Gary North's REALITY CHECK
Issue 409 December 31,
2004
THE SEASON OF PREDICTIONS AND DIETS
This is it: the last day of the year. There will be
one last round of overeating, matched by overdrinking.
The
January issues of ladies' magazines are at the supermarket
check-out lines. The front covers will be filled with
wonder diets that will let you lose ten pounds in two
weeks.
In the good old days, when direct-mail solicitations
for economic newsletters printed on paper still arrived in
my mailbox, there would be several that announced,
"Inside. . . . 7 Astounding Predictions for 19[xx]"
Those were the days.
The problem with predictions is the same as the
problem with diets: people don't take action. They read
the diet articles while munching leftover Fritos and
cheese
dip. They read the 7 predictions -- or 9 or 13 -- and
then
toss out the report. They don't actually sit down, look
at
their portfolios, compare the assumptions underlying their
portfolios with the assumptions underlying the
predictions,
and make adjustments. They don't change their eating
habits, and they don't change their investment habits --
or, these days, their non-investment habits.
FAITH TESTED, FAITH RETAINED
The recent scandal over the accounting practices of
Fannie Mae, the Federal National Mortgage Association,
raised a few eyebrows, but not many. After all, what's $9
billion among friends? Also, the fact that the now-fired
head of Fannie Mae received $20 million in salary,
bonuses,
and stock options in 2003, up 8% from 2002, has not
aroused
the media to an Enron-like feeding frenzy, possibly
because
the gentleman is a person of color, but probably because
Fannie Mae, unlike Enron and WorldCom, is chartered by the
Federal government. After all, we can hardly blame
capitalism for the evils of government, and the media
sharks are intent on blaming capitalism for corruption,
not
the State. According to a December 23 report on
Bloomberg's site,
Congress chartered Fannie Mae and Freddie Mac to
make funds more available for home loans. Fannie
Mae, started by Congress in 1938, went public in
1970. That year, Congress created Freddie Mac,
which was first publicly traded in 1989. The
companies have retained privileges granted by the
government that allow them to offer lower rates
than many banks. (http://snipurl.com/bm7f)
Still, the Enron-like nature of the Fannie Mae
scandal
is sobering. The accounting system was unable to detect
an
overstatement of $9 billion. In fact, the accounting
system seems to have deliberately misinformed the
shareholders. In a September 23 story in the "Washington
Post," we read about the report by the Office of Federal
Housing Enterprise Oversight regarding Fannie's accounting
methods.
The report also detailed numerous transactions
over several years where it said Fannie Mae
management intentionally smoothed out gyrations
in its earnings to show investors it was a
low-risk company. Fannie "maintained a corporate
culture that emphasized stable earnings at the
expense of accurate financial disclosures,"
regulators said in a letter to the company.
Chief executive Franklin D. Raines and the board
of directors were not singled out for blame, but
the report criticized "a culture and environment
that made these problems possible." It did name
J. Timothy Howard, the company's vice chairman
and chief financial officer, saying he "failed to
provide adequate oversight" of key control and
reporting functions and had jobs in which he both
set earnings targets and then the accounting
policies that could be used to meet them.
The report said company management didn't
adequately investigate allegations of
irregularities by a former employee, Roger
Barnes, who couldn't be reached for comment last
night. It said his concerns were "substantive"
and his cooperation with regulators important to
their examination.
The findings echo those made last year about
Freddie Mac, the other large government-chartered
mortgage finance company. Regulators, who
launched their Fannie Mae inquiry after the
Freddie Mac problems came to light, found that
Fannie failed to follow the rules in accounting
for complex financial instruments known as
derivatives, which the company uses to hedge
against movements in interest rates. Much of
rival Freddie Mac's accounting problems involved
accounting for derivatives.
That probe resulted in a $125 million fine and a
management shake-up at Freddie Mac.
http://snipurl.com/bm7p
With this report, the stock's price went into a
tailspin. Within two days, it had fallen from $76 to $67.
By the end of the month, it was around $63. But then it
rebounded. It went over $72 by late December. Then came
the departure of Raines and Howard. The stock fell below
$70. (http://snipurl.com/bm7s)
The point is this: the stock, despite this kind of
error, is not considered risky. The fact that this
institution plus Freddy Mac dominate the residential
housing market, having issued trillions of dollars of
mortgages to investors, has not significantly affected
mortgage rates. The public does not think there is a
problem. They expect housing prices to rise.
I agree, at least for those regions where rental
income will still pay for the monthly mortgage, taxes, and
insurance. But the reason I think housing in such areas
is
still a good investment is demographic. The United
States'
population in 2025 is likely to be 358 million people, up
from today's 285 million. We remain the fastest growing
nation demographically in the industrial world.
What I do not think is likely is the continued
willingness of investors to invest in long-term mortgages
at today's low mortgage rates. The Federal deficit is so
large, and spending by the Federal government so immense,
that there will be no way to finance this debt through the
conventional bond markets at today's rates. The Federal
Reserve System is going to loosen the money spigot at some
point in the next four years to keep the boom alive.
Rates
will rise. Mortgage eligibility will fall.
Bubbles eventually burst. The bubble known as the
dollar has already burst. It's down against foreign
currencies. That this was inevitable was obvious to me as
early as 2000. I told my "Remnant Review" subscribers on
September 1, 2000, that the euro was a good investment.
This was not a perfect call. In my January 19, 2001
issue,
I reported:
The euro had risen to the 95 cent range by
the first week of January. In the September 1
issue of Remnant Review, I recommended buying the
euro. That recommendation was premature. It was
worth 90 cents then. I should have waited two
months. It fell to 83 cents. It looked like a
bad call. It was surely not a great call; I
missed the bottom. But in international currency
matters, it's very hard to call a bottom for any
currency. I think we have now seen it for the
euro in relation to the U.S. dollar.
With the euro in the $1.35 range today, we have seen
the steady decline of the dollar. The day of dollar
hegemony is broken.
The dollar has not collapsed, but it has steadily
declined. There has been no panic rush by central bankers
to sell dollar-denominated assets. The Australian central
bank has been replacing the dollar with other assets, but
it has been a maverick. Other central banks are now
likely
to follow. But no central banker wants to be the one who
pulls the plug. The banks all are loaded up with T-bills.
It is the steady erosion of international confidence
that is the threat. People are not rushing for the exits,
but foreign central bankers with large holdings to defend
are now looking around to see where the exits are.
People learn slowly. They do not act on what they
see. They act in terms of emotion, and smooth moves
create
no emotionals highs or lows. That's why Fannie Mae
smoothed out the numbers.
The stock market, as measured by the Standard &
Poor's
500, peaked at 1540 in the spring of 2000. It bottomed in
early 2003 in the 800 range. Today, it is in the 1200
range. (http://snipurl.com/bm86) In short, it has not
simply gone nowhere for five years; it is down. Yet there
are still millions of investors who believe that an index
fund of American shares is still to road to wealth. The
mania of 1999 has cooled, but the basic outlook -- buy
American stocks and hold for long-term appreciation -- has
not been abandoned. Five years of evidence to the
contrary
has not shaken the faith of the typical investor.
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WHAT WILL AMERICANS DO FOR A LIVING?
For as long as Asian policy-makers continue to play
the mercantilist game, gaining dollar reserves instead of
gold, the subsidy to American consumers will go on. We
will still buy our digital toys at low, low prices. And
not just digital toys, either.
Maybe you saw the article about a Chinese city that
produces socks. Probably you didn't.
DATANG, China - You probably have never heard of
this factory town in coastal China, and there's
no reason you should have. But it fills your sock
drawer.
Datang produces an astounding 9 billion pairs of
socks each year -- more than one set for every
person on the planet. People here fondly call it
"Socks City," and its annual Sock Festival
attracts 100,000 buyers from around the world.
Southeast of Datang is Shenzhou, which is the
world's "Necktie Capital." To the west is
"Sweater City" and "Kid's Clothing City." To the
south, in the low-rent district, is "Underwear
City."
This remarkable specialization, one city for each
drawer in your bureau, reflects the economies of
scale and intense concentration that have helped
turn China into a garment behemoth. On Jan. 1, a
new trade regime will end the decades-old system
of country-by-country quotas that split up the
world's exports among roughly 150 countries. Now,
China is banking on its immense size and
efficient operators to grab an even larger share
of the world's clothing orders.
Neither Adam Smith nor Karl Marx could possibly
have imagined that this kind of capitalism would
evolve from a communist system in quite this way,
with an obscure town in the middle of nowhere
becoming the world's sock capital. But these
days, buyers from New York to Tokyo want to be
able to buy 500,000 pairs of socks all at once,
or 300,000 neckties, 100,000 children's jackets,
or 50,000 size 36B bras. And increasingly, the
places that best accommodate those kinds of
orders are China's giant new specialty cities.
http://snipurl.com/bm9k
The American mass market textile industry is as good
as dead. A few companies will eke out a living by making
specialty items for the rich, but basically, the American
textile industry is going the way of Alabama cotton-
production system of 1859. All the weeping and wailing of
textile producers, and all the quotas and tariffs passed
by
Congress ever since 1950 did no ling-term good. It only
delayed the industry's burial. "Norma Rae" (1979) was a
well-acted movie, all about an attempt to organize a union
in an undercapitalized textile company in the South. It
sang the old songs of the 1930s, but it was a lost cause
in
1979, let alone now. The unions can organize all they
want: 100% of closed factories. It will do them no good.
Socks City has spelled the end of the Amalgamated Clothing
and Textile Workers Union. The union can't organize Socks
City. The WTO won't allow tariff hikes. "Solidarity,
Forever" is no longer bring sung in union halls by anyone
under 70.
Asia has broken the back of the industrial unions in
America. It will soon break the backs of similar unions
in
Europe, which is far more unionized than the United States
ever was. Every time the dollar falls, European importers
can buy Chinese products cheaper, because China fixes the
yuan at parity with the dollar. Imports from China keep
getting cheaper in Europe, along with imports from
America.
What will Europeans do for a living?
At some price, they will find something to do. So
will Americans. Human labor is valuable. It is also
substitutable. Men will find a way to sell something of
value to the market. But the terms of trade with low-cost
producers will force wage cuts in industries that are
competing with Asian peasants newly arrived from the farm.
THE DOLLAR WILL CONTINUE TO FALL
The great reversal is not here. The hegemony of the
dollar is fading. It is erosion time. This need not
become a collapse. The effect of a few percentage points
per year is sufficient to crush the industrial labor
unions, as well as undercapitalized enterprises.
American consumers are doing this. They want better
deals. As long as foreign investors and foreign central
banks want to buy American debt and ownership of American
companies, thereby holding up the value of the dollar,
American consumers will get good deals from abroad. We
all
want good deals. Capitalism is making it possible for
Asians to offer us those good deals. That's what freedom
does.
The implications of the shift in the terms of trade
have not yet registered forcefully in the stock market.
Investors act as though nothing has changed, as if they
will be able to spend their way into prosperity by taking
on more debt. Americans have bought into the Keynesian
myth: "A nation can get richer by deficit spending." What
was applied at first to government deficits is being
applied to the consumer debt the disciples who have
adopted
the theology of the Church of Keynes.
People should be allowed to make their own decisions.
If they want to buy now and pay later, that's their choice.
But when creditors at last perceive that they will not be
repaid in money of equal value, let alone appreciating
value, they will no longer lend at today's low rates.
That's when more bubbles will pop.
CONCLUSION
Nobody seems to care that Fannie Mae has hit a speed
bump. Nobody thinks the days of wine and roses in the
mortgage markets cannot go on much longer. A scandal of
this magnitude barely warrants a column in the business
section.
The tip of the credit iceberg is visible. Not many
people want to admit that there is danger ahead. They
want
to believe that there is always a pain-free soft landing
for every bubble.
When the Titanic went down, it was possible for
hundreds of people on the upper deck to survive. The
lifeboats were not filled. They were moving away from the
ship, to avoid the vortex that the sinking ship would
create. A man with a life preserver could have leaped
into
the freezing water and swum toward safety. But hardly
anyone did this. Maybe they didn't recognize the
opportunity. Maybe they had a sense of honor. Maybe they
thought, "If everyone did this, the lifeboats would fill
up. I won't jump."
The fact was, so many poor people had been
deliberately locked below decks by the crew, all of the
rich could have survived by jumping. I would have jumped
as soon as I saw that (1) I could not save those women and
children locked below decks; and (2) no one else was
jumping.
Look at your career through the eyes of a sinking
industry. America will not sink into the depths, but your
employer may. Don't count on your retirement fund,
either.
Spend some time in the next week re-examining your
prospects, given a falling dollar and increasing
competition from low-wage earners. See what changes you
really ought to make.
*************************
Appendix 109
Testimonial #467 comes from a man who bought the
library of a deceased man. His widow sold it to him. In
it, he found Abraham's materials. He runs a mobile
computer publishing company. It's a niche market.
1. The more you tell the more you sell.
For years I have marketed software, accessories,
knowledge products, upgrades, and refurbished
devices for the mobile market. My company,
Thaddeus Computing, has been on the cutting edge,
serving first laptop customers when HP introduced
the first DOS laptop, then palmtop customers,
when HP introduced the first DOS palmtop. We now
support Microsoft-based Pocket PC customers with
our widely distributed magazine -- last print run
150K.
This confirms a basic principle of direct-response
marketing: you sell to people who are informed and
interested in your product or service. The more copy you
write -- if it's lively, informative copy -- the more you
will sell. As more and more readers put down your ad,
those who do keep reading are getting closer to buying.
Write your copy for them, not the ones who will quit
reading. The narrower the market, the hotter the hot
buttons.
I like the way you draw the reader in, tell your
story, use evocative compelling words. I feel
like you have been speaking to me, directly, all
these years. I like your sincerity and how much
your writing communicates that you believe what
you say. I like the personal nature of your
communication, and I have on and off been able to
set up a similar relationship with my readers and
catalog buyers. When folks see me at trade shows,
they feel they know me. I also like your choice
of fonts, bold, caps, headlines, etc to bring the
reader in. I try to emulate that -- but it is hit
and miss.
Talk to people. Don't talk over their heads. Don't
talk to them as children. Don't talk to a committee.
Talk
to your representative customer. Make the reader into
another customer.
2. No risk for client
Like you, I try to take the risk for the client
in our offers. Since through the years we have
refurbished and resold mobile equipment, assuming
all the risk is a key USP [unique selling
proposition]. The customer doesn't have to worry
-- we'll give money back, we have generous
warranty/repair policy. Our core magazine product
also comes with standard no-risk offer.
This should be obvious. You should bear more of the
risk. You're making the claims. Stand behind them.
Create a way to persuade the reader that you do stand
behind them.
3. Generosity
We always try to give more than promised, and
give free unadvertised extras. . . .
4. High Perceived Value and Bonuses
We always try to come up with high perceived
value and bonuses.
If you are in sales, these rules will produce more
revenue than your existing marketing does. And you are in
sales . . . even if you're just trying to get a better
job.
You're selling you.
-------------
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