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Contributed by Bill Bonner
Publisher of: The Fleet Street Letter



Today:  Gold and Deflation

*** A boring day on Wall the rally continues...

*** Insiders sell growth stocks...and buy value...

*** California utilities - a credit event...lessons of the mania...bankruptcy is hot...telecommuting...and 

*** 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 
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 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 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'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 

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 

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 

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. 

Still, the balance did 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 

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 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 

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 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 

More to come....

Bill Bonner
About The Daily Reckoning:
The Daily Reckoning... "more sense in one e-mail than a month of CNBC."  That's what readers are saying about The Daily Reckoning.

Bill Bonner, recognized internationally as a brilliant writer, entrepreneur
and publisher of The Fleet Street Letter, offers you his daily market
commentary absolutely FREE. For the first time, outsiders are getting a peek into his powerful and profitable investment insights. Bill's practical contrarian advice empowers even average investors to protect their hard-earned wealth and achieve amazing gains.

Bonner writes his email letter from Paris, France, each morning --
describing the wacky, wonderful world of investment, politics and everything remotely related. Irreverent. Sharp. Honest. Thoroughly, unabashedly contrarian. It's also among the fastest growing e-letter on the Internet.  It's a brand new service... but it has a distinguished history..

For nearly 62 year, The Fleet Street Letter, the oldest investment
advisory letter in the English language has consistently delivered
invaluable economic and political foresights to savvy investors. Current readers regularly enjoy impressive investment gains even as the market falters. Here's more from his online readers...

"My small portfolio has followed true to my wife's description of my
investment philosophy, "buy high and sell low." However, that has changed since I started religiously reading DR... I credit this reversal of fortune directly to The Daily Reckoning"

" Your Daily Reckoning is the best in business commentary... mixing
serious warnings and the state of the market with gentle humor"

"It is actually better than some of the newsletters that I pay to

"Your statements and philosophy have kept me from storming into the market and in fact [I'm] making some money in put options" (Frank)

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Last modified: April 01, 2001

Published By Tulips and Bears LLC