In the Right Light

"You have to try to look beyond appearances… as God does."

Pere Marchand
From Sunday’s sermon

"Paris is like a beautiful woman," said my friend Adrian. "She has her moods. She can be temperamental and sassy – such as when the subway workers are on strike — but she is always beautiful."

"Yes," I added, unwilling to let a good metaphor pass without overworking it, "living here is like being married to a beautiful woman. You appreciate her every morning and every evening."

But Paris is more like a mistress than a wife. You can enjoy her for a few weeks or a few months. She will not sulk or complain when you go away. And she’ll be just as pretty and just as much fun when you come back.

What’s more, she changes with the seasons, the arrondissement and the light. One day, she is elegant and sophisticated. Another, she is hot-tempered and spicy. And the next week, she is warm, relaxed and comfortable.

In the fair light of summer, she is as fresh as a Norwegian fashion model at an outdoor cafe. While in the drizzle light of winter, she is broodingly romantic… like the steamed windows of a Montparnasse bistrot.

The light makes a big difference.

Lit up by the incandescent figures of the Labor Department, the U.S. economy seems to be beginning a remarkable recovery from the mildest recession in history.

But light can disguise as well as reveal. In the accommodating light of "pro forma" earnings – any company might look good – even one that is close to bankruptcy. And in the dim flicker of a romantic candlelight dinner almost any woman might make a man feel silly – especially if he drinks enough. And while it is true that all women have their charms, Daily Reckoning readers are advised to luncheon with their paramours al fresco before proposing marriage.

What does the U.S. economy look like in broad daylight? In the following letter, we take a peak… aided by our old friend Kurt Richebacher.

"Fed Chief Declares Recession at an End," says Friday’s headline in USA TODAY. Few of the papers’ readers doubt that better times are coming soon. Not that there has been anything especially wrong with recent months. Stocks are high and rising. Unemployment is low. Housing prices are rising and there is plenty of credit for anyone who wants it.

From appearances, things could scarcely be better for the U.S. economy; it has put the recession behind it.

With so little attendant suffering that most people never even noticed. And now the way is clear for another upswing of growth. Numbers are being revised upwards. Plans revisited. GDP growth in the 4th quarter, for example, was first reported at only 0.2%, then revised to 1.4%. Productivity, first clocked at 3.5% in the 4th quarter, has since been reconsidered to above 5%. Boom is in the air.

Normally, productivity goes down in a recession – because workers cannot be cut as fast as sales fall off. Besides, businesses are reluctant to let their employees go for fear they will need them in the next boom phase. Output per man hour typically falls.

But rising productivity is just one of the very peculiar features of what must be not merely the mildest, but the strangest, recession ever.

As recessions go, the most recent one is remarkable not for the pain that it inflicted, but for the pain it didn’t.

We have provided you with enough detail on all of these phenomenon, dear reader. We will not trouble you with more. Besides were are trying to see the picture more clearly; we don’t want to get distracted by the facts.

"The comforting explanation of the recession’s unusual briefness and shallowness," writes Dr. Richebacher, "is that corporations have been unusually quick to cut excesses and costs. This, it is argued, promises fatter profits in the upturn – and therefore justifies today’s lofty share prices."

But, "whatever some economic data and indicators may say," Dr. Richebacher continues, "the essential conditions for a sustainable recovery simply do not exist."

What are the essential conditions for a decent recovery?

Perhaps the foremost is that there must be something to recover from. Is the stock market depressed? Are there long unemployment lines? Are cobwebs forming at the entrances to shopping malls and real estate agents?

If so, it has not been reported in the press. What then is there to recover from? GDP growth rates are puny… ah, there’s room to grow there. But what will make GDP rise faster?

The consumer did not slack off during the ‘recession’ last year. He has no pent-up need for a need for a new house or a new car; he bought them during the slump! Nor has he any more money to spend. He has less in savings than he had at the beginning of 2001. The only way he could step up his spending would be by borrowing more.

But his debt is already beginning to chaff at his withers.

The gap between what he earns and what he spends – the ‘financing gap’ – has reached its widest in 50 years. It cannot go in this direction forever. He will soon be unable to make his payments. Nor can the nation’s financing gap – the current account deficit, the amount by which purchases from overseas fall below sales o foreigners – get infinitely bigger. In the ’50s, the financing gap was narrowed when people suddenly stopped buying. Consumer spending fell from 75% of GDP to 67%.

And how will corporate profits grow? Recessions normally force businesses to cut expenses and pay off debt. Like a man who’s been in a treatment program, they’re then ready to go on a real binge of borrowing and capital spending when the occasion presents itself.

But who will lend to them before they dry out and clean themselves up? As mentioned above, management payrolls have actually increased during the ‘recession.’ So has corporate borrowing, reaching a record of $4.93 trillion by the end of September 2001.

The cost of carrying this debt is a bigger burden than most people realize – and it is growing. Ned Davis Research points out that with wholesale prices falling at an annual rate of 2.6%, average real interest rates are over 10%, "one of the most painful rates for debt service in our history."

Business profits may bounce… but what would cause a sustained recovery? Consumers are already spending at a record pace. And "considering the prolonged stagnation and even decline of consumer incomes," writes Richebacher, all retailers can do to stimulate demand is to cut prices. "Such actions don’t increase overall demand," he explains, "they borrow from future demand." And they lower corporate profits.

So where will the corporate profits come from? How will the U.S. economy produce a healthy recovery from such a weak and ineffective recession? How can you justify today’s stock prices?

"The big crash in U.S. stocks has yet to happen," says Richebacher.

More to come… as the Daily reckoning continues…

Bill Bonner
March 11, 2002

If there was a recession, it was a flop.

The usual effect of a recession is to correct the mistakes of the previous boom. Consumers and businesses are supposed to take a good hard look at their balance sheets, pay down debt, lower prices of stocks and real estate, and build up a little in savings for the next boom.

None of that has happened. Corporations added $500 billion to their debt load last year, while consumers continued their free spending ways. "Biggest retail gain in nearly 2 years," is the news from LA.

In the 4th quarter, consumers stepped up their buying of big-ticket items at a 13.5%. "Consumer Credit Shows Sharp Rise," notes the Hartford Courant. "Credit Card Debt Buries Young Adults," adds the Chicago Tribune. In January of this year consumer credit rose at a 9.3% annual rate.

Throughout 2001, businessmen kept right on consuming capital. Consumers, too, went about their business as if nothing had changed – spending money they didn’t have and are not likely to get. At one point last year, the savings rate dipped down to negative 4%.

Meanwhile, stocks are about where they were when the recession was supposed to have begun. The Nasdaq is only a few points from where it stood in March a year ago. S&P price/earnings ratios are 2 to 3 times the long-term average, depending on how you figure the earnings.

And even the unemployment picture is hardly one we associate with real recession. Factory workers were laid off in respectable numbers but the roll of fat of a service economy – managerial workers – actually grew. Stephen Roach reports that "managerial bloat" increased 2.9% last year.

One out of every three employees hired in the last three years is a "manager," increasing the managerial class to 15.3% of the workforce.

And now that the recession is over economists are expecting either a ‘mild’ recovery or a robust one. Isn’t it more likely that the recovery will be at least as big a flop as the recession? More below…

But let’s get to Eric’s report from Wall Street:


Eric Fry writing from New York…

– A rising stock market is the "opiate of the people."

– Under its narcotic effect, reports Rob Parenteau at the Prudent Bear, "consumer cyclical spending growth never fell negative, housing prices never corrected, equity market multiples never fell below long term averages, the trade deficit never returned to balance, and perhaps most important of all, private sector balance sheets never got cleaned up. All of these departures from normal business cycle recessions are in fact intimately related – they are all expressions of continued financial imbalances in the US economy."

– Still, investors grin at foibles like rich valuations and deceptive accounting. And rallies bring smiles and wash away all worries.

– Furthermore, when share prices are rising, investors are well rewarded for minimizing the negatives and accentuating the positives.

– The see-no-evil stock market is thriving. Last week, the Dow gained 2% and the Nasdaq bolted 7% higher. Year- to-date, the Dow has moved solidly into the black by advancing more than 5%. The Nasdaq has clawed its way back from large losses to being only about 1% under water year-to-date.

– Helping to spur stocks along was the news Friday that the economy added 66,000 non-farm payrolls in February, the first gain since July. The report was certainly an uptick from January’s revised loss of 125,000 jobs. But the manufacturing sector continues to struggle – losing 50,000 jobs during the month.

– Employment is out of ICU perhaps, but it remains in serious condition. "U.S. Unemployment Rate Unexpectedly Falls to 5.5% as 66,000 Jobs Added," read a Friday headline on But the headline immediate below read: "Kmart to Fire 22,000 Workers, Close 284 stores."

– The economy may not be 100% just yet, but the stock market’s recuperative powers are truly amazing. So complete is the stock market’s recovery that the major market averages are almost exactly where they were a year ago, when One World Trade Center was merely another New York City address and Enron was just one of many hot New Economy stocks. On March 12, 2001 the Nasdaq closed at 1,923. One year later, the volatile index stands 6 points higher at 1,929.

– The post-9/11 and post-Enron Wall Street looks and behaves remarkably like it did before all this bad news came along. Fortunately, neither the economy nor the stock market has utterly collapsed. Unfortunately, the "corporate transparency" issue has been put out to pasture… already.

– Investors seem to have reached a kind of d?tente with corporate America and Wall Street. They expect to be told a few white lies, but they seem to assume that the marketplace is honest enough to permit stocks to keep heading higher… And isn’t that all that really matters?

– "Trust," according to a recent Golin/Harris survey, "is eroding across numerous business sectors." By a 7- to-1 margin survey respondents said, "Recent economic events have created a crisis of confidence and trust in the way we do business in America."

– But this growing distrust of corporate America does not mean that these same 7 out of 8 respondents distrust, even for a minute, the stock market’s ability to deliver 15 to 20 percent annual gains.

– Ironically, Grolin/Harris is owned by Interpublic Group (IPG), a company that has demonstrated quite an aptitude for creative cash flow accounting – so creative, in fact, as to be less-than-trustworthy.

– Back in early January, IPG’s CFO Sean Orr told a group of institutional investors at a Salomon Smith Barney conference that his company was producing significant free cash flow. Accordingly, slide number 31 in his PowerPoint presentation showed $249.6 million of free cash flow for the first nine months of 2001.

– There’s just one small problem. Based on a conventional definition (cash from operations less capital expenditures), IPG’s free cash flow for the nine months ended September 30, 2001 and was a NEGATIVE $712.2 million – or as Apogee Research (formerly Grant’s Investor) points out, "[N]early $1 billion less than the amount claimed by Orr at the recent conference."

– Apogee Research analyst Robert Tracy rang up Orr to ask him about the considerable gap between the two numbers. Orr responded, "There’s no publicly disclosed information that is going to allow you to do a clean reconciliation between the two sets of numbers you are talking about."

– Nonetheless, Orr asked IPG’s treasurer to assist in the reconciliation. Alas, after two lengthy phone conversations between Tracy and the treasurer, the company never successfully reconciled the number presented on its slide. Instead, the treasurer provided a reconciliation that fell about $30 million shy of the number in the slide show.

– No satisfactory explanation was given for the discrepancy. Interestingly, it does not seem to matter. No Wall Street analyst questions the company’s curious rendering of cash flow. Whether the difference between conventional cash flow accounting and the company’s secret formula be $1 billion or $1 trillion, or even $1 gazillion, the same investors will line up to buy the stock… just because Wall Street tells them it’s prudent to do so.

– I wish I could say that Wall Street has become a more honest place… but I would be lying. The same CEOs, CFOs and analysts who were telling the truth one year ago are probably still telling the truth today. And those that were lying one year ago are still lying today… and that’s the truth.


Back in Paris…

*** Poor Japan! While the U.S. suffered a phony recession, Japan experienced a real one. GDP fell 1.2% in the 4th quarter of 2001. It was the 3rd losing quarter in a row, bringing the total economy down 4.5%.

The Japanese are getting worried. They’ve been promised a recovery for the last dozen years… and they’ve seen what happened recently in Argentina. So what are they doing to protect themselves? They’re buying gold. Gold sales rose 24% last year… and are still going up.

*** Mr. Deshais, our gardener, seemed to take no offense when the sheep ate our rhododendron. But when a ragondin attacked his vegetables, he went to war. Native to South America, the ragondin is a type of huge water rat – a little like a beaver, with a rat-like tail – that has invaded Europe in recent years. They are such a nuisance that they are trapped, poisoned, and shot by every farmer in the area.

Mr. Deshais set a box trap and soon had a prisoner – not a ragondin, but a regular field rat. He called over his little dog, Tina, to act as executioner. Opening the gate of the trap, I expected the rat to make a dash for safety. Instead, Tina darted into the wire cage, grabbed the rat by its back and shook it furiously. In two or three seconds, she had placed the limp body on the ground and was ready for a new assignment.

*** "Paris is so beautiful," said Maria, as we walked across the Pont Neuf. "I want to go to New York when I get older, but I think I’ll always want to come back to Paris."

It was early evening and the river was rushing by underneath the bridge as though someone had opened the sluiced upstream. The water was a light green color. And somehow, the color seemed to have leached into the stones and the sky too.

The light in Paris changes the look of the city. But whether in the bright light of summer or the half-light of a winter afternoon, Paris is stunning. More below…

*** Speaking of Paris… a friend sent me this little joke:

French Intellectuals to be Deployed to Afghanistan to Convince Taliban of Non-Existence of God

The ground war in Afghanistan heated up yesterday when the Allies revealed plans to airdrop a platoon of crack French existentialist philosophers into the country to destroy the morale of Taliban zealots by proving the non-existence of God.

Elements from the feared Jean-Paul Sartre Brigade, or ‘Black Berets’, will be parachuted into the combat zones to spread doubt, despondency and existential anomie among the enemy. Hardened by numerous intellectual battles fought during their long occupation of Paris’ Left Bank, their first action will be to establish a number of pavement Cafes at strategic points near the front lines. There they will drink coffee and talk animatedly about the absurd nature of life and man’s lonely isolation in the universe. They will be accompanied by a number of heartbreakingly beautiful girlfriends who will further spread dismay by sticking their tongues in the philosophers’ ears every five minutes and looking remote and unattainable to everyone else.

Their leader, Colonel Marc-Ange Belmondo, spoke yesterday of his confidence in the success of their mission. Sorbonne graduate Belmondo, a very intense and unshaven young man in a black pullover, gesticulated wildly and said, "The Taliban are caught in a logical fallacy of the most ridiculous. There is no God and I can prove it. Take your Tongue out of my ear, Juliet, I am talking."

Marc-Ange plans to deliver an impassioned thesis on man’s nauseating freedom of action with special reference to the work of Foucault and the films of Alfred Hitchcock. However, humanitarian agencies have been quick to condemn the operation as inhumane, pointing out that the effects of passive smoking from the Frenchmen’s endless Gitanes could wreak a terrible toll on civilians in the area.

Speculation was mounting last night that Britain may also contribute to the effort by dropping Professor Stephen Hawking into Afghanistan to propagate his non-deistic theory of the creation of the universe. Other tactics to demonstrate the non-existence of God will include the dropping of leaflets pointing out the fact that Michael Jackson has a new album out and Jesse Helms has not died yet. This is only one of several Psy- Ops operations mounted by the Allies.

The Daily Reckoning