Osama Bin Smoot
Reed Smoot and Willis Hawley are household names. But only in the households of economists. There, the names Smoot and Hawley come up from time to time, rarely in a favorable context. Were it not for a single piece of exceptionally lunkheaded legislation masterminded by the two in 1930, the pair might have passed into history unremembered. Instead, the two politicians are widely blamed for snuffing out candles during the darkest period of U.S. economic history.
What makes people prosperous, we ask again. Is it pieces of paper or lumps of gold? But if printing currency could make people wealth, the Germans in the early ’20s would have been the world’s richest people. Presses ran night and day to supply Fritz und Frau with paper currency. But so quickly was the new currency marked down that workers demanded to be paid twice a day…so they could rush out and spend their new bills before they became totally worthless.
Likewise, if gold made people rich, Spain would have gotten immeasurably richer in the 16th century – after its conquistadors discovered a whole new world of it. Instead, as reported in these letters, Spain was not enriched by the new gold that flowed into its coffers, but impoverished. Even today…the world’s chief suppliers of the yellow metal, Russia and South Africa, are far down on the list of the world’s most well-heeled nations.
No, dear reader. It is not money that makes people wealthy, but the ability to make things that you can trade with other producers. Money is only valuable insofar as it represents real productive assets.
It follows that anything that inhibits people from being able to produce or trade makes them poorer. War, for example, typically impairs trade. On the other hand, war-time factories gear up for extraordinary feats of production, so it often appears that people are getting richer – even though their output is of little peacetime value.
Other impediments to production and trade include high taxes, tariffs, theft, piracy, inflation, currency crises, and so on. In 1930, pressed by conniving businessmen for protection from foreign competitors, Misters Smoot and Hawley chose tariff barriers as a way to stymie world trade. They succeeded all too well. Foreign nations were soon raising retaliatory barriers of their own. Soon, trade slowed and the entire world went into a deep recession.
Smoot & Hawley have long since shuffled off this mortal coil. But Osama bin Laden, Pat Buchanan, and George W. Bush are, we assume, still alive. Any one of them could do as much damage as Smoot and Hawley combined.
"The U.S. economy will take a staggering $639 billion hit through 2003 and lose as many as 2 million jobs as a direct result of the Sept. 11 air attacks," says a Reuters report.
But that is just the beginning.
"Globalization is in trouble," writes Stephen Roach. "One of its key premises – increasingly frictionless cross-border connectivity – is in doubt as the world responds to terrorism. The events of September 11 have imposed the equivalent of a new tax on trade, capital and information flows…National borders will have to tightened. Cross-border transfers will take longer. Insurance rates on shipping will go up, as will premiums for worker compensation…"
Here at the Daily Reckoning, we suspect that terrorism is over-bought. A huge, worldwide network of terrorists – armed with the latest technology, supported by billions in secretive funds, enlisting an almost unlimited number of suicidal maniacs – is supposed to exist. Everybody says so. But not a one of these fanatics has bothered to strike a single blow against the U.S. since September – even as U.S. armed forces sought to destroy the terrorist’s leading archangels.
In Palestine, hardly a week goes by without an explosion going off somewhere. What is wrong with the anti-American terrorists? The axle of evil barely seems capable of a single turn against the U.S. Perhaps there are not really as many terrorists as people think.
But the world’s anti-terrorist industry is geared up and enjoying a boom – at the expense of the world’s economy.
Barron’s recently published an alarming article on the nation’s rail system. "It’s high time Americans had more security for freight containers," says the headline. Why? Because "whole trains of containers on flat cars ride the rails through U.S. cities, past key industries such as oil refineries, over and under highways, through tunnels and across bridges, some of which are potential bottle-necks in the national freight-transportation system."
What’s in the containers? Nobody really knows. It takes too long to inspect them all, so most of them are never opened until they reach their final destination. In the meantime, the contents could be controlled electronically – even by a simple cell phone.
A container could be loaded at any one of hundreds of terminals all over the world – in India, Pakistan, the Persian Gulf, North Africa…it could make its way through the major freight terminals at Rotterdam or Hong Kong and then enter the U.S. at Baltimore or Los Angeles. Osama bin Laden, by the way, is said to have owned 20 freighters. Who knows what might happen.
But a lot of people don’t want to find out. Even at substantial cost and delay, they want the boxes inspected before they even reach the U.S., which would mean substantially higher shipping rates.
"The risk premium of globalization has just gone up," comments Stephen Roach. "That undermines the global earnings stream of multinationals. Suddenly, the brave new world looks a lot less frictionless than it did before."
"The costs of terror are one thing," Roach continues. "But globalization now faces challenges from the business cycle, too. The world is in a rare ‘synchronous recession’: all the major economies are stumbling at the same time. This is unusual for three reasons. First, the global economy is more dependent than ever on trade, which now accounts for a 24% share of world GDP."
That’s a lot more, Roach points out, than in previous global recessions. In 1975, global trade was only 17% of world GDP. It was only 19% in 1982.
Roach: "Second, the world faces the sharpest ever boom-bust in trade. Global trade volumes surged by a record 12.4% in 2000 but shriveled after the pop of the tech bubble, with 2001 likely to show an increase under 1%.
"Third, the world has become unbalanced, far too dependent on the American growth machine."
In the last 20 years, the U.S. growth machine has powered the entire world. But who will power the U.S. when its growth engine stalls? Maybe no one.
Signing off for the week,
February 01, 2002 — Paris, France
Stocks rose yesterday as the lumpeninvestoriat rushed to get in on the next bull market. They’re pretty sure a bull market is coming; everybody says so.
So what if stocks are trading at prices only seen at the end of bull markets, not at their beginnings? So what if profits as a percentage of GDP have fallen to levels not seen since the Great Depression? So what if consumer debt has reached a record relative to income – 18.9%? So what if corporate bond defaults hit a new record high in January?
So what if, as Dr. Kurt Richebacher reports, the U.S has just suffered the "steepest decline in economic growth that has ever happened," from an annual rate of 4.1% 1998-2000 to negative 1.1% through the third quarter of 2000? So what if the tiny positive bump in growth in the 4th quarter was almost all a feature of auto sales and defense expenditures (neither of which can be sustained for very long)?
"On bold investor of the future!," writes the Mogambo Guru, "Thou art surely an idiot."
But "wow! That was a brutal recession! I sure am glad it’s over," says Eric Fry.
Well, you just never know.
In the late ’90s, Americans enjoyed the biggest financial bubble in history. Now, here we are, early in the next millennium, and we are blessed again – this time with the feeblest recession ever. Maybe no recession at all…"Some day I wouldn’t be surprised if we go back and take a look at this whole episode," said Charles Lieberman on CNNfn, "and really question whether or not we really had a recession."
Could it be, dear reader? Could we all be wrong about symmetry…about sheep…about everything? Is it really a New Era, after all? More below…but first…
Eric, what do you really think?
Eric Fry in Manhattan…
– That bear market was pretty nasty, too. What a relief to have that behind us! And thank goodness everybody has stopped spreading all those frightening stories about accounting fraud. That was very upsetting.
– Without any brand-new reasons to sell stocks, investors decided to buy some more yesterday. The Dow jumped another 157 points to 9,920, while the NASDAQ tacked on 1% to 1,934.
– Happily the bad news is behind us, and the economy is back on an even footing. The fourth quarter’s 0.4% GDP growth is all the proof that most folks require.
– But even if the national economy is rebounding, the country’s largest city is still reeling. "New York City’s economy deteriorated sharply in January," says Crain’s. "The composite number for the business conditions index [from the Institute for Supply Management] registered a chilly 32.6. That number is down sharply from the 62.2 registered in December."
– American corporations are beset by some chilling numbers as well. "Cash Flow and Profits Drop to Record Low Versus Debt," proclaims the latest Moody’s Credit Perspectives. As of the third quarter of last year, corporate cash flow and profits both fell to record lows relative to corporate debt levels.
– In fact, cash flow based on this measurement peaked in 1994, while profits peaked in 1997. So much for the "productivity miracle."
– What kind of productivity miracle causes corporate cash flow relative to debt to shrink steadily between 1994 and 2001? And what is so miraculous about pretax profits relative to debt collapsing between 1997 and 2001?
– Furthermore, isn’t it curious that corporate cash flow relative to debt hit its high-water mark in 1994, but profits relative to debt did not top out until three years later in 1997? How, you ask, did earnings continue to rise without a commensurate increase in cash flow? Accounting, my friends. The biggest productivity miracle of the last decade may have occurred in America’s accounting departments. The corporate bean counters discovered ever more innovative ways to show a profit on the books, even when the "profits" produced no cash.
– Meanwhile, the cash-flow spigot in U.S. households is not exactly dashing. A steadily rising number of credit card holders are paying their bills late, or not at all. The bad loans write-off rate has now risen for 10 straight months, while the delinquency rate has risen for 12 straight months.
– Curiously, these credit card repayment trends are deteriorating despite soaring mortgage originations. How can this be? Shouldn’t refinancings help consumers "pay off those credit card debts," just like the late-night TV ads promise? They should be…but they aren’t.
– In such a world of indebted corporations and consumers, a world of overvalued stocks and Fiat currencies, a world where CEOs sometimes don’t tell the whole truth and nothing but the truth, shouldn’t the gold price rise…even just a little? The answer is an unequivocal "probably."
– But like resisting a bad habit, many investors try to suppress the urge to buy gold. As longtime gold investors are well aware, the gold market has been a financial "Lorelei" – the mythical Rhine River siren who beckoned mariners dangerously close to the rocky shoreline. The seductive yellow metal, which promised to succor investors in times of trouble, has instead suckered investors – luring them onto the shoals of capital loss.
– "A Financial Times article from last Friday reports that gold retailers in Tokyo are seeing an increase in bullion sales" observes Strategic Investment editor Dan Denning. "Japanese savers are cashing in their yen holdings and taking home gold."
– Are the Japanese ahead of the curve, just like they were with sushi and Pokemon? Will we Americans follow their lead if our currency’s value recedes? The Financial Times story implies that we might. The British journal relates: "Yoshihiro Matsumoto, who runs the gold retail division at Mitsubishi Materials, says, ‘Normally, our customers buy 1kg-5kg of gold, but recently, they’re buying huge amounts. And most people want to take their gold home rather than have it in a bank deposit box.’ Yoshiko Mizutani, who manages a retail store called The Gold Shop, explains it succinctly: ‘Customers tell me that even if the price of gold falls, it’ll never fall to zero. But if their bank goes under, they worry their savings could disappear.’"
– Don’t the Japanese know that they could buy Cisco instead?…Oh, the things that Abby Joseph Cohen could teach the Japanese!
Back in Paris…
*** Last night, you editor was deeply troubled by all this good news. It was as if he’d just learned that his dog had died and his wife had run off with the cheese monger. But he couldn’t quite believe it.
*** Passing along the rue de la Verrerie towards the metro, he espied the oracular figure often seen passed out on the pavement in front of the Paradis Bar. But last night, the Chinaman must have been unable to cadge any serious coins from pedestrians…or perhaps he had just been a guest of the local gendarmerie…for the little nipper was as sober as a Baptist.
*** "What gives," I asked him. "Is it true? Is that all there is to the recession? Is it over…or has it just not happened yet?
*** Expecting a grunt, your correspondent was surprised by the reply: "I have been pondering the same set of curious statistics," came the answer. "I believe the current optimism is misplaced."
*** "Ah…I’m flattered that you have asked," said the inscrutable face, a twinkle rising in the eyes, "but I do not give strategic economic forecasts for nothing. If you wish me to continue, a donation of 10 francs will be required."
*** So, I reached in my pocket and handed the oracle a 10-franc coin.
*** "You see," he said, "around here they call me a Chinaman. But I’m really Japanese. I was once a fund manager for Nokimura, with one of the largest equity portfolios in the country. Well, do you remember when the Japanese market started going down in January 1990? The economy headed down, too. But soon, stocks rallied. And the economy bounced too. Real GDP rates never went negative in the early ’90s in Japan. And by 1993, growth rates were actually increasing. And like everyone else, I believed the glory days were still ahead, not behind us. By 1993, it looked like both the bear market and the economic slump were over. I went long stocks. I didn’t want to miss the next big boom. Boy, was I wrong…"
*** At this point, the Chinaman broke down. Tears filled his eyes. I reached into my pocket again, handed him another 10-franc piece and walked on.
*** More on the recession that hasn’t happened yet…below.