The Recession-That-Wasn't

With the bubble’s excesses still unmitigated – and with even more hot air billowing into the balloon – the job left undone by the 2001 ‘recession’ becomes more formidable by the minute. This DR Classique, originally published on 14 March 2002, inspired themes in Chapter 8 of Financial Reckoning Day.

Phony boom, phony recession… what next? A phony recovery! What a strange recession? It was like a zebra – but without the stripes. And only one leg… on which he seems to hop… underwater… .

Recessions typically correct attitudes and asset prices – and repair balance sheets. Debts are written off or paid down while savings rates mount.

But none of that happened. Stocks are higher than ever. Businesses are more heavily in debt than last year. Savings rates are pathetic. And the consumer?

"Emboldened by low interest rates, board discounting and ready cash form their mortgage refinancings, consumers spent through the recession as if they were flush," says a TIME article on the subject. "Now they are in debt and won’t be able to pick up the spending pace much in 2002."

How can you have a recovery without a boost in spending? And what would happen if consumers actually slowed spending instead?

"Equity market strategists are relying on U.S. consumers to maintain their strong demand for goods so that manufacturers can increase production and earnings," writes Hugh Whelan. "Better corporate earnings, especially if associated with high productivity growth, allow robust wage increases, which then feed back into more consumption. It will be something of a miracle, though, if this rosy scenario pans out… the consumer has been the beneficiary of several one-time occurrences: energy price declines, low interest rates, tax refunds and last year’s tax rebate."

Miracles do happen. But our advice, gentle reader, is to play the odds.

The one thing that the ‘recession’ did do – and do impressively – was lower corporate profits. But thanks to new productivity, we are told, corporate profits are going to come back – justifying share prices and boosting the economy. Consumers may be in no position to increase spending, say the bulls, but businesses can increase capital investment and profits and lead the economy into another boom.

And so, today’s important question: What happens next? Do profits shoot up – making the investors and economists feel like geniuses again? Or, does a real recession sneak into the patsies’ assets, like a Democrat into the public treasury?

The entire economics profession and almost every investor in the world seems to have crowded into one side of this trade. We will take the other.

Will the recovery be sharp and robust? Or will it be soft and easy-going? No other possibility seems to have occurred to the pundits on CNBC…

But what if there were no real recovery at all? What if the recession-that-wasn’t of 2001 turned into the recession-that-was of 2002? You are reminded, dear reader, that we have no crystal ball… nor has God whispered the answer in our ear. But, as a matter of principle, markets often give investors what they least expect and most deserve.

Readers will also recollect that getting rich is not as simple nor as easy as some might think. If lower interest rates could really make people wealthy, why not lower them to zero tout de suite? And why would Japan – with it’s zero rate policy for nearly five years – not be the richest nation in the world.

Nor is the money supply itself the magic ingredient. If introducing more currency into an economy could make it rich, Argentina would have been fabulously wealthy in the late ’80s, instead of at the edge or ruin.

No, it is not that easy. Like everything else worth getting in life, getting rich requires giving something up. Even love requires an investment… and one gets a kiss by giving one. And for the faithful… Jesus could not have risen from the dead had he not been crucified. Every bit of human progress requires some sacrifice. Could it be any different for an economy?

To achieve wealth, one needs to set aside assets and invest them for a return in the future. Seems simple enough. But in the New Economy of the late ’90s, investors came to believe that they could have the gain without the pain. And consumers – the patsies of the new economy – believed they could spend more and more money they didn’t have. The central bankers lured them to their ruin, telling them that spending was the ‘patriotic’ thing to do!

But instead of investing in productive new plants, equipment and technology, businesses switched their attention to raising share prices. Mergers, acquisitions, share buybacks and employee stock options were all the rage.

Most people think that huge amounts of money were invested in new Information Technology, which produced a glut of capacity. This is not true. Small amounts were invested – which were then magnified by the number crunchers using their ‘hedonic’ amplifiers. Information technology does not require a lot of capital investment. Then again, it produces little in extra profit.

After pretending to invest big money in the new technology, the number crunchers in the private sector then pretended that the investments were profitable. More reckless than most, Enron’s accounts show to what extent the pretenders would go.

But you can’t produce real profits without making real investments. That is why profits have fallen so sharply – so little was invested to produce them. And that is why profits are not likely to rise quickly or easily. First, businesses need real savings – ones that they can invest in real projects that might make people richer. Then, consumers have to reduce their debts so they can afford to buy them. All this takes time – maybe a decade or more.

A society that invests heavily and carefully in new plants, equipment, technology, training and research is a society that gets richer. It can produce more of the things in which wealth is measured. A society that consumes its capital instead… gets poorer. And sooner or later realizes it.

Your editor,

Bill Bonner

December 03, 2003 — London, England

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the NY Times and international best-seller: "Financial Reckoning Day: Surviving The Soft Depression of The 21st Century" (John Wiley & Sons).

What a delight! What joy! It’s back! There is madness everywhere… How exhilarating…the pure, unmitigated greedy insanity!

It was so much fun ridiculing the pretenses of the New Era…the Information Age…the bubble…the Peace Dividend…the End of History….and the New Digital Man.

And then, boo hoo, along came the bear market of 2000-2002…All of a sudden people seemed to sober up. For a moment, it looked as though they might even lock up the liquor cabinet.

Then, the politicians began to drink. But politicians are mean drunks. The madness that had made the stock market so amusing took on a sinister regard. The Clash of Civilizations…Nation Building…Bringing the Gift of Democracy to the Desert Tribes – the entertainment was no less mad than the New Era, but much less fun, for the script had been rewritten as a tragedy, rather than the comedy it had been.

We giggle and guffaw when we see rich humbugs humbled…we laugh out loud when puffed up IPOs finally blow up…we even smile when the lumps get what is coming to them. But we take no pleasure in body bags…for they never seem to contain the right bodies. That is the trouble with war, dear reader. The bodies are always those of the fools who undertook the errand…rather than the fools who sent them.

But now, we are pleased to tell you, madness is back in style on Wall Street, where it belongs…maaaadder than ever.

The "return of the tech bubble," is how London’s MoneyWeek describes it. The Bubble Reloaded is another headline we’ve seen. The Nasdaq 100 is up more than 70% in the last 12 months. It now trades at – get this, dear reader – 97 times this year’s earnings. Yahoo trades at a P/E of 112; Amazon, that great River-of-no-Returns stock, trades at 93 times earnings.

These are not merely optimistic numbers, MoneyWeek quotes a pair of analysts, "they’re hallucinatory…Somehow this rally feels like the…sequel to a movie you hoped never to see again."

What could possibly justify such high prices? Well, spectacular growth. But a Goldman Sachs survey "shows that companies expect to raise spending on technology by only a modest 1.3% in 2004," MoneyWeek continues.

"Hype and nonsense are back in style on Wall Street. Actually, most of it has recently been emanating from Main Street, where chat-room and stock-board aficionados are pumping low-float plays to the trading masses, hoping their mangy dogs will bark for a few days.

"For example, voice-over-Internet protocol, or VOIP, stocks exploded last week in a tulip-inspired mania. Hound after hound, these issues took off for the stratosphere, with superdog 8×8 Inc. (EGHT:Nasdaq) trading its entire 25-million-share float for two sessions in a row. The move’s origins came from chat rooms to stock boards to the normally sedate Wall Street Journal, of all places.

"…It was strikingly similar to another rocket ship that took off during Thanksgiving week in 1999, when a questionable rally left vacationing market makers holding large short positions into historic losses. That half-day session left such big footprints it forced the entire industry to change their practices to avoid a similar fiasco.

"These manipulative rallies feed on themselves because so many players down the food chain benefit by the short-term insanity. Last week I saw newsletter writers, traders, and people who should know better help their own cause by highlighting low-float stocks that were getting sucked up by the public on every mention, rumor and innuendo. To my industry friends and associates, I say: Cut it out, because it’s this kind of greedy self-interest that will come back to haunt you one day."

Our calendar does not tell us which day ‘one day’ will be. But if this is like Thanksgiving ’99…we won’t wait long.

Over to you, Addison, for more news:


Addison Wiggin, weighing in with the market’s latest…

– Is it for real? Or just election year steroids?

– The Institute of Supply Management manufacturing index rose to 62.8…the highest point it’s reached in two years. The index measures a distinct boost in factory output in November. That’s the 5th straight month for the index above the 50-point mark, which indicates output is expanding rather than declining.

– "Activity is picking up from such an incredibly low level," Lara Rhame, an economist with Brown Brothers Harriman, told Bloomberg. "This sector is going to continue to be very cautious about adding employees." Factories have ditched jobs for 39 straight months, bringing overall payrolls to their lowest point since 1958. The latest jobs report comes out on Friday and will be keenly watched by lackeys all over the West Wing.

– "U.S. productivity at its highest level in 20 years," reports CBSMarketWatch.

– Stocks have borne the litany of bullish economic news with ennuie. Yesterday was no different. The Dow slouched 46 points to 9853. The S&P and Nasdaq also slithered lower; nearly 4 and 10 points, respectively.

– "America’s newfound cyclical vigor is hardly an accident," writes Morgan Stanley’s Stephen Roach. "Washington has learned an important lesson from the early 1990s. Eight years ago, the credo was, ‘It’s the economy, stupid.’ This year, it’s politics, stupid. Deep in our hearts, we all know predicting the future is next to impossible. It stretches the imagination to conjure up a macro scenario that is based on an exquisitely timed interplay of political and economic cycles. Yet that’s precisely the mindset today – heedless of the costs America will incur as Washington attempts to underwrite yet another Rosy Scenario."

– A Congressional Budget Office report released yesterday suggested that about half of the nation’s baby boomers will not have enough savings to maintain their current standard of living during retirement. "Households with inadequate retirement savings will confront an average of 19 years of living expenses they can’t pay for," reports the LA Times. What’s even more disturbing? The conclusion was drawn from studies completed in 2000, during the very apogee of the nation’s "boom."

– In the 1990s, we note in Financial Reckoning Day, "baby boomers remade the economy in their own image. Once relatively high-saving, high capital investment, and high valued-added, the economy shifted from producing what the boomers needed in the long run to giving them what they wanted short term."

– The trend has renewed with vigor over the past 8 months. "America’s seemingly open-ended appetite for leverage remains one of the most disturbing imbalances of the post-bubble period, in my view," Roach also points out this week. "For households, the debt culture took on a new role in the latter half of the 1990s, as America’s consumption dynamic shifted from being income-driven to one that was increasingly wealth-dependent. The first wave of wealth effects was supported by the equity bubble. Once that bubble popped, however, wealth support then shifted quickly into property markets. The difference between equity- and property-induced wealth effects is profound: Apart from margin debt, the former is funded mainly out of a psychological sense of well being; in the case of property, mortgage debt and its ever-frequent refinancing are the principal means of extracting incremental purchasing power from housing assets.

– "The income shortfall of a jobless recovery," Roach continues, "a far more serious problem today than in the recovery of the early 1990s, only heightens America’s dependence on wealth-based, debt-intensive support to aggregate demand. Such a shift in the growth paradigm appears to have limited the post-bubble fallout in the early years after the stock market plunged.

– "In the end, however, as wealth effects have morphed into a far more pervasive cultural phenomenon of excess leverage, the ultimate post-bubble payback may be all the more severe. That’s especially the case if America’s coming current-account adjustment sparks the predictable consequences of higher interest rates." Or, we may add, the dollar falls precipitously.

– "U.S. growth can be strong and the dollar can still fall," says a currency trader in Bloomberg this morning. The Dollar fumbled its way to its fourth consecutive historic low against the euro yesterday. During intra-day trading in London the dollar fell to $1.21…closing the day in New York at $1.20. A bevy of Forex traders interviewed by said they’re expecting the dollar to go as low as $1.24 over the next few months.

– With the notable exception of the Bank of Japan, the central bankers of all the G7 nations who met in October in Dubai, have sung in key. "The finance ministers and central bank chiefs of the G7 and EU ‘official approval’ of the devaluation of the U.S. dollar," says private banker Thomas Fischer writing in The Sovereign Individual, a monthly communiqué from the Sovereign Society, "now seems confirmed."

– "All G7 nations now officially acknowledge the need for a weaker dollar. The G7 has called for an end to targeted devaluations by Japan and to the rigid exchange rate system in China. In addition, Wim Duisenberg, head of the European central bank, now speaks of the need for a ‘multi-faceted approach’ to address global fiscal imbalances. Currency traders interpret this statement as a disguised pronouncement that the euro may climb further against the U.S. dollar.

– "One way to profit from currency fluctuations," suggests Fischer, "is to borrow funds in a currency that is falling and invest the proceeds in an appreciating currency. This strategy is often referred to as a ‘multi-currency sandwich.’ Current conditions in the currency markets make such trades attractive.

– "Overseas private banks commonly lend money in a choice of currencies to clients who have assets held by the bank. You can leverage your deposit depending on the securities you purchase. You benefit from the difference between the higher returns on the leveraged investment and the lower cost of borrowing. Switching between currencies and securities can occur with a single telephone call and you can exit from the program whenever you wish."

Bill Bonner, back in London…

*** Readers who are getting tired of our ‘Dollar is Doomed’ discussion may want to skip this little note.

"Nice growth, shame about the currency," says the Financial Times. For while the U.S. economy has grown in dollar terms, Americans have gotten poorer in terms of what their currency will buy on the open, world market. So far, the decline of the greenback has barely been noticed. There has been no stampede out of dollars. The U.S. is still managing to fund its twin $500-billion deficits without significantly increasing interest rates. American consumers have noticed little price inflation of imported goods. Only those of us who live overseas – who have seen our purchasing power cut by 50% in the last 18 months – have cause for complaint; and who cares about us?

Surveying press reports, it appears that the average macro analyst expects the dollar to continue to fall…say by another 20% or so. Dr. Richebächer, our favorite and most virulent dollar critic, predicts it will plummet by half its value.

A brutal collapse of the dollar is "in nobody’s interest," the journalists point out. But being the worrywarts we are, we can’t help but note that WWI wasn’t in anyone’s interest, either. Nor was the Great Depression. Nor is rap music or ‘modern’ art, for that matter. Still, nasty stuff happens.

*** What kind of a cynic would not love this wonderfully mad world? The Chinese work around the clock…save their money…and then lend it to rich spendthrifts who cannot possibly pay it back. The Americans take the money, mortgage their houses…and their government…and their children’s solvency…to buy gee-gaws and gadgets that they don’t need from the Chinese, even stomping on old ladies in their rush to load up on bargains at Wal-Mart. The Chinese then build more factories and hire more workers to create more products for the people who couldn’t pay for the last products they sold…while the Americans, noticing only the rate of spending and borrowing, think they are ‘recovering’…getting rich again, without actually saving any money. Meanwhile, the currency in which all these transactions take place loses its value, day after day.

*** Rumor has it that two of the world’s richest and shrewdest investors – George Soros and Warren Buffett – are selling the dollar short. "Find the trend whose premise is false and bet against it," is Soros’s famous advice. Soros made a billion dollars in a single day – about 10 years ago, as we recall – betting against the British pound. At the time, the British government was assuring the world that that pound would not fall. Soros kept his mouth shut and held his short positions. Suddenly, the pound gave way and Soros was a richer man.

Could the dollar give way suddenly, too? There is not much to stop it. Foreigners hold $9 trillion of U.S. dollar positions. Each day they lose millions of dollars. They must be getting tired of it. Even central bankers get tired of losing money, eventually. Would it be so surprising if they suddenly rushed to the exits and made Soros a richer man still?

*** Those readers still with faith in science and the perfection of man by rational thinking may find these items from the English press interesting: First, a "holy man" from India says he has neither eaten nor drunk for 70 years. Medical science took his claim as a challenge and put him in a sealed hospital room for 11 days under constant surveillance, reports The Times of London. To their amazement, the man neither ate nor drank…yet still seemed to be in perfect health. No explanation was offered by science, but the holy man said that he had been visited by spirits as a child and given the gift.

Balanced against this apparent affront to science was another article from Germany detailing an excess of rationalism. A man apparently went onto the Internet to a site specializing in cannibalism and offered himself up as a meal. His offer was accepted. According to the report, he was slaughtered, cut up and eaten by another German. The Polizei are looking in to it.