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--- Begin Message ----Caveat Lector- Gary North's REALITY CHECKIssue 299 December 9, 2003 BUSH IMITATES REAGAN'S ECONOMIC POLICY Every incumbent President seeks the cooperation of the Federal Reserve Board in the 12 months that precede a presidential election year. No President wants to go into November with a sagging economy. The last time an incumbent President faced a recession in an election year, he lost. That was George Bush, Sr. His son does not want to repeat that experience. The advent of recession in March, 2001, followed Reagan's experience of a recession in 1981. Reagan countered with tax cuts for the top income tax brackets. He kept government spending very high. This was traditional Keynesianist policy, and it was called that in 1961, when President Kennedy followed the same procedure. But it was labeled "supply-side economics" in 1981. The Federal Reserve had been tightening money since October, 1979. That was what pushed the economy into recession in 1981, which cost Jimmy Carter his job. These tight money policies created a crisis for the Mexican peso, forcing it way down, thereby increasing its dollar- denominated debt burden. In the summer of 1982, Mexico responded by nationalizing the banks and threatening to default on its debt. The FED started pumping money, and it has not looked back. Then Reagan hiked Social Security taxes in 1983 because the system had technically gone bankrupt: more outflow than income. Reagan ran enormous deficits throughout his time in office -- the largest in peacetime American history. Again, this was Keynesianism, but it was called supply-side economics, even by supply-siders. BUSH'S PROBLEM Spending more money than it takes in is easy whenever a nation gets into a war. No President has to justify war expenses and a rising deficit when the country is at war. The Bush Administration was able to get us into two wars because of 9/11. The Iraq war is now costing the taxpayers and debt buyers about $2 billion a week. This war came with a tax cut. This is the equivalent of Lyndon Johnson's "guns and butter" taxing and spending policies. Johnson refused for four years to raise taxes to pay for the war in Vietnam, but he did not lower them. He had inherited lower tax rates from Kennedy. He did not raise taxes until he imposed a mild 10% income tax surcharge in 1968. By then, the FED had pumped in so much money to fund the debt that price inflation was becoming a problem, not to mention an outflow of American gold. The rumor mill has it that the President's senior election strategist, Karl Rove, has told him, "No war in the fall of 2004." The move by Secretary of State Powell to get NATO to replace the U.S. in Iraq indicates that the rumor is true. The UN refused to take up the slack, so Powell went to NATO. It sounds as though NATO is willing. I'll believe this when I see our troops being brought home. The recent call-up of Army reserves doesn't indicate that there will be an easy retreat from the region next year. But there may nevertheless be a not-so-easy retreat, following Iraqi elections. We will declare a victory and leave. It is likely that chaos will result, when the "warring" Iraqi factions actually go to war. It is also likely that almost nobody in America will care. American voters are ready to be told that Iraq is behind us. So, I think American troops will probably be out of Iraq by the end of next summer. Those few that remain will be adjuncts of NATO. Why NATO would be willing to shoulder this burden is unclear to me, other than because of U.S. pressure. This new mission surely has nothing to do with the defense of Western Europe against the Soviet Union, which is why NATO was created in 1949. But the March of Dimes still marches, despite the conquest of polio after 1955. Bureaucracies don't close down just because their original justifications disappear. What is unlikely to change is the size of the Federal deficit. War costs will not disappear overnight, and Medicare costs will absorb any spare dollars in the budget. The on-budget national debt will continue to rise rapidly for the foreseeable future. The policy of massive deficit spending can go on for as long as investors are willing to buy government debt at interest rates of 5% or less. But they are willing to do this now because they have not yet come to believe that the booming stock market is permanent. Why would anyone buy bonds at 3% or 4% when the stock market is producing a 20% annual return? Only because investors don't yet have confidence in the stock market. Why would foreigners buy T-bills at under 1.5%? The fall in the dollar more than wipes out that rate of return. The answer is simple: they are trying to keep the exchange rate from moving against their export-based manufacturers. They are willing to buy an investment -- the dollar -- that has moved against them by 15% because they are under pressure from special-interest groups in the exporting sector of their economies. Foreign demand for T-bills is heavily influenced by central bank purchases. Doug Noland reported on December 5, The Bank of Japan increased foreign exchange reserves by another $18.3 billion during November to $623.8 billion. Year-to-date, foreign reserves are up $172.3 billion, or 42% annualized. Japanese foreign reserves increased $63.7 billion during all of 2002. Taiwan's central bank foreign reserves increased $6.2 billion during November to $202.8 billion, with reserves expanding at a 28% rate through the first 11 months of 2003. South Korea increased its foreign reserve position by $6.0 billion during November to $150.3 billion, expanding reserves at a 26% growth rate so far this year. This willingness of central banks to expand their own currencies to keep them from rising against the dollar is keeping pressure on American manufacturers. This keeps them from passing on all of their cost increases to customers. What cost increases? Raw materials. THE BOTTOM OF THE FOOD CHAIN Natural gas prices are going through the roof. They are up by close to 40% in the past few weeks. (Since I live on a property that has its own natural gas well, this doesn't affect me. If I used propane, it would.) Tyson Foods, a local company that supplies a big percentage of the nation's beef, has raised beef prices due to increasing demand. Honda is charging almost 10% more on its Acura TL than it did a year ago. The rich will pay, so they will be asked to pay. The Reuters Commodity Research Bureau's index of commodity prices is up by almost 10% since last March. This indicates that there is rising demand for raw materials, even though users -- manufacturers -- are unable to pass on these rising costs to consumers. There soon will be a squeeze: rising raw materials costs, rising consumer demand, and strong competition from imports. Something has to give, and what is most likely to give is the international value of the dollar. The National Association of Purchasing Management- Chicago (its new name: Institute for Supply Management) reported in November that prices paid jumped by 15 points to 67.3 in just two months, the highest since July, 2000. A former Federal Reserve economist, Roger Kubarych, told a Bloomberg reporter that he worries about rising price inflation, despite assurances to the contrary by FED Board Vice Chairman Roger Ferguson. A December 2 Bloomberg story continued. The dollar's 15 percent decline against the euro this year has made some imports more expensive. Crude oil prices stood at $29.85 a barrel yesterday on the New York Mercantile Exchange, up from $25.24 on April 29. Inflation in the costs of services, which account for 85 percent of the U.S. economy, rose 3.2 percent in the 12 months ended in October, with increases in everything from medical costs to education. Producer prices rose 0.8 percent in October while the costs of goods excluding food and energy jumped 0.5 percent. Gold prices, often a barometer of inflation, topped $400 an ounce the week ended Nov. 21 for the first time since 1996. The American economy is slowly recovering, though unemployment remains high at 5.9%. This is good for the Administration. But the dark cloud on the horizon is the tightening supply of raw materials and the falling dollar. The Bank of England has raised its equivalent of the federal funds rate to 3.75% from 3.5% in order to keep price inflation from exceeding 2%. Except for Japan, which remains in a slightly price deflationary mode (-0.3%), the world's price level is inching above 2%. This means that anyone who holds T-bills or a commercial CD is losing money. He pays an income tax on his earnings, yet even if his income were tax-free, he would be falling behind. Are people nuts? Why are they willing to do this? Because they don't think the stock market will hold up. They don't want to go into real estate. Why not? Because they know the truth: rising inflation will produce higher interest rates, which will end the recovery or place limits on it. The booming stock market is the result of falling interest rates. But price inflation will force an increase in interest rates. Noland reports that China is no longer buying U.S. bonds. Instead, the country is using its dollars to buy oil. Although still intervening heavily in the foreign-exchange market, in the last few months China has radically scaled back its purchases of United States bonds. In September, Chinese institutions were actually net sellers of U.S. government and agency debt by $2.8 billion, even though foreign reserves rose by $19 billion. Now, economists and market strategists are beginning to wonder what Beijing is doing with all the dollars it is buying. Chinese state media provided a partial answer in early December, reporting that Beijing plans to build up a 90-day, 50-million-tonne strategic oil reserve. At current crude prices of around $30 a barrel, that will cost China $10 billion. Bankers and brokers in Hong Kong predict further large purchases of strategic materials, together with the possible acquisition of equity stakes in overseas suppliers over the coming year. If pursued, China's diversification away from U.S. government bonds will be bad news for Washington, which has relied heavily on China's debt purchases to fund its fiscal and current-account deficits. In Asia, some economists even say Washington had it coming, suggesting that the switch is subtle retaliation for current U.S. trade pressures on Beijing. This is consistent with my belief that China will become a competitor in the consumption of raw materials. This is also the view of "investment biker" James Rogers. Rising demand cannot be concealed on world markets. --- Advertisement --- Make 3.5 Times More Money Than Wall Street's Best Stock Traders Using the world's most powerful Momentum, Strength and Trend indicators, the MST Trader System finds stocks about to rise or fall quickly -- in 7 days or less. And once it finds a stock on the move, I recommend an option play to maximize your profits. The results are gains of 31%, 55%, 86% and 102%! That's 3.5 times more than any investor could make trading the same stocks. The next recommendation is only days away. http://www.agora-inc.com/reports/MST/OptionsRC/ ----------------------- A WAVE OF CORPORATE BOND PURCHASES Into this market of skepticism regarding stocks, companies are issuing huge amounts of bonds. As of last week according to Noland, "it was a huge week for debt issuance, with almost $20 billion sold." Smart investment money is buying bonds. This tells me that smart investment money is not impressed by the increase in stocks. But if smart investment money is convinced that locking in rates of 5% is a good idea, smart corporate money is saying, "Let's stick it to them, good and hard." Corporations are replacing higher-yield debt with lower-yield debt. Corporate insiders are saying, "let's take their money." They are saying, "rates will rise later." Corporate insiders are also unloading their own stock at unprecedented levels. This says that they expect to make more money by going for diversification rather than trading on the knowledge of their own industries. They are losing faith in the traditional way to wealth: buy stock in your own company, where you have a competitive advantage in knowledge. They are thereby announcing: "Our knowledge of our specific industries reveals to us that we are losing our ability to compete, both as companies and as senior managers." As Nixon's Attorney General John Mitchell famously said, before he was imprisoned, "Watch what we do, not what we say." CONCLUSION The stock market has hit a ceiling: Dow 10,000. It may break through, but when it comes to ceiling breaking, gold's penetration of $400 is more impressive. The ability of the stock market to maintain its pace is facing a challenge by the falling value of the dollar. Consumers are shopping, but they are not saving. The future of capitalism is dependent on saving. When foreigners decide not to bankroll the America's Federal deficit of $500 billion a year and its balance of payments deficit of $500 billion a year, then the consumer will find out that there are no free lunches in life. Interest rates will rise, bonds will fall, mortgage investments will fall, and the stock market's giddy increase, which is not based on rising profits, will end. Your best investment is still you. -------------------------------------- Appendix 65 One of the fundamental principles of business success is to discover what it is that you're selling. You are not selling widgets. You are selling solutions based on widgets. The closer you come to solution-selling, the more committed your clients will become. It is a major step in any company to get its employees to stop thinking "widgets" and get them thinking "solutions." We are all feature-oriented, not benefits- oriented. Anyone who sends out a resumé fills it with features: "I did this. Then I did that." He should be saying, "I can do this for you, and my resume is proof that I can deliver what I promise." Barnes & Noble doesn't sell books. It sells an experience to book lovers: soft chairs, Starbucks coffee, visual contact with other book buyers -- a sense of community, however impersonal. The company gets you into the store, and if you are a book nut, you buy something. Something catches your eye. "I've just got to have that!" Amazon sells books, but Amazon has never made a profit. Here is Abraham Case Study #298--a testimonial from a man who runs a classic widget operation, but who has shifted focus. He got his employees to make the shift with him, which isn't easy. I immediately put into effect the following procedures and polices. I did a complete review of all my companies' procedures. I instituted weekly workshops focusing on our core activities. We are in the automotive aftermarket, specifically engine machining and crankshaft grinding. I developed through workshops the procedures for handling the work and dealing with the clients (formerly called customers). A customer is someone who buys occasionally, or maybe only once. A client is someone who has a stake in the company because of repeat business and dependence. The owner had to make salesmen out of his employees. Do this, and you will raise profits. All shop people are now trained in the seven steps to every sale. When a client comes in the door they are first greeted with a friendly smile then walked through the shop, while being shown the shop we explain the equipment and at the same time tell the history of the company. Also during the tour we are setting up a very high buying criterion that other local competitors cannot match. Then the customers [he should have written "clients" -- he is still using the older terminology] are taken through a menu of the services that we offer (seven things to sell all customers). By doing this we have increased the average sale from $120 to $400-$1000 per client. This sounds like a lot but it was actually easy once we understood the concept of fiduciary responsibility. The product line is the same. The location is the same. Yet the change in positioning brought huge increases of revenue per sale. What was the essence of the change? To move from salesman to consultant. We now make sure that every client is sold everything that he needs to complete the job and nothing less, acting as a consultant instead of a salesman we now understand and can articulate a complete solution to his problems. My people now sell more parts and services, and we were able to broaden our offer even more by setting up two strategic alliances. The two additional profit centers (pillars in our Parthenon) are outsources that I initiated with a heat treating company and a company that does engine balancing. I offer their services on my menu, and we are selling them to forty percent of all new and old clients. I now actively look for strategic alliances at every opportunity. We also instituted a formalized referral procedure where we ask the clients names of people like themselves and give them literature to take. Our referral client percentage has increased by thirty percent. Again, all of this was based on a change in marketing and clients' perception. It was not based on changes in the product line. Don't think "product features." Think "client benefits." Outside of our company, I am negotiating right now to partner with one of our competitors, who only grinds cranks and does not have the full service shop I do. By partnering (the details have yet to be worked out, but I am making it very attractive to him), we will control the market in our area, and his clients will increase my parts sales by 50%. The conceptual shift came with the perception of the customer as a client. This was based on the simple but profound concept of the lifetime value of the customer. Understanding the concept of lifetime value of a customer (which no one I know in small business seems to understand) was pivotal in my pursuit of this competitor. The money he leaves on the table with each of his clients is enough to make it more than worth my while to make him a generous offer. I also am in the process of procuring a client database from another acquaintance that operates a multi store auto truck parts business. I am writing a sales letter that he will endorse to his clients, which introduces my services. I also am doing the same with one of my hard parts suppliers who does not have a machine shop, therefore we are not in competition. This will add 5000 names to my data base. The mailing materials are in the works (sales letter and brochures) and follow the easy formula laid out by Chet [Jay's partner] in the presentation on effective brochures. I am amazed how easy it is to develop these materials and how powerful they are. Here is what a skilled professional has discovered. He has made the shift in positioning his own business in his mind. Only then could he re-position it in his customers' minds, let alone his competitors' minds. I feel that for the first time in twenty years I am truly being proactive as opposed to reactive. I am astounded at how many people (me included) never even thought about the concept of proactive vs. reactive. For more information on how you can make this mental shift and then implement it, find out more about Jay Abraham's encyclopedia. I have recommended it in the past. It's for business owners who are moderately successful and who are ready to make the move to a much higher performance standard. Call Carl Turner at 1 (888) 818-8878 (USA) or 1 (310) 944-9106. ------------- -- Been to the Daily Reckoning Marketplace Yet? -- If not, you ought to see what you've been missing. 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