Dead Wood

I apologize for leaving you on the edge of your seat.

Our conversation ended on Tuesday with a tantalizing question. At least, it seemed tantalizing to me. Most people would find it as boring as a Congressional hearing. But those of us with a mischievous curiosity about the way the world works want to know the answer.

Here at the Daily Reckoning, we have been boring readers for more than two years with our comparison of the U.S. bubble economy of the late ’90s to Japan’s bubble economy of the late ’80s.

The parallels are obvious. Both countries were the great innovators of their times. Both countries were admired worldwide for their new technology and business- management successes. Confidence inspired credit and borrowing… and led to huge increases in capacity in the leading industries as well as the amount of debt.

In both countries, stocks tripled in the last 5 years of the bubble market. And in both countries, the bubbles burst – with stocks down nearly a third in the following 18 months.

Where do the parallel lines diverge?

Economists think they know.

“American policy makers give themselves higher marks for speed of response,” reports the Wall Street Journal. “The Fed had cut interest rates by 4.5 percentage points in just 10 months. It took the Bank of Japan 4 « years to do the same.”

This speed, they believe, will be decisive. From here on, they say, things will be different.


We don’t know, dear reader. And we have a hunch they don’t either.

“What do the world’s leading economists and policymakers know about the causes behind this U.S.-led global economic downturn?” asks Dr. Kurt Richebacher, “What does Fed Chairman Alan Greenspan know? Reading reports from very different sources, we long ago realized that the great majority of economists even in highly responsible positions are at a complete loss to understand what it going on. There is a sea of statistics… but little or no effort to sort out the decisive causal processes.”

In this great Information Age, economists have more information at their fingertips than ever in history – enough digits to satisfy a Hindu goddess. What they lack is theory… a frame of reference that makes sense of what is going on around them. Having rejected the analogies of history, to them each sunrise is as fresh and unknown as the day the world began… with no idea of how or when it will it end.

For the last two years we have tried to provide what most of the world’s economists and analysts lack – a suitable analogy. And so, again today, we return to the land of the rising sun to see how the day of zero interest rates turned out.

Japan has had short term rates near zero for more than 5 years. Even with the delay, you might think that – by now – free money would have had an effect. Instead, the story in Japan seems to get worse and worse.

“After more than a decade of economic slump, the populace has sunk into a deep pessimism that threatens to become self-perpetuating,” explains another Wall Street Journal reporter working the same beat, “The fear that profit and income will only decline over the long term has persuaded corporate executives and families alike that their sole recourse is to cut spending. Slack demand has led to falling prices for goods and land. Falling prices have bred deeper cost cuts by businessmen and more heroic efforts to save by individuals. Companies are paring down old debt rather than borrow anew for capital investment.”

“Theoretically, if interest rates are lower, you should use more money,” the WSJ quotes a Japanese householder, “But actually you end up not using it because things just aren’t looking that bright.”

Even after a 12-year slump, Japan’s nominal GDP collapsed at a 10% annual pace in the 2nd quarter of this year – this despite a key lending rate of 0.001%.

In Japan, it is not only easy for businesses to borrow – it is almost mandatory. Government, bankers, and businesses support each other… even when it seems contrary to their own interests. Government – through the Bank of Japan – made plenty of money available at negligible rates. Bankers made the money available to their customers, both the solvent companies and the insolvent ones. In a recent incident, Shinsei Bank, owned by Ripplewood Holdings of New York, was told by regulators that it had to lend to customers who would otherwise fail. And businesses tend to borrow money – whether they need it or not – just to be good partners.

“Nature is very hard,” I recall my gardener musing as he pruned back a grape vine. “You have to cut away the dead wood and the weak parts all the time… Just as you have to cull out the weak animals and thin out the vegetables. In order to get a good crop of anything you have to destroy much of it.”

Thanks to easy credit, little culling, pruning or thinning has been done in Japan. Businesses that should have been pulled from the garden in 1990 are still absorbing sun and water… and still making payroll, with borrowed money. Matsushita Electrical Industrial Co., for example, will lose more than $2 billion this year. Yet, it refuses to cull a single of its 130,000 employees. The nature of business is not hard in Japan… it is made soft and easy with lower rates and easy credit policies.

“By trying to suppress a recession,” comments James Grant, recently returned from a trip to Nippon, “Japanese authorities have managed only to perpetuate it.”

American economists don’t understand what is wrong, but they think they know what to do about it – the same thing the Japanese did… lower rates. But it has already been 10 months since Greenspan began cutting rates. Since then, he has cut 450 basis points from short term inter-bank rates. This puts the lending rate about 2% below the estimated inflation rate.

What this suggests to us, dear reader, is that “tight money” is no more the source of economic trouble in America than it is in Japan. Banks can borrow money and pay a negative interest rate of 2%. Corporate borrowers – if their credit is good – pay not much more. Money is not merely free at these interest rates – people are being paid to take it.

Still, American economists and policy makers cling to the belief that America’s downturn is not like Japan’s… and that the easy-credit policies that failed in Japan will work in America. Since the days of Herbert Hoover, Americans have considered consumer spending the key to economic progress. And they believe they can either fire it up… or dampen it down… by adjusting short term inter-bank rates.

They were wrong in the Hoover Administration, we believe. They are no less wrong today.

More tomorrow…

Bill Bonner
November 15, 2001

“Most boys can’t stop thinking about the VIRGINS.”

– Bassam Khalifi, 16, a Hamas youth leader in Gaza’s Bureij refugee camp.

Bassam Khalifi, and tens of thousands of other young fundamentalist teens like him, present a huge threat. It’s not just politics… or religion… it’s also raging teenage hormones. But, what’s that got to do with virgins?

Better yet, now that the Taliban’s on the run, what’s it got to do with the US economy – and your portfolio? More than you can imagine.

* * * * * * * * * * * * * * * * * * * * * * * * *

Automakers sold a lot of cars and trucks last month. Lured by low prices and zero financing deals, consumers responded to Fed Governor Robert McTeer’s urging and bought so many new vehicles that they boosted total retail sales figures by 7%.

Neither personal incomes, nor productivity, nor business profits were up a corresponding amount. In fact, most measures of economic health and progress fell in October. Unemployment is still rising….and more companies are warning of lower earnings so far this quarter than in the last.

So we have to ask ourselves – will the nation’s economy be saved by this rush of consumers to spend what they don’t have on something they don’t need? Is consumer spending the key to financial progress…and can it be goosed up by the Federal Reserve? More on this subject, below…

The biggest spenders in America are the Baby Boomers. But they’re getting older and becoming more reflective. What if, in their reflections, they decide that spending is not only unaffordable, but unfashionable?

“I’ve had enough…” said Mick Jagger to Le Monde, “it is more and more important to get away from what’s called ‘modern life’ with its social pressure towards success and money….”

If Jagger can’t get no satisfaction from materialism… will the boomers be any different? But let’s return to Wall Street. Eric, are investors getting what they want?


Eric Fry in New York City…

– Today, Kabul…Tomorrow, Dow 36,000! Aren’t there a few more towns in Afghanistan that we could capture? Kandahar ought to be good for at least 500 Dow points.

– Beating earnings estimate by a penny is nice way to get stocks moving higher. But beating up on the Taliban is a heck of a lot better. The Dow jumped another 73 points yesterday to 9,824, while the Nasdaq gained 11 to 1,903.

– Earnings don’t really matter right now, of course, because the market is “looking ahead.” Apparently, it “sees” a financial Eden in which global terrorism is antiseptically conquered; in which consumers without jobs spend lots of money; and in which companies without sales report robust profits.

– Is there any reason to doubt that this will be so? After all, we’ve already conquered Kabul and we’ve learned that consumers will spend almost any amount of money as long as free credit is available.

– Zero-interest car loans attracted plenty of interest in October. “After a month of therapeutic penny pinching,” writes Christoph Amberger, Publisher of Agora’s Taipan Group. “American consumers are on the prowl again, doing what they do best… spending money imagined and real. The Commerce Department announced today that they boosted retail sales in October by 7.1% – the biggest one-month gain ever recorded.”

– “Much of the strength derived from a record 26.4% increase in car sales, boosted by zero-percent financing,” continues Amberger. “And what goes better with that new car smell than a new Armani suit – even if you may no longer be employed when you receive your credit card statement? Sales at clothing stores increased by 6.9%, erasing a 5.9% drop in September.”

– The news is not exactly rosy. If you exclude auto sales, for example, retail rose only 1% over September’s depressed total. Still, investors responded to the Commerce Dept. report by buying stocks, especially the stocks of retailers – most of which advanced at least 7% or 8%. Leading the charge? Our favorite “river of no returns” on-line book retailer Amazon soared an astounding 30%.

– Curiously enough, several retail companies also reported some less-than-terrific numbers, yesterday. Abercrombie & Fitch announced that its same-store sales plunged 15%. Federated Department Stores reported that its same-store sales dropped 8.6%. High-end jeweler Tiffany’s forecast a “low-double-digit percentage” decline in U.S. same-store sales. Tiffany also announced a 34% drop in quarterly earnings and rising inventories.

– Consumers may not be buying as much jewelry at Tiffany these days, but that didn’t stop Newmont Mining from offering to buy two gold mining companies yesterday: Normandy Mining and Franco Nevada. The $5.16 billion deal would make the combined company the world’s largest gold mining operation with annual production of 8 million ounces and nearly 100 million ounce of reserves. That’s a lot of baubles and bangles at Tiffany.

– Franco soared on the news, which no doubt brought a smile to the face of Daily Reckoning “Blue” readers. Editor Dan Denning recommended the stock earlier thissummer and it has climbed more than 35% since then.

– Speaking of metal, zero-percent financing is helping to move a lot of it of car dealer’s lots. It’s nice to know, that, even in a recession, you can sell a product as long as you almost give it away.

– Offering zero-percent financing is a costly gimmick. October’s record car sales will not produce anything close to record profits. In fact they may not produce any profits at all. Be that as it may, Ford Motor Company has decided to extend its interest-free loan offer on its cars and trucks until January 14th. The reasoning must be something like: if two aspirin are good for you, 20 aspirin must be better.

– I was up in midtown Manhattan yesterday for an investment conference and it felt like I’d stepped into a time machine. The date was March of 2000 – stocks were rallying; stocks with no earnings were rallying even more; sidewalks were brimming with cell-phone-toting movers and shakers; and restaurants were packed.

– For a recession, things seemed pretty darned agreeable.

– Because stocks are “acting well” and because our recession is not the severe, soup-line variety, investors are finding it much easier to buy stocks than to sell them. That’s all well and good. But the stock market seems to be running well ahead of fundamental economic realities.

– “We have begun to work off the excesses of the late 1990s,” says Fred Hickey, editor of The High-Tech Strategist. “Companies are cutting operating expenses and capital expenditures in order to improve profitability and reduce overcapacity. Consumers have begun to retrench and save a little…which means that 2002 is likely to be a rotten year economically. Stock prices do not yet reflect this reality.”


Bill Bonner Back in Paris…

*** “Kabul residents greeting Northern Alliance soldiers entering the capital” says the caption. The photo on page 4 of the Herald Tribune shows a photo of a smiling bearded man in battle fatigues reaching for the outstretched hands of civilians in Kabul. “Bush ‘Very Pleased,’…” reports the headline at the top of thepage.


This face looks familiar…yes, it’s the same face in a photo that appeared in the London press yesterday. I picked up a copy of the Daily Mail as I was leaving Waterloo station. Next to the photo was a headline, “Chilling truth about the butchers who routed the Taliban.”

*** The good news from Afghanistan is that the Taliban are on the run and bin Laden may soon be captured. The bad news is that many of the people doing the chasing are just as bad.

*** As so many readers have told me, the war in Afghanistan bears no resemblance whatsoever to the U.S. involvement with unreliable, “incapable and mad” local allies in Vietnam. Still, the Daily Mail tells us a little about the devils with whom we have made a bargain:

The war on drugs seems to have been pushed to a back burner, as the U.S. allies in Afghanistan typically support themselves with heroin sales. But that is the least of it.

The Daily Mail reports that “100 boy soldiers are killed in cold blood,” as the Northern Alliance took the town of Mazar-I-Sharef. The boys were found hiding in a school and massacred, according to the report.

What the Afghanis don’t know about revenge isn’t worth knowing.

This was not the first time the town has seen mass executions. When the Alliance last took Mazar-I-Sharif in 1997, they killed 2,000 Taliban prisoners. And in Kabul, “as many as 50,000 people were slaughtered,” says the Daily Mail article, before the Alliance forces were driven out in 1998. General Dostum, one of the Northern Alliance warlords who once worked for the Soviets, punished a soldier by crushing him under a tank. Another warlord,, General Mazari, invented an entertainment called “dead men dancing,” in which a man’s head is cut off; then, gasoline is poured down his neck and set afire.

But Mazari was captured by the Taliban and thrown out of a helicopter.

The Daily Reckoning