*** The Cisco Kids get ponchoed again...CSCO below $27.
*** Mr. Market changes his mind....the Big Techs get
whacked...and the whole economy heads down...
*** The winner's curse...options hurting capitalists and
the proletariat...what happened to the Day Traders...'Yo
Momma's Last Supper'...and more!
*** Reuters reports that the IMF expects the US economy to
grow at 1.7% this year.
*** The Philadelphia Fed estimates growth at 2.2% - down
from 3.3% just 2 months ago.
*** Both of these estimates could turn out to be high. But
even if they are accurate they leave no doubt that the U.S.
economy has lost its miraculous vitality...and the New
Economy is not much different from the old one. The
business cycle lives. But what is new? More below...
*** After investing too much in the latest tech wonders,
investors are now discovering that their investments are
worth less than they thought. Not that Mr. Market was wrong
about Amazon.com when the stock was at $200...and the
Nasdaq was over 5,000. Mr. Market is never wrong. But he
changes his mind about things. Yesterday, he took the
Nasdaq down 4.4% - or 106 points. And Amazon.com he
repriced at $12.50.
*** The story was similar throughout the Big Tech sector.
Companies on which investors had spent billions of dollars
slipped down to the point where they are worth only a few
million.
*** Cisco, for example, is a "must own" New Economy stock
that sits in almost every institution portfolio like a lump
of old French cheese in a warm room. The aroma was good
when it was fresh - but now, it stinks to high heaven.
Billions have been lost on Cisco, whose shares sank
yesterday to $26.50. The stock has lost 68% of its value
since it hit a high of $81 last year.
*** Cisco was singled out for rough handling because its
CEO dared to speak the truth in Europe over the weekend.
"It makes no difference what the Federal Reserve or the
latest statistics say," Mr. Chambers told a Swedish
newspaper, "What we see now is absolutely not a soft
landing. Ask anyone in American manufacturing industry and
they will say that we are in a recession. If the situation
does not change before the half year stage there is a risk
of a domino effect whereby the rest of the world will be
imminently affected." Again, more below...
*** Cisco, Amazon, GE all suffer from what Richard Thaler
described as the "winner's curse." Thaler noticed that the
winning bidder for oil drilling rights almost always paid
too much. Estimates of the value of the rights varied
greatly, he pointed out. The winner was the one with the
most optimistic view. But, the most optimistic view was
rarely the correct one.
*** Cisco, Amazon, and GE - were the big winners of the
late 90s - each one dominating its space, and paying far
too much for acquisitions, customers and just about
everything else. They are all doomed...
*** One thing for which leading companies paid too much was
labor. Not hourly labor - but top talent, which was
typically awarded huge bonuses and stock options.
*** This became a feature of 'late, degenerate American
capitalism' - companies were operated for the benefit of
employees and customers, and not for the benefit of the
capitalists.
*** Chief executives tended to get multi-million dollar
compensation packages - including bonuses - even when they
run down a firm's balance sheet. And employee stock options
effectively redistributed capitalists' money to the working
stiffs.
*** "As a clear illustration of the latter point," writes
Marshall Auerback on the Prudent Bear site, "consider the
case of Microsoft... An owner of 100 million Microsoft
shares (340,000 initial shares split-adjusted) in 1986
would have had a 2.8% share in the company at the time. If
the share count had remained unchanged since 1986 the value
of this 2.8% holding would have amounted to $8.4 billion if
today's $300 billion is accepted as fair approximation of
true market value. However, as a result of the prolific
share issues to employees, a holding of 100 million shares
today represents a 1.8% ownership interest and is worth
approximately $5.4 billion at current market value.
Shareholder dilution skimmed 36% of potential appreciation
off the top."
*** "This is the kind of dilution that Warren Buffett,
amongst others, has extensively criticised.," Auerback
continues, "But whereas Buffett was a virtual lone wolf in
respect of his attacks on the practice, the number of other
market participants critical of the impact of this
egregiously unfair dilution has multiplied now that the
costs of such activities are becoming more readily apparent
in the context of a declining Microsoft share price."
*** But employees, like everyone else, often end up getting
what they deserve, not what they expect. The Wall Street
Journal: "As the Internet bellwether's stock has plunged
more than 80% this year, many Yahoo! employees are likely
holding options that are currently worthless, or have a
value that's a lot lower than when they were awarded. With
options having lost much of their appeal, there's likely to
be an increased need at Yahoo! to pay out cash to retain
and attract people."
*** But many of those who were previously attracted now
have a problem. The New York Times: "Stock option and tax
experts say thousands, if not tens of thousands, of
employees are waking up to a real hangover as April 15
approaches. The reason is that investors generally incur
taxes when they use their options to buy stock. Even if the
stock price plummets, the tax bill remains unchanged.
Whether through bad luck, mismanagement, market
restrictions, ignorance or greed, many people failed to
sell enough stock to cover the bill. They treated paper
gains as real and even borrowed against them. And they
presumed that when tax time came, the money would be
there."
"Many people have fallen into the trap where they owe more
money in taxes than they got out of their stock options,"
said Kaye A. Thomas, an authority on stock options, "Some
people have basically been bankrupted by their tax
liability."
*** The dollar rose, knocking the euro down to 91 cents
yesterday. Gold, always on the other side of a dollar
trade, fell $2.20.
*** "Leading energy research firm Cambridge Energy Research
Associates said Thursday that world oil production capacity
will grow from 79 million barrels per day in 2000 to 92
million barrels per day in 2005," reports Dan Ferris. Dan
reminds us that Information Technology uses a tremendous
amount of power. "The Internet's dirty little secret," he
says, "is that it runs on coal."
*** "Forget the free-market talk from Curtis Hebert, the
new head of the Federal Energy Regulatory Commission,"
writes John Myers of Outstanding Investments. "He indicated
in a television interview this past week that California
had created its problems, and California was going to have
to solve them. Then he extended the emergency supply orders
that makes gas and electrical suppliers sell to California
utilities even though they don't want to out of fear they
won't be paid." But there's still room for investors to
make money... (See: Depression Era Big Government in Force
in California)
*** What happened to the day traders? We hear nothing about
them. "Day Traders go back to day jobs," says a headline in
the Arizona Republic. Day trading was never anything more
than gambling. But the odds were much better in Las Vegas
than in Manhattan.
*** Maria prepared a delicious dinner last night. I know
you don't care what we had for dinner, but I will tell you
anyway: Salad, duck pate, Brussels sprouts, fried potatoes,
stewed tomatoes and sausage. Only the sausage was
bought...everything else came from our own garden, grown
and preserved by Mr. Deshais. I am bucking the trend of the
last 2 millennia: I'm going to buy some pigs so we'll be
able to make our own sausage for next winter.
* Live like royalty on $14 a day
* Own an exotic beachfront getaway for $35,000
* Enjoy dinner in a fine restaurant for $7 per person
* Employ a maid or gardener for $2 a day
* Buy comprehensive health insurance for $20 per month and
a lot more!
"What nobody saw, though some people may have felt it, was
that those fundamental data from which diagnoses and
prognoses were made, were themselves in a state of flux and
that they would be swamped by the torrents of a process of
readjustment corresponding in magnitude to the extent of
the industrial revolution of the preceding 30 years.
People, for the most part, stood their ground firmly. But
that ground itself was about to give way."
Joseph A. Schumpeter, Business Cycles, 1939
When I returned from Paris to the little town of
Montmorillon last Friday night, a cloud of black smoke
arose from the center of town.
"We had better take the back roads," said Elizabeth as she
picked me up at the station.
In the center of town, a sleepy little burg whose last role
on the stage of world events was performed during the
Hundred Years' War with Britain in the 14th century, when an
angry mob had formed. And there, where the two principal
roads meet, a pile of tires burned - sending black smoke up
over the church spire and Mayor's office.
The point of controversy was the subsidies paid to farmers.
Most unhappy are the beef producers, who have been caught
on the horns of the 'mad cow' dilemma. Though only a
handful of people have come down with the disease, fear is
widespread...so that the price of beef has fallen.
And then, last week, a relative of 'mad cow' disease was
reported in sheep. There is no evidence that anyone was
ever made sick by the sheep disease, but it was enough to
throw another panic into the farm community. So, all over
France, last week, farmers demonstrated for higher
subsidies.
"Where you stand depends upon where you sit," goes the
expression. My neighbor, Pierre, is in favor of more
subsidies for farmers. Catholic, conservative...he
nevertheless sits on a tractor a good portion of the day
and believes the state has the responsibility to make sure
he gets a fair price for his beef. Already, about half his
income comes from government subsidies, but he wants more.
"Farmers always complain," said Maitre Boulzaguet at
Saturday's party...dismissing the demonstrations.
Yes, they always complain about the weather....and about
farm prices. What is unique to our age is that they also
expect their success or failure to be a collective
responsibility.
Governments never tire of trying to rig prices. Politicians
always try to favor their friends and destroy their
enemies...interfering in the market as much as they can in
order to bring about some unnatural result. But never
before have the markets been so jimmied on such a grand
scale and at such colossal risk.
What my neighbor Pierre expects from the European Union,
the average American investor and householder expects from
the United States Congress...and the Federal Reserve -
protection from the crises of capitalism and from the
consequences of a free market.
"In effect," according to economist Paul Krugman,
"capitalism and its economists made a deal with the public;
it will be okay to have free markets from now on, because we
know enough to prevent any more Great Depressions."
The presumption is that while the economists and policy
makers of 1931 did "everything wrong," those of 2001 will
do everything right.
I will put the question to you: Will the same Euro-policy
makers who react to farmers' demand for higher subsidies
with promises of more taxpayers' money do 'everything
right' in a financial crisis? Will the same U.S. policy
makers who react to every financial threat with promises of
more cash do 'everything right' when a debt crisis reveals
itself? Will Japanese officials, who - on the advice of
American economists - have dropped interest rates to zero
and taken on more public debt per capita than any nation in
history...do the 'right thing' in a real pinch?
The question answers itself.
Farmers will act like farmers and politicians like
poltroons...which has always been the case; but what is
new?
What is new is the extent to which the farmer's plight and
the investor's risk has been globalized, securitized and
derivativized.
Progress, as I've opined in these letters, depends on an
increasing division of labor. More and more, people
specialize...and improve both the quality and quantity of
their output. They also develop specialized tools and
equipment that make further productivity gains possible.
In the Agricultural Economy, few people specialized. Local
economies were small and relatively self-contained. A
gardener, like Mr. Deshais, might produce the vegetables
for a hamlet...while someone else produced the dairy
products, but that was about as far as it went.
Thus, an economic crisis was fairly small too. A drought
might affect all of Europe, for example, but the pain would
be local - each village and farm suffering according to its
unique situation and how much of previous harvests it had
managed to save. Little help was expected from the larger
community.
But the division of labor got a big boost from the
Industrial Revolution. Factories, machines, railroads, and
communications made it possible for people to specialize on
a grander scale. Just a few shoe factories in New England,
for example, might provide footwear for thousands of
people. And just a handful of farmers could feed entire
cities.
Specialization produced economies of scale - allowing yet
further improvements in output per unit of investment. It
also made it possible for most people to forget about
storing grain for lean years. Henceforth, savings would be
of a more abstract form - deposits in banks, stocks, bonds,
and cash.
But "every economic era is afflicted with its own unique
curse," as Michael Mandel puts it in "The Coming Internet
Depression."
The grander scale of commerce, labor, and production
created by the Industrial Revolution produced problems of a
grander scale too.
The most costly of these was WWI. Before 1914, wars came
and went in Europe. Armies marched hither and
yon...fighting, dying, and generally making life miserable
for everyone.
But the damage was limited. The economy of the pre-
industrial era would only support a limited number of
people not involved in farming. And part-time soldiers
could not stay in the field for long. As in ancient Greece,
wars were often conducted between planting and harvesting,
guaranteeing that conflicts would be fairly short.
With the Industrial Revolution came the capacity for
warfare on of a larger magnitude. Not that anyone wanted
bloodier and more costly wars. But that is the point,
people do not get what the want. And even if it were
possible to correct the errors of the past, there are still
plenty of new ones that can be made.
Not long after WWI came a crisis of capitalism, which,
thanks to the errors of politicians, developed into the
Great Depression. This, too, was a depression that couldn't
have happened in the agricultural age. It was made possible
by an extended division of labor...which suddenly broke
down and created an economic collapse on a grander scale
than had ever been seen before. There had been many period
panics in the capital markets, of course. But they affected
relatively few people and tended to be short-lived.
In the Great Depression, as in previous economic crises,
savings proved indispensable. And the savings that worked
best were those of the least abstract form - food, shelter,
gold, and cash in hand. Stocks and deposits in banks
proved, very often, ineffective.
And now, 6 decades later, information technology has
permitted a further extension of the division of labor. The
whole world economy operates on a much vaster scale than it
did in 1929. Labor is much more specialized. Wealth has
become even more abstract - often existing only as
'information' in electronic form - and savings are few.
Securitization, derivatization and globalization have
changed things greatly - but we still don't know to what
effect.
Bill Bonner is,
in spite of himself, a natural born contrarian. Early each morning, Bill
writes The Daily
Reckoning—his take on the financial markets and what’s going
on in the world—and sends it off by e-mail before most Americans’
alarm clocks have buzzed. Many readers say it's the first thing they want
to read when they get up—not only because it's informative and thought
provoking, but also it's inspiring, in its own quirky and provocative way.
Of course, there's
much more to Bill than his daily market commentary. He's also the founder
and president of Agora Publishing, one of the world's most successful
consumer newsletter publishing companies. Bill's passion for international
travel and big ideas are reflected in the company he's successfully built.
In 1979, he began publishing International Living and Hulbert's
Financial Digest . Since then, the company has grown to include
dozens of newsletters focusing on health, travel, and finance. Bill has
vigorously expanded from Agora's home base in Baltimore, Maryland since
the early ’90s—opening offices in Florida, London, Paris, Ireland, and
Germany.
Agora's publication
subsidiaries include Pickering
& Chatto, a prestigious academic press in London and Les
Belles Lettres in Paris, best known as a publisher of classical
literature in bilingual editions.
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Last modified: April 01, 2001
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