After a few days of light fare — telling you about my trip to England — I suppose you are ready for something a bit heavier. Something with “bottom,” as the English say.
Reading the latest installment of Dr. Richebacher’s newsletter, I think I have found the perfect thing.
“At long last,” says the keeper of the flame for the “Classic” school of economists, “the great global bear market in stocks has arrived…and just [as in 1929] the consensus wants to believe that it is a mere correction, even a healthy correction.”
The two key questions, according to Dr. Richebacher, are “the potential magnitude of the decline in stocks prices… [and] the potential repercussions on currencies and economies around the world, primarily…on the dollar and the U.S. economy.”
Those questions may turn out to be premature. The dollar rose yesterday. If, as many think, the euro’s rally of the last couple of weeks is already over, the correction may be finished. (Though I doubt it.)
But Dr. Richebacher is not trying to predict the future. He is merely trying to understand the present — which, as you will see, implies certain things about what will happen next.
The word “virtual” used to mean “actual” or “real.” But it has come to mean just the opposite.
Dr. Richebacher believes, as I do, that wishful thinking investors, opportunistic entrepreneurs, dreamy philosophers and tech-worshipping futurists have created a “virtual reality” — in which almost every detail of current economic life is misrepresented or misinterpreted to produce a picture that is basically unreal.
Not only that, economists themselves have contributed to the fraud. Failing to understand what causes real economic progress, they cannot detect an imposter. The current “boom” has not created real wealth. It has created virtual wealth. Few people can tell the difference.
Webster’s defines virtual as “existing in effect or essence though not formally recognized or admitted.”
That is the problem; the wealth isn’t really there. And since it isn’t really there, sooner or later the emptiness will be exposed.
“Classical economics” was the third revolution in the field — after the Mercantilists of the 17th century and the Physiocrats a bit later. “For the Classics,” writes Dr. Richebacher, “healthy economic growth inherently implied investment-led growth…”
At first glance, the New Era economy seems to have had a lot of investment-led growth. Huge amounts of money have poured into the investment markets. At the venture capital level, money flowed like champagne at Ascot. Someone would fill your glass as soon as it was emptied. But, like everything else about the New Era, it turns out that the investment has been virtual, rather than real.
“What critically matters for long-term economic growth,” continues Dr. Richebacher, “is the net increase in the capital stock after depreciation…and that is growing rather moderately.” Also, “it has to be taken into account that net investment spending in the 1980s had…collapsed. The gains in the 1990s therefore reflect a rise out of a deep hole.”
According to the Classics and Dr. Richebacher, real investment must come from real savings. “Any credit expansion, uncompensated by savings,” writes Dr. Richebacher, “is in essence of inflationary nature…”
Capital is the result of savings. You cannot create capital out of thin air. Otherwise, a country such as Tibet would be the richest country in the world — they have plenty of thin air. Virtual capital is like a virtual coat; it may look good on paper, but it won’t keep you warm.
Credit looks like real money. At the micro level, you can’t tell it from the real thing. It provides the illusion of capital and the illusion of wealth. If you can borrow enough money — you can be virtually rich.
As I’ve pointed out here several times, the illusion of wealth causes people to change their behavior, at the margin. They believe they have more wealth than they really do. They cannot distinguish between what is real and what is virtual. But believing they have more than they need, they spend some of it. And when they buy a new coat, though, they buy a real one, not a virtual one. Real wealth is consumed.
Savings have been neither virtual nor real. They barely exist — even in our imaginations. So, the virtual wealth produced in the last five years has been almost all built upon credit. That is to say, they have been of an inflationary nature. But since the inflation has been in the price of shares — who was going to complain?
The Internet itself, as suggested by Professor Gordon, is a virtual revolution, not a real one. It represents an advanced evolution of the telecommunications revolution that began in the 1800s, not a “first order” innovation.
Likewise, corporate profits tend to be virtual rather than real. While brokers and naive investors share the “whisper numbers” in advance of an announcement — and get excited when earnings come in at a penny more than the forecast — corporate profits, generally, have been disappointing. Profits have been going down since 1997.
A chart of profit margins shows that profits rose from ’91 until late in ’97. Why did they decline since then? Even there, the failure can be traced to the difference between the virtual and the real…
But perhaps I should leave that for tomorrow…and tell you why the U.S. corporate model failed…and what it means for the future of stock prices.
Paris, France June 22, 2000
*** The summer rally continued yesterday — on the first day of summer. The Dow managed to climb a few points yesterday — up 62. The Nasdaq did, too — up 50 points.
*** Will the rally continue? Well, it doesn’t look good for the bulls. For even while the averages rose, the broad market seemed to be going in another direction. Only 1,255 stocks on the NYSE advanced while 1,598 declined.
*** Reversing the trend of the last couple of weeks, 55 stocks hit new highs while 75 hit new lows.
*** What’s more, oil rose to about $33. Even if you order something on the Internet, it still has to be delivered. And it is typically brought to your house or office in a truck — which runs not on electrons, but on good old fossil fuel.
*** This is, as I opined yesterday, probably the last summer of such consumer and investor euphoria for many years. People will want to take advantage of it — getting in their huge land barges and driving somewhere. Demand for gasoline will be high.
*** This thought must be worrying transportation stocks – – they are breaking down. In fact, many of the big names in American business are down 30% to 50% — companies such as GM and Ford…builders, airlines, retailers.
*** Meanwhile, a few big tech stocks in the Nasdaq continue to give the impression that this is a healthy market. “The correlation between the Nasdaq and the Dow Jones Average, which is more representative of the “Old Economy,'” wrote Marc Faber in April, “has never been as low as at present.”
*** Marc pointed out that the divergence between the hot sector and the rest of the market tends to peak out just before the entire market goes down. “Thus over the last 18 months [remember, this was written in April], the Nasdaq 100 has outperformed the S&P 500 by more than 150%. In the early 1970s, however, the `nifty fifty’ outperformed the S&P 500 by only 40% in the 18 months preceding their peak. For oil stocks in 1980, the outperformance was 70%.”
*** “If you don’t at least own AngloGold (AU: NYSE), you’re making a big mistake,” says Real Asset Investor Dan Ferris. “Last time the current account deficit was like this was in the mid-`80s, when gold went from $284 to $500, and the dollar lost more than 50% against the yen and the D-mark.
*** Warren Buffett is sticking with his methods. He bought Justin Industries, maker of building materials and boots, for $600 million in cash. I own a pair of Chippewa boots, bought from L.L.Bean, but made by Justin. They are so well made, it looks as though they will last a lot longer than I will.
*** Professor Gordon, mentioned here yesterday, studied U.S. productivity figures from a slightly different angle. He found that if there has been any increase in productivity at all — it is only in the Information Technology sector. (I have pointed out several times that the figures for productivity in this sector have been corrupted.) In the rest of the economy, that is…the other 88% of it, productivity growth has been “negligible.”
*** Parisians got up late and went to work with tired eyes today. Few people slept well. Paris must have been the noisiest, liveliest city in the world last night as the Fete de la Musique, the only successful innovation of Mitterand’s socialist government, got under way. There must have been hundreds of bands performing. There were rock bands on nearly every corner of the Latin Quarter. People filled the streets. Bongo drummers bongoed until morning. Dancers strutted their stuff and swayed in the streets.
*** Jules, 12, is a film fan. His idea of “quality time” with his dad is going to see an action movie together. So we went to see “Gladiator” last night after work. I enjoyed the film — especially the battle scenes; it did not seem nearly as dumb as most of the movies Jules watches.
*** After the movie, we found the streets jammed and people jamming. One band sounded as though they had never met each other before last night — and a few still needed an introduction to their instruments.
*** We walked down the middle of the boulevard St. Germain, enjoying the energy, the crowds and the enthusiasm of the music lovers, if not the music itself. Then we turned up the Rue Babylone. Here we found the street blocked by police. But a helpful woman explained that there was a special invitation-only party in the Matignon Palace garden — roughly equivalent to the White House in Washington. She passed along her invitation and Jules and I went in.
The garden was beautiful. Paris has a lot of these private “hotel particulier” gardens, hidden behind stone walls. But this one was stunning. Twin alleys of boxed- shaped linden trees formed a broad walkway up to an improvised stage. There a crowd listened to a very professional pop group, whose music and costumes were execrable.
Just as we were getting ready to leave, Jules grabbed my arm:
“There’s Jospin,” he said, pointing off to the right.
Jules recognized the Prime Minister of France not just from photos. His friend Xavier’s father plays some role in the government and got both boys close enough to shake hands with Jospin and France’s President Chirac, during the Armistice Day celebrations in November.
Most countries are far more relaxed and civilized than America in the manner in which they protect their leaders. In the United States a president is treated as if he were a Roman Emperor. Large phalanxes of praetorian guards with wires coming out of their ears, each one of them prepared to jump in front of a bullet, try to keep the chief executive from harm.
Few people want to see a man killed, but of all the men who might be killed, a president seems like one of the most dispensable. There are plenty of others who will take the job. And at least as many people would probably be delighted as aggrieved.
I walked over to Jospin and extended my hand.
“Bonsoir,” I said.
“Bonsoir,” he replied.
I thought about offering him some advice…
“Let’s get going,” said Jules.
*** One of the most interesting bands was on display down near La Motte-Picquet. It was a rock band with a hard edge. It caught my eye because there were several men dancing in front of it — each one shirtless and in jeans.
They were big men…many had beer bellies and most had tattoos. And they danced in a strange way. Instead of swaying and hopping like the dancers down on the boulevard St. German, they roamed around bumping into each other and engaging in mock combat. They seemed to know the songs too — and raised their fists to yell out the key lines. These men, I believe, were France’s answer to the yobs, skinheads and soccer hooligans for which England has become famous.
*** Agence France Presse reports, smugly, that France has the best health rating in the world — according to a study done by the World Health Organization. Living in France, rather than America, I am likely to live 4.5 years longer.
*** But the big story today is that researchers will hold a press conference and announce that they have found water on Mars. I have no further details. I’ll get interested when they discover a good vintage wine.