Sacramento on the Siene

“California is still one of the best places in America to build a successful small business. All you have to do is to start with a large one.”

— Last week’s Wall Street Journal

Down by the river, crews of workers are turning the banks of the Seine into a beach. They put up palm trees – planted in huge wooden boxes so they can be removed at the end of the summer – set up beach chairs…even dump sand. Soon, people will be sunning themselves in the center of town.

It could be Southern California.

France is the world’s 5th largest economy. California, if it were a nation, would be ranked just ahead of it.

France has a little more land…and more than 20 million more people, but each Frenchman produces a little less than the average Californian.

Both have palmy trees and sunny places in the south; both have balmy people and shady characters in the north. Californians and French each think they are exceptional. Both have huge holes in public finances. And neither France nor California has a reserve currency of its own with which to fill them.

The French believe their centralized “model” is unique, exceptional…and better than any other.

Americans have recently become even more conceited; they think their system of democratic capitalism is superior to that of other nations – and especially superior to the French, whom they see as hopelessly socialized.

Not only do Americans think their system is superior, they believe it is destined to prevail over French social welfarism…in the same way that Marxism was once thought to be destined to triumph over the West…by immutable, historical determinism.

And yet we, who live and work under both systems, find the sting of the one lash little different from the sting of the next. It is the ways they are alike that irritate us; it is the ways they are different that please. Neither in Sacramento, Baltimore nor Paris can a man go about his business as he pleases. Even in family matters, the state thinks it knows best. In France, a woman who gives birth to her third child is required to stay away from work for 6 months to take care of it. In California, a new law provides state payments to an employee who stays away from work for the purpose of “bonding with a child new to the family.”

An entrepreneur may find it easier to start a business in California and pay slightly lower taxes…

…on the other hand, he will not eat as well, the women he ogles will not be as slim…he will not be permitted to drive as fast…nor to smoke in restaurants…and the building he works in will probably be uglier.

Americans delude themselves that their system of free enterprise was what beat the collectivists in Russia and now races ahead of the rigid social welfare model in France. They think they see victory signs in every pair of golden arches and Schwarzenegger movie they spot overseas.

They practically broke out into applause when Jean-Marie Messier consciously Americanized his French water company, turning it into a aggressive, debt-soaked entertainment conglomerate.

And then, of course, Vivendi did what leveraged American companies did following the blow-out of the early 2000s; it almost went under. And then, it was the French turn to applaud. The American system of cutthroat capitalism didn’t work, they said.

Colbert was one of the first great centralizers in France. He, too, created the first public pension system. In 1673, he put into place a system that would pay sailors to do nothing after they reached a certain age. The plan was intended to combat piracy, because the old sailors often took to that devilry after they could no longer get honest work; it was the only way they could feed their families.

Later, Otto von Bismarck took up the idea and created the first modern social welfare state in Germany in the late 19th century.

“We’ll take care of you,” said the central planners in Paris, Berlin…and later, Moscow.

“This was the exact opposite of the idea [which came, notably, out of the Scottish Enlightenment] that a man should take care of himself,” explained Michel at lunch the other day.

“America was founded on the idea that the individual knows what is best for him and should be free to seek happiness in his own way.”

These two ideas – central planning on the one hand…and individual planning on the other – were what separated America from the rest of the world. Americans think their model triumphed over the central planning model of the Soviet Union…and is now beating the pants off Europe’s lighter, softer versions. But it is just the opposite. Even in America, no one really argues against central planning anymore. That’s why there is a Federal Reserve System…a progressive income tax…social security…the SEC…OSHA…EEOC…FDA…and all the rest of the expensive impedimenta of a modern welfare state. Colbert, Bismarck and Marx have won, in other words, not Adam Smith.

Returning to California, we find in the land of the free the very problem that now preoccupies the French. And if you were planning to attend the Avignon Festival, the world’s largest theatre hullabaloo, this year – forget it. It is closed because France’s entertainment industry workers are on strike. They don’t care much for their government’s pension reform suggestions, and have let it be known in the traditional way.

Lacking a reserve currency, France must ultimately find an honest way to pay for the social welfare promises it has made. Or it must cut back on the promises. Those promises will cost $7 trillion, says Gerard Maudrux. Finding less than that under the seat cushions, the prime minister has proposed a longer period of work and set off a period of social unrest.

Meanwhile, the Golden State has the same problem. When the going was good – in the late ’90s – public pension benefits were increased 50%. Typically, no money was set aside to pay for them. Instead, California operates a miniature version of the U.S. Social Security system. It is pay-as- you-go, without a printing press in the basement to help out when the going gets tough.

The state receives about $65 billion in taxes. It is scheduled to pay out about $20 billion more than that next year. Over the next 2 years, the total shortfall is expected to be nearly $40 billion. Balancing the budget would require either a 47% tax increase…or a 35% tax cut. (We know which we would choose…but nobody asked us.) Most likely, Californians will get a little of each…and more public debt…and a new governor, too.

California readers know the story better than we do.

We write only to offer sympathy; they are not alone. Their state…their nation…and their situation is not so different, after all. Even a private company, General Motors, is in a not-so-different predicament. Unable to pay its pension promises, GM borrows…just like France and California.

Somehow, the same bad brew was taken up all over the world. Whether called French dirigisme…the quest for shareholder value…or dynamic American capitalism, they all have the same bitter aftertaste: neither voters, retirees, nor shareholders are likely to get what they were promised.

Bill Bonner
July 11, 2003


The Dow fell 120 points yesterday. Gold rose a bit. The dollar fell.

So, now we ask ourselves – is the rally over?

No one knows the answer. But no one needs to know it.

Yes, dear reader, you can buy stocks and hope some greater fool comes along and buys them from you at a higher price. But what fool is not already invested in this market? Serious investors are fleeing, not buying.

A recent newspaper column reassured investors that long- term buy and hold is still the best way to make money. Even including the last 40 months, it pointed out, investors would have made 10% annual gains over the last 10 years.

Of course, those 10 years included the biggest bubble years in all history. And the Dow began the period at only 3521. Knock 5500 points off today’s Dow and yes, maybe then investors could expect 10% annual gains. If they were lucky.

Or how about bonds? At least there you have a guaranteed yield, right? Right. Except the yield on short bonds is barely more than the inflation rate. And what do investors think? That bonds are going to go up in price? That Greenspan is going to cut rates even further?

But with the benchmark rate at 1%, how much cutting is there likely to be? How much are you likely to make – even if the economy does sink in Japan’s direction, with deflation and even lower yields? Not much, is our guess.

In a long slump, issuers of junk bonds would go bankrupt. And the issuer of the safest bonds – the U.S. government – would act as if it wanted to go bankrupt. It would drop dollar bills from helicopters, Ben Bernanke has implied, if that were what it took to avoid deflation.

We doubt that these measures would stop the slump. But we don’t doubt that they would stop bond buyers from turning a profit.

And now Eric Fry, tanned and fit after a sojourn at the beach, brings us the latest news:


Eric Fry in Manhattan…

– Unemployed consumers took a breather from buying tech stocks yesterday, as the Nasdaq slipped nearly 2% to 1,716 and the Dow tumbled 120 points to 9,036. The blistering hot Nasdaq could stand to cool off a bit…

– “Shades of 1999, the rally in technology stocks continues to amaze – and worry – Wall Street,” the Atlanta Journal- Constitution observes. “It amazes because of the 29% year- to-date rebound in the tech-laden Nasdaq composite index, and the 57% rise since the index’s low point last Oct. 9…It worries because it looks a lot like the kind of steep ascent that occurred in the late 1990s and culminated in the index’s all-time high of 5,048.62 on March 10, 2000.”

– The amazingly rapid ascent of Nasdaq leaders like Yahoo is also a bit worrisome…at least to those investors who are prone to worrying about such things. Shares of the Internet icon have more than doubled since January 1st and have more than tripled since last October.

– Investors clipped about 8% off of Yahoo’s market cap yesterday, when it reported earnings that were merely ‘in line’ with expectations. But that means that the stock still sports a nosebleed of more than 100 times its estimated 2003 earnings. Will Yahoo spearhead another Nasdaq rally during the second half of the year as the stock’s valuation soars to 200 times earnings? Could happen…but probably won’t.

– Yesterday, your New York editor returned from a four-day junket to Cape Cod. His “New York Yankees” license plate did not endear him to the rabidly pro-Red Sox populace of the Cape, but his cheerful New York personality triumphed over the locals’ prejudice. Remember, we always look on the sunny side of things here at the Daily Reckoning.

– The Cape is quintessential New England-style Americana. It hosts a timeless annual ritual that includes fried clams, lobster rolls, ice cream and sunburns. It’s true that sunburns are not quite as common as they used to be. But, amazingly, even with the invention of “spf 30” sunscreen, many vacationing Bostonians haven’t figured out how to use the stuff.

– Anyway, after four days of mulling about Cape Cod and overhearing the locals talk about having “a bowl of clam chowdah down by the hahbah,” your New York editor is a little bit out of touch with the happenings in Lower Manhattan. So he checked in with some of his contacts to see what’s going on in the financial markets.

– “Inflation is returning,” says Andrew Kashdan of Apogee Research, “and no matter what Greenspan says, that’s not necessarily a good thing. Rising raw material prices are likely to squeeze already-thin profit margins.

– “For all the apparent yearning for inflation (at least in some corners of our nation’s capital), there seems to be scant celebration of the real thing. And for good reason…It’s bad enough that some companies lack pricing power, and a squeeze from higher raw materials prices will only make it harder for them to profitably move the goods piled up on their shelves. Profits, employment and investment will all suffer.

– “As for the prospect of a significant deflation in consumer prices, Paul Volcker has an uncommon viewpoint: ‘If I were setting odds on deflation in the U.S.,’ says the former Fed chairman, ‘the probability wouldn’t reach 0.1%. I see no prospect of real deflation like we had in the U.S. and other countries in the 1930s.’

– “Whether or not the current Fed chairman agrees with his predecessor (and Apogee), we can’t pretend to know. And Greenspan is in no position to give us a forthright opinion so long as his finger is suspended over the switch on the printing press. As the Financial Times put it, the Maestro is ‘indicating just enough worry about deflation to justify low interest rates. The game rests, therefore, on frightening people, but only a little.’ Perhaps we’re in the minority, but we’re more than a little scared…about inflation.”

– The bond market, too, seems to be a little bit scared about inflation. Bond yields have been rising briskly for the last few weeks. Furthermore, despite the pronounced weakness in the stock market yesterday, bonds still could not muster a rally. The 30-year Treasury bond fell 9/32 to yield 4.71%.

– “Long-term interest rates have jumped over the last several weeks,” says Bridgewater Associates, “and this jump is already starting to bite households. The average rate on 30-year mortgages has risen 31 bps in the last four weeks, and predictably, this increase has cut significantly into the refinancing boom that has helped to lower household debt burdens.”

– Last week, the Mortgage Bankers’ Association’s measure of new applications dropped 18% from the prior week and 27% from its peak in May. Therefore, Bridgewater concludes, “unless rates fall to new lows, the stimulative effect of mortgage refinancings is going away…The big question in our mind, as far as interest rates are concerned, is whether the US economy can survive a significant interest rate rise. We think it probably can’t. Households and the economy as a whole are more sensitive to an interest rate rise than ever before. Refinancing has been at record levels and will soon collapse if rates don’t resume falling.”

– If refinancings stumble, the economy will stumble close behind.


Bill Bonner, back in Paris…

*** Gold is $344. That is more than it was yesterday, but less than it was a few weeks ago. But how will it seem to us in 5 or 10 years…after Ben Bernanke, Alan Greenspan and Robert McTeer have melted down every press at the bureau of printing and engraving in their desperation to head off a Japan-style deflation?

At today’s price, it takes 26 ounces of gold to buy the Dow. Investors – if they think about it at all – are inclined to think that next year, it might take 27 or 28. We pride ourselves on the elasticity of our imaginations – did we not think that George W. Bush would be a decent president? – but we cannot stretch our imaginings so far as to believe that Alan Greenspan’s dollars, and the stock market itself, will rise against gold in the years ahead. The world’s investors and central banks have favored stocks and dollars over the last 20 years. Now, they have plenty of them – held at basis cost far above what they are really worth. They will almost certainly be marked down…and gold marked up…before this decade is over. Our prediction: sometime in the next 10 years or so, you’ll be able to buy the Dow for just one ounce of gold. Our advice: buy gold any time the price drops below $350. Then, when it rises above $350, buy more.

*** It is quiet in Paris. The whole family has left. Washington, Baltimore, Miami, Bordeaux, Normandy, Milan; they are working and vacationing in various corners of the western world. Only your editor is still at his post – enjoying himself in the streets of Paris…

*** “You can’t do this like a German machine,” said the tango teacher, turning her big smile towards your editor. “Every step is a poem…it must be graceful, elegant.”

Demonstrating, she caressed the floor with the sole of her foot, spun around and kicked backwards.

“Oh là là…but it’s meant to be fun, too. It’s like everything else in life. Tango has a structure…but sometimes the beat almost disappears, and you have to improvise…you have to let yourself feel the rhythm in every cell of your body and get yourself in harmony with it. Then, you can do what you want.”

Your editor was having trouble. Not every cell was cooperating. Some seemed unable to feel the rhythm. More than a few didn’t seem to know which foot they were located on. Others had no idea what she was talking about.

But he stumbled on – in the Daily Reckoning tradition – with hardly a leg to stand on.

The Daily Reckoning