Looking Out for #1

I can resist anything but temptation.

Oscar Wilde

As Alan Greenspan discovered, principles are fine. But when you’re looking out for #1, you need to retain a little flexibility. It’s all very well to do the right thing from time to time, but doing the wrong thing can be so much more fun.

Greenspan, you will recall, believed with his whole heart in the principle of gold backing for a nation’s currency. Without it, he asserted, central bankers would be tempted to inflate away the value of the currency for their own political convenience. Those sentiments were fine – until he became a central banker himself and found it convenient to dispense with the principle.

In this regard, the Randian, Greenspan, has much in common with the Republican, Bush. Free Trade sounds like the sort of principle a man can get behind. Trade is what allows people to do what they do best – and then exchange that for what others do best. Free trade facilitates the division of labor and economic progress. So obviously beneficial is it that no respectable economist would oppose it; even democratic politicians generally support it. There were few temptations that Bill Clinton could resist. Still, respecting the spirit of the GATT agreements had become such a habit during the Reagan administration that favoring free trade continued through the Clinton years.

"Everyone understood that there were certain things that you didn’t do," writes Paul Krugman in the New York Times, "no matter how convenient they might be in terms of short-term political advantage."

"In the case of steel," he continues, "Karl Rove weighed three electoral votes in West Virginia against the world trading system built up over 60 years, and the answer was apparently obvious." Bush broke with the Free Trade principle.

For a nation that relies on the kindness of strangers in order to live beyond its means, stepping on foreign toes would seem to be a bad idea. Already, the European Union, Japan, Brazil, South Korea and China have vowed to retaliate…and the dollar is falling. Couldn’t Bush see the likely consequences?

Mathematician John Nash won a Nobel Prize in 1994. More recently, he became a household name thanks to the film "A Beautiful Mind." Nash’s contribution was to Game Theory, in which he devised games that illustrated how people would look ahead to figure out what others were likely to do and adjust their own strategies accordingly. (We have discussed these games here in the Daily Reckoning.) The point of them is that players have to guess about each other’s moves…looking ahead not only to what they will do in their first move, but also their reaction to others’ moves.

"Nash imagined a world of ‘rational’ people…" wrote Gene Epstein in Barron’s. "Pretty soon, these beautiful minds reach a kind of stalemate, nowadays called a Nash equilibrium: the point at which no player can improve his situation, given the other players’ optimal choices."

"In other words," Epstein goes on, "President Bush didn’t raise tariffs on steel in March, although he did, since he knew the Europeans would retaliate, which they did."

Should Bush have known better?

Not at all, Epstein explains. The trouble with Nash’s description is that you can never be sure what game people are playing. Bush wasn’t playing the "international trade" game…he was playing "electoral politics," a game with very different rules.

In Nash’s beautiful mind, rational people play their games, looking out for #1 by anticipating each other’s choices and coming to an equilibrium.

But in the real world, no one knows what game he is playing, let alone what games his competitors are up to. Instead, people squirm around like 8-year-olds…seeking an advantage by pulling a girl’s pigtails and making noises that sound like a duck breaking wind.

Your correspondent…

Bill Bonner
May 28, 2002 — Paris, France

The markets in the US were closed yesterday. We’ll head straight to New York, so Eric can get us up to speed…Eric?


Eric Fry, reporting from Wall Street:

– Well, Bill, last week’s stock market action shows that it’s not much fun holding a candle or stocks during a bear market. Unrequited love is the certain outcome. Like a freshman boy that pines for the affection of a sophomore girl, investors have no chance.

– For a fleeting instant – a couple of weeks ago – the stock market smiled upon investors, thereby fanning the flames of their passion. But it was merely a polite smile – which is the most vicious and deceptive sort of civility.

– Two weeks ago, the Nasdaq rallied five days in a row and all seemed right with the world. But then, the daydream ended. On Friday, the Dow slipped 111 points to 10,104, while the Nasdaq shed 36 points to 1,661. The declines finished off a rough week for stocks in which the Dow lost 2.4% while the Nasdaq dropped 4.6%. The S&P 500 retreated about 2%.

– Gold, ever the contrarian, gained nearly $10 on the week – or 2.8% – to finish at $320.40 an ounce. And the yellow metal continues to be the talk of the town, dazzling fans and skeptics alike. At its Thursday peak, the benchmark contract touched $323.30 an ounce to make a new two-year high.

– For all the fireworks in the gold market, it remains a remarkably petite sector. The global gold share market is only about $70 billion, and that’s after the massive rally that has occurred over the last few months. What’s more, the open interest of all gold futures contracts currently trading on the Comex totals little more than $6 billion.

– The universe of gold stocks and Comex open interest combined totals less than $80 billion – or less than half of Intel’s $191 billion market capitalization.

– That means that the gold market seems particularly Lilliputian compared to the limitless supply of dollar bills furnished by the Greenspan Fed. And debt is growing even faster than the money supply.

– "At the end of 2001, outstanding credit in the United States totaled almost $29 trillion," Dr. Kurt Richebacher observes.

– Given the rapidly growing supply of greenbacks – not to mention the nation’s ever-expanding debt levels – gold holders might decide eventually that swapping an ounce of gold for 320 dollar bills is a bad trade.

– Part of gold’s growing appeal is that it has no CEO. It has no chairman of the board, and most of all, it has no option-laden management team. It is simply "Gold." And that’s a refreshing change for investors who have grown tired of suffering abuse from self-serving corporate managements.

– At the recent Berkshire Hathaway annual shareholder meeting, Warren Buffett and his partner Charlie Munger heaped contempt on the culture of stock options. Munger called these options "demented" and "immoral," and noted that the surgeons at the Mayo Clinic seem not to require options for professional motivation.

– Part of what makes these options programs so immoral is the way that managements use them to transfer wealth to themselves from the common shareholders. The "theft" occurs so gradually that – like a rotting floorboard – you might never notice it until you fall through the floor. But it is no less destructive for occurring gradually.

– The only real incentive these options created was the incentive to gut balance sheets in order to goose the share price. As compensation became tied to share options, managements discovered that increasing leverage was usually the most direct means to a rising share price, and hence rising option values.

– Traditionally, conservative cash-rich companies grew slowly, if surely. But that isn’t the kind of story that creates excitement about a stock and earns a "growth multiple." The best way to get a growth multiple is to borrow money. Borrowing a bunch of money permits a company to "buy earnings" by acquiring other companies.

– This growth-by-acquisition strategy fuels the sort of rapid earnings growth that causes investors to drive a share price higher. At the same time, companies can borrow money to conduct stock repurchase plans, which also boosts the share price.

– "For many years [U.S. corporations] systematically ravaged their balance sheets by [conducting] massive stock buybacks and by buying marginally profitable businesses just to boost near-term earnings," writes Dr. Kurt Richebacher. "For any reasonable observer, it was blatantly obvious right from the beginning that these corporate policies aimed at boosting profits per share in the shortest possible time were essentially destructive to balance sheets and profits in the long run."

– America’s balance sheets have been gutted and they won’t heal quickly.


Back in Paris…

*** Henry looked like an angel on Saturday evening. Standing on the steps of the Basilica of Sacre Coeur in Montmartre with the rest of his class, the 11-year-old looked as though he had already joined the celestial choir. He was dressed in a white robe and held his hands as if in prayer. All he needed was a halo.

*** We had just trudged up the hundreds of steps to the church, along with tourists and pickpockets, and found him there – posing for a photo session in advance of the ceremony.

*** That was the last we saw of him until it was all over. There were 236 children being confirmed in the faith that day. Henry was surely the only one who – at least before Saturday – was not actually French Catholic, but a Maryland Episcopalian! But no one seemed to notice or care. The festivities went on with such pomp and splendor…with incense swinging and a whole host of clerics in various ecclesiastical get-ups…it was if something much more important – say, a royal wedding – were going on. Even if Henry were being restored to the crown of France, I don’t know what they could have added.

*** There were so many parents, grandparents, and godparents present, the entire, vast basilica – which seats more than 3000 – was filled, leaving us with seats far in the rear and off behind a massive column.

*** Big TV monitors had been installed to help those in the back who had not brought binoculars to keep up with what was going on. But the images on TV were so indistinct, all the children looked the same.

*** Still, we could hear…

*** "We all have ideas," your editor heard Monseignor Chabant remark. "Sometimes wonderful ideas. But ideas are not enough. You need something more in life…you need the Holy Spirit…"

The Daily Reckoning