From Funeral to Funeral

In an world where science and reason do not suffice – and where the future can be anticipated, but not predicted – lives and dies a funny little creature called man…

"Come now, you who say, ‘Today or tomorrow we will go to such and such a city, and spend a year there and engage in business and make a profit.’ Yet you do not know what your life will be like tomorrow. You are just a vapor that appears for a little while and then vanishes away."

– James Chapter 4

The New York Times, as reported in France’s Le Monde, marks the 25th year of its "Science" coverage with a worry. It notes that while 90% of Americans say they are interested in science, barely 50 out of 100 are aware that it takes a year for the earth to make a full circle around the sun.

In an election year, of course, people will believe anything. A politician might go all the way to the White House, in our opinion, by proposing to add a month to the calendar in order to give everyone an extra 4 weeks vacation. He might also suggest rounding off the number Pi in order to make it easier to remember…or reducing the boiling temperature of water, in Fahrenheit, to a round number, say 200 degrees.

But how the chattering classes would screech! They have come to adore ‘science’ the way jackals adore road kill; they would be nothing without it. "Better living through chemistry" was their motto back in the 60s, when mood-altering drugs were popular. We mustn’t lose "the primacy of reason," says French president Jacques Chirac, 40 years later.

The burden of the following little reflection is that Jacques Chirac is a dreamer and much of what pretends to be scientific is a fraud.

Scientific Market Forecasts: Reason Alone

Reason never was primal. Not even secondary. Whoever made an important decision based on reason alone? What fool ever decided what he would eat…what he would drink…with whom he would sleep and work…and what he would do with his life…on the basis of unadulterated reason? No one we have ever met.

Instead, reason is so heavily diluted with greed, fear, envy, love, hope, and other emotions, you can barely taste it. It is rarely more than a rationalization for what people want to do anyway. "The head is merely the heart’s dupe," noted la Rochefoucauld famously. Reason is really only used for things that don’t really matter, such as choosing stocks and cooking eggs.

Still, when the Federal Reserve tells us that the economy is likely to improve in the coming quarters, most people believe that there is something more in this pronunciamento than just wishful thinking. They imagine there is some ‘science’ backing it up. A man reads such a forecast like a favorable report from his latest physical examination. ‘All clear,’ he thinks the doctor wrote. He cannot hear the quacking noises in the background. Nor does he realize that there is no real science behind the Fed forecast at all. Just statistics…and many of them phony.

Science is marvelous; who are we to argue with it? But Daily Reckoning readers are cautioned: don’t take it too seriously. We recall that Harry Markowitz won a Nobel Memorial Prize in Economics for proposing a model to predict future risk in markets. Two of his disciples and fellow Nobel winners, Myron Scholes and Robert Merton, used his work to help them run a hedge fund, Long-Term Capital Management. Within 4 years, Long-Term had come and gone – blown up by a ‘science’ that any decent trader would have laughed at.

Scientific Market Forecasts: Each Corpse Another Lesson

Science evolves from funeral to funeral, it is said. Each corpse is another lesson…another scientist gone mad and another theory gone bad. Each exquisite cadaver is another reminder that there are only two kinds of scientific theories – those that have been disproved, and those that have not been disproved yet.

Science is all very well for predicting when a soft-boiled egg will be done. But it is little help in predicting when people will get spooked by the market. At sea level, water will begin to boil at 212 degrees Fahrenheit. Investors could boil over any time.

‘Scientific’ market forecasts…and detailed economic models…pretend that man is something he definitely is not – reasonable and rational. He is neither. If he were, the whole jig would be over. Since he could be expected to act in a rational way, ‘scientists’ could model his behavior and figure out what he would do next. Would he buy stocks…or sell them? Having the answer, the rational investor would position himself immediately to benefit from whatever future the model showed. But in a matter of minutes, the model would blow up…for our rational investor’s positioning would have changed the model’s inputs.

People believe that things improve. They think Darwin’s Theory of Evolution describes a world constantly mutating towards perfection. Every day, we add more and more information…and every day, our formulas become more accurate and more reliable.

If only it were true!

Scientific Market Forecasts: Suffocating under All the Data

"The more data you have, the more ignorant you are," explains our friend Michel. "If, for example, you get quarterly reports of corporate earnings, rather than annual ones, do you know more? No, because it’s easier to manipulate quarterly returns. Imagine that you got returns every month…or every week…or every hour. You’d have much more data, but actually much less knowledge of what was going on. You’d suffocate under all the data."

But in the world of finance and economics, confidence increases with data. If stocks go up one year, people are happy, but not confident. If they continue to go up…year after year…confidence increases with every passing year. Thinking scientifically, they reason: if stocks have gone up for so long, odds are that they will continue to go up.

As confidence grows, the odds become exaggerated, skewed by emotional inertia. Unpredictable by real science…risk is under-priced. Eventually, a collapse comes, as it always does.

It has been a long time since the world’s money system – or its reserve currency – have fallen apart. The event happens so rarely, it is practically unimaginable to most investors. They believe the current system will live forever. Consequently, insurance against its demise is extremely cheap. We don’t know, but it may turn out to be one of the best investments ever made…when the funeral is finally held.

Bill Bonner

November 21, 2003

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the NY Times and international best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

Today’s International Herald Tribune has front-page photos of the blast in Istanbul. We ask ourselves…when do people begin to wonder, if ever? When do they wonder if America’s War on Terror can really be won? Or whether it makes any sense at all.

Maybe it just stirs up more problems? (Addison, explores one potential problem splashed across the headlines in London this morning, below…)

And when they begin to wonder, mightn’t they wonder about America’s current account deficit, too? And whether Americans will be able to pay their debts? And what America’s paper money is really worth? And the stocks and bonds issued by U.S. businesses and government – denominated in the aforementioned currency…what are they really worth?

Today, the Chinese must be wondering. Along with the Japanese, they are the largest buyers of American debt in the world. Most of their nations’ currency reserves are in dollars. And their largest single source of new jobs, factories, profits, and technology is the U.S. market. The Chinese have even pegged their own currency to the U.S. dollar in order to stabilize this very important relationship.

But day after day, the dollar drops…and with it falls the real value of China’s billions in U.S. dollar reserves, most of which are in Treasury bonds. The bankers buy U.S. debt partly in order to keep Americans supplied with E-Z credit, so they can continue to buy. But they must be wondering if it is worth it.

The slipping dollar does them no harm, it might be argued. Since the yuan and the dollar are linked, it poses no danger to their U.S. trade, and against the rest of the world, it actually makes Chinese products more competitive. But along comes the conservative Bush administration with a relic of Soviet-era central planning – a tariff against Chinese textiles. Henceforth, the Bush team would have it, if you wanted to sell a pair of Chinese-made underpants in the Land of the Free at the free-market price, you’d have to smuggle them in.

We wonder about the misbegotten moment when Mr. Smoot first met Mr. Hawley. The two protectionists of the early ’30s couldn’t have known it at the time, but theirs was a meeting as comic as when Abbott met Costello and as lamentable as when Lincoln encountered John Wilkes Booth. The rendezvous doomed millions of Americans to poverty. After the passage of the Smoot-Hawley Act, world trade collapsed…and with it the U.S. economy. Soon, one out of every four working men were out of a job…and the stock market took a quarter of a century to recover.

"China to raise tariffs on U.S. goods," says yesterday’s news from Reuters.

It must have made somebody wonder…

Over to you, Addison, with more news:


Addison Wiggin on dollar watch…

– "Bloodbath!" writes our London correspondent Adrian Ash, "Yesterday’s attacks on the British Consulate and HSBC [one of England’s largest banks] in Istanbul dominates the press here today. ‘Will Britain Be Hit Next?’ asks the Daily Mail in two-inch lettering."

– The Istanbul Stock Exchange shut down trading after it dropped 7.4%…stocks fell across Europe.

– "With gunships hovering over London," continues our colleague, "an air exclusion zone up to 35,000 feet above…the gates to the Mall locked…5,000 extra police on the capital’s streets…and retailers reporting a 25% loss of business thanks to the Emperor’s visit…it looks like al-Qaeda has done what it does best. It caught soft targets off-guard, unprotected and unprepared."

– The attacks, as you would expect, gave ammunition to the crowd already assembled to welcome George W’s visit to the city. "This would not have happened had we not gone to war," an anti-Bush protester told the FT. Police estimate 110,000 protesters marched and shouted ‘F**k Bush!’ together – making it the largest mid-week demonstration in the nation’s history. "They toppled a homemade statue of ‘the Emperor’ in Trafalgar Square," Mr. Ash says, "mocking the U.S. felling of Saddam statues in Baghdad in March."

– "Those who can never win elections, always take to the streets," writes Antti Nupponen, an Iranian writer, referring to the demonstrations in London. "Street politics enables them to escape debate on complex issues that cannot be reduced to a few simplistic slogans." The article, passed on to your editor by a helpful Daily Reckoning reader, suggests that perhaps it was no accident the bombs were exploded while the president publicly supped on tea and crumpets with Her Majesty, the Queen.

– The protest in London was organized by a group called the "Stop The War Coalition," a rag-tag group of Ex-Leninists and Islamists brought together for one purpose: to stop the War on Terror. "The first to advocate a leftist-Islamist alliance against Western democracies was Ayman Al Zawahiri, al-Qaeda’s #2." The idea has apparently been endorsed by Ilich Ramirez Sanchez, the Venezuelan terrorist known as "Carlos the Jackal."

– "Only a coalition of Marxists and Islamists can destroy the U.S.," the cheerful Carlos wrote in his recently published book: Revolutionary Islam. The folks who have taken to the streets in London yesterday also consist of a rag-tag group of U.S. haters: anti-abortion groups, opponents of capital punishment, anti-globalization fanatics, and advocates of the Kyoto protocol. But, "a good part of the planned demonstration will," writes Antti Nupponen, "as always, consist of what Lenin called the ‘useful idiots,’ men and women of good faith whose political naïveté makes them natural targets for experts in agitation propaganda."

– Organizers of the demonstration, for example, have only "authorized" 4 slogans to be printed on signs and t-shirts: "Stop Bush", "Stop Blair" "U.S. Out Of Iraq and Afghanistan," and "Bush Go Home!" So much for the madness of crowds, huh?

– "Ironically," comments our reader who furnished the piece, "the protestors are ignoring the president’s two greatest [current] follies: excessive unbalanced fiscal spending and trade protectionism!"

– "Street politics is for those who wish to abolish individual political judgment," Nupponen sums up, "the cornerstone of democratic life. Street politics encourages the irrational tendencies of crowds that could turn into hunting packs or lynch mobs. Power won in the streets produces only ochlocracy (rule by the worst)."

– Despite the origin of the ochlocracy’s message – that Britain should distance itself from America, and fast – Mr. Market seems to have assumed the role of useful idiot. The dollar fell back a penny against the euro, finding its way to $1.19 for the second time this week. "Investors are not prepared to hold U.S. assets," Tony Dolphin, a money manager at the $32 billion at Henderson Global Investors, told Bloomberg. "When you get news like this of attacks, investors are inclined to run away from the dollar."

– Investors maybe, but what about the Bank of Japan? If the BoJ’s late trade support of the dollar on Tuesday is officially confirmed, the move would take the total number of U.S. dollars Japan has bought since August to around $80 billion – almost exactly $1 billion a day, and enough to fund nearly 75% of America’s foreign trade gap over the same period.

– How long, we keep wondering, in light of the geo- political absurdity, can the BoJ continue to ride to the dollar’s rescue? According to Derek Halpenny, a currency economist at Bank of Tokyo-Mitsubishi, not too long. Halpenny told the Financial Times the BoJ has only Y8,500bn left in its foreign exchange fund. By today’s exchange rate of 107, that means the BoJ can continue to support the dollar…for just 79 more days.

– Oil futures contracts for December and January fell across the board. The falls were arrested on news of the Instanbul blast…and fears of another wave of terrorist activity in the Middle East following the bombings in Turkey and Iraq. The markets in New York didn’t seem to take the bomb news too kindly, either; all fell. The Dow lost the most – 71 points to 9619.

– Curiously, gold fell on the news, too…back again to $393. "Investors continued to unwind gold futures from near record-long positions," currency trader Kevin Morrison told the FT, echoing comments made by our own Dan Denning in this space yesterday. We were wondering if last week’s front page spread on gold in the USA Today Money section would signal a worrisome contrarian indicator…and well, it looks like it has.


Bill Bonner, back in Paris…

*** Fortune magazine tells us that federal government liabilities are expected to grow by $1.6 trillion this year…and every year. That amount is equivalent to the value of all the gold ever brought up from the earth since the beginning of time.

Gold, or paper? The supply of paper is exploding. The supply of gold is still very limited. We don’t know which nag will win this race…but we’d be a fool not to take the odds offered by gold.

*** Patriotism has been called "the last refuge of scoundrels." It may also be the first. We were thinking of protective tariffs and wondering…

…as a practical matter, why would we want to pay more for a pair of underpants in order to help George W. Bush get re-elected?

…and as a moral or ethical principle, why is so important for an American to earn 10 times more than a Chinaman?

The world economy grows by specialization. Bananas, to choose an example that we had for breakfast, are not grown in America, because foreigners can grow them better, and cheaper. Everyone benefits. But force Americans to grow bananas – using protective tariffs, quotas and other restriction – and the world economy shrinks; Americans pay more for bananas and people are poorer everywhere.

Protectionism is sordid and absurd, but that doesn’t mean it isn’t popular. ‘Saving American jobs’ has a nice campaign ring to it.

*** Every bubble has to find its pin. That is not our plan…it just seems to be the way things work. American military power swelled to bubble proportions following the collapse of the Soviet Union in 1989. Where would it find a pin, we wondered? No nation…and no conventional army…could stand against it.

With no pins sharp enough to do the job, new ones had to be invented. Somehow, and unintentionally, the Bush administration had to extrude a titanium enemy worthy of itself. Thus did the "War Against Terror" come into being. Finally, a foe had been found who could not be defeated by high technology and superior military force. The trouble was, this new enemy was too small, too weak, too dispersed and unfocused to be anything more than a very dangerous nuisance…especially after 9/11, when the whole world turned against it. But now we read, in yesterday’s International Herald Tribune, that the war against Iraq seems to have helped terrorists "regenerate" themselves. "Now they are once again able to carry out attacks on a major scale," noted August Hanning, head of German military intelligence.

The Daily Reckoning