To Err is Human
The first half of this decade was like none other. It was almost as if you simply couldn’t lose money. No matter how hard you tried, the market simply wouldn’t allow it. Unfortunately, all good things must come to an end, and as Bill Bonner points out, the end is just beginning.
(Based on a speech to a group of dear readers in Melbourne, Australia…along with some things we wish we had thought of).
Mistakes are always being made. In a properly functioning economy, these errors are made…and corrected. People go broke. Investments go bad. Projects are cancelled…discarded…and rejected.
But in the last quarter century, interest rates were generally falling. It was a very forgiving economy. Mistakes were still made. But the cost of being wrong went down. You could pay more for a house than you should have paid…but no problem; you could refinance at lower interest! And then, the price would go up – problem solved. Or, you could overpay for a stock. Again, falling interest rates were generally pushing up stock prices – you almost couldn’t lose.
Then, in the five years from the summer of ’02 to the summer of ’07, mistakes practically vanished. People might have wanted to go broke – but the credit industry wouldn’t let them. Central banks and the lenders kept showing up with more money! You could buy a house…or a Structured Investment Vehicle; no matter how dumb you were, you’d be rescued by easy money and rising asset prices. You might even look like a genius.
Looking at the economy itself, as the flood of money gushed in…mistakes disappeared beneath the surface. Typically, in the United States, there was about one quarter of correction – with negative growth – to every four or five quarters of expansion. But more recently, the ratio of correction to growth fell to only one quarter out of every 19. Are we approaching the perfection of the human race, with fewer errors than ever before…or are there a lot more mistakes in need of correction?
We will not leave you on the edge of your seats. An unanswered question is like an unconsummated marriage; you have the burden of it without the satisfaction. So here it is:
Instead of fewer errors in the last six years, investors made more of them.
It is not from success that we learn, but from failure. So, we are grateful to the Soviet Union. It showed what you could do with central planning and price controls. At first, prominent economists in the West believed the numbers coming from Moscow. Then, they noticed that the figures were a little fishy. Finally, with the Soviet economy on the brink of collapse, they realized they had been bamboozled. The Soviets had managed to create a value-subtracting economy. They took raw materials from the ground…added labor, organization, skills and capital…and transformed them into finished products – which were worth less than the raw materials themselves! The harder they worked, the poorer they got.
They weren’t the first to prove that price controls don’t work. Every time they are tried – by everyone from Emperor Diocletian to Richard Nixon to Robert Mugabe – the result is disaster. Why? Because controlled prices are liars. They will tell you whatever you want to hear; they mislead investors, businessmen and consumers.
Once, almost three decades ago, we were on a plane from Moscow to Minsk, in White Russia. Seated next to us was a young woman with a toilet seat on her lap.
"What are you doing with the toilet seat," we wondered.
"Oh…I couldn’t find one in Minsk. So, I went to Moscow to get one."
Further investigation showed that price controls had caused toilet seats to disappear from the market in Minsk…while they had reduced the price of an airline ticket to about $10. The young woman did the reasonable thing, under the circumstances. So did the Soviet economy; it self-destructed a few years later.
Western economists love to tell tales like this. It makes them feel superior. But few notice that their own central banks control the most important price of all – the price of credit. Nor do they notice that an artificially-low price of credit caused an entire generation of Americans – and Englishmen, too – to make errors. They borrowed too much and spent too much. So great were these errors that their entire economies started walking backward – destroying wealth for the average person, subtracting value from Americans’ houses…wages…and other assets.
Yes, it’s true. The average person in America is poorer now than he was five years ago…and maybe even poorer than he was 30 years ago. As we have pointed out many times in The Daily Reckoning, he has more debt…higher expenses (prices of food and fuel have soared)…but he had more or less the same real income.
How is it possible for a booming economy to make people poorer? Well, that is what mistakes are all about. Setting the price of credit too low, the feds caused a whole generation of Americans to misjudge how rich they were. They did what people do when they think they are richer than they really are – they over-spent. Over-borrowed. Over-leveraged themselves. In short, they over-did it.
And even if they saw they weren’t actually richer…they believed the promises of modern ‘zoo capitalism.’ Since the Reagan/Thatcher revolutions, people have come to believe in a new kind of capitalism – in which the dangerous beasts were all behind bars. It was Capitalism Without Fear…growth without recession…boom without bust…creation without destruction. It was capitalism presided over by central bankers – with the power to set the price of money wherever they want. Deficits didn’t matter, people believed; Dick Cheney said so. It was capitalism without mistakes, where no matter how stupid you were…no matter how high you reached…or whatever dopey thing you jumped into…you landed in honey.
It was almost too marvelous.
Until next week,
The Daily Reckoning
December 14, 2007
It was raining in Baltimore yesterday. Today is overcast. Rain, sleet and snow are said to be on their way.
Well, what do you expect? It’s almost winter. And winter is traditionally a tough time.
"Things have changed so much," said a friend yesterday. "Now, when we travel, for example, we go from a heated car to a heated terminal to a heated plane to a heated cab to a heated office. We no longer know what the weather is outside. And we certainly don’t care.
"I think that is part of why we are so blasé about economic and financial threats. There just doesn’t seem to be any real world anymore. It is all controlled. Everything is under control. We have that illusion…that we can control the weather…that we never actually have to suffer it."
But winter is still a lean time for many people. USA Today:
"Soaring fuel prices are creating a crisis among low-income people and senior citizens who can’t afford to heat their homes…"
"This is a scary, scary winter. I don’t know what folks are going to do," said one do-gooder.
Core rate inflation is still nothing to worry about. But they don’t include food or fuel in the core rate. And residential heating oil is expected to average $3.23 a gallon this winter – up 30% from last year. Propane is up 250% – from only 50 cents a gallon to $2.50.
People now blame China for everything. Food up? China is too hungry. Fuel up? China is using too much energy. Now, China is even getting blamed for the price of Christmas trees.
"Chinese Demand Sends Christmas Tree Prices Soaring," says the headline. Followed by:
"A combination of rising Chinese demand and the biofuel boom is pushing up Christmas tree prices in Germany. Producers say they just can’t keep up with demand from Asia’s economic giant.
"According to the German timber industry’s umbrella organization, the HDH, demand for Christmas trees is rising due to increasing exports and the growing number of single-person households. Meanwhile the supply of trees has decreased because several thousand hectares of tree plantations in Germany have been given over to more profitable uses, such as lucrative biofuel crops."
So the Chinese are greedy for Christmas trees too!
*** In the Middle Kingdom itself, prices are rising so much that government officials have decided to do something stupid. They’re holding prices down. The NY TIMES:
"That fear of inflation – not to mention political and social unrest – has led Beijing to prevent the country’s mostly state-owned oil companies from increasing diesel prices at the pump in pace with global oil prices. Raising fuel prices for farmers, whose incomes have lagged behind those of city dwellers and who need diesel for their tractors, is one concern. Lower diesel prices also essentially subsidize every manufacturer in China’s elaborate export machine.
"Low diesel prices frequently make trucks more cost-effective than trains, which pollute less. Sales of large freight trucks in China outpace those in the United States by a wide margin. Demand for diesel at service stations is so great, and supplies are so tight, that rationing and shortages have become common. Truck drivers idle for hours only to be allowed to buy as little as five gallons of fuel."
Let’s get this straight. China holds the price of fuel down so that its factories can continue making cheap products for the United States. The United States, meanwhile, prints dollars so that its consumers can continue buying cheap products from China. Then, China accumulates dollars – its trade surplus is nearly a quarter of a trillion this year. Then what happens? What do they do with the money?
Ah, this is where it gets interesting. There’s a new trend in global finance. Both the exporters – like China – and the oil producers – such as Saudi Arabia – have to figure out what to do with the loot. They need to find a way to use it without destroying its value. So, they are creating their own Sovereign Wealth Funds.
More to come…
*** Not much action in the markets yesterday – except that the price of gold fell sharply. Still above $800…and still a good buy, in our opinion. And there is a way to get gold out of the ground – for a penny per ounce. No shovel required.
*** And commentators are still wondering what this stock market is doing. Up, down…up, down – where is it going? We don’t know. But it still looks to us as though there is much greater risk on the downside than there is the hope of reward skyward. Recession looks inevitable. Earnings are falling. Where’s the upside?
Even Alan Greenspan now says the U.S. economy is "getting close to stall speed." How would he know? He must have read it in the paper.
Most likely, stocks have begun to turn down. The tide has turned. That great wash of liquidity that buoyed up all asset prices – from apartments in London to soybeans to trash art – is ebbing. We saw it first at the very margins – the low, tidal sub-prime flats that began to dry out in the summer. Now, we’re beginning to see it in deeper sectors of the economy.
But wait, we know what you are thinking, dear reader. What about all this new liquidity the central banks are putting into the system? Won’t it turn things around? Won’t it reverse the tides? Won’t it prevent a recession?"
Yes, the central bankers are working overtime. They’ve launched a concerted, coordinated effort to make sure the banks have money. As the Financial Times put it, Ben Bernanke has gotten out his helicopter (referring to a remark he made before he became Fed chief, in which he said he’d drop money from helicopters if that was what it took to prevent a Japan-style slump).
As we said yesterday, central bankers may be able to kill a boom. But they can’t necessarily revive one that is determined to die. Occasionally, they run into the problem economists describe as ‘pushing on a string.’ They make money available to banks. But the banks aren’t able to get the cash to the people who really need it. Remember those poor people who can’t buy heating fuel? Well, between a rich Wall Street banker and a poor person in Detroit are a whole legion of intermediaries – not a one of whom wants to lose money. Who wants to lend money to someone who may not pay it back? They’ve tried that; it didn’t work. Who wants to lend to a lender who lends money to people who can’t back it back? Ditto. And who wants to invest in debt based on a loan to a lender who lends to lenders who lend to thousands of people who can’t pay it back? Been there; done that too. That’s when the string starts to bend. The feds push more money ‘into the system,’ but the system doesn’t want it.
Is that what is happening? Is that what will happen? We can’t tell you that. But we can tell you that it does happen from time to time. It did happen in Japan recently. And it’s bound to happen here, sooner or later. That, of course, is when Ben Bernanke really does start looking around for a helicopter.
"I think the market will be rough for a while here," says Capital & Crisis’ Chris Mayer.
"There are more write-downs from banks coming, more credit troubles and more weak earnings reports from financial stocks. Then there is the spillover effect, as housing and mortgage troubles extend to other areas. Lots of bad news, and where the market will go is anybody’s guess.
"Instead of guessing which way the market might go, I think it’s better to focus on things you can control. So you have to make the decision to be in or out of the market. Then you have to decide how much you want at risk in the market. I can’t tell you how much you should invest, because that decision will be different for everybody.
"If you decide to stay in, you have to be willing to put up with some short-term pain. At Capital & Crisis, we own some nice assets in our portfolio, and over the long-term, we should do very well. I expect we’ll have some big winners. But that doesn’t mean that between now and then there won’t be some nasty patches.
"Investing is a long-term game. The best investors hold onto their stocks. And their winners come to dominate their portfolios."
*** Impressions from our travels:
Johannesburg: sun, traffic, brown, green, black, orange, malls, shorts, razor wire, security barriers, Blacks in the backs of pick-up trucks, business parks, walls, gates, California, Texas, highways, wealth, growth…
Mumbai: haze, smog, crowds, colors, horns, smells, spices, sandals, skinny people; fat, brown flesh; mildew, stains on white buildings; art deco, noise, shiny leaves, dust, scarves, dyed hair, body odor, sleeping on sidewalks, tiny taxis, pictures of ganesh, beggar girls in bangles and bright skirts…
Melbourne: palm trees, skyscrapers, beaches, tans, pedal pushers, pants with huge pockets, young people, cottages, roses, flowers, streetcars, steel, glass…