Grand Illusion II

Immediately following the end of WWII Americans turned their attentions to making and consuming ‘things’. From 1945 onward, year in and year out, Americans had more and more things available to them.

Household wealth increased each year. Neither wars, pestilence, inflation, the incompetence and imbecility of government, natural calamity, nor even bulls and bears on Wall Street could stop it. Wealth building survived the Korean War, the Vietnam War, the Gulf War…recession, inflation, stagflation…John Kennedy, Lyndon Johnson, Richard Nixon…treasury bond rates of 18%…television…the Energy Crisis, Flower Power, Watts… Michael Dukakis, Barbra Streisand, Lee Greenwood…disco, a vast right wing conspiracy, recovered memory syndrome…Jimmy Carter, Andy Warhol – even the Laurence Welk show.

Through all these horrors Americans added to the ‘things’ they had and the ‘things’ they were able to make. A bull market in wealth building was underway – one that would last for more than half a century.

By the mid-1990s, Americans had become the masters of all the worlds’ ‘things’ – buying up 20% of the entire world’s exports, with a dollar that seemed to become more valuable with every additional unit in circulation, and an economy that seemed to have entered a New Era – where the number of ‘things’ an ordinary American family might possess seemed almost unlimited. That is, as long as the rest of the world was willing to provide these ‘things’ in exchange for dollars…and finance a trade deficit which, last year, equaled more than the entire U.S. federal budget during the last year of the Carter administration.

By the late ’90s most people have convinced themselves that there was something different about this economy from all those who came before. For the first time in the history of mankind, ‘things’ seemed less important, economically. Instead, it was the ‘information’ behind things that mattered.

All of a sudden, it seemed like a new world. Anyone could make things – anywhere. The real money was in ‘information’ itself.

Information, it was argued, would eliminate waste, reduce costs, and put an end to the business cycle. Previously – the Age of Ignorance, you might call it – businessmen tended to over-expand and over-produce in good times. This led to over-capacity and inventories that needed to be drawn down before a new growth phase could begin.

“Information” would make recessions – and bear markets, for that matter – a thing of the past. There would be no further need for inventories since ‘information’ would allow manufacturers and distributors to match supply perfectly to demand.

Savings are a form of inventory – a reserve of purchasing power for capital improvements or unexpected setbacks. But the new Information Economy needed little of either.

Henceforth, there would be no unpleasant surprises…and productivity increases and cost reductions would finance the fastest economic growth the world has ever seen.

What a wonderful world we had stumbled upon, dear reader – an economic Shangri-La…where even time itself could be mastered, like a hunting dog. Just whistle and you could get tomorrow’s profits fetched for you today. It was no longer thought necessary to wait for compound interest to build wealth. You could have it all – now.

And you could feel good about yourself – even feel superior – as you were mortgaging the family home to buy stock in companies that made neither ‘things’ nor profits.

Information Age companies were said to have a new form of capital, one that didn’t show up on the balance sheet: intellectual capital.

Who knew what this new capital was worth? Any price might be too low.

“Owning brick manufacturers, shoe makers, car insurance firms and candy retailers – like Warren Buffett does – isn’t going to make the world a better place,” as info- believer Porter Stansberry put it recently. “Buffett doesn’t create wealth like Venter.”

Craig Venter is the CEO of Celera, a company that spent hundreds of millions to increase the world’s supply of information. Buffett’s companies, by contrast, make old fashioned ‘things’. Buffett’s businesses make profits. Venter’s does not.

In the 1990s, the grand illusion of the Information Age took hold of American imaginations. Let the foreigners make ‘things,’ they said to themselves, we will consume them. Information Age companies reached ebullient levels on Wall Street, while the makers of ‘things’ became nearly as demode as gold bugs.

But something remarkable happened last year. For the first time in 55 years – household wealth declined. The story has gotten relatively little press attention. Like the Russian’s treatment of its own troops, the report is scarcely believable…how could American households lose wealth in the very same year that the “Information Economy” reached its fulgurous climax?

Could it be that ‘things’ are still what really matters – at least for purposes of calculating wealth? And could it be that an economy that turns from producing things to consuming them is one that has taken the road to ruin?

“Even in these days of the vaunted New Economy,” writes author Eamonn Fingleton, “[manufacturing capacity] is an absolutely critical factor in world economic competition. And the results are apparent in Japan’s extraordinary trade performance in recent years. In fact Japan’s current account surpluses for the decade of the 1990s totaled 2.1 times their level in the 1980s…

“And how has the United States been doing on trade? The contrast with Japan could hardly be more startling. As the American manufacturing base has shrunk, America’s trade deficits have soared. For 2000, the current account surplus is likely to be a record 4.4 per cent of national output. By contrast, the worst deficit in the 1980s was just 3.6 per cent national output – a record that was widely considered disastrous at the time…

“In fact, so strong are Japanese savings that Japan is now exporting more capital in real terms than any nation since America’s days of global economic dominance in the 1950s. While the Japanese economic bureaucrats are loathe to draw attention to this fact for fear of fanning protectionist sentiment in Washington, the results are starkly apparent in little-noticed IMF financial statistics for national external balances. These show that in the first nine years of the 1990s, Japan’s net external assets jumped from $294 billion to $1,153 billion. Meanwhile, America’s net external liabilities rocketed from $49 billion to $1,537 billion.”

So, I put the question to you, gentle reader, who got rich in the 1990s? The people who made ‘things’ while their stock market collapsed? Or the people who produced ‘information,’ while prices of their stocks soared?

And now that the 55-year-long bull trend in wealth building in America has been broken – what comes next?

We will see, dear reader, we will see.

Your correspondent…

Bill Bonner Paris, France March 16, 2001

*** Even a Freudian psychologist, dropped from a high enough point, will bounce a little. On Monday, the Dow fell 436 points. Then, it bounced a little on Tuesday, dropped another 317 points on Wednesday, and bounced again yesterday.

*** The Dow rose 57 points to close slightly above the 10,000 mark.

*** It was a relief to bullish investors to see the Dow above 10,000…but how long will it last?

*** Investors must be getting a lot of margin calls. The Financial Times reports that margin debt declined 29% last year – as investors paid up or got knocked out of their positions. This was a sharpest decline in the history of the NYSE.

*** Still, at the end of January, margin debt stood at $197 billion – more than twice the level at the beginning of 1997, the year that margin debt first rose above $100 billion.

*** Fred Hickey, who publishes a popular technology stock letter, says he expects the Dow to fall to 5,000 and the Nasdaq to drop below 1,000.

*** The Nasdaq lost 31 points yesterday, remaining below 2,000. But who cares about the Nasdaq anymore? The action has moved to the Dow.

*** And investors are getting restless. The Wilshire 5000 has lost 27% of its value since March 24th of last year. That represents a loss of wealth of $4.6 trillion, an amount equal to half the total annual output of the U.S. economy…or about $50,000 per family.

*** “Everyone is out of work and everyone feels like they’ve been the victims of a big Ponzi scheme,” said a voice at the Silicon Summit II, hosted by Tom Brokaw.

*** People are not quick to take responsibility for their own foolishness. Instead they look for someone else to blame. CNBC says it is already getting emails calling for Greenspan’s resignation. He kept rates too high for too long, they say. “Greenspan is the devil incarnate from the point of view of ordinary Americans,” said Bill Meehan of Cantor Fitzgerald. “Some people have seen 80% of their pension funds wiped out.”

*** From demi-god to devil in less than 60 days? Not quite. Most people still think that Greenspan has the power to reverse the bear market by lowering the fed funds rate. Reuters reports that the “Clamor grows for bigger rate cut.”

*** “People ask me why I don’t say ‘sell everything,'” writes James Cramer on But Cramer cannot understand how lower rates, in an economy that is still adding jobs and is not bothered by inflation, can fail to lift stock prices. “I want to buy here,” he concludes.

*** Out of 8,000 stock recommendations tracked by – only 29 were sell signals. “Investors who aren’t bullish are not very well served,” concluded Addison. He’s putting the finishing touches on a new investment advisory service for people who want to make money in the markets, but don’t believe the Dow or Nasdaq are going up any time soon …watch this space…

*** Gold fell another $2.60 – as the Bank of England auctioned off tons of the stuff. Gold mining companies fell an average of 3%.

*** The euro fell below 90 cents in yesterday’s trading.

*** The trade deficit hit a new record last year – $435 billion, up 31% from the $341 billion in 1999.

*** According to the Leuthold Group, the median dividend yield for the S&P 500 since 1957 has been 3.4%, the source of about a third of the total return from stocks for the last half a century. But now, the S&P 500 yields only 1.1%.

*** Rob Peebles: “The ’80s and ’90s were the best back to back decades for stocks in 200 years. If stock market returns revert to their long-term average, stocks could go nowhere for some time. The bottom line? The dividend yield may be telling investors who think the market is near a bottom to wait. And then wait some more.”

*** A friend sends me this from “”…the best and worst performing industries over the last 3 months:

Best Performing Industries

Industry Name Percent Change (over time selected)

Tires 42.26%

Toys 33.87%

Auto Parts 31.26%

Oil Drilling 24.70%

Autos And Parts 22.49%

Household Products, Durable 21.43%

Tobacco 21.28%

Furnishings 20.80%

Automobiles 18.15%

Factory Equipment 18.11%

Worst Performing Industries

Industry Name Percent Change

Communications Technology -50.76%

Advanced Ind. Equipment -41.64%

Technology, Hardware And Equipment -33.58%

Technology -32.72%

Technology, Software -30.21%

Industrial Equipment -29.70%

Biotechnology -26.39%

Wireless Communications -25.73%

Computers -24.59%

Consumer Electronics -21.16%

*** Japanese banks are thought to have ‘imbedded losses’ equal to 5% to 10% of the nation’s GDP. “It has reached the point where things are going to go bust,” said an analyst interviewed by the Financial Times.

*** “Watch Japan. Japan is a particular tinderbox at the moment,” said Bill Gross of PIMCO, the biggest bond fund in the world. “The world’s second largest economy is teetering on the brink of recession,” he added. That means the world’s two largest economies are both in trouble. Is the whole world in trouble? Maybe…more below…

*** “You mean, the Russians were shooting their own soldiers?” Addison asked me. “Why would they do that?”

*** As the film, ‘Stalingrad,’ illustrates, things happen which – even in this Age of Unlimited Information – are hard to believe or understand. Stalin sent the young Nikita Kruschev – a man who had proven effective at starving and murdering millions of Ukrainian farmers – to Stalingrad to try to rescue the situation. Kruschev handed a loaded pistol to the military commander and told him to blow his own brains out – which he obligingly did. Then, Marshal Zhukov came to take the command. In one instance, Zhukov lined up a group of Russian soldiers and shot every 10th man. He warned them that if they tried to retreat, he would kill them all.

*** At the beginning of the campaign, the Germans captured hundreds of thousands of Russian troops. Few survived prisoner of war camps, but if by the grace of God, a man lived to return to Russia after the war – the Soviets charged him with treason for allowing himself to be captured and sent him to Siberia!

*** On a lighter note, last night Addison showed a few friends from the Baltimore office the way to Le Pied au Chameau (The Camel’s Foot) a Moroccan restaurant around the corner from the office. He tells me they dined on among other items from the menu – an actual camel’s foot (I’m sorry I missed it). Afterwards, they danced with a belly dancer.

The Daily Reckoning