DR Weekend Edition

The Daily Reckoning
Weekend Edition
5/9/2004
Paris, France
By Addison Wiggin and Eric Fry

Warm weather finally reached New York City on Friday, but Wall Street seemed to inhabit its own personal Ice Age. While a 20-something crowd of bare-chested men and bare-bellied women tanned their tattooed torsos in Manhattan’s Union Square Park, the Arctic winds of rising interest rates whistled along Wall Street. Almost every typeof investor suffered some sort of financial frostbite, as no asset class provided shelter form the harsh conditions. Whether an investor owned stocks or bonds or gold, all shivered side-by-side, like ill-fated members of the Donner Party contemplating what grim fate might await them.

Only cold, hard cash provided protection from the interest rate freeze-out, as the US dollar jumped 1% against the euro and 2% against the yen. Meanwhile, gold tumbled $8.00 last week to $378.75 an ounce – a six-month low – as the XAU Index of gold stocks dropped to a 10-month low. Most other commodities also tumbled sharply last week.

Over at the New York Stock Exchange, the Dow slumped 108 points to 10,117, dragging the index down to a 3.2% loss for the year. The Nasdaq slipped just two points to 1917, but nurses a 4.2% loss for the year to date.

Blame the widespread carnage in the financial markets on rising interest rates… (with an assist from Pfc. Lyndie England and Secretary of Defense Donald Rumsfeld. England, the soldier seen smiling behind a naked cluster of abused Iraqi prisoners and Rumsfeld, the Secretary seen scowling behind the naked truth of his
own incompetence, both contributed to the growing sense of unease on Wall Street. But let’s ignore the Washington follies and turn to weightier matters, like the bond market).

If we may switch metaphors, dear reader, the bond market has become a financial Frankenstein – terrifying investors as it chokes the life out of the stock market. This frightening progeny of the mad Doctor Greenspan is all the more frightening because it no longer heeds the commands of its creator.

When Greenspan first started pumping heavy doses of easy money and microscopic interest rates into the comatose US economy, he imagined that his experimental science would create a new and powerful sort of
bond market – capable of powering a new and powerful sort of economic expansion.

For a while, Greenspan’s creation seemed a genuine marvel – as powerful as the Hulk, while as docile and obedient as a geisha. Greenspan’s 45-year-low interest rates empowered an economy that lacked savings or employment growth or trade surpluses or budget surpluses or any of the traditional economic drivers. For a while, the bond market seemed to foster a semi-permanent boom that never triggered inflation… .

Eventually however, the well-mannered marvel morphed into a terrifying freak of nature, capable of manic price movements and unimaginable evil… if allowed to roam freely within our acutely interest-rate sensitive economy.

Friday’s “stronger than expected” employment report created an ideal occasion for the bond market to victimize investors once again, as the yield on the 10-year Treasury lurched from 4.60% to 4.77% — the
highest rate in nearly two years. Less than two months ago the 10-year yielded less than 3.70%.

While rising rates are beginning to scare the daylights out of investors on Wall Street, fear may soon start spreading to Main Street as well, where the legions of folks holding adjustable-rate mortgages may be forced to imagine the unimaginable: rising rates. They may be forced to imagine a life in which their mortgage payments re-set HIGHER, while resurgent inflation causes the value of the dollars they earn to “re-set” lower.

We suspect that Mr. and Mrs. Consumer are even less prepared for the ill-effects of rising interest rates than the Dow Jones Industrial Average. Best case, rising rates will end the of “cash-out” mortgage refinancing boom. Less-than-best case, millions of Americans will find themselves in the vice-grip of adjustable-rate financing … Get out your hats, gloves and heavy jackets, a cold summer is coming.

Eric Fry,
The Daily Reckoning
May 9, 2004

THIS WEEK in THE DAILY RECKONING

CELEBRATING DEFEAT 5/7/04
By Bill Bonner

“… The French had a number of advantages – similar to the advantages Americans were bringing to bear in Vietnam 10 years later. They controlled the air. Using airpower, they brought in 15,000 soldiers to a remote airfield west of Hanoi. The idea was to install themselves there, disrupt Giap’s supplies, block his move into Laos, and bring him to a pitched battle in which superior French firepower would be decisive… “

FLATLINERS 5/6/04
By John Mauldin

“… Essentially, Estrella and Mishkin showed how every U.S. recession in the post-WW2 era has been preceded by a negative yield curve. By a negative yield curve, we mean that short-term rates are higher than long-term rates, which is not the natural order of the world. Normally, you should be paid more interest for holding longer-term bonds and taking more risk… “

PERVASIVE STUPIDITY 5/5/04
By Dan Ferris

“… I just nodded as Pat asked his rhetorical questions. He got it. He understood. I realized how rare it is to find anyone who understands how absolutely efficient the stock market is at reflecting the pervasive lack of plain business sense that characterizes the average person’s approach to investing… ”

THE SUZERAIN 5/4/04
by Christopher Mayer

“… this added uncertainty is not without consequence. Capital as a financial concept is defined by the price of money. Monetary calculus takes place in dollars, or yen, or euros, amongst a myriad of other monetary symbols. When that money price no longer reflects the realities of supply and demand, becoming distorted – as is often the case when the political mixes with the economic – you have the ingredients for a crisis… “

ECONOMIC PARASITISM 5/3/04
By The Mogambo Guru

“… The obvious way to make money on the deal is to buy a bank. If you can’t get one of them, then buy gold, because all bank multiplications of the money supply in excess of the growth of GDP lead directly to inflation. In fact, the main conclusion is that, like the Austrian school, expanding the money supply automatically produces inflation, as when Nuri says “Price inflation is a precise, mathematical measure of the macroscopic energy dynamics of a system which adheres to physical laws.” And where does this energy come from… “

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HEADLINE, NEWS And INSIGHT:

The Mighty Metal
by John Myers

“… Why am I so confident the Midas metal is set to soar to higher levels? Two reasons – or really two certainties… first of all, Washington refuses to accept a crushing deflation. Second, vast numbers of people are generating new wealth – wealth that they will no doubt spend but also save… some of it in the form of gold bullion… “