Finance Digest for Week of October 4, 2004

ON TOP DOWN UNDER

Cast your mind back, if you will, to the late 1990s. Having decided that technology was the only business worth betting on, investors the world over poured billions of dollars into companies that, by way of example, thought it sensible to spend $200 billion on 3G mobile-phone licences. Those were the days when companies with even the most tangential connection to the New Economy sucked in punters’ cash at a prodigious rate. Those, in contrast, which sold things that you could drop on your foot, or -- horror! -- stuff dug out of the ground, were about as popular as last year’s Nokia at a rave.

Nowhere, perhaps, was perceived as being more Old Economy than Australia, a country, after all, that seemed to exist merely to grow wheat, breed sheep and mine minerals. Australian shares rose in the late 1990s, but their performance was flaccid compared with the show on Wall Street. Until, that is, the technology bubble popped. Though shares in most rich countries have risen strongly over the past couple of years as profits and confidence have returned, almost all of the big markets are still some way from their highs. The S&P 500 is still 27% below its peak, the FTSE 100 is down by a third, and the Eurotop 300 is off 42%. Australia’s All Ordinaries index, by contrast, has been bouncing from one record high to another this year, during which it has risen by 10%, largely because of the soaring price of energy and metals. Unlike most other rich countries, Australia is a net exporter not just of metals and coal but of energy too.

A resurgent Japan, Australia’s biggest export market, is part of the explanation for bumper export prices. But the destination of choice for Australia’s exports is China, which has a scarcity of the very commodities that Australia has in abundance. A more subtle reason for the rise in commodity prices is that following the Asian financial crisis of 1997, and with the world’s attention focused firmly on technology, investment by energy and mining companies dropped precipitously. With capacity thus constrained, a pick-up in demand from the likes of China could only lead to one result: higher prices. Thus do Australia’s ports, like those elsewhere in Asia, operate at full capacity. And thus, too, after two decades of under-investment, is oil at $50 a barrel.

But the tale also has a twist or two. Australia’s good fortune relies on China avoiding a stumble. But that is not the stockmarket’s only vulnerability. Strong exports of commodities notwithstanding, the country is likely to have a current-account deficit of 5.5% or so of GDP this year. Worried that the country is overheating, the central bank has put up interest rates, and may again. Higher interest rates are likely to further depress house prices, which had risen to giddy heights before suffering a reverse this year. Largely unaffected by the technology bubble, it remains to be seen whether Australia can weather a property bubble.

THREE WAYS TO BEAT A FLAT MARKET

Suppose Warren Buffett is right about the stock markets being under house arrest for another ten years. History speaks. The S&P did not recapture its 1929 highs until 1954. The Dow first brushed 1000 in 1966 but failed to break out for good until 1982. It got as low as 577 in 1974. So if Buffett is correct, forget indexing. Forget buy and hold. If you want to achieve boffo returns, you will have to adopt one of three methods: pick tomorrow’s superstars, time the market or time prices. All three can work. Two will be very hard work; the other requires less footwork but scads more patience and independence of mind.

Picking tomorrow’s superstars will require four talents: a deep scientific understanding of nano, the ability to see market forces at work, financial acumen and an instinct for discerning the Dells from the Gateways. Market timing seems to me to be a sucker’s game. If you see something that all the king’s horses and men have not spotted yet, then go ahead: Time the market. Otherwise, don’t. Now timing prices I can buy into. Markets may be efficient; not so, stock prices. Especially not small-cap stock prices. Big mutual funds do not touch them. Analysts have hardly a word to say. So the little stocks sit there, sometimes loved, often not. When they are not, opportunities arise.

SNIFFING OUT BOMBS IN PROFIT-AND-LOSS STATEMENTS

What the accounting gods give, the accounting gods can take away. The Financial Accounting Standards Board is thinking about forcing U.S. companies to reserve funds for future taxes that would be due on foreign earnings if and when those earnings come ashore. While it is unclear whether the plan can muster enough support to pass the seven-member board this year, the concept is in deliberation. With number-crunching rectitude popular, the plan could well take effect soon. And that could do a lot of damage to companies that make most of their profits abroad. Some multinationals, in fact, make all of their income abroad.

U.S. companies pay U.S. income tax on earnings of their foreign subsidiaries only when those earnings are sent back home. On the theory that those profits will be repatriated in the distant future or maybe never, present FASB rules permit the parent to reserve nothing now for those future tax liabilities. How much damage would be done to a company’s bottom line by an FASB about-face? That is hard to gauge because international taxation is so complex and the relevant figures are not disclosed to shareholders. The U.S. corporate income tax rate is 35%. However, foreign income taxes can be credited against the U.S. tax bill. But there would be a U.S. tax due on profits that, by dint of either tax shelters or country of origin, have been only lightly taxed overseas.

In a globalized economy a lot of profits are at stake. Last year the cumulative total of untaxed foreign earnings for S&P 500 companies went up by an estimated $88 billion, an amount equal to 20% of their earnings from continuing operations. For the moment the debate has only to do with how to report profits to shareholders. Setting up a reserve for a deferred tax liability does not increase a corporation’s cash outlays. However, there is nothing to stop Congress from changing the law to collect tax on unrepatriated foreign earnings. To make up our roster of potential losers under the FASB proposal, accounting watchdog Jack I. Ciesielski, who pens The Analyst’s Accounting Observer, scanned the footnotes of S&P 500 companies. ...

KENNETH FISHER LIKES THE STOCK MARKET BECAUSE THE SCRIBBLERS DO NOT

One reason this stock market is so spiffy is that journalists are so dour on it. They reflect and, in fact, promote low investor sentiment. The setting is perfect for a nice rebound. The journalists I have in mind are primarily not from the U.S. but from Europe. In America the scribblers are somewhat mixed, but overseas they are morose, depressed, sarcastic. Among British business journalists, you cannot find one important writer who does not think stocks will fall and interest rates will rise markedly. They are consistently bearish. They think British markets will fare badly and American and the other European ones will fare worse. That is a bullish sign for me. I love it.

Several then wrote about my optimism and why they think I am wrong. But none cited arguments that are not cited by everyone and hence already discounted in pricing. In 2000 economic writers were optimistic, specifically on tech. Even in 2002 they could hear a bullish argument. They cannot now. With time they will revert to more optimism, and with it provide motivation for readers to buy. You want to buy before their readers do. In Germany and France writers are also depressed.

Another reason I like this spiffy market is that so many great companies sell on par to the market’s average valuations. Below are four of them. You do not really have to pay extra to get good quality. These are great firms with basic growth characteristics and only a whisker of a valuation premium to the market’s average.

PLUCKING FLOWERS FROM THE WALL

John Keeley, manager of the $170 million Keeley Small Cap Value Fund, likes being a value guy: “You probably make fewer mistakes than you do in the growth area,” he muses. “There are fewer moving parts.” Here is how Keeley, 64, keeps it simple. First, he largely ignores technology and health care stocks. Second, he limits his buying to five kinds of companies: those coming out of bankruptcy, those looking very cheap relative to book value (excess of assets over liabilities), spunoff subsidiaries, utilities, and converted thrifts and mutual insurance companies. These days Keeley’s fund, a Forbes Honor Roll member holds 114 stocks. Not quite half fall into the spinoff category. It has been a winning formula. The Keeley Small Cap Fund has returned 14% annualized since its launch in October 1993, versus 10% for the S&P 500.

Keeley subscribes to the Spinoff Report from Horizon Research Group. He looks for healthy cash flow (in the sense of net earnings plus depreciation). In the late 1980s Keeley got wise to another category of unloved stock when several mutual savings banks in Chicago converted to become publicly traded. Keeley gets a calendar of anticipated mutual-to-stock conversions from SNL Financial in Charlottesville, Virignia. Do not buy stocks of convertees willy-nilly, he says. Low price-to-book ratios remain important, if harder to find these days. Unlike other public offerings, Keeley explains, the point of mutual conversions is not to raise equity capital but rather to prime the company for an acquisition. In the last 15 years 70% of thrifts that have converted have been bought.

What about stocks that are cheap relative to their book value? These are scarce nowadays, with the average stock trading at 3.5 times book. But they can be found. Example: Phoenix, a 153-year-old insurance company and money manager catering to the affluent. Keeley’s interest in utilities, which make up 7% of his holdings, is a recent one. With deregulation, he says, “they got into things they shouldn’t have.” But as the companies refinanced and wrote off bad investments, Keeley saw opportunities. If you do not want to pay the 4.5% sales load to get Keeley’s fund, buy some of the stocks it owns.

RATE-RISE PROTECTION

Treasury Inflation Protected Securities (TIPS) and inflation-linked corporate bonds protect against inflation, not against higher interest rates. These are not the same thing. In the mid-1990s we had high rates and low inflation. Investors are concerned this could happen again. A strategy that helps protect investors in this kind of impending storm is to invest in variable-rate securities, which come in both bond and preferred stock forms, whose coupons or dividends are not fixed but rather keep pace with rising interest rates.

THE FEARFUL ECONOMY

One reason economic statistics are weak: Businesses are hoarding cash and stockpiling commodities. Can we blame them? Increased levels of risk and uncertainty cause people to make adjustments. U.S. businesses have taken hoarding to new levels. Moody’s has reported that the ratio of liquid financial assets to debt on the balance sheets of U.S. nonfinancial companies has recently hit a 35-year high. Given the course of events in the Middle East, the hoarding of cash has been prudent. How has it been accomplished? By cutting costs and improving productivity, businesses have increased cash flow. They have hung on to the cash by shying away from capital expenditures.

While the hoarding of cash has dramatically improved the balance sheets of businesses, it has left the economy starved of fuel. For one, employment growth has been sluggish. Also, investment -- the big swing factor that gives rise to booms and busts -- has been flat. In addition to accumulating cash hoards, businesses have attempted to increase their stocks of commodities. They do not want to be caught short. Their quest for liquidity in the commodity sphere has thrown most commodities into a bull market phase. Moreover, we do not know how much of the 2001 and 2003 tax cuts will be retained and how much rescinded after either a Bush or Kerry Administration takes office. Talk about risk and uncertainty. Keep your commodity allocation at 10%. And do not expect the stock market to exhibit much strength this year, no matter who is elected.

WHEEL BARGAINS

Things look gloomy for the auto industry. Interest rates are on the rise and gas prices are high. Analysts are slashing sales forecasts for Detroit’s biggest car companies; an inventory overhang is forcing Ford and General Motors to cut fourth-quarter production. If you sell cars for a living, this is bad news. If you are a contrarian investor, auto stocks are starting to look interesting.

Value investor Irwin Michael, who manages $575 million at ABC Funds in Toronto, recently took a big stake in General Motors in each of his three funds. GM currently sells at a 13% discount to its book value and at six times Michael’s 2004 earnings forecast of $7 per share. Ford has a 2.8% yield and sells for 11 times trailing 12-month earnings. Toyota edged past Ford last year to become the second-largest vehicle manufacturer in the world. Toyota, which trades at 12 times trailing 12-month profits, is cheap relative to both the S&P (19 times) and the Japanese market (27). As one of the better-managed companies in Japan, Toyota is not a bad way to play that nation’s continuing economic and stock market recovery.

ARTWORKS RUSHED TO AUCTIONS AS SELLERS SENSE TOP OF MARKET

At collectors opening their mailboxes this month will find auction catalogs bursting with famous images. Sensing that a heated market may soon reach its peak, collectors have consigned hundreds of millions of dollars worth of artworks for the November sales at New York’s auction houses. Sotheby’s and Christie’s say the estimated sales totals are the highest in nearly 15 years.

Usually it is the so-called 3-D’s -- death, divorce and debt -- that motivate people to sell at auction. But this fall, in addition to the many millions of dollars that the auction houses are estimating people will pay to get what some in the business call “wall power”, many collectors have simply decided that now is the moment to cash in. While few sellers will acknowledge it, many seem to be asking themselves how much higher prices will go before the bubble bursts. Officials at Sotheby’s and Christie’s report that the estimates for their evening sales of Impressionist, modern and contemporary art, which begin on Nov. 3, are the highest since May 1990, six months before the art market crashed.

Asked if she was finally selling her collection of contemporary photographs because the market for those artists is particularly strong now, one woman replied: “I don’t like all the hype. If you look at the world and see how things are falling apart, there’s something almost unreal about spending so much money on art. Is this all we have to hold on to?”

INVITING CHINA TO DINNER

An extra place was laid at the high table of economic statecraft on Friday October 1st. For the first time, China joined finance ministers from the G7, a group of big, rich nations, for dinner in Washington, DC. Given that China’s purchasing power (over $6 trillion taking account of price differences between countries) now outranks all but America’s, the dinner invitation would seem overdue. America’s Treasury Department described the engagement as “historic”. Certainly, failure to engage would have left the G7 looking increasingly anachronistic.

But was China invited because it is now recognized as a major economic power, or because it is still viewed as a major economic nuisance? In its communiqué, released before the dinner, the G7 called on economies that lack exchange-rate flexibility to try a bit of it. The G7 issued a similar communiqué this time last year from Dubai, and another five months later in Florida. The Americans feel that East Asian currencies are too cheap, held down by governments fearful of market forces. As a consequence, the dollar is too expensive, undermining America’s exporters and contributing to a vast deficit in the country’s balance of trade. China, which has maintained a peg of 8.28 yuan to the dollar since 1995, is seen as the chief culprit.

The G7 once held great sway over exchange rates. When it met, in a previous incarnation, in New York in September 1985, it engineered a near-30% decline in the dollar. When it reconvened a year and a half later in Paris, it promptly halted that decline. By breaking bread with the Chinese, the current G7 is tacitly admitting that it can no longer achieve very much without them.

Also, in the communiqué they released, the G7 promised to review progress on debt relief by the end of the year. These efforts have a longer history than most realize. Rich countries have been easing the terms and lengthening the maturities on past loans to the poor since the 1980s. Britain’s recent proposal is a bold attempt to declare year zero and start again. Unfortunately, much of this history shows that bad debts are not the fundamental problem in many poor countries. Bad government is.

Guess Who’s Coming To Dinner?

After many years of being the subject of intimate dinnertime gossip, China was at last given a place at the exclusive Group of Seven table last Friday. Notwithstanding recognition of the country’s increasing importance in the global economy implied by the invitation, China certainly did not act like an eager guest overanxious to please its hosts, who were particularly keen to see a faster pace of revaluing the renminbi. In fact, the “guest” was rather ungracious: it warned US policy makers not to push too hard for an imminent revaluation of its currency, in effect telling Mr. Snow to be careful what he wished for.

The rumours of an imminent revaluation of the renminbi always seemed implausible given the Bush Administration’s own longstanding policy of benign neglect towards the dollar. Although Mr. Snow has occasionally paid lip service to the Rubinesque mantra that a strong dollar is always in the best interests of the United States, he has often undercut this notion by affirming the need for markets to determine its proper level. So why the sudden frenzy last week? The key seems to be a September 28th China Daily article which likely reflected ongoing concerns that Beijing shares about the future long term course of the greenback. “To ward off foreign exchange risks, China needs to readjust the current structure, increasing the proportion of the euro in its foreign exchange reserves,” it concluded. That the story was published against a backdrop reported purchases of gold by China added to the fevered speculation that a substantial revaluation was imminent.

But even if China was prepared to accommodate the Treasury’s request, the fact remains that Beijing must find a counterparty that does not share its concerns over the long run purchasing power of the dollar in order to divest itself of some of its US dollar holdings. There are not many of those around. But for the actions of the official sector, especially the Asian central bankers, the dollar would likely be in freefall if current portfolio preferences of the private sector are anything to go by.

The Bank of China’s deputy governor, Lu Ruogu went so far as to suggest. “If you force China to change it will hurt the United States. You destroy a goose that will give you a golden egg.” More like a poison chalice than a golden goose in reality, but for all the talk of US pressure (acted out in kabuki-like fashion for purely electoral purposes), America’s monetary authorities are in reality likely to continue to countenance the current dollar-renminbi exchange rate, particularly in light of the horrific data coming out of the Fed’s latest flow of funds statement: US total debt has risen 8.2% year-on-year to a record 298 per cent of GDP at the end of the second quarter. Turning off the Chinese credit spigot, therefore, is certainly not desirable – at least not until after November 4th.

China also has its own domestic reasons for moving to revalue very slowly, and on a schedule not subject to intense foreign pressure. This is not to say that China is not planning for a future in which a large write-down of their dollar foreign exchange holdings becomes inevitable. Minmetal’s, one of 53 state-owned enterprises administered by Beijing, recently announced acquisition of Noranda, Canada’s mining giant, for about $5 billion must be analysed in this context. The proposed transaction shows China’s increased readiness to spend some of its stash of $480 billion in foreign exchange reserves to alleviate the country’s dependence on foreign-owned resources. But have the Chinese overpaid and does it in fact represent the future? Long-time China observer Simon Hunt ascribes most of the noise surrounding the purchase (concomitant with the talk of revaluing the renminbi), as symptomatic of the usual speculative frenzy that one sees at the peak of commodity bull markets.

Adding to Hunt’s skepticism is the simultaneous bursting of the housing and automobile bubbles in China, to which the markets have hitherto paid little attention. Given this shaky domestic backdrop, export growth becomes all the more important. The status quo, therefore, serves Chinese interests as well as those of Washington for the time being. Undoubtedly, there will be more Noranda-like deals. But as far as a big imminent shopping spree goes, Hunt merely suggests that this idea, like the plans to revalue renminbi itself, will be done on Beijing’s timetable, not the rest of the world.

But with China proving to be such an uncooperative dinner guest in Washington last week, what is the likely future response on the part of the G-7 to such transactions? For now, very little. But in the future, as trade pressures become more acute, rising protectionism is almost inevitable. Would this threat not also accelerate the country’s dollar diversification strategy, if for no other reasons than self-preservation? Such a momentous reckoning may well become the dominating crisis in the next presidential term, whoever is elected. At that point, the United States (and, by extension, the dollar) will lose its aura of unilateral superiority, and the country will be forced to undergo wrenching change. China might be swept along with this as well. Future G-7 dinner invitations could find both parties with their plates full, but appetites suppressed by the resultant stress.

TWO BOSSES, TWO PERSPECTIVES ON RISK

I had two bosses in my life of contrasting characteristics in about every trait. The first, whom I will call Kenny, was the epitome of the suburban family man. He gave the appearance of someone I would trust with my savings -- indeed, he rose quite rapidly in the institution in spite of his lack of technical competence in financial derivatives (his firm’s claim to fame). But he was too much a no-nonsense person to make out my logic. He once blamed me for not being impressed with the successes of some of his traders who did well during the bull market for European bonds in 1993, whom I openly considered nothing better than random gunslingers. I tried presenting him with the notion of survivorship bias in vain. His traders have all exited the business since then “to pursue other interests” (including him). He was articulate, extremely presentable thanks to his athletic looks, well measured in his speech, and was endowed with the extremely rare quality of being an excellent listener. In spite of all this, he was a perfect time bomb, ticking away.

The second, whom I will call Jean-Patrice, in contrast, was a moody Frenchman with an explosive temper and a hyper-aggressive personality. Except for those he truly liked (not that many), he was expert at making his subordinates uncomfortable, putting them in a state of constant anxiety. He greatly contributed to my formation as a risk taker; he is one of the very rare people who have the guts to care only about the generator, entirely oblivious of the results. In contrast with Kenny,, Jean-Patrice dressed like a peacock. No family-minded man, he rarely came to work before noon -- though I can safely say that he carried his work with him to the most unlikely places. In spite of his slight corpulence, women seemed to find him irresistible.

I am still amazed at this flamboyant man’s obsession with risks, which he constantly played in his head -- he literally thought of everything that could possibly happen. He forced me to make an alternative plan should a plane crash into the office building (way before the events of September 2001). He had a horrible reputation as a philanderer, a temperamental boss capable of firing someone at a whim, yet he listened to me and understood every word I had to say, encouraging me to go the extra mile in my study of randomness. He taught me to look for the invisible risks of blowup in any portfolio.

While Kenny knew how to climb the ladder of an institution, reaching a high level in the organization before being forced out, Jean-Patrice did not have such a happy career, a matter that taught me to beware of mature financial institutions. It can be disturbing for many self-styled “bottom line” oriented people to be questioned about the histories that did not take place rather than the ones that actually happened. The contrast between Kenny and Jean-Patrice is not a mere coincidence that I happened to witness in a protracted career. Beware the spendthrift “businesswise” person; the cemetery of markets is disproportionately well stocked with the self-styled “bottom line” people.

BANKING LAW WILL SOON HAVE “FLOATING” CHECKS BOUNCING

If you are in the habit of “floating” checks, get ready to experience a sinking feeling. A new law designed to speed up the time it takes banks to process checks will take effect Oct. 28, making it harder for consumers to avoid bouncing them. People who write a check from a depleted account a few days before payday -- a custom known as floating a check -- should break this habit, consumer advocates say, because the money probably will be withdrawn much sooner than usual.

“A lot of people who have never bounced a check before now are going to bounce their first one after Oct. 28,” said Gail Hillebrand, a senior lawyer with the Consumers Union, a nonprofit advocacy group that has criticized the law. By mid-2005, consumers could be bouncing almost 7 million more checks and paying an additional $170 million in fees each month, according to the Consumers Union. More than 40 billion checks are processed each year, according to the American Bankers Association.

Until now, checks had to be physically transported -- whether it was across town or across the country -- before they could be cleared by a bank. The Check Clearing Act for the 21st Century, also known as Check 21, tries to make this process more efficient by allowing banks to replace original paper checks with “substitute” checks that are made from digital copies of the originals. Because digital copies can be transported across computer lines, money can now come out of a consumer’s account hours after a check is deposited instead of days.

FANNIE MAE EXECS FACE THE MUSIC

The mortgage giant’s two top executives are scheduled to appear before a congressional committee to answer questions arising from a scathing report by Fannie’s regulator on the company’s accounting and management culture. All indications are that Fannie and its supporters on Wall Street and in Washington have been waging a behind-the-scenes campaign to discredit the report, which was released Sept. 22 by the OFHEO. Before the House Committee on Financial Services on Wednesday, Fannie CEO Franklin Raines and CFO Timothy Howard are expected to mount an aggressive and highly polished self-defense. When challenged in the past, Raines has shown himself to be particularly good at building smokescreens around Fannie’s accounting.

Using findings in the report, it appears that Fannie may have excluded nearly $12 billion of derivatives losses from earnings, making Fannie look as bad as Enron or WorldCom. So what line of defense might Raines and Howard take? A well-connected Washington source says the Fannie execs will argue that, since the derivatives did their job by supposedly protecting the company against adverse movements in interest rates, the way they were accounted for is of little concern from an economic perspective. But given that this argument is so weak, it is hard to see it being the main tenet of the company’s defense. Do not be surprised, then, if Fannie honchos also decide to advance some of the other pro-Fannie arguments that have been circulating since the OFHEO report came out.

OFHEO has been extremely clever in its approach. Fannie really does not have a leg to stand on. People expect Raines to make a convincing effort in Congress to overcome the skeptics. But the evidence stacked against Fannie is so weighty that Raines may just flame out like former Enron CEO Jeff Skilling did when he tried to defend himself before Congress.

Misconduct? It’s Only Half the Story....

For decades, Fannie Mae’s and Freddie Mac’s “mission” allowed them to leverage a unique emotional appeal -- the American dream of homeownership, as if George Bailey ran the whole thing in a sequel to It’s a Wonderful Life. These two government-sponsored entities still had firm control of their public image as recently as December 2001, when Money magazine said that Fannie’s chief executive “may be the most confident CEO in America”.

But these days, the only place Fan & Fred “control” their image is on their respective web sites. Last year’s financial scandal at Freddie Mac led to a large fine and the dismissal of its top three executives. And in the past two weeks, Fannie’s regulator issued a report alleging what may be the most disturbing charges to date -- including that Fannie’s accounting books were cooked so that its top executives could receive millions of dollars in bonuses. Now the heat really is on both, via newspaper editorials, Congressional hearings, an SEC inquiry, and a criminal investigation by the Justice Department.

Even so, any findings of misconduct will at best be half the story when it comes to the true economic ramifications of scaled-back operations at Fannie and Freddie; they own or control nearly half of all U.S. home mortgages, and their outstanding debt and derivatives contracts reportedly stand at $1.7 trillion. George Bailey managed a savings bank in a small town: He would not know a derivative contract from a cell phone. Fannie and Freddie could be the government’s Frankenstein monster -- large, unpredictable, and powerful enough to do catastrophic damage.

THE NEGATIVE TRENDS THAT FOLLOW A DOWNTURN IN SOCIAL MOOD

Social mood drives events, not the other way around. While this insight is not complex, it is counterintuitive: the “other way around” is precisely how most people see the world. Yet once you do grasp this insight, it transforms your ability to understand and anticipate every conceivable social trend. When the dominant long-term mood is positive, it makes perfect sense that strong growth will follow in the economy and stock market -- not to mention optimism in the culture, from movies to music to fashion. Once that mood turns, however, it also makes sense to see and expect a host of negative trends that follow. Some are merely distasteful, such as pornography becoming “mainstream”. Others are far more disturbing indeed -- such as the rising frequency of suicide.

It is no coincidence that 1932 marked the peak number of U.S. suicides in the 20th century (17.4 per 100,000), which of course was the worst year of the Great Depression. Nor is it an accident that 2000 saw a 40-year low in suicides (10.4 per 100,000), as that year concluded a period of growth in the economy and asset values which had lasted nearly two decades. Now, this is not to say that the suicide rate reflects an inverse correlation with GDP or the stock market; it does not. What is more, I realize that tossing out statistics like these is too sterile a way to treat an issue that can be painful beyond description. There is a larger point to make -- namely that as negative social mood turns more negative still, expressions of this mood will be anything but sterile.

WHY ARE EUOPEAN BIRTH RATES SO LOW?

European birth rates are dangerously low, warns The Economist. The U.S. is facing a similar challenge, but Europe is aging much faster because European women are having even fewer children: “1.5 per woman, below the replacement rate”q This spells trouble for both the “new” and the “old” worlds -- but for Europe, the trouble may come sooner. A decline in the number of workers and a jump in older population are expected to start dragging on some EU economies as early as 2005, and in coming decades.

In the U.S, lower birth rates are often explained by the fact that most families must have two incomes these days, forcing American women into jobs, which leaves them less time for children. For European women, however, staying at home seems little incentive to have more kids. In Mediterranean countries, where fewer women work, birth rates are below the EU average. In Scandinavian countries, where most women work, birth rates are higher. Increasing financial support for parents -- a common remedy tried by the European governments -- has not produced consistent results.

What is the problem, then? Once again, it comes down to social mood. But European stocks have been in an uptrend since early 2003, indicating an improving collective psychology, so why have the EU birth rates not turned up? Well, we have observed that at least in the U.S., “conceptions tend to respond quite immediately to long-term upturns in stock prices.” Does this mean that the European rally since 2003 has not been the start of a new long-term bull market?

AOL’S BUYOUT VALUE CONSIDERED

A favorite Wall Street parlor game right now is to put a value on America Online, the Time Warner Internet unit that is reportedly up for sale. The deal chatter intensified Tuesday with reports that Steve Case, the AOL founder and former chief, might be interested in grabbing the company. The notion that AOL is on the block is of course laden with irony: It was just three short years ago, at the height of the bubble, that indomitable-seeming AOL bought apparently ailing Time Warner.

Of course, the deal soon turned into a nightmare for everyone involved. Demand for AOL’s subpar and irritating-to-use product sagged dramatically as Internet users became more discerning. In addition, Case’s company was appallingly run and became the subject of federal investigations, still ongoing, into potential accounting irregularities. Time Warner managers reacted by wresting control from AOL honchos and even expunging AOL from the corporate name. It would be no surprise if Time Warner sought to wash its hands entirely of the unit by selling it. But at what price?

While Time Warner obviously wants as much as it can get, first it must convince a buyer that AOL can resume growing and that it can keep reaping those rich cash flows. The price often bandied about is $10 billion -- which is far below the $170 billion market capitalization that AOL had when it announced its intention to buy Time Warner. In this climate, where optimism about the tech sector is again riding high, it is all too possible that AOL could actually fetch $10 billion -- and perhaps a bit more. But in truth, the company may be worth no more than $6 billion. A cash-flow-based calculation using AOL’s much smaller rival EarthLink gets surprisingly close to $10 billion. However, another type of EarthLink comparison also gets us to $6 billion: If AOL were to sell for $10 billion, the buyer would be valuing each subscriber at $313 -- which is 65% more than the level where the market is valuing EarthLink’s subscribers right now. Is AOL really 65% better than EarthLink? It seems very unlikely.

A FLASH IN THE PAN?

The pan-Asian currency markets are in dire need of a makeover. These economies are critically important and inexorably interrelated to the still-tentative Western recovery. They are characterized by a hodgepodge of exchange rate regimens: fully free-trading currencies in Australia and New Zealand and purely price-fixed exchange rates in China. From everywhere in between, there is the gray scale where, with a wink and a nudge, lip service is paid to the marketplace, while intervention rules the roost.

These exchange mechanisms create barriers in trade, transactions and investing. When the product manager of a company in Japan or the United States sends a price list to Malaysia, what price do they use? In what currency should it be quoted? Can it change throughout the year? Can an investment in a joint venture produce triple-digit profits, only to see a seemingly random governmental change in exchange rates wipe out the earnings? These questions, and so many more, demand answers.

It is time for this community to recognize who they are collectively, and then to begin the long march to the ultimate great leap forward -- a single currency to shepherd the economic zone into a dominant role in the 21st century. It is time to create the “Pan”. It is time to form the group and fix the date for the launch -- say 2015. There are certainly enormous political and cultural barriers to overcome. Asia looks as bad as Europe did as the plans for the euro were being set in stone! There are a number of great reasons for Asian countries to join together to create the Pan. From the Asian side of the table, the most powerful argument for the single currency is that with central control of exchange reserves, the Pan Central Bank would hold sway over U.S. policy makers, who are debt-burdened to the rest of the world.

On the other hand, with political disharmony reigning in East Asia, even talks of currency unification could lead to regional meltdown. Then there is the potential fight over which currency the new one will be based on. Political differences aside, the wide economic gap among the region’s nations hampers the single currency idea. A single Asian currency means a single Asian central bank -- and that would greatly increase the potential for currency crises, precipitating bigger economic bubbles. When the value of a currency has more to do with global politics than with its intrinsic worth, the stage is set for economic meltdown.

The bottom line? Even attempting to force such disparate economies into a single mold could incite violent political skirmishes in the region. And the creation of yet another mega central bank paves the way for expanded political/financial manipulations ... and global negotiations in which the United States no longer takes the chair.

ALCHEMY’S NEW PARADIGM

Throughout the middle ages, one of the driving zeals of mankind’s awakening intellect was that of Alchemy. Its two driving forces were the primordial desires to prolong life and to reduce toil and labor by creating instant wealth in unlimited quantities. The Alchemist sought both the “elixir vitae” -- or the water of life, the key to eternal or prolonged life of centuries rather than decades ... and the “philosophers stone”, which would enable him to turn all metals, such as lead, into gold. Great alarm was felt lest an Alchemist should succeed, and ruin the state by providing boundless wealth to some designing tyrant, who would make use of it to enslave his country. In England in 1404, an act of parliament was passed declaring the making of gold and silver illegal. But this law soon subsided and future kings issued patents and commissions to try and find the philospoher’s stone.

We scoff at the duped medieval serfs and many of the intelligensia as well who believed in Alchemy. But now 99% of the current western population today probably do believe that gold is a barbaric relic, and that fiat money is more valuable, because of media propaganda to this effect and lack of access to the alternative viewpoints. Not only that, but thanks to a wonderful invention known as a printing machine, we can have unlimited quantities of paper money at almost zero cost, as outlined in a famous speech by the Fed Reserve’s Ben Bernanke entitled “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” The new paradigm according to the Federal Reserve Chairman Alan Greenspan is evidenced in this quote: “I have been quite surprised, and I must say, pleased by the fact that central bankers have been able to effectively simulate many of the characteristics of the gold standard by constraining the degree of finance in a manner which effectively has brought down the general price levels.”

So the “science” of Alchemy may have been brought up to date. But is the paper money system -- which simulated the gold standard -- now as good as gold? All previous attempts at Fiat money systems (meaning paper not linked to gold) throughout history from John Law in France to the Reichsmark in Germany -- to name only a few well known landmarks -- have eventually failed and the value of each currency has returned to the value of the paper it was printed on, i.e., approaching zero. The jury is out on the judgement of this new paradigm. But history has always rhymed in the past. What will happen this time? Take another very close look at the Emperor. Is he really clothed in gold foil, or in paper, or is he really naked?

CRACKS APPEAR IN HOUSING

The homebuilders are among the most hotly debated sectors in the financial markets right now. On Monday evening, Pulte Homes revised its third quarter and full year guidance downward due to signs of tempering home price increases in the Las Vegas region. Apparently in the past few months, new home inventory in the area has nearly tripled. Pulte’s Las Vegas cancellation rates have skyrocketed to 75% in September. This compares to an industry average of 25%. Pulte has been the most aggressive homebuilder in raising prices in Vegas and clearly buyers showed that there is a limit to these price increases. Management said that the cancellation rates were so high because homeowners were having problems selling their existing homes (they bought a new house before they sold the old one), and that customers were better off canceling and buying a cheaper house as prices have declined to that extent.

Because homebuilders have been able to aggressively raise prices of homes in areas like Las Vegas, Southern California, and Washington D.C., all these price increases have gone directly to the bottom line. While Pulte is saying that this is a Las Vegas-specific issue, if similar dynamics present themselves in other parts of the country, we could see significant earnings revisions at many of the homebuilders.

Investors have argued that residential real estate is supply constrained and homebuilders are simply creating supply for the excess demand. At the beginning of the year, Pulte said there was about 1,400 homes for sale in Las Vegas, new and existing combined. Currently, there is about 14,000. This ten-fold increase was caused by the aggressive price acceleration and one of the basic tenets of economics, higher price produces higher supply.

THE MORAL HAZARD MERCHANT

The International Monetary Fund, which met this weekend, plays an important role in third world finance, bailing out countries in difficulties and acting as an arbiter with private creditors. Unfortunately, it appears thereby to be doing more harm than good. Nouriel Roubini and Brad Setser, two alumni of President Clinton’s Treasury Department, have published a study “Bailouts or Bail-ins?” reviewing the past history of IMF country rescues, and proposing lessons for the future -- it was reviewed at the Institute for International Economics. Both the speakers and the audience were favorably disposed towards the IMF’s activities in this regard; I did not share their enthusiasm.

Overall the IMF’s bailout record is at best very mixed, and its activities in this field suffer from two enormous disadvantages: (i) they lead to “moral hazard” that hugely distorts the activities of the private loan market, and (ii) by providing a bailout for unsatisfactory economic policies, they delay economic failure until it will no longer be identified in the mind of a democratic electorate with the bad policies that caused it. The “moral hazard” comes from two sources. One, well recognized by the IMF, is that private lenders to countries with an IMF program in place may rely excessively on the IMF’s control mechanisms, thus lending more money than they should.

The second, and far more pernicious moral hazard comes from the operating methods of the international institutions. Private sector debt is effectively subordinated to their obligations in a restructuring, and new money may even be made available by them. Countries who wish to bilk their private creditors can do so, provided they remain on civilized terms with the IMF bureaucrats, without any threat of being cut off from international finance, as would be normal for a borrower that defaults. This removes the private creditors’ principal bargaining weapon and makes default to private creditors an only too attractive option for the populist and immoral such as Argentina or the simply ruthless such as Russia.

The IMF’s propensity to delay economic disaster is if anything even more serious than its creation of moral hazard. Had Brazil been allowed to default in 1998 and have suffered the hardships consequent on being cut off from international finance, there would have been a good chance that blame would have been placed where it belonged. Instead, if Brazil defaults in 2005 or after, blame will be placed by the right on Lula and by Lula on the free market, not something that has ever really been tried in Brazil, and of course on the IMF itself. Absent the IMF, Argentina would have defaulted in 1997 or so, at which point the poison of Peronism, that has impoverished Argentina for half a century, might finally have been discredited. Instead, it defaulted in December 2001, destroying an admittedly incompetent Radical government but one which represented the principal institutional rival to Peronism. The result in 2003 was the election of yet another Peronist, of a still more pernicious kind, on a platform of international default and internal socialism.

There is a better way. Before 1914, there was no IMF. More recently, before about 1980, there were no IMF bailouts of Third World countries. Mark Weisbrot, of the Center for Economic and Policy Research, has demonstrated pretty convincingly that the economic growth rate of the Third World in 1980-2000 was far lower than in 1960-1980. Most plausibly, before 1980 the IMF did not provide bail-outs to them, so Third World countries found it difficult to get themselves into staggeringly heavy levels of debt that they were unable to repay. Further, bad policies had bad consequences, in terms of cut-off from the international capital market, in those days controlled by the world’s major banks. Thus the market’s correcting mechanisms were able to function effectively, and there was less spectacular mis-allocation of resources.

The IMF, which provides pretend-loans that countries have no real need to repay, is operating a Ponzi scheme to the benefit of its staff and of the most populist and immoral Third World governments. It should be closed.

KEEPING YOUR EYE ON THE BALL

Watch a golf pro or a baseball player. Before they get ready to hit, they have a routine, which is always the same. They have narrowed their thoughts down to a few simple steps. What happens to a golfer if he is thinking about his next meeting when he is in the middle of his back swing? Getting distracted when a 98-mile-per-hour baseball is coming at you will not help your batting average. I have probably done at least 100 interviews on radio and TV this year, as well as lots of speeches. Not really realizing it, I have developed a routine over the year that serves me well. While not really all that glib in person (I think I do much better in print where I can edit my thoughts), I do seem to be able to not embarrass myself. Except for last Wednesday. I varied my preinterview routine. Not my finest interview, although I have been assured it was not “all” that bad. However, no one used the word good, either.

Successful investors have a preinvestment routine before they “hit” an investment. Thorough research, in-depth due diligence and thoughtful analysis about how an investment fits into their overall portfolio is all part of it. In my experience, there is a strong correlation between the amount of work and research done before an investment is made and the success of the investor. Good research does not guarantee the performance of any particular investment, but it does help you avoid more of the bad ones. This goes for whether the time horizon for the investment is 30 minutes or 30 years.

Successful investors even develop contingency plans for what to do when a special investment or situation comes along that requires a little quicker action. The goal is to not let your emotions or too much information rule your investment routine. It is at precisely such moments when the excitement of the opportunity, the thrill of the big score, comes our way and our emotions are running ahead of our thought process that we need to fall back on our preinvestment routine.

My most embarrassing investment moments, the ones talked about late at night by my fellow professionals, and I bet yours, too, are when we make that knee-jerk emotional snap judgment. We look back and say, “If I had stuck to my preinvestment routine, I would have found the flaw before I lost my money.”

GDP GROWTH NOT AS ADVERTIZED

The Gross Domestic Product (GDP) is one of the broader measures of economic activity and is the most widely followed business indicator reported by the U.S. government. Upward growth biases built into GDP modeling since the early 1980s, however, have rendered this important series nearly worthless as an indicator of economic activity. The analysis in this Installment will indicate that the recessions of 1990/1991 and 2001 were much longer and deeper than currently reported, and that lesser downturns in 1986 and 1995 were missed completely in the formal GDP reporting process. Furthermore, the current economic circumstance is suggestive of an early-1980s-style double-dip recession.

The distortions from bad GDP reporting have major impact within the financial system. For example, Alan Greenspan’s heavy reliance on productivity gains to justify some of his policies is equally flawed, since the methods applied to GDP estimation influence the numerator in the productivity ratio. As with the CPI distortions discussed in Installment III, the Federal Reserve Chairman knows better. With reported growth moving up and away from economic reality, the primary significance of GDP reporting now is as a political propaganda tool and as a cheerleading prop for Pollyannaish analysts on Wall Street.

The construct of the GDP is heavily reliant on economic theory for composition, unlike other data series such as retail sales or the trade deficit, which are relatively simple surveys that end up contributing to the GDP estimations. Frankly, most economic theories have little practical use in the real world. Concepts such as free trade being a boon to the world’s economy, a weak currency helping turn a nation’s trade deficit, or personal income including what the average homeowner would receive from himself in rental income if he charged himself to live in his own house, fall in to the “not in the real world” category. Varied academic theories, often with strong political biases, have been used to alter the GDP model over the years, resulting in Pollyanna Creep.

As an example of how far from reality the GNP/GDP/GDI reporting has gone, consider data from a high quality and unbiased resource: the IRS. Based on its analysis of income tax returns, the IRS reports that, “For the second consecutive year, Adjusted Gross Income (AGI) fell, decreasing by 2.3% to $6.0 trillion for 2002. This represents the first time since prior to 1950 that total AGI reported on individual tax returns has fallen for two successive years.” Although the BEA considers the IRS data, it never has been able to reconcile the differences between GDI assumptions and IRS reality. Of course, the BEA sticks with the GDI assumptions, which have income rising in 2001 and 2002. Part of the difference is in imputations, such as from living in one’s own house or receiving free checking from a bank.

In the introduction to this series on government reporting, I mentioned political manipulation of the GNP/GDP in the Johnson and first Bush administrations that went beyond overly positive methodological changes. There are suggestions of other direct manipulations over time, specifically involving the Clinton administration and the current Bush administration. Most recently, a bizarre annual revision to the GDP data eliminated the 2001 recession, at least as traditionally defined with two consecutive quarters of real GDP contractions.

Based on my analysis of the GDP/GNP revisions and redefinitions over time, over-deflation and economic reporting as published before later political corrections, reporting of real GDP growth at present is overstated by roughly three percent per year against a more realistic, pre-Pollyanna Creep period. Both the 1990/1991 and 2001 recessions were deeper and longer than currently estimated. The recession from July 1990 to March 1991 (timing per the NBER) really began in late-1989 and persisted into 1992, perhaps even 1993. Such was evident in the underlying data of the time. Due to the NBER’s early call of the recession’s end, however, the first “jobless recovery” was seen. Similarly, the recession that was timed from March to November 2001, began in late-2000 and persisted into 2003. Again, because of an early call to the recession’s end, a “jobless recovery” was seen. As the economy once again appears to be faltering, or losing traction, risk is high of renewed or a double-dip recession, of which the 2001 downturn eventually will be counted as the first leg.

Inflation lurks in the dregs of my Starbucks brew.

A morning java costs 11 cents more at a U.S. branch of Starbucks Corp. this week, following the first price increase from the Seattle-based chain in four years. That made me wonder whether the buckets of overpriced, overheated liquid caffeine served in those fake living rooms littering the world are the only places inflation is hiding.

Bill Gross, who is almost as ubiquitous as Starbucks in his role as cheerleading captain for Pacific Investment Management Co. and its $400 billion in assets, sees a “con job perpetually foisted on the American public about the low level of inflation.” In his October bulletin, the “bondfather” argues that core inflation, which excludes food and energy, would have been 0.5 percent to 1.1% faster since 1987 if the government had not manipulated figures using so-called hedonic pricing, which tries to account for quality improvements by adjusting prices lower. Prices are rising about 1 percent faster than the official inflation statistics, he says, while economic growth is about 1 percent slower.

There certainly seems to be a lot of inflation out there once you start looking for it. The Dow Jones-AIG Commodity Index, which measures price changes in futures contracts on 20 commodities, is up more than 25% this year and 70% in the past five years. One place you are still not getting any evidence of inflation is the U.S. government bond market. Print out a 30-year graph of the 10-year Treasury yield. Go grab a Komodo Dragon Blend, and park yourself on a Starbucks sofa. Ask yourself whether that yield line looks more likely to head up or down. Then go sell some Treasuries.

WHY DO BANKS WANT TO GET INTO THE HEDGE FUND BUSINESS NOW?

The growth of hedge funds has been extraordinary. Depending on whose numbers you believe, there is now some $1 trillion invested in anywhere between 6,000 and 8,000 such funds worldwide. To the traditional hedge-fund investor -- the very rich -- has been added in recent years pension-fund money, attracted in part by the apparent diversification that such funds offer, but more, if they are being honest, by the returns. Alas, the flood of money into hedge funds appears to be pushing those returns down sharply. One cannot help wonder whether this is the motivation for recent hedge fund sell outs: they are, after all, meant to be good traders.

You can understand the attraction for the sellers. They want more stable sources of capital and better distribution for their funds. Moreover, the sharp decline in hedge-fund returns has spooked them. Over the past six months, the CSFB/Tremont investable index of hedge funds has lost just over 2%. Some of these poor returns are down to markets being boring. But there are also problems of a more structural nature. Hedge funds have to make money from someone else: it is not a victimless crime. And the victims are fighting back by becoming more sophisticated. There are also more mouths to feed. Such is the weight of money flowing into the industry, and the lure of 1% management fees and 20% performance fees, that many traders have set up their own hedge funds. But hedge funds do not do anything magic. There are only a limited number of strategies.

Hedge funds’ problems are compounded by the fact that they are not the only outfits chasing diminishing returns. Investment banks’ proprietary-trading arms, which punt the banks’ own capital, do much the same thing. Banks have also started to park a lot more of their capital in hedge funds. This allows them to gamble without the extent of such activities appearing on their balance sheets. But having invested in the funds themselves, why do banks now want to buy them too? If Lehman Brothers or J.P. Morgan needs the trading expertise then the wisdom of doing so much punting on their own behalf would be questionable, to say the least. Moreover, the Morgan name is presumably familiar to most and does not rely on a couple of talented traders who could walk out of the door at any time. Bringing hedge funds in-house is fraught with difficulty. Many of those that were set up under the aegis of a bank subsequently flew because the banks meddled too much.

IN WHOM DO YOU TRUST?

We recently heard the story of a man who, in just five short years, lost half of his SFr150 million fortune simply by entrusting it to the care of one of the country’s big, prestigious banks. Naturally, he is suing. But, large as the sums involved may be, he is not alone -- either in his loss or in his resort to litigation. We hear more and more such stories of late. They are stories of people who are tired of losing money, tired of being deceived, and tired of being charged fees for advice that is often dishonest, incompetent, or perhaps both. Financial history is filled with examples of fraud and incompetence. Indeed, it is to these shenanigans that we owe the patchwork quilt blanket of regulations that threatens to suffocate us with every breath. The politicians who rush in, after the event, to sew on new squares do so ostensibly to promote fairness and transparency.

Yet, despite the exponential increase in the amount of regulation and the construction of a vast and expensive enforcement apparatus, can we honestly say that any of the sheep really feel they are better sheltered from the wolves -- those who would take advantage of either their naivety or their foolish greed? We do not think so. Rather, we believe that the effect of this patchwork of legalism has been to transform what used to be unsystematic risk into endemic risk -- one that is an integral part of the system itself.

The phrase “unsystematic risk” is business school jargon for that which we would not expect to occur in the normal course of business. This can be contrasted with the usual risks to which an enterprise is exposed: costs may go up and profit margins down, competition may intensify, technology may render our plant and equipment obsolete, and rising interest rates, labor costs, raw material prices, and insurance premiums could devour our margins. However, these are all problems which we -- or, rather, the entrepreneur in whom we invest -- can seek to overcome. We can never make any investment without running these sorts of risks -- indeed, the returns to our investment arise directly as the reward we earn because we are running them.

On the other hand, if the accountant is fudging the books, or if the company declares assets which do not exist, or if the CEO is otherwise deceiving his shareholders and creditors -- clearly, this is a very different sort of hazard. This is what we mean by “unsystematic” risk. If we are to avoid losing our capital to “unsystematic risk” we must shed our innocence, arm ourselves with a healthy distrust of authorities and large institutions, and maintain a certain disregard of the numerical standards that most take for granted.

ADDING INSULT TO THE MARTHA’S MISFORTUNE?

Ms. Martha Stewart began her term of incarceration today (Friday). I will bet you a steak dinner that some editorial scribbler somewhere this weekend will not be able to resist adding insult to the lady’s misfortune, with a let-this-be-a-lesson-to-you sermon -- you know, how the prosecution of bad guys (and gals) “will make executives think twice before lying to shareholders and federal officials.” Heard that sermon already, you say? Oh, right, I guess you must have, given that the above quote is from The New York Times on March 8 of this year, just a couple of days after Ms. Stewart’s conviction.

As usual, the media was (and is) miles behind the real pace of this trend. The same Times article went on to suggest that only real white-collar criminals need to worry. After all, it mused, “No one expects corporate executives to suddenly give up their pay packages...” Tell that to Mr. Richard Grasso, the former head of the New York Stock Exchange. He was told by the current head of the NYSE to return $120 million of a board-approved salary that Mr. Grasso earned under the terms of his employment contract; he will also be defending that contract in court, against charges brought by the New York state attorney general.

Whatever I believe here is NOT the issue: what most investors and the public believe IS. The Times piece got at least one thing right: “In aggressively prosecuting white-collar cases, prosecutors are both reflecting the public’s increased anger toward executive misdeeds and helping to stoke that anger.” This anger is young; it is going to mature and grow stronger.

IN HINDSIGHT, WE MIGHT HAVE DONE THINGS DIFFERENTLY

If they had it to do over, the folks putting together that $239 million satellite probably would have checked to make sure the bolts were in. At least two or three of them. The bolts were supposed to hold the thing in place while workers were moving it around. Instead, the satellite fell on the ground. At least that is the story according to a 113 page report on the incident that happened about a year ago. That is a lot of pages to say “They forgot to put the bolts in before they starting jacking with it, so it fell off the table. Like we said, there were no bolts in there. It made a really loud crashing sound. Workers said they would probably remember to put in the bolts next time.”

What could the other 112 pages say?

The authors of that satellite report should take some notes from Federal Reserve Vice Chairman Roger W. Ferguson, Jr. Unlike the Fed Chairman who could spend twenty minutes ordering a scotch and soda and still leave the bar tender confused, Mr. Ferguson got right to the point in his speech this week to National Bankers Association members. The topic was “savings”, which is pretty good topic if you have to attend a bankers’ association meeting, and certainly better than listening to some compliance guy drone on about the latest regulatory plague. Also surprisingly, at least given Mr. Greenspan’s fondness for ginning up a billion in credit here or there, the Vice Chairman was actually “for savings”. In fact, the VC called savings “important” as opposed to “something that people do while waiting to close on their vacation home.”

Remarkably, Mr. Ferguson reviewed the recent history of the U.S. savings rate, which happens to have a history much like a rock dropped from atop a cliff, without making a bunch of excuses for it. You know, the excuses about why it’s really not that big of a deal that so many of us are buying flat screen TVs instead of socking money away in the event of a rainy day, like retirement. No sir, the V.C. came right out and said that since the early 1980s, the personal saving rate has fallen to 1.5% of disposable income down from about 11%. He even said that the paltry savings rate could have “have important implications for the ability of the country to finance investment in plant and equipment.”

That is not to say the Vice Chairman did not present “some economists’” views of why the plunging savings rate is not as bad as it looks. But the bottom line, Mr. Ferguson says, is that “the problem of inadequate national savings is still there.” Maybe if we had it to do over again, we would have done it differently.

THE WHACKY WORLD OF MODERN ECONOMISTS

Pity the poor economist. He is a pariah at dinner parties. His conversation is dull. His face has no expression. His opinions are commonplace. He might as well be on reality TV. And so what if the world’s economies need to be “rebalanced”? Not only do we not know what it means, we can do nothing about it anyway. If you spend 15 minutes a year trying to figure out the world economy, Peter Lynch used to say, you have wasted 10 of them. Peter believes in buying stocks. Keeping it simple, he believes in buying the stocks of companies he knows. That way, he figures, what he does not know cannot hurt him.

Lynch ran a major equity fund in a bull market. He was lucky enough to get out before the bull market was over and smart enough to write books for people who were dumb enough to believe that stocks always go up in the long run. You did not need to convince them this was so: Their gains were proof enough. You did not need macroeconomics, either; you just needed a bull market. The poor macroeconomist gets no respect. Which is the way it should be; typically, he deserves none.

Generally, his employer determines the economist’s opinions. And typically, he is bullish. Even government economists usually have a bullish bias; neither presidents nor prime ministers are re-elected on bad economic news. What is more, honest economists have few insights that are not obvious: You cannot spend more than you make forever, the old-timers would tell you. The dollar will go down in price if you print too many of them, they figured. If something gets too far out of whack, they predicted, it is likely to come back into whack sooner or later.

These insights are hardly enough to command much respect, let alone a high salary. So early in the last century, ambitious economists set to work creating a set of propositions that were not based on ordinary common sense -- but on wishful thinking. Given the authority to manipulate short-term lending rates, bank regulations and money supplies, they offer to “manage” an entire nation’s economy. And if central bankers of major nations are able to collude on policy, they believe they can manage the entire world!

These vaulting pretensions required undergirders at least as absurd as they were. Hurricanes blew across Florida in record numbers this autumn. Rebuilding would be good for the economy, they told us. Every cloud now has two silver linings. Every disaster brings relief even before it happens. Drought, pestilence, famine and war -- nothing is so awful that it does not bring on a new burst of something wonderful. Of course, if destruction really were so beneficial, it is surprising that economists do not encourage it. We still wait for a pair of them, armed with the courage of their convictions and a jerrycan, to burn down each other’s houses. “Stimulus,” they will say. “Arson,” we will reply.

But “stimulus” is just one of the twisted beams that hold up modern economics to ridicule. The “disappearance of whack” is another. If Peter Lynch had tried his approach in the bear market of the 1970s, for example, today he might be just another poor schmuck, rather than an investment icon. Bear markets take down the stocks you know along with those you do not; they maul the geniuses as well as the morons.

The world’s two most important economies sit at opposite ends of a shipping channel. In one direction, ships head east loaded to the gunwales with geegaws and gadgets. As they make their way across the Pacific, they pass other ships coming back -- empty. On one end of the trade are a billion Chinese making things at a furious pace. At the other, Americans enjoy the extraordinary lightness of being that comes with acquiring things without having to pay for them. Asians work and save. Americans borrow and spend. If you asked a dead economist, “Something’s got to give,” would probably be his judgment. Living economists are not worried. It is just another thing to be managed, they believe. They do not concern themselves with the huge pile of debt built up by consumers and government; these too can surely be managed. Here again, economists replaced the old, obvious insights of an earlier age with absurd new ones.

What we are really creating is a world economy that is dangerously out of whack. But who cares? When it blows itself up... imagine how stimulating that will be!