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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter



Today:  Anatomy of a Bust

*** Poor James Glassman...if only he had half a brain!

*** Greenspan cuts rates for the 7th time...has he 
finally appeased the gods?

*** Oh la doesn't look good for investors: 
stocks at their highest levels ever, as the world sinks 
into recession... 

*** Poor James Glassman. If only he had half a brain! 

*** He should have panicked when the fear first came 
creeping up his back. 

*** Instead, he let his left brain talk his right brain 
out of doing what it wanted to do - sell out. He's 
holding "for the long run" - when, he's darned certain, 
stock prices will be higher. They're always higher in 
the long run, aren't they? Life always gets better, 
doesn't it? 

*** Well, yes...except when it gets worse.

*** Yesterday, things got worse for investors worldwide. 
With no virgin and no volcano anywhere in sight, Alan 
Greenspan cut the fed fund rate by another quarter of a 
point. It was hoped that this 7th cut would do that which 
the previous six had been unable to do - touch off the 
"rocket fuel" of cash that is said to be lying around. 
But instead of shooting up...the stock market blew up.

*** Eric, can you give us the details?


Eric Fry in New York:

- The Dow Jones Industrial Average dropped 146 points 
yesterday to 10,174, while the Nasdaq Composite Index 
tumbled 50 points, or 2.7%, to 1,831.

- Greenspan seems like a nice enough guy and it's clear 
he means well, but can somebody please tell him that his 
interest rate cuts don't really do anything?

- Stocks, in particular, are putting the lie to the myth 
of Greenspan's magic interest rate. They've been 
declining all year. No doubt about it, the stock market 
is a rough place these days. How rough? Even James 
Cramer, founder/columnist and self-
anointed investment guru, is losing money.

- Cramer's personal portfolio, updated daily in the 
"RealMoney" section of, has lost 8% since 
April Fool's Day, 2001. The starting date is, I'm sure, 
pure coincidence...

- The genetically bullish Abby Joseph Cohen reduced her 
earnings estimates for the S&P 500 and trimmed her year-
end price target - again - for the index from 1,550 to 
1,500. Considering that the S&P 500 currently trades at 
1,157, she has left herself plenty of room for future 
price target reductions.

- Neither Cramer nor Cohen's brand of investment genius 
operates "24/7," but only in bull markets. In bear 
markets, it's a pretty safe bet that Mr. Market doesn't 
care what either one of them predicts.

- Down in the dark, dank caves far removed from proper 
society, where gold bugs, class-action securities 
lawyers and other social outcasts congregate, the 
question on every investor's lips has been, "Is this the 
big one?"

- Is it? Could it be? Is this the beginning of the epic 
new millennial gold rally?

- The bullion price has advanced about 4 � % over the 
last three weeks. What's more, the XAU Gold Stock Index 
has gained almost 14% since Greenspan kicked off his 
rate-cutting adventure on January 3rd. By contrast, the 
Dow has dropped more than 4% since then and the Nasdaq a 
perfect bear market 20%. 

- It's enough to make a guy bullish on gold.


Back to Bill in France...

*** Oh la we say here in La Belle France...God 
does not share His plans with us here at the Daily 
Reckoning. But He occasionally drops a hint. 

*** The Wall Street Journal reports that P/E ratios are 
typically understated, because companies tend to inflate 
the divisor, that is...earnings. If earnings were 
brought down to GAAP standards, the P/E ratio of today's 
S&P 500 would be 36.7 - the highest it has ever been.

*** So, let me pose a rhetorical question; Does it make 
sense to own stocks at the highest prices in history 

-rate cuts have just been cut for the 7th time - 
after which, investors dump stocks!

-consumers are tapped out - savings are at their 
lowest level ever, consumer debt at its highest

-durable goods orders are falling - they fell 2% 
in June, after a rise of 2.7% in sales 
dropped 5% in June

-unemployment is rising - AOL announced another 
1700 layoffs yesterday. Ford says it is cutting 
5,000 jobs. And Futjitsu is eliminating nearly 
15,000 employees...

-world trade growth is off 60% since last year... 
while world GDP growth is falling below the IMF's 
2.5% recession threshold

-business profits are falling...down 17% in the 2nd 
quarter with no sign of improvement...

-And the dollar is, finally, going down?

*** People believe in stocks "for the long run" because 
equities tend to go up more often than they go down. But 
nature does not give something away without taking 
something back. In order for stocks to go up most of the 
time, they have to go down A LOT some of the time... 

This may be one of those times.

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The Daily Reckoning Presents: A Guest Essay in which the 
author takes a look at the "vicious cycle" currently 
consuming the markets...

by Eric J. Fry

The vicious cycle of falling corporate profits that 
prompts cuts in capital spending and layoffs, that 
fosters less consumer spending, that leads to even lower 
corporate profits - it's just getting warmed up.

During the boom, $50 million, give or take, would buy a 
standard suburban garage stocked with two PCs, two 
recent college grads and a B2C business plan scrawled on 
a napkin. We called this "investing" - or more 
specifically, venture capital investing - and, from 
coast to coast, folks lined up to give it a whirl. 

Since then, we have learned that $50 million is a lot of 
money, especially when it is gone. We have also learned 
that much of what passed for investing was nothing more 
than rank speculation. Like a bottle-blonde, it only 
looked like the real thing. Enter the bust, phase one: 
Billions of dollars of VC money went "poof," along with 
another $5 trillion or so of stock market wealth. And 
sooner or later, we're going to miss this money. 

The astonishing thing is that hardly anybody acts like 
it's far. The line of people at Starbucks 
waiting for $5 cappuccinos is just as long as it's ever 
been. (I know. I stand in it.) What kind of pathetic 
excuse for a bust is this? Five trillion dollars 
disappears and still people buy lots of expensive cars, 
houses and espresso drinks. 

"A few quarters of weak GDP growth? A collapse in 
capital spending offset, in part, by the indomitable 
leveraged consumer? Is that all there is?" colleague 
James Grant muses. "No, it seems to us. The millennial 
adjustment is far from over. Telecom and tech were not 
the whole bubble, only the most visible portion."

Make no mistake, the bust isn't over - in fact, it's 
just getting warmed up. All Greenspan's horses and all 
Greenspan's men, not to mention all Greenspan's interest 
rate cuts, won't be able to put this economy back 
together least not any time soon.

About the only way to get things back on track is to 
clear away the debris of the boom years. "Busts are 
indispensable," says Grant. "At least - behold Japan - 
no proper boom can be built on the uncleared debris of a 
preceding boom. What is this debris? Business and 
financial error as reflected in misbegotten investment 
projects, bad debts, impaired balance sheets, wild 
expectations. The job of the bust is to redress these 
mistakes - in effect, to mark them to market..."

"Bust" is just a four-letter word for vicious cycle. It 
takes a little time to crank these babies up, but once 
they start humming, there's no shutting 'em down. The 
cycle goes something like this: Corporate profits fall; 
businesses curtail capital spending; businesses lay off 
workers; the newly unemployed and the now-paranoid 
remaining workers, in their part-time role as consumers, 
spend less money. And once everyone starts spending less 
money, corporate profits fall even further. You get the 

Come, let's take a closer look at the bust currently 
underway. First off, corporate profits are falling. The 
surge in productivity that Greenspan and all the ivory-
tower dwellers crow about did not prevent business sales 
from dropping 1.1% in the second quarter - the first 
such decline since the last recession in 1990. 

Expressed another way, the quarter-to-quarter annualized 
decline in business sales registered at a minus-2% rate 
in the first quarter and worsened to minus-2.8% in the 
second quarter. "Meanwhile, [corporate] profits stumbled 
from a year-to-year growth rate of 19.8% in Q3 2000 to a 
21% decline by Q1 of this year," reports Moody's. 
"Without a real upturn in revenues and is 
hard to imagine hiring activity gathering speed..."

Indeed, quite the opposite is occurring. Cutting 
expenses is the hot topic in boardrooms across the land. 
Businesses are slashing both discretionary capital 
expenditures and non-discretionary costs, otherwise 
known as employees. After rising by a cumulative 287,000 
in the first quarter, non-farm payrolls reversed course 
in the second quarter, shedding 217,000 jobs. "The 
annualized growth in state unemployment benefit 
recipients soared from 37.5% to 90.1% over the same 
span," Moody's relates. "July's 3.06 million state 
unemployment benefit recipients was the highest [number] 
since October 1992." Clearly, hiring activity is not 
gathering speed.

Furthermore, a decline in hours worked reflects the 
weakening demand for labor. "After rising by a meager 
0.2% year-to-year in the first quarter, hours worked in 
the productivity series declined 0.5% annually in the 
second quarter," observes Moody's. "Hours worked last 
year entered into a year-to-year decline in 1990's third 
quarter, or what was the first quarter of the last 
recession. Since 1950, annual drops in hours worked were 
recorded in nine instances," Moody's goes on. Eight of 
the nine coincided with recessions.

Enter Greenspan, armed to the teeth with rate cuts and 
money-supply growth. His six rate reductions in six 
months were - like Evil Knievel trying to jump the Snake 
River Canyon - an audacious feat never before attempted. 
Throughout its 88-year history, the Federal Reserve had 
never before cut the discount rate six times in less 
than six months (thank you, James Stack). 

Greenspan has "succeeded" in cutting rates, to be sure, 
but the cuts seem to have done little more than reduce 
the number of Denny's "Grand Slam" breakfasts that 
retirees can afford to buy each week. Neither consumers 
nor businesses are borrowing as much as hoped, or, for 
that matter, as much as needed.

Throughout the Greenspan regime, the Fed has always 
attempted a kind of recessionus interruptus whenever 
trouble loomed, by fostering an environment in which it 
is easy to borrow money and, therefore, to spend it. In 
other words, the Fed lowers interest rates and expands 
the money supply, thereby enabling banks to lend more 
money at cheaper rates. 

Businesses and consumers then avail themselves of the 
"inexpensive" debt and start spending money they don't 
have. Soon, the economy recovers, and paying back those 
old debts becomes no worse than a manageable nuisance. 
At least, that's the theory.

This go-round is no different, as far as the Fed is 
concerned. Greenspan's game plan for reversing the 
current slowdown relies on the hope that businesses and 
consumers, even if they stop spending the money they 
actually earn, will start spending whatever money they 
can borrow. But it's not happening and that's why this 
economy is in trouble.

Initially, when the Nasdaq bounced last April and a 
handful of economic indicators followed suit, the Fed 
seemed to be succeeding in its mission to revive the 
economy. But that brief respite now looks like a fluke, 
more the result of surging home-equity borrowing than 
any Greenspan magic. But for the largesse of home loan 
lenders and their relaxed lending practices, our economy 
would be in the tank. Mortgage refinancings through July 
surged 469% year-over-year. 

"Aha!" you say, "the result of lower interest rates." 
Not quite. Many homeowners refinanced not to lower their 
payments, but to take equity out of their homes. Fully 
half of this year's record $660 billion of refi 
transactions put money in the borrower's pocket, 
according to Mortgage Servicing News. In most of these 
cases, the monthly mortgage payment actually increased. 
Susan Sterne, of Economic Analysis Associates, 
Greenwich, Conn., reports that home-equity mining has 
become, for some, a kind of career. "There are people 
[in hot areas] who live on refis of appreciated 
housing," Sterne says. But not even a record $660 
billion of refi cash can compensate for $5 trillion of 
stock market losses and rising joblessness.

All the more so because home-equity mining looks to be a 
one-off phenomenon. Putting aside the unthinkable 
possibility that home values might decline, thereby 
slamming shut the door to more home-equity borrowing, 
the willingness and capacity to borrow, both practically 
and psychically, may be pushing up against the limits. 

"Private sector credit as a percentage of GDP has fallen 
to 137% (from a peak of 143% in 3Q00)," Walker and 
Fishwick observe. "Bank lending to commercial and 
industrial categories is now running negative year-over-
year. Commercial paper outstanding to non-financial 
companies has fallen to $234 billion from its peak of 
$350 billion a year ago."

Which brings us back to the beginning of our vicious 
cycle. If businesses and consumers don't spend, 
corporate profits don't rise. In fact, they fall. If six 
rate cuts have not managed to break the downward cycle, 
why should the seventh?

Eric Fry

Eric J. Fry, the Daily Reckoning's "man-on-the-scene" in 
New York, is the former editor-in-chief of Mr. Fry has been a specialist in 
international equities since the early 1980s and was a 
portfolio manager for more than 10 years.

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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: August 23, 2001

Published By Tulips and Bears LLC