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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

SANTA FE, NEW MEXICO 
THURSDAY, 17 MAY 2001 

 

Today:  Fight the Fed?

*** Mr. Market likes rate cuts...at least, he did 
yesterday...

*** Dow not far from record high...even Amazon rises...
but history does not favor a new bull market...

*** Consumers have little money to spend...gold moves 
up...gold shares up 10%...

*** Yesterday, Mr. Market reconsidered the significance of 
the Fed's recent rate cut. Upon further reflection, he 
determined that what had at first seemed a non-event was in 
fact an extraordinary and economically transforming event. 
Why this is so, he is not exactly sure. But he is sure that 
it is so. At least for one day.

*** The Dow soared 342 points. In so doing, the indomitable 
index reclaimed and promptly surpassed the 11,000 level to 
close at 11,215.

*** The Dow, which last reached 11,000 - albeit in the 
reverse direction - eight months ago, now stands little more 
than 500 points below its all-time high. The NASDAQ, 
although still several 3-woods away from its all-time high, 
put in a solid day's work on Wednesday by advancing 3.9%.

*** 'If this is a bear market, let's have more of them!' 
investors must be thinking. But Daily Reckoning readers are 
cautioned that Mr. Bear is a wily animal. The DOW rallied 
50% from its 1929 crash low of 195.4 to its April 1930 peak 
of 294.1, before resuming a decline that carried the index 
down to the ultimate bottom of 41.6 in 1932.

*** "After the initial stock market crash in October 1929, 
the country remained sanguine," writes Fred Hickey of the 
High Tech Strategist. "The Harvard Economic Society issued 
a series of optimistic forecasts, including one in May 1930 
that claimed that business 'will turn for the better this 
month or next, recover vigorously in the third quarter and 
end the year at levels substantially above normal.' Does 
this sound familiar?

"In 1930 President Hoover famously declared, 'Prosperity is 
just around the corner.'" It is no small bit of irony, 
Hickey points out, that Leo Reisman and His Orchestra first 
recorded "Happy Days are Here Again" in November of 1929.

*** "The most important lesson that can be learned from 
studying past manias is that, with no exceptions, every 
completed mania has seen stock prices fall until they are 
below the original starting level," writes a reader of Bill 
Fleckenstein's Market Rap. "History does not favor the 
current bear market ending soon, despite daily predictions 
of a bottom from Wall Street media."

*** If, as the saying goes, markets make opinions, the 
opinion now being made would seem to be that Greenspan's 
got the cure. The economic plague is over. Celebrate! Kill 
the fatted calf, make merry, buy tech stocks and, if at all 
possible, break out the credit card to buy a little 
something nice for the spouse and kids.

*** "If at all possible" is a high bar for the consumer to 
clear these days. "Not only is consumer debt outstanding at 
a record relative to disposable personal income, interest 
payments are also," the ISI Group points out. US consumer 
installment debt now totals a record 21.7% of disposable 
personal income, while the payments necessary to satisfy 
that debt total 3.1% of disposable personal income, also a 
record. Looked at another way, US private debt now equals a 
record 147% of America's Gross Domestic Product. ISI 
concludes, "To be sure, consumers and corporations are the 
most highly leveraged they have ever been going into a 
slump."

*** The latest auto sales reports suggest that happy days 
are not quite here. GM and Ford both reported 16% sales 
declines in April. Non-Mercedes Chrysler's sales fell 18%.
Maybe the reason is as simple as: Consumer wants to spend. 
Can't.

*** "Just maybe the consumer will draw down credit lines 
only to maintain a satisfactory standard of living," 
grantsinvestor.com suggests, "forgoing the new Jeep Liberty 
or Maytag dishwasher in favor of keeping his already 
heavily indebted head above water." The article goes on to 
state that "likewise, corporations will borrow money for 
'general corporate purposes' like paying officers' bonuses. 
Not, we repeat, not to buy routers from Cisco, trucks from 
Volvo and blocks of airline seats from American Airlines."

*** Charles W. Peabody, the brilliant bank analyst from 
Mitchell Securities, Inc., observes that revolving home 
equity and credit card loan growth both peaked in January.
"This may be the first indication that the consumer doesn't 
have the appetite for more debt," he writes. "The big 
question is whether this diminished appetite is because the 
consumer is losing confidence, and thus, unwilling to spend 
or can't spend anymore because his debt service burden is 
already too high. Either answer bodes poorly for the 
economy over the next six to nine months."

*** Amidst the frenzy on Wall Street yesterday, a little 
bit of buying sloshed over into the gold market as well. 
The precious metal continued its winning ways on Wednesday 
by climbing almost $4 per ounce to $272.40. The Amex Gold 
Bugs Index soared more than 10%.

*** "No joke: Newmont Mining has outperformed Cisco the 
last two years," writes Eric J. Fry of grantsinvestor.com. 
"Shares of Newmont, the Denver-based gold producer, managed 
a 16% gain over the last 24 months, compared to CSCO's 26% 
loss.

"Might these archetypes be sending a message?" he asks. "As 
the tech sector abdicates its throne, are resource stocks 
laying claim to it? Chairman Greenspan's seemingly 
inflationary monetary policy improves the odds. By 
expanding the money supply at double-digit rates and 
cutting the fed funds rate five times into the face of a 
rising CPI, the Fed may be spurring greater demand for gold 
than for PCs and cellphones - for the time being at least."

*** Even Amazon rose yesterday. But Dan Ferris sends me 
this note: "Amazon's 5 year return on capital, -103.2%. 
Yes, that's NEGATIVE 103.2%." 

*** Dan is also the source of the following comments on 
credit quality: "The median corporate bond rating stands at 
BBB, weak investment grade, the lowest since 1981, the 
first year that statistic is available. Also, just 28% of 
the junk-bond universe holds the top junk rating, according 
to Moody's Investors Service, the lowest proportion in at 
least 80 years, a span including the Depression."

*** I am in Santa Fe, New Mexico, where I will be attending 
my son's graduation from St. John's College this weekend. 
Santa Fe has a style all its own. I lived here, briefly, 
about 30 years ago. But the place has changed. It's gone 
up-market. I hardly recognize it. More to come.

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FIGHT THE FED?

"Almost half of the 1300 employees of the Peruvian Central 
Bank of Reserve of are related to one another," Bloomberg 
reports. Central banking is, after all, a government job. 
It is different from, say, the local Department of Human 
Resources, only in that its employees are better paid and 
get better press. Even the Federal Reserve - perhaps the 
world's most powerful and prestigious bureaucracy - is 
still, like every other government agency, a scam, a 
sinecure, and waste of money.

At least, that is the working hypothesis of today's letter.

Not much in life is certain. That is why it is such a 
comfort to have government. One of the few things you can 
depend on is that government officials will do the wrong 
thing. Even when they occasionally seem to do the right 
thing - it turns out later on that it was at best 
accidental, and at worst, the wrong thing after all.

"The last successful government program," observed New York 
mayoral candidate Jimmy Breslin, " was WWII." Since then, 
there have been a number of wars declared and undeclared by 
Washington hawks. But in almost every instance bureaucratic 
instincts and motives were hopelessly wrongheaded.

In the war on drugs, as we observed here just the other 
day, the government seeks to put drug dealers out of 
business by interdicting supplies. This is just the wrong 
thing to do, since it increases profit margins. The more 
taxpayer money spent trying to keep illegal drugs off the 
market, the more profitable the business becomes and the 
more entrepreneurs rush in to fill the unsatisfied demand.

Yesterday's USA Today brought news that the shooting war 
has moved to the suburbs as dealers battle it out for 
control of the Ectasy market - made especially rich by 
government decree.

If government really wanted to put dealers out of business 
it would flood the market with illegal drugs - give it away 
on street corners for free. But what profit could there be 
in that? Not only would it put the drug dealers out of 
business - it would also put the DEA out of business too.

Likewise, if the bureaucrats really wanted to win the War 
on Poverty - they would tax poor people at a higher 
rate...not reward them with subsidies and handouts. So, 
too, would health officials cease to coddle the sick and 
infirm. If they really wanted a nation of healthy people 
they would revoke public health insurance benefits for 
people who eat too much or watch TV all day, and perhaps 
shoot a few smokers and fat people in the streets.

Thus do bureaucrats go about their business - making worse 
whatever problem they're supposed to be fighting, while 
actually increasing their own power. But as we will see 
tomorrow, it is a rare person who will not give up his 
dignity and his common sense in a bid for riches, fame or 
public office. 

Even Alan Greenspan, once an Ayn Rand devotee, could not 
resist the lure of power. In order to get his picture on 
the cover of TIME, something he could never do as an 
'Individualist,' he has become a collectivist central 
planner. 

Unlike other activities in life - from shopping for 
vegetables to running a Rotary club - government 
distinguishes itself in a singular way: by its ready use of 
force. Instead of coming to terms with people in a polite 
and dignified way, government orders them around like 
prisoners of war. The results are almost always pathetic 
and absurd.

Could it be any different with Alan Greenspan and the 
Federal Reserve? Could the interest rates proclaimed by the 
Greenspan Fed be superior to those set by buyers and 
sellers? Could this be one - and perhaps the only one - 
instance where government is superior to the market, and 
where the judgment of powerful government bureaucrats is 
superior to that of millions of investors and lenders?

Raising these questions, I realize that I put myself 
directly in the path of the rush of popular opinion. 'Don't 
Fight the Fed' blows the common sentiment. 

The odds favor the Fed, it is believed. Because easy money 
has to go somewhere... and because stocks rise more often 
than they fall anyway. The Fed, clearly committed to 
cutting rates until the economy turns around, seems to be 
offering investors a no-lose wager. If at first the Fed's 
cuts fail to boost stock prices... Greenspan will try, try 
again - and keep trying until the market finally responds. 
And yet, anyone betting on government bureaucrats to win 
the War on Poverty, the War on Drugs, or any of its other 
wars since 1945 would have found himself on the losing end 
of the wager.

Even the Fed itself has a reliable record. Charged with 
protecting the currency, it has done the exact opposite. In 
the 100 years preceding the creation of the Federal Reserve 
System, the dollar went up and went down, but it ended the 
period about where it began, worth as much in 1913 as it 
was in 1813. Since then, thanks to the Fed's management, it 
has lost 95% of its value.

Having failed so miserably, the Fed has done just what 
every government agency seeks to do - expand its mandate. 
Now, the Fed has taken on the job of managing the economy 
as well as the currency.

Mr. Greenspan believes, at least publicly, that the Fed can 
manipulate key interest rates and keep the economy 
expanding almost eternally. And the public believes it, too. 

Even people who have not yet begun to shave believe it. 
Teddy Chestnut, of Montclair (New Jersey) High School, said 
he was "almost positive" that the Fed would cut another 50 
basis points this week. "People are losing confidence," he 
explained, "and right now spending is the only thing 
keeping us out of a recession."

If the Fed merely cuts rates, Teddy seems to think, 
consumers will be inspired to do more of what they do 
naturally...and the economy will continue its record 
expansion. It is, of course, possible that the economy 
functions in exactly the way Teddy imagines - with the 
complexity of a grandfather clock. Greenspan has merely to 
adjust the pendulum to make it run faster or slower as 
desired. This view helped Teddy's team win $40,000 from 
Citibank in a remarkable competition called the "Fed 
Challenge." The challenge for the kids is to think like 
central bankers. That is, to think like central bankers who 
believe that Alan Greenspan is a bureaucrat like no 
other...one whose decrees actually lead the nation where it 
wants to go.

How likely is that, dear reader? Should you 'fight the Fed' 
or not?

I will take up the issue next week. 

Regards,

Bill Bonner 

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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: May 17, 2001

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