The Trouble With The Whole World
“Kim An Wu, a 55-year-old housewife,” says a report in William Fleckenstein’s SiliconInvestor.com column yesterday, “believed the [South Korean] government’s vow last year that it would foster technology stocks. She spent more than $250,000 to buy shares listed on the Kosdaq index.
“Instead of profiting from the Kosdaq’s Internet and mobile phone stocks, Kim posted a loss. No longer able to afford the home she hoped to buy for her soon-to-be- married son, Kim is so incensed that she phoned the presidential palace yesterday to complain. ‘The only way I can make up for my losses is through the stock market,’ she said, standing amid a grimfaced group of retirees at a Seoul brokerage today, as stocks slipped yet again. ‘So I want the government to do something fast.'”
The article went on to say “housewives and retires watched, dazed, yesterday and today as screens on broking floors quickly filled with green, that in many parts of Asia marks declines.”
Ms. Wu may not know exactly what she wants the government to do. But the central bankers who work for the world’s governments know. Another dose of ‘liquidity’…of cash…of credit…usually sends equities higher.
“Look at this,” said Addison to me yesterday, excitedly pointing to a group of charts. “Credit expansion and stock market growth go together.”
Sure enough, the group of charts, from a study done in 1996 – produced by the Japanese central bank – showed that credit growth paralleled stock price movements. When stocks were in a boom – credit growth was too. (None of the parallel lines, I noted, went up forever.)
Japanese monetary officials made a reasonable inference: looser credit policies must CAUSE stock market increases.
In 1996, Tokyo was looking for a way to boost its economy and stock market. Lower interest rates – lowering the cost of borrowing – looked like a decent bet. Besides, it was about all central bankers could do. So, interest rates came down. By 1999 they had reached what the Financial Times called “effectively zero.” Yet, even free money failed to revive the Japanese economy or its stock market. Why?
Digital Man is stumped. To him, everything works by simple cause and effect logic. When the cost of borrowing goes down, the demand should increase. And yet, not even giving money away could persuade Japanese business and consumers back into the credit market.
But Analog Man, more heart than brain, understands. He knows it is his fault. He knows that, were it not for him, the world would be a different place.
Paul Erdman, former analog gloom-and-doomer, explains [via Gary North] how monetary officials reacted to the Long Term Capital Management crisis of 1998. The LTCM geniuses had gotten themselves into multi-billion-dollar dry hole…into which the entire world’s financial system threatened to slide.
But the Fed, according to Erdman, “pushed immense liquidity into that system within hours and saved the day.”
Erdman, reborn a digital man, does not believe night follows day: “In this information age,” he says, “we live in a new world in which decision makers are immeasurably better informed…”
Daily Reckoning readers who have endured my letters on the value of information will be tempted to click off at this point. Let me reassure you… my point in today’s letter has nothing to do with the value of information. It is not the nature of information that interests me today, but the nature of man.
Whatever technological improvement the ‘information age’ represents it is neither the first nor the last to get investors noticeably aroused. The railroads, internal combustion engines, electricity – all of these were seen in the same light as we see information technology today. And each time, investors “under-reacted…and over- reacted” in what has become a predictable fashion. They got excited…they bid up prices to outrageous levels… and then there came a bust.
But, Erdman continues: “The business cycle may not be dead. But there are increasing grounds to believe that the boom-and-bust phenomenon is. Which reinforces the view that the place to keep your money is in index funds, not in gold.”
In short, if the central bankers were able to ‘save the day’ in 1998 – why not now? Why not forever?
A boom is accompanied by an expansion of credit…a bust, by a contraction of credit. The Japanese tried to create a boom by reducing interest rates – making credit more affordable. But, it didn’t work. They were not able to get their own people to borrow yen.
But animal spirits still ran high in the western world. The ‘yen carry trade’ developed. Speculators borrowed yen and then invested the money in U.S. stocks and bonds.
Speculation is, however, a zero-sum game. (Actually, taking into account the friction costs…it is a minus sum game.) So there have to be some losers as well as winners. And with trillions of dollars at stake, it was only a matter of time until a there was a big, big loser. LTCM would have been that big loser – had not the Fed stepped in.
A little later, the Fed and other central bankers stepped in to save the world from the Asian currency meltdown. Then, two years later, they protected the system from a Y2K shock.
These efforts at rescue, resuscitation and protection have produced a moral hazard of grotesque proportions. The amount of derivatives outstanding today is estimated to be as high as $100 trillion. And the debt in the U.S. economy has reached $26 trillion.
Most interesting, from our point of view, for a boom to continue, it needs an expansion of credit – at a faster and faster rate. A man with a $1000/wk lifestyle and a $100,000 debt needs a lot more new cash than the man who lives on $100/wk and owes only $10,000.
Likewise, it takes a lot more money to move a billion- dollar company up in price than a million-dollar one.
As the boom of the late 90s continued, reports Dr. Kurt Richebacher, “the rise in indebtedness gathered ever greater speed in relation to economic activity… In 1999, nominal GDP growth of $509 billion compared to aggregate financial and non-financial debt growth of $2.208 billion. For each dollar added to GDP there were 4.3 dollars added to outstanding debt.”
“There is something healthy,” Grant’squotes Mike Brosnan, an official at the Office of Comptroller of the Currency, “…about having a little downturn. It reminds you that the world is a risky place.”
Thanks to the work of the world’s central bankers – saving the system from the Japanese bust…LTCM…the Asian currency meltdown…and Y2k…the world has become an even more risky place.
Paris, France September 20, 2000
*** After taking the Nasdaq down 11% so far in September, Mr. Bear decided it was time to let up. The tech-heavy index rose 3.73%.
*** Leading the index, of course, were the Big Techs. Qualcomm jumped $7 to $77.50. Cobalt Networks rose $16 after Sun Micro said it would buy the company for $2 billion. Intel scrambled back above $60.
*** The tech rally on Wall Street gave hope to Asian markets overnight. South Korean stocks bounced a bit. Even Japan rose 2.07%.
*** But the world’s equity markets are plagued by what is becoming known as the Four E’s: Earnings, Energy, the Euro and the Economy.
*** Oil rose overnight. October light crude rose above its Gulf War peak – to $37.14 – earlier in the week, and is trading this morning at $37.08. The American Petroleum Institute said oil supplies are still falling. There are 22 million fewer barrels of oil in inventory now than 1 year ago.
*** “In 1973, there were 15 oil-fields producing over 1 million barrels of oil per day,” says John Myers. “Together they accounted for almost 30% of the world’s daily supply. Today only two of these fields produce more than 1 million barrels a day.” The others are getting ‘long in the tooth.’ Are higher oil prices harbingers of scarcity to come?
*** The higher oil price hit utilities hard yesterday and worried the Dow down 19 points. The Advance/Decline ratio fell further – with 1380 stocks advancing, while 1494 declined. Twice as many stocks hit new lows on the NYSE as new highs – 122 to 62.
*** Higher oil prices cut into corporate earnings, of course, too, which further depresses the animal spirits of stock buyers. Walmart – the world’s biggest retailer – fell 6%, reflecting what may be a downturn in consumer spending, as well as, earnings.
*** Amazon fell $2 too – to close at $40.
*** The euro also fell. The French franc, which tracks the euro, is now at 7.7 to the dollar – a new low for this cycle. The IMF called for concerted intervention. Every financial news medium seems to be telling the story of the euro’s collapse. Is it possible that this marks the near-bottom for the euro? Uh…yes!
*** “As indicators of popular sentiment,” writes Dan Ferris, “magazine covers and other news sources are like the Oracle of Delphi in ancient Greece.” Dan points to a recent cover of The Economist. The title says, “EUROSHAMBLES.” The subtitle reads, “No fuel, roads blockaded, a vanishing currency and blundering governments.”
*** “It’s a sign,” says Dan, “of pessimism that is widespread enough that somebody thinks he can sell magazines with it. That would normally be an easy buy signal, the way The Economist’s now-famous “Drowning in Oil” cover was an easy buy signal for oil when it appeared in March ’99.”
*** But even Dan cannot bring himself to buy the euro whose time, he believes, “will never come.” *** Nor is he persuaded to sell oil even though he mentions a rash of articles in the press about how oil “could go to $60 a barrel.” Perhaps it is still too early for the euro… and not yet too late for oil. But if you have made a lot of money on oil – you might want to move some of that money to euro bonds.
*** The Economy, meanwhile, is a composite of the other three E’s. Higher oil, a higher euro and lower corporate earnings lead to lower stock prices… which leads to a reversal of the ‘wealth effect’ – which tracks consumer spending. As consumers spend less, they reduce debt…and the credit cycle enters the contraction phase. The economy goes into a slump, stocks fall further, and life as we have known it on planet Bubble comes to an end. (More below…)
*** In fact, “today’s New Era story about the wondrous effects of information technology,” says the good Dr. Richebacher, “has its precise parallel in the 1980s: Reaganomics and supply-side tax cuts… the end of the that ‘new era’ is well-known: dollar collapse, recession and the S&L disaster.”
*** Gold rose 50 cents. Gold is supposed to be a watchdog on inflation and financial excess. But this old hound seems to have gone blind and deaf. The money supply continues to rise twice as fast as the GDP… and the annual trade deficit is approaching the total of GDP growth. But nary a woof or growl out of gold.
*** Speaking of gold, reader B.G. asks: “You and other writers have been very high on Anglo Gold. After reading the comments about Barrick’s hedging of their gold, I asked Anglo about their positions. Steve Lenahan, Executive Officer, Investor Relations, stated, ‘…on 30 June 2000, approximately 41% of five years’ production was hedged out until 2009, with some 77% of that in the first five years’… Comment?”
Doug Casey responds: “Hedging production has been an excellent idea over the last decade, in that it’s greatly improved returns for the companies that have done so, with the exception of a few relative newcomers to the game, like Ashanti and Cambior, who came close to bankrupting themselves on the metal’s brief spike some months ago. Hedging has been especially profitable for Barrick, its originator. But, as more companies hedged, it’s reduced the returns of hedging. And the longer the gold bear market has gone on, the riskier it’s become. ”
“Personally,” Casey continues, “I’m leery about owning any company with significant hedging. The entire thing could blow up much in the manner of Long Term Capital. The whole point of owning gold stocks is to have leverage when gold goes up. If your company is hedged, it not only won’t profit from higher gold prices, but may go under due to being short in a bull market. What’s the point?”
*** We had some problem with our digital technology yesterday. The Daily Reckoning was late. I don’t know what the problem was…but Addison tells me it has been fixed.
*** Elizabeth comes back today. Thank God. Sophia is staying up late, worrying about what she’s going to do after she finishes high school this year. Maria is upset because she couldn’t get into the ballet class she wanted. “My whole career is ruined,” she told me yesterday, close to tears. Jules’s school is threatening to toss him out if he doesn’t get his vaccination shots up to date…and Jules is hoping they do so. Henry, usually the teacher’s pet, says his teacher has developed a bad attitude towards him. And Edward, 6,…is…well… Edward. Being a single dad isn’t easy.