Revolution #9

“This is real,” said my lunch companion yesterday. We were seated in the elegant dining room of the Maryland Club, founded by Napoleon Bonaparte’s brother, Jerome. The Corsican became attached to a Baltimore girl, Isabel Paterson, and lingered here longer than he expected.

Baltimore’s women once played a large role on the world stage. A century after Isabel, Ms. Wallis Simpson captured the heart of Edward VIII. He gave up the British crown to marry her.

The Baltimore woman sitting across from me used to be a commodities trader.

“But no one is interested in commodities,” she explained. “As Marty Zweig says, ‘don’t fight the tape.'”

So what is she doing now? Advising dot-com entrepreneurs on how to get to the public markets. Many of them have no money, no business plans and no credit — so she is paid in stock options.

“How’s business?” I asked.

“Great,” she replied, speaking for a whole industry…and perhaps a whole generation.

She went on to describe one of the businesses with which she is involved.

“The atmosphere is crazy,” she said. “Those guys work 24-7 [the current expression for `all the time’]. They sleep in the office. It’s more like revolutionary party headquarters than a traditional business.” Hmmm…

The company in question is trying to sell newsletters on the Internet. I’m conceited enough to think that I know something about the newsletter business, having worked in it for the last 22 years. So I asked for details.

Turns out that a group of entrepreneurs has raised $10 million based on a business model which, in my opinion, has no hope of success.

“Oh yeah?” she replied when I explained that a person would have to be a fool to invest in such a venture, “Well, the fools have already made 10 times their money — the company is getting bought out for $100 million.”

All of a sudden, it was clear who the fool was. He was eating a hamburger…sitting across from a former commodities trader…and feeling once again like the barbarians were settling into his house for the winter.

“It’s real,” she repeated. “The Internet changes everything.”

Occasionally, I get responses from people who get `The Daily Reckoning’ for the first time. “Boy are you out of it,” is the gist of many messages, echoing the theme we hear so often. “You don’t just don’t get it. Thanks to the Internet, it’s a new world.”

But just saying so doesn’t make it so. Is it really a new world? Or will we have to make do with the old one, at least for a few more years?

Long time `Daily Reckoning’ sufferers will realize that I am very susceptible to what George Orwell called “the lure of the profound.” If there is a well around, I will fall into it.

For the benefit of new readers, of whom there are many, my goal is to try to connect as many of life’s dots as possible. Then, with a dim understanding of what is going on around us, I look for the “trend whose premise is false” — because that is where you find investment opportunities. Investments are priced either too high or too low, depending on the false premise du jour.

Alas, I often stoop to profundity…and fear I will do so again today. What’s worse, it is profundity on a subject that I had promised to avoid — the New Era of the Internet. I keep going back to it. It is like a bad accident that hasn’t happened yet. I crane my neck to see it — knowing that I will be appalled.

Alan Greenspan has raised the same question: is it real? Is it “a once in a century acceleration of innovation,” as he hypothesized in a speech to the N.Y. Economic Club, “which propelled forward productivity, output, corporate profits and stock prices at a pace not seen in generations, if ever.”

Or, “just one of the many euphoric speculative bubbles that have dotted history”?

I will answer this question…and provide a more profound explanation for the New Era of the Internet…tomorrow.

Your very profound correspondent,

Bill Bonner

Baltimore, MD February 3, 2000

P.S. For the benefit of new readers, I’m including the Contrarian’s Glossary along with this message.

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BILL BONNER’S CONTRARIAN’S GLOSSARYFin de Bubble — This is the term I use to describe the spirit of our age. We live in a world which is waiting for something to happen. In the meantime, people are all very optimistic about the future — especially the financial future. Like people during the “fin de siecle” period of the Gay ’90s and pre-WWI, they are impressed by technological progress and see few clouds on the horizon. WWI ended the “fin de siecle” sentiment. What Archduke waits to be assassinated so our fin de Bubble can be entered in the history books?

Chateau — This French word might be translated as “money pit” or “place for people who don’t like Internet stocks to lose their money.” By way of introduction, I am the publisher of a group of investment services, called Agora Financial Publishing. We have offices in Paris, London and Baltimore. I had a choice. I shuttle back and forth between these offices. But I chose to live in France and bought a chateau not far from the late David Ogilvie’s much larger pile. Chateaux are the only investments that have lasted — in a single family — for the very long run…a period of 1,000 years or more.

Dirigisme — This is also a French term. It is the modern French version of Plato’s ideal form of government — where you get smart people together and they tell everyone else what to do.

America’s Last Great Capitalist — New Era advocates maintain that the end of communism and the rise of the Internet have ushered in a golden age of capitalism. Not so. Instead, capitalism is dying. Marx defined capitalism as the system in which investors put up the money to build factories…and workers were then exploited by them. This is no longer the case. The new workers don’t need capitalists to provide the machinery of wealth building. They own their own laptop computers. They’ve seized the factories. This is bad news for capitalists. Money no longer counts. It’s human capital that is important. This is the capital that workers carry around in their capitas. Microsoft’s main competitor, the Linux operating system, was built as freeware…an “open source” product that relied on voluntary efforts from programmers all over the world, cooperating without the benefit of payrolls or health insurance. No capitalists were involved. And no investors could profit from it. Linux is also made available free over the Internet to anyone who wants it. The pros say it is better than MS-DOS.

Creative Destruction — The economist Schumpeter came up with this expression. It describes the natural process of open markets — where old companies and old technologies are destroyed by new ones. Dirigisme tries to block the forces of creative destruction. By contrast, laissez-faire, another French term, lets the chips fall where they may. Bill Gates, America’s Last Great Capitalist, built his company on the dirigiste model. Linux is an example of the laissez-faire approach. Gates created vast wealth. Linux, and/or the process of Creative Destruction, will destroy it.

Investing — This the activity that many people say they do but few understand. It involves studying the likely stream of income from an investment, anticipating its growth or decline and adjusting for risk. Most of today’s “investors” wouldn’t know a balance sheet if it bit them on the derriere — which, I predict, it will.

Graham and Dodd — These are the guys who wrote the book on investing.

Warren Buffett — their most brilliant student.

Gambling — what you do with your excess money when you are too lazy to invest the way Buffett does. Speculating — This is what you call gambling when your wife asks what you doing.

Internet Investing — This oxymoronic term describes what people who don’t speak French do with their unwanted money. For example, they buy Microsoft, or our “River of No Return” stock, Amazon. The convention among Internet stock buyers is that the company is worth a P/E equal to its rate of growth. Thus, MSFT, growing at 25% per year, should sell for 25 times earnings. It sells for twice that much now…50 times earnings. That’s a lot of money for a mature company that is bound to be the victim of creative destruction. AMZN is growing at 70% per year. But the trouble is, it has no earnings. So you can’t apply the formula. Most likely, AMZN will never make money. Most likely, it will disappear…just as the 400 publicly-traded radio companies of the `20s disappeared…and the 497 auto companies.

The Heart of Darkness — where Internet investors go…the horrors!

Moore’s Law — a key to understanding new tech investing. Moore said that computer power would double every 18 months. Interestingly, statisticians use this device to ramp up the GDP figures…arguing that a computer purchase today is worth more than the actual dollars exchanged. They never applied this logic to autos or any other sector, but some $300 billion of these fictitious “chained dollars” have been added to the nation’s GDP.

Metcalfe’s Law — Metcalfe noticed that a system like the Internet becomes more valuable the more people use it. Like the telephone, the first phone is virtually useless. The millionth, by contrast, is exceptionally useful. Thus, the value of the system itself increases exponentially as its use becomes more widespread. Another curiosity, Metcalfe’s Law helps explain why the dollar has been such a hit all over the world. Investment Biker, Jim Rogers, driving around the world with his girlfriend, Paige Parker, reports that he can use dollars almost everywhere — and in many places where even the government won’t accept its own currency. Dollars have become a worldwide medium of exchange — made more valuable simply because they are so ubiquitous.

Triffin Paradox — The trouble with making a currency the world’s leading brand is that do to so, you have to print a lot of them…and export them vigorously. Each dollar is an IOU from the government. The more outstanding…the weaker the issuer’s balance sheet and the less each one is worth. Eventually, Triffin and Metcalfe will have to come to terms.

Bonner’s Law — This one is eponymous. It describes the interaction of Moore, Metcalfe and the process of creative destruction. Moore and Metcalfe are used by Internet investors to justify high prices. Why not pay a lot, they say, when the whole industry is evolving at an exponential rate? Bonner’s Law predicts that the revved up speeds of creative evolution in the Internet marketplace will produce revved up rates of destruction too. Moore + Metcalfe = Creative Destruction squared. Investors may want to gamble on Internet companies. But they should pay very low prices, not high ones. Low prices recognize the truth — that the company is most likely to fail.

Buffett vs. Gates — This is shorthand for the conflict between the older, Graham and Dodd investment approach…and the younger, Bill Gates/Jeff Bezos wealth creation formula. The eminent Graham and Dodd investor, Warren Buffett, for example, won’t buy Internet stocks or even Microsoft…though he knows the company and plays bridge with Bill Gates. Internet investors, on the other hand, who tend to be younger, believe that Moore and Metcalfe trump Graham and Dodd. This technology is exploding so fast, they say, the old standards no longer apply. The old guys just don’t get it. Who will “get it” in the end remains to be seen.

Esperanto Money — this is the term I apply to the euro. Esperanto was a made-up language designed to make it easier for people to communicate. It flopped. The euro will flop, too.

Gold — Gold is a heavy, yellow metal, rarely seen or spoken of. It is a barbaric relic that has been going down in dollar terms for the last 20 years. It is about the only thing you can leave on the seat of your car in Baltimore without worrying about the windows being smashed.

The dollar — more valuable than gold…the dollar has nevertheless been going down in value since the Federal Reserve system was set up more than eight decades ago to protect it.

Bernoulli’s Principle — Three centuries ago, the Swiss mathematician noted what economists call the declining marginal utility of money. Each additional dollar you earn is worth less to you than the last. For example: suppose you have $5 million. You are offered the chance to flip a coin. Double or nothing. If you win…you gain an additional $5 million — which won’t change your life dramatically. But if you lose — you are wiped out, which will make a big difference. The implications of this are that zero-sum “investing” games…even with 50/50 odds…don’t make sense.

Schadenfreude — a marvelous German word that helps contrarians through bull markets that refuse to end. It describes the delicious pleasure you take in seeing other people lose the money you never made.

M1, M2, M3, M&Ms, MMMM… — these purport to measure the money supply. But few people know what they’re supposed to mean…and those who do can’t agree on what they really mean…don’t worry about them.

The Bed & Breakfast stage — This is a new phase in the life cycle of humans…wedged in between the career phase and traditional retirement. It usually kicks in when children have left home, careers have run their courses and a man’s balance sheet begins to look better than he does.

Sand, Small Towns and Old Towns — Where people go to have their mid-life crises.

Internet Time — that’s the speed at which traffic flies by the corner of Moore and Metcalfe…and what makes it such a dangerous intersection.

Head and Shoulders Pattern — Not to be confused with the dandruff shampoo, a head and shoulders pattern on a chart vaguely resembles the head and shoulders of a man. A very strangely shaped man. It is thought to be a precursor of a decline. But if the market doesn’t go down…the technicians take another look and tell you that it didn’t look like a head and shoulders after all. It was really a horse’s rear end.

A significant base formation — This is what you get when you sit around and eat too many doughnuts while reading the financial news.

Irony — This overused word refers to the contrast between what one anticipates or hopes for and the often- cruel, comic or curious actual results. Irony and poetry are the unseen regulators of investment markets, making sure people get what they deserve, rather than what they expect.

Festivus — Festivus is the name given by Philippe Muray to the latest phase in European (including American) civilization. The gods are all dead. So are the politicians. Who would die for his religion today? Who would die for his politics? Or for matters of principle? Serious ideas, holidays, ideologies, virtues, religions, cultures and convictions have all been hollowed out. They are no longer honored. They are merely celebrated.

*** Well, Mr. Don’t-Rock-The-Boat Greenspan did as expected and raised rates a quarter point. And the market did as expected, too — nothing.

*** The Dow was up a piddling 37 points. Nasdaq was up 21.

*** GM was down three after rising yesterday. I asked Karim Rahemtulla, who is an expert at option investing, “shouldn’t we be selling puts on GM?”

*** “Exactly,” he replied. “The speculators will pay you for the right to put the stock to you at a lower price.” Sounds like a good deal to me. GM is a bargain at current prices. I certainly wouldn’t mind buying it at a lower price.

*** Gold rose $2.30. The big news has been in palladium and platinum — up to $502 and $466 per ounce, respectively.

*** I had my old friend Rick Rule on the phone yesterday and asked about the prospects in the mining and exploration sector. “It’s the best market since ’91,” he replied. This may come as a shock to investors whose portfolios of Vancouver stocks are such an embarrassment that they hide them from their wives. But Rick thinks as I do — low stock prices are a good thing. It means you can find real bargains. Rick mentioned ATNA, which has $9 million in cash but a stock market capitalization less than that. Another company, Southwest Gold, is also valued at no more than its cash and other securities holdings. Like GM, the businesses are free.

*** The euro did not exactly turn around yesterday. But it did stop falling. At this level, cash-rich, stock- rich U.S. companies surely have their eyes on European acquisitions. I know I’m thinking about it. But my budget is modest — I’m just thinking about buying an apartment in Paris. I’m afraid we won’t see the dollar this high again for many years.

*** Europe is certainly not cheap, though. Almost all European stock markets were up dramatically last year. Germany went up 39%. France was up 51% (the CAC 40). But the further you go east, the better markets did. Polish stocks rose 41%. Ukrainian stocks were up 80% and Russia…is this a typo?…300%!

*** Meanwhile, IPOs in the United States last year gained an average of 187% from the offer price.

*** Amazon promised to lead investors out of the jungle yesterday and the stock soared 12%. Though the company reported its largest loss ever and ended last year with 50 cents in losses for every dollar of revenue, investors believe the company may be beginning to emerge from the heart of financial darkness.

*** Russia has taken Grozny. Remember that the Russians had offered a reward of $1 million for the head of Chechen general Basayev. No mention made of how much they would pay for other body parts. Alas, it was another body part they got when the general stepped on a landmine on his way out of the city.

*** I’m flying down to Nicaragua tomorrow. I’m looking at property on both coasts. I’ll let you know what I find.

The Daily Reckoning