October 10th, 2006 Price: Subscribe »

ARCHIVED COMMENTARY

Yesterday’s sharp plunge looked like a prelude to…well, nothing, actually.  You don’t have to be a chartist to see that the entire 184 points of Tuesday’s decline failed by a country mile to take out last week’s lows in the Dow. For that reason, it barely qualified as a bearish impulse leg on the 15-minute chart, much less the “daily.” That’s what gratuitous volatility is all about: Swings get larger and larger, until even a 300-point day in the Dow can be said to have occurred within a range that is technically meaningless.

 

(Click on chart to enlarge)

 

Of course, that will never discourage the punditry from trying to imbue with meaning seismic jitters such as we witnessed yesterday. They chalked up the decline to a downtick in consumer confidence, and to less-than-robust May sales for Wal-Mart. Oh, and did I mention that that on-again, off-again red herring, the “fear” of inflation, was said to be a factor as well? Just try to sell the inflation argument to the real estate speculator in Tampa who’s having trouble flipping a condo for less than he paid for it.

 

Amateur Scavengers

 

Speaking of real estate, I received a flurry of letters from a lurker, Frank P., who seems determined to convince me that all things connected with the economy and the housing market are simply hunk-dory. Coincidentally, a front page story in the Wall Street Journal yesterday described how amateurs are starting to move in on bankrupt homeowners, scavenging for bargains just as they’ve been inspired to do by those get-rich-quick infomercials that run every night, all night long, on the telly. How comforting it is to think that these enterprising bottom-fishers, many of whom could not have qualified for a CETA job, are cushioning the U.S. economy against the onslaught of a deflationary juggernaut that has been accreting strength for the last 20 years. Wish them well, since they may actually be our last line of defense when Helicopter Ben discovers that getting the money spigot to gush anew will require breathtaking sums of new borrowing by the likes of you and me.

 

 

Frank P. sent me several articles quoting “experts” who do not even acknowledge that a housing bubble exists.  Here’s a sample from Bloomberg: “Bubble, what bubble? Those of us who are U.S. housing bears may be growling needlessly when it comes to irrational exuberance in the hottest areas.

 

“Maybe we're looking at traditional gauges in the wrong way, and there is indeed a ``very orderly and moderate kind of cooling'' going on and there won't be a huge crash in prices, as suggested by Federal Reserve Chairman Ben Bernanke on May 18.”

 

Bubble Fears Overblown?

 

And here’s another demurral, even more insipid, from CollegeNews.org: “Fears of a real estate bubble are overblown, and homes remain undervalued in many markets, according to new research from a pair of Pomona College professors who developed a fresh methodology for gauging bubble trouble. By comparing the cash flow generated by owning a home to the cost of renting a comparable house, economics professors Gary Smith and Margaret H. Smith found bubble conditions in only one of the 10 metropolitan U.S. housing markets evaluated.”

 

In fairness, perhaps we should acknowledge that eggheads are paid to churn out exactly this sort of swill. Drop these guys in the middle of the 1930s dustbowl and they’d have told their client it was suitable for a waterslide theme park: “By comparing water-table levels for the last ten years, two Pomona College professors have determined that the dryness in the region can be alleviated or even eliminated by clamping down on golf courses that have been watering daily.”

 

$210Tr Virtual Economy

 

None of which is going to convince our irrationally exuberant friend Frank that maybe, just maybe, things are not quite as rosy as they are cracked up to be by CNBC’s talking heads. “Frank,” I wrote, “consider that a global economy in goods and services amounting to $54Tr last year was just a small piece of a market in leveraged financial instruments with an aggregate notional value of $210Tr (per BIS data). As Crosscurrents’ Alan Newman likes to point out, the business of the U.S. and the rest of the world is no longer business, but financial speculation. For years, Alan has tracked the dollar value of stock-market transactions each day, at one point identifying a dot-com climax in trading activity that in dollars was equal to nearly four times America’s daily GDP.

 

“When we speak of ‘turning on the money spigot,’ it implies that large amounts of additional borrowing must take place to ‘actualize’ the expansion of liquid money. The process in practice requires that some asset class be inflated to collateralize the new borrowing. Housing has served in this role, and the securitized debt that lies downstream of mortgage-payment receivables is a big piece of that $210Tr of securitized, leveraged borrowing.

 

Questioning Greenspan

 

“The bottom-line, Frank, is that it would take no more than a small downtick in real estate values to catalyze the deleveraging of a $210TR credit edifice. And just what, one might ask, have the huge amounts of borrowing that have taken place over the last five years gotten us?  Answer: The weakest economic recovery of the postwar period. If you want a credible source to corroborate this, try Richebacher, a buddy of Paul Volcker’s and an economist from the old school. He asks the sort of simple questions that make Greenspan and his banking cronies look like either liars or dolts. Such as:  How can the Fed Chairman speak of a capital investment boom at a time when household savings growth was negative?  Or this: How can the inflated value of our homes be considered ‘wealth?’  Etc., etc.”

 

Not easily swayed, Frank fired back with a New Paradigm salvo: “What is happening globally and affecting the U.S. is a major economic structural change which affects production, marketing and design (innovation).  For example, it took Greenspan years to really trust the higher productivity numbers that began to occur in the late 80s as a result of this new economic structure. 

 

“For others who understood organizational dynamics, there was no reason even to speculate whether productivity would rise.  Their experience and knowledge in organizational structure and organizations already had told them ‘yes.’ Most financial people have no understanding of macro-business and organizations and how they facilitate and organize the performance of work. Their lack of understanding shows up as voids in their analysis.

 

Brave New World

 

“I think a thorough reading of Anatole Kaletsky, Charles Gave, Louis-Vincent Gave's book, Our Brave New World would be of benefit. Here’s a description: ‘In recent years, we have seen companies become far more efficient in the way they use their resources, whether capital or labour. This important change is not only having micro consequences but also has big macro implications, including a fall in the volatility of our economic cycle, a higher tolerance for debt, higher prices for assets... In Our Brave New World, we explain some of the important changes our world has gone through in recent years and try to draw some investment implications. This 130-page book was published in September 2005.”

 

Frank wasn’t impressed with my Alan Newman citation either, when he wrote, “Alan Newman's view is pretty myopic (‘the business of the U.S. and the rest of the world is no longer business, but financial speculation’).  That is a general problem -- analytical myopia --  with the analysis and analysts you are following.”

 

New Paradigm Poppycock

 

My reply -- the last word, since, as you will already have inferred, I’ve got more pressing concerns:

 

“Like all diligent reporters, I try to get at the truth by piecing together data from many sources, including anecdotal. This technique allowed me to flatly assert, for instance, in 1999 reports that I prepared for institutional-investor clients of Dresdner bank, among others, that the Y2K bug posed no more of an economic threat than the late, great comet Kahoutek.

 

“With respect to the global economy, and with all due respect to you, I regard the New Economic Paradigm as so much poppycock -- in this instance a sales tool used by Kaletsky at al., probably on the advice of their literary agent. And you needn’t condescend to ‘financial people.’ I was an English major myself, albeit one who was as absorbed in the writings of Adam Smith, Mises and Hayek as in the Western literary canon. Anyone familiar with the works of these economists understands not only why the U.S. and global economies are mortally sick, but why all those who would claim otherwise are egregiously misinformed.

 

Dismal Science Slipping

 

“Austrian School economists in particular have explained not only why there is no ‘new paradigm’ at work, but why there never will be. Austrians like Richebacher have stood up against a tide of ignorance that has all but swamped the already Dismal Science. They have shouted the truth: that the emperor is wearing no clothes – or, to put it in more relevant terms, explained exactly why we cannot all get rich selling each other Information and Financial Services. This is notwithstanding the fact that many have indeed become hugely rich, to the tune of billions, selling paper assets to greater fools.

 

“The following question greatly oversimplifies things, but I would ask it again, since you ignored it the first time around:  Why does a global economy that produces $54Tr in goods and services need a $210Tr financial economy to support it?  And for that matter, what is so ‘analytically myopic’ about Alan Newman’s observation? If the dollar value of stocks traded each day on the NYSE has indeed been nearly four times the daily GDP, what else might we infer other than that financial speculation has become the main business of America?”

***

 

Hidden-Pivot Seminar

 

Quite a few of you have indicated you are likely to attend the hidden-pivot seminar in New York this October. I’ve also heard from about a half-dozen Australian readers and subscribers who said they’re interested but that it would be too far to travel. However, I’m willing to come to Sydney or Melbourne if I can fill a class, so let me please hear from you if that would work.

 

The New York session will be a no-frills version of the course that I gave in Denver, offered at a significant saving over the original price. After that there will probably be just one more session offered – in San Francisco, late in 2006 or early 2007 -- but that would be the last for a long while.

 

The course includes post-grad mentoring via a chat group that some of my former students have set up. If you’ve been impressed with the accuracy of my forecasts, this is an opportunity you should not pass up. Please let me know via e-mail if you are serious about coming.