The Last Big Bubble

The Daily Reckoning Presents: A Guest Essay from “the nation’s leading advocate for financial safety.”


On September 11, nineteen fanatic terrorists broke America’s heart. But even as we continue to grieve for our fallen countrymen and women, the second devastating impact of that contemptible deed is being felt – on the world economy.

The unsettling new environment guarantees that we are about to experience more than an economic slowdown…more than a mere recession. We are about to witness the deepest stock market crash and depression since the 1930s.

Please don’t misunderstand: Things will not fall straight down. The most powerful institutions and central banks in the world will do everything in their power to prop up their economies and stimulate temporary stock market rallies.

But their efforts are a drop in the bucket compared to the trillions that had already been lost in stocks around the world. Even before the Twin Towers fell on September 11…

* THE ASIAN BUBBLE was a distant memory. The Nikkei had lost an incredible 75% of its peak value.

* THE TECH STOCK BUBBLE was in shambles. The Nasdaq was down 66%, $5 trillion in wealth destroyed.

* THE WORLDWIDE REAL ESTATE BUBBLE was ending too. In Japan, prime real estate was selling for a meager ONE SIXTH of its peak value.

All this BEFORE the terrorist attacks on September 11. But one giant bubble was still standing: The core of the great American economy, held up by just one thin thread – the confidence of the American consumer.

By early September, the American consumer was living in an increasingly smaller and more lonely world, shielded from reality by credit cards, home equity loans, a couple of SUVs, and the nearest shopping malls.

And, strangely, until late August, consumers were still spending freely despite the bad economic news. Home sales were holding firmly. Retail sales were still OK.Consumers were the last hope for the American economy.

But all that ended when the Twin Towers collapsed. The thin thread of consumer confidence was cut – irreversibly and irretrievably severed.

Everywhere in America today, consumer confidence is gone. Seven out of 10 Americans are fearful, depressed, or terrified. They feel powerless to restore their sense of physical security. So they are scrambling to restore their feeling of FINANCIAL security, to somehow build a cushion to fall back on during the coming hard times.

Problem: Right now, most Americans HAVE NO CASH. They’ve been living from hand to mouth for years. In the past, whenever they needed cash, they just grabbed the nearest credit card…or took out still another loan on their home.

No more. Now, many feel a growing pressure, even a compulsion, to sell something – anything. Stocks. Property. Goods.

This past weekend, we talked to automobile dealers here in Palm Beach County, Florida. Even though GM and Ford are offering ZERO percent financing for new cars, the dealers are getting no takers. None. Zilch.

Yes, they ARE getting a lot of phone calls. But the calls are from customers who want to SELL their cars – not to buy. Many families in this area have two cars for transportation. Plus, they also have one or two EXTRA cars for leisure, fun, or just conspicuous consumption. And Palm Beach County is not unique. It’s the same in key areas all over the USA.

The CEOs up in Detroit and the economists up in New York figured that, once someone buys a car, that’s it. It’s off the market. They forgot that the United States has the largest used car market in the world. They never imagined that, instead of consumers making net purchases, you could see them unleashing net SALES.

And don’t forget the mass selling still coming in the stock market. Last week, many investors called their brokers to sell. But they didn’t want to seem “unpatriotic.” So they mumbled sheepishly that they were doing it “only because they had to” – only because they “needed the CASH.”

Or the brokers called THEM, asking for more margin money. Like the Bass brothers who got a margin call to sell 135 million shares ($2 billion) of Disney. Brace yourself. This is just the beginning of the forced liquidations in the stock market – to raise desperately needed cash.

Back here in Palm Beach Gardens, where I live, an associate called a handy man this week to give him a small job. The man was practically in tears with gratitude. All his other jobs had been canceled. He was completely out of cash. He had no idea where his next dollar was going to come from.

In New York, four Broadway shows have closed down. Not just for a few days. Forever! They were out of cash.

The leading airlines in America were equally cashless. They were estimating losses of $2.5 billion for the year before the September 11 tragedy. Now, they say their losses in 2001 will be many times larger. They asked Mr. Bush and Congress for close to $25 billion; they’re getting “only” $15 billion. But giving them money is like throwing salt into the sea. Even after 115,000 layoffs and even after flight bookings begin to pick up, they’ll still be running way below capacity. If that continues, the $15 billion will be gone like a puff of smoke.

I’ve dug back into the history of America’s 10 largest great corporations – AT&T, Ford, GM, GE, etc. – and found that, before the Crash of 1929, they used to keep as much as $2 in cash on hand for every dollar of current liabilities (bills and debts coming due within 12 months). Now, I see many of those same companies are down to a dime – one measly alloy dime – on the dollar. Nearly all American individuals and institutions are equally cashless.

This has been true for a few years. The difference now is that they’re desperate to GET to cash, but don’t know how. That’s the sea change we are now witnessing. You can already hear the sound of millions of American consumers slamming their wallets shut.

Americans will unite behind the President and rally for the country. But will they buy a new gas-guzzling SUV every year? Take luxury fly-away vacations every summer? Gleefully charge their credit cards and go deeper and deeper into debt?

No, those days are gone. Mark my words: It’s going to be many, many long years before we see another wave of consumer spending like the one that had energized this economy before the events of September 11.

Best wishes,

Martin Weiss, Ph.D.

for The Daily Reckoning

Martin D. Weiss, Ph.D., the nation’s leading advocate for financial safety, has helped millions of Americans with his ratings of stocks, mutual funds, insurance companies, banks, brokerage firms and HMOs. And he has testified before Congress repeatedly, advocating full disclosure of risk to investors.

That’s why Forbes has called Martin Weiss “Mr. Independence,” the Wall Street Journal says he runs a “feisty firm,” and Esquire noted that his is “the only company…that provides financial grades free of any possible conflict of interest.”

Today, subscribers to Martin Weiss’s newsletter, the Safe Money Report, get this kind of widely acclaimed information PLUS specific advice on how to convert it into investment profits.

See: The Safe Money Report

From Julian Snyder courtesy of Richard Russell:

“After 1929, the strangely forgotten (or covered up) fact is that the Fed cut interest rates rapidly from 6 to 2 percent by early 1930. Pundits of the day called the non-response to the cuts ‘pushing on a string.'”

Greenspan has been pushing on a string too. Rates have been cut from 6.5% to 3%, with results comparable to those of ’29.

Consumer spending – the last pillar of support for the American Dream Economy – is now collapsing. “Home sales slow after attack,” says the Associated Press. “Retail Sales Plunge After Attack,” observes Reuters. Consumer confidence has taken its biggest hit in 5 years.

“The bottom line throughout 300 years of capitalism,” Snyder goes on to explain, “is that economic expansion, no matter how handled, is, at the end of the day, like a balloon. When production has filled warehouses with unsold goods, when credit is at its limit, when the consumer is mired in debt, when big media advertising can no longer con or beat the consumer into spending more money, and the most ambitious marketing plans (at home and abroad) have gone awry, the balloon bursts or is rapidly deflated.

Usually, the greater the expansion, the more severe the contraction. “President Franklin Roosevelt’s WPA and deficit financing policies proved in the end to be futile. In 1940 the economy was still in depression. Only Pearl Harbor saved the economic day with the need for massive war production.”

But is war always bullish? A DR reader challenged us to find out. “The two wars most relevant to current conditions [are] the U.S. Civil War and the War of 1812, when the British burned the White House to the ground. In no other war EVER has the U.S. suffered any damage to the continental U.S. Do us a favor…go to the Library of Congress and find out what Baltimore real estate or some other asset of relevance did from 1811 to 1813.”

So, I sent Becky (our ace researcher) to the Internet as the next best thing. “Baltimore real estate in 1812?” I detected a “mission impossible” doubt in Becky’s voice. “I guess next you’ll want me to find Osama Bin Laden.”

Becky was unable to concoct an index of Baltimore real estate during the War of 1812 – from the material available on the Internet. But she found that Civil War stock prices did indeed rise – 170% from 1861 to 1864.

During WWI, however, stocks rose only 40%. Alas, prices rose 80% during the same period…which was followed by the recession of ’20-’21. At the bear market bottom, of 1921, stocks were down 37% from their wartime high and 13% below their pre-war values.

But let’s see what happened yesterday on Wall Street. Eric? (Watch Eric – this week only – on CNNfn, 9:30 to 11:30 a.m. est.)


Eric Fry on the scene in Manhattan:

– Consumer confidence took a header in September, but it was hardly a surprise. There is nothing confidence inspiring about watching two of America’s tallest skyscrapers collapse and kill thousands of our citizens.

– The consumer confidence index plunged to 97.6 in September from 114 a month earlier, according to the Conference Board survey (conducted partly before and partly after the Sept. 11 terrorist attacks). It was the largest monthly drop since October 1990. The future expectations index also fell sharply to 79.2 from 93.7 the prior month.

– Although this latest drop in consumer confidence was dramatic, it merely continues a months long trend. Most of the root causes of shriveling confidence preceded the attack. Things like rising joblessness and falling stock prices have been weighing on a heavily indebted Mr. and Mrs. Consumer for some time. (More below in this week’s guest essay…)

– Wall Street shrugged off the expected bad news, as investors focused on the task of buying marked-down – but still richly valued – stocks. The Dow advanced 56 points to 8,660, while the Nasdaq squeaked ahead 2 points to 1,502. Of course, some stocks are richly valued for a reason.

– Wal-Mart, for example, sells for a plump 30 times earnings. But that’s because the giant retailer continues to mint money in an environment where many retailers are struggling to avoid losses. Of course, Wal-Mart may owe part of its resilience to the fact that it operates in suburban America – far from New York City. The farther one moves away from “ground zero,” the easier it is to buy a new toaster and a complete set of commemorative Elvis Presley dinner plates.

– Looking out over the next few months, the retail landscape will not exactly be feast or famine – more like tuna fish sandwich or famine. Will anybody be feasting?

– After wrapping up my appearance on CNNfn yesterday, the TV station offered to call up a car service to drive me to my office. I accepted. As we rode along through the bustling streets out of Manhattan, I asked the driver if his business had picked up since the attack. My thinking was that all those Manhattanites who might now be less inclined to ride the subway would be more inclined to call up a car service to take them to and fro. “Business is awful,” he answered. “It’s off about 70% since the attack.”

– The problem, as my driver explained it, is threefold: fewer people are going to airports, nobody is going to lower Manhattan and all businesses are scared.

– It’s hard to make lemonade out of those lemons. The best that one can say is that air travel will likely pick up over the coming months. In the meantime, it will be rough going for the airlines, the hotel companies, the theme park operators, etc.

– The way it’s looking right now, if you go to Aspen this winter, you might have the place to yourself. But if we assume that most Americans will be traveling less, will they not be doing something else more?

– Maybe they will go out for dinner and a movie a little more often. Or maybe they will play Monopoly with the family more often. Or maybe they will start reading the Daily Reckoning from start to finish each and every day. (Maybe we’ll start writing twice a day!)

– In other words, subtle lifestyle changes might benefit specific industries and/or specific companies. One hedge fund manager told me that reduced spending on vacation travel will mean rising discretionary spending on children’s clothes and toys. He likes Toys “R” Us. Call it the “guilt” trade if you will. The fund manager’s hypothesis is that if Dad cancels the vacation to Disney World, he’ll have to make up for it somehow. Maybe he will buy an extra toy here and there.

– Even if consumers rein in their spending a bit, there is some good news out there for this ol’ economy of ours. Oil prices are falling, government spending is accelerating, government bailouts are rising, tax cuts are in place and Greenspan (remember him?) is expanding the money supply rapidly. All told, our economy may just rebound in spite of itself.

– Of course, any rebound will likely be short-lived until corporate cash flows and balance sheets start to improve. Greenspan’s magic interest rate alone can’t pull those rabbits out of any hat.


Back in Paris:

*** “Finally, we give Afghanistan 72 hours to turn over bin Laden,” wrote a helpful citizen. “If they don’t, we give them 72 hours notice so that their civilian population can evacuate the city and then bomb the city out. Next, the second city is bombed out. Etc. And so on until bin Laden will not even have a tower to use his cell phone…”

*** “We’re wasting time,” said another, to a reporter from Le Figaro. “We’re strong enough to do the job alone. It was New York and the Pentagon that were hit – not the Eiffel Tower. Sad to say, but I think we need blood and fast.”

*** “Of course, it would be better to avoid civilian casualties,” added an accountant, “but if there’s no other way, we shouldn’t hesitate. The Twins weren’t a military target. Innocent people were killed, so I don’t see why we should worry.”

*** “Bomb them all,” said another New Yorker, “let God sort them out.”

*** The speaker, giving voice to America’s new spirit of thoughtfulness and honesty, was – perhaps without realizing it – paraphrasing the remark of one of Christendom’s greatest protectors – Simon de Montfort. More about him tomorrow…