Making The World Safe for Profligacy
“Things do tend to regress to the mean,” explained a Daily Reckoning reader, (or words to that effect). “But there’s no law that says they have to. What we’re seeing is just the feedback loops in nature that tend to limit change. And yet, men today are much taller than men used to be. Does this mean that they will soon be shorter again?”
And so, dear reader, the much-anticipated second half arrives today. And we greet it with a familiar question: will there be a ‘recovery’ as predicted…or must the economy and the stock market sink lower, so that the long-term averages can be re-established?
Since this is a new half, a new answer would be nice. Either affirmative or negative, either way, a simple ‘yes’ or ‘no’ would be an improvement on the ‘who knows’ long-time Daily Reckoning sufferers have come to expect.
But some things never change. Here at the DR, we put our faith in the eternal verities – including the inalterable, inevitable ignorance of our species. We did not know what the future would produce in the last half. Nor do we know what the second half will bring.
Still, we daydream about what the future might bring – so that we may be ready for it.
Since WWII, Americans have suffered only fairly mild recessions and a relatively few casualties of war. So long has this period of peace and prosperity lasted that most people feel it is permanent.
Our greatest enemy – the Soviet Union – is not only in retreat; it has ceased to exist! And we get richer as we are getting bigger and taller, year after year, with no counter-trend expected.
While the total amount of credit in our economy has doubled in the last 8 years – from $15 trillion in ’92 to an estimated $30 trillion today – the risk of default has been spread out all over the globe. The trillions of dollars… and U.S. dollar-based assets (stocks, bonds, business, real estate)…all depend on the continued economic health of the U.S. economy and the strength of its currency.
As described in these pages, government-sponsored agencies, Fannie Mae and Freddie Mac, have been the fastest-growing lenders of the last decade. Borrowing money and selling shares in the capital markets, these GSE’s use the money to buy mortgages, taking advantage of an implied federal backing. Formerly, banks themselves bore the risk of default on their own mortgage lending. Now, the risk is globalized – banks are insured by the Federal Reserve, whose dollars are held by Bavarian dentists… as well as car dealers in Baton Rouge.
“Re-packaging and transformation of various kinds of debt instruments from mortgages to credit card receivables has led to layer upon layer of financial intermediation,” writes economist Paul Kasriel. “Financial risk can be more easily shifted today. But risk shifting is just that – shifting. The amount of risk is not reduced.”
Just the opposite. In the pernicious way nature works, the appearance of smaller risks encourages people to take bigger ones. While everyone, individually, may feel protected by hedges, counter-trades, swaps, derivatives, and flexible capital markets…collectively, all are exposed to a risk roughly equivalent to the sum of open credit positions.
From 1952 to 1982, Kasriel reports, total debt as a percentage of capital stock never exceeded 52%. But as new means were found to spread the risk around – apparently reducing the risk to individual players – the total amount of credit grew spectacularly. “Debt as a percent of the capital stock had moved from about 48.5% in 1982 to 92% in 1999.”
Globalization of risk is not new. During the last 19th and early 20th centuries, the governments of Europe globalized their security risks, by entering into an extended web of alliances. If Germany invaded Serbia, Russia would come to its aid. If France were to attack, Austro-Hungary, Germany would defend it. Each nation figured that these alliances reduced its exposure to military catastrophe.
From 1870 until 1914, Europe enjoyed peace and unprecedented prosperity. People began to think that they had grown in stature and would never again have to go to war with one another. Marxists believed the working classes of all nations would make common cause with one another and refuse to fight. The bourgeoisie believed that economic growth and education would make war a thing of the past.
As it happened, the system of globalized security risks may have reduced small conflicts, but it made big ones much more likely. Could the globalization of financial risk do the same?
The Financial Times, commenting on Greenspan’s rate cuts: “This just might work, though the success of central banks in rescuing post-bubble economies is decidedly limited. But it may also merely postpone the economy’s day of reckoning. The central bank risks making the world safe in the short run by rendering it still more dangerous in the long run.”
More on this tomorrow…
July 2, 2001
Yesterday, we returned to America for our summer vacation. No one at Charles de Gaulle airport asked if we packed our own bags. Nor did anyone care if a stranger had given us something to carry on-board. That only seems to happen in America…
“Oh yes,” you might be tempted to reply, “a nice man with a turban on his head gave us this little box to take to his mother. It’s a clock; see, you can hear it ticking…” But you don’t. Because you know that the half-wits at the airport security stations take themselves seriously.
Nobody seems to be interested in blowing up Amtrak trains, greyhound buses or crowded escalators. But who can honestly say that they have not tried to blow up a 747 at least once in their lives?
Actually, almost everyone. According to the International Herald Tribune, the last and only reported domestic incident happened in 1955 – when a man gave his own mother a bomb to take on airplane, in the hope of claiming the insurance money. Because of this, supposedly, for nearly half a century, Americans have been forced to submit to such remarkably transparent questions that a terrorist or matricidal maniac would have to be a total imbecile to get tripped up by them.
I found more evidence of this cultural difference driving into work this morning. No one dared to drive faster than 75 mph – despite the fact that it was a 6- lane highway at 4 am. The French would be driving at 100 mph and more.
A friend of mine in France was astonished recently when I told him I had made an honest income tax declaration. “Why would you do that?” he asked. “Nobody but a fool would tell the government the truth.”
Are we law-abiding Americans fools?
I don’t know, dear reader. So, let’s change the subject. Here’s Eric’s report from Wall Street:
– A technological glitch shut down a promising tech- stock rally last Friday. With an hour left in the trading day, the Nasdaq’s systems seized up. Nasdaq officials tried to keep the party going by allowing trading to continue until 5 PM. But most of the guests had already left.
– When trading finally ended, the Nasdaq Composite Index clung to a 35-point gain – capping off a 6.3% advance for the week. The Dow finished 64 points lower on the day and lost 1% on the week.
– Interestingly, even after Greenspan’s “cautious” quarter-point rate cut, bond yields soared higher. The 30-year Treasury bond yield climbed to 5.76% Friday from 5.68% the day before. Maybe inflation is not quite deadafter all.
– Nor has Greenspan’s helping hand been enough to keep stocks from falling into the red during the first six months of the year. None of the major stock market indices gained ground. The Dow fell 2.6%, the S&P 500 dropped 7.3% and the Nasdaq brought up the rear with a 12.6% decline. “Fighting the Fed” has been a profitable stance so far this year.
– However, within the losing indices were some very notable winners. S&P 500 member JC Penney topped the other 499 stocks with a 139% year-to-date gain.
– The CBOE’s Volatility Index – a measure of investor fear reflected in stock options trading – is now below the bearish levels that correctly predicted last year’s initial puncture of the tech bubble. Illustrating complacency in full-flower, smartmoney.com’s Igor Greenwald observes, “The herd is back to graze on tech bargains, meaning apparently the shares of any chipmaker whose warning falls short of outright bankruptcy.”
– Hewlett-Packard Chief Carly Fiorina, must think the 1960s have returned to San Francisco, man. The latest wacky idea out of Fiorina’s HP is to ask each of its 45,000 US employees to take a voluntary pay cut. That’s right, it’s optional. They don’t have to, if like, ya know, they don’t want to.
– The best that anyone can say about this touchy-feely cost-cutting effort is that it is not the worst initiative to emerge from HP since Fiorina took charge. That distinction belongs to the knuckled-headed idea of spending billions of dollars over the last couple of years to buy Hewlett-Packard shares. Thanks in part to the extravagant buyback campaign, the thousands of employees now being asked to forego pay are certainly not “feelin’ groovy.”
– Don’t think that Fiorina will not share their pain, however. Spokesman Dave Berman says that she might be turning in her company car.
– Lucent spinoff, Agere Systems Inc, said it plans to cut about 4,000 jobs, or about 24% of its remaining work force (any volunteers?), as it tries to deal with the severe downturn in the semiconductor industry. These latest cuts are in addition to the 2,000 announced in April.
– Thanks to these job losses and the many others occurring in the tech sector, more folks are leaving San Francisco than are moving in. USA Today reports: “Nor- Cal Moving Services…says 60% of its Bay Area traffic is outbound this year, vrs. 20% last year. ‘It’s a dramatic shift in population,’ says company President Peter Mazzetti.”
– Lucent also reported this week that a single strand of fiber optic glass could transmit ten times more information than previously imagined. “So what?!” asks the DR Blue’s Dan Denning. “We already have too much of the stuff anyway. There are 39 million miles of glass fiber ready for use in the U.S – and only 5% of that fiber is lit – the definition of overcapacity.” But optic fiber is just the beginning…
– “There is so much unsold product on the shelf,” explains Denning, “that ‘capacity utilization’ – currently at 77% – is at its lowest rate in 18 years. In other words, companies are going idle just to draw downexisting inventories.
– “So here’s the question of the week: with too much inventory, falling profits, and a slowdown in consumer spending, why would any sane CEO take advantage of Alan Greenspan’s generosity to take on more debt – to build more factories to make more products – which they can’t even sell right now? This is not a trick question.”
Back to Bill in Baltimore…
*** Hmmm…Greenspan lowers rates…and long-term interest rates go up! They’re supposed to go down. And the dollar goes up; it’s s’posed to go down too. And stocks – which are supposed to go up – have come down since Greenspan began cutting rates in January.
*** Do rate cuts have any effect? Edward Leaner, director of UCLA’s Anderson Business Forecasts: “We’re like a primitive tribe, in which we want to pray to a god and have him cure the problem. The god happens to be Alan Greenspan. When that volcano is going off we pray to him, and if the volcano stops, we think he did it. Right now we’re praying pretty hard to him.”
*** All over America, graduates of high schools and universities – that is, people who have no idea how the world actually functions – are being encouraged to change it.
*** But my old friend, Doug Casey, has been trying to change the world for many years. His most recent newsletter reveals how: “In case you’re wonders what my other hobby, besides polo, is, it’s pitching this plan to Third World governments. They’ve bought every cockamamie scheme that’s come down the pike since the days of Karl Marx. Why shouldn’t they go for something that actually makes sense?”
*** What makes sense to Doug is to take one of these basket-case countries, such as Haiti or Surinam, public! Doug made his pitch to Haitian officials recently. Watch this space for the IPO.