Corrupted Thinking in a Money Culture
Through stocks and bonds to housing and mortgages, the unparalleled U.S. credit machine keeps chugging along, spinning illusions…
It is the general view that the U.S. economy has outperformed the rest of the world in the past several years. Judging by real GDP growth rates, this is true. Yet the reason why is obvious, easily explained, and disastrous in its consequences: the U.S. credit machine has no parallel in the world. It is geared to accommodate absolutely unlimited credit for two purposes – consumption and financial speculation.
There has developed a tremendous and growing imbalance between the huge amount of credit that goes into these two uses and the minimal amount that goes into productive investment. Instead of moving to rein in these excesses and imbalances, the Greenspan Fed has clearly opted to sustain and foster them.
Today it is customary to measure economic strength by simply comparing recent real GDP growth rates. It always becomes fashionable when U.S economic growth is higher than in Europe.
From a long-term perspective, however, economic policy and economic growth are about physical resource allocation, that is, available tangible capital stock and labor. How much of the current production is devoted to consumption and how much to capital investment? Looking for economic health and strength, generations of economists have focused on two economic aggregates: savings and investment, in particular net savings and net investment.
Economic Sluggishness: Used to Be Truisms
It used to be a truism among economists of all schools of thought that the growth of an economy’s tangible capital stock was the key determinant of increased productivity and subsequently of good, high-paying jobs. And it also used to be a truism for economists that from a macroeconomic perspective, tangible capital investment into factories, production equipment, and commercial and residential building represents the one and only genuine wealth creation.
But in America’s new money culture, policymakers and economists make no difference between wealth created through saving and investment in the real economy and wealth created in the markets through asset bubbles, engendered by extremely loose money and credit.
In 1996, an article in Foreign Policy entitled "Securities: The New Wealth Machine," explained how securitization – the issuance of high-quality bonds and stocks – has become the most powerful engine of wealth creation in today’s world economy. Whereas societies used to accumulate wealth only slowly, they can now do so quickly and directly, and "the new approach requires that a state find ways to increase the market value of its productive assets." In such a strategy, "an economic policy that aims to achieve growth by wealth creation therefore does not attempt to increase the production of goods and services, except as a secondary objective."
This a perfect description of the corrupted economic thinking that is today ruling in America not only in corporations and the financial markets, but even among policymakers, elevating wealth-creation, that is, bubble- creation, to the ultimate of wisdom in the policy of economic growth.
There can be no question that the rapid sequence of asset bubbles – stocks, bonds, housing – that the United States has seen in the past few years were crucial in stimulating economic growth. Considering, though, its tremendously lopsided effect on consumer spending and the associated consumer-borrowing orgy, we are unable to regard this as a reasonable and sustainable policy. It works in the short run from the demand side, but it has come at heavy structural costs.
With these remarks, we wanted to make one thing perfectly clear. It is not profits, savings and investment that drive U.S. economic growth. It is America’s unparalleled credit machine, and that alone, which makes all the difference in economic growth and wealth creation between America and the rest of the world.
Economic Sluggishness: The Consensus and Why It’s Wrong
In the consensus view, the U.S. economy is breaking out of its anemic growth pattern. A few signs of accelerating economic growth have led to this forecast, in particular the 8.2% spurt of real GDP growth in the third quarter of 2003 and within it sharply higher investment technology spending, up 22%; surging profits, and also surging early indicators, among them in particular the November ISM survey for manufacturing. Various indicators are at their strongest in 20 years.
We strongly disagree with this assessment. The growth spurt in the third quarter was exceptional, due to a one-off splurge in tax rebates and a burst in the mortgage refinancing wave. As to investment spending, what essentially matters is the change in total nonresidential investment, and that continues to show virtual stagnation. The widely hailed surge in IT investment came overwhelmingly from the hedonic pricing of computers, which has been abolished. Recent profits reports have indeed been impressive, but their success is vastly different between sectors and not as straightforward as the official numbers imply.
Yet our disbelief in the U.S. economy’s breakout from its protracted sluggishness has one main reason: All the economic growth of the past two years, anemic as it was, is traceable to a seemingly endless array of asset and borrowing bubbles. Quoting analyst Stephen Roach, "the Fed, in effect, has become a serial bubble blower" – first the stock market bubble; then the bond bubble; then the housing bubble and the associated mortgage refinancing bubble. As a result, consumer spending has been surging well in excess of disposable income for years.
The idea was that sustained and rising consumer spending would in due time stimulate investment spending. It has grossly failed to do that. Our assumption rather is that consumer spending will slow as the asset and consumer borrowing bubble are sure to fade. Seeing no big investment recovery, we expect a surprisingly weak U.S. economy in 2004.
For the Daily Reckoning
January 27, 2004
Editor’s note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
In the January issue of his newsletter, Dr. Richebächer gets to the bottom of Greenspan’s easy money policy and exposes its long-reaching effects, including the creation of dangerous asset bubbles and spiraling U.S. dollar.
When everything is make believe…you don’t know what to believe.
Americans pretend to get rich by mortgaging their houses and spending the money. Their government pretends to protect future generations by running up huge debts that they will have to pay. The Fed pretends to rescue a debt- soaked economy by splashing on more credit! The Chinese pretend to build their economy with the largest vendor- financing scheme in history – lending more to their American customers than they can ever hope to get back.
In a perfect world, people know nothing…and they know it. But on today’s conceited ball, people know less than nothing…and think they know everything. They have more information than ever before…but it is phony information, based not on reality, but on pretense.
We refer to a great many things…almost anything, in fact. But here at the Daily Reckoning, we turn our attention to the economy: it is a dismal calling, we know, but we have to earn a living.
What triggered this reflection was a particularly lame editorial in today’s International Herald Tribune in which NYTimes columnist Bob Herbert worries that "Outsourcing jobs is a threat to the U.S. economy."
He quotes Craig Barrett, CEO of Intel: "The big change today from what’s happened over the last 30 years is that is no longer just low-cost labor that you are looking at. It’s well-educated labor that can do effectively any job that can be done in the United States."
Mr. Herbert thinks he has identified a problem. Like every earnest editorialist, he urges action. "We can grapple with this problem now, and try to develop workable solutions. Or we can ignore this fire in the basement of the national economy until it rages out of our control."
The NYTimes began grappling with this problem two weeks ago, when a tag-team of Senator Charles Schumer and former Wall Street Journal editorialist Paul Craig Roberts wrote an op-ed piece on the subject. The two wrasslers were all for fighting it out in a free marketplace…as long as we were winning. Their point was that the advantage seems to have shifted to the Indians and Chinese. They, too, wanted someone to do something about it.
Thanks to Greenspan and Bush, plenty of jobs were being created, they noted, but they were jobs in Guandong Province, China and Bangalore, India, to use a couple of examples out of thin air.
What neither Greenspan, Bush, Roberts, Schumer or Herbert know is anything. How many jobs would be outsourced if America had to settle its accounts in real money? How many foreigners would find employment in overseas factories if the Fed had not cut rates and lured Americans into a spending spree? What is the net effect on U.S. prosperity of cheaper imports…do lower costs offset lower earnings? Why is it better for an American to earn $25 per hour than 25 Indians to earn $1 each; why do Americans deserve more? What will happen when the whole fraudulent system blows up…and Americans are left with debts they can’t pay…and foreigners are left with mountains of products and no one to sell them to?
As always…we wait to find out…
Over to Eric…with more news:
Eric Fry in the wilds of Manhattan…
– Sometimes, the most obvious trade is also the most profitable trade…(until it isn’t). American stocks are rising almost every day – so what could be more obvious than buying more of them before they go up again tomorrow?
– The "dumb money," taking note of the obvious, does the obvious thing: it buys stocks. Of course, it roils the "smart money" when the "dumb money" adds to its winnings day after day. But sometimes, this can’t be helped…sometimes the dumb money prospers, no matter how much their prosperity irks hyper-analytical contrarians and perma-bears.
– Thus does the dumb money add to its pile of dumb money. (Occasionally, the pile grows to such a spectacular size that it becomes "stupid money.") Meanwhile, during times like these, the "smart money" watches its supreme intelligence reside in an ever-smaller stack of dollar bills. Occasionally, during the stock market’s most manic phases, the smartest members of the smart money contingent can become so destitute that they can scarcely afford to buy a paperback copy of Graham and Dodd’s "The Intelligent Investor."
– Today, stocks are going up…and they keep going up, no matter how many admiring fans they attract along the way. Sentiment indicators be damned; the more that investors love stocks, the more stocks soar. The lumpeninvestoriat’s ardor for equities has been sufficient to power all the major stock market indices to new multi-month highs. Yesterday, the Dow and Nasdaq both soared to fresh two-and- a-half-year highs. The blue-chip Dow jumped 134 points to 10,703, while the tech-powered Nasdaq soared 30 points to 2,154.
– Meanwhile, the dollar drafted behind the advancing stock market, gaining altitude steadily throughout the day. By the end of the New York trading session, the greenback had gained about three quarters of a percent to $1.247 per euro. But the rallying U.S. dollar and stock market seemed to sap enthusiasm for bonds and gold. Treasury prices slumped, pushing the 10-year yield up to 4.13% from 4.07% last Friday. Gold dipped $1.30 to $406.70 an ounce.
– Returning to the stock market, exactly how passionately does the lumpeninvestoriat love its common stocks? Professional options trader, Jay Shartsis, provides a partial answer.
– "Well, they finally did it," Shartsis says with amazement. "The NYSE daily new lows list fell to absolute zero last Friday. Of course, new lows have been running next to nothing for the past six months now. – "I’m looking at a chart of the 10-day new highs versus new lows for the combined NYSE and Nasdaq, which goes back to 1992," he continues. "What is truly remarkable about this chart is that through the ‘roaring ’90s,’ there were always a fair number of new lows. Even after 1995, when the mania went into high gear, there were always a few hundred new lows on a 10-day basis, with some sharp market corrections that sent the 10-day new low figure over 3000. How long can this go on?"
– Turning his attention to another once-reliable sentiment indicator, Shartsis notes, "Smaller traders haven’t been this optimistic since 2000. Option volume surged last week – reported to be 40% greater than any week in the past few years. Forget about a 5% correction; the last time the market had a 3% correction was nearly four months ago. Last Friday, January option expiration day, the equity put/call ratio for the four listed option exchanges combined dropped to a 0.31, its lowest reading (lots of calls) in more than three years." – The mutual-fund-buying lumps may be even more exuberant than their option-buying counterparts. The Vanguard Group, America’s second-largest mutual fund company, reports that it must hire hundreds of workers to handle a phone-call glut at its three customer service centers. The surging call volumes have left Vanguard customers waiting on hold for an average of 6.7 minutes, according to Boston-based researcher Dalbar Inc. The average wait for fund companies is 58 seconds…
– Of course, when you really think about it, is 6.7 minutes too long to wait for professional money management?
Bill Bonner, back in Paris…
*** "Money continues to pour into this market," says the Street.com. Where’s the money coming from? Real earnings are going down.
People are practically being forced into speculating in stocks. Savers cannot afford to leave their money in CDs. The interest they earn is less than the increase in the cost of housing and energy. So, they go into junk bonds and junk stocks – desperate for a decent return on their money. Fools rush in…
*** Howard Dean says he is troubled by Greenspan’s "willingness to bend in political winds." Is he kidding? We do not approve of vulgarity, but if even a junior senator from a small state breaks wind anywhere in the continental 48, the Fed chief is practically blown over.
*** America needs honest political labels, we conclude. The terms "Republican" and "Democrat," "liberal" and "conservative," have almost no meaning worth trying to look up. George W. Bush is the biggest spender on military and social programs the U.S. has ever seen. Yet, the media make believe that he is a ‘conservative.’ His agenda has nothing in common with traditional, modest conservatism. It is a radical program of Guns and Butter that will add $1.9 trillion to federal debt over the next 10 years.
The neo-conservatives tell us that all this spending will make the nation safer and freer. We are ‘rising to the tasks of history,’ says the president. If only future generations, who will be shackled to the ball and chain of Bush’s deficits for decades to come, would appreciate our sacrifices on their behalf!
*** Today, we pause for a moment to celebrate Mozart’s birthday…and to commemorate the lifting of the siege of Leningrad in 1944.
Hitler and Stalin had agreed to take Poland and carve it up between them. Two years later, Hitler attacked the Soviet Union itself. Hitler’s sorry war strategy called for attacks to the north, east and south all at the same time. Within two months, Leningrad (now known as St. Petersburg) was surrounded. Almost three million Russians were trapped in the city, with no access to food or fuel.
The winter of 1942 was especially hard. Temperatures dropped. There was little heat, little food…and even water was scarce. When the siege was finally broken on January 27, 1944, a half million people had died.
What a difference 60 years makes! It is as if these events took place on a different planet…or among a different species. Who would believe that this happened during the lifetime of many people reading this message…among civilized Westerners? Now, of course, we grapple with our problems before it is too late. We find "workable solutions." And things always work out for the better.