Prisoners Of The Average

“Every sweet hath its sour; every evil its good…. For every grain of wit there is a grain of folly… Nature hates monopolies and exceptions…”

Ralph Waldo Emerson

“We are all going to paradise!”

He sings this popular French song from time to time, but he is neither a singer, nor French. He might be Chinese, Korean, or maybe Japanese… He speaks both French and English…both with a heavy accent. No one seems to know where he came from nor what he is doing in the neighborhood where I have my office.

Yesterday, he was stretched out on the rue de la Verrerie – lying on his back with his head resting on a paving stone, as peaceful and serene as an abandoned car. His ribs stood out as though he were starving, with deep hollows where most men his age have slabs of fat.

All we know about him is that he is our village idiot. He sings at the top of his lungs, gets drunk, and passes out on the pavement.

In paradise, dear reader, perhaps a man can drink all he wants, and stay happily drunk forever. But in this world, a binge of inebriation comes at a price…a headache, or perhaps only a period of quiet repose.

That is the way of all nature. Every extraordinary event is compensated by many boring ones. Every big debt is offset by a big credit. Every large breath of air we take in must be followed by one just as large that we let out.

We are all prisoners of the average. This is not merely an intuition…it is based on observations too varied to try to organize by genus and phyla. So I will just heap them up in front of you: darkness and light…yea and nay…heat and cold…good and evil…sickness and health…wealth and poverty…beauty and ugliness…subjective and objective… positive and negative…big, little…high, low…just, unjust…you name it.

There are times, of course, when things seem to get so out of balance that it is hard to recall where the average was.

Stock market investors, for example, enjoyed an extraordinary period of returns from August of 1982 until January 2000. During that period, the Dow went from under 1,000 to over 11,000, giving investors a rate of return of 18.2% per year.

“Stocks do not always do as well as they did in the ’80s and ’90s,” notes David Tice. “In fact, those were the best back-to-back decades for stocks in 200 years.”

After such a binge of profits, is it any surprise that, for the last two years, the Dow has taken a rest? Dow stocks have gone nowhere since May of 1999.

The Fed has helped twist the U.S. economy into an extraordinary, almost grotesque, form. By keeping the price of credit too low for too long, and giving the impression that it could guarantee boom-like conditions forever, America’s central bankers have encouraged people to act in a way that previous generations would have thought imprudent: buying too many stocks at prices that were too high, spending too much money, and borrowing too much to pay for it.

Alan Greenspan nurtured the idea that the U.S. economy of the late ’90s was an exception to nature’s demand for ordinariness. Information technology was supposed to be so different that the old averages would no longer apply. And the central bank itself was credited with a talent that no central bank had ever before had: an ability to keep the economy expanding forever, without interruption.

Mr. Greenspan was allegedly capable of preventing the return to average debt levels and average stock prices. His trick? Cutting rates whenever normalcy threatens. Yesterday the Greenspan team cut rates for the sixth time. Five previous cuts failed to produce the desired effect. But there is always hope for the 6th, or 7th. If a real fed funds rate of zero doesn’t do the job, perhaps – 1% or -3% will.

Paul Kasriel reports that total debt as a percentage of the nation’s nominal capital stock has gone from about 45% in 1982 to more than 90% today.

“The U.S. borrowed from the rest of the world on average an amount equal to 4 «% of nominal GDP,” in the 12 months ending in March, Kasriel elaborates, adding that this was “the highest absolute and relative borrowing form the rest of the world in over 40 years.”

Will this unusually carefree spending be followed by a period of penny-pinching? It seems a good bet.

‘Res nolunt diu male administrari,” you might say. Of course, practically no one, apart from perhaps the Pope, would have any idea what you were talking about. So, translate: “Things refuse to be mismanaged long.”

Your editor,

Bill Bonner
Paris, France
June 28, 2001

“Fed’s Magic Tonic Isn’t Working,” says John Crudele in the NY Post. Why not? Because banks are tightening lending standards to protect themselves from a wave of defaults. Corporate bonds yields are up since January. Credit cards have reached minimum interest levels. And mortgage rates are higher than they were before Greenspan began cutting rates.

Greenspan can lower the fed funds rate – but that doesn’t necessarily cause the price of credit to fall.

Still, what else can the Fed chairman do?

“If Greenspan were truly a manly man,” Eric Fry reports from Manhattan, “he’d have marched out today and barked, “Inflation be damned!” and ordered interest rates cut by one-half a point. Instead, we got a wimpy 1/4-point cut. Chairman ‘Baby-steps’ returns to form.”

That is the problem with having fame and power, dear reader, it robs a man of strength. “The President [pays] dearly for his White House,” observed Ralph Waldo Emerson. “It has commonly cost him all his peace, and the best of his manly attributes. To preserve for a short time so conspicuous an appearance before the world, he is content to eat dust before the real masters who stand erect behind the throne.” There is a price for everything… Every credit has a debit. For every village idiot there’s a genius. And for every period of above-average returns in the stock market, there must be a period when returns fail to measure up. More below…

But first, let’s hear from Eric about what happened on Wall Street yesterday:


From Eric Fry in New York:

– Bloomberg news succinctly captured the Street’s view, calling the Fed’s 1/4 point cut “an action that suggests they expect the economy to rebound and don’t want to risk stoking inflation by reducing rates too much.”

– Because the 25-bps reduction seems more measured than desperate, bonds and the dollar both “liked” the modest cut. Gold, on the other hand, “hated it” – falling $4.20 on the day.

– Mr. Market’s reaction fell somewhere in between. A little more irrationally exuberant rate cutting from the Fed might have been nice. On the other hand, the modest rate reduction means that Greenspan and Co. think the economy is recovering (right?), which should be good for stocks (right?)

– After weighing the pros and cons. Mr. Market reached no clear conclusion. The Dow dropped 37 points – its fourth losing session in a row – while the Nasdaq tacked on 10 points.

– America’s economy is probably the largest ever to run on “hope” for extended periods of time. Greenspan, like any good “Confidence Man,” fans those hopes to achieve his goal of keeping the US economy moving along. With his interest rate cuts of various sizes, he encourages folks to attempt heroic acts of consumption and indebtedness they might otherwise avoid.

– Consider, the impressive resilience of home and auto sales… while consumers are fully aware that current economic conditions stink, they remain resolutely persuaded that the near-future will be much, much better. (Keep hope alive!)

– Consumer confidence bounced Tuesday to its highest level of the year – rising to 117.9 from 116.1 in May. That too is good, right? Yes, but the consumer is not quite so confident as he appears. The Consumer Confidence Index contains two other indices – one that measures current conditions and one that measures future expectations. Bridgewater Associates reports that while consumers’ expectations for the future are rising, “consumer attitudes towards their present situation continue to decline.” Specifically, as the future expectations index surged 7%, the overlooked present situation index fell 3%.

– Faith in future economic prosperity cannot sustain consumer spending indefinitely. Only 6.7% of the survey respondents said that they would buy a car in the next six months, the lowest number in years.

– Likewise, despite the recent resiliency of housing sales numbers, consumers’ plans to purchase a home dropped in June. ISI confirms the findings: “Our survey of 13 geographically diversified homebuilders slowed for the third week in a row…traffic has been slower again in Northern California, and cancellations are occurring in the Bay Area. As one [survey] participant puts it, ‘The lights are out!'”

– A lot of folks in the know agree with the consumer that the “present situation” isn’t so great.

– Delta Air Lines’ President, Fred Reid, told Business Travel News this month, “Business travel is dropping off precipitously… We are in the deepest slump I’ve seen in a decade or more… We don’t see it getting deeper, but we also don’t see it getting better.”

– Anivan Banerji, director or research at the Economic Cycle Research Institute, speaking to Grant’s: “Given that – industrial production, employment, manufacturing and trade sales – are going down in a way seen only in recessions, either we are in a recession, or this is the worst non-recession ever.”

– The “Stock Market for the Next 100 Years” just announced its first job cuts in 15 years. Blaming – what else? – “market conditions,” the Nasdaq plans to trim its workforce by 11%. The most debilitating market condition of all is the fact that the number of IPOs has collapsed 78% so far this year. When you’re in the bubble business, there is nothing fun about bubbles bursting.


Back to Bill in Paris…

*** Yesterday, I reported that things will either get better or they will get worse. “The current stagnation of the US economy is unstable,” adds Martin Wolf in the Financial Times. “The US central bank is in a race against time. If it does not succeed in re-starting the economy soon, a further slide seems almost certain.”

*** Why is this? “Suppose then that the present stagnation continued,” Wolf explains. “Given the excess capacity, downward pressure on profits would increase. Productivity growth would initially remain slow, further squeezing profits. This would force large-scale redundancies, accelerating the rise in unemployment. The combination would threaten a still highly valued stock market. It would almost certainly shrink investment. Above all, it would shake consumer confidence. The overwhelming probability would be a deep recession, followed by a painfully slow recovery, as in almost all post-bubble economies.”

*** But who knows? Yesterday, the Fed put the key interest rate down to 3.75%. With inflation at 3.6%, this puts the real rate at near zero. Will free credit have the same effect in the U.S. as it had in Japan?

*** “In early 1929, after the markets had gone through a choppy period and just months before the worst stock market crash of the 20th century,” John Myers tells me, “Bernard Baruch – one of the great speculators of his time said:

‘For the first time in history, we have sound reason to hope for a long period of peace. For the first time, the business men of all nations are supplied with statistical information, together with some understanding of the laws of economics. For the first time, we have sound centralized banking systems in all the countries and closer cooperation between those systems internationally. Because all these factors are favorable, and because of the universal stirrings of desire and ambition… I believe in the industrial renaissance.'”

*** “Baruch was already shorting stocks during that period,” Lynn Carpenter, editor of The Fleet Street Letter, explained it to me: ‘The government asked Baruch to talk up the economy.'”