The Virtue of Being Worthless

Approximately 80 steel bridges currently spanning the American landscape currently have weaknesses much like the one that caused the I-35W bridge collapse in Minneapolis. And it gets even scarier when you realize America’s infrastructure crisis involves roads, schools, dams, power grids and water pipes, too. Free Market Investor’s Christopher Hancock explores…

Strong economies need strong infrastructure.

Strong infrastructure needs strong spending.

More spending means more government contracts. More contracts mean more campaign donations.

It gets better.

Every elected official represents a district with a broken bridge. A new bridge needs a new ribbon and a new name. Hence, the more bridges they build, the more votes they receive.

And here’s the best part. They accomplish this benevolent feat without losing lives or raising taxes! Better yet, everyone in Washington can play along.

Unfortunately, more spending means more debt. The U.S. Congress will turn to the U.S. Treasury. The Treasury wants to balk. But they turn on CNN, and another bridge collapses over the mighty Mississippi.

So they shrug.

The U.S. Treasury will turn to foreign buyers. Foreign buyers should (will) require a higher rate of return for holding a depreciating currency. Interest rates should (will) rise. The race to sell U.S. assets to foreign hands keeps flowing south like the mighty Mississippi.

To make matters worse, analysts forecast future rate cuts. The latest Federal Reserve committee meetings on Oct. 9 showed a consensus supporting a 50 basis point cut… maybe so, maybe not. We really don’t care. We have no idea what direction interest rates are heading. But we do know this.

The American dollar should (will) continue heading south.

Eurozone finance ministers quiver. On Oct. 8, the day before the U.S. leaked a forthcoming rate cut, the Europeans announced their intentions to actively depreciate the euro against the Chinese reminbi, the U.S. dollar and the Japanese yen. They claim a weaker euro will ease pressure on the European economy.

Europe, in a sense, showed its hand. And the Fed quickly trumped it one day later. Go, Fed!

This dubious policy is finance-speak for this: The sovereign nations of the world are engaged in a perpetual sprint to boast the least valuable currency. They’re in a race to the bottom, so to speak…a race to become, well, in a sense, worthless.

The reason: Currency depreciation makes domestic goods less expensive to foreign buyers. Consequently, a perceived re-emergence in a nation’s domestic manufacturing may take place, as foreigners demand cheap "Made in the Most Worthless Currency" widgets.

You see, it’s a win-win for Washington.

Washington’s charitable handouts (debts) buy the bridges that buy the votes. Those charitable handouts (debts) also undermine the dollar-denominated debt.

The cheap dollar creates cheap exports. More exports create more jobs. More jobs… more votes. The cycle continues.

But here’s the real kicker: Devaluing the greenback devalues the foreign debt that started this whole mess to begin with. So in the long run, we don’t owe as much as we borrowed, inflation adjusted.

It’s a win-win for Wall Street, too. The municipal underwriting business takes off. Banks now repackage municipal debt like mortgage debt.

The fees keep rolling. Seven-figure bonus days are here once again.

However, this game has one or two setbacks.

First, higher spending sans higher taxes works only when foreigners demand our debt. But that may not be the case much longer. The Chinese have eased their appetite for American IOUs.

Second, more debt means we print more money. More M3 means more inflation. You haven’t noticed the effect yet, dear reader, because Chinese imports have delayed the hangover. But the days of importing Chinese deflation are coming to an end, as well.

Despite what others may think, Alan Greenspan is no dummy. He knew when to jump ship. Greenspan said that over the long run, the biggest problem facing the U.S. economy is "the re-emergence of inflation," and rising interest rates.

We concur with Mr. Greenspan.

High inflation combined with high interest rates kill the middle class. That’s the real long-term problem of fiat currencies. A fiat money system prompts legislative profligacy and inevitably produces inflation. The system stimulates the growing gap between the haves and the have-nots.

Consequently, the have-nots will turn to their elected saviors in Washington. They’ll demand a change.

Washington will listen with empathetic ears. They’ll yell at the rich while they tax the poor. Like Alan, they’re no dummies. They know who really puts them in office.

So in the end, they’ll assuage their disgruntled voters with more contracts for more new bridges. Which, in turn, will most likely precipitate further inflation. Remember, personal taxes can go only so high before even the rich revolt. Most studies project that watermark near 50%. So tax hikes can go only so far.

As Bill Bonner points out: "The goal here – as with all government programs – is to produce the desired benefits while pushing the costs onto someone else. That’s how politics work. You promise something… and you force someone else to pay for it. You rob one Peter voter… and spread the loot among the Pauls."

And so we’ll beat on, dear reader… like boats against the current.


Christopher Hancock
for The Daily Reckoning
December 6, 2007

P.S. That picture, dear reader, looks bleak. We know. We’re not happy about it either. Aside from certain domestic infrastructure stocks, we’re still firm believers in buying cheap foreign assets.

We believe that our long-term investment in Southeast Asian property development and infrastructure stocks looks sound. It feels sound. Of course, feelings mean squat.

While the dollar keeps falling, your assets should remain invested in businesses that derive revenues in sound foreign currencies. When those dividends get converted back into U.S. dollars, you should have more discretionary spending to buy Blackberries, handbags and iPods.

Better yet, Hong Kong property stocks own many tangible assets denominated in Chinese yuan. As the yuan begins to appreciate, the values of those assets will appreciate as well.

Yesterday, the Dow decided to keep us wondering. It rose almost 200 points. In our view, the tide is going out. The credit cycle peaked out this past spring…and the great wash of cash and credit is now ebbing.

But if we’re right, we’d expect to see asset prices go down. So far, housing prices ARE going down. The last figures we saw showed U.S. housing prices down 13%. Robert Shiller, who probably knows more about housing cycles than anyone, says they’ll probably go down 30%-40%. In Britain, houses just registered their third losing month in a row – with many more to come.

You can count on lower housing prices – at least in real terms – dear reader. Because there is no way that the average house can remain out of reach of the average buyer for very long. Houses are consumer items, not investments. They will fall in price to a level where the consumer can afford them.

But stocks are not consumer items. They are capital items…investments that go up and down based on various things – animal spirits, credit, earnings, etc. Earnings are going down (they always revert to mean)…and the credit cycle has probably turned negative.

Yesterday, the number one man at Legg Mason (NYSE:LM) said that credit markets were in the worst shape in 47 years. And a Washington Post writer opined that it was the "biggest mess since ’29."

That leaves "animal spirits" – Keynes’ term for market sentiment. The animals are still believers. They’ve come to think that capitalism will make them rich…and that capitalism’s custodians will make sure that nothing goes wrong. And whenever they begin to doubt it, Ben Bernanke and his fellow zookeepers throw them some red meat. A rate cut is coming…and a plan to rescue the mortgage market – relief is on the way!

But can the feds always save investors from their own mistakes? Can they make sure that stocks remain high forever? Can they protect the dollar…and make bad loans good again?

No…of course not. But that doesn’t mean they won’t try! The animals would be very disappointed if they didn’t.

Our old friend Rick Ackerman comments:

"We always expected the Fed to pull out all the stops when the U.S. economy began to slip into the void, but we never could have imagined the spinmeisters would invent ‘mortgage welfare’ even before recession had been officially declared. Treasury’s latest plan is designed to make it easier for certain ARMs borrowers to temporarily freeze their starter rates to avoid foreclosure. We know the situation is dire because the big lenders are signing on without even having their arms twisted…Paulson’s plan is not merely being fast-tracked, it is being shot out of a legislative cannon."

But will the feds hit the mark? Will they be able to reverse the tide…or like King Canute, merely look like silly old fools?

We’ll see, won’t we?

*** "You gotta have Plan B. That’s what we’ve learned from living in Africa," said a colleague last night. "Americans are so naïve. Well, I guess you should say that they are happily naïve…and so far, they’ve been able to be naïve without negative consequences…a situation that is probably changing.

"You believe you can turn on the lights…and they’ll always go on. You think you can walk down the street and you won’t get hi-jacked or robbed (well, maybe you wonder about that). You think your Social Security system will look out for you in your old age…and that your officials will be more or less honest…and that your dollars will have some value. Well, you may have some questions about that, too…

"But here in Africa, we’ve learned better. Things don’t always work the way they should. Governments change. Circumstances change. You can’t really count on anything. We’ve seen what happened in Uganda…Ivory Coast…Nigeria…and what is happening now in Zimbabwe. Zimbabwe was a great country. Now it is a disaster. A total disaster.

"That’s why, if you’re smart, you’ll have a Plan B. We all have a Plan B…meaning, we have another passport…and a bank account outside the country…or something, so we won’t be stuck if things really go bad.

"Not that we expect it here anytime soon. I think South Africa has more good years ahead of it…at least 5 to 10. But as for the long run, who knows? It’s an African country. And you can’t count on anything forever. The different tribes of Africans are struggling for control of the country. Mbeki is a Xhosa. This fellow Zusa is a Zulu. He’s been tried for rape…his top people have been involved in all sorts of corruption. And you’ve got all these drug dealers and criminals coming down from Nigeria. They just sneak across the border. There doesn’t seem to be any way to stop them. Which way the country goes depends on which tribe gets control…and how fast they’re able to work their control down into the judicial system and other parts of the administration.

"So you have to have some way to get out of the place, if it goes really bad. And you have to have a Plan B to protect yourself against all sorts of failings. That’s why we have our own generators, for example, because we can’t depend on the power system to work properly. And it’s why I keep a stash of Krugerrands. You don’t know which way the paper currency will go. But those gold Krugerrands will always be good money."

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. Long time DR sufferers know where we stand on gold. We think of it as wealth insurance…after all, the long-term value of the greenback is zero. Why not pad your portfolio with our favorite yellow metal? For a limited time, a new U.S. government-backed guarantee lets you own gold with no risk…but with 100% of the gains should gold prices take off.

The Daily Reckoning