“A man gains no wisdom before he is dealt his winters in this world…
“Is it any wonder my heart grows weary,
As I think about the proud warriors and the mead halls that once knew them…
And how, day by day, all the earth ages, drooping unto death…”
– The Wanderer
The dollar and the U.S. empire are on the edge of greatness, we think. But on which side?
The thought occurred to us during a moment of reflection at Dulles Airport. The sun had just peeked up over the main terminal. Birds sang in the trees. A bright, warm spring day began in the nation’s capitol.
“Morning in America,” we recall, was the theme of the first Reagan term. The Great Communicator planted the supply-side seeds…and the whole country seemed to bloom. American capitalism was in a bull market. For the next two decades, investors harvested the rich rewards.
Success is self-correcting, we observe. Every bull eventually finds its bear. Every bubble eventually finds its pin. And every empire eventually finds its Vandals.
Technology and science may march ahead…but markets, politics and love affairs make little forward progress. Instead, they turn in cycles of big-hearted confidence followed by dreary moments of despair…punctuated at both extremes by episodes of such absurd hyperbole that an observer can only yuck or gasp.
Matthew Lynn: The Divine Right of Kings
Collectively, people do not go from darkness to light… but race from one myth to another, we notice. They believe in the Divine Right of Kings and then roll over to the Sublime Right of Democracy…They put their lives in the hands of the church in one epoch…and then trust their government in the next. In one era, an Empire is thought eternal; in the next it is the Nation-State. After bouncing off the cushion of Faith in the Middle Ages…they head directly for the opposite side of the table, where they bump into the Illusion of Reason.
In 1998, it may have been self-evident that American Capitalism was the wave of the future; when the future arrived, the proposition looked much less sure. “For the past two decades,” writes Matthew Lynn, a Bloomberg columnist, “the economic news coming out of the U.S. has been almost invariably upbeat. Now the pendulum has swung.
“The dollar’s dominance over currency markets is slipping. The trade deficit is starting to spook economists. The stock market shows no sign of recovering. And the funeral pyre of bruised and tattered corporate reputations grows higher by the day: Now even Vice President Dick Cheney’s former company is being investigated for cooking the books.”
“Capitalism began a major uptrend in the Carter term, when people were least expecting it,” adds Jim Grant. “And it has begun a major downtrend in the administration of George W. Bush, again taking the country by surprise.”
Matthew Lynn: Not Wise, Just Wary
Here at the Daily Reckoning, we don’t trust ourselves with predictions. We are not necessarily wise; just wary. We don’t know what the future holds. But we know we can’t make money thinking what everyone else thinks…or believing in every myth that catches the public’s eye. So, we look for the uncrowded side of the trade…and sometimes find ourselves all alone.
American capitalism has been on nearly everyone’s wish list for the last 20 years. Not that we think there is anything necessarily wrong with it. But it has looked over-bought for several years. We squint and try to imagine the other side of the trade…what it would look like if it were over-sold.
In the early ’90s, bookstores removed titles lauding Japanese business practices and replaced them with books in which American tycoons played the lead roles. Soon, American businessmen were everyone’s heroes. Even in the most despoiled and backward swamp or jungle…you could find people who admired Bill Gates, Jack Welch or Jeff Bezos.
Matthew Lynn: Business Heroes in Disgrace
But now, many of those American business heroes are in disgrace.
“Enron Corp., Arthur Andersen and Henry Blodget…” Matthew Lynn explains, “Between them they have managed to make much of the corporate and economic achievements of the last decade look fake. The model American company that pulled off a couple of mergers a week, pushed forward funny- looking numbers by 30 percent a quarter, all hyped by breathless analysts and supported by a board paid in share options by the million no longer looks nearly as attractive as it did a year ago.”
And then, says Lynn, there is the “breaking of the technological dream. The story of U.S. economic leadership was largely the story of the rise and rise of the microchip. Computing was a completely American industry. While that industry was still powering forward, so was the U.S.
“Technology is still going to be hugely influential for years to come, but it has started to move away from the entrepreneurs and innovators. In this decade, technology will be about better design and cheaper prices – and refining technologies so they are cheaper and look better has usually been what European and Asian companies do better than American companies.”
Matthew Lynn: The Failure of US Leadership
Lynn also mentions the failure of U.S. policy leadership. After preaching free markets and free trade for two decades, George W. Bush has set a strange example – like a Baptist swilling beer from the pulpit. [Former] Secretary of the Treasury Paul O’Neill is currently touring Africa with a rock singer from Ireland with only a single name, Bono. Africans may still enjoy a concert, but after steel tariffs and welfare payments to farmers, we wonder how many will sit still for a lecture from sanctimonious American policy-setters? Instead, they are likely to follow Mr. Bush’s example…doing even more damage to globalized American businesses.
Would it surprise you, dear reader, if investors’ hearts turn weary…as one by one, the proud suits of America, Inc., disappear from the boardrooms that knew them…
…and a new group of books appears on the shelves – such as “Wealth and Democracy,” by Kevin Phillips, in which the author argues that whatever awful thing happens to the titans of American business – they’ve got it coming…or “The World We’re In,” in which English author Bill Hutton maintains that the European model of capitalism is superior to the U.S. version…
…and foreign investors decide that they could get by with just a little less of their money in U.S. financial assets…
…and foreign central bankers come to think that they have more than enough U.S. dollars in their vaults…
…and hour by hour…the day grows older…finally drooping into evening?
June 19, 2003
Where are we? We mean, where are we economically, of course.
Physically, we are right here in our office in Paris on a cloudy day. And metaphorically?
Do you really want to know where we are metaphorically, dear reader? Of course not, but we will tell you anyway.
Here. We are out on this rock with our arm stuck in a contradiction; we expect both inflation and deflation. “You can’t have it both ways,” say readers. Either inflation destroys bonds or deflation destroys stocks, they say. “They’ll both be destroyed,” is our bet.
We are in the 32nd year of the Dollar Standard. Look in the vaults of the world’s central banks. What do you find? We don’t know, but we’ve been told that 75% of their reserves are in the form of ‘dollars.’ What’s a dollar? Well…it is what it is…a piece of paper that can be exchanged for other things.
When the dollar standard began in 1971, a dollar could be exchanged for 1/34th of an ounce of gold. It was precisely because many people – especially the French – thought this was too good a trade to pass up that the U.S. government decided to put a stop to it. Henceforth, said the Nixon administration, effectively defaulting on its obligations by devaluing the dollar, the dollar is only worth whatever it will buy in the open market.
That announcement set off alarm bells all over the world. Investors began to wonder what they could get for their dollars. The Fed had a printing press back then, too; the Fed, of course, offered the world enough dollars to keep the wheels of the economy turning…but investors worried that they Fed might overdo it. Sure, easy money could make the wheels spin, but they might eventually come off! By 1980, a dollar brought only 1/840th of an ounce of gold. Investors expected to get even less in the future.
Mr. Market never sets up an expectation without also setting in motion the means of disappointment. Along came Paul Volcker, who tightened bank lending rules, stiffened up interest rates, knocked down inflation rates and thus built the foundation for the Great Boom that lasted the next two decades.
We think the Great Boom ended in 2000, when the stock market finally topped out. The following year, the dollar topped out, too. In the summer of 2001, a dollar bought 1/260th of an ounce of gold. Now, 2 years later, it buys only 1/360th of an ounce.
But what do we know? Yesterday, gold fell $6 in price as the dollar rose. Now that the Fed really is putting on the speed, investors seem not to notice. Their expectations are at an epic high. Whee! Most believe the Great Boom will continue racing along forever. The percentage of bearish investment advisors is at its lowest point in 16 years. Gold has been the best investment of the last 2 years…but who believes it will continue?
Instead, Fund managers and the lumpeninvestoriat lend money to the U.S. government as if it were the best credit risk in the world…and buy stocks as if they had read tomorrow’s newspapers and saw higher prices.
And here at the Daily Reckoning, we don’t know quite what to think. That stocks are no bargain seems obvious. That U.S. Treasury bonds are a ‘reward-free risk’ seems clear enough, too. That such extraordinary confidence (what could be lending to the world’s biggest debtor – who openly promises to devalue his currency…at the lowest yields in 50 years – but an exhibition of extreme, almost lunatic confidence?) should eventually give way to fear and loathing also seems not only self-evident, but actually simpatico. It is the way the world works: day turns to night, good yields to bad, exceptional is replaced by mediocre; Volcker is replaced by Greenspan…tight money is followed by loose money…and then the wheels come off!
But when and how?
More below…meanwhile, Eric Fry with the news from Wall Street:
Eric Fry in Manhattan…
– “Nazflation” continues!…Yesterday, the Nasdaq Composite gained half a percent to 1,677 – another new one-year high. Meanwhile, the Dow slipped 29 points to 9,294. Government bonds slipped for a third straight session, as the 10-year Treasury note’s yield soared to 3.36% from 3.17% on Monday. Apparently, bond investors are having second thoughts about the imminent threat of deflation.
– Tuesday’s CPI data – by showing a hefty 0.3% jump in consumer prices, excluding energy – offered a tantalizing morsel of inflation…
– Ahhhh!…How sweet it is!…That first delicious taste of a new inflationary trend! Like most sinful little pleasures, inflation is not a healthy indulgence. But for now…mmm…it is a welcome delight, or so most stock market pundits seem to believe. Inflation is welcome because – unlike that Puritanical deflation – it makes debt repayment easier, boosts home prices and fluffs up corporate profits. It is all pleasure and no pain…sort of.
– The pain arrives a little later, of course, when a dollar bill buys fewer goods and services that it does today, and when savings are “inflated away” to be worth much less than the nation’s savers anticipated. But stock-buyers do not seem to worry about any of this. Rather, they trust the Federal Reserve Chairman when he tells them that inflation is a good thing, and that the evils of deflation must be vanquished at any cost.
– The lumpeninvestoriat aren’t worrying about much of anything these days, except the risk of not owning common stocks. As a result, an impressive “echo-bubble” in the stock market has been swelling larger and larger, right before our eyes. Like its predecessor, the epic stock market bubble of the 1990s, the echo-bubble features more speculation than substance…Negligible earnings growth and nosebleed evaluations are no impediment to rising share prices.
– And like its predecessor, the echo-bubble is powered by the Fed’s easy money campaign. The implicit ‘threat’ of receiving an invisible 1% yield from CDs or money market accounts is chasing investors out of cash assets into riskier assets, like long-dated bonds and common stocks. This Fed-inspired casino mentality has been driving the stock market from MERELY expensive levels to VERY expensive levels.
– It is fueling “Nazflation,” as Michael Belkin puts it. The Nasdaq Composite is up 25% this year – that is Nazflation of about 56% annulized. “Negative real interest rates are forcing investors out the risk spectrum,” says Belkin, editor of the Belkin Report. “Treasury bills and money market funds yield 1%. U.S. CPI inflation is more than twice that level. That is a powerful incentive to move into higher-yielding debt (junk) and lottery tickets (Nasdaq stocks). If we sound skeptical about the process, that is correct…We disagree with the Fed’s policies, but we don’t run the asylum. If the Fed wants to push investors out the risk spectrum and inflate another mini-bubble, it certainly has the power.”
– The Fed’s “power,” of course, is nothing more than the public’s collective eagerness to buy expensive stocks. Were it not for investor infatuation with stocks-for-the-long- haul, the Fed would be powerless to incite speculation. But the Fed can, and does, incite speculation. In fact, it is doing so right now. However, the tech rally may soon run out of steam.
– “Despite the recent good times, the situation for tech bulls is dire,” writes Fred Hickey, editor of the High Tech Strategist. “The cables and turnbuckles and epoxy that have been holding up these monstrously overpriced tech stocks are fraying and breaking. When it becomes clear that the second-half recovery won’t occur and that the second-half earnings surge is a pipe dream, there will be a panic among bullish investors that will end in ruin for many of them…Then we’ll hear wishful comments about the fallen bull market for tech stocks similar to those made by seven- year old Nicholas Niles at the foot of New Hampshire’s Old Man of the Mountain: ‘If only there were magic stuff that could make it hitch back up there.'”
– Also, like its predecessor, the echo-bubble is equally vulnerable to the pinprick of economic reality. Like the epic bubble market of the 1990s, the echo-bubble will – we fear – end badly for many investors. Why not book your profits and take the summer off?
Bill Bonner, back in Paris…
*** We have no doubt that the economy is in capable hands and that everything gets better every day, in every way. Still, the U.S. Treasury secretary says it might be hard to find a job. “Job outlook weak in CA,” adds the LA TIMES. “Prospects for jobs low in Michigan,” joins the Detroit Free Press.
*** China, believes Marshall Auerback, has the power to shut down the U.S. economy…the way the IMF pulled the plug on Argentina. We reported Auerback’s thoughts yesterday. The subject must have been on the U.S. Treasury secretary’s mind the same day. In today’s news, we find this headline in the Washington Post: “China may float currency, says Snow.”
We turn back to Auerback for elaboration: “When they make the break from the dollar tie, it is highly conceivable they will have stockpiled a huge amount of gold to back their unit (which may also explain why the Chinese government has been so reticent to provide full disclosure on its official sector purchases of gold over the past decade). Once they feel they have those in order, then they make a play toward becoming the Asian region’s reserve currency and ultimately the world’s preferred currency.
“The notion of the remnimbi-based Asian currency union may seem far-fetched today, but so too did the idea of a European currency union, but 15 years ago. In many respects, an Asian monetary union predicated on the RMB would face considerably less difficult obstacles than the euro. In contrast to “Euroland”, an Asian currency union predicated on the RMB would start with the presence of one dominant country, China (both economically and culturally), thereby facilitating the adoption of an existing currency, as opposed to the creation of a new one and the concurrent abolition of a multiplicity of national currencies. There is also a huge Chinese Diaspora in the emerging Asian countries; consequently, many of the traditional linguistic and historical barriers that pertain in the EU do not apply to anywhere near the same degree in Asia. There is a common, cultural Confucian ethic throughout the region. There is also a natural predisposition toward saving, making the region the largest repository of global reserves. If such reserves are backed by a large chunk of gold holdings (now being perversely leased or sold by countless Western central banks), then the notion of China at the epicentre of an Asian monetary union becomes eminently more credible.
“What this means in relation to America is that the latter, like Argentina circa 2001, no longer controls its own economic destiny. In the case of the United States, the Sword of Damocles is not the IMF, but China. The death knell for the U.S. economy may well be when the Chinese elect to float their currency because at that stage, many of the other Asian central banks (with the possible exception of Japan) may well find yet another compelling alternative to the U.S. greenback, thereby sending the latter into free fall, creating untold damage to the U.S. credit system. American policymakers, who persistently call for the Chinese remnimbi to be floated, ought to be careful what they wish for. It could well be the precipitating event for the final denouement in this extraordinary period of financial history.”
*** The bell may indeed be tolling for the U.S. economy – but is its music reminiscent of the bandone¢ns of Argentina…or the kotos of Japan? Our own Addison Wiggin, managing editor of the Daily Reckoning, will be speaking on the subject at the upcoming Agora Wealth Symposium in August. He’ll also be giving out complimentary advance copies of the book he’s written with Bill Bonner: “Financial Reckoning Day: Surviving The Soft Depression of The 21st Century” (John Wiley & Sons).
If you’d like to meet Addison – together with your New York editor, Eric Fry, and a host of leading investment analysts from the far reaches of the Agora clan – you can still sign up for an early bird discount. But you’ll have to hurry…they won’t be available for long…