Unsafe at Any Speed

Ralph Nader recently organized a press conference to discuss what a bad job Alan Greenspan is doing.
Professor James Galbraith of the University of Texas "called for a congressional investigation into why the Fed’s army of economists failed to forecast either the stock market bubble or the recession."

Here at the Daily Reckoning, we urge Congress to take up Professor Galbraith’s suggestion. We can’t imagine anything quite so entertaining as the resulting report. What might investigators find, that a bureaucrat misplaced a decimal point? That the folks who work at the Fed actually knew a recession was coming…but
didn’t want to alarm the population?

The trouble with humanity, we believe, is a lack of imagination. For anyone with a chemical trace of
imagination can see that if the Fed could accurately forecast anything…it would never happen as it was
supposed to. If the Fed believed a bubble was forming…wouldn’t it do something? If a GS-12 statistician, working in some barren office in Washington, realized he could predict recessions, or stock price bubbles…mightn’t he be tempted to buy a pair of suspenders and manage a hedge fund?

Fed economists cannot forecast anything worth forecasting. If they could, they’d move to New York and try to make a buck or two from it. Still, it would be amusing to see an investigation. Like a Marx Brothers’ movie…we would not expect much good to come from it…but it would be fun.

Here at the Daily Reckoning, dear reader, we do not crunch numbers the way they do at the Fed. We like
numbers and see no reason to subject them to unnecessary pain and suffering. We are neither monetarists nor Keynesians nor even fundamentalists in the usual sense…and certainly not econometricians. We continue the work of the original economists – the Scottish moral philosophers, Adam Smith and Adam Ferguson.

Instead of trying to anticipate the future, we try to understand the world around us…and how it works. We
search for the essential, guiding principles – buy low, sell high…don’t cross against the light…don’t eat
yellow snow – and try to apply them to the present situation. We follow the rules, in other words. We try
to figure out what should happen and do the right thing – and we are content to let Fortune punish us or reward us as we deserve.

What, essentially, is going on in today’s market? What is the right thing to do?

Today, we offer more ruminations and guesses…

Is it rising stock and house prices that make people wealthy, or something else?

"It is something else," answers the economist.

What, then?

"In line with traditional economic thinking," answers Dr. Kurt Richebacher, "our attention is centered on net
fixed investment in tangible assets – factories, machinery, offices, etc – as the key source of long-term
economic well-being. First and foremost, net fixed investment is the single most important factor in
creating national wealth and productive power; and second, it is moreover the economy’s most important
profit source."

People invest in businesses in the hope of making a profit. Without profits there is no reason to invest.
"We live in a society organized in such a way that the activity of production depends on the individual
businessman hoping for a reasonable profit," wrote John Maynard Keynes, a dead economist. "The margin which he requires as his necessary incentive to produce may be a very small proportion of the total value of the product. But take this away from him and the whole process stops."

In 1995, total profits of U.S. industry were about $400 billion. In 2001, total profits were once again about
$400 billion. In 6 years of effort, not a single extra dollar of profits was added to the annual total. The whole process has not stopped, but it is slowing down.

If profits fail to pick up…mightn’t the whole process slow even further?

"Company reported earnings per share…are taking the worst beating, being actually down by more than 60%
against a year ago," continues Dr. Richebacher. "Whopping write-offs and extraordinary charges to earnings are ravaging company-reported profits. All of a sudden, multi-billion dollar goodwill write-downs and
restructuring charges are littering American and British corporate income statements."

The ’90s produced "the weakest profit cycle in the whole postwar period," says Richebacher. And now companies are taking huge charges for bad acquisitions, IT investments that produced nothing, and other wasted spending. When money was cheap…businessmen treated it cheaply.

What might make profits go back up? Much of the profitability of U.S. companies in the early ’90s came
from reduced interest charges. But with the Fed Funds rate at 1.75% and long rates headed up in recent weeks, there is little hope of further cuts in interest expense.

What usually makes profits go up is net fixed investment – new and better machinery that produces more, higher quality goods and lower cost. Net fixed investment is the difference between gross investment in new machinery and depreciation charges, which is the accounting profession’s way of recognizing worn out or obsolete machinery.

But net fixed investment is disappearing.

"Next year, something unprecedented and extremely negative will happen to U.S. non-residential fixed capital formation," writes Dr. Kurt Richebacher. "As rising depreciation charges seem set to overtake declining gross investment spending, net fixed, nonresidential investment will turn negative. The last time this happened was in the Great Depression. The outlook is further clouded by the danger that the consumer will also retrench."

Maybe stocks will turn up – even without profits. But what moral philosopher would bet on it? Equities are as unsafe as the Corvair, we believe.

Bill Bonner, fastening his seat belt.
January 11, 2002

Bill Gross runs the largest bond fund in the world, with $48 billion in assets. "The dollar may not explode," he writes, "but it has got a leak with an almost indistinguishable hiss that should grow louder as 2002 winds on," he wrote.

All over the world, currencies are leaking air… mostly against the dollar. The South African rand…the Argentine peso…the Japanese yen…currencies are deflating everywhere you look.

Canada moved to a floating exchange rate policy back in ’70. It floated higher against the dollar until April ’74, when it hit $1.04. But it’s been sinking ever since, and sank to 62 U.S. cents on Christmas Eve, 2001.

Why are all these currencies falling? Because the countries need weaker money in order to remain competitive. How can the U.S. keep a strong dollar while everyone else cuts the value of his currency to undersell U.S. firms? It can’t. U.S. manufacturing is suffering. Detroit has lost 8% of world market share since the beginning of the boom in America. And since the bust began, U.S. manufacturing firms have experienced a longer period of consecutive monthly declines than any time since the Great Depression.

The dollar has to come down too. But wait. It has to have something to come down against. How can the dollar fall when other currencies are falling too? Ahh…this is where it gets interesting. Nations will compete – as is happening in Asia now – to see who can ruin the value of his own currency fastest. And all paper currencies will fall against non-paper currency, gold.

Right, Eric?


Eric Fry from New York…

– The bad-news-good-stock trend continued yesterday. The Gap reported that its same-store sales in December fell ONLY 11%. The stock promptly jumped more than 12%.

– Imagine how well the stock might how done if the company had managed to sell even fewer clothes! Oh well, there’s always next month.

– But The Gap’s miserable same-store sales report was not enough to spark a rally. The Dow Industrials lost 26 points to 10,068, while the Nasdaq eked out a 2-point gain to 2,047.

– Meanwhile, far removed from the center court of finance, the gold market is putting on quite a show. The barbarous relic has actually rallied for three days in a row and has gained $8.50 per ounce to $287.40.

– Perhaps nervous short-sellers in the gold market are buying gold to cover their short positions, now that the notoriously unhedged Newmont Mining appears to be winning the fight to acquire Australia’s Normandy Mining. One story making the rounds is that if Newmont prevails, it might buy back the gold that Normandy has sold short, thereby triggering a short-squeeze that drives the gold price higher.

– If this sounds a little complicated, all it means is that gold might rally…On the other hand, it might not. Virtually overlooked amidst the brouhaha about the S&P 500 falling in 2001 for the second straight year is the little-remarked fact that the XAU Index of gold shares gained almost 6% in 2001. And it has already jumped another 7% this year. Long-time gold stock investors call that a bull market.

– The Wall Street Journal reported yesterday that the Ford Motor Company might incur restructuring charges totaling a whopping $4 billion. That’s a lot of money, even for a great big American car company. The number is so large, in fact, that some Wall Street analysts expressed concern about the company’s cash burn-rate… as if the venerable auto manufacturer were a mere product-of-the-bubble Internet company.

– Ford will divulge details today of its "major" restructuring plan designed to restore profits and cash flow. Funny how these plans to "restore profits" always cost so darn much money.

– The company has already announced that it "plans to produce a recovery with great new vehicles and better quality." Aren’t Chrysler and General Motors both planning to do the same thing?…Not to mention Toyota, BMW, Volvo, etc.

– For example, Chrysler’s top brass aims to boost its annual sales by one million vehicles over the next five to ten years. "It is a staggering goal in a global auto market already choking on too many cars and trucks," said the Wall Street Journal.

– How exactly will all of the Big-3 automakers increase their market shares at precisely the same time? Who’s going to buy all these great new cars? The same people who, thanks to zero-percent financing, just bought a great new car two months ago?

– Speaking of excess capacity, "The national average for office vacancies rose to 12.3% in the third quarter of this year, from 8.1% a year earlier, according to Torto Wheaton Research, the real estate data unit of CB Richard Ellis Services," the Wall Street Journal reports. "The office-leasing market in Manhattan is dead right now," my well-placed industry contact informs me.

– More news from the beleaguered-consumer front: Household liquid financial assets (LFAs) are dwindling, says Moody’s. After climbing to a 29-year high in 2000 – when LFAs totaled nearly three times household debt – LFAs have fallen to little more than two times household debt currently.

– The bear market in stocks beginning early in 2000 deserves most of the blame for the dwindling household liquidity. When the stock market was booming during the back half of the 1990s, savings accounts were for losers. The best way to "save" was to buy a tech stock mutual fund and hang on for the ride. Therefore, it’s not surprising, that the liquid financial assets of households relative to debt levels topped out in the first quarter of 2000, right along with the stock market. It’s been downhill ever since.

– "Who or which demand component could possibly lead the predicted U.S. economic recovery?" wonders Dr. Kurt Richebacher. "Rising capital spending by debt-laden corporations confronted with collapsing profits? Or higher spending by the debt-laden consumer confronted with huge wealth losses in the stock market, rising unemployment and stagnating or shrinking disposable income?"

Beats me.


Back in Paris…

*** Ten months into a recession and people are buying more big ticket items then ever. New mortgage applications rose 20% last week. New refinancing applications rose 32%. Auto sales are strong.

*** What kind of recession is this? It is one like no other in U.S. post-war history. Then what is it like? More below…

(Bill had to rush off to catch a train to London…but on his way out the door, asked me to inform you that on this day in 49 B.C., Julius Caesar crossed the Rubicon. Neither Bill nor any of the rest of us are sure how this fits into today’s Daily Reckoning…but there it is. Becky, your Daily Reckoning

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