ve been hit by a big loss,” Lynn Carpenter points out. “And that’s why we have seen Nasdaq bounce back three times, as it has fallen below 2300. It’s not just foolish bottom fishers. It’s very normal human beings looking at a disaster and doing the most normal thing in the world… saying ‘NO! This can’t be happening! Six months ago I thought Nasdaq should be about 2250. It took a while to get there. But now it would not surprise me at all to see Nasdaq at 1800 before summer is over.”

*** “This doesn’t look at all encouraging. Coke may be just one stock, but in many ways it defined the entire-post 1982 disinflationary theme,” points out Kevin Klombies, of the charting service Intermarket Relationships Analysis. “The market loved Coke to such an extent that it gave the stock a constant, compounding growth rate right through the 1987 crash and the 1990 Gulf War/recession. But today, there’s bad news. Coca Cola has just broken down through a trend- line which extends all the way back to 1982…”

*** By contrast, China, the country which, as of yesterday, has officially taken the lead as the country with the greatest trade surplus with the US, has recently privatized 300,000 state-owned businesses. And “of China’s approximately 1.3 billion people, two-thirds are under 30,” writes The Fleet Street Letter’s Chris Matthai. “That gives China one of the youngest populations of any country in the world. More importantly, these young Chinese have all been brought up in an era of capitalism and entrepreneurship. They can look forward to promotion based on merit, not party loyalty, and pay commensurate with responsibility, not seniority.”

*** Gold rose 40 cents yesterday. The market for the metal is as inert and lifeless as the metal itself. But something is going on in the mining sector. The HUI, the index of pure gold mining stocks, rose 3% yesterday. And the lease rate of gold has more than doubled from 0.7% to 1.75%. Could supplies be getting tight?

*** I don’t know. But a few weeks ago I was wondering: If you were looking for a group of stocks which has been neglected, despised and under capitalized, where might you look? Two things came to mind: Africa, where all stocks are held in contempt. And gold-mining companies – which are beneath contempt. Mightn’t there be some African-based mining companies that offer extreme values?

*** I posed the question to Brent Cook, an expert on the mining industry, and got the following reply:

“South Africa has the richest mineral endowment in the world. Which way it goes is not clear. There are very upscale malls that are robbed by AK-47 carrying blacks during lunch. Very high class neighborhoods that have seen squatter camps numbering 10’s of thousands move into the nearby fields. The AIDS death rate is so high that bodies from the camp receive a shallow burial next to the lavish homes. Ruins the weekend BBQ. Harmony Gold [is] probably the best SA gold company leveraged to gold.”

One of the most repulsive companies is Banro, [operating] in what many would consider a repulsive country – The Congo.

“The only thing nice about the Congo,” says Brent, is that its president, Laurent Kabila, was recently shot in the head ‘in the presence of his generals.’

“Upon hearing of his death,” Brent reports, “Bernard van Rooyen, managing director of Banro Resources (YBN.V), surmised that a serious stumbling block to mine development had been removed. The stock has moved from C$.12 to over C$.50 on this agreeable news…[but] the country needs to turn around before any real mining investment can take place-it will be a long time.

“Tenke Mining is probably in the best position to gain from change in perception in the Congo. They are carried for ~15% by BHP and Phelps Dodge on the largest undeveloped copper deposit in the world, if BHP or PD ever can commit to the over $1billion investment needed to build this mine (Tenke-Fungurumi) in the Congo.

“Tenke, with a C$15mil market cap, is also carried on a copper-gold exploration property by Rio Tinto at 5,000m in the Andes.

“Then there’s the gold property Barrick got in Tanzania that also hosts about 700 (dead and buried) miners (tough PR).

“First Quantum is producing copper in Zambia and doing a good job of it. They are also working with Gencor to re- build some of the larger copper complexes in Zambia plus hold claims in Congo. Zimbabwe Plats has ~300mil oz of platinum group metal at “their mine in Zimbabwe and a AU$110mil market cap. BHP just pulled out, they couldn’t make the mine work at a profit. There are many other small mining and exploration companies that at one time had Internet size market caps and now sell for next to nothing.”

Further details are available from Mr. Cook:

The Daily Reckoning