The Janus Economy
Capital Insight’s Sean Corrigan takes a close look at the twin evils of inflation and deflation. And suggests that, like the two-headed beast of Dr. Doolittle, the world’s markets are asking: "which way do we go…which way do we go"?
The manic enthusiasm for property – the so-called "housing boom" fuelled by loose credit on both sides of the Atlantic – has another, darker face. Alongside the flourishing residential real estate boom, we also have an ongoing commercial property glut.
In the U.S., for example, office vacancy rates are between 16-22% in key metropolitan districts such as Miami, LA, Atlanta, Dallas-FW and Boston.
The Denver-Boulder high-tech "corridor" is suffering so heavily that "For Rent" signs swing over 35% of the buildings there.
In London, the first quarter of 2002 saw the worst take- up in a decade with lettings (rentals) running at half the rate of two years ago, and with speculative construction amounting to around 16 months’ current absorption.
But this real estate anomaly is only one manifestation of what might be termed the Janus Economy.
Janus, to step back a bit and explain, was the Roman God of gates and doors, beginnings and endings, represented by a double-faced head, each looking opposite directions.
For some time the economies of both the U.S. and the UK have been grappling with the twin evils of deflation and inflation. One represents the collapse of over- investment in the IT sector. The other is the result of a coordinated effort by central bankers around the globe to try and stave off economic crises.
While technology in the U.S. has undergone a once-in-a-lifetime bust, with "networkers" off 77% since the 2000 top and "telecoms" down 68%, health care is up 185%, home builders gained 190% and defense is up 245%.
Where does this all lead? Luckily – or maybe not – we have a model, which teaches us…almost nothing. Witness an article in the Japan Times this weekend, where the latest crank suggestion came from one Professor Ron Dore of the London School of Economics.
The mad professor thinks the only way for Japan to get out of the mess it is in is to…um…create inflation. Dore has come up with the novel idea that during the spring wage talks, the Japanese government needs to coerce the private sector into boosting wages across the board by at least 4 percent…thus creating inflation and giving consumers confidence.
Companies would then be willing to invest in new ventures as they could envisage better returns, he argues. Professor Dore appears to have neglected to calculate the threat posed by inflation to the companies who must pay the wages. With increased labour costs, companies will be forced to shed labour to reduce the wage bill again.
"Such a coordinated wage rise has never happened in post-war history, but then neither has such a prolonged period of deflation," enthuses the Prof.
Could this perhaps be because when Herbert Hoover persuaded businesses to coordinate a real wage rise in 1929 – by keeping dollar wages flat in the face of declining prices – there soon followed exactly such a "prolonged period of deflation," one which has since gone by the colloquial title "The Great Depression"?
Probably not. Because academics don’t do history like the rest of us. The professor is not likely to ascribe any cause – especially not one contrary to economic theory – to the greatest financial crisis of the 20th century.
Inflation is a monetary phenomenon, pure and simple. If people are given more money than they wish to hold, they will exchange it for goods or assets. To the extent that these are also not supplied in a greater profusion than the demand absorbs, their prices will rise.
The change in prices will not be homogeneous. If only it were, there might be a faint hope of at least some offsetting benefits. Instead, when the newly increased money begins to work, it will critically alter costs throughout the economy and thus exert sizeable influences on business planning.
These influences – being highly arbitrary – are usually unpredictable and almost inevitably damaging to investment and profitability.
Think of it this way. If high consumer spending is keeping labour rates elevated and is diverting energy resources, building materials and whatever else to realtors and shopping malls, multiplexes and therapists’ couches, "productive industry" has a harder fight not just for the end dollar, but also for the means of producing a final product.
This is true even absent inflation, but if extra money is added to the mix, a wedge is now being driven between those who create and those who destroy.
With this extra money, people will increase their spending first on necessities – such as health insurance and energy – and on ineluctables – such as government defence spending – and their prices will rise. Rising prices in these areas will attract more production, as well as more credit and capital to reinforce their enhanced cashflows. Products with rising prices will tend to be bid out of the hands of productive industries and hence withdrawn from them, stifling their expansion.
It is crucial to realize that whereas producer credit can lead to wasteful business misdirection and specific over-expansion (i.e. the New Era), consumer credit can also end up impugning economic well-being by divorcing the use of "purchasing" power from "earning" power…or productive capacity.
As long as foreign producers or their governments are willing to make up the shortfall – the former, by what is the equivalent of a global USD vendor financing programme, the latter, through what is effectively an export subsidy expropriated from their own consumers – all may seem well to Fed Chairman Greenspan and his cohort across the ocean, Eddy George.
However, in an article in the Yomiuri Shimbun this weekend, the downside effects of attempting to inflate your way out of a deflationary spiral are clearly laid out.
"Consumer goods manufacturers," says the article, "are unsure whether to pass a surge in material prices onto consumers, despite the ongoing deflationary crisis. Steel and chemical manufacturers have repeatedly raised prices of industrial materials following a decline in inventories and surging oil prices…Semiconductor prices have tripled since autumn…prices of steel, fibre materials and materials for liquid crystals have also risen.
"So far, only the prices of personal computers, gasoline and some other consumer goods have increased as a result, but economists warn that more price increases would further hamper consumer spending."
However, manufacturers of finished goods would most likely suffer a drop in profits if they did not pass rising prices of materials onto consumers.
"This dilemma," continues the article, "has caused manufacturers to resist attempts by material makers to increase their prices. Meanwhile, industrial material makers that have long suffered production cutbacks and falling profits are determined to try to recover profits by at least maintaining the current prices."
Ahhh! The curse of wish fulfilment in the Janus Economy. Janus was worshipped in Rome at the beginning of the harvest time, planting, marriage, birth and other types of beginnings, especially the beginnings of important events in a person’s life.
One wonders, with one face looking back at the failure of capital allocation during the New Era and the other looking forward to the uncertainty of opening the global money spigots what – if anything – we ought to be celebrating this spring.
for The Daily Reckoning
April 24, 2002 — London, England
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 U.S., 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.
Poor Bernie Ebbers! If only he had a gym teacher’s pension and a fishing pole. Life in the fast lane is fine, until there’s a pile-up.
The pile-up in telecom continued yesterday. Companies kept smashing into one another. One slams on the brakes of capital spending…the next one’s revenue is cut; it smashes into the company ahead, only to be rear-ended by the company following.
"It is like a really bad horror movie," says Money. "Just when you think that things can’t get any worse, they do."
Lucent is down nearly 30% this year. Nortel has lost half its value. Even AT&T has suffered nearly a 25% loss since January 1st.
Things are so bad at Ericsson that the company had to send out a cash call – asking shareholders to buy more stock in order to help the company pay down its debt.
But the demolition derby in telecom has been particularly punishing for Bernie Ebber’s Worldcom. The stock traded at $64.50 in June of ’99. Since then, it’s been so heavily dented and banged up that you can buy the stock for $3.41 – a loss of 95% of its value.
What else is happening on Wall Street? For that we turn to our intrepid reporter in lower Manhattan, Eric Fry:
Eric Fry on Wall Street…
– Another down day on Wall Street, as more grim news from the telecom sector ushered stocks lower. The Dow lost 47 points to close at 10,089, while the Nasdaq dropped 28 to 1,730. Former telco darling Williams Communications – following a well-trodden path – filed for bankruptcy protection yesterday. Meanwhile, the shares of Ericsson and Worldcom both continued their death spirals. So far this week, Worldcom has lost about 45% of its remaining market capitalization.
– The devastating two-year bear market in tech and telecom shows no signs of abating, and yet many of the analysts who promoted these former high-flyers have sailed through the devastation relatively unscathed…until now.
– If Wall Street analysts’ careers were traded like stocks, Merrill Lynch analyst Henry Blodget’s career would have to be downgraded immediately to a "Sell." At best, it is a "Market Underperform."
– That’s because the New York Attorney General Eliot Spitzer has discovered incriminating internal e-mails from the superstar Internet analyst in which he trashed the very same stocks he was recommending in his "research" reports.
– In one email, written on October 10, 2000, Blodget described the Internet company 24/7 Media as "a piece of shit," even though he was publicly recommending the stock as a "short-term accumulate and long-term accumulate."
– In effect, Blodget seemed to have established a dual rating system – one for the gullible public and one for his buddies.
– Back in the go-go days of October 2000, Blodget probably thought himself quite clever for encouraging investors to buy stock in a company that he privately knew to be a piece of you-know-what. But in the post- Enron days of April 2002, Blodget’s behavior appears to some folks to have been more criminal than clever.
– The news of Henry Blodget’s scandalous emails broke a few days ago. But it came to light for the first time yesterday that the Justice Department has taken an interest in the troubling disparity between the public Henry and the private Henry.
– Michael Chertoff, the head of the Department’s criminal division, told Bloomberg News that criminal charges are possible if investigators find that research analysts tilted their "buy" and "hold" recommendations to help their firms win investment-banking business. Do we really need an investigation to answer that question?
– Traditionally, the SEC would be the government agency responsible for investigating alleged wrongdoings by Wall Street analysts – not the New York Attorney General and certainly not the Justice Department.
– But now that the government’s big guns have strolled into the Corruption Corral, Henry Blodget’s largest concern might no longer be whether his annual bonus will be $2 million or $5 million. Instead, he might find himself worrying about things like conjugal visits and getting enough clean pairs of socks.
– Yesterday, I attended the "Grant’s Spring Investment Conference." Given the bearish outlook of most of the speakers, the "Spring DIS-Investment Conference" might have been a more appropriate title. Of the eight presenters at the conference, only one expressed a bullish thought…and that was about gold.
– In short, it was a vintage Grant’s affair, where bears are welcomed and bulls are tolerated.
– Kicking off the bearish barrage, Charles Peabody, the contrarian-minded banking analyst at Ventana Capital, argued that J.P. Morgan Chase might be forced to cut its dividend before the end of the year and that, therefore, "the stock might fall into the low 20s."
– Next up, Akio Mikuni, founder of Japan’s first independent bond rating agency, described the unpleasant string of events that might cause Japanese government bond yields to skyrocket. Mikuni explained that the bad- loan situation in Japan remains a very big problem. As he put it facetiously, "In Japan, charity begins at the banks."
– Later in the day, James Bianco, president of the fixed-income research firm that bears his name, took the podium to explain why the high-growth days at Fannie Mae and Freddie Mac are numbered. He also cautioned that these two "government-sponsored hedge funds" are much more vulnerable to rapid changes in interest rates than most investors appreciate.
– Pierre Lassonde, co-CEO of Newmont Mining, delivered the lone bullish presentation of the conference. Predictably, he was bullish about gold…very bullish. The basis of his conviction is a simple demand and supply analysis: Investment demand for gold is picking up from Tokyo to Toledo. Meanwhile, the annual supply of newly mined gold will be falling steadily over the next few years.
– Based on the numbers, therefore, Lassonde believes the yellow metal has entered a new bull phase.
– Unfortunately, Lassonde was the only presenter to hand out a glossy, four-color outline – the kind of pricey, high-sheen document that a "Global Crossing" or a "Corning" might have passed around to the attendees of a high-tech conference in February of 2000.
– As a rule, value investors don’t like to see glossy handouts. That’s because, as a rule, bona fide early bull-market stories are told in black and white…if they are told at all.
Back in the land where Le Pen is mightier than Le Sword:
*** The election results have everybody in a tizzy. "Don’t go down the Rue St. Martin when you leave the office," said a colleague yesterday evening. "They’re demonstrating against Le Pen at the Hotel de Ville. The police are suited up like robo-cops…and they’re charging the demonstrators, swinging their clubs. I had to run down a side street to get away from them."
*** Most French people we know seem embarrassed by Le Pen. "The French are not racists or xenophobic," explained the voice of reason, coming from my French teacher, Sylvie. "We’ve always welcomed refugees and immigrants. And France has always benefited from them.
"The voters just wanted to send a message to the politicians. There are problems in France that no one seems to have the courage to talk about, much less solve. The immigrants from North Africa are a problem. Crime is up. There are social problems we never had before in France. But it is politically incorrect to say anything. Le Pen is the only major candidate who had the courage to speak of these things."
*** "What’s everybody so worked up about?" wondered my daughter, Maria. "What’s the matter with Le Pen?"
"He’s very anti-immigrant," I explained.
"Well, what’s wrong with that? You know, I was on the metro near the Gare du Nord. The car was packed and most of them were immigrants. I don’t have anything against immigrants, but I wish they would bathe more often. It smelled terrible."
"Wait, Maria, we’re immigrants too…"
"Yes, but we’re good immigrants…"
"Well, that probably depends on who you talk to. I’m sure there are plenty of French who would rather we Americans stayed home too…"
*** Here at the Daily Reckoning, we like immigrants – and not just because we are ones. We find people entertaining and have almost never met one whom we would like to get rid of. (We’ve never met John Ashcroft.)
*** But many people worry that the world is getting too crowded. They fear that too many people put too great a strain on the world’s resources. Not so, says P.T. Bauer:
*** "Poverty in the Third World is not caused by population growth or pressure," Bauer wrote a few years ago in The Independent Review. "Economic achievement and progress depend on people’s conduct, not on their numbers. Population growth in the Third World is not a major threat to prosperity."
*** Bauer explained: "There is ample evidence that rapid population growth has certainly not inhibited economic progress either in the West or in the contemporary Third World. The population of the Western world has more than quadrupled since the middle of the eighteenth century, yet real income per head is estimated to have increased at least fivefold. Much of this increase in incomes took place when population was increasing as fast or even faster than it is currently in most of the less developed world.
"Similarly, population growth in the Third World has often gone hand in hand with rapid material advance. In the 1890s, Malaya [now Malaysia] was a sparsely populated area of hamlets and fishing villages. By the 1930s it had become a country with large cities, active commerce, and extensive plantation and mining operations. The total population rose through natural increase and immigration from about 1.5 million to about 6 million, and the number of Malays from about 1.0 million to about 2.5 million. The much larger population enjoyed much higher material standards and lived longer than the small numbers of the 1890s."