In The Dust

“There are some kinds of pain in life that cannot be avoided. They must be endured. With a little luck, by someone else!”

Bill Bonner

No suitable quotation came to mind…so I made up my own.

For when we parted company yesterday, we left with a question mark hanging in the air like the odor of a bad cigar in a small bedroom: People thought the Fed had the ability to prevent recession, but now that we have one, does the Fed have the ability to end it?

Fed Governor Robert McTeer, last spotted on a Las Vegas street corner offering “Free Rent” to passersby, thinks so. “We are not going into deflation,” he told an audience last week.

“Deflation is the hardest rock in the investment universe,” I told the audience in Las Vegas. Running into it is painful. But McTeer and others still believe they are in control of the economy and can drive it in any direction they want.

Here at the Daily Reckoning, we’re not so sure. If they actually knew where they were going, why did they drive into the corn field of recession in the first place, we wonder. And if they really could choose any compass setting they wanted…why did they choose to run full throttle towards the immoveable object of deflation?

Bonds are up. Gold is down. Commodities are sinking. Unemployment is rising. And the entire world economy is deflating.

“At the Hyatt resort in Bali,” begins a Washington Post article, “80 percent of its November bookings – British car dealers, European druggists and Hong Kong bankers – have been canceled.

“In Japan, everything now comes with zero percent financing – and even so, loan demand is so depressed that some banks are simply depositing their excess cash in other banks.

“In Argentina, auto sales are down so much – 40 percent, compared with this time a year ago – that Fiat has been operating its plants there just one week a month.

“And the annual staging of ‘Aida’ at the Great Pyramids in Giza, a high point of Egypt’s tourist season, has been canceled because of security concerns. What already was a global economic slowdown has been gathering momentum since Sept. 11, dashing hopes for a quick U.S. economic turnaround and raising the specter of worldwide recession. J.P. Morgan Chase & Co. now forecasts that global economic growth will barely exceed 1 percent this year and the next, which would be the worst performance in 20 years.”

“History tells us that recessions trigger deflationary forces,” observes Morgan Stanley economist Stephen Roach. “For the world as a whole, I would judge the risk of deflation to be higher than at any point in 70 years. Therein lies the risk: Financial markets seem largely unprepared for such a possibility.”

But myths and illusions die hard. One of the most enduring myths of the New Era was that the Fed had mastered the boom/bust cycle. Since the Fed could eliminate recessions, there was thought to be no reason why corporate earnings should decline and, therefore, no reason for bear markets. So why not pay 200 times earnings for a stock, if the price only went up?

Since the beginning of this millennium investors have been reminded that stocks can go down as well as up…and as recently as last week, it was reported that GDP fell in the 3rd quarter for the first time in a decade.

So the New Era wishful thinkers have turned their attention from explaining why the Fed would never allow a downturn to explaining how it can correct the one we have.

The “general rollback of risk-taking animal spirits all could have been avoided,” wrote Republican economist Lawrence Kudlow in May. “It was the Fed that killed the market.”

Mistakes come along just when you need them. Unwilling to give up on the idea of the Fed’s control of the markets, economists now blame the Fed for raising rates at the wrong time…or failing to cut them fast enough.

“If ever there was a greater example of a central planning blunder, I can’t think of it,” Kudlow continued. “Most if not all of it could have been avoided if government officials paid attention to the message of the markets…Bear market downturns represent investor pleas for new government policies.”

Rich Karlgaard took up the same theme in the same place. “Absurdly tight money has choked a ten-year boom,” he writes.

Kudlow and Karlgaard both appeared in the American Spectator magazine…which turned out to be a wealth of post-New Era delusion.

Even the Fed’s mistake will not stop the economy, Kudlow concluded back in May, because “the underlying forces driving the New Economy are real and not easily suppressed.”

Arthur Laffer, writing on page 42 of the same issue, is hopeful too. Not only is the New Economy unstoppable, but now “The Fed’s Back on Track.” “While I can’t be sure how much longer the mistake the Fed made in 1999 [raising rates] will continue to reverberate through the economy, my belief is that the longer-term outlook is pretty good…By the end of 2001 the economy should be back to its normal long-term growth [ha ha]…The Fed is now doing a great job.”

And over on page 45, George Gilder, considerably poorer since the New Era ended, but no less hallucinatory, writes:

“We are not in a tech slump, or a business-cycle slump, but a policy slump.” In Gilder’s mind, too, government has the power to unleash the remarkable forces of the New Economy, which he says “far from being over-hyped, is still painfully under-appreciated.”

“The Coming Boom,” he entitled his article, predicting “a new phase of wealth creation that will leave the Buffetts in the dust…A reasonable guess is that the opportunities of the next decades are roughly ten times more promising than the opportunities opening in the mid-1980’s multi-trillion-dollar wealth explosion.”

“The telecosm will prevail,” he continues, “and investors who understand its dimensions will be able tospurn the catastrophists and prosper from the largestopportunity in the history of the world economy.”

Here at the Daily Reckoning, we admit, we do not understand the dimensions of the telecosm. Whether we use feet and inches or the metric system, we can’t even figure out where to hook our measuring tape. Perhaps we should toss it in a full barrel of water and measure the overflow…but we can’t get a grip on it.

But we doubt that the Fed is any better at curing a recession than it was at preventing one. Especially this one.

So we will stand, humbly, in the dust, doubtful that the pain of a deflationary downturn can be avoided…and eager to let Gilder’s disciples and McTeer’s admirers be the ones to suffer from it.

Your editor,

Bill Bonner
November 6, 2001

Today, the Fed is expected to continue its “March to Zero” by cutting rates again – its 10th cut this year. This will bring the key lending rate to its lowest point since 1961. Now that the borrowing rate is below the inflation rate – money is, effectively, free to member banks.

Richard Russell reports that the Fed has also added $167 billion to the money supply in the last 5 weeks.

The authorities are doing everything they can to inflate the economy. But so far, they might as well be trying to revive a corpse.

Gold fell $1.30 yesterday. And long bonds – those most sensitive to inflation – went up!

It is not inflation that lies ahead, Mr. Market may be telling us, but d-d-d-deflation…such a scarything that I can’t even say it without stuttering.

But stock market buyers don’t seem to notice…or care…do they, Eric?


– Anyone who might just be awakening from a two-month coma could take a quick survey of the financial markets and conclude that nothing much happened while they were incommunicado. Stocks are about where they were two months ago and so is the U.S. dollar.

– But the world has changed and I will shimmy out on a limb by saying that the changes are not bullish – not for stocks and not for the dollar. That doesn’t mean stocks can’t go up, of course. Like an Islamic extremist, Mr. Market sometimes believes what he wants to believe, no matter how little sense it makes.

– The Nasdaq finished yesterday at its highest level since the end of August. And in a flash of deja vu, networking stocks like Cisco – along with Internet stocks of all stripes – powered the Nasdaq to a 2.7% advance. The Dow gained 117 points to 9,441.

– After the close of trading, Cisco performed a masterful encore performance of that Wall Street classic, “The Pro Forma Earnings Game.” The company doubled Wall Street expectations with a pro-forma earnings report of four pennies per share – that’s four whole cents per $18 share. Of course, after including all those time-and-again “one-time” charges, Cisco’s theoretical profit turned into a LOSS of four cents per share.

– Meanwhile, revenues collapsed by nearly one third. All this terrific news caused Cisco’s stock to jump about 5% in after-hours trading, bringing its advance since late September to more than 60%.

– The more the economy deteriorates, it seems, the higher the stock market rises. Just think how much higher stock prices would be if we could kill the economy for good.

– Without a doubt, we are witnessing a new and different sort of stock market “bottom,” typified by “values” like Cisco Systems. Even after tumbling more than 75% from its all-time high of 82, Cisco sports a whopping $140 billion market capitalization – more than 100 times hoped-for fiscal 2002 earnings and nearly eight times its current run-rate of annual sales.

– Clearly, Greenspan’s reflation efforts are working a little magic on Wall Street. The Fed’s easy money campaign is providing fuel aplenty to power stocks higher…for awhile. And as the market rallies, it fans the latent bullish passions of many hopeful investors – hopeful that 40 times earnings is actually cheap; hopeful that the biggest jump in unemployment in more than 20 years will be good for consumer spending; hopeful that our war against an invisible, Hydra-headed foe named “Terrorism” will be quick, painless and economically stimulative.

– We wish the hopeful investors well, even if we do not share their optimism.

– Out in the real economy, businesses continue to struggle. Ski lodges are one of the myriad U.S. industries to gripe that business is worse this year than last. “Snow isn’t the only thing starting to fall at the nation’s ski areas,” USA Today reports. “So are prices. While the start of the ski season remains a few weeks away at most resorts, some ski lodges are slashing rates by 20% or more.”

– David Tanner, president of Rocky Mountain Vacations, tells USA Today “I’ve never seen rates come down this far this early in this season.” Despite the lower prices, advance bookings are lagging well behind last year’s pace. Vail Resorts reports that its bookings are off 15% to 20%.

– “Jobs, the fear of losing them and the perceived ease of getting them, are perhaps the single greatest influence on consumer behavior,” writes Barron’s Alan Abelson. “Until this year, we had an extraordinary stretch – reaching back almost a decade – in which the great job machine cranked out additions to payrolls with exhilarating regularity.” The booming job market, says Abelson, stoked an “urge to splurge, got housing on a roll, fired up the stock market, bubble and all, and imbued [the consumer] with a feeling of entitlement, or at least inevitability, so far as jobs went.”

– However, Abelson predicts, “The job picture is apt to get worse, conceivably a lot worse, before it gets better…as it does, we suspect, it will take a grand toll on retail sales, on housing prices, which can offset a substantial portion of the benefits of lower mortgage rates, and, yes, on the stock market.”

– Hopeful investors, cover your ears!


Back to Baltimore…

*** “The Heartland Hunkers Down” proclaims a headline at “Businesses have been crawling into a shell,” the article quotes economist Mark Zandi. Slowly, but surely, people are being laid off, costs are being cut, and spending is being trimmed.

*** Yet, Americans remain optimistic…or delusional. The most recent Gallup polls show that they believe the economy will soon come back to life…stocks will continue to go up…and the nation’s leaders are doing a fine job. The Gallup pollsters found that 84% of those polled approved of the way Congress is handling things – the highest rating ever recorded. President Bush – at 88% – enjoys the highest approval rating ever given to a living president.

*** If only presidential approval ratings were a tradable investment! A lot of money could be made on the short side. For whenever anything finds such epic levels of favor in the public’s eye…it is just a matter of time before it is held in contempt.

The Daily Reckoning