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Bubble Aftermath
The Daily Reckoning
Baltimore, Maryland
Wednesday, 13 November 2002
-------------------
*** Smokes go down in flames...second homes go
up...
*** Stocks up a little. Gold up a lot...derivatives, even
more!
*** Australia - the US' greatest ally...the city that
fibs... nightmares, bad dreams...and more...
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Philip Morris is a contrarian's stock. Its main product
is something that nearly everyone seems not to like.
Baltimore used to call itself "the city that reads." Now,
"Welcome to Baltimore," say billboards as you enter the
city, "the city that doesn't smoke." Neither
advertisement is truthful.
When something has gotten so out-of-favor that the city
fathers make a motto out of it, we think, it has to be a
good investment. But yesterday was not a good day for Big
Mo. It fell 14% - on news that sales were slowing. Two
years ago, we liked the company because it was cheap when
others were expensive. Then, we liked it even more as the
rest of the stock market fell and Big Mo actually went
up. Yesterday, it got cheaper even as most stocks went
up. But we liked it just because we like it.
Smoking is not the only bad habit a man can take up. USA
Today reports that homeowners have been taking out about
half the amount of the increase in value of their homes
in 'cash-out' refinancings.
"They're selling their homes one brick at a time," said
Ian McAvity in New Orleans, "and using the money to buy
groceries."
Well, not just groceries, it turns out. The USA Today
article tells us that more and more homeowners are
refinancing their homes in order to buy a second one. The
second home market is even hotter than the market for
primary houses. In California, for example, houses in
vacation areas grew at a 27% annual rate in the last
quarter. Overall, real estate went up by only 16%.
Not only do the buyers think they will enjoy their second
home, they believe they are making a safer investment
than putting their money in stocks. "What will happen
when real estate prices go down?" one was asked.
"The cycle will come back," he replied. "If you weather
the storm for 2 or 3 years, things will work out."
Whatever they are smoking, we wonder to ourselves, it may
not be made by Philip Morris. Houses in Japan have fallen
for the last 10 years - and are now down to just half
what they were at the peak.
Could it happen in the U.S. too? We'll see.
Addison has made his way back to Paris from New
Orleans...he's covering the markets from there.
Addison?
----------
Addison Wiggin, writing in Paris...
- "I hope you're all looking after the $24,240 you are
each responsible for," wrote Sean Corrigan, our London
correspondent yesterday, referring to the $128 trillion
derivatives market. According to a November 8th report
issued by the Bank for International Settlements (BIS),
the central bankers' central bank, we've now managed to
'hedge' the full median income of your average Anglo-
American breadwinner.
- To put things in perspective, that figure is about 16
times the market cap of the entire S&P 500.
- The BIS report specifically indicates a sharp 37% rise
in gold futures over the past year...to $279 billion; a
number that is roughly equivalent to the current market
value of 27,000 tons of the metal itself. At this rate,
it'll only be a few months before every ounce of the
world's above ground gold reserves (c. 29,000 tons) are
covered against any "evil speculative price
fluctuations."
- "The 'gross market value' [the bit left over after all
the contracts have been cancelled out] of gold
derivatives is some $28 billion," says Corrigan, "which
means the Big Boys in the market could sell the 12-member
Amex Goldbugs index and still come up $3 billion short."
- Isn't it nice to know that your paper money has been so
protected against any change in the value of its hardest,
if most residual, backing?
- Meanwhile, in another room of the casino...following
encouraging words about the prospects of the U.S. economy
from the Fed Vice Chair Roger Ferguson, all the major
U.S. indexes starting selling off early gains. The Dow
gave back about 100 points to close up a measly 27 at
8386. The S&P 500 ended 6 points higher at 882...while
the Nasdaq gained 30 and finished its session at 1349.
- According to USA Today, Vice Chair Ferguson told a
conference in Pittsburgh that "the Fed still has
firepower left should the economy need additional
stimulus." How comforting, really, given the effect of
the last 12 volleys.
- The 'overnight rate' is mighty close to rock bottom at
1.25 percent, but "the central bank has...room to
maneuver should a shock hit the economy." Ferguson added
that one of the biggest risks to recovery is geopolitical
uncertainty, but expressed optimism that the Fed's latest
rate cut would stoke a recovery in the coming year and
called the risk of deflation remote.
- Greenspan speaks before the Joint Economic Committee
today. Perhaps, he'll be even more effective as his No. 2
in talking down the markets.
- We here at the Daily Reckoning have been speculating
for some time that given the deteriorating investment
environment in the US, foreign investors will soon enough
tire of financing local consumption. But if a report in
The Sydney Morning Herald can be believed, U.S. consumers
can do nothing if not count on their staunchest allies to
chip in when called upon.
- "Australian investors are being lured to the U.S. like
moths to a flame," the opening lines of the article read,
"fund managers are picking the worst bear market in 70
years to send record levels of portfolio investment to
the US."
- "Australia's appetite for badly performing U.S. assets
appeared to be unrivalled," says National Australia Bank
strategist Greg McKenna. "Of the first-world investment
market, it does seem we are the only ones who are
continuing with gusto to buy U.S. assets. Australians
have burnt a lot of cash investing in the U.S. over the
past couple of years.
- "Privately, some fund managers and equity strategists
blamed the accelerating push into U.S. markets on the
'tyranny' of asset consultants, who they say are pushing
managers to increase exposure to [U.S.] assets, but
denying them the flexibility to deviate from weighting
indices." (Think those boys were trained on Wall Street?)
- By August 31, the U.S. had received a total of $US482
billion in net portfolio investment inflows, of which
only $65 billion went into equities...the rest financed
government and corporate debt. Now that we've consumed
all of our own savings, doesn't it feel good to be
snacking on our friends' from down under?
- Harvinder Kalirai, an economist for State Street in
Boston, warns: "the 'deteriorating quality' of U.S.
capital inflows would trigger a major US dollar
adjustment...When the dollar falls it's going to be very
rapid." What then, mate?
----------
Back in Baltimore...
*** While stocks went up a little yesterday, gold went up
a lot. December gold rose $3.24.
*** Is the stock market signaling a stronger recovery?
"Tracking the developments in the economy and the
financial markets, both stocks and credit," writes Dr.
Kurt Richebächer, "we see nothing but aggravating
conditions. Renewed drastic weakness of the US economy is
the great shock waiting to happen to the world. A
slumping dollar will turn it into a nightmare."
*** Bad dreams haunt us all, at one time or another.
Last night, coming out of a restaurant in mid-town, a
colleague tripped on a step, fell, hit her face on the
curb, and knocked herself out. Your editor rushed to her
assistance.
"Sit her up," said one helpful passer-by.
"Lay her down," said another.
"We'll take care of this," said the paramedic. "We know
what we're doing."
Your editor spent much of the night in the Johns Hopkins
emergency ward with his colleague. He was surprised by
how young and pretty the nurses and doctors were. Not
enough to make you want to get hit by a truck, he thought
to himself, but something to look forward to if ever you
are.
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------------------------
The Daily Reckoning PRESENTS: The length and severity of
a bust depends partly on the magnitude of the 'real'
maladjustments which developed during the boom...and
partly on aggravating monetary and credit factors. We've
got both in spades.
BUBBLE AFTERMATH
by Kurt Richebächer
"Encouragement of consumption is no benefit to commerce,
for the difficulty lies in supplying the means, not in
stimulating the desire of consumption; and we have seen
that production alone furnishes those means. Thus, it is
the aim of good government to stimulate production, of
bad government to encourage consumption."
Jean-Baptiste Say,
"A Treatise on Political Economy", 1803
Since World War II, all recessions in the United States,
as well as in the rest of the world, had their main cause
in monetary tightening by the central bank, implemented
in response to rising inflation rates. As soon as the
central banks loosened their shackles, economies promptly
took off again.
Also important, the business cycles in America and Europe
never used to coincide and cumulate, but instead used to
follow each other. The fortunate effect of this regular
sequence was that it stabilized the world economy.
Now, for the first time in the whole postwar period, the
U.S. economy has slumped against a backdrop of the most
aggressive rate cuts by the Federal Reserve and the most
rampant money and credit growth ever. Implicitly, the
forces depressing the U.S. economy this time are
radically different from those that fueled past
recessions. It is the goal of this essay to explore and
identify the unusual causes of this economic downturn.
Among these causes, the profit implosion is the most
obvious and also the most important. Essentially, it must
have its own specific causes. Searching for them, we
identified three major profit killers: first, a surging
share of depreciation charges in gross investment;
second, inflexible, record-high interest charges; and
third, the gaping trade deficit.
Widespread hopes of an early rebound in U.S. corporate
earnings are doomed.
But there is another crucial novelty to this economic
downturn: its global synchronization. The problem is that
the global economic upturn of the past few years was
equally synchronized, as economies around the world
adjusted to the roaring U.S. asset and spending bubble.
During 1997-2001, American spending on imported goods and
services exceeded earnings from exports by altogether
$1,428.8 billion. To put this into perspective, U.S. GDP
growth during these four years was $1,055 billion in real
terms and $1,763.8 billion in nominal terms.
It is a familiar postulate of Austrian theory that the
extent of the bust following a boom tends to be rather
proportional to the scope of the excesses and the
adherent economic and financial imbalances that
accumulated during the boom. Gottfried Haberler's
'Prosperity and Depression' (1937) says: "The length and
severity of depressions depend partly on the magnitude of
the 'real' maladjustments which developed during the
preceding boom and partly on aggravating monetary and
credit factors."
This postulate of the proportionality between boom and
bust has convinced us from earliest times. Manifestly, it
is diametrically opposite to conventional thinking in
America that, under the influence of Milton Friedman,
discards past boom excesses as things of the past. Past
is past, and the only thing that counts for the present
and the future is current monetary policy.
In this view, the Depression of the 1930s owed nothing to
any credit excesses and related maladjustments in the
economy and the financial system during the boom years,
but resulted exclusively from the Fed's flawed policies
after the stock market crash. Common to this opinion is
furthermore the conviction that proper monetary policy is
capable under all circumstances of preventing recession
and depression.
It goes without saying that this kind of thinking is
prone to foster illusions about what monetary policy can
do. What we generally hear and read from American sources
reveals that there is, in fact, a widespread, inordinate
complacency about the U.S. economy's woes, even though
troubling economic data abound lately.
A strong, preconceived view appears to hold sway that
everything is bound to come up roses in the end. We stick
to our view that the world economic prospects are
significantly more bleak than most people realize.
Regards,
Kurt Richebächer,
for The Daily Reckoning
P.S. The existing imbalances and structural distortions
are too big and the room to cut interests far too small
to fight the spreading weakness. But as to prevailing
illusions, America is apparently on top. The rest of the
world clearly lacks the dynamics for self-made economic
growth. But Europe, above all, has no prior excesses to
cope with. Our particular concern about the U.S. economy
arises from the recognition that the world's greatest
bubble in history has in many ways grossly imbalanced it,
hampering growth for a long time to come.
The decline of profits is already the worst since the
1930s. What's more, it started long before the economy
began to slow down.
Editor's Note: Dr. Kurt Richebächer's articles appear
regularly in The Wall Street Journal, Strategic
Investment and other respected financial publications.
France's Le Figaro magazine did a feature story on him as
"the man who predicted the Asian crisis." Dr. Richebächer
is currently warning readers to remain cautious in the
face of...
The Bogus Recovery
http://www.agora-inc.com/reports/RCH/TodaysProfit/
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