Ironic Twists

“It is the most aggressive monetary easing by the Fed in such a short period of time since 1929-30,” reports Dr. Kurt Richebacher from his home in Cannes, France.

Dr. Richebacher follows with the obvious question:

“Will it work?”

Here at the Daily Reckoning, we have no ready answer. But we believe that great markets work like great novels – with a plot that involves an ironic twist or two. We cannot imagine a great novel in which the dramatis personae get exactly what they expect. (Suppose Scarlett had married Ashley Wilkes and lived happily ever after? Margaret Mitchell would have sold a few copies to her friends and relatives and that would have been the end of it.) Nor would we want to live in such a world; it would be as sincere and earnest as a poem by Maya Angelou.

And so, with our accustomed optimism, we look forward to a twist or two in the story of ‘Alan Greenspan, Public Servant or Master of the Universe?’

In today’s letter, we think we have found one.

A story in yesterday’s USA Today tells us that credit card customers are still paying high rates of interest on their balances – despite 5 rate cuts in 5 months. Mr. Greenspan can cut rates further, but the credit card companies have already reached the minimum interest rates at which they are willing to lend. Bank One’s platinum Visa, for example, has a minimum interest rate of 15.9%.

Also in yesterday’s news was an item describing the stiffening of the yield curve. Not usually a subject for polite conversation, the yield curve tells us what rates of return lenders require over what periods of time. Greenspan has been able to push down short-term rates – by making money available to member banks at real rates approaching zero (the nominal rate less the rate of inflation). But long-term lenders seem to have long-term memories. Perhaps their recollections reach back even to the 1970s, when inflation effectively wiped out many years of interest earnings, not to mention capital values.

Long-term lenders, as wary of inflation as the credit card companies are of credit risk, try to leave a few points between themselves and ruin.

And thus consumers, looking for relief from high debt levels, will find little succor from the Fed. Neither short-term credit card interest rates, nor long-term mortgage interest rates are falling.

But that is not all.

Yet another report from yesterday’s news told of a Fed governor’s comments on the bubble. Inexperienced entrepreneurs went to sophomoric venture capitalists, he explained, to raise money for unproven projects that were soon touted by amateur analysts and sold to novice investors. “Thank God, the banking sector stayed out of it,” he concluded.

But why, for perhaps the first time in history, did the banking industry miss an opportunity to lose money in a financial aberration? Have bankers gotten a lot smarter since they financed the stock bubble of ’20s or the Emerging Market loan bubble of the ’70s, or the Texas oil bubble of ’80s…or nearly every real estate bubble that ever happened? Probably not. The answer, dear reader, lies in the character of the financial markets, not in the character of the bankers themselves. The former, we will wager, has changed; the latter has not.

Instead of borrowing from banks, entrepreneurs and businesses were able to raise capital from investors. The banks, always ready to throw good money into a bad deal, were bypassed.

And so it turns out that Mr. Greenspan, Master of the Universe, cannot really control even the one thing that is supposed to be within his domain: the cost of credit. The banking system, through which his reflationary gas is pumped, no longer works the way it used to. The tubes have been disconnected. The result: Mr. Greenspan pumps…but the vapors go where they were not expected.

“Outright worrying, if not frightening,” writes Dr. Richebacher, “is the total absence of any effect of this quick succession of rate cuts on the U.S. bond market… this interest rate [the fed funds rate] has lost its former central importance in the financial system simply due to the fact that the activity of borrowing and lending in the U.S. …has shifted heavily away from the banks and towards the markets and a huge panoply of non- bank financial intermediaries that largely fund themselves in the money market.”

The fed funds rates has been cut 2.5%. And the money supply, as measured by M2, has been increasing at rates from 10%-14% so far this year. What has happened so far?

The economy has gotten worse. Sales are falling. Profits are disappearing. Productivity has collapsed. Jobs are becoming scarcer and consumers are getting poorer.

But, stocks rallied. From April 2nd to June 2nd, the Russell 2000 gained 22%. Now that rally seems to have run its course.

Analysts are still bullish. Economists are complacent. Consumers are optimistic. All seem to believe that the boom of ’82 – 2001 will go on forever, with only minor setbacks. What kind of ironic twists awaits them, dear reader?

We will find out.

Your commentator,

Bill Bonner
Paris, France
June 19, 2001

P.S. If bankers as a class are no smarter today than they were, say, in the Texas Oil Boom, could the same be true for central bankers? “Following the steep fall of stock prices in October-November 1929,” Dr. Richebacher explains, the Fed lowered rates not just 5 times – but 6 times… “twice in November and four more times until June 1930, always in 50 basis point steps. In response, the stock market rapidly recovered, ending 1929 up 25% from its low of Nov. 13.”

But Wall Street was not looking ahead, it was looking backwards, wistfully. After the spring rally, stocks fell again and did not recover until 1956. Many of the most popular of the stocks from the late ’20s never recovered. The great boom of the ’20s ended, ironically, in a Great Depression.

*** Capital spending (new orders) fell 4.6% in April…with a 10.3% drop in spending on computers and electronics.

*** And no wonder. A front-page report in the International Herald Tribune tells us that the telecom industry, for example, has laid 100 million miles of fiber optic cable in the last few years. 97% of those lines are still ‘dark’…and most may never be used. Apparently, even after they are in the ground, it takes a lot of money to light them up.

*** Cisco’s sales dropped 30% quarter to quarter. Yahoo’s sales fell 42%. In Silicon Valley overall, sales are expected to be off by 50% in the first half of this year.

*** Yet, nearly three quarters of analysts who cover Cisco, for example, now recommend buying the stock. Cisco is down about 80% from its high, but almost all analysts seem convinced that, in time, it will come back…

*** “Of course, if you’re holding tech stocks for years and are willing to wait out the many ups and downs to come,” writes John Futrelle in Money, “you need not concern yourself with whether the absolute bottom comes next quarter or even next year.” That’s right, John, sooner or later you will lose money…

*** Investors still have faith…that this little storm will soon blow over and things will be back to normal. The trouble is, their vision of what is normal has been distorted by nearly two decades of above normal stock market returns. Alas, those good old days may never return…and most tech stocks may never return to their previous highs.

*** But let’s see what happened on Wall Street yesterday… over to you, Eric:

– The NASDAQ rolled craps – scoring its seventh losing session in a row. The tech-heavy index, which fell 39 points, had not posted seven consecutive daily losses since 1998. The Dow eked out a 22-point gain.

– The drone of tech company CEOs warning about an “unexpected earnings shortfall” is becoming white noise on Wall Street. Yesterday, Oracle, Solectron and Level 3 Communications all weighed in with downbeat comments.

– Only about one-third of the companies in the S&P 500 will survive over the next twenty-five years, authors Richard Foster and Susan Kaplan estimate in their book, Creative Destruction. Yet, as professional investor Richard G. Leader sees it, the board members of these ill-fated companies will still “pay huge sums to the very managements responsible for leading these companies to their deaths.”

– Nortel Networks, for example, made headlines last week for taking a colossal $19 billion write-down in the current quarter. The company’s stock price and earnings prospects are both on life-support. Yet, Nortel President and CEO John Roth shared the company’s pain last year by making $6.9 million in base pay…and another $135 million by cashing in Nortel shares as it plummeted from $89 to $9. Leader observes: “Mr. Roth now plans a very comfortable retirement…as 30,000 former Nortel workers look for new jobs.”

– And that’s just the beginning. “Nextel shareholders saw their stock plummet from $73 to $14 – as their president cashed in $31 million of stock options. The president of JDS Uniphase put $25 million in the bank… as [the company’s stock] declined from $140 to $12. The list goes on and on…”

– Here’s a suggestion from The Daily Reckoning: rather than accept huge bonuses, CEOs losing that kind money ought to go the way of the samurai…and commit ritual disembowelement.

– “Working from last year’s Golf Digest listing of Fortune 500 CEOs ranked according to their golf handicaps,” writes’s Jay Akasie, “we came up with some screaming sell signals.”

– It’s called the “CEO Duffer Index”. In short, there’s a stunning correlation between suffering companies… and CEOs who post impressive golf scores. Scott McNealy, for example, had his 3.3 handicap trumpeted in print – a year later? Sun’s stock price was buried in a sand trap, having plummeted 58.1%.

*** “Argentina’s famed economist Domingo Cavallo has pulled out all the stops,” notes my friend, Steve Sjuggerud, today on the Daily Reckoning website. “On Friday – despite the illusion that Argentina is moving in the right direction and that someone competent is at the reins – Cavallo announced a major hair-brained scheme, which is not only strange, it’s ripe for corruption and abuse. Now, the 18% we were enjoying on Argentine bonds is only suitable for those with an iron stomach for risk… ”

*** And…Lynn Carpenter has had a hot hand lately. “Enron has been burning cash in a hot market while the other oil majors were making money…” she wrote recently. “Debt was increasing fast and dangerously while its competitors have hardly any. And Enron was the New Economy gurus’ pretty-boy pick — they were predicting its web ventures would make it rich. Wrong.” Last Thursday, Lynn says she waited until her charts showed the smart money where to go… by Monday she and her readers pocketed 71%.

*** “More U.S. household wealth evaporated in the first quarter of 2001 than in all of 2000 – which was the first year in half a century in which American net worth declined,” Reuters tells us.

*** How can consumer spending hold up? Consumers’ spirits may be willing. But their purchasing power is getting weak…more below…

*** “When is the new economy coming back?” my dinner companions asked me last night. Elizabeth and I were dining with French neighbors. On their minds was the same question that must occur at dinner parties all over the world: when will this little downturn be over?

*** “Forget it,” I replied, putting a damper on the conversation. “The new economy is history. We’ll have to wait for the new new economy… and that won’t come along for many years…”

The Daily Reckoning