The Magic Economy
“If the U.S. economy is better than the rest of the world at rolling with the punches, and better at taking advantage of the opportunities that pop up, well, that’s what you’d call a sustainable advantage.”
– FORTUNE Magazine
“Do you believe, like I believe, in magic?”
– The Lovin’ Spoonful
America’s march toward perfection continues as though nothing can stop it.
Technology – in the vanguard position in the late ’90s and widely regarded as the great hope for the future of the human race – collapsed in the early 21st century. But, the rest of the economy stepped over the dying dot.coms and bleeding techs and kept right on marching.
Then, it was the telecoms who took bullets…while corporate profits fell all up and down the line. Finally, on September 11, the WTC towers took direct hits and nearly everyone – including your editor – thought that this blow would stop the advance.
But U.S. consumers got out their credit cards and fired away…blasting their way forward. The recession that should have checked the advance was turned aside by a fresh assault of loose credit, discounts, and reckless financial undefinedlan. And so the march of economic progress continues – moving the GDP forward at a stunning 5.8% annual rate during the first quarter of this year.
Who can help but be impressed?
“After predicting that the economy would tank after Sept. 11,” says Fortune, “many forecasters have turned downright giddy.” If the worst profits collapse since the Great Depression and the bloodiest attack against Americans since WWII did not bring the U.S. economy to a halt…can anything?
Who can do nothing in the face of such an opportunity? What good and faithful servant wants to bury his talent…now, when the future seems so promising?
(And yet, dear reader, just planting gold coins in the backyard for the last three years, on a risk/reward basis, would have beaten almost any other investment alternative.)
Americans are convinced that their economy is practically invincible – bulletproof, able to magically surmount any adversity. But, after the collapse of technology, they have no explanation for it. The economics profession rushes to fill the need…but lacks the necessary equipment. For no economic theory adequately explains how people can get richer and richer, faster and faster, forever and ever – while going deeper and deeper into debt.
“Productivity,” lamely suggests Alan Greenspan, hoping no one will look more closely. “Flexibility,” says Fortune magazine, and “a steadier hand at the Fed.” America’s economy is “the most flexible and dynamic economy in the world,” says Bruce Steinberg. “It’s magic,” says the Daily Reckoning.
Many experts suggest that the Fed is merely getting better at central banking. Milton Friedman argued that a main cause of the Great Depression was that the Fed of the early ’30s was too timid about increasing the supply of money and credit. Every central banker in the world has read Friedman’s guesswork; most believe it. Alan Greenspan must have committed it to memory.
“During each financial crisis,” writes Mario Ricchio of the Ricchio Report, “the U.S. Federal Reserve and its cohorts at Freddie and Fannie liquefy financial markets at the first sign of distress. We can trace Greenspan’s tracks as far back as the 1987 stock market crash and work back through crisis in SE Asia, Brazil, Russia, Japan and now Argentina.”
But this time really is different, Ricchio observes. “Greenspan is not fighting external issues or a slowdown in U.S. consumer spending as much as he is trying to counter a slowdown in US Corporate profits.” “If the economic recovery has a soft underbelly,” adds Robert Samuelson in the Post, “profits would seem to be it.”
The Fed has already done what it could to help corporate profits. It cut short-term interest rates by 475 basis points. Companies responded by trading long-term debt at high rates for short-term debt at lower rates. Still, profits fell 6.3% last quarter – the 5th consecutive declining quarter – after a 16% drop in 2001. Reported earnings for S&P 500 companies fell even more – down 51% last year.
“Without higher profits,” Samuelson explains, companies have the funds to finance new investment in factories, software or machinery. Poor profits also underpin stock prices. Poor profits may mean a poor market, dragging down consumer confidence and spending.”
Normally, you can buy a dollar’s worth of earnings for about $16. Today, a dollar’s worth of earnings on the S&P will cost you nearly $45, says Samuelson.
There are not many more rate cuts possible. The banks are cutting lending sharply. Technology is yesterday’s news. The consumer is tapped out and the dollar is falling. Under the circumstances, why would investors pay nearly $45 for something that is usually available for just $16?
They must still believe in magic.
May 02, 2002 — Baltimore, Maryland
The dollar fell to its lowest level against the euro in 6 months – following a visit to Capitol Hill by Paul O’Neill.
“It is not possible any more to actually fool markets for very long,” said the treasury secretary, explaining why he did not intend to intervene on the dollar’s behalf.
Here at the Daily Reckoning, we’re more impressed by the opposite observation; we marvel almost every day at how long the markets can be fooled. And we see nothing that has changed the situation. If anything, investors are more credulous than ever before. (About which, more below…)
But Mr. O’Neill is probably right about the currency markets. There are not many good reasons to buy U.S. dollar assets – and plenty of reasons not to…which are getting harder and harder not to notice.
A foreign investor in U.S. assets has gotten nothing for his trouble for the last three years. His stocks have gone down. He has received almost nothing in dividends. And now the dollar is falling against his own currency…and against gold.
And even though the first quarter was clocked growing at 5.8%, a close look at the old jalopy reveals a number of loose nuts and bolts. Final sales, as opposed to inventory rebuilding, actually slowed from the previous quarter. And profits fell for the 5th quarter in a row – something that hasn’t happened since 1970.
Consumers are still purchasing – but they may be running out of purchasing power. Debt has risen to more than 100% of disposable income for the average household – the first time that has ever happened, we believe.
But who knows, maybe a miracle will happen – like it did for the New Jersey couple who won a $59 million lottery jackpot. The couple had 70 credit cards and had run up $600,000 in debt. Maybe all America’s consumers will win a lottery – or maybe they will just go broke.
Eric, what’s the latest from the big casino?
Eric Fry en direct from Wall Street…
– As the Daily Reckoning has pointed out from time to time, Mr. Market is a rather manic-depressive fellow. And apparently, he neglected to take his medication again yesterday. The Dow tumbled 100 points early in the day, then jumped more than 100 points in the afternoon.
– By day’s end, the Dow had gained 113 to 10,060. Likewise, the Nasdaq recovered from a 2% drop early in the day to finish with a modest 11-point loss at 1,678.
– Mr. Economy – like his cousin, Mr. Market – also blows hot and cold. On the one hand, most of the Wall Street analysts examining Mr. Economy’s psychiatric records have pronounced him to be returning to “normal.”
– And yet, he doesn’t seem to be “all there.”
– Take yesterday’s economic stats, for example. Construction spending fell 0.9% in March. Also, the Institute for Supply Management’s purchasing management index for April dropped to 53.9 from 55.6 in March. The new orders index dropped as well – to 59 in April from 65.3 in March. Not much to cheer about there. Meanwhile, the national campaign to spend our way to prosperity is running out of fuel. Employment is still falling, but debts keep rising.
– “Late payments on credit cards have reached a five- year high,” says Strategic Investments editor, Dan Denning. “Write-offs by banks of uncollectible debt have reached an 11-year high…Personal bankruptcy filings are expected to hit an all-time high this year. Shockingly, household debt for older Americans is skyrocketing. According to data released last week, household debt for those 65 and older is up 164%.”
– Meanwhile, the economy at large is piling up a different kind of debt. It’s called a current account deficit. Ours is large and growing, and that’s one of many reasons why the U.S. dollar is, as traders say, “better sold than bought.”
– “Investors may finally be abandoning the U.S.,” Bill observed yesterday. And he cited a couple of pretty good reasons why foreign investors may be tiptoeing toward the exits: “So far this year, the U.S. stock market is the worst-performing market in the modern world…and the price of U.S. financial assets is high, while the quality is increasingly suspect.”
– Paul Kasriel, the thought-provoking economist from Northern Trust, offers another reason to steer clear of greenbacks: There are too many of them!
– “Could it be,” Kasriel muses, “that the dollar is weakening because the folks who are currently advancing us over $1 billion a day are beginning to think that they are going to be paid back in cheaper dollars? Isn’t that the message that Greenspan is sending?…If you have a lot of dollars invested in the U.S. and the guy who has been printing dollars like a hyperactive counterfeiter says he is in no hurry to stop, wouldn’t you start to get a little concerned about how much your dollar interest and receipts will buy in the future? Maybe that’s why the dollar has been falling [and] gold has been rising?”
– Hmmmm…gold as money…what a novel concept.
– By definition, an investor who sells dollars, or dollar-based assets, must buy something else. Among dollar alternatives, gold is clearly the sentimental favorite. But the world of non-dollar investments is as varied – and sometimes as exotic – as the wildlife in Madagascar.
– Foreign currencies like the euro and the Swiss franc offer a “quick and dirty” diversification outside of the dollar. Foreign stocks provide another valuable type of diversification. But foreign real estate is an increasingly interesting – if somewhat exotic – investment option.
– Foreign real estate is, of course, the domain of Kathleen Peddicord’s International Living. Even for those of us who are not in the market for a hacienda in Bolivia, International Living is a fascinating read. Somehow, Kathleen and her team manage to examine and describe a fascinating array of investment opportunities in foreign real estate.
Back in Baltimore…
*** “Why can’t we stop this madness?” asked the treasury secretary recently.
*** What madness?
*** The “U.S. Could Face Debt Crunch,” says a Washington Post headline. As predicted in this space, the big federal budget surplus disappeared before it ever arrived. And now it seems that the federal government – so recently so flush – is in nearly the same situation as poor Bernie Ebbers…faced with a mountain of debt and no way to climb it.
*** But the feds aren’t even thinking about hiking boots and nylon ropes…they’re worried about how to make the mountain bigger. By law, the federal government is not allowed to go further than $5.95 trillion in debt. That may seem like plenty to you or me, but it is not enough to keep up with the expense of conducting a worldwide WAT [war against terror] and buying votes from coast to coast. As a result of such spending, the feds have a big payment to make in June and not enough money to make it.
*** So, Congress has to get on the ball and do something. Here at the Daily Reckoning, we can think of a thing or two. When his expenses exceed his revenue, a sensible man cuts his expenses. But the last sensible man in Washington was probably Warren Buffett’s father – who went back to Omaha, we believe, during the Eisenhower administration. So, instead of cutting expenses, the nation waits for Congress to raise the debt ceiling.
*** Speaking of madness, May Day celebrations in France normally attract about 50,000 people of varying political persuasion. Yesterday, 500,000 showed up at the Place de la Republique alone. They marched down to Place de la Bastille…and over to Place de la Nation. One and a half million people were dans les rues (in the streets) across France. Young people are upset that Jean-Marie Le Pen has been getting so much attention around the world for having made it to the final round of the French presidential election.
*** Apparently, members of my staff were among them… they took a lot of pictures.