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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

PARIS, FRANCE 
WEDNESDAY, 10 JANUARY 2001 

 

Today:  Adverse Selection

*** Europe growing...America Shrinking: What happened to 
the U.S. miracle economy?

*** Will the U.S. lead the next phase of the world's 
technological evolution? Maybe not...

*** Internets up...Amazon stretches out creditors...GE 
down...Too big to save?

*** The big news today is that Europe is now growing faster 
than the U.S. European growth is estimated to be about 3% 
in 2001. Even with the flattering light of hedonic 
measures, and the extensive cosmetic surgery done on 
American income statements, the U.S. doesn't look so good. 
Byron Wien, chief economic strategist at Morgan Stanley 
believes the U.S. economy will shrink 1.25% annualized in 
the first half of the year. 

*** And Barron's reports that consensus earnings for U.S. 
corporations for this year are below those of the year just 
past. 

*** Is it any wonder the euro has gained 12% against the 
dollar since the end of November? The European currency 
fell back a little yesterday, but still closed just below 
$.95 - way above the 83 cents of last autumn.

*** All of a sudden, it looks like the dollar has 
competition. And so does America. Unemployment in Euroland 
is coming down. It dropped 2.35% last year - the biggest 
decline in 35 years. Incomes are up. Savings are strong. 
Debt levels are low.

*** Nor is Europe particularly concerned about a slowdown 
in the U.S. Despite the massive trade deficit in the U.S., 
exports to the U.S. make up only between 2% and 3% of 
Europe's GDP.

*** America led the most recent phase of the world's 
technological evolution. Thanks to companies such as 
Microsoft and Intel, almost every desk in the world has a 
computer on it. But now it appears that the world is 'spent 
out' on computers. And profit margins are falling too - as 
the whole industry becomes more competitive and components 
become commoditized.

*** What will be the next stage? Will America dominate it 
too? Not necessarily, says Bloomberg columnist Matthew 
Lynn. The next big boom could be in pharmaceuticals or 
genetics - where the Europeans are as strong as anyone. 
Europe is leading the way on the next generation of mobile 
phones, too. And the European manufacturer, Airbus, not 
Boeing, is developing the huge new Airbus 380 plane - 
capable of making up to 500 passengers miserable on a single 
flight.

*** The Dow dropped 48 points yesterday. The Nasdaq gained 
45. Again, breadth was good. 1622 stocks rose on the NYSE; 
1285 declined. There were 165 new highs; but only 14 new 
lows.

*** Why the good breadth? Leading techs disappoint 
investors and get marked down. But people - especially new 
investors with no experience of bear markets - still 
believe in 'stocks for the long run.' So they move their 
money to other stocks. A headline in the Atlanta JC tells 
the story: "401(k) Investors Still Aggressive."

*** "The greater fool market is still working feebly," 
writes the Fleet Street Letter's Lynn Carpenter. "There are 
still hopefuls out there who will buy a good story and 
don't know how to pick stocks. If you want to make money on 
your riskier stocks, do it now. Sell your growth stocks 
unless they are very high-quality, profitable businesses. 
Unload your doubtful techs if you have any. Take profits on 
stocks that have grown overvalued. Today there are buyers, 
maybe. Tomorrow there won't be." (see: 7 Ways To Beat The 
Market - Again - In 2001)

*** Internets were the big winners yesterday - with 
TheStreet's index up 8.6%. Amazon was a winner too - plus 
10%. But diving into the murky waters of the Amazon.com's 
income and balance sheet statement, a researcher from 
Grant's found that the company was taking longer to pay its 
bills.

*** The rise of the euro is a much under-appreciated event. 
It means, for example, that the Fed will pay a heavy price 
for lowering interest rates. Foreign investors look first 
and foremost at currency trends before making an 
investment. How could it make sense to buy a T-bond with a 
yield below 5% - when you lose 12% on the falling dollar?

*** And how does it make sense to buy dollar-based stocks 
that are losing 10% - 50% of their value in the course of 
the year? It doesn't. And a few basis points won't change 
the logic. (see: 50 Basis Points To Sustain The 
Unsustainable)

*** When foreign investors lose money on their U.S. 
investments, they can be expected to do the logical thing - 
sell. This selling pressure drives down asset prices even 
further.

*** "Analysts Wonder," says a headline from the Kansas City 
Star, "Whether Fed's Rate Cut Will Be Enough To Loosen 
Tight Lending Market" Well, they might wonder. But the 
current malaise is a product of rates that have been too 
low for too long - not that have been too high. More 
below...

*** GE fell another 2% yesterday. The company has big 
exposure to derivative positions...plus it owns so many 
different companies in so many different industries - it 
can't help but be hurt by a business slowdown.

*** FDIC said that net charge-offs are up 16% from the 3rd 
quarter of 1999. A third of these bad loans were made to 
business borrowers.

*** And this from a DR reader who has found a star (or two) 
to steer by:

As a business astrologer, I looked at Pacific Gas and 
Electric's astrological cycles today (Friday, Jan. 5th). If 
they have a zillion fairy godmothers, maybe they could 
prevent bankruptcy, and I'm not even sure that would help 
their situation. It looks like they will be sold
off in pieces shortly after they go bankrupt VERY soon 
(days).

Bank of America is also in trouble (stopped trading!), but 
astrologically it looks like they will manage to escape 
bankruptcy."

*** My source then offers an interesting reflection: "I 
only know that a year ago I read an article about the mega-
banks, of which Bank of America is one. It used to be the 
big banks were considered to be 'too big to fail', so they 
were merged with other larger banks whenever this occurred. 
Now the mega-banks are so big, they can't be saved..." 

*** Securitization, Derivatization, Globalization. Remember 
these words. You will be able to use them to pass an 
American history test in the year 2100.

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ADVERSE SELECTION

"Why will DaimlerChrysler want to add significant new 
manufacturing capacity in 2001 - no matter how low rates 
go," asks Christopher Byron in an MSNBC article, "in the 
face of having just announced that the company plans to cut 
auto production by 25% in the year ahead?"

Byron wonders, along with many others, how a rate cut from 
the Fed stimulates demand. After a man has stuffed himself 
with foie gras and canard a l'orange, for example, a 
restaurant is not likely to entice him to spend more by 
lowering its price on poulette fermiere. All it might do is 
to draw in new customers - those who could not afford the 
previous prices - who are still hungry: that is, customers 
it may not really want.

"Adverse selection" it is called - when policies designed 
to encourage one group end up stimulating another, 
unintended - and perhaps less suitable - group. It is just 
one part of a whole group of perverse phenomena - all of 
which seem to find expression in Greenspan's rate cut. In 
an attempt to avoid the consequences of too much credit 
over too long a period, the Fed chairman is offering the 
market what it needs least: more credit. 

Lower interest rates are intended to induce qualified 
borrowers to take up loans and use them to good purpose. 
But who would borrow when asset prices are falling, shelves 
are clogged with inventory, and borrowers already have 
borrowed too much? Any sane man knows what to do when he 
has over-eaten...it is time to push back from the table, 
light up a cigar, and have a drink!

But the latest figures show that people are still borrowing 
- despite the most ravenous gorging on debt in all history. 
Consumer debt rose $12.9 billion in November - a 10.29% 
rate, annualized. This follows an increase of $17.3 billion 
in October.

Countrywide Home Loans, a California lender, says 
refinancing requests rose 30% since the Fed's rate cut 
announcement. And credit card debt rose $4.8 billion in 
November, after going up 7.9% in October. 

Who are these borrowers? And why are they borrowing?

Greenspan made a critical mistake on Jan. 3. He lowered 
rates - between FOMC meetings... and by 50 basis points. 
These two features signaled to the markets that the problem 
was large...and urgent. Large problems are not solved by a 
single rate cut. In every case, it has taken a series of 
rate cuts over many months to cure a declining economy. 
Thus, more rate cuts are almost guaranteed.

"Anyone who had been planning to make a discretionary 
purchase expensive enough to require a loan or mortgage," 
continues Byron, "now has a powerful reason to stop, lean 
back and simply wait, secure in the knowledge that loan 
rates will be lower 6 or 9 months from now."

This is the law of perverse outcomes at work. Greenspan's 
action has the effect of discouraging borrowing - at least 
by those who are creditworthy.

But it may accelerate borrowing by those who are not - and 
make the resulting credit collapse worse. Xerox borrowed $7 
billion from banks before its lines of credit were 
exhausted. Now it is forced to sell assets under the worst 
conditions - when it has to do so to raise operating cash.

A similar phenomenon of adverse selection may be occurring 
among retail borrowers. Caught in a squeeze of lower stock 
values, higher debt servicing costs, and stagnant incomes - 
they may need the money to meet operating expenses. 

This is a problem that could get much worse. The total of 
outstanding credit card debt is less than $500 billion. 
But, thanks to aggressive credit card marketing, there is 
$2.4 trillion of unused lines of credit available to credit 
card customers. How much of that will get used up - like 
the loans to Xerox - just to meet cash-flow obligations?

If only Alan Greenspan were really at the controls of some 
vast machine! He might twist a knob...he might push a 
lever...and the machine would do as he wanted. 

Instead, Greenspan's lever sends the machine going in an 
unexpected direction: "History shows us," writes Charles 
Peabody optimistically, "that such injections of liquidity 
(while they can arrest the deflation process of a 
particular asset) rarely seek out the devaluing asset, but 
instead seek out the inflating assets."

Rate cuts do not restore things to the way they were before 
the downturn, in other words, they create a new bubble 
somewhere else! Alas, life is such a tangle....such a 
jungle of mixed and contradictory motivations...with such 
dense underbrush that you can scarcely see where you are 
going.

In every respect, Greenspan's rate cut seems doomed. It 
causes qualified borrowers to hesitate...while inviting 
unqualified ones to go more deeply into debt. And it 
produces a new round of inflation in an unintended sector. 

Or, it does nothing at all! 

"Today's economy is far more responsive to movements in 
stock prices than it is to short term interest rates," says 
Ray Dalio of Bridgewater Associates. As long as stock 
prices are going down, rate cuts are not likely to have 
much effect. In Japan, the central bank reduced rates 
following its bubble deflation of 1990. Rates went all the 
way to zero - with no effect on either the Japanese economy 
or Japanese stock prices. Instead...the liquidity in Japan 
flowed all the way across the Pacific...and lifted the 
yachts of tech entrepreneurs on Puget Sound and 
stockbrokers and analysts on Long Island.

Your correspondent....

Bill Bonner
 
 
 
 
About The Daily Reckoning:
The Daily Reckoning... "more sense in one e-mail than a month of CNBC."  That's what readers are saying about The Daily Reckoning.

Bill Bonner, recognized internationally as a brilliant writer, entrepreneur
and publisher of The Fleet Street Letter, offers you his daily market
commentary absolutely FREE. For the first time, outsiders are getting a peek into his powerful and profitable investment insights. Bill's practical contrarian advice empowers even average investors to protect their hard-earned wealth and achieve amazing gains.

Bonner writes his email letter from Paris, France, each morning --
describing the wacky, wonderful world of investment, politics and everything remotely related. Irreverent. Sharp. Honest. Thoroughly, unabashedly contrarian. It's also among the fastest growing e-letter on the Internet.  It's a brand new service... but it has a distinguished history..

For nearly 62 year, The Fleet Street Letter, the oldest investment
advisory letter in the English language has consistently delivered
invaluable economic and political foresights to savvy investors. Current readers regularly enjoy impressive investment gains even as the market falters. Here's more from his online readers...

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Last modified: April 01, 2001

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