Dot.Com Dollar

“[W]hat the United States owes to foreign countries it pays – at least in part – with dollars that it can simply issue if it wants to.”

Charles de Gaulle,

President of France

1965Gold, as we all know, is believed to be defunct. It has been tossed on the scrap heap of monetary history…along with notes issued by the Bank of Howardsville, Virginia, and the Confederate dollar…neither of which could compete with the stronger, better-positioned U.S. dollar.

Gold has been made unnecessary, we are told, by the “just in time,” zero inventory policies of ATM-connected households. People who don’t save dollars certainly see no reason to save gold. And its job as a back brace for central bankers has been eliminated. The work of disciplining the currency markets is done today by bond vigilantes and the market itself. With inflation-adjusted treasury bonds, for example, which pay only slight less interest than a non-adjusted bond, who needs gold?

Never since the Middle Ages have people had so much faith in something they couldn’t see. Then, it was the power of the Almighty God, whose works were both mysterious as well as omnipresent. Today, it is the almighty dollar – manifested more often in strings of digital code than actual pieces of paper.

Faith in “the system” must be at an epic high. A family in Duluth, with no savings of any sort, is so confident that its needs will be met that it lays in no supplies… neither food, water, heat – nor a medium of exchange with which to buy these things. Instead, the head of the house is sure that when she goes to the nearest ATM machine…or uses one of her 13 credit cards…the programmers and clerks that tend to these things will not let her down.

A year ago, this confidence was put to the test. Computer nerds remembered that they had failed to allow for the biggest numerical change in the Gregorian calendar in 1,000 years…when 1999 turned into the year 2000. Programmers, IT engineers, professional alarmists, and our own Gary North warned that if the problem were not corrected in time (and there was widespread doubt that it could be) the entire system could collapse.

Whether by expensive intervention or cheap dumb luck this did not happen. The present year was rung in without so much as a single ATM machine in Tajikistan reporting a failure. This, of course, has confirmed the impression that the system is invulnerable.

The system in which people seem to have most faith is the Federal Reserve one. Custodian of the dollar, and helmsman of the world’s largest floating economy, the Fed has reached a level of public confidence only surpassed, perhaps, by Biblical figures. In fact, I have it from one of my usually unreliable sources that they no longer serve fine wines at meetings of Fed officials. They serve water, and Alan Greenspan turns it into wine.

“That makes two leaps of faith by our count,” writes Jim Grant, still keeping his eye on those interest rates, “the first being the universal acceptance as money of the slips of paper designated ‘legal tender for all debts, public and private,’ or words to that effect. Not only do people accept, indeed covet, this intrinsically worthless medium of exchange convertible into nothing except other units of legal tender, but they also trust implicitly the public servants who manage it.”

You may have guessed from the title to today’s letter, however, that not everyone participates in Fed-worship. On the question of Greenspan’s divinity, there are a still a few un-believers amongst us.

“What is really sustaining bullish sentiment about the U.S. stock market and, propping up the dollar,” asks Dr. Kurt Richebacher, a longtime agnostic on the Fed chairman, “When asked, everybody pulls the same trump card: Faith in the economy’s superior qualities, and faith in the unique wisdom of Mr. Greenspan. His name stands for two tacit presumptions: first, that any signs of undesired economic weakness will prompt the Fed to instant rate cuts; and second, that the U.S. economy and the financial markets will just as promptly respond to any monetary easing.”

“There is no doubt,” Dr. Richebacher continues, “that he will instantly fight any threat of recession by immediately cutting rates and loosening his credit reins. In reality, he will face the catch-22 situation of his life…an incalculable risk on the grossly overvalued dollar… The U.S. currency is vulnerable to any slight shift in market perception and psychology as never before.”

It is vulnerable because in many ways…the almighty dollar has come to resemble a stock.

The distinctive feature of the dot.coms was huge losses and a lack of substance. The dot.coms had only ideas – funded by huge inflows of capital, which was squandered on operating losses.

How like the dollar, actually. Taking the U.S. dollar economy as a whole, current account losses are running at a record high – more than $1 billion every day, including Sundays and holidays. And where is the substance in the dollar? At best it is only a piece of paper. At worst, it is only an electronic notation.

The dollar is not only losing money at a record rate…it has record levels of debt too. Throughout the economy, debts have soared in the last few years. One particular form of debt is worth mentioning: financing the current account deficit has been accomplished mostly by the sale of U.S. corporate and government bonds. Foreign holdings of these U.S. dollar liabilities now total $2.7 trillion. And net foreign indebtedness has roughly doubled – from about $830 billion to more than $1.6 trillion since 1995.

Faith in the dollar has been so strong that many of these foreign holdings are un-hedged. Yet, in a matter of seconds foreigners can hedge their U.S. dollar balances with derivative positions. All it would take would be a hint of weakness…and the hedges would be put on these gargantuan dollar holdings…which would trigger an almost overnight collapse of the dollar itself.

Neither book value nor earnings give investors much of a handle on the dollar’s value. Like dot.coms, the dollar trades on faith and hope, not substance. And like dot.coms, it is vulnerable to huge shifts in sentiment.

When Richard Nixon was president and the Grateful Dead were at their first peak in popularity an ounce of gold would get you only about $35. Seventeen years later, when Jerry Garcia was again filling stadiums, the gold price had risen to its own cyclical peak of $825 – an increase of 2,360%.

Since then, the dollar has shot up like a in slo’ mo’…up nearly 80% against gold, that is to say…in very real terms.

Dot.coms issued stock just like the Fed issues dollars and in exactly the same amounts – as much as they could get away with. As long as investors were willing to take up the new currencies, all was well. But in March, a crisis of confidence developed. Investors began to lose faith. Suddenly, the currency – which had been tendered for all sorts of debts – was vulnerable. Many of these stocks have fallen 90% and more. Many will surely sink to the level of a Confederate dollar or an Argentine Austral.

Could a crisis develop in the dollar? Of course it could. And it will. In fact, the recent dollar top on May 17th, could mark its beginning.

Best wishes for a sunny, beautiful weekend.

Your correspondent, back on the job in Paris.

Bill Bonner

July 21, 2000 Paris, France

P.S. Why not hedge against inflation by buying U.S. inflation-indexed bonds? Because the debtor is in charge of keeping the indexes. We have seen, lately, what happens to inflation figures in the imaginative hands at the BLS.

*** Today just happens to be Mr. Paul Reuter’s birthday. So, I will begin this installment of the Daily Reckoning with a headline from the news service he began more than a century ago:

“Stocks Soar on Tech News, Greenspan Cheer”

*** The tech news to which Mr. Reuter’s employees refer was an increase in IBM earnings. Sales have gone down at Big Blue for 3 quarters in a row, but profits went up. So investors were excited and bid up the stock – lifting the Dow substantially.

*** Mr. Greenspan’s cheer, meanwhile, came from his Congressional testimony, in which the Fed chief said he saw no decline in productivity and from which analysts concluded that he was not likely to hike rates again next month.

*** On the strength of these two inconsequential bits of information investors drove the Dow up 147 points – leaving it above its most recent rally peak…and further confusing the bear market outlook.

*** The Nasdaq responded positively too – rising 128 points, leaving it in the black for the year…by 2.83%.

*** The summer fun was widely shared. 1698 stocks advanced on the NYSE. Only 1138 fell. 69 hit new highs. Only 47 hit new lows.

*** Bonds rose too – the bond vigilantes have decided to stop worrying and join the fun.

*** And gold rose a little, up 80 cents. Platinum rose $10.90

*** Last, and perhaps most important, the dollar bucked the trend and fell. I thought the dollar had topped out back in the middle of May. The dollar index hit 112.08 on May 17 and then fell to 105.12 on June 8. Since then it has been coming back, reaching 109.65 two days ago and threatening to put in a new top. But yesterday, it fell back…confirming, at least for the present, that the dollar has joined what Richard Russell calls “the Top Out Parade.”

*** Marc Faber notes that, in this market, even stable ‘old economy’ companies are getting tossed about like a peanut at sea. “Procter and Gamble, for example,” says Faber “was rising rapidly and reached a high of US$118. Just six months later, its stock price has been halved. And Circuit City: in mid-May of this year, its stock fetched US $64; then, barely a month later, it had fallen to US$35. Or consider Office Depot: it reached a high of US$26 last summer. Then it slid to around US$10, and although it recovered to US$15 in mid-April. It is now at US$6.”

*** “Northrop Grumman isn’t grouped among the high-tech stocks or listed on Nasdaq. But its as high-tech as it gets.” says the Fleet Street Letter’s Lynn Carpenter. “With a P/E of 8.7, price to earning growth ratio of 0.8 and price to sales of 0.42, it’s obviously worth looking into. I did, and it didn’t surprise me a bit that Northrop has brought our Fleet Street readers a fine 27% return in three months.”

*** I asked Lynn what she thought of the tobacco companies in the wake of the Engle decision:

“A contrarian and a value investor has to love the smokers,” she replied. “But Camel or Marlboro? Phillip Morris, the Marlboro Man-ufacturer, is a bargain at P/E 7.3, P/S 0.68 and is going for half its earnings growth rate. But if you really want to be contrarian, take a look at RJR’s Camel-cade.” {Lynn, a linguist in an earlier career, loves to play with words.) “RJR has [an even lower P/E] and a not-too pricey price to earnings growth ratio of 1.3,” she continued. “They both pay hefty dividends, too…7.9% for MO and 11.4% for RJR.”

“But what I like best is that extremely rare thing…both have sell ratings from some analysts. One more thing: Insiders are buying RJR heavily and steadily.”

*** The tobacco companies are pretty darned cheap. Here are some more cheap stocks, companies that have the misfortune of being traded in Bangkok rather than New York – courtesy Doug Barnett of Quest Management, by way of Marc Faber.

“When it comes to compelling investment opportunities,” writes Mr. Barnett, “Thailand…has no equal.” Foreign investors have pulled out of the market – leaving prices at levels resembling US cigarette makers.

*** KCE Electronics, for example, is one of the 100 top PCB manufacturers in the world. Net profit is expected to increase at almost 30% this year. The pretty darned cheap stock is available at only 6.2 times earnings.

*** Regional Container Lines is a market leader trading at 5 times enterprise value and only 2 times earnings. It is not a tiny company, but one that has thousands of ships and containers and an annual profit of about $70 million in the current year.

*** Or how about this – a company selling at 78% discount to net book value…the 38th largest stock in Thailand. Banpu is in the power generation business. Shares are trading hands at less than 20 Thai baht each. But, according to Barnet, “Banpu should convert non-core assets into nearly 5 billion [Thai baht] of cash, or nearly 24 [THB] per share.

*** The Pizza Company owns and operates over 280 fast- food restaurants in Thailand. Earnings have grown at 21% year over year, and are expected to continue growing at more than 25% for the next 4 years. Barnett forecasts that EPS will grow 29% this year. But the stock is trading at only 5.8 times earnings.

*** Today is the first day of Thermidor, according to the calendar of the French Revolution. The Jacobins, rational to a fault, created a perfectly logical – and totally absurd – new calendar, which was rejected as soon as the revolutionaries were tossed out. Today is also the hottest day of the year, in the Northern Hemisphere, according to meteorologists.

*** But here at my new office, on the corner of Rue des Lombards and Rue St. Martin…with the bells of St. Merry ringing in the background…it is not hot at all. It is pleasantly warm, under a clear blue sky.