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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter

PARIS, FRANCE 
THURSDAY, 11 OCTOBER 2001 

 

Today:  Beyond the Khyber Pass

*** Yields fall...savers lose money...

*** But war was bullish yesterday...

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For every silver lining there is a cloud.

Yields on 3-month T-bills fell to 2.18% yesterday 
- a level not seen since people were wearing "Ike & 
Dick, Sure to Click" buttons in August of 1960.

But a Daily Reckoning reader spotted the dark 
shape of a cumulonimbus approaching: "Dad...[and] his 
generation are dealing with this personal issue today. 
While he and many his age receive pensions, there are 
many who depend on their interest income for a large 
part of their living expenses. He finds it curious that 
so little is being said about this 50% cut in people's 
income when so many have been affected."

Alan Greenspan-san cuts rates in an effort to 
inflate the currency. But lower rates reduce the 
spending power of savers.

"Even the talk of reducing tax rates...pales in 
comparison to the amount of interest income already 
ripped out of the wallets of the people with real 
money..." comments the Mogambo Guru, with typical 
reserve. "This sacrificial cohort have witnessed their 
income from that stash of cash slashed by more than 
half. Net of taxes, they are actually losing real, 
inflation-adjusted money, and it staggers the 
imagination to believe that they have any intention of 
spending the little dribs and drabs they are making, 
since they are already going into the hole...the 
consumer is tapped out at the same time he is worried 
about his job and getting killed in a war with 
terrorists. He obviously ain't a-gonna be buying 
anything but groceries and two bucks worth of gas."

Maybe so. The most recent figures show credit card 
balances have risen to $8,100, from $3,000 in 1990. 
Delinquencies are at 29-year highs. One out of 10 FHA 
loans is late. And one month after the terrorists' 
attack, mall traffic is still off 9%.

But both the cannon and the herd on Wall Street 
are still thundering, right Eric?

*****

Eric Fry, not far from the Hudson:

- It looks like war is bullish after all. Or maybe 
anthrax is bullish. Whatever the reason, stocks soared 
yesterday. 

- Come to think of it, maybe the job losses announced 
yesterday at Goldman Sachs and CS First Boston are also 
bullish. Or maybe the 7,000 job cuts at Motorola and the 
disclosure that it will lose money for the 4th straight 
quarter were cause for celebration.

- Why stop there? AIG's announcement that its insurance 
losses from the World Trade Center attack will total 
$800 million - not the $500 million it first estimated - 
must have been a positive for stocks as well. 

- Or maybe it was the combination of ALL these bullish 
events that spurred the Dow 188 points higher to 9,241, 
and the Nasdaq to charge ahead 3.6% to 1,626.

- It's starting to look good for the patriots who 
purchased stocks on September 17th. The S&P 500 index now 
stands more than 1% above where it opened on that first 
day of trading after the attacks. Of course, things are 
looking even better for the slightly more cautious and 
patient patriots who purchased stocks a few days later 
at much lower levels.

- I doubt that Bill has been a big buyer of stocks 
lately, but he does declare himself "bullish on 
deflation"...and perhaps with good reason. Many things 
are deflating these days: U.S. stocks (until recently), 
commodities, Manhattan apartment rents, and even al-
Qaeda training camps.

- Providing additional deflationary evidence are falling 
bond yields, shrinking payrolls, and slowing economic 
activity. But just because what is, is, does not mean 
that it will remain so.

- At present, our economy looks more like Japan's in the 
1990s than like our own in the 1970s. But if bell-bottom 
pants and platform shoes can make a comeback (they 
have), couldn't inflation return as well? Finance, like 
fashion, is cyclical.

- Bill is quite right that current trends in the U.S. 
economy are deflationary. I am persuaded, too, by his 
symmetrical, even poetic, prediction: "When Greenspan-
san began cutting rates, the Fed funds rate was 6.5% and 
the savings rate was near zero. Before the present trend 
is exhausted, the savings rate will be 6.5% and the Fed 
funds rate will be near zero."

- Even though deflation holds sway at the moment, all 
the Fed's horses and all the Fed's men are trying to 
"reflate" our economy again - and they just might 
succeed.

- As we draw near the land of swelling passbook accounts 
and the invisible interests rates that Bill predicts, we 
should expect to find a fresh crop of inflationary 
phenomenon sprouting all around us.

- Already, President Bush's approval rating is inflating 
rapidly. Beyond that, Greenspan and Bush are both trying 
hard to spur our economy along and the plan goes 
something like this: Greenspan prints the money, Bush 
spends it.

- Unofficially, our government will be spending tens of 
billions of dollars rebuilding New York and "smoking 
terrorists out of their holes." Officially, the gang in 
Washington is backing a $60 billion spending package 
designed to cure the economy of whatever ails it.

- Meanwhile, Greenspan is pulling on the monetary oars 
with both hands. In the last 12 months the federal funds 
rate has plunged from 6.5% to 2.5% and the money supply 
is soaring. M2 is climbing at a 10.5% annual rate - the 
steepest such increase in 18 years.

- "If you look at the Federal Reserve's reaction time 
since the bubble popped in March of last year," observes 
James Stack, editor of Investech, "it is conspicuously 
shorter than the central bank of Japan's was in the 
early 1990s. In fact, Greenspan has brought down 
interest rates in half the time..."

- Considerable monetary and fiscal stimulus of the sort 
we are now witnessing threatens to smoke inflation out 
of its hole. Toss a falling dollar and a rising oil 
price into the mix, and voila, say "hello" to 10% CD 
rates.

- Resurgent inflation would make financial geniuses out 
of all the folks who are refinancing and fools out of 
the lenders. But I guess that could never happen. When 
did a banker ever make a bad loan?

- Deflation is a trade, but inflation is the trend.

*****

Back on the banks of the Seine...

*** We went to see "Tristan and Iseult" on Tuesday 
night, part of Elizabeth's program of cultural 
improvement. "Tristan and Iseult" is one of the oldest 
love stories in the western world. But this production 
was set to French pop music and included a troupe of 
acrobats from somewhere out on the Eastern steppes. The 
whole thing was rather amusing in an unintentional 
way...and the inevitable death scene at the end, in 
which both hero and heroine finally lay dead...came none 
too soon.

*** The spectacle was staged at the Espace Pierre 
Cardin, located across the road from the American 
embassy. Americans were warned - in the Tuesday's issue 
of the International Herald Tribune - to maintain a "low 
profile..." Rather than take down the Stars and Stripes 
and hoist the banner of, say, Tonga, the U.S. embassy 
beefed up security. A double row of barricades 
surrounded the building...and three busloads of police 
were on hand...mostly napping or dining in their 
buses...though one seemed to be watching a security 
camera. 

*** Of course, anyone who wanted to could have easily 
driven a truck full of explosives through the light 
metal barricades...but, at least on Tuesday night, 
people seemed to have better things to do.

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BEYOND THE KHYBER PASS
by Bill Bonner

After yesterday's rally, the Dow has made up about half 
of what it had lost since January, 2000. 

The same people who never saw this bear market coming 
now see it going. The lows were hit, they believe, in 
the aftermath of the September 11 attacks. And now that 
the dogs of war have slipped their leashes, there seems 
to be nothing standing in the way of a full recovery and 
even a new bull market. Tax rebates, rate cuts, fiscal 
stimulus on a grand scale - all the blood that can be 
squeezed out of taxpaying turnips - can now be used in 
the fight against terrorism and bear markets.

And what enemy could stand against such power? 

The U.S. is, we don't need to remind readers, the 
world's only superpower. It can bomb poor little 
countries such as Afghanistan 24/7...in no corner of 
their godforsaken country are its citizens safe from 
U.S. military might. From carriers at sea and bases 
scattered around the world, the U.S. can focus its high-
tech, ultra-sophisticated military hardware...worth 
billions of dollars...on enemy positions almost 
anywhere...and bring destruction down on the diapered 
heads of goatherds at any time of night or day.

Can there be any doubt about which side will win?

Americans will not be the first Westerners to make war 
against the Afghanis. Alexander the Great, fresh from 
his victory against the Persians at Gaugamela, in 331 
B.C., turned towards Afghanistan. He brought with him 
the military superpower of 4th century B.C. - the 
Macedonian army. Within a few months he had conquered 
most of the Afghan tribes, but never could completely 
subdue them. There were constant revolts that plagued 
his garrisons. Gradually, the Greeks withdrew. The last 
Greek outpost - at Ay Khanom - was overrun by a nomadic 
raid in 130 BC.

More recently, the world's runner-up superpower - the 
Soviet Union - tried to control the country. Afghan 
terrorists (then known as "freedom fighters" in the 
West) threatened the communists' allies in Kabul. 

The Soviets dominated the skies of Afghanistan. But, 
once on the ground, they found themselves fighting a war 
on Afghan terms. The Soviets had a number of advantages. 
Their lines of supply were notably shorter than those of 
the U.S., half a world away...and they were probably 
willing to be more ruthless than U.S. forces. 
Nevertheless, they took losses, and finally decided to 
exit...just as America had exited Vietnam a few years 
earlier...disgracefully.

Will Americans do any better? We don't know, dear 
reader, but if success in the present war were a 
tradable commodity, we would be short. 

And what of the economic front? Do not economies always 
leap up at the sound of cannons? The U.S. has of course 
the world's only super-economy too. In the last decade 
of the 20th century, it raced ahead of its challenger, 
Japan, with a spectacular burst of innovation and what 
looked like wealth-creation. It now has the most 
flexible, dynamic economy in the world, it is widely 
believed...and a Fed chairman who is lauded in popular 
books and lionized in the popular imagination. 

The Fed still has 250 basis points it can cut from the 
fed funds rate - before reaching zero - and the 
government has hundreds of billions it can spend on 
fiscal stimulus projects. Even the farmers are expecting 
a big increase in their ill-gotten gains, thanks to the 
new, patriotic spirit of spending other people's money 
on everything and anything that might give the economy a 
lift.

Of course, the world's number 2 economic superpower 
tried these things too. 

I will not revisit the Japanese story, dear reader. You 
have suffered through it often enough.

But, perhaps the knowledge gives you an edge. To most 
Americans, Japan's economic troubles are as remote and 
mysterious as what lies beyond the Khyber Pass. Could 
there be useful lessons hidden in that forlorn 
landscape? Could there be traps...ambushes...useful 
tales designed for our edification and enlightenment?

But it is not information that gives Daily Reckoning 
readers an advantage, if they have one. It is intuition. 

Most Americans are wrong about how the world works. It 
is not a digital world...it is an analog one. What 
happened to Alexander is analogous, in some ways, to 
what happens to us. What the Japanese economy suffered 
has lessons for us too. Even the story of Tristan and 
Iseult might help us better understand what goes on in 
the hearts of our sons and daughters...and maybe even in 
our own.

Technology may build up like digits...little by 
little...accumulating over time. But man's use of 
technology - for profits...for war...or improvements in 
his standard of living - follows the deep cycles of the 
human heart...rising on tides of confidence, then 
falling as the tide ebbs towards fear and uncertainty. 

It is a world where the left side of the brain invents 
excuses and rationales for what the right side of the 
brain wants to believe. "The mind is merely the heart's 
dupe," said La Rochfoucauld. It is a world ruled largely 
by the heart...full of sin and sorrow, sturm und drang, 
madness and the kindness of strangers.

It is not a "buy and hold" world. It is a world 
dominated by fear and greed, progress and backsliding, 
epic levels of self-assurance followed by almost 
unimaginable despair. These cycles can last much longer 
and carry us much farther than anyone imagines. It is as 
if each generation had to discover for itself how bad, 
and how good, things can get. 

America has just left a period of nearly 20 years of 
economic expansion...culminating in the highest stock 
prices ever seen on Wall Street, as well as such an 
apogee of confidence that people cut their savings rates 
to near-zero while paying more than 200 times earnings 
for stocks. Nature in her magisterial simplicity 
suggests the next phase: a huge wave is followed by a 
huge trough. Or, climbing a high mountain of the Hindu 
Kush, a hiker discovers a steep decline on the other 
side. There is a neat symmetry to all things natural - 
and markets are natural. No one designs them. No one 
controls them. Nor can they ever be fully understood, 
or predicted. 

All we have is an intuition...that high peaks are 
bordered by deep valleys...that things normally regress 
to the mean and that investors generally get what they 
deserve, not what they expect. 

Economists confirm, by observation, what we feel must be 
coming:

"The length and severity of recessions," wrote Professor 
Gottfried Haberler in 1936, "depend partly on the 
magnitude of the 'real' maladjustments which developed 
during the preceding boom and partly on aggravating 
monetary and credit factors..."

What went wrong for the Japanese? Perhaps nothing. A 
long period of above-normal growth needed to be followed 
by a long period of below-normal growth...just to bring 
the long-term trend back to the mean. 

What went wrong for the Soviets? Perhaps nothing. Since 
the days of Alexander, Afghanistan has been a graveyard 
for foreign invaders; the Soviets' airpower could not 
reverse the long-term trend. 

Will America's superior firepower, technology, money, 
brains, luck, Greenspan, or determination break the 
long-term trends? 

Again, we don't know, dear reader, but if our success in 
fighting recession and bear markets were a tradable 
commodity, we'd be short. 

Your correspondent...this side of the Khyber Pass...and 
keeping a low profile...

Bill Bonner




 
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 11, 2001

Published By Tulips and Bears LLC