Even More Unexplanatory
"Excessive debt accumulation was, of course…a prime ingredient in the financial condition that was to overtake a large sector of the economic system: illiquidity. It was, indeed, an illiquid, over-expanded colossus of debts, rather than an excessive money supply, on which the price structure of the late 1920s rested."
in The Twilight of Gold
"In death, all debts are paid."
The world’s most powerful group of price fixers is meeting this week in Montreal. None were elected. But the public seems to prefer to leave the world economy in the hands of un-elected bureaucrats, rather than elected ones; its admiration for democracy goes only so far.
Central bankers have a lot to talk about, we are sure – comparing perks and publicists, for example. Still, between cocktails and dinner, the managers of the world’s managed moneys might let the conversation wander…over to the curious U.S. recession and even curiouser recovery.
"This downturn pattern has no precedent in the whole postwar period," writes Dr. Kurt Richebacher. "Investment spending is unusually weak and consumer spending unusually strong. Yet this pattern has at least one ominous parallel, but before World War II: the U.S. economy of 1926-29."
Neither angelic economists, nor the archangels at the world’s central banks have an explanation. In today’s letter, we rush in.
"Debts gotta be paid," we remember writing yesterday.
"Or otherwise settled…" we add today.
"Last year," explains Dr. Richebacher, U.S. national income grew by $178.6 billion. Debts, on the other hand, increased more than $2 trillion. Debts of the nonfinancial sector were up $1.1 trillion, and debts of the financial sector by $916 billion. All in all, debts rose more than 10 times faster than income. Broad money, by the way, increased $882.7 billion. Consider that barely 9% of the total credit creation in 2001 turned into GDP and income growth.
"In the fourth quarter of last year," (Richebacher never lets up…), "the consumer increased this outstanding debt by $610 billion, but his spending on goods and services increased by only $120.6 billion. Businesses borrowed $377.65 billion while cutting their outlays on fixed investment and inventories by $163.3 billion."
Telecom debt alone now equals nearly as much as the combined total of the S&L crisis of the ’80s and the junk bond crisis ’90s – about 5% of GDP. Taxpayers ended up paying an amount equal to 3% of GDP to bail out the S&Ls.
We left off yesterday wondering why stocks are not going up. If the nation really were looking ahead to a recovery, shouldn’t stocks be able to see it coming?
Instead, stocks seem to see trouble.
"I view the U.S. economy as being in the early stages of a post-bubble shakeout," writes Stephen Roach. "Most others see the context quite differently – as a fairly standard business cycle, dominated by a powerful, yet self-correcting, inventory dynamic. Only time will tell who’s got this one right."
While we will wait for time to tell the tale, along with everyone else, we still can’t help but wonder: What will become of all this debt?
There are only three possibilities. Sooner or later, debts are either paid off, written off, or inflated away. Taking up the third possibility, we note that the Founding Fathers defined a dollar as 371.25 grains of fine silver. Determining the value of gold coins, the Coinage Act of 1792 decided that an ounce of gold was equal to 15 ounces of silver.
Later generations found the legal connection between precious metals and paper money inconvenient. The issue was debated off and on for years – whenever some backwoods yahoo decided to make an issue of it. For example, Nebraska congressman Howard Buffett took it up in 1948. "So far as I can discover," said the father of the world’s second richest man, "paper money systems have always wound up with collapse and economic chaos. If human liberty is to survive in America, we must win the battle to restore honest money."
More than half a century later, we look back nostalgically at 1948’s dollar…and its liberty. Neither has survived. Back of the envelope calculations tell us that today’s dollar is worth only 5% to 20% of what it was worth when the Coinage Act was passed.
Almost no one misses liberty. And few would mind if the dollar kept waving a long goodbye. In fact, most economists, consumers and politicians count on it. They are betting that a gentle decline in the dollar…along with yet more money and credit from the Fed….produces yet another inflationary boom in the American economy.
But, "for the first time in history," concludes Dr. Richebacher, "the economy and stock market have slumped against the backdrop of rampant money and credit creation.
"These unprecedented experiences raise some highly critical questions; Why has the deluge of money and credit failed to boost the economy and financial markets in any significant way? And what, exactly, is behind the US economy’s miserable profit performance? These are the two most important questions to scrutinize."
Central bankers rule the globe, we are told. "One begins to see the global economy as a vast network of interconnected strings," explains William Pesek, "all being controlled from above by Greenspan, Macfarlane (central banker of Australia) and a handful of other monetary policy makers."
Yet, following the biggest pull on credit lines in history…the world’s economy has barely budged. Central bankers, perhaps after dinner, might want to check their twine.
June 07, 2002 — Paris, France
Slowly – but surely – the big millwheels of divine justice…oops, I mean a bear market…grind away at stock prices. Day after day…the great boom ages, drooping unto death.
At least…that’s how it looks to us!
While the headlines focus on stocks, the real news is DDGU…dollar down, gold up again yesterday. The euro hit a 16-mo. high against the dollar. And gold rallied back above $325.
"One of the biggest risks we see to continued demand for US assets," says a report from Morgan Stanley analysts, "lies with the growing attraction to gold. According to the World Gold Council, purchases of gold investments surged 36% in the first quarter, with strong demand emanating from Vietnam, Japan, China, and Pakistan.
In Japan alone, demand for gold more than doubled in the first quarter of this year from the same period a year ago. As global uncertainties continue to mount, America’s lender of last resort – Asia – may be tempted to shift dollar-denominated assets to gold, a development that would undermine the last pillar of dollar support."
The economist, meanwhile, calls it a "Dollar Cliffhanger." Most economists believe that the dollar decline will be ‘painless.’ A gradual decline in the value of the buck will make it easier for U.S. companies to export and allow the European Central Bank to maintain a more free and easy monetary policy. Everyone comes out ahead – except perhaps the Asians, and who cares about them?
But what if the dollar goes down hard?
Then, says the Economist, it’s an entirely different story. Beginning in ’85, the dollar dropped in half in the next 2 years. If that happens again, hint the Economist editors, there will be hell to pay.
Eric, do you have something to add?
Eric Fry in New York City:
– After slipping backstage for a quick cigarette break, the "obvious" trades returned to center stage yesterday. The dollar and the stock market both fell, while gold rallied.
– Dispiriting news from the technology sector got the stock market off on the wrong foot. Just one day after Oracle’s better-than-expected-but-still-bad earnings forecast buoyed the stock market, Intel’s worse-than- expected revenue forecast walloped the market. The Dow stumbled ever lower throughout the day to finish the trading session with a 172-point loss at 9,625. The Nasdaq fared even worse – dropping more than 2% to 1,555.
– The negative "Intel effect" slugged the market twice yesterday – once before the start of trading and once more after the closing bell.
– In the wee hours of Thursday morning, Merrill Lynch analyst, Joseph Osha, issued some downbeat remarks about Intel and several other semiconductor stocks, while slashing his rating on Intel from "strong buy" to "neutral." Osha warned, "With one month remaining and few signs of a near-term PC upgrade cycle, the prospects for sequential growth in the June quarter are quickly fading."
– The Merrill analyst also pointed out that the chip stocks he researches sell for an average of 51 times this year’s earnings and 32 times 2003’s hoped-for earnings, which, he correctly observes, ain’t cheap. Osha’s downgrade of Intel apparently troubled the sorts of investors who still read Wall Street research and who still care about analyst ratings. The stock fell 4%.
– Adding fuel to the fire in which semiconductor stocks were immolated yesterday was a report from the Semiconductor Industry Association predicting that sales in the chip industry would grow only 3.1% in 2002…NOT the 6% growth it had predicted in November.
– After the close of trading, news from Intel HQ went from bad to worse. The company announced that its revenue in the second quarter would be $6.2 billion to $6.5 billion – a somewhat lower range than the $6.4 billion to $7 billion of sales that the company had predicted just two months ago. Making matters worse, Intel said its gross profit margin would be only about 49% – falling well short of both its 53% target and the 51.3% margin achieved in the first quarter.
– "When you trade at 7.3 times revenues, you can’t afford an error," Sean Corrigan, the Daily Reckoning’s man-on-the-scene in London, points out. "When you are the market leader, the room for maneuver is even more limited." Intel’s stock tumbled another 8% in after- hours trading. Expect the fireworks to carry over into today’s trading.
– But while stocks were sliding yesterday, gold tacked on another $3.70 to $325.80 per ounce. This, despite the fact that a front page Wall Street Journal story raised the loaded question, "Was That the End of The Gold-Price Rally?" The thinly veiled implication was that gold had no business rallying in the first place. Maybe the Journal is right. Or maybe gold has every reason in the world to rally and just decided to take the day off.
– Gold has jumped 17% year-to-date and the XAU Index of gold shares has soared 54%. So a little R&R might be in order. But even if gold naps on occasion, there is plenty of action around to rouse it from its slumber.
– The dollar continues to wobble on the clay feet of a yawning trade deficit; the Middle East and the Kashmir border remain geopolitical tinderboxes and US inflation is quietly on the rise. In short, we have nearly ideal "growing conditions" for gold.
– Therefore, despite gold’s 22 years of heartbreaking performance – an investor might require greater courage (or ignorance of history) to proclaim the end of the gold rally, than to retain faith in its perseverance. We don’t know where gold is heading. But our guess is that buying gold is a less bad idea than buying Intel.
– "There’s an old saying that the market sometimes climbs a wall of worry," observes Tobias Levkovich of Salomon Smith Barney, "but what we’ve got now is a ‘cliff of concern’ that’s much steeper. Besides the usual concerns about market fundamentals, you’ve got this big intangible factor of corporate distrust and geopolitical worry."
– Well said, Tobias. There is indeed a cliff of concern jutting from the financial landscape. But how do we know that Mr. Market is looking up at the cliff of concern, trying to figure out how to scale it? Just maybe, Mr. Market is standing atop this cliff, about to step off of it.
Back in Paris…
*** "U.S. jobless claims decline but hiring stays soft" says an FT headline. "Never in any recession of the last 30 years have continuing jobless claims peaked, dropped temporarily and then resumed their ascent to new highs," adds ContrarianInvestor.com. What a strange recovery! No jobs, no profits, no stock market gains…what does the market see? More below…
*** Foreign investment in U.S. financial assets has dropped 60% in the last year. Note that foreigners don’t actually have to sell anything to lower their aggregate exposure to the U.S. dollar; they just have to stop buying.
*** It’s always a pleasure to meet Daily Reckoning readers here in Paris. Occasionally, we get visitors… and join them for drinks at the Paradis. Last night, Maria and I enjoyed dinner with a pair of pretty women from way out on the western plains – the little town of Hays, Kansas.
"What do people do in Hays?" I wondered.
"We’re still trying to figure that out," came the answer.
*** TRENTON MAKES, THE WORLD TAKES – "I well remember that sign on the bridge across the Delaware River at Trenton, since my undergraduate days at Princeton in 1940’s," recalls a DR reader. "The college kids came up with their own version: ‘THE WORLD REFUSES, TRENTON USES.’"