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 dollar and the U.S empire are on the edge of greatness, we think. But on which side?
The thought occurred to us in our moment of reflection at Dulles Airport. The sun had just peaked 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 observed yesterday. 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.
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."
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 there was 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.
But now, many of those American business heroes are in disgrace.
"Enron Corp., Arthur Andersen and Henry Blodget," 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."
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. 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 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 04, 2002 — Paris, France
DDGU – yes, of course. But the big news yesterday was the big drop in the stock market, about which Eric has more details below.
The majority view has come to be that the recovery will be long and slow rather than quick and robust…and that stocks will show modest gains. But stocks have been in a bear market for at least 2 and a half years. During that time, the Dow has fallen…but gracefully. While most people still expect stocks to rise, we guess, they’re getting used to a gradual sell-off and probably getting a little tired of it.
It is not what people don’t know that hurts them, we recall, but what they think they know that ain’t so. That is where the entertainment is…and also where the profits are, taking positions where you profit from the mob’s mistake.
So we wonder…how will most people be wrong? Will stocks shoot up more than expected? Or will they fall suddenly, sharply, disastrously?
We notice several signs that American consumers and investors may be nearing a breaking point.
Older Americans – those 65 and up – are declaring bankruptcy at a rate 244% higher than they were 10 years ago. Fewer people are finding jobs – the number of people collecting long-term unemployment benefits is at a 19-year high. Credit card payments are getting stretched – late payments are at a 5-year high. And while we reported that consumer spending was rising at 5 times the increase in consumer income…we erred. The Commerce Department corrects us; adjusting for inflation and taxes, consumer incomes actually fell in April by 0.1%.
Meanwhile, U.S. fund managers say they expect to reduce their weighting of U.S. equities. Fewer than one in 4 of the managers said he thought U.S. corporate profit outlook was brighter than other regions.
And foreigners, too, are beginning to wonder why they hold so many U.S. stocks and bonds. In 2001, net inflows of capital into U.S. markets equaled $44 billion each month. But in each of the first 2 months of this year, only $14 billion came in.
For foreigners, the choice is painfully obvious. U.S. stocks have not only been in a bear market for nearly 3 years…this year, they’ve underperformed most overseas markets. Plus, the dollar has lost 9% against the euro and yen. On top of this, an investor can get twice the rate of return on 3-mo. deposits in London…and 3 times in Australia…what he can get in New York.
Would it be such a big surprise if investors suddenly forsook both U.S. stocks and the dollar?
Eric…what are they up to on Wall Street?
Eric Fry, reporting from Manhattan:
– The stock market has "fallen and it can’t get up!" The Dow tumbled another 215 points yesterday to 9,709, while the Nasdaq dropped more than 3% to 1,562. Gold bounced a little, while the dollar fell to a new 16-month low against the euro. – "Fresh allegations of misconduct by captains of industry depressed the ailing stock market Monday," Smart Money’s Igor Greenwald reported. "News from the executive suite was heavy on death and taxes, from the evasion probe that ousted the boss of Tyco International to the reported suicide by the treasurer of El Paso."
– All in all, it was not a great day for stocks.
– "There is no bull market, because there is a bear market," Bill helpfully explained last week. This fact is so obvious, even Bill and I can see it. In fact, it is not merely obvious that stocks ARE in a bear market, but also that they DESERVE to be in a bear market.
– It’s obvious that the expensive U.S. stock market should become less expensive…and so it is. The dollar, likewise, seems overpriced, given fundamental shortcomings like a gaping U.S. current account deficit, for example. A dollar sell off would seem to be a likely outcome…and that’s just what’s happening. Gold, on the other hand, seems somewhat underpriced, given the dollar’s weakness, global currency instability and rising geopolitical tensions. Obviously, therefore, gold should climb higher…and so it is. But how much longer can these obvious trades thrive?
– "Yes, we realize the consensus is not always wrong," writes Alan Abelson in this week’s Barron’s. "But we also know that history records not a single instance of anyone ever getting rich betting the consensus was right."
– Are the obvious trades due for a short-term about- face? For a couple of days, at least, shouldn’t the stock market and the dollar both rally, while the gold price falls?…Then again, selling US stocks and the US dollar seem like such obvious trades, why resist the urge?
– Trying to outwit the market is a tricky game. So sticking with the obvious trades might just be the best bet for now, especially when it comes to the dollar.
– Abelson observes that a "mounting consensus among the currency cognoscenti" anticipates a continuing dollar decline. "Feeding that growing conviction has been the recent weakness of the greenback, which last week sank to a 16-month low against the euro…As an admitted card-carrying contrarian, our first instinct was to view the swelling ranks of dollar worry-warts as reason enough to buck the crowd’s gathering bearishness on the buck…What gave us pause, though, was that Lawrence Lindsey urged one and all not to worry, insisting everything was fine and dandy with the dollar…And when he chooses to reassure the public that there’s no need to worry about the dollar, it means the administration is worried stiff about the dollar. And, it should be."
– As Bill remarked yesterday, "The dollar has been the most successful paper money in history. Thus, it needs a great correction to bring it to mediocrity."
– Merrill Lynch paid $100 million to settle with New York Attorney General Eliot Spitzer. But will Merrill’s wounded clients be so easily mollified? Unlikely, predicts Strategic Investments editor Dan Denning. "[The settlement] is not the end, but just the beginning of Merrill’s long legal nightmare. This will make the Microsoft case look like traffic court."
– Spitzer himself says that the $100 million bounty paid by Merrill is "a statement that they indeed have done wrong." More importantly, as one former attorney told me last week, "No jury in America will regard a $100 million payment as anything other than an admission of guilt." Armed with this quasi-admission of guilt, class- action attorneys from coast-to-coast are readying lawsuits against the giant brokerage firm.
– The outcome won’t be pretty for Merrill. The coming judgments and verdicts against the firm could be, according to Spitzer, "in the magnitude of several billion dollars in terms of potential exposure." During a bull market, investors don’t line up to bring class-action lawsuits against America’s largest financial institutions. Everyone is too busy piling up paper profits. Only during bear markets do class-action lawsuits crop up on the financial landscape.
– "Poised for a cyclical rebound," says Jim Grant, "are recrimination, reflation and reform." Recrimination is budding already…Reflation and reform are only germinating.
Back in Paris…
*** "I CHARGE YOU WITH THIS:" wrote a Daily Reckoning reader, "Tell us – your life blood, your ever-loving subscribers – the TEN BEST places to hedge our investment bets against future terrorist acts. Certainly gold will spike. Index shorts will, as well. But please, tell us ALL of the best ways we can defend our diversified portfolios against just such an occurrence."
*** We wish we knew. But remember…there’s a time for every purpose under heaven. There’s a time to get rich…and a time to refrain from investing. Most likely, the U.S. economy is in a bear market. And the U.S. also has embarked on a war against terrorism… which is bound to produce a few surprises. This is a good time to stick close to home, close to what you know, close to who you know and close to what you like. It is also a good time to own things such as income- producing property; essential, profit-making businesses; and solid, tangible things…such as gold. More below…
*** The advantages of monarchy over democracy are rarely reported in the popular press. One of those benefits is that kings and queens can speak the truth without pretending to be ‘one of the people’.
"Air travel has become much more comfortable," Prince Philip observed, quoted in the pages of the International Herald Tribune, "unless you have to travel in something called ‘economy class,’ which sounds ghastly."