Can You Spell "Sound Money"?

DailyReckoning.com
Ouzilly, France
Monday, August 11, 2008

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*** After so many weeks of stormy, bearish, depressing news...it was time for a little blue sky and sunlight...

*** China faces some tough times ahead...the U.S. will learn: you have to fall down before you can pick yourself back up...

*** The comeback of the greenback?...Georgia on our minds...a French vacation...and more!

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We are on vacation.

And so is the rest of France. The little church was crowed yesterday, mostly with Parisians and their children. It was also the 50th wedding anniversary for a friend...a retired army colonel and his wife. But the occasion was marked by more sadness than joy. Only three weeks ago, one of their sons was killed in a traffic accident. We felt so sorry for him; we didn’t know what to say. We wished he could worry about the stock market...or the monetary system...or the war in South Ossetia – but it was all no more than the buzzing of a fly compared to the loss of a child. We were meant to celebrate their golden wedding anniversary, but who could offer more than empty words?

“Oui, mon vieux...yes, my poor old fellow,” was all we could say. We hugged him and said nothing more.

Yes, we are on vacation...but this is The Daily Reckoning , after all. And there are always things to be reckoned with. Some important. Some trivial. Some sacred. Some profane.

But come 1PM, the lunch bell is going to sound and stand up from our computer and not touch it again until tomorrow. Then, after lunch, we’ll round up our crew of involuntary workers – three boys – and get to work. We have about 125 shutters in need of scraping and painting.

“Hey Dad, why do we have to do this? I mean, other people take a real vacation...I just spent the week with Paul and his family. They were really on vacation... and we just work.”

Henry also did some calculations: “Besides, if you add up all the expense of maintaining this place, it would probably be cheaper for us to take a vacation somewhere else...somewhere where somebody else paints the shutters...”

You’ll find our reply below...but first, we have the trivial world of finance to deal with.

Not that we have much to say about it. Yesterday, the Dow rose 302 points. The price of oil fell $5, to $115. After so many weeks of stormy, bearish, depressing news...it was time for a little blue sky and sunlight.

Stock markets all over the world are on the rise. Even financial stocks...and automakers...and airlines – all seem to be recovering.

One major exception – China. The Shanghai index fell more than 4% on Friday...and is still falling this morning.

But outside Shanghai, the word on the street is that “the worst is over.” They liken this to the ’70s, noting that after inflation peaked out, stocks rose strongly, and gold collapsed. In fact, the period – 1982-2000 – was probably the most agreeable financial period in most peoples’ lives. The Dow rose 11 times, while gold fell to less than a third of its peak. Interest rates went down in fits and starts over the entire period, not reaching a bottom until 2003. What could be better? Assets rose in price...while the cost of borrowing fell. This was the era of globablization, free trade agreements, cheap shipping costs, the entry of China and other nations into the world market system, Wal-Mart, technology and just-in-time inventory – all of these things helped to lower the cost of many manufactured goods. What a great time to be an investor!

But Daily Reckoners are warned: the stock market didn’t take off until stocks had been beaten down to very low prices – with P/E ratios of 5 to 8 (currently, they’re 14-18). Bonds didn’t take off until yields had peaked out over 15% (currently the 10-year note yields 3.95%). Which is another way of saying...the cost of borrowing didn’t go down until it had become almost impossible to borrow. And inflation rates didn’t retreat until they had hit 14% annually.

The moral of this story is simple enough. You have to fall down before you can pick yourself up.

Another big story in the financial press this morning has the dollar as its hero. The greenback rose three full pennies against the euro on Friday. It now stands at $1.50 per euro. Yes, the dollar is coming back too – or so you might think.

As to the dollar/euro exchange rate, we have no prediction to make. It’s like a spelling Bee where both contestants are dyslexics. Neither the euro’s masters nor Ben Benanke can spell “sound money.” The European central bank lends at twice the rate of interest of the Fed. But the Europeans are expanding their money supply faster.

Compared to dollars and euros, gold is a Webster’s Unabridged Dictionary. Every word is spelled perfectly. Our guess is that both dollars and euros will lose ground against gold. Here too, many commentators think the top in gold has come and gone. It’s down nearly 15% from its near-term peak. But again, it appears to us – and maybe to us alone – that the ‘70s-style trends have yet to run their course. Stocks still have to be crushed. Inflation still has to reach higher than an official rate of only 5%. Yields have to reach higher than 4%.

And the monetary system rigged-up by the Nixon Administration in ’71 still has to fall into ruin.

*** “Oil rises on troubles in Georgia...”

The headline is a sign of our time. Today, the world believes in money. In economics. In material progress. Everything else takes second, third, or fourth place. It is easier to see small changes in the price of oil than big changes in the way you look at the world. You can tell when the world changes; but when you change it goes unnoticed.

If this were August 1914, instead of August 2008, the headlines might read:

“French Bonds Fall on Invasion of Belgium.” Or, if this were August of 1939, the headline might read: “Oil prices jump on threatened German invasion of Poland.”

Or how would the modern press report the big event of 2000 years ago? “Miracle worker’s earnings cut short by untimely crucifixion...”

But in years zero, ’14 and ’39, money was not the main issue. People believed in politics, nationalism, racism, religion...and reported the news otherwise.

Today, it is money that counts.

The price of oil fell heavily last week. It ended Friday at $115. But this morning, it is rising – on news of a political struggle in South Ossetia. And if this continues, we wouldn’t count on the price of oil to stay ‘low’ for long. The only good news is that when energy is under the gun, the soaring oil price itself opens you up to all kinds of soaring investments. Read more here .

The region is between Russia and Georgia, on the Black Sea. Ossetians, whoever they are, have been there since the days when the ancient Greeks set up colonies around the Black Sea. In the 1930s, the Pontic Greeks were still there – until Stalin deported them to Kazakhstan. The Ossetians, too, disappeared into the maul of the Soviet Union. They were forgotten for most of the 20th century. Then, when the Soviet Union disbanded – there they were. But who then had the right to tell the Ossetians what to do? The Russians? Or the Georgians? The Russians expressed themselves on the issue over the weekend. According to one report, 2,000 people have died in the fighting.

U.S. Vice President, Dick Cheney, had Georgia on his mind over the weekend. He reportedly said that this violence “must not go unanswered.” What sort of response he had in mind, we don’t know. But inasmuch as the United States and Russia are the world’s two most heavily armed nuclear powers, there may be more at stake than the price of oil.

*** “If you added up the cost of maintaining this place, it’s probably a lot more than a nice vacation,” Henry argued. “We had to replace the roof a few years ago. We have Damien, [the gardener] who keeps an eye on the place. We had to have the plumber come and fix the furnace. You put a new door on the kitchen. It must cost a lot of money. We could have gone to spend a month in a nice hotel on the Cote d’Azur, for example.”

Henry had just come back from a week spent with friends. They didn’t paint shutters, or fix stone walls, or weed the garden. Instead, they went sailing...and to movies...and restaurants.

“Oh...and I was surprised by how much people hate Parisians,” said Henry. “They think Parisians are rich and snobby. And they’re right. You know Paul’s father would see someone with Paris license tags, doing something stupid, and he’d roll down the window and yell out – ‘Go back to Paris...’ or something like that.”

“But wait...Paul’s family is from Paris...they are Parisians...”

“Yes, but his father got local license tags. So when he’s on vacation, he pretends to be from the area and yells at the Parisians...

“But we had a good time sailing...it was nice to take a real vacation. Not like around here. We never get a vacation here, because there’s always so much work to do just to keep the place from falling down. Really, Dad, I don’t see the point....”

Henry is right, at least insofar as the money is concerned. When you add in all the costs of maintaining a summer house – or, at least this summer house – it is far more than the cost of a real vacation. In addition to all the costs Henry mentioned, there’s the cost of heat. Even though we’re rarely here in the winter, we still have to heat the place or it will soon be ruined by mildew. And here in Europe, it costs a fortune to heat a large, old, un-insulated house through the winter. Then, there are taxes...insurance...and the inevitable repairs.

What we’re discovered here in France is the same thing that Americans all across the nation are discovering – houses are ways to spend money, not to make it.

“Well, why do you keep it?” Henry wanted to know.

“Sentimental reasons, Henry. This isn’t an investment. And it’s not just a vacation spot. This is our home. We’ve spent the last 13 years fixing it up. We’ve restored it. We’ve planted trees and gardens. And you children have grown up here.

“Besides, our lives are otherwise rather nomadic. I work in London. Your mother and Edward live in Paris. You children are spread out all over the world. You’re going to be in Virginia next year. Maria is out in Los Angeles. We need a place to call home...a place to keep our sacred family documents....”

“You mean, a place to keep grandma’s recipe for bread pudding and Maryland beaten biscuits?”

“Yes...and your monkey outfit from when you were in the school pageant... We need a permanent family stronghold...a family seat...a place where the whole family could gather every summer.”

“Well, why didn’t we just stay at the family farm in Maryland?”

“Because my business took us to Europe...and because the whole area changed so much...with all those shopping malls and housing developments...it didn’t seem like home anymore. We had to retreat...”

“Well, I don’t mind that...I like this place. I just don’t like having to work all the time we’re here.”

“But that’s just part of the charm of it. Imagine if we had gotten a condo at the beach at Ocean City? We’d go crazy. We’d just sit around and read all the time. Here...we get to do a little stonemasonry in the morning and paint the shutters in the afternoon...”