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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

BALTIMORE, MARYLAND 
WEDNESDAY, 11 JULY 2001 

 

Today:  No Saving Grace

*** Important milestones yesterday on the road to 
ruin... 

*** Nasdaq breaks 2,000...going the wrong direction! 
"Shoppers put the brake on borrowing"...and the world 
economy breaks down...

*** Airlines in free fall. Hotel rooms empty. 
Manufacturing at 37-year low. "Popularity is 
poison"...bedding down the girl scouts...and more!

Two very interesting and ominous things happened 
yesterday.

First, "shoppers put the brake on borrowing" as 
the Seattle Times reports it. This could be the first 
sign that the consumer is finally coming to his senses. 
More details in Eric's report.

"Refinancing of mortgages by homeowners is taken 
as a sign of optimism, and that things are improving," 
says the Mogambo Guru. "They are, in fact, probably just 
the opposite. There are many good reasons why a person 
would want to trade equity in his house for a little 
ready cash. In this case, with the consumer saddled with 
record-breaking debt amid a faltering economy, it almost 
certainly means that the homeowner is on the verge of 
bankruptcy, and paying off some current short-term 
creditors with a long-term loan." 

The second important bit of news was that 
Singapore announced it was in recession - the first 
Asian economy to make it official. Singapore's economy 
is not merely easing off - it is imploding, down 10% in 
the 2nd quarter. All over the world, an economic slowdown 
is developing, spreading as a sort of international flu 
epidemic.

Both of these items suggest the end of the 
American miracle economy. Year after year, Americans 
have bought more and more goods and services from abroad 
- on credit. Money is thus taken out of the U.S. 
consumer economy. But it comes back - as foreigners use 
it to buy U.S. stocks and bonds. It has been this 
marvelous circle - and not a productivity miracle - that 
helped to keep the dollar and U.S. stocks and bonds 
high...without causing consumer price inflation in the 
U.S. 

But now it is coming to an end - and a dangerous 
one.

"Foreigners own a near-record 36.7% of all 
outstanding US Treasuries, a record 13.3% of federal 
agency bonds, and an unprecedented 22.7% of US corporate 
bonds," reports James Grant. "Moreover, as of 2001's 
first quarter, a record 12.2% of the market value of US 
equities accrued to foreign investors."

What will happen as Americans stop spending...and 
foreigners stop investing in the U.S? Could it happen? 
We will see. But first, let's hear from Eric, who is 
visiting me right here in Charm City, USA:

*****

- The Nasdaq breaks 2,000! But not the way that Alan 
Greenspan, James Cramer, or Joe Battapaglia might have 
had in mind. The week-kneed index limped through another 
trading day and fell 64 points through to 1,963. The Dow 
fell 124 points.

- Isn't the stock market supposed to rally when the Fed 
is cutting interest rates? It looks like Mr. Market is 
missing his cue, and he's not alone. Neither are 
corporations nor consumers borrowing on cue. 

- Instead, the more Greenspan lowers rates, the less 
folks are borrowing. For example, the amount of 
corporate bank loans and commercial paper outstanding 
has been falling. "In an unprecedented fashion, credit 
creation has turned negative at the same time that money 
growth has accelerated," ISI observes.

- Likewise, the consumer may be losing his appetite for 
additional debt. Consumer credit rose by a seasonally 
adjusted 4.9% annual rate - the slowest rate in two and 
1/2 years. May's pace of borrowing was less than half 
the pace of April.

- Without rising employment, Greenspan's magic interest 
rate will work no magic whatsoever. "The biggest risk 
facing the U.S. economy centers on a forthcoming loss of 
jobs that might eventually prompt another slowdown by 
household expenditures," says Moody's John Lonski. "The 
Challenger Layoff Report estimates that the number of 
announced job reductions shot higher by 248% year-over-
year during 2001's first-half."

- Amazingly, manufacturing employment has now fallen all 
the way back to where it stood in 1965.

- "We continue to believe that the U.S. economy is on 
the mend and that the recent pullback in stock prices is 
part of an ongoing recovery process that will carry 
stock prices higher from here." The "royal we" who 
uttered this prophecy is none other than Wall Street 
strategist and perma-bull, Joe Battapaglia. When the 
market was going up every day, folks like Joe took great 
delight in branding skeptics as "broken clocks." Look in 
the mirror, Joe.

- "All but 5% of the stocks that crossed the analysts' 
desks on Wall Street won a buy rating last year," writes 
Lynn Carpenter, "And what do the analysts know? Whatever 
they learned in their last job... which was writing term 
papers for professors." (see: Wall Street and The 
Business of Sham Wisdom) 

- Yesterday, I rode the gleaming new Amtrak Acela train 
down to Baltimore. The speed train was designed to whisk 
its riders up and down the Eastern seaboard much faster 
than a conventional train. Instead, the Acela delivered 
me to my destination one hour late. Is there a parable 
here? Weren't those sexy new-era Internet stocks 
supposed to whisk investors rapidly to the land of early 
retirement? Yet, as the "Internet Express" has derailed, 
only the tired old value stocks have been pulling into 
the station on time.

*****

Back to Bill:

*** What is going on in France while we're back in the 
U.S.?

*** Well, Laurent Fabius, France's finance minister says 
the U.S. is at fault for the world economic slowdown. 
How the world turns! For the last 12 years, western 
finance ministers have been pounding on the 
Japanese...and U.S. economists routinely mock France's 
economic "dirigisme." Now, it is our turn to suffer the 
slings and arrows of foreign criticism and advice...

*** And from Ouzilly, my son sends the following report:

"Dad, Suzannah and I were checking our e-mail yesterday 
evening when there was a knock at the front door. Upon 
answering it, I discovered on the stoop an entire girl 
scout troop. It struck me as odd that they weren't 
holding any cookies for sale as is the American custom. 
So, I was very shocked when I asked if I could help them 
and they replied that they needed a place to stay for 
the night! I looked confused, but they assured me that 
Pierre [a neighbor who looks after the place when we are 
gone] said it was OK... So, after getting used to the 
idea and sympathetic to their exhausted state, we took 
them in. So they stayed the night... We got some 
pictures..."   (Girl Scouts At Ouzilly )

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The Daily Reckoning Presents: a Wednesday 'Special 
Guest' Essay... "In which the author refutes pundits' 
efforts to portray American finances as much better than 
they really are." 


NO SAVING GRACE 
by Paul L. Kasriel 

[A]n article in the June 23 issue of The Economist... 
cites various studies suggesting that the decline in the 
U.S. household saving rate is the result of a faulty 
definition of saving and/or has little economic 
significance because of a skewed distribution. 

The message of the article is: cheer up. Things could be 
worse. My message...is the punchline to [an] old joke: 
"So, I cheered up. And sure enough, things got worse." 

...[A]ll you have to do is look at the behavior of the 
current account deficit in recent years to know that 
Americans are spending more than they are producing. In 
effect, a current account deficit measures the net 
dollar amount of goods and services the rest of the 
world is lending to the U.S. If an individual runs a 
current account deficit, it means that she is spending 
more than she is earning or producing. What enables her 
to do that? Borrowing. If a country runs a current 
account deficit, it means that the country is borrowing 
from the rest of the world so that it can spend in 
excess of its production. 

In the four quarters ended 2001: Q1, the U.S. borrowed 
from the rest of the world, on average, an amount equal 
to about 4 1/2% of our nominal GDP - the highest 
absolute and relative borrowing from the rest of the 
world in over 40 years. This, my friends, is prima facie 
evidence that no matter how you cut it, the combined 
American saving rate for households, businesses and any 
other group you want to include not only has gone down 
in recent years, but it has gone deeper into negative, 
or dis-saving, territory. Now, this is not necessarily 
an economic "bad thing." 

If we have been using the goods and services the rest of 
the world has lent us to enhance our ability to produce 
enough in the future to pay the rest of the world back 
what it wants, and to, at the same time, increase our 
standard of living, then all of this national borrowing 
will have turned out to be an economic "good thing." 

Let's hope that those miles and miles of fiber optic 
cable that have been put down pay off!

The Economist mentions a study by the Fed that shows 
that the richest two-fifths of the population accounted 
for the decline in the U.S. household saving rate. The 
poorest two-fifths increased their saving rates 
significantly. 

Interesting, but so what? The fact remains that the 
household saving rate, in the aggregate, fell. 

If you are still feeling cheerier, I offer this to 
depress you: Total debt outstanding as a percent of the 
nominal capital stock has risen to 92%. The debt 
includes debt issued by the private sector as well as 
debt issued by the government sector; debt issued by the 
non-financial sectors as well as debt issued by the 
financial sectors. The capital stock includes that of 
the private sector as well as the government sector. 

>From 1952 through 1982, total debt as a percent of the 
total capital stock ranged from approximately 42% to 51 
1/2%. But national leverage started on an uninterrupted 
upward trend in 1983. Debt as a percent of the capital 
stock has moved up from about 48 1/2% in 1982 to 92% in 
1999. Bear in mind that we are finding out that a lot of 
the capital stock produced in the late 1990s is not 
worth very much in this new century. Though the value of 
the capital may go away, the debt will stay - stay until 
it is written off as un-collectible, that is. 

The mid-1980s was the era of leveraged buyouts in 
Corporate America. The late 1990s was the era of 
leveraged buybacks in Corporate America. "Financial 
engineering" began to be all the rage in the mid-1980s. 
Repackaging and transformation of various kinds of debt 
instruments, from mortgages to credit card receivables, 
has led to layer upon layer of financial intermediation. 

Financial risk can more easily be shifted today. But 
risk shifting is just that - shifting. The amount of 
risk is not reduced. The mortgage markets have become so 
"efficient" and competitive that households can very 
easily "monetize" the equity in their houses. Perhaps 
that is why homeowners' equity as a percent of the value 
of their houses has, in recent years, fallen to its 
lowest level in the postwar period. Easy credit terms on 
asset-based loans lead to escalating asset prices. 
Leverage is terrific when asset prices are rising. But 
it's oppressive when credit terms tighten and asset 
prices start to fall. 

Have you noticed the increased frequency of financial 
market crises since the mid 1980s? Mexico/the oil 
patch/Continental Bank, the U.S. stock market, banks and 
S&Ls, Mexico again, Asia, Russia, Brazil, Long-Term 
Capital Management, the U.S. stock market again, Turkey, 
Argentina. 

What's the trigger for the next financial market crisis? 
The bursting of the housing market bubble? And have you 
noticed what the palliative for these crises has been? 
The Fed cuts interest rates, which encourages the 
creation of even more credit. That's why the leverage 
ratio in the U.S. economy is the highest it has been in 
the post-World War II period - maybe even the highest in 
the post-World War I period. 

Deflation is anathema to debtors (like George Costanza, 
I've been waiting a long time to use that word). 
Inflation is music to debtors' ears...There are more 
voters who are debtors than who are creditors. As a 
result, expect increased political pressure for the Fed 
to keep inflating...it's politically correct now to 
inflate.

Paul Kasriel


Paul L. Kasriel is head of economic research at Northern 
Trust Co. A version of this article appeared on 
Grantsinvestor.com on June 29, 2001.

As a reader of The Daily Reckoning, you are cordially 
invited to join Grantsinvestor.com, "a new destination 
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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: July 11, 2001

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