Sitting on Bayonettes
"Seizing a city is a very different matter from holding it." Since the tech-wreck in 2000, the Fed’s army has fought the war and captured the city…now it must protect the prize.
There is a time for everything.
Yesterday, we meant to tell you – perhaps we did – about our conversation with a young French analyst. "Dynamism," he said, "that is what separates America from Europe. You Americans are ready to take action. While we Europeans hesitate."
There is, of course, we explained, a time for action…and a time for reflection. One of the curiosities of life is that people – amidst the masses – tend to get mixed up. They tend to reflect when they should act, and act when they should reflect.
Dynamism is said to be the salvation of the U.S. economy. Yes, Americans owe too much to too many people. Yes, they spend too much. Yes, Asians will do their jobs cheaper. Yes, their stocks and real estate are very high. Yes, their incomes are going down. Yes, they have leveraged the entire country at artificially low interest rates…and yes, millions of them will go bankrupt when interest rates rise.
But no, there is nothing to worry about, because America has such a ‘dynamic’ economy.
Even the Europeans admire it. They think Americans are naïve and stupid. But they, too, believe the dynamic U.S. economy will not fail.
America’s Dynamism: Dynamism will Destroy the US Economy
The burden of today’s little essay is that not only will dynamism not save the U.S. economy…it will destroy it. "You can do anything with bayonets…except sit on them." Our French Daily Reckoning correspondent, Philippe Bechade, quoted Talleyrand to make his point. The French foreign minister under Napoleon explained that seizing a city was a very different matter from holding it. For the latter, you needed at least a minimum of cooperation from the citizens. You had to sit down with them and make a kind of peace. And you couldn’t sit on bayonets.
Then again, "Napoleon never ordered a bombing of a wedding on pretext that enemy soldiers were in attendance…certainly not based on dubious intelligence available," continued Bechade.
"Talleyrand would have declared, ‘Sire, worse than a crime, you have committed an error.’"
There is a time for everything. A time to take action. A time to refrain from embracing foolish action. And a crime for every purpose under heaven.
George W. Bush and Alan Greenspan are the dynamic men history needs. They are the men for their time. America needs to be taken down a notch, and they are just the men to do it. George W. Bush’s contributions to America’s destruction are right out in the open: clumsy wars…and wanton new spending programs. Alan Greenspans’s crimes are less obvious.
America’s Dynamism: Greenspan’s Error
But following the collapse of the Nasdaq in 2000, and the recession of 2001, Mr. Greenspan did not sit idly by. He and his crew fixed bayonets and charged. But in lowering its key interest rate below the inflation rate, and holding it there for longer than ever, the Greenspan Fed has committed a grave error. It has enticed the consumer deeper into debt. It kept alive marginal business and investment projects (by making it easy for them to refinance old loans)…and encouraged new ones. (Once again, as reported this week, we have IPOs coming to market with neither profits nor products.) And it fueled huge new bubbles at home and abroad. Real estate in many areas of the U.S. is soaring. A report from the Federal Reserve shows the value of U.S. housing stock rising from about 60% of GDP in 1945 to nearly 140% today. Houses in Southern California have sprouted wings; new buyers can barely catch them before they take off. And in China, a bubble of capital goods consumption has set the entire nation into a smelly, noisy, dizzying construction boom…and driven up the price of oil and other raw materials all over the world.
Before the industrial revolution, a laborer in China, India, or Massachusetts enjoyed about the same reward for his efforts. But the introduction of machinery in the West gave the Yankee a huge advantage; soon an hour of his time was worth 10 times…or a 100 times…more than that of an Indian. Now, China and India are catching up.
Mr. Greenspan hoped his E-Z credit would lead to a rise in hiring and wages. He knows as well as we do that only if consumers have more money to spend will a real boom get underway. He got the increases he was looking for but not where he was looking for them. The new factories were built in China, not America…and Chinese workers gained the extra income.
Putting up its factories at a feverish pace, China develops more competitive capacity every day. This too, is what Alan Greenspan’s low rates have wrought. Americans are more in debt than ever. They own less of their own houses than ever before. The average American worker earns 6%, in real terms, less than he did a quarter of a century ago. During the same time, the average Chinese salary increased 29 times.
America’s Dynamism: Rushing into the Information Revolution
Americans tried to compensate for the loss of real earnings by becoming more dynamic and carefree than ever. They rushed into the Information Revolution…believing that this new technology would keep them far ahead of the rest of mankind. Then, they rushed into stocks…and real estate…and borrowing more money…and spending more money. They seemed ready to do anything – including invading woebegone foreign countries – if they thought it would keep them on top of the world.
If he knew what he was up against, the average American would squirm; he has charged into debt…now he sits on his bayonet! He owes more than ever…works harder than anyone…or, at least longer hours. And now, he is faced with approximately 1 billion workers in Asia against whom he must compete, head to head.
If any man is to blame for this, it is Alan Greenspan. It is not all his doing, of course. But no man did more to help it along.
We write not in anger, but in resignation. Americans have come to believe that they can get something for nothing – forever. They don’t think they will ever have to pay their debts. They imagine that they will forever earn 10 to 100 times as much as a man in China or India. They believe their economy is immune to the laws of economics…that it is so ‘dynamic,’ it can survive record debt and deficits forever. Mr. Greenspan has come along at precisely the right moment; he will show them otherwise.
for The Daily Reckoning
May 28, 2004
Everybody knows inflation is rising…everybody knows interest rates are going up. But nobody knows what to make of it.
Here, your Daily Reckoning editor does an about face. He doesn’t think inflation or interest rates are rising…yet. And he thinks he knows exactly what not to make of it.
He admits that he has no real evidence for these opinions. The price of oil fell below $40 yesterday. Durable goods orders dropped nearly 3% in April. New home sales fell more than 11% in April…the biggest slump in 10 years. And the inventory of unsold houses has reached its highest level in nearly a quarter of a century.
"So far, there are few signs of awakening inflation," writes his old friend, Martin Spring. "In the U.S. the latest annual rate of increase in ‘core’ personal consumption prices (excluding volatile and therefore supposedly temporary increases in food and energy items) is only 2.2 percent. In Japan, the world’s second biggest economy, retail prices are still falling – down 0.2 percent in the 12 months to March; they have been declining almost continuously since 1995. In Germany, the third-largest economy, consumer prices have risen just 1.6 percent over the past year."
Still, these are the facts available to everyone…even those who have come to the exact opposite conclusion. Still, we have a hunch. We share it will you, dear reader, with the understanding that you won’t think it is worth a penny more than you paid for it. Okay?
Labor is the largest component of prices. And labor, thanks to the benefits of globalization, is in a very long-term deflation. In real terms, at least, labor is getting cheaper. (More below.)
As we mentioned yesterday, Alan Greenspan will do all he can to try and create inflation. That is what he was appointed to do – to try to goose up the economy before the election. In the last reported week, for example, the money supply (M3) rose by $48 billion. The Fed would like nothing better than to see this cash end up in paychecks. But it is not happening. Employers see no need to increase wages; they can always outsource the work to India!
People who do not earn more can only spend more by dipping into savings or borrowing. That is what has been happening. Spending from either source produces a temporary boom; unlike wages, it is like money from heaven, with no offsetting expense. But also unlike wages, it goes away in a sudden and deflationary whoosh. People reach the point where they have to stop borrowing. Then, the spending returns to wage income…and then drops below it, as the wage-earner has to use a portion of his income to pay the interest and principal on his debt.
Yes, but the Chinese and Indian economies are booming. They’re using more and more oil…more and more raw materials…surely they will drive up prices for everyone.
Yes, until U.S. consumers stop consuming and their economies stop booming. (More on that below, too…)
Over to Addison for more news…
Addison Wiggin, from Historic Baltimore…
– Gold is at $396.00…up $6.90 in New York trade yesterday, and within a whisker of $400 again. $400 has acted as impenetrable resistance since the late ’80s…could this be our last opportunity to buy gold for less than $400 an ounce? Mr. Market is keeping his cards close to his chest…
– Meanwhile, the dollar tanked yesterday. The euro gained 1.4%, nearly 2 cents, to trade at 1.2266, a new 8-week high. Against other currencies, the dollar’s fall was even more impressive. Versus the Swiss franc, the buck lost two centimes to trade at 1.2460…a massive 2.2% decline and a fresh three-month low. Japanese yen, Sterling, Kiwi and Aussie dollars all made big gains. We turn to the FT for an explanation…
– "Dollar hits 8-week low versus euro on weak U.S. data," screams the headline on the FT’s homepage. We scroll down and the story begins: "The dollar’s recent slide accelerated on Thursday as soft U.S. economic data intensified fears that the market had factored in U.S. interest rates rising too far and too fast." Apparently the upward revision in fourth quarter GDP was less than expected, while weekly jobless claims disappointed. GDP grew at 4.4% in the fourth quarter, according to government statistics.
– But over on Wall Street, the major equity indices all closed higher. The venerable Dow ran fastest yesterday…it added 95 points, closing at 10,205, a gain of 0.94%. The Nasdaq and S&P turned in a more muted performance, both gaining half a percent to close at 1,984 and 1,121 respectively. We turn to the same paper for a curious explanation…
– "Wall Street cheered by economic data," claims the headline. The word bite continues: "The broader U.S. markets rallied on Thursday as investors cheered three positive developments: crude oil dropping below $40 a barrel, continued strong earnings and upbeat economic data." Apparently, "markets interpreted the rate as comfortable but not so robust as to cause the Federal Reserve to act severely when it begins raising interest rates…and investors gained a further degree of comfort about the state of the job market…"
– Confused? So is the FT! Is U.S. economic news "weak" and "soft" – or is it cheering and "upbeat"? Was the dollar’s reaction appropriate, or the market’s…or both? We don’t know. But here at the Daily Reckoning, we have a guess as to what’s going on…Mr. Market is calling Greenspan’s rate-hike bluff.
– Maybe Mr. Market has noticed Greenspan’s limousine in the White House parking lot more often than usual. Maybe Mr. Market suddenly sees how convenient both the deflation and the rate-hike stories are to the Fed’s agenda. Whether it’s intentional or not, by touting deflation and the threat of higher interest rates, the market will naturally keep a lid on gold prices and bond yields. Flawed mainstream thinking will naturally assume that inflation poses no risk – look at the bond market, they’ll say, bond traders cannot be wrong. And all the while, the credit spigot is wide open and pumping.
– "Greenspan & Co. will talk rates up, with the help of a willing media, but not move them very much or very quickly," predicts Kenneth Thomas, a finance professor at the University of Pennsylvania’s Wharton School, in an article in the Christian Science Monitor. Thomas used the Freedom of Information Act to request information on Greenspan’s personal calendar, and found that Greenspan’s visits to the White House have quadrupled since Bush replaced President Clinton.
– Thomas labels Greenspan a ‘social butterfly.’ "His visits lead to two intriguing questions: How involved is the Fed chairman in setting White House policy? And do those friendships with the highest-level officials of the Bush administration alter what Greenspan does with interest rates?"
– Fed Funds futures indicate a quarter-point rate hike by the end of June, and three more by December. "For all the worry in U.S. markets about what the Fed will do and when the Fed will do it, it’s possible that a good bit of the Fed’s dirty work might already have been done for it – by Wall Street itself," reckons CNN Money.
– The Wonks in Washington are obviously still reluctant to raise rates, whatever they may say. They know the debt- soaked economy can’t take the stress, and that they must keep the Ponzi scheme lubricated with liquidity. But the best news, and gold traders know it, is that whatever happens…$396 gold will probably look like a bargain for many years to come.
Bill Bonner, back in Paris…
*** "Central bankers have been blowing bubbles," continues Marin Spring. "Because the flood of cheap, easy money has been far more than that necessary to finance economic growth, the excess has poured into investment assets of all kinds. Many asset markets have developed into bubbles – not only the hugely important and politically sensitive residential property market, but also others such as equities, bonds and commodities.
"Central bankers would like to gently deflate those bubbles. But they know that significant increases in interest rates wouldn’t deflate them, but pop them – with dangerous consequences for economies, financial systems and even political stability. The risks are huge. So I am sure central bankers will remain extremely cautious about pushing up rates."
*** In deflation, of course, stocks will crash. But what about inflation?
Again, Martin Spring:
"Barclays Capital recently completed a study of how four real asset classes – equities, property, commodities and index-linked government bonds – have shielded investors against inflation over the long term. Some of its conclusions are startling:
"In all three distinctly different inflation periods of the past century – deflation during the 1920s/30s, high inflation in the 1970s, low/stable inflation in recent years – UK equities "produced negative real returns."
"For most of the past century, equity performance deteriorated as inflation rose…"
*** As Addison notes above, gold rose $7 yesterday – to $396. Gold is a ‘buy’ at any price below $400, in our opinion.
*** For many years, at least in Baltimore, a kruggerand was about the only thing you could leave on your car dashboard overnight, without finding your windshield smashed in the morning. But now, from England, comes news that the yellow metal is once again worth stealing. Police at Heathrow Airport say they stopped an attempt to steal $70 million worth of bullion from a cargo warehouse last week. [Ed. Note: Who pulled off history’s greatest gold heist? Answer: The Spanish, who made off with 3 million kilograms from South America. How do we know? Well, we’ve been perusing one of the 290 copies of first edition Pickering and Chatto’s "The History of Gold and Silver" we found in our London warehouse.
*** Oh, and here’s another column by Thomas L. Friedman. We’re so grateful to the New York Times for publishing Friedman on Friday. By the end of the week, we need a laugh.
Friedman, as long-time Daily Reckoning suffers know, is a leading warmonger for the New York Times…and now, wanders around the globe telling people what to do. But like almost all people who tell others what to do, his ideas are nearly always imbecilic.
"Old rules still work," begins the piece. So far, so good. But what ‘old rules’ could Friedman be talking about? He seems perfectly happy to advocate lying, cheating and stealing…when it’s for a purpose with which he agrees. Nor have we ever heard of an idea so grandiose and absurd that Friedman did not espouse it.
This morning we read to the end of Friedman’s article without ever finding out what ‘old rules’ the man favors. Instead, we found a lot of new claptrap proposals. He proposes, for example, to set up a new bipartisan commission "looking forward." He’d call it the "National Commission for Doing Things Right."
We wonder what the point of the commission would be, because Friedman then tells us what the right way to do things is. He says the way to fight terrorism is to embark upon "a huge expansion of the U.S. Embassy libraries around the world." He also wants "a huge expansion of scholarships for foreign students to study in America."
The gist of Friedman’s proposal seems to be that if these people only knew us better, they would love us as much as we love ourselves. He seems completely unaware that most of the 9/11 terrorists actually had lived in the U.S. for some time prior to the attack.
Friedman then suggests that all Americans pay a new tax – a "Patriot Tax" of 50 cents-a-gallon, which would be used to finance his other goofy plans…which are aimed, he says, at "getting more people to voluntarily sign onto our values."
It never seems to have occurred to him that other people have values of their own…or that they might not like us.
"Do unto others as you would have them do unto you." This ‘old rule’ seems as sensible today as it did 2,000 years ago. We wouldn’t especially appreciate an Iraqi who tried to get us to sign onto his values – especially if he had a gun in his hand. We doubt it works the other way, either.