Vindication for the Fed?
Sir Alan applauds himself for his success in preventing all but "an exceptionally mild recession." But what exactly was "exceptionally mild" about the recession – and is it a good thing? The good doctor has his doubts.
Manifestly, there is general overwhelming optimism about the U.S. economy. Positive arguments abound:
Thirteen rate cuts and the lowest interest rates in decades; runaway money and credit creation; rampant fiscal stimulus; the long and strong rally in the stock market; persistent, massive wealth creation through rising house and stock prices; an impending, powerful boost to output from a widespread need to replenish run-down inventories; reported strong profit gains promising an additional strong boost to business investment, returning job growth; surging commodity prices; and the strong stimulus to exports from the slide in the dollar.
To be sure, a more impressive list of growth-boosting influences is hard to imagine. More and more economic news-beating expectations seem to have carried away many people. Late in 2003, there was even widespread talk that strong economic growth in the New Year would soon force the Fed to start pre-empting inflation by tightening monetary policy.
It did not carry us away. Much of what we read and hear reminds us of a book by Paul Krugman, published in 1990: "The Age of Diminished Expectations." The main subject of the book was the observation that "relative to what everybody had expected twenty years ago, our economy has done terribly." Krugman expresses his amazement "how readily Americans have scaled down their expectations in line with their performance, to such an extent that from a political point of view our economic management appears to be a huge success."
Mild Recession: The Fed’s Perceived Success
It seems to us that in particular, there is a general perception that the anti-recession policies pursued by the government and the Federal Reserve during the last few years have been a great success, considering above all the rapid sequence of severe shocks imparted to the economy through the bursting of the stock market bubble, Sept. 11, corporate scandals and the Iraq war.
Yet, according to this mantra, America experienced its mildest ever recession. For many people, even outside the United States, all this is just further proof of the U.S. economy’s wonderful flexibility and resilience.
In a recent speech to the American Economic Association in San Diego, Fed Chairman Alan Greenspan applauded himself once more for his successful policy with the following words:
"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful. Despite the stock market plunge, terrorist attacks, corporate scandals, and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession – even milder than that of a decade earlier."
He offered mainly two explanations – "notably improved structural flexibility" and "highly aggressive monetary ease."
Mild Recession: Every Single Word Is Wrong
We are tempted to say that we disagree with every single word.
In the first place, we reject the general perception of America’s "exceptionally mild recession." Measured by real GDP growth, that certainly appears true. But that is a very arbitrary measure. The officially declared end of the recession in November 2001 was by no means the end of the bubble’s painful aftermath.
That painful aftermath has continued for more than two years, and not only in terms of protracted, sluggish GDP growth, but above all in America’s worst by far postwar performance in employment and associated growth in wage and salary income.
Consider: While real GDP surged in the third quarter at an annual rate of 8.2%, wage and salary income adjusted for inflation edged up at an annual rate of 0.8%. Citing Paul Krugman: "In the six months that ended in November 2003, income from wages and salaries rose only 0.65% after inflation." For most workers real wages are flat or falling even as the economy expands. For America’s employees and workers, numbering almost 150 million people, there has been no recovery.
In light of these facts, all talk of America’s mildest recession in the whole postwar period is outright absurd. It plainly serves to delude people. GDP numbers are an abstract statistical aggregate. What truly counts for people is what happens to their employment and their income. By these two measures, the U.S. economy is experiencing its longest and deepest recession since the Great Depression of the 1930s.
Mild Recession: Makes No Sense
For the bullish consensus, this tremendous, unprecedented discrepancy between real GDP and employment growth in the United States finds its ready and also most convenient explanation in the simultaneously reported record-high, unprecedented productivity growth, accruing from corporations that are becoming marvelously efficient through cutting labor costs.
We do not buy this explanation. It does not make any sense to us. Investigating the relevant statistics, the first thing to note is that the U.S. economy’s growth pattern since the early 1980s has become increasingly geared toward consumption. Its share of GDP during these years has steadily risen from barely 63% to recently 70%. For most other industrialized countries this share is between 50-60% of their GDP. Since end-2000, the U.S. recession’s start, consumer spending has accounted for 101.6% of real GDP growth.
To us, an economy in which consumption has been taking a steeply rising share of GDP for years is in essence an economy ravaging its savings and investments, both being normally the key source of productivity growth.
In consideration of these and other facts, we feel flatly unable to buy America’s trumpeted productivity miracle. There is one obvious statistical source: artificially low inflation rates.
We can make a simple test by comparing both real and nominal GDP growth between the United States and the eurozone over the period from end-2000 to the third quarter of 2003. Measured by real GDP, the U.S. economy grew overall by 6.9%, compared with 4.5% for the eurozone. But measuring by nominal GDP growth, the difference contracts sharply – a U.S. growth rate of 13.1% over the whole period compares with 12.2% for the eurozone.
As we have repeatedly pointed out, the U.S. economy’s superior growth performance during the past few years, measured after inflation, had its source largely, though not solely, in the application of lower inflation rates. For the United States, the price deflator for GDP in the third quarter of 2003 since end-2000 had risen a mere 5.8%, as against a reported 7.5% for the eurozone.
Considering the U.S. economy’s parabolic credit excesses, the relationship between inflation rates should be the opposite. But pressured by politicians and in particular by Mr. Greenspan to produce the lowest possible inflation rates, America’s government statisticians have worked hard to comply, in particular by counting quality improvements as price reductions. Understating inflation rates, in turn, overstates real GDP. A more accurate GDP deflator would lower real GDP growth to a rate that would certainly correlate better to the poor employment performance.
In our view, the prevailing perception that the U.S. economy experienced but an "exceptionally mild" recession – and now continues to perform exceedingly better than the eurozone economy – needs drastic revision.
for The Daily Reckoning
February 24, 2004
P.S. This particularly applies to the job market. For decades, all through the postwar period, job creation has been the U.S. economy’s outstanding superior feature among the industrialized nations. But that has radically changed. Since 2000, America is by far the worst performer in this respect. Following past postwar recessions, payroll employment was on average up 4% after two years. This time, it is down almost 1%. Something very ominous is going on.
Editor’s note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
This essay was adapted from an article in the February edition of:
The Richebächer Letter
The answer is "No."
The question is the one we posed a week ago: has the world seen $400 gold for the last time?
Which leads to this week’s question: will it seen $300 gold again, too?
What we are questioning is our whole economic worldview…or our Weltanshauung, as we like to say around the office.
We think we know what is going on. But there is more under heaven and earth than is contained even in our philosophy. God does not share his plans with us. Instead, he merely whispers in our ear…when we are half-asleep or half-drunk…’just do the right thing!’
Then, when we sober up, we ask…’but what’s the right thing?’
We do not know.
But everywhere around us, we see people doing things that couldn’t possibly be right. Yesterday’s news brought word that home sales and mortgages "may beat records," according to Bloomberg. Americans can’t pay their bills already. How could it make sense for them to be buying new houses and taking out new mortgages?
Elsewhere, we discover that people are still buying stocks at prices near their highest levels in history…We say no more about this. We know no better than anyone else what stock prices will do, but buying at these prices can’t be the ‘right thing’ to do.
And in the current Economist, we discover that it is not only the lumps that are erring on the side of recklessness. Apparently the banks, too, have been taking bigger and bigger positions in their trading rooms in a manner that is "not dissimilar" to the geniuses at Long Term Capital Management…before that hedge fund blew up.
Even foreigners can’t resist upping the ante; they continue to invest in U.S. assets, the Fed reported last week. "Depending upon where you get the statistic," writes our friend John Mauldin, "foreign central banks own between 39-45% of our government debt. Throw in private investors and it is even larger. At current trade deficit levels, this would grow to 65% within five years.
"The U.S. has accounted for 96% of the growth in world trade for the last few years. Thus, foreign nations have to be willing to either not take depreciating U.S. dollars and suffer the inevitable slowdown in their economies, or take less for their products in order to be able to keep their work forces producing and economies bumping along…"
We don’t know exactly what is going on, but hardly a day goes by that we don’t notice more evidence of it. We see it in the world economy…in its money system…and in politics, too. It is the top of a credit cycle, we think. People seem far too confident…far too complacent…far too sure that they will get what they want, rather than what they deserve.
We don’t know how this confidence will be undone. But our Weltanshauung…or is it our Erfahrung…tells us that it will be undone sometime, somehow, somewhere. Otherwise, it would be an even stranger world than we think. Things would go up without coming down. We would have summer…but no winter. There would be good, but no evil. You could borrow without having to pay back. You could drink all you wanted without getting a hangover…and whiskey would run from public fountains all over the republic.
We have been in the paradise world of Nicaragua for the last few days. Perhaps everything has changed. But that is not the world we remember.
In the world we remember, gold rises…because the smart money knows there is something wrong. It buys gold as protection…and is happy to get it at a lower price.
Over to Eric Fry, with the dream-spinners in New York City:
Eric Fry on Wall Street…
– "The dead cannot talk," your Paris-based editor often laments. Therefore, most investors seek the counsel of the living. Too often, however, investors seek the counsel of the living who make their livings on Wall Street providing misguided counsel to investors.
– However, an obscure minority of investors seeks the counsel of the deceased – men like Benjamin Graham and Leonardo Pisano Fibonacci. Mr. Fibonacci shed his mortal coil about 800 years ago. But his insightful mathematical observations have gained a kind of immortality among "technical" investors…If forced to choose, we’d rather "listen" to the deceased Italian mathematician than the living Wall Street strategists.
– But before we turn our attention to Mr. Fibonacci’s latest insights, let’s recap yesterday’s trading action. In the stock market, the Dow slipped 9 points to 10,610, while the Nasdaq tumbled 1.5% to 2,008 – only four points above its starting point for 2004.
– Gold managed to stop falling for one day, as the yellow metal climbed $1.30 to $399.30 an ounce. But gold stocks continued sliding anyway. Since topping out in early January, gold stocks have showered abuse on gold stock investors. Nevertheless, gold stock investors – like the boyfriend of a beautiful, but mean-spirited girl – are trying very hard to keep the flame alive. (After all, look how beautiful she is!) But the daily abuse is making it easier and easier to turn away from gold and seek a kinder, gentler (and more profitable) investment elsewhere…
– Re-enter Mr. Fibonacci. The insightful mathematician determined that life on this orb often unfolds along predictable numerical patterns. He also had a penchant for illustrating profound mathematical principals with commonplace metaphors. He wrote, for example, "A certain man put a pair of rabbits in a place surrounded on all sides by a wall. How many pairs of rabbits can be produced from that pair in a year if it is supposed that every month each pair begets a new pair which from the second month on becomes productive?"
– We do not know the answer to Fibonacci’s hypothetical question. Biology is not our beat. But we have observed the following predictable pattern: "A certain man put a pair of Wall Street investment bankers in a room, along with a pair of investment banking clients. After several months, and despite multiple attempts by the investment bankers to procreate with the investment banking clients, the investment banking clients do not ever beget a new pair. But they do lose whatever money they possessed upon entering the room."
– Today’s technical analysts have seized upon Fibonacci’s work to find – they believe – somewhat predictable patterns in the direction of financial markets. Broadly speaking, of course, financial markets are extremely predictable…they go up, then they go down, then they go up again.
– But predicting the precise moment when a given market that is going up will begin to go down is a bit more problematic…even for Fibonacci scholars. That said, a lot of technical analysts pay close attention to what they think the dead man’s special numbers are telling them.
– Relying on a few "classic" Fibonacci numbers, Elliotwave.com deduces that the S&P 500 will hit an important peak on or about Feb. 25, 2004. "The all-time high for the S&P 500 was recorded on March 23, 2000," explains options pro Jay Shartsis. "Adding a Fibonacci 987 days to that date points to Feb. 25, 2004. Then, taking the post-Sept. 11, 2001, panic lows seen on Sept. 21, 2001, and adding a Fibonacci 610 days, we also get Feb. 25, 2004, as a top target for the S&P 500."
– Are you still with us?
– "Last Thursday was close enough to qualify as a near bull’s-eye by my thinking," says Shartsis. "It would seem to me that this targeting is further affirmation that an important top is at hand, as suggested by the very wild and negative divergence presented by the Nasdaq and transports vs. the Dow."
– Not to be outdone by the dead mathematician, Shartsis points out a few numbers of his own: "On Dec. 1, the Dow was at 9899 and there were 627 new daily highs on the NYSE. Yesterday saw the Dow hit 10,688 but there were only 233 new daily highs. That is a striking negative divergence on a Dow gain of 740 points."
– Fibonacci also has something important to say about the gold market, according to Greg Weldon, editor of Weldon’s Metal Monitor. "Gold mining shares are ‘rolling over,’" says Weldon. "So how low can gold go? The long-term, weekly charts offer several possible DOWNSIDE targets." Weldon presents an array of "Fibonacci retracement" numbers to pinpoint possible downside targets at $387, $362 and $342.
– Certainly, the "downside" seems to be the path of least resistance for the gold market right now. But in a world of leveraged financial markets and half-a-trillion dollar current account deficits, the path of least resistance has a way of changing rather abruptly. Based on our work – and on the Fibonacci numbers WE use – gold will either go lower, or it will go higher. If it goes higher, we will be delighted. If it goes lower, we will trade a few more of our dollar bills for ounces of gold.
Bill Bonner, back in Nicaragua…
*** "We should have bought property down here when we first got here," said Elizabeth as we were surveying the Pacific Coast from a fishing boat yesterday.
"But how could we know it was going to go up so fast," your editor wanted to know.
"It seems pretty obvious in retrospect," his wife continued. "It’s beautiful country…and more and more Americans want to find something like this."
"Sounds like that would have been the smart thing to do. But, remember dear, we don’t try to do the smart thing. We try to do the right thing. And we don’t know what that is…"
"Please don’t start that…"
*** "It was terrible. I went to my sister’s house with my two little children. Sylvio was just a baby, only two years old. And when I got there a man with a hood over his head put a machine gun in my back."
A Nicaraguan friend was describing what the country was like in the late ’70s. (Missing out on rising real estate prices is not the worse thing that can happen to a family.)
"The Sandinistas were kidnapping people and holding them for ransom. And when that happened, you didn’t want to go to the police because they would just come in and kill everyone – including you. So, I called my brother-in-law…and he negotiated with these guys. There were six of them. They all wore hoods. They were very rough. And they told us that if they didn’t get the money they asked for they would kill the children first.
"But it was Sunday. The banks weren’t open. So, my brother-in-law had to go around to everybody he knew…and still he couldn’t come up with enough money. So we thought they were going to kill us all.
"But my brother-in-law, he negotiated a deal…somehow he paid them off. The next day, we left Nicaragua with all the family."
*** In the mid-1900s, almost all problems seemed to have a political solution. Nicaragua was not the first to fall into the trap. But unlike Russia, which took 70 years to get out, Nicaragua was back on the bumpy capitalist road within a single decade. Now, groups of Sandinista sympathizers still occasionally gather to chant their dreamy slogans…even while speculators conclude multi-million-dollar real estate deals.
*** A reader correction: "For the record, the Dow-to-gold ratio peaked at almost 45-to-1 (not 30-to-1) on August 25, 1999…the Dow closed at 11,326.04 and gold closed at 252.55."