The Height Of Idiocy
The Daily Reckoning Presents: An attempt to grapple with
the tough business of economic prognositication…
"The only element in the universe more common than hydrogen is stupidity."
I’m not a fortune teller. In fact, the only things anybody knows about predicting – even if you gussy the concept up by calling it "forecasting" – are 1.) Predict often and 2.) Never give both the time and the event.
The worst offenders are those who pretend they know where the economy’s headed. Statistics – so often the basis of conjecture with regard to the economy – are so subject to interpretation, and so easy to take out of context, that most of the time they’re best used as fodder for cocktail party conversations.
Still, as potentially wrong-headed and tendentious as the subject is, "the economy" is occasionally worth talking about simply to establish a clear point of view.
In fact, I place the phrase "the economy" in quotes because I don’t even accept the validity of the concept, nor that of "the GDP"; they’re both chimeras.
The idea of GDP gives the impression that it is not individuals that produce goods and services, but rather a machine called "the economy." This leaves the door open to all manner of nonsense, like the assertion that what may be good for individuals may not be good for the economy, and vice-versa.
For instance, an advance in the GDP doesn’t necessarily mean increased prosperity: What if the government embarked on a massive pyramid building program, an archetypical example of public works? GDP might rise, but it would add absolutely nothing to the well being of individuals. To the contrary, the building of the pyramid would only divert capital from wealth-generating activities. On the other hand, if a scientific breakthrough was made which cut energy consumption by 80% for the same net output, or magically eliminated all disease, the GDP would collapse because it would bankrupt the energy and health industries.
But people would be vastly better off.
Entirely apart from that, the whole idea of GDP gives the impression that there actually is such a thing as the national output.
In the real world, however, wealth is produced by someone and belongs to somebody. We’re not ants or bees working for the hive. The whole idea of a GDP just allows the "authorities" to bamboozle people into believing they can actually control "the economy," as if it were some giant machine.
The officials pretend to be the Wizard of Oz, and Boobus americanus is trained to think they’re omniscient. Thus whenever the rate of growth slips "too low," officials are expected to give "the economy" a suitable push. Conversely, whenever "the economy" is growing too fast, the officials are supposed to step in to "cool" it.
It’s all an embarrassing and destructive charade.
I remain of the opinion that we’re headed into the biggest economic smashup in history.
That’s an outrageous statement, and it’s always dangerous to say something like that. After all, the longest trend in motion is the Ascent of Man, and that trend is unlikely to change; indeed, it’s likely to accelerate. And it’s usually a mistake to bet against an established trend. Furthermore, science and technology will continue advancing, people will continue working and saving, entrepreneurs will continue to create. And downturns in the economy have always been brief. There’s a good case for staying bullish.
Even most of those who talk of a recession tend to write it off as either a simple reversal of recent "irrational exuberance," or a passing change in people’s psychology, or temporary shock from the 9/11 events. Unfortunately, it goes much deeper than that. Those things have very little to do with what recessions are all about.
A recession, according to the conventional parlance, is a period when economic activity declines for two or more quarters. That’s a description of what happens, but it’s really not very helpful, much like saying a fever is a period during which your temperature is above 98.6 F. A better definition of a fever might be a period when the body’s temperature is elevated as a consequence of fighting an infection, in that it gives you some insightinto the cause as well as the effect.
That’s why I prefer to say a recession is "a period of time when distortions and misallocations of capital caused by the business cycle are liquidated."
What causes the business cycle? Excess creation of credit by a central bank (e.g., the Fed). The injection of artificially created money and credit into a country’s economy gives both producers and consumers false signals, causing them to do things which they otherwise would not do. The longer the upswing of a business cycle continues, the longer and more severe the down cycle will be.
A depression is just a really bad recession.
One thing that – contrary to popular opinion – can help get an economy out of a recession is a large pool of savings; savings give people the money to invest in new production, as well as the money to buy that production.
That’s why it’s the height of idiocy for pundits to talk about how patriotic it is to go out and shop. It can only deplete the capital that will be needed in the future, and deepen the bottom with more bankruptcies, stealing consumption from the future.
That’s why the Fed’s lowering interest rates on the federal funds rate from 6% to 2.5% since January is such a bad idea; it encourages people to save less and borrow more. This engineered decline may well, after a certain lag time, cause a cyclical upturn – but it will only aggravate the underlying problem, guaranteeing yet a bigger bust.
We’re going to see lots more bankruptcies before this is over. Bankruptcies are about debt.
There’s no question we’re already in a recession, and have been for over a year; here come the GDP stats: Year-on-year industrial production fell by 5.8% in September, the 12th consecutive decline. Non-farm employment was down by almost 200,000 in September alone. The GDP’s rate of growth fell to an annual 0.3% in Q2, from 1.3% in Q1. And Q3 and Q4 are going to be much worse.
We’re on schedule to make 2001 the biggest year in history for personal bankruptcies, well over 1.5 million. The average amount of debt per household is 15% of disposable income, the highest ever. The average credit card debt per household is over $9,000-about three times the level of 1990.
Until just last month, stats show consumers were adding credit card debt at 16% per annum. Total revolving consumer credit rose more than $75 billion, to over $700 billion. The percentage of both delinquent credit card loans and mortgage payments are the highest since 1992.
In the last recession, in 1990, 71% of credit card users carried their balances forward, making only partial payments from month to month; only 29% paid their bills off in full each month. During the boom of the ’90s, with full employment and stocks skyrocketing, the number financing their balances dropped to a low of 56% in 2000.
That number is going to be heading up with all the economic indicators going into reverse at warp speed. Figuring 18% interest on the average balance of $9,000, about 2,000 non-tax-deductible dollars a year, and figuring how many people are already living paycheck to paycheck, and not counting the fact that the unemployment rate could go at least to the levels of 20 years ago before this is over, it seems like really big trouble.
The Federal Reserve indicates that – not counting home mortgages – Americans are over $1.6 trillion in debt. Home mortgage debt, however, is the biggie, increasing by $1.2 trillion over the past three years alone.
Of course it’s looked grim plenty of times before. But this is just the start of a recession, not the bottom of one.
This isn’t just an American problem, because the U.S. is truly the engine of the world’s economy. But a lot of the drive behind the engine is the gigantic trade deficit. The $450 billion the U.S. sent abroad in the last year alone, after over a decade of increasing deficits, has caused a lot of capital investment that will become uneconomic, and created a lot of economic activity that will come to a screeching halt when that deficit inevitably reverses.
The whole world is levered on what happens in the U.S..
The effect in economies around the world will be devastating. The Smoot Hawley tariff of 1930, which acted to collapse world trade, greatly exacerbated the last depression. It could be that economic conditions in the U.S. alone could do it this time, without the overt"assistance" of the government.
In fact, the U.S. and Japan account together for 46% of world output. When the U.S. radically decreases its buying of foreign manufactured goods, and the Japanese do the same with raw materials as a consequence, it’s going to hit world trade like a sledge hammer.
I don’t believe we’re looking at just another cyclical downturn this time. We could be – but I don’t think so. The meltdown of the bubble economy; the dissipation of perhaps trillions in the busted tech boom; the negative wealth effect from the collapse of stocks; now real estate, and next the dollar; the huge buildup of capacity which will go idle; the historic debt burden; and now a war that could go on for many years add up to a truly deadly combination.
Noting a real trend he called "The Top-Out Parade," [oft noted here in the Daily Reckoning] Richard Russell pointed out some time ago: "Daily new highs topped out on Oct. 3, 1997. Advance/Decline ratio topped out on April 3, 1998. Transportation stocks topped out on May 12, 1999. NYSE Financial Average hit its peak the next day. Utilities registered their high on the 16th of June 1999. NYSE composite topped out a month later. The Dow itself hit a high of 11,722 on Jan. 14, 2000. The NASDAQ peaked on March 10 at 5,048. The S&P topped out on the 24th of March at 1,527. What’s left? The dollar."
Of course, since the dollar is by far the biggest market in the world, constituting the reserves of almost every government on the planet, the de facto currency of probably 50 countries, and the savings of hundreds of millions of people around the world, when it collapses, it will cause a financial earthquake, Magnitude 10.
Use any rallies as selling opportunities. Diversify your assets out of the U.S.. Build a good position in gold. Buy gold stocks with speculative capital. Get your debt, if any, down to comfortable levels.
for The Daily Reckoning
Yale Professor, Robert Shiller, quoted in the Wall Street Journal: "We face a big unknown today in how consumption and investment will evolve in the next few years. Will consumers further cut their spending in response to terrorist threats? Will they continue to cut back travel and vacations? Will they cut back their demand for housing, and reduce the price for housing, thereby further amplifying the downward wealth effect? Will business become too pessimistic to launch new campaigns, sink money in new plants and equipment, and hire and train new employees? Will entrepreneurs be unwilling to commit themselves to new risky ventures that will drain their time and emotional energy in return for some uncertain possible reward in the future?"
Questions, questions, questions. And who knows the answers?
No one. But we don’t mind making a guess and proposing a reason.
The chips fell a little yesterday. Our guess is that whenever the percentage of stocks to GDP is greater than the average investor’s I.Q. – the chips are too high. We wouldn’t be surprised to see the chips fall and keep falling, until they are finally down to a level where people are no longer so confident of the future that they’re willing to buy a stock at a price 30 times its earnings and with a measly 1% dividend yield. Unsure about the return OF their money, they’re going to want a bigger, surer return ON their money to make up for the risk.
Bonds have outperformed stocks this year, but have headed down lately because investors think they see the end of the downturn. But Fed. Governor Meyer admitted yesterday that it would be "misguided" not to cut rate further if the economy refuses to respond.
So far, we see no evidence that the economy is improving…and we would not be surprised to see lowerrates, and higher bond prices, in the months ahead.Over to you, Eric.
Eric Fry in Manhattan…
– Hey! What happened? Where did all those confident consumers go? Contrary to the expectations of the "imminent recovery" crowd, consumer confidence dropped in November to its lowest level in seven and half years.
– This latest confidence reading reflects unalloyed anxiety. The "present situation" component of the confidence index fell to 93.5 this month from 107.2 in October.
– What might we glean from this latest report? Not much more than what we should have known already – when unemployment rises, confidence wanes.
– Is confidence waning on Wall Street as well? Don’t you believe it!
– "Call buying is off the charts," an institutional options trader informed me yesterday. "The sentiment is extremely bullish."
– Likewise, the VIX Index of options volatility indicates that fearlessly bullish investors are out in force. But then, we kind of knew that already. Many traders rely on these signals from the options market as contrary indicators. When the indicators show extreme levels of bullishness, the stock market often falls shortly thereafter. By contrast, high levels of bearishness – as existed in mid-September – often precede significant market rallies.
– At the moment, the crowd is bullish…which is bearish for stocks.
– Yesterday, the Dow tiptoed toward the 10,000-mark, before getting a little spooked and finishing 110 points lower at 9,872. The Nasdaq gyrated between a 37-point and a 23-point gain before falling 5 points to 1,936. Perhaps yesterday’s negative finish heralds a change in the wind for the stock market – a change that is not bullish. Certainly, investors do not lack for reasons to sell stocks.
– Through the end of October, industrial production has dropped 7.3% year-over-year. Capacity utilization has dropped a similar amount. Both of these key manufacturing indicators have suffered their most severe yearly slumps since 1982.
– Within the other major industrialized countries, Bridgewater Associates observes, "Production growth still stinks, and if anything the industrial sector’s problems look like they are getting worse, not better."
– If our economy were as robust as Abby Joseph Cohen would have us believe, why are folks taking out new mortgages for the purpose of buying almost anything except homes?
– Mortgage refinancing activity has soared 500% year-to- date. Yet, the number of new mortgages for home purchases has actually fallen this year. And so have home prices. Despite the remarkable decline in mortgage rates over the last 12 months, new single-family home prices have fallen year-over-year.
– A contributor to the DR discussion boards provides an eyewitness account from ground zero "in the HEART of the Silicon Valley." He writes, "Home sales have increased from 5 pages of ads of open houses in the local paper to 25 pages. You now have a choice of 3-4 homes on the same street…Just the tone of the valley has changed; my kids and I went to a mall on a sunny Saturday; it looked like a ghost town. Let’s have a reality check: Layoffs, businesses folding, homes and apt. vacancies, lack of shoppers…believe me it’s FAR from getting better."
– For every story we read about the imminent, hoped-for recovery, there is at least one troubling tale about the present, undeniable slowdown – one of the more poetic recent anecdotes being the dismal attendance two weeks ago at the technology company love-in in Las Vegas known as Comdex. "From the moment the media, exhibitors, analysts and attendees got off their respective flights at the Las Vegas International Airport, it could be seen that Comdex 2001 would not be living up to its previous self," PCstats.com reports. "The first tip-off was how easy it was to get a cab…As the cabbies themselves said, last year they averaged about 25 rides a day, this year it was down to 10 or 15."
– So just how poorly attended was this Comdex confab? "NTT DoCoMo, a Japanese firm that makes some of the wildest cell phones you will ever see on the planet, had a large booth this year with a small armada of Booth Babes. At most times, the lovely ladies equaled or outnumbered the number of visitors to the NTT pavilion."
– In hard numbers, pcstats.com writes, "When the number crunching had been completed, the attendance figures from last year, which stood at about 211,000 people, were down to a mere 57,000 in 2001."
– Better luck next bubble.
Back in Paris…
*** What else?
*** Well, today is the anniversary of the invention of the guillotine.
*** What else do you need to know?