Something's Coming... Something Big

“On Long Island,” the LA Times tattles on a man 3,961 kilometers away, “bakery worker Carlos Gaviria said the market collapse has caused him to rein in his personal spending. If enough people do the same, he said, it could add up to something big.”

“What’s going on on Wall Street…tells me that whatever money I have, I have to hold on to, because it isn’t predictable what’s going to happen tomorrow,” Gaviria said. “By holding my money, maybe I am affecting the economy itself.”

Gaviria, an economist might explain, is slowing down the velocity of money and contributing to an economic slowdown. Instead of spending it immediately, he’s letting it sit around for a day or two, hoping it will get comfortable and stay longer.

“What exactly is happening in the financial system when the money velocity collapses?,” asks Dr. Kurt Richebacher in a recent letter. “In short, it inherently reflects a general attempt to replenish money balances (liquidity) following a prior depletion during the boom.”

“Cash is trash” in a boom. But in a bust, cash becomes as precious as water on a long desert hike. The shift in “liquidity preference” doesn’t happen very often. But when it does, it causes “something big.”

In this case, the “something big” is what Dr. Kurt Richebacher calls “The End” – the end of a two-decade economic expansion in America that began when Paul Volcker said he was ending double-digit inflation and meant it.

Volcker drove up interest rates…squeezed credit…and eliminated inflation. Thereafter, interest rates could begin a long and fruitful decline…allowing consumer credit, spending, and stock prices to begin a long march to glory.

Twenty-something years later, the assault on Dow 36,000 has run its course. Businesses and investors stopped making new investments more than a year ago. They began to see that they had already spent too much and worried that further investment might be bad money after good.

But consumers have soldiered on, hoping that they would soon be resupplied and reinforced. Quartermaster General, Alan Greenspan, lowered rates 7 times – cutting in half the cost of borrowing at the Fed Funds rate. A relief column – the 2nd half recovery – was said to be just over hill.

There were a few false sightings…and a few scouts thought they could hear the fife and drum in the heavy summer air. Even now, His Most Excellent Treasury Secretary, Paul O’Neill, says that the U.S. economy is merely suffering from a “cyclical downturn” which would end “later this year.” But it is already September… and already the weather has an autumnal chill.

Is it any wonder that some of these loyal consumer troops are anxious? Laden with packs of debt heavier than any consumers have ever borne, menaced by rising unemployment – up a full percentage point in the last year – and with supplies running out…how long can they continue?

“Sauve qui peut” – the whispers run up and down the ranks. It is every man for himself and his family…

Here at the Daily Reckoning, we have a growing intuition that the markets serve an even greater purpose than distributing capital, setting prices, and providing entertainment. They seem to be an important source of moral lessons, too.

Indeed, at the beginning of each day we ask ourselves: which sin or weakness will Mr. Market punish today?

Will he strip the greedy of their bull market gains? Will he ruin the fearful with inflation? Will he plunder the gullible or reduce the too-proud pundits to tears? Even Daily Reckoning editors are not exempt, we remind ourselves, as we watch the spectacle from what, we hope, is a safe distance.

Surely all vices are paddled, but so too are some things that pass for virtue.

Fed governor Robert McTeer tells consumers that it would be unpatriotic to cut spending now. The health of the entire economy, he points out, depends on the willingness of consumers to continue doing the “irrational” – spending money they don’t have…thus adding weight to their packs even as their food runs low.

Have the gods gone crazy, dear reader? Would they really allow a world in which a man, doing what is sensible and right for himself and his family, makes things worse for his friend, neighbors, and fellow countrymen?

Or does Robert McTeer err? Could it be that additional consumer debt – like an errant army pushing deeper into enemy territory after its supply lines have been cut – invites an even bigger debacle?

Robert McTeer is a fool, of course. So is any consumer silly enough to continue his march to insolvency. But, here at the Daily Reckoning, we suffer fools gladly. In fact, we celebrate them.

No fools, no bubble. No bubble, no bust…no cycle of madness and reason that eventually brings perfectly good investments down to prices that are attractive again. Today, the P/E ratio of the S&P is 24. A dollar’s worth of stock brings you only 4 cents of earnings…and much less in actual dividends. At the bottom in ’74, a dollar would buy you 14 cents of earnings. And in 1980, you would have gotten 12 cents.

Consumers – like tech investors two years ago – offered themselves in sacrifice to the market gods. They did the irrational – buying at prices that were insane…and spending long after prudence urged restraint…

Today, we salute them both.

Bill Bonner, paying homage, once again, to the fools…lest he be counted among them!
September 11, 2001

P.S. Most likely, stocks will soon rally (they will not go gently into the good night of a major bear market). But something big is on its way. Just as the biggest fools of all – buying tech stocks at the very top of the bubble – could not prevent a collapse of share prices…nor will foolish consumers be able to prevent an economic collapse. The economy will sink.

And soon, the bubble, the boom, and the bull market on Wall Street will all be dead. James Grant, writing in the NY Times, seems to have found the perfect ancient inscription for their headstones: Mundus vult decipi; ergo decipiatur.” The World wants to be deceived; let it therefore be deceived.

“All Eyes on Consumer Spending,” says a NY Post headline.

It is like watching a decrepit man after a late- night booze session. Whether in amusement or horror, we all wait for the American consumer to totter over.

Unemployment is rising, with twice as many layoffs in August as in July. Debt delinquencies and write-offs are soaring; banks wrote off nearly $8 billion in loans in the 2nd quarter, up 50% from a year ago.

Understandably, consumer spending – which has held up the economy for the last 12 months – is finally falling over.

“For a whole lot of people,” the LA Times quotes Carl Steidtmann at Deloitte Research, “debt reduction and trying to rebuild their savings is of utmost importance right now.”

“A few big-screen TVs here, a few minivans there, and before you know it you’ve got a recession,” says the LA Times.

As a matter of fact, the jobless rate has now risen by a full percent. This has never before happened without a recession. (A more detailed look at the American consumer…below…)

First, more details from Wall Street…oops, I see that Eric has been delayed in a storm in Bermuda… so Addison is reporting the latest news.



Addison from across the desk:

– er…

– Yes…a remarkable feature of bear markets is the number of “sideways” trading days. The market stops, like an animal holding its breath to hear, and waits for something…anything…to happen. Will it be a strong rally or…pandemonium?

– Yesterday was one of those days. The Dow held its breath for 7 hours…and came out less than one point ahead. Likewise, the S&P and Nasdaq tacked on 6 and 7 points respectively. Nobody wanted to be the one to make the first move.

– “Many appear to be still clinging to the hope that this time will be the fabled ‘bottom’ we keep hearing is just around the corner,” writes Lance “Crash” Lewis of Prudent Bear fame. “In the meantime, we’ll have to see if the bulls can bounce us forward for a few days…or if we simply resume acceleration downward [today].”

– Regardless whether today is “Turnaround Tuesday,” as the traders say, or not – the trend is unmistakably down. The Dow for the year has shed an even 11%, the S&P has lost more than 17% and the Nasdaq is off by 32%. The year’s big losers are getting hammered even harder: The Nasdaq 100 is down 42% for the year, and’s Internet index is off by nearly 53%.

– The Blue Team’s David Tice, mentioned also this morning in an LA Times article, thinks we’re going to see Nasdaq 500 before we’re through – another 70% drop from where we stand today.

– Estimates for a “recovery” by year-end were revised downward yesterday by The National Association of Business Economists. “But,” says CNNfn, “two thirds of the 31 economists [polled] expect the economy to recover by the end of the year.” These economists further declared that the Fed’s actions this year in dealing with the slowdown were “just right.” We’ll see…

– Meanwhile, “Dot-com kids return to school,” says a headline in The Arizona Republic. The article tells a story about Colvin Pitts, age 22, who left Stanford last year for a $45,000 a year programming job, with $70,000 in stock options. This year he’s back in class…as the company he signed on with went the way of the…and his options? “I could net about $200 if I sold them today,” he says.

– China – the country – will launch a mainstream mutual fund, says the Financial Times. Professor Song Fengming of Tsinghua University helped devise the fund in an attempt to develop China’s volatile, oft manipulated, financial markets. “The Chinese stock market has all the characteristics of an emerging market and no real blue chip stocks,” says the professor. Derivatives are on the way.


Back to Bill:

*** Let’s see…what else…

*** Well, the FTSE in London just sank to a new low – wiping out the last 3 years’ worth of gains. And in Japan, household spending fell for the 4th month in a row…down 1.6% in July.

*** Paul O’Neill, America’s excellent Treasury Secretary, is over in that part of the world. According to the Financial Times, he’s putting pressure on the Japanese to reform their economy.

*** Soon, we imagine, the Japanese will return the favor.

*** Last night, Elizabeth and I endured a three-hour parent-teacher meeting at Henry’s school. It is a different world…where pettifogging teachers lecture parents for hours on how to maintain school discipline and decorum. Woe to student and parents if the child’s briefcase is disorderly!

*** Then again, the kids seem to learn something.

The Daily Reckoning