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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter



Today:  Intellectual Capital

*** It's the economy, stupid! Why rate cuts won't work...

*** Dow and Nasdaq give back the rally...

*** Russia on the verge of default...California lawmakers: 
dumb and dumber...the euro slides...and more...

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*** 'It's the economy, stupid!' That thought must have 
occurred to investors in the wee hours of last Thursday 
morning. "They were reminded," says the Chicago Tribune, 
"that a slowing economy and lower corporate profits were 
behind the [Greenspan's rate] cut, and the markets promptly 
gave back the rally."

*** Both the Dow and the Nasdaq gave back a little more of 
the rally on Monday. The Dow fell 40 points. The Nasdaq 
dropped 11. Breadth, however, was reasonably good with 
1,613 stocks advancing on the NYSE and 1,330 declining. 

*** The winners yesterday were the gold mining companies - 
up 6% as measured by the HUI. The losers were the biotechs 
- down 5%. Could this be a trend in the making?

*** New Era of Networks announced a larger loss than 
investors had expected for the 4th quarter; investors cut 
the stock by 44.9%. The world's biggest company, GE, fell 

*** Good old Philip Morris, meanwhile, was the day's top 

*** "It isn't a sure thing," said Byron Wien, investment 
strategist at Morgan Stanley Dean Witter & Co., recently 
quoted in NYTimes article, "that just because the Fed 
eases, the stock market goes up. The key differentiating 
factor is whether we are in a recession."

*** As long as the economy is healthy - lowering the cost 
of credit will boost economic activity and feed into stock 
prices. But after a credit bubble splurge people get spent 
out - they lose their appetite and ability to take on more 
loans. Even though the Fed lowers its Funds and Discount 
rates - the lower rates don't necessarily reach borrowers. 
Lenders demand higher rates to compensate the greater risk 
of default. And borrowers - faced with falling asset prices 
- know that the real rate of return on the borrowed funds 
may be extremely negative. In such case, the Fed can cut 
rates - but nothing will happen. It is said to be "pushing 
on a string" - to use a phrase from the dismal science.

*** Moody's estimates that the rate of default on junk 
bonds will rise 50% this year. Personal bankruptcies, too, 
are increasing sharply.

*** "Everyone remembers what happened when the Fed eased in 
1995 and 1998," Wien explained, "but both were because of 
financial crises not recessions." 

*** "In June 1989," the NYTimes adds, "after a period of 
rising interest rates, the Fed began to ease, initially 
cutting the Fed funds target rate to 9.5625%. The day of 
the first cut, the S&P 500 stood at 326. About 18 months 
later, when the Fed funds were at 7%, and the nation was in 
recession, the S&P had risen a mere 2 points."

*** "This economy is unraveling at a very rapid rate," Mr. 
Wien concluded. Montgomery Ward is going 'chapter'. There 
was one corporate bond default on each of the first 4 
business days of the New Year - bringing the total for 2001 
to $1.3 billion in less than a week. In the last quarter of 
'99, LTV and Wheeling-Pittsburgh filed 'chapter' - bringing 
the total to 9 U.S. steel makers to go bankrupt in the last 
2 years. Two of California's leading utility companies are 
close to bankruptcy. And Xerox is selling off pieces of its 
business to try to stay alive...while the entire movie 
theatre industry seems to be in ruins. More below...

*** California lawmakers are considering a proposal to take 
over the power system. "Deregulation's not working," said 
the state's treasurer. The state, of course, has big he pointed out. It can force people to pay 
taxes - it doesn't need to wait for permission for a rate 
hike. This allows it to borrow at lower rates - permitting 
the state to pile up much bigger losses over a much longer 
time. Plus, it has the power to ignore its own permit, land 
use, environmental, health, safety and other silly 
regulations that make it so hard for honest companies to 
make money. 

*** Russia seems to be on the verge of a default, too. It 
owes its western creditors - the 'Paris Club' - about $48 
billion. That may not seem like much to you and me - but 
it's a lot for a country that, for 70 years, ran everything 
the way California is proposing to run its power system.

*** The euro slid a little - but still closed above 95 

*** "The true, key source of this fateful boom and the 
bubble is all too conspicuous in the monetary data," wrote 
Dr. Kurt Richebacher in a recent report. "Since 1995, broad 
money has increased a stunning $2.6 trillion, or 60%. Total 
credit supply has surged $9.3 trillion, or 54%, to $26.5 
trillion. But the most violent crescendo has taken place 
since late 1998, after the Fed's easing in the wake of the 
Asian-Russian crisis. Broad money in the short span of time 
since then has virtually exploded by $1.5 trillion (27%) 
and overall credit supply by $5.3 trillion (25%). Compare 
these astronomical money and credit figures with annual 
nominal GDP growth since end-1998 of around $775 billion." 
(see: Fighting or Hiding Inflation?)

*** We drove back into Paris on Sunday night. There was a 
lot of bellyaching, but all of the children headed off for 
school on Monday morning without a hitch. Paris is cold, 
gray and rainy - wonderful weather, actually, for sitting 
in a brightly lit bar (such as the Le Paradis next door) 
with a large caf‚ crŠme.

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"What will he do?" Anne asked me.

She referred to my son Will, who joined in our dinner party 
on Saturday night. As I explained to her, Will graduates 
this year, with a degree from St. John's College. After 
about 4 times as much formal schooling as Abraham Lincoln, 
Will is prepared for almost nothing. But at least he has 
read the classics and can quote Aristotle to provoke bar 

In France, students are not educated. They are 'formed,' 
prepared to do something. A young man without a 'formation' 
is forced to become a manual laborer. 

"Well, he as a good foundation in the humanities," Anne 
said generously.

"Yes," I replied, "he has intellectual capital."

And so, dear reader, I come to the subject of today's 
letter: intellectual capital. Does it really make 
businesses more valuable than their balance sheets reveal? 

Le Monde, France's equivalent to the Washington Post or New 
York Times, adds to readers' intellectual capital every day 
- giving them ideas, information, and misguided opinions 
masquerading as news. Colleges and universities add 
billions of dollars worth of intellectual capital to the 
nation's stock every year. Does it really pay off? Is 
intellectual capital something real - or just another big, 
empty phrase? I will leave that for another day and stick 
to investments today.

The q ratio compares the price of a company's stock to the 
replacement cost of its assets (roughly, book value). Over 
the long haul, the q ratio has been fairly stable and had a 
predictive quality. Whenever stocks were extremely 
expensive relative to their underlying asset value - or 
extremely cheap - the odds increased that stock prices 
would soon move to bring q back to its mean.

As I have previously reported, q is now very much in 
overvalued territory and seems to be anticipating a return 
to much lower stock prices. In fact, in their book, Valuing 
Wall Street, authors Andrew Smithers and Stephen Wright, 
calculate that the Dow should fall to somewhere between 
1620 and 4590 in order to bring it into line with previous 
correction episodes.

But an alert DR reader reminded me that James Tobin 
himself, creator of the q ratio, came to believe that it 
had become irrelevant to the New Economy. His point was 
that businesses had much more "intellectual capital" than 
appeared on the balance sheets. If you increased the 
denominator of the ratio - that is, the replacement cost of 
the business - by the actual value of this intellectual 
capital, the ratio would fall into more common territory. 
It would show, perhaps, that stocks are not overvalued 
after all.

Intellectual capital is not something new. One has only to 
gaze at the face of Notre Dame cathedral a few blocks from 
my office to see that even hundreds of years ago people 
knew how to do extraordinary things. Stonemasons and 
architects spent their lifetimes perfecting their skills. 
If you had put a value on their enterprises - you would be 
a fool to neglect the level of craftsmanship they could 
turn out. 

But why would you ignore it? You could see from the output, 
comparing my stonewalls to the fa‡ade and flying buttresses 
of Notre Dame, that the medieval builders had far more 
intellectual capital than I do. I may know more about the 
derivatives market...or more about tobacco farming...but 
intellectual capital in the abstract is useless. It only 
has value when it is applied to a specific purpose. It is 
the output that gives it value. A man could 20 years 
studying computer science at MIT - and then get a job 
tending bar in Cambridge. Of what value is his intellectual 

People have always had intellectual capital - and always 
applied it to improve their standards of living. They built 
pyramids and bridges, raised crops and laid out 
railroads...they turned out TVs, radios, automobiles, 
microwave ovens - and all manner of other devices - by the 
millions. Yet only now, in another humbug contrivance of 
the Information Age it is thought that businesses might be 
worth more because of the "intellectual capital" held by 
the workers behind the scenes.

If the capital is worth anything at all, it has to be 
because makes things better in the real, physical world. 
Otherwise, it might be like faith or sunrises - which make 
things better, but not in a way you can capitalize. 

"The Labor Department's figures [for] 'average gross weekly 
earnings' ...for the 10 years since 1990," reports Dr. Kurt 
Richebacher, show "an overall increase from $259 to $271. 
This was a gain of 4.6% over the whole period, or less than 
half a percent per year."

If this intellectual capital has any value, it's not doing 
the much good for the people who are supposed to have it. 

But if employees are not getting the money, maybe it is 
showing up in earnings? Earnings have been rising by 15% 
per year since 1990 - twice as fast as GDP. But it appears 
to have little to do with extra productivity. "The main 
source of the prolonged profit improvement during the 
1990s," notes Dr. Richebacher, "was a sharp decline in the 
corporate interest bill...In 1990, corporate interest 
accounted for 6.3% of national income, in 1995 for 3.7% and 
in 1998 for 3.3%. This decline has actually provided two-
fifths of the profit advance over this period." 

What's more, a look at Price/Earnings ratios show stocks to 
be extremely overvalued - even after the bear market of 
last year. The Dow is trading at nearly 19 times earnings - 
or 50% above its average. Even if there is intellectual 
capital at work - it is not enough to bring the P/E ratios 
into line with historical standards.

So, if there is intellectual capital lurking under the 
balance sheets of U.S. firms - what does it do?

Unless there is a measurable output - intellectual capital 
is a worthless as an analyst's recommendation. And if there 
is measurable output - there is no need to pretend that the 
business is worth more than it appears to be worth, thanks 
to the illusive "intellectual capital."

Stay tuned...more tomorrow from your very own intellectual 

Bill Bonner

"Dad, could I get a job in your business?" Will asked me.

"Of course," I replied. "But it might be better to work for 
one of our competitors; wreck their business first."

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Last modified: April 01, 2001

Published By Tulips and Bears LLC