The Evil Genius of John Maynard Keynes
The Daily Reckoning
Paris, France
Tuesday, August 24, 2004
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*** Stocks to "melt up," says Forbes columnist...
*** Vacations...sunsets...and the vacant $500-a-night
views...
*** The airline industry...Wall Street...Flimflam...and
more!
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---------------------
"I don't see what the problem is," said Forbes columnist
Ken Fisher over dinner last night. "This economy is great.
I don't see any problems. Stocks are cheap - at least
compared to junk bond yields.
"Look, at the beginning of the year, everybody was singing
the blues about the twin deficits...because the dollar was
going to collapse, interest rates were going to rise and
the stock market was going to melt down. And guess what
happened? Nothing. We're still waiting. None of those bad
things happened.
"And yet, everybody's still so negative. I think what we're
going to see is a big surprise later this year...a melt-up
in the stock market, when people get tired of worrying and
start thinking about making money again."
Could prices "melt-up"?
Of course they could. But when we look around us, what we
see are many more reasons why stocks are likely to get
cheaper, rather than more expensive. Stocks hit a major
high four years ago. They don't usually go for another
major high - without hitting a major low first. The whole
cycle takes about 30-40 years, peak to peak. We have a long
way to go down before another major bull market begins.
Buying stocks before the next low is achieved is very risky
business; you'll be fighting nature all the way.
There is also the interest rate cycle, the rising oil
price, the unresolved trade deficit, consumer debt,
mortgage debt problems, the decline of the dollar,
declining consumer incomes and a shortage of jobs. Any one
of these alone could lead to an economic slump or falling
stock prices. Together, they could conspire to create an
extreme financial collapse. Not a melt-up but a meltdown...
Nothing much has happened so far this year. The Dow seems
frozen in one spot, at about 10,000. Gold is stuck at $400.
Each time we think one of them might be thawing out or
breaking away, a cold blast comes down...and the move comes
to a chilly halt.
Sooner or later, something's bound to melt. By our
guess...more likely down than up.
More news from Eric Fry...
---------------------
Eric Fry, reporting from the Pacific Coast...
- Work is the new vacation...R&R is d�mod�. According to
the glossiest of America's glossy travel magazines, working
vacations are all the rage. Trout fishing is out; counting
butterfly larvae in the Amazon is in.
- For just a few thousand dollars, the vacationing "Type A"
can enjoy a week in Tanzania monitoring mating cheetahs.
Alternatively, for a modest fee, hardworking Americans can
take a break from their labors by working for someone else.
Pitched as an opportunity to check out a "dream job," they
could spend three or four days learning to make cheese or
learning to run a bed-and-breakfast or learning to tend
bar.
- Your New York editor cannot relate...when it comes to
vacationing, he is a traditionalist. Vacations are for rest
and relaxation. He tries to do nothing at all...and usually
succeeds. Occasionally, he yields to the restlessness of
his co-vacationers and does a little something...like
driving to a different beach for the day.
- Over the last few days, your New York editor has visited
various Hawaiian and Californian beaches...and he has not
missed a single sunset. Few natural wonders can compare
with a sunset in the Pacific. And yet during one
particularly spectacular sunset, your editor turned toward
the five-star hotel behind him and noticed that every
single one of the hotel's balconies was empty. In other
words, the hotel guests were either taking in the sunset in
some other location or were holed up in their rooms
watching The Apprentice. In other words, almost every one
of the hotel's $500-a-night guests had elected to do
something other than watch the sunset from their $500-a-
night hotel room.
- Who would spend thousands of dollars to fly to Hawaii and
stay in an ocean-view room at a five-star hotel merely to
miss the sunset? Almost everyone with the money to do so,
it seems. Have Americans forgotten how to relax?
- "The indigenous Hawaiians never invented a wheel or
anything else of value," grumbled a fellow tourist to your
New York editor last night.
- "Why would they?" came the reply.
- "Well, don't you think they should have invented
something of value?"
- "Why would they?" came the reply again. "And you're
wrong, by the way."
- "Huh?"
- "Didn't Hawaiians invent the surfboard? The Greeks and
Romans lived next to water for thousands of years and never
invented a surfboard."
- "Are you serious?"
- "Yes," your editor replied. "And let's not forget that
Hawaiians also invented the mai tai. Maybe you should
reconsider your definition of 'advanced culture.'"
- Hawaiians did not invent the sunset, of course. But the
skies over the Hawaiian islands host some of the most
beautiful sunsets in the world. Meanwhile, 6,000 miles from
Maui, investors watched the Dow sink slowly below the
horizon yesterday.
- The blue chip index drifted 37 points lower to 10,073.
The Nasdaq Composite Index was virtually unchanged at
1,838. The price of crude oil also fell, as the benchmark
October contract dipped 67 cents, to $46.05. That's more
than $3 below the record-high price of $49.40 a barrel
reached last Friday.
- Hope, more than substance, seemed to push the price of
crude oil lower. Investors hope that there will be some
sort of resolution to the standoff in Najaf between
militiamen loyal to rebel Shiite cleric Muqtada al-Sadr and
U.S. armed forces. Investors also hope that the Russian
government will cease and desist from threatening to push
Yukos into bankruptcy. But as yet, neither hope boasts much
in the way of substance.
- The resurgent gold price took a breather yesterday,
pressured by strength in the dollar, after climbing nearly
$9 over the prior two sessions. The precious metal slipped
$2.40, to $411.
- Once again, the financial markets are becoming as
fascinating as they are treacherous. Once again, investors
must ask themselves, "Which market is 'right?'" The gold
market (seconded by the oil market)? Or the stock market?
Is the gold market correctly anticipating a climate of
rising geopolitical tensions and price pressures? Or is the
stock market correctly anticipating a MOSTLY favorable
climate for the U.S. economy?
- We don't know the answer, but our temerity leads us to
favor gold's clairvoyance...and besides, we like the way
gold glistens...kind of like a Maui sunset.
---------------------
Bill Bonner, back in Paris...
"The airline industry as a whole has lost money, ever since
it began," said British analyst Tim Price. "It has been a
net destroyer of capital."
Airplanes are one of the most successful new technologies
of all time. Invented only a century ago, now the skies are
full of them. Yet had you bought the shares of all airlines
as they came to market, you would have actually lost money
over the entire period.
Employees made money. Passengers enjoyed the convenience of
air travel. Airplane manufacturers and suppliers made
money. A lot of money changed hands. But the capitalists
who financed the airline industry made nothing.
Go figure.
On the other hand, we wonder if investors - overall - ever
make any money...and whether Wall Street, itself, is not a
net destroyer of capital.
"I saw one study," Tim continued, "that showed that during
the last bull market of the '80s and '90s stocks rose at an
annual rate of 17%...but investors really only made an
average of about 5%. And this was during the greatest bull
market of all time. Think what actually happened during
bear markets."
How could it be, dear reader?
We have a hypothesis. Wall Street, we believe, is a giant
flimflam outfit. The "flim" is investors' natural
inclinations to do the wrong thing at the wrong time for
the wrong reasons. A stock goes up - investors buy it. They
are throwing bad money after good - indirectly
overcapitalizing a good business, inviting its managers to
waste money on projects that are much less likely to pay
off than those that got them going. Eventually, the shares
go down and investors lose money.
The "flam" is the cost of doing business on Wall Street.
Brokers, analysts, lawyers, shills, market makers, coffee
makers, rainmakers, bookmakers - nothing comes cheap. The
flam is the friction in the machine, which Warren Buffett
estimates as high as 30% of all capital invested.
*** "Paris insulted. Paris bruised. Paris martyred. But
Paris liberated. By herself. Liberated by her own
people..."
Charles de Gaulle stood at the Arc de Triomphe and
exaggerated. Sixty years ago today, Paris was liberated
from the Germans. A French captain, accompanied by Spanish
troops, drove up to the town hall and took charge. The day
before, the German commander, von Choltitz, had been given
a direct order by Hitler himself: Reduce Paris to ruins.
But the Allies were only a few days away...the Germans were
going to lose the war...and von Choltitz was no fool.
Earlier, Paris Mayor Pierre Taittinger, had paid him a
visit and spelled it out for him: One way or another,
history would remember the German - either as the man who
destroyed Paris or the man who saved it.
Capt. Dronne, Gen. de Gaulle, Gen. Le Clerc, Col. Rol-
Tanguy, Gen. Eisenhower - a lot of men could claim to have
liberated Paris. Ernest Hemingway claimed he had liberated
the bar at the Ritz.
But von Choltitz was the real hero of Paris' liberation. A
career soldier, he knew he had to obey his commander in
chief. But he had a talent as rare in a military man as
good manners in a teenager: He was able to see his
duty...and have the good sense not to do it.
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---------------------
The Daily Reckoning PRESENTS: The mainstream use the term
stagflation so loosely, it's becoming a buzzword. But few
people actually know what it means or what causes it.
Here's the answer...
THE EVIL GENIUS OF JOHN MAYNARD KEYNES
by Sean Corrigan
Seventy years or so ago, Keynes saw that if Muhammad would
not go to the mountain for a lower paycheck, the mountain
must come to Muhammad.
What Keynes realized was that if modern institutional
arrangements and political short-termism were going to
prevent wages from falling far enough in the bust in terms
of the dollars and cents people were paid in (if wages were
"sticky downwards" as economists have it) - unlike the
price of beach hats during a rainy summer, which, as far as
politicians are concerned, can fall all they like - he
could achieve the same result by making the dollars and
cents themselves worth less!
Monetary inflation can price people back into work so long
as they are under the illusion that they are not suffering
a real cut in their wages, concluded Keynes...and the
message spread.
Sooner, rather than later, of course, that illusion was
dispelled. Soon, the workers and their representatives, not
to mention the pensioners and welfare recipients, began to
watch the published price indexes very closely and at the
first hint of an uptick, they would all demand to be
compensated for the loss to their purchasing power that
that increase comprised.
Indeed, before very long, they were making the process
pretty much automatic, by building indexation clauses into
working agreements and state benefit payments.
So as more and more money was pumped into the world economy
in the 1960s - led by a U.S. trying then, as now, to have
both guns and butter - and as this inflation pushed prices
up ever more rapidly, workers became ever quicker to adapt
to the change, making any lessening of their real cost to
employers ever more transient and unreliable.
Inflation, then, was not reducing unemployment in anything
like the manner the Keynesians had predicted, and this was
solely because the plumbers had outsmarted the professors
and the sausage makers had gotten a jump on the central
bankers.
In due course, this helped hasten the monetary breakdown of
the early '70s. Nixon put America into another partial
default (FDR having been the first to do so) by closing the
gold window. The breakdown of the Bretton Woods system,
which Keynes himself had helped to construct before his
death, soon followed.
Then, as the dollar - for so long propped up only by the
purchases made, largely unwillingly, by all the other
central banks - plummeted, and war broke out in the Middle
East, the oil producers decided they would not sell their
resources artificially cheaply for depreciated paper, an
aversion naturally heightened by the fact that some of
these same resources were being used to fuel their enemies'
assault tanks and jet fighters.
Here another blunder was made by unthinking mainstream
economists, under pressure from their political masters.
Instead of accepting that oil was henceforth going to cost
more dollars than it had before, and instead of reigning
back on the creation of money, so that the inflation that
brought this about might be slowed, energy costs were
baldly dropped from the calculations. About this time, the
concept of something called "core" consumer prices - a
measure excluding first energy, but later also food prices
- became the vogue.
Now, if you had spent $10 on gas and $5 on groceries
yesterday, by rights, when gas went up to $12 overnight -
and assuming you would rather be without your shallots than
without your Chevy - you should have had only $3 left with
which to buy food today - and the price of food should have
fallen to reflect this new economic reality.
No extra money (no inflation) and no overall rise in price,
only a relative change in these prices would have ensued.
But no! Most central banks, anxious not to see money
diverted from domestic producers to the account of the
foreign oil magnates, simply had another $2 printed up so
that you now had $17 to spend in place of your original
$15, so $12 for oil and $5 for food could be simultaneously
accommodated, at least in accounting terms.
What they failed to notice, of course, was that this did
not give full voice to the more urgent requirement for gas,
nor did it truly reflect individuals' lesser relative
demand for green beans and that by "monetizing" the oil
price rise, they were only making matters worse!
They also struggled to see that the sheiks still got more
of the pie, both in monetary and in real terms, despite
their efforts to confound this shift in free market
valuations.
Remember, too, that while all this was going on, organized
labor and the political parties that represented it were
perhaps at the zenith of their powers, and so as prices
rose, wages and benefits rose just as fast, if not actually
faster.
This meant that, rather than becoming cheaper, workers
were, in many cases, getting pricier, and goods, as we saw,
that are more pricey do not tend to sell as readily as
those that are not. Unemployment, therefore, rose.
Whereupon there was another reason to inflate again, for
once the market adjusts to a given volume of money and a
given matrix of prices, to prevent another relapse, the
artificial stimulus must be reapplied, and in increasing
dosage to boot.
This process - in another failure of economic vocabulary -
became known as "cost-push" inflation, or as the "wage-
price spiral." That way, the real culprits - the men whose
hands were covered in printer's ink - could conveniently
lay the blame for the woes of the world onto militant union
leaders at home or onto sinister Arab princes abroad.
At the same time, "fiscal drag" - by which we mean the
process wherein tax thresholds and depreciation allowances
are not adjusted fully in line with rising prices - was
bleeding businesses of internal funds, limiting their
ability indirectly to employ others higher up the cone of
production, by placing orders for capital equipment and
plant via continued investment.
Moreover, with foreign exchange rates going wild, with
interest rates more volatile than for many a long year and
with commodity prices soaring alongside labor costs, few
businessmen were able to make any meaningful plans for the
future.
Indeed, the whole question of what constituted a profit
became vexed when historic costs of inventory or equipment
recorded on the books bore little relation to prices being
charged on current markets.
Further, with all this "core" consumer price nonsense and
amidst all these ex-food and ex-energy shenanigans, all
manner of relative prices were being distorted, too, as our
green beans and gas example illustrates. It cannot be over-
emphasized that relative prices are the kinds that provide
the most important market information of all to any
entrepreneur.
This is because, in many ways, the entrepreneur is
effectively someone who takes a recipe out to a shop, buys
the ingredients listed there, and then bakes a cake to be
sold later in his or her market stall. If he can't
accurately price the flour and the sugar, the fruit and the
butter, and measure the total against his estimate of what
someone is likely to pay for the finished pastry, how can
he expect to make a profit by his efforts?
So in addition to being unable to afford the higher wages
arrived at under threat of strikes, or through subjection
to government "arbitration" and the forced complicity with
national pay deals, on top of having capital consumed by
the interaction of flawed accounting systems and rapacious
government revenue departments, company executives and
business owners alike found themselves increasingly
uncertain as to what it actually was they should be doing
if they were to make a profit; even one, at root, that they
couldn't properly quantify if and when they were to make
it.
Naturally, then - either voluntarily or by force of
circumstances - they did less of everything. Production was
cut back. Joblessness rose, and stock prices plunged -
though sometimes the extent of their fall was disguised by
the coincident steep fall in the value of people's money.
For a while, as all this went on, the politicians and the
central banks fell back on their two most readily utilized
means of Depression-busting - a resort to the command
economy means of maximum prices, mandatory wage caps and of
restrictions on the mobility of capital and, of course, to
more inflation to combat the spreading stagnation of output
and work.
Ultimately, however, this was recognized as being
inherently self-defeating and, clad in the political
camouflage of an adherence to the "new" doctrines of
monetarism, the Anglo-Saxon central bankers - a distinction
we draw because their more conservative continental
counterparts had, as ever, been a deal less susceptible to
such follies - began to do what was long overdue: They cut
back sharply on the pace of credit creation and let the
inevitable bust work itself out at last. For such a belated
recognition of economic reality was Paul Volcker
apotheosized and allowed to ascend the monetary Mount
Olympus from whence he appears occasionally to berate the
poor mortals who succeeded him!
And that, ladies and gentlemen, was what stagflation was
all about - and a fairly horrid experience it was, too.
Regards,
Sean Corrigan
for The Daily Reckoning
Editor's Note: Sean Corrigan is the founder of Capital Insight, a
London-based consultancy firm that provides key technical analysis
of stock, bond and commodities markets to major U.S., UK and
European banks. He is also a co-manager of the Bermuda-based
Edelweiss Fund. Corrigan is a graduate of Cambridge University and
a veteran bond and derivatives trader from the City.
Corrigan served with distinction for two years as The Daily
Reckoning's "man on the scene" in London's financial district.
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