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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

OUZILLY, FRANCE 
FRIDAY, 5 JANUARY 2001 

 

Today:  Spent Out Economy

*** Rally Fizzles...no follow through on Greenspan boost
...is the Greenspan Put shot?

*** The dollar gives back most of Wednesday's gains...

*** "When Stuff Happens..."...what does Greenspan know that 
we don't?...'How to Survive the Slump'...and more!

*** "Yesterday's Rally Fizzles" announces the headline on 
TheStreet.com. After a spectacular run-up on Wednesday - 
following the Fed's 50 basis point cut - neither the Dow 
nor the Nasdaq could follow through.

*** The Dow closed down 33 points - on huge volume. The 
Nasdaq lost ground too - down 49 points. The Internets fell 
3%. Could investors just be pausing for breath before 
another big move to the upside? Or has the Greenspan Put 
been shot?

*** We'll know soon enough. Ominously, while the Dow and 
Nasdaq at least held onto most of their gains from 
Wednesday, the dollar fell sharply against the euro. On 
Wednesday, the dollar registered its biggest increase 
against the euro ever. But 24 hours later, global investors 
must have realized that lower rates in the U.S. are not 
good for the foreign exchange value of the dollar. 
By the end of yesterday's trading, the euro was back to 
94.71 cents.

*** "Asian Investors Sense Alarm in Fed Move," a Bloomberg 
headline informs us. "Why now and why 50 basis points," 
asks Ng Cheong Lip, a Singapore fund manager, "Maybe the 
situation in the U.S. is really bad."

*** The last time the Fed cut rates between meetings of the 
FOMC was during the Russian default crisis of Oct. '98. Are 
there other big defaults coming?

*** The worry echoed around the world as investors waited 
for another shoe to drop. Could there be a size 12, EEE 
problem - like the Long Term Capital Management crisis - 
about to hit the trading floor? Might there be a major 
financial institution about to fail?

*** "What does Greenspan know that we don't?" asked analyst 
Paul McCulley. "When stuff happens, the Fed eases," 
McCulley notes, leaving investors to think that Greenspan 
is always ready to rush in and save the day with lower 
rates. And if you look at a chart of stock prices during 
Greenspan's tenure you can see that each time stocks were 
threatened - the Fed dropped rates. Naturally, investors 
have come to expect help from the Fed at critical moments. 
More below...

*** "I consider Greenspan a menace to society," writes 
William Fleckenstein. "Rather than talking about people 
managing their risks, he seemed to embrace the new era. My 
complaint with him is not yesterday's ease, it's the 
implication that he is bailing out the stock market and 
once again 'writing a put for the stock market'."
(see: Rate Cut Rally, A Day Late And Maybe A Dollar Short)

*** A quick, gratuitous opinion: Greenspan's rate cut has 
given investors a marvelous opportunity - to get out of 
overpriced stocks. Sell the rallies. 

*** California's largest utilities are on the verge of 
bankruptcy - but everyone knew that. And they're not likely 
to be helped by 50 basis points. In fact, few people will 
get much out of it. Again, more below....

*** Curiously, breadth was decent yesterday - with 1590 
stocks advancing on the NYSE and only 1366 declining. And 
only 7 stocks hit new lows, while 272 hit new highs.

*** The Financial Times reports that PC sales in December 
fell 2%; PC sales have gone down for the last 5 months.

*** Did I recommend a coal company to you last year? I 
should have. The FT also reports that coal has been in a 
bull market since July of '99 - rising from $26.55 per ton 
to $42.45 recently (coal delivered in Northern Europe).

*** The January 8th cover of TIME magazine tells us "How to 
Survive the Slump." But magazine covers are notorious 
laggards. If TIME editors are talking about 'the slump', it 
must be almost over. 

*** "The last big winner from Time," writes Caroline Baum a 
Bloomberg columist, "was its selection of Jeff Bezos as Man 
of the Year in December 1999. Bezos, the perennially perky 
CEO of Amazon.com Inc., an on-line retailer for whom profit 
is a motive, not a reality, was anointed at a time when 
Amazon's stock was trading at $97, near its all-time high 
of $106.69 set on Dec. 10. Amazon is currently down 84 
percent from its high at $17.56." 

She continues: "Examples of other classic magazine covers 
that provided good sell signals are: 

- Time magazine's 'Interest Rate Anguish' in 1982, ushering 
in one of the biggest bull markets in bond market history; 

- Business Week's 'Trouble in the Government Bond Markets' 
on May 28, 1984. In the following two years, 30-year bond 
yields were cut in half to 7 percent; 

- Time's Nov. 9, 1992, cover story, 'Can GM Survive?' GM 
stock returned 60.5 percent in the following 12 months; 

- Time's counter, 'Detroit Shifting into High Gear,' a 
December 1993 cover story, one month before GM went into 
reverse; 

- The Economist's March 6, 1999, cover story, 'Drowning in 
Oil,' predicting $5 crude. Crude oil was trading at about 
$13 at the time and marched relentlessly higher to $37.20 
in September 2000." 

*** A careful reading of the TIME article shows that the 
editors have not lost their touch. "If you own stocks," 
they write, "the worst is over. ...Now grab some bargains 
on cars, mortgages and investments." What a relief. I was 
afraid I would have to change my whole perspective. But no. 
Since TIME's editors tell us the slump is over...we can be 
sure it is just beginning. What's more, it will probably 
not be a slump at all - but a catastrophic financial 
collapse.

*** "As a small, but concrete, indication that the Winter 
of Woe is starting to bite," writes Alex Green, "consider 
this: In Potomac, (Montgomery County) Md. as you know, net 
worth is (or was) extremely high. Yet, our local library is 
unable to keep the Wall Street Journal from being stolen. 
I'm guessing but the odds are that some poor sod ...has 
stocks to check and A) can't afford to subscribe to the 
paper but B) doesn't want to stay in the reading room where 
people can see him cry."

*** Yesterday evening, after work, I helped Maria, 15, with 
her math. The problems were simple - if a product sells for 
11 francs and 20 centimes including sales tax...and 10 
francs wholesale, what is the sales tax rate? But some 
people have a mind for math and some don't. "Those sound 
like fun," said Henry, 10, a bright, cheerful, figuring 
kind of look on his face. "Can I do some?" But Maria's face 
was blank. "Sales Tax Rate? Hmmm...was that an American 
movie...or a song by Fiona Apple?"

*** Well, Benoit called the countess...and then paid her a 
visit. "She was very friendly," he reported. "And she said 
she would happily sell the fireplaces. But the French 
Commission on Historic Monuments has seized the property. 
Even she no longer has the right to touch the stones."

Tis a pity. 

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SPENT OUT ECONOMY

Greenspan's 50 basis point rate cut triggered an immense 
rally on Wall Street. The announcement took place just 
after noon, while fund managers and analysts were eating 
their customers' lunches. Before the sun set on Wall Street 
investors were about $900 billion richer. On paper.

What more proof could we want that Alan Greenspan can work 
miracles...that he can create wealth out of thin air?

And yet, who knows, in a few more trading sessions that 
wealth may be wiped out...and more to boot.

The problem with humankind - to start this letter off with 
the proper profundity - is the same as the problem with the 
New Era itself. The New Era required a new, digital man to 
make it work - one who would respond rationally, logically, 
and unemotionally to whatever came his way. He would simply 
add things up - as a computer might...and come up with the 
right answer every time.

But we homo sapiens analogos don't operate that way. 
Instead of ciphering the data, we try to make sense of 
things by comparing new information to other things we 
think we understand.

We don't say, "the stack of wood was 2.235 meters high." We 
say it is "as high as a pile of 15 tort lawyers..."

We don't know precisely how thick each tort lawyer is...but 
it doesn't matter. We only know things by analogy and 
metaphor...and can imagine how much nicer things would be 
if tort lawyers were stacked.

Human minds, except for those of Wall Street analysts, are 
flexible enough to absorb almost any new set of facts into 
the nuance of known metaphors. But the trouble is that the 
metaphors are never perfect. 

In the popular imagination, Alan Greenspan is seen as the 
pilot at the controls of a vast airplane. He can lower the 
flaps or raise them - according to his wont. If the plane 
flies too high, or too low, it will be because of 'pilot 
error' - because Greenspan reacted too much or too little.

But the U.S. economy is not an airplane. The metaphor is 
inadequate. The economy is far more complex...infinitely 
complex, in fact. And in one critical respect, it is unlike 
any machine ever made: it anticipates the pilot's moves - 
and resists them.

"A common characteristic of financial crises," wrote Henry 
Kaufman in his recent book of memoires, "is that most 
market participants fail to anticipate them. If they did, 
the crisis wouldn't materialize, for the majority of market 
participants would take countervailing actions that, 
collectively, would mute the developing turmoil. Only a few 
see the storm approaching. The vast majority - after 
contributing to the making of the crisis in the first place 
- are caught off guard when the tempest hits, and suffer 
the consequences accordingly."

Alan Greenspan is reacting to what may or may not turn out 
to be a crisis. No one doubted that Greenspan would cut 
rates. The only question was when and by how much. And 
since everybody knew what the Fed chief would do - months, 
and even years, before he actually did it, they already had 
priced the Greenspan Put into their investment decisions. 
Those who believed Greenspan would lower rates - and that 
lower rates would make stocks go up again - were already 
fully invested. The rate cut had been discounted by the 
market months in advance, in other words. And since it had 
already been discounted - it will change nothing.

The only surprise in Greenspan's move was the timing. He 
might have waited a few weeks for the next FOMC meeting. 

The real surprise will come when the analogy proves 
misleading. Greenspan has opened the throttle and raised 
the flaps. But will the plane go up?

If liquidity were like jet fuel, the engine would roar and 
the plane would power higher. But it is not. It is more 
like pig food. Put it in a bucket and hold the bucket up to 
a pig's snout - and you may be able to lead the animal 
where you want him to go. Then again, you may not.

There is a phenomenon in economics known as "spent out 
demand." It is what happens after people have been on a 
spending spree. 

"I don't care how low you take mortgage rates and what kind 
of incentives you put on cars or how many rebates Best Buy 
offers," comments Jim Paulsen of Well Capital Management. 
"Demand is saturated. The only solution is we use up those 
goods we have."

Also saturated is the demand for credit. Consumers and 
investors were quite sure Greenspan would cut rates...or do 
whatever is necessary...to keep America prosperous. They 
saw no need to wait for him to prove it. They went ahead 
and acted on this belief - and thereby cut Mr. Greenspan 
off from his controls.

Confident of an era of permanent prosperity, protected by 
The Maestro himself, consumers cut savings rates from about 
9% in 1991 down to nearly zero in the year 2,000. Household 
debt service rose to 13.7% - near an all-time record. 
Durable goods spending had been between 22% and 26% of GDP 
from '50 to '95. Last year, it hit 30% - "off the charts," 
said Paulsen. 

Looking at the 5 1/2 years from the beginning of '95 to the 
middle of last year, GDP rose $2.7 trillion. But corporate 
and consumer debt rose $4.7 trillion. And total credit and 
debt creation rose $8.9 trillion.

The entire nation - anticipating the Greenspan Put - dared 
to spend and go into debt as never before in history. 

Is there anyone in America who still needs a new gas-
guzzling SUV or pick-up? Is there anyone who failed to 
refinance his house when the real, net cost of borrowed 
funds was a gain of 15% per year? Now that the net, real 
cost of borrowed funds is closer to a loss of 30% - will 
people rush to refinance, merely because Mr. Greenspan has 
cut the Fed Funds rate by half a percentage point?

People are saturated with confidence in the Fed chairman. 
They can only be disappointed.

More to come...

Bill Bonner



 
 
 
 
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Last modified: April 01, 2001

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