Mers El Kabir

“People for the most part stood their ground, but the ground itself gave way beneath them.”

Joseph Schumpeter
Describing the beginning of the Great Depression

“Your comparison of the British attack on the French fleet in 1940 with the Japanese attack on Pearl Harbor in 1942 is ridiculous,” writes one English reader of the Daily Reckoning.

“It was hardly a surprise attack on the French,” he continued, “Europe was already at war.”

Even my old friend, Adrian Day, protested. The Vichy government had gone over to the German side, he pointed out.

61 years ago, Paris was an occupied city. The German army had arrived on the 14th of June.

And on this day, the 22nd of June 1944, France and Germany signed an armistice. France had been beaten in what it calls its ‘funny war’ – a 6-week conflict in which the biggest army in Europe was whipped decisively.

What went wrong?

As the threat of war increased in Europe in the late ’30s, France put her faith in two things: the Maginot Line – a line of fortifications along the west bank of the Rhine – and the ‘elan’ of its fighting men.

“Elan” can be roughly translated as ‘spirit’ or ‘enthusiasm.’ The idea was taught in France’s military schools – that as long as the army maintained its ‘elan,’ it would not lose.

But elan only goes so far. In a matter of days, the fortresses of the Maginot Line were by-passed and nearly the entire French army was either outflanked, cut off, or in full retreat. French commanders had no understanding of blitzkrieg warfare; they didn’t know what was happening to them and had no plan to deal with it.

The French government could talk all it wanted about preserving the fighting spirit of its troops – but with the wehrmacht bearing down on them, the soldiers themselves threw down their guns and fled.

Will American consumers do the same? Will they throw down their credit cards? Will they reject McTeer’s patriotic appeal to ‘spend, spend, spend’ and decide to look out for their own balance sheets?

Two things, it is believed, stand in the way of recession (and further stock market declines), dear reader: rate cuts and consumer confidence.

So far, the rate cuts have failed to produce an economic turnaround. “We notice a total failure of the Fed’s rate cuts,” writes Dr. Richebacher in his latest letter. But as long as the elan of American consumers holds out, it is widely believed, the economy will not fail.

“It is not so much the recession call itself that matters,” explained Alan Greenspan in one of his recent Congressional testimonies, as long as there is no “breach of confidence.”

“We note in the public discussion,” adds Dr. Richebacher, “a peculiar emphasis on the key role of confidence in sustaining economic growth.” Interest rate cuts are made, it is said, not merely to reduce the cost of credit but to increase consumer and investor confidence, in the same way that the huge Maginot fortifications increased the feeling of security among the French, even though they were already useless from a military point of view.

“To us,” Dr. Richebacher continues, “this focus on the fuzzy concept of confidence suggests a general refusal …to recognize the true nature of the unfolding economic and financial quagmire…”

What menaces the U.S. economy and Wall Street is not a lack of confidence, but too much of it. Investors were so confident that stocks would rise in price that they bought shares at preposterous prices. Businessmen, feeling the whoosh of easy money in their hair, increased investment in all manner of projects, some sensible but many not. And consumers, confident that the good times would last forever, stopped saving altogether.

Confidence, a virtue in moderation, turned out to be a vice in excess – like a drunken soldiers on leave in a foreign country, Americans thought they could get away with anything.

Meanwhile, the tanks are advancing.

Businesses are “facing a savage profit squeeze…the sharpest in the whole post-war period” says Dr. Richebacher. But here too, the facts are distorted by what he calls “a confidence game.”

The profits that were supposed to have been turbo- charged by information technology “never happened,” he charges. Instead, profits actually fell in the second half of the 1990s – that is, after information technology had been put in place.

Even then, profits were amplified – using options and other accounting tricks to inflate the real picture, while keeping investors’ confidence up. And now, companies are producing profits down 10% to 50%…but still reporting that they earned ‘a penny more than expected.’

Faced with falling profits, businesses are cutting back.

“Everybody is cutting expenses and laying people off,” reports the Mogambo Guru. “But those expenses were somebody else’s revenue. In fact, a lot of people’s revenue. And now there is less money to pay the crowd of creditors outside the door.”

“We learn from the Levy Institute that something unusual happened in the first quarter,” observes Dr. Richebacher, mortgage refinancing and credit card debt both went up. “In the past, households always used part of their mortgage refinancing to pay down costlier credit card debt. This time, sharply slower income growth forces them to step up their credit-card borrowing to maintain their lifestyle.”

How long will consumer confidence hold out? We don’t know. But we doubt that it will collapse on it own – instead, it will be smashed, like the French fleet at Mers el Kabir.

The French entered the ‘funny war’ with all the confidence in the world. They could scarcely imagine that their elan and their Maginot line would both be in ruins less than two months later. Days later, their former allies, the British, attacked the French fleet.

“Were the French at war with the British in July of 1940?” I asked Luc, a French colleague with whom I share an office. “Had the French committed a single hostile act towards the British?” I might have added.

“Non,” came the answer.

And yet, provoked only by the gritty reality of the situation, the British fleet steamed up to the harbor near Oran in North Africa and demanded the French surrender their ships.

No naval commander with a shred of dignity or honor could have consented to the request. The French stood their ground. But, as it happened, the ground gave way beneath them.

The British opened fire. When they were finished, the French fleet had been demolished, and 1200 sailors were dead.

Your correspondent, reporting on what the French call their “day of mourning.”

Bill Bonner
Paris, France
June 22, 2001

P.S. The French destroyed what was left of their fleet themselves. They blew it up in the harbor at Toulon rather than let it fall into German hands.

*** “Have bankers gotten a lot smarter since they financed the stock bubble of the 1920s, or the Emerging Market loan bubble of the 1970s, or the Texas oil bubble of the 1980s…or nearly every real estate bubble that has ever happened?” I asked earlier this week.

*** “Absolutely not!” comes the reply from my colleague, Eric Fry on Wall Street. “If anything, bankers have evolved into even less intelligent forms of life. Instead of loaning money to risky Internet start-ups, they now purchase stock in risky start-ups through their venture capital subsidiaries. For example, JP Morgan Chase’s venture capital subsidiary invested more than $9 billion – or 35% of the entire company’s tangible net worth – in various start-ups and (ad)venture funds.”

*** “If bankers are making better loans,” Eric continues, “it is only because their VC subsidiaries found the least credit-worthy borrowers before the loan officers could. Bankers never met a bubble they didn’t like. Yesterday, Alan Greenspan told Congress that although the quality of loans at US banks has deteriorated, there is no sign yet that lenders are denying credit to sound borrowers. Very true, Alan. In fact, there is no sign yet that lenders are denying credit to unsound borrowers, either.

*** “Revolving credit debt is soaring 16% annually, thanks to declining repayment rates. In other words, folks continue to obtain and use credit cards, they just find it inconvenient to pay down their balances sometimes – like when they don’t have a job, for example.”

***

Here’s the rest of Eric’s report:

– Yesterday was the longest day of the year in the northern hemisphere. But it wasn’t long enough. The longer the trading day wore on, the higher stocks rose. At the closing bell, the Dow had gained 68 points and the Nasdaq 27 points. No single news item can claim credit for the modest advance, but there was a wee bit of hopeful news on the employment front. Initial jobless claims in the week ended June 16 fell 34,000 to 400,000 from a revised 434,000 in the prior week.

– The encouraging news is welcome, to be sure, but the discouraging news is legion. Extended-stay hotels in Manhattan are “feeling a chill,” NYPost.com reports. Demand for rooms is softening as the “high-tech conferences and corporate transitions that fueled their expansion run out of gas.”

– “The Baltic Freight Index shows that cargo ships have a lot more room to spare…for stowaways and the like,” writes Jay Akasie, of grantsinvestor.com. The index, which measures freight rates for dry bulk cargo like coal, iron ore and grain shipped on 11 major trade routes, is a handy indicator of global economic activity. “When economic malaise takes a bite out of car sales in Japan, for instance, steel manufacturers need less iron ore and coking coal, which drives down freight rates (and opens up space for the aforementioned hitchhikers).” Since peaking last fall, the Baltic index has been sliding steadily.

– You may consider yourself lucky…but don’t think that makes you one of the “Fortunate 100” – a list of the highest-paid chief executives in New York, as compiled by Crain’s New York Business magazine. How does one become so fortunate? There’s no simple answer, but suffice it to say that a scrupulous devotion to reasonableness and fairness won’t advance the cause.

– Consider Michael Mahoney, CEO of Viatel and newly admitted member of the Fortunate 100. In March of last year, Mr. Mahoney exercised 200,000 options to buy and then quickly sell Viatel stock. How fortunate for him that his prescient sales netted him $6.6 million dollars before his company filed for Chapter 11 bankruptcy protection.

– And what about Kevin Ryan, CEO of DoubleClick Inc? He, too, was a very fortunate lad. Kevin exercised almost 400,000 options on his company’s stock last year to net himself a cool $16.8 million. He initiated his sales last February when the stock hovered around $100. DoubleClick is still with us, if just barely. The stock sells for around $11.

– Mahoney and Ryan, while fortunate indeed to have cashed in so many options last year, were hardly alone. The top 50 “earners” (more like lottery winners) received better than three quarters of their total pay via stock options and the like.

– By contrast, Greg Maffei deserves a spot in the “Unfortunate 100.” In 1999, Mr. Maffei swapped his title, CFO of Microsoft, for the title, CEO of 360networks – a tech start-up. In his new role as go- for-broke entrepreneur, Maffei tried very hard to go broke. He borrowed $77.5 million from his new employer to buy its stock. Now that the shares of 360networks sell for 25 cents each, Mr. Maffei’s 62 million shares are worth about $15 million – a cool $62 million or so less than the amount of money he borrowed to buy them. Maffei has got to be asking himself, “Was it really so bad counting beans for Bill Gates?”

***

*** Well, the second half is here…where’s the second half recovery? Wouldn’t it be a surprise if there were no recovery? Suppose instead the economy limps along for the next 10 years, always on the verge of recession, like Japan. Could it happen? Yes, dear reader, it could.

*** Both individuals and corporations need to reduce debt. But they could do it little by little over a long period of time. Cutting back on spending gradually – while Greenspan cuts rates even more – might prevent a sharp break in the economy, while almost guaranteeing a long period of very sluggish growth.

*** And what about stocks? Richard Russell argues that the stock market is going ‘dead.’ After 5 years of high volatility, we could be facing 5 years of low volatility. In this case, investors would be stuck with high-priced, low dividend stocks that go nowhere for years.

*** “The recent levitation of the Nasdaq is not only a testament to the power of bear market rallies,” writes the DR Blue Team’s David Tice, “but also to the willingness of investors to renew their faith in the riskiest stocks. For example, the quartile of $1 billion-plus companies with the highest P/Es soared 30 % from April 4 to May 16. Risky tech stocks did especially well [while] the fundamentals get worse by the week. These stocks are prime for a fall… ”

*** French consumer spending fell for the 2nd month in a row. The euro, which I thought was a bargain early this year, is an even bigger bargain now. It is down 9% against the dollar since January.

*** Maybe people are cutting back on air travel, but how did so many Americans get to Paris? The streets are packed with them…walking around with maps and water bottles as if they were crossing the Sahara.

*** May I offer some sartorial advice? The whole point of most of our striving in life is so that we can feel superior to our fellow human beings. After food, sex and shelter…it is vanity that prods us forward. But how superior can you feel – especially in an elegant, sophisticated city – when you are wearing baggy shorts and running shoes? Think Audrey Hepburn. Or Cary Grant.

*** Now let me take up a particularly natty subject: pants. Of course, women should never wear pants in public – unless they are gardening. Summer dresses are appropriate. Or maybe a dignified blouse with a very form-fitting skirt. And, oh yes, make sure the top is as low-cut as you dare.

*** But how about khakis on men? I’ve wrestled with this problem for a long time. Are khakis acceptable? The answer I have come to is ‘no.’ Linen or wool are okay, but khakis are just too casual. And men, don’t forget jackets and ties are de rigueur at all times – even when you are playing croquet.