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* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you will
receive Bill Bonner's DAILY RECKONING. This will help you
to keep pace with the changes in the markets. Bonner and
I agree on most things in the field of economics, so the
two letters will reinforce each other.
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BACK TO JAPAN
THE DAILY RECKONING
PARIS, FRANCE
TUESDAY, 13 NOVEMBER 2001
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*** Foundations of recovery...or financial suicide?
*** Fresh terror on Wall Street...then calm...and trends
to the darkside...
*** Visions of deflation...oil wars...and economic
stagnation...sacre bleu, what next?
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Are they digging the foundations of a recovery? Or
are they digging their own financial graves?
I refer to the people who are buying cars and
refinancing their homes. Auto sales hit a record in
October - thanks to zero interest financing. Household
mortgage credit jumped 11.4%.
"Lock me in" say homeowners, as 30-year mortgage
rates fell to 6.46%. Refinancings are running 40% ahead
of the level a year ago. The volume of business is so
heavy that the industry can barely keep up.
Two generations of Americans have dreamed of 6%
mortgages. When inflation rates were at 4% or 8%, a 6%
mortgage was a bargain. But what if inflation goes
negative? Who wants to be "locked in" to a mortgage at
6% when deflation is knocking prices down 2% per year?
While people were standing in line to get
mortgages at 6.46% yesterday, few noticed that the
Producer Price Index fell by 1.6% in October - the
biggest drop ever.
More widely reported was the fact that corporate
profits are also deflating - by 72% in the 3rd quarter,
compared to the same period a year ago.
Wall Street deflated a bit too, right Eric?
*****
Eric Fry in Manhattan...
- Fearing a fresh terrorist onslaught, investors dumped
stocks nearly from the opening bell.
- "Too fast!" exclaimed Options Underground's Bryan
Botterelli, "In the morning we were trading solidly up,
which should have given us an hour or two before our
expected bottom move kicked in. Instead, we saw a
violent spasm downward, which cleared out the bears -
exactly as predicted - but in about five minutes instead
of two hours."
- But then, the early news reports coming across the
wires indicated that the tragedy was an honest-to-
goodness accident - and not the work of al Queda. So
investors regained their nerve and resumed buying
overpriced stocks. The Dow recovered from a nearly 200-
point drop to finish the day 54 points lower at 9,554.
The Nasdaq recovered from negative territory to gain 12
points to 1,840.
- Put simply: Terrorist attacks are bearish.
Malfunctioning General Electric aircraft engines are
bullish.
- Tourism stocks struggled all day, however. AMR,
American Airlines parent, led the airline sector lower -
no surprise there. But many hotel company shares dropped
even more than the airline stocks. Four Seasons, for
example, dropped 8%.
- Times were tough enough for the tourism industry, even
before yesterday's plane crash. Nobody I know is
searching for additional reasons to avoid traveling.
- "At Club Med, the water is turning chilly," the Wall
Street Journal reports. The global travel company is
shutting or mothballing several resorts from Tunisia to
Tahiti. All told, Club Med is taking 15 of its 120
resorts out of commission. The problem of course is soft
demand. I'm guessing that airplane crashes, whether
accidental or the work of terrorists, will not boost it.
- If it's any comfort, Club Med has some illustrious
company. The Walt Disney Company announced a dispiriting
68% drop in earnings for its latest quarter. Worse,
nearly every facet of its business is suffering: theme
park attendance is down; hotel occupancy rates are soft;
and its ABC broadcast network's fall season is suffering
from poor ratings.
- Disney's core theme park operations are suffering an
especially severe slowdown. Recently, attendance at
Disney World in Florida has fallen 25% below last
year's. Per capita spending is also lower. That's not a
good combination.
- From the looks of things, many Americans now prefer to
"cocoon" in front of their TV sets and watch CNN, rather
than to fly to some far-flung vacation destination.
The stay-at-home trend, together with the rising
unemployment trend, together with cautious corporate
spending trend, all add up to falling demand for crude
oil. And as demand drops, so do prices.
- Crude oil fell almost one dollar per barrel yesterday
to $21.83. Heating oil, unleaded gasoline and natural
gas all suffered steep price declines as well.
- Oil and gasoline prices have been relatively cheap for
so many years now that most of us think very little
about where our next barrel is coming from. But maybe we
should. According to John Myers, of Outstanding
Investments fame, our oil supplies from the Middle East
are far less reliable than most folks have come to
believe. "Remember, beneath the Saudi desert sands lie
one-third of the world's oil reserves," says Myers.
- Unfortunately, the ruling royal family is in a very
precarious position. "They are walking a tightrope
between satisfying the United States and appeasing the
radical elements inside their country." Myers fears that
growing Islamic extremism within Saudi Arabia
jeopardizes our access to the world's most bountiful
supply of oil.
- "Nobody puts the words 'oil' and 'national security'
together anymore," writes the New York Observer's Terry
Golway. "After all, Jimmy Carter tried that, and what do
we remember about Jimmy Carter? He was the guy who gave
a speech in a cardigan sweater." Nevertheless, Golway
thinks it's high time we begin preparing for the day
when we lose access to Saudi oil. The time has come, he
says, for Americans to forfeit "their inalienable right
to burn obscene amounts of gasoline."
- Golway concludes: "There has been talk about the need
to empanel a new Manhattan Project to outthink and
destroy terrorism. Getting the country's best scientists
together to replace the internal-combustion engine would
be just as important."
-"Buy a small car if you like," says Myers. "But I
suggest buying Canadian oil and gas stocks, along with
the occasional call option on crude oil."
(see: Maniacs In The Desert)
http://www.agora-inc.com/reports/RASS/edmention
*****
Back in Paris:
*** More deflation news from my friend, John Mauldin:
"So far this year, inflation at the wholesale level has
been declining at an annual rate of .8% (WSJ). The
Commerce Department said last week that its favored
measure of inflation - the price index for gross
domestic purchases, or prices paid by U.S. residents -
fell by 0.3% in the third quarter, a sharp reversal from
the 1.3% increase in the second quarter and the first
quarterly decline in 40 years.
"Bank loans are down. Many readers ask where is all the
money going that the Fed is creating? Part of the answer
is that banks are taking money out of the system. Growth
in commercial and industrial loans, which reflects bank
lending to small businesses, has contracted for the last
three consecutive months.
"Large firms, which issue 'commercial paper', have seen
these markets dry up, as non-financial commercial paper
(non-financial institutions like banks or insurance) is
down almost 40% if I read the chart correctly. Either
they can't get the money or don't want it. Either way,
that is neutralizing the money creation activity of the
Fed.
"That is deflationary, any way you read it. It is also
called pushing on a string." (http://www.2000wave.com)
* * * * * * * * Advertisement * * * * * * * * * *
Conveniently, the WTC attacks are being blamed for a
surprise "slowdown" that has rocked the U.S. economy.
Suddenly, it seems, corporate profits are dropping;
investors are less sure...consumer confidence has been
shattered.
But...the writing WAS ALREADY ON THE WALL!
And according to one of the world's leading economists,
we "ain't seen nothing yet." Experience proves that if
you've been listening to the Fed's high-octane "new
paradigm" propaganda you're in trouble...it can ruin
you. Here's what you need to do - right now - if you
haven't prepared for:
The Coming Economic Crisis
http://www.agora-inc.com/reports/RCLF/BigProfits
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BACK TO JAPAN!
by Bill Bonner
Many readers wrote last week to say they did not
appreciate my analogies.
"Afghanistan is nothing like Vietnam," said one. "The
comparison is ridiculous."
"You should stick to writing about economics," advised
another, "at least you seem to know something about
finance. You know nothing about war."
In deference to these readers, I return today to
investment. In truth, I know no more about it than I do
about war, but it seems to inspire fewer.
Besides, our money is at stake in the world of finance.
War is merely a matter of life and death - with a little
luck, someone else's.
So, we take our leave of both Afghanistan and
Vietnam...and run our little bark ashore - in Japan!
"With each passing week," begins a Wall Street Journal
article, "the similarities increase. In the 1980s, Japan
was considered the model capitalist economy; in the
1990s, the U.S. held that distinction. In both cases,
the good times ended with the bursting of a stock market
bubble, pricked, at least in part, by a nervous central
bank. In both cases, predictions of a quick turnaround
proved to be wrong."
So often have we visited Japan in these letters that
long-suffering Daily Reckoning readers are probably
beginning to feel like frequent travelers. And the
Japanese, accustomed to our visits, are beginning to
check our visas carefully...wondering if it isn't about
time we have outworn our welcome.
But it is an analog world, not a digital one. We only
understand what is going on in a new circumstance by
comparing it to something familiar to us. And so we
journey to Japan again, a country that is becoming as
familiar as the kitchen sink.
"I don't think it's apt to make a comparison," says U.S.
Treasury Secretary Paul O'Neill.
The U.S. economy bears no resemblance to that of Japan
1990-2001...nor to itself 1930-1940. (Nor is the war in
Afghanistan in any way comparable to Soviet's effort in
Afghanistan, say what could be a majority of Daily
Reckoning readers...nor to the U.S. war in Vietnam.)
Why not? Because, in every respect, the outcome we can
expect - say the bulls - will be better than any of the
proffered examples. Let us hope so. But hope is no
substitute for experience.
"They're not an open economy," says O'Neill of the
Japanese, "One of the things that has really been
beneficial to our economy is this openness and the
challenge that we have permitted to come in here, from
foreign suppliers from all over the world..."
Of course, no comparison is ever perfect. Every
situation is different. The economy is always new.
But the novelty of a situation is often less instructive
than its essence - that is, the things that are not new
about it. In the mid-80s Japan was enthusiastic about
memory chips and automobiles. In the mid- and late-90s,
it was the Internet and the telecosm that set American
imaginations on fire. Japanese auto companies built 13.5
million units in 1990...a decade later, they are still
below that level, at only 10 million units.
In North America, telecom companies spent billions of
dollars to lay millions of miles of fiber-optic cable.
"Build it and they will come" was the motto of the time.
Now it is built, but less than 3% is being used. Excess
capacity, whether of chips or cable, tends to reduce
prices.
Another distinction without a difference between Japan
and the U.S. is the concentration of bad debt in the
Japanese banking sector, for which no parallel is said
to exist in America. Yet, for every dollar of bad
business debt held by Japanese banks, there are probably
at least one or two of bad business and consumer debt
held by America's innovative lenders.
The junk bond default rate just hit a 10-year high.
American Express alone lost more than $1 billion on
junk. Meanwhile, sub-prime lenders, such as Providian,
are now demonstrating how hard it can be to collect a
debt from a sub-prime borrower in a recession.
"The large amount of consumer debt outstanding in the
U.S. is the ticking time bomb that could rival the bad
loans dragging down Japanese banks," notes a Wall Street
Journal article. Unlike Japan, where the personal
savings rate never fell below 12%, savings nearly
disappeared in the U.S. in the late '90s.
The illusion of wealth in Japan was gunned up by massive
increases in the prices of real estate. In America,
housing prices rose modestly, except in a few places
such as Manhattan and Silicon Valley, where the
increases were extravagant. But, in America, the
illusion of wealth arrived daily in the stock price
quotations. More people in America owned stocks, so that
"the share of total household financial assets comprised
by equities in the U.S. was 30.4%," writes John
Youngdahl, an economist at Goldman Sachs (in Grants
Interest Rate Observer), "whereas in Japan this
percentage stood at 16.5% in 1990 despite significant
overvaluation in that market."
The overvaluation of which Youngdahl speaks was about
the same in the U.S. as in Japan. Stocks in the U.S.
nearly tripled in the last 5 years of the '90s. In
Japan, they nearly tripled in the last five years of the
'80s.
While stocks rose at about 25% per year, business fixed-
investment in both countries rose at less than half that
rate...but still almost twice the rate of growth in
private demand. In its essence, both countries were
adding more capacity than consumers could use.
Each bubble subsequently burst, with each country's'
stocks down about a third in the 18 months following the
peak.
But Youngdahl, O'Neill and others focus on the response
of politicians and central bankers. In the U.S.,
enlightened officials acted promptly. In Japan, they
dithered.
The Fed has cut 4.5% from key rates in just 10 months.
The Japanese central bank took 4-1/2 years to do the
same work. Congress rushed out a plan to spend $100
billion to stimulate the economy. The Japanese Diet took
longer.
Will the speed of U.S. official response be decisive?
Can credit-fueled overcapacity be corrected faster by
offering more credit, more cheaply, more quickly?
I don't know. But we will soon find out.
Your editor, still trying to develop a taste for raw
fish...
Bill Bonner
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