Imperial Over-Stretch Marks

October 14, 2002

"Political history is largely an account of mass violence

and of the expenditure of vast resources to cope

with mythical fears and hopes."

Murray Edelman

Both high and low, the world is full of regrets. Women often regret the men they didn't marry; men regret the women they did.

George Bush, Sr. regrets not having taken out Saddam Hussein when he had him in his sights.

Alan Greenspan must regret not having warned against a collapsing bubble. Even if he didn't want to prick it himself, all he would have had to do was to say something and today he might be regarded as a sage, like Warren Buffet, instead of a mountebank.

Dennis Kozlowski must regret trying to save a few dollars in sales tax...and Martha Stewart must rue the day she met Sam Waksal.

Maybe James K. Glassman really was just trying to explore how stocks should be valued in his 1999 book. But he must surely wish he had chosen something other than "Dow 36000" for a title.

Of course, many of today's regrets might list 1999 as their date of conception. For that was the year that inhibitions were at an historic low. People were ready to sneak into the cloakroom and embrace anyone and anything - no matter how absurd.

"Think of the Internet as an economic-freedom metaphor of our time," Republican economist Larry Kudlow declared to Barron's in August of that gossamer year. Kudlow's problem with alcohol was history. He can't even claim he was drunk when he said it: "I believe the future economy will outperform all expectations. The Dow Jones Industrial Average will reach 15000, then 30000, then 50000 and higher."

Kudlow was no longer drinking. Instead, he had been driven mad by sobriety and the New Era. Nine months later, "it was the Fed that killed the market," he raved in The American Spectator. The policymakers had been spooked, he ranted, "by too much prosperity...too many investors creating too much wealth."

"But the underlying forces driving the New Economy are real and not easily suppressed," he continued.

In Kudlow's mind, there are no natural cycles in capitalism. People just get richer and richer...unless government functionaries and elected officials err. "Had Washington moved earlier [by lowering interest rates]," he said, "the demoralizing $5 trillion stock market wealth deflation, a crippling manufacturing recession, tens of thousands of job layoffs in technology and service industries, and a general rollback of risk-taking animal spirits all could have been avoided."

If the Fed had merely been able to see into the future... it could have figured out the interest rate that the market needed just when it needed it. Maybe then, there would have been no bear market, no Enron, no ImClone, no telecom disaster, no dot.com bust, no profit collapse.

And if the Fed does make a mistake, which he seems to admit is a possibility, no problem. It just "represents investor pleas for new government policies."

Of course, the proposition is absurd. As Hyman Minsky pointed out, and the experience of the last 10 years illustrates, nothing fails like success. All it takes is a period of stability to lure investors into believing that the market is risk free. That is when they begin doing things they will later regret - like buying Amazon.com at $200.

Once bought, what government policy could make the stock worth what the investor paid for it? People do stupid things all the time; the worse that can happen is that they succeed...for that sucks them down into even greater mistakes. Better to meet with failure right away...and regret it sooner rather than later.

And so we come right to the point of today's letter: we think there will be a lot more regrets before the present down cycle is completed - and not all of them will be matters of money.

Homeowners will regret adding to their mortgages, for example. Deflation will lower their expenses, but it will make money harder to come by. If the nation sinks into outright deflation, real interest rates will rise, even as nominal rates hold steady. Homeowners will find themselves paying high real rates on big mortgages while real estate prices fall.

Investors will regret holding onto their stocks too. If we're right, the Dow will eventually fall below 5000... and it could take 10 years to do so. It could be a long, miserable period for stockholders.

But what does Kudlow think the government should do about it, we wonder...(if only for amusement)?

"The shock therapy of a decisive war will elevate the stock market by a couple of thousand points," he says.

There are probably people who would bomb Paris for a few thousand Dow points. But we are doubtful if war really will produce the advertised benefits. In fact, we suspect that he may be courting fresh regrets.

Just as investors got a little light-headed and foolish when they saw how much money they were making in the late '90s, we worry that many people have been driven a little mad by military success.

Politics is not our beat here at the Daily Reckoning. We readily admit that we know as little about it as we want to know - which is almost nothing.

But we can't help but notice that the waves of boom and bust, madness and regrets, that overpower the markets also seem to swamp politics. And a few people - such as Larry Kudlow - seem to be sopping wet almost all the time.

The naturally occurring gold-silver alloy is called electrum.

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