Wednesday, January 16, 2002

Faber Article

Folks,

There is a side argument in this article which says innovators shine at a
particular time; by his description, that time is drawing near.

John



THE MONETISATION OF THE AMERICAN ECONOMY
by Dr. Marc Faber

Although there are a number of different "business cycle" theories, it has
always been my view that economic expansion and contraction phases
are caused by a number of different factors, and that their durations can
vary considerably, depending, again, on many different social, economic,
and political conditions. That said, I'll try to explain what I believe is
happening today in the U.S. Economy.

In the 19th-century, the U.S. economy was still a predominantly agrarian
economy. In 1900, despite America's rapid industrialization, agriculture
still employed twice as many people as did manufacturing, with farm workers
making up close to 40% of the U.S. labor force, down from 70% in
1840. Today, farm workers account for less than 3% of the labor force.

The relative importance of agriculture versus manufacturing in the 19th
century is also evident from American export figures, which show that in
1850 over 83%, and in 1890, 75%, of exports were agriculture- based. It is
thus easy to see that, in the 19th century, agriculture was by far the
most important sector of the U.S. economy and that, therefore, movements in
agricultural prices were the dominant factor for the entire economy.
When, for whatever reason, farm prices rose (poor harvests, droughts, wars,
etc), the agricultural sector thrived because farmers' incomes would
rise.

When agricultural prices fell, farm incomes would decline. Declining farm
incomes would then reduce the purchasing power of farmers and lead
to less demand for manufactured goods. Periods of weak growth or recessions
followed. But to explain 19th-century American business cycles
purely as a function of agricultural price movements is an
oversimplification.

During times of rapidly rising agrarian prices, what was the incentive for
farmers to innovate and to lower costs by producing more efficiently with
new production methods?

In periods of falling commodity prices we find all the great waves of
innovations in periods. The reason? During such times the only way to
increase one's income was to produce more cost-effectively through the
application of new inventions and innovations. The canal boom in the
1830s, the railroad boom of the 1870s, and the 1920s' electricity,
chemistry, and motor booms all occurred during times in which commodity
prices fell.

All these periods of great innovations were, however, driven not only by
the desire to cut costs and improve productivity in order to boost profits,
but also by a favorable environment for financial assets.

Declining commodity prices led to falling interest rates and, therefore,
rising bond and stock prices. In turn, the combination of declining interest
rates and rising equity prices lowered the cost of capital and improved the
profits of the manufacturing sector. Hence, all major financial manias,
such as the canal and railroad booms, and the 1920s' and 1990s' U.S. stock
market manias, also occurred in a weak pricing environment! But at the
same time, each innovation and stock market boom period preceded financial
busts, which led to recessions or depressions. Why?

During periods of weak prices, monetary conditions remain very
accommodative, since there is no inflation. Moreover, the combination of new
inventions, rising corporate profits, vibrant financial markets, and easy
money is a powerful tonic for capital spending. Both rising stock prices and
declining interest rates are obviously reducing the cost of capital and, by
themselves, lead to more capital investments.

Easy-money monetary policies bring about, through a combination of a wave
of innovations and booming financial markets, massive
over-investments and a gross misallocation of capital because the profit
opportunity expected to arise from the innovation is so great that it leads to
excessive borrowings by consumers as well as businesses. The downturn or
bust is ushered in when the over-investments lead to excess capacity
and a collapse in prices, which in turn drive down profits and, along with
them, stock prices, which then weaken the economy even more. Thus, you
have negative wealth effect and cutbacks in capital spending due to rising
capital costs.

This is where we stand today. The weak pricing and easy money environment
of the 1990s led to a huge stock market and capital-spending boom,
which was largely financed by debt and foreigners who bought U.S. real
assets, equities, and bonds.

However, today the situation is more complex because we are faced with a
fundamentally totally different set of economic and financial, and now
suddenly also geopolitical, conditions than ever before in economic
history. Why? Every economy has a dominant driving force. I explained above
that in the U.S. economy of the 19th century, agriculture was the dominant
sector, which would largely drive economic activity according to rising
or falling prices for agricultural commodities.

In the Middle East, since the 1970s, rising or falling oil prices bring
about, in the absence of an important and efficient manufacturing or service
sector, vibrant or sluggish economic conditions. For countries like Taiwan
and South Korea, exports are the engine of economic expansions and
contractions. So, what is now the driver of the U.S. economy? Certainly, it
is no longer agriculture!

Moreover, whereas the manufacturing sector may have been the engine of the
U.S. economy in the 1920s and probably still was in the 1950s,
today it only accounts for slightly more than 20% of GDP and, therefore, it
doesn't have a very meaningful impact on the economy as a whole.

Compare manufacturing to, say, the U.S. financial markets and you will
realize that it is the financial markets, and financial transactions, that
are the
key driver of the economy.

Just think of the U.S. stock market capitalization, which at its peak in
March 2000 reached a stunning 183% of GDP, more than twice the level
prior to the crash in 1929 when it reached 81%, and significantly higher
than the Japanese stock market capitalization as a percentage of GDP in
late 1989.

Prior to the vicious bear markets that followed the speculative excesses
leading to both the 1968 and early 1973 tops, stock market capitalization as
a percentage of GDP stood at 78%. Compare this to major market lows, when
stock market capitalization as a percentage of GDP stood at 16% in
1942, 34% in September 1974, and 34% in July 1982. Even after its decline
over the last 18 months, the U.S. stock market capitalization as a
percentage of GDP - at present amounting to more than 130% of GDP, compared
to an average of 50% since 1926 - is still extremely high and
supports my view that the equity market, along with the credit market, is
the economy's largest, albeit certainly not "strongest", lever for the
economy.

The rising importance of the financial sector in the U.S. economy has also
been reflected in the strong performance of U.S. financial stocks. The
performance of the S&P 500 Financial (Diversified) Index - which includes
stocks such as American Express, American General, Fed Home Loan
Mortgage, Federal National Mortgage Association, MBIA, MGIC Investment
Corp, Morgan Stanley Dean Witter, DSCVR&C, and SunAmerica -
reveals that their resilience in an otherwise rather weak market - at least
until last fall - is striking.

On the debt side, the evidence also points to a disproportionately large
debt market compared to the real economy. Total U.S. market debt which
does not include loans by financial and non-financial institutions)
currently amounts to about 270% of GDP, compared to an average of
approximately 145% of GDP between 1950 and 1980.

At the stock market's peak in 1929, total market debt reached 160% of GDP!

If, indeed, a substantial part of economic growth over the last 20 years or
so, not only in the U.S. but all over the world, was driven by an
expansion of the financial markets - most notably the credit market - then
it follows that this disproportionate financial expansion must go on at all
costs in order to sustain further economic growth.

The almost endless supply of money available for the corporate and
household sectors leads to poor investments by corporations - projects that
don't make any sense - and to personal consumption growth that outpaces
income growth declining savings rate.

The turning point of this financial pyramid then occurs when it becomes
evident that the corporate sector over- invested. Competition then drives
down prices as a result of the additional supplies, which in turn bring
about the profit deflation in the corporate sector we are presently witnessing
among industrialized countries. The profit deflation subsequently leads to
a reduction in employment and lowers the value of equities, which
brings about a deterioration of the consumers' leveraged balance sheet.

When the economy weakens, this increased leverage on the part of the
consumer leads to a substantial rise in the number of personal bankruptcies,
as happened recently.

Faced with these conditions, the consumer has two choices. He will either
be forced to borrow even more in order to maintain his consumption,
thus leveraging his already shaky balance sheet even further, or he will
cut back on his spending.

The strong, and in the long term unsustainable, growth in consumer finance
may sound alarming, but when you consider that in the first seven
months of 2001 the credit card industry mailed out more than 2 billion
solicitations, an increase of 61% over a year ago, this expansion of credit
should come as no surprise. Capital One was responsible for 29% of all
solicitations. (Note that for every man, woman, and child in the U.S.,
seven credit card solicitations were sent out in just seven months, with an
average response rate of only 0.4%!)

Another disaster in waiting concerns other government- sponsored
enterprises such as Fannie Mae and Freddie Mac, which are currently
benefiting from a deluge of mortgage refinancing. According to the Prudent
Bear's Doug Noland, over the last three years, Freddie Mac's assets
grew by US$308 billion (134%), while shareholders' equity only increased by
US$5.6 billion.

In the present situation, Mr. Greenspan's accommodative monetary policies
will remain largely ineffective for the U.S. economy. Corporate profits
will continue to slide and disappoint. Poor corporate profitability and
negative cash flows will lead to further cutbacks in capital spending and to
additional layoffs in the U.S.

And when it becomes obvious to everyone that further layoffs are on the
cards and that the U.S. economy will fail to recover in the next six
months, retail and car sales, along with the housing market, will finally
cave in as well.

Marc Faber
for The Daily Reckoning


Tuesday, January 15, 2002

Re: A Question On Exporting

In a message dated 1/14/02 9:37:41 PM, writes:

First, if you can, turn off html when emailing me, I never turn it on so your
emails are hard to decipher. Answers follow...

However lets say you are contacted or catch wind of a goose and turkey egg
farmer in lets say China.

***Has poultry farming long been a passion of yours? Or have you longed to
learn fowl ranching?***

He is farm is rather small but due to demand and his success in the past
three years he has the capital to increase his production rate by buying more
hatchlings. He is prepared to pay.04 USD to .05 USD an egg.

***So he should review Chinese import records to find the best place in the
world to buy eggs, and then follow up with the best supplier in that
determined country.***

And wants an initial purchase of 5000 to 8000 hatchlings from a US source.

***So his maximum order would be $500.00 us dollars (8000 nickels). You'd
have to get these for at most 2.5 cents each. I just got a buy-one get
-one-free deal at safeway which yielded 36 eggs for the price of 18. Lemme
see, that was about 5.25 cents an egg, for chicken eggs, and very poor
quality ones at that. You'd have to have a profound passion for this work,
and a government's ability to fund lost causes.***

How would an exporter research a source?

***I am sure, with a passion, one would find the egg ranchers association,
the poultry husband association, and no doubt the organic farmers as well and
learn all one could learn. A google search online would give one plenty of
leads. ***

Once he has found several sources and found the best quality for his customer
should he buy wholesale and resell to the farmer?

***One would have to search the world over to answer this question; that
might take years.***

If he does not have the capital or know any willing investors, could he work
as an agent? How do agents set up a contract and fees? What are the usual
cuts? That probably depends on what is being sold and how much of the
paperwork and logistics the agent does for the seller. Am I on the right
track?

***No. ***

This is all assuming the buyer is reliable and honest.

***Sadly, this has become subjective.. we now only determine if the deal
makes sense. Forget reliable and honest. Everyone is, until they burn you.
Then they are not. If the deal makes sense, burning you is pointless***

Out of curiosity can agents make residual income. For example an agent makes
a deal. He matches a buyer and a seller. The terms of the contract state
that the agent will receive 5% for the deal and 5% of every other deal which
is through the same buyer. Does this ever happen?

***Certainly, but money for nothing doesn't last long. Either the fool that
agreed finds his costs are too high to compete against others and goes out of
business... or being a fool his biz never gets going.***

The buyer and the seller would have know of each other if it was for the
agent. And if they had a long term relationship wouldn't the seller be
grateful enough to consider such terms considering the company would not have
been making this extra cash flow if it was not for the agent.

***Right***

I think the disadvantages of working as an agent is one: As a whole
mostly one time sales. Therefor the agent must work like a real estate agent
finding multiple sellers. Plus he/she only gets a small chunk of the profit.


***Even real estate agents will tell you they'd starve without repeat biz and
referrals.***

The wholesaler makes a greater profit.

***and has greater risks***

And if you are the manufacturer selling directly to the buyer, I think
you would make that much more.

***and have even more risk.***

Please correct me if I am wrong. I am trying to learn as much about
business as I can. I thank you for your time and having to view my naive
ideas is probably frustrating for you. Thanks again

***O contraire! it's fun. Start with something you love. The rest falls in
place.***

John


An Eye On Russia

Greetings!

You may have caught wind in my classes a bias against trading with Russia
born of exprience and reputation: first, it has been the case since I began
trading with the Chinese in the 70's that to trade via Hong Kong was always
better than trading directly with the mainland Chinese. When Russia opened
up, I assumed it would be the same, and time bore that bias out. Now my
sense is things are changing fast.

After debacle of 1997 in Russia, and the ouster of the last President,
Yeltsin, the new president Putin has been making some moves that free traders
would spot as very encouraging indeed.

1. Russia has a gold coin currency, the chervonets, that runs simultaneously
with their paper currency, the ruble. Nothing assures a stable currency and
sound govt financing than a gold standard, and an alternative to paper
currency, as Russia now has, is a huge step forward. The coin is tax-exempt,
clearly signalling the Russians mean business with this coin, in the most
literal sense of the word.

When you deposit any savings in a bank in USA, a complex leveraging begins in
which your savings is used to create more "wealth" out of thin air to lend to
others. To put it mildly, some say this has gotten out of hand, with too
much wealth assumed, and malinvestment following miscalculation.

If in Russia you turn your savings over to a bank and get a gold coin in
return you got a perfect bullet to keep the government from inflating away
your value, or wrecking your savings. It many ways it is a small thing, but
it has a profound impact.

2. According to the Economist magazine, a new tax code aims to rationalise
the tax system, reducing the number of taxes and the corporate tax burden.
Changes to the tax regime, which came into effect in January 2001, include
the introduction of a flat rate of personal income tax of 13%, reduction of
the value-added tax (VAT) burden and simplification of the administration of
social security contributions. The corporate tax rate is to be lowered from
35% to 24% at the start of 2002.

Folks, Hong Kong has done exceptionally well with a similar tax regime... and
since tax burden is often the difference between one country's products being
competitive, or not, Russia is clearly planning to compete relatively freely.

3. And this may be off the wall, but In an interview published today by the
Polish newspaper Gazeta Wyborcza, Putin said, "There is no problem in
relations between

Russia and the Vatican. I am willing to invite the Pope at any time." Putin
said that John Paul II "wishes this visit to be an important event, which
means renewing full relations with the Russian Orthodox Church. This,
unfortunately, does not depend on me."

So what? So the Russian government has grown up to the point it does not
feel threatened by "outside influences." This too is a profound shift.

I might add one more thing: Russia has "Islam problems" far more pressing
than any USA faces. To have the USA in Afghanistan sure takes the heat off
the Russians, by giving Islamic radicals something tangible to organize
against. USA suckered Russia into invading Afghanistan in the '80's, and
turnaround is fair play. We may be seeing a country that has become far more
subtle, wise and mature than we suppose.

John


Monday, January 14, 2002

Argentina... A View

Argentina’s history to live beyond its means and to default on its

foreign obligations--a tradition that goes back to the early nineteenth

century--became the institutionalized ideology of the country under Juan

Domingo Perón, who first ruled the country from 1946 to 1955. In its

modernized version, this ideology has guided the transformation of

Argentina into a system of "techno-bureaucratic clientilism," which is

primarily oriented at providing privileges to those who are employed in

or linked to the public sector. At the top of the bureaucratic hierarchy

is a technocratic elite whose function is to take care of the funding of

its clientele, primarily by obtaining foreign loans.



In its relations with the bureaucrats of the International Monetary

Fund, Argentina’s power elite used to feel like brothers in mind. In

various respects, the ideology of "el peronismo" shares a number of

similarities with the IMF’s view of how economic policy should be

handled. Both are in agreement when assuming, first, that an economy

should be run by them, i.e., a bureaucratic elite; second, that an

economy must be stabilized, controlled, and managed by government

intervention; and third, that it is primarily the demand side which

matters. Both are in agreement by assuming that the attainment of

macroeconomic figures as given by some specific statistical aggregates

would imply sound economic policy.



It came as a profound shock to the Argentinean political establishment

when the government proved unable to get new loans from the IMF in

December 2001. An implicit contract between the IMF and Argentina had

fallen apart. Therefore, it came as no surprise that the economic and

financial crisis turned into a profound political crisis. In Argentina,

the legitimacy of a government is closely tied to its capability to

aliment its clientele. When the government of De la Rúa and Domingo

Cavallo had to admit that it could no longer fund the system, it became

certain that they would have to dismiss. The interventionist fury in the

second half of 2001 and, later on, the bloody turmoil in the streets--as

well as the confusion at the governmental level, with five presidents in

just about a month--demonstrated that Argentina’s system of legitimacy

was about to fall apart.



The collapse of Argentina signifies the breakdown of an economy as much

as\xa0the end of a political system. But the default of Argentina also

shows the failure of an economic model which presumes that economic

growth and development can be achieved by accumulating external debt.

Argentina represents another case in the long chain of economic

collapses brought about by excessive external credit accumulation. The

fall of Argentina is also a case in the long chain of the failures of

the doctrine which holds that economies should be managed, stabilized,

and controlled by bureaucrats.



By not paying out the credit tranche of $1.3 billion in U.S. dollars in

December 2001, the International Monetary Fund probably did the best

thing in decades. The alternative would have implied the continuation of

financing an inherently corrupt system. By not providing further loans,

the IMF may have triggered reconsideration and change, not only in

Argentina, but also in other highly indebted countries that suffer from

similar structures, as they exist in Argentina. In these countries, the

authorities have long given up serious efforts to strengthen their

productive systems, concentrating instead on getting funds from

abroad--or, more specifically, formally adhering to the IMF policy

targets as their intermediate economic policy goals. In these countries,

the national financial sector, the government, and those connected to

the public sector via a more or less subtle system of privileges have

formed a symbiosis in combination with the international creditors and

the International Monetary Fund, which, during the past two decades, has

degenerated its prime function into holding this wasteful system

together.



In its original meaning, "crisis" signifies a turning point that can

either lead to improvement and recovery or to more severe deterioration.

In the case of Argentina, with the future of the Argentinean people in

mind, one must hope for the abandonment of its interventionist economic

system with its reliance on a bureaucratic apparatus and its self-chosen

dependency on foreign credits. But there is always the risk that, due to

biased analysis, the wrong lessons will be drawn from a crisis. It would

be another tragedy in the making if opinion should prevail that it was

the currency board per se that lay at the basis of the default and that

a dismantling of this regime, along with a devaluation of the peso,

would be enough to put Argentina on the road to prosperity.



----------------



Dr. Antony P. Mueller is a professor of economics at the University of

Erlangen-Nuremberg, Germany. He was a Fulbright Scholar in the U.S. and

currently serves as long-term visiting professor at the Universidade

Federal de Santa Catarina in Brazil under the German-Brazilian academic

exchange program.