Among the obscure financial reports that have more pages than readers is one from the Bank for International Settlements. The staff economists had toted up the figures and found a massive black hole in the universe of money movements. In order for one country to run a current account deficit some other country must run a surplus. Money flows between nations is a zero sum business. By definition, what goes into one set of national accounts has to come out of another.
It is impossible for the entire Earth to run a current account deficit, just as it is impossible for everyone to have above-average income or uncommonly smart children. And yet, there it is, according to James Grant, a negative $213 billion worldwide net current account deficit, as if the money had been wired to Mars. We draw no particular conclusion or inference from this bizarre figure, nor do we take any offense. The missing billions are probably in a desk drawer in the accounting department of the BIS for all we know. Besides, $213 billion does not seem like a lot of money to lose in a $31 trillion world economy.
More interesting in the BIS report were the relative figures – the amounts of money changing hands from one nation to the other owned from one nation to the next. For there, the numbers are bigger…and likewise preceded by minus signs. In 1997, the U.S. ran a current account deficit of $140 billion. That is the difference in the goods and services sold by Americans to the rest of the world and those sold to them. By 2002, the deficit had risen to $435 billion.
Both sides took it as a fair trade. Americans got automobiles, champagne and geegaws. Foreigners got dollars. But as Americans bought more and sold less, the rest of the world accumulated dollars. By the end of 2001, foreigners had $9 trillion in U.S. dollar assets, reports Dr. Kurt Richebacher.
Pity the poor Europeans, says Richebacher. As much as Americans might have admired their New Economy of the late ’90s…the Europeans admired it even more. Now they are the major holders of dollar-based assets outside of America…and are stuck with them.
The Frenchman cannot sell dollars to Americans – for what would Americans exchange for them; all they have is more dollars! All the foreigners can do is trade their greenbacks amongst themselves, like used polyester cargo pants…and hope they don’t go out of fashion.
But who knows? The Frankfurter banker…the baker in Milan…or the fund manager in Amsterdam might begin to favor corduroy…or maybe tweed. Why he might do so is the subject of the rest of today’s letter.
"The single worst threat not only to the U.S. economy and its financial markets but also to the world economy, implying to foreign investors huge currency losses on top of their huge houses in stocks and bad loans," writes Richebacher, is a "looming dollar disaster."
"When the dollar’s plunge develops in earnest," he predicts, "it will…be brutal for the U.S. financial markets, which have become hostage to massive foreign capital inflows."
Foreign-owned assets in the U.S. rose by $895 billion in 2001 after increasing by more than $1 trillion in the year before. Much of this money went into stocks, providing "the single strongest support for America’s stock market during these critical years…"
The poor Europeans were clueless. "No European would ever dream of taking equity out of his home," says Richebacher. "And Europeans don’t have credit cards either…they just have debit cards."
Nor could the eurolander imagine what would happen to him next. His Nasdaq stocks lost 70% of their value. His S&P stocks fell by 40%. Even his Dow stocks dropped 30% of their value. And on top of that, the dollar fell off by another 15%.
He thought he had placed his money in the strongest, most flexible, and most dynamic economy on the globe. (The poor frog’s own economy seemed as stiff as a dead republican. It was so rigid, regulated and soooo ’80s…as G.W.B. reminded the English, he didn’t even have words in his language to describe the entrepeneurial, laissez-faire economy of America in the ’90s ).
And then he discovered that the U.S. companies he bought had cooked their books and went bankrupt…and that the U.S. federal budget surpluses that were supposed to be "as far as the eye can see" disappeared overnight…and that G.W.B. had gone a little mad in his War Against Terror…that the suburbs were a wasteland…the food was inedible…the average American was too fat and too much in debt…
…and heck, he didn’t look good in cargo pants anyway!
And so, he begins to feel like "un pigeon" – a French fool, a Danish dupe, a Czech chump, or a Polish patsy.
What will he do now?
Not only does he finance the Americans’ current account deficit – running at about $1.5 billion per day – he also bankrolls Americans’ investments abroad. Europeans are not the only ones who may want to flee dollar assets. But with no current account surplus, Dr. Richebacher explains, Americans can only diversify into foreign holdings by importing capital from foreigners. Unless the BIS really has discovered a black hole in the system of international capital flows, the foreigner must be willing to accept dollars for whatever he is selling.
"These U.S. foreign investments amounted to $439.6 billion in 2001, after $581 billion in 2000," Richebacher elaborates. "There results a need for capital inflows into the U.S. between $900-$1,000 billion per year just to keep the dollar stable and the U.S. financial system afloat.
"Our nightmare is that continuous bad news about the U.S. economy and an associated continuous fall of the dollar will sooner or later induce a significant part of foreign investors and lenders to pull out of the dollar."
Here in Paris, we Americans sleep soundly – even at our desks. But all around us, heaving, tossing and turning…Europeans must fear for their money. Will they switch from polyester to tweed…if only to sleep more soundly? We think so.
July 31, 2002
The euro rose casually yesterday, as if it were on vacation. What to expect when the summer is over…more below…
Stocks seemed to have no particular destination in mind yesterday either. They set off downhill in the morning as if they were going somewhere…but then started to dilly-dally and ended up back near home by the close of business hours.
Investors are hoping that the Big Turnaround has begun. And we think it has – just not the turnaround they were expecting. Our guess is that the world’s consumers-of- last resort…Americans…are getting weary. They’ve been carrying the entire world economy on their shoulders for many years – buying things they didn’t need from places they couldn’t find on a map with money they didn’t have. Now, they’re facing retirement with no money and are feeling a little edgy about it. It won’t be long, we think, before they stop shopping and begin to save.
Maybe they’ve already begun…
Walmart and Target reported sales below expectations yesterday. "Consumer confidence sours, sales down," says a NY TIMES headline.
Altogether, the debt total in the U.S. is $27 trillion, Dr. Richebacher told us on Saturday. At even 6% interest, it costs $1.6 trillion annually just to keep the creditors from foreclosing. But this is what happens at the end of a credit expansion – people owe so much money they need a lot of ready cash just to stay in the same place. Last year, credit increased by more than $2 trillion. Yet, stocks still fell on Wall Street and the economy barely grew.
Here’s the latest report from Eric:
Eric Fry, in Manhattan:
– How quickly fashions change on Wall Street! "Selling the rallies" has become embarrassingly demode…"Buying the dips" is all the rage once again.
– Yesterday morning, the Dow dropped about 171 points before the financial fashionistas started their dip- buying. By day’s end, the blue chips had battled back to a slim 31-point loss at 8,680. The dip-buyers bought the Nasdaq even more enthusiastically – turning an early morning loss into a 9-point gain.
– The gold market attracted a few stray dip-buyers as well, as its price rose $1.30 to $303.70 an ounce.
– One week ago, many investors – feeling like death row inmates – feared an imminent financial demise. But now they’re breathing a sigh of relief. The huge stock market rally of the last few days has granted a temporary stay of execution.
– To be sure, most of the investor-inmates found themselves on financial death row for good reason; they committed the capital crime of "buying high" – an act that almost always meets with a severe punishment…And we suspect that this time around will be no different. A temporary stay of execution does not mean that investors have been acquitted of their crimes against prudent investing…Mr. Market is still deliberating.
– Despite the rebounding stock market, consumer confidence is sliding. The Conference Board’s July index of consumer confidence tumbled from 106.4 to 97.1, its lowest level since February. Consumers’ expectations about the future took an even steeper turn for the worse. The future expectations reading plummeted to 95.7 from 107.2.
– Is this any way to kick an economic recovery into high gear? As we’ve all learned by now, a fretful consumer is a thrifty consumer – also known as a "saver." And while a nation full of savers is nice thing to have in the long run, it’s no help at all in the here-and-now. If consumers don’t consume, the economy doesn’t grow.
– As it is, the economy is on some pretty shaky ground…which is yet one more reason why investors should treat the current stock market rally with a healthy dose of skepticism. Erring on the side of caution is well advised. A growing number of cautious investors are rediscovering the virtues of dividends.
– "Wall Street pros are talking more about dividends," Barron’s observes, "not so much for their steady income value, welcome as that is, but because of what dividend payouts say about a company’s financial health and management’s priorities."
– Lynn Carpenter, editor of The Fleet Street Letter, has been well ahead of the curve on this particular investment trend.
– "In our core portfolio, 14 of 20 stocks pay dividends," Lynn remarked in her July issue. "It is one reason we still boast positive numbers this year, even though the market has fallen once again." Lynn explains that dividend-paying stocks "not only hold up better in a bear market, they revive well when bull markets come back."
– Over time, dividends can make an astonishingly large contribution to a portfolio’s total return. "Locking in attractive dividend yields shortens an investor’s break- even period in a stock purchase," Barron’s explains, "and lowers the stakes on trying to call the absolute bottom. Bryan Taylor, president of Global Financial Data, has studied the little-used total-return version of the S&P 500 index, and has found that by this measure an investor who bought at the market top in 1929 got even in 1945 – nine years earlier than the S&P 500 price index recouped all its Depression-era losses. Dividend yields today are far lower than they were then, but the broader point remains…"
– Unfortunately, not even cautious, dividend-seeking investors are likely to enjoy a tailwind from the general market trend. The stock market as a whole is still pricey, and that makes for rough sailing.
– "Wall Street says the worst of the stock market is behind us," writes Thom Calandra of CBS MarketWatch. "The brokers’ highly paid strategists, sweating bullets, are urging America to buy early and often.
"History will demonstrate the stock market’s cheerleaders are premature…Our modern American bull market began in 1990, with the Dow at 2,365…Raging bull markets, when they crash, always end lower than where they started. Yes, Wall Street most likely will enjoy the kind of snapback rallies we are seeing, when the Dow stages 400-point-plus rallies," says Calandra.
"[But] the S&P 500 is still selling for more than twice the historical average for a bear-market low. The highest price-earnings ratio seen at a major market bottom during the past 60 years is approximately 12.5, technician Paul F. Desmond at Lowry’s Reports tells me. That was in June 1962."
– When venturing into the stock market these days… travel lightly. Mr. Calandra, by the way, will be speaking at the New Orleans conference alongside Bill and me in November. I’m told that today is the last day you can score a super-early bird discount. Don’t miss out.
Back in Paris…
*** "It is not really like Japan," Dr. Richebacher contradicted me over the weekend. "It’s far worse. Japan had savings. And the Japanese never owned a lot of stocks. What’s more, Japan was a single economy and a creditor nation. Japan doesn’t affect the entire world. America affects the world."
We were discussing how bad the situation might get. "Stocks are headed to more reasonable P/E levels," say the analysts, as if they expected it all along. The dollar is adjusting to a more reasonable level, say the economists, as if they could have told you that 6 months ago. What a wonderful world…everything is suddenly becoming so reasonable.
"Don’t count on it," said Dr. Richebacher. "This is the biggest financial bubble the world has ever seen. There has been nothing like this since ’29…and even then America had a surplus, savings…and it was a creditor country! Few people have any idea how serious this situation is…" More below…
*** Bond defaults hit a record in the second quarter. Pensions were underfunded by $111 billion last year…an amount 425% greater than the previous year’s underfunding.
*** "Is this the bottom?" wonders USA Today. We don’t know, of course. So we put the question to our local oracle. We found him – the strange little oriental dipsomaniac – passed out on the steps of St. Merry’s church. He wore only a pair of ragged black pants and a huge sombrero, which left his ribs sticking out like mountain ranges that rose up each time he took a breath.
"Is this the bottom?" I asked, nudging his cadaverous leg with my foot.
"Is this the bottom?" I asked again, repeating the gesture with my foot to try to rouse him to a feat of clairvoyance.
"No…it’s my thigh…"
"Very funny…but I want to know if stocks will continue to rally…" I persisted.
"Look to the East…watch the birds," he replied cryptically, "…a dying sparrow never flies west."
"What is that supposed to mean?" I asked.
"I don’t know…but it is as good as any forecast you’ll get. And a lot cheaper. Do you have any spare change?"