Debt Express

“We may make Atlanta, but we’ll all be dead.”

One of Jimmy Rogers’ railroading songs

Clickety clack. Clickety clack.

There is always a lot of ‘noise’ in an economy. The latest numbers, for example, show such a mixture of facts and figures that it is hard to make sense of them.

Corporations are issuing bonds at a record pace. $88 billion of them were taken up by investors in the month of May alone. And, in early May the junk bond market had its best week in 12 months, with $500 million flowing into the risky investments.

Consumers seem to be heeding McTeer’s appeal to patriotism. Countrywide Credit reports that it funded $102 billion of new mortgage loans in the month of April – an increase of 130% over a year ago. And Mercedes Benz reported its best results ever in the month of May.

And there is the gold price. Down $9 last week, gold seems to be telling us that inflation is, as our Fed chief tells us, no problem. Gold stocks were less sure – declining only 5% over the week.

Meanwhile, the number of bankruptcies rose 17% in the first quarter. So far this year, 581,105 people have declared bankruptcy…up 23% from this period last year. What should you make of that?

With all this racket, how will we know when the economy is really breaking down?

It is hard enough to see what is in front of our very eyes, let alone what is coming around the bend. Is the economy expanding or contracting? No one really knows. We have to wait to find out, looking backward to see where we have been.

We don’t know where we are, but most people believe they know where they are going – towards the clear skies of economic growth, full employment and 15% per year stock market growth. No need to consult a map, nor even to look out the window; Alan Greenspan is at the throttle. He’s wearing his Casey Jones cap and has his hands on the controls.

As we found out yesterday, the throttle may not be connected to the fuel line…and the brake may be more operational in theory than in fact…but there is no need to alarm the passengers. This train is bound for glory, after all. Get on board now…or you’ll be left behind!

“With effortless adjustments to short-term interest rates, so the thinking goes,” as Doug Noland put it in a recent bulletin, “central bankers have both the skill and capacity to orchestrate positive and enduring effects to financial markets, while stimulating just the right amount of additional demand to perpetuate a non-inflationary U.S. economic boom. With the Fed able and more than willing to ward off any financial difficulty or economic slowdown, the only thing to fear is fear itself.”

It is too late for business. Already fearful, business is cutting back. Employees are being laid off. New projects are being shelved – at least until excess inventories are sold off.

Thank God for the consumer. “With industry already in a slump,” explains an article at S.F. Gate, “the only thing that has kept the nation out of recession has been the willingness of consumers to dig into their pockets and buy. That spending has been fueled by an ever-increasing use of credit.”

Borrow, borrow, borrow, urges McTeer of the Dallas Fed. Spend, spend, spend. It’s our only hope.

But there is a limit to how much debt consumers can handle. Amid the clatter of news and facts is a whisper of what is being called “consumer stress.” Credit counselors report a 30% increase in business this year over last. Bankruptcies are increasing, as noted above. Consumers seem to be ‘maxing out’ their ability to borrow and spend. In April, for example, people spent $49.7 billion more than they earned. How long can this go on?

What the Fed can’t do, it won’t do. It can’t erase inventories, or turn a bad business into a good one. Nor can it wave a wand and make consumers’ debt balances disappear.

What the Fed can do – lower the Fed funds rate…and increase ‘liquidity’ – it can be counted on to do. The funds rate can go to zero, and in real terms, below zero. Will a funds rate of zero prevent stocks from regressing to the mean? Will it light a fire under productivity and GDP growth? Who knows. But in Japan, it had no such effects.

And liquidity? It ‘has to go somewhere’ is the popular expression. But it might well go to rebuilding consumer savings accounts…or offsetting deflationary consequences of a stock market meltdown…or, yes dear reader, even to increasing the price of bread, houses and movie tickets.

There were those – many and famous – who urged investors to buy tech stocks and dotcoms a year ago. But only half the population – the upper half by income – got to take advantage of this advice. Consumers with more modest incomes, or perhaps better sense, did not get a chance to lose money on the tech mania. But now, they have an opportunity to do something equally stupid: They can climb aboard the Fed’s ‘Debt Express,’ Destination: Unknown.

Your editor,

Bill Bonner
Paris, France
June 5, 2001

P.S. What the Fed cannot do might nevertheless happen. Alan Greenspan, if nothing else, is famously lucky. It was his great luck to step onto the #1 Engine at the Fed reserve switch yard after Paul Volcker had sharply raised interest rates, thereby shutting off the supply of oxygen to inflation. It was Volcker who took the heatanddidthedirty work.

Greenspan has had a downhill run ever since… coasting on the slope of declining interest rates, with no inflation threat on the horizon. Maybe he’ll get lucky again.

*** Last week Dallas Fed chief McTeer proclaimed that the stock market correction was “overdone.” Yesterday, Chairman Greenspan assured the nation, “Inflation is not a significant problem at this moment [and] there is also very little in the way of short-term inflationary expectations.”

*** It is certainly comforting to know that our economic woes are now behind us. Now that everything is settled, we can get back to buying stocks.

*** Maybe inflation is not a “significant problem,” but it can be a nuisance. And like an ill-mannered guest who leaves beer cans in the planter boxes, he can make a mess of things:

– Most commodity indices have been heating up since late March.

– “Resource currencies” like the Australian dollar and the Canadian dollar have been rallying of late.

– Long-term bond yields have been rising ever since the Fed began cutting rates in January.

– Until very recently, inflation-indexed Treasury bonds have been outpacing conventional bonds for months, suggesting that Mr. Market worries somewhat about resurgent inflation.

– Even Old Man Gold rose from his rocking chair to stretch his legs for a spell before returning to the chair for another long nap.

*** And what of the Consumer Price Index itself? If it were a common stock, momentum investors would take one look at the CPI’s upwardly trending price graph and start buying.

*** The revelation from on high that the inflation problem is behind us boosted the Dow 71 points to 11,061 – once again clearing the 11,000 mark. The Nasdaq managed only a six-point gain.

*** “It is the responsibility of economists to point out false dawns,” writes CLSA economist Eric Fishwick, who does not see the sun rising on this economy just yet. Consumer spending will be a critical component of any sustainable upturn, he says. However, “in real terms, retail sales have stopped growing [and] they are not yet contracting, which has happened in previous cycles.”

*** Meanwhile, the sun appears to be setting in the Old World. Business confidence is weakening across Europe – from Sweden to Germany to Spain.

“French manufacturers were more pessimistic in May than at any time in almost two years as domestic and foreign orders dropped,” the International Herald Tribune reported late last week. The index of business confidence, as compiled by French statistics office INSEE, has dropped six months in a row. As Deutsche Bank economist David Naude told the IHT, “This is clearly a cold shower after they slightly crazy idea that France could escape the international slowdown.”

*** Inflation has risen in Europe; unemployment is up too. Economic growth, on the other hand, is down. Europe, like America, faces the prospect of a recession. And Europe, like America, turns its weary eyes to Alan Greenspan, the one man who might rescue the situation. Bill has more, below…

*** The euro declined 8% in May – because of the weakening economic picture in Europe, it is believed. It now stands just a bit over 84 cents.

*** Part of the problem – or advantage, depending on the way you look at it – in Europe may be that Europeans just don’t work enough. Richard Russell cites an OECD study showing that Americans work far more hours than their Old World counterparts. In 1970, for example, Germans and Americans each worked an average of about 1900 hours per year. But last year, Americans worked nearly 2,000 hours, while Germans put in only 1700.

*** But who’s better off? People who work less and save more? Or those who work harder and harder to get themselves further into debt? You decide.

*** Have you read the “Technology and Health” page in the “B-section” of the Wall Street Journal lately? It has become a kind of obituary page for technology companies. Last Friday, page B2 reported that Tellabs struggles from “worsening industry conditions,” Hewlett-Packard suffers falling revenue from decreasing “worldwide sales of computer servers,” and Ibis Technology “cut its staff 14%.”

*** Investors looking for a rapid turnaround in the technology industry might want to take note of the latest GDP report from Taiwan. The tech-heavy Asian economy’s first-quarter report was its lowest in 26 years. Dante’s Inferno seems to anticipate tech stock investing in 2001: “This way for eternal suffering. This way to join the lost people…Abandon all hope, you who enter!”

*** According to a new study by two professors at the University of Chicago, only 5% of analysts ever issue a sell signal. J.P. Morgan analyst Michael Freudenstein must be one of the few. He warned investors last Thursday to think twice before buying the stock of either Merrill Lynch or Goldman Sachs. The problem, as he sees it, is a “continuing decline in investment banking activity.”

*** He didn’t mention his employer. But investment banking produces 60% of J.P. Morgan’s operating earnings. Furthermore, as grantsinvestor.com’s Andy Kashdan and Robert Tracy point out, Morgan’s investment banking revenues fell 22% year-over-year in the first-quarter.

*** “If one were to build a banking behemoth from scratch with the idea of maximizing exposure to a weakening economy and struggling capital markets,” they write, “the finished product would bear a striking resemblance to J.P. Morgan Chase.”

Eric Fry

And more notes of a less serious nature…

*** It was so beautiful in the country this weekend, it was hard to leave. Pierre had cut the hay in the field behind the house and rolled it into giant bales. Squint, and it looks just like a painting by van Gogh.

*** Young animals of all species are adorable. We have baby ducks, turkeys and chickens. One of the little ducklings hatched with a bad foot. The poor thing hops and scuttles around. “I should probably put him out of his misery,” Mr. Deshais had remarked last week. Somehow, the duckling survived – at least while it was enclosed in a protected space. But now it is out in the fowl yard with about 30 other ducks, none of whom have ever heard the parable of the Good Samaritan nor ever seen a handicap parking space. The deformed duckling was still alive when we left last night. But nature will take her course.

There are also four little pigs in the sty. We bought them at a neighbor’s farm just after they were old enough to be separated from their mother. They were cute, too, rooting around in the yard. Of course, adult animals can be attractive too, with the right sauce.

*** Pierre spent Sunday afternoon fixing his hay rake. “Every year it is the same thing,” he told me. “I drive along; then I hear a clacking noise. It is not too bad at first, so I wait. But it gets worse and worse. Then, by the time I decide to stop the tractor and check, the noise ceases. So, I don’t worry about it… Of course, then I notice that the rake isn’t working. The noise stopped because the piece finally broke off… so I then have to search for it in the hay.”