The Internet Depression, Part III

“Almost everything that’s supposed to be ‘new’ about the New Economy has happened before.”

Robert Samuelson

Yesterday marked the anniversary of one of the biggest, most costly, and most pointless battles of human history. The siege of Verdun was begun in February, 1916, and lasted until the following December. When it was over 300,000 men had died…but to no apparent purpose. Neither side had gained an advantage.

People make mistakes. Then they gradually learn and stop making them. Then, they make them again…or new ones.

WWI is commonly blamed on big abstract ideas – nationalization, militarization, mechanization. We learn the words in history class, but they give us little clue about why people would engage in such suicidal absurdities.

The Great Depression, too, has been blamed on bad ideas. “Official dependence on outdated cliches – such as maintaining the gold standard…” was how one financial historian put it.

“The Great Depression,” explains Michael Mandel, “was marked by a rolling deflation, in which country after country jacked up interest rates in order to staunch the outflow of its gold. In each country the central bankers thought they were doing the right thing. And perhaps individually, they were. But collectively, they brought on a collapse in the global economy.”

Yesterday’s CPI reminds us that today’s central bankers have plenty of opportunity to make mistakes too. The bond vigilantes may be taking a siesta, but there are plenty of investors and money managers all over the world who are wide awake. Inflation and falling Fed funds rates may signal to them that it is time to take their money elsewhere.

“Most of the wealth effect,” Mandel wrote last year, “and the shopping spree that goes along with it, is due primarily to the soaring price of technology stocks.

“From the second quarter of 1999 to the second quarter of 2000,” he writes, “the tech sector, including the telephone companies, was responsible for all the increase in market value of the S&P 500. That’s despite the fall of the Internet stocks in early 2000.

“Looking back a bit farther, between the middle of 1995 and the middle of 2000, about 45% of the rise in the market value of the S&P 500 came from the tech sector. Just four companies – Intel, Microsoft, Cisco, and America Online – were responsible for more than a $1 trillion increase in the market value over that five-year period.”

In the last 2 years of that boom, at least 20% of the rise in market valuations was thanks to investment from overseas.

We are now witnessing a correction of the boom in big tech. Since Mandel wrote, more than a trillion dollars has been taken out of tech valuations.

“The closest historical precedent,” he elaborates, “is the behavior of auto sales and stocks in the months before the crash of ’29. The automobile industry of the 1920s was the equivalent of today’s high-tech sector…”

Auto stocks peaked in March of ’29 and fell 15% by September. “Investors reacted to the drop in auto stocks by shifting into other stocks,” Mandel tells us, “what [they] did not realize, however, was that the fallout in auto sales and auto stocks was a sign that the leading sector of the economy, the one that had driven growth, was faltering…”

Mandel thinks he sees something new about the New Economy. Funding for technological innovation has moved from private tinkers, university labs and corporate R&D budgets to the capital markets. Since the IPO of Netscape in 1995, he says, it has been a New Era. Wall Street has vastly increased the availability of capital to new technology. Innovation has been securitized.

This might be a good thing. It promises to greatly increase the rate of innovation, which Mandel believes also increases the rate of economic growth. But it comes at a price…technological improvements, upon which economic growth depends, are now subject to the boom/bust cycles of the markets themselves.

And just as the upswing of the new tech cycle takes the economy further and lasts longer than the cycles of the industrial age, so might the downswings, Mandel argues.

Even without the gold standard, central bankers can find themselves in similar trap. Mandel explains: “The Fed may face a no-win choice if the economy heads into a tech downcycle. Cutting interest rates to boost the economy makes the dollar less attractive to foreign investors, and only accelerates the outflow of money.”

Economists John Eatwell and Lance Taylor, authors of “Global Finance at Risk,” add:

“the potential disequilibria – portfolio shifts away from the U.S., bigger international obligations on its debt, and growing financial stress on the household sector – could begin to feed on one another and on the views of the markets. At that point…all hopes for global macro stability could disappear.”

Mandel is a Christopher Columbus of an economist. He has run aground on something big…but he doesn’t know what it is. His maps show little of the new world into whose waters he has drifted.

So here, dear reader, I will try to fill in the missing geography…

More tomorrow.

Your Magellan of the markets…

Bill Bonner Paris, France February 22, 2001

*** What happened to Mr. Bear, I asked last week?

*** Our furry friend returned to Wall Street to maul the big techs and a few other favorites. Cisco, for example, dropped down to $25. Sun sank below the $20 horizon. And EMC, long considered safe, lost $6.32.

*** The Dow fell 206 points – bringing the index down 3% in the first three days of the week. 1073 stocks advanced on the NYSE; 2024 declined.

*** The Nasdaq 100 has suffered even greater damage this week – falling 7%. And the Internets, as measured by, have dropped 8%.

*** Gold stocks have gone nowhere. But nowhere is at least the right direction when everything else is going down.

*** For all the sound and fury, stock market investors have little to show for the last two years. Neither the Dow nor the Nasdaq have made the slightest progress.

*** IBM lost 4% yesterday, Walmart got discounted 6%, and investors decided to do it themselves with Home Depot – knocking 7% off the price.

*** Home Deport is adding 22.5 million sq. ft. of retail space this year, according to a Merrill Lynch report. “Even after the stock market starts its descent,” predicted Michael Mandel in his book, “The Coming Internet Depression, “there will be a substantial lag before it hits the economy. … The loss of stock market wealth may also take quite a while to pull down consumer spending….”

*** The stock market action was blamed on an unexpectedly bad CPI number – 0.6% increase in consumer prices for the month of January, rather than the anticipated 0.3%.

*** Like the PPI number last week, this could be a fluke. But for the moment, both CPI and PPI are singing the same song, which goes something like the 1920s classic: “I’m forever blowing [up] bubbles…”

*** “Now that you’re seeing inflation in both the CPI and PPI…how long will it be before foreigners start to bail on the dollar,” asks Dan Denning. “The Fed keeps cutting rates to prop up the markets. But what does that do? Just makes more dollars…and each new dollar makes all the others worth less. So, lower interest rates discourage ownership of U.S. treasuries, lower stock prices discourage foreign ownership of U.S. stocks, and higher inflation gives everyone an incentive to get rid of their dollars that much more quickly.”

*** On the heels of the CPI number, the Commerce department also announced America’s trade imbalance rose to a record high of $369.7 billion last year … up nearly 40% from 1999. “America suffered the biggest shortfall with China,” reports AP, “a record imbalance of $83.8 billion, 22 percent higher than in 1999. The deficit with Japan, which for decades has been the front-runner, also set a record at $81.3 billion, an increase of 10.8 percent over the 1999 imbalance.”

“Look at these trade debt numbers,” Denning continues, “…if foreigners decide they’d rather own euros than dollars…look out below.”

*** Yes, look out below, dear reader, the CPI number is just about Alan Greenspan’s worst nightmare. As long as inflation number remains low, he and his merry band of currency destroyers at the Fed think they can lower interest rates at will, in order to get the economy moving. Now they have to worry that lower rates, at a time of rising CPI numbers, will cause people to dump dollars.

*** Bill Fleckenstein: “It’s interesting that all of a sudden these numbers have gotten worse now that new folks are in charge of the Bureau of Labor Statistics (BLS). I’m sure that’s just a coincidence though.”

*** How will Americans make it through a financial crisis? Not very well. AP reports that the median net financial assets for U.S. households is just $9,850. “The ‘typical’ U.S. household has net financial assets, including retirement savings, of less than $10,000,” said the report, “and many families lost wealth in the late 1990s as consumer debt increased.” Fifty-three percent of households surveyed by the Consumer Federation said they lived “paycheck to paycheck.”

*** John Myers, our man on the scene in Calgary notes: “The buzz among oilmen in North America is that the Middle East is a powder keg; there could be a supply crunch that will lead G7 nations to begin a new round of developing domestic energy sources. How does this translate to profits? More money will flow into the development of oil and gas in the relatively virgin pools of Alberta and Saskatchewan.”

*** “Before leaving office, Clinton did more than just secure pardons for everyone on his and Hillary’s Christmas card list,” Myers also writes, keeping an eye on the ‘crisis’ in the West. “He issued an order that seemed more in keeping with the old Kremlin than the White House: natural gas and electricity suppliers must continue to ship to California regardless of whether their utility customers can pay. Clinton’s Energy Secretary, Bill Richardson, placed the order, citing it in the interest of ‘national defense.’ National defense! Who are they kidding? Bush’ man Hebert extended the order”

*** Amazon, our favorite ‘River of No Returns’ stock has now fallen 88% from its peak 14 months ago. But Bezos says “the company has never been in better shape.” Analyst Ravi Suria figures that Amazon will spend $130 million on debt service this year, $120 million on capital expenses, and $50 million on restructuring. In addition, it will lose $140 million on operations. Taken together, these expenses add up to $50 million more than the company has available.

*** Bezos sold $55 million of his own shares in the last few months.

The Daily Reckoning