Can things get better? The view from the trough

The year 2001 may go down as the year we were paid back for the financial excesses of the 1990s.

Recession is biting the North American economies, Continental Europe is feeling the first nibbles, and the United Kingdom is likely not far behind. Japan has known little else for four years and other Pacific Rim countries are battered.

The mining industry is especially sensitive to the economic cycle, and now we head into another year where lower metal prices, sagging industrial demand, and overcapacity are taken as inevitable. As for the junior exploration industry, it can hardly get worse after last year.

The despair did not come from nowhere, for the late ’90s bull market, we would argue, bears the primary responsibility for the hard economic times in which this industry — and others — find themselves. The bull market distributed capital badly, starving the sectors that have always been the engines of economic growth. Now, old-style heavy industry has little to invest in, even with the cost of capital at historical lows.

It is a good thing that markets are usually right, because when they are wrong, they are massively and destructively wrong. The destruction of value in the collapse of the bull market has been staggering, and — considering current share prices compared with standard measures of value — it may not be over yet. Charles Mackay, in his classic of financial manias and mass psychology, Extraordinary Popular Delusions and the Madness of Crowds, observed that men “go mad in herds, while they only recover their senses slowly, and one by one.” Some investors are still only recovering their senses today. The bubble may have ended with a bang, but it was inflated by a world that is ending with a whimper.

The terrorist attacks in September — war crimes, and crimes against humanity, let us not mince words — may have shocked financial markets, but they were not the cause of the recession. Of terrorism, the best that can be said is that the West’s mind has at last been concentrated. The popular reaction in September was to say that “the world changed” with the attacks on New York and (as some forget) Arlington: it provided a neat cover story for the people that suddenly had the veil lifted from their eyes. But it wasn’t the world that had changed.

Luckily — and we choose that word carefully, because at the outset, it seemed like a damned close-run thing — some leading Western powers reacted with resolve, instead of cravenness, this time.

It would be good if Canada had taken a leading role, instead of pretending to help by sending a naval presence and pretending to sympathize by offering lukewarm support for the American attacks on a government that harboured Al Qaida. We owed our seat at Versailles to the soldiers that plugged the gap at Ypres and took Vimy, and we owed our weight in the Cold War world to what we did on the North Atlantic, and in Ortona and Falaise. We became the United Nations’ peacekeeper of choice by having the fastest and meanest army in the world on call for Suez and Katanga, not by playing international nice-guy.

The wicked of the earth have, for thirty years or more, made the calculation that we in the West would let our horror or our delicacy outweigh our courage. Too often they have been right: we have appeased and looked for “root causes,” and they laughed quietly and planned the next one. This time they may get the terrible swift sword they have ever deserved.

To blame the current weak economy on the September attacks is to confuse a witchdoctor’s chants with his patient’s sudden recovery: they may have happened close in time, but there is only the slimmest causal connection. The recession in the general U.S. economy was well under way before the attacks; our own probably started in the third quarter, something that likely will be confirmed once year-end data are in. And it takes only a quick look at metal prices and commodity indexes to see that our own industry has been mired in bad times since the beginning of 2000. Neglect a run-up of commodity prices in 1999, and it’s been five years since the mining sector last saw the sun.

A basic ingredient of the recession is the misallocation of capital that grew out of the market bubble. People in this industry shook their heads at the mad valuations the market was placing on half-made business plans in electronic commerce; but the money chased the money that chased the dreams — and now it is effectively lost to the real economy, which could have used a little capital in the late ’90s. Most particularly, the vast debts piled up by the telecommunications industry (estimated at US$200 billion among the eight European telecommunications giants alone) are excess capacity that the economy will have to work off, either incrementally over the next decade or in a sharp, self-perpetuating downturn. What might the resource industries have done with a little of that US$200 billion? What might other industries have done? Even some governments might have made better use of it, which says much.

The mania for discarding regulation in the financial markets, while it made some people rich and gave us all a slickly produced morality play to watch, contributed to the atmosphere that fed the flames of the bubble market. The kind of creative accounting that would have cost some people their licences in previous years was rehabilitated as financial wizardry, and the absurd valuations it justified were shouted from the rooftops by the cheerleaders of the financial industry. At the same time, hard assets were being denigrated. Like the fixation 1980s industrial strategists had on turning the “sunset industries” out in the cold, any public company with physical infrastructure and cash flow was consigned, in advance, to the dustbin of history.

The con men, the mystics and the pompon girls are remarkably insouciant about the falsehoods they peddled. Kenneth Lay and Jeffrey Skilling will walk away from the smoking ruin of Enron as rich men, in marked contrast to their employees and shareholders. The analysts that predicted new market heights through the bull market are hiding behind the fine-print weasel clauses at the bottom of their reports. Over at Goldman Sachs, Abby Joseph Cohen thinks you can get an 18% return in the U.S. market next year. Step right up.

While it is fair to rail at the carnival barkers that fed public expectations, the investors that rose to the bait through the whole course of the bull market should have known better, too. The public are grownups, and can stand to be told that there is no such thing as easy money for the small investor.

At the lowest point of the Great Depression, the financier Bernard Baruch wrote an introduction to an edition of Mackay’s Delusions, in which Baruch said: “I have always thought that if, even in the presence of dizzily spiraling prices, we had all continuously repeated ‘two and two still make four,’ much of the evil might have been averted.”

Two and two only ever make four. No more, no less. We have a whole new business cycle to get it right this time. We wish our readers, and our industry, a better 2002.