'Tis Only My Opinion!

June 2002 - Volume 22, Number 6


You can Fool . . .

Is the Economy beginning to improve or not?

If you listen to the torrent of government statistics, the bleatings of the CNBC and other financial commentators, and the guidance of various Wall Street Pied Pipers, you might make a case that the economy has bottomed and things will get better.

Do I believe that scenario? Not hardly!

Gold marches on and the dollar continues to fall!

DDGU is the new code word for the "in" crowd. If you aren't in the know, it means "Dollar down, Gold up."

Step back and look at two interacting indicators.  If the economy was truly improving, would the dollar be falling almost every day since the end of January 2002.

Obviously, foreign investors who own about 40% of all publicly-held US Treasury notes and bills and a large percentage of all US stock equities do not agree.  If the foreign investors agreed, why would they be pulling their money out of the stock market at an increasing rate.  A recent study by Bridgewater Associates makes the following points about foreign ownership of US assets.

  • Foreigners own 40% of the US treasury market, and when you back out the Fed holdings, they own 48% of the liquid treasury market. Foreigners own over $8.2 trillion of US assets, while we own only $5.6 trillion of assets in the rest of the world.  To put it in perspective, that $2.6 trillion difference is 26% of GDP.
  • Foreigners hold 24% of corporate bonds, 13% of the equity market and 22% of US corporations. Foreign ownership has risen from 33% of US GDP in 1990 to 78% today.

 The U.S. investor is too close to the trees in the forest to see the conflagration that is burning just over the next rise.  Yet the foreign investor can see the smoke rising in the increasing balance of payment deficit which is approaching $500 billion a year, the increasing federal deficit and federal debt that is bumping the debt ceiling, the high levels of consumer credit debt, the increase in the various measures of the money supply like M2, and M3.  Reading the smoke signals tells a totally different tale and they sense a major rout coming.

As a result, the US dollar is under pressure and gold continues to increase in value despite the best efforts of the various bullion and central banks to stem the march to $325 per oz.

As we prepare this month's Opinion, the price of gold hit $328 per oz. this morning in London. The impact of this level on the commercial shorts could be very interesting. While the commercials have generally been correct in the gold market, it is my expectation that this time around they are not on the correct side of the trade. Rather they are trying to protect their massive gold carry trade positions and if the price stays above $325 for long, several bullion banks and central banks which have lent bullion may find themselves in trouble.

The volume in the June contract during the past two days has been very large. This is rather unusual and could signify a problem.  The bullion banks, JP Morgan Chase, Citibank, and others could well have a large risk problem. Perhaps, that is why the head traders at JP Morgan Chase, Morgan Stanley, and others have found themselves looking for new positions or taking early retirement.

An old Indian chief adage . . . where there's smoke, there is often a fire!

So what is causing the difference.  It is simply this. Foreigner's have too many dollars and see the US dollar deteriorating.  They also have had many more problems with fiat currencies.  The US trade deficit continues to trouble them and they have lost faith in the recovery of the US economy.  The result is simply that the outflow of foreign holdings will cause the US stock market to continue its downward slide.

This week, we talked to a large foreign investor who just had sold their position in one of our largest banks that had been held for years.  Where were the proceeds being reinvested, we asked?  "Gold bullion, silver bullion, Euro currency and industrial diamonds" was the answer. But what about the interest return? "We'll forget interest at these rates, we don't want to lose principal!"

Foreigners are finally wising up.  For years, they have been sending material things like cars, apparel, shoes, computers, etc., to the US and only getting back paper for it. Now the value of that paper is becoming suspect despite our military power and they want something more tangible that will represent their wealth.  Not only have many foreigners lost confidence in this recovery and the value of the US dollar but they also want to diversify their US dollar holdings.  Can you blame them?


Can't We Just Get Along?

Ah, that overused phrase of Rodney King is back to haunt us again.

Is NATO finished?

During the past week, the US and Russia signed another treaty reducing the extent of nuclear arms.  With the demonstrations against the war on terror in many EU countries during Bush's visit, it is interesting that the Bush Administration is looking beyond NATO to forge alliances.

The EU position of trying to soften Bush's stance against terrorist states could well cause Britain to leave the EU.  Bush stated the case clearly . . . "Either you are with us in the war against terrorism or you are not."  With the clear superiority of US military might apparent to all, alliances with Russia and China could negate the need for NATO and relegate the socialist nations of the EU to almost "third world" status.

The Middle East problem continues

Unfortunately, the participants in the various Middle East nations are not interested in getting along. The Kashmir problem continues to vex the Pakistani and Indian population. Now the saber rattling has brought them to the brink of a nuclear confrontation.  Certain estimates indicate that over 12 million could die in the initial exchange of nuclear weapons and untold more via fallout.  Now you know why the US tried to prevent nuclear proliferation for years.

This dispute goes back centuries and is another in a long line of contests between various religious beliefs, e.g., Islam and Hindu.  These religious wars are often only terminated with the "Genghis Khan solution."

What is the "Genghis Khan solution?" Simple . . . make sure you eliminate all males or make them slaves, and subjugate the women.

  • The Press Trust of India reports, “Pakistan has threatened to use nuclear weapons even if India stuck to conventional arms in any conflict, asserting that it has never subscribed to "no-first-use" of atomic weapons and that ruling out their use would give New Delhi a ‘license to kill’.”…

  • USA Today reports, “a U.S. government team is in India to plan the possible evacuation of 1,100 U.S. troops and up to 63,000 U.S. citizens from both countries.”

Whether Secretary of Defense Donald Rumsfeld can contain the Kashmir problem is problematical. I find it interesting that it is Rumsfeld going to the area as opposed to Secretary of State Colin Powell. Perhaps, Powell's time is limited as Secretary of State.

Arafat's PLA tests Israeli patience

The Palestine-Israeli problem continues to fester despite the revived peace process. However, despite Arafat's exhortations, the suicide bombings continue and the patience of the Israeli's is wearing thin. If violence breaks out between Pakistan and India, it is my expectation that the Israeli army will mount major attacks on the Palestine areas in an attempt to reduce the PLA and their radical groups infrastructure further while the world's attention is focused elsewhere.

The Wahhabi syndrome

If that occurs, many of the old families that rule the Middle Eastern oil countries could be in great difficulty.  The Wahhabi could very well turn against the Saudi royal family and oust them.  The economic situation in Saudi Arabia and other surrounding countries is not good.  Moreover, the ruling class is unwilling and/or unable to assist the population to increase its standard of living and its education levels. The result is an under-educated civilization by Western standards and a political environment which continues to feed upon envy and perceived and/or real slights.

In Iran, Iraq, Jordan, Syria, Turkey, Lebanon, Egypt, and all throughout the region including most of Africa, the seeds of discontent have been planted and at some point in the future will need to be addressed.  The problem is primarily religious differences in the Middle East. In Africa, aids, starvation and poverty take the spotlight in countries which are basically ruled by dictators and despots.  While elections may be held, the results are tainted.

When you don't have a clue, get out of town and sight-see!

Secretary of Treasury O'Neill's trip with Bono to Africa is nothing more than a sight-seeing tour.  Of course, there will be promises of more aid added to the burden to be carried by the American taxpayer. Yet, there is nothing that the US can do to solve their problems. We have given how many billions in foreign aid both public and private since 1950 to the African continent. And we have not solved a thing! If anything, the aid has prevented the people from finding solutions while keeping dictatorial governments in power.

Teach a Man to Fish and He’ll Eat for a Lifetime

Despite the Peace Corps, the Red Cross, all the missionaries and other do-gooders, the African sub-continent standard of living is less today than many years ago.  For decades, the white settlers in Rhodesia and South Africa fed the populations and also exported to areas outside the area.  Today, the communist and socialist governments in that area have killed or forced out most of their white populations thus destroying the agricultural and economic productivity of these areas. It is no surprise to me that people are starving.

While many liberals suggest that we must have compassion and feed the starving, I disagree.  They made their bed, let them lie in it!  Unfortunately, we have been giving the African population a fish and not teaching them to fish.

Rodney King's cry of "Can't we Just Get Along?" is another one of those "feel-good" ideas but in the hard cold cruel world in which we live, it sounds good ... but when push comes to shove, it is soon forgotten.


CEO pay versus the Stockholder's interest!

Warren Buffet made the point recently that today's CEO is greedy! The stock option ruse that is used to pay the CEO's not only is obscene but hides the cost of the pay from the shareholders who are paying it. Congress and FASB must change the accounting method for options.

Michael Armstrong of AT&T has presided over the destruction of Ma Bell through his misguided acquisition policies. Yet, has he been fired?  No, the incompetent board of directors of AT&T continues to reward him with stock options, bonuses, and perks. And he is not the only one!  Let us not talk about rewards for performance because in most cases in today's corporate environment, the shareholders are not getting increased value for their investment.

Yesterday, the bond rating of AT&T was cut to just above junk. Yet, fair-haired Armstrong continues to draw his hefty salary while the stock sinks to record low levels. Am I missing something?

Until shareholders begin to elect directors that are not politically correct directors and elect directors that are not hand-picked by management, unfortunately they will continue to get the shaft from greedy CEO's.

Look throughout the corporate sector. Today, there are only seven (7) corporations whose debt is rated 'AAA.'  The Board of Directors of all the other companies that have lost their 'AAA' status ought to be recalled and their top management not only fired but sued for malfeasance and dereliction of duty.


Productivity is a joke.

U.S. productivity scored its greatest increase in 19 years during the first quarter, the Labor Department said Friday. Productivity in the non-farm sector rose at an 8.4% annual rate, just a hair slower than the 8.6% estimated earlier.

The Federal Reserve continues to use the fiction that productivity is increasing while it is simply a function of the way the numbers are crunched even as they downgrade Q1 to 8.4%.  In economics, production is defined as the creation of economic value. But to me, the definition should be the production of wealth and must take into account the cost of living.

Actual production in the US is down.  Just look at the number of manufacturing jobs that have been lost overseas or to NAFTA. Now Mexico is fretting about losing jobs to lower priced labor.

Service is not production.  Many years ago, a HBS colleague argued that we only needed to be a service-oriented economy.  It was obvious to me that he had not read Adam Smith's treatise on wealth. Service consumes wealth and does not produce it!

Just what does the US produce?  Go to any store and check the labels.  You won't find hardly anything that has a "Made in U.S.A." label.  Until our politicians decide that we need to protect the homeland and bring back manufacturing plants to the continent, we shall be vulnerable to attack.  One of the reasons we can't rebuild our air-launched cruise missile inventory quickly is that many of the components are no longer made in the USA and the tooling has been destroyed.

Globalization will subvert our ability to defend ourselves.  In the event of a war, our stockpiles of military hardware will quickly be consumed. Whether we will have the machine tools and the raw materials to make replacements is problematical.


Has the Economy Bottomed?

Consumer confidence is up as is consumer debt. The savings rate is again headed negative despite the recent modification in the calculation by the BEA to make the rate positive.

The Chicago purchasing manager's index continued to rise adding hope that maybe the bottom is here.  While new orders were rising in April, the real problem is that retail sales except in discount stores has not kept pace.  Even Wal-mart suggested last week that sales were not meeting plan.

I find it interesting that ocean freight rates have not increased during the past 45 days and that the breaking yards are still getting ships.  When one understands that a lot of merchandise must arrive in this country by ocean container, you can only conclude that the economy is not growing substantially.  Perhaps, "muddling through" is as good as it gets.

While the intervention of the Japanese caused the dollar to rise overnight against the yen, Moody's again cut the bond ratings by two notches of the Japan local currency bonds citing that it felt that things were not as rosy as the politicians and the Nikki economists were suggesting.  Last week, the Japanese spent a few billion trying to stem the tide of the yen against the dollar to no avail.

The Japanese bureaucrats don't realize the problem is not with the yen but with the dollar.  As foreigners reduce their holdings of US stocks, bonds and other assets, the dollar will continue to deteriorate against other currencies and not just the yen.

We are now entering pre-announcement time for 2nd Quarter earnings.  With layoff's continuing to increase, sales stagnating, is it any wonder that the economy is not booming!

Before I am willing to say that the economy has bottomed, I will wait.  With the market suffering four straight down days of distribution without a climatic sell-off, my reading is that we have the current stock rally stopped and the market will continue to slide downward from here despite the upbeat statistics.  


But then - 'Tis Only My Opinion!

Fred Richards
June 2002

Corruptisima republica plurimae leges. [The more corrupt a republic, the more laws.] -- Tacitus, Annals III 27

This issue of 'Tis Only My Opinion was copyrighted by Adrich Corporation in 2002.
All rights reserved. Quotation with attribution is encouraged.
Tis Only My Opinion is intended to provoke thinking, then dialogue among our readers.

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Last revised - July 6, 2008