March 16, 2003

You can bet your bottom dollar

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In 1770, John Fitzpatrick, an Irish-born trader and failed speculator, opened a shop in the town of Manchac in the Gulf of Mexico.The territory was first under British rule, then French, then Spanish. He ran his shop through the American War of Independence, the Spanish occupation and the period when the territory was repackaged into the Louisiana parcel and sold by the French to the British. Fitzpatrick led an otherwise uneventful life as far as we know, except that he created the famous squiggle that gave us probably the greatest brand in the world. John Fitzpatrick, born in New Ross, gave us $ – the dollar sign.

Fitzpatrick first used the squiggle in 1768 in his accounts. He then used it in correspondence with bookkeepers and suppliers. No one knows why, but he was copied, possibly because he lived and traded in a border area between four empires vying for financial, as well as political supremacy. When he died in 1791, he had no idea that his squiggle would come to symbolise the United States in a way that nothing else did – not even the Declaration of the Republic, the White House or the Stars and Stripes. It also came to define the currency of thirty other countries, yet Fitzpatrick never visited any of them and only lived in the US in his latter years.

The dollar and its famous $ sign came to be accepted in the nether regions of the NewWorld because it was credible. People trusted the US dollar, not because it was never devalued, but because it was devalued less frequently than other currencies. By 1864, the currency had acquired sufficient cachet for the Americans to put God and the dollar on the same pedestal. The following year every dollar coin had the inscription “in God we trust” engraved on it – a true store of wealth, immune from inflation and other earthly ills.

Inflation,which is always politically engineered, devalues currencies, debases trust and takes years to work its way out of investors’ perceptions. The boom/bust of the financial markets between 1995 and 2000 can be regarded as a very debilitating inflationary period. The value of money disappeared in 1996/97. People knew the price of everything and the value of nothing.

Investors began to believe that Irish companies such as BaltimoreTechnologies were actually worth the billions of paper dollars the stock markets said they were.The higher the share price, the more cash was debased.Shares became the financial equivalent of cigarettes inWeimar Germany; money had no value, people were advised to put all their cash into shares and many dutifully did.

But a share, like a currency, is only a promissory note. It is a promise on the part of the management to pay the investor back more money tomorrow than he has invested today. The only way to guarantee this in the aggregate is if more similar bets are placed tomorrow than were placed today. This is why the financial industry has to extract more cash out of us tomorrow than it did today to keep the pyramid from collapsing.

The more cash that goes in, with a limited supply of stock,the more likely it is that the promise will be delivered on. As long as this remains the case, wealth can be created based on the basic logic of not being the last man placing the bet.The problem is that when a bubble bursts, the farce of shareprice inflation is exposed and the long-term casualty is trust. Investors’ trust in the promise disappears and without trust, people have to look at different ways to build wealth.

In the financial markets we are seeing a breakdown of trust between the investor and the asset that made him rich over the past twenty years, namely paper-wealth. Without the rebuilding of this trust, it is hard to see a sustainable rally in stock markets. In a sense there is also a global inconsistency at work because the central banks of the world have rarely pumped as much money into the systems as they are doing at the moment.

This inconsistency rests on that fact that the more money that is around, the more likely interest rates are to rise sooner rather than later. And so even though bonds have out-performed stocks, it is bonds which should suffer.

According to some of our gurus in Dublin, this in itself should signal a move to buy stocks. But while being right on bonds, the gurus may be wrong on stocks because the leap from falling bond markets to inevitably rising stock markets is more blind faith than hard logic. Why should stocks naturally rise because bonds are falling? I’ve no idea.

Undeterred, many SSIA advisors are urging clients to switch their money from the deposit-based investment or bonds to equity-based products. The logic underlying this strategy is based on the fact that stock markets are so depressed now that valuations are beginning to look interesting. For example, if a company is paying a dividend, the investor can get both this dividend and any upside if the share rebounds.

Consequently, the investor can get an income from the dividend that may be well above the rate of interest and there is the possibility of a capital gain. At first blush this appears persuasive, but here is the rub: investors don’t trust paper wealth. They want real things instead such as gold, copper, metals, non-listed companies, cash or anything that is not a promise of jam tomorrow.

Look at history. All boom/bust cycles led to prolonged periods when once favoured assets stay in the doldrums for years. Having risen for almost twenty years between 1960 and 1980, the prices of all commodities went into freefall for two decades. Irish property prices weakened consistentlyfrom1978to1989relativetoall other assets. Stocks returned very little throughout the 1970s after the late 1960s “nifty-fifty” era.

All booms and busts are characterised by seven stages. Cheap money, followed by euphoria, leading to borrowing, prompting mania, followed by a bubble, giving way inevitably to distress and culminating with panic. The panic period, described brilliantly by German speculators of the 19th century as schusstuerpanik, or shut-door-panic when everyone tries to flee the party bolting the door behind, can go on for a while.

This week we have seen the panic phase continue. If the decline in the FTSE 100 Share Index over the last ten trading days to Thursday were to continue at the same rate, it would hit zero in only 64 days. Similar death rates apply to many other leading indices.

Death will not happen, as Thursday’s rally shows, but we might not have reached the absolute bottom yet because investors have lost trust.Why should they invest in companies that have lost paper fortunes? What should be the signal to buy?

Nathan Rothschild – who was knocking around about the same time as the obscure John Fitzpatrick – said: “The time to buy is when blood flows on the streets.” This is what market players are hoping for.

Maybe the war will provide the opportunity, but given geo-political problems, underlying economic weaknesses and systemic fragility in stock markets, this war is likely to do nothing to re-establish international trust. Quite the opposite.