Deflation
The Daily Reckoning
Paris, France
Wednesday, 10 July 2002
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*** Stocks down again yesterday...DDGU...so what's new?
*** Bush's re-election campaign: WAT abroad, SWAT at
home...
*** Asian Crisis in North America? The Great Stock
Illusion...incredible arrogance...and more!
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Another bummer day in New York. (Eric's taking the day
off, so I'm giving you the news from Lower Manhattan
myself.)
The Dow fell 179 points. The S&P slipped 2.5%. And
utilities dropped to levels not seen since early '98 -
wiping out 4 years of price gains.
Meanwhile, the dollar fell and gold rose. DDGU...
And this all happened after President Bush got out the
handcuffs, went on TV and continued his campaign for re-
election: WAT abroad, SWAT at home. "We must find them
[the evildoers in corporate America] and expose them
now," said the nation's CEO. Bombing raids on Lower
Manhattan are now being discussed in the Pentagon.
The Wall Street Journal did a fair job of exposing one
of them recently - in its article on George W. Bush's
career as a stock manipulator at Harken Energy. But now
that Bush has moved from the boardroom to the Oval
Office, the man may pretend that he never held an honest
job in his entire life. And maybe he didn't.
But no one seemed very impressed with the Bush plan.
"Being lectured by the Bush White House on ethics,"
suggests our own Sean Corrigan, writing from London, "is
likely to raise more sneers than cheers."
Immediately following the speech, Judicial Watch - a
public interest law firm (if that's not an oxymoron) -
said the president's "rush to crackdown on corporate
fraud seemed intended to deflect attention away from his
and Cheney's own business practices" and filed a suit
against the Vice President himself, relating to his time
as CEO of Halliburton. Justice Watch's chairman, Larry
Klayman, said: "To look the other way for the vice
president would be to set a precedent that the
Washington elite are above the law." (We'd never have
suspected THAT might be the case.)
In the meantime, "Asian Stocks Favored as U.S. Investors
Flee," says a headline in the Jakarta Post.
"If you thought Thailand had corporate governance
problems, you haven't been following the soap opera that
the American securities business has become," opined an
editorial in the Bangkok Post.
When the Asian Crisis of '97-'98 was in the news,
fingers wagged at the East. They should follow the
American example, said the IMF...the World Bank...the
fund managers and western tycoons. Now, the Asians are
watching what they believe may be an even bigger crisis
developing in the U.S. Can we blame them for gloating
just a little?
And in Europe, Chancellor Gerhard Schroeder of Germany
said the scandals uncovered in the U.S. so far were just
the "tip of the iceberg."
Corrigan observes, "Relishing the humiliation - after
all, schadenfreude is about the only form of merriment
for which the Germans are noted - the Chancellor seized
his moment to rail against the American Way."
At an election rally, Schroeder told an audience of BASF
workers, "Now it has been revealed that egotism
practiced at the top under the catchphrase 'shareholder
value' is worth less...than a system based on a fair
balance between the interests of workers and employers.
[In the US] the individual employee is not valued and
shareholder value is everything."
What's this? First Barron's. Now Forbes...the major
financial media is muscling into our territory.
You and I, dear reader, have known for a long time that
the promise of long-term stock market riches was largely
a myth. Stocks go up; then, they go down. Companies come
and go...you win some, you lose some. Your portfolio
grows at about 7% per year over your entire career.
Then, along comes a bear market, which knocks off half
your gains...just as you were getting ready to retire...
Then, you get audited by the IRS and you die.
But hey, we didn't design this strange ball we live on.
We just keep our eyes open and try to enjoy the show.
Besides, we're just talking about money - and who cares
about that?
"The Great Stock Illusion" is the title of the Forbes'
piece. Citing the work of Robert Arnott and Peter
Bernstein, the article explains that investors have made
about 7% per annum on their stock market investments
going all the way back to 1871. But, as was also pointed
out to us by John Mauldin, who covered the Arnott study
with some precision, of those 7 points, 5 came from
dividends. The S&P 500 now yields 1.5%, so investors
hoping to make a lot of money in the future will almost
certainly be disappointed.
But wait, instead of paying our dividends, aren't
companies such as Microsoft putting earnings to work so
as to earn even more money and increase the capital
value of the stocks? Alas, Arnott and Bernstein
discovered that lower payouts almost always mean lower
future earnings, not higher ones.
Nothing ruins a good man, a good nation, or a good
business faster than too much easy money. It turns out
that retained earnings are treated no better by
corporate managers than the money they take in from
banks and yahoo investors - it is often squandered on
foolish empire-building projects, extravagant executive
compensation, and absurd mergers.
"There's an incredible arrogance in management, thinking
that its 10th-best idea is better than shareholders'
first best idea," said Arnott.
Forbes explains the result: "When the dividend payout
ratio - the percentage of earnings paid out as dividends
- climbed above 50% in the late 1950s, subsequent ten-
year earnings growth was between 2% and 4% a year. When
the payout ratio fell below 50% in the mid-1970s,
subsequent earnings growth plunged into negative
figures."
"We're coming off peak earnings in 2000 with the lowest
[dividend] payout ratios ever," Arnott added. See also:
The Profitless New Economy
dailyreckoning.com
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DEFLATION
by Bill Bonner
There is no greater genius than the man who bounces our
own ideas right back at us.
That was our first thought upon reading a subscriber's
letter to Richard Russell, on his website.
The subject was the fate of the dollar...and the
economy. Like Barron's and now Forbes, the writer had
come to the same conclusion we had: both are headed
down.
We take it for granted that stocks are in a bear market.
What goes up, goes down. That stocks are on the downside
of the cycle seems almost too obvious. Of course, it if
were any more obvious, the yahoos and patsies would have
seen it already and already forsaken stocks. They have
not yet; so the bear market must continue.
But what of the rest of the story? Whither the dollar?
What will happen as the Fed desperately tries to revive
the economy and the stock market? Will inflation
suddenly erupt, like a pimple on a 14-year-old...and
spoil the picture?
Most economists will tell you that the economic system
is controlled by mood changes at the Fed. When the Fed
governors feel the need for a little more bustling about
in the nation's shops and factories, they administer a
little "coup de whiskey", as Fed chief Norman Strong
once put it. When they are in the mood for calm, by
contrast, they take away the whiskey bottle and the
party soon dies down.
Since WWII, the Fed's mood swings do seem to correspond
with the ups and downs in the economy. But sometimes
things happen even if America's central bankers are not
particularly in the mood for them.
"Despite a flood of money and credit creation, and
despite widespread predictions of recovery, the markets
refuse to cooperate," writes Dr. Kurt Richebacher in his
July letter. "Why? In short, because we are not
experiencing a cyclical recession, and therefore a
cyclical recovery is not on the way. Instead, the U.S.
economy is sick to the bone."
The sickness doesn't seem to yield to a shot or two of
whiskey. "For the first time in the postwar period,
monetary easing - even the most aggressive easing in the
Fed's history - is proving a flop in kindling a stock
market rebound," Richebacher explains.
But all this extra money in the system is bound to have
some effect, right? Won't it show up as inflation - if
not in equities, at least in consumer prices?
Ah...maybe not.
"China is exporting deflation at a very rapid rate,"
explains Mr. Russell's correspondent. Almost no matter
what Americans or Germans can make - the Chinese can
make it cheaper.
Plus, "Russia is now moving towards becoming the world's
largest supplier of most industrial commodities
(including oil) and they too will use their competitive
advantage and sell their goods cheaper than anyone
else," he continues.
But as we mentioned above, nothing ruins a good economy
faster than too much easy money. Thanks to Alan
Greenspan and the Fed, "the U.S. private sector debt
alone is over 280% of GDP," Russell's reader explains,
"and is the largest debt pile in world economic history.
The U.S. telecom sector alone has more debt than the
entire Japanese property sector did or has."
"In the first quarter of 2002, consumers borrowed at an
annual rate of $695 billion - breaking all previous
records," Dr. Richebacher elaborates. "Their incomes, on
the other hand, rose at an annual rate of only $110
billion. And for the 12 months ending in April of this
year, $5.9 dollars of debt was added for every $1 of
growth in GDP."
Adding debt to the system is inflationary: there is the
illusion of greater purchasing power, which boosts up
whatever market is hot at the time. Stocks went up in
the '80s and '90s; now real estate is having its turn.
If only it could continue forever! Alas, that is not the
way of the world. For each additional dollar of debt
produces less and less economic progress...and is
therefore a heavier burden than the dollar that preceded
it.
At some point, people realize that they cannot afford to
continue borrowing - their debt-service payments have
become too much of a burden. Instead, they have to cut
expenses and pay down debt. Then, prices fall...sales go
down...jobs are lost...and the economy sinks into a
deflationary recession.
This, of course, has been the economic history of Japan
for the last 10 years.
More to come...
Bill Bonner
p.s. There is another little detail to the Japan story
which the letter writer noticed: "It amazes me that most
people miss the appalling demographics in the Western
World," he continues. "This is the thing that keeps me
awake at night. By the time a 31-year-old retires at 60,
almost 50% of the population of the Western world and
Japan will have retired before him..." (Hmmmn...) |
