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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

OUZILLY, FRANCE 
TUESDAY, 20 FEBRUARY 2001 

 

Today:  The Coming Internet Depression

*** The business cycle is un-dead. Can it be put off by 
making the sign of the dollar?

*** O'Neill believes in the perfectibility of capitalism... 
and why not?

*** Random acts of gratuitous marketing...Living 
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*** The dead presidents were honored yesterday with a 
holiday on Wall Street. So, things are pretty much as we 
left them on Friday. Wholesale prices are increasing at 13% 
per year - annualized from the latest month's data. And 
tech companies are announcing that they either have no idea 
what the last part of the year will bring (Dell) or don't 
like what they see (Nortel).

*** This week should be interesting too. The giant 
retailers - Nordstrom, J.C.Penny, Liz Claiborne, to name a 
few - will post their results. And on Wednesday, the 
Consumer Price Index for January will be revealed.

*** The trouble with recession is that people get laid off, 
lose income, and don't buy as much stuff. Then, the people 
who sell stuff notice that their earnings are falling and 
they stop investing in the machines and people that make 
the stuff. The supply of stuff goes down until consumers 
begin to notice that they need stuff again.

*** What I have just described is, of course, the business 
cycle - which was declared dead in 1998...but is suddenly 
looking rather un-dead. Like it or not, the U.S. economy is 
now cursed with this ghoulish specter. 

*** It is commonly believed that the beast can be put off, 
simply by waving a dollar bill in front of its face. Like 
making the sign of the cross in front of a werewolf, the 
dollar sign is supposed to cause a recession to shrink back 
into the shadows.

*** On this trick does Mr. Greenspan, the most celebrated 
recession-slayer of all time, rest his faith and his 
policy. Will it work? Not forever, certainly, but maybe one 
more time, allowing the Fed to puff up the bubble to an 
even greater extreme. That is what makes this all so 
interesting, don't you think? When the bubble finally 
blows, now or later, the demons of economic hell will be 
loosed upon the world. 

*** Asked if capitalism can exist without crisis, Paul 
O'Neill, U.S. secretary of the treasury, responded, "why 
not?" Well, that's what we try to chronicle for you, dear 
reader, in these daily reckonings. It can't exist without 
crisis, because crisis is what you inevitably get when 
people get carried away with one idea or another. 

*** But O'Neill seems to believe in the perfectibility of 
capitalism. He said he thought the Great Depression was the 
result of bad policies - monetary, trade and fiscal. "We 
did everything wrong," he said. 

*** Will we do everything right this time? I don't think 
so, dear reader, I don't think so. Capitalism is inherently 
unstable. It is a system of booms and busts. Government 
policy cannot stop the boom/bust cycle...it can only make 
them worse.

*** O'Neill says he thinks the economy is growing at 
between plus 0.5% and minus 0.5%. 

*** "The American middle class is full of families that 
could not write a check for the rent, utilities, insurance 
and car payment at the same time," writes Lynn Carpenter. 
Lynn's convinced that the true barometer of the economy 
comes not from the major indexes, or the Fed funds rate, 
but from the balance sheet of the average family. 

*** "Families need to put a new television on their credit 
card..." Lynn points out. "Yet, since 1974, rent and 
utilities have fallen from 23% of an average family's 
spending to 17%-in real terms, after inflation. Food has 
gone from 19% of the budget to under 14%. What's going on 
here? For one thing, that 26% reduction in housing costs is 
offset by a 600% increase in the portion of the budget 
spent on recreation! Families are also tripling the amount 
they devote to apparel and shoes, and doubling what they 
spend on transportation..." (see: J. Paul Getty, The 
Richest Man in Babylon...).

*** A number of class action suits against Nortel have been 
set in motion. Plaintiffs charge that the company misled 
investors...and note that company executives sold $7 
million of Nortel shares within 3 weeks of the profit 
warning announcement. Nortel, once at C124.50 is now around 
C30. The shares rose C2.25 yesterday in Toronto.

*** The 9 major tobacco companies are up an average of 90% 
so far this year. But, uh oh, analysts have turned bullish 
on tobacco. Philip Morris, which we suggested to you a year 
ago, now trades at $47.

*** A friend sent me a remarkable exhibit from the 
'practice random acts of kindness' school of marketing. "We 
can't make your tuna salad just the way you like it," says 
the letter. But Amazon.com can send customers 10 1-cent 
stamps to help them adjust to the postal rate increase in 
January, which is what it did. In big ways in and small 
ones, Amazon continues to redistribute shareholder's money 
to customers. "Short Amazon" says the accompanying message 
from my friend. (also see: Still A Great Short)

*** "Everything is out of phase," said our gardener, Mr. 
Deshais, this morning. A week ago, we were outdoors in our 
shirtsleeves telling each other that winter was over. 
Today, I am sitting so close to the fire I can smell my 
sweater burning - and looking out the window at the plum 
trees already in bloom. It has turned very cold. Snow has 
been forecast for later in the week. 

*** "I'm going to kill the goose," Mr. Deshais added.

"Why," I asked naively, "what did it do?"

"No, no, Monsieur Bonner," said the ever-practical 
gardener, "we now have room in the freezer, so there's no 
reason to continue feeding it."

Later, I went out to the woodshed to see what he was up to. 
The goose was strung up by his feet. The white feathers of 
its neck had turned red...and were dripping. Not quite 
dead. I wondered what it must have thought. The poor thing 
watched Mr. Deshais's little dog, Tina, drink the pooled 
blood on the ground. Mother nature is no sentimentalist.

*** "Live Large," urges a headline at Forbes.com. I 
imagined the scene...a fat person, finally liberated from 
the restraint of embarrassment, rises triumphantly at a 
meeting and tells his fellow weight watchers: "Stuff it! 
I've had it with starving myself. I'm going to Live Large!"

But no, the Forbes message - which might be better phrased, 
"Live Grandly," offers readers a chance to win 3 nights at 
the Forbes chateau, which I believe is in the Loire Valley 
not too far from here.

*** Not to be outdone, I will offer DR readers a similar 
contest. First-place winners will get 3 nights free in my 
chateau d'Ouzilly. Losers will get 4 nights. Details to 
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THE COMING INTERNET DEPRESSION


Paul O'Neill notes that the Great Depression resulted from 
doing all the wrong things. This is the view made popular 
by Milton Friedman. 

As historian Sean Cashman described the situation in the 
late '20s and early '30s:

"The people running the economic machinery simply did not 
fully understand the system they were operating. Official 
dependence on outdated cliches - such as maintaining the 
gold standard, balancing the budget, and opposing inflation 
- all posed insuperable barriers to an early solution to 
the crisis."

"But after a while," as Friedman observed, people "stop 
making the same mistakes." What he forgot to say is that 
they begin to make new ones.

An historian, looking back on the boom of the late 90s, to 
which we have already borne witness, and its resolution in 
the early 2000s, which we await, is likely to notice both 
kinds of errors. That is, he will see the classic errors 
made by investors and policy makers - ignoring the business 
cycle....allowing themselves to get swept off their feet by 
greed and hubris...and believing that they could get 
something for nothing. Plus, he will see some entirely 
new errors too - products of the unique set of 
circumstances at the end of the 2nd millennium and the 
beginning of the next.

"Every economic era is afflicted with its own unique 
curse," announces the opening sentence of Michael Mandel's 
book, "The Coming Internet Depression." 

"Agricultural economies were tied to the rhythms of the 
harvests," he continues. "Villages would prosper when crops 
were good, and suffer, when drought or pests withered the 
fields. A long enough drought could devastate a region or 
even a civilization."

"Up until the business cycle of 1857, or perhaps 1866," 
Mandel quotes Charles Kindleberger, "the harvest was the 
measure of business conditions. A bumper crop lowered the 
price of bread...crop failure, on the other hand, led to 
depression."

In the long period pre-dating the industrial revolution, 
most of the economy of all nations was the farm economy. 
There was not much more than that. A bad harvest was bad 
news. But at least it was local bad news. People in the 
affected area suffered a decline in their standards of 
living. Economic slumps meant reduced rations. This 
affected all agricultural economies - even those in the New 
World. Skeletal remains of colonists in Maryland during the 
1600s, for example, show that they suffered from periodic 
malnutrition. 

If the economic crisis was particularly bad, and people had 
not saved enough in coin or grain, they starved to death.

But the Industrial Revolution changed things. It virtually 
eliminated the threat of starvation, by vastly boosting 
farm productivity...and by reducing the cost and time of 
transporting food. It compressed space - so that people in 
London could enjoy bananas from Latin America and people in 
New York could eat lamb raised in New Zealand. 

Mandel: "The gradual shift to an industrial economy 
seemingly made growth more controllable and predictable. No 
longer was prosperity tied to the harvest... The new source 
of wealth was systematic investment in capital goods - 
machinery, factories, railroads, electrical and telephone 
systems - which could be used to multiply human 
productivity. At the same time the rise of the modern stock 
and bond markets in the second half of the 1800s provided 
financing for large capital projects on a scale never 
before dreamed of. The dawn of mass production permitted 
industrial economies to achieve unprecedented growth rates 
and living standards.

"It soon became clear, however, that industrial economies 
were prone to new types of economic fluctuations. Worse, 
these shocks were broader, more pervasive, and in many ways 
more violent than any country had experienced before. 
Starting in the middle of the 19th century, national and 
global capital markets opened up the door, for the first 
time, to national and global economic crises - the boom-
and-bust cycles in business investment and labor markets 
that we now recognize as the familiar business cycle."

After more than 200 years of observation, the business 
cycle should come as no surprise. Yet, each generation of 
investors and businessmen seems condemned to rediscover it 
on its own...at least once, and often several times.

As recalled in these letters, the railroad industry of the 
19th century saw several full turns of the boom/bust cycle. 
Fortunes were invested in the belief that you couldn't 
overspend on such a promising new technology - only to 
discover that too much had been spent. Investors went broke 
episodically, right up into the 20th century, as if each one 
was the Adam, the Alpha Man, of the investment world. "The 
total investment in American railroads came to roughly $10 
billion in 1890," Mandel tells us, "an enormous sum at a 
time when the entire annual output of the economy was on 
the order of $13 billion."

As further recalled in these letters, the auto industry 
repeated the experience of the railroads - again, as if no 
one had ever before invested in a new transportation boom. 
Into this new investment Eden, billions of dollars were 
devoted to competing for the automobile 'space.' Five 
hundred separate companies were created.

But the business cycle still operated, in the 20th century 
as in the 19th. What went up so magnificently, fell with 
equal flamboyance.

"The depths of the collapse," Mandel writes, "were 
staggering. In the twelve months prior to October 1929, 
America's automobile factories produced over 4.7 million 
cars. In the year after the crash, automobile factories 
production fell by 40%, as consumers simply stopped buying. 
By 1932, production had fallen to only 1.12 million cars, 
75% BELOW ITS PEAK. Over the stretch from 1929 to 1932, the 
number of automobile production workers fell by 45%, a 
decline that traumatized whole states. And that drop 
underestimates the economic impact: auto company payroll 
expenses actually dropped by 65%."

More recently, the classic error and cause of the business 
cycle has been repeated in the go-go industry of our time: 
Information Technology. Fortunes have been spent on 
computers, the Internet, and telecommunications. So much 
excess capacity has been created that it will take years to 
work it off.

Mandel cites the example of Toys R Us, which in 1999 felt 
compelled to spend $86 million to set up a website in order 
to meet the challenge posed by eToys. EToys went public in 
May of '99. The stock rose 200% in the first day of 
trading. It looked as though the toys online space was 
going to be worth billions. Toys R Us couldn't let eToys 
get it all.

But a year later, online toy sales didn't look so good. In 
fact, it appeared that eToys had spent too much on too 
small a market. The shares, which had traded at $76 on the 
first day of trading, closed on Friday at 15 cents. The 
company has gone bust.

"Like most failed e-tailers," reports Forbes, "eToys 
overspent, building out infrastructure and floating an 
expensive marketing campaign in anticipation of a market 
that didn't materialize fast enough to support the 
business."

Among other evidence of overbuilding, eToys is left with a 
1.2 million-square-foot distribution center in Blairs, Va., 
which opened in August 2000. "They built a great 
distribution center, but the volume you would have to do to 
make the place profitable is astronomical," Forbes quotes 
an analyst, "No one's e-commerce activities could even come 
close." 

Of course, these are merely the classic, traditional errors 
of the business cycle. In the present case, they have been 
permitted to go to greater excess than usual, thanks to the 
credit industry and the Fed...but the mistakes are the same 
as those made by the financiers of the railroads or the 
stock buyers of the '20s or the Japanese real estate 
investors of the 1980s.

Tomorrow, we will look at what is really new about the New 
Economy...and why it threatens an even more calamitous 
correction.

Your correspondent....

Bill Bonner
 
 
 
 
About The Daily Reckoning:

Daily Reckoning author Bill Bonner

Bill Bonner is, in spite of himself, a natural born contrarian. Early each morning, Bill writes The Daily Reckoning—his take on the financial markets and what’s going on in the world—and sends it off by e-mail before most Americans’ alarm clocks have buzzed. Many readers say it's the first thing they want to read when they get up—not only because it's informative and thought provoking, but also it's inspiring, in its own quirky and provocative way.

Of course, there's much more to Bill than his daily market commentary. He's also the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies. Bill's passion for international travel and big ideas are reflected in the company he's successfully built. In 1979, he began publishing International Living and Hulbert's Financial Digest . Since then, the company has grown to include dozens of newsletters focusing on health, travel, and finance. Bill has vigorously expanded from Agora's home base in Baltimore, Maryland since the early ’90s—opening offices in Florida, London, Paris, Ireland, and Germany.

Agora's publication subsidiaries include Pickering & Chatto, a prestigious academic press in London and Les Belles Lettres in Paris, best known as a publisher of classical literature in bilingual editions.

 

 
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Last modified: April 01, 2001

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