The Fall Of King Dollar

So what now?

The dot.coms have done pretty much what we thought they would. They have been crushed. The squeezing is far from complete, of course. Many companies still have cash…and hope. For most dot.coms, both accounts will be drawn down to zero in the months ahead.

And now the big techs are being ground down, too. These are real companies with real revenues. They will not disappear. But they will soon trade at prices similar to those of other stocks – that is, between 10 and 20 times earnings, rather than 100 times earnings.

The destruction of the techs will take time. But it will happen. Because, as I explained yesterday, investors’ emotional attachment is to the hope of getting rich in stocks, not to any specific group of stocks. Technology has merely provided a rationale.

Investors will find other stocks. They will continue putting their money “in the market.” They will still believe that stock market investing is the surest way to wealth. They will believe it until, one by one, they can no longer afford to believe it.

And here I will offer a prediction:

The decisive event…which will turn the dream of stock market riches into a nightmare…will be the fall of the dollar.

Few Americans care about the dollar. Perhaps only those of us who live overseas and see the daily price fluctuations notice it. But it is upon the King Dollar that the U.S. economy and its markets rest. But the dollar is a strange monarch…because it depends on foreigners for its power. The burden of today’s letter is that a revolution is coming. If I am right, the dollar will soon be pulled from his throne and decapitated.

“We continue to wait and to look for the dollar’s impending collapse,” wrote Dr. Kurt Richebacher.

When? How?

“The decline…will start once the economic news begins to disappoint,” continues Richebacher. The 3rd quarter GDP figures were disappointing. Hedonics, technology, flexibility – suddenly, all the reasons why the U.S. economy would grow faster than Europe no longer mattered. Because, in real terms, Europe seems to be at least keeping up with the US, and maybe surpassing it.

The U.S. is the most successful paper currency of all time. While Europeans and Asians produced cheese, wine, shoes and walkmen…the U.S. produced dollars. For many years, dollars have been traded for the foreigners’ products with no trace of regret on either side.

As the automobiles and designer clothes piled up on U.S. docks, the dollars piled up in overseas banks. “Today, as a matter of fact, Europe’s central banks [alone] sit on a huge dollar hoard of $222 billion,” says Richebacher. And “gross foreign dollar holdings today exceed $7 trillion…”

Even these enormous dollar holdings fail to describe the magnitude of the flow of cash out of the U.S. At least $400 billion comes back into the U.S. this year – to finance the current account deficit. That money comes willingly, as long as people have faith 1) in the U.S. economy and 2) and in the superior rate of return from U.S. investments.

On both points, faith is being shaken. Stocks are down. And now the U.S. economy is slowing down.

“Everybody hedges against a falling euro, but nobody hedges against a falling dollar,” observes Dr. Richebacher.

Even in the Age of Information, investors and business people are where they always are: closer to the clueless point on the information spectrum than anywhere else. With no direct experience nor any points of reference, they are caught up in the latest collective thinking. The dollar is strong because of ‘technology in America’ or because the U.S. economy is ‘more flexible,’ ‘dynamic’ and so on. The fantasy du jour is that the euro must always go down and the dollar must always go up. And yet, all it would take would be a little hedging on the part of investors and dollar-holding foreigners to send the dollar plunging.

“[T]he dollar’s stability depends on the perseverance of capital inflows of preposterous magnitude,” continues Richebacher. Not only do Americans mortgage their homes in order to consume foreign products, U.S. corporations borrow money on European markets to take advantage of Europe’s higher saving rates.

Fannie Mae, Freddie Mac and the Fed Home Loan System were set up to help disadvantaged borrowers obtain home financing. After the biggest boom in mankind’s history, apparently a lot more Americans are disadvantaged. The assets (mostly mortgage loans) of these three institutions rose three times since 1993 and now approach $2 trillion.

Did this money go into new and better housing? Dr. Richebacher calculates that only one tenth of that money was actually used in residential building. Where does the money go? Some of the borrowed money is used to increase American’s standard of living. And the rest seems to go into U.S. investment markets.

Where do these three institutions get the money they lend? Much of it, it turns out, directly or indirectly, is borrowed overseas. U.S. corporations borrowed $282 billion overseas in 1999 and $71 billion in the first quarter of 2000, reports Dr. Richebacher.

Normally, real GDP and real incomes rise together. But for the last two years, disposable incomes in America have been going up only at half the rate of the GDP. Though incomes increased at a 4.8% annual rate in the first quarter of 1998, they went up at only 1.9% in the first quarter of 2000.

But spending continued to increase even faster than the GDP rate. This spending, coupled with the paper profits of the stock market, allowed people to increase their standards of living while feeling richer from the ‘wealth effect’ at the same time. It was gain without pain…wealth without effort or sacrifice.

And it was an illusion. Now, with the wealth effect in reverse, even the slightest pullback in the dollar will prove disastrous. The cost of imported goods will go up. Credit from overseas lenders will dry up. Purchases of U.S. assets will fall. Foreign dollar holders – including dollar-based bonds and equities – will sell. Living standards will fall in America.

People will feel poorer, not richer.

But other then that, things will be fine.

Your cheerful correspondent,

Bill Bonner

Ouzilly, France October 3, 2000

*** Not very much in the news today. Which is a good thing because I’ve got to rush out and see a man about fish.

*** Our pond has finally been cleaned out, reshaped and, after a couple of days of rain, refilled. It’s time to stock it with fish.

*** Meanwhile, a couple of Daily Reckoning readers from California have come to visit. They’ve been driving around France and have seen more of the country in the last two weeks than I’ve seen in the 5 years I’ve been living here, albeit off and on.

*** Back to the financial world…the techs managed another rally yesterday. Intel stepped up to the microphone yesterday and announced that sales were back on track. And the Bureau of Labor Statistics came out with some good news of its own. This was all the encouragement tech diehards seemed to need.

*** The Nasdaq rose 95 points. Techs and nets were up across the big board. IBM rose $3. Even Amazon rose again and is now almost back at $40. Maybe I’ve been wrong about the big River of No Returns all along. Great company. Great stock. (Note to Bezos: Please keep buying books from us.)

*** A couple noteworthy exceptions to the tech rally – Worldcom lost nearly $1.50. And Oracle fell about 10% on rumors that someone is leaving.

*** Someone is definitely leaving The company fired about 15% of the staff and the CEO, Heidi Miller, named by Fortune as the “second most powerful business woman” in America, resigned. But her puissance may have dimmed a little in the last 9 months. Since she assumed command of the company, the stock has lost 90% of its value.

*** The Dow got no help from Intel (a Dow component) nor from the BLS figures. The Dow fell 19 points.

*** 1760 stocks advanced; 1114 declined. 93 hit new highs; 35 saw new lows.

*** The BLS also tossed out news that non-farm productivity rose 3.8% in the 3rd quarter. It is up 5% – if you believe the BLS numbers – from a year ago. Unit labor costs rose only 2.5%, after falling in the 2nd quarter.

*** Auto sales fell 1.5% in October.

*** Are the tires on the runway? Has Fed succeeded in bringing about a ‘soft landing’ – reducing the rate of growth of the U.S. economy to a more ‘sustainable’ pace?

*** “Yes, I think we have,” said regional Fed Governor Edward Gramlich.

*** Oil fell a modest 71 cents on news of another Mid-east cease-fire.

*** “The Saudi royal family has announced they will not tolerate violence against the Palestinians,” writes Outstanding Investment’s John Myers. “Saudi Arabia is the world’s largest oil producer. The Saudi’s can push oil prices into the stratosphere… traders remember that the Yom Kippur War was the launching pad for the first oil embargo in 1973…”

*** “But, even without war in the Middle East, oil may stay expensive,” says Myers. Oil prices trending hire are part of what he calls: ‘The First Great Event of the 21st Century.’ “According the M. King Hubbert Center for Petroleum Supply Studies ‘The world has been consuming far more oil than has been discovered since 1980 … We now burn four barrels of oil for each new barrel [located in the ground]’.”

*** “In 1956, Hubbert, a geologist, predicted that oil production in the lower 48 U.S. states would rise for 13 more years, peak in approximately 1969, and then fall off,” explains Myers. “In short, he was right. Oil production peaked in 1970 and has been falling since then. But that’s only the beginning. When you apply Hubbert’s techniques to world oil, you find out we’re just a few years from peak production. The world has produced roughly 800 billion barrels of oil. There’s about another 850 billion barrels in proven reserves, and an estimated 150 billion barrels yet to be discovered. In other words, we’re almost halfway through the world’s supply of oil.”

*** One way to play this trend is to keep an eye on energy companies. For example, “Calpine is America’s fastest growing power company,” also from John Myers. “Its earnings for the third quarter marked the 17th consecutive quarter in which earnings grew. According to CEO Peter Cartwright, ‘By the end of 2004, we expect to be one of the nation’s leading and most profitable power generation companies, with more than 40,000 megawatts of generation on line in attractive energy markets throughout the U.S.’ Calpine is up 50% since May.”

*** The dollar index rose 5…as the euro settle a little but held at over 86 cents.

*** Gold rose 50 cents.

*** “El Salvador earned the distinction as the ‘Hong Kong of Latin America’, finishing as the 12th freest economy in the world in this year’s Index of Economic Freedom,” writes Steve Sjuggerud. “I expect El Salvador to dollarize in the next decade eliminating local currency risk, and government has done a nice job keeping its hands out of the economy as well, consuming less than 10% of GDP (imagine that in France).” Unbelievably, Mugabe-torn Zimbabwe, says Sjuggerud, managed to finish in 146th place… meaning that there are apparently 15 countries worse off than Hell on Earth.

*** George Bush was arrested for drunk driving 24 years ago. But he says that when he turned 40 he decided to give up alcohol and take up politics – that is, to stop abusing himself and begin abusing others.

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