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-Caveat Lector-
- REMINDER -
On the days that I don't publish, like today, you receive
Bill Bonner's DAILY RECKONING. This will help you to keep
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on most things in the field of economics, so the two letters
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Bad Times, Good Money
The Daily Reckoning
Paris, France
Wednesday, 18 September 2002
* * * * * * * * * * * * * * * * * * * * * * *
*** Net worth declining...Debt increasing...
Doesn't borrowing make you richer?
*** Fannie and Freddie may have cracked...delinquencies
at 20-year high...
*** Morgan takes a hit...offshore accounts...Saddam's
reply...overpriced houses...and more!
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"Stocks sink Americans' net worth," says a USA TODAY
headline.
Figures from the 2nd quarter show household net worth
down by 3.4%.
The other headline that caught our eye was this one from
Chicago:
"Fed says debt climbing at fastest rate in a decade."
>From the article we learn that non-financial debt has
been increasing at a 7.8% annual rate.
"Behind the scenes, the Fed is working feverishly to
keep the music from stopping," writes Randall Forsyth in
Barron's. "Greenspan & Co. have their monetary pedal to
the metal again."
It used to be axiomatic that borrowing boosted the
economy. It increased sales and business investment. For
each additional $1.40 borrowed, according to Dr.
Richebacher, you got about $1 of GDP growth. But lately
something has gone wrong. In the period 1997-2001, it
took $2.60 of extra debt to produce another dollar of
GDP. And more recently, the figure has been more like
$4.80.
Why so little growth for so much debt?
There has been "a major change in the use of credit in
the United States," writes Richebacher. Can you guess
what that change is, dear reader? Instead of borrowing
for investment and growth, people are now borrowing just
to keep up appearances. Take out a bigger mortgage and
buy a big screen TV that came all the way from China...
or one of those SUVs that they make in Detroit. People
have been encouraged to consume...but not to produce.
Without the increase in auto sales the economy would be
in recession. But is Detroit booming? What automaker is
going to hire people or build another assembly line when
he can only sell his cars by offering zero percent
financing and cutting his price margins?
And what about refinancing your mortgage? Why not?
Mortgage rates - after tax - are lower than the annual
growth in house prices. You get cash to spend...but how
is anyone richer as a result? You owe more money, but do
you have any better way to pay it back?
According to an undersecretary of the Treasury, the
increase in debt is no problem, because debt levels as a
percentage of net worth are not as high as they used to
be. But if your house doubles in price, are the mortgage
payments easier to make? It is earnings, salaries, and
dividend yields that really count. You can't live off
paper profits.
Fannie Mae and Freddie Mac may have finally cracked
yesterday; their stocks fell 4.73% and 3.26%
respectively after it was revealed that Fannie's
'duration gap' slipped to negative 14 months. From the
press reports, we could not quite figure out what a
'duration gap' is, but it must be a bad thing.
The Mortgage Bankers Association reports that
delinquencies are at a 20-year high. Greg Weldon says
the number of foreclosures is the highest in 30 years.
Fannie Mae can buy all the mortgages it wants; if people
can't make their payments, Fannie gets knocked on her
derriere.
The big decline in Americans' net worth is still ahead,
we think. It will happen at about the same time Fannie
Mae and Freddie Mac hit major new lows - when the real
estate bubble finally finds its pin. Then, the music
stops...Americans will stop borrowing...and stop
spending too.
And now a report from our Wall Street reporter who,
today, is far from the canyons of Manhattan...
******
Eric Fry at the Supper Club meeting in Colorado...
- Even from way out here in Colorado Springs, the action
on Wall Street yesterday looked pretty horrible. The Dow
tumbled another 172 points to 8,207, while the Nasdaq
fell 16 to 1,260. Even worse, the misery did not end
with the ringing of the closing bell. After the close of
trading two major bellwether stocks - J.P. Morgan Chase
and Oracle - both warned of disappointing earnings. Both
stocks dropped more than 7% in after-hours trading.
- Morgan's warning was nothing short of disastrous. The
banking giant said third-quarter earnings would be well
below analyst expectations due to weak trading profits
and to write-offs of commercial loans to troubled
telecom and cable firms. Adding insult to injury,
Standard & Poor's and Fitch both slashed the bank's
credit rating yesterday afternoon.
- Bad news for the stock market was great news for the
bond market. Treasury bonds soared, driving the yield on
the 10-year Treasury note down to 3.85% from 3.90% late
Monday. Apparently, investors are fleeing stocks in
favor of any investment that promises a plus sign.
- Oracle's profit-shortfall announcement is but the
latest indication that life in Silicon Valley isn't as
rosy as it used to be. The bubble years are dead and
gone, and many a valley resident will miss them.
- Tim Lucier is a former comptroller for tech companies
in Silicon Valley who now drives a taxi for a living,
and he has some very interesting things to say about the
bubble years in Silicon Valley. (Thanks to my mother-in-
law [a faithful DR reader and better off for it!] for
bringing this story to my attention.)
- "Lucier's switch from Silicon Valley powerhouse to San
Francisco cab driver is merely an extreme example of a
trend that has been playing itself out in the Bay Area
for the past few years," the San Francisco Chronicle
reports, "an industry wide shakeout that followed the
popping of the Internet bubble.
"But Lucier's situation is a bit more interesting than
most, because this is a guy who looked after the
accounting for a series of valley companies at a time
when tech firms were accountable to virtually no one.
The picture he paints of those days is not pretty."
- "It was a new age," Lucier tells the Chronicle. "There
were no rules. You made them up as you went along...
Making things look good for just two years. That's what
the valley was all about."
- Financial chicanery was especially prevalent amongst
the valley's corporate management. "The CEOs had a lot
of money coming in from VC companies," Lucier said.
"They didn't know what to do with it so they moved a lot
of it offshore. The VCs never knew...It was a given that
this kind of thing was going on."
- Lucier claims that senior execs at one particular
software company asked him routinely to siphon off $10
million a week and transfer the money to offshore
corporate accounts. "After the money was in those
accounts, anything could have happened to it," Lucier
said.
- If Lucier is to be believed - and we have no reason to
doubt him - there may be a silver lining for our
economy. Up to this point we had assumed that all the
money investors had lavished upon dot.com-this and
dot.com-that had been frittered away on things like
sock-puppet commercials. If, however, it turns out that
some of this money has been squirreled away in offshore
bank accounts, maybe our national savings rate is higher
than reported. And maybe our economy is just a wee bit
stronger than we thought...(Hey, a man can dream can't
he?)
- Still, for every former dot.com executive who
embezzled millions, thousands of folks lost everything
as the bubble collapsed. Thousands lost their jobs as
well as their savings.
- The tell-tale signs of a boom gone bust are visible up
and down the Silicon Valley, according to "Eric B.," a
recent contributor to the Daily Reckoning discussion
board. In his post entitled, "My Silicon Valley
Commute," Eric B. writes, "Every morning I drive about
16 miles to get to work. I have to go across a toll
bridge and this used to be an extreme bottle neck. My
commute was in excess of one hour's time in the AM and
45 minutes in the PM. I now sleep in much later and
enjoy a commute of around 20 minutes to work. My
brother-in-law was a top sales executive during the hey-
day of the "Dot Com" era, he has been living off his
severance package and investments for 1 1/2 years now
waiting for the return of this market segment (a classic
case of denial!) 50 to 60% of the parking lots of
Silicon Valley corporate campuses are empty..."
- Oh well, easy come, easy go.
[Editor's note: Want to make your opinions count? Visit
the Daily Reckoning discussion board: The Daily
Reckoning Discussion Board http://www.dailyreckoning.com]
******
Back in Paris...
*** USA Today gives us the "contenders for the most
overpriced real estate market in the U.S.A." - Tacoma,
Wash., Naples, FL, Boston, Denver and San Diego. If you
have property in those markets and are thinking about
selling, too soon might be better than too late.
*** Markets tend to peak on Sept. 22 more than any other
day, says Paul Macrae Montgomery, who studies "non-
rational" relationships between markets and other
phenomena. After the September highs come the familiar
October drops...such as those in 1978, 1979, 1987, and
1989. October was also the month of the Asian crisis
(1997) and the month the geniuses failed at Long Term
Capital Management (1998). It was also the month that
the market crashed in '29.
*** Mutual funds have less cash in their portfolios than
they had a few months ago, said Michael O'Higgins to
Barron's. And mutual fund investors are very near to
losing real money - their savings. Their stock market
gains are already gone, he points out. The celebrated
fund manager believes fund investors could panic soon -
if the market drops further. If so, the funds will be
forced to liquidate their positions. Who knows, maybe
this October will be the month that the panic we've been
waiting for finally comes?
*** A big story in the Paris newspapers: "Baghdad
Embarrasses the U.S." Saddam called Bush's bluff, the
story tells us. "Come on down," the Iraqi dictator
seemed to say. "Have a look around. I've got nothing to
hide."
What will the American president do now, they want to
know.
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* * * * * * * * * * * * * * * * * * * * * * *
BAD TIMES, GOOD MONEY
By Bill Bonner
It is unwise to be too sure of one's own wisdom. It is
healthy to be reminded that the strongest might weaken
and the wisest might err.
- Mahatma Gandhi
Today, we will not pick on the Fed chairman. We promise.
Cross our hearts and hope to die.
We are moving on. The chairman will get whatever the
Fates have prepared for him. God help him.
But the evil that men do lives after them. As the Caesar
of central banking continues towards his reward, the
world's financial system lunkers on too - towards
correction.
"For the first time since WWII, the world is in the
grips of a synchronized global economic downturn,"
writes Dr. Kurt Richebacher. "We are looking for
financial turmoil in the United States of a gravity
without precedence in the whole postwar period."
Greenspan spent the last 16 years puffing up not only
his own reputation, but also the biggest credit bubble
ever.
Not that we have any special information on the subject,
but we take it for granted that what inflates is also
subject to deflation. Central banking in the time of
Greenspan became such a popular sensation that it seemed
to many that it was a permanent success. The Greenspan
Fed had increased the supply of credit more than all the
Fed chiefs and Treasury secretaries back to the time of
Washington. Nobody complained, as the 'inflation' went
directly into stock prices. It began to look as though
the science of central banking had been mastered, and
the business cycle had been brought to heel too. For,
had not Greenspan proven that he could increase credit
without triggering inflation? And didn't that give him
the ability to head off a recession by cutting rates
quickly?
But nothing fails like success. Or, as economy Hyman
Minsky pointed out, nothing can be more de-stabilizing
for an economy than a long run of macro-economic
stability.
American entrepreneurial capitalism, combined with
enlightened Greenspan central banking, seem to have
taken the risk out of stocks and paper money. The Fed
seemed capable of managing both for the benefit of long-
term investors. Is it any wonder they bought and
borrowed when it made sense - in the '80s - and
continued to buy when it didn't - in the '90s?
Both the credit bubble and Mr. Greenspan's own bubble
reached their zenith about a year ago, by our reckoning.
Both now seem to be losing gas.
We noted on Monday that gold hit its lowest point since
the early '70s about the very same time that Mr.
Greenspan's stock seemed to peak out, with the
appearance of the Bob Woodward book, "Maestro" in
November of 2000.
Mr. Greenspan had become the biggest news story in the
entire world. Sure, there were probably a few primitives
in fishing villages in the New Hebrides who had never
heard of the man. But to the world's intelligentsia
economica, the chairman of the Federal Reserve system
was 'household,' as well known as Ronald McDonald, Cher
or Jim Beam.
On the day the book came out, you could have bought an
ounce of gold for $264. But it would have cost you
$11,152 to buy the whole Dow. That was a big change from
the late '70s. Then, the Dow and an ounce of gold
changed hands for about the same price.
But since the book "Maestro" appeared, the Maestro
himself has been in a bear market. More and more often
you see him criticized in the press. Unlike Kozlowski
and Blodget, he has not been blamed for stock market
losses - yet. But the longer the slump continues...and
the closer the U.S. economy edges towards deflation...
and the more stock prices fall...the more people will
wonder about the curious bubble the Fed chairman
wrought.
Mr. Greenspan's stock does not trade publicly and is not
quoted on any exchange. But Daily Reckoning readers may
still profit as it goes down. Gold is the nemesis of
managed currencies. It is what investors turn towards
when they lose faith in the managers. Since the
appearance of "Maestro," the price of gold has risen
20%. The Dow has fallen nearly 30%. These are trends we
expect to continue at least until Mr. Greenspan's
reputation is fully corrected.
"Gold is heading for $1,000," writes my old friend
Martin Spring. Over the last 12 months gold has risen
15% against the dollar. Gold mining stocks, after taking
a beating this past summer, are back up about 40% since
January.
"In recent years," Martin continues, "there's been an
almost-perfect negative correlation between US shares
and the gold price...which means that if Wall Street
continues to fall, it's almost certain bullion will
rise."
Martin notes that global demand is currently exceeding
mine and recycling production by about 400 tons a year.
So little money was spent on new exploration and mine
development in the last decade, production will probably
fall further, until the price of gold hits $400 - $500
an ounce, high enough to encourage additional
investment...
But why would gold go up in a general price deflation?
"Gold can also prove to be a good defensive investment
in deflationary times, as it was in the '30s," Martin
explains. "Over the past three years the bullion price
has risen 23% despite a fall in inflation both actual
and anticipated by the markets (as shown by the
declining differential between the yields of fixed and
inflation-protected government bonds.)"
Gold is real money, after all. It is decent money when
Fed chiefs prosper. It is even better when they don't.
Your correspondent,
Bill Bonner
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