Under the Economic Sun
There may be nothing new in Economics Land…but the Mogambo Guru educates us in lessons of old.
The Fed has now jumped back into the fray, increasing total credit by $7.8 billion last week, although the trend in increases seems to be somewhat flat here lately. Even the foreigners who have their holdings at the Fed stepped back from the plate a little. I’m just naturally suspicious that maybe they thought the potential bad press, "Foreign custody holdings go over one trillion!" was too scary. Or it was a fluke. Or some other reason.
And if you think that foreigners accumulating so many U.S. assets and claims on assets is not so bad, then I turn my eyes and stare directly into your soul, and I see that you think those old aphorisms of "Neither a borrower nor a lender be" is a load of hooey. And you think that those old sayings about how the lender comes to hate the debtor, and vice versa, are also a real hoot. And you forget that that preachy old Aesop fellow probably had some moral in a story about bees and ants, or squirrels and grasshoppers or lions or something, anthropomorphic animals borrowing something from some other bee, or ant, or squirrel, or grasshopper, or lion. And then can’t pay. And then gets eaten.
And there are, of course, many, many more references in all of classical history and literature, all the way back to 10,00 years ago when Og borrowed some clams from Caveman Mutual to buy spear points, and of course the classical wipeout when the bank went belly up is all part of history now, or it would be if it weren’t censored out of the history books by the government.
Creating Inflation: The Tale of the Borrower and the Lender
But, and this is the first important part that I want you to take away from our little chat together, one of the constants in the universe is that the Tale of the Borrower and the Lender, in whatever incarnation it takes, always has an unpleasant ending. Always. In fact, I shall call it the Always Unpleasant Ending Effect, which we will refer to as AUEE, or better yet the Mogambo AUEE, which you can further shorten to MAUEE, which is a pretty good phonetic spelling of where I am going if this AUEE thing works out with me winning the Nobel Prize in Economics next year like it should, and when they hand me that cool million bucks, man, like, I’m outta here. I mean, the subtle hostility of sullen and angry neighbors is one thing, but to have to listen to people trying to exorcise demons out of my house by chanting is getting to be pretty unnerving, and so you can see I really could use that Nobel Prize money.
The big problem with economics is that there has been nothing new under the economic sun for thousands of years. There has always been a Borrower and a Lender. There has always been government, and taxes, and buying and selling, and borrowing and lending, and investing and interest, and sleazy powerful people enriching themselves, running off into the night with the company payroll, and bosses sexually harassing employees, and of course graft, and corruption, and nepotism, all those relatives needing favors and jobs, and friends needing favors and jobs, and so on. It wouldn’t surprise me to find that this is actually where the phrase "some things never change" comes from. And all of them trying to live, as has been said many times, at the expense of everybody else.
The only variable that makes the big difference in the long-term economic health of a nation has been (pause for effect) the nature of the money. When money is something that the government cannot, or will not, depreciate by over-issue, then everything is fine, and the economy burbles along with attenuated booms and busts.
But burbling aside, borrowing from the savings of the people who save money is inherently self-limiting, and pretty soon all the available savings have been borrowed and spent, and then interest rates rise due to the smaller supply of loanable funds, businesses slow down, a recession ensues, the idiot businesses die and the strong businesses find a way to hold on, people start saving their money again, prices fall to some more reasonable value, and then the cycle starts all over again.
Creating Inflation: Bustlets
That’s why the busts in the old days were usually concentrated little ‘bust-lets,’ more appropriately characterized as a few people getting their fingers burned from being greedy and stupid, with lots of innocent little people having to pay a price, as they always do. Yet the nations always survived, and went on making progress from there.
But today everything is different, and the sky is suddenly dark with ominous clouds, and very low notes from some hidden organ lets you know that something spooky has appeared. You look out of the window and you see buzzards sitting on the bare branches of long-dead trees, and everything is colored in shades of gray and black. The voice-over sounds eerily like Vincent Price saying, "When money, the delicious blood of life, is conjured up by mad scientists in forbidden laboratories in secluded castles late at night, or printed up in state-of-the-art modern printing and engraving facilities of a mindless, zombie- like government body, then a strange, forbidden, and very dangerous voodoo alchemy will cause rips in the time-money continuum, and dead economists will rise from their graves! Their ghosts will be angry and vengeful, and they will torture you with all the pains and horrors that only over- issuance of money can cause!"
This is nothing new at all, and that is why the Founding Fathers were so careful to include in the Constitution, in black and white so there would be no mistake, that money shall only be silver and gold, because the government cannot depreciate the currency by printing up more silver and gold. And therefore the time-money continuum should never be ripped open, and vengeful specters should not rise from their graves to haunt and vex us, and macroeconomic idiocies would not be committed, and I would not have anything to write about, and then I’d have to end up getting a real job, and then I’d end up getting fired because I’m an idiot, and then I’d end up committing some crime out of my frustration and constant failure, and then go to prison and be a burden on the rest of society until I died, many years later, old and bitter.
So amid the gloom, doom and imminent onslaught of vengeful specters, why does the stock market go up? One reason is that the central banks of the world are financing the whole mess by flooding the system with money, and so that damn money has to go somewhere. And where the heck do you put that much money? I helpfully suggested that I would be happy to store a bunch in my basement, and even guys from outlaw biker gangs are afraid to go down there, so it is certainly safe. But no dice.
Ergo, the big-ticket items like the stock market, the bond market and the world’s real estate are the easiest places to go, and so, like water and electricity finding the shortest way to lower ground, that’s where the money goes. And price doesn’t matter anymore, because tomorrow there will be another big bundle of money coming, and it has to go somewhere, too. And then the day after tomorrow, there is going to be another big bundle of money coming that has to go somewhere…
Creating Inflation: Screaming, Roaring Price Inflation
And I gather from this consensus opinion of the world’s biggest hotshots that if everybody inflates their money supply at the same time, then the resultant, roaring global price inflation won’t matter, because roaring inflation in stocks, and the blistering inflation in bonds, and the screaming inflation in houses, and the soaring inflation in every freaking other thing in the whole economy, will be all hunky-dory with them, because everybody is in the same boat.
And it certainly fights the Fed bogeyman of deflation, which in this case means keeping the absurdly over-priced, over-valued, over-subscribed, over-leveraged assets of any kind from falling so much as one red cent in market price, and the government stands ever-ready to finance any buying, by anybody, at any time, for anything, if it is for a higher price, which keeps prices from going down. The ultimate in government control of the economy!
But, in the final analysis, the government is actually creating inflation, the one thing that is most feared, so that the current prices of overpriced assets will keep inflating! This doesn’t sound insane to you? Huh? How can it NOT sound insane? To even espouse such a mentally ill notion is nothing more than having a raving lunatic at the controls. And when you examine the rules and regulations of the railroad industry, for example, you’ll find that there is an actual prohibition against using insane people as locomotive engineers. Fortunately for Greenspan and the Fed, our central bank and government seem to have no such prohibition.
The Mogambo Guru
for the Daily Reckoning
October 27, 2003
P.S. The thing that survives and prospers is gold. And so when the government finally has its back up again the wall, and it will, and gold soars in price to levels undreamt of, prices that never appeared even in my most magnificent and greedy dreams, which usually involves an eager-to-please Barbara Eden, starring as the genie in "I Dream of Jeanie," granting one of two wishes to me, starring as Maj. Anthony Nelson, handsome and brave and single astronaut, these gold-owners will probably be the people the government comes after.
The reason I bring this up is that Marc Faber, author of the infamous Gloom, Boom and Doom report, warns – and this is the second warning like this that I have read in the last week alone – that maybe the government will end up confiscating gold, again, since they have already demonstrated that they have the power and willingness to do that. It is a concern, all right. But they give you dollars for it, so they are not actually confiscating it from you. They are forcing you to sell it to them, and get a fair and just number of dollars for the gold. This is the Fifth Amendment prohibition against a ‘taking’ without just compensation, that is in the Constitution, thank God. But, there you are with dollars, the one thing you didn’t want.
The added worry, for me, is that this Supreme Court has already amply demonstrated that they are willing to misinterpret and/or ignore the Constitution according to their wishes, and they will allow new things for the federal government to meddle in, tax, regulate or confiscate. After all, they are already on record as making anything they figure may be in the temporary common good, or suits their tastes, or satisfies their private agendas, suddenly Constitutional. And things that they don’t like are un-Constitutional, to add a little symmetry to their do’s and don’t’s. So, one may assume, even if you are not even fractionally as paranoid as I, that the prohibition against ‘takings’ is just another part of the Constitution that is now just, alas, pretty words. It’s a worry, alright.
Richard Daughty is general partner and C.O.O. for Smith Consultant Group, serving the financial and medical communities, and the editor of the Mogambo Guru economic newsletter, an avocational exercise the better to heap disrespect on those who desperately deserve it.
The Mogambo Guru is quoted frequently in Barron’s, The Daily Reckoning, and other fine publications.
During a radio interview last Friday evening, your editor suddenly stopped short: the economy is out of control, he realized.
"There has been a meaningful breakdown," explains Stephen Roach, "of the time-honored relationship between aggregate demand and employment growth in high-wage, developed countries like the U.S."
The Fed can cut interest rates all it wants, in other words. It can bring short-term rates down from a 45-year low to a 55-year low. It may bring about a boom in asset prices…and even a boom in consumer spending, but it cannot bring about a real boom in the economy. Because half of all the manufactured items the consumer buys are now made overseas…and it is overseas where the new factories are built. When the consumer spends, his money stimulates the economy. But not in America. It’s the Chinese economy that feels the tickles.
We are now nearly two years beyond the bottom of the 2001 recession. If the economy had followed the path of previous recoveries, says Roach, there would be 4.3 million more jobs available. And maybe there are…just not in the U.S..
Artificially low interest rates do have an effect, of course. They make it almost irresistible for the American consumer to go deeper into debt. The Chinese, Japanese, Taiwanese, Malaysians, Indonesians, Indians and dozens of other groups should bow down before him; he nails himself to a cross of debt, so that other people in other countries may have a more abundant life.
Richard Berner, Stephen Roach’s colleague, adds that "a new measure [of consumer indebtedness] suggests that the recent peak in the ratio of debt service to disposable income is roughly 100 basis points higher than the previous peak in late 1986; the old measure put them at roughly the same level. So it would appear that consumers have taken advantage of lower interest rates to lever up recklessly."
The U.S. national savings rate has fallen to 0.5% of GNP in the 2nd quarter of this year. In the 1960s, the net private savings rate was 8.5%; today, it is less than half that amount. Without the savings of foreigners, the whole weird system would come to a quick end. There is madness on both sides of the wide Pacific, in other words. In Asia, people save 20% to 40% of their incomes and lend to Americans. In North America, people save barely anything. Instead, they borrow from the Asians in order to be able to buy more imported products and boost employment in foreign countries.
Looking ahead, we guess that the madness will come to an end: the dollar will fall, Asians will begin spending their money on themselves, and Americans will spend years working their way out of debt. But, peering through a dark glass at the newspapers of the future, we think we can make out the headlines…but not the dates.
Over to Addison, in Paris, with more news on the markets…
Addison Wiggin at the Daily Reckoning HQ…
– As painful as it may be for your American expat editors, desperately trying to support their wine habits in Paris, the "Dollar decline[d] an 8th week in 9 against [the] euro," says a Bloomberg headline. The dollar fell to $1.17 per euro on Friday – a penny lower than its Monday opening.
– For the week, gold jumped $17 to $389.20 an ounce. The broader market indices all fell…The Dow by nearly a percentage point and half; the Nasdaq by two and half. They closed Friday at 9,582 and 1,866, respectively.
– "To be sure, the ‘recovery’ is statistically pleasing…But something is not quite right with this thing," wrote Eric Fry, our man on the scene in New York, in The Daily Reckoning Weekend Edition. "Our Greenspan- sired recovery is a freakish changeling – not the hardy, all-American variety that we are used to seeing. We are happy it’s here, but boy is it ever ugly! Sure, GDP boomed during the third quarter; yet, many American workers are struggling to find a job…and many of America’s blue-chip companies are producing noticeably un-boom-like earnings."
– A quick harvest of the headlines this morning yields more of the same fermented fruit. "Earnings do not live up to hopes," reads a headline from the Philadelphia Inquirer. "Wealthy won’t spend more for holidays," reads another from The Rocky Mountain News in Denver.
– And yet, here’s a curious one from the New York Times: "Gains In Wages Expected To Give Economy A Lift." The logic of the recovery scenario is about as impeccable as the FDA’s chestnut: "you are what you eat." The idea has been dumbed-down enough to get repeated ad nauseum in the minds of nine-year-olds around the nation, but doesn’t possess a lick of truth. At least, we haven’t noticed any new arrivals from the States mutating into a globulous mélange of Bordeaux and Brie…nor do we detect any changes in our own exteriors when we look in the mirror.
– The economic version goes something like this: ‘Low rates and tax cuts will lead to new job growth.’ Sure, sounds great on the surface…but let’s look under the hood. "Wage increases for almost all income levels are giving important and unexpected support to the nation’s economy," says the NY Times piece. "If the gains continue, they offer hope that the rapid economic expansion of recent months could prove more durable than other spurts of growth over the last two years."
– So far, so good. The Commerce Department expects to report this Thursday that the economy grew about 6% during the July-September quarter. But what’s this? "Most of that growth," the article explains, "stemmed from a sharp rise in consumer spending, driven largely by a continuing boom in mortgage refinancing and checks that were mailed out as part of the recent tax cut." Aha, there it is: low rates and tax cuts will lead to job growth.
– Wages are rising faster than inflation – that much appears to be true. The Economic Policy Institute, reports the Times, says wages have increased faster in the past quarter than any other post-recession period. They’re up more than 2% since after being adjusted for inflation – to a median rate of $14 an hour.
– But here’s the problem…or problems…"hours worked" are actually falling, and incomes "excluding tax cuts and home refinancings" are in high reverse. If you measure income year-over-year and include "tax cuts and refinancings," personal income appears to have risen as high as 8% this year; take them out and they’ve fallen by as much as 2%.
– "What appears to be happening," writes Stephen Sleigh, with the International Association of Machinists and Aerospace Workers, "is that companies that are staying in business want to hold on to the people they have." But no new jobs are being created. The workers who are staying on the job are getting squeezed off the time clock by the Greenspan hobby horse ‘productivity increases’…not to mention competition from Mr. Samir and Mr. Wong, who are busy toiling away on the other side of the planet.
– Never fear. To make up for falling incomes, while simultaneously keeping up with the Joneses, Mr. Smith simply whips out one of his 16.1 credit cards and blissfully continues about his delusional day. Americans following the FDA’s "you are what you eat" dictum have gorged themselves to a 64% obesity rate. Consumers following the Fed’s recovery recipe are doing the same to the debt side of their financial ledgers.
– Likewise, a company that must pay more in wages has less dinero in the bank to build new factories or refurbish rusting equipment. And that’s the crux of the economic problem with the low rate/tax cut remedy for a collapsing bubble.
– "It seems investors made a bad bet when they bid up stocks sharply higher this month in anticipation of strong third quarter earnings," says the Philly Inquirer. "The earnings have been good, but not magical." One wonders what the policy strategy for goosing up the 4th quarter will be.
– Thus far, the recovery resembles a rat on a treadmill undergoing chemical experiments. We suspect one of these days, the geniuses in the lab coats are going to pick up the wrong beaker…and the rat is going to keel over dead from exhaustion.
Bill Bonner, back at Ouzilly…
*** We are in the country for the kids’ school vacation. The days are bright and sunny…but the nights are clear and very cold. After a long, hot summer, people are sure that a cold winter is coming.
"Onions…" said a guest yesterday. "You just look at the skin of the onions. When they are thick…it means the winter will be cold."
"Well…are they thick this year?" came the question.
"I don’t know, I didn’t bother to look last year…"
*** A wise man, we recall writing on Friday, might hold onto a little cash…just in case tomorrow’s investment opportunities are better than today’s. Now comes news that one very wise man, Warren Buffett, has "more cash than [investment] ideas." The Sage of Omaha regrets not having sold Coke at the end of the ’90s…and now believes that cash will be a better investment than most stocks or bonds.
*** Among the stocks Buffett is not buying are our old friends, Amazon.com and eBay. Amazon has tripled since the beginning of this year – to $54, or 10 times its price 2 years ago. The River of No Returns has never made a dime of profit…though it hopes to do so by the end of this year. At least eBay has earnings…at which it is priced at 93 times. Sell the techs, dear reader, sell the techs.