Sun Sets on Empires
"Nature hates monopolies and exceptions."
Ralph Waldo Emerson
In the summer of 1588 the "Invincible Armada" of King Philip II of Spain headed towards the Low Countries. You and I, dear reader, can spot the error already. Philip would have done better to call his fleet an "almost invincible armada," or perhaps even better, "The Best Little Armada We Could Put Together At the Time." Calling an armada "invincible" is like calling a Worldcom "unbeatable"; it is a challenge to the gods… and an invitation to destruction.
The Armada’s mission was simple, but not easy – to pick up soldiers in the Netherlands and transport them to England. It had been 500 years since anyone had attempted an invasion of England. The last assault, led by William, Duke of Normandy, was a big success. Philip was ready to have a go at it again.
The reasons for the campaign were not so simple. In the jargon of today, he might have labeled his effort a "War Against Terror," for English pirates had been terrorizing Spanish shipping for years. The pirates were not necessarily sponsored by the English crown. But they, literally, found safe harbor in English ports.
Of course, there was more to it. Religion, for example. Just as George’s WAT has a subtext of religion, so did Philip’s. Henry VIII of England had rejected the authority of the pope and set himself up as head of the Church of England. Then when his daughter, Elizabeth, ordered the execution of her Catholic rival, Mary Queen of Scots, Philip (who had been King of England 30 years prior, when he was married to Mary I) thought the time had come for action.
By 1588, Spain had become a powerful empire – with colonies in the New World that had made them rich. Money poured into Spanish coffers during the 16th century – the country imported it like America imports big screen televisions, giving little in return. Finally, like all empires…Spain needed to find a way to destroy herself. Whereupon, the English fleet appeared on the horizon.
History records the Battle of Gravelines as one of the most important naval engagements ever. The Spanish ships were trapped against the Flemish coast. The Spanish commander, the Duke of Medina, decided to use a portion of his fleet to hold off the English, while the rest made their way to open water.
The English engaged the defending Spanish ships with a 10-to-1 numerical advantage. Soon, 3 of the huge Spanish galleons were sunk, with 600 Spaniards killed and more than 800 others wounded. "The decks ran with their blood," said eyewitness accounts.
Most of the English ships, having done their work and run out of ammunition, sought their ports. The Spanish, badly battered and realizing their cause was doomed, decided they could not fight their way back through the Channel. Instead, they sailed north intending to make their way around Scotland (they had neglected to bring maps of the area) and thence back to Spain by the open Atlantic.
What the English began the weather finished. On September 18th, the Spaniards ran into one of the worst storms ever to smash into Scotland. In high seas off Cape Wrath, the Invincible Armada proved vincible; it broke up. Ships sank. Others ran out of food and water. Sailors manned the buckets day and night in an effort to keep the leaky vessels above water…but many soon ran out of energy or died of scurvy, dysentery, and fever.
Do empires really make people better off, we ask again today? We know the answer – no. What Spaniard was better off because of the Invincible Armada? How many Athenian lives were improved by the campaign against Corinth? Even if the campaign had been a success…what possible good could have come from it? But what does it matter? Once a nation is lured into it, the trend has to run until it comes to an end. Bubbles and empires have a logic of their own; that they will end in grief is a foregone conclusion. Still, they are entertaining to historians and stock market kibitzers.
The sun was never supposed to set on Philip’s Spanish empire. But it sank along with the armada in 1588. Financially, Spanish fortunes had begun taking on water many years before.
"The Spanish Crown had already defaulted on its loans in 1557, and further defaults occurred in 1575, 1596, 1607, 1627, and 1647," explains Marc Faber. "Because of these defaults by the Spanish Crown, major financial centers in Europe such as Antwerp, Genoa, and Lyons, which had been the prime financiers of the Spanish loans, also experienced several devastating financial crises.
"Moreover, the 16th century was highly inflationary. Between 1500 and 1600, prices in Europe rose by almost five fold as a result of the huge increase in gold and silver in circulation, which had been shipped from the Spanish possessions in the Americas. And when the shipments of precious metals began to diminish after 1580, the entire Spanish peninsula experienced a terrific depression, which lasted for a good part of the 17th century."
"The British Empire was in many ways probably the most successful empire in history," continues Faber, "because, unlike the Roman and Spanish Empires, it didn’t depend on its colonies for its wealth."
Britain acquired its empire a little like America seems to be putting hers together- by inattention. Little by little, with no master-plan to guide it, Britain assembled its component parts…and awoke one day to find itself in the pink.
"Yes, I remember when I was a child," said one of our English editors last week. "The map at school was covered in pink. And everything that was pink was a British colony."
For a time, Britain enjoyed the rosy cheeks of the master race. "However," Faber writes, "over time, the empire proved to be extremely costly to maintain and in the 20th century it gradually had to give up its overseas possessions and lost out to other nations economically."
To whom did it lose out? To America, certainly…but also to the poor Swiss! Throughout the 20th century, the sun set every single day on the Swiss Federation. But that didn’t stop the Swiss franc from rising, nearly everyday, against the British pound. In 1915, a British pound could have been exchanged for 13 Swiss francs and a half-pound of cheese. Today, a pound brings you only 2.3 Swiss francs. And forget the cheese.
And while the British economy grew sluggish in the 20th century, the Swiss economy boomed. By the end of the century, GDP per person in Britain was only around $20,000. The Swiss, meanwhile, were producing $28,550 in GDP per capita.
But pity the poor yodelers. They never got the glory of empire. They never got to admire themselves on maps or in headlines. What Swiss president gets to send troops to remote hell-holes…to join a peace-keeping mission…or fight terrorists? How often do the Swiss get to cheer on their heroes…and mourn their dead? Who even knows who the president of Switzerland is? Who could care?
The poor Swiss had to mind their own business…and watch the sturm and drang of the world pass them by, like gophers watching a combat of bull elephants.
May 16, 2002 — Paris, France
P.S. Even gold cannot scoff at the laws of supply and demand. A big increase in the supply of gold in 16th- century Spain caused a big decrease in its value – compared to the things for which one might want to exchange it.
But here at the Daily Reckoning we like gold, not because it breaks the laws, but because it is law- abiding.
Gold from the New World petered out in the 17th century and prices stabilized. Since then, few discoveries of new gold have been big enough to upset prices.
In ancient Rome, by contrast, the denarius kept losing value for centuries – until it disappeared completely. "All…problems [in Rome]," explains Faber, "required vast sums of money to be solved, or, as was usually the case, to be postponed. But each time a new problem cropped up, the money printing press was turned on, which led to a further debasement of the currency and higher and higher inflation rates – two factors whose importance in the fall of Rome cannot be overlooked."
How long will the world’s latest imperial currency – the dollar – survive? We don’t know…but the temptation of central bankers in the 21st century is little different from those of the 1st, 2nd and 3rd – to increase the supply of money and credit whenever it is needed. Sooner or later, this is bound to turn the dollar into an artifact of monetary history – like the denarius. When? We don’t know. But when we find out, we hope to have a few gold coins in our pockets.
How do they manage, dear reader?
I mean, those indefatigable American consumers. Word came yesterday that they are not only still spending, but spending more. April retail sales were up 1.2% – the most in 6 months.
Where do they get the money? It is not as if employers were offering big sign-up bonuses. Instead, they’re looking for ways to cut payrolls in order to preserve a little more cash on the bottom line. Whence cometh, then, the moolah…the loot…the juice…the green…the bread…the scratch…the dough…the skin…the hamiltons, franklins, jacksons and washingtons?
No sooner had I posed the question, silently, then a box popped up on my computer screen!
"Apply Today! And get cash out of the equity in your home. Now is the time to get a Home Equity Loan – before the Fed raises rates. Lowest rates since 1961!"
Ah ha! Does this electronic burning bush reveal the secret? Readers will recall that before the Fed cut rates…it raised them. But whether it raised or lowered rates, the effect on the supply of money and credit was the same; they both went up.
Whether you look at M3, total Reserve Bank Credit, or the expansion of credit overall, you see that they have been going up at near-double digit rates for a very long time.
For many years, the extra cash and credit made its way to the equity markets, inflating the Dow and Nasdaq. Then, the Nasdaq deflated and the Dow stagnated. And yet the flow of credit continued.
Where did it go?
House prices were 8% higher in April than they were a year ago. In the Golden State, they were 19% above last year’s levels. Happily, there are still people ready to convert this equity power into spending power – as evidenced by the advertisement on my computer screen.
What happens next? Well, that we’ll reckon with tomorrow…
Eric, what’s going on on Wall Street?
Eric Fry, from the belly of the beast…
– Well, well, well. Look what we have here; inflation is returning like a long-lost prodigal. "The ‘inflation trade’ is heating up," we noted early yesterday morning. And shortly thereafter, the Labor Department announced that the consumer-price index (CPI) jumped 0.5% in April, the biggest monthly increase in a year.
– But since inflation is just about the farthest thing from investors’ minds at the moment, the CPI report scarcely caused a ripple. The bulls overcame an early morning tussle with the bears to fight to a draw by the closing bell. The Nasdaq eked out 6 points to 1,726, while the Dow slipped 54 to 10,244.
– Yesterday’s CPI report looks like more than just a fleeting anomaly. Even the so-called core index – designed to "de-inflate" the CPI by excluding food and energy – climbed 0.3%. One month does not a trend make, of course. But what about four months? During the first four months of 2002, the CPI has increased at a 3.8% annual rate (seasonally adjusted), compared with an increase of 1.6% for all of 2001.
– If my math is correct, that’s a 138% jump in the rate of inflation. Is it just possible that the impossible is occurring? Is inflation returning?
– Faithful Daily Reckoning readers know where I stand on this issue: Inflation is on the comeback trail. But you don’t have to take my word for it. Inflationary auguries are popping up like pimples on a teenager. As I pointed out yesterday, "In earlier financial epochs, a rising gold price and rising oil price – coupled with rising interest rates – signaled a coming inflation. Should this epoch be any different?"…Stay tuned.
– In addition to releasing the worrisome CPI report yesterday, the busy bean-counters at the Labor Department disclosed that industrial production and capacity utilization both improved in April. Industrial production advanced for the fourth straight month, while capacity use edged up to 75.5% – its highest level since last September.
– However comforting these inklings of economic recovery may be, a new bull market in stocks is hardly a fait accompli. Corporate America’s pint-sized profitability alongside the stock market’s rich valuations looks like a toddler shuffling across the floor in his daddy’s size-11 shoes. In fact, based upon historic valuation norms, the U.S. economy needs to do a whole bunch of growing before it fills out its oversized P/E ratios.
– No less an investment luminary than Warren Buffet – when addressing the faithful at the recent Berkshire Hathaway shareholder meeting in Omaha – conceded that attractive stocks are hard to find these days.
– Jim Grant elaborates: "Although attendance was greater in Omaha than at the April 23rd Grant’s conference, investor sentiment was not appreciably more bullish. The enormity of Berkshire’s $36.5 billion bond portfolio, said Munger, was testament to the ‘lack of value in the [stock] market.’ Buffett said there had been times when he had more ideas than money – the mid- 1970s, for instance. ‘Now I’ve got more money than ideas.’"
– A lot of the troops in the trenches share Buffett’s apprehension. Many "mid-cap value" managers, for example, are throwing up their hands in exasperation over the slim pickings within their investment universe. Morgan Stanley’s Steven Galbraith says, "I’m talking to mid-cap value managers and they are getting money in hand over fist – and they don’t know what to do with it."
– Likewise, in a recent Barron’s story, Michael Santoli notes that many "small-cap value" managers are closing their funds to new investors. "If these managers feel they are close to getting more money than they can efficiently and intelligently deploy," Santoli wonders, "might it not be time for investors to ease up on this trendy area?"
– Lastly, Apogee Research’s Andrew Kashdan observes, "While the small and mid-cap indexes have been rising, their P/E ratios have been rising as well. Whereas the current S&P MidCap 400 P/E is nearly 35, its average P/E since mid-1995 is about 24. And for the SmallCap 600, the current P/E of 43 compares to an average of 29 going back to 1993.
– "For what it’s worth," Kashdan concludes, "we also noticed that James Glassman, whom readers will no doubt recall as the co-author of Dow 36,000, recommended mid- caps in the Washington Post two Sundays ago. Glassman proclaims of this sector: ‘They’re not too big, not too small, not too hot, not too cold. They’re just right.’ After reading those words, trying to suppress our contrarian instincts would be futile."
Back in Paris…
*** House prices are inflating. Whether or not the housing bubble bursts, we have no doubt that the pressure of new credit will strain the seams elsewhere in the economy. But we are not as sure as Eric that it will produce a general inflation of consumer prices. We will wait to see.
*** "The press has a responsibility to present an unbiased view," said a bureau chief from Le Monde at dinner last night. "But all reporters are human. They all have their own points of view. So, what we try to do is to pit one perspective against another. In the Arab- Israeli story, for example, we had one Muslim reporter in Ramallah and a Jew in Tel Aviv. Each presented the news…and gave his ideas of what we should do…"
"But wait," I interrupted. "There is a much deeper bias in the news media. Both points of view are similarly prejudiced towards politics. Both suggest that this is a problem I should be concerned about, should have an opinion about, and should be willing to meddle in… however indirectly, through actions of my government. If people ignored the situation…and minded their own business…the problem would have gone away many years ago…"
They looked at me as though I were crazy. Maybe they were right.