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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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How low will these stocks go during the long Third Stage of collapse?The Bank of Japan started tightening in December, raising the Overnight Discount Rate from 4.25 to 6 percent over the next eight months. The Nikkei fell by about one-third, and the first deflationary Triple Waterfall since 1929 had completed the First Cascade. By the time the bank had begun easing, a self-reinforcing deflationary crash and recession process was established. As asset prices fell, Japanese banks were hollowed out. Without a dynamic banking system, the economy lost its vibrancy. The worse the problems for the banks, the more stock and real estate prices fell, and the greater the financial problems of the banks. The only speed in this downward spiral was the acceleration as segments of the economy chased their own tails. A key component of the Shared Mistake that destroyed Japanese financial and economic global leadership was an inability among the elites to distinguish asset inflation from economic inflation. The asset inflation that drove stock and real estate prices to incredible levels was rooted in the national desire to build domestic inflation hedges in a global economy in which inflation would always and forever be the primary challenge to the price system. Since Japan did not produce oil, gold, or silver, it lacked the domestic inflation hedges enjoyed by North Americans and Arabs. But what the Japanese consensus ignoredand in Japan a consensus can be as stiff and unyielding as concretewere three important aspects of the inflation question: First, despite the monetary torrent and soaring asset prices, actual inflation was low, held down by productivity gains and by the determination of Japan Inc. to remain globally competitive. Second, the nation was already entering demographic deflation, a condition that was almost unknown to demographers, and therefore a special case requiring unusual caution. Not only were the Japanese living longer in retirementthe Japanese live longer than anyone except the ruling clique in Beijingbut the collapse in birthrates meant the nation was not even replacing itself, let alone growing. That meant the real estate bubble was an even greater menace to the nations longer-run financial stability than it would be if the next generation were more populous than the current generation. To whom will one sell the small homes being built at prices of roughly $1000 (U.S.) per square foot of floor space? Third, the Japanese banking system never really complied with the Basel Accord because it never faced up to the implications of grossly inflated asset prices for its asset-based lending. Nor did it use reasonable valuations for much of its lending to keiretsusbusiness alliances in which each company owned stock in other members of the groupwhich included suppliers and customers. Once those asset prices began to shrink to realistic levels, and once global competition began to challenge the weaker members of the keiretsus, these houses of cards would collapse. Finally, the end of the Cold War removed one of the few remaining con tributors to global inflation (as discussed in The Costs of War, in Chapter 4). Japans Triple Waterfall smashed the image of Japan Inc. as global economic shogun who could pick and choose his conquests at will. In 1989, for example, American CEOs representing industries as disparate as automobiles, office equipment, and banking openly talked of the real possibility that their industries would be totally dominated by Japanese companies within five years. (Bankers were particularly worried because Japanese banks were gradually taking over corporate lending in the United States based on their willingness to make loans at rates so low that no U.S. bank could compete.) Then, rather suddenly, the Triple Waterfall washed away that seeming invincibility forever, substituting a gnawing, cancerous deflation. That deflation, born in the Triple Waterfall of Japans sense of endless superiority and uniqueness, was too powerful a force to contain within those islands. Like the wind, it spreads across the Pacific, changing pricing structures everywhere it touches down. Since 1997 it has been joined by an even stronger wind that started in China, a wind that is a new threat to the reeling power of Japan Inc. THE NASDAQ CRASH: 1997 TO ? Why was anyone surprised? In retrospect, what is most astonishing about this display of folly, foolishness, and fraud on a scale that would awe Cecil B. DeMille or James Cameron is that it was such an accurate replay of previous Triple Waterfalls that anyone with knowledge of stock market history could not possibly have been astonished at the outcome. This one went through each of the three stages in the run-up exactly according to script. It reached a peak that was equivalent to silver at $54 and gold at $875, and then began a collapse that has been a near-perfect three-stage plunge to oblivion. In the final stages of that 1999-2000 orgiastic rush, the Fanaticism stage had such power that it exceeded any previous mania. Tech stock buyers in January and February 2000 were so out of touch with reality that they had more in common with the Kool-Aid drinkers in Jonestown than with the Jazz Age bathtub-gin slurpers who were buying stocks in September 1929. That Wall Streets best and brightest were urging investors on to this mass financial suicide is the greatest indictment of the ethics and competency of the Street in its long and colorful history. There was norepeat nointellectual justification for tech and telecom stocks at those levels. At the peak, Nasdaqs multiple was 351 times earnings (when the earnings of money-losing companies were included). Two and a half years later, after a 75 percent collapse, Nasdaqs multiple was infinite, because collectively its member companies were losing money. Even with a 75 percent plunge, the index had not pushed the great mass of tech and telecom stocks into a range that investors using conventional stock market valuation techniques could find acceptable (see Charts 2-1 and 3-6 through 3-8). As the collapse unfolded, some people whose voices could not be heard above the shouting during the Fanaticism stage emerged. Some of them compared this mania to Dutch Tulipmania (1634-1637), and Wall Streets Shills & Mountebanks were shockedshocked!at the comparison. Tulip bulbs were mere trinkets, but these were real companies! That comparison is easy, and amusing, but as a few revisionist historians have observed, its unfair. They argue that sheer survival might have explained why the famously phlegmatic Dutch seemed to go crazy for unique or rare tulip bulbs. Comparing Nasdaq at 5000 to Dutch tulips at the peak is unfair to the Dutch. The mania occurred during a phase in the Thirty Years War when Spanish Catholic troops were making progress toward a reconquest of the Netherlands. Since the Reformation, Spanish generals had been known in the Netherlands for applying the practices of the Spanish Inquisition to Dutch Calvinists. That meant red-hot grills, burning at the stake, and other Spanish enthusiasms. The Dutch army under Frederick Henry, Prince of Orange, was in trouble when tulips took off. Why? Some market historians argue that it was, in part, a matter of survival. The Dutch bourgeois included many of the worlds best horticulturists, and, goes the argument, they could escape to Protestant Germany or Britain and set up business again if the Spanish conquered Holland. Unique (not, if youll pardon the pun, garden variety) bulbs could be for skilled horticulturistsat least in theorywhat diamonds would be for German Jews three centuries later. There was no such justification for tech stock buyers in 1999-2000. They were in the grip of the greatest collective idiocy in the history of finance, fueled by the most shameless sales pitches in the history of finance. At the core of this sordid sales phenomenon was the endless repetition of a seductive trade-off: between New Economy and Old Economy stocks. By labeling everything tied to computers, telecom, and the Internet as New Economy, and the companies that collectively delivered more than 90 percent of GDP as the Old Economy, the Shills & Mountebanks were able to justify price-earnings ratios that made Japanese bank stocks at their 1989 peak look like deep-value stocks in comparison. Some years ago, William F. Buckley, Jr. wrote a column about a news story of a high school boy who objected to a music class that included some exposure to the music of J. S. Bach, rather than entirely rock music. Who cares about Bach? this youth griped. Hes just some dead white guy. Buckley lamented the sterility in this young mans consciousness. The anti-Bach boy could have been a symbol of the Nasdaq-driven stock mania. This was a market that loudly proclaimed that none of the old rules applied: earnings according to previous rulesobsolete; price-earnings ratiosobsolete; tangible asset ratios on the balance sheetobsolete. In place of these antiquated concepts of equity (and bond) valuation, we were told of new metrics (which meant totally new rules for valuing stocks). None of that old dead Bach stuff. Among these metrics were the number of patents issued to companies, and the number of hits on their Web site. In The Closing of the American Mind, Allan Bloom described the cumulative degradation of an education system that occurred when teachers and students alike disdained the best of the past in favor of whatever was cool and new. That melancholy treatise came out in 1987, long before the tech Waterfall. But the mind set he described was the perfect breeding ground for the prejudices and inanities that would coalesce and metastasize into the New Economy, a construct that would devastate financial markets, impoverish many, wound millions, impose a recession on America and the rest of the industrial world, spring China from the margin of that industrial world to the most formidable competitive force within itat the expense of millions of jobs in the Westand spawn more centimillionaires and billionaires than all the economic progress of history. How low will these stocks go during the long Third Stage of collapse? Many (particularly the dot coms, whose lifespan was the financial equivalent of the mayfly) have already paid the full price, having gone bankrupt (but not before enriching their insiders and Wall Street). Some of those, such as WorldComor WorldCon, as it became knownhave joined the ranks of the undead, living in the dark world of Chapter 11. Many others will go to the cemetery or to WorldComs world. Others will survive, and will ultimately prosper as being the last left standing. Like other Triple Waterfalls, this one unleashed an excess of capital spending that leaves a huge hangover of excess capacity. Unlike, say, the oil Triple Waterfall, there were hundreds of firms with multi-billion-dollar market caps functioning in this mania, which meant the overspending was on a previously unimaginable scale. As of the summer of 2002, only 4 percent of all optical fiber cable was litwhich means the overcapacity was 25 to 1. Nor will this cable rust: It is glass, heavily enrobed in protective coverings. It will lie, intact, at the bottom of the sea like the Titanic. Unlike the Titanic, however, whose demise created opportunities for less sumptu ous steamships, those cables will live on as near-zero cost competitors for the livingcompanies living dangerously as they burn through the money left in their treasuries from their heavy financings made when people really believed that demand for fiber would continue to grow forever at 60 percent a year. As the mania took hold, the wise Paul Volcker sounded a warning: The fate of the world economy is now totally dependent on the growth of the U.S. economy, which is dependent on the stock market, whose growth is dependent on about 50 stocks, half of which have never reported any earnings. Charles F. Lummis, having fractured his right arm so badly that the bone protruded, and being alone in the desert, gave his canteen strap two flat turns about the wrist, buckled it around a cedar tree, mounted a nearby rock, set his heels upon the edge, and threw himself backward. He fainted; but the bone was set. |
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