Low In The Water

Bill Bonner
The Daily Reckoning
Sep 29, 2006

The Daily Reckoning PRESENTS: The remarkable events in the last few days have been greeted by the market, not with shock and awe, but with such a coma-like indifference that we feel like holding a mirror under its nose and taking its pulse. Read on...

A hedge fund registered the largest single loss in history - $6 billion, more than twice the loss of Long Term Capital Management. In Mexico, millions protested the presidential elections and teachers in Oaxaca threatened revolution. Thailand's elected government was replaced in a military coup. In Hungary, citizens rioted. Hugo Chavez told the UN that the United States of America was run by the 'devil.' This same US of A is now widely thought to be preparing a military strike against Iran. In the homeland, housing registered the first nationwide decline in 11 years. And for the first time in 90 years, America ceased being a net-capitalist nation; now it pays more to foreign creditors than it receives from its overseas investments.

Yet, these remarkable events in the last few days have been greeted by the market, not with shock and awe, but with such a coma-like indifference that we feel like holding a mirror under its nose and taking its pulse.

Venezuela may be run by a fox or a fool, depending on your point of view, but what kind of investor buys its bonds at only 2.3% over U.S. Treasuries? And Thailand may be a nice place to lie on the beach, but investors who lend money to the Thai government for barely a single percentage point more than lending to the U.S. government may have had too much sun.

It is as if someone has put lithium in the Manhattan water supply. And now, the Zen-like calm threatens the entire world financial system.

Markets make opinions. Even sober institutional analysts are enjoying a tranquility normally available only to the brain dead: "The results suggest that the important drivers of volatility reduction seem to be structural, and may therefore have a permanent effect on volatility... "says a study sponsored by the Bank of International Settlements. After a long period of serenity, investors begin to expect it. They forget that the winds can howl... and the seas can suddenly well up... sink boats and knock down whole cities.

But opinions make markets too. Seeing no menace, investors reach for yield... stretching... grasping... standing on tippy toes... and piling on debt. Not only do they become more exposed to risks... they actually hasten the danger towards them, practically reaching out to grab it. As they do, storm insurance becomes a greater and greater bargain.

Today's lack of panic is not limited to sovereign debt. On the 14th of September, the Ford Motor Company announced that it would lose $9 billion making automobiles in 2006. There was a time when a loss like that would have caused investors to race for the exits... or at least, the bathroom. But on the 15th of September, trading in Ford debt continued as normal. Investors seemed not to notice - or care.

Nor do investors seem to care that Goldman Sachs, already the biggest 'hedge fund' in the world, is exposing itself to far greater risk than its closest competitors; value-at-risk, the measure by which the security industry calculates its exposure, has gone up 48% for the entire industry, since 2001. But for Goldman, the increase is almost triple that -136%. Another important measure, assets-to-equity, rose 29% for the industry, while it went up 49% for Goldman. Still, in mid-September, Goldman lenders stood willing and able to front the company $1.5 billion, at a rate only 1% point greater than a 10-year loan to the U.S. Treasury.

There is a difference between lending to Thailand or to Goldman Sachs, and lending to the U.S. Treasury. And it is not merely a difference of degree. Thailand may squeeze its citizens. Goldman may swindle its customers. But only the U.S. Treasury has the power to do both.

That is why U.S. Treasuries are regarded as such safe credits. In a storm, it is Treasuries you will probably want to own... not Goldman or Baht bonds. In what circumstances, then, should you run after the meager extra yield? Only when you think storms are a long way away.

Of course, we don't know anymore than anyone else what the future holds. We only note, today, the perverse tendency of our species. When seas are calm, we load up our boats so heavily that even a stone thrown in the water would swamp them.

What lends point to this little reflection is a comment by Alexander Kaletsky in the London TIMES. Kaletsky cites an IMF paper with nary a snicker of contempt or mirth:

"The IMF this year has stuck its neck out... it has predicted an unprecedented fifth year of rapid growth in the world economy. It has suggested that the world expansion is becoming ever more soundly based... and it has presented persuasive arguments on why this growth could be sustained for years."

The arguments are persuasive to Kaletsky because he already believes them. To the rhetorical question - is this too good to be true? - the columnist answers in the optimistic: "not necessarily."

"The really interesting part of the analysis... deals with some of the longer timer structural underpinning of what looks increasingly like a golden age of global non-inflationary growth... the IMF has now thrown its huge analytical weight behind a number of theories promoted in this column over the past few years."

The theories to which Kaletsky refers include two that will be familiar to readers of The Daily Reckoning -one suggests that information technology is paying off... and the other, that globalization is. We don't deny either. But do these twin blessings really calm troubled waters so completely and eternally that the global economy can glide out to sea with the heaviest load of debt in history... and the lightest heart ever recorded?

Of course, we don't get to see tomorrow's weather any sooner than anyone else. Perhaps the IMF is right. Maybe, in the next 12 months, the seas will be as placid and quiet as a strangled nun. We have no way of knowing otherwise.

So far, at least, the great ships of globalized commerce and hedge fund driven hypermarkets have encountered no difficulties. The world economy is on course to grow another 5% or so in the year ahead, claims the IMF. So calm are the seas that the captain has put his feet up and his head back. The lookout has picked up a Sudoku game he is trying to work out. And the passengers are so cocksure that all is well, they have traded their life vests for rubber ducks from Asia... and their lifeboats for pick-up trucks.

As to the new technology and globalization... this crew thinks they invented it. But they are mistaken in that too. This is hardly the first time for either. Back in the '20s, came a burst of new technology even bigger and more powerful than the Information Revolution. Automobiles, electric fans, refrigerators, radios, telephones, and mechanized agriculture - the new technology was breathtaking. And globalization? Back then, too, ships plied the seven seas... laden with pineapples and bananas from plantations in Latin America... tea from India... rubber from Malaysia... tobacco from Virginia... and automobiles from Detroit.

Even today, Trenton, New Jersey, hangs onto its old motto - now rusty and fraudulent - "Trenton Makes, The World Takes." In the '20s, it was burnished and true. Globalized commerce created a boom in Trenton back then. Products from the town and its hinterland were loaded onto transport and shipped all over the world. So still were the seas of international trade... and so obviously fruitful to all concerned was the maritime traffic... that many people back then also thought nothing would ever stir them up.

Prices for Trenton's properties and Trenton's companies soared. Trenton became famous as a major manufacturing center for steel, rubber, wire, rope, linoleum and ceramic.

But then came what was supposed never to come. The Great Depression hit Trenton, like the rest of the United States. By 1933, one-tenth of the population of the entire state had become dependant on the government for its living. So bad was the situation that New Jersey gave out begging licenses to the poor after state funds ran out. In 1937, even the local gravediggers went on strike. The landscape had turned so bleak that during the radio broadcast of "The War of the Worlds," when Orson Welles announced that a "huge, flaming object" had fallen on a farm twenty-two miles from Trenton and extra-terrestrials were on their way, there was widespread panic... as people clogged the highways fleeing the state and others blockaded their homes against the Martians.

Actually, in a strange coincidence, a huge flaming object did descend on New Jersey in 1937. The German zeppelin, Hindenburg - flying loaded with hydrogen - caught fire while approaching a mooring mast in Manchester. It took only half a minute for the blaze to devour the vessel and kill 36 people. It might have been an omen... two years later; the Second World War broke out.

But, there was a bright side to things. While almost 10% of New Jersey's population was carted off to the war front, the employment situation in the state did finally get better... now, New Jersey shipyards were bustling once again - this time, with the construction of battle ships, aircraft carriers, cruisers and destroyers. All told, the state received 9% of all allied war-related contracts during the war years.

At the height of its boom in the 1920s, New Jersey could never have known that it was on the edge of the worst depression in U.S. history. And it could never have guessed that the bust ahead of it would run so deep and last so long that it would take a world war to fix.

All of America rode low in the water in the 20s, and got swamped in the storms that blew up later. Today, there are only 100 basis points between the gunwale of the world's safest credit and the water line of one of its riskiest; marine insurance must be a good buy.

Bill Bonner
email: DR@dailyreckoning.com
website: The Daily Reckoning

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