Just What I Said E-Book

Caroline Baum

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Bloomberg
• Sprache: Englisch

Seitenzahl: 486

Veröffentlichungsjahr: 2010

Beschreibung

Not for nothing do her initials also stand for "Central Bank." For nearly two decades, Caroline Baum has produced incisive commentary on central bank policy, the ebbs and flows of the economy, and how they influence the bond market. Her much sought-after, real-time analysis is read by a devoted audience on the BLOOMBERG PROFESSIONAL service within seconds after it appears. The word on the Street is that reading Caroline Baum is an economic education in itself. This selection from her more than 1,300 Bloomberg News columns, arranged by major themes and with new introductions by the author, condenses and organizes that wisdom for the first time in print form.

Leseprobe

Table of Contents

Praise

Title Page

Copyright Page

Dedication

Preface

Acknowledgements

Introduction

Chapter 1 - Ye of Little Faith

ONE-WAY STREET

THINK BEEF

SIMPLE MODEL

SHORT BEATS LONG

KEY DIFFERENCE

DOWN GREENSPAN’S WAY

SPENDING LEADS INCOME

DENIAL

VOODOO ECONOMICS

EMPIRICAL EVIDENCE

BAA MINUS

EXECUTIVE BOB

Chapter 2 - The Bubble, or This Time Really Is Different!

REALITY CHECK

SELLERS VANQUISHED

EAGER BEAVERS

THEMES AND VARIATIONS

LESS THAN ZERO

NEW NEW THING

‘AT THE MARGIN’

THEORY OF RELATIVITY

STAGES OF GRIEVING

GURU-ITIS

PERFECT COMPETITION

ET PHONE HOME

WHO’S ON FIRST?

BOTH WAYS

FULL CIRCLE

IT’S A DUCK

RAH-RAH, SIS-BOOM-BAH

PREEMPTIVE STRIKE

OLD/NEW ECONOMY

PAST WASN’T PROLOGUE

TECH ONLY

EVEN THE MAESTRO

RECESSION DRIVERS

MISALLOCATION OF CAPITAL

LACKING PRESCIENCE

LOOSE DEFINITION

CAVEAT EMPTOR

Chapter 3 - Still Nonsense After All These Years

TAX CUTS

BORROW

DESTROY TO CREATE?

HALF-CROCKED THEORY

THE SOONER THE BETTER

WHY NOT EASE?

PUSH-ME PULL-YOU

ALWAYS AND EVERYWHERE

QUARTERLY NOISE

BAD FIT

ORDER OF THINGS

PUSH-ME PULL-YOU

KILL IT

NEW CHALLENGES

SHAKY FOUNDATION

WHAT HIGH RATES?

INVERSE CORRELATION

IT’S THE ECONOMY

SPENDING SPLURGE

FINITE UNIVERSE?

SMALL SLICE

RESTRAINED SUPPLY

EVIDENCE

LOSER

SATIATED CONSUMERS?

DATA MASSAGE

NEW NEW THING

PENT-UP NONSENSE

PRODUCTIVITY PRIMER

COMPETITION

OLD SAW

FIXED NONSENSE

OVAL OFFICE TEMPS?

NEW DEAL REVISITED

POLITICS, NOT POLICY

POORLY PUT

SITUATION WANTED

Chapter 4 - Myths Under the Microscope

FREE TO CHOOSE

DRIVEN BY INVESTMENT

DATA DISCONNECT

GUARANTEED DEFICIT CUTTER

LIMITED OPTIONS

DETAILS

TWO BIRDS, ONE STONE

NOT ZERO-BOUND

SOGGY STRING

MISGUIDED POLICY

PINK PARROTS

GLOBAL GLUT

POKING HOLES

GOING WAY OF FARMER

THEY WERE EXPENDABLE

ALMA MATER

SUPPLY-SIDERS

MONETARISTS

SCHOOL FOR SCANDAL

SUPPLIERS BEWARE

BORN TO PUMP

CORRELATION ISN’T CAUSATION

NONSENSE

Chapter 5 - First Principles

GOLDEN OPPORTUNITY

MCMOSCOW

ALL AMERICAN

SUPPLY AND DEMAND

INVISIBLE, UNMOVABLE HAND

BRING BACK INSECURITY!

MORAL WIMPS

MISGUIDED

CAN’T FOOL MR. MARKET

UNINTENDED CONSEQUENCES

WELFARE STATE

SUPPLY AND DEMAND

DISCRIMINATORY PRACTICES

BIG PICTURE

FREE TO ADJUST

FORCED LABOR

SAY’S LAW SAYS IT ALL

WHAT IS UNSEEN

HOLIDAY ON ICE

CAN OF WORMS

DON’T ASK, DON’T TELL

DOUBLE EPIPHANY

BASTIAT’S BROKEN WINDOW

GENERALLY INCORRECT

IN THE BEGINNING

REDEFINING HELP

SHORT-RUN ILLUSION

IT’S ABOUT INCENTIVES

OLD-WORLD BAGGAGE

A NEW WAY

Chapter 6 - Understanding the Yield Curve

UNUSUAL CITATION

SO SIMPLE IT’S HARD

UNOBSERVABLE OBSERVATIONS

STRANGE TIMING

FALLING ROCKS

MISUNDERSTOOD

CAUSE OR EFFECT?

PHONE HOME

SHIFTING CURVES

FUZZY THINKING

EXPECTATIONS HYPOTHESIS

HUH?

LOOP-THE-LOOP

BASIC MICROECONOMICS

FORGETTING SOMEONE

WHY, NOT WHAT

Chapter 7 - The “Political” Economy

LOSE/LOSE

MORAL HAZARD

TAX THE RICH

BIG BURDEN

STONE COLD

POSTCARD RETURN

SAVE THE TREES

WHO DOES IT?

CONFLICT OF INTEREST

GREENSPAN VOTES NO

IMPOSSIBLE INSULATION

PRIVATIZE

DIRTY LITTLE SECRET

UPENDING MARX

UNION INFLUENCE

CHILEAN MODEL

POWER TO THE PEOPLE

RUBINOMICS

UNPAID ADVERTISING

IN PLAY

THE RUBIN FED?

QUESTIONABLE STIMULUS

Chapter 8 - Sir Alan

CAST OF CHARACTERS

SCREENPLAY

STARRING ROLE

DIALOGUE

EDITING PROCESS

CLOSE-UP

CAPITALIST CLASS

LABOR POWER

PROLETARIAT REVOLUTION

DUMB AND DUMBER

HE’S NAKED!

SUPPLY AND DEMAND

GOOD OR BAD?

REDUNDANT CAPS

BIG, BIGGER, BIGGEST

WHEELIE

PUBLIC VS PRIVATE

REVELATIONS

INFLATION RATIONALIZATION

FISCAL FORUM

PRODUCTIVITY HOPES

MAN FOR ALL SEASONS

KING’S RANSOM

SHINING ARMOR

Chapter 9 - What Would We Do Without a Dollar Policy?

SHHHHHH!

EMPTY WORDS

MUCH ADO

FOOL’S GOLD

UNDESIRED OUTCOME

GROUCHO’S CLUB

REVERSAL OF FORTUNE

SUPPLY AND DEMAND

HELP WANTED

SENIOR STATESMAN

ELECTION 2004

SAY WHAT?

TRUTH HURTS

RISK FACTORS

LIFE EXPERIENCE

JOHN LOMAN

A BILLION CONSUMERS

JOB DESCRIPTION

Chapter 10 - Off the Charts

FADE THE COVER

ONCE BITTEN, TWICE WRONG

CRUDE CALL

THAR SHE GOES!

SPORTING TYPES

‘TIDAL AFFAIRS’

CONCEPT RALLY?

ROUND TRIP

WELCOME BACK

Chapter 11 - Odd Ducks

THE OLD-FASHIONED WAY

STRANGERS BEARING GIFTS

WHO NEEDS DEMAND?

BREATHING FIRE

OX BEFORE THE CART

NO SLEEPING TIGER

FLEET OF FOOT

DOGGEDLY BORING

DENNIS THE BOAR

ONE-WAY ADJUSTMENT

REACH OUT, TOUCH WHOM?

SATISFACTION

STUCK ON SWIFFER

‘SOFTWARE’ WORKS

MOPPING UP

SPOIL THE DOG

Chapter 12 - Oil Things to Oil People

RUNNING INTERFERENCE

KUDLOW AND KEYNES?

USUAL SUSPECT

INVISIBLE HAND

NEW GUSHERS

REVISIONIST HISTORY

EITHER/OR

UNIQUELY INELASTIC

RAPID RESPONSE

ALL FALL DOWN

JUST THE FACTS

WHAT ABOUT INVESTMENT?

RESPONSE TO OIL

WHERE’S THE SHOCK?

SPIGOTS OPEN

WASTED ENERGY

ENERGY EFFICIENCY

Chapter 13 - Rewriting History

CREDIT HISTORY

NAME CHANGE

REAL BAILOUT

HELPING HAND?

CONFLICT OF INTEREST

TEXTBOOK EXAMPLE

LOWER TAXES, HIGHER REVENUE

BOB AND WEAVE

THOSE PESKY FACTS

PRICE DISCOVERY

STATIC VS DYNAMIC

FEEDBACK LOOP

BEYOND RUBIN

REVISIONIST HISTORY

HIPPOCRATIC OATH

LIVE (DEBT) FREE OR DIE

PR DISASTER

GOOD AS GOLD

OTHER ILLS

Chapter 14 - Men in Black

THE GROUP

METAMORPHOSIS

AUTHORITATIVE VOICES

NO GUARANTEE OF SUCCESS

COVERT OPERATIONS

MAGIC WAND

SEPTEMBER SURPRISE

Chapter 15 - No One Else Would Write About This

TWIN PEAKS

R & R

HOUSE NOT A HOME

RETAINING WALL

LESS LEISURE

POOR SERVICE

LESS ISN’T MORE

SOVIET MODEL

GIVING SEASON

CAMPAIGN GIMMICK

Chapter 16 - Love Affair

GOOD NEWS, BAD NEWS

MADE TO BE BROKEN

TBA

DOMESTIC DIFFERENCES

SEPARATION AGREEMENT

MISCOMMUNICATION

REUNITED

FLIRTATIONS

OLD FLAME

NEW RELATIONSHIP

CO-DEPENDENCY

Chapter 17 - Bumbling Bureaucrats

PRESS PUSSYFOOTING

ARCHITECTURAL ACCIDENT

TYRANNOSAURUS TENDENCIES

DON’T ASK, DON’T TELL

RX FOR REFORM

IMF REINVENTED

SLIM FAST?

U.S. IS IMF

HISTORY REPEATS ITSELF

FED’S FOUL-UP

MORE IS BETTER

DO SOME GOOD

Chapter 18 - The 2004 Election

BIG SPENDER

NOT CREDIBLE

PRIVATIZATION VS AVOIDANCE

REPARATIONS

Chapter 19 - Readers Write Back at You

SUPPLY AND DEMAND

INCOME RISING

LOST DOLLARS

BACK TO THE ’70S?

Index

About Bloomberg

About the Author

PRAISE FOR Just What I Said:Bloomberg Economics Columnist Takes OnBonds, Banks, Budgets, and BubblesBY CAROLINE BAUM

“Caroline Baum is one of the few topical commentators who writes things that have lasting value. This compilation provides a history of the economic issues of the time and timeless insights.”

PAUL H. O’NEILL Former Secretary of the U.S. Treasury

“Caroline Baum is a rarity—an economics commentator who actually understands economics and writes about it with clarity and passion. Read her and learn! Read her and enjoy!”

GREG MANKIW Professor of Economics, Harvard University Chairman, U.S. Council of Economics Advisors, 2003-2005

“If you are interested in the Fed, interest rates, the budget deficit, taxes, China, or anything economic under the sun, Caroline Baum is a must-read.”

LAWRENCE KUDLOW Host, CNBC’s Kudlow & Company

“Not many financial journalists’ columns repay a reading months or years later. Caroline Baum’s knack for making complex ideas understandable and her irreverent style make her book one of the rare exceptions.”

DR. ALLAN H. MELTZER The Allan H. Meltzer University Professor of Political Economy, Carnegie Mellon University

“Caroline Baum demonstrates that economics (the “dismal science”) can be made lively, humorous, creative, and professional. The book Just What I Said is economics in action. It is beautifully written and well argued and is always on the mark. Complex subjects are made simple through Baum’s masterful application of the basic principles of economics. Read it, you will like it and learn a lot.”

DR. JACOB A. FRENKEL Vice Chairman, American International Group, Inc. Former Governor of the Bank of Israel

ALSO AVAILABLE FROM BLOOMBERG PRESS

Dealing with Financial Riskby David Shirreff

Guide to Financial Marketsby Marc Levinson

Inside the Yield Book:The Classic That Created the Science of Bond Analysisby Sidney Homer and Martin L. Leibowitz, PhD

Flying on One Engine:The Bloomberg Book of Master Market Economistsedited by Thomas R. Keene

The Trader’s Guide to Key Economic Indicatorsby Richard Yamarone

A complete list of our titles is available at www.bloomberg.com/books

ATTENTION CORPORATIONS

This book is available for bulk purchase at special discount. Special editions or chapter reprints can also be customized to specifications. For information, please e-mail Bloomberg Press, [email protected], Attention: Director of Special Markets, or phone [phone].

© 2005 by Bloomberg L.P. All rights reserved. Protected under the Berne Convention. No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher except in the case of brief quotations embodied in critical articles and reviews. For information, please write: Permissions Department, Bloomberg Press, 731 Lexington Avenue, New York, NY, 10022, or send an e-mail to [email protected].

BLOOMBERG, BLOOMBERG ANYWHERE, BLOOMBERG.COM, BLOOMBERG MARKET ESSENTIALS, Bloomberg Markets, BLOOMBERG NEWS, BLOOMBERG PRESS, BLOOMBERG PROFESSIONAL, BLOOMBERG RADIO, BLOOMBERG TELEVISION, and BLOOMBERG TRADEBOOK are trademarks and service marks of Bloomberg Finance L.P. (“BFLP”), a Delaware limited partnership, or its subsidiaries. The BLOOMBERG PROFESSIONAL service (the “BPS”) is owned and distributed locally by BFLP and its subsidiaries in all jurisdictions other than Argentina, Bermuda, China, India, Japan, and Korea (the “BLP Countries”). BFLP is a wholly-owned subsidiary of Bloomberg L.P. (“BLP”). BLP provides BFLP with all global marketing and operational support and service for these products and distributes the BPS either directly or through a non-BFLP subsidiary in the BLP Countries. All rights reserved.

This publication contains the author’s opinions and is designed to provide accurate and authoritative information. It is sold with the understanding that the author, publisher, and Bloomberg L.P. are not engaged in rendering legal, accounting, investment-planning, or other professional advice. The reader should seek the services of a qualified professional for such advice; the author, publisher, and Bloomberg L.P. cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader.

ISBN-13: 978-1-57660-219-5

The Library of Congress has cataloged the earlier printing as follows:

Baum, Caroline

Just what I said : Bloomberg economics columnist takes on bonds, banks, budgets, and bubbles / by Caroline Baum. -- 1st. ed. p. cm.

Summary: “Analysis and commentary on economics, the Federal Reserve, monetary policy, the bond markets, and politics, selected from among 1,300 columns written by Caroline Baum since 1998 for Bloomberg News, the electronic business and financial news service”--Provided by publisher.

Includes index.

HC106.83.B38 2005

330.973’0931--dc22 2005016435

To the memory of my father,who always believed in meeven when I didn’t believe in myself

Preface

JOURNALISTS HAVE a love/hate relationship with their work. We love the process—coming up with an idea, reporting the story, following its twists and turns, unearthing new details along the way, crafting the lead and the kicker—but we hate the result.

Not at the time, of course. A week or a month later, when we reread the story, what jumps out at us is all the ways we could have made it better.

Perhaps that’s why I declined previous overtures to produce a book of columns, which I’ve been writing for 18 years, the last seven for Bloomberg News. I was afraid I’d be so critical of my work that I would be unable to see its long-term value, no less to present it in a manner that would be compelling to readers so many years after the fact.

By the time Bill Inman, editor of Bloomberg Publishing, and Jared Kieling, Bloomberg Press’s acquisitions editor, approached me last year, I was ready to take the plunge. I suspect their solicitousness had something to do with it.

First I had some questions. Who would buy this book? All my columns are archived on the Bloomberg Professional service. Why would any regular reader of my column buy the book?

Bill had the answer. Plenty of people, especially pre-Internet dinosaurs, like books. They like to touch and hold them. They like to carry a book around, read it on the train, plane, or in front of a crackling fire.

What’s more, Bill said my ability to make thorny subjects simple, not to mention lively, would have broader appeal in a world where a basic understanding of economics and financial markets is necessary in everyday life.

I was warming to the idea, even though I was dreading wading through the entire Baum “oeuvre”: the 1,300 columns I’d written since joining Bloomberg in February 1998 (I wrote a column for Dow Jones for 11 years prior to joining Bloomberg News).

Bill told me how well the columns held up, how their value transcended the time and circumstances in which they were written, how their themes were as relevant today as when they first appeared. He wanted the best of those columns collected in one volume for people who, like my regular readers, follow the financial markets and value my perspective.

What follows, then, is a compilation of my columns on the macro-economy, bond market, interest rates and policies that affect them. I arranged them by theme—and was surprised as the chapters started to accumulate. Here I thought I wrote the same six columns over and over, and somehow I managed to come up with 19 different themes.

Readers tell me they sense the joy I get from writing my columns. I hope you experience the same joy reading them.

CAROLINE BAUM West Tisbury, Massachusetts

Acknowledgments

THIS IS A BOOK OF COLUMNS, so any debt of gratitude must start with those individuals who make my column happen several times each week.

I owe so much to my longtime editor, Steve Dickson, whose steady hand keeps me on course. Steve respects my voice, and I respect his. It doesn’t get any better between writer and editor.

Steve is a great wordsmith, and many of the catchy column headlines bear his stamp.

Bill Ahearn oversees the work of all the Bloomberg News columnists with the wisdom and judgment acquired from years of experience. Bill has taught me patience (no mean feat since I live in real time), to trust myself to get it right even when it’s coming out wrong.

I want to thank Matt Winkler, editor in chief of Bloomberg News, who recruited me in 1998. Matt has supported me and promoted my work for the last seven years, giving me some time off from my day job to devote my full attention to the book.

Thanks also to my Bloomberg News colleagues, who are always willing to offer their expertise—and expert sources—in their respective fields when I venture outside of mine. This is true of Bloomberg reporters and editors around the globe, who treat me like royalty when I travel.

I’m grateful to the economists who took me under their wing early on and educated me. An inquisitive student who wants to get it right is irresistible to a teacher, but some folks went beyond the call of duty. I’m indebted to Paul Kasriel, the late Bob Laurent, and Tim Schiller for teaching me to use economics to think about the world; and to Jim Glassman and Joe Carson for always having time to walk me through hard concepts and help me translate theory into something practical and readable.

Thanks also to Jim Bianco, who’s never too busy to unearth some arcane data series to help prove a point.

With these people as my teachers and the market as my classroom, you could say I’ve had one hell of an education. If, over the years, I’ve managed to convey ideas to my readers with the same infectious enthusiasm with which they were conveyed to me, then I will consider myself successful.

This book would not have been possible without the efforts of Bill Inman at Bloomberg Publishing, who approached me with the idea, and Jared Kieling of Bloomberg Press, who turned the idea into reality with his astute suggestions and editing. Barbara Diez Goldenberg, Bloomberg Press design director, shepherded the project from beginning to end, which greatly enhanced my peace of mind.

I would not be able to do the work I do with the intensity it requires without balance in my life. I’m blessed to have such a wonderful circle of friends, sources and colleagues who listened patiently as I rattled on about the book project.

I’m especially grateful for the love and friendship of Steve Cary over the years and for the guidance and grounding of Pat Hill.

And thanks to my mother, who has never understood the concepts of “online” or “newswire” (and probably harbors suspicions about how I earn a living). Finally she’ll have something in hard copy to adorn her cocktail table.

Introduction

IN THE OLD DAYS, business and financial news was relegated to—where else?—the business and financial section of the newspaper.

Every once in a while a big leveraged buyout or merger would hit the front pages. But business news mostly played second fiddle to the major political stories of the day.

The 1990s changed all that. During the latter part of the decade—the real go-go years—everyone was interested in the daily ebb and flow (mostly flow) of the stock market. And it wasn’t the staid Dow Jones Industrial Average or the Standard and Poor’s 500 Index that captured people’s attention. The public was interested in the high-flying Nasdaq, which rose 571 percent from the start of 1995 to its high close of 5048.62 on March 10, 2000.

The stock market drove the economy, not the other way around. At its peak in March 2000, total stock market capitalization was 1.8 times the size of the U.S. economy. The wealth generated by the appreciation in equity prices from 1995 through 1999, even if unrealized, encouraged consumers to spend more of their earned income. Venture capital beckoned to anyone with a half-baked idea and “dot com” after the name. Businesses took advantage of inflated share prices to raise capital and invest in more plants and equipment than they could realistically utilize.

The stock market became the filter through which we viewed the world. Anything that affected equity prices immediately became big news.

When a series of rolling economic and financial crises hit Asia, Latin America and Russia starting in 1997—compounded by a homegrown crisis at mega-hedge fund Long Term Capital Management—it roiled stock markets around the world and was front-page news for days and weeks at a time.

Alan Greenspan became the central banker to the world. And because the Federal Reserve had lifted its veil of secrecy in 1994, publicly announcing policy changes in real time, ordinary folks were able to follow along with the pros. Monetary policy had gone mainstream.

Business news became big business. Television executives pounced on the opportunity.

First came FNN, the Financial News Network, which was acquired by General Electric Co.’s CNBC. CNN, the first 24-hour all-news cable channel, begat CNNfn, dedicated to financial news (CNNfn is now defunct). Bloomberg L.P. started its own business-news cable channel. And News Corp. Chairman Rupert Murdoch has announced his intention to launch a Fox business-news cable channel.

Business anchors became household names. Then they became stars.

Reporters took us onto the floor of the New York Stock Exchange and into Chicago’s futures-trading pits, where men and women in brightly colored waiters’ coats made peculiar hand signals and screamed at one another.

It may have looked like reality TV, but it was capitalism in action.

There was just one problem with this round-the-clock business and financial coverage: There wasn’t enough real news to fill the airwaves 24/7. So the shows, which tried to differentiate themselves from one another via catchy names, devoted more and more time to chitchat. Viewers could listen to Myron the money manager hawk tech stocks or Henry the hedge fund operator talk about opportunities in “busted converts.”

Back then, before New York Attorney General Eliot Spitzer cracked down on the financial services industry, the guests didn’t have to reveal whether they had a position in whatever they happened to be pitching. (You could be pretty sure that most of them did—and were looking to sell at higher prices.)

Small-cap value fund managers opined about Fed policy. Economists handicapped geopolitical risks. Youthful Internet CEOs offered investors “return on vision” in place of actual profits.

Experts were in demand, their expertise compressed into a three- to five-minute segment. (As long as they were an expert in something, it didn’t matter if the subject under discussion was their particular area of expertise.)

And there’s the rub: With so much time to fill, most of the filler was sound bites.

What business anchors and reporters lacked in knowledge they made up for in enthusiasm. CNBC was known as the cheerleader for the Nasdaq bubble. The network threw a party when the Dow closed above 10,000 for the first time in April 1999. The anchors looked as if they were attending a wake when the index broke through 10,000 on its way south.

Anyone hoping to get real insight into how the markets and the economy operate and interact from these snippets would have been disappointed. TV makes it all look quite glam, what with Internet IPOs soaring several hundred percent the day after the sale. But there’s plenty of humdrum stuff that gets lost in the glitter.

That’s where I come in. Humdrum, in the right hands, can be exciting.

The operation of the Federal Reserve—how the central bank creates reserves out of thin air and destroys them in the same way—would normally make for dry, scholarly reading. It wouldn’t even fly as a PBS series.

What if the Fed chairman could be disrobed to reveal an ordinary human being under the sphinxlike facade? What if the emperor has no clothes? It would sure make all that stuff about the sources and uses of reserves easier to swallow.

That’s my job: to make knotty subjects understandable and fun.

I once wrote a column comparing Alan Greenspan to Alfred Hitchcock. The connection may not be immediately apparent, but after reading every word Greenspan has uttered since he became Fed chairman in 1987 and seeing most of Hitchcock’s films, it was to me. The column was light; it was deep. (It’s in chapter 8.) It’ll give you a unique perspective on how Greenspan operates.

I had another flight of fancy (no pun intended) as I was watching birds flock to my new bird feeder. Could the avian world shed any new light on the law of supply and demand? Bird-watching became a lesson in economics. (See chapter 5.)

Then there’s mop technology. Isn’t it time someone applied Moore’s Law—the observation that the memory capacity of computer chips doubles every 18 months—to the vast home-products market, where most of the 111 million households surely own a mop? You’ll read about that, too, in this book (chapter 11).

In the midst of the late 1990s productivity boom, like most consumers I spent hours on the phone with tech support trying to get help with my home computer. While I was on perma-hold, it dawned on me that the degradation of services was a particularly insidious, albeit unmeasured, form of inflation. That realization became the basis for my belief and analysis that we are understating service-sector inflation.

Economics, in other words, can be demystified and explained via the raw material of daily life.

I didn’t come to this line of work with pre-formed ideas. Most of my education and training was on the job, not in the classroom.

I was pretty green when I started out in 1987, reporting on the daily happenings in the U.S. Treasury market and injecting some flavor into my copy. I asked a lot of questions. I talked to a lot of people. I read and studied on my own and even went back to school to take some economics courses.

My views on how the economy works evolved over the years. With increased understanding came a fundamental belief in free markets, which infuses all my writing.

Like the agora of ancient Greece, modern-day markets are the forum where buyers and sellers come together (not necessarily in a physical sense) to exchange something, be it goods, services, financial assets or contracts to buy or sell assets in the future. They engage in voluntary transactions at a price they determine.

This is the basis of the free-market capitalist system, which has proved to be the superior method of organizing an economy.

Command economies, where the state controls the means of production and distribution and sets prices, can’t possibly deliver the goods and services consumers want because they have no price signals to guide them. That’s why “Soviet Union” is preceded by the qualifier “former.”

Just thinking about how markets miraculously perform so many functions—Chinese manufacturers know exactly what consumers in Chicago want—inspires a sense of awe. I hope I impart that sense to readers.

I’ve organized this book thematically rather than chronologically. The columns in each chapter may not be topically consistent, but they all exemplify a common theme.

The chapters—even the individual columns—stand on their own and need not be read in any particular sequence.

My approach can best be described as didactic. I take my readers on a journey, walking them through the same discovery process I traveled before them, imparting some knowledge—and hopefully a nugget or two of wisdom—along the way.

If you were to ask me what I hoped to accomplish by presenting these already-published columns in book form, along with expository writing to inform each chapter, it would be this: to help the reader see things in a different light; to inspire in him a sense of awe at the way a market economy magically delivers the goods and services consumers want at the prices they’re willing to pay; and to encourage him to challenge conventional wisdom (there’s a reason it’s called “conventional”), even if a supposedly respected authority says it’s so.

I leave it to you to decide whether I’ve succeeded.

1

Ye of Little Faith

NO INSTITUTION commands as much attention from financial market participants and the financial press as the Federal Reserve. Every word Fed officials utter, every nuance, inflection and choice of verb tense, is dissected and analyzed for its policy implications.

Expectations about Fed policy are immediately incorporated into market rates. The press reports what policy-makers say and how the markets react.

Traders read the stories, hoping for new information or insight from reporters with known access to the Fed chairman. Markets react again, and the whole cycle is repeated.

What’s so curious, given our obsessive relationship with the Fed, is how little credit it gets for affecting economic outcomes. Just when the Fed has been most aggressive in its efforts to stimulate or curtail economic growth, faith in the power of interest rates seems to falter.

“It’s not working this time,” the cries go out.

The Fed affects aggregate demand, or the total demand for goods and services in the economy, by manipulating the benchmark overnight interest rate, known as the federal funds rate.

There are lots of theories about how this works. Economists trained decades ago generally have adopted the Keynesian view that the Fed lowers short-term rates solely to bring down long-term rates, which in turn reduces the cost of home mortgages and corporate borrowing for capital expenditures.

If that’s the case, why do central banks around the world target a short-term rate? Rather than hoping market forces guide long-term rates to the desired level, wouldn’t it be easier to buy and sell long-term bonds to influence the price?

And if low long-term rates were the panacea they’re cracked up to be, how can we explain Japan’s lost decade in the 1990s, with the yield on the 10-year Japanese government bond plummeting from 8.25 percent to 0.5 percent? (Hint: Sometimes low long-term rates are a symptom of a sick economy, not a cure.) The yield has been consistently below 2 percent since late 1997.

Many of the columns you’ll read in this book, in this and other chapters, reflect my view of how interest rates work. For now, let’s just say that interest rates change the incentive to spend and to save. When businesses and consumers aren’t being paid to save—when bank deposits pay a barely discernible rate of interest, as they did in 2003 in the U.S.—they spend. (American consumers never seem to need much prodding.)

High real interest rates, on the other hand, encourage the public to defer consumption.

The thrust of Fed policy comes from the interaction between short-and long-term rates: The central bank sets the first; the market determines the second. The spread between the two is an excellent, real-time gauge of the stance of policy.

Don’t expect to see this indicator widely advertised. Such a simple, accessible tool might compromise the livelihood of all those econometric modelers.

If the Market Can Do the Fed’s Work, Who Needs the Fed?

April 23, 1999

MILTON FRIEDMAN, Nobel laureate in economics, has long advocated getting rid of the Federal Reserve and replacing the central bank with a computer.

What Friedman means is that the economy would be best served by a steady rate of growth in the money supply. Since two Fed staffs in New York and Washington doing reserve projections have been unable to hit the Fed’s target (definition: something aimed or fired at) of 1 to 5 percent growth in the broad monetary aggregate M2 in almost two years, the odds are good that a computer could perform the function better than the Fed’s marksmen.

While there is no talk of sacking Fed Chairman Alan Greenspan in favor of Microsoft’s Bill Gates just yet, the Fed has already relinquished one of its roles—that of the economy’s main driver—to the market, according to a May 3 Business Week article titled “The Fed’s New Rule Book.”

“In the face of all this uncertainty, FOMC members are now counting on the market to help regulate the economy for them by raising and lowering long-term rates to keep inflation in check,” writes Business Week.

Business Week is just echoing the views expressed by the Federal Open Market Committee. With the exception of St. Louis Fed President William Poole, who understands the relationship between long and short rates, Fed officials were quick to cite the rise in long-term rates in February as a harbinger of slower economic growth.

ONE-WAY STREET

Isn’t it curious that the Fed didn’t rely on the market to do its work last fall? In a huge flight to quality into U.S. Treasuries after Russia’s default in August, the yield on the 30-year bond plunged 100 basis points to an all-time low of 4.69 percent on Oct. 5. Yields on two-, five-and 10-year notes fell to 3.77 percent, 3.90 percent and 4.10 percent, respectively.

Yet the Fed felt compelled to do its own work, lowering interest rates three times, for a total of 75 basis points, on Sept. 29, Oct. 15 and Nov. 17. At the time of the Sept. 29 rate reduction, the 30-year bond yield was already 5 1/8 percent.

Maybe the causality works only in one direction: Rising long rates slow the economy down, but falling long rates don’t provide any stimulus!

That lopsided effect begs the real question of why we need a central bank if the market can do the job.

“If that notion were true, you have to ask yourself why some markets are so good at it and some are so bad,” says Bob Laurent, professor of economics at Loyola University.

Citing the years of hyperinflation in Brazil, Laurent wonders what’s wrong with the Brazilian market. “They never seem to get it right,” he says.

Those who argue the market can do the Fed’s heavy lifting base their case on the idea that rising long rates will sap demand for credit, including home mortgages and corporate borrowing. They never bother to ask themselves why interest rates (the price of credit) are rising: Is it the result of increased demand or reduced supply?

THINK BEEF

My first economics teacher (we’re talking street economics here) used beef instead of credit to make the point. If all of a sudden people decide to consume more beef, assuming no change in the supply of beef, the price of beef will rise. In that case—represented by an outward shift in the demand curve—the higher price won’t reduce demand because increased demand is the reason the price rose in the first place!

What if hoof-and-mouth disease pares the cattle herd in half? The price of beef will rise in that case, too. But the inward shift in the supply curve produces a higher price and a lower quantity demanded.

Now substitute credit for beef. If increased demand for credit pushes the price up, how can one argue that the higher price will cause demand to slow?

On the other hand, if the price rises because supply is being curtailed, then the higher price will crimp demand.

SIMPLE MODEL

Calculating the supply and demand for credit at any given time is a Herculean effort. Guess what? You don’t have to. All you need to know is two interest rates: one long, one short.

Think of the overnight federal funds rate as a proxy for supply. By adjusting the supply of reserves relative to the banking system’s demand, the Fed can pretty much put the funds rate where it wants.

Think of the long rate as a proxy for demand. It ebbs and flows in response to the demand for credit and inflationary expectations. The spread between the two rates provides more information than all of Wall Street’s proprietary models combined.

If the long rate is rising at the same time that the Fed is holding the short rate steady, you can be pretty sure that the rise in long rates is expansionary, not contractionary.

Every central bank in the world conducts monetary policy through a short-term interest rate. There is no reason why they can’t use a long rate as their policy tool, buying and selling bonds to satisfy the banking system’s reserve needs.

SHORT BEATS LONG

The fact is, they don’t. If you ask economists to rank the two rates in terms of their economic importance, the ones who have bothered to test them will rate the short rate as number one, hands down.

“The shorter the maturity of the interest rate, the better predictor it is of future economic growth,” says Ken Landon, senior currency strategist at Deutsche Bank in Tokyo. “The relationship between long rates and future growth is relatively weak and may merely be the result of the high positive correlation between short and long rates.”

Long rates matter, but they don’t matter nearly as much as everyone thinks. And if you want to know what effect the rise or fall in the long rate will have on demand, first take a look at what the short rate is doing.

POSTSCRIPT: Subsequently, during the deflation scare in June 2003, yields on Treasury notes and bonds fell to the lowest since the U.S. government began holding regular auctions in the 1970s. These lows—in some cases, the lowest since the late 1950s—are still in place: two-year note, 1.06 percent; five-year note, 2 percent; 10-year note, 3.07 percent; 30-year bond, 4.14 percent.

The Fed Gets So Much Attention Yet So Little Credit

July 10, 2000

THEY DON’T call it “Bearron’s” for nothing.

The weekly financial magazine’s featured columnist, Alan Abelson, has been dissing the 1990s bull market in his “Up and Down Wall Street” column for, what, the last 5000 Dow points?

So it’s not surprising to find Barron’s once again in doubting mode. This time it’s the notion that the Federal Reserve is well on its way to slowing economic growth to a sustainable, noninflationary pace, obviating the need for further rate increases. In the current issue, “Economic Beat” columnist Gene Epstein claims that the second-quarter slowdown is a case of déjà vu all over again.

Epstein’s not the only one to identify a pattern of weak second-quarter growth in the midst of an economic boom. That phenomenon was observable in 1998 and 1999 as well, with second-quarter real gross domestic product growth slipping to 2.2 percent and 1.9 percent, respectively, well below the 4.7 percent annual average in both years.

Analysts have come up with a variety of reasons to explain the Q2 washout, even though their hunches are relegated to the benefit of hindsight, not foresight. Among the usual suspects are: early tax refunds due to the popularity of electronic filing, which boosts spending in the first quarter at the expense of the second; unseasonably mild winter weather; and a big tax bite in April for those who don’t like giving the government an interest-free loan for a year.

KEY DIFFERENCE

Spending is apt to rebound in the third quarter, Epstein maintains via his surrogate, economist Jason Benderly. Benderly expects GDP growth for the year to come in at 4.7 percent on a fourth-quarter-over-fourth-quarter basis, about the same as in 1998 and 1999.

Why do the Federal Reserve and Chairman Alan Greenspan get so much attention if, according to the Epstein/Benderly hypothesis, they are so irrelevant?

While there does seem to be a statistical quirk in the second-quarter data, there is every reason to believe that economic growth won’t return to last year’s blistering pace. The reason is that the overnight federal funds rate is 175 basis points higher than it was in June of last year, which is slowing the growth rate of the nation’s money supply and lifting private borrowing rates.

The idea of explaining economic performance and inflation “ex-Fed” is endemic on Wall Street, where curiously a cottage industry is paid to discern every changing inflection in the Fed chairman’s tone. Only on Wall Street is the Fed followed, feared and forecast—and quickly forgotten when it comes to the explanation of economic outcomes. Fed policy-makers are guilty as well, discussing inflation in terms of temporary effects from oil prices and the dollar.

DOWN GREENSPAN’S WAY

On Main Street, despite its lack of sophistication, things are much simpler. Folks are grateful for the extended period of prosperity and thank the Fed for good economic management. Alan Greenspan even “got a street in the suburbs,” according to the Chicago Sun-Times, when Arlington Heights named one of its thoroughfares Alan Greenspan Way.

Benderly points to exports and government spending as two potential sources of economic growth in the second half, which seems sound given the shift in relative growth away from the U.S. and the expressed desire on the part of both the administration and Congress to find new uses for our tax dollars.

What makes less sense is Epstein’s contention that rising wages and salaries—up an annualized 6.7 percent in the first half of this year compared to 6.5 percent in 1999—ensure increased spending since this is “the kind of income that tends to get spent.”

SPENDING LEADS INCOME

Rising income is not necessarily a precondition for spending, just as falling income is not a precondition for a cutback. If that were the case, an expanding economy would never turn down since income is always rising until something makes it stop. Similarly, the economy would never emerge from recession if falling income were the determining criterion.

Clearly, something motivates consumer and business decisions to cut back on spending during good times and to increase spending when things look pretty glum. Usually it’s the interest rate, or what they can earn if they forgo current consumption.

Nowhere in the Barron’s article does it suggest that just maybe monetary policy might be a consideration in how the economy performs after what is expected to be a relatively soft second quarter.

Any discussion about the economy without reference to Fed policy is like bemoaning the shortage of available housing in New York City without any mention of rent control (which is exactly what the New York Times did yesterday).

DENIAL

The Fed may very well end up raising the federal funds rate another 50 basis points before it can call it quits. After all, a body in motion remains in motion until it is acted upon by a countervailing force. And a $9 trillion economy hurtling through space at a 6 percent rate in the three quarters ended in March doesn’t lose half its momentum with a small nudge.

What’s so interesting about the relationship with the Fed is that attitudes can run the full gamut in a short period of time yet always return to the same place.

In this cycle they’ve gone from denial last year (higher interest rates won’t slow the New Economy) to acceptance after the Nasdaq lost one-third of its value in the spring (maybe they do matter) to grief (the Fed’s overdone it) and back to denial (the Fed’s done so let’s get down and party).

POSTSCRIPT: As it turned out, the second quarter of 2000 was the last hurrah for the U.S. economy. Even with inventory accumulation accounting for more than half the growth, real gross domestic product was hardly weak, rising an annualized 6.4 percent. It was the last strong quarter before a 0.5 percent decline in GDP in the third quarter and a recession in 2001.

Is the Fed Irrelevant? Citizen Rubin Thinks So

Aug. 9, 2000

IT WAS the best of times: Alan Greenspan at the helm of the Federal Reserve and Bob Rubin at Treasury. The relationship between the monetary and fiscal authorities was unusually warm and friendly.

The Rubin Treasury adopted a firm “no comment” policy on the Fed. The mood at the weekly breakfasts between the two most important economic policy-makers in Washington was described as open and amiable.

The fact that their 4½-year shared tenure coincided with the best economy in more than a generation probably contributed to the con-geniality.

What a surprise it was, then, to learn that Rubin thinks the Fed’s role in managing the economy is overrated.

In a June 27 interview with Charlie Rose, broadcast on PBS, Rubin said the following:

“There’s an enormous tendency to overstate the role of the Fed in how our economic system works. If the Fed did absolutely nothing for the next two years, and if, in fact, inflationary forces started to assert themselves, then the bond markets would reflect that, and you would have the same constricting effect that you have if the Fed moves.”

Every time I hear a comment like that, I have the same reaction: Why do we have a central bank? So that the U.S. can be part of the club, rubbing shoulders with other central bankers at the monthly Bank of International Settlements meetings? To provide a workplace for legions of academic economists?

VOODOO ECONOMICS

Earlier in the interview, Rubin told Rose that when he came to Washington in 1993, he found his previous experience on Wall Street—“an understanding of markets, some understanding of how economic matters worked”—relevant to his job as, first, the chairman of the president’s National Economic Council, and then Treasury secretary from January 1995 to July 1999.

There is nothing in his assessment of the Fed’s role to suggest he understands anything about how economic matters work.

“It’s very hard to respond to that view,” says Jim Glassman, senior economist at Chase Securities. “It’s become folklore.”

If the market is, as Rubin implies, its own central bank, “what’s its agenda?” Glassman wonders. “What is it trying to achieve? Two percent inflation? Three percent inflation? The market’s job is to price risk, not determine outcomes.”

Rubin’s assessment that short rates don’t matter, that long-term interest rates equilibrate the economy on their own, is a holdover from the 1980s concept of the bond vigilantes. Any errant behavior on the part of the central bank and bond traders will hoist long-term interest rates and punish the economy accordingly.

EMPIRICAL EVIDENCE

Hasn’t he done the analysis? If he did, he’d find that short-term rates beat long-term rates hands down, both in their correlation with economic activity and in their ability to influence it.

Ken Landon, senior currency strategist at Deutsche Bank in Tokyo, compared the two-year change in various interest rates with future growth in gross domestic product.

“The historical record clearly shows that rates at the short end of the yield curve have the closest correlation with the rate of economic growth,” Landon says. “As you go out the curve, the correlation goes down.” (Correlation describes the relationship between the movements in two series and does not imply causality.)

For example, the two-year change in the overnight federal funds rate has a negative 0.54 correlation with economic growth. That means 54 percent of the change in GDP growth can be explained by the change in the funds rate alone. The correlation is negative because a rise in rates has a depressant effect on GDP growth and vice versa. A perfect correlation is 1, in which case 100 percent of the movement in one series can be explained by the movement in the other.

BAA MINUS

Moving out the yield curve, the correlation between future GDP growth and the change in 10-year and 30-year yields is -0.31 and -0.33, respectively.

Curiously, Landon found that the corporate bond rate has almost zero correlation with economic growth. For Aaa-rated corporates, the correlation is -0.19. For Baa-rated corporates, which Greenspan cites as a restraining or stimulating force on economic activity now that Treasury buybacks are distorting the sovereign yield curve, it’s -0.09, which is close enough to zero for government work.

Regression analysis, which uses independent variables to explain a dependent variable (that is, establish causality), produces similar results.

“If all rates—long and short—are rising, it has a negative relationship to economic activity,” says Bob Laurent, professor of economics and finance at the Illinois Institute of Technology’s Stuart School of Business.

Most of the time, short and long rates move together. “But if you separate the two, if you hold the short rate constant and the long rate rises, it’s actually positive for the economy,” he said.

EXECUTIVE BOB

How can higher long-term rates be positive? With any price—an interest rate is nothing more than the price of credit—there are different implications depending on whether the increase is coming from the supply side or the demand side.

Think about it. Let’s say interest rates are rising along the entire yield curve with the exception of the federal funds rate. You can be pretty sure that the Fed is passively pumping out additional reserves—increasing the money supply—to meet the banking system’s increased demand, which is how it works when the central bank targets an overnight rate.

In this case, monetary policy is expansionary. Mr. Greenspan used this sort of Wicksellian argument early in the year to justify raising rates, suggesting that holding the short rate down would be inflationary.

It’s a good thing Trader Bob Rubin went to Citigroup and not to the Fed (his name still comes up as a possible candidate for Fed chairman under a Democratic administration). Everybody’s favorite Treasury secretary, Rubin has been able to get away with such economic nonsense as claiming the U.S. contribution to the International Monetary Fund “doesn’t cost the taxpayer a dime.” (If there’s no cost, why not contribute a lot more?)

At least we now know that he thinks the Fed is redundant. Hopefully he’s pushing paper at Citigroup and leaving macroeconomic analysis to the research department.

2

The Bubble, or This Time Really Is Different!

ASSET BUBBLES have been around since folks went gaga over tulip bulbs in 17th-century Holland.

While the nature of each bubble varies—it may be financial assets, real estate or some exotic item that the public will pay seemingly any price to own—they all have a few things in common.

First and foremost, they end badly. At some point, there’s no greater fool to take an overpriced asset off the last buyer’s hands. The game is up. Reality sets in. Prices collapse.

Second, because human nature doesn’t change, the reaction to bubbles is pretty consistent over time. The whole process from onset of bubble to residue of bust is not unlike the five stages terminally ill patients go through—denial, anger, bargaining, depression, acceptance —as set out by the late psychiatrist Elisabeth Kübler-Ross in her 1969 book, On Death and Dying.

Bubbles borrow from the same lexicon. The language used to describe and deny the bubble in technology and Internet stocks in the late 1990s was no different than that heard in the late 1920s.

In fact, if you changed a few names and dates, and substituted “Nasdaq” for “Radio” (Radio Corporation of America, the speculative darling of the 1920s), John Kenneth Galbraith’s The Great Crash: 1929 would read like a history of the late ’90s—complete with scandals that came to light after the bubble burst.

The first reaction to intimations a bubble may exist is denial. “This time is different,” the believers intone.

In the 1990s, investors didn’t care if a company had any “E” (earnings). The concept behind the business was enough to justify the “P” (price).

It’s one thing to buy a stock because the price is going up; people do that every day. An entire industry of commodity-trading advisers uses black-box models specifically designed to buy “momentum.”

It’s another thing to convince yourself that momentum signifies value.

During the high-flying tech bubble, investors who never would have looked at food-retailing stocks decided that selling groceries (a low-margin business) on the Internet (a low-margin medium) was a brilliant idea.

Modern-day bubbles in economies with developed financial systems are fueled by excess money and credit creation. Yes, people act crazy. But without the complicity of the central bank, asset bubbles would be deprived of their needed fuel.

If too much money flows into goods and services and pushes up the price level, it’s called inflation. When that same money chases financial assets or real estate, it should be a clue that monetary policy is too easy.

That puts central bankers in the uncomfortable position of having to determine whether asset prices are divorced from the fundamentals. There’s no way a handful of folks setting the nation’s monetary policy in Washington, D.C., have better information about asset prices than the thousands of risk-takers putting their money on the line every day in the market. And they admit it.

While former Supreme Court justice Potter Stewart’s definition of pornography—“I know it when I see it”—may hold for asset bubbles as well, it provides no guidance for an ex-ante response.

Federal Reserve Chairman Alan Greenspan maintains that the best tactic is to respond aggressively when the bubble bursts.

European central bankers aren’t so sure. For them, bubble prevention remains the most effective cure.

DENIAL

This Time Is Different—It’s Always Different

Dec. 28, 1999

IT HAPPENS in every business cycle. An asset or asset class gets overvalued—exactly which one varies—and the reaction is always the same.

Normally sane financial market professionals proclaim that “this time is different.” Toss out the old rulebook; it’s a brand New Era.

No less a seer than Federal Reserve Chairman Alan Greenspan often remarks that he has seen many so-called New Eras come and go (go being the operative verb here).

What’s different this time around is the rationale for the share prices of start-up Internet companies that have no earnings, and in some cases no revenue, yet trade at ridiculous multiples.

Listen closely to the talking heads on the business news programs. They are starting to believe their own rhetoric.

“Interest rates don’t matter.”

“Interest rates are just a cost of doing business.”

“Interest rates won’t slow the New Economy down.”

“Tech stocks are impervious to higher interest rates.”

While interest rates may not matter when it comes to financing—venture capital is fighting to get in the door—they do matter when it comes to valuing future cash flows, better known as earnings.

Based on that dinosaur known as the dividend discount model, a company’s value is nothing more than the present value of the expected future cash flows.

REALITY CHECK

“Unless you have permanently eliminated traditional valuation models from the equation, somewhere out there revenues are going to have to validate what’s inherent in the stock price,” says Bob Barbera, chief economist at Hoenig & Co. in Rye Brook, New York.

Barbera says that if you do a back-of-the-envelope calculation for many of the flying-high-without-earnings stocks and give the companies the benefit of the doubt (rosy assumptions about growth and margins), “there are going to be a great many disappointments. “There aren’t enough FedEx trucks to deliver all the stuff they’d have to sell to justify the price.”

Alas, sane voices, along with value investors, have been left in the dust. It’s as if the enthusiasts got stuck in the first stage of psychiatrist Elisabeth Kübler-Ross’s five stages of dying, introduced in her 1969 book, On Death and Dying.

Kübler-Ross found that people diagnosed with a terminal illness progress through a series of emotions to cope with the grief: denial, anger, bargaining, depression and acceptance.

It’s one thing to buy momentum, to buy a stock price rather than a company (the opposite philosophy to the one espoused by legendary investor Warren Buffett). It’s quite another thing to convince yourself that it’s something other than what it is.

SELLERS VANQUISHED

How is it that the Nasdaq has rallied almost 50 percent since mid-October, registered 59 record closes this year and produced an 86 percent return in 1999?

“We’ve completely destroyed the speculative seller,” Barbera says. “He’s gone bankrupt over the last four years.”

The traditional seller, comprised of the public and institutional money managers, has been absent as well.

“More than ‘In God We Trust,’ the public swears by ‘buy the dip,’ ” Barbera says. At the same time, “money managers have decided, if we go over the waterfall, we are going together. The last guy to say he was raising cash—Jeff Vinik—was dead in a year.”

Denial on the part of investors. Fear on the part of sellers. The only thing missing is overly enthusiastic lending on the part of the banks.

Banks are renowned for over-extending credit, based on the theory that the underlying collateral can never go down. They did it with the oil and gas industry in the 1970s and 1980s, emerging markets (at least twice), real estate, junk bonds and hedge funds.

EAGER BEAVERS

Now banks are using lending relationships with non-investment-grade companies to secure plum—and lucrative—underwriting deals. Last week it was reported that Chase Capital Partners, the venture capital arm of Chase Manhattan Bank, was aggressively targeting the equity business of non-investment-grade companies.

As long as the underlying collateral rises in price, everything is fine. Chase’s start-up ventures accounted for 17 percent of its profit this year, according to Chief Executive William Harrison.

If some of these small companies were to go belly up, the macroeconomic effect would be small. It’s when the loans go bad that things get dicey.

“As long as it’s an equity-related phenomenon, it’s fine,” observes Paul DeRosa, a partner at Mt. Lucas Management Co. “If these companies have debt outstanding, when the stocks crash and several banks have exposure, that’s where the real threat lies.”

THEMES AND VARIATIONS

Bad loans and dysfunctional banks are what crippled the U.S. economy in the early 1990s and what have kept Japan depressed for the better part of a decade.

History repeats itself, not in exactly the same way each time but in a similar enough manner to make one pay attention to the cautionary signs.

Maybe this will turn out to be a New Era where companies’ prospects are so bright as to justify even the most inflated expectations for revenues and earnings. On the other hand, maybe what we’re seeing is momentum so strong that it has scared off all the sellers and offered up greater and greater fools that are always willing to pay a higher price.

Evaluating the Tech-Stock

Interest-Rate Nonsense

March 15, 2000

DAY AFTER DAY, some equity strategist goes on TV to declare that higher interest rates don’t matter when it comes to technology stocks.

These cutting-edge start-ups have so much venture capital chasing after them, the thinking goes, that the idea of borrowing money has never even crossed these Young Turks’ minds.

Borrowing costs are only one of the many direct and indirect channels through which interest rates affect a company’s share price—probably the least important one.

Starting with the old model, a company’s stock price is determined by earnings expectations plus a risk-free interest rate, which is used to discount future earnings streams, plus an adjusted risk premium.

In this so-called dividend discount model, the interest rate clearly matters but not because of the company’s actual cost of borrowing.

“The idea that the value of future earnings streams are impervious to higher interest rates is a crock,” says Steve Wieting, an economist at Salomon Smith Barney. “The effect of a change in interest rates on the cost of a firm is trivial compared to the idea that the value of those future earnings streams depends on alternative investments, opportunity costs and tolerance for risk.”

Many technology companies have no earnings; smaller losses than the prior quarter’s are considered a clean bill of health in the quarterly earnings report. By all rights, interest-rate increases should be more devastating to stocks whose profits are over the horizon.

LESS THAN ZERO

“For any given cash flow, a higher discount rate makes the present value of the cash flows worth less,” says Tom McManus, portfolio strategist at Banc of America Securities. “In bond terms, the duration of the cash flows is longer. The effect of higher interest rates should be greater.”

Should be, but isn’t. Since the Federal Reserve started raising interest rates on June 30 of last year, the technology-heavy Nasdaq Composite Index has appreciated by 70.6 percent while the Dow Jones Industrial Average is down 7.7 percent, with losses pared after today’s 3.3 percent rally. Dow cyclical stalwarts like International Paper Co. and DuPont are down 27 and 26 percent, respectively, in the last nine months.

There is one more channel, probably the most important one, through which interest rates affect a company’s stock price: “the presumed sensitivity of demand for a company’s product,” McManus says. “No matter how good the management of a company, they have no control over demand as affected by interest rates.”

NEW NEW THING

The fact that he said “presumed sensitivity of demand” suggests the perceived rules may be changing in this area, too.

“There’s a feeling that tech companies are immunized to the increase in interest rates because tech has become an ‘absolute must-have,’ the corporate equivalent of spending on staples,” he says.

In other words, the demand for technology is inelastic. Cheap or expensive, companies gotta have it. Gas, food and tech. A new “ex” category for the CPI.

At least that’s a better argument than claiming interest rates don’t matter because tech companies don’t borrow.