Wages of Sin

Why worry about money when you have a printing press? As long as there’s paper in the machine, you’ll never run out. Well, as Bill Bonner explains, the problem arises when people forget that with every fiat currency, less is more.

Capitalism is a panacea, after all. It cures symptoms of affluence as well as poverty.

We file this report, coincidentally, from Manchester…where, according to legend, the industrial revolution began. Modern tools, steady money, and fossil fuel were put together, creating so much gas, it lifted mankind out of the mud of the Middle Ages and carried him aloft. Thrifty Scottish economists – notably Adam Smith and Adam Ferguson – saw what was happening and took note of the moral lesson: by foregoing the satisfaction of current consumption, savings could be invested in factories, machines, and new discoveries that increased the output from human labor.

In the same amount of time, thanks to his new tools, a workingman could produce more things. And, soon, the things made him rich. According to MeasuringWealth.com, during the second half of the 18th century, the typical British workingman earned about 60 pounds per year. It took only 4.25 pounds sterling to buy an ounce of gold, so he earned the equivalent of 14 ounces of gold, which is worth about 6,622 pounds sterling at today’s rates. A century later, in 1971, to be exact, his earnings had risen to the equivalent of 49 ounces of gold per year – or about 23,000 pounds sterling at today’s rate.

(Readers who are good at math will already be asking questions. The average wage in Britain today is only 23,177. In terms of gold, wages have gone nowhere for the last 37 years.)

But whatever wonder James Watt and the people of Britain’s industrial heartland wrought, their descendants in America have worked another one; in the midst of the greatest financial and technological boom ever, they have managed to actually reduce the value of their own labor.

Yes, dear reader, this week we turn our weary eyes away from the poor, the weak, and the huddled masses struggling to keep up with the price of rice…and focus on people who are struggling to keep up with their credit card payments. Here is a group of people upon whom nature piled so many blessings, she crushed the wit out of them. And, their wealth is being squeezed out too.

The United States of America has rich farmland, from sea to shining sea. Still, it is a net importer of food. In fact, it is a net importer of practically everything that can be moved. Every day that goes by it receives about $2 billion more of these moveable objects than it sends out in exports.

Prior to the Nixon administration, such an imbalance could not persist for very long; but however much God blessed America – with her purple mountains majesty and her fields of golden grain – was nothing compared to the way she was favored by the post-1971 monetary system.

"As ye plant, so shall ye reap," it saith in the Bible. But in the period from 1997-2007, Americans could reap without planting. They could consume without earning. They could invest without saving, and spend as much as they wanted without running out of money. They were the world’s luckiest people – they had the world’s reserve currency…and access to the whole world’s credit.

The miracle that fundamentally altered the world monetary system happened on August 15, 1971, when Richard Nixon "closed the gold window," at the U.S. Treasury. Before then, every nation’s currency was anchored to gold. Governments settled their imbalances in yellow metal; since each unit of paper currency represented an option on the treasury’s gold, it forced officials to be wary of issuing too many. But after August, 1971, the world’s monetary system upped anchor and sailed with the tide. Now, it all floats on a sea of paper money – and no one knows what’s beneath the dark ocean surface.

The Chinese merchant who sold widgets and geegaws to spendthrift Americans could not use dollars to pay his wages. He needed local currency. So he traded his dollars for yuan. And where did the Central Bank of China get enough yuan to buy up trillions of dollars? It had to create them. All over the planet, as the world’s stock of dollars rose…so did its inventories of local currencies. And then, what could it do with its dollars? Before 1971, it would have presented them to the U.S. Treasury and received one ounce of gold for every 41 paper dollars. In order to protect the nation’s gold, central bankers would have taken away the punch bowl and turned out the lights. Rates would have gone up; foreigners would have been encouraged to hold dollars (rather than exchange them for gold); Americans would have been discouraged from spending dollars – effectively stifling U.S. consumer spending and bringing the current account back into balance.

Then, in 2001, the U.S. financial authorities, led by Alan Greenspan, thought they faced a crisis. They panicked – giving Americans even more credit rope. With nothing to stop it, the supply of cash and credit rose at an even faster rate. And thus it was that Americans wrapped their good fortune around their necks like a noose. Instead of practicing the virtues that had made them rich – saving money, building new factories and learning new skills – they borrowed even more heavily than before.

And now their houses are being foreclosed and their bills are coming due. Worse, the value of their most important asset – their time – is being marked down with the dollar. According to our source, the typical American workingman in the late 19th century was already earning considerably more than an Englishman – 25 ounces of gold per year, rather than 14. He, too, became much richer as the industrial revolution progressed. By 1971, he was earning the equivalent of 82 ounces of gold, worth $76,000 today. But then he forgot his lessons. He stopped saving…his income fell…and his dollar dropped. Adjusting the average hourly wage for consumer price inflation, he earns slightly less today than he did during the Carter administration. Adjusting his wages to the fall of the euro, we find the average American earns less than the average Frenchman. And adjusting his wages to gold and we see he has lost a half century of wage progress. Today, he earns only the equivalent of 40 ounces of gold – or only about $38,000.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

April 18, 2008 — London, England

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now

First, the news headlines:

The Dow went nowhere yesterday. Gold dropped $5. Oil held at just under $115.

There is also a growing realization that the U.S. economy is sinking into recession (about which, more below…)

Yesterday, we organized our thoughts on the economy into a series of 4 points:

1. There’s a whole lot of ‘flation’ going on.

2. The de-flation takes the air out of housing and the financial industry; the in-flation gasses up commodities, gold and oil.

3. Together, they are re-adjusting the U.S. economy (and, to a lesser extent, the United Kingdom and other Anglo-Saxon economies) downward…reducing the value of assets and labor (more about that too…keep reading), but also reducing the value of their debts.

4. This is fine with us…it’s just capitalism at work.

Last night, leaving the office, we walked by a TV studio. The wind was blowing; it was a spring day in London but it could have passed for January in New York. Still, there was a long line of people waiting to get into the studio.

Further down the street was another line – this one a line of bums and down-on-their-luck street people – waiting for a food truck. One was wrapped up in a sleeping bag on the sidewalk…another was shaking his head at no one in particular.

But here at The Daily Reckoning headquarters, we’ve never seen the line we wanted to join. We’d rather go hungry than wait behind others for a sandwich. And as for wanting to see a TV show…we’d have to be crazy.

We only bring it up to remind ourselves that people love lines. In Russia, before they abandoned communism, if people saw a line forming, they’d get in it…figuring that there must be bread or cucumbers, or maybe a list where they could sign up to buy a car, at the other end. In Paris and London, people wait in line to get into nightclubs. And in America, the line of young people trying to get into Harvard, MIT or Johns Hopkins is unbelievably long.

No, dear reader, count us out. But most people do not like being alone. They don’t trust themselves to figure out what they should do. Instead, they look around and see what others are doing…

That is why financial markets tend to move in such broad patterns. People get in line…share the same sentiments…believe the same things – even when those beliefs are far-fetched or absurd. One day they believe that the world is coming to an end…the next, they believe it will never end. In 1999, we recall that President Clinton remarked, "things could be better." Now, if you read the papers, you might think they couldn’t be worse.

Sometimes it is hard to know what people are really thinking. Pollsters have found that they often say one thing – often what they think they should say – while they actually believe the contrary. And poets have figured out that they often don’t know what they think.

This subject matters to us because crowd behavior affects prices. When people think the sky is falling, they don’t want to lend money; why bother, they think they won’t get it back…or won’t be around to enjoy it. Interest rates go up fast. Asset values plummet.

But there’s the paradox: the sky is said to be falling…but investors aren’t running for cover. The S&P is still selling at nearly 20 times earnings. In other words, a person who buys a share is willing to wait 20 years to get paid back out of earnings – if all remains the same. Twenty years is a long time in the stock market. Like dog years, companies measure time in quarters, not years. Only one of the original Dow companies – General Electric (NYSE:GE) – is still on the list. So, a 20-year outlook is fairly optimistic.

Historically, the range of price/earnings ratios varies from about 10 on the low side to 25 on the high side. Anything below 10 is usually a great buying opportunity. Anything above 25 is usually a great selling opportunity. At 20, the market is expensive…but not outrageously so.

What makes us wonder is how stocks could remain so expensive in the face of what appears to be such bad news?

Yesterday, for example, brought more depressing headlines.

"US Economy: Worse than Believed," begins the Washington Post, citing the Fed’s Beige Book report.

"Offering a picture of [the] US economy being squeezed from all directions, the Beige Book, a compilation of anecdotal reports of US business conditions prepared by the US Federal Reserve, showed economic conditions in the US have weakened almost nationwide in the past six weeks."

Manufacturing output is down. Construction is down. Demand is down. Business Week points out that statisticians made it look like consumers were spending more than they actually were – by jiggling health care costs. Handled properly, says BW, consumer spending figures would show a drop since last November.

Out in California, house prices have fallen 26%, adds another piece from Business Week.

Rice hit another record high – amid more grumbles from the sweaty mobs.

Australia is ‘drying up,’ adds the International Herald Tribune.

The art market is "bracing for a bust," says this morning’s news.

Our own MoneyWeek cover story tells us, "Why the credit carnage is far from over."

And even Harley Davidson (NYSE:HOG) has had to announce cutbacks.

What is this world coming too?

Nothing bad, apparently.

Because people are still buying stocks at 20 times earnings. And they are buying Treasury bonds with yields that are scarcely above the level of consumer price inflation. In short, they don’t think the sky is falling at all.

*** Back to our subject…

Herding together may have been a good instinct back in the days when humans evolved…when they were as frequently prey as hunter. But times change, and the old instincts become enemies. In a financial downturn, the instinct to do what everyone else does is definitely no friend.

So we look to see what everyone else is doing…so we can run in the other direction. Are they selling out? Are they dumping houses and stocks? Are they buying gold?

The answer: no.

A poll of Americans shows that most think that now is a good time to buy a house. They believe that a bottom has been reached in the housing bear market – with prices down only about 12% nationwide.

At the end of 2007, when Barron’s asked market strategists to look ahead to 2008, they opined that stocks would rise 4% during the year.

Not one of the 12 market strategists polled by Barron’s said he saw a recession in 2008. Today, more economists expect a recession – many think it is already here – but nearly every one of them believes it will be mild, and will be followed by a rebound in the second half of the year.

And then, there is Ed Yardeni…whom we put in a class by himself. Yardeni, and Abby Joseph Cohen, typically speak for the most credulous part of the crowd – the part that will believe anything. (At the end of the dotcom bubble, for example, it was Yardeni who had taken Y2K hysteria mainstream, predicting a digitally-inspired recession for 2000. It was he, too, who thought he had identified a whole new subspecies of human being – the Digital Man – who understood how the communications revolution had created a New Era…and left the human race divided between those who ‘got it’ and those who, like your editor, suspected the whole thing was a bubble.)

What does Yardeni think of today’s economy? He has crossed over to the "Dark Side," he says. He believes the economy fell into an employment-led recession in February.

But don’t worry about it. "Just because I crossed over to the Dark Side on the near-term economic outlook doesn’t mean I can’t have a Light Side outlook for the stock market… blab, blah, blah…that would put the market up 15% to 20%…by the end of this year."

That’s enough for us. Sell!

And our old friend Marc Faber recalls a similar quotation from R.W. McNeal, a market analyst writing in 1929:

"Some pretty intelligent people are now buying stocks… Unless we are to have a panic – which no one seriously believes – stocks have hit bottom."

The Daily Reckoning