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Espousal of the Fattest
The Daily Reckoning
London, England
Wednesday, 11 December 2002
--------------------
*** Poor Cherie Blair...
*** Stocks up, gold down...Pigs fly over Broad and Wall...
*** Markets head to disorder...the dollar too...smartest
readers in the world...who says reindeer can't fly?
--------------------
All we can tell from The Times of London is that the Dow went
up and the price of gold went down yesterday. So, we leave
the rest of the financial reporting to Eric today and move on
to more serious matters.
"I am sorry," says the front page headline in The Times,
hanging over a large picture of the Prime Minister's wife
like a prison sentence.
We searched high and low in the paper to try to find out what
Cherie Blair was so sorry about. She is no "Superwoman," she
admitted. Permitting itself an opinion in prime time news
space, it was the "tortured cry of career mothers
everywhere," continued the headline.
Career woman, lawyer, mother, Prime Minister's wife...Cherie
was "juggling a lot of balls," the paper explained. Was it
any wonder she let one or two drop?
"Sometimes I feel I'd like to crawl away and hide," Ms. Blair
continued. Yet, after several pages of newsprint, we were
still not sure what ball the woman dropped.
The poor woman is "crumbling down..." She had to delay her
press conference by 40 minutes for "fear of cracking up."
All of Britain now knows how she feels. And how the press
have made her life difficult and how tough it is for a modern
woman to 'have it all,' - career, family, friends,
investments, politics. All now know, for example, that Cherie
is Catholic, has at least a few dodgy friends, including one
'lifestyle advisor' that must have gotten incarcerated on a
bum rap...and that she does exercises to 'release sexual
energy'. But at least, from the Times account, few would be
able to spot Cherie's lost balls unless they tripped over
them.
Your editor thought he saw one. Cherie Blair, he believes, is
one of the first victims of the housing boom. It appears (and
much of this is guesswork) that Blair bought apartments in
Bristol, hoping to take advantage of a bull market in
housing. Her mistake was that she did so in the company of a
man whom the British are trying to deport, for various crimes
and misdemeanors unmentioned in the Times' Wednesday edition.
Asked about it by nosey reporters, she seems to have
forgotten key conversations.
But whatever she did, the Prime Minister's wife said she did
no wrong and pledged not to do it again.
Eric, the financial news, please...
-----------
Eric Fry from New York...
- Once again, pigs flew over Wall Street. What might seem
miraculous out on the farm is a fairly routine event at the
corner of Wall and Broad. Yesterday's porcine aviators
included Lucent Technologies, which flew 8% higher and Nortel
Networks, which soared 19%. Several other stocks also took
flight, as the Dow climbed 101 points to 8,574 and the Nasdaq
gained about 2% to 1,390.
- After so many down days, a "relief rally" was probably
overdue. But we doubt it will provide very much relief, or
for very long. The biggest problem with bear-market rallies
is that there's no good reason for them. So they tend to
disappear from the scene as abruptly as they first appeared.
"2003 could be the year when the earnings forecasts of
analysts might actually - for once - be trustworthy," writes
Barron's Michael Santoli.
- On the other hand, 2003 might turn out to be the fourth
straight year of woefully errant forecasts from the pin-
striped prophets. And wouldn't it be interesting if the
market fell for an unprecedented fourth straight year...But
that could NEVER really happen, could it?
- "Right now," says Santoli, "the consensus view from
analysts of 2003 operating profits for S&P 500 companies is
about $55, up 14% from this year. That's down from an
expected 17.8% gain as of Oct. 1." Remember that $55
number...It may be a very long time before you see it again,
at least in the same sentence with "operating profits for S&P
500 companies."
- I'm heading off to Nicaragua tomorrow, just to see for
myself what this Central American El Dorado is all about. But
before I go, I thought I'd fire off one more salvo about
inflation...just to be sporting.
- To refresh, I anticipate resurgent inflation, not because I
trust the Fed to "create" it, but because I do not trust the
Fed to prevent it. Currencies degrade. That's just what they
do. And they degrade even faster when central banks are
established to prevent them from degrading.
- To borrow from the Second Law of Thermodynamics: all matter
tends toward greater "entropy" - a.k.a. disorder. And the
forces of monetary entropy have always tended to promote
inflation and to erode the value of paper money. Or as Bill
artfully put it, "Mediocrity is always in style. While we aim
for excellence in cheese and liquor, it is the mean, the
normal, the ordinary that we look for in stocks, business and
politics...we've noticed that that is the way things work."
- So it is with currencies and inflation. The US dollar has
been excellent for far too long. Now the Fed aims to make it
no better than mediocre. We think the Fed will "succeed."
Mediocrity, therefore, is what we should expect. That means a
falling dollar and rising inflation.
- "Despite the Fed's 'guarantee' to prevent deflation, there
is no assurance that they can create substantial inflation,"
Bill Gross reasons. "But a determined Fed and a spendthrift
Congress that may at some point in the next 24 months produce
a $500 billion fiscal deficit are a powerful combination -
the deflationary China card notwithstanding."
- Although some financial markets are starting to "detect" a
whiff of inflation, most are still priced for a deflationary
- or at least, a disinflationary - economy. A 10-year bond
yielding 4.05% does not exactly scream, "Inflation!" If
inflation is returning to any measurable degree, therefore,
bonds are still expensive, the dollar is expensive, gold is
cheap and most other commodities are also cheap.
- In other words, it's not too late to "invest in inflation".
For example, the inflation-phobic investor might trade a few
paper dollars for some of the shiny gold stuff that old-
timers call "real money." Or maybe sell bonds and buy TIPs -
the government's inflation-protected bonds. TIPs would seem
to offer a low-risk way to invest in inflation.
- As Paul Kasriel explained in yesterday's Daily Reckoning:
"The spread between the Treasury note maturing on 2/15/11 and
the inflation-protected Treasury note maturing on 1/15/11is
about 1.45 percentage points. These inflation-protected notes
preserve an investor's return against a rising CPI...Why not
buy the inflation-protected note and short the unprotected
one? Isn't the current spread between the two likely to widen
with inflationistas in control at the Fed?"...Good question.
Hasta luego...
------------
Back in London...
*** "Santa is dead, priest tells horrified children." For
some as yet unexplained reason, the British press loves
stories of naughty and absurd vicars.
"The Rev. Lee Rayfield told children and their parents...that
Santa's reindeer would burst into flames if they went [fast
enough to deliver all the presents on Christmas eve]...
killing [Santa]," says the page 7 Times story.
The vicar is, of course, a fool. Here at the Daily Reckoning,
we rise to Santa's defense as if it were an invitation to a
free drink: if reindeer could resist the law of gravity, dear
reader, why could they not also resist the law of combustion?
*** We get away with nothing. Our readers are too smart for
us:
Hello Editor,
Hugo Stinnes was not Germany's Central Banker in the late
teens and early 1920's. Stinnes was a huge German
industrialist. He owned coal mines, iron mines, steel mills,
shipping lines, hotel chains, even his own bank in Holland,
where he kept money for safe keeping. But in the end, even he
came to grief both physically and financially. He dropped
dead and his entire enterprise built on inflation fell in
ruins.
Reichsbank President was Rudolf Havenstein. As a point of
interest, German universities cut themselves off from
classical economic thinking 50 years before. They developed
what they called the "Historic school" of economics, and this
dominated the universities where all of the economists were
trained. Of course, we now all know that "historism" come
Marxism was a dry gully.
But we have not learned much, as Keynesianism has dominated
Western economic thinking for about 65 years or so. We are
about to learn that it, too, is yet another dry gully.
In the past, U.S. economists have been badly misled by Irving
Fisher in the thirties, and in more recent times,
regretfully, by anti-gold monetarist Milton Friedman.
Only the Austrian school, led by the late Ludwig von Mises
and then F.A. Hayek and a number of Mises' students, has led
the way to economic sanity.
Regards,
Ronald Kitching
Australia
P.S. The Austrian school is now brilliantly coordinated by
the Ludwig von Mises Institute at Auburn University Alabama.
Interested people can learn about them at www.mises.org
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The Daily Reckoning PRESENTS: Austrian school crusader,
Sean Corrigan, on why rate cuts won't salvage the post-bust
economy...on either side of the Atlantic.
ESPOUSAL OF THE FATTEST
by Sean Corrigan
As the matronly European Central Bank hoists up her skirts
to join in the mad whirligig being danced by the Fed and
the Bank of England, I'd like to try to show you how
today's easy money - with interest rates at 40 year lows -
might actually be causing the current problems afflicting
British and American business, not curing them.
To begin with, let me state an assumption: no business -
unless protected by a government-imposed monopoly - has the
power to set its own realized selling price. Instead, the
firm's customers express their own individual sets of
preferences by interacting on the free market. It is the
customers who establish what they are willing to pay for
what the company offers for sale.
In a free market, the most rarefied form of democracy
exists: we all get precisely one vote for each and every
dollar we have at our disposal. If one group of people has
access to more dollars than you, those people will be
outvoting you. They will be outbidding you and possibly
pricing resources out of your grasp - whether these be
directly or indirectly employed labor, raw materials,
unfinished goods, plant and equipment, office or factory
space.
If the extra dollars were earned fairly and squarely on the
market, that's not only your tough luck, it's absolutely
intrinsic to the way the free market functions to improve
everyone's lot in life. It's how successful businesses
accrue the advantages which tend to reinforce their
success; a success which can only be gained in the first
place by satisfying their customers better than all their
competitors could.
But if the extra dollars are derived from sources outside
the market, it's not only unfair, but it risks short-
circuiting the whole positive feedback loop and stultifying
growth in the economy. The negative effect is instantly
recognizable if we are talking about theft, fraud,
protective tariffs, or government subsidies. But what
people don't recognize is it also applies to people who
borrow newly printed money, too. Effectively 'free' money
turns our commercial Survival of the Fittest into a venal
Espousal of the Fattest.
During the bubble years, the people with the extra dollars
were the Tech and Telecom companies, the pass-the-parcel,
Dot.com, Pie-in-the-Sky POs and the bankers and lawyers who
were at the front of the queue when the money spigot was
opened wide. People in genuine, productive businesses were
losing out, except where they could redirect some of their
own output to serve these misjudged, misreported, or plain
misdealing, enterprises in their heyday.
That's how we ended up with 500 million miles of fiber
optic cable laid, but we were short of many drugs and other
forms of medical provision; why we spent billions on unused
3G phone licenses, but ran short of refinery capacity; and
why new power stations proliferated to the point where
there is now perhaps a 30% oversupply, yet basic transport
is as problematic as ever.
When the Bubble finally collapsed under the weight of its
own contradictions, the overcapacity in select industries
was revealed and is now widely understood. But what far too
few people have yet worked out is that bubble era companies
got to 'vote' all those unearned dollars purely because of
a credit boom; a boom that was at best tolerated, and at
worst enthusiastically endorsed, by central banks with
their twisted view of the world. (Thank you, Chairman
Greenspan!)
What, in turn, have the central banks attempted to use as a
remedy for the credit boom in the months since...and why
hasn't it seemed to work?
Well, We, the People, though it has cost us dear, have
taken away the right of the fantasists and fraudsters to
vote with unearned dollars. The structure of the economy,
at least, is no longer so heavily overweight in these
capital intensive, technologically saturated companies. But
what has replaced them? A different batch of people voting
with unearned dollars: the almighty consumers!
Despite record levels of personal debt, the economy now
rests on the hope that consumer spending will be an
effective replacement for the lost bubble dollars...and
that businesses left gasping on life-support can collect
just enough of these extra dollars in their cash registers
to avoid embarrassing their anxious creditors any further
than they must.
Since everyone of us is a consumer - whereas very few of us
worked for, or profited from WorldCom, Enron or Boo! - this
doesn't seem like grand larceny so much as a little
innocuous fiddling with our expenses. Very few consumers,
however, have been taught to worry about the perils of
over-consumption, so the expense fiddling goes unnoticed
and unconsidered...but over-consumption is still
responsible for giving rise to damaging imbalances.
For proof of misplaced investment during the boom, you only
have to look at the gleaming corporate headquarters of
hubris - what a friend of ours calls the 'Edifice
Complex'...or Marconi's share price...or central London
property vacancy rates.
Today, consumers voting with unearned dollars is just as
surely rigging the auction: distorting price-cost
relationships everywhere; driving a wedge between
consumption and production; swamping the honest demand
which can only arise from our taking part in valuable
production; and throwing demand in general so out of kilter
with supply that it sets the economy at war with itself.
Worse, while there remains hope that bubble companies may
accidentally end up justifying their existence, bubble
consumers are like spoilt five-year-olds whose doting
parents keep giving them treats today in return for dubious
promises of better behavior tomorrow. The Tech and Telecom
bubble may have burst, but we consumers are just as surely
putting resources out of the reach of many businesses by
bidding them up beyond the point where they can reasonably
expect to make a profit.
No expectation of profit means no investment and no
expansion into the gaps left by the failed bubble companies
- despite the flood of easy money. That means less income
for workers, suppliers and shareholders. That means we all
become ever more reliant on accessing credit - this time to
maintain the pretence that our material standard of living
hasn't been jeopardized by the boom years.
The demand for credit becomes more and more insistent even
as our creditworthiness spirals lower and lower. And the
hullabaloo we raise about our discomfort? It induces the
central bank to seek novel ways of adding ever more
unearned dollars to the system - even though they were the
root of all the problems.
That's why Easy Money equates to Hard Times...and why we
shouldn't keep mindlessly bleating for the Fed, the Bank of
England or the European Central Bank to continue reducing
rates to ever more artificially depressed levels.
Regards,
Sean Corrigan,
for The Daily Reckoning
P.S. That crafty old pirate William Paterson, inspiration
behind the founding of the Bank of England, came to
understand only too well that being 'the man' who
controlled the creation of the unearned dollars meant he
could reap more benefits for himself than he ever could in
the days when the Jolly Roger flew from his flagstaff. But,
even canny old Cap'n Paterson might not have fully
appreciated that the creation of easy money also does just
as much to disrupt the patterns of honest trade and that
such disturbances leave everybody poorer as a result.
Editor's note: Sean Corrigan is the founder of Capital
Insight, a London-based consultancy firm which provides key
technical analysis of stock, bond and commodities markets
to major US, UK and European banks. Corrigan is a graduate
of Cambridge University and a veteran bond and derivatives
trader from the City. Corrigan serves with distinction as
The Daily Reckoning's 'man-on-the-scene' in London's
financial district.
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