Gone With The Wind

“There’s just as much money to be made in the wreck of a civilization as the up-building of one.”

Rhett Butler

In ante-bellum Georgia, few people could imagine what a war with the North might bring. They knew wars took courage… horsemanship…and discipline. They figured they had plenty, and boasted, in the words of one of the Tarleton boys in Margaret Mitchell’s novel, that they could “lick the Yankees in less than a month.”

But it was not to be. After 4 years of struggle, the south was beaten, devastated, and occupied by a foreign army. It was a new era, after all.

Things do change. New Eras do come along, but only at great cost…and unexpected suffering.

“Practically breaking the bank with a $3 million publicity campaign,” reports Frederick Sheehan in his Quarterly Market Review for John Hancock, “Warner Brothers’ escapade swept the nation.”

Sheehan was not referring to ‘Gone With The Wind,’ which we made our entertainment last Saturday night, but to another film which revolutionized the movie industry – The Jazz Singer, the first talking picture, released by the then third-rate studio, Warner Brothers.

“Predictions for this new technology were mixed,” writes Sheehan. “The reasons for this ambivalence were many, including the terrible quality of the sound.” Said Tallulah Bankhead of the audio: “They made me sound as if I’d been castrated.”

But you can’t stop a good innovation. Soon, “everyone in Hollywood was …scrambling for money, and in the heat of the bull market , it was easy enough to borrow and then borrow some more. By 1933, the technology was standardized and much improved, 99.5% of all movies were now ‘talkies’…”

If ever there was a new technology that was a winner – it was talking pictures. We do not have to consult the dusty tomes of economists for proof. Nor do we need to stretch our imaginations. All we have to do is to open our eyes. Everywhere you go in the world, or nearly everywhere, you find U.S.-made movies. It is Planet Hollywood. American movies…and the actors and actresses who make them …are known worldwide. They are among our most successful and most profitable exports.

The old era of silent films fell faster than the confederacy. Only a few years after the introduction of ‘talkies’ they were being watched by crowds of millions. Even Josef Stalin loved American films. He worked until the wee hours of the morning – personally approving the lists of hundreds, sometimes thousands, of people who were to be murdered. Then, his labors finally over for the day, he retired with a few henchmen to a private studio…not to discuss Karl, but to watch Groucho.

Surely investors who put their money in this world-changing new technology were richly rewarded. Alas…what a confusing, frustrating…and astonishingly baroque world we live in. Sheehan reports that by 1933, “the entire motion picture industry had defaulted on its debt (there was one exception: Loews). The studios struggled to survive.”

What went wrong? The studios were trapped by technology as well as enriched by it. They were forced to invest huge amounts of money [like today’s telecoms or Internets?] in order to remain competitive. “They had no choice,” explains Sheehan. “Profits of the industry tripled between 1927 and 1929. They had achieved this apparent success, but at an enormous cost. …The industrial system as it had evolved for the previous three decades needed to be completely overhauled; studios and theatres had to be totally re- equipped and creative personnel retrained or fired. In order to fund this conversion, the film companies were forced to borrow $350 million. What William Fox and Sam Warner did not anticipate was a stock market crash.”

One of the myths that has grown up around the Depression was the audiences turned to the film industry for entertainment and escape. Maybe so…but going to the movies was discretionary spending…and sales dropped for the motion pictures just as they did for the auto industry. In 1931, movies brought in $831 million. By 1933, sales had fallen to $546 million.

Even on a VCR, the sunsets, fires and panoramas of “Gone With the Wind” are impressive. They are the work of one of the greatest success stories in Hollywood – the Technicolor Corporation. Formed in 1915, the company had a monopoly on supplying color to the film industry. After the spectacular success of ‘Gone with the Wind’ and the ‘Wizard of Oz,’ both made in 1939, movies began a conversion to color almost as rapid as the switch to talkies in 1927. Technicolor was the sole supplier of color to Hollywood until 1947. Still, against the current of falling stock prices on Wall Street, Technicolor could make no progress. The stock never recovered to its ’20s high.

“In the end,” comments Barrie Wigmore in his book, “The Crash and Its Aftermath,” the movie industry thrived, the Warners and the Foxes retained control, but the investors went broke.”

Fox Films hit a high of $106 in 1929. By 1933, you could buy it for 75 cents. RKO fell from $76 in ’29 to 25 cents in 1932. Warner Brothers dropped from $67 to 50 cents.

The money investors put up – funding the development of some of the most successful new technologies for one of America’s most profitable new industries – was lost. Like the Old South, it was gone with the wind.

Bill Bonner Paris, France January 24, 2001

*** Investors are looking forward to next week. The FOMC meets and is widely expected to cut the Fed Funds rate by 50 basis points. Futures trading shows investors put an 86% probability on a rate cut of 50 bps.

*** Over the last 18 years, investors have learned that it is usually unprofitable to fight the Fed. When the Fed cuts rates – stocks rise.

*** And so, in anticipation of another breath of hot air into the bubble economy, investors boosted up the Dow by 71 points and the Nasdaq by 82. There was not much rhyme or reason to it – other than the hope that things will be better now that Greenspan & Co. are back on the pumps.

*** “No matter what you read or hear about widespread bearish sentiment,” Marc Faber wrote recently, “the fact is that investors and strategists have remained stubbornly optimistic… brokerage industry strategists are now allocating a record 64.7% of their clients’ assets to the stock market, which is by far the highest in the history of this indicator. [And according to Investors Intelligence] …52.9% of advisers are bullish, which is just within 4% of the all-time high figure in January and March of last year…”

*** The Fed is in bubble mode. MZM (money of zero maturity…or cash as it is commonly called) is rising almost 5 times as fast as the economy itself…that is, at a 12.9% annual rate. Adjusted reserves are soaring at a 16.7% annual rate.

*** This is, of course, inflation: more money relative to the goods and services that it can buy. Will it produce an increase in the consumer price index? An increase in stock prices? Or nothing at all?

*** While the Fed tries to pump up the bubble economy… there are still some serious leaks. Earnings, debt, bankruptcies. If investors lose confidence – they can whack the markets for a 10%…20%…or even 50% loss in a matter of days.

*** Let’s go back to the big numbers. The stock market is worth $14 trillion. Even a 10% drop would mean a loss of capital (money) equal to $1.4 trillion. How much would a 12.9% increase in MZM offset that? Not much, dear reader, not much.

*** And, there’s Bush’s tax cut. There’s another $500 billion that might be made available to consumers…that should get the bubble air stirring, right? But, again, it represents less than a 5% move in stock prices. When this market is ready to go down…neither rate cuts nor tax cuts are going to stop it.

*** Is it ready to go down now? Well, not yesterday. Twice as many stocks rose as fell on the NYSE yesterday. 140 hit new highs, while only 7 hit new lows.

*** In Bill Clinton’s final budget, a federal surplus is projected of $4.42 trillion for the years 2001-2010. But economists at Economy.com say that the figure will be more likely $1.8 trillion. And that it won’t be a surplus, they predict, but a deficit. All you have to do, says Economy.com, is change a few of the assumptions about the stock market over the next few years and you get a very different result.

*** The NY Conference Board’s Index of Leading Indicators fell for the 3rd month in a row. It dropped 0.6% in December, its sharpest decline in 5 years. Three consecutive months of falling figures is usually an advance warning of recession.

*** Here’s another interesting note to log in the “Too Big To Fail” category: “Bank One’s bad consumer loans were 61% higher last quarter than they were the previous year,” reports the Motley Fool. “Additionally, Bank One took a pre-tax write-down of $575 million for currently impaired assets, including vacant real estate and abandoned car leases.”

*** Friend Justin Ford writes: “The nation’s plummeting savings rate is not a new phenomenon… did you know, Irving Fisher died penniless? Apart from being the Fed chairman during the ’29 crash, Fisher was a renowned Yale economics professor and entrepreneur in the 1920s and 1930s. He had built a multi-million dollar fortune. But he also neglected basic lessons about investing… Yale had to buy the house he was living in so he could live out the rest of his days there.” Justin’s been working on a program called ‘Seeds of Wealth’ designed to help young people learn the value of saving and investing. I’ll tell you more about it later.

*** The dollar went nowhere yesterday. Oil fell 23 cents.

*** The Bank of England’s gold auction was oversubscribed 5 times over. There were plenty of buyers for gold – but the price of the metal fell 30 cents yesterday. The mining index, XAU, lost 2%.

*** Marshall Auerbach, on the uncalculated threat of derivatives: “Ashanti Gold, a large West African gold producer, was not the first mining company to enter into gold hedging arrangements via the OTC derivatives market. But the derivatives used by Ashanti to undertake such hedging were unusually complex … to the extent that nobody in the marketplace could truly understand them. Investors were fobbed off with the argument that the company had the situation ‘well in hand’, when questions about these exotic hedges were posed.

*** Then, “when the European central banks surprised the gold market in the autumn of 1999,” continues Auerbach, “with the announcement of the Washington Accord (an agreement to restrict the amount of gold sold by the European central banks to a fixed quantity over the next 5 years), the gold price soared un unprecedented $80 in just 4 trading days. Unfortunately for both [Ashanti] and its shareholders, Ashanti’s derivatives’ bet did not incorporate this sort of rapid price spike as one of a possible range of scenarios … the resultant margin calls pushed the company to the brink of bankruptcy. Seventeen major bullion banks had exposure to Ashanti, yet NONE were able to quantify the extent of their liabilities until one of the Goldman Sachs’s ‘rocket scientists’, who helped design the original derivatives contracts for Ashanti, was parachuted across the Chinese Wall and able to make the relevant calculations.

*** And yet, “OTC derivatives in the gold market,” says Auerbach, “are but a tiny irrelevance in relation to the trillions of dollars of exposure in the area of interest rate and foreign exchange derivative structures…”

*** “The world of Wall Street spin is like a dozen simultaneous games of 3-dimensional chess,” writes Howard Kurtz in his book Fortune Tellers, passed on to me by Harry Schultz, “…a dizzying match in which stock prices, corporate earnings & millions of individual investments are riding on the outcome. Amid the endless noise, whom do U trust? … Street analysts have too much power, for the media mindlessly trumpets their predictions as if set in stone. And if the assessment turns out badly wrong, well, too bad. Zero accountability.”

*** Schultz adds: “Analysts praise company stocks while trying to win that firm’s investment banking biz, & few make the connection. Via airwaves & press, fund managers tout stocks in which they’re long. Rarely are they asked if they own the stock, & even if they admit it, no one screams: interest conflict!”

*** “Martha Stewart Living has swept Wall Street off its feet right along with the rest of the world,” says GrantsInvestor analyst Rosa Ann Tortora. “But as cracks begin to show in this fabulous facade, investors may want to reconsider their paean to gracious living.” The company currently trades with a p/e of 55 and a $1 billion market cap. But, according to Rosa Ann, Martha’s Internet project is hemorrhaging cash. And she thinks there’s some money to be made on the short side.

*** The collector car market is still hot, says the Arizona Republic. Two recent auctions produced record sales and turnout. A ’34 Ford street rod built by Boyd Coddington sold for $130,680. A ’35 Duesenberg sold for $1.045 million. A ’68 Shelby GT500KR sold for $85,575.

*** A front-page article in The International Herald Tribune warns that Europe’s forests are in bad shape. Nowhere does the paper explain that European forests are victims of European government – which pays farmers to plant unprofitable crops on land that would otherwise go back to wilderness.

*** And poor Christine Deviers-Joncour. The woman was paid $9.25 million dollars by oil company Elf Aquitaine. And now she is being forced to explain to a court why her services were so valuable. The money, it is alleged, was a bribe to former French foreign minister Roland Dumas, to whom she was mistress. Christine says she worked tirelessly for the money. Yes, Judge Sophie Portier said: “You put your body and soul into the job.”

The Daily Reckoning