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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter



Today:  Inflation or Deflation?

*** Value picks...become greater values...

*** Fed funds rate now lower than inflation...banks get 
free money...

*** Inflation? What inflation? Government 
payrolls...defense more!

Barron's "value picks" became slightly better 
values yesterday. GE, for example, fell 2%. Fannie Mae 
dropped 1%.

But who cares?

Stocks are priced - according to the Wall Street 
Journal's reconstituted numbers - at 36 times earnings. 
Whether they are going up or down doesn't matter. They 
are far too expensive for a sensible investor. The rule 
in investing is to buy low and sell high. If you buy 
high, won't work (unless you are lucky 
enough to sell to an even greater fool.)

But what if you are holding stocks? People don't 
seem to mind holding stocks at prices they would never 
buy them. But it is the same are either long 
a stock or you are short. The middle ground is an 

If a $100 stock goes to $ doesn't matter 
whether you bought it yesterday or 10 years ago...the 
loss is the same.

Of course, many people believe that the huge 
losses in the stock market have not really hurt 
investors...yet. Because the stocks were bought years 
earlier at even lower prices. The losses, they argue, 
have been mostly "paper losses." But this market is now 
at levels not seen since the end of '98. Anyone who 
invested money after that date is facing a real loss, 
not just a paper one.

Those who invested prior to the end of '98 have made 
no money, collectively, in stocks for the last 3 years. 

Eric...over to you...


Mr. Eric Fry, in the land of milk n' honey:

- The stock market was open for business yesterday, but 
there was no real good reason to show up. Stocks 
thrashed around all day and by the time trading ended, 
the Dow was down a little and the Nasdaq was up a 

- Without Alan Greenspan cutting interest rates or 
President Bush stopping by, what chance did the stock 
market have of putting on a big rally?

- But just because the Fed Chairman took the day off 
doesn't mean he won't be cutting rates again soon.
"What is clear is that in monetary matters, there will 
be no erring on the side of stringency," writes Caroline 
Baum of Bloomberg News. "The inflation-adjusted federal 
funds rate is now -0.2 percent. In other words, banks 
can get free money from the Fed and, thanks to the steep 
yield curve, lend it out or buy Treasury securities for 
a nice profit."

- Yet, despite Greenspan's monetary largesse, inflation 
is on the minds of almost no one these days. "CPI 
inflation has slowed around the world, and based on the 
significant global slowdown in economic activity, it's 
likely to slow even more," predicts International 
Strategies & Investments.

- Maybe so. But if one feature of the investment 
landscape has changed since September 11th, it is that 
inflation is no longer an impossibility. The Bush 
Administration will be waging just as fierce a war 
against a slowing economy as it will be against the dark 
forces of terrorism. The early battles in the economic 
campaign feature deep interest rate cuts (so far, nine 
cuts in little more than nine months) and an exploding 
money supply.

- What's more, defense spending is on the rise, and not 
just temporary. "Arguably the U.S. may have under-
invested in national security during the 1990s," writes 
Moody's John Lonski. "As a percent of real GDP, defense 
spending had dropped sharply from 1987's latest peak of 
7.4% to 2000's 3.8%, which was the lowest such share 
since 1941, at least. Stepped-up spending on national 
security might curb productivity growth, where the 
latter would eventually add to inflation risks."

- "Wartime is associated with...inflation," observes Jim 
Grant in Grant's Interest Observer. "Belligerent powers 
spend as necessary, borrowing to finance the inevitable 
shortfall in tax receipts...No Unites States war known 
to the research department of this publication has been 
waged in a deflationary setting." (

- The trend makes Jim both bearish on the U.S. dollar 
and bullish on the inflation-indexed/protected Treasury 
Notes known as TIPS. "[Wartime spending] has, in the 
past, been inflationary, even in the gold-dollar era, 
which ended in 1971. Now, the dollar is [only] a unit of 
paper, convertible into nothing except small change. Yet 
so persistent is the deflationary undertow that the TIPS 
market, on the brink of war, is cheap."

- Increased government spending in the form of rising 
defense payrolls, while somewhat helpful to the overall 
economy, is a poor substitute for private enterprise. 
"When government payrolls expand faster than private-
sector employment," Lonski writes, "some combination of 
slower productivity growth and more rapid wage gains 
have tended to emerge...When government employees rose 
from the 16.5% of non-farm payrolls of the 1960s to the 
18.2% of the 1970s, the average annual rate of growth of 
unit labor costs shot up from the 2.1% of the 1960s to 
the 6.3% of the 1970s." 

- In support of Mr. Lonski's argument I submit exhibit 
A: the post office and exhibit B: the DMV. 

- From the glass half-full dept ISI predicts that the 
U.S. economy will recover in 2002. Among the reasons 
cited: G7 short rates, which tend to lead economic 
activity by 12 months, peaked in November 2000 and since 
then have declined a record 38% - from 4.75% to 2.95%. 
This has been a much sharper decline than the -6% over 
10 months in 1990 or the -17% over 10 months in 
1981/1982. And more easings around the world are in 
store (we expect a 2% Fed funds rate).

- Oil prices, which also tend to lead economic activity 
by 12 months, also peaked in November 2000 and have 
declined roughly -30% since then. Fiscal policy is 
already stimulative and is likely to become more 
so...federal spending, particularly defense related, is 
set to accelerate.


Back in Paris...

*** "Global Slump Could Last Until 2003" says an OECD 

*** The outlook for Japan? "Dismal." And in America? Job 
losses in September were up 77% over August...and 4 
times those of the level a year ago. Recession is a 
"done deal." And Warren Buffett predicts that it will be 
like a winter nap...longer and deeper than most people 
can imagine.

*** What's more, the World Bank notes that the downturn 
in growth is likely to push thousands of very poor 
people over the brink. As many as 40,000 children under 
the age of 5 will die, it estimates.

*** But what is tragedy abroad is comedy at home. The 
forces of bullish illusions are infiltrating 
everywhere...apparently even in my own business. 

*** An informer in Baltimore passed along this report: 
"Earlier today a Legg Mason rep. met with Agora 
employees to go over 401(k) investing strategies...his 
goal was to make us feel GOOD about investing... 
especially for the long term (as he defined as the next 
3, 5, or 10 years). Here are some of his comments 
concerning today's market:

"'Today's market is UNDERVALUED'...he said...'we are at 
historic lows...The market is drastically mispricing 

"I didn't want to be rude," says my source. "But, I 
couldn't let him lie like I asked 1 simple 

"I asked him how he could sit there and say our market 
is at a historic low, when the average P/E ratio on the 
S&P 500 is around 25 or 26...and the historic average is 
11 or 12! 

"His response: 'That is a good question, and I have an 
answer. You see, today's companies aren't valued the 
same way as they were 50 years ago. Companies today are 
valued on cash flows...not simple price to earnings. (I 
don't really know what that means...but I let him 
continue). You see, there weren't growth companies
back in the 40's or 50's like there are today. So, to 
say that a company with a P/E of 35 is overvalued 
compared to a company with a P/E of 8 (in the 1950's) is 
absolutely untrue. He says using yesterday's ratios in 
today's market is not only impossible...but dead wrong!

"Here is his investing strategy NOW: 


"One of the WORST things to do in today's market, he 
said, is hold cash. Now is the time to fully invest in 
stocks...especially since they are at their 'historic 

"Here is a quote that I liked: 'Today's businesses 
aren't going out of business. What we need to see is 
consumer confidence...we've reached the bottom!
There's no where left to go but up!"

"I had to laugh."

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* While investors thought they were going to get rich - 
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* While consumers heeded the Fed's call to "buy..." - financial security was going bye-bye under 
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by Bill Bonner

Japan has seen it all. Stocks crashing for a decade. 
Unemployment rising. Billions in stimulus with no 
effect. Rates cut to zero. 

What the Japanese have not seen is the very thing you 
might expect when you give away money: inflation. 

Instead, prices have fallen. Consumer prices have been 
falling at annual rate of 2%, and asset prices - both 
real estate and stocks - have collapsed to a third to a 
fifth of their previous levels. 

Here again, without hardly trying, the Japanese may have 
become trendsetters. 

American investors, yesterday, looked as far into the 
future as they could. What they could see, we don't 
know. But we know what they didn't see: inflation.

Bonds hate inflation. At the sight of inflation on the 
far horizon, bonds fall in price...and yields (the 
return per unit of capital invested)...jump. Yesterday, 
the yield on a 10-year T-note didn't jump. It 
4.46%. Meanwhile TIPS, bonds with inflation protection 
built in, were paying 3.08%...a mere 0.37 % above the 
current inflation rate...and only 1.38% less than you 
can get from the non-protected note. This differential 
is a rough measure of what investors expect from 
inflation. It has reached a new, very curious low level.

It is new because never before have investors estimated 
the rate of inflation over the next ten years at such a 
low level - 1.38%. It is curious because never at any 
time in the last 3 decades has the inflation rate been 
anywhere near that low. Instead, it has averaged 1.9% 
for the last 30 years and now stands at 2.7%. 

Investors are betting that inflation will decline to 
half the current rate...and stay at a level it hasn't 
seen since the Nixon administration. 

Investors - perhaps the same investors who saw no risk 
of a bear market - now see no risk of inflation. 
Indeed, inflation seems as remote a risk today as an 
attack on the WTC was in August, a risk - at the time - 
so slight that owners thought it unnecessary to fully 
insure themselves. 

This is doubly curious, because never - since perhaps 
the Vietnam War - have governments shown themselves so 
eager to do what they do best...destroy their own 
currencies. And never, far as we know...has a 
war failed to produce a substantial increase in domestic 

"War is Keynesian," writes Gary North. It is always 
financed by deficit spending and monetary inflation. 
Conservatives yell and scream that they want more 
freedom, but when war clouds or recession clouds roll 
in, conservatives join the Establishment's Amen chorus 
for more government, more restrictions on liberty, and 
more inflation."

The same people who once believed a peace dividend was 
good for the economy now believe a war will be even 
better. Those who urged Japan to build bridges to 
stimulate its economy seem to believe that destroying 
bridges will be just as good.

And where once they looked with pride on a budget 
surplus and a social security lock-box, they now cast 
their eyes appreciatively upon deficits and an open 
Congressional checkbook. If the taxpayers won't spend 
their own money, they reason, government will spend it 
for them... 

And those who never saw an economic downturn or bear 
market see them going away, thanks to 
all this stimulus provided by the Fed and Congress.

Even in this post-irony age, we feel a great paradox 
coming on. Like the onset of the is but a 
chill...a mere, expectant frisson now. But soon, it may 
have us shaking feverishly and begging for relief.

Wars may be lost or may be won...either way, if enough 
stimulating firepower is used, a nation's currency 
always seems to be among the casualties. 

Here at the Daily Reckoning we are agnostic on 
inflation. We have little doubt that eventually the 
dollar will go the way of the austral, the confederate 
dollar, the sou, the livre, the reichsmark, the wara, 
stamp scrip, the Old Franc, the continental, the ostmark 
and every other paper currency ever created.

All things, paper currencies included, eventually 
regress to their intrinsic value. The dollar will be no 
exception. It has lost 95% of its value since the 
Federal Reserve was set up to protect it. Sooner or 
later, the Fed will succeed in eliminating the last 

But, we also note that Japan has been unable to kindle 
inflation - despite all its efforts. And we suspect that 
Mr. Market will have some surprises for us first.

In America, people are on the hook for more debt than at 
any time in history. We suspect they will twist and turn 
a the Japanese...before they are let off 
by inflation. 

Bill Bonner

P.S. But I promised that today's letter would be about 
gold. And so it is. 

"Gold thrives on uncertainty," observes an article from 
the BBC. "And the world has shifted into a new climate 
of insecurity. Risks have increased markedly. The 
attacks on the United States were the start of the 
drama, not the climax."

Andy Smith, precious metals analyst at Mitsui Securities 
in London, and no gold bug, believes the yellow metal 
"could go to $340 an ounce within the next three 
months...and continue to soar after that."

Maybe. Maybe not.

But in a world of full of risk, a little bit of 
insurance seems a healthy precaution. Gold, at $289, 
seems cheap protection.

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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: October 05, 2001

Published By Tulips and Bears LLC