Heart of Gold
"Here’s a trick question," writes our U.K. correspondent, Sean Corrigan, "what is the best performing currency and the best performing asset since that last Fed decision?
"Excluding the deadbeat Turkish Lira, which managed to become slightly less worthless over the period, the answer is, would you believe…gold. The archaic metal rose 3.5% in US$ terms, making it the best ‘currency’ choice. And outside the stock markets of the smaller Asian nations – also rebounding from the depths of despair – and Mexico, gold has also been the best performing asset. It beat every major bond market index we can find, too.
"Taking into account the dollar’s extraordinary rise, gold is at a 4 1/2 year high in world terms…not bad for a ‘barbarous relic’, eh?"
Why would people want to own gold now?
In a bull market, people are as empty of questions as a group of teenagers in sex education class. They think they know it all already. And if they don’t, they are embarrassed to admit it.
As long as Enron’s stock was rising, for example, no one seemed to care about off-the-books liabilities. But now, suddenly, every sentence seems to be followed by a question mark.
If Enron could hide that much in liabilities, what is hidden away in the footnotes of other companies? Which Fortune 500 company is the next Enron?
Christopher Byron has a candidate: WorldCom. It’s "one of the biggest house of cards ever erected by the financial engineers on Wall Street." Investors have put $100 billion into the firm. It is going to write off $50 billion in "goodwill" gone bad and will "almost certainly," he says, go belly up.
"Recessions uncover what auditors miss," goes the Wall Street expression. When the kettle cools, a skin of slime appears on the surface. Then, people begin to wonder…what’s in the soup? That is the nice thing about gold. It is the same inside as out…and from one day to the next…
From Argentina comes news of a dangerous outbreak of inquisitiveness.
"Where is our money?" people ask.
"Out, out…all politicians out," chant the protestors. "We want our money…"
Argentina, as elsewhere in the civilized world, has a system of managed paper currency. But Argentina also has a history of mismanagement that few nations can match.
Still, Argentines put their money in banks like everyone else, with the understanding that they could get it back when they needed it. Imagine their disappointment when, upon turning up at the bank to claim their loot, they are told they cannot have it. By government decree, citizens of the pampas are forbidden to withdraw more than $800 of their own money per month.
Recently, the Supreme Court ruled that it is unconstitutional to restrict withdrawals in this way.
"Demonstrations began," reports the BBC, "soon after Mr. Duhalde [Argentina’s president] went on television and warned Argentines that despite the court ruling, they should not expect to see their savings soon."
They certainly will not see their savings today or tomorrow; Duhalde closed the banks.
"But why not just give the people their own money," we ask innocently.
But we were not born yesterday. At the center of modern banking system…the spot where you might expect to find a heart…lies a prevarication. It is a harmless lie most of the time; occasionally, it is a nasty one.
The banks do not have the money. Because they have borrowed short (from you) and lent long (on mortgages, Treasury bonds, and so forth). At any given time, they have only a small fraction of the money depositors have lent them.
Nor is the money the banks are supposed to have necessarily worth what it was when depositors gave it to the teller in the first place.
What follows is a brief history of Argentina’s money. Readers with not much time on their hands may skip it…for the story varies little from the usual script, except that the Argentines tend to act out their roles, as they do everything else, to excess.
In 1853, a new constitution put an end to a period described by professor Alberto Benegas Lynch, Jr., as a "situation of moral and economic prostration" in Argentina.
With brief relapses, the next 90 years were good ones for the country, "a period of enviable economic progress which brought Argentina to 8th place among the civilized nations of the world." Professor Lynch attributes this prosperity to the fact that "the first 75 years we enjoyed, almost without interruption, the advantages of the classical gold standard, a bank note being exchanged for 1.7 grams of gold." Back then, Argentina’s financial system had a heart of gold.
But in 1932, a central bank was created. At first the damage was slight, says the professor, "owing to the strict limits placed on the authority of the bank." But then, a military coup by Juan Peron in 1943 changed everything. "The Central Bank was transformed from a relatively independent body into the lackey of the government."
"Monetary reserves were sadly depleted, international trade fell to a quarter of its earlier volume, real incomes and salaries contracted sharply, indebtedness increased, agriculture and cattle raising, so basic to Argentina’s economy, were largely despoiled, many subsidized and protected industries were created as a further burden on the people, all in the midst of a terrible moral corruption."
By the ’70s, Argentina had fallen from an economic level equal to Western Europe down to that of an "underdeveloped" nation. By 1972, the year in which Professor Lynch wrote, the cost of living had risen to 360 times what it was in 1943. And the peso, which traded at 3.5 to the dollar in 1943, had fallen to 1,400 to the dollar.
But the quality of Argentina’s money had barely begun to suffer. The average inflation rate in the early ’70s had risen to 100% per year. By the early ’80s it reached 369% per year…rising to 1,382% annually in the late ’80s.
In the early ’90s, Argentina decided to protect itself from its own mismanagement by tying its peso to another currency – the U.S. dollar. This plan brought troubles of its own…and had to be abandoned a few weeks ago. Already, the peso is down 40%. Argentines know what is likely to happen next. Naturally, so does the government. That’s why they are preventing their citizens from having access to their money. If they could get at it, they would surely exchange it for something more solid…U.S. dollars or gold.
Most of the time, paper money deteriorates at an acceptably measured pace. Inflation rates of 3% or 5% cause few mass demonstrations. And most of the time, banks are able to pay off the few depositors who want their money back.
But every once in a while, things go wrong. Then, people ask questions: Is the company whose stock I own telling the whole truth? Are the earnings really what they say? What about the liabilities? Will I be able to get my money back when I want it? How much will it be worth then? What if the dollar takes a dive against the euro? What if inflation gets much worse?
Of course, it doesn’t matter until it matters. And then, it matters a lot. And then, people appreciate assets like gold, a metal which sits at number 79 in the periodic table – and never moves.
February 02, 2002 — Paris, France.
Who would have believed it? At the beginning of 1990, the Nikkei Dow was within a few points of 40,000. Friday – 12 years later – it fell to 9700.
Meanwhile, in New York, the Dow eased off to close at 9907. For the first time, the Japanese are ahead of the Americans in the dash to the bottom.
U.S. stocks are still lollygagging around near the very top of their price range – as if it were still 1999. But sooner or later, we guess, they’ll get their running shoes laced up and get into the race.
"Bankruptcy filings of major companies soar," reports the L.A. TIMES. The article tells us that 257 companies filed for bankruptcy protection last year…representing $258 billion in assets.
But consumers are becoming more and confident – the index has been rising for the last 3 months. The increase in consumer spending was clocked at 5.4%, annualized, during the last quarter.
"Never before have consumers spent with such a vengeance in the depths of recession," writes Stephen Roach. "In the 28 quarters of the past 6 recessions, real consumption growth averaged a scant 0.5%. In only two of those quarters did consumption growth come in at 3.5% or greater. And those spending bursts borrowed from the immediate future; they were both followed by declines in the subsequent quarter that averaged 1.4%. The lesson is clear: with jobs and income under pressure, paybacks are the norm in the aftermath of mid- recession consumption spurts."
The economy grew by 0.2% in the last quarter, says the Department of Labor.
But wait, "94% of that gain," writes my friend, John Mauldin, "was in ‘consumer durables,’ with 70% of that being in cars."
Besides, John continues, the GDP numbers tend to be revised downward later. "The actual numbers in a few months will show last quarter to negative," he predicts.
Many people think the recession is over. We tend to think it hasn’t quite begun yet…
Eric, what’s the news from Wall Street?
Eric Fry on Wall Street…
– So many statistics, so little insight. A torrent of economic data flowed through the business sections of national newspapers last week. Among the highlights, the unemployment rate edged down from 5.6% to 5.4% and the ISM Purchasing Managers Index rose a little.
– To generalize, the numbers were less bad than they have been in recent months. To generalize further, nearly everybody who writes or talks about stocks for a living concludes that the data proves our economy is on the mend.
– Despite the bullish interpretations, however, the stock market reacted with a yawn. The Dow slid 12 points to 9,907, while the Nasdaq fell about 1% to 1,911. For the week, the Dow managed to gain only a smidge, while the Nasdaq and S&P 500 both fell more than 1%.
– So what should we make of all this better-than-awful news that we’re hearing about the economy? Is the recession that scarcely began already over?
– Who knows, maybe we can have a massive bubble economy that does not burst, but merely deflates a little. And maybe indebted consumers and over-leveraged corporations are just the thing to lead an economic revival. And maybe foreigners will keep sending almost half a trillion dollars our way every year to compensate for the fact that we Americans prefer not to save any money. And maybe today’s cautious investors will be kicking themselves 10 years from now for not recognizing the golden opportunity afforded them in February of 2002 when stocks could be had for a mere 35 times earnings.
– Or maybe not…there is an alternative interpretation. First of all, in markets past, 35 times earnings was closer to a top than a bottom. Secondly, the nation’s leveraged consumers and corporations are far more likely to pay down debt than to boost spending. The trend may already be starting. Consumer spending fell 0.2% in December after falling 0.3% in November. Corporate capital spending also continues to plunge. Meanwhile, corporate bankruptcies soared 46% in 2001, according to the FDIC.
– The little bounce that we’re getting isn’t likely to last more than a quarter or two.
– If the TV detective Colombo were writing this column, he might say about now, "You know…I see that the recession is the shallowest on record. But something just doesn’t seem right to me. You see, my problem is that this doesn’t feel like a shallow recession…and then it hit me! Of course! It’s only shallow in "real" terms. In other words, it’s only shallow after subtracting out nonexistent inflation.
– "But do you know what happens when you look at GDP in nominal terms? (I couldn’t believe it myself) Nominal GDP suffered the steepest drop in more than 30 years."
– Nominal dollars are the ones you actually have in your pocket and in your bank account. So when nominal growth collapses, you feel it.
– Economists can comfort themselves all they want with inflation-adjusted data, but if nominal growth does not improve, consumers won’t spend. And if companies don’t start earning more honest-to-goodness nominal dollars, all the "real" growth in the world will not be enough to pull the economy out of its slump.
– A lot of folks are hanging their hopes for 2002 on the expectation that corporations will replenish their lean inventories.
– When you flush a toilet, you assume it will refill immediately…and it usually does…unless it’s broken.
– When an economy "flushes" inventory (like the auto industry has done recently) most economists assume the inventory will be replenished immediately…and it usually is…unless the economy is broken. It could be time to call the plumber; America gives very little sign of replenishing inventories.
– To the contrary, credit market trends portray a corporate American that is retrenching. If corporations were in the process of replenishing inventories, we should expect to see borrowings pick up. They aren’t. In the corporate paper (CP) market, for instance, the dramatically lower interest rates have failed to attract borrowers.
– "Despite the continuing slide of commercial paper (CP) yields, the amount of commercial paper outstanding has yet to pick up substantially," Moody’s observes. "The latest yield on prime three-month paper now hovers around 1.64%, down slightly from its 1.70% month-to-date average, and almost 400 basis points lower than its average a year ago."
– Non-financial paper outstanding collapsed almost 30% in January compared to last year, the 10th straight month for which year-to-year declines for this type of paper have topped 10 percent. Further, says Moody’s, bank loans outstanding are also falling.
– No borrowing = No spending = No growth.
Back in Paris…
*** Gold is back in the news. "Gold rush hits Japan as savers seek safe havens," reports the Financial Times. The gold share index rose 2.4% on Friday…the metal itself is at a 2-week high. And so far this year, gold shares are the top performing group. What’s up with gold? More below…
*** Editorialists are howling over the Enron losses as if someone had stepped on their toes. In their pain, they seem to have lost all sense of reason and proportion. Syndicated columnist William Pfaff: "The greed and corruption that went into the Enron affair is a bigger threat to the United States than Osama bin Laden will ever be…"
*** Elsewhere on the same page of the International Herald Tribune, Flora Lewis too sees a comparison between Osama bin Laden and Ken Lay: "There is an underlying link between the great shocks that brought down two power houses of capitalism, the World Trade Center and Enron…" she writes. "These shocks oblige an effort to think more deeply…"
*** Yet, somehow, Ms. Lewis manages to avoid any real thinking at all. Instead, she says the two events reveal "a need for an evident ethical dimension in the decisions, both private and public, that intervene in all aspects of life and add up to the texture of society."