Courtomer, France Friday, June 13, 2008

First, a quick look at what happened in the markets yesterday.

The Dow rose 57 points. Oil held steady – but at a near record price of $136 a barrel. The dollar rose…and gold dropped $10.

The big news this morning is that retail sales actually went up last month – at 1%, twice what economists expected.

What? How can consumers continue to spend? They’re supposed to be cutting back. Maybe they’re spending those rebate checks.

Meanwhile, we find import prices up 2.3% in May, mostly because of higher oil prices. And the NY Times tells us that commodity price increases show “no let up.” Floods in the Midwest are aggravating the situation – driving up corn prices to new record highs.

“Inflation expectations rise sharply,” says the Financial Times.

The Fed’s ‘Beige Book’ tells us that the economy is “generally weak.”

We spent the week with a group of Internet marketers. The financial publishing business has gone electronic in a big way. In this business, you either learn how to publish on the Internet…or you fail.

Your editor, who grew up without air-conditioning, let alone without the Internet, finds it hard to keep up.

“You’ve got to understand the semantic dynamic of the bot-driven crawlers,” said one of the speakers. We had no idea of what he was talking about, but the others present nodded their heads in approval.

That is just one of the problems with growing older; you grow wiser…but wiser about things that no longer exist. When the car is slow to start, for example, we naturally think we need to clean the carburetor or check the points. Then we realize that there isn’t a carburetor and there aren’t any points. The cars have gone electronic too.

The other thing that has gone electronic is money.

In our decaying wisdom, we’re suspicious of the new electronic money. The old paper money was bad enough. Given the opportunity, central banks would print it up…far more of it than they should. Soon, there would be a lot more pieces of paper than there were things that it would buy. Now, the authorities who control money don’t even have to get ink on their hands. They can create money electronically. In fact, there is no limit on how much they can create – theoretically. Just add zeros. Add them electronically. The sky’s the limit.

But real wealth is not created so easily…

Real wealth is not electronic. It’s not just 1s and 0s – not just digital…not just phantoms that disappear when the power goes out. Real wealth is physical…things you can touch, eat, drive around in, and live in.

Real wealth and “money” are connected. But this new electronic money has plenty of stretch in it. Houses, for example, are real wealth. But in money terms, their value varies. In the ten years – 1996-2006 – for example, the price of America’s houses almost doubled. Of course, they were essentially the same houses…a little bigger perhaps…with a few more marble countertops, but otherwise not much different. What had happened that made them more valuable? Well, they weren’t really more valuable…just more expensive. America’s elastic money had stretched out to make them more expensive.

But now the elastic is snapping back. Houses are down 13% – according to Case/Shiller – from a year ago. And now an analyst at JP Morgan says they’ll probably go down about 30% before the snapback is finished in 2010.

This, he says, will cost Wall Street about $1 trillion in losses on mortgage-backed securities. It will cost the nation $4 trillion in “lost access to capital.”

Whoa! That’s the trouble with stretchable money – when the elastic snaps, it can hurt.

*** The other trouble with these new electronic systems is that they are hard to fix. When your car wouldn’t start in the ’60s, you lifted the hood…took off the distributor cap and checked for sparks. Or, you removed the carburetor and made sure it was working properly. Even when you didn’t know what you were doing, skinning your knuckles once or twice seemed to cure most minor mechanical problems.

But when an electronic system breaks down, it’s hard to figure out what is wrong…and almost impossible to fix. When money is in paper form, it is pretty easy to understand how it works. Simply count up the bills in circulation. If the supply is going up…prices are likely to follow. But this new electronic money has most people stumped. The Fed sends an electronic credit to the Bank of America, which in turn gives an electronic credit to its credit card holders. Now, they can go out and buy things. Do they have “money?” How much “money” is in circulation?

Then, the American shopper buys something made in China – where else? – so that the Chinese producer ends up with a credit in his account in dollars…which he trades with the Bank of China for yuan. The BoC doesn’t want the yuan to go up…so it creates more yuan, electronically, to trade for the electronic dollars it has received.

This was the ‘great money machine’ – an electronic machine – that was responsible for creating so much of the world’s liquidity…and the world’s bubbles.

But as we said yesterday, this machine seems to be slowing down…maybe even breaking down. America’s trade deficit is shrinking. In fact, it seems to us that the elastic currency is snapping back in America’s face. Its import prices go up…while its major asset – housing – goes down.

The import that people care most about is oil. It’s causing the highest gasoline prices Americans have ever had to pay. And it’s calling into question the whole ‘car culture’ society. In America, much more than in Europe, people live in individual, standalone houses – which are much more expensive to heat and maintain than row houses or apartments. They also live far from their work…their schools…their restaurants…and their shops.

Here in Europe, big shopping malls have become common. The small shops couldn’t compete with them on price or choice. Still, now that the price of oil has gone up so dramatically, the latest reports tell us that shoppers are turning their backs on the big malls; they prefer to walk out to neighborhood stores.

But in the United States, there are few neighborhood stores left…in fact, there are few neighborhoods. Instead, in many areas, houses were flung out like confetti from a parade float. They may have fallen a mile from a major shopping mall…or the wind might have carried them 50 miles away.

“Oklahoma’s painful car culture,” is changing the way people live, says an article on CNN Money. Out on panhandle, it is not unusual to drive 70 miles to get to work. In their big SUV and pickups, commuters might have to spend $50 a day – just to get to work. It’s not surprising that they are looking for alternatives – bikes, carpools, and buses.