When the Rock Began to Roll
Capitalism and democracy are basically incompatible. Like a glutton and a piece of chocolate cake; one of them never lasts long. At least, that is the burden of today’s message.
The genius of capitalism was described by Adam Smith more than 200 years ag Let a man seek his own advantage; sometimes he will flourish. Sometimes he will flounder. But always, the process of innovation and failure will reward the ‘common good.’
"It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest," is how he put it.
The genius of Reagan and Thatcher was that they allowed capitalism, more or less, to show its stuff. Arthur Laffer doodled the essential insight on a napkin: let people keep more of what they earn…and they’ll earn more. Lowering marginal tax rates would increase gross tax receipts, he prophesied. Ronald Reagan simplified: just "get big guv’mint out of the way," and everything else will take care of itself.
The result was a boom the likes of which the world had never seen.
Barclays Equity Gilt study, which the bank has been publishing for the last 53 years, takes a long view of the performance of British stocks and finds that for nearly 100 years – from 1899 to 1985 – U.K. stocks actually lost investors money. Compared to retail prices, the real return on equities over that entire period was negative. But in the 20 years following, share prices – in real terms – more than doubled.
In America, the capitalists’ stock rose even more. The Dow index went up more than 1,000% from ’82 to 2000.
Nor was this boom confined to the Anglo-Saxon economies. The Russians wised up fast, knocked down the wall, renounced communism and cut tax rates down to a third of the level in Britain. The Chinese kept their government but changed their creed: ‘To get rich is glorious,’ said Deng Shao Ping. The Indians dropped the "license raj" and got down to business. The whole world bustled and boomed.
But into this Eden slithered a serpent. And the snake teased and tempted all who would listen. "Spend…leverage…speculate," he hissed. To the marginal householder he said: don’t be a fool; borrow…buy a bigger house…it will only go up in value. To the marginal lender, he said: don’t bother verifying income or checking financial statements; you can sell the debt to Wall Street. To the speculators, the financial engineers, and the genius banks, hedge funds and investment houses he whispered: make some dodgy loans…go for risky, high yield investments; if you get in trouble, there’s always the government to bail you out.
Capitalism was just doing what it was supposed to do. Success leads to excess…and then to failure. But the juice in the credit system quickly dried up. The British bank, Northern Rock, for example, was worth 5.3 billion pounds last year. At the moment it was nationalized on Sunday, it was worth only 375 million – a loss of 93%. The market in complex derivatives worldwide seized up…in 2008 new issues declined 97% from the year before. Wall Street bonuses fell. Country house prices slipped.
So, it came to pass that investors, bankers, and homeowners had eaten of the forbidden fruit. And suddenly, they looked at each other and realized that they were buck-naked. They should have been ashamed of themselves. Instead, they looked around for a chump.
Then, of course, the financial titans who had showed no interest in sharing their profits and bonuses…became exceptionally generous with their losses. And the captains of their government, too, saw their opportunity when the rock began to roll. Saving Northern Rock would have staggered Sisyphus. But the U.K. government rushed in boldly where angels Richard Branson and the bank’s own management had trod so cautiously.
"It is the right thing to do," said the Chancellor of the Exchequer, Mr. Darling, putting principle ahead of personal safety. "We are acting on behalf of the public," he went on, hinting that taxpayers might even come out ahead, as if the government hacks had outsmarted the speculators and bankers, and would sell Northern Rock back to investors at a profit.
‘Capitalism doesn’t work,’ said the sore losers and whiners. ‘It favors the rich,’ said the envious. "It needs to be controlled," said those who wanted their own fat fingers on the knobs and levers.
Only one candidate for America’s highest office is a friend to capitalism – Dr. Ron Paul. Many people have never heard of him. To the voters, he is incomprehensible. To the press he is invisible. Winning candidates do not favor capitalism for a simple reason. Who benefits from the rough and tumble of real capitalism? Nobody in particular.
Whose company will win the race for better technology? Which hedge fund will bet right on the direction of bond prices? Who will win the contest to make more money? Nobody knows. Particular groups vote for their particular interests now, while the real beneficiaries of capitalism – the unborn, the untested, and the unimagined – don’t vote at all.
The baker, for example, wants his own costs controlled and the bakery across the street put out of business. The factory owner wants the borders sealed against foreign imports. And the working man thinks he should have his job as a matter of right. What they all want is protection from capitalism…from the future…and from the unknown. Everyone wants a softer cushion under his derriere and he’ll vote for the politician who offers it to him most convincingly. And almost every voter wants to stop free markets from doing what they do best: separating fools from their money. Now, at least in the case of Northern Rock, the government will have to do it.
Enjoy your weekend,
The Daily Reckoning
February 22, 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, let’s look at the headlines:
"Manufacturing data add to recession worries," says the Financial Times. The Philadelphia Fed says its index of factory output sank to a 7-year low this month.
Stocks didn’t like the report – the Dow finished down more than 142 points. Oil didn’t like it either…it slid off its all time high. But gold seemed cheered by the news, hitting a new record high above $950. Commodities rejoiced too – with the CRB up to a new all time high of 544.
"Gold nears $1,000 as stagflation fears grow," says another FT headline.
"The fight against inflation is being sacrificed in G7 countries to avert the risk of recession and investors are likely to seek gold as an inflation hedge," said one trader at Nomura Securities, adding that she expects the price of gold to AVERAGE $1,000 this year.
There you have it, dear reader. The world’s leading central banks are more worried about recession than inflation. And investors are betting that they’ll cut rates further to fight it. Lower lending rates…and easier credit conditions, generally…will cause higher levels of inflation.
Until now, central banks could get away with soft money policies, because the Chinese offset increases to the supply of money with massive increases to the supply of labor. Millions of Chinese moved from the farms to the factories – lowering the price of labor worldwide…and with it, prices of consumer products.
But there are many things cheap labor can’t produce – oil, for example. And gold. And copper. And food. Copper is up 22% so far this year. Gold is up 11%. Wheat is off the charts. And oil broke through the $100 barrier just this week.
Inflation has become a worldwide phenomenon. High cost copper…expensive oil…and rich food prices are working their way into the whole global consumer price structure. Inflation in China itself is over 7%…with wages rising more than 10%. Yes, the trend toward lower consumer prices led by China and Wal-Mart seems to have bottomed out.
Now, we’re looking at higher labor costs in China…and higher prices for Chinese exports. Along with higher prices for just about everything else.
Everybody loved inflation when it pushed up their stocks and house prices. But they hate it when it boosts the cost of their bread and taxi fares. Only gold investors like consumer price inflation. Hence, the smart money is wagering that the price of gold will go up…and so is our money!
It almost makes you feel sorry for Ben Bernanke and the other central bankers. They are caught between Scylla and Charybdis…between the cannons of inflation to the right of them…and the big guns of inflation to the left. They enter the valley of death without a prayer and without a clue.
Of course, if they hadn’t been such dumb clucks in the first place, they wouldn’t have gotten themselves into this jam. But, heck, that’s what markets are for…that’s what life is for…to reward virtue and punish error. These fellows challenged the gods – pretending that they could control the markets and the business cycle. Of course, they couldn’t. All they could do was to use the old familiar Keynesian flimflam…print a little extra money so as to trick people into thinking they were wealthier than they really were.
Then, they’ll spend more and invest more. It will look just like a real boom. Over and over again – from the crash of ’87…to the Asian crisis…through the LTCM meltdown…and then the big dotcom crash…followed by the mini-recession of 2001…now the collapse of subprime and the bear market in housing – the Fed reached up its sleeve and slipped out an ace.
The trick may work longer than you expect it to, but not forever. Now, Mr. Market has pulled out his pistol and placed it on the table. He’s watching carefully…if sees that old, tattered ace of spades, there’s gonna be bloodshed.
Consumer prices in the United States are rising at a 4.3% annual rate – almost exactly the same rate at which Richard Nixon declared a state of emergency and imposed price controls. Oil is over $100 and gold is nearing $1,000. If the history of the ’70s replays itself, consumer price increases will hit double-digit levels within a few years…and the price of gold will shoot up over $2,500.
We doubt that it will happen like that. Because the financial situation of the United States – the world’s leading economy – is much worse than it was in the ’70s. By almost any measure you can think of – household debt, government deficits and debt, stock market prices, competitive position, housing prices, trade balance, savings, net assets – the United States is fundamentally (and probably irreversibly) weaker than it was 35 years ago. That could have a surprising effect…pushing the U.S. economy deeper into the ‘stag’ part of the territory…and upping the ante for the inflationists. Deflation could hit so forcefully that price gains never have a chance.
All we know is that, now, the gods are having their revenge. And while it may be painful to investors, homeowners, workers, and just about everyone else, it is nevertheless instructive. And for a mischievous economist – still fun to watch.
"Fed fights to avoid ills of the ’70s," says a headline in the International Herald Tribune. You can guess the story. Inflation on the one hand. Deflation on the other. What’s the poor Fed going to do?
Just about everyone expects it to take the easy way out – to cut rates again in March…try to play the old trick again…and as far as inflation is concerned, well, devil take the hindmost!
But just about everyone also expects the economy to soften in the first half of the year, but somehow improve after mid-summer’s eve. As to the first expectation, we are at one with the majority. As to the second, we are on our own.
*** The United States is now a net importer of food, we read recently. If we understand that correctly, there is no longer enough food Made in the USA to feed Americans’ appetites. Colleague Dan Denning began a nervous discussion on the topic when he sent this article from the Financial Times, with its headline reading: "The next crisis will be over food"
From the article: "…what is really catching the attention of Goldman Sachs (NYSE:GS) now is the outlook for agricultural prices. Or as Jeff Currie, head of commodities research at the US bank, says with disarming cheer: ‘We think we could go into crisis mode in many commodities sectors in the next 12 to 18 months…and I would argue that agriculture is key here."
"Mr. Currie argues…if the world today was a rational economic place, then regions such as the Gulf which are food-constrained ought to be investing heavily in agriculture. And since the US is the world’s biggest agricultural supplier, this implies that the Saudi Arabians, say, should be snapping up farms in Wisconsin – as America secures oil in the most efficient manner by sending teams of Texans to Riyadh.
"But in practice numerous investment controls prevent Saudi Arabians from buying Wisconsin farms and Americans owning Saudi oil wells. And these controls are not being dismantled now. On the contrary, mutual mistrust is now rising. Hence the fact that Gulf leaders are currently considering desalinating sea water to plant wheat in the desert – while the US and Europe are trying to turn corn into fuel.
"Such exercises might make sense in domestic political terms; but they are apt to be fiendishly expensive. Thus the upshot of this misallocation, Mr. Currie would argue, is even more inflation – even if the world does experience some form of growth slowdown.
"Now, for any investor who is long on commodities right now (and I would guess that club includes Goldman Sachs), such trends might seem to smack of good news. For anybody who is dirt poor in the developing world, however, the picture is disastrous.
"But leaving aside this very real human tragedy, what should also be crystal clear for investors is that this is not a picture that points to 21st-century capital markets progress; nor is it likely to breed stability in the medium term. Anyone who thinks this decade’s problems start and end with credit, in other words, may yet receive a rude shock; sadly, we live in a world where soybeans may yet pack as painful a punch as subprime."
"The globalization of the food supply has been great," Dan continues. "3,000 mile chicken Caesar salads, as Jim Kunstler puts it. But just in time, calorie delivery is running straight into more conventional realities…like droughts…floods…and plain old high prices.
"I always thought the French position on retaining the ability to produce your own food was never fully discussed as a strategic choice. It is one thing to outsource your textile industry…or your industrial base…or your supply of oversize sweat pants.
"But outsourcing your supply of food and water…depending on unfriendly or unreliable trading partners to keep sending fresh fruit and poultry…or thinking the global system of trade will forever expand and never again contract…these are all dangerous assumptions that could leave you with an empty national stomach at night."
Our Daily Reckoning suggestion: plant a garden.
*** No absurdity is so great that the editors of TIME magazine don’t report it with admiration. One of the most absurd comments we have heard recently comes in the latest edition, where Deepok Chopra explained why God should be a woman.
"The next stage of human evolution has to be survival of the wisest, not the survival of the fittest. For that we need intuition, compassion and a woman God."
Deepok should take up investing…maybe trading derivatives…a career where hallucination goes unnoticed, if not always unrewarded.
His idea, of course, is the central religious humbug of our era – that man can create God in his own image, not the other way around. If we "need" a caring, nurturing God…well, that’s what we’ll get. A companion notion is that God wants us to be rich (an idea arising, not surprisingly, in an age of Mammon Triumphant). Another comes with the environmental movement – that God favors those who drive hybrid cars.
Good luck with that, Deepok. But we have a sneaky suspicion that you’ll get from God what God wants you to have, regardless of what you want or what you think.
*** A last note, for the week, on gold, from our old friend Lord Rees-Mogg:
"In 1908, good farmland in England was worth about 45 pounds per acre. Similar land would now be worth about 4,500 pounds an acre…On that basis, land has risen by about 100 times…over the last century.
"We can be more precise about gold. In 1908, an ounce of gold was worth four sovereign coins. At the current dollar price of $900, an ounce of gold is worth about 450 pounds, or about 110 times what it was worth a century ago."
As a store of value, gold is not perfect. But it’s a whole lot better than paper.