The Way We Were

The Daily Reckoning Presents: THE MOGAMBO GURU explains why based on an overwhelming accumulation of historical precedent, one can reasonably expect that we will have several decades, or more, of increasing misery from a depression.



The American economy will probably not recover for at least a decade. There is no reason to expect that it will. The immutable laws of economics have not gone away, nor have they changed overmuch in the history of the world.

Since before the time of the Pharaohs, all nations have contended with the same financial forces in existence today. They had (in one form or another) money, debt, and taxes.

They all had government spending. And every single one of these nations, in all of history, was eventually ruined by its government. Their money was debased to the point of worthlessness by the government spending too much to do too much, and then the country collapsed.

Why should we expect to be any different?

To combat the evil of the debasement of the money, the Founding Fathers wrote into the Constitution that money will only be of silver and gold.

As thinkers of the Enlightenment era, Jefferson & Co. surely studied history and saw, with alarm, what happened to every nation that resorted to fiat money: the value of the money went to zero and the people were pauperized.

They believed that there had to be constraints on government spending, and the only constraint available was to limit the currency to something relatively rare and valuable. Ergo, the gold standard, which limited spending to the amount of gold and silver you had.

But the Supreme Court, in its infinite wisdom, rather in a series of idiotic decisions that is part of its lasting shame, acquiesced to the fraud of allowing absolute disregard for this important, crucial piece of the Constitution. No longer would the dollar be, “as good as gold.” Et voil…, fiat money.

Since the sixties the government has been on a deficit- spending spree. That is, they “borrow” money and spend it. This is, of course, the Keynesian approach to battling a recession. It works. How could it not?

There is, unfortunately, a price to be paid. And the price is the accumulation of debt. Piles of it. Whole mountains of debt. Keynes himself said that the debt accumulated during a stimulus program has to be paid back out of the subsequent recovery. Congress, to its sorry shame, forgot this part of the equation.

We now have $6 trillion of “official” government debt. The interest on the debt already eats up a third of government revenues. And it never goes away – except by paying it or repudiating it. Normally, debt can only accumulate to some limit. One limit, obviously, is when total debt service eats up 100% of revenues. In reality, it is a much lower amount. And when that point is reached, the game is over. Normally.

Enter the central banks. After three decades of fiscal stimulus by Congress, the geniuses at the Fed decided the economy also needed direct, constant monetary stimulus – to help the government pay the interest on the ravenous debt.

The Fed, you’ll recall, is a government-mandated, semi- secret club of the banks, all meeting together behind closed doors. Their “job” is to safeguard the banking system. They set monetary policy for the government in the name of “the common good.” Meaning: “making sure the banks are profitable.”

Since the Fed does not actually have any money to pay for anything, they invent magical money. It literally appears on a whim, out of thin air, onto account balances at the bank. The Fed says, “I have – presto! – money! Take this money and sell me some of that government debt you are holding. Look, now you have money to lend!”

This is such an obvious fraud that it is also obviously only an emergency power of the Fed. It was not supposed to be used as “party favors” during the boom. But under the woeful stewardship of Alan Greenspan through the 90s, that is exactly what it became.

Week after week, month after month, year after year, the Fed poured pure adrenaline into the banking system. It wasn’t just for investors that Alan Greenspan pronounced the mania as “irrational exuberance.” He was also describing the actions of the Fed. The operative word is, of course, “irrational.”

It is not rational to expect that fiat money will forever hold it’s value. It never has. It is not rational to expect that a stock market will forever go up. None ever has. It is not rational that a country can forever spend more than it makes. None ever has. It is not rational that debt can grow forever larger. It never has. It is not rational to believe that a government can keep getting bigger forever. None ever has.

The enormous amounts of money magically brought into existence during the decade of the 90s also made superstars of every hotshot with a penchant for numbers and access to Other People’s Money. In each case, it was a matter of cleverly coming up with another idea to “free up” untapped sources of money, and putting it “to work.”

Receivables were constantly sold forward, ordinary debt was broken into weird little pieces and sold at premiums, unrealized profits were borrowed against, equity in anything was borrowed against, futures bought, options sold, etc. The velocity of money zoomed, as the vortex twirled round and round, twisting tighter and tighter, sucking in more and more money with each revolution.

The Japanese, for their part, lent mountains of money at zero percent interest, which was immediately snapped up around the globe and plowed into something, anything, making that “something” go up in value. You could almost hear them exclaim, Frankenstein-like, “It lives! We are geniuses!” You can still hear the echoes of the masses replying, “You ARE geniuses! You are gods! Here’s my money!”

Add the newly formed IRA’s, 401(k)’s, and a plethora of retirement plans, and trillions of dollars got sucked into the stock and bond markets. Interest rates dropped when the money went into the bond market. Investments boomed liked nobody’s business when it went into the stock market. IPO’s! Mergers! Acquisitions! Construction! Houses! Malls! Real estate! Antiques!

Congress, always eager to butt into everything, passed NAFTA, GATT and God-knows what all free trade stuff. Companies moved production of goods offshore, taking advantage of the wide differential in wages and regulatory burdens to fatten bottom lines. The goods were then imported into the USA for manic Americans to buy, via credit.

And credit was everywhere in abundance, because money was everywhere in abundance. And the Americans bought everything that was offered! By the ton! Consumer credit soared to $1.6 trillion! Commodity prices tumbled, as hard-scrabble foreign nationals now had cheap entry to the US for their low-tech commodities production, and thus kept primary inflation at bay.

No wonder services boomed! What else is there to buy, now that we are chock-a-block full of TV’s and cars and houses and vacation property and investments and snowmobiles and vacations and swimming pools and videos and clothes? We actually thought we could have an economy based on services. Laid off from the plant? Who cares? Get a job in services! The factory production of actual tangible products is absent in the U.S.A.? No problem! Get a job in services!

So, here we are. Debt up to our eyeballs for toys that are mostly broken and old. Debt up to the government’s eyeballs. Debt up to the state’s eyeballs. A fiat currency. A gargantuan government. A huge trade deficit and a huge current account deficit (meaning goods shipped in and dollars shipped out of the country) to provide the consumer goods, while we merely peddle these imports and services to one another. A nation of retail clerks and hairdressers today, a nation of pyramid- builders and quarry workers yesteryear.

So what is so different now? Nothing. Another page in history, telling the same old story over and over again. Mogambo sez: if the story is always the same, why should we expect the ending to be any different?


Richard Daughty,

for The Daily Reckoning

Richard Daughty, general partner and C.O.O. of Smith Consultant Group, serving the financial and medical communities, is the writer/publisher of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.

For the last quarter, the average diversified mutual fund fell 16.22 percent, according to Morningstar Inc. It was the biggest three-month decline since the fall of 1987. The two biggest funds, Vanguard & Fidelity Magellan, are down more than 20%. (Conversely, a fund managed by the DR Blue Team’s David Tice – The Prudent Bear Fund – is up 41.9%…)

Earnings are falling at least as fast. S&P 500 earnings are expected to decline 22.4% in the 3rd quarter, the worst in a decade. And the earnings over the last 12 months are the worst in history.

But Peter Lynch, who used to run the Magellan Fund, is in advertising now…urging investors to stick with stocks for the “long haul.”

“Wall Street pundits,” observes the Dallas Morning News, “believe investors are already beginning to look across the current valley in earnings to better times in the first quarter of 2002.”

How do they know times will be better in 2002?

Factory output fell 1% last month…to a level where only 75% of capacity is being used. Commodity prices are falling. Debtors are going broke. And consumers don’t want to buy.

Harry Schultz puts it this way: “The psychological effect of the ‘Nasdaq Shock’ was to make a lot of people say to themselves: Maybe I don’t need the new model car I want to buy. Maybe I should delay buying that boat, or bigger/better located house. Maybe take a less expensive vacation, one closer to home.”

Why would earnings rise? A French couple we met over the weekend described their trip to Utah:

“We took a hiking and river rafting trip. It was superb, the best trip we’ve ever taken. We went for days without crossing a road or seeing another person…along with a group of Americans. The food was terrible but they were all so nice…But it is strange out there. We would see a mountain in the distance and we’d say to ourselves…I guess we’ll be there this evening. But three days later, it would still be just as far away…Things can be a lot farther away than you think.”

Eric, what do you think – how far away is the other side of the valley?


Monsieur Eric Fry de Manhattan:

– If folks keep behaving as if stocks are actually in a bull market…who knows…we might just get a bull market. Somehow, stocks keep plugging away to the upside, no matter how dire the news headlines may be.

– The Dow rose 36 points yesterday to 9,384, while the Nasdaq Index tacked on 1.5%, to 1,722.

– Investors, like teenagers on a first date, find Mr. Market so attractive that he can do no wrong. Rising earnings would be a nice attribute, but declining earnings are “kool” too. Where will this infatuation lead? I’m afraid to look.

– “The bond market has a message for stock investors: Curb your enthusiasm,” writes the Wall Street Journal’s Gregory Zuckerman. Although stocks have recouped their losses since Sept. 11, Zuckerman points out that “Prices of corporate bonds, including junk bonds, are still down sharply from their pre-attack levels.”

– Typically, whenever recessions approach, corporate bond prices fall more than Treasurys. That’s because investors start to care more about the return OF their money than the return ON their money. Currently, Zuckerman notes, “The spread, or difference in yield between junk bonds and Treasurys, is nine percentage points, its widest level since 1990.”

– So who’s right? The upbeat stock investors or the pessimistic bond investors?

– Fred Hickey, editor of the High Tech Strategist, would give the nod to the bond crowd. “Ultimately, the economy won’t recover until the excesses of the ’90s are worked off,” Hickey predicts. “Consumers have to reduce their consumption in order to whittle down their huge debt balances. Savings rates must rise. The nation’s mammoth trade deficit, which absorbs most of the world’s free cash flow, can’t be sustained much longer and must be reduced. The manufacturing overcapacities resulting from years of capital spending binging have to be absorbed. Stock market valuations have to come down to more reasonable levels. There are no easy solutions to these problems.”

– Bulls and bears alike agree that current economic and geopolitical conditions in the United States are as unsettled as they have been at any time in the last 20 years – and maybe at any time since the Vietnam War. But the investment response to these troubling conditions varies greatly from person to person. Some buy “depressed” tech stocks, while others prefer to wait out the crisis in short-term Treasuries.

– Curiously, very few investors seem to be seeking refuge in the gold market. Yet, “the succinct bull
argument for gold today,” Jim Grant, editor of Grant’s Interest Rate Observer observes, “is that, for the first time in a quarter-century, all the world’s major economies are in recession together. Trying to lift them out of it, governments and central banks will err on the side of doing too much.”

– Al Friedberg of Friedburg’s Commodity and Currency Comments agrees: “Monetary expansion around the world has accelerated in direct proportion to the severity of the economic bust. Growth rates of the broad-based monetary aggregates in the U.S. have ratcheted upwards for over five years, remaining well above 10-year moving averages. The inflationary implications…are as obvious as they are ominous. Can we capitalize on this ‘inevitability?'” His response: Absolutely. Buy gold.

– Friedburg also points out that the special circumstances that brought gold to its current low estate are disappearing. For one thing, the lion’s share of dis-hoarding by central banks has occurred already. “Henceforth, official supplies are predictable and digestible.” For another, net forward selling by the mining companies will not be increasing, as their hedge books are already very large. In fact, “Goldfields reported that mines added to demand by lifting hedges on 41 tonnes during this year’s first half.”

– “The Fed today [may] face the Japanese predicament of striking a match but lighting no fire,” Grant allows. But he anticipates that Greenspan’s aggressive monetary response to this state of affairs will spark an inflationary reaction. “Value investors must swallow hard to buy [gold].” Grant concludes. “Following the roll-up of the European currencies, only four basic monetary alternatives present themselves: euros, yen, Swiss francs, gold. Of these, only gold is beautiful to look at and not replicable on a high-speed printingpress.”

-Shares of Freeport McMoRan, a gold play recommended by the DR Blue Team, are still trading at a 19% discount to their redeemable value.


Back in Paris…

*** Elizabeth and I went to see Moliere’s “School for Wives” last night, in which a man in his 50s buys a young girl from a destitute mother and keeps her away from the world so that she’ll grow up to be a perfect wife – loyal, obedient, and faithful.

*** I felt sorry for the poor man. His project was doomed from the start, as any half-wit could see. Walls were never built so high as could keep a woman from acting like a woman. But he persisted in his efforts to completely control and dominate his young Agnes until she finally had him groveling at her feet, beating upon himself like a madman and begging for mercy. Not much has changed, since the 17th century at least, neither in love nor in markets.

*** After the play, we went for dinner at Le Grand Caf? on the Boulevard des Capucines. “I felt sorry for the poor man,” said Elizabeth. “But as Moliere put it, if he didn’t want the trouble of having a real wife, he shouldn’t get married.”

The Daily Reckoning