Imperial Over-Stretch Marks (cont'd)

"America remains the unrivaled leader of the world – the big power…without which nothing good happens."

Thomas L. Friedman,

America is the "single surviving model of human progress," said George Bush the younger, to the West Point graduating class, perhaps exaggerating just a little. He might have conceded, if he’d thought about it, that there are elements to the American model that might not yet have attained perfection.

The American model of human progress, it turns out, depends heavily on the kindness (or naivete) of strangers: America prints money; foreigners make products. The foreigners send their products to the U.S.; Americans send their dollars abroad.

Alert readers will notice the defect immediately… for what would happen if foreigners changed their minds? Then who will pay so that Americans can continue living beyond their means? And who will finance the U.S. budget deficit, expected to rise about $400 billion thanks to increased military spending?

The system survives as long as foreigners are willing to accept U.S. paper assets for more tangible ones. We don’t know how long that will be, but we note that the value of paper tends to vary inversely with the amount of it available. No Fed chief provided so much American paper as Alan Greenspan. In fact, as reported here on several occasions (we keep mentioning it because we can barely believe it) Greenspan has increased the world’s supply of dollars more than all the Fed chairmen and all the Treasury secretaries in U.S. history.

Still, the foreigners schlep and sweat and gratefully take surplus dollars in payment – about $1.5 billion per day. Typically, when a nation’s trade deficit rises to 5% of GDP, something has to give. What usually gives is the nation’s currency; it goes down, making imports more expensive and exports more attractive. So far, this has not happened, we are told, because the dollar is no ordinary currency – but an imperial currency, the leading brand of the world’s only remaining super, superpower. How that protects it from the age-old cycles of over-stretch and regret, we don’t know. More likely, the dollar will eventually do what all over-stretched currencies do, imperial or otherwise; it will snap.

"I see one possible way out," writes Stephen Roach, " a sharp depreciation of the US dollar…a significant depreciation of the dollar – at least 15% to 20% on trade-weighted basis, in my view, would go a long way in cracking the mold of US-centric global growth…"

"Oh no, I guess this means Mr. Bush will begin his war soon," said a neighbor this weekend. She was a woman of about 70, in a hunting get-up, with knee socks and a big brown sweater. Her low voice, mannish hair and bright red face was slightly comical. But she was also carrying a 44 caliber pistol and waving it around the room. "But, heck, what’s life without wars," she roared. "Every so often, maybe we need a war. I just hope the price of gas doesn’t go up."

What set off my neighbor was the news that Congress has given the go-ahead, not by declaring war as required by the constitution, but by passing the buck to the president; Bush is free to attack America’s enemy du jour – Iraq. How Iraq achieved this honor is anybody’s guess. But enemies come and go… along with models of human progress.

In the 40s, Germany and Japan were our enemies and the Soviet Union was our friend. Then, the roles reversed for the ’50s and ’60s. And then, in the ’70s, Iraq was our friend and Iran was an enemy. And, of course, Cuba, North Vietnam and North Korea… were our enemies at various times.

But who knows? Maybe a change of government will do as much good for Iraq in 2002 as it did for England in 1066. Today, we write not to criticize the president’s war plans… nor Congress’s pusillanimous dereliction – it may all work out for the better, for all we know. Instead, we merely wallow in the absurdity of it all.

The durability of Christianity, we thought to ourselves during this Sunday’s sermon, comes not just from the enormous promise that it makes, but also from its adaptability. Christians believe that if they can just get God on their side, everything will work out. Even dying is nothing to worry about; "Even unto the grave, Halleluia" we chant, with faith that death leads to a better life without mortgages or election campaigns. And in the meantime, people are free to do almost any lunatic thing they want.

Jean Mayol de Lupe was an army chaplain in the French army in WWII. He was wounded, held prisoner by the Germans and eventually decorated with the same award later given to Alan Greenspan – the Legion of Honor. Greenspan, a cynic might say, got his "cravat" for proving that you could inflate the currency and get away with it… Mayol de Lupe proved that you don’t have to be an analyst or a politician to be a fool.

The 1930s were a great time to be a fool…there was a bull market in foolishness such as the world had never seen. It seemed as though nearly half the world was keeping company with socialism, communism or fascism. Mayol de Lupe was convinced that bolshevism was a great threat to Catholicism… and that the only thing that might save it was Hitler’s national socialism. After France had surrendered, he organized a voluntary corps of French soldiers to go to help the Germans in their war against the Soviet Union. Already 66 years old, he nevertheless went to the Eastern front himself along with his troops. The priest wore a SS Waffen uniform, ended his sermons "in the name of our Holy Father Pious 12th and our Fuhrer Adolf Hitler," and described the French volunteers’ work… "what a beautiful mystery, a wonderful tale, that our boys write with the points of their bayonettes."

In Mayol de Lupe’s eyes, the Soviet Union was the Iraq of the hour… and Nazi Germany the world’s superpower. Many in Europe – including many in France and England – felt that the dynamic new Germany represented the force of the future, that it was "the only surviving model of human progress."

And so the poor old coot stretched on the Nazi uniform and went to war.

Your editor…

Bill Bonner
October 14, 2002

P.S. After the war, Jean Mayol de Lupe was arrested and jailed for notorious collaboration.

Something’s gotta give, we recall writing last week… Either panic…or a serious rally. Stocks can’t keep going down week after week, month after month without something happening. Investor’s Business Daily says its gauge of mutual funds is down 34% so far this year.

How long can investors continue this orderly retreat, we’d like to know?

Early last week, investors seemed to be on the edge of panic. Here at the Daily Reckoning, we were looking forward to it. Because a good panic is what this market needs; something that will drive stock prices down from absurdly expensive to absurdly cheap – and get this bear market over with.

But by Friday, investors seem to have recovered their insanity. The Dow rose 310 points, with GE up 7% and IBM plus 11%.

Hey…and nice volume!

Could there be an important rally forming? Could the Dow bounce to 8,000 or even 9,000? Could Mr. Bear be up to one of his sly tricks? Could the poor lumpeninvestoriat be lured into even graver error – adding to its holding of stocks just before Mr. Bear returns to his work?

Need we give you the answer, dear reader?

Let’s hear from Eric, who is closer to the asylum. Maybe he can provide some more insight:


Eric Fry, writing from New York…

– After three straight years of falling share prices, more than a few long-time bears are wondering if it might be time to adopt a more upbeat and wholesome view of the stock market. They’re wondering if they might not be pressing their luck by remaining too bearish for too long. Of course, we don’t know anyone like this, but we’ve heard about them…

– Then too, there’s the irresistible temptation to try to "call the bottom" so soon after having correctly "called the top."

– Recently, the long-time bears over at contemplated this "contrarian dilemma." Has the time come to toss off the leaden mantle of bearishness and cavort with the bulls? Herewith, a few of their thoughts on the matter (Hint: They’re still bearish):

"Contrarian thinking and investment decision making is an art. An acquired feel for the rhythms and circumstances of any current market environment set against the context of personal prior period experience. We remain firm believers that questioning and ultimately positioning against the extremes of crowd behavior remains a valid investment discipline.

"We’ve come a long way in this bear toward destroying many a cherished belief regarding common equity that took years to instill in the broader investment community during the prior bull market run. Anecdotes surround us that pessimism and negativity have moved ever nearer to centrist thinking than not over the recent past…Folks like Bob Prechter are being allowed airtime on CNBC to seriously espouse views of impending economic depression. During the final bull blow off some years back, Prechter would have only been granted precious minutes on CNBC to be ridiculed as a clown."

– Even so, ContraryInvestor counters, "As much as we would like to lean against the increasingly icy winds blowing at the corner of Wall and Broad, we must respect the fact that the pocketbooks of Main Street drove the prior mania and it is only very recently that those pocketbooks have begun to close.

"Over the last four months, we are looking at close to $90 billion having been redeemed in the domestic equity fund complex…[and still] current household ownership of equities relative to total household financial assets is simply miles away from what would rationally be considered levels of disenchantment or disgust."

– Net-net, ContraryInvestor remains bearish. "We’re just not convinced that we have witnessed extremes in public behavior as of yet, despite what ‘feels’ like price extremes in certain segments of the equity markets."

– But that doesn’t mean we have to wake up each and every day with a bearish disposition. Apogee Research’s Andrew Kashdan, for example, predicted last Friday morning that there would be an imminent "reprieve from the carnage." Kashdan based his market-timing call on the extreme readings of the VIX Index – a.k.a., the Fear Gauge.

– "The VIX," as Kashdan explains, "measures the implied volatility on S&P 100 options. The idea is that extreme levels indicate panic and often signal an impending reversal. But during the past year rallies followed peaks like those the VIX is touching now. It has, in fact, surpassed its post-9/11 high, and is just short of its July peak.

– "Perhaps Thursday’s [and Friday’s!] rally will be another one-day wonder," Kashdan allows, "but it could be the start of something bigger…Barton Biggs of Morgan Stanley says that what we are seeing is ‘the mirror image of the boundless optimism of three years ago. There is an epidemic of fear and pessimism.’" However, Kashdan doubts that this "epidemic" is sufficient to produce an absolute bottom. "Enjoy it while it lasts," he advises.

See: Apogee Research


Back in Paris…

*** "For every borrower who gets a boost in purchasing power, [from lower interest rates], there is a lender who loses." Nobel prize-winning economist Franco Modigliani explained to Stephen Roach why lower interest rates do not automatically increase consumer spending. In fact, consumers are generally net lenders, not net borrowers. Even in 2001, households received $1.091 trillion in interest and paid only $592 billion.

*** "The consumer is the most dangerous portion of the picture," Modigliani continued. The Seattle Times elaborated: personal bankruptcies in Washington State have increased 20% in the last year. Home foreclosures have nearly doubled in the last two years.

The average credit card debt is $8,562, compared to only $2,985 in 1990. In the early ’90s, 16% of disposable income went to debt coverage; now the figure is 22%.

The Seattle paper, following the current fashion of the trade, brings us the sad tales of people who lost their jobs, lost their homes, their cars, and even their spouses. We fear that such carelessness may become even more common, as the Great Deflation continues. (We were surprised to find the story of a friend of ours… a Daily Reckoning reader, who ran up $250,000 worth of debt on 26 credit cards. His was not consumer debt, however; he was borrowing on credit cards to launch a business.)

Consumers spent less in September than they had the month before; retail sales were down 1.2%.

*** Gold was down slightly on Friday. My friend Doug Casey explains why gold stocks might be the next Big Thing:

"There are now scores of millions of people out there who’ve had their appetites whetted for "hot", volatile sectors of the market. They’ve lost a lot of money in the last couple of years, but they’re still players. Most tend to be trend followers who are anxious to jump on board any sector that’s moving, especially if its got a credible story to go with it. Gold stocks are made to order for these folks. You saw what they did to the Internet stocks, and they’ll do it here. Better yet, as hard as promoters will try to meet the demand by forming new companies and printing up new share certificates, I don’t think they’ll be able to meet the demand. People in the gold stock finance business just aren’t used to thinking that big…"

*** And finally, today is the anniversary of the Battle of Hastings in 1066. William the Bastard, Duke of Normandy, arrived in England with an army of 4,000, one-tenth the force of today’s NYPD. He confronted Harold, King of England, not far from the coast, on a small hillock.

According to eyewitness accounts, the Normans attacked. As they approached, the housecarls stepped out of the English line; there, free to move about, they whirled their maces and heavy swords while the bowmen behind them let fly their arrows. The Normans recoiled.

But then, Harold received an arrow in his eye. And the English, seeing the Normans withdraw, made a serious mistake. They left their positions and gave chase, whereupon the Norman cavalry turned upon them…and soon had them in pieces. It is very hard for horsemen to break up well-disciplined men in formation. But, when they are dispersed in open country, they are more easily dispatched. And when they turn their backs and run, they are defenseless. Captured, Harold was drawn and quartered.

What happened after the battle was even more remarkable; even with such a tiny band, William met with almost no resistance and was able to kill, burn, and loot at will…thus was there a change of government on the sceptered isle, and William became known to history as "William the Conqueror."

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