The Great Wal-Mart of China
Do you wonder why the statistical "recovery" is so anemic and why a return to corporate profitability seems so elusive? Wonder no more. Capital Insight’s Sean Corrigan argues that Wal- Mart, for many the symbol of free market America, is exactly what is wrong with Federal Reserve fecklessness and the legacy of Rubinomics.
While that bastion of Big Tech, the Nasdaq 100, has fallen all the way back to levels first seen in 1997, Wal-Mart has been holding it’s own against the great bear market ’00 – ?. It’s only down 15% from this year’s high.
Investors’ last hopes, it would appear, are pinned on the indefatigable US consumer to help make them some money in the stock market. But today, we wonder whether the company’s $240 billion in annual sales are truly a success story for America, Inc. at large.
Wal-Mart has, after all, been stigmatized as "Communist China’s factory outlet" by its detractors because a significant portion of the merchandise Wal-Mart sells is manufactured in China and other low-cost labour markets.
Of course, in a world of true free trade and hard money we wouldn’t care where the cheap goods came from. But there’s irony in this particular story of the triumph of "managed trade".
In fact, Wal-Mart’s role is a classic illustration of why you can never have only a little socialism – or a "Mixed Economy", or "Compassionate Conservatism", or a "Third Way" – or what ever the current political buzzword happens to be.
Here’s the real story. Rather than buying "goods" themselves, all those Chinese workers, busily toiling away for the greater good in America, tend merely to help their home authorities stack up surplus dollars in official reserve balances. They save.
If they did buy goods with their wages from US companies, whom they have helped force out of the grocery business into other – presumably more lucrative – lines of endeavour, that would be good for all concerned. Fair exchange is no robbery, as the saying goes. In such a case, Say’s Law – supply creates its own demand – would apply. We would all be getting rich on a balanced diet of mutual exploitation and comparative advantage. (Economist talk for: You cut my hair well, I’ll mow your lawn better.)
But, in actuality, the Chinese simply surrender their dollars to the People’s Bank of China. The bank, in turn, issues more of its own intrinsically worthless paper Renminbi against them.
Arguably, there are people in the States who benefit from this arrangement: Wal-Mart shareholders; MBNA and the other credit card firms who finance Americans’ weekly shopping binges; possibly Fannie Mae, whose bonds the Chinese authorities frequently buy; and Wall Street, which securitizes and trades all the contingent cash flows thus generated.
US consumers themselves – though they seem to be benefiting from Wal-Mart’s lower prices – are left thereafter with little recourse but to borrow more dishonest money churned out by the Fed’s fiat machine in order to pay their tab.
Why? The only means consumers have to "earn" the funds needed to keep the cycle healthy is by producing other products more competitively and selling them back to China – or to others who later sell goods to China. But the Chinese aren’t buying. Thus, Americans simply go deeper into debt.
Too bad for America. At least the Chinese are prospering from the arrangement…right?
Not so fast. Chinese labourers toil long hours for what, by Western standards, are insufferably low wages…only to acquire savings in an inflated domestic paper currency held in shaky government banks…which is then lent on to deadbeat, state-owned industrial enterprises, or SOEs.
At the latest count, Chinese savings had amounted to Yuan 8 trillion ($960 billion), having risen by the mind-boggling proportion of 16% in the course of a single year.
The inflated money in China, meanwhile, keeps the inhabitants needlessly impoverished by misdirecting the allocation of all-too scarce capital…not least by concentrating resources in the hands of central planners and party apparatchiks – many from that noted hotbed of entrepreneurialism, the People’s Liberation Army!
Profits of the Chinese SOEs fell 20% in the first four months of 2002 to under $7 billion, despite accounting for roughly half the total $3 trillion economy. Not much of a return on capital, is it?
Chinese holdings of foreign reserves went up tenfold during The Bubble. They now hold $220 billion – largely in Greenbacks. Money supply, as a partial consequence, expanded three-fold to hit $2 trillion…a rate of expansion three times as fast as even the profligate Chairman Greenspan has managed in the US.
The result? Bad debts amount to around a quarter of all loans at the "Big 4" Chinese state banks.
In an attempt to force-feed growth, the Chinese authorities have fallen heavily into each and every pitfall such thinkers as Hamilton, List and Keynes did. By attempting to make mere money substitute for capital, by pursuing what is known as a mercantilist "development" programme – valuing useful imported goods less than sterile monetary reserves and sheltering favoured exporters to earn them – and by preventing the free market from working its invigorating magic on the masses yearning for self-improvement, they’re actually impoverishing their nation.
For its part, the Chinese government has ended up by owning junior claims on a significant stock of the homes built in recent years in America – a portfolio of plasterboard palaces ripe for the coming real estate bust. They’ve also helped to finance a government ever more keen to point missiles back at them.
Wal-Mart, Wall Street, the Military-Industrial Complex and the Housing Agencies may do well, for the short- term, but the benefits to the rest of us are a little more elusive even at the beginning.
The Daily Reckoning
July 11, 2002
P.S. The great money flood of ’00 and beyond has also made liars, cheats and swindlers out of a whole generation of businessmen and bankers – as such episodes of fiat money inflation have done, without exception, throughout the historical record. Congressman Ron Paul pointed out the absurdity of the fiat regime on the floor of the US House of Representatives last month:
"Trust in paper is difficult to measure and anticipate, but long-term value in gold is dependable and more reliably assessed. Printing money and creating artificial credit may temporarily lower interest rates, but it also causes the distortions of malinvestment, overcapacity, excessive debt and speculation. These conditions cause instability, and market forces eventually overrule the intentions of the central bankers.
"That is when the apparent benefits of the easy money disappear, such as we have dramatically seen with the crash of the dot-coms and the Enrons and many other stocks.
"Now it is back to reality. This is serious business, and the correction that must come to adjust for the Federal Reserve’s mischief of the past 30 years has only begun. Congress must soon consider significant changes in our monetary system.
"Congress must soon consider significant changes in our monetary system if we hope to preserve a system of sound growth and wealth preservation. Paper money managed by the Federal Reserve System cannot accomplish this. In fact, it does the opposite."
The wasteful dissipation of "classic liberal capitalism" potential benefits is why the world’s economies are in the mess they are in.
And, though unspoken, why so many governments are being led to engage in dangerous military adventurism abroad…and a no less perilous encroachment on freedom at home.
Editor’s Note: Sean Corrigan is the founder of Capital Insight, a London-based consultancy firm which provides key technical analysis of stock, bond and commodities markets to major US, UK and European banks. Corrigan is a graduate of Cambridge University and a veteran bond and derivatives trader from the City. Corrigan serves with distinction as The Daily Reckoning’s "man on the scene" in London’s financial district.
Panic now…avoid the rush.
That was our advice after seeing stocks rise sharply last Friday. Monday morning was as good a time to panic as ever. After falling 179 points on Monday, the S&P 500 was down another 3.4% yesterday. And utilities dropped 5.9%!
All that after the money supply, MZM, rose by 13.2% last week. And president Bush assured investors not to worry about financial crimes – he is on the case!
Man oh man…what’s going on? Is this a bear market or something?
The latest Lipper report tells us that 99% of equity funds lost money in the second quarter, with the average loss about 14%.
"If 14% was the average," writes the Mogambo Guru in a reflective mood, "what was the standard deviation? Methinks, or more rightly meknows by statistical certainty, that a whole lot of somebodies lost a lot more than that. Some less, too. But these in this latter group can still manage a wan smile, whereas those in the former are broken, scared witless and desperate."
How long will it be before these broken hearts give up and admit it to themselves – it’s over? We don’t know, but more and more, their eyes seem to be wandering…in search of new friends.
They may have noticed, for example, that the best performing fund in the last quarter was a U.S. Treasury bond fund – up 5.2%. Would it be so surprising if they suddenly decided to dump their stock funds and strike up a friendship? Five percent isn’t much – but it’s a lot better than a 14% loss.
Even though investors are selling stocks, there has still been no panic on Wall Street. Instead, slowly and steadily, the conceits, pretensions, myths and madness of the Great Affair are being discredited. It is like a girl who marries a rich business tycoon only to discover that he is broke…and already has another wife and family – living in a trailer in West Virginia.
Man oh man…what a disappointment. Could you blame the girl for taking up a handsome traveling salesman? At least he has a job….
Eric, more details…please…
Eric Fry in New York…
– A chunk of stock market capitalization about the size of Rhode Island tumbled into the sea yesterday. 283 points peeled away from the mighty Dow, as the blue chip index fell to 8,813. Meanwhile, the newly re-constructed S&P 500 eroded 3.4% to 920, and the Nasdaq slipped 2.5% to 1,346 – a new 5-year low.
– And just like that, another dramatic bear-market rally bites the dust. Last Friday’s 300-point Dow rally is nothing but a memory – an inconsequential blip on the Dow’s cascading price graph. This is no way to build investor confidence!
– "I am going to become a park ranger," one dispirited and disgusted investment advisor groused to me yesterday…Okay, it’s true, buying stocks isn’t quite as much fun as it used to be. But becoming a forest ranger doesn’t seem like much of an improvement. Aren’t forests going up in flames as fast as stocks are?
– Furthermore, even though the stock market is smoldering right now, owning stocks is still a great idea for the long haul, right? Surely, "buying and holding" an S&P 500 Index fund is still the very best way to amass wealth, isn’t it?…A small, but growing, number of investors is starting to have some doubts. This long-term investing stuff isn’t as easy as it looks on TV…and ripping open the monthly brokerage statement is not nearly as exciting as it used to be.
– Unfortunately, most professional investors aren’t much help. Although, bless their hearts, they’re trying.
– Yesterday on CNBC, (my new favorite TV station), one money manager assured the viewers, "You can always find stocks that will outperform…But the question is whether they will outperform enough to go up." This seemingly benign little remark offers an interesting glimpse into the world of professional money management.
– Whether a stock "goes up" is an important consideration for the millions of investors who can’t buy their groceries with "relative performance." The clerk at the grocery store checkout counter does not care that your mutual fund manager only lost 20% of your money while the S&P 500 fell 25%. The clerk expects to receive dollar bills.
– Unfortunately, finding a stock that goes up is not the goal of most professional money managers. Their job – literally – is to find stocks that will perform better than the S&P 500. In the world of mutual fund managers, a stock that falls 30% is a terrific investment as long as the S&P has fallen 31%. To be sure, life is more fun – relatively speaking – when stocks go up…But it’s all relative.
– Despite the pain and suffering investors are enduring these days, fear is not widely evident. Gold, for example, did not rally yesterday in response to the stock market’s travails. The yellow metal fell $1.40 yesterday to $315.10 an ounce.
– If investors were truly running scared – and not just running out of money – wouldn’t the gold price continue to soar? Investors as a group may have become somewhat less bullish. But there is no sign of panic.
– Astonishingly, despite the staggering and still- continuing destruction of wealth on Wall Street, a bearish viewpoint remains a minority opinion. And even the bears aren’t that cautious.
– The "Cautious Investor" – circa 2002 – does not buy gold or stash dollar bills in the mattress or stockpile cans of green beans in the basement. Rather, today’s Cautious Investor swaps out of a Growth Stock fund into a Value Stock fund. And if things get really dicey, the Cautious Investor might cash out his Emerging Technology Fund and park the cash in a Blue-chip Biotech Fund.
– In other words, folks, most investors still act like stocks are more likely to go up than to go down. Bear markets don’t end until most folks think the other way around.
– During bear-market rallies, Barron’s Alan Abelson advises, "What’s important is not the rally part, but the bear-market part."
– Abelson’s advice may be especially true this time around.
"The process of remediating the monstrous mess created by the bubble years in the economy and the market both is by no means over," says Abelson. "The insidious effects of the looting of Corporate America’s good name by the scoundrels entrusted with its stewardship are hardly dissipated. Pure and simple, it beggars belief and runs counter to common sense and logic that the biggest stock market bubble in history won’t engender an equally powerful bear market…Before it’s over, it will, and it won’t be over until it does."
Back in Paris…
*** Barron’s, Forbes…and now even the International Herald Tribune, which rarely reports on a trend before it is over, has picked up on our story. Maybe the stock market won’t recover quickly…maybe the economy will be in an on-again, off-again slump for years, says the paper. "Experts are making comparisons to ’29 in the U.S. and to Japan in the ’90s,’" continues the article.
*** Deflation…deflation…deflation…the money supply goes up…but the bond market is telling us to watch out for deflation, not inflation. The yield on 10-year Treasuries is 4.73%. Compare that to the yield on inflation-adjusted TIPS of the same length, 3.11%. That leaves us with just 1.62% of difference. Which is another way of saying the bond market believes inflation will not exceed 1.62% for the next 10 years. A year ago, the difference was 2.20% – so investors actually think there is less risk of inflation now than there was 12 months ago.
*** Man oh man…inflation hasn’t been at 1.6% since…well, the Eisenhower administration. Why would inflation go that low again? Because there is a mountain of debt that needs to be paid down…because the Chinese and Russians are undercutting everybody’s prices… because the stock market is imploding…and the housing market will probably not be far behind…and because of a huge demographic shift; people are getting older throughout the western world. Old people do not spend as much as younger people. They do not live large; they live little and spend less.
*** A few months ago, it seemed a foregone conclusion that the Fed would soon raise rates as the economy warmed up. Here, we repeat our humble guess at the time: the Fed may raise rates, but not before it lowers them first.
*** "While it is fun for Dems to beat up on Bush," writes my old friend from Texas, John Mauldin, "his ‘insider trading’ is not a real issue, except for the name insider trading and the fact that corporate ethics is big today. In June of 1990, he filed the required papers to sell 212,000 shares of Harken, which he later sold at $4. As an ‘insider’, this is required and is done every day. What Bush (or more likely, his accountants) failed to do was file the form to say he actually did sell. This was quite common at that time, as there was a different regulatory climate, and many ‘insiders’ filed late. When new rules took effect, directors and managers all across America got notice in March and April of 1991 that they needed to file the forms, and Bush, along with many thousands of others, did so. There was nothing unusual or sinister. Oh, yes, Harken did drop to around $1 or so, if I remember right. So Bush avoided a loss. That is, unless he had held, when it rebounded to $8. Hardly worthy of a Bernie Ebbers or Jeff Skilling. Let him who has never filed a government form late cast the first stone. If you find such a man, let me know. I will send him to my attorney, who will show him a dozen forms he completely failed to file last year."
*** But we do not fault Bush for the Harken affair; his willingness to break the letter of the securities laws is one of his better qualities. What we find less admirable is his use of the accounting scandal, like the War Against Terror, as a crowd-pleaser.
*** But that is the weakness in a democracy, dear reader – pleasing the crowd is the ultimate virtue.
*** "There was a time," explained my friend Michel, "when rulers felt they had been given their right to govern by God himself. Frederick the Great, Louis the 14th, the Medicis all sought out classical scholars to help them realize the model of the ‘good prince.’ They didn’t care at all what the people wanted. Their goal was merely to do ‘the right thing.’"
*** But a democratically-elected ruler has no concept of "right" or "wrong" beyond what the mob wants at the moment. The majority can’t be wrong…and a president can only do his duty by doing what the majority wants done, no matter how lame and preposterous it is. If the mob wants to see heads roll – in Afghanistan or on Wall Street – well, bring out the scaffold!