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Contributed by Bill
Bonner
Publisher of: The
Fleet Street Letter |
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OUZILLY, FRANCE
TUESDAY, 10 APRIL 2001 |
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Today:
Capital
Spending Bust
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*** Another slow day on Wall Street - Amazon up 34%!
*** Money supply, credit - expanding at double-digit
rates...
*** Protection against inflation...the miracle of
the modern world...the grammar snoots...and more...
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*** Another relatively slow day on Wall Street.
Light volume. Little news.
*** So starved for excitement were investors that
when Amazon.com founder Jeff Bezos said that yes,
Amazon.com would lose money, but no, not as much as
expected, the stock rose more than a third. Of
course, a third of AMZN is not nearly as much money
today as it was a year ago. That only left the stock
at $11 and change.
*** AMZN led the Internets to an 8% increase for the
day.
*** What else happened? Well, IBM fell 2% following
a negative article in Barron's. And GE rose 2%, for
no apparent reason.
*** The Dow ended up 54 points. The Nasdaq rose too
- up 25.
*** Broad money supply (M3) rose by $66 billion last
week. Consumer borrowing is still expanding at a 10%
rate. Revolving debt, too, is increasing at about a
10% annual rate.
*** "Money supply as measured by M2 and M3 growth
has skyrocketed since the beginning of the year..."
says Daily Reckoning contributor Michael Belkin. "In
fact, the surge is equivalent to those that
accompanied the Fed's Y2K credit expansion over a
year ago, or the late-1998 LTCM bailout. Those were
bullish events for the U.S. equity market...that is,
until the monetary binge ended." (Has The Fed
Abdicated Its Authority?)
*** How long can money and credit continue to expand
nearly 10 times as fast as the economy (that is, the
value of all the goods and services the money and
credit buy)? Good question. Answer: not forever.
*** But while money comes into the system, it also
goes out. The LA Times reports that the city of Los
Angeles alone stands to lose $193 million from the
bankruptcy of Pacific Gas & Electric. In Japan,
banks are writing off 4 trillion in bad loans. And
the Toronto Globe & Mail puts total U.S. stock
market losses at $6 trillion.
*** One of the miracles of the modern world is the
way the dollar has, so far, held steady...or
actually risen. Yesterday, the dollar rose again,
slightly...pushing the euro back below 90 cents and
knocking the price of gold down $1.70.
*** This miracle is viewed as an enduring one by
investors - as evidenced by the widening gap between
the CPI and the "break-even" rate on inflation-
indexed bonds. On February 28 of this year, the
Consumer Price Index was clocked at 3.5% - that is,
the cost of living was said to be rising at that
rate annually.
*** On March 26th, the 10-year inflation-indexed
Treasury yielded just 3.36% - for a negative real
yield and only 1.65% less than a regular non-indexed
Treasury obligation. This latter figure is Mr.
Market's implied expected increase in the CPI each
year for the next 10 years. If the inflation rate is
higher than 1.65%, investors who bought the indexed
Treasuries will come out ahead. If the inflation is
less than that amount, investors who bought the
regular Treasuries will be the winners.
*** Are you still with me? I hope so. Because I
haven't come to my point yet: 1.65% is a low number.
In fact, it is lower than any of the numbers the CPI
has registered for the last 30 years. According to
Grant's Interest Rate Observer, "the CPI has risen
by an average annual rate of 2.67% over the past 10
years, by an average of 3.57% a year over the past
20 years and by an average of 5.04% a year over the
past 30 years."
*** After destroying their currencies - little by
little - the world's central bankers are undoubtedly
getting good at it. Of course, there is no law that
says they have to continue doing what they do best.
But nor is there any law that prevents them.
*** If you consider Treasury inflation-protected
securities (TIPS) as insurance against inflation,
the cost of protecting yourself is cheap. It is
cheap because most investors do not believe there is
much risk. "TIPS constitute one of the world's few
investment bargains not measured in troy ounces,"
says Jim Grant.
*** Dallas Fed chief, Robert McTeer, said he
expected the economy to grow at a 1% annual rate in
the first quarter and then to slip into negative
territory.
*** Lynn Carpenter: "The cover article in the March
19 Forbes gives the ten best tech trends to invest
in...'even in a down market these will pay off,'
Forbes swears. Maybe so. I checked. To be fair,
Forbes gave four pans: Motorola, Sirius, Amazon and
The Street...and they did drop an average 32%.
*** "But the winner list? Even worse." says Lynn.
"The average loss was 35%. Only one of the 16
recommended stocks is up, Network Associates. The
other 15 are down. Some really down, like Palm -67%,
Level Three -63%, ECM -78%, Brocade -57%, Foundry -
45%. This is in seven weeks...even after Nasdaq had
already dropped 40%. Fools do rush in, don't they?
*** "Forbes picked Global Crossing to buy," Lynn
adds, "It fell 39%. I picked it too, as a short play
for Contrarian Speculator. We bought a put option
last Thursday and made 80% in three days on half our
contracts. We're now up 113% on the remainder - and
looking for more."
*** "Splitting infinitives sounds bad," said
Elizabeth.
"But it only sounds bad because you believe it is a
mistake," I replied, fresh from reading "Tense
Present" in Harpers. "The rule comes from Latin,
where you can't split infinitives, and was
misapplied by 19th century grammar snoots. It made
them feel superior to the hoi polloi."
"Yes," said Elizabeth, "but that's true of
everything. Once you know how things should be -
that's the way you think they are best. You judge
things by applying the standards...the rules of
refinement..."
"But once you know that the rule against split
infinitives is a mistake, like pronouncing the 't'
in often," I continued, "you can split all the
infinitives you want - and feel even snootier than
the snoots."
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CAPITAL SPENDING BUST
"Three successive announcements that the Fed was
lowering its targeted short-term rate - from 6.5
percent Jan. 3 to 5 percent as of March 20 - have so
far brought about no significant response form the
economy itself," Chris Byron notes. "Factory orders
are declining, gross domestic product continues to
inch downward, durable goods orders are slipping and
leading indicators are weakening."
It is possible, of course, that Mr. Greenspan & Co.
have not yet found the magic interest rate that
sparks new growth in the economy and sets investors'
hearts on fire. He still has 500 points that he can
try - on the downside - and an infinite number on
the upside.
But it is also possible that there is no magic rate
- and as the Japanese have demonstrated, sometimes
even free money is not cheap enough to entice
borrowers.
"As economists now increasingly realize," Byron
continues, "the boom of the 1990s was rooted to an
significant extent, in the soaring value of
financial assets on Wall Street, which are now
disappearing."
"The growth of those assets had dramatic and far-
reaching consequences for the economy," he explains.
"Among other things, they encouraged individuals to
stop saving for retirement since rising asset values
on Wall Street were, in effect, doing the saving for
them. The freed-up capital poured into the economy
has sustained a surge in consumer spending, creating
a level of demand for consumer goods that had not
before existed."
In today's letter, to quickly give you (there, I
split an infinitive for you) a warning of what is
coming, I attempt to explain how a boom in capital
spending misled businessmen, economists and
investors.
"An entire generation of companies like WorldCom and
Cisco Systems...grew to spectacular multi-billion-
dollar valuations," Byron elaborates, "[and] helped
fuel a huge boom in capital spending - an investment
explosion that in turn generated an enormous
outpouring of goods and services for which there
was, and is, no demand..." Byron adds.
It looked for all the world like a bubble. Sober men
and women were buying stocks at levels that seemed
absurd. With straight faces, CEOs announced multi-
billion dollar acquisitions of start-up companies
with no revenues. Popular books promised a Dow of
36000. Financial magazines - not satire rags - told
all the world how to GET RICH...STAY RICH...AND LIVE
RICH FOREVER.
But economists - including the most famous and
powerful practitioner of the dismal science who ever
lived, Alan Greenspan - saw two things in the
developing boom that made them think it was solid
and enduring.
First, corporate earnings rose. And second, so did
productivity.
"In the past 50 years," writes Marc Faber in Forbes,
"after tax profits have increased at an average rate
of 7.6% a year, compared with 7.4% growth in nominal
GDP. However, in the past 9 years, corporate profit
growth accelerated, particularly for the S&P 500
companies, whose operating earnings have grown by
13.5% a year on average, compared with 5.8% growth
in GDP. This was the highest annual earnings growth
rate over a 9-year period since World War II."
Meanwhile, productivity doubled to 2.4% in the 10
years beginning in 1990.
The increases in productivity and corporate earnings
seemed to confirm that the billions spent on new
Information Technology were paying off...and that
the Information Age was for real.
That was then. This is now:
"Today, CEOs are scrutinizing the payback from all
the IT spending," reports an article in Fortune
Magazine. Despite the productivity gains, Fortune
says, "now even Greenspan seems to fear that all
these gains were induced not by IT itself but by
spending on IT. In other words, if a firm buys a new
computer, the very act of spending will add output
to the economy, and assuming employment remains
steady, increase productivity..."
What did corporate America really get for all the
billions spent on routers, computers and software?
What did it gain from all the preaching, hectoring
and lecturing it endured from the oh-so-superior
technophiles? Probably not much. But for a while,
the spending had a very flattering effect on
corporate income statements as well as on
productivity levels.
Capital investments, unlike consumer spending, are
treated as current income by the seller, while the
cost is expensed, over time, by the buyer. The net
effect is to leave businesses with higher profits in
the short-run, but expenses spread out for years to
come. These expenses should be offset by higher
levels of productivity and future profits - but, in
this respect, IT spending could be a big
disappointment.
Typically, businesses borrow to make capital
improvements. Thus the future expenses are not just
bookkeeping entries on next year's operating
statement. They are real debts that have to be paid.
"The U.S. corporate sector now has the highest-ever
burden of debt as a percentage of revenues. In a
sluggish and possibly deflationary environment,"
Marc Faber warns, "this will wreak havoc with
profits."
If stock prices continue to fall - as they should -
consumers will cut back on spending. Businesses have
already cut back on IT spending - as evidenced by
the rising inventories at Cisco and other Big Tech
suppliers. In Silicon Valley, they are calling it a
"buyers' strike." But that is probably the most
optimistic way to look at it. Strikes can be
suddenly called off. What would induce businesses to
invest big money in IT once again? A rate cut,
perhaps?
"Even an interest rate of zero cannot revive the
capital spending boom," Christopher Byron concludes.
"So get used to it, Greenspan, you're now going to
be blamed for being unable to fix a problem you
never should have created in the first place...and
nothing you can say or do about it now seems to
matter much either way."
Your humble scribe, reporting the news...sticking to
the essentials,
Bill Bonner
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| About
The Daily Reckoning: |
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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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