Taking the train up from Poitiers yesterday reminded me of the old couple I had seen on the train a year ago. Perhaps I already told you about them.
They had gotten on at one of the small village stations. He was a thin bent man in a heavy sweater. She was plump and pleasant looking. What was unusual about the couple was that he carried an automobile tire with him and the train seemed completely new to them both.
They took seats in the first class cabin – looking very out of place among the business travelers. And no sooner had the train left the station than they opened an enormous old rucksack. Out came bread, cheese, sausage…even wine. The train went no further than an hour or so in either direction – but these travelers packed as though they were going to cross Siberia.
Still more remarkable was their reaction to the train’s itinerary. They must have lived in the area all their lives, so they were familiar with the local towns. But they seemed surprised to find them along their route.
“Well, what do you know,” said the man to his wife, “we’re in Lussac. I didn’t expect to go to Lussac. Isn’t it amazing…But I guess it’s the way of the world. Progress…”
“Yes, isn’t it peculiar…” she replied.
Then, a few minutes later.
“And look, it’s Mignaloux…how about that…” said the woman. “What a strange route this train is taking…”
But the train was taking its usual route – a straight line between Limoges and Poitiers.
Finally, the conductor passed to collect tickets.
“Do you realize that you’re in the first class compartment?” he asked.
“Why no…we didn’t know they had a first class…”
“And did you realize that you’re going in the wrong direction?” he asked, a touch of gallic satire in his voice.
“Oh! Well, I’ll be,” declared the man. “That’s why the towns were all in the wrong direction…”
At the next stop, the couple got off, taking their tire with them, and boarded a train in the opposite direction.
“What turnips,” said the conductor to no one in particular.
What innocents! For at least half an hour, they were willing to believe that somehow the wonders of the Machine Age (that is, a train built no later than 1955, running over track that had been laid in the last century) had rearranged the geography of France; thanks to the wonders of technology you could now go east by heading west!
And yet, were they really any more naundefinedve than American economists…who, for at least half a century, have argued that people can get rich by borrowing rather than saving…and spending rather than investing?
A good man, left to his own observations, knows better. He doesn’t waste his money or drive recklessly. Over time, he realizes that the way to get ahead is simple: get up early, work hard, save as much money as possible and invest it wisely.
But give the guy a theory that allows him to believe that he can get rich by spending his money instead of saving it and he’ll swallow it like a shot of whiskey on an empty stomach. Under the influence, confidence will flush his cheeks, his spirits will rise, and his wallet will come out as fast as a purse on the Paris metro.
He’ll spend…as long as he’s able.
“What really matters for the consumer’s future,” Dr. Kurt Richebacher points out, “is not his present confidence but his ability to spend as determined by the hard financial facts facing and awaiting him: stagnating or falling income, rising unemployment, soaring indebtedness and renewed wealth destruction by plunging stock portfolios.”
In the last two years, stock portfolios have lost $3.9 trillion in value. But houses have gained about $2 trillion. Since more people have more of their wealth in houses than in stocks, the resulting “wealth effect” has been about even. (On Thursday, we will take a closer look at what rising home prices did for the U.S. economy and what is likely to happen in the housing market in the months ahead.)
With his spending power intact, and his confidence high, the consumer was an easy mark for more credit. How could he say no to SUVs at zero-percent financing? And home refinancing at artificially-low interest rates was, likewise, irresistible.
“Yes, confidence is very important,” Richebacher continues. “No less important, though, is the distinction between justified and unjustified confidence. Unjustified confidence is the primary cause of all borrowing and spending excesses and the following crisis.”
Far from sustaining the economy, the over-confident consumer destroys it. For, just as east is still east – even with modern technology – so is the way to get rich unchanged by modern finance. It is not spending that makes people wealthier, it is anti-spending: saving.
Dr. Richebacher: “Saving, in actual fact, is the indispensable condition for economic growth because it releases the resources that can be used to produce plants and equipment, adding to the nation’s capital stock. But this is true only for saving out of current income, coming from current production. Saving essentially implies abstention from consumption.
“A country without genuine saving out of current income is effectively unable to increase its productive capital stock. This is not a theoretical assumption; it is a categorical fact. Whatever reduces savings essentially reduces investment.
“In America, ironically, major capital gains in the stock market [or gains from real estate], far from replacing saving, have the opposite effect of stimulating dissaving on the part of the consumer…to the extent that the capital gains boost consumer spending at the expense of saving, they decrease the economy’s investment and growth potential.
“Generations of economists used to consider it a truism that net capital investment is the essence and the key condition for economic growth with rising prosperity. In the short run, while capital goods are produced, net investment creates growing demand and profits; and in the long run, after the capital goods have been installed, it creates growing supply and productivity.
“Consumer and government credit, on the other hand, create demand only as long as they keep expanding. Once they stop, the music stops.”
Sooner or later, the music trails off. Because, over the long run, consumers can only spend what they earn. Credit can move spending forward. But it can’t create spending power out of thin air. Otherwise, the World Bank could simply extend an infinite amount of credit to the citizens of Afghanistan and Bangladesh and make them all rich.
The basic geography of the modern financial world has not changed. You still need work, savings, and investment to produce more and better products…and give consumers the money to buy them.
For more than 50 years, American economists have aided and abetted a naundefinedve and wishful illusion: that saving was not necessary.
April 16, 2002 — Paris, France
P.S. Dr. Richebacher is one of the few thinkers I know who has a good bead on what’s happening in the economy. I believe reading him regularly will greatly enhance your understanding of today’s markets…if you don’t already, I encourage you to subscribe to his newsletter.
We’re shocked by the latest revelations from Henry Blodget. The dot.com analyst cost investors billions of dollars – with his recommendations of various dodgy companies at various prestigious prices.
But generous spirits that we are, we had attributed his spectacularly bad advice to nothing more shameful than imbecility. How disappointed we are to discover that it was not stupidity, but cupidity, that inspired Merrill Lynch’s most notorious analyst.
In private emails, Henry reveals he was more knave than fool. As reported over the weekend, Blodget knew many of the companies he was recommending were nothing more than a “piece of sh**”. Pity he didn’t share the observation with his customers.
But this news does not shake our confidence in Wall Street analysts. Richard Bernstein keeps what he calls a “sell side indicator,” based on what Wall Street strategists are recommending. To refresh your memory, when the strategists are unusually bullish, stocks usually fall. When they are uncommonly bearish, stocks can be expected to rise.
Currently, according to Bernstein, strategists believe this is “one of the best times to buy equities in the past 16 to 17 years,” indicating, he says, a coming decline in stock prices of 18% over the next 12 months. The “sell side indicator” has been one of the most accurate forecasting tools we’ve ever found. We don’t think it will let us down now.
Eric, what’s happening in New York?
Eric Fry on the Street…
– A bomb threat spooked the market yesterday. But it was General Electric that really blew things apart.
– In response to a bomb warning phoned in from the Netherlands (by a 13-year old boy, it turns out), banks in Washington, D.C. shut down for the day. Somehow the nation managed to keep operating, even though the bank shutdown prevented members of Congress from getting to their PAC money.
– Meantime, General Electric shares blew up in investors’ faces once again – the result of a few editorial grenades hurled by Gretchen Morgenson of the New York Times. 97 Dow points did not return to their barracks, although 10,094 Dow points will live to fight another day. The Nasdaq fell 2 to 1,754.
– Morgenson’s critical story – although mostly a rehash of the now-familiar tales of GE’s aggressive accounting – detonated on impact and blasted another 5% off of GE’s market cap. For those investors keeping track of the equity market “body count,” General Electric lost almost $17 billion of market value yesterday and has lost nearly $100 billion of its value since early March.
– That’s a big number, even for the U.S. stock market. In fact, the $100 billion investors have lost in General Electric shares over the past few weeks more than erases the $80 billion American homeowners managed to suck out of their home equity during the entire refinancing boom of 2001. You know, this stuff doesn’t grow on trees. $100 billion here and $100 billion there, and pretty soon Williams Sonoma might start selling fewer $500 espresso machines than expected.
– For years, GE seemed to regard the unfailing adulation it received from investors as a kind of divine right. But as my friend Michael Martin (a stockbroker with R. F. Lafferty in New York) reminded me yesterday, investor attitudes toward stocks like GE and IBM have changed dramatically over the last few months. Michael lives just outside the “blue-chip triangle” of IBM headquarters in Armonk, NY; GE headquarters in Fairfield, CT; and GE Capital Services headquarters in Stamford, CT. In his neck of the woods, criticizing GE or IBM has always been socially unacceptable. “It just wasn’t done,” he says. “But now it’s open season.”
– Also in the category of “Things you would not have seen one year ago” comes the following Bloomberg News headline: “Goldman Turns Down Request by General Electric for More Credit…[GE] recently asked 11 of the biggest banks and securities firms for as much as $1 billion whenever it needs the money,” Bloomberg reports. “Only Goldman Sachs Group Inc. said: ‘No thanks.'” Goldman’s decision, according to Bloomberg, “was based on a simple mathematical equation: General Electric doesn’t give it enough investment banking business to compensate for the puny fee on any loan that may be made…”
– Then again, maybe Goldman considers underwriting a General Electric bond issue to be an unexciting risk/reward opportunity. As a triple-A credit, GE has nowhere to go but down.
– “I disagree that GE is a triple-A credit,” Pimco president, Bill Gross said last week. “I think GE is a double-A credit.”
– GE’s swelling off-balance sheet obligations may be part of the reason Gross considers the company a double- A credit. In its most recent annual report, GE divulged that it had amassed $43.2 billion of debt within so- called special-purpose entities (SPEs). The only apparent “special purpose” these entities fulfill is to shift debt off the balance sheet. But they are no less an obligation of GE’s for being somewhat hidden from view. And if these debts were put back on the balance sheet, GE’s debt load would increase by about 20%.
– It’s hard to get off the slippery slope once you’re on it. And GE’s stock is clearly on the slope. Even so, no matter how popular GE-bashing may be at the moment, it is unlikely to become the new national pastime.
– Indeed, by the time Gretchen Morgenson gets around to pillorying a company in the New York Sunday Times, a “trading low” is probably close at hand.
– Longer-term, however, GE is certainly vulnerable to a credit downgrade. Remember the mighty “Japan Inc.?” The former economic juggernaut that used to enjoy a pristine triple-A status has seen its credit rating downgraded three times by Standard & Poor’s in just over a year.
– Japan’s outstanding debt now totals a whopping 140% of the nation’s gross domestic product, according to Ministry of Finance. That’s the highest debt level among the Group of Seven industrialized countries.
– GE-bashing may come and go, but piling up mountains of debt never goes out of style.
Back in Paris…
*** IBM says its revenues were a little light in the first quarter. Sales were off $1 billion and earnings down 30% from the year before.
*** Nortel, meanwhile, reported first quarter revenue off 50%! And Tom Seibel said the quarter was the worst the industry had ever seen.
*** “The technology recession of 2001 will go down as the worst in Silicon Valley’s recent history,” reports the San Jose Mercury News, “a year when the biggest companies lost staggering amounts of money and tech sales shrank for the first time in at least two decades.”
*** The Mercury News’ annual survey of the 150 largest public companies reveals that Silicon Valley’s biggest companies reported a combined loss of $89.8 billion last year – exceeding their profits for the previous eight years combined. Sales plummeted by $55 billion, the first time revenues failed to grow since the survey began in 1985.
*** “There’s not a sector, at least in recent memory, that has collapsed like this,” said Donald Strazsheim, former chief economist at Merrill Lynch and now president of Global Advisors.
*** Revenue is also off in Washington. If the federal government’s tax receipts decline again this year it will be the first time Washington has seen back to back years of falling revenue since the 1950s.
*** Meanwhile, George W. Bush is presiding over the biggest spending increase since Lyndon Johnson’s “Great Society.” Between ’99 and ’03 spending will increase 22% as the Bush Administration focuses on “ensuring the safety of Americans” by spending prodigious amounts of money on dubious projects all over the world.
*** Among the expense items is a $10 billion fund that will allow the president to bomb anyone he wants without having to ask Congress for money…and 13 brand new military bases. The U.S. is even negotiating with Vietnam to take over Cam Rahn Bay again.
*** A modest observation and prediction, of no particular consequence: the billions spent by the Johnson administration in the ’60s did not make American society any greater than it had been before, nor will the billions spent by the Bush Administration make the homeland any more secure.