THE COMING BAD YEARS -- G&D
WEEKLY COMMENTARY
July 24, 2001
By James R. Cook
"What, me worry!"
Alfred E. Neumann
In this the most dangerous economic period since the great depression, Americans remain unfazed. Head-in-the-sand optimism prevails. The sinister economic news stays muted and negative reports get spun into bullish fluff. Lost to all are the serious implications of a massive malinvestment in technology. A sudden and severe collapse in high tech has burst the greatest equity bubble in history but investors remain steadfastly bullish. Unfortunately, there’s much more misery to come.
Self-delusion and wishful thinking are the hallmarks of today’s economists and Wall Streeters. Washington spinmeisters and their pals in the media argue that everything’s going to be okay. No wonder the public stays fat and happy. The myth-makers and money managers insist that our economic decline stems from a too-tight Federal Reserve policy. All that’s required to fix the economy is to lower interest rates and boost money growth. But money was never tight. The current decline began in the face of five years of stupendous money and credit growth. Furthermore, after six months of lower interest rates and booming money supply growth, the downturn is accelerating. Easy money isn’t working this time and the odds are that it won’t.
Years ago I learned there’s hell to pay in a business without profits. Today there’s a ferocious profits decline in high-tech that’s spreading to other business sectors. Without these profits, capital investment shrinks dramatically. One of today’s fairy tales argues that a liquidation of excess inventories is well under way and that’s the cure for a recession. Well, the inventory correction has barely started. The real problems are the slashing of margins, plunging corporate profits and a collapse of fixed investment. This is the worst investment decline since WW II. But in the face of this horrendous earnings data and worsening economic information, the financial world "blows off" the bad news.
Furthermore, despite what you hear about consumers standing their ground, they have sharply cut back. The growth rate of consumer spending has been halved and those figures stand to be adjusted downward. For one thing, consumer incomes are stagnant. Retailers are worrying about a sales and earnings decline. Neiman-Marcus revealed a 5½% sales reduction over June a year ago. Many large companies cannot stand this kind of sales decline without major cutbacks. A few decades ago my company suffered through a 75% sales decline. It was gut-wrenching, hang-by-the-nails survival. I would look out my office window at mighty Control Data directly across the street and wonder what would happen to them in such a decline. A few years later it took a lot less than that for them to disappear. After only a small percentage loss they were gone. Today’s highly leveraged corporations with run-down balance sheets can’t stand very much sales and revenue weakness. But they’re likely to get it. They are all so vulnerable that failures could snowball into an epic collapse.
Wall Street pulled the wool over everybody’s eyes when they convinced people that low savings didn’t matter. The big lie that stock investing and bank savings were one in the same was rudely exposed by the NASDAQ collapse. But they’re still passing off the story that capital gains and savings are synonymous so it’s reasonable for consumers to keep on spending. Over the past decade the consumer saw fit to accept that advice and in combination with easy money and credit they shifted the onus in America from savings to spending, from husbanding capital to consuming capital. A damaging pattern of overconsumption and a gross misallocation of resources into shopping malls and office towers have meant fewer production facilities. Lost along the way was the age-old wisdom that prosperity can only come from savings and from the accumulation of capital in tangible productive assets. Instead, we are violating fundamental principles of economics.
And, despite what you’ve heard about a productivity boom and a profits miracle they too are propaganda. The productivity figures are rejiggered by the government while corporate profits have underperformed the economy for years. Another Wall Street fabrication is the so-called benefits inherent in mergers, acquisitions, downsizing, restructuring and cost cutting. This financial engineering may work for one company, but when too many undertake this process in unison, it depresses capital investment and hurts the overall economy. It’s just one more reason that profits are deteriorating and the American goose is cooked. This profits problem is more than a business cycle downturn, it’s now become structural. That means it’s not going to get better anytime soon as Wall Street is wont to believe.
It’s bad enough that the public is misled into believing that somehow runaway money and credit expansion, negative savings and overconsumption are some kind of dynamic new economic formula. But even worse is the subterfuge that a monstrous rise in the trade deficit produces benefits. In reality, it’s just another profit depressant for business. Domestic companies can’t raise their prices in the face of foreign goods competing with them. And the money sent out of the country for goods benefits foreign producers at the expense of our own. Foreign indebtedness enables us to borrow from them (amazingly enough) for even more consumption. It also allows them to aggressively buy up American production facilities. The great contemporary economic thinker, Kurt Richebacher suggests that America is selling its factories to sustain its appetite for consumer goods.
Despite all the smoke and mirrors about America’s economic performance and Wall Street’s refusal to see danger ahead, the ugly truth remains that no nation in history has ever been able to prosper with negative savings, capital consumption and massive borrowing. This is no new formula for permanent prosperity, but the blueprint for financial disaster. We have eaten the seed corn and our complacency will soon be torn up by its roots.
When these ugly facts finally seep into the American psyche, a financial panic will likely ensue that wipes out much of the wealth of America. Too much of the money we once kept in banks has found its way into mutual funds and stocks. It can quickly evaporate when too many sellers materialize. Very few can exit the financial markets at once.
The U.S. money supply growth that everyone is counting on has been offset by a fall in velocity. Consequently, the Fed may be pushing on a string. Demand for money and liquidity are putting downward pressure on conventional assets. Skittish foreigners are holding a big chunk of our paper. The world is sinking into a depression. Nevertheless, Americans are still pie-in-the-sky-dreaming about stock market profits and relentlessly buying the dips. Never has economic reality been further removed from investor sentiments.
Stop listening to the propaganda about permanent prosperity and a renewed boom. Make room in your mind for the seed of doubt we are trying to sow. Question the popular economic assumptions to the point that you consider defensive action. Go against the crowd and the mainstream for only a small part of your assets and you will be safe. Keep a sliver of pessimism alive. There is no way out for this great nation but for a painful and severe economic retrenchment. Most people will not get through it in one piece. Only the most nimble, prudent and clever will emerge unscathed.
GOLD AND SILVER
"Gold and silver, silver and gold, your greatest chapter is still to be told."
Given the sorry economic circumstances we write about, it’s absolutely mandatory to have a minimum of 10% of your total net worth in precious metals. This small percentage can be enough to offset the ravages and losses to the rest of your assets should our warnings prove to be accurate. Just because our previous recessions were mild and the stock market bounced back doesn’t mean that will happen again. There is no foolproof guide to what lies ahead. Protect yourself. Add up your net worth. Establish what 10% of that amounts to. Call us and buy silver.
Why silver before gold? It’s true that in a totally free market gold has been mankind’s money. However, governments hamper economic freedom and they have substituted paper money for gold money. Some day, probably quite soon, gold will make a comeback as money. To do this there must be a significant quantity of gold above ground and available. Although the value of gold is dwarfed by the value of other assets and its total size wouldn’t fill a large arena, there’s still enough gold to perform a monetary function.
Silver is different. It has much greater demand by industry and the recorded above ground supply is minimal. Silver could probably not perform the exchange functions of money, no matter how high its value. There’s not enough of it and it’s constantly being used up. That doesn’t mean it wouldn’t be hoarded and relied on in a financial crisis. It retains one important characteristic of historical money; it stores value. That’s the thing that paper money doesn’t do.
Silver will always be purchased as a hedge, but unlike gold it has a constant, growing industrial demand. In our opinion, it makes a slightly better asset to own for preservation of capital and potential profits. Furthermore, its price could explode at any time.
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