Globalization and Its Discontents

The dollar is dropping in Paris. Is it dropping in New York? It depends on whom you talk to.

“New York city residents are turning their pockets inside out to pay higher income taxes, property taxes, subway fares, rents and (if the cabbies get their way) taxi rates,” wrote Jim Grant recently. Grant is skeptical of deflation. Almost everywhere he looks, prices are rising.

And yet, bond buyers – generally regarded as the shrewdest of investors – drive bond prices higher almost every day. They see no inflation.

People hardly know what to think. Today, we offer a suggestion.

We begin, like a good democrat, with larceny. Here is a passage purloined from Bill Gross:

Current Account Deficit: Too Little Demand, Too Much Supply

“In any case, let me attempt to outline as simply as possible the global economy’s primary problem: It suffers from a lack of aggregate demand and too much supply. Because of globalization and Chinese overproduction; because of high debt levels and its suffocating impact on business investment and personal spending; because of a creeping, almost imperceptible demographic muting of consumption in aging societies such as Japan, Germany, and Italy; because of market bubble popping and the negatives of receding wealth; because of the dragnet of post 9/11 and now SARS, because of all of that and more we live in a world where we have too much relative to what we can afford to, or want to spend.”

Bill Gross did not say so, but what the world lacks is not dollars, but spending power. There is an important difference. A man who is deeply in debt may still have a functioning credit card or two. But that doesn’t mean he is willing or able to go further into debt. And if he does not borrow in order to spend…two important things never happen. The supply of dollars does not increase – for they have not been created “out of thin air” to satisfy his lust for credit – and the spending that might have happened does not.

The world in which these things don’t happen is not the world of Alan Greenspan – it is the world of Eisuke Sakakibara…a world slowing down, not one that is picking up speed.

If you accept this outlook, continues Gross, “then certain private sector behavior becomes more understandable. In order to get out from under the 16-ton sledgehammer of debt, companies use cash flow to build reserves or retire bonds – they don’t invest. Consumers begin to put away money instead of spend, which was the pattern of the late 90s. And the combination induces a negative spiral or vicious cycle of even more conservative behavior, including job layoffs, which leads to muted growth in personal income. In combination, this private sector response to a high-debt, reduced-wealth, increased-risk-laden economic environment can produce a slowdown or even a recession – Japan off and on for years now, the U.S. in 2001/2002, Europe in 2003.”

Current Account Deficit: Half a Trillion

“Then there is the problem of our growing current account deficit…” Gross points out.

The magnitude of the current account deficit is about a half a trillion dollars. On that point, there is little disagreement. It is the nature of it that stirs debate.

“At the current level of the current account deficit, I’m not particularly troubled by it,” said America’s Treasury Secretary recently. “It is really a small part of the size of total U.S. GDP and is certainly manageable.”

At 6% of GDP, the U.S. current account deficit may not be completely unique in economic history. But no nation ever had a deficit of such size and managed it successfully. Instead, huge imbalances have a way of causing trouble, no matter which central banker is on watch when the problem comes up. The real problem is not what appears in the international flow-of-funds reports, but what barely appears anywhere. “The crucial internal effect,” explains Dr. Kurt Richebächer, “is that the spending for the import surplus essentially diverts revenue and profit to foreign producers. On the other hand, the money being spent abroad comes largely from income that has been earned from domestic producers. The end result: these have the cost, while foreign producers have the revenue and the profit. This is the widely unrecognized big problem implicit to the monstrous trade deficit.”

How will it end?

Current Account Deficit: America is Not Japan

Either Americans will have to pay an “inflationary tax” as the prices of imports rise, says Bill Gross, or they will suffer a “negative wealth effect” as they are forced to cut back their expenditures and save their money. One way or another, he continues, there must be a piper around somewhere…and he will have to be paid.

In this regard, America is no Japan. Japan was already a large net creditor to the rest of the world. Instead, America is more like Argentina, as described above, where the “negative wealth tax” wiped out nearly the entire middle class in a single generation.

As in Argentina a few years ago, for every dollar’s worth of goods and services America sells overseas, nearly two dollars of imports come into the nation’s ports. So great is the imbalance that thousands of empty containers pile up in New Jersey; (they came full, but there is nothing to ship back in them) and trillions of dollars pile up in overseas bank accounts.

One tries to imagine the stacks of containers and money in awe and wonder. How could a system of globalized free trade – in which one must presumably give as much as one gets – get so out of whack?

Earlier this week, Joseph E. Stiglitz, Nobel prize-winning economist was in town. His biography explains that he “has helped explain the circumstances in which markets do not work well, and how selective government intervention can improve their performance.” He might as well have hung a sign around his neck saying “humbug,” for the message could not be clearer. Everybody knows that markets do not work well…they just work as they work, giving fools a way to lose their money that doesn’t require heavy drinking or trips to Las Vegas.

Current Account Deficit: Stiglitz’s Speech

Nevertheless, Stiglitz wrote a book entitled “Globalization and Its Discontents,” which we didn’t want to read, but we still thought the man might have some entertaining thoughts on the process that has lead to America’s huge pile of empty containers. So we dispatched one of our ace reporters to the scene of his speech.

“He said he expected deflation in the U.S.,” began the resulting report.


“He didn’t say.”

What Stiglitz did say is that politicians have to carefully control the process of globalization, or it might get out of hand. He had in mind third-world countries, where standards of living have fallen after the IMF gave bum advice. He was thinking of Argentina over the last 5 years.

We couldn’t help but think of America over the next 5.

Bill Bonner
May 16, 2003


Heh…heh…we can almost see the small, satisfied smile on Eisuke Sakakibara’s face when the news came out yesterday.

Sakakibara, for the benefit of readers who haven’t been paying attention or couldn’t care less, was Japan’s finance minister for many years, during which time he was the leading figure in the war against deflation, fighting on the losing side, of course.

You often gain more from failure than from success, we point out from time to time, just to be contrary, and you learn more from defeat than from victory. Usually, what you learn is “not to do that again.” No exception, Sakakibara now says that the fight against deflation was a hopeless cause from the get-go.

Deflation is not a monetary phenomenon after all, he says; monetary policy will not stop it. Instead it is a structural problem…one that America and Europe will have to learn to live with, too. (More on this subject… below…)

“No way,” say America’s can-do economists and monetary authorities. “We’ll target a positive inflation number,” say they.

But yesterday, the producer price number that came out for April was the most negative one ever seen, since record- keeping commenced in ’47. Most of the decrease in prices was blamed on lower energy prices. But even if you take out food and energy, and get down to what is called the “core” number, it is still negative. Core Producer Prices dropped 0.9% in April, its sharpest decline in 10 years.

The “weak inflation number” now disturbs economists nearly as much as a “strong” PSA reading. There was a time, of course, when men lost as little sleep worrying about low inflation as they did about their prostate glands. But those days are over. Now, we all know, they are both a source of trouble.

And Eisuke Sakakibara knows, more than most mortals, how many sleepless nights a weak inflation reading can cause. The latest figures from America sound as though they might have been rehearsed in Japan. Car prices fell 2.6% in April. Light trucks were down 4.6% – the biggest decline in 20 years. Cigarettes fell 9.6%. Gasoline cheapened up by 22.3% and heating oil by 29.3%.

Meanwhile, factory orders declined for the 3rd month in a row in the Philadelphia area. Industrial production fell 0.5% in April. And last week, for the 13th week in a row, more than 400,000 people lined up to file initial unemployment claims.

And to top it all off, personal bankruptcies hit a new record in the first quarter – up 9.5% from the year before.

We know the economy is on the mend…and stocks are definitely going up this year – everybody says so…analysts, economists, fund managers, investors, Treasury Secretaries, central bankers, TV presenters, newsletter gurus, lumpeninvestors…

On the other hand…there is Eisuke Sakakibara, in Tokyo, with his little schadenfreudian, I-told-you-so smile…

And there is Eric Fry, too…with his little Eric Fry smile in New York:


Eric Fry in the wilds of Wall Street…

– Hopeful investors resumed paying hopeful prices for stocks yesterday. The Dow climbed 65 points to 8,713, while the Nasdaq added 1.1% to 1,551. Meanwhile, both gold and bonds – unlikely bedfellows though they may be – continued their synchronous rallies.

– Gold, traditionally considered an inflation hedge, gained 30 cents to $352.80. At the same time, Treasury bonds, traditionally considered a deflation hedge, advanced for the 8th day out of the last nine – pushing yields to fresh 44-year lows. Investors, it seems, are so confused that they are buying everything.

– To be fair, confusion is a perfectly understandable response to the ambiguous data issuing from our economy. On the plus side, initial jobless claims fell for a third straight week. Three-in-a-row may not seem like much of an achievement, but it’s the longest streak in a year. Additionally, the New York Fed’s Empire State business sentiment index recovered dramatically this month – surging to 10.6 in May from minus 20.2 in April. The 30.8-point jump was the largest in the touchy-feely index’s brief two- year history.

– Despite these nascent signs of economic revival, however, evidence of economic weakness remains abundant. Industrial production dropped 0.5 percent in April – its sixth drop in nine months. Capacity utilization tumbled to a two-decade low. April’s auto production dropped 2% as GM and Ford each announced plans to slash production by more than 10%.

– Meanwhile, deflation-mania picked up a fresh tailwind yesterday, as the producer price index dropped an eye- popping 1.9%. Prices excluding food and energy, or the “core rate,” fell 0.9 percent – the largest one-month decline in a decade.

– Despite the economy’s uncertain health, stock market investors seem all too eager to give it the benefit of the doubt. They seem to find the favorable – albeit sparse – economic data more persuasive than the abundant, negative economic data.

– “A new multiyear bull market has begun!” The bulls proclaim. To which the bears counter, “But we have not finished correcting the excesses of the bubble. Stocks are still very richly priced in an historical context. Dow 5000 is a likely target.”

– We suspect that neither the bulls nor the bears will get exactly what they expect, at least not WHEN they expect it…That said, we’re kind of partial to the bearish middle road – i.e., a lengthy, go-nowhere market that frustrates bulls and bears alike. John Bollinger of Bollinger Capital Management calls this “the giant sideways.”

– Morgan Stanley’s Barton Biggs imagines what this “giant sideways” might look like. “The usual pattern following a massive, encompassing bubble that has sucked in and then destroyed the multitudes is for a sharp, initial break of 50-75% over a period of two to three years,” Biggs says. “Then the afflicted market tends to take a breather and drift sidewise for several years. Almost invariably during this period, at least one major rally of 30-50% (and often as many as three) retraces as much as half the fall from the peaks. Some market historians classify these rallies as mini, cyclical bull markets…

– “What is interesting is that usually in the past, these upward thrusts originated from valuation levels that were not cheap by any means. The most prominent examples are the two cyclical bull markets in the U.S. in the 1930s following the Crash, and the three big rallies in Japan in the 1990s…According to the basic thesis of the bears, the history of world-class bubbles shows that they take decades, not a few years, to heal, and that the U.S. in the 1930s and Japan in the 1990s are the models to study.”

– One such bear is Charles Minter of Comstock Partners. In a recent interview with BusinessWeek, Minter predicts, “We suspect that we won’t start a new bull market until we get to stock valuation levels that established major market bottoms, like in 1932, 1949, 1974, and 1982. The Standard & Poor’s 500 index is trading at around 30 times earnings right now. For 80 years, its price-to-earnings multiple has typically ranged from approximately 10 to 20 times earnings. It’s 10 at the end of bear markets and 20 at the end of bull markets…We think the S&P 500 is going to decline below 600, probably below 585.”

– Hmmm… sounds about right.


Bill Bonner, back in Paris…

*** Gold rose slightly yesterday, even as the dollar rose, too.

*** Seven out of ten insiders are selling, reports Richard Russell. While the dumb money buys into this bear market rally, the smart money is still getting out.

*** Bonds were up again; 10-year notes yield just 3.52%. Depending upon the inflation number you use, real yields are barely positive.

*** Bill Gross, who runs the giant PIMCO bond fund, has taken up the longstanding Daily Reckoning guess: euro bonds will outperform U.S. dollar bonds. Euro bonds offer higher yields, notes Gross. What’s more, the European Central Bank’s key rate, at 2.5%, is twice the Fed rate – which gives them more room to make cuts, and drive up bond prices. Germany, Italy, and Spain are all nearing recession, reports the BBC. The ECB will almost certainly cut rates.

*** Gross did not even mention the additional threat of a falling dollar – which would further flatten euro bonds. We bring up the subject…more below.

*** Old friends came into town yesterday with updates from their around-the-world travels. “What has happened in Argentina is unbelievable,” came a report that might as well be from the future as from the pampas. “When I first moved down there in ’81, about the same percentage of people were said to be living in poverty as in America – about 10%. And the country was run by a junta of generals. It was a military dictatorship. Then came democracy….and everyone started looking to the next election for solutions to economic problems.

“Now something like 60% of the population lives in poverty. There are still rich people and still poor people. But most of the middle class has been wiped out in a single generation.

“And now nobody cares about elections anymore. The political parties couldn’t agree on how to hold a primary, so they never did. The candidates just presented themselves. Nobody seemed to care. They barely reported it in the papers. And then Menem dropped out. So this guy Kirchner was elected without anyone ever voting for him.”

Meanwhile…a report from the Far East…

“It is not as bad as the international press makes out,” says a friend from Hong Kong. “Sure we all wear masks, but the disease seems to be under control. The number of new cases has dropped to single digits. And it never actually made it to the good parts of town. If you look at a map of where the cases were concentrated, you see that they were all in these housing estates – where people are crowded in together. But in the good parts of town, there were almost no cases.

“Besides, SARS is supposed to be a cold-weather disease, like the common cold. It could be eliminated this summer.”

*** [Ed note: One last “international” update – but this time from your editor’s very own home, here in France. As in summers past, International Living is inviting a small group of 12 readers to the Château d’Ouzilly, for a week of wine tasting, cheese sampling, cooking lessons…and other delights of rural France.

The Daily Reckoning