Special Update #17

IN THIS ISSUE:

1. Politics: Republican Wimps!

2. US Prepares for War on Iraq

3. The Economy: More Good News

4. Possible Threats to the Economy

5. Japan Headed for Collapse?

6. Conclusions

INTRODUCTION

I began these Special Updates shortly after the events of September 11th. I didn't know where they would go after 911, and I still don't. What I originally hoped to do was bring you information from my wide range of sources that you probably don't read elsewhere. With my heavy writing schedule for my newsletters around the first of each month, I planned to work on the Updates in between my newsletter writing schedules. Therefore, at the most, I could write only 2-3 Special Updates a month and devote the remaining time to my monthly newsletters.

It has now been six months since I started the Special Updates. All along the way I have felt like I needed to have a set schedule for when they were written and e-mailed out. Seems like everything is on a schedule in my business. However, after writing 17 Updates, I have reached the conclusion that a set schedule is not necessary or even advisable.

I think the frequency of the Updates should be driven by events and topics, rather than a rigid or semi-rigid schedule. Bottom line: I will write these Special Updates whenever, and however often, based on when I feel I can bring you info, views and/or analysis that I believe you will find interesting and valuable.

THE "INCUMBENT PROTECTION" ACT

Let me warn you, I am really STEAMED at the REPUBLICANS!! On Thursday the House of Representatives passed the campaign finance reform bill. After more than 16 hours of heated debate, the House voted 240 to 189 to ban unlimited "soft money" donations to the national parties. 41 Republicans joined 198 Democrats and one independent to pass the bill after supporters defeated nearly a dozen amendments from House Republican leaders aimed at killing the bill. The Senate is expected to pass a similar measure and, sadly, President Bush is expected to sign it. I am very disappointed in the Republicans and the president if he signs it! The problem with the Shays-Meehan "campaign finance reform" bill is that it does nothing of the kind. It does very little to 'clean up' the system. One of the big public selling points of this bill is that it seeks to limit all of the 'evil' soft money that controls Washington. Well, it doesn't. The bill does not prohibit all soft money, but only the soft money which can be used against INCUMBENT politicians.

Soft money donations to political parties, which tend to favor challengers, is banned under the bill. There are also restrictions on television ads placed within 60 days of the election or 30 days of the primaries. This, too, favors the incumbents. The bill also doubles the amount of money a member of Congress can raise per person from $1000 to $2000.

So how does this bill reform the process for the better? It doesn't! It is designed to MAINTAIN THE STATUS QUO. Some Republicans spoke out against this sham, but even more voted for it. This is a failure of the system as a whole. Folks, these are the same people that vote themselves pay raises in the middle of a recession. Is it any surprise that they have slanted any 'reform' to protect the incumbents? The only real reform will come from term limits. Don't look for that on the legislative agenda, no matter who is in charge.

We just have to face the fact that many of our Republican leaders are only Republicans on certain issues. On others, they are just self-serving politicians, no better than liberal Democrats. And on the campaign finance reform bill, President Bush is one of them - if he signs it!

There are those who believe Bush will sign the bill only because he is confident that the Supreme Court will overturn it. Those in this camp believe Bush is doing the right thing because if he vetoes it now, it will only come back again later (probably true), whereas if the Supreme Court overturns it, the issue may finally be dead forever. This may, in fact, be the very plan that the Bush administration is following. I would like to buy into it, but it's not a certainty that the Supreme Court will overturn. If Bush doesn't like the bill, I say he should VETO it!

There is another camp that believes Bush will sign the campaign finance reform bill specifically because it could well make him INVINCIBLE in the 2004 election. Why? Remember how much money Bush raised last time?

You can probably triple that number by 2004 due to his soaring popularity and the war on terror! Bush will not take any public money for his campaign, so he will not be subject to campaign reform limits. He could conceivably have $300-400 million dollars in his coffers by the start of 2004! If so, he could be invincible!

Is this why he apparently will sign it? I don't know. Better question: are the Democrats too DUMB to have figured this out?? Ditto, I don't know.

WAR PREPARATIONS FOR IRAQ

Stories released on Thursday claimed that the Bush administration made a decision in January to attack Iraq for purposes of removing Saddam Hussein. According to the surprisingly detailed reports, the Pentagon and the CIA have been formulating a plan that could involve some 200,000 US troops, and that the plan has been delivered to President Bush in the last few days. The stories indicate that the attack could begin as early as May or June. You can read the story in the links below.

Our good friend Dr. George Friedman at Stratfor.com, on the other hand, does not believe the US will attack Iraq anytime soon, at least not in a major ground war. In addition to the obvious risks of another groundwar, including the possibility of chemical and biological weapons, Dr. Friedman does not believe that the Bush team has been able to identify anyone suitable to place in power in Iraq.

While the Guardian story below may, or may not, be completely accurate, I believe the Bush administration has made a decision to go after Iraq. Why? Secretary of State Colin Powell has made an amazing turnaround in the last few weeks. Powell, who has clearly been the "dove" on the president's war on terror team, has recently turned very hawkish. He has even been openly supportive of Bush's "Axis of Evil" rhetoric. This suggests, to me at least, that plans are being made to invade Iraq.

Another reason I believe we're planning to go after Iraq is President Bush's decision to send Dick Cheney, and not Colin Powell, to visit Israel and eight other Arab nations in the next few weeks. It seems pretty clear that the president wanted his VP to deliver the news that we are serious about attacking Iraq.

The question is, why was this leaked to the press? Unlike the Clinton administration which often purposely leaked sensitive information to the press to gauge public reaction, President Bush disdains such leaks. Perhaps this story was revealed to the press as part of a plan to unsettle Saddam Hussein and make him think more seriously about allowing weapons inspectors back in his country. Or it may have been leaked to make Saddam begin preparations for an invasion from Kuwait as the reports suggested when, in fact, we may be planning to attack from somewhere different.

I think it is safe to assume that letting this information out just as Cheney is planning a high profile visit to the region was not a mistake. We'll just have to see how this develops.

THE ECONOMY REVISITED

In Special Update #16 I focused on the economic outlook and specifically, on the growing signs that the recession was turning around. Just days after that Update was sent to you, the government released the first estimate of Gross Domestic Product for the 4Q of 2001. The Commerce Department's report surprised everyone, showing that GDP actually GREW by 0.2% (annual rate) in the 4Q. The consensus estimate for this report had expected GDP to DECLINE by apprx. 1% (annual rate) in the 4Q.

Now, the so-called "advanced" GDP report will be revised two times in the weeks ahead, and most economists expect the number will be revised lower. But there is no guarantee of that. Even if it is revised lower, it will not be revised down to anything near -1%. The economy was definitely stronger than expected in the 4Q.

If the latest GDP report happens to remain in positive territory, or even if the final reports show zero (0.0%) in the 4Q, we will have avoided a recession as widely defined. The widely accepted definition of a recession is TWO consecutive losing quarters of GDP. At least based on the advance estimate, subject to revision, we have not had a true recession to this point, at least on the national level.

I understand this analysis will not play well to someone who has been laid-off for a year. There are sectors of the economy that are in recession and have been in decline for well over two consecutive quarters. But at the national level, we have not.

I received the Bank Credit Analyst's (BCA) latest report for February, and they are now even more positive and encouraged that the economy will continue to rebound. Like most analysts, they do not believe the US economy is going back to 4-6% growth in GDP anytime soon, but they believe the recovery will be STRONGER than is currently expected by most economists.

BCA believes that the ONLY reason the economy would not continue to rebound is if there are unexpected, negative surprises. Absent that, they predict the economy will remain positive for at least the next couple of years. Their latest forecast is made despite the fact that public and private debt levels remain high.

Their view is that it will be these high debt levels that prevent the economy from returning to the go-go days of 4-6% GDP growth, but that growth of 1-3% a year is very possible over the next couple of years - again WITHOUT more negative surprises.

POTENTIAL NEGATIVE SURPRISES ??

Unless you are a new addition to our mailing list, you know by now I really have a problem with the gloom-and-doom crowd that sees a CRISIS around EVERY corner. When it comes to listing the possible negative threats/surprises we might face, it is REALLY TEMPTING to quote from members of the gloom-and-doom crowd regarding all the potential crises they drone on and on about. But I won't.

Here's what I see as the most likely REALISTIC negative surprises we might face over the next year or two that could derail the economic recovery:

MORE TERROR ATTACKS. We all have seen what the 911 attacks did to our economy, the stock markets and our lives in general. As I said in Special Update #1, "The world has changed forever." We cannot know if there will be more serious terrorist attacks. We can only hope and pray there will not, and that our increased security will protect us, but we cannot be sure.

On this note, I don't know about you, but I was VERY NERVOUS on New Year's Eve as I watched the enormous celebration in New York's Times Square. What better place for another attack. I was also very nervous as I watched the Super Bowl in New Orleans earlier this month. And I am nervous about the Olympics. But increasingly, I am more and more confident that our beefed-up security is increasing the odds that another major terrorist attack won't happen.

My growing confidence is still not without worry, though, given all the information I read and read and read about what threats still exist and those that may be planned for the future. Yet they have not happened, so I am cautiously optimistic.

TROUBLE IN THE WAR ON TERROR. I assume that everyone reading this knows that our military campaign and victory in Afghanistan was a CAKEWALK! Yes, we exercised a good deal of air power and sophisticated bombs, but we employed very minimal ground forces (thanks in part to the Russians - reread Special Update #12, if you haven't seen it), and we had minimal casualties. In the big picture, Afghanistan was nothing.

Our military actions, or potential actions, in the Philippines, Libya, Somalia, Yemen will be even more insignificant than those in Afghanistan. However, if we attempt to seriously go after Iraq, Iran and/or North Korea, the potential for major negative surprises INCREASES substantially. Should things go wrong on these fronts, the implications for the US economy and the investment markets could - and I emphasize could - be very negative.

MANY MORE ENRONS OUT THERE? You have all heard more than enough about Enron, so I won't belabor it except to say there was obvious fraud, deception, securities violations, accounting malpractice, etc., etc. and the people involved should go to jail for a long time.

Yet to hear the gloom-and-doom crowd tell it, there are HUNDREDS or THOUSANDS more Enrons out there just waiting to be discovered. I got an e-mail just today from a prominent gloom-and-doomer all but promising that there will be countless more Enrons that unfold and go bankrupt among America's largest corporations later this year. This, he all but promised, will send the stock market into oblivion.

Then there's the contingent of ever-negative, hand-wringers on Wall Street that have been warning that JUST the possibility of more Enrons will guarantee that the stock markets will head downward for the foreseeable future. But where's the evidence?

As you will read in my February newsletter, I do NOT expect we will see very many more Enrons. Not to repeat, but certain people at Enron were obviously willing to break the law, risk going to jail and risk losing all of their personal wealth.

I am in a highly regulated industry. My companies are audited routinely and are subject to reviews and examinations by multiple regulatory bodies. It would be VERY HARD for me to steal your money. I would have to corrupt too many people, including independent auditors and lawyers who make too much money to be corrupted by me, assuming I was willing to do so.

This is true in most companies. As a result, I don't expect dozens (much less hundreds) more Enrons to be imploding in the future. There may be others but I expect the number to be few.

COULD JAPAN COLLAPSE? YES.

We hear bad news about Japan all the time, but most Americans have no clue how serious this has become. Japan's economy, the second largest in the world, has been in a recession for the last 10 years. The once invincible Japanese stock market has been in a monster bear market for over a decade. What follows may not seem that interesting or important, but you need to get up to speed on Japan's worsening problems, if you are not already.

Japan is now at the edge of the cliff and a financial and economic COLLAPSE is now very possible. Here is a quick history of the Japanese quagmire from Stratfor.com in case you are not up on this issue:

"The Japanese economy has been mismanaged for more than a generation. The government historically sanctioned near-free loans to Japanese industry to allow massive expansion regardless of profit. Ultra-low interest rates prevented banks from making money from lending, their traditional revenue stream, so they purchased stocks and used the dividends to support their profit margins.

Companies in turn used their property as collateral to back up additional loans. Property values surged because expansion was seen as a priority, allowing Japanese firms to leverage their extremely expensive land holdings into yet more loans and more expansion.

The economic equation changed in 1990 when the Japanese property bubble burst. Companies holding suddenly depreciated collateral had to borrow even more simply to keep level. Banks, spooked by the rapid deterioration of their stock portfolios, began making loans to firms they knew should be going belly up -- firms in which the banks often held stock. To prevent a meltdown, the government stepped in with more cheap credit, ultimately reducing interest rates to zero.

But by this point, consumers, whose spending makes up 55 percent of Japan's economy, were spooked too. As Japanese spending began to contract, firms found themselves with less and less income to use to finance their own operations. In textbook fashion, firms invested less, expansion slowed and deflation set in.

In what became an increasingly desperate attempt to shore up domestic growth, the government began a campaign of stimulus spending, first drawn from the budget surpluses that so impressed Americans in the late 1980s.

But Japan was a highly developed economy when the process of stimulus spending began. The network of roads, bridges and dams the government built were redundant and wasteful. What the spending did do was empower the construction companies.

As they gorged on federal cash, they hired swathes of Japanese workers, ultimately employing one-tenth of the entire non-agriculture work force.

The construction firms, long the ruling party bedrock, became a politically powerful albatross from which the government would never free itself.

Prime ministers came and went, but rhetoric aside, all followed the same broad policies for fear of rocking the boat: cheap money and no reform, leading the country to where it stands now: in irreversible decline."

On February 10, Japan's finance minister announced a new economic and monetary plan which was heralded as the panacea. Unfortunately, a closer look at the plan reveals it is just more of the same old approach. It is now believed that the other G-7 nations have quietly decided to let Japan go over the cliff. Here is Stratfor's latest analysis:

"The global recession induced by Sept. 11 accelerated Japan's already chronic decline. The most glaring symptom of the country's economic degradation is deflation. Low consumer and business confidence, a pain-averse populace and a reform-shy government have combined to stall economic activity.

Consumer prices fell 0.7 percent in 2001, the fastest decline in 30 years. Japan's consumer price index is now mimicking the longer-term decline in wholesale prices, which plunged 1.4 percent last year and an additional 0.2 percent in January, the 16th-straight monthly decline.

That deflation is now feeding into all sectors of the economy. Bank lending dropped 4.6 percent in 2001, the fourth yearly decline, as businesses cut investment. The long-term investment drought has been a major factor behind Japan's 5.1 percent export drop last year, which occurred despite a government-engineered 16 percent drop in the yen.

Unemployment has spiked up to a record 5.6 percent, a number that in itself is a gross underestimation since Japanese firms prefer to cut hours, not workers. High unemployment has helped push household spending down 1.8 percent for the year, which in turn feeds back into the low investment numbers.

The fact is that the government, despite printing currency like mad, no longer has the cash to rescue itself. The economy shrank every month in 2001, leaving the government with fewer resources to tap. The situation is so dire that Shiokawa has floated the idea of revoking the raft of tax cuts and exemptions the government granted citizens and firms over the past 10 years, in failed attempts to stimulate growth, to help balance the books.

Assuming the incredibly unlikely event that Japan doesn't engage in any more deficit spending, by March 2003 Japan's federal debt will reach 140 percent of GDP, approximately $5.6 trillion. Debt servicing alone consumes 35 percent of all budgetary outlays.

The longer-term outlook for government revenues is even bleaker. The government anticipates that Japan -- saddled with one of the world's oldest populations -- will have a negative population growth rate by 2007. The country has already entered an era of declining revenues and increased pension costs as its baby boomers retire.

A new twist is that the Japanese people themselves are now second-guessing the government. The price of gold, the favored investment of those fearing downward volatility, was at a two-year high this week. Meanwhile, Japan's bad-loan problem continues to grow: its 17 largest banks registered a 13 percent increase in bad loans from last Sept. 30 to the beginning of January 2002.

The daunting question for the G-7 is how do you salvage an economy so large, so dysfunctional and so integrated into the international system?

While recommendations in the past have suggested tackling the country's mountain of bad loans, stimulating consumption or avoiding debt, at no point has the G-7 registered what is likely the final, morbid conclusion: Japan can't be saved."

The point is, if Japan's long recession worsens into a depression later this year, it could have negative implications for stock markets around the world, including ours. Maybe it won't happen, but Stratfor and BCA believe Japan is now closer to a full-blown collapse and depression than at any time since its economy went into this long contraction.

ARGENTINA, VENEZUELA, WHO'S NEXT? Much has been written over the last couple of months about the economic and financial collapse of Argentina.

As Argentina's woes were unfolding, I read numerous predictions that its demise would send the US stock markets into another downward funk. As it turned out, the US markets were much more concerned about the Enron debacle than about Argentina's problems.

Now it seems that Venezuela may be the next South American country to go down the tubes like Argentina. Venezuelan president Chavez abandoned the bolivar exchange rate on February 13 and allowed the currency to "float." On the first day, it plunged over 22%.

WILL THESE EVENTS DERAIL THE US ECONOMY & STOCK MARKETS?

Obviously, it is impossible to know if there will be more serious terrorist attacks. What we do know is that the US economy held up much better than expected after September 11th. Could the anticipated war with Iraq turn ugly and make US consumers retrench? Certainly. However, I believe we have the strongest defense team in recent hist ory, I would not plan on them making any serious mistakes if we go after Saddam Hussein.

Will the Japanese economy and banking system finally go over the cliff and drag the world economy down with it? Unfortunately, we cannot rule it out. Japan is definitely a "wild card" especially when it comes to forecasting the economy and the investment markets. All we can do is keep our ears tuned to the latest developments.

Could more Enrons cause the stock markets to take a nosedive? I doubt that there are more corporate bankruptcies on the scale of Enron on the horizon. Even if there are, they should be few in number. The greater question is, will there be a move, across industry sectors, to revise accounting practices and significantly reduce income and earnings?

There are some who believe that Enron-like accounting practices, where they understate expenses and overstate revenues and profits, are widespread. In following, they believe there will be a massive write-down of earnings in the month ahead, which could tank the stock markets one more time.

But as noted above, I don't see evidence of that, and neither does BCA. I could be wrong, but I expect that most large corporations are not "cooking their books," so I do not buy into the theory that massive earnings cuts are coming. In fact, the opposite could be true with the economy on the rebound now.

SPOOKS AROUND EVERY CORNER

Sooner or later you have to accept the fact that there will always be those who promise that the sky is falling, that a crisis always lies just ahead and that there are spooks around every corner. These people are out there in good times and in bad. Actually, it's more interesting to be a pessimist who always contemplates what all could go wrong, as opposed to an optimist that believes things will be okay and probably even continue to get better over time.

Remember the quote I cited a few weeks ago about a prominent gloom-and-doomer? "He's predicted 12 of the last 4 recessions." These people are always going to be out there spewing their crisishell-in-a-handbasket theories, usually to promote something they are selling.

As for me, I am sticking with The Bank Credit Analyst which believes, even more confidently as of their February issue, that: 1) the US economy is on the rebound barring any big negative surprises; and 2) the stock markets will trend higher, although with continued high volatility, and outperform bonds over the next year or longer.

That's all for now.

All the best,

Gary Halbert

SPECIAL ARTICLES

Will Bush veto campaign finance reform?

Interesting take on campaign finance bill, and why Bush will sign it.

Decision made: Saddam must go.

Powell's new doctrine.

Cheney's Mid East trip portends things to come.

The truth is too much for Bush's critics.

Bush effect continues to dog Dems.

OTHER ARTICLES OF INTEREST

McAuliffe's pot of gold.

Never ending: the Clinton gift scandal.

An interesting take on why the Dems are doing so poorly.

Al who?