July 2003 Newsletter
Issue Seven, Volume Four

THE FINAL STRAW?

By Mike Gasior

No matter how many facts I may offer to defend my viewpoint, my faithful readership is likely to have grown sick of my seemingly endless forecasts of economic gloominess. A reader even wrote me after last month's edition to illustrate how the economy had managed to achieve significant acceleration in growth rates in the past (a possibility I dismissed as wishful thinking) and somewhat scolded me for not ever having the viewpoint that "the glass is half full".

I am far from a pessimistic person and quite frankly, I find it difficult to see ANYTHING in the glass. For me, it isn't an issue of the glass being viewed as being half empty, or half full. My duty is to report accurately what I view as actually being in the glass and from an economic vantage point I view the glass as empty. While this is not the worst moment in economic history by a large margin, it is certainly an extremely difficult moment and one that will take more time to work through. We are far from being through the tunnel the 1990's created and we are even further from the glass being half anything. Events of the past 30 days have only solidified my views and opinions; not weakened my resolve.

Some of the funniest reader mail after last month was to search for more detailed dirt on my experience with Ms. Stewart on our flight from Seattle to St. Louis. Suffice it to say that I will only share such torrid (and fairly profane) details after at least several cocktails at some pub. My favorite note included a saying I hadn't heard in years, but made me laugh out loud and you may enjoy. The reader wrote that they had a saying in their family:

"If you don't have anything nice to say about someone, sit next to ME!"

With that thought in mind, let me get to the details of what might have provided the final straw that breaks this economy's back.

THE FINAL STRAW?

The trend in interest rates in recent weeks has been a rapid rise in intermediate rates. The yield on the 10-year Treasury has shot up from a low of 3.11% back in June, to almost a 4.40% yield at the close of business July 29th.

Just a week ago Alan Greenspan was testifying in front of Congress and stated that the Federal Reserve was prepared and willing to keep short term interest rates at their current lows, or even take them lower still until the risk of deflation has deteriorated further. While I may agree with Senator Jon Corzine of New Jersey on very few things politically, I completely and thoroughly agreed with the question he posed to the Fed Chairman during Chairman's testimony.

Senator Corzine simply pointed out that there had been 13 reductions in interest rates by Federal Reserve since 2001 as well as tax cuts of between $3 trillion and $4 trillion, depending upon who you asked. Senator Corzine said to Chairman Greenspan that this is hardly "gentle stimulus" for the economy yet there has been no improvement to the economy to this point; and in truth, economic conditions have worsened during this time period.

Even Federal Reserve Board Governor Ben Bernanke stated that one of the Fed's primary forecasters of inflation, Personal Consumption, might fall another half of a percent before year-end. His viewpoint is based on the premise that even a growth rate of 4% (more than 3 times the rate of growth in the first half of 2003) will not be enough to absorb the extreme level of excess capacity that exists in the U.S. economy.

What can be gleaned from these statements and facts is that the Federal Reserve is clearly concerned about such low levels of inflation and even the prospect of deflation.

If there seems to be no concrete evidence of inflation on the horizon, then why in the world are interest rates going up? The answer lies in the most simple principal:

Supply and demand.

The Bush administration itself claims that the Federal budget deficit will be $455 billion this year and $475 billion next year. These estimates were BEFORE this current rise in rates, which are going to substantially raise the budget's interest expense line. This will add almost $1 trillion in new debt to the almost $7 trillion of debt the United States already on its books.

Of all the statistics that I consume on a monthly basis, none has struck me with more force than this; until now the U.S. Government had not seen declining revenues for four (4) consecutive years since the Great Depression. Couple this with tax cutting and increased spending and we enter the current era of large deficits and huge issuance of debt by the government.

I complained in my December 2002 newsletter about the Federal Reserve. I lamented about the huge amounts of money the Federal Reserve was printing and injecting into the economy to stave off deflation. To remind you, the Federal Reserve printed $3 trillion new dollars between 1997 and 2001 and increased the money supply as measured by M3 by 61% during that period. Although I called for Alan Greenspan's resignation in that issue as well, he has so far ignored my request.

What sent me over the edge this month was finding out that the Fed is using lots of the dollars that they are printing to BUY U.S. Treasuries in an effort to keep longer-term rates low, and Treasury prices up. This strategy may now prove to be a recipe for disaster as investors began to piece this puzzle together. Since I always want my readers to have a clear picture, let me carefully arrange the pieces for easy assembly:

--The Federal Reserve has been printing dollars at a breakneck speed in an effort to avoid deflation, perhaps cause minor inflation and provide liquidity to the economy.

--The Federal Reserve has been using some of these freshly minted dollars to buy U.S. Treasuries in an effort to hold down longer-term rates and prop up Treasury prices. In the past year the Fed has increased their holdings of U.S. Treasury securities 11%, taking them from $582 billion to $647 billion.

--The U.S. Government is currently in debt to the tune of around $6.9 trillion and that level could reach $10 trillion in the next 10 years.

--State and local governments are also facing massive budget deficits and are issuing oceans of new debt.

This simple combination has created a serious problem in terms of the supply of bonds being issued and the willingness of investors to fund this increasing debt load. The result has been falling prices on bonds and rising interest rates. A classic imbalance of supply versus demand.

THE PROBLEM

The difficulty that this current rise in interest rates will have on the U.S. economy is that it will almost immediately send the real estate market into the tailspin that I warned of. The impact on mortgage rates has already begun and the effect on housing starts, sales and prices will be felt in a significant way by the fourth quarter of 2003. This may even impact the extremely important holiday shopping season.

The only leg the U.S. economy has been standing on for the past two tears has been real estate. Homeowners have been monitizing the equity in their homes to fuel continued spending even when their income and capital gains have been stagnant or dropping. If this rise in interest kicks the real estate leg out from under the economy things will begin to get ugly.

You will see a final frenzy in mortgage and corporate refinances during the next 30 to 60 days and then things will grow eerily quiet. I told you last month not to believe the forecasts of 3.6% to 3.8% growth in GDP. Since I wrote that many voices within the Federal Reserve have told you the exact same thing. I can't help but find it funny that so few people are getting the message.

OR ARE THEY?

I saw Treasury Secretary John Snow on CNBC the other day telling the interviewer that the economy was "spring-loaded to go."

Most economists that work for the brokerage firms and banks were even forecasting that the Consumer Confidence Index would rise from its June level of 83.5 to an even more optimistic 85.0 in July. Unfortunately consumers aren't seeing things the same way as John Snow or those economists. The July number was just released and plummeted instead to its lowest level in months of 76.6.

Another statistic released by the Conference Board is related to how difficult it is to find it job. This number rose from 31.9 to 33.1, which it the highest level since 1994.

I read last week that Ford announced that they planned to reduce their payroll costs worldwide by 10%. Since I can't imagine the U.A.W. is planning to let their union membership accept a 10% reduction in earnings, I can only suppose we're talking about a 10% reduction in employees. Ford says this will affect 79,000 white-collar employees worldwide, but didn't specify exactly how many jobs would be eliminated.

So I've reached one of those moments where I worry I'll be viewed as extremely negative, but can someone honestly tell me where these is ANYTHING that can be put into the glass so I can view it as half full? I hate to use such technical terminology on you, but things just look plain icky.

ANOTHER UNRELATED FINANCIAL TRAIN WRECK

Let me lay some scary numbers on you and then ask you a couple of questions.

Here is the amount of money the following networks are going to LOSE on their sports programming over the next three years.

--Turner = $1,400,000,000

--Fox = $1,300,000,000

--CBS = $1,200,000,000

--ABC = $1,100,000,000

--ESPN = $900,000,000

--NBC = $400,000,000

--FX = $300,000,000

--TOTAL = $6,600,000,000

Actually the most shocking thing about those numbers for me was learning that the FX Network was going to lose $300 million on sports programming since I wasn't even aware that they HAD any sports programming.

Now here are my questions for you:

1) Do you think these networks will continue to bleed money like this for much longer?

2) Do you think the next time the sports leagues approach the networks to bid on broadcast contracts that the networks will up the ante even further?

3) If you answers to questions one and two were no, then can you imagine that athletes salaries can continue to expand at the rate they've expanded during the previous 10 years?

This isn't really rocket science here, but it might certainly make for some interesting conversation.

A TERRIFIC DVD

I love music and I have accumulated a fairly extensive collection of concert DVD's since and I find them fun to watch during the 100 days a year I spend on airplanes.

I just recently bought the newly released Led Zeppelin DVD and it was extremely nice to be reminded how good of a band this was. The DVD contains footage from several concerts between 1970 and 1979 and it is difficult to imagine the level of innovation these musicians achieved over 30 years ago. I saw them at Madison Square Garden back in 1977 and have enjoyed their albums since then. Watching the performances on the DVD reminded me that Zeppelin was one of the best live acts you could ever see.

When you see Jimmy Page take a cello bow to his Gibson guitar, you wonder what ever happened to that sort of musical originality. And if you will indulge me for one second, John Bonham is the best rock and roll drummer who has ever lived. When you watch his drum solo on the song 'Moby Dick', please be reminded he is accomplishing that sound with a single-kick drum pedal, which should create shame for those double-kick drummers and their theatrics.

A recent debate among some friends and myself causes me to give you MY list of the 10 greatest rock bands or groups of all time. What is sad is that I will likely receive 500 emails about this list and 5 emails about the amount of money the Federal Reserve is printing; but here goes.

Of course this list is subjective, but it is made on the basis of my personal preferences, historical importance, body of work, as well as me giving credit where credit is due, even if I can't call myself a fan.

1) The Beatles
2) The Rolling Stones
3) The Who
4) Led Zeppelin
5) Bruce Springsteen and the E Street Band
6) Nirvana
7) Crosby, Stills, Nash and Young
8) The Band
9) Aerosmith
10) Guns and Roses

There are a few obvious choices that could have easily made the list that I didn't name, like The Doors, The Mamas And The Papas, Kiss, Fleetwood Mac, Bon Jovi, The Police, The Beach Boys and a few others. Most interesting to me, is that I listed The Beatles as number one although I barely listen to their records compared to how often I play The Stones or The Who.

I'm confident you'll make your objections and votes clear to me. I haven't forgotten the Eminem backlash.

I'M SORRY BUT I HAVE TO SAY THIS

Screw Saudi Arabia.

To hear that the Saudi Foreign Minister Saud al-Faisal was at the White House complaining that the United States was making them look bad was enough to make me want to heave. Their complaint is that the 28 blank pages in a document investigating the events of September 11th insinuate that the Saudi government was involved in the actions that killed 3,000 people. Obviously neither they, nor I, know what is contained in those empty pages.

What I know for a fact is that 15 out of the 19 men who flew the planes into those buildings that day were Saudi. I know for a fact that Osama bin Laden is Saudi. I know for a fact thanks to MANY public reports that Saudi citizens helped provided funding for the highjackers before the attacks. I know that the Saudi government held a telethon to raise money for the highjackers families AFTER the attacks. I also know the Saudi government DIDN'T hold any telethons for the 3,000 families of the victims killed by the 15 Saudi citizens.

My suggestion to the Saudi royal family is that they save their lectures and crocodile tears and keep their mouths shut. I don't want to engage a debate here about whether or not the U.S. and Britain had enough of a beef with Iraq to attack them. I might suggest, however, that I can personally list more reasons for being angry at Saudi Arabia. It's time for them to go silent.

WELCOME TO THE OLYMPICS

I have taken all the abuse I can handle with regard to my brainteasers being way too simple so the time has come to pick up the pace quite a bit with this months question. Hopefully this will lay to rest some of the criticisms for the time being. So here goes:

"As Jack finished a section of the novel he was reading, his wife posed a curious question. 'Dear, suppose you took the page numbers of the section you just read and added them together? What would you get?'

Jack summed them rather quickly and said 'Well, I may have to check my arithmetic. It's either 412 or 512, I'm not sure.'"

Which is the correct answer and WHY?

In an effort to stem braggarts who want to tell people they solved the puzzle after visiting my website and checking the answer first I am not going to add the link for the answer until Monday, August 4th. If you REALLY can't stand waiting, drop me an email (by replying to this newsletter) and I'll send the answer as soon as I can.

Go to the following URL after August 4th to see if you got the logic for answering this question:

http://www.afs-seminars.com/brainteaser_July2003.html

http://www.afs-seminars.com

Copyright 2003, Michael Gasior. All Rights Reserved.

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