UNREASONABLE EXPECTATIONS
by Bill Bonner
"The U.S. economy has surpassed all reasonable expectations,"
writes David Hale, chairman of Prince Street Capital hedge
fund, in Barron's.
In our view, both the economy and the stock market flew by
reasonable expectations sometime in the middle of the last
decade. Both went up when they should have gone down.
Here at the Daily Reckoning, we have a forecasting approach
all our own. We do not try to figure out what will happen,
for it is impossible to know. Instead, we look at what ought
to happen. Without 'will' we have only 'ought' to do the work
of forecasting. 'People ought to get what they've got
coming,' we say to ourselves. In the markets, they usually
do.
In the late '90s, even after the nation's greatest central
banker, Alan Greenspan, noted that investors had become
irrationally exuberant, they seemed to become even more
irrationally exuberant. And then, when recession and bear
market threatened, these irrational investors were sure that
the very same central banker who couldn't stop a bubble could
nevertheless stop it from springing a leak.
Alas, this proved a vain hope; a bear market beginning in
March of 2000 reduced the nation's stock market wealth by $7
trillion - to January 2003. But another remarkable thing
happened at the same time - nothing much.
"The 2000-2002 stock market slump failed to produce a
financial crisis," writes Hale. "Wealth losses in the U.S.
equity market since March 2002 have been unprecedented. They
have been equal to 90% of GDP, compared with 60% during the
two years after the 1929 stock-market crash. But during the
past two years only eleven banks failed in the U.S. compared
with nearly 500 during the 1989-1991 and thousands during the
1930s."
And in the economy - the same remarkable lack of anything
special. Unemployment lines grew longer, but not so much as
you would reasonably expect. And consumer borrowing and
spending didn't fall, as you might reasonably expect, but
rose. "In 2002, mortgage refinancing shot up to $1.5 trillion
compared with a previous peak of $750 billion in '98," Hale
tells us.
Following a mild economic downturn in 2001...and after the
opening shots in the War Against Terror..."it is difficult to
imagine a more benign scenario than the 3% growth in output
that the economy actually enjoyed during the past year," Hale
concludes.
What bothers us about this situation is precisely what
delights Mr. Hale - we could not reasonably expect it. What
ought to follow a spectacularly absurd boom is a
spectacularly absurd bust.
But the Japanese bubble wasn't completely destroyed in a year
or two either. Economists don't like to cast their eyes
towards Japan - because they cannot explain it. Neither
monetary nor fiscal stimuli seem to have done the trick. But
if you could grab the back of their heads and turn them
towards the Land of the Rising Sun they would see that after
a mild recession GDP growth continued in Japan following the
stock market peak in '89 - at about 2% to 3% per year. This
went on for several years. But then the economy went into a
more prolonged slump. By 2000, GDP per person was back to
1993 levels!
In both cases, Japan and the U.S., what ought to have
happened was something very different. Why something
different didn't happen is the subject of today's letter...
along this additional forecast for 2003, or beyond: it will.
Japan's example, we are told, doesn't apply anywhere outside
of Japan. Because the Japanese created a form of capitalism
which was almost unrecognizable to westerners. It was a
system of cross-holdings, state intervention, cronyism, and a
stock market that had become a popular sensation. In the
financial frenzy of the late '80s, Japanese companies ceased
to act like capitalist enterprises altogether, for they
ignored the capitalists. Profits no longer mattered. Assets
per share had become an illusion. All that seemed to count
was growth...market share...and big announcements to the
press.
What kind of capitalism could it be where the capitalists
didn't require a return on their investment? And was it so
different from the U.S. model? American businesses seemed to
care even less about their capitalists than Japanese ones
did. As stock prices peaked out on Wall Street in early 2000,
profits had already been falling for the last 7 years.
They continued to fall, sharply, for the first 2 years of the
slump. Executive salaries soared - first as profits fell...
and later as many of the biggest companies in the country
edged into insolvency. Plus, the managers gave away the store
in options to key employees - further disguising the real
costs of business.
Despite all the hullabaloo about investing in New Economy
technology actual investment in plants, equipment and things-
that-might-give-investors-higher-profits-in-the-future
declined. In the late '90s, net capital investment dropped to
new post-war lows.
Instead of paying attention to the business, U.S. corporate
executives focused on deal-making, acquisitions and short-
term profits - anything that would get their names in the
paper.
You'd think an owner would get upset. But none of this
mattered to the capitalists - because they had ceased to
exist. Old-time capitalists who put money into businesses
they knew and understood... with the reasonable hope of
earning a profit... had been replaced by a new, collectivized
lumpeninvestoriat whose expectations were decidedly
unreasonable. The patsies and chumps expected impossible
rates of return from stocks about which they had no clue.
Management could run down the balance sheet all it wanted. It
could make extravagant compensation deals with itself. It
could acquire assets for preposterous prices... it could
borrow huge sums and then wonder how it would repay the
money. It could cut dividends...or not pay them at all; the
little guys would never figure it out.
The lumpeninvestoriat in Japan, as in the US, ought to have
jumped away from stocks, debt, and spending immediately
following the crash in the stock market. The market could
have plunged...and then recovered. But government
policymakers and central bankers were soon out in force -
spreading so many safety nets, there was scarcely a square
foot of pavement on which to fall.
Of course, the little guys never knew what they were doing in
the first place... was it such a surprise that they did the
wrong thing again; holding on... dragging out the pain of the
correction...and postponing a real recovery? In Japan,
analysts got weary waiting. Then, the slump continued...
slowly and softly, like a man drowning in a beer tank.
For the moment, the U.S. economy continues to run ahead of
'all reasonable expectations.' Eventually, reasonable
expectations will catch up. Or, at least they ought to.
Bill Bonner |
