Blue turns to gray And try as you may You just don’t feel good You just don’t feel alright…
"Blue Turns to Gray"
The Rolling Stones
The economy reminds a casual observer of Keith Richards after a concert: he is still standing, but he looks as though he might have died during a riff in ‘Sister Morphine.’
"We are at a loss for words," writes popular economist Paul Samuelson. "If nothing else, this baffling economy has defeated the vocabulary of economics."
Popular economic theory has only black and white, growth and recession, boom and bust…and a logic that has been proven dead wrong. Interest rates go up, they say, and an economy stifles; they go down and the economy grows. But in Japan, rates have been near zero for years… while the economy, off and on, sinks. American economists paid no attention. Japan was different. People eat raw fish…and make wine, yech, out of rice! No wonder they’ve got problems.
But now it is coming home. After 475 basis points of rate cuts in America, we are supposed to be in a recovery, "but it doesn’t feel like one," says Paul Samuelson.
It doesn’t feel like one, and here we offer a hypothesis as to why this may be: because it is not one. It is something else. In the rest of today’s letter, we offer Samuelson and others a few old words to help us all understand just what it is.
Monday, we suggested ‘bear market’ to describe what is happening in today’s market. Today, we offer "savings" and "debt" to explain why.
The words will be unfamiliar to modern American economists. In the last decade, Alan Greenspan, until recently the world’s favorite economist and now a Knight of the British Empire, rarely used them. Instead, his speeches were greased with the hip new lingo of the New Era. Scarcely a single discourse failed to slip in ‘structural productivity growth’ wrought by ‘technical innovation.’ Missing were the tougher words of an earlier generation of economist – ‘savings’ and ‘debt’, for example. Also missing was any warning to investors about the huge bubble the illustrious chairman had suffered to expand during his watch at the Fed…or any effort to do anything about it.
Mr. Greenspan’s carefully-chosen words and inaction won him a wide audience of admirers, friends and accomplices. Mr. and Mrs. Clinton, for example. Ken Lay. Dennis Kozlowski. The folks who run Fannie Mae… millions of negligent investors and almost everyone else who saw a chance for easy money. None was reminded that he needed to save in order to expect to improve his lot in life. Neither did the Fed chairman nag about debt levels. "Borrow as much as you want," he seemed to say. "This hot new productivity thing will make us all rich." When Mick Jagger received his knighthood, his partners were miffed. They accused him of ‘selling out.’ No such squeal was heard when Greenspan greeted the queen; it was understood that the former libertarian gold bug had sold out long ago.
But the Queen’s honors committee is slow to catch on. By the time it has noticed a rising star, the poor thing is often already burnt-out…and cold as a dead analyst. "Now, hardly a day passes," says a Reuters report, "without some newspaper carrying a column sniping that [Greenspan] did not do enough to prevent the explosion in asset prices and mismanaged its aftermath."
The French had better timing. They gave Mr. Greenspan their highest award, the Commander of the Legion of Honor, 18 months earlier. "Like great musicians, you combine outstanding technical abilities and analytical skills," said Ambassador Bujon de l’Estang, as if he were Napoleon conferring a battlefield decoration on a sergeant, "with charisma and gusto."
The French ambassador to the US seems to have discovered that Alan Greenspan once played saxophone in a jazz band. He couldn’t leave it alone:
"Like most great soloists you are also a team player. Most of all, you share with great musicians one additional attribute: an infallible ear…"
Mr. Greenspan had a good ear, no one can argue with that. He knew what tune the world still wanted to tap its toe to when he put on the "Cravate" of the Legion of Honor in January 2001 and began cutting interest rates. And he knew the words people wanted to hear, too. But that was then; this is now. And Greenspan’s latest honors are mocked. He should have been given "the Order of the Bubble" says David Hale in the Financial Times. And now as economists search for new words, we offer them old ones.
"It seems to us an exceedingly straightforward logic," writes our favorite old-school economist, not yet noticed by the Queen’s honors committee, Dr. Kurt Richebacher. "Moreover, it has historical experience on its side. Assessing the present economic situation in the United States, the key point to realize is that for years it has been exposed to the most inordinate credit excesses in history. It has been crystal-clear for a long time that it was a typical bubble economy, being defined as an economy where unusually sharp rises in asset prices fuel extraordinary borrowing and spending binges, either in businesses (Japan) or by consumers (America)."
An economy makes progress, Dr. Richebacher explains, by saving money – that is, taking resources away from consumption and using them to build better machines or new technologies or more efficient systems.
Savings require discipline, forbearance and sacrifice. They are the ‘something’ without which you don’t get but ‘nothing’. But the word was forgotten by the last generation of American economists…and replaced in the dictionary of central bankers by the word ‘credit’, which promised to do the same work at much less cost.
Central bankers could create credit out of thin air. And it was widely believed that merely manipulating the cost of this credit – by raising or lowering short term rates – was the whole secret of keeping a modern consumer economy on the road to growth.
Credit was as big a hit in the America of the 1990s as its star central banker. But that was when Greenspan was called the ‘maestro.’ Now Greenspan’s ear seems to fail him…the cool, blue jazz has turned gray…and the chattering classes are looking for new words to describe him.
More to come…
October 2, 2002
"Could Stock Markets Go Even Lower?" asks the headline story in yesterday’s afternoon edition of Le Monde.
We could answer that question for Le Monde readers. But there are some things people have to learn for themselves. You can read about bear markets all you want…but, like dying, it’s never quite the same as the real thing.
The Herald Tribune also felt the markets deserved front page space yesterday. "Grim data unnerve markets worldwide" the headline tells us. "Europe dives as ‘disastrous quarter’ ends," it continues.
"The resilience of U.S. consumers has been key to keeping the global economy afloat. Despite terrorist attacks, a collapse in stock prices and a sharp slowdown in business spending, Americans have splurged on new cars – the better to haul home bargains from the shopping mall.
"But now there are signs that consumers may no longer be able to carry the load…"
Aw…how to you like that? Just when you most need him, the hero of the great capitalist retreat of 2002…the Atlas of the world economy…shrugs! "Chain Store Sales Down," explains a Washington Post headline. Eric has more details below…
According to the dominant theory of the day, consumer spending is vital. Without it, the world as we know it comes to an end. But investors hardly seemed to notice. They bid up stocks anyway. The Dow soared. Bonds took a beating. And gold dropped $3 or so. People think bear markets always hit their big bottoms in October. Well, it’s October and a lot of investors are thinking that the big bottom they’ve been waiting for has just sashayed in front of them.
Could be. But our guess is that Mr. Bear is up to his tricks. After 6 months of steady attacks that have brought desperate investors to the edge of panic, we had a feeling he would try to pull a stunt like this. If we’re right, he’ll let stocks run up for a few days (or maybe much longer!) – long enough to convince the stockholders that buy-and-hold isn’t such a bad idea after all…and maybe Abby Cohen is not as clueless as she has seemed lately…and maybe Alan Greenspan was being modest in Jackson Hole; maybe he really does know what he’s doing.
Then, when the frets and fearfulness have been calmed – he will be back, red in tooth and claw – more vicious than ever. And readers of Le Monde will have their answer.
But first, the news from Wall Street from our man on the scene and in-the-know, Eric Fry:
Eric Fry in New York City…
– Well Bill, the bond-bubble derby ain’t over yet! Yesterday’s sell-off in the bond market chalks up a point for "Team Bond Bubble" here in New York. The score now stands: Paris office: 1, New York office: 1…The 10-year Treasury bond tumbled about three quarters of a point yesterday, erasing all of the prior day’s gains and pushing its yield back up to 3.68%. No particular news appeared to trigger the sell-off. Bonds just seemed to crumble under the weight of investor passion-by- default for fixed-income.
– The stock market, by contrast, seemed to be lighter than air. The Dow floated 346 points higher to 7938, while the Nasdaq drifted 3.55% higher to 1213.
– On Monday, Wal-Mart lowered its sales forecasts yet again. The company now expects same-store sales for the month to grow only 3% and 4%. That’s well below its prior forecast of 4% to 6% growth. Unfortunately, Wal- Mart’s sluggish sales trend typifies American retailing these days. It seems that the indefatigable consumer is…well…fatigued.
– To our collective economic chagrin, we Americans are finally observing what those of us at the Daily Reckoning had long suspected: Mr. Consumer cannot, in fact, leap tall buildings in a single bound and Mrs. Consumer cannot run faster than a speeding bullet.
– They’re both just ordinary folks with an extraordinary number of credit cards. The months-long "strength" of consumer spending is now shown to be little more than an illusion. There’s nothing "super" about their consumption at all, except the size of the debts that remain. Will their accumulated debts prove to be a sort of economic kryptonite to our economy?
– And as if towering debts aren’t problem enough, the sluggish stock market is likely to sap whatever urge to splurge remains. "If the markets continue to push share prices down," quipped one financial daily, "canceling the baby-blue Porsche 911 and the family winter Caribbean holiday will be the least of investment bankers’ worries."
– So far, the newly idle-rich investment bankers don’t seem to be doing much other than living off their severance packages. Normally, when recessionary times take hold, some of the folks who lose their jobs try their luck at hanging out a shingle and starting their own businesses. But not this time…Hmmm…Maybe the investment bankers simply lack a transferable skill.
– "For the first time in more than 50 years, entrepreneurs are failing to lead the United States out of recession," writes USA Today. "In the previous nine recessions since 1948, self-employment rose as laid-off workers started companies." USA Today points out that Bill Gates and Walt Disney both launched their great American success stories during a recession.
– Meanwhile, the manufacturing sector isn’t looking so super either. The September Chicago Purchasing Managers Index tumbled to 48.1 from 54.9 in August – the lowest reading in seven months.
– "For all intents and purposes, we’re still in a profitless, jobless recovery," writes Alan Abelson, "and the only question is how long the recovery sticks around."
– Ask a Wall Street employee when the economy might recover and the answer is likely to be, "Any day now." But take a sampling of opinion from Main Street and the response is much less hopeful. A recent poll of American CFOs by Duke University finds these manicured accountants to be much less optimistic than they were just a few months ago. According to the survey results, CFOs are less bullish on their own companies’ prospects, wary of spending and hiring and glum about their ability to raise prices.
– Another survey from ChangeWave Research indicated that IT spending in virtually all sectors is dead in the water. A brand new survey from CIO Magazine reaches a similar conclusion. Based on the magazine’s survey of chief information officers, corporate technology buyers aren’t likely to start breaking out their wallets until well into 2003, if not 2004.
– "Seemingly impervious to such findings," writes Barron’s Eric J. Savitz, "Wall Street analysts predict that S&P tech-sector earnings will grow by 42% next year, according to First Call."
– Says Doug Cliggott, who heads the U.S. research arm of Stockholm-based Brummer & Partners. "I’d put that number in the ‘ain’t no way, no how’ category." Cliggott also dismisses the consensus forecast that S&P 500 earnings will grow 18% next year as an idea that "just seems wacky."
– Make that, super wacky.
Meanwhile, back in Paris…
*** Okay, Eric, since you seem to want to make a big thing of this bond market contretemps, here’s what we think in Paris.
We think we’re in a once-in-a-lifetime bear market. But we don’t think it came out of nowhere. Nothing comes from nothing, as they sing in the Sound of Music, nothing ever could. The bear market is the product of something, and that something is too much credit, too much debt, too many dollars, too much spending and too little real investing over the last two decades.
Heavily indebted consumers…and businesses…would like nothing better than to see higher rates of inflation – which would erase their debts and drive bond prices down. But we don’t think the world works that way. People do not get what they want…or what they expect; they get what they deserve. And if they don’t, they ought to.
We reported yesterday that non-financial debt recently topped the $20 trillion level. Mortgages, credit cards, installment loans…at an average of 7% interest…it takes $1.4 trillion per year in interest payments to stay current, or about 12% of GDP! Could this be right? Is my calculator defective? Have I misplaced a decimal point?
If not, you can see the problem immediately, dear reader. The higher the debt levels reach, the harder it is to keep up with the interest payments. Eventually, the debtors can’t keep up…which is why delinquencies are at record levels and, as Moody’s reported yesterday, credit quality fell again in the last quarter for the 18th consecutive time.
This is not an inflationary situation. It is a deflationary one. Debtors have to cut back on spending…sales go down…unemployment goes up. People stop borrowing. Money slows down along with the economy. Prices fall as fewer people are buying and suppliers cut prices to make the sale. Interest rates typically sink…and bond prices rise.
This is what has happened in Japan. Economists say it won’t happen in America. But these are the same people who said the Fed would be raising rates by now, in order to head off inflation in a vigorous recovery…and who now say they lack the vocabulary to describe what is happening in this ‘baffling economy.’ So, we will keep our own counsel; we will wait and see.
*** Of course, interest is not just paid…it is also collected and used to pay the phone bill. Pity the poor folks on the receiving end. As short term rates dropped more than 400 basis points, people living off earnings from cash in money market funds have been suffering.