Contributed by Bill
Publisher of: The
Fleet Street Letter
WEDNESDAY, 11 JULY 2001
No Saving Grace
*** Important milestones yesterday on the road to
*** 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 |
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
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
But now it is coming to an end - and a dangerous
"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
*** 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
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,
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
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
for thoughtful investors," for a 30-day free-trial. Just
click here: http://www.grantsinvestor.com/agora.html
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The Daily Reckoning:|
author Bill Bonner
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoninghis take on the financial markets and whats going
on in the worldand 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 upnot 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 90sopening offices in Florida, London, Paris, Ireland, and
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.