Day of Patrimony, II

Degrade first the Arts if you’d Mankind Degrade. Hire Idiots to Paint with cold light & hot shade: Give high Price for the worst, leave the best in disgrace, And with Labours of Ignorance fill every place.

William Blake

We reread our letter from Monday and wondered what we had been trying to say. Today, we hope to find the point and come to it. Not that we have any better idea on Wednesday morning than we did on Monday. So, we will toss the words out again, counting on Friedrich Hayek’s ‘spontaneous order’ to arrange them in good order. This technique does not always take us where we intended to go, but it often takes us where we ought to be.

Here at the Daily Reckoning, dear reader, we favor Hayek’s Austrian School of economics, if only because it is the only one simple enough for us to understand. People go about their business and create a ‘spontaneous order’ – like natural languages and beehives. Constantly evolving, through good times and bad, they are never perfect – but they are what they are and can rarely be improved by government edict or central bank legerdemain.

A man can make a mess of his life and his business. Acting in concert with others, he can cause markets to boom and bust. But if you really want to bring on an epic disaster, you need politicians and central bankers.

The typical man – especially the successful one – cannot bear the uncertainties of life; he is always afraid things will turn against him. So, when the politicians promise him stability, he listens with three ears. He is perfectly happy for the bankers to set interest rates, for example, if he believes it will secure his financial position…and perfectly content to trade away his liberty if he thinks it will make him safer.

What he actually gets is only a temporary advantage. For sooner or later, the stability that the meddlers have given him blows up in his face. Having crimped the hose of evolution, the many small adjustments that a society needs back up into a huge bubble, which sooner or later must burst.

What goes up must come down, say the Austrians. Every bubble must be followed by an equal and opposite bust, they add. Real prosperity can only be had by schlepping and saving, they conclude; anything else is a fraud.

It makes sense to us.

In the Great Bubble Economy of 1996-2002 fraud crept into every financial orifice. It was supposed to be the Information Age, yet ‘Labors of ignorance’ filled every place. Instead of real earnings, investors filled their heads with operating earnings and believed that stocks were always a good long-term investment, even at 50 times earnings. Instead of real savings, consumers fluffed out their balance sheets with the inflated equity in their own homes.

And then, of course, there was the Social Security ‘lock box’ which existed only in fantasy…the ‘peace dividend’…the federal surplus…and all the rest. The standards, customs and habits that had kept people honest seemed to yield to convenience and comfort…much like starched white collars had given way to Lacoste golf shirts.

Taking the train down from Paris, we were offered lunch for 46 euros. Since we had not dejeuned, we took the proposal and tucked in to a rich repast of confit de canard sluiced down with half a bottle of rose wine. Intending to work, we instead fell into a state of near- unconsciousness, from which we did not revive until we had reached Lausanne. There, we stared at the stately homes around the lake. Built of stone and concrete, with oversized roofs and faded wooden shutters, they looked as though they had been there forever.

In our dreamlike state, we remembered our visit to Chateau Bois Morand. Priced at 7 times the average American home, it beckons to new owners like a movie queen to a truck driver: Come hither. Take me and I will make you more than you are.

What an awful investment! It had probably never sold for anywhere near what it really cost to build. Even now, after the biggest boom in Western history, it is still priced at probably less than 20% of replacement cost.

And yet, drifting back to the days before central banking and stock markets, when even kings lived like pigs and terrorists lurked behind every bush, had not its stone walls provided protection? How much was that worth? And had it not already sheltered 20 generations? And had not each one been encouraged…stimulated… pushed forward and uplifted by the grandeur and rigors of the place? For you have only to move in and you are immediately in a different class of society; you are a ‘chatelain,’ and are expected to act the part. You are expected to live up to your house.

It is just a feeling, of course…the kind you get on moving trains when you are half-drunk…a presentiment perhaps…but we worried that the bear market may be more than just a financial event, or even an economic one. Something bigger and more painful.

Houses are thrown up all across America and priced at more than the cost of construction. Owners believe they have found a kind of paradise…like a drunk on Sunday finding an unlocked liquor store…where they can pad around in complete comfort and get rich without saving. Their houses demand nothing from them. There are no cold drafts, no cold stones…not even shutters to close at night. An owner can sink as low as he wants…as long as he can make the mortgage payments – which, at today’s low rates, are a snap.

Likewise, a marginal student at Harvard – without any special exertion – can now expect to graduate ‘with honors.’ One from a favored minority group may only have to show up for class.

"The American models stand out in Milan," Maria told me over dinner last night. "They all seem to slouch…"

All across the country, the innocent and the connivers slouch toward comfort. A long period of stability, progress, peace and prosperity has brought on a lazy-boy relaxation where it is dress down Friday all week long.

But in bear markets things go wrong. We wonder how the average American will react when they do.

Your ever-humble editor,

Bill Bonner
September 25, 2002

P.S. Maybe the Chateau Bois Morand would be a good investment after all. Crash, bear market, deflation, inflation…at least it would still be there.

Darkness spreads throughout the Northern Hemisphere. The days grow shorter. Stock markets grow cheaper.

The French index is below 3,000. The London index has dropped below 4,000. And the U.S. Dow, of course, is now below 8,000.

Germany has long been the powerhouse economy of Europe. But on Monday, the DAX fell nearly 5%. In Paris, the CAC 40 fell 4%. And here in Milan, "Shares crumble in ‘nightmare,’" says the paper.

"I’m ready to pack up and go and sell ice cream," said a trader to Reuters. "This market has been a nightmare for the last six months. I’m in shock."

Yesterday, as Eric reports below, the Dow retreated to a place it had not been in 4 years…and the Nasdaq fell to a 6-year low.

At least things are not as bad in Europe or North America as they are in Japan. There, stocks fell yesterday too…but are so low now that 19 years of stock market gains have been wiped out. But hey, it took 13 years for the slow-motion bear market/recession in Japan to get to this stage. We’ve still got plenty of time to catch up. Fund managers, analysts, and economists are shocked. For years, they’ve been telling the public that shares couldn’t go down; they came to believe it themselves.

Nor can they believe the ‘negativity’ among investors. After all, the media tells us that the economic recovery is still on track. "I’ve never seen such a divergence between actual economic performance and market perceptions," said the chief economist for Bank of America Securities.

"The latest indicators look good," added Treasury Secretary Paul O’Neill, vying for the Herbert Hoover Memorial Trophy.

"I should have married a financial analyst or a fund manager," comments our Paris-based reporter Lorraine Amiel in the new French version of the Daily Reckoning, "they are always so optimistic…they always see ‘la vie en rose.’"

But poor Lorraine misplaced her rose-colored glasses. "I see black," she concludes.

And "poor Mr. Market…" writes Eric Fry this morning, "Could we blame him if he refused to get out of bed tomorrow morning? Talk about a dead-end job; every day he does the same tedious thing – get up, wait for the opening bell, suffer six and a half hours of abuse from investors, wait for the closing bell and trudge on home."

Eric’s report continues:


Eric Fry, in Manhattan:

– Yesterday investors heaped yet more abuse on Mr. Market by driving both the Dow and the Nasdaq down to new lows for this very lengthy and very painful bear market. By the closing bell, the Dow found itself stripped of 189 points at 7,683 – a level it last visited in 1998. By comparison, the Nasdaq emerged unscathed, losing only three points to 1,182. Even so, the Nasdaq found itself at a new six-year low. The last time the star-crossed index closed as low as it did yesterday was Sept. 12, 1996.

– "On that day," writes Aaron L. Task of, "the Dow closed at 5771.90 and the S&P 500 at 671.15. "Certainly, the [Nasdaq] was the epicenter of egregious excess in the late 1990s and is thus suffering more in the aftermath of the bubble. But the Dow and S&P were not innocent bystanders during those halcyon days. One could argue the Dow and S&P will not follow the [Nasdaq’s] lead back to levels of six years ago, but it’s not entirely unthinkable."

– Even part-time trivia buffs will recall that 1996 was the year – on December 5th, to be exact – when Alan Greenspan delivered his infamous "irrational exuberance" speech. Shortly thereafter, Greenspan seemed to recant his heretical remarks and began devoting himself wholeheartedly to the business of bubble-building. And he built a magnificent bubble. Then one day, sadly, it sprung a leak that even the master bubble-builder himself could not repair.

– As the bubble slowly and pathetically deflates, so do the price targets of Wall Street’s once-esteemed strategists. This week, Steve Galbraith, domestic equity strategist at Morgan Stanley, slashed his 12-month target for the S&P 500 from 1,200 to 1,050. Does anyone other than Steve care about his price targets? Would it not be better for him if he simply crawled under a rock and hid out for the rest of the bear market?

– Meanwhile, the dismal stock market action is breathing fresh life into the gold market. The December gold contract jumped at $3.10 to $327.20 per ounce. The rallying gold market is no comfort to stock market investors, of course. Then again, there seems to be no comfort for stock market investors these days.

– "Almost everything that can go wrong is now going wrong," says Comstock Partners. "The economy is slipping badly with production declining, consumer confidence falling, leading retailers coming in under plan, the leading indicators dropping, and capital spending still in the doldrums…Adding to the worries, the corporate governance problems just keep multiplying, terrorism remains a threat and the world awaits an invasion of Iraq."

– Comstock continues: "The market’s fourth significant bear rally over the past two and a half years peaked on August 22 and has since started another decline. So far every such decline has gone to new lows, and we don’t expect this time to be any different."

– Nor do we…


Back in Milan…

*** "Bad things happen in bear markets," writes Dow Theory sage Richard Russell. A war against Iraq, for example, would cost between $100 and $200 billion. Even for Washington, that ain’t pocket change. Which means that the federal budget – whose surplus was a source of strength and comfort in the bull market – would run even deeper deficits than are now being forecast.

But things have a way of going a lot badder than people expect. Stocks, for example, do not typically sink to a level where they offer fair value; they keep falling until people are sick of hearing about them.

Other things go wrong too – things people never expect. Yesterday’s paper brings news that fourth graders in Japan are "using obscene language, often directed at the teacher…by the sixth grade, a growing generation of pre-teenage rebels has begun walking in and out of the classrooms at will, mocking the authority of adults and even attacking teachers who try to restrain them."

This might not be unusual in, say, the public schools of Baltimore. But in Japan, the "classroom collapse" is the latest thing to go bad in a long, slow-motion bear market than began in 1990 and continues to today. It is also "the latest insult to the pride of a society that more than a decade ago thought it had most everything figured out," says the International Herald Tribune.

One of Richard Russell’s readers sent the following message to illustrate how things might go unexpectedly bad for America: "Speaking of the very bad things that can happen during bear markets, did you read about the very large war games of a few weeks ago? A retired 64 year old Marine general, commanding a mid-Eastern country that we were attacking in the year 2007, decided not to wait for American forces to attack and he struck first. He used unconventional communications that could not be intercepted, and numerous civilian small planes and boats to ram our fleet in suicide attacks. Small boats also launched Chinese silkworm anti-ship missiles. The results: 16 US warships including a carrier sunk, thousands of marines and sailors killed. Apparently, even after 9/11 and the USS Cole, our admirals and generals don’t believe that anyone else could launch an unconventional attack against our military and severely damage us. Maybe some of the bad things that can happen during a bear market will include such events."

*** The Republic National Committee sent the following email:

"President Bush’s decisive leadership has united the American people in the face of extraordinary adversity. He is confronting the challenges of our time with bold resolve, and the American people have rallied behind his efforts to win the war on terror, protect our homeland, and strengthen our economy."

A modest prediction: none of these objectives will be realized. Not that we have any inside information, nor even any useful experience. But after years of living on a French farm, we know a canard when we see one. The idea of ‘preventive war’ has a waddle we could spot from across the pond.

Napoleon had much the same idea – to strike his enemies before they could make war against him. He had some spectacular successes, of course. But those were his undoing. Nothing fails more spectacularly than spectacular success. In the end, all of Europe was against him.

A further note to George W. Bush: you’re no Bonaparte. *** Ouch… the following message pains us greatly. Because it is too true. Except in a small detail…

"I read with great interest the Daily Reckoning each morning. I’ve been reading it for about eight months now, and have learned a tremendous amount…enough that my IRA is actually up 5% on the year rather than down 25% like the stock market in general is, since I’ve avoided putting my IRA money into stocks and own bond mutual funds and gold instead, thanks in part to your advice.

Anyhow, one thing I wanted to mention to Bill Bonner and the rest of the staff. You guys occasionally make mention of the American consumer and how willing he/she is to spend spend spend beyond their means. At times a hint of moral judgment comes into your commentary. I understand this and agree to some extent…a lot of people do live beyond their means, buying houses and SUVs that they really can’t afford, etc.

But many, many people do all the right things and still have problems saving and investing. It appears to me that the DR staff is, perhaps, just a bit out of touch with the way "average" American families live. Trying to save and invest on a family income of, say, $40,000 a year when having to deal with the costs of things like health insurance and child care can be very difficult.

A case from my own experience is illustrative. My wife and I own two cars, a 1993 Oldsmobile Cutlass Ciera and a 1995 Ford Aspire, neither could be considered luxury vehicles. Our income would be classified as upper middle class, in the $50-70,000 range depending on how my small business is going. Over the last year and a half, we’ve put most of our "extra" income into debt elimination… we rent our home, we own our cars, we have only a small balance on our credit card, we paid off our student loans and some large medical bills leftover from my wife’s pregnancy. We’re doing everything right.

But in the last six weeks, our two automobiles have broken down five times, resulting in repairs in excess of $3,000. We were fortunate in that we had the money to pay, although our savings account has taken a big hit.

But many, many families who make less than we do, would have been devastated by these car breakdowns, forced into putting most or all of the charge on credit, assuming they HAVE credit.

I mention this only because I feel that many people who are wealthy, such as Bill Bonner, are insulated from the kinds of things that can massively, suddenly, and easily ruin the finances of average people…car breakdowns, medical bills, etc. Sometimes a tinge of "people get what they deserve" look-down-the-nose judgment comes through in his commentary. As I said, I don’t deny that many people ARE spendthrifts, or try to live beyond their means. But I feel that the Daily Reckoning would benefit if Bill would be a little less snotty about the coming economic cataclysm. A lot of people are going to be badly hurt by what’s about to happen, and most of them aren’t going to deserve it."

Your editor responds, looking down his long, gilded nose:

Uh…er…well…okay. The markets make fools of us all, sooner or later. Rich and poor, innocent and scheming… we all have our turns. Can you forgive us, dear reader, for feeling just a little haughty and self-righteous on one of those rare occasions when it is not we who look like utter imbeciles?

The Daily Reckoning