Fed economists, like other bureaucrats, may be incompetent supernumeraries. But they are not idle.
They prepare research papers with titles such as "Finding numerical results to large scale economic models using path-following algorithms: a vintage example." Most of these papers may never be read by anyone (not even their authors) – but a recent one was, relatively speaking, a bestseller.
"Preventing Deflation: Lessons from Japan’s Experience in the 1990s," rolled off the Fed’s presses only last month. Had it been published earlier – say, 2 1/2 years ago when the Daily Reckoning first began suggesting that the U.S. seemed to be following Japanese economic trendsetters – it would almost certainly have been as ignored as the other products of Fed publishing.
For, at the time, no one but we, dear reader, believed there could be any lessons in the Japanese experience worthy of learning. The Japanese seemed so hopelessly out of it…unable to do anything right. America, on the other hand, could do no wrong. It was as if the two countries were on opposite sides of the planet.
But that is one of the great charms of this old ball we live on – it turns.
While the U.S. enjoyed such a bright sunny boom it misled an entire generation…Japan suffered a dark 12- year long night of bear market, recessions, bankruptcies, and deflation.
It seemed impossible that Japan’s somber comedy might someday come to North America. But then…as the Dow dropped below 8,000…Worldcom went belly up…and durable goods orders fell by 3.8% in June…all of a sudden, in the words of a Credit Suisse First Boston bond market strategist, "everyone’s talking about the Fed’s deflation paper…You’re starting to see a lot of people talk about Japan and comparing it to here."
"How bad could it get?" asks a CNNMoney headline. "Think Japan" it answers.
Most investors, economists, and kibitzers still believe that the U.S. economy is on the mend…and that stocks will soon correct what they see as a "disconnect."
"The current stock market decline is unprecedented at this stage of the business cycle," explains William C. Dudley, writing in Barron’s. "In all other business cycles since 1945, stocks rose sharply during the 12 months surrounding the end of the recession. The worst previous performance was a 20% jump in the S&P 500."
So far, the recession, recovery and stock market have followed post-war examples in no respect. The recession failed to correct much of anything – except business investment…leaving the recovery with little to recover from. By the recession’s end, stocks were still high…and consumers were still spending money they didn’t have.
And now the stock market. It should be going up. Instead, Dudley says it’s 38% below the worst ever post- war example…and still seems to be going down.
The figures have been as strange and unappealing as the geriatric prostitutes of the rue Lombard. Perhaps there was once a day when we could have gotten excited about them…but that day is long gone. Now they are just too fugly. So, instead, we turn for entertainment to what might be the most popular Fed paper ever written…and wonder: what will the very same economists who foresaw neither Japan’s troubles nor our own come up with? And, will America’s central bankers be able to do what their counterparts in Japan could not?
Alan Greenspan is still a hero of the Information Revolution, we noted a few days ago. By contrast, Yasushi Mieno, 26th governor of the Bank of Japan, is just another central banker…one whose bad luck was only that it was his own little derriere in the first chair at the Bank of Japan, presiding over the world’s second largest economy during its largest ever decline. Greenspan is still regarded as one of the men who "saved the world" after the crisis of ’98. Mieno is widely viewed as one who nearly destroyed it…at least, that is the implication of the Fed’s research paper…and the widely-held view of American economists.
"If there is one thing we’ve learned from Japan’s experience," wrote Paul Krugman in the NY TIMES, "it is that when you face the risk of a deflationary trap…it makes no sense to save your ammunition."
Mieno fired away in the early ’90s. Like Greenspan, he cut rates…eventually, down to nearly zero. But that he might have shot off more…faster…is the criticism implied by the Fed economists. Mieno is accused of being too timid in destroying his own currency…a mistake, we bet, that Greenspan will not repeat.
"We draw the general lesson from Japan’s experience," conclude the Fed economists, "that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus – both monetary and fiscal – should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity."
Fire away! Inflation can be dealt with later. Deflation, on the other hand, has no known central bank cure.
Greenspan’s sleep, we would guess, must be disturbed from time to time by thoughts of "turning Japanese." The mainstream press has taken up the idea…and his staff economists are offering solutions. He will, no doubt, do what he always does – make more money and credit available. Instead of raising rates, as was forecast 3 months ago, he is more likely to cut them…
But even that must worry him. There may be no point in holding back ammunition…but what if he already lacks the firepower to blast away the approach of deflation? People are getting older…they are deeply in debt… stocks are still overpriced – what can he do? Can he stop the world from turning?
And if he cuts rates again…and still nothing happens…? What then?
What became of Mieno, he must ask himself?
Your correspondent…signing off for the week…
July 26, 2002
Were it not for the wonders of today’s labor-saving devices…you would have more notes today, dear reader.
But we are having technical difficulties this morning…
Nevertheless, we note that the whole world seems to be sitting on the edge of its chair…hoping the bear market is over.
"Have stocks finally hit bottom?" asks a WSJ headline.
On the editorial page, Professor Jeremy Siegel gives an answer:
At these levels, says he, "the market looks very inviting."
Four times since this bear market began, big rallies have encouraged investors to believe the worst was over.
March 16, 2000 – Dow up 499 points April 5, 2001 – up 402 April 18, 2001 – up 399 and then July 24, 2002 – up 488
Each time investors thought they had found the bottom. And each turned out to be just another good time to sell out. Will this latest rally be any different?
We don’t think so. Because stocks are still expensive by every measure but one; they are cheaper than they used to be. But P/Es on the S&P today are around 30. Even at the top of the bubble market of ’29 they were only 26.
What kind of a bottom is this?
"Problems are not going away any time soon," writes John Crudele in the N.Y. Post. What problems?
Too little savings…and too much debt. And too many bad investments and bad loans made over the last 10 years. And, of course, equities that are still too high.
And one more thing…the consumer economy is giving way to an economy dominated by grey-haired old coots who won’t even buy a subway ticket without a senior discount.
The segment of the population aged 35-54 hit its peak last year, reports Dismal.com, rather ominously. These people – who are society’s big spenders – made up 44% of the population last year. From here on…it’s downhill.
The boom is over, we think. Get over it.
Eric, what do you think?
Eric Fry, reporting from Manhattan:
– The chip sector made it pretty tough for the stock market to score back-to-back victories yesterday. A dire capital-spending forecast from Taiwan Semiconductor snuffed out the tech sector’s latest mini-rally, which in turn snuffed out the Nasdaq’s latest mini-rally and weighed down the rest of the stock market. Heaping injury upon injury, AOL tumbled 15% on news that the SEC had launched a "fact-finding" investigation into the way that America Online books certain advertising transactions.
– The Nasdaq erased nearly all of Wednesday’s 61-point gain by falling 50 points, or 3.9%, to 1,240. The Dow dipped a mere 5 points to 8,186.
– It’s an old story in the tech sector, but sad just the same; without capital spending and/or corporate demand for technology equipment, the tech industry will remain mired in a slump indefinitely.
– By now, even the most ardent bulls on Wall Street have learned to steer clear of the tech sector. Most investors prefer to gingerly step over the bloodied and grotesquely disfigured tech stocks, rather than to embrace them.
– Why bother, it’s frightening enough to buy a stock these days – any stock – without buying a tech stock. we are in one of those wonderfully torturous kinds of markets in which any move that one makes feels simultaneously like a good idea and a bad idea. The market is so volatile that a "good buy" at 10:00 AM can look like an idiotic buy by 11:00 AM. "Buyer’s and seller’s remorse, in one and the same transaction," as Jim Grant said to me yesterday.
– Meanwhile, out on Main Street, there is neither buyer’s nor seller’s remorse…just remorse. That’s because there’s a scarcity of transactions taking place in the economy. There’s simply not much buying or selling to feel remorseful about.
– Existing homes sales skidded 11.7% in June. Meanwhile, durable goods fell 3.8% last month, and orders for core capital goods dropped 5.2%. Without sales, profits are awfully hard to come by.
– It’s fun to talk about "the market." But the market is never exactly one thing, especially at extremes. For example, we all know that the Nasdaq has collapsed more than 70% from its peak and that the Dow and S&P have also tumbled a goodly amount. And yet, despite the horrific performance of these high-profile indices, a few low-profile pockets of the US stock market have managed to gain some ground.
– Small cap value stocks, for example, soared to new all-time highs earlier this year, before heading south in recent months like their large-cap counterparts. Even so, many small-cap value funds show a positive performance since the Nasdaq peaked in March of 2000.
– Now we find ourselves at the opposite extreme. The stock market has been falling for quite a while and everyone is searching for "the bottom" – that certain, final bear market low. Most investors are wondering when, if ever, it will be safe to re-enter the market… First, the bad news: it may not be safe to re-enter "the market" for several years, or several percentage points to the downside, whichever comes first. Based on the indices, the final low may yet be months or years away. Now the good news: many individual stocks have probably hit their final bear market lows already.
– It is interesting to note, for example that the shares of Japan’s Toyota Motor Corp. and the Nikkei Index both hit their bull market peaks in late 1989. Both stocks declined over the ensuing two years. But in March of 1992, a funny thing happened. Toyota shares hit their ultimate bear market low, and the auto company’s shares gained 140% over the ensuing decade. But the Nikkei Index has not been so fortunate. It has continued to fall another 45% since March of 1992.
– The US market will likely remain a very tough place to make a buck for the next several years. But one thing is becoming very clear: value is cropping up once again. After several fallow years, the green shoots of value are sprouting on Wall Street. A bumper crop of value it is not, but there may be at least a garden-sized plot of attractive stocks.
Back in Paris….
*** Well, actually, we’re not in Paris. We’re out in the country getting ready for a group of Daily Reckoning readers who are coming for the weekend.
*** It will be interesting to hear what they have to say….
*** These poor, dear readers will also have to listen to our very own Ouzilly Band, which is back with a couple new numbers this year, despite popular demand…
*** More to come, on Monday…