Drip, Drip, Drip: Then the Dam Collapses

So do stock markets.

Day after day, there is bad news from the banking sector in Europe and America. There is bad news from the housing markets all over the world. There is bad news from the Institute for Supply Management, which reports on the state of suppliers. The service sector in January fell to 41.9%, with 50% as the borderline between contraction and expansion. In December, it was 54.4%. This is a very sharp decline.

The drip, drip, drip of bad news has a cumulative effect. It undermines investors’ confidence in the economy. This calls the stock market into question.


Panic selling does not hit a market without warning, smashing it into a meltdown that lasts for years. It hits after years of nagging doubts, followed by months of bad news in relentless sound bites, and then one unpredictable event that triggers a massive one-day sell-off, which is followed by more days of sell-offs.

Woe unto the investor who is caught fully invested in that initial sell-off. He will look in horror, paralyzed, denying the obvious. The market keeps going down, day after day. Tout TV commentators (age 30) interview fund managers, who deny that it’s a meltdown, recommend “buying sector stocks,” and say, “Buy on the dips.” Dips? The market is collapsing. Then the poor soul who bought and held finally calls his broker or sends a message to his retirement fund: “Sell!”

Too late.

Once smashed, a market can take years to recover. Gold and silver did not recover for 21 years, 1980—2001.

We have seen this kind of sell-off more recently. It began on March 24, 2000. On that day, the NASDAQ peaked, intra-day, at 5132.52. It closed at 5048. This marked the end of the dot-com bubble. You need to see a graph of that collapse, just to remind yourself of just how bad it can be next time.

It bottomed on October 9, 2002 at 1114.

On January 2, 2002, it closed at 2059. That was down 60% from the peak. The chart of that decline looked bad. But wasn’t good news straight ahead? Hadn’t the bad news been discounted? No. The NASDAQ fell another 46% over the next ten months. Look at the chart.

Today, it is in the range of 2300.

The consumer price index has risen by over 20%, 2000 to 2008. ( It rose by 15%, 2002—2008. So, discounting for price inflation, the NASDAQ is lower today than it was in early January, 2002. Plus, the person who bought and held in 2002 suffered a 46% loss of capital in 2002. Had he sold in January and repurchased in October in a tax-deferred IRA or other retirement fund, he would have avoided this loss.

I know people who told me in January, 2000, that the NASDAQ’s price/earnings ratio of 206 was reasonable. I thought it wasn’t, and I warned my readers to sell in February and March.

No one on Tout TV ever mentions this. No one says, “This can easily happen again.” No one says, “The NASDAQ has been in a bear market ever since March 24, 2000. The recovery after October 2002 is a bear market rally. That rally is fading.”


Day after day, the Dow is up or down 100 points or more, sometimes 200, sometimes more. Why? If the best forecasting minds on earth agree on the value of shares, shouldn’t the Dow rise or fall by under 50 points? Shouldn’t there be a trend, one way or the other?

We are seeing massive moves in and out of shares. The experts are not only not agreed, they are not agreed in a fundamental way. These are not random moves, in the sense of movements in response to unknown changes in perception at the margin. These are clashes between fundamental views of the future of this stock market and the international economy.

Yes, these views are at the margin. All economic change is at the margin. But these are much larger moves than normal. The investors at the margin are much more aggressive, and they do not agree on what is coming.

The investor with money in his pension fund looks at these swings, and he has to wonder: “What’s going on? Why is the stock market so volatile? Why are downward moves so big? Why does the market rebound briefly, then fall again?”

He sees volatility, and he senses confusion at the top. The big boys who allocate enormous pools of money just cannot get their act together. Yes, there are always bulls and bears, but the bears rarely are in a position to swing the market this widely. When they are in this position, this indicates that the stock market is at a crossroads.

Volatility is great for about 3% of commodity futures speculators. These are the people who make money. But volatility is not good for stock market investors. It points to major changes in both the economy and the market.

Most stock investors do not want volatility. They want steady capital gains, year after year. They have not gotten this since March, 2000. What they have gotten is a nearly flat Dow Jones and S&P 500, and a much lower NASDAQ, accompanied by steady price inflation. They are getting poor slowly. They have not yet lost hope in the stock brokers’ mantra, “The U.S. stock market has risen by 7% per annum.” Not in 1966—1982. Not since 2000.

The victims who invest in a broad index of stocks have lost money for eight years. They refuse to change. They refuse to call their fund managers and say: “Sell my stocks and move the money into a money market fund.”

Yet they watch what is happening, and they get nervous. They refuse to sell. The smart ones who have automatic investing each paycheck have most of this money go into stocks. But they don’t like what they hear about subprime loans. They don’t like what they see in the stock market charts.

We are now entering the doubt stage. It has taken eight years of negative returns in stocks. These years can never be recovered.

Meanwhile, gold went from under $300 to over $900.

The stock market touts who never told you to buy gold now tell you it’s too risky. The “Wall Street Journal” ran a story, “How to Survive The New Gold Rush” on January 29. What was the advice? Don’t buy gold. Why not? (1) Gold can be “extremely volatile.” (2) Gold “hasn’t always kept up with inflation.” (3) Better to invest in a commodities funds, “advisers say.” What advisors? The blind boneheads who didn’t put gold in their portfolios or recommend gold, from $257 to $900. Instead, they said “buy an index fund of U.S. stocks.” And what did that do for investors after March, 2000? Nothing, at best. Capital losses at worst (NASDAQ).

In short, these unnamed advisors are losers until proven innocent. Losers deeply resent winners. They deeply resent gold because gold’s rising price announces: “The policies of the Federal Reserve System, the U.S. Treasury, and Wall Street have produced losses for eight years.”


Some of my subscribers have read my warnings about real estate, Federal spending, and the tight-money policies of Bernanke’s FED for two years.

Others have refused to read my reports.

A few people have taken me seriously and have reallocated their portfolios. They got out of stocks and into other asset classes, such as gold.

But most readers have just sat there. They have nodded in agreement, but they have not picked up the phone to call their broker or pension fund manager to tell them to sell their shares.

The average investor doesn’t read information sources like mine. They prefer to rely on the mainstream financial press, which is advertising-supported. They prefer to read articles that are favorable to stocks, which is what mainstream financial press advertisers are paying editorial departments to publish.

But doubts are growing. Day after day, the news from the banks, from the American auto industry, and from the housing sector is depressing. The drip-drip-drip factor is eroding the foundation of confidence that is necessary to sustain rising stock markets.

We are seeing the undermining of the foundation of the bulls: investor optimism. There is no way that the news coming out of the financial sector can be interpreted as optimistic. The good news relates to specific companies. The bad news applies to entire sectors of the economy, and two of the biggest, housing and autos, are in trouble. General Motors lost $39 billion in 2007. How does any company lose that much money and still stay in business? Yet the recession has not hit yet.


In the February 13 issue of “USA Today,” on the front page of the Moneyline section, we read this headline: “Car loans stretch to 7 years or longer.” The subhead is accurate: “Down the road, risky practice could hurt sales.” But it was not sufficiently scary. Here is what is should have read:

Auto industry adopts subprime loans. Owners will walk away when their cars’ equity is gone.

The depreciation effect in autos is constant and unrelenting. Unlike houses, which used to appreciate — if owners put enough maintenance money into them — cars depreciate from the moment the new owner drives off the lot. Seven years out, nobody but poor people and me will buy that car.

Here is some car buyer who doesn’t understand compound interest, equity, and upside-down loans. He just wants a new car. He cannot afford to buy one for cash. He has no savings. But he wants that new car. So, he signs his name on a $25,000 car loan that he will be paying for when the car is worth $2,500.

Using an amortization calculator, we find that a $25,000 loan at 6.5% for 7 years requires a monthly payment of $371.24. That means $4,455 a year. What will the car be worth in year 7? Probably less than $4,455.

Then there is the question of falling demand for cars. In years five through seven, he will not buy a new car. Why not? Because his old car, which he will still owe money for, will have no equity. He will still be in debt. The debt will exceed the re-sale price of the car. The only way that he will get enough money to pay off the loan is for the new car company to offer to buy it at a trade-in price large enough to pay off his debt: above market value.

Alternatively, the car company will re-finance his old loan and apply it to a new loan. But then the new loan is really upside-down.

The entire auto industry will be forced to extend subprime loans to buyers who are ever deeper in debt. These are subprime buyers of depreciating assets. They are the people who will default on their home loans and walk away. They will walk away from auto loans, too.

America’s two consumer industries, housing and autos, are now utterly dependent on long-term debt. They cannot survive without massive permanent debt. The public accepts this, and therefore submits to lifetime debt. They do not intend to pay it off. They intend to roll it over.

This is also the assumption of the U.S. Treasury. Its debt is perpetual. It is for consumption — the purchase of votes — and not production. The voters have accepted lifelong debt, at an ever-expanding rate, as basic to all politics. This attitude is universal in the West. It is not confined to the United States.

“Deficits don’t matter.” This is what politicians proclaim to voters, and economists then affirm as the well-paid court prophets of the modern world. Debt is forever. The pious Christian in the pew prays, “Forgive us our debts, as we forgive our debtors” (Matthew 6:12). But when the ultimate debtors — the banks and the governments — decide to inflate away their debts, the pious souls who prayed that prayer and voted for the politics of debt will at last understand that God is not mocked. “For they have sown the wind, and they shall reap the whirlwind” (Hosea 8:7a).


The volatility of stocks point to economic conditions that are not understood. The economic fools in high places who approved the subprime loans that are now going bad did not see what was coming until July, 2007. These fools committed their firms and their clients to debt packages that were toxic. They did not understand their credit portfolios any more than the subprime borrowers understood the adjustable rate loan contracts that they signed.

Governments and central banks are now bailing out the dim-witted bankers to the tune of billions of low-interest loans and direct funding. Governments are also offering band aids — or proposals for band aids — to postpone the debtors’ day of reckoning. But politicians know whose bread must be buttered: the multinational bankers’ bread. They will be bailed out. The home owners, busted, will return from whence they came: the land of the renters.

No one really cares. They don’t care that large banks are too big to fail. They don’t care that small home owners are too small to be worth saving. As long as the government intervenes to keep the debt structure alive, voters don’t care whose money gets used to do the bailing.

We are addicted to debt. But as the addiction grows, it becomes too big not to fail. It will fail. The question is: In what way? Outright default or mass inflation? I predict mass inflation.

But not yet. Not this year. The downward pressure of the contracting housing sector and autos will keep downward pressure on prices.

The drip, drip, drip of bad economic news will eventually break the average mutual fund investor’s will to resist this downward pressure.


“To whom? At what price?”

February 18, 2008

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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