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Fleck Rap



Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at

"An Economy on Thin Ice"

We have to go to the videotape to catch the activity Friday afternoon, as Ford (F) pulled a page from Oracle's (ORCL) playbook by preannouncing that day after everyone had gone home. What I found interesting in Ford's news about taking earnings estimates down for the year was their point that higher costs were hurting them, as was the weaker dollar.

New Reality Show: "Ford Factor"

I think that underscores the stagflation problem confronting the economy in general. We have higher costs, creating more inflation, which the Fed is theoretically supposed to fight. Though they have timidly tightened, they're behind the curve on inflation. Even if the dropping-money-from-helicopter pilots at the Fed feared inflation, they'd be in a box -- as far as doing a lot about it, because the economy is weakening. Of course, given those same inflation pressures, it will be very difficult for them to ease any time soon, even if we get a stock-market dislocation. Thus, what I took away from Ford's predicament was just another example of the box the Fed is in.

Speaking of our macro problems, in The Washington Post this weekend, Paul Volcker penned an editorial called "An Economy on Thin Ice," which obviously shouldn't have made anyone get all warm and fuzzy (more about that below).

Getting an 'A' in Complacency

With those two "items" as reference points, you probably would not guess that the market opened higher Monday morning, yet ex the auto sector, that was in fact the case, as the tape was green across the board. Selling quickly ensued, however, such that we were modestly red a couple hours into the day. As we went modestly red, the VIX dropped about 5%, showing a complete lack of fear and, I might say, understanding on the part of most stock-market operators. How one can be sanguine about the equity market at this moment in time is beyond my comprehension. Nevertheless, that was the scene in the early going.

After the early excitement, the market flopped and chopped in a tiny range. If you got out your microscope, you could see that the Nasdaq spent most of the time at the day's lows, whereas the S&P drifted around near the day's highs. But given that the highs and lows were so close together, this is really a distinction without much difference.

Is There a Skunk at Armonk?

Beneath the surface, I didn't see anything terribly earth-shaking, other than to notice that IBM (IBM) was again very heavy today. While I've made no secret of my belief that IBM has been hollowing out their business and using a cookie jar approach to making the numbers for the longest time, the stock trades like IBM might preannounce, though I doubt they will, since they never have.

Away from stocks, the dollar was a bit weaker. My favorite technical analyst, Justin Mamis, suggested that the dollar rally has failed. As he noted in his Monday morning weekly call, he can see the case where the both dollar and the euro would be perceived as problems and gold could be seen as the "only real currency." Considering that Justin would be the first to admit that things fundamental aren't his ken, I found it interesting that this astute market observer came to that conclusion, based on all the different moving parts.

In any case, the dollar index was down 0.3%, and that pushed the precious metals modestly higher. Oil closed up 1%, after having trading down 2%. Fixed income managed a decent bounce.

Prosperity Built on Quicksand

I'd like to take a moment to reprise Paul Volcker's article, because he makes some worthwhile points that I obviously agree with. He starts off by saying that although everything looked okay superficially (from an economic standpoint), "under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it."

Next, he complains about the fact that we're bogged down discussing Social Security, and that we've been relying on foreigners to finance our savings shortfall. In passing, he takes a swipe at the present-day bubble: "Homeownership has become a vehicle for borrowing." In other words, he too notes the housing ATM.

After describing how we've been bailed out by foreigners, he says: " I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change." My response to that: If a crisis is what we get, then change will come with a bang, not a whimper.

Continuing on, he suggests that, "Japan and Europe should work promptly and aggressively toward domestic stimulus and deal more effectively and speedily with structural obstacles to growth." He says that America, "by some combination of measures, should forcibly increase its rate of internal saving, thereby reducing its import demand. But can we, with any degree of confidence today, look forward to any one of these policies being put in place any time soon, much less a combination of all? The answer is no. So I think we are skating on increasingly thin ice."

Now, I am a very big Paul Volcker fan. Nearly all the good things that have accrued to the country financially in the 1980s and early 1990s were a result of his courageous work as Fed chairman from Fall 1979 to Spring 1987. That said, I am somewhat disappointed that he almost completely ignores the incompetence of our domestic monetary policy and, more importantly, fails to suggest any "combination of measures" that should be implemented to help boost our savings rate and trim our consumption.

A Potent Pill to Induce Real Prosperity

One of the most obvious would be to raise short rates to a level commensurate (i.e., 5% to 6%) with the underlying rate of inflation and "take back" some of the absurd stimulus that Greenspan has foisted on the economy repeatedly over the last decade. This would simultaneously increase savings, reduce consumption, and hurl us into recession. But we are headed there anyway. So let's get on with it before even more damage is done.

Volcker gives passing notice to the fact that our budget surpluses have turned to deficits, but there were never any surpluses. There were, but they were a function of the tax receipts from the mania, which should never have been construed as sustainable. It was the belief in the "new era" and "new economy" and prosperity forever -- fostered by the monetary bubble -- that deluded people into thinking that the country doesn't have to get its house in order, from a financial standpoint.

Similarly, it's been the bailout of the stock-mania bust, via the housing ATM, that makes everyone so complacent -- witness that when problems start to hit and you have General Motors (GM) and Ford in trouble (on top of American Int'l Group (AIG), MBIA (MBI), and Fannie Mae(FNM)), folks' response is to buy stocks, or second and third homes to "flip."

Nary a Word That Should Have Been Heard

The mentality that rules this country from a financial standpoint is a direct consequence of reckless monetary policy under Greenspan. Therefore, I would like to have seen Paul Volcker point the finger of guilt where it should be pointed, at his successor.

But I do agree with his summation: "A wise observer of the economic scene once commented that 'what can be left to later, usually is -- and then, alas, it's too late." He is so right. It's already too late. The only question is when all hell breaks loose.

position in fnm, gm, ibm

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