richard russell

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    August 4, 2003

    I want to start the month of August with this absolutely incredible statement from Fed Chairman Greenspan. --

    "Is it important for an economy to have manufacturing? There is a big dispute on this issue. What is important is that economies create value, and whether value is created by taking raw materials and fabricating them into something consumers want, or value is created by various different services which consumers want, it presumably should not make any significant difference, so far as standards of living are concerned, because the income, the capability to purchase goods is there. If there is no concern about access to foreign producers of manufactured goods, then I think you can argue it does not really matter whether or not you produce them or not."

    I must admit that I blinked and did a double-take when I read this statement. Is Greenspan losing it? Or is he just generating some goofy rationale to explain away why the US is losing its manufacturing base to the rest of the world and mainly to China?

    The ability to make something and then sell that "something" to customers domestically and throughout the world is critical. And what about the trade balance? Doesn't that mean anything? The US is not going to bring about real prosperity by raising a nation of accountants and lawyers and salesmen and burger-flippers. It's the ability to manufacture products and to sell those products throughout the world that builds a nation's wealth.

    Following World War II the US was undisputed manufacturer to the world. Our economic strength was unequalled and unchallenged. We were making products that everybody needed and wanted, and we were selling those products to US consumers and to the rest of the world.

    What do we make now? Federal Reserve Notes and debts. And as long as the world continues to accept our Federal Reserve Notes (we call them "dollars") US citizens will enjoy a high standard of living. But our current prosperity is all built on debts and deficits. And debt, like the proverbial tree, will not "grow to the sky."

    I was lucky enough to have a very smart father. Fifty-six years ago my dad took me aside (I had just graduated from NYU) and he told me, "Richard, there are two ways to make real money. The best way is to produce a product and sell that product to the world. The second best way is to go where the money is -- in other words, get in the money business."

    I took my dad's advice -- I tried both of his suggestions. I spent ten years in the US textile business as a designer and an executive. By the late 1950s I saw the writing on the wall, and I turned to my first love, the stock market. Today the US textile business is almost gone -- it's been exported to overseas. As for the stock market, it's clearly still here, and I'm as fascinated with it as ever.

    How about Greenspan's observation that manufacturing is not necessary to a nation's prosperity? I think he's dreaming or maybe he's putting some kind of foreign substance in his morning bath water. I know what my father told me. I wonder what Greenspan's father told him…..

    You remember that I said the Fed wants one situation above all. That situation is asset inflation. The two areas the Fed is most concerned with are housing and the stock market. Up to now the Fed has had its own way. Housing continues to rise -- but with interest rates now heading sharply higher I have to wonder how long housing can continue to be a savior.

    As for the stock market, it too may have stalled out. Too early to tell.

    And what's this? The latest report on the money supply that I received this morning is that M-3, the broad money supply, dropped a big $28 billion during the week ended July 21.

    On top of this, gold is selling off.

    So I have to ask -- is the Fed's frantic fight against deflation becoming a losing battle? Are the global forces of deflation defeating the Fed?

    Instead of creating $1 trillion in additional liquidity during a 12-month period, will the Fed have to go for $2 trillion, $3 trillion? It seems to me that the Fed will have to go all out to hold off the relentless forces of deflation and correction.

    A new Fed governor coming out almost daily and telling us "how good things are going to be" is simply not doing the job. Which is why Richard Russell listens to the markets rather than the blabbing of economists, Fed governors, Fed chiefs, Wall Street analysts, newspaper reporters, CNBC or anybody else.

    So as the market moves to within a half hour of the close, here's what I see.

    I see the M-3 money supply taking a big drop.

    I see oil up over $32 which puts pressure on business and on consumers. Rising oil serves as a "tax," and is deflationary.

    I see bonds having had their worst two months collapse in memory. Rising interest rates are deflationary.

    I see December gold breaking below 350. A declining price for gold is deflationary.

    I see the 30 year mortgage at 6.17%, high for the year. Rising mortgage rates are deflationary.

    I see the big banks such as Lehman and Morgan in head-and-shoulders formations and either on the edge of breaking down or actually (Lehman) breaking down.

    What do I think? I think there's a damn good chance that the markets are telling us that the Fed is losing control of the situation -- and that the forces of deflation are beginning to win out. That's what I think.

    Question -- I wonder if our foreign creditors are beginning to see the US as a bad credit risk? How much longer will they be willing to accept low-yield US paper for their goods and merchandise?

    Richard Russell’s Dow Theory Letters
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