Great Expectations

“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.

The Hangover Theory: A Dullard, a Wimp, and a Wuss

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.

“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: Perversely Seductive

“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.

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.

The Hangover Theory: The Disappearance of Ought

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.

“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. What will be tomorrow? We don’t know. But we note, ominously, that even though modern economists took the moral ‘ought’ out of their calculations, they could not take the moral hazard out of the market.

The masses, the lumpeninvestoriat, scarcely noticed – but the more economists and investors ignored the ought…the more the hazard grew.

More on moral hazard…and gold…tomorrow.

Bill Bonner
Paris, France
January 9, 2003


The world’s ‘growth engine’ is running out of gas; the end of the world is coming.

The U.S. has accounted for 60% of the world’s GDP growth in the last 5 years – most of it by way of increased consumer spending. Put credit cards in their hands and Americans will outspend anyone on the planet. As a percentage of national GDP, consumer spending has steadily risen since the ’60s, while the current account deficit and business profits fell. That’s the post-war American consumer-led economy!

The beauty of it is the financing. Americans didn’t buy more and more from other Americans…they bought from foreigners, with dollars furnished by the Fed. The foreigners were nice enough to send the money back…in exchange for stocks and bonds and other financial assets – thus closing the deficit gap.

What a marvelous system! If only it could last forever. Alas, that’s the trouble. Except for Christmas fruitcakes, nothing does.

“Profits and business investment have suffered their worst decline since the ’30s,” says an Economist article from last fall.

Is it any wonder?

Their profits are going to overseas producers. Nor were American employees getting rich. In the past 30 years, the real average annual salary rose only 10%, over the entire period, from $32,522 in 1970 to $35,864 in 1999 (in 1998 dollars).

And now comes a report that health care costs are soaring – up 8.7% last year alone. Is it any wonder businesses are reluctant to hire new employees? Is it any wonder consumers are finding it hard to continue spending money twice or three times faster than they earn it?

If it can’t go on forever, to paraphrase Herbert Stein, it won’t. Sooner or later, the consumer exhausts himself; he goes broke and can spend no more. This won’t be the first time we thought we noticed it happening…but signs of consumer exhaustion are mounting. Auto sales were off last year – despite giveaway incentives. The Christmas shopping season was a disaster. And home sales may fall 10% this coming year, says a report from Houston.

But along comes the Bush administration with a $600 billion plan of fiscal stimulus. That ought to be enough fuel to keep the world economy running, right?

“[It] sounds like a lot of money,” says an article in the International Herald Tribune, “but in a world economy that generates more than $40 trillion in output each year, it is little more than a drop in the bucket.”

Everything comes to an end sooner or later, even the world as we have known it. More below…


Eric Fry in New York…

– The stock market’s stellar start in 2003 is looking a lot less celestial. After bursting from the ashes of 2002 like a supernova, stocks “flamed out” once again yesterday. 145 Dow points went up in smoke, as did 30 Nasdaq points…And just like that, the stock market looks like the same old black hole for capital that it has been for the last three years.

– Meanwhile, gold continues to dazzle and amaze. Gold for February delivery soared $6.60 yesterday to $354.30 an ounce – the yellow metal’s highest level in nearly six years. The message from the gold market would appear to be unequivocal: Beware inflation! Alan Greenspan’s Fed has failed to revive the economy. But it has succeeded very nicely in reviving inflation, or at least the traces of it. The inflationary antibodies coursing through our economy (and the global economy) are becoming more numerous by the day…

– After three straight losing years in the stock market, investors may be a tad less confident than they used to be about stocks-at-any-price. But their faith in stocks- for-the-long-haul remains unshaken. Ironically, stocks- for-the-long-haul isn’t all it’s cracked up to be.

– “The five-year average annual return for the S&P 500 through 2002 was negative 0.6%,” Barron’s points out, “versus an 8.55% gain for 10-year Treasuries. For the past 10 years it’s a close race, with stocks at 9.34% to bonds’ 8.36%. And for 30 years, it’s even closer, at 10.68% for stocks to 10.11% for government bonds.”

– Kinda funny isn’t it? Over the past five years, boring old bonds have trounced stocks, especially those super- exciting tech stocks. And over the past 30 years, a couch-potato investor who sat around watching TV and “clipping coupons” from Governments would have earned nearly as much money as an investor who battled for a buck in the stock market trenches day after day.

– And yet, Wall Street still preaches the gospel of stocks-for-the-long-haul. The gospel is partly true: if you pay rich prices for stocks, it can be a very long haul before you make any money at all. Historically speaking, stocks have been a sensational investment only when purchased on the cheap. But they have been a lousy investment when purchased dearly. It may seem obvious that “buying high” is less successful then “buying low.” But this truism is one that most of Wall Street quite obviously ignores.

– In fact, they’re ignoring it right now. Despite the blatant and pervasive after-effects of the 1990s bubble economy, and despite the still-high valuations prevailing in the U.S. stock market, bullishness reigns.

– Unfortunately, says Doug Cliggott, a bullish disposition toward stocks will be as expensive in 2003 as it was in 2002. Cliggott made a big splash last year as the lone strategist from a major Wall Street firm to predict that that stocks would fall in 2002. While still employed by JP Morgan, Cliggott predicted the S&P 500 would ring out 2002 at 950, or 17% below its level at the close of 2001. Looking ahead to 2003, Cliggott remains an unrepentant bear. “I can’t come up with a reason why a high market multiple is warranted,” he says matter-of- factly…Nor can we.

– Most investors have discovered over the last three years that richly priced stocks – like a herd of pigs spilling out of an airborne C-130 – have a hard time staying airborne.

– It’s true that expensive stocks sometimes soar higher on temporary flights of fancy. But like their cloven counterparts, they are no less certain to cascade earthward – eventually – and hit the ground with a hideous thud. When flights of fancy fail to levitate the U.S. stock market, and U.S. stocks do finally splatter on the hard ground of a bear market bottom, it will be time to start buying with both hands. But we aren’t there yet, as Jim Grant artfully explains.

– “The place to find a safe and remunerative investment is usually where others aren’t looking for it,” says Grant. “What appears safe is often risk-fraught, e.g., the crowd-pleasing U.S. stock market at the March 2000 peak…On the other hand, what appears risk-fraught often turns out to be safe and remunerative. Paradoxically, a washed-out stock market is one of the safest havens in all the kingdom of money, though the sight of it will curdle milk. At the bottom (which, we think, we have not yet seen), recriminating bulls will be prepared to believe that common stocks do not excel in either the short run or the middle run. Concerning the long run, they will not want to hear about that any more.”

– Keep an ear to the ground and listen for the “thud” that signals value.


Back in Paris…

*** Tech stocks have been crushed. Is this the time to buy them? The moms and pops in the lumpeninvestoriat may think so, but what are the insiders doing? “In the past six months, in [the top 10 tech companies],” reports Alan Abelson in Barron’s, “there were 137 sellers against three – that’s right, three – buyers. All told, the buyers purchased 92,000 shares, while the sellers unloaded 47.6 million shares.”

Any resemblance between today’s buyers and real capitalists, we keep pointing out, is a case of fraudulent impersonation.

*** “Three out of four Frenchmen oppose war in Iraq,” says the headline in today’s Figaro. The poor frogs just don’t get it. But what do you expect?

“Why do Americans want to attack Iraq?” our friend Michel asked at lunch yesterday. “Why not attack North Korea or Zimbabwe?”

“I guess they don’t like Saddam,” your editor replied.

“Why not? What has Saddam ever done to people in Minnesota or Arizona?”

“Beats me. I never even met Saddam.”

“Sounds to me like the lumpen voters are just as benighted as your lumpen investors – none of them seem to have any idea of what he is doing,” Michel concluded.

The Daily Reckoning