Worse Than 1973
The S&P 500 peaked in January 1973 and five months after the peak was the start of the horrible 1973-1974 bear market. Sound familiar?
When I tell people that the present situation resembles the 1970s, they immediately think of July 1979, when Jimmy Carter gave his famous "malaise" speech on national TV. The stock market had been dead for six years, and blue chip U.S. stocks had price-earnings multiples in the single digits. The CPI was rising at double-digit rates, and interest rates were galloping higher to keep up.
"It’s not that bad," people say today. But I’m not thinking of 1979, I’m thinking of 1973. And it’s true, it’s "not that bad." It’s worse.
Where are we on the dollar devaluation timeline today, compared to the 1970s? In the 1950s and 1960s, the dollar was pegged to gold at $35/oz. In the 1980s and 1990s, the dollar floated, but its value stayed fairly stable around $350/oz. In 1971, the dollar’s link to gold was destroyed, and the dollar devaluation began. In May of 1973, it hit $95/oz for the first time. This roughly equivalent to where we are today, having gone from $350/oz. to about $950/oz. When Jimmy Carter was making his speech, the dollar was in its last great collapse, to a nadir of 1/850th oz. of gold just seven months later. The equivalent today would be a move to $8,500/oz. of gold.
The S&P 500 peaked in January 1973, so mid-May 1973 was about five months after the peak. This was the start of the horrible 1973-1974 bear market. The S&P 500 most recently peaked in October 2007, so mid-March 2008 is about five months after that peak.
However, we seem to have diverged quite a bit from the 1973 script. Arthur Burns, the Fed’s Chairman in 1973, might be nicknamed "Easy Art" today for his efforts to get the economy going again in 1971. His cheap-money, low interest-rate policies started the trend of 1970s devaluation. However, by May 1973, he was already getting nervous. Commodity prices were soaring, and the dollar’s value kept sinking against gold. The economy was roaring. The Fed funds rate ended 1972 around 5.3%, but by May 1973 it was already up to 7.84%. In July 1973, it averaged 10.40%. It was primarily this increase in interest rates – an effort by a hawkish Fed to stop the devaluation trend – that led to the breakdown of the stock market. Combined with the inflation, the economy crumbled soon after.
It is safe to say that the Fed will not be at 10%+ in a couple months. The ECB was recently termed "ultra-hawkish" in the U.K.’s Telegraph newspaper, for a policy of keeping a 4.0% rate unchanged. Today’s breakdown in credit markets, caused by a lending binge that did not exist in the early 1970s, has effectively eliminated any chance of serious inflation-fighting activity.
Ah, the bulls say, but certainly that is a positive, no? The Fed is expected to cut rates further. The two-year U.S. Treasury bill yields less than 2.0%. The deteriorating economy is expected to put a lid on inflation.
But in economics, two wrongs don’t make a right. With Ben Bernanke pouring gasoline on the dollar pyre in an effort to warm up "frozen" debt markets, the inflation in coming years may well exceed that of the 1970s. People may look back on the 11.2% increase in the official CPI in July 1979, from a year earlier, and laugh that such a wimpy figure could be considered "malaise." On top of that, the credit breakdown and housing collapse will do whatever additional damage they have left to do. Most people didn’t even have credit cards in the early 1970s, much less a debit card that makes withdrawals from 401(k) plans.
The Fed’s lower interest rates haven’t helped the situation much. But then, today’s problems were not caused by rates that were too high. Were lower rates ever really the point? The dollar’s slide may not be just an unfortunate side effect, but the real goal of the Fed’s easy policy. You could argue that, today or in the 1930s, a devaluation would have made debts easier to pay back, by inflating workers’ salaries and other prices. Ben Bernanke himself has made this argument, in a coy way. Unfortunately, the Fed is finding that today’s credit-collapse recession is indeed "putting a lid on inflation" – namely a rise in wages – while inflation of household expenses continues unabated. The resulting squeeze on household budgets has made debt service even more unlikely. Whoops!
If there’s a lesson to be learned from the 1970s, it is that even a hawkish Fed and 10%+ interest rates are not a reliable solution to currency decline. Neither Easy Art nor Hawkish Art produced a healthy economy. The real problem, in the 1970s, was that the dollar left its golden anchor. The real problem, today, is that it never went back.
The credit collapse recession is grabbing all the headlines now, but in six years, when Barack Obama appears on TV wearing a sweater, with a new batch of government solutions to the $600/barrel oil price, will we even care? By that time, I think people will be ready to do what should have been done many years ag repeg the dollar to gold. No more of this floating currency, inflation/devaluation, Fed manipulation nonsense.
for The Daily Reckoning
March 06, 2008
Nathan Lewis is the author of Gold: the Once and Future Money, published by Agora Books and J Wiley. He runs an investment fund in New York.
The Dow rose 40 points yesterday.
Remember our hypothesis: that the feds’ inflation will show itself much more prominently in gold and commodity markets than in the stock market…and that deflation will hurt stock and property prices more than it hurts the price of gold.
Yesterday didn’t prove anything. But it provided a nice illustration.
While stocks barely budged…gold, oil, and commodities all hit new record highs.
Gold is now so close to the $1,000 it can feel the body heat. It jumped $22 yesterday to end up over $988. The CRB also hit a world record and the price of oil closed over $104.
While gold, commodities and oil soar, price deflation in the housing market brings millions of Americans closer to sanity. They’re finally realizing that they can’t get rich by spending money they don’t have on things they don’t need.
Bankruptcy filings rose 18% in February. One of the big mortgage lenders, Thornburg (NYSE:TMA), of Santa Fe, New Mexico, defaulted on a $320 million loan. Investors sold the stock. Just a week ago, it was a $12 stock. Now it’s a $3 stock.
Everything is getting ‘marked to meltdown,’ says the Wall Street Journal. Lenders approach a new loan as they might come upon the rim of an active volcano…worried that it might blow up in their faces at any minute. Yields on auction rate financing for municipalities and hospitals have almost doubled. And when the auctions fail, they can really explode. That’s why the Port Authority found itself paying a 20% rate on money it needed.
All of this is tempting the feds to intervene. Look at it from their point of view: if they do nothing and things get worse, they’ll be accused of inaction…or worse, insensitivity. Nothing is worse than inaction. The people curse it. The professionals loathe it. Doing nothing is always and everywhere detested by practically everyone. In marriage, it is grounds for annulment. In business, it is cause for dismissal. And in war it is a ticket to a court martial.
Of course, an economy is never inactive. It is always doing something – as millions and millions of people go about their business as best they can. When the feds ‘do something’ to an economy, it is not as if they were writing on an empty piece of paper. Instead, they are scratching out the verses written by private citizens and replacing them with their own clumsy doggerel…and pushing the economy in some direction it doesn’t want to go. Sometimes they are successful – as, for example, at the beginning of this century, when a torrent of new cash and credit produced the world’s biggest housing bubble. But sometimes, Mr. Market insists on going where he wants to go.
After five rate cuts and one massive tax rebate program, the feds are wondering what to do now. The New York Times reports that Bush and Bernanke are "inching towards" a federal bailout of homeowners. Already, Bernanke has been urging bankers to forgive a portion of their mortgage loans. And Rep. Barney Frank, who wrote in the Financial Times recently that laissez-faire capitalism was all very well…as long as politicians got to tell the capitalists what to do, has proposed that the federal government buy distressed mortgages. George W. Bush, who will go along with anything, is said to be studying the legislation with the sharp eye of a Helen Keller.
A bailout is probably coming. But will it work?
More and more observers seem to be coming to the conclusion we reached – prematurely, it turned out – at the end of the ’90s.
Morgan Stanley’s Stephen Roach:
"The current recession has been set off by the simultaneous bursting of property and credit bubbles. The unwinding of these excesses is likely to exact a lasting toll on both homebuilders and American consumers. Those two economic sectors collectively peaked at 78 percent of gross domestic product, or fully six times the share of the sector that pushed the country into recession seven years ago.
"For asset-dependent, bubble-prone economies, a cyclical recovery – even when assisted by aggressive monetary and fiscal accommodation – isn’t a given. Over the past six years, income-short consumers made up for the weak increases in their paychecks by extracting equity from the housing bubble through cut-rate borrowing that was subsidized by the credit bubble. That game is now over."
Roach goes on to compare America, circa 2008, to Japan at the end of the ’80s. Japan ran loose credit policies in the ’80s, which led to bubbles in stocks and property. America’s loose monetary policies of the ’90s led to a bubble in the stock market…and then an even bigger bubble in housing in the ’00s. Faced with a meltdown in the ’90s, Japanese authorities knew they had to ‘do something’ and they did – they took the recommended doses of both fiscal and monetary policy. But the medicine didn’t work.
"The toughest, and potentially most relevant, lesson to take from Japan’s economy in the 1990s," Roach continues, "was that the interplay between financial and real economic bubbles causes serious damage. An equally lethal interplay between the bursting of housing and credit bubbles is now at work in the United States.
"American authorities, especially Federal Reserve officials, harbor the mistaken belief that swift action can forestall a Japan-like collapse. The greater imperative is to avoid toxic asset bubbles in the first place. Steeped in denial and engulfed by election-year myopia, Washington remains oblivious of the dangers ahead."
We’re not sure they’re oblivious to the dangers; we just doubt that they can do anything to make things better. On the other hand, we don’t doubt that what they will do will make things worse.
*** Listening to Bill Buckley give a speech was a painful experience. It was like watching an old cow give birth. The words came out so slowly…and then you were inevitably disappointed. You expected more. A man who took so long to choose his words ought to come up with something better. But Buckley’s words were always a little slimy.
Still, the pompous tone did its job. The common, naturally-conservative American thought he heard an angel singing…and thought he saw something practically divine in Buckley’s palaver. He had found a nobility he could bend to…a man whose looks, wealth, and education and family rivaled the Kennedy’s.
"For people of my generation, Bill Buckley was pretty much the first intelligent, witty, well-educated conservative one saw on television," said fellow warmonger William Kristol, editor of the Weekly Standard, at the time the show ended. "He legitimized conservatism as an intellectual movement and therefore as a political movement."
This past week saw a downpour of regret at the death of William F. Buckley. It was Buckley, it was said, who revived American conservatism. This is something he certainly did not do. He came not to praise traditional conservatism but to bury it. In its place, he invented something new…or rather, it invented him.
People come to believe what they must believe when they must believe it. When they have a modest republic, they believe in the modest sentiments and simple creed of republican government. When they are citizens of a great empire, on the other hand, they come to see things differently. Always and everywhere, someone takes the lead, expressing the new sentiments better, more persuasively, or perhaps more memorably, than others. William F. Buckley was born into a republic that was fast becoming an empire. President Wilson arrived in Le Havre at the end of WWI. He came neither as a tourist nor a businessman…that is, not as an honest traveler. Instead, he came to sort out the Old World’s problems and brought 17 Points to help do it. The cynical, worldly Europeans laughed at him. Even God needed only 10 commandments, they said. Wilson was so humiliated he had a stroke and never recovered.
To their credit, the American people were slow to put on the imperial purple. The conservatives among them wanted to retain the old form of government, with its limited aims and limited means. Conservatism was a more innocent creed back then. There was no place in it for handing out pills to old people. The idea of trying to remake another country, half way around the world, into an American-style democracy, would not have been scorned; it would have been unimaginable. Back then, of course, there was no homeland. The idea would have made no sense. Americans’ interests stopped at the Rio Grande and the 49th parallel. The foreigners would have to take care of themselves. Even home-grown 100% Americans were expected to look out for their own kith and kin. "Balance the budget, protect the borders, and otherwise leave people alone," was the extent of conservative ambitions.
But the world wouldn’t stand still. After WWI, Americans had largely gone back to minding their own business. But then came the Great Depression; all of a sudden bread was in demand and activism was in style. People wanted the Roosevelt administration to do something. It rose to the challenge…and then some. And then came the Japanese assault on Pearl Harbor and the whole country mobilized, under government direction. To win it.
After the war, there was no going back. America was the leading world power. "Isolationism" became a kind of insult. A few of the old conservatives – such as Frank Chodorov, Robert Taft and Warren Buffett’s father, a US Congressman – kept wearing their old starched collars. But the fashion had clearly changed. They could vote against government spending programs…and they opposed further military adventures abroad… but they couldn’t win national elections and they couldn’t participate in the great fun of having an empire – getting to boss people around all over the world. There was no glory in being a conservative. No power. No money. No style.
Then, with the Cold War, even the old diehards went shopping for new clothes. In their minds, it was a contest between good and evil…freedom and communism…black and white.
Indeed, the Cold War played roughly the same roll as the War on Terror would half a century later – it perverted the old conservative values.
"We are again being told to be afraid," wrote Frank Chodorov. "As it was before the two world wars so it is now; politicians talk in frightening terms, journalists invent scare-lines, and even next-door neighbors are taking up the cry: the enemy is at the city gates; we must gird for battle. In case you don’t know, the enemy this time is the USSR."
Few Americans had even met a communist, but they were certain that if they didn’t go toe to toe with them in places like Korea, Berlin and Vietnam, they’d soon be stealing the family silver in Dubuque. The urbane, witty, charming and cosmopolitan William F. Buckley:
The "invincible aggressiveness of the Soviet Union" imminently threatens the United States, he said. "We have to accept Big Government for the duration – for neither an offensive nor a defensive war can be waged…except through the instrument of a totalitarian bureaucracy within our shores."
And thus was the fabric laid out…cut and sewn…for America’s new conservative outfits. Now, they could fight totalitarians by being totalitarians.
Buckley’s contribution to American political life was that he helped bring conservatives to the levers of imperial power – but at the cost of rejecting everything important they ever believed. Henceforth, conservatives – notably George W. Bush – would be America’s most activist presidents – adding trillions to Americans financial burdens, extending domestic programs, and projecting U.S. military power to places Americans had not even known existed. And henceforth, ‘conservatives’ would distinguish themselves from ‘liberals’ principally on cultural issues – such as whether gay couples could marry, when to pull the plug on a coma victim, and whether it was proper for a Southern state to use elements of the old confederate banner in its state flag.
In the early 50s, Ike Eisenhower, a conservative Republican president of the old school, warned against letting the "military industrial complex," get control of the nation’s agenda. But it was too late. Just as the Great Depression brought the liberals and conservatives together on the domestic agenda…so did the cold war bring them together on military policy. Now, they were all Keynesians at home…and Kennedys overseas…willing to impose any burden on their neighbors…and force the next generation to pay any price…in order to enjoy bread at home and military circuses abroad.
There was even some doubt about the real source of Buckley’s money and support for his money-losing magazine. Rumors said it came directly from the military industrial complex itself – maybe via the CIA…where Buckley had been an agent. But who would bother to look into it? Who was left to oppose the imperial program of big spending in the 50 states…and big spending all over the world? The empire was now a source of power…glory too…and money – trillions of dollars worth of government contracts and giveaway programs.
Bill Buckley merely cut conservatives into the deal.
*** And finally, we leave you with a note from colleague Chris Mayer:
"Arresting fact of the day: Between March 10, 2000 and January 31, 2008, the average annual return from the S&P 500 is 1.52%, according the Financial Times. That’s nearly eight years of earning practically nothing on stocks. After factoring in inflation, the returns are negative.
"Inflation is rearing its ugly head again in a way we’ve not seen since the 1970s. The top story after the first two months of the year must be the commodity price surge. Commodities – things like wheat, gold, oil, metals – are off to their best start in more than half a century.
"The historic global benchmark for commodities, the CRB Spot Index, jumped 12% in February, the highest since July 1974. It’s up 15% for the first two months of the year, its best showing since 1956.
"Still, we have the Federal Reserve chairman saying: ‘I don’t think we’re anywhere near the situation that prevailed in the 1970s.’
"Is he smoking something, or what?
"The American economy is definitely slowing. Whether it is or isn’t actually contracting is a matter of debate. Just looking at how companies are doing, it’s not hard to see that North American operations are off. Overseas, though, it’s a different story. Companies with operations in China or India report that business is good.
"So it’s an interesting market for investors. Sometimes, it’s like picking over a minefield, because the price swings seem so great. But it’s that volatility that creates room for the stock picker to operate."
Chris is looking into a quirky and unappreciated commodity that could pay off big for his Capital & Crisis readers. Stay tuned for that…and in the meantime, be sure and check out his recently released book, Invest Like a Dealmaker: Secrets from a Former Banking Insider.
The Daily Reckoning