Shock and Awe

“I think we differ principally in that you assume the future is a mere extension of the past whereas I find history full of unexpected turns and retrogressions.”

– Winston Churchill

Our mouths hang open.

What kind of a mad, mad world is it we live in?

Our subject today, dear reader, is bonds. U.S. Treasury bonds, to be precise. They are said to be safe investments. Are they?

We are old enough to remember Eisenhower. Which means we should be old enough to know that the investment world is full of surprises. In fact, we rather enjoy them. That people should lose the most money from the most popular and fashionable investments seems not only natural to us, but fitting. That they should make the most profit from the most despised investments, too, seems right. It is as if the markets brought a little bit of the kingdom of God down to the ground, where the last are first and meek investors inherit the earth.

Deficit Spending: Peter G. Peterson

Still, we shiver when we consider the current status of the most popular and fashionable investment today – U.S. treasury obligations.

Peter G. Peterson – not to change the subject, but to elaborate upon it – is the worst kind of political hack. We have never met the man, but by reputation, he is honest, smart and earnest. Like Paul Volker, former head of the Fed, Peterson is willing to look at numbers, speak his mind, and do what he thinks necessary to keep the system solvent. Were there more of his stripe in government, people might come to trust it.

Fortunately, there are also men like George W. Bush and Alan Greenspan.

We have been accused of having a bias against Bush and Greenspan. We deny the charge. We love them both, in roughly the same way and measure that we like performers on the hit show ‘Jackass.’ After so many years of putting up with mediocrities, it is a genuine relief to have such exceptional mountebanks in high office. And while a Peterson or a Volker might have supported the dollar with sound fiscal and monetary policies, thus sustaining the illusions of paper money for another generation or more, this dynamic duo seem ready to destroy the dollar right before our eyes. And the bond market, too. It should be fun to watch.

“Among the bedrock principles that the Republican Party stood for since its origins in the 1850’s,” writes Peterson in the New York Times, “is the principle of fiscal stewardship – the idea that government should invest in posterity and safeguard future generations from unsustainable liabilities. It is a priority that has always attracted me to the party. At various times in our history (especially after wars), Republican leaders have honored this principle by advocating and legislating painful budgetary retrenchment, including both spending cuts and tax hikes.

Deficit Spending: Fiscal Wonder Drug

“Over the last quarter century, however, the Grand Old Party has abandoned these original convictions. Without ever renouncing stewardship itself – indeed, while talking incessantly about legacies, endowments, family values…and leaving ‘no child behind’ – the GOP leadership has by degrees come to embrace the very different notion that deficit spending is a sort of fiscal wonder drug. Like taking aspirin, you should do it regularly just to stay healthy and do lots of it whenever you’re feeling out of sorts.”

When George W. Bush took office, Peterson explains, the next 10 years were expected to produce a $5.6 trillion surplus. By the end of 2002, that number had been reduced to $1 trillion. More recently, the figure has sunk to minus $10 trillion; the national economy seems to be feeling more and more out of sorts.

That is just the public debt. Private debt has risen, too. Altogether, corporate, individual and public non-financial debt rose from about 140% of GDP in the Eisenhower years to nearly 200% of GDP today.

But when a team of economists set in motion by former Treasury secretary Paul O’Neill did a full exam, they found that public debt alone, including health and pension liabilities for the baby boomers, measured more than 400% of GDP…$44 trillion.

Even more surprising than the diagnosis is the quack treatment now being applied, like leeches, on the collective economic body. Though the problem is clearly too much debt, too much credit, too much spending, too many deficits (budget and trade) and too many dollars…both Bush and Greenspan hold up a needle the size of jackhammer and squirt in more.

Deficit Spending: A Short Field of Vision

Easy credit has seemed to produce such happy effects over the last 50 years. They cannot believe the near future will be unlike the recent past.

And we cannot say that they are wrong. We merely note that their field of vision is remarkably short. If they merely looked across the Pacific, to Japan, they would see that producing stable, modest rates of inflation is harder than it looks. Or they could look across the Rio Plata, to Argentina. Or to America itself in the 1930s.

Of course, we can anticipate their answer as well as you can: this is different. True; that it is. But though modern easy credit in the U.S. may be different in circumstance, it is not necessarily so in result.

Today, the most astonishing thing about this mad investment world is neither the extremity of the U.S. financial condition, nor the absurdity of the official response. Perhaps at no time in the past has the U.S. balance sheet looked so bad. Still, investors are willing to lend the country money at the lowest yields in two generations. The two-year Treasury note yields only about 1.6%. A five-year note brings the lender only 2.9%. Adjusted for current inflation, the likely rate of return is about zero. Who in his right mind would make such an investment?

Never before have investors had so much confidence in something that deserved so little.

Bill Bonner
Paris, France
June 13, 2003


The Dow inched up 13 points yesterday, to settle in at 9,197.

From its low on March 11, the Dow has now risen over 20%… and when compared to the other major indexes, it’s pulling up the rear. The S&P 500 has increased by 23% and the Nasdaq has raced ahead 28%.

As 20% is generally considered enough to suggest a change market trend from bull to bear…we’re at least inclined to ask, have we entered new bull?

But having done our duty and posed the question, we’ll spare short-time readers of the Daily Reckoning the pretense of suspense and get right to the answer: no.

“The real trouble with this world of ours is not that it is an unreasonable world,” wrote the popular historian G.K. Chesterton, “nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.”

In other words, the world maintains the appearance of mathematical precision, but ‘reality’ often thwarts the calculator – human or otherwise. You may have heard Bill Bonner suggest, on occasion, that given the lack of certainty about the world, we can only know things by way of analogy.

By analogy, you may have also heard us say, Japan offers the best possible explanation of what’s going in the stock market today. After the collapse of the Japanese market in 1989, the Nikkei has rallied more than 25% on 5 separate occasions, while still continuing its death march. Despite the rallies, over a 14-year period, Japanese stocks have still lost 80% of their value.

Austrian economists provide an explanation for the short upward bursts in an otherwise down-trending market.

“The tighter monetary stance that the Fed introduced on June 1999 has likely triggered the present bear market,” Frank Shostak explains. By the time rates reached 6.5% by May 2000, there was a sharp fall in the ‘momentum of money’ AMS (an Austrian measurement of the money supply) which corresponds with the tighter stance adopted by the Fed.

“Now, since January of this year, the growth ‘momentum of money’ shows a visible rebound,” Shostak continues. “The yearly rate of growth jumped from 1% in January to 5.5% in May…[which] should provide strong support for the stock prices of various non-productive activities at the expense of wealth-generating activities.”

In other words, given the Fed’s penchant for printing money, stock prices could rise dramatically, but earnings will remain…well, unearnt.

Indeed, while the market rallied, the P/E ratio of the S&P 500 stocks (using reported earnings) increased to 34 in May…from 33 in April. That, dear reader, means the P/E is traveling in the opposite direction from the historical average… which Shostak puts at 18.

So…Eric, what’s the word on the Street?


Eric Fry, writing from New York…

– Alan Greenspan isn’t omniscient after all!…Only two days after warning the nation that soaring natural gas prices pose a risk to the economy, the price of natural gas plummets. Yesterday, the July contract dropped 59 cents, or nearly 10%, to $5.62 per million British thermal units. It was bound to happen eventually…the natural gas price can’t go up each and every day. Only stocks possess that sort of magic.

– Yesterday, the magical Dow Jones Industrial Average advanced 13 points to 9,197, while the Nasdaq added half a percent to 1,653. These meager gains were enough to push both averages up to new one-year highs. Ironically, while the stock market soars on the wings of hope, the economy shuffles along like an octogenarian on a Boca Raton sidewalk.

– Weekly jobless claims dipped to a still-dismal 430,000 this week, while May retail sales edged up a lackluster 0.1 percent. Business inventories rose a scant 0.1% in April. In short, there’s a whole lotta nuthin’ goin’ on out on Main Street, which makes the stubbornly high energy prices all the more worrisome. Notwithstanding Thursday’s steep selloff in natural gas prices, Mr. Greenspan may have cause for concern about rising gas and oil prices.

– Yesterday’s steep “correction” in the natural gas pits was long overdue. The clean-burning fuel has more than doubled over the last couple of years, and has continued rising this year. But finally, the bears got a chance to sell the market, thanks to the news that the nation’s underground gas supplies jumped 10% last week.

– Even so, natural gas inventories remain 35% lower than a year ago, and 25% lower than the five-year average. So it might be premature to kiss the natural gas bull market goodbye…Which also means that it might be a bit premature to dismiss the bold prediction by T. Boone Pickens a couple of months back: “Gas prices would not fall below $4.50 again in my lifetime.” The life-long oilman’s prediction would have been a bit more audacious if he were 26 instead of 76.

– Nevertheless, the point is clear: the bull market in natural gas is for real. The primary reason for Pickens’ bullishness is a familiar one – demand “exceeds” supply.

– John Myers emphatically agrees. “The bull market in natural gas is the real deal,” says Myers, “and Canadian oil and gas companies will be the biggest beneficiaries of the rising gas prices. Canada’s got lots of gas and the United States needs it. Although Canada supplies only about one-sixth of U.S. natural gas consumption,” Myers explains, “it has been supplying about half of all NEW U.S. gas demand for the past decade.”

– In other words, Canadian companies have become the marginal suppliers to the North American market, which is why Myers focuses his research efforts on selected Canadian companies. In the past year, North American natural gas inventories have dwindled to the lowest level in nearly 30 years. “[But] there is virtually nothing that can be done to increase the supply of natural gas,” one industry expert testified this week. “This is a multi-year process, and big projects – whether it’s LNG [liquefied natural gas] importation or natural gas from the north – take a long time.”

– “Some industry watchers are calling the natural gas supply-demand imbalance a ‘crisis,’ albeit a silent crisis,” the Pittsburgh Tribune-Review notes, “because few outside the industry have been concerned.” It’s true, no one is organizing mass protests against rising gas prices. And yet, many folks suffered a doubling of their energy bills last winter. Many companies are also feeling the pinch of rising oil and gas prices.

– “If crisis means to you that we will run out of fuel (natural gas), that we will freeze in the winter or melt in the summer, you have little to worry about,” said Richard Levitan, president of the consulting firm Levitan & Associates, Boston. “If crisis means to you economic shocks, then get ready.”

– We are ready. We suspect that John Myers’ readers are ready. But what about the owners of 10-year bonds yielding 3.16%, or the owners of stocks selling for 30 times earnings?…Are they ready?


Addison Wiggin, back in Paris…

*** Is Martha Stewart…a political prisoner?

*** Martha, it seems, had a feeling the 4,000 shares she owned in ImClone were going to tank…so she put in a sell order on them. She claims she placed the order before her pal Sam Waksal – former scientist and CEO of ImClone, now convicted felon – told her anything about the company’s balance sheets. At first, her broker backed her up – then he rolled over.

At least, those are the details as far as we can tell by sifting through the drivel that portends to be the news these days. For all we know, she may have added too much yeast to a bunt cake, and served it to the wrong people. But something disturbing this way comes.

For their part, the SEC has not accused the matron of Maytag of “insider trading,” a charge that may have been warranted were she to have actually peeked under the hood at ImClone. But they do charge her with “obstruction of justice”…for what? For mounting her own defense? We don’t know.

But a NYTimes piece quotes a former attorney for the SEC: “The deterrent effect is immeasurable. Even if the government puts a thousand hours into building this case against Martha Stewart, the risk-reward ratio is enormously positive and constitutes a very prudent allocation of government resources.”

“One cannot discount the role of politics here,” writes William Anderson, an adjunct professor with the Mises Insitute. “The government is seeking to make her into a political prisoner. It is politics, not the pursuit of justice, which is driving this case…Her wealth and public persona make her a convenient target of a very political U.S. Department of Justice, and of U.S. attorneys who see the example of the Guiliani path to fame and fortune.

“In the end, we are likely to have a well-known person owning a felony record and being sentenced to prison or, at best, receiving a suspended sentence or probation,” Anderson continues, “and a once-prosperous company in tatters. Oh, and we will see some federal prosecutors being fundefinedted as though they had just solved the Case of the Century. These are dark times, indeed, for the pursuit of justice in the United States of America.”

Dark times, indeed…dark times.

Addison Wiggin

The Daily Reckoning