Something Wicked This Way Comes, Part I

What does it mean when the least absurd policy position comes from the White House? That every other position must be fraudulent, delusional, or dumb…

Rev. Al Sharpton is clean. He is not an economist. He is against outsourcing. That those qualifications did not cinch the democratic nomination for the man disappointed many people.

That he has not been outsourced himself disappoints many others. For surely a crackpot fakir could be found in India who is ready to make a public spectacle of himself at half the price. For that matter, all of Washington could be outsourced to the banks of the Ganges at a fraction of the price…but no one has yet suggested it.

Joined by Dennis Kucinich and Ralph Nader, Sharpton believes the U.S. should disavow free trade altogether. As long as we are members of the Word Trade Organization, explained Kucinich in a debate last week, we cannot "protect the jobs…this is the reason why we have outsourcing going on right now. We can’t tax it. We can’t put tariffs on it."

Outsourcing American Jobs: Absurd and Preposterous

To be non-partisan about it, all the candidates’ positions on outsourcing seem absurd or preposterous. There are those who want to stop it. And those who see no problem with it.

Everywhere we look is an opinion that is fraudulent, delusional, or dumb. Mr. Kerry refers to "Benedict Arnold CEOs" as if an executive who tries to lower labor costs is committing an act of treason. Rumor has it he is considering eliminating the foreign tax credit, which gives U.S. companies operating overseas the right to offset their U.S. taxes against the tax they pay – on the same income – overseas. If removed, hardly any U.S. company could afford to do business outside the U.S. In France, for example, a U.S. company would pay more than 70% of its earnings in taxes.

One of the least absurd policy positions comes, astonishingly, from the White House, where President Bush believes that better primary education is the solution to the outsourcing menace. If Americans could spell better, and add and subtract correctly, they would be better prepared for jobs at Walmart, we presume. Alan ‘Bubbles’ Greenspan supported this view in recent remarks: "The capacity of workers, after being displaced, to find a new job that will eventually provide nearly comparable pay most often depends on the general knowledge of the worker and the ability of that individual to learn new skills," he said. And if they can’t find work at the wages they demand, he seemed to want to add…it’s their own damned fault.

The most popular view of outsourcing, among economists at least, is the Alfred E. Newman, "what, me worry?" approach. Don’t fret, they say. We’ll think of something…we always have. We’re masters of innovation, after all.

Many economists – including Alan Greenspan himself – maintain that the lack of jobs is a sign of something good happening…like the putrid smell of a garbage pile…indicating that the little microbial recyclers are doing their job. "Productivity," they say, "accounts for most job losses, not outsourcing."

We can’t seem to get a grip on the logic of it. Nor can we remember a time when productivity actually threw people out of work – except in individual industries at special moments. The invention of moveable type, the steam engine, electricity, telephones, gasoline motors, jet planes, post-it notes, screw-off caps on wine bottles – each increased productivity.

But did they cause generalized unemployment? Nope. Instead, increased productivity freed up resources for new projects…which sopped up workers almost immediately, at higher labor rates! We don’t see that happening this time. Why? Greenspan does not even seem to ask the question. He finds the ‘productivity’ idea useful, so he sticks with it.

Outsourcing American Jobs: A New Era

"Over the long sweep of American generations and waves of economic change," continued Greenspan the other day, "we simply have not experienced a net drain of jobs to advancing technology or to other nations." Could something be different this time? Could this be a kind of ‘new era’ in American economic history? The answer we give is ‘yes’…but we will give it in a future essay. Here, our burden is must more modest…and our proof comes more readily to hand. For here, we argue only that America’s leading economic policy makers are either rascals or numbskulls.

Major tops in the credit cycle seem to correspond with major bottoms in political economy, we conclude. From high offices all over the nation come the explanations, excuses, rationales, and obiter dicta; we don’t know whether they are corrupt or merely stupid. But when the guardians of the public financial mores begin urging people to acts of recklessness, we cannot help but notice. Buy more, says one Fed governor. Borrow more, says another. Don’t worry about debt, interest rates or the loss of jobs, says the captain of them all. It is as though the National Council of Bishops had come out with a public statement urging wife swapping. The experience may not be unpleasant, but it is unseemly of them to say so.

"Go out and buy an SUV," urged Fed governor McTeer. We learned recently that 17 million people heeded his called, each year, for the last 4 years. Automotive News reports an estimate that nearly a third of people who walk into showrooms are now "upside down," owing more on their current vehicle than it is worth.

McTeer, Greenspan et al helped this binge and other borrowing by lowering interest rates down to Eisenhower-era levels. Even the mainstream media is beginning to catch on to the fact that E-Z credit is not always a blessing.

"Alan Greenspan is essentially lending money at a loss," began a surprising editorial in today’s International Herald Tribune. "This cannot go on indefinitely, and it should not go on much longer…It increased corporate profits and prompted consumers to refinance their mortgages and to spend their way into plenty of other debt…Many homeowners, and consumers in general, are borrowing recklessly, betting that rising housing prices and easy credit are here to stay…Americans may be in for a rude shock when the real estate market levels offs, and when millions discover that the adjustable rates of their mortgages and other loans can be adjusted upward."

Directly and indirectly, many will have Greenspan to thank. The Fed chairman has an uncanny way of arriving at ideas…just at the exact moment when they can be of most benefit to his superiors – and his own career. To Greenspan the conservative economist, the stock market looked ‘irrationally exuberant’ in the mid-’90s, until a member of Congress pointed out to him that he would be better off keeping his mouth shut. A gold bug in the ’70s…now Greenspan has become the biggest purveyor of paper money the world has ever seen. Similarly, large federal deficits seemed at odds with his creed…until it suited him to think otherwise.

Outsourcing American Jobs: Greenspan Changes Again

And now, as the debts and deficits mount up, Greenspan undergoes another intellectual metamorphosis. An article in the N.Y. Times explains:

"Many mainstream economists are worried about these trends, but Alan Greenspan, arguably the most powerful and influential economist in the land, is not as concerned.

"In speeches and testimony, Mr. Greenspan, chairman of the Federal Reserve Board, is piecing together a theory about debt that departs from traditional views and even from fears he has himself expressed in the past.

"In the 1990’s, Mr. Greenspan implored President Bill Clinton to lower the budget deficit and tacitly condoned tax increases in doing so. Today, with the deficit heading toward a record of $500 billion, he warns more emphatically about the risks of raising taxes than about shortfalls over the next few years.

"Mr. Greenspan’s thesis, which is not accepted by all traditional economists, is that increases in personal wealth and the growing sophistication of financial markets have allowed Americans – individually and as a nation – to borrow much more today than might have seemed manageable 20 years ago."

And here, dear reader, is the money paragraph:

"This view is good news for President Bush’s re-election prospects. It increases the likelihood that the Federal Reserve will keep short-term interest rates low. And it could defuse Democratic criticism that the White House has added greatly to the nation’s record indebtedness."

Out of convenience, rather than ideology, Mr. Greenspan has come to see goodness in all manner of credit. Lately, he has praised lending to ‘subprime’ borrowers…and applauded homeowners for switching to adjustable rate mortgages. Debt levels have risen from $54,000 for the average family in 1990 to $79,000 last year. Mortgage foreclosure rates, personal bankruptcies and credit card delinquencies have been rising steadily and are at record levels.

But none of this seems to bother the chief of America’s central bank.

Bill Bonner
The Daily Reckoning
March 19, 2004

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the international bestseller: Financial Reckoning Day: Surviving The Soft Depression of The 21st Century (John Wiley & Sons).

Mr. Mizoguchi has gotten tired of wasting Japanese money on American debt. At least, that’s the guessing from Wall Street this morning. [Eric elaborates, below…]

So the dollar fell, gold rose and the stock market muddled through. It was a GUDD day, in other words. And our guess is that it marks the beginning of Phase II of the Great Bear Market in both stocks and the dollar. The Dow will fight to stay above 10,000…and then give way…maybe dropping down to 5,000 or 6,000. Gold rose more than $4 yesterday…taking it already up to $411. It will probably go to $500 before this phase is over. And the dollar…at about $1.23 to the euro today…will probably drop to about $1.50.

But this is just guesswork – barely worth the paper it’s not printed on. Still, we offer these guesses in the spirit of calculating a widow’s assets. If the breadwinner gets hit by a beer truck, she needs to know what she’ll have left to live on.

No one knows when the beer truck is coming. So you have to make some guesses. And that means not merely looking at what you think will happen…but what it would mean if you were wrong. The most likely thing to happen is…nothing. That’s what usually happens; things just muddle along in their own sloppy way. Ninety percent of investors and consumer households in America are counting on it: stocks will continue to go up, more or less…real estate will continue rising…and people will continue to refinance their houses and buy more and more things on credit.

That this cannot go on forever doesn’t seem to worry anyone; the end of the world never seems to come along when you think it should.

But betting on ‘muddle through’ is not always a good wager. Blaise Pascal figured that the cost of being wrong about eternal damnation far exceeded the price of faith. Perhaps he would not be able to covet his neighbor’s wife or eat fish on Friday…but he didn’t especially like fish…and his neighbor’s wife wasn’t all that fetching anyway.

Neither are the gains you might anticipate from the extension of the credit bubble. If things continue as they have for the last year and a half…a typical lumpeninvestor could expect a few dollars of profit in his stocks…a 10% gain, on paper, in his house…a bigger SUV…a few more household gadgets…and a deeper hole of debt to toss them in. That’s the upside in all its tawdry glory.

On the other side of the bet are the losses you might suffer when it comes to an end. Imagine that interest rates are forced up by foreign lenders’ unwillingness to lend. Imagine that adjustable rate mortgages suddenly look like bad deals…and millions of people have trouble keeping up with payments…driving down house prices by 20% to 30%…[More on this below, too…]

Imagine that stocks lose a quarter to a half of their value. Imagine that the job picture doesn’t improve…but gets much worse. Imagine that Alan ‘Bubbles’ Greenspan is disgraced as a debt-mongering scoundrel, and that crowds gather under a tree in front of the Treasury building in Washington, with a rope in their hands and revenge on their minds. A quarter of a century ago, you could get a 15% yield on U.S. government paper…and a mob burned an effigy of Paul Volcker on the steps of the capitol. Imagine that.

"Muddle through" may still be the most likely outcome most of the time…but sometimes, it is a bad bet.

Over to Eric, with more news:


Eric Fry, reporting from the Street of Dreams…

– The stock market took a breather yesterday, as the Dow dipped 5 points to 10,296 and the Nasdaq dropped 14 points to 1,962. Meanwhile, the dollar tumbled and gold soared. The monetary metal, which gained $4.00 to $411.35, drew its strength from the dollar’s weakness.

– The greenback slumped another 1.1% against the euro to $1.238, which must have brought self-satisfied smiles to the faces of Alan Greenspan, Treasury Secretary Snow and all the other dollar-debasement advocates. A strong currency – like a "submissive wife" – is a concept that the modern mind holds in contempt. In place of these long-standing ideals, now weak currencies and submissive husbands have become the norm.

– "Hmmm…maybe I should read this," said your New York editor’s girlfriend while browsing in a bookstore recently. She had chanced upon a copy of "Why Men Love Bitches." Intrigued by the title, she picked up the book…

– "No, it’s not true, it is definitely not true," we insisted. "Please trust me on this one. I think the author has embarked on an irresponsible mission, like teaching kids how to try drugs, or teaching Republicans how to wage wars…Please don’t buy this book. I love you because you’re NOT a bitch. Really, I’m sure about this."

– "Well, I don’t know," she replied with a wry grin. "I need to think about this…Maybe I should be a bitch."

– "Well, if you have to think about it," your editor reasoned, "then you’re not really a bitch, just a pale imitation…and who wants to be a pale imitation? I think you should just stick to what you do well – being kind to me." She smiled again: "Maybe I’ll come back here tomorrow…"

– Returning to the topic at hand…whatever became of the quest for a strong currency? Once upon a time, every country on the globe desired a strong currency, and every country envied the U.S. dollar as the "gold standard" of strong currencies. Indeed, the world’s premiere monetary brand was convertible into gold until 1971.

– But those days are long gone. Today, frailty is chic and some countries will spend billions of dollars to contrive an appropriately weak exchange rate for their money.

– Japan’s central bank sold a staggering $95 billion worth of yen in the first two months of this year in a vain attempt to weaken it. Unfortunately, the yen weakened only 1% against the dollar during that timeframe…and today, the yen is STRONGER than when the sales began on January 1st.

– Yet all along, the campaign to weaken the yen has faced stiff resistance from the counter-campaign to weaken the dollar, not to mention the various rearguard actions – like the campaign to weaken the Yuan, the campaign to weaken the Brazilian real, the campaign to weaken the euro…

– The poor Japanese; they’ve exhausted themselves by banging their collective head against a monetary brick wall. A massive current account deficit is what you want when you’re trying to debase your currency. Japan’s $100 billion foreign exchange intervention has been no match for America’s half-a-trillion dollar current account deficit. That’s why weakness is the path of least resistance for the U.S. dollar. It’s also why the Japanese, temporarily, are refraining from currency intervention and allowing the yen to strengthen.

– When rumors of Japan’s policy shift surfaced on Monday, the yen soared immediately. It has continued soaring since then – gaining more than 3% from last Friday.

– If the Japanese cease meddling in the forex markets, the dollar will have to fend for itself. The outcome, we predict, would not be pretty. Imagine the toughest French boxer alone in the ring against Mike Tyson…

– "Tokyo could lose its reason for intervening if Japan’s economic recovery really takes off," the New York Times explains, "with more consumption and capital spending shifting some of the burden off exports. There are already signs that may be happening."

– The Japanese government, in its monthly economic report released Monday, said spending by consumers was ‘picking up.’ On the same day, a report showed that sales at department stores in the Tokyo area rose in February for the first time in more than two years. Meantime, Japan has just reported 6.4% GDP growth figures for the quarter ended December…its best performance since the Nikkei began its 14-year collapse and real estate turned sour in 1990.

– If the Japanese cease buying dollars, the U.S. Treasury market might also have to fend for itself. Imagine the toughest boxer from Liechtenstein versus Mike Tyson…"Japan has accumulated the largest foreign-currency reserves in the world at $777 billion," the New York Times notes, "much of it invested in United States government debt. Japanese investors accounted for about half the purchases of United States Treasury securities last year."

– Obviously, if the Japanese ceased buying dollars, they might also cease spending dollars on things like U.S. Treasury notes. Without Japan’s "artificial bid" in the Treasury market, where would interest rates go? Much higher, would be our guess.


Back in Paris…

*** The Japanese are no longer backing the U.S. credit market. What does it mean? "What I think is going to happen," explained colleague Dan Denning a few days ago, "is that prices on anything that is backed by debt are going to go down. That’s what a debt-deflation is all about. Houses, stocks, corporate bonds…and trillions of dollars worth of debt-backed derivatives – are going to fall. They’ve been bid up by debt, not by genuine yields or purchasing power. And now they’re bound to become cheaper as the debt behind them is marked down and withdrawn.

"On the other hand," notes Dan, "the prices of primary materials – gold, oil, platinum, copper, commodities of all sorts – are going up. Because they are not backed by debt. Instead, they are bought up, in competitive markets, all over the world. As the dollar goes down, the price – in dollars – goes up. Demand will go down, somewhat, as Americans pull in their belts. But there is a huge new demand coming from Asia."

*** Since we are guessing about all sorts of things, we will take a further gazelle-like leap into the unknown. Modern communications and sophisticated derivatives were supposed to destroy the monetary use of gold. Who needed to hold an inert metal when you could protect yourself from any financial trend – even the collapse of the dollar – with a few clicks on a keyboard.

But every click from one paper asset to another…or from one derivative position into another…carries its own risks and uncertainties. Most people, businessmen or consumers, would prefer not to speculate with their own money. They would prefer to know that it had a fixed value that they could depend upon.

Instead of destroying gold as money, modern information technology is likely to destroy paper as money. Because now, it is as easy to quote a price in units of gold as it is in dollars or euros.

How long will it be before people get tired of speculating…and stipulate prices in terms of gold, or a new gold-backed currency? How long will it be before the ‘legal tender’ laws become irrelevant, with long term contracts that adjust prices – at the stroke of a keyboard – to this new gold standard?

*** A DR reader writes: "You often allude to the lumpeninvestorate and one can’t help but think you are referring to middle America when you do. At least that’s what I’ve always thought. I’m fast coming to the conclusion that the lumpeninvestorate includes about 99.5% of the public. Let me explain…

"We bank with a small five year old bank, one of many that have formed over the last five or ten years I’ve been told. Today the bank had lunch for their board members, some of their key shareholders, and a few key customers. Twenty five people in all, most of whom are supposedly "sophisticated" Reg’ D investors.

"The President of the bank gave a very upbeat assessment of the economy and the future. He asked for comments and questions. All in all it was a very upbeat talk. In fact, I couldn’t help but feel great about the future. Eventually, I got around to my version of belching.

"I began by saying I had some concerns about the economy, particularly the trade deficit, the budget deficit, and the falling dollar. I asked if anyone else had any concerns about the economy and the future. Complete silence ensued. After an awkward moment the President said he had concerns at the macro level, also, but he did not think it would affect the micro level. Several people nodded in agreement and the upbeat conversation continued on."

The Daily Reckoning