The Hardest Place Of All
“Investors are trapped between Scylla and Charybdis,” I grandly began my speech at our Las Vegas conference. Scylla and Charybdis were to the classical world what “a rock and a hard place” are to Americans today.
Of course, investors are always trapped – between the risk of loss when they invest their money…and the risk of loss from not investing it. Even cash has suffered greatly throughout most of the 20th century – losing about 95% of its value to inflation.
But now investors are up against the hardest rock in the entire investment universe: deflation. It is unyielding, uncompromising, and unforgiving. On the painful side of life’s ledger – where mistakes and illusions are corrected – deflation sits as one of life’s major disappointments, along with war, pestilence, aging, and divorce.
Deflation is a horror to central bankers, politicians, debtors, investors, and businessmen. Gone is the growth, the launch parties, the happy press releases, the sycophantic reports…and the surpluses and the profits. And there is not much they can do about it.
Fortunately, it is also as rare as a liquor store that makes home deliveries.
Not since the Roosevelt administration has the amount of money it takes to bribe a building inspector, pay off a congressman or hire a divorce lawyer actually gone down.
Americans are accustomed to seeing the cost of life’s essentials go up, not down. They have no experience with deflation, and no resistance to it. They have bet heavily on inflation – loading up on debts rather than credits. Deflation makes debts harder to pay. People lose their jobs. And their assets, except for cash, are marked to a market that goes nowhere but down.
The only recent example of deflation in a major economy comes to us – like so many other recent imports – from Japan.
“The main long-run problem that Japan has,” explained Dallas Fed governor Robert McTeer last week, “is that they had a banking crisis similar to ours but they still have it. They didn’t get the RTC (Resolution Trust Corp), they didn’t get the bad loans off the books. So they have been limping along with a wounded banking system for ten years now. Meanwhile, they went into a period of actual deflation, so prices are actually going down in nominal terms. And under those circumstances, people find it advantageous to save now to spend later, because you are going to have lower prices later. So it is a self-fulfilling thing; the more people slow down on their spending, the more income falls. And they are having a hard time getting out of it. And they’ve also got a fairly old population, pension problems and so forth. And the age factor also probably helps in that decision to save rather than spend.”
Daily Reckoning readers who look in the mirror occasionally might have noticed that America’s population is also aging. And those that read the newspapers might have noticed that the U.S. financial system has its own debt problems to reckon with. Just last week, for example, Leo Hindery, former CEO of Global Crossing, allowed as how 80% of the world’s $900 billion in telecom debt might be uncollectible: “You’re going to easily lose $600 billion here just on the debt side.”
Investors may lose $600 billion, dear reader. But it won’t be “easily.” It will be hard. That amount is equal to about 5% of GDP. Few creditors can afford that kind of a loss. For they have creditors too. And as the telecoms default, it will threaten other dominos of the financial system.
But don’t worry, says McTeer. “We are front-loading monetary policy here to get out of this thing fast. We are not going to do it in dribs and drabs, and let it linger on. We are not going to go into deflation.”
Though Alan Greenspan, Robert McTeer and others pull hard on their oars to avoid getting sucked into the deflationary whirlpool, your editor suggests that you put on your life vest.
“For the First Time Since Ike, a Whiff of U.S. Deflation,” writes Floyd Norris in the New York Times. “And now one measure of deflation is here. The government’s quarterly growth report, which showed that the economy shrank in the third quarter, reported a decline of 0.4%, at an annual rate, in prices for personal consumption expenditures. It was the first quarterly fall in nearly half a century, since the second quarter of 1954, at the end of a recession. What is new here is that deflation is spreading from the industrial world to the consumer. The Commodity Research Bureau’s index of raw industrial prices peaked in 1995 and now is at a 15-year low, off 16% this year and 40% from its high. Yesterday’s report from the National Association of Purchasing management showed the pricing power of manufacturing companies is at its lowest level since 1949.”
But a hidden deflation has been underway for many years, argues economist Jude Wanniski. Gold is the world’s ultimate money…its money of last resort. But gold has been getting cheaper, compared to everything else a dollar will buy, for 23 years. As recently as the mid- ’90s gold traded above $380 an ounce. Now it is $100 cheaper.
“In 1995, I predicted that inflation’s days were numbered,” writes Wanniski. “A year later, I warned of a new, more exotic enemy – deflation.
“The current deflationary process in the U.S. began in late 1996,” Wanniski explains in last month’s American Spectator magazine, “when the dollar price of gold and all other commodities began to fall. In ’97-’98, the pivotal price of oil plummeted from $25 to $10 per barrel…”
On January 7, Wanniski says he met with Dick Cheney and warned that “the administration had inherited an economy with a rare disease curable neither by Federal Reserve interest rate cuts nor by the timorous and dilatory series of tax rate reductions then being proposed…”
Then, continues the former Wall Street Journal economist, “in late February, I advised my Wall Street clients that, until the problem was corrected, there would be no reason to buy equities…”
Can the problem be corrected by Dick Cheney and the administration? Can the pain of deflation be prevented, as Robert McTeer assures us?
The Fed governors were recently thought to be able to avoid recession. Now that we have one will they be able to end it quickly?
Stocks were recently considered great investments because stock prices only went in one direction – up. Now that they have been going in the other direction for a year and a half, are they a great investment becausethey are cheaper?
The “peace dividend” was recently thought to be one of the reasons why stocks would continue to go up. Now that the fighting has begun, will stocks go up because we are at war?
Answers to these and many other fascinating questions as the Daily Reckoning continues…tomorrow…
Your editor, back in Charm City…
November 5, 2001
“Housing weakens,” reports a NY TIMES headline. “The already sinking U.S. economy is developing a new leak,” the story explains. Office vacancies are at a 5- year high. Throughout the entire housing industry – new construction, home sales, remodeling – there are signs of weakness.
One sign of weakness in the housing market waved at me yesterday. I was sitting in a cab headed out to the airport in Las Vegas when I saw, standing at an intersection, a man dressed in a clown suit…he waved and pointed to a sign he was carrying – it said “Free Rent”.
Builders must be getting desperate.
But the whole economy is being held up by clowns.
Remember Robert McTeer, Fed governor from Dallas? He urged consumers to “buy an SUV” in order to head off recession. Last week, he assured a Texas Chamber of Commerce gathering that “we are not going into deflation.” How can he be so sure? More below…
McTeer needs to check his map. Or maybe read the paper. “For the first time since Ike, a whiff of deflation” a NY TIMES headline informs us. Consumer prices are already going down, says the Bureau of Labor Statistics.
Copper hit a new low of 61.40 cents on Friday. Crude oil is barely above $20 – while the threat of a new Mideast war escalates. Go figure.
“Unemployment soars by 700,000” a Washington Post story tells us. September was the “worst month in 20 years,” concludes the TIMES of London.
“Consumer spending plummets,” reports the Dallas Morning New. The NY Times adds “recession expected to spread worldwide.”
“When people lose their jobs,” said the chief economist for S&P in a flash of insight, “they can’t pay their bills.” He added that U.S. credit card losses could reach 8%.
And the Confidence Index dropped to 84.7 last week.
But I am convinced, after spending a few days in Las Vegas, that the biggest threat to America is neither from war nor from pestilence, but from self-indulgence, bad taste, and bad judgment. Some of the people pulling the levers in Las Vegas looked so unhealthy and uncouth that a case of anthrax could only be an improvement.
“Did you hear the news?” asked the cab driver enthusiastically last night. “The Diamondbacks won the series…”
“Who are the Diamondbacks?” asked your editor, who always likes to be well-informed.
The cab driver looked at me as though I was from another planet. He probably reported me to the FBI as soon as I got out of the cab.