*** California utilities - a credit event...lessons of the
dot.com mania...bankruptcy is hot...telecommuting...and
more...
*** The rally on Wall Street continued yesterday after a
shaky start. Volume and breadth book looked good - with
over 2 stocks rising for every one that fell on the NYSE
and nearly that good a ratio on the Nasdaq. There were 383
stocks hitting new highs on the NYSE; only 53 hit new lows.
*** The Dow ended up 65 points. The Nasdaq managed a small
gain - 18 points.
*** Intel and Micron both fell about 5%. Intel is trading
almost down to $30. Other big techs - Sun Micro, Cisco and
JDS Uniphase - were off about 4%.
*** But eBay has gained about 40% in the last 5 trading
sessions. And Juniper has done nearly as well.
*** Insiders, it turns out, are value investors. They sold
shares this year at a rate 55% higher than in '99. And they
bought 21% fewer shares. Among the biggest sellers were
Bill Gates and Paul Allen - who together unloaded $10
billion in MSFT shares. Generally, the heaviest selling was
in the tech area.
*** But insiders at value-laden Phillip Morris were buying
- about $91 million worth. MO - which I suggested to you
early in the year - turned out to be the best performing
stock on the Dow...up 95% for the year.
*** Natural gas is up an almost unbelievable 300% since the
beginning of the year. "Contrarians take note..." writes
Dan Ferris, "The chemical sector is getting hammered by
high natural gas prices. When people start saying that
natural gas prices will be high for the next ten years,
that'll be a sell for natural gas, and a buy for
chemicals..." Is it time to look at W.R. Grace?
*** The increase in fuel prices has hit California
utilities especially hard. Losses by the two largest power
companies in the state could reach $13 billion by the end
of January. And if the companies' credit ratings are
downgraded, they will be unable to borrow the money they
need - and may be forced into bankruptcy.
*** Isn't it amazing how one event (a temporary shortage of
natural gas) runs into another event (colder than expected
temperatures) just as the moment when yet another event,
apparently unrelated, (a credit squeeze) begins? When
things go bad - they tend to go bad all at once.
*** A Wall Street economist quoted in a Bloomberg article:
"This is a credit event. It's not just simply an energy
development." The article by Noam Neusner continues: "A
default by the two utilities could make previous credit
crises negotiated by Greenspan and Treasury Secretary
Lawrence Summers ... look like a walk in the park. That's
because most major credit problems of the last decade have
been overseas, and this one is at home - and its effect
could be felt throughout the U.S. When hedge fund Long-Term
Capital Management was on the verge of going under, it
threatened its broker-dealer investors. By comparison, the
two California utilities count among their creditors money
funds used by millions of ordinary investors."
*** Larry Summers and Alan Greenspan are two thirds of "The
Committee to Save the World." Are they up to the task?
*** The Financial Times includes an analysis of the dot.com
mania and the lessons learned. One lesson was simply that
technology doesn't always work as well as it's supposed to.
Another: that most new business models are failures. But
the third lesson from the FT is especially important:
"Nothing destroys value like underpriced capital. The
dot.com bubble will be studied not so much for its
technical or entrepreneurial innovation, but as a capital
market anomaly. In the closing years of a long bull market,
the suppliers of capital - much richer on paper than a
decade before and more willing to take a flyer - poured
money into venture capital funds and then into the
premature initial public offerings that validated those
venture capital investments. This virtuous circle brought
in more venture money and more successful IPOs, rewarding
investment bankers, lawyers and other facilitators
handsomely in the process. "
*** "This surge of money," continues the FT article,
"produced the biggest mispricing of capital since the
Japanese equity warrant boom of the 1980s. When capital is
nearly free, the need to discriminate between new ideas
disappears. Clearly, the dot.com boom was a disaster. "
*** Investors are becoming much more discriminating. They
are trying to sort out the good models from the bad ones.
While they have taken huge losses - they are still
confident that they will discover stocks that go up at
double-digit rates. The attitude among investors, so
recently completely irrational, now seems reasonable: Find
the good techs. Buy. Hold. Wait for better times.
*** Unfortunately, markets are not at all reasonable and
cannot be reasoned with. They do what they want - which
probably means purging all the techs - good and bad...
bankrupting millions of businesses and investors...and
hammering almost all stocks down to such low levels that
people will no longer want to stoop to pick them up.
*** "Bankruptcy Lawyers Become Hot Products" says a
headline in the International Herald Tribune.
*** Working from home is a pleasure - for a week or two.
Then, after the novelty and convenience wears off - it is
even more tedious than going to the office. The LA Times
reports that the idea is losing favor in business
management circles too. "Telecommuting doesn't put anybody
ahead," said Larry Prusak, director of IBM's Institute for
Knowledge Management, a think tank in Boston that has
researched telecommuting trends. "Workers lose because they
aren't in the office enough to be taken seriously for
promotions," he said. "Bosses lose because nobody's around
to keep ideas alive and work through projects."
*** Well, no snow yet. But it has gotten colder...and the
sky is cloudy. So, Edward goes to the window from time to
time to see if the snow has begun. It rains often in this
part of the world. But snow is fairly rare.
*** I'm learning a new trade. Something to fall back on if
the Daily Reckoning doesn't work out. I'm taking advantage
of one of Mr. Deshais's periodic attacks of sobriety to
learn stonemasonry. We began yesterday to take down some of
the stone walls - which looked as though they were going to
fall down. I tend to underestimate these projects. Which is
probably a good thing. Because if I realized how much work
was involved I might never start.
*** We took down the leaning and bulging sections of the
wall. But once these stones were off, the center could not
hold. The walls are built of stone and mud...with just a
lime/sand mixture called "chaud" on the outside. When you
begin taking them apart...it's hard to find a place to
stop. We just kept taking off the stones and digging out
the dirt until we had demolished a 100-ft wall about 3 feet
high and two feet thick. Now we have to rebuild it.
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In July of 1927, Ogden Mills, the U.S. Secretary of the
Treasury organized a remarkable meeting at his home on Long
Island. He had invited the most powerful money men of his
era - the central bankers of England, France, the U.S. and
Germany.
Present were Benjamin Strong of the Fed, Montagu Norman of
the Bank of England and Hjalmar Horace Greeley Schacht of
the Reichsbank.
Emile Moreau, head of Bank of France, hated travel almost
as much as he hated England's central banker. So he sent a
subordinate to represent him.
The problem before them was gold. More to the point, the
problem was the run on England's gold because of the
mispricing of the pound sterling by Norman. Strong was a
close personal friend of Norman's. Schacht and Norman were
friendly too. It was the French who were causing problems.
France was threatening to redeem its credits with the Bank
of England by drawing down England's stock of gold.
Strong decided to help take the pressure off the pound by
lowering U.S. interest rates and making U.S. gold available
to the French. An economist at J.P. Morgan remarked shortly
after: "Monty and Ben sowed the wind. I expect we shall
have to reap the whirlwind...We are going to have a world
credit crisis."
A credit crisis did develop. But only after two years of
ballooning debt. The stock market had already nearly
doubled since the end of 1924. Then, following the Long
Island conference, Wall Street shot up another 50% in the
second half of '28. Then, in the three months' leading up
to August of '29 - it ran up another 25%.
New credit instruments were developed - such as installment
purchase plans - so more and more people could participate
in the prosperity. "Everybody Ought to be Rich" wrote John
J. Raskob, director of General Motors and Chairman of the
Democratic Party, in Ladies Home Journal magazine. Then, as
now, it was widely believed that new technology - radio,
telephone, automobiles, electrical appliances - were making
possible a whole new era of wealth.
And yet, then as now...the New Era proved an illusion.
I can almost hear you groan, dear reader. "Oh no," you must
be saying to yourself... "not another letter about the New
Era!"
But before you turn off your computer and begin looking for
lost socks, let me reassure you. Today, I write about
neither stocks nor technology - but about gold.
And what I want to show you is what happens when a New Era
credit bubble collapses.
"Why would I want to buy gold?" asked a DR reader recently.
"You said yourself that deflation is in the offing...not
inflation. Won't gold go down instead of up?"
Of course, I do not know what gold will do. But I will show
you what happened on the last occasion of deflation in
America.
In the last half of the `20s, the Fed began to become
nervous by what it saw as excessive borrowing and
`irrational exuberance' in the stock market. In 1925, the
Discount Rate charged to commercial banks for Fed funds was
only 3%. In a series of increases, it rose to 5% in 1928.
But the mania continued. Finally, in August of '29, the
rate was hiked to 6% and the bubble was pricked.
These rate increases are blamed for the bust that followed.
But the real rate of return on borrowed funds was so high
that it is doubtful that these rate increases had much
effect. If you could earn 25% on your money in 3 months in
the 2nd quarter of '29, on Wall Street, a 1% increase in the
cost of money would not be a serious deterrent. Then, as so
recently, money from Europe rushed into the U.S. to take
advantage of rising stock prices. An extra point of
interest cost did little to tilt the balance away from U.S.
investments.
Still, the balance did tilt...so much that investment slid
from the positive to the negative side of the scales in a
trice. Stocks crashed. Businesses failed. Prices fell. By
1931, wholesale prices were 24% below those of '29 and
would soon drop another 10%. 15% of the labor force was
thrown out of work by 1931...two years later it would reach
25%. Over 10,000 banks failed.
Banks back then were like mutual funds...or stock
portfolios... today. There was no deposit insurance. Losses
were real. Final. The wealth simply disappeared.
But what happened to gold? Did it fall more than 30% along
with other wholesale prices?
No. Quite the contrary, it rose. Fearful of banks, wary of
stocks...people turned to gold to protect their wealth.
Bank deposits fell. People preferred to keep their cash -
or gold - in hand. This was a problem. Because the
financial system depended on the health of the banks...and
their willingness to lend. When people withdrew their
money, the banks failed and depositors became even more
fearful of the banking system.
Failing banks became such a problem that President Hoover
tried persuasion to convince people to leave their money in
the banks. He sent straight-talking Col. Frank Knox around
the country on a campaign to discourage hoarding of
currency or gold. Knox is better remembered as America's
Secretary of War in WWII. He is famous for his remark to
T.V. Tsoong, the Chinese Ambassador. Putting his arm around
the ambassador, Knox proclaimed his confidence in the
American war against the Japanese: "Don't worry, T.V.," he
assured the Chinaman, "we'll lick those yellow bastards
yet."
As banks failed, the supply of money declined. Thus, the
value of money increased (prices fell). The U.S. was still
on the gold standard, so the value of gold increased
accordingly. But soon, forward-thinking economists, led by
Britain's John Maynard Keynes, saw the need for more
money...and more credit...to get the economy moving again.
Gold seemed to bar the way.
Frightened that America might devalue the dollar (in terms
of gold), investors began to move their capital abroad - or
into gold itself. In February of '33 there was a run on
U.S. gold - $160 million left the treasury. Another $160
million was called away in the first four days of March.
The commercial banks were losing gold too - over $80
million went out of their vaults in the last 10 days of
February...and $200 million more in the first 4 days of
March.
Arthur Dewing, professor at the Harvard Business School,
was so alarmed that he went into the Harvard Trust Company
on Harvard Square and took out his entire balance in the
form of gold coins. "When the crowds inside the bank
reported Dewing's action to the people on the street,"
writes Peter Bernstein in his book, Power of Gold, "a mob
gathered on the Square, fighting to get into the bank to
follow the example set by the distinguished professor."
Dewing was subsequently criticized for "unpatriotic
behavior," and left the faculty soon after.
Into this rush into gold came wheeled the next America's
next president, Franklin Roosevelt. On March 8, Roosevelt
held his first press conference - assuring the nation that
the gold standard would remain. On March 9, he pushed the
Emergency Banking Act through Congress - giving him the
power to regulate or prohibit gold ownership. And less than
a month later, he replaced Hoover's persuasion with
outright force - the leader of the free world made it
illegal to hold gold.
And two month's later, Roosevelt even abrogated all
contracts in which payment was stipulated in terms of gold
- including obligations of the U.S. government.
Anything so popular that the government declares it illegal
is bound to be a good investment. Gold rose in value - by
market demand, confirmed by government edict - by 69%
between Roosevelt's inauguration in March '33 and January
'34. In terms of purchasing power...gold had risen almost
100% during the biggest deflation in America's history.
"This is the end of Western civilization," declared Lewis
Douglas, Director of the Budget. And, in a sense, it
was....
More to come....
Bill Bonner
About
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Last modified: April 01, 2001
Published By Tulips and Bears
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