Grand Theft Auto

Word came from Baltimore yesterday, that someone had walked into the office on Mount Vernon Square and stolen a laptop computer.

Despite a full employment economy, a summer rally on Wall Street and the approach of the November elections, some people still decide to go freelance. Rather than get an honest job, invest, or wait for the booty of politics to come their way, they decide to go for it, the cash that is, directly and immediately.

Jules’ video game, Grand Theft Auto, is not the least bit subtle about it. Its message: crime pays…and it can be fun too.

As you will see, crime does pay. Because it pays so well, people are forced to take precautions against it. One of those precautions – dating back many centuries before the founding of Wall Street – is owning gold.

The destination of today’s letter is gold – and its price. But we will visit some strange and wondrous places before we arrive – including crime… punishment… politics…and the real nature of marriage.

So let us begin. My oldest son, Will, and his girlfriend, Suzannah, set out on a 12-mile hike this morning. They will walk down country lanes, through quiet villages… and have a picnic lunch beside a lake that was dug by monks in the 13th century. This, of course, has nothing to do with our journey today…but I envied them as they set off.

I envied Jules too – briefly – as he played his game. It looked like fun – stealing cars and careening through the make believe streets of his video game. Running down pedestrians and ramming police cars!

“If everybody could be trusted not to steal cars,” writes Matt Ridley in “The Origins of Virtue, “cars need not be locked and much time and expense could be saved in insurance premiums, security devices and the like. We would all be better off. But in such a trusting world, an individual can make himself even better off by defecting from the social contract and stealing a car.”

In a trusting world, gold would be just another element – like mercury or chocolate. But the world is not entirely free from sin. At least, it never has been.

There are still crimes, petty and grand, against which you need protection. You can put a guard at your door… or an alarm system. Petty criminals can be fended off with petty measures. But protection against the great criminals – the scam artists and politicians – takes more care.

In the old days, the forebears of Bush and Gore – that is, the emperors, dictators, pharaohs, and other rulers – issued their currencies and decreed them legal tender… just as the U.S. government in cooperation with the Federal Reserve System does currently. As long as the coin of the realm was minted honestly, it was difficult to game the system. But crime paid, then as now. And it didn’t take rulers long to discover that it was cheaper to issue money in paper form, rather than in gold.

Those in charge of currency were confronted with a rare form of what is known as “the prisoner’s dilemma.” Two prisoners are faced with the choice: give evidence against the other and reduce your own sentence…or stick together and both will convicted of a lesser charge. If they stick together, as a group, they will serve the least time. But each may serve less time – if he gives evidence against the other. Naked logic suggests the most rational choice – turn state’s evidence. Squeal. Defect. Look out for #1.

Paper currency was a disaster to society. But it paid off for its issuers. They were able to steal from the people they were supposed to be protecting. As Ridley put it, “true logic leads you into collective disaster.” The world has lived through the collective disaster of hyper- inflation many times. At one point, the Romans issued coins made of leather. But the official currency was so devalued by the market – Roman tax collectors refused to accept it in payment of taxes. They demanded the real stuff – precious metal.

The best protection was to own gold. The coins could be hidden. They could be carried. An ounce of gold would buy a good quality toga and a belt during Caesar’s time. But while the imposter currencies inevitably went bust, gold retained its value.

That has happened even in our time. Throughout the entire 20th century, during which time the elder Bush and the elder Gore were often in positions of power, the U.S. dollar lost value. In fact, it lost about 95% of its value.

But in 1900, an ounce of gold – which was worth about $15 back then – would buy a man a suit of clothes. Here it is, the year 2000, and an ounce of gold – now worth about $280 – will still buy a suit of clothes. Though not at Brooks Bros.

But something has changed. The division of labor has progressed to such a point that people no longer feel the need to stock food. Or firewood. And there are new ways to protect against inflation.

Adam Smith wrote that the division of labor increased as the size of the market increased – and that it expanded as communications improved. His guesses were later proven by a biologist named John Bonner (no relation) who studied slime mold. He discovered that slime mold cells did indeed tend to specialize as the size of the colony expanded. No proof has been offered on the communications point – but it seems as though it must be true.

Thus, we may presume that the division of labor is making rapid advances – with the advent of the Internet and globalization. A person with wealth to protect has a great number of options. He can buy inflation-indexed bonds. He can buy foreign currencies. He can buys stocks – which provide dividends, and whose value often rises with inflation. He can even buy stocks of gold mining companies. He can buy a chateau in France…or an island off the coast of Scotland. He can go onto the Internet and bid on paintings, jewelry, antiques – directly from Christie’s gallery.

The market itself – the universal joint and master- switchboard for the division of labor…in which the labors of millions of people all working for their own self-interest are marked to market… priced… valued… and exchanged – seems to have made gold unnecessary.

But in equal measure, it has made the dollar vulnerable as never before. In a split second – the bond traders, currency traders, and ordinary investors can switch out of dollar-denominated investments. They can move to.

In a matter of moments – it could be over for the dollar. But gold will still be in its position on the periodic table. And an ounce of gold will probably still be worth a suit – or at least a pair of pants.

“We are not ready to suspect any person of being defective in selfishness,” wrote Adam Smith in his Theory of Moral Sentiments. If that applied to Roman Emperors, it applies no less well to Republican presidential candidates. And no less to the issuers of dollars as the issuers of stock. What is good for the issuers is not necessarily good for the market as a whole. And the logic of self-interest could lead to a collective disaster – a collapse of the dollar, as well as U.S. stocks and bonds, against other assets.

As always…

More to come,

Bill Bonner

Ouzilly, France August 8, 2000

P.S. Tomorrow, I will describe the curious way ‘the market’ transforms bad into good… and the curious paradox of marriage.

*** It must have stopped raining in New York. The ‘summer of love’ spirit seems to have gotten a boost over the weekend. The Dow rose 99 points yesterday – as hopes for no further rate hikes spread and deepened.

*** The Nasdaq rose too – up 75 points. The market looks strong. Advances led declines by 1708 to 1136. More than 4 times as many stock hit new highs as new lows. It looks like the summer rally will continue.

*** The big number today will be the productivity report – coming out this morning. The report, from the Bureau of much-Labored Statistics, is expected to show non-farm labor productivity increasing at a healthy, but not spectacular, rate of 4.5%.

*** Meanwhile, Jim Grant, of Grant’s Interest Rate Observer, has commissioned his own shadow BLS and anticipates a real productivity number closer to 2.5% – taking out the imaginary, ‘hedonic’ gains from greater computer power, leveraged by the ‘substitution’ effect of declining computer prices.

*** All of this hocus-pocus is great fun. Most likely – almost inevitably – the Internet and new communications tools are increasing productivity. They are doing so by extending the division of labor…making it possible for people all over the world to work together…in more and more specialized ways. But, as I describe below, there are limits…

*** Gold rose 50 cents. Platinum went down a big $8.60 cents.

*** The euro bounced. It is now worth more than 91 cents. Has the rally petered out? Has the world’s demand for green paper really peaked – as I suggested, on May 17th? We’ll see.

*** Bill King tells us that August, not October, is the worst month for stocks. He also notes that this is the biggest week for IPOs in 17 years.

*** “The Comeback Continues” announces Red Herring, referring to the IPO market. New offers include techs, medical companies, and plain, old-fashioned goofy long shots – such as California Pizza Kitchen, and Krispy Kreme Doughnuts (which even spells donuts in the old economy way.) The doughnuts are up 180% since the April offer.

*** Earnings announcements by corporate America are coming in – some good, some bad. But overall, according to the Amernick Report ( earnings rose a very healthy 32.73% year to year. Still, stocks are down for the year. Why?

*** One reason – among Nasdaq stocks, P/E ratios are so lopsided – with so much P to so little E – that even a big increase in earnings is meaningless. Prices are running 145 times earnings. So even a 100% increase in earnings still leaves stocks at an absurd 72.5 P/E.

*** Another reason: the best earnings are to be found among the big companies. So, taking the S&P 500, for example, the earnings yield is currently 3.44%. But the CPI is now 3.67%. Earnings are not even keeping up with inflation. This is something new. And surely dreadful.

*** Speaking of earnings, an LA Times piece explains that dividends from earnings were a quarter of the total returns from stocks until the 1990s. They were 40% of total return in the 1960s, and 70% of the ’70s total return. The S&P dividend yield is currently only 1.1%. If this represents a quarter of the total return investors may expect from stocks – the total will only be 4.4%. This is why the smart money is moving to bonds…and utilities. Higher rates of return without the risk of owning expensive stocks.

*** Miami, Manhattan, San Diego – from the ‘Frisco bay to the Chesapeake housing costs are soaring. This from a DR reader: “I just received a rental survey from the New Hampshire Housing Finance Authority. The statewide median gross rental costs have increased from $665 per month to $697 per month. Only a five percent increase but sill much higher than the BLS says is happening. This study also showed that Merrimack County, NH rents rose a whopping 22.8%.”

“For the BLS statistics to be accurate,” continued my correspondent, “wouldn’t housing costs need to be dropping somewhere in the country? Where are the costs dropping?”

*** “It was just an election promise that had to be kept,” said one French employer interviewed by a Washington Post reporter. He was referring to France’s 35-hour work week. Widely viewed as a foolish joke in the rest of the world – the French have been forced to take it seriously. But they’ve found clever ways to live with it…and even used it to increase the flexibility of their labor rules, which are so complicated that no human being could possibly understand them without drinking a bottle of wine and eating a few slices of rancid cheese.

*** In Paris, officials of the labor ministry still try to find ways to stop people from working more than the allowable workweek – but all around them an explosion of entrepreneurialism is taking place. Young, aggressive business people work around the clock – at home, in cafes, on laptop computers. Even fugitive innovators, who fled France for the Silicon Valley or London, are returning. “In France,” said one former functionary turned Internet entrepreneur, “the ‘royal way’ is no longer civil service or big business, it’s creating companies.”

***** “It’s a city with history and charm and a large central plaza surrounded by old Spanish colonial buildings,” writes Kathie Peddicord from Granada, Nicaragua. “…the buildings are painted bright blues and greens and reds. The women walk proudly to and from the market balancing baskets on their heads, smiling, and holding hands with each other. The children ride bicycles in the main square.” – and you can still pick up a colonial mansion for $50,000… or less. We like it so much we’ve recently opened an office there…

*** “They’ve really got it together,” reports another friend, just back from the Republican National Convention. “Nothing is being left to chance.” All the lies and humbugs have been carefully worked out in advance.

*** Meanwhile, Al Gore seemed to take a big chance – choosing an orthodox Jew, and Clinton critic, for a running mate. Joe Lieberman had advocated an investigation of Al Gore’s campaign fund abuses. What will he say now?

*** Gore said he wanted “someone who can be a good partner with me in fighting for people.” Fighting for people? Against termites, potatoes, aliens? One of the monumental talents of career politicians is the ability to say things that sound nice to the mob, but have actually no meaning whatsoever.

*** Bulls v. Bears, title bout? I have noticed an interesting debate brewing in the Daily Reckoning discussion board. Among the contributors the Fleet Street Letter’s Dan Denning writes “…whenever there’s broad public participation in the stock market, whenever there is so little saving and so much borrowing – to pay for profits that don’t exist, and whenever it is so widely believed that it’s riskier to be out of the market than fully invested in it…then stocks are about as overvalued as they’re going to get.” His ideas have sparked some interesting “bull” in response…

“We will rape the horses and ride off on the women. And we will trim the hedges of very small villages.”

The Three Amigos