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The Curse of Lawrence of Arabia
The Daily Reckoning
New Orleans, Louisiana
Friday, 8 November 2002
-----------------------
*** The unkindest cut of all? Fed cuts rates...investors
sell...
*** What will Yardeni say next? We watch carefully, so we
can do the opposite...
*** Gold up, dollar down. Outright deflation in goods. My
two daughters, and more!
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-----------------------
The unkindest cut?
The Dow fell 2% yesterday - 184 points, as investors began
to wonder if analysts looked around for a reason and if
the 12th Fed rate cut would do more good than the 11
before it.
The Fed began cutting rates nearly 2 years ago. After the
first one, we recall economist Ed Yardeni saying something
like: 'Don't worry. If this doesn't work, the Fed still
has 600 basis points to go.'
Yardeni was famous for two remarkably wrong ideas. It was
he who had made the Y2K scare respectable, encouraging the
Fed to make additional liquidity available, just in case.
It was he, too, who had thought he had discovered a new
race of human beings at the end of the '90s - digital man,
the guy who 'got it.' What he actually discovered, it
turned out, was the old race of homo sapien ignorantus,
who thought himself a genius after a quarter-century bull
market.
Digital man seemed to go extinct only months after Yardeni
discovered him - after the crash of the Nasdaq. And the
Y2K problem was, of course, a total flop.
We guessed that Yardeni would be wrong about rate cuts,
too. At the time, the Fed funds rate stood at 6%, and the
savings rate was near zero. 'Before this is over,' we
think we remember writing, the Fed funds rate will be at
zero and the savings rate will be at 6%.
Both are getting close.
Why would Yardeni think rate cuts would work? Because they
have always worked in the past, he would answer.
He may not have looked back far enough. As Alan Greenspan
noted, you'd have to look in 'dusty old history books' to
find a period similar to our own. Of course, neither
Yardeni nor the Fed chairman would want to do that.
In the present downturn, unlike the typical post-WWII
slump, there has been no shortage of credit or confidence.
Au contraire, there's been too much.
"Home lending explosion has created more than just a
record number of McMansions," reports a Dow Jones
newswire. "There are also record numbers of homeowners now
in bankruptcy protection."
Chapter 13 has become required reading for many Americans,
thanks largely to the encouragement of Alan Greenspan and
the credit industry. Mortgage debt has risen 50% in the
last 4 years, to $5.7 trillion. The number of people
asking for Chapter 13 protection is rising at an 8% annual
rate.
"I think we're seeing only the front end of the wave,"
says Elizabeth Warren, a Harvard professor who specializes
in consumer bankruptcy. One out of every 5 homeowners has
refinanced his home in the last 12 months.
The nice thing about Chapter 13 is that it allows you to
hold onto your home; you have to promise to catch up on
your payments, but you can take years to do so.
Mortgage lenders say that refinancers use the money to pay
down other debt. But fewer than one in three of them did
so in the last year. Meanwhile, revolving debt has risen
5% per year for the last 5 years.
Job losses, bankruptcies, less overtime, falling prices -
all were beginning to have a sobering effect on the U.S.
consumer, we thought. But along comes Alan Greenspan on
Tuesday, like a man coming to an AA meeting with a bottle
of whiskey under his arm.
Another rate cut will allow the biggest, longest-lasting,
and most reckless lending spree to continue a while
longer, he hopes...at least until his term is over.
We're not sure. Auto sales are dropping fast. Usually, at
this stage in the business cycle, consumers have 'pent up
demand' for items such as cars and houses. Then, a rate
cut can push them towards making the purchase. But after
getting used to zero-percent financing, even 1.25% looks
like up.
More credit may or may not be what the American consumer
wants. But thrift is what he needs. Sooner or later, we
keep saying, he'll have to realize it. When that happens,
even Mr. Greenspan's 80-proof will not prevent the economy
and stock market from going where they are destined to go.
In the meantime, we're enjoying the show. Like watching a
drunk make his way over the ice, we're just waiting to see
how he falls.
Dan Denning is back again today, with more market news for
you...
----------
Dan Denning, reporting from Paris...
- "Is that 15 zeros or 18 zeros?" Françoise asked me. "I
have no idea," I said, "But it's a lot of money." The rest
of the office briefly joined me in figuring out just how
much a quadrillion is. The confusion was prompted by a
headline from The Daily Yomiuri, "Asset Deflation Costs
1.16 Quadrillion Yen." I haven't used the word quadrillion
since making a bet on the playground in 3rd grade. And I
was only joking then.
- It's no joke in Japan. The article referred to a white
paper released by the government. The paper concludes that
the total value of the country's assets - including land
and stocks - has declined by 1.16 quadrillion yen since
the bursting of the bubble in 1990. The consensus here in
the French office is that a quadrillion is a thousand
trillion, or 18 zeros.
- The destruction of a nation's wealth is surely no
laughing matter. And using a funny-sounding term to
describe the total collapse of an economic system doesn't
begin to do justice to the scope of the damage. One thing
is for sure: that kind of asset destruction could never
happen in America.
- Or could it? Just this morning I spoke with Dr. Kurt
Richebächer on the phone. Dr. Richebächer is our resident
Austrian economist - he identifies the excesses of credit
markets and their effects on asset values. He's been busy
the last 10 years. He told me he'll be making a trip to
New York City later this month to visit with his old
friends Paul Volcker and Henry Kaufman.
- The old school of inflation fighters know Dr.
Richebächer pretty well. But the new school of would-be
inflation igniters has no idea how bad things are going to
get, especially for the dollar. Dr. Richebächer, who's
working on a book about the U.S. asset bubble, told me,
"you have no idea how bad it's going to get, my dear."
"Hasn't it already been pretty bad?" I replied, referring
to the $9 trillion in stock market wealth wiped out. "Yes,
my dear, yes. But not as bad as it's going to get."
See: The Impending Profit Disaster
http://www.agora-inc.com/reports/RCH/TodaysProfit/
- For its part, the market is paying no heed to Dr.
Richebächer's dire warnings. But already Wednesday's rate
cut is losing its potency. Used to be you could throw a
rate cut in the middle of a room full of stock traders and
you'd get a party that would make even Dennis Kozlowski
blush. But now, some investors are complaining about the
rate cuts.
- As we noted in this space yesterday, rate cuts punish
savers by reducing the yield on cash savings to near zero
- and sometimes below zero after a firm's management fees
are included. A negative rate of return is a powerful
incentive to get out of cash and into something
else...something like...say...stocks. Perhaps that's what
the Fed had in mind all along. Pushing that $2 trillion in
the money market off the sidelines and into the stock
market game.
- But is the Fed fighting a losing battle with investors?
After all, even a 1% gain is better than losing 12% a
year. That's right, even after October's bear-killing
rally, the Dow is down 12% for the year. And even with
October's rally, Merrill Lynch reports that mutual fund
investors took $20 billion out of stocks for the month.
That makes it five straight months of net outflows
(redemptions exceeding new money). Altogether, some 3.3%
of total mutual fund assets that were under management in
May have now left the playing field. Will a rate cut
reverse this kind of defeatism?
- Or will it just make things worse, and show how
ineffective the Fed is at igniting stock market rallies?
If anything, the Fed may ignite a bear market in the
dollar. Instead of making dollar-denominated assets more
attractive, the Fed is lowering the yield on the dollar.
Michael Derks, a strategist at the Commonwealth Bank of
Australia in London, says: "It seems as though the dollar
is responding to interest rate differential arguments
rather than interpreting the Fed's move as bold and
stimulatory for the economy."
- He was referring to the fact the European Central Bank,
unlike it's Fed counterparts, did NOT cut rates. And by
holding the line, they make euro-denominated assets more
attractive. For example, fixed-income investors on three-
month euro deposits now get a yield 1.63% higher than
dollar-burdened investors.
Even if the dollar loses value in big chunks, it's still a
long way from $9 trillion to $1.16 quadrillion. But maybe
not as long as you think.
---------
Back in New Orleans...
*** GU-DD. The price of gold rose yesterday. The dollar
fell. Mark the trend. The dollar is now worth less than
the euro, but not as much less as we think it will be.
*** And guess what? Prices are falling. The latest chain-
weighted Fed numbers show that the prices of goods are in
outright deflation - they fell 0.8% in the last quarter.
Only services, still rising at 1.8% per year, keep the
overall inflation rate positive. But even in services, the
inflation rate is falling fast. Like Germany and Japan,
the U.S. could be in deflation soon.
*** The Fed is spooked by these numbers, we think.
Investors will spook too, if not tomorrow...sometime in
the next 10 years.
*** But there is good news, I told the audience at the New
Orleans Investment Conference yesterday. Back in the 60s,
Charles de Gaulle noticed that the U.S. could make the
dollar worth whatever it wanted. At the time, the 'gold
window' at the Fed was still open; a foreign nation could
still step up and ask to have its dollars redeemed for
gold. De Gaulle figured he would rather have gold than
dollars and started a trend.
By 1972, the Fed was alarmed. Gold was rushing out too
fast. So, Nixon 'closed the gold window,' setting off a
boom in the gold market that carried the price of the
metal up 2,000%.
If a government wanted protection against the dollar, they
had to buy gold on the open market - which drove up the
price.
But individual Americans were prohibited from owning gold.
My friend Jim Blanchard, who began this New Orleans
conference, started a "Committee to Legalize Gold." After
a few years, he succeeded.
Which brings us back to the good news. The 'gold window'
at the Fed is still closed. But there is a gold window
open in the market. By the end of the '70s, you could buy
the Dow stocks for about the same price as an ounce of
gold. Gold investors thought they were geniuses. Today, an
ounce of will barely buy 4% of the Dow, and goldbugs -
including your editor - are widely considered idiots.
But a major bear market has a way of turning things
around.
Our advice is the same as de Gaulle's: take advantage of
the gold window while it is still open to you.
*** "My two daughters couldn't be more different," I
explained to a friend yesterday.
Maria, a fashion model, has become very critical and
demanding - like the French. She holds herself up straight
and sometimes seems almost haughty in her bearing, as well
as her conversation..
Sophia, a college student, is much more easygoing. "She is
more American," I said. "She is relaxed, wears blue jeans
and sweat shirts...and is likely to slouch, no matter how
many times I tell her not to."
Maria, the younger girl, is more confident and has her
father wrapped around her little finger.
Sophia is more timid and more independent, much less apt
to turn to her father for advice or money.
"I have a hard time staying in close touch with Sophia," I
told my friend, who knows them both. "We don't seem to
have much in common or much to say to each other when
we're together."
"Yes," he replied, "but she's the one who needs you most."
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------------------------
The Daily Reckoning PRESENTS: The Daily Reckoning takes a
peek behind the curtain at 'The Oil Raj' - a system of
governance originated by the British colonialists, adopted
by the post-WWII conglomerate known as the U.N., and at
the heart of the U.S. case against Iraq. Jack Wheeler
reports...
THE CURSE OF LAWRENCE OF ARABIA
by Jack Wheeler
The most legendary American journalist of the 20th century
was Lowell Thomas. I had the opportunity to meet him in
1978, when we were both guests on The Merv Griffin Show.
Off camera, I asked him, "Do you feel you contributed,
however inadvertently, to the political mess that is the
Middle East today?" He looked at me sharply and asked me
what I meant. "Well, after all," I answered, "it was you
who gave Lawrence's promise to the Hashemites so much
power." His eyes narrowed, and he responded, "That was a
long time ago."
In 1917, Lowell Thomas was a young, ambitious journalist
in search of an interesting story in the lost backwater of
World War I. In Jerusalem, he met a small (5 foot 4)
British Army captain assigned as a liaison officer to
Arabs living in a desert no one had ever heard of. Thomas
saw his chance. His breathless dispatches had the purpose
of creating a myth around the liaison officer who had
begun teaching Arab tribes to blow up Turkish trains
nobody cared about in the desert nobody ever heard of.
The liaison officer's name was T.E. Lawrence, but Lowell
Thomas called him "Lawrence of Arabia." In 1919, Thomas
went on a lecture tour in the United Kingdom and United
States, showing pictures of Lawrence posing in a sheikh's
robes in a London studio, and entranced audiences with
stories about the 'White King of the Arabs.' By the time
the Treaty of Sèvres was negotiated in 1920, with Lawrence
in attendance and the media mob hanging on his every word,
the British felt compelled to keep Lawrence's promise to
the chieftains of an Arab tribe called the Hashemites.
The political structure of the Middle East today is the
result of that promise. The Treaty of Sèvres permitted the
British to seize pieces of the Ottoman Empire, which had
ruled the Middle East for centuries, but joined the
Germans in WWI. Instead of British colonies, the pieces
were called League of Nations 'mandates,' for which the
Brits needed puppet rulers.
One of these 'mandated' areas was the west coast of
Arabia, a desert region called the Hejaz. Lawrence had
promised the chieftains of the Hashem tribe that if they
would join the British against the Turks, they would get
to rule the Hejaz as their own kingdom. Thus the Hashem
patriarch, Hussein Ibn Ali, became the King of the Hejaz.
At Lawrence's insistence, the Brits installed Ali's son
Feisal as ruler of the 'mandate' of Syria, divided the
'mandate' of Palestine in two, and installed Feisal's
brother Abdullah as ruler of the part east of the Jordan
River (the western part eventually became Israel 28 years
later, no thanks to the British).
Lawrence (and Thomas) had bought into the phony claim that
the Hashem tribal leaders were directly descended from
Mohammad himself. The Hashemites claimed that this assumed
mantle of Islamic holiness gave them a right to rule,
without elections, all Arabs everywhere. So the Brits
created the Hashemite Kingdoms of Hejaz, Jordan and Syria.
Except, the chieftain of the Wahhabi tribe from central
Arabia, Abdul Aziz ibn Saud, kicked Ali out of Hejaz, took
it over, and called his entire conquered area Saudi Arabia
- while France claimed Syria was their 'mandate' and
kicked out Feisal.
As a consolation prize, Lawrence insisted the Brits
install Feisal as the ruler of yet another "mandate," that
of Mesopotamia. Created out of three former Ottoman
vilayets (provinces) without any regard to national
coherence, this area was renamed Iraq. The Hashemite
Kingdom of Jordan still exists (the current ruler,
Abdullah II, is the first Abdullah's great-grandson), but
the Hashemite Kingdom of Iraq was erased (with the entire
"royal family," including Feisal's grandson Feisal II,
slaughtered) by a military coup in 1958. Through the help
of Soviet KGB agent Yevgeny Primakov, Saddam Hussein
completed his control over the Iraqi military regime by
1979.
The bottom line to this saga is that Iraq is not a real
country - like, say, Persia (Iran) which has existed for
2,500 years. It is an artificial construct and can only be
held together by force. Iraq and its people have no
history of nor familiarity with democratic institutions.
The three former vilayets of which it is composed still
have no mutual cohesiveness. Mosul in the north is
Kurdish, Basra in the south is Shiite Arab, Baghdad in the
middle is Sunni Arab. The Kurds, Shiites and Sunnis all
hate each other. It takes a Saddam to hold the place
together.
And that's why Saddam has been kept in place and allowed
to ignore all those U.N. Resolutions. A disintegrated Iraq
could easily mean an independent Kurdistan, which the
millions of Kurds in Turkey, Syria and Iran would clamor
to join, splitting apart those three countries. It could
mean an independent Basra, or just an inchoate anarchy,
another Somalia. The fear of these post-Saddam scenarios
is what drives much of the international frenzy against GW
taking Saddam out.
It is to GW's enormous credit that he has the intelligence
to realize that the threat of Saddam's rule vastly
outweighs the threat of its dissolution, and the
determination to eliminate the former. It will be near
impossible, however, to eliminate the latter. Let us hope
that GW accepts this reality and assiduously avoids
desperate attempts to put the Humpty Dumpty of a post-
Saddam Iraq back together.
America's and the world's security must no longer be held
hostage to a promise made by a junior British officer to a
bunch of camel-herders wandering around a lost desert 86
years ago - a promise made important by an ambitious
journalist's romantic froth of promotional puffery,
resulting in incalculably tragic consequences as the Curse
of Lawrence of Arabia.
Regards,
Jack Wheeler,
for the Daily Reckoning
A Real-Life Indiana Jones
Dr. Jack Wheeler climbed the Matterhorn at age 14 and swam
the Hellespont at age 16 (LIFE Magazine 12/12/60). His
Ph.D. in Philosophy from the University of Southern
California led to numerous articles on geo-politics in the
early 1980s, where he informally advised the Reagan
Administration on ending Soviet Communism in Latin America
and Eastern Europe. Wheeler's geo-political
insights inform the investment strategies at Strategic
Investment and Strategic Trader Alert (See:
http://www.agora-inc.com/reports/STA/FindWealth/)
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