Massive Deflation

“All over the Anglo-Saxon world,” said Dr. Kurt Richebacher on Saturday’s visit, speaking with a strong German accent, “it’s the same. High debt, low savings…low real capital investment in real industries.

“And they all think they’re getting rich. That is the amazing thing. They think they can get rich by spending their money.

“Where did this consumer spending idea come from? That’s what I want to know. It’s crazy. No respectable economist ever thought you could get rich by spending your money. It’s saving that produces wealth – the opposite of spending. It’s saving and investing and profits. Anything else is pure mumbo- jumbo, nonsense.”

Dr. Richebacher was an infantryman in the German army in WWII.

“I was injured after only a few days,” he reports. “Then I spent two years in a hospital recovering. It was there that I discovered an interest in economics…”

A half century later, Dr. Richebacher is retired from his post as chief economist of Dresdner Bank. He lives in the south of France, walks with a silver handled cane and drives a sporty BMW.

Here at the Daily Reckoning, we recognize that predictions about the future are little more than tall guessing. Still, we can’t quite break the habit.

Lately, we’ve been wondering how long the current business downturn and bear market might last. “How bad will it get?” Daily Reckoning readers want to know. Here we offer another guess.

Intuition tells us that nature is symmetrical. Americans climbed a mountain of rising stock prices and apparent economic prosperity over the last 18 years. We imagine that the other side of the mountain will be similar. What goes up, we figure, will go down about as much.

Experience tells us that this is how things work in the topography of markets as well as that of mountain ranges.

Every bubble is fully corrected. Every one. There have been no new eras. None.

Each correction has taken prices – whether it was the price of gold or of Kuwaiti stocks – back to the long term trend. There have been no exceptions. Ever.

In the 20th century, there were two 17-year bear markets – one from ’29 to ’46 and another from ’65 to ’82. And there were two major bull markets, one 20 years long, from ’46 to ’66, and another 18 years long, from ’82 to 2000.

Each major bull market has been corrected by a major bear market of nearly equal duration. How could it be that, this time, an 18-year bull market will be set right by only 18 months of falling prices? How could it be that prices at the bottom of this short bear market cycle are still higher than at the top of previous bull markets? The idea contradicts both intuition and experience.

Kurt Richebacher points out that it contradicts theory too.

“This is the worst bubble in economic history…worse than ’29…worse than Japan…

“There is no theory of economics that says that consumer confidence is the key to prosperity,” he says. “What matters is savings and business profits. It is profits that are the key. And this new Information Age. What a joke! It is the Misinformation Age. Everybody had so much information they didn’t seem to notice anything important. That is true for economists too.

“Nobody noticed that profits were collapsing. Now we know that the new technology is essentially profitless.”

Dr. Richebacher is an essentialist. He reduces economics to its important features and rarely takes his eye off them. So concentrated is his attention on these economic verities that his conversation rarely strays. You feel a Maryland legislator could choke to death on a granola bar right in front of him and he would continue talking about productivity figures. At least you hope so.

“At the end of July, some new information came out that completely demolished the myth of American prosperity. Productivity proved to be no better than it has always been. In fact, the number is still flattered by these hedonic adjustments that they make. The real number for productivity growth is probably zero. All this new technology has made no improvement in productivity.

“And profits, too…the number was revised downward at the end of July. Now we see the whole technology sector is operating at a loss. And even at the height of the tech boom, profits were greatly inflated by stock market profits. Since the end of ’98, the entire technology sector has made no profits. Nothing. It has been a profit catastrophe.

“The real cause of the economic slowdown is the lack of profits – which has lead to a collapse in capital spending. But who notices? No one!”

No one but Kurt Richebacher and a handful of Daily Reckoning readers.

Instead of guessing about the future, Dr. Richebacher noticed that Americans have been impoverishing themselves in the last few years. Believing that they were getting rich in stocks (and now real estate), Americans stepped up consumer spending – thus wasting the savings that real prosperity requires.

“The problem in America is not consumer confidence,” explains Dr. Richebacher, “but the excessive confidence that Americans feel in the future. And the Europeans believe in this American delusion even more than the Americans themselves. They continue to finance U.S. deficits. Total U.S. dollar assets outside of America have now reached $9 trillion – almost equal to U.S. GDP.”

Foreigners may be dumb, Dr Richebacher believes, but stupidity runs in cycles, just like stock market prices and hemlines. Pretty soon, Europeans are going to feel they are a little bit too exposed to the dollar. They’re not necessarily going to dump all their dollar holdings, but they are going to hedge.

“When the hedging begins,” Dr. Richebacher ventures a guess, “we will have massive deflation of all kinds. The dollar, stocks, bonds, real estate. Everything.”

Stay tuned…

Bill Bonner
September 4, 2001

Markets were closed in America yesterday. Nothing much happened.

No news is good news.

But a friend who is visiting has noticed that one of Pierre’s bulls seems to have a gift for stock market prophecy.

“I’m not kidding,” he told me over dinner. “I think I’ve found a new bull market indicator. Since last week I’ve been watching the big bull in the field next to the house. If he’s down in the south end of the field in the morning – stocks fall on Wall Street that day. If he’s in the north end – stocks rise. He spent most of his time in the south end of the field last week. But on Friday, he was up a little.”

Yesterday, my friend did not bother to check the bull. Markets were closed. I have not yet received today’s report on “Ol Ferdinand.”

“Bill, how do I get in on that tobacco program?” asked a DR reader, by email, this morning. “I figure I can not grow tobacco as well as the next guy. Heck, I can not grow a lot of tobacco. But, at $1 a pound, I’d be content to not grow just 50,000 lbs a year. I’m not a very ambitious farmer, as you can see.”

“When are they going to start paying publishers not to publish?” asked another reader. “I’ll bet you’ll be happy when they introduce that program.”

The Daily Reckoning