Herbert Hoover, R.I.P.
Fear is contagious. It smells. Animals will eat your lunch if they smell your fear. Fear has economic and political consequences. The Bush administration, says Jim Davidson, has foolishly put fear on steroids.
"History repeats itself, first as a tragedy, next as a comedy."
– George Santayana
I hope you are at least registering a few chuckles as George W. Bush does his Herbert Hoover imitation. Each time that Bush has followed in Hoover’s footsteps and tried to assure investors that shares were a bargain because the economy is "fundamentally sound," the market has sold off. The sell-off when he held forth on valuation issues on July 22nd was particularly emphatic, with the Dow plunging 234.68 points, the S&P 500 falling 27.90 and the NASDAQ giving up 36.50.
As I have hinted on previous occasions, I wish that Bush would repair his focus, not because I wish him ill, but because I wish the market well. It won’t be good for President Bush’s reputation when the straggling remnant of the once large legion of day traders conclude that every ostensibly encouraging statement Bush makes is an infallible sell signal.
And it won’t be good for America or the world if the enemies of markets gain greater political ascendancy in the United States. In other words, it would be a disaster if Bush were to stumble along any further in Herbert Hoover’s footsteps.
To see how dire a disaster could be lying in store, you need only glance at Argentina, a once rich and promising country that has been destroyed in the past year. Indeed, per capita income among Argentines has plunged by more than 70% since January of this year, a breathtaking decline. Most of the blame goes to Argentine politicians, but Bush and his ham-handed Treasury Secretary, Paul O’Neill, also deserve mention as ghostwriters of the catastrophe. The U.S. Treasury idiotically advised Argentina to abandon its currency board system, which automatically made the Argentine peso worth a dollar. This was like advising someone swaying at the top of an abyss to take the plunge. Even worse, the Bush administration didn’t just dish out the wrong advice, they gave an ally a shove over the edge into destitution.
Of course, Argentina has not featured prominently in the US headlines. While we lost Argentina, Brazil, Uruguay and probably much of the rest of South America, we did have success in the God-forsaken reaches of Afghanistan. I applaud that success of Bush policy, but as investors, you and I should both temper our applause. A drawback of the Afghan success and the whole "War on Terrorism" is that it has helped play to and reinforce the sense of fear that has gripped the American psyche.
Fear has its consequences. You can’t keep Americans constantly agitated about terrorism and have no follow- up consequences. The Bush administration has foolishly put fear on steroids. The effect has magnified far beyond the War on Terrorism. Fear is contagious. It smells. Animals will eat your lunch if they smell your fear. Fear has economic and political consequences. Fear is the emotion that sits on the teeter-totter with greed. The balance between the two of them governs investment markets. Fear has lately gotten fat on the steady diet of worry over terrorism. This has tipped over the scales and helped reduce stock valuations to bear market depths.
I suspect that Bush and his advisers believe that trying to keep public attention focused on the "War on Terrorism" helps underscore popular support for Bush, which soared with his handling of the attack on Afghanistan. But I fear that they have made a grave mistake. I suspect that the cause and effect are more complicated, and possibly counter-productive for the Republicans.
Because people in a fearful frame of mind become negative on their own prospects, and begin to behave and think like losers. The administration needs to understand, as Franklin Roosevelt shrewdly did, that "fear" is to be feared, not cultivated. When people are in a fearful mood, they behave fearfully. They are sellers. Sellers of stock. And, indeed, they tend to sell themselves short, demanding succor and support from government, a game at which the Democrats have better credentials than Republicans.
This is why I say that Bush is stumbling along in Herbert Hoover’s footsteps. By that, I mean no disrespect to George W. Bush, who is ill-advised and so preoccupied with trying to unravel Osama bin Laden’s turban that he has no time to think about the important issues facing the economy.
Nor do I intend any disrespect to the memory of Herbert Hoover, who was an intelligent and decent man who had the misfortune to be standing at the band stand the last time the music stopped. Hoover did, in fact, play a part in prolonging and deepening the Depression. But his sins, like those Bush seems to be indulging now, were of a different character than political enemies of either man would willingly admit.
Bush, like Hoover, is stumbling into disaster, not because he is an advocate of laissez faire, but because he is implicated in closing markets, intensifying regulation and increasing the scope of government – all mistakes that are being repeated to much applause in today’s headlines.
After 1929, the Hoover policy of protectionism and regulation resulted in a protracted bear market, which took a quarter of a century to recover to 1929 levels. I am convinced that part of the reason the economy and the engines of innovation sputtered so badly after 1929 was the fact that leaders compounded rather than counteracted a general failure of nerve. With fear the predominant emotion, everyone suddenly felt smaller, less competent, less responsible and incapable of self- reliance.
The demand for protection and coddling took precedence over the celebration of opportunity and enterprise in the hearts of men. Herbert Hoover, a reputed superman, who faced the oncoming Depression with a far more enlarged reputation than George W. Bush, intervened vigorously in the free market. He attempted to regulate prices and wages higher, through protectionism, government price-fixing and a massive government stimulus program, including exaggerated efforts to stabilize the "family farm." They didn’t work.
It is little remembered that Hoover vigorously expanded government during his term beginning in 1929. In fact, Hoover was so conspicuously a big spender that Franklin Roosevelt gained much political currency during the 1932 elections by proposing to trim Hoover’s bloated government spending by 25% and balance the budget. Roosevelt denounced Hoover for "the greatest spending administration in peace times in all our history." Roosevelt would soon outdo Hoover as an architect of spending, but that doesn’t change the fact that Hoover pioneered the "government stimulus" approach to reviving the economy. George W. Bush, too, has proven to be a big spender.
The Republicans seem intent on rediscovering their legacy as the "party of Hoover." The perceived problem with accountancy and executives hogging the returns from shareholders presented an opening, a missed opportunity, to address the underlying difficulties. Namely, the complexity and incomprehensibility of the U.S. tax laws, and their consequences in turning stock investment from a yield play into solely a capital gains exercise for most investors.
But President Bush and his supporters in Congress lavished their attentions elsewhere. They utterly failed to grasp the issue or to inform public perceptions as to the causes of the mismatch between the reality of corporate finances and their representation in accounting entries.
In fact, the whole sorry episode of earnings misstatements represents Exhibit Number One in evidence of the ill-effects of the monstrous U.S. Tax code, compounded by ill-conceived securities regulations. The double-taxation of dividends is directly implicated in such nonsense as the Enron compensation committee voting to dispense 75% of the company’s annual profit as bonuses for top executives.
If the shareholders had been looking for the dividends, as well as capital gains, this would never have been allowed to happen. But nobody on the Enron board had to care about retaining cash to pay dividends. Equally, if corporate accounting is screwed up, it is largely because the tax laws are unknowable and securities regulation is ill-conceived.
for The Daily Reckoning
September 3, 2002
Editor’s Note : James Davidson has enjoyed great success founding new companies in a variety of industries. He’s a graduate of Oxford University, and a renowned author and venture capitalist whose articles have appeared in publications from The Wall Street Journal to USA Today. He currently sits on the boards of over 20 thriving, technology-driven companies. Davidson’s latest research and investment picks can be found in:
Vantage Point Investment Advisory
Not more than 100 meters from the front door of the Daily Reckoning headquarters here in Paris is the beginning of the rue Quincampoix, site of the ancien Banque Royale.
The markets were closed yesterday, so if you’ll permit a slight detour through history, we can get started. It won’t take long.
Mississippi John Law was a rake. A gambler. A murderer. He was also the architect of the first system of fiat money the world had ever known. The banknotes issued by Law’s brainchild, the Banque Royale, were also the source of the first great investment bubble of modern times.
"By 1720," says Paul Strathern, author of Dr. Strangelove’s Game, "John Law was the richest man on earth. Some claim that he was the richest man in history." At the height of his scheme’s success, Law’s possessions included the French central bank, the entire Louisiana territory, which stretched from the Gulf of Mexico to the Great Lakes, from the Appalachians through the Midwest to the Rocky Mountains. His company had a monopoly on French trade with the Americas, India and the Far East.
Law, a commoner, was given the title of Duc d’Arkansas. (Don’t we know someone else who was recently knighted for their involvement with a fiat money scheme? Hmmnnn…) Law owned over a dozen grand chateaux and an entire block of streets near the Place Vendome.
But Law wasn’t the only man to become wealthy. "People from all walks of life made hitherto unimaginable fortunes," writes Strathern. "A waiter made 30 million livres, a beggar made 70 million, a shopkeeper made 127 million…a new word was even coined by the aristocracy to describe these people: they were referred to disdainfully as ‘millionaires’."
But the good times didn’t last. In fact, before long the confident Law, the man "of cool calculation and dazzling innovative ideas" would be "but a shadow of his former self," broken, discouraged and in debt to the tune of some 6.7 million livres; "reduced to an ageing trembler with a pronounced tic."
How did the great bubble collapse? First, let’s check in to see how the millionaires of our own time are faring. Eric?
Eric Fry in New York…
– The laboring US stock market took the day off yesterday. But most foreign markets were open for business…unfortunately. Global capitalism would have been better off if all the world’s markets had hung out the "Closed" sign.
– Japan’s Nikkei Index slid 1%, while most European bourses fell 1% to 2% each.
– Weighing on share prices was the news that the European manufacturing sector slowed for the second straight month. "The Reuters Purchasing Managers’ Index for the dozen countries sharing the euro fell to 50.8, from 51.6 in July," Bloomberg News reported. Meanwhile, French unemployment climbed to the highest level in 22 months. It’s look like "double-dip-itis" may be spreading from the New World to the Old World. Europe seems to be coming down with at least a mild case.
– Since the financial markets are providing nothing but bad news, we’ll turn our attention to Washington D.C. for a little comic relief.
– Yesterday, we stifled laughter at Greenspan’s assertion that he was powerless to prevent, or even to dampen, the stock market bubble without simultaneously destroying the economy. "It was far from obvious," said the Fed Chairman in a speech last Friday, "that bubbles, even if identified early, could be preempted short of the central bank inducing a substantial contraction in economic activity, the very outcome we were seeking to avoid.
– "Some have asserted," the Chairman continued skeptically, "that the Federal Reserve can deflate a stock-price bubble – rather painlessly – by boosting margin requirements."
– But he rejects this notion on the basis that margin debt "never amounted to more than about 1-3/4 percent of the market value" of the stock market. True, but that 1 3/4 % also represented the epicenter of speculation. Raising the margin requirements, therefore, would have served the dual purpose of reining in the most speculative activity in the stock market, while also sending an unambiguous message from the Fed that the stock market had become dangerously speculative, both for individual investors and for the economy at large.
– To be sure, raising margin requirements might not have succeeded in preventing a stock market bubble. But utilizing this tactic certainly would have done no harm – except to Greenspan’s cozy relationship with Wall Street. Raising margin requirements, like laser surgery, could have excised the most virulent forms of speculation, without harming the rest of our national economic organism. Why not try it? The question remains unanswered.
– "History tells us that ‘jawboning’ asset markets will be ineffective unless backed by action," Greenspan said. On this point we are in complete agreement with the Chairman. Despite occasional half-hearted jawboning about the stock market’s excesses, the Fed never backed it up with decisive action. Greenspan never raised margin requirements and the rest, as they say, is history.
– "In essence," writes Jim Puplava, "the Fed is now trying to distance itself from the bubbles that are created by its own policies. Those policies helped to create the greatest stock market bubble in the nation’s history…far worse than the last bubble created during the 1920’s. Even today after a substantial downturn in all the major indexes, the stock market prices remain far more overvalued than the peak of the stock market bubble of the 1920’s…The Fed and government are now looking for a scapegoat. Corporate fraud, uncontrolled financial markets, personal greed, manias, and malinvestments are nothing more than the visible manifestations of monetary creations by the Fed.
– "Asset bubbles are the direct creation of Fed policy," Puplava continues. "This is frightening to think about when you consider that through its latest round of rate cutting, the Fed has created another asset bubble in real estate to take the place of the one that preceded it in the stock market. By lowering interest rates to the lowest levels since the 1960’s, the Fed…has created a mortgage bubble directly related to the current bubble in real estate prices. Like the stock market bubble that preceded it, the Fed takes pride in the fact that consumer wealth has improved with rising real estate prices, and therefore the tremendous mountain of new debt taken on by households is not a problem.
– It’s ironic, isn’t it? The same Alan Greenspan who denies responsibility for the stock market bubble is busily inflating a real estate bubble…if it really is a bubble. Greenspan, we have no doubt, will tell us the answer…well after the fact.
Back in Paris…
*** So how did Law go from being the richest man in history to a quivering wreck, drooped-lipped and suffering from a nervous tic?
The source of the scheme’s success was, in fact, the root of its destruction. It was a big ‘con’ game…the banknotes printed by the Banque Royale were based on ‘future earnings’ of the Louisiana territory in the heart of the American continent.
Trouble was, no one knew what Louisiana held in store. "The territory had been discovered and claimed for France less than forty years prior in 1682," says Strathern. "Those who knew about these things in Paris were generally agreed that Louisiana was a large island off the coast of America, which either contained, or was near to the mouth of a river called the Mississippi."
As you might imagine, keeping the faithful confident was a bit of a task for Law and his crew. At one point, Law ordered all the beggars in Paris to be rounded up. He fitted them with shovels and pick axes and marched them through the streets of Paris…then all the way to La Rochelle, some 534 kilometers to the West! La Rochelle was the port from which voyagers would embark for the New World. They carried shovels and other mining paraphernalia purportedly to harvest all the gold they would find in Louisiana.
Confidence began to ebb, however, when the same harried faces began reappearing in the dark alleys from whence they were rounded up. Before long throngs of lumpeninvestoriat were trying to bring down the doors of the Banque Royale en masse, in an attempt to redeem their plunging banknotes and shares of Law’s monopoly- holding trade firm: the Mississippi Company. France was bankrupted. Law died 7 years later.
"The ‘system’ by which the financial world runs today," writes Strathern, "is based on similar foundations. But it is hedged about with a host of checks and balances designed to alleviate instability. They do not eliminate it. Instability would appear to be fundamental to any such system, and is arguably the very nature of how it works."
Addison Wiggin, The Daily Reckoning