Issue # 61  December 22, 2002
NOTICE:  All contents © 2002 by George A. Ure, MBA except other authors as noted.  This document is intended for the sole use of subscribers and may not be transmitted, reproduced, or in other way used without the written prior express consent of the author.  This publication is by subscription:  $50/year for web browser accessed delivery to a password protected site or $150/year delivered by personalized email in HTML..  Please pass along a copy to your friends and suggest that they subscribe.  To subscribe, send a check to: Guru Press, 1355 West Palmetto Road, #281, Boca Raton, FL  33486-3383.  You may also subscribe using PayPal.  Your username and password are both your email address, in all lower case to access the protected web site, so don't forget to include it!   Address comments and correspondence to: george@ure.net.    Read the disclaimer: http://www.urbansurvival.com/disclaim.htm This report is based on sources believed reliable and makes no specific investment advice.  Before you invest in anything, seek professional advice and remember, you can only spend it once, unless you are a member of the Fed, in which case you can spend it as fast as you can print  it.

Rock Soup

There was on old Danish fairytale that my late Grandmother on my Mom's side told us as kids.  It was something about "rock soup".  The story goes something like this:  (thanks to: http://www.gaebler.com/rock-soup-vendors.htm )

"Three hungry soldiers are on their way home after a war and stop at a village to eat. The villagers see them coming and are not eager to share their food with the soldiers. They hide everything -- including their tomatoes, cream, potatoes, barley, and beef -- and tell the soldiers that they too have no food and are hungry.

Thinking quickly on their feet, the soldiers respond that they know how to make Rock Soup, a great soup made with just rocks and water, and that they will feed the entire village.

Intrigued with the possibility of making soup from a rock, the villagers provide a rock and boiling water and begin to set the tables.

As the water boils, one of the soldiers states that although the soup is just about ready, a tomato would make it even better. A villager secures a tomato from its hiding place and adds it to the soup.

And the Rock Soup would be even more delicious with an onion, comments another soldier. A villager quickly finds an onion and adds it to the soup.

Within a few minutes, using the same strategy, the soldiers are able to get meat, barley, vegetables, and cream from the villagers to complete the Rock Soup.

The villagers and the soldiers feasted together and the villagers were surprised to learn that you actually could make excellent soup from rocks and water."

Now, the Gaebler Ventures site takes the Rock Soup story and turns it into a management lesson - about companies that are hired as "expert consultants" and yet little or nothing really productive on their own.  Instead, they get the client firms to do all the work and then take the credit. It's an excellent point and drives home something I've said about most "consultants" for years. They mostly sell rock soup.

The other trick to the consulting game is something called the "take away sale". The way this works is by creating artificial scarcity.  We all know that scarcity builds demand.  Scarcity is also one of the most important engines of modern advertising for high end products.  The way it works is by creating a demand for an overpriced product by using the threat of "loss" or decline of "status."

Let's take the luxury automobile market...  Where the reverse sale is used to all the time.  Walk into a dealership wearing up here of jeans, and the good salesman will immediately begin qualifying you.  Qualifying is the nice sales term for finding out if you could really afford the product the company is trying to sell you.  In a Corvette dealership not too many years ago, an acquaintance of mine bought a Corvette and just about invoice because he was the master of the takeaways sale. He knew the "game."  I learned most of what I know about that take away from him.

When the salesperson asked him how was he going to handle all of the women that he could pick up by driving this new Corvette convertible, my friend simply one upped the salesman by looking at him in the eye and saying "I can drive any car I want, and I thought I'd try a Corvette this time."  He then went into a short speech about how he didn't really care whether it was a Corvette, or a Mercedes, or Lexus for that matter.  Well, as you can expect, the car salesman quickly dropped his pretentiousness, and got down to business of dealing an automobile.

Consultants do very much the same thing, in how they use the negative or takeaway sale to close a sale.  Consultants will walk into a company and invariably say "Look what I can do for you, how easy it will be for us to turn around the situation like yours, but alas and I don't know if we have time to fit to win to our busy schedule."  You get the picture- the executive of the troubled company will trip all over him or herself in order to convince the consultancy to "please make some time to fit us in."

The danger of the takeaways sale, or the reverse sale, is that at some point, people suddenly "get it' and the reverse sale blows up in the salesman's face.

Now we get to the point of this week's report: in a sense, valuation of the U.S. dollar is not unlike rock soup.  Because it is not a gold backed currency, the U.S. dollar is largely a game of confidence.  Like rock soup.  With the recent statements of the Federal Reserve Board, announcing their willingness to print dollar bills in order to reflate the economy, we can expect to see an exodus from U.S. denominated investments over the next six months.  It seems likely to us that such an exodus will take place in a confused way because of the pendency of two potential wars.  One of these is of course Iraq while the other is North Korea.

With the revelation recently that North Korea would begin operating its plutonium production reactor again, the West is placed in a difficult position of potentially facing two adversaries that can seriously weaken our ability to win either conflict. We've talked about the "three front war" scenario in the past.  (Iraq, Taiwan, and North Korea in an orchestrated sequence.   It therefore came as no surprise that Secretary of State state Powell is taking a relatively low key posture given his military understanding of reality, but Defense Secretary Rumsfeld clearly stated on the 23rd that he believes the U.S. can successfully fight two wars at the same time.

For the purpose of helping to get a little more perspective on how the world is evolving into a "split deflation" scenario, I've put together something I call the World Aggregate Index.  The way this works is very similar to the U.S. Aggregate Index you've been seeing every visit here (including this one) and it's posted below.  I've taken the eight most prominent world markets and normalized them as of September 1999.  The chart below shows what has happened to the U.S. since that "norming" date - which was purely arbitrary:

You can clearly see that worldwide, markets have continued their decline.  With this evidence on the table, now is probably as gooda time as any to ask "Why?"   A second question, "what would you do about it?" is also a fair one to ask.  So let's dig in, shall we?

The first thing we can see is that for most of this year, when the US was dropping faster than the rest of the world, it would seem at least intuitively that a larger cap non- U.S. stock would do better than the market overall.  Indeed, if we take a company like Honda, where sales are closely tied to the U.S., we see that Honda was in fact a better performer when the U.S. was sinking faster than the world.

However, while it's a generalization, it may not be true in all cases, especially if the underlying economy is on the ropes, such as the case of Bayer, the large German pharmaceutical company. Still, it's enough of an idea that it bears watching for a while.

Meantime, we need to remain mindful of one of the dynamics of international trade, be it Hondas, currencies, or simply commodities. Understanding this dynamic is central to "getting it" when considering the dynamics of world trade. 

Let's begin with three countries, A, B and C that are initially at a static condition of equally valued currencies.  The first move in the trade war is B's.  They decide that their currency is more valuable than A's.  Then C follows suit, but not quite matching B for domestic reasons. 

The net impact on A is that they will be forced to make a currency adjustment, but it will likely lie somewhere between B and C, and therefore, to the degree that their currency adjustment doesn't quite match B's move (of 5%), the system will tend toward greater stability, although it will take many iterations of the modeled conditions to arrive at that stable point again.  If you map it out, it goes something like this:

Now in the case of B's initial move, they are saying, in effect, that their currency is really worth 5% more than everyone else, and therefore, they ought to be able to purchase goods made in A or C for $0.9524 cents instead of a dollar. C, however, doesn't match B because they want their goods to be more competitively priced than B's in order to spur an increase in consumption of it's exported goods.  So from A's perspective, C is now a better trading partner.

What we've outlined here is the inflationary case.  The reality of today's world is that the exact opposite is going on, that is to say, prices are deflating. They are in the case of B saying "Hey, our goods no longer cost $1.00...instead we have dropped our prices to 95% of what they used to be." 

This sets off the whole round of global price cutting, which while it results in short term stability, albeit at lower prices, also implies that at some point the whole world economy blows up because there has been no corresponding revaluation of debt.

It's like everyone agreeing that starting tomorrow we're all going to make exactly half as much as we do today, and correspondingly, things like new cars, and food, even new clothing will cost exactly one half of what it does today.  All of which sounds like nirvana, until it comes time to make the house payment.  That's the fly in the ointment - which we call the Debtberg.  The people who sold us the house never agreed to the violent change in the economy - and because we owe them $100,000 today, we will still owe them $100,000 tomorrow.

At a global level then, these features of economic reality spell out how fast disaster will take place:

• We have seen that global competitive devaluations continue to ripple around the world for many iterations.

• We see that simultaneously, existing debt is not being restructured fast enough to accommodate the massive economic displacements resulting from the devaluations.

• Ergo, the only outcomes that are possible are:

  • An increasing number of bankruptcies must occur such that the total global debt load is reduced correspondent to the global deflation that is now underway.

  • There must be a inflation of a massive scale in order to get the "price" of goods and services back to previous levels so the overhanging debt may be supported.

I think it should be obvious to anyone with a nickel's worth of brains, that we are presently in a global deflation and that bankruptcies are continuing to increase as an every faster rate. 

Reflecting this, the price of housing is beginning to drop in some areas, and as it does, we can safely see that over the next year or two the foreclosure and bankruptcies rate will continue to increase.  It will also signal a change in many financial instruments, such as collateralized mortgage obligations (those baskets of mortgages) because going forward, the discount used in pricing will have to incorporate a much larger "bad debt" component.

To put it mildly, we are not even close to the end of the beginning, but we are getting closer to the beginning of the end.

Over the next few weeks, the Think Tank has hinted around that they have been working on a new kind of web bot run that will help us define the long term outcomes of some of this.  But to summarize their initial findings, here are a couple of snippets to consider:

• It appears that Planet X will not be the factor that so many alarmist sites are trying to make it out to be.  Instead, what we are seeing is something much different - and larger - in nature.  Perhaps a change in the heliosphere itself.

• The preliminary work seems to suggest gold will continue to accelerate upward.

There's also something interesting that can be seen if you look at sunspot numbers and how major wars and financial panics have worked out over the past few hundred years...

Well, interesting stuff, but there's a lot more work to be done before we get around to the annual forecast.  For now, let's look at the charts for last week and see if we can divine any guidance from them:

To the degree that we're able, we will adjust our expectations accordingly. 

Write when you get rich!

George Ure