Long view: Waking up the bears
By Barry Riley - 7 Apr 2000 22:01GMT
Even the ringing tone of the telephone seemed unusual: low-pitched and rasping. I picked it up with a degree of instinctive fear - and rightly so because it turned out to be a call from Mortimer Duhm, the arch-bear.
Bears are forced into hibernation for long periods; then, they burst out of their caves with renewed energy. In Mort's case, though, it was a cold wind from the markets that woke him up, not spring sunshine. "I see that the London Stock Exchange has shut down," he hissed, referring to this week's computer glitches. "You remember that the last time it happened, after the October 1987 hurricane, was only days before the global stock market crash."
Wall Street was wobbling badly, I agreed, but there was still plenty of resistance. After the 500-point collapse in the Dow Jones Average on Tuesday, and the 11 per cent crash in the Nasdaq index, the markets bounced straight back again.
"Yes, the manipulation continues for the moment," snapped Duhm. "It was suspiciously similar to the dramatic recovery in October 1998. Wall Street now believes that the US government and the big investment banks will always organise a rescue, helped by the occasional Saudi billionaire. But moral hazard is piling up and time is running out.
"The bull run has become ever more intense and concentrated, finally climaxing in an eccentric technology bubble. The old economy had plainly become overpriced, so the concept of the new economy was invented by Wall Street and Alan Greenspan, with stock market ratings justified by ever-rising prices. But it has become a vast Ponzi scheme."
I was aware, I said, of all the conspiracy theories about the role of the US authorities in fuelling the great bull market which had done so much to restore President Clinton's popularity. But why, then, was the US government threatening to break up Microsoft, the biggest technology company of them all?
"It's simple," snapped Duhm. "The financial and legal sides are just not working on the same wavelength. The whole bubble has been pumped up by the US Treasury working in cahoots with the Federal Reserve. It began in the mid-1990s as an idea for boosting economic growth. Then it got out of control, and has regularly had to be propped up through liquidity injections and interest rate cuts."
It was certainly interesting, I replied, that bodies like the Institute of International Finance were accusing the Americans of generating economic fragility and encouraging wild volatility in asset prices. The current account deficit had hit $28bn a month. You could add that an incredible binge by American consumers was in progress and the US was mopping up the world's savings. The surge in the oil price was an early warning signal; but that was easily presented by politicians as the fault of greedy sheikhs rather than the American love of unnecessary off-road gas guzzlers.
I remembered that the last time I talked to Mort Duhm, he was obsessed with alleged similarities between Thailand, which crashed in financial ruins in 1997 after a currency collapse, and the US. All that had happened since, though, was that the US had boomed ever more strongly, hitting a 7 per cent economic growth rate by late 1999. Even so, Duhm insisted: "We are getting very close to the edge. Being the world's biggest debtor is safe only when you have complete political mastery.
"The Asian problem was solved by transferring the financial imbalances to the US itself. That is a patch-up, not a solution. The Americans have squared the circle temporarily by persuading foreigners to invest in US technology. But now, that illusion is collapsing. The US depends on foreign governments being willing to keep piling up dollar assets - especially Asian countries and oil producers.
"True, the US deliberately left Saddam Hussein in power in Iraq in order to keep the Saudis and Kuwaitis frightened and submissive. That's recently helped to buy the Americans time over the oil price. But now they face China which, through its massive trade surplus with the US, has acquired an economic weapon: it can attack the dollar as part of the political battle over Taiwan."
"Hold on," I replied. "You could also argue that China has acquired a big stake in the dollar and needs to keep it healthy. I'm rather more interested at the moment in the internal risks. Investors have chased ever more risky investments, in a classic mania. Safe companies have collapsed in price. As we have seen in the past week or two, the risks of equities have increased. Logically, the prospective return must go up to compensate, which is another way of saying the market must begin again from a much lower level."
"Yes," said Duhm, "and it will wipe out many investors in the process." I could just imagine the rare smile on his face. "Watch those hedge funds, in particular. Julian Robertson, who has just shut down Tiger Management, was not typical but he demonstrated the level of instability. This was an orderly withdrawal. Just imagine what will happen when real disaster overwhelms some of the others who have been leveraging their positions in technology stocks. This week, there have already been signs of forced selling by small investors financed by margin debt but, when the big funds collapse, the impact will be much greater."
Perhaps so, I answered, but should we be so afraid of a stock market crash? Admittedly, the 1987 collapse had hurt quite a few investors, but the underlying economies had continued almost unaffected. The worst aspect was that the central banks had overcompensated by cutting interest rates at the time, which had proved inflationary.
The line began crackling and Mort became more and more difficult to hear. "Irresponsible credit growth and stock market gains have fuelled this US consumer boom. There's a 20 per cent growth rate in real estate lending," he snapped. "When the bubble bursts, there will be colossal bad debts and a slump in demand. But the Fed won't be able to cut interest rates because the dollar would tumble and inflation, so far suppressed by cheap imports, would soar. My new web site has the detailed arguments."
The line got worse. "Disaster....derivatives....depression...." He finally faded out. I didn't complain to the telephone company.
Mort certainly provides a challenging alternative to all the bullish talk that comes out of the stockbroking fraternity. Sometimes, I think that, if he didn't exist, I would have to invent him.
[end]
Carl
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