Great Expectations

Making room for ‘Ought’ – and debunking the perfection of mass markets along the way – Bill Bonner follows the trail of the gold market. This DR Classique was originally broadcast on January 9, 2003, and served as the inspiration for Chapter 9 of Financial Reckoning Day, a NY Times Business Bestseller.

"Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold." — Leo Tolstoy

We wander. And we wonder. Whither gold, we ask? We have already given you our conclusion. We don’t know if gold will go up or not, but it ought to do so.

Today, we take another look at ‘ought’ – and hope to discover more of life’s secrets.

If ‘Ought’ were a person, it would not be a bartender or a good-hearted whore. Ought is not the kind of word you would want to hang out with on a Saturday night…or relax with at home – for it would always be reminding you to take out the trash or fix the garage door.

If it were a Latin noun, Ought would be feminine, but more like a wife than a mistress. For Ought is judgmental…a nag, a scold. Even the sound of it is sharp…it comes up from the throat like a dagger and heads right for soft tissue, remembering the location of weak spots and raw nerves for many years.

Ought is neither a good-time girl nor boom-time companion, but more like the I-told-you-so who hands you aspirin on Sunday morning…tells you what a fool you were…and warns you what will happen if you keep it up. "You get what you deserve," she reminds you.

Modern Economists: Not What They Ought, What They Want

A man who lets himself be bossed around by Ought is no man at all, in our opinion. He is a dullard, a wimp, and a wuss…a logical, rational, reasonable lump. Thankfully, most men, most of the time, will not readily submit. Instead, they do not what they ought to do, but what they want to do. Stirred up by mob sentiments or private desires, they make fools of themselves regularly. Besides, they can’t help themselves.

Of course, Ms. Ought is right; they get what they deserve. But sometimes it is worth it.

Modern economists no longer believe in ‘ought’. They don’t appreciate her moral tone and try to ignore her. To them, the economy is a giant machine with no soul, no heart…no right and no wrong. It is just a matter of mastering the knobs and levers.

The nature of the economists’ trade has changed completely in the last 200 years. Had he handed out business cards, Adam Smith’s would have borne the professional inscription: Moral Philosopher, not Economist. Smith saw God’s ‘invisible hand’ in the workings of the marketplace. Trying to understand how it worked, he looked for the ‘Oughts’ everywhere. Everywhere and always people get what they deserve, Smith might have said. And if not…they ought to!

Today, the ‘Ought to’ school of economics has few students and fewer teachers. Only here at the Daily Reckoning is the flame still alive, flickering. Most economists consider it only one step removed from sorcery.

Modern Economists: The Hangover Theory

"Call it the overinvestment theory of recessions of ‘liquidationism,’ or just call it the ‘hangover theory,’" Paul Krugman begins his critique of the ‘Ought to’ school. "It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion…

"The hangover theory is perversely seductive – not because it offers and easy way out, but because it doesn’t," he continues in his December 1998 attack. "It turns the wiggles on our charts into a morality play, a tale of hubris and downfall…

"Powerful as these seductions may be, they must be resisted, for the hangover theory is disastrously wrongheaded…" he concludes.

In Krugman’s mechanistic world, there is no room for Ought. If the monetary grease monkeys of the Great Depression of the ’30s or of Japan of the ’90s failed to get their machines working, it was not because there are any invisible hands at work or any nagging moral principles to be reckoned with…but because they failed to turn the right screws!

It is completely incomprehensible to him that there may be no screws left to turn…or that the mechanics might inevitably turn the wrong screws as they play out their roles in the morality spectacle.

Krugman is hardly alone. As the 20th century developed, mass democracy and mass markets gradually took the Ought out of both politics and markets. In the 19th century, a man would go bust and his friends and relatives would look upon it as a personal, moral failing. They would presume that he did something he oughtn’t have. He gambled. He drank. He spent. He must have done something.

Modern Economists: No Personal Failings

But as economies collectivized, the risk of failure was removed from the individual and spread among the group. If a man went broke in the ’30s, it wasn’t his fault; he could blame the Crash and Depression. If people were poor, it wasn’t their fault; it was society’s fault for it had failed to provide jobs. If investors lost money, that too was no longer their own faults…but the fault of the Fed…or the government. If consumers spent too much money…whose fault was it? The Fed had set rates too low…or something.

In every case, the masses recognized no personal failing. Instead, the failure was collective and technical…the mechanics had failed to turn the right screws. Ought had disappeared.

In politics, the masses recognized no higher authority than the will of the sacred majority. No matter what lame or abominable thing they decided to do, how could it be ‘wrong’?

Likewise, in markets, economists won a Nobel Prize for pointing out that mass markets could never be wrong. The Perfect Market Hypothesis demonstrated that the judgment of millions of investors and spenders must always be correct.

The whole method of modern economics shifted from exploring what a man ought to do…to statistical analysis. "There is more than a germ of truth in the suggestion that, in a society where statisticians thrive, liberty and individuality are likely to be emasculated," wrote M.J. Moroney in his ‘Fact From Figures’ book.

Modern Economists: State Arithmetic

"Historically," Moroney explains, "statistics is no more than ‘State Arithmetic,’ a system by which differences between individuals are eliminated by the taking of an average. It has been used – indeed, still is used – to enable rulers to know just how far they may safely go in picking the pockets of their subjects."

Economists attached sensors to various parts of the great machine as if they were running diagnostics on an auto engine. Depending upon the information, they twisted up interest rates…or suggested opening up the throttle to let in more new money.

Of course, it was absurd. Had not the perfect market already set rates exactly where they needed to be?

The day before yesterday, the gold market judged a price for an ounce of the metal at $347. Yesterday, the masses set the price $7 higher [and today – eleven months later – the price stands at $408]. What will it be tomorrow? We don’t know. But we note, ominously, that even though modern economists take the moral ‘ought’ out of their calculations, they cannot take the moral hazard out of the market.

The masses, the lumpeninvestoriat, scarcely notice – but the more economists and investors ignore the ought…the more the hazard grows.

Bill Bonner

Decemeber 09, 2003

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the NY Times and international best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

You do not make money when thing are as they ought to be. You make money when things are as they ought not to be. Properly priced stocks, for example, are no more enticing than a woman of sure virtue. It’s the mispriced stock and the uncertain woman that offers hope of a really good time. And with certain women, and certain stocks, at certain times…you practically can’t miss.

As longtime Daily Reckoning sufferers know, we are connoisseurs of madness and gourmets of absurdity. When stocks are absurdly priced, it is a reasonable bet that they will be less absurd sometime in the future. And when the world goes mad…it is almost certain that it will come to its senses, sooner or later.

The trouble is, prices can get even more absurd…and the world can get even madder…and stay that way longer…than you can imagine.

Surely it is mad for Americans to think that they can grow rich by spending money. But that is what most believe, and a delusion the Feds encourage.

And surely it is mad for the Chinese to think they can build their economy by selling things to people who can’t pay for them. But that is what the Chinese seem to think.

And American economists now believe they have made a decision to almost write off their hundreds of billions worth of U.S. dollar assets. Don’t worry, they say; the Chinese have no choice but to continue lending to Americans – it is the only way they can keep their economy growing. After all, they are building factories…they are learning trades…they are producing things – is not that the only measure of wealth?

Alas, just as Americans can only make believe they are rich…by spending money they don’t have…the Chinese can only make believe they are growing their economy. Yes, factories go up everywhere…but they are destined to meet a demand that doesn’t really exist.

But both the Chinese and the Americans still believe…they still have faith in the future. Things always get better, don’t they? "The Nasdaq-crash from three years ago never really caused investors to turn bearish," explains a letter from Steve Puetz. "Before the crash, investors believed that stocks always go up in the long-run. And when Internet and technology stocks collapsed, and non-technology stocks suffered a milder bear market, investors simply viewed the sell-off as another buying opportunity.

"During the bear market, many investors were simply holding back and waiting for a sign that the bottom was in place. So when the stock market began moving higher last spring, many hesitant investors began jumping on the bull market bandwagon. As the market continued moving higher, it converted more and more fence-sitters. During the past few months, virtually any remaining skepticism has disappeared, and a consensus formed that a new bull market has begun, and the economy is on its way to a normal cyclical recovery. [Ain’t that the truth…we just cordially parted ways with our publicist for Financial Reckoning Day, and she is returning a portion of her retainer because no media – neither print, radio, nor TV – want to hear our "reckoning day" message.]

"Never in history has a market bubble:

* endured for such a long period of time, and

*consumed tens of trillions of dollars of debt,

* while credit quality sank so low.

"For nearly twenty years, the Federal Reserve has been fighting recession at the slightest hint of a downturn. The reason the Fed has been quick to fight recession is because the U.S. financial system is too weak to handle a serious economic downturn. Before 1982, the Federal Reserve frequently engineered recessions to cool off the economy. But no more.

"While most people may think that monetary stimulus by a central bank is a good thing, there is a huge downside to this type of activity. By halting recessions prematurely, inefficient and over-leveraged businesses are allowed to stay in business. By allowing over-leveraged operators to stay in business, and then flooding the economy with even more credit, the average credit quality within the economy sinks to ever-lower levels.

"In an attempt to avert a serious recession, the Federal Reserve embarked upon a super-easy monetary policy during the past two years. As a sign of its resolve, the Fed pushed short-term interest rates all the way down to the 1% area. That’s the lowest that short-term rates have been in over fifty years. In the past, 1% interest rates have only been seen during the depths of depression.

"Certainly, the United States economy has never seen near- record low interest rates at a time when retail sales and housing construction where near all-time highs! This unusual combination has only come about because of repeated efforts to halt recessions time-after-time over a twenty- year period."

This absurdity will come to an end someday, Mr. Puetz assures us.

When? When the Chinese and other creditors come to their senses and stop lending. That is already happening. Every day, America must borrow another $1.5 billion in order to maintain her current levels of spending…or the dollar will fall.

Well, the dollar is falling. Yesterday, it hit yet another new all-time low against the euro…and an 11-year low against the British pound. Europeans invested a net of about $28 billion a month in U.S. dollar assets, during the first 8 months of the year. But in September the number went negative – by $400 million. The end must be coming…

Here’s Eric with more news:

Eric Fry in New York…

– Due to the unseasonably heavy snowstorm in New York last weekend, your North American correspondent found himself temporarily snowbound. So he did what he had to do…He girded himself for the harsh elements, grabbed his trustiest snow shovel and trudged out into the swirling snowstorm. After 30 minutes of shoveling, he had cleared a nice path from the house to the hot tub. His back was now aching…But isn’t that what a hot tub is for?

– Later that day, your editor soaked his aching back in the hot tub, while the snowflakes drifted down from the heavens like so many discarded dollar bills…The beleaguered buck can’t seem to "catch a bid," as the traders say. No one buys dollars anymore, except foreign tourists and central banks. Yesterday, the greenback tumbled for the fourth day in five, hitting another record low against the euro of $1.222.

– But the stock market enjoyed itself yesterday, despite the dollar’s misery. The Dow advanced 103 points to 9,965, a mere 35 points away from 10,000, while the Nasdaq added half a percent to 1,949.

– So swiftly is the dollar declining that few investors dare to sell gold. Even though many stock market technicians say that gold is "overbought," who dares to sell the precious metal when the dollar is so overwrought? Yesterday, gold slipped a couple of dollars during the morning, but then recouped its losses to gain 20 cents on the day to $407.50 an ounce.

– In the gold market, "buy-the-dips" has replaced "sell the blips." Every time the metal falls a few dollars, eager buyers start showing up. The gold market has not known such steady, bullish buying for a long, long time. Ever since the gold price topped out above $800 an ounce 23 years ago, the gold market has doled out far more agony than ecstasy. But the new millennium has been very kind to gold investors…and to investors in almost all other commodities. The steady drop of the U.S. dollar and the steady rise of our national indebtedness has rekindled a keen interest in the ancient monetary metal.

– But while gold is grabbing the headlines, base metals are grabbing the biggest profits. The gold price has jumped a hefty 40% over the last two years, but the nickel price has nearly tripled and has reached its highest level since May 1989. If we didn’t know any better, we’d say that a new inflationary trend is underway. Alan Greenspan, Ben Bernanke and the other fellas at the FOMC promised us they’d do whatever it took to combat deflation…and so it has come to pass. Deflation is vanquished…and the U.S. dollar is in the M.A.S.H. unit, an incidental victim of friendly fire.

– "The Federal Reserve is planting the seeds for future inflation," says Steve Forbes of Forbes magazine. "The symptoms of an oncoming inflation are abundantly clear. Commodity prices have soared. The best barometer of monetary disturbance, gold, is now reaching $400 an ounce, the highest level since 1996…Greenspan & Co. have ample opportunity in the weeks ahead to reverse course and get our monetary ship on an even keel. The longer the central bank waits, though, the messier and more costly the cleanup will be…Other countries are not ignoring the incipient storm clouds. The Australians recently raised interest rates. So did the Brits."

– Helping to fuel our new inflation is a very old national tendency: buying things we don’t need with money we don’t have. At the Federal level, the Bush Administration is throwing money around like Democrats in Republican clothing. "President Bush and the Republican-led Congress are spending money at a rate not seen since World War II," the Christian Science Monitor reports. "The lasting fiscal legacy of the Bush administration will include a historic rise in domestic spending that could affect everything from consumer interest rates to a fiscal landscape that could force epic tax increases in future.

– "Much of the $2.2 trillion that Washington is expected to spend in fiscal year 2004 is for mandatory spending on Social Security and Medicare," the Monitor continues. "But so-called discretionary spending has also increased some 22 percent during the Bush presidency, from $734 billion in 2002 to $873 billion in 2004."

– President Bush is not the only American to borrow money he can’t repay in order to buy things no one needs…or wants. Almost every month, American households set new records for indebtedness. And yet, most folks think the economy is booming. What’s wrong with this picture?

– "Particularly worrisome," says Morgan Stanley’s Stephen Roach, "are the ever-mounting imbalances of a U.S.-centric world. Nowhere are they more evident than in our forecast of America’s gaping current-account deficit, a shortfall that we estimate will rise to an astonishing 5.8% of GDP in 2005. Not only is that a record for the U.S., but in dollar terms – $710 billion – it is a record for the world, requiring foreign investors to provide America with nearly $3 billion of capital inflows every business day by 2005. America’s current-account deficit is a by-product of what I view as two of the world economy’s most unsustainable trends – a saving-short, overly indebted U.S. that is living well beyond its means, and the inability or unwillingness of the rest of the world to stimulate domestic demand."

– The gold bull market may take a breather, but we have a hunch it isn’t over yet.

Bill Bonner back in Baltimore…

*** Ivanhoe Energy is in the news. It’s the little mining company that has investors so excited. It is said to have a huge deposit of copper and gold – in Mongolia. So Bob Friedland, chief promoter, has spun the company as a China Play! In May, you could have bought a share of the company for 50 cents. Now, it will cost you $4.35…or 75 times revenues. Note to insiders: don’t forget to sell.

*** The U.S. has a national savings rate of 0.6%. Any increases in spending – whether for the war in Iraq, Medicare, or bribe money – has to come from foreigners. The Europeans have caught on to the scam and are not sending the U.S. any more money. Only the Asians are left…especially the Chinese. Who would have guessed that America would one day depend on communists to pay for its wars and its drugs? Thank God for the Chinese…Thank God they’re so thickheaded.

*** "The greatest story of the last 25 years has been the political revival and economic development of China," writes our friend William Rees-Mogg in the latest issue of Strategic Investment. "It is a story of which the West is still only vaguely aware. Yet China over the next 25 years will change the whole world economy and dominate the eastern half of the continent of Asia. This development will be so huge that no global investment decisions can be made without taking it into account.

"The U.S. balance of trade? A question of China. The price of oil? A question of China. The European automobile industry? A question of China. General Motors? A question of China. The U.S. budget deficit? A question of China. The market for Microsoft? A question of China. The price of gold? A question of China.

"We have been living in a restricted global world, inside the confines of the advanced industrial economies. If one could calculate the interaction of the American, European, and Japanese economies, one could pretty well identify the trends of the future. Now one has to take the Chinese factor into all one’s forecasts. It is the new variable in every equation; it is already the one that changes most rapidly, and it will soon become the biggest."

*** The Bank of International Settlements say OPEC is moving its money out of dollars. Perhaps you should, too. [We’re putting the finishing touches on a "Special Reckoning" report designed to show you how to protect your assets should the declining dollar become an all-out rout. The report – "Bonfire Of The Currencies: 7 Ways To Sell The Dollar" – will be available in a few days.]

*** It is a beautiful morning here in Baltimore. Cold weather has driven the bums out of the park…and snow has covered their beer cans and needles.

*** Your editor felt as though he should move his family back to America as soon as possible; he is in danger of becoming a euro-snob. Leaving the Air France flight in Boston, he made his way through the snow to a different terminal. There he encountered a scene entirely unlike the one he had left at Charles de Gaulle airport. Instead of the polite, coldly well-mannered, attractive agents at Air France, he found himself confronted by people who might otherwise be flipping burgers…or doing smash-and-grab from parked cars.

"Relax…" advised the agent. "The flight is an hour or an hour and a half late. The weather has slowed up the entire system on the East Coast. So get comfortable…"