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--- Begin Message ----Caveat Lector- Gary North's REALITY CHECKIssue 227 April 1, 2003 WILL THERE BE A POST-WAR STOCK MARKET BOOM? This is no April Fool's trick issue. In the week preceding the invasion of Iraq, the stock markets boomed. The U.S. markets rose, and so did the British FTSE. We began hearing the familiar litany, "We have seen the bottom." The litany has become a mantra for the "buy and hold" crowd. Month after month, year after year, the mantra is proven wrong. Still, they drone: "Stocks always go up in the long run." Even if it's true, it has paid to be in T-bills or short-term CD's in the short run. On this point, Bill Bonner and I have been in agreement for the past three years. We have done our best to get our readers out of stock market index funds. We have kept hammering away at the main theme: we are in a primary bear market. Yet, even after three years of declines, the number of stock market analysts who say that we are in a primary bear market is so low as to be invisible. The people who watch the Tout TV shows do not get to hear the case for the bear market on a regular basis. For Tout TV, it's always time to buy. Always, the interviewers ask, "What stocks look good?" Never do they ask: "Which stocks look bad?" The message: always buy or hold, never short. I told my REMNANT REVIEW subscribers to get out of NASDAQ stocks in February and March, 2000. I told them to short the S&P 500 in November, 2000. The short funds I recommended then are up over 100%. I told them this February to expect a pre-war boomlet, but to be prepared to buy more short funds as soon as it peaked. It has clearly peaked. The Dow fell below 8,000 yesterday. It can't sustain a run above 9,000. I realize that most readers have grown tired of hearing the bad news. But, at the same time, they have seen the bad news come true. The vast majority of stock market investors are still holding on in the hope that the market will rebound. This has kept the final collapse that marks the end of a primary bear market from taking place. So, the bear just keeps grinding away at people's portfolios. As investors, we all have to make decisions in the face of incomplete information. These days, we hear about the fog of war. That phenomenon surely exists. But there is a fog of information in the economy, too. The stock markets have now backtracked, beginning on the first Monday after the war began. This raises a key question: Was the one-week boom a product of pre-war euphoria that did not count the costs of war and reconstruction? If it was, then the prediction that we have seen regarding the bottom of the bear market, which has now lasted for three years, is called into question. Its brief recovery may have been a euphoria-driven hope that will not survive the post-war U.S. budget deficits. These deficits are about to escalate to levels undreamed of by the voters. To forecast accurately what lies ahead, we need to consider carefully the effects of rising taxes, rising Federal deficits, and the political fallout. We must begin with a consideration of the Laffer Curve. THE LAFFER CURVE Arthur Laffer's famous curve graphically shows that tax cuts can increase government revenues when tax rates are on the downward-sloping side of the curve, which they are most of the time. To see the curve, click here: http://www.investopedia.com/terms/l/laffercurve.asp The Laffer Curve has been an affront to Democrats. The curve testifies to the presence of the politics of envy, which implicitly announces: "I don't care if the economy will boom and government revenues will rise by lowering the top marginal tax rates. The rich deserve to be taxed at a higher rate than the poor." If tax cuts really do reduce the deficit by stimulating investment in the economy, then the public's cost of envy-driven politics rises. When the cost of something increases, less of it is demanded. Democrats lose votes. Democrats refuse to accept the truth of the Laffer Curve. So, when Reagan pressured Congress to cut the top marginal tax rates in 1981, and the economy began its long boom, Democrats pointed to the rising deficits of the Reagan era. They ignored the fact that Congressional spending soared at a rate higher than tax revenues increased -- and they did increase. Reagan refused to veto spending bills, a fact not mentioned by his supporters or his critics, then or now. Also forgotten: the legal bankruptcy of Social Security in 1983, the SS tax hike in that year, and the TEFRA tax hike of 1986. The Laffer Curve seemed to have failed. In 1990, President Bush rammed through a tax hike. This tax increase was accompanied by a recession. I had predicted that recession in 1989. The tax hike retarded the recovery, but it did not cause the recession. Bush lost his presidency because of the sagging economy and rising taxes. "Read my lips: no more taxes" came back to haunt him. So, the results of Laffer curve was still ambiguous in the minds of most economists. In 1993, Clinton got a marginal tax hike. The bill was passed by only one vote in the House of Representatives. The Clinton era's economic boom began. (Actually, the recovery had begun in the second half of 1992.) Tax revenues steadily rose. The Federal deficit went down. This chain of events seemed to refute Laffer. We hear little about the Laffer Curve these days. In 2001, President Bush got a mild tax cut. It was heralded as a $1.3 trillion tax cut, but as with all such figures, it was back-loaded: the savings come in the years close to the end of the proposed 10-year period. Congress and the President can vote later to reverse these cuts. We can be sure that if Bush loses in 2004, and if the Democrats take back both houses of Congress, that tax cut will be revised. A week ago, I predicted that there would be no more tax cuts. Before the day was over, the Senate voted to scale back the Administration's proposed tax cut bill by 50%. This was the Senate's quid pro quo for the Administration's first bill for the war: $75 billion. They've only just begun. --- Advertisement --- Double Your Money in 9 Days...In This Market? You Bet! Forget the gloom and doom! Not everything is in a bear market. You could have seen profits of 77%, 90%, and even 145% in just the past few weeks. The most recent pick jumped 116% in 9 days. If you need to shore up your portfolio... or rebuild it... read this Free report. Click here for Fast Profits http://www.agora-inc.com/reports/RTA/TodaysProfit/ ----------------------- GOVERNMENT SPENDING IN OUR FUTURE The post-war Iraq reconstruction cost estimates are all over the map. I have seen one academically serious estimate as high as a trillion dollars. Let's consider a less horrendous estimate. These are estimates by Prof. Warwick McKibbin of the Australian National University. He is a specialist in international economics. Here are some of the basics: (1) infrastructure = $30b to $100b; (2) peacekeeping = up to $100b; Iraq's debts owed to Western banks and governments = hundreds of billions. (This estimate seems too high to me, but if it's anywhere near accurate, and a U.S.-established Iraqi government defaults on these debts, the Western alliance will be buried. The international banking system will be put under tremendous pressure.) The pre-war oil revenue was barely enough to pay for the socialistic government's expenses in Iraq. It will cost from $10b to $50b to upgrade the oil facilities, although private companies will probably pay for this. He also notes that the U.S. has spent $10 billion for peacekeeping in Afghanistan, as of last September. http://www.abc.net.au/insidebusiness/content/2003/s819869.htm Meanwhile, three weeks ago, Karzai asked Bush for an additional $10 billion. The U.S. Budget Director claims that the United Nations' oil-for-food revenue can be used to pay for Iraq's reconstruction: $11b to $14b a year. This, of course, assumes that all of this oil revenue won't be needed for basic day-to-day support costs for Iraq, an assumption that is not shared by most international economic analysts. He also says that there will be $6b to $8b in funds stolen by Hussein and other Ba'ath Party leaders. (WALL STREET JOURNAL, March 31.) Exactly where these funds are located and why the U.S. has not already confiscated them as an act of war has not yet been revealed. An Associated Press story (March 22) reveals the extent of the disagreement over this estimate. LONDON - Despite Iraq's enormous oil reserves, experts say money from the sale of Iraqi crude wouldn't cover the costs of rebuilding the country's power plants, bridges and other vital infrastructure after war with the United States. Twelve years of U.N. economic sanctions have crippled Iraq's oil industry, and a postwar government would need several years and billions of dollars to restore production to 1990 levels. At the same time, oil prices are expected to fall after a U.S.-led attack, making it harder for Iraq to boost revenues from its No. 1 export. Several analysts and energy specialists challenged a view held by some U.S. officials that Iraqi oil resources could alone generate enough cash to build Iraq's economy and the foundation for a viable, pro-American government in Baghdad. "There's an over-inflated notion in Washington about how large Iraqi oil revenues are and a very skewed notion about how much it's going to cost to rebuild the country. ... The numbers don't add up," said Raad Alkadiri of The Petroleum Finance Co., a Washington consultancy. Postwar reconstruction would cost about $25 billion a year, but Iraq would earn no more than $14 billion to $16 billion a year from oil during the first 18 months after a war, and exports would rise only slowly after that, Alkadiri said. A self-financing rebuilding project is wishful thinking, said Philip Verleger, an energy consultant and fellow at the Council on Foreign Relations. He sees a bill to American taxpayers of "a couple hundred billion dollars." . . . Of Iraq's current oil revenues, 72 percent pay for humanitarian needs, leaving just $3 billion to $4 billion a year that might go toward economic reconstruction. "There's going to be absolutely nothing left over to pay for the U.S. military, and I think the U.S. government is fully on board with that," said Rachel Bronson, director of Middle East Studies at the Council on Foreign Relations. Not everyone agrees that Iraq would be constrained from pumping a lot more oil. Iraq has 112 billion barrels of proven crude reserves, second only to Saudi Arabia's and "more than ample to provide the funds needed to rebuild and boost economic growth," Heritage Foundation fellow Ariel Cohen argued in a research paper in September. That's provided a postwar government scraps Iraq's state-run oil company, privatizes its energy industry and make its economy investor-friendly, he said. . . . http://www.onlineathens.com/stories/032303/bus_20030323037.shtml On Sunday night, "60 Minutes" ran its weekly "two defunct politicians" weekly feature. Each week, Clinton and Dole regale us with their opinions in a point- counterpoint format. Clinton told us that he was all in favor of the billions of dollars that the reconstruction of Iraq will cost, but then said America deserves an equally large "investment" by the Federal government: in education, in infrastructure, etc. Dole rebutted: we should focus only on the war right now. He did not challenge the suggestion that America should pay for all this. He only said, in effect, "Let's not discuss domestic spending right now." This was pure Dole. It has been the Republican Party Line for two generations: "more spending, but not now." Franklin Roosevelt beat them up, and they have long since adopted the New Deal. The war in Iraq will make it impossible for most Republicans in Congress to resist vast increases in foreign aid spending, for the money will be spent in the name of the liberated people of Iraq. Then there is the issue of who will get the contracts. The initial money for construction projects totaling $1.7 billion will go mainly to American firms, according to the WALL STREET JOURNAL (March 31). (Halliburton isn't one of them, according to a news report yesterday.) Here is a short list: http://www.forbes.com/2003/03/28/cx_pm_0328subs.html The debate between Blair and Bush over the extent of UN participation in the post-war governing of Iraq is tied directly to the question of government money and its distribution to domestic big business. It is a question of which nations' taxpayers are going to foot the bill, which will in turn determine which nations' largest construction firms will receive the contracts. Right now, it's clear that Americans will be asked to foot the initial phases of the bills. This idea will be sold to the voters in the name of American national sovereignty. "America blew up Iraq's buildings, so American taxpayers have a moral obligation to rebuild them." Furthermore, "America will run the whole post-war show." Democrats will be tempted to accept this arrangement because of the two-fold political benefit: (1) government spending will increase and (2) labor unions will benefit. The biggest American construction firms are unionized. But Democrats will balk at any suggestion of tax cuts. There are no detailed official post-war cost estimates coming out of Washington. What we can be sure of is this: reconstruction will cost more than anyone in high political office is willing to say publicly today. The costs depend on how long we must keep troops stationed there. We have had U.S. troops in Saudi Arabia since 1990. There is no sign that this will change. Troops in Afghanistan and Iraq will be equally permanent. REGIONAL RESENTMENT IS ALSO PERMANENT We know that al-Jazeera broadcasts anti-American programs, but so do a dozen other regional Islamic satellite networks. From everything I have seen on English-language satellite news networks, support for Saddam is spreading fast in the street demonstrations of the Middle East. Crowds gather, and someone is always holding up a placard with his photo on it. The United States is now regarded by the Islamic world as an illegitimate invader. This is the fulfillment of Osama's plan. His goal has always been to create a jihad mentality in the region against the United States. He has written this repeatedly. Andy Rooney, who is usually amusing, did not try to be funny this week on "60 Minutes." He pointed out the obvious: when the government could not capture Osama, it switched its target to Saddam. That this was said on a program with an audience as large as "60 Minutes" is significant. (He also said that whatever PR person who came up with the phrase "shock and awe" should be fired. The Iraqis were not shocked, and they are not in awe.) My prediction is that the American media will turn on Bush when the shooting stops. The campaign of 2004 will begin within 60 days of the surrender of Iraqi forces. It may take only 30 days. His popularity will fall steadily in the post-war period when it becomes clear that Americans will have to pay more than they thought for reconstruction. At that point, the Democrats (Daschle, above all) will start talking about sharing peacekeeping authority and expenses with the United Nations. Also on "60 Minutes" was a segment on shoulder-held anti-aircraft missiles. The latest report from the government is that these weapons are now in the possession of terrorist groups. In March, representatives from the American airline industry were brought to Washington to get briefed on this problem. The head of the air transportation division of Homeland Security was interviewed by Ed Bradley at some length on this matter. So was Sen. Charles Schumer, who has introduced a bill to spend $10 billion to refurbish American planes with anti- missile defensive technology. Schumer painted a chilling picture of what would happen to the airline industry after a plane is shot down by terrorists. The industry is already close to bankruptcy, he said, which is true. American Airlines (AMR) just barely averted bankruptcy on March 31. He argues that the government should spend $10 billion now in order to forestall a far more expensive bankruptcy in a post-attack world. This assumes that the proposed defense technology will actually work. It also assumes that Americans will believe that it works. DOES WAR BENEFIT THE ECONOMY? Some of you may be familiar with the essay by Frederic Bastiat on the broken window. He wrote it in the late 1840's. Henry Hazlitt used it in his marvelous book, ECONOMICS IN ONE LESSON (1946). Bastiat refuted a familiar argument that violence is beneficial. Say that someone throws a rock through a window. Look at the benefits! Window repairmen will be hired. They will order glass. The benefits spread through the economy. Then he pointed out the fallacy: think of what the money would have been used for. It wasn't buried in the earth. Bastiat called this the fallacy of the thing unseen. We see the broken window. We don't see the things that will not be built, or will not be invested in, because of the cost of replacing the window. The economics of John Maynard Keynes, which was dominant in college textbooks from 1948 to 1975, and is still influential, is based entirely on the idea of the productivity of the broken window. Keynes (pronounced "Canes") argued in his classic book, THE GENERAL THEORY OF EMPLOYMENT, INTEREST, AND MONEY (1936), that "Pyramid- building, earthquakes, even wars may serve to increase wealth. . . ." (p. 129). http://www.worldandi.com/public/1988/may/mt7.cfm Every bomb uses materials and labor that could have been used in the manufacture of a consumer good. It's great for the economy of McAllister, Oklahoma, which for 60 years has been the bomb-production town of America, where the bomb plant is now running three shifts for the first time since the Vietnam war, but it's not great for Detroit. These days, McAllister's economy is booming. (Sorry; I couldn't resist.) The rest of the U.S. economy isn't. (I stopped for lunch in McAllister on March 19, as I always do when I drive to or from Dallas. There are no signs that say "bomb capital of the free world.") The economics of war is destructive. That's why the stock market's boomlet in the week before hostilities began was irrational. As the other Bush said in 1990, "This will not stand." If we really have seen the bottom of the stock market, it is not because the war in Iraq is in some way an economic benefit. CONCLUSION When you read that the worst is over for the stock market, read more carefully. Look for arguments. See to what degree the forecaster is relying on Keynesian assumptions about the benefits of rising taxes, rising deficits, and the wealth effects of blowing up buildings on the other side of the world. -------------------------------- Appendix 31 Abraham Case Study #126 is extremely important. The author has gone to great trouble to break down his discovery into a format that any business owner can (and should) imitate. The issue is a company's unique selling proposition (USP). What is the supreme reason why a customer spends money with the firm? Most businessmen don't know. They don't bother to ask their customers to find out. When a company identifies its USP, it must restructure everything to reinforce this core benefit. It must find what the author calls the big promise. It is not enough to make the promise. The company must demonstrate it. The author offers this list of USP questions. I cannot emphasize strongly enough how important it is for a business owner to go through this exercise. Here are the ones I think are the best in the list. List the unique reasons why people do business with your company. What is the primary advantage your company has over your competitors? What are the primary advantage each of your major competitors offers? Write down one clear and concise headline (I prefer 17 words or fewer) for an advertisement promoting this USP. Write a paragraph on what you uniquely offer to benefit your customers. The author says that two lunch meetings of two hours each caused "a total mind shift of the middle management team." This was part of the process of gaining agreement regarding the core message of the company. The results (among many) were a 200% increase in referrals and an increase of 300% in repeat business. ------------- -- Been to the Daily Reckoning Marketplace Yet? -- If not, you ought to see what you've been missing. 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