No Saving Grace
The Daily Reckoning Presents: a Wednesday ‘Special Guest’ Essay… “In which the author refutes pundits’ efforts to portray American finances as much better than they really are.”
NO SAVING GRACE
by Paul L. Kasriel
[A]n article in the June 23 issue of The Economist… cites various studies suggesting that the decline in the U.S. household saving rate is the result of a faulty definition of saving and/or has little economic significance because of a skewed distribution.
The message of the article is: cheer up. Things could be worse. My message…is the punchline to [an] old joke: “So, I cheered up. And sure enough, things got worse.”
…[A]ll you have to do is look at the behavior of the current account deficit in recent years to know that Americans are spending more than they are producing. In effect, a current account deficit measures the net dollar amount of goods and services the rest of the world is lending to the U.S. If an individual runs a current account deficit, it means that she is spending more than she is earning or producing. What enables her to do that? Borrowing. If a country runs a current account deficit, it means that the country is borrowing from the rest of the world so that it can spend in excess of its production.
In the four quarters ended 2001: Q1, the U.S. borrowed from the rest of the world, on average, an amount equal to about 4 1/2% of our nominal GDP – the highest absolute and relative borrowing from the rest of the world in over 40 years. This, my friends, is prima facie evidence that no matter how you cut it, the combined American saving rate for households, businesses and any other group you want to include not only has gone down in recent years, but it has gone deeper into negative, or dis-saving, territory. Now, this is not necessarily an economic “bad thing.”
If we have been using the goods and services the rest of the world has lent us to enhance our ability to produce enough in the future to pay the rest of the world back what it wants, and to, at the same time, increase our standard of living, then all of this national borrowing will have turned out to be an economic “good thing.”
Let’s hope that those miles and miles of fiber optic cable that have been put down pay off!
The Economist mentions a study by the Fed that shows that the richest two-fifths of the population accounted for the decline in the U.S. household saving rate. The poorest two-fifths increased their saving rates significantly.
Interesting, but so what? The fact remains that the household saving rate, in the aggregate, fell.
If you are still feeling cheerier, I offer this to depress you: Total debt outstanding as a percent of the nominal capital stock has risen to 92%. The debt includes debt issued by the private sector as well as debt issued by the government sector; debt issued by the non-financial sectors as well as debt issued by the financial sectors. The capital stock includes that of the private sector as well as the government sector.
From 1952 through 1982, total debt as a percent of the total capital stock ranged from approximately 42% to 51 1/2%. But national leverage started on an uninterrupted upward trend in 1983. Debt as a percent of the capital stock has moved up from about 48 1/2% in 1982 to 92% in 1999. Bear in mind that we are finding out that a lot of the capital stock produced in the late 1990s is not worth very much in this new century. Though the value of the capital may go away, the debt will stay – stay until it is written off as un-collectible, that is.
The mid-1980s was the era of leveraged buyouts in Corporate America. The late 1990s was the era of leveraged buybacks in Corporate America. “Financial engineering” began to be all the rage in the mid-1980s. Repackaging and transformation of various kinds of debt instruments, from mortgages to credit card receivables, has led to layer upon layer of financial intermediation.
Financial risk can more easily be shifted today. But risk shifting is just that – shifting. The amount of risk is not reduced. The mortgage markets have become so “efficient” and competitive that households can very easily “monetize” the equity in their houses. Perhaps that is why homeowners’ equity as a percent of the value of their houses has, in recent years, fallen to its lowest level in the postwar period. Easy credit terms on asset-based loans lead to escalating asset prices. Leverage is terrific when asset prices are rising. But it’s oppressive when credit terms tighten and asset prices start to fall.
Have you noticed the increased frequency of financial market crises since the mid 1980s? Mexico/the oil patch/Continental Bank, the U.S. stock market, banks and S&Ls, Mexico again, Asia, Russia, Brazil, Long-Term Capital Management, the U.S. stock market again, Turkey, Argentina.
What’s the trigger for the next financial market crisis? The bursting of the housing market bubble? And have you noticed what the palliative for these crises has been? The Fed cuts interest rates, which encourages the creation of even more credit. That’s why the leverage ratio in the U.S. economy is the highest it has been in the post-World War II period – maybe even the highest in the post-World War I period.
Deflation is anathema to debtors (like George Costanza, I’ve been waiting a long time to use that word). Inflation is music to debtors’ ears…There are more voters who are debtors than who are creditors. As a result, expect increased political pressure for the Fed to keep inflating…it’s politically correct now to inflate.
July 11, 2001
Paul L. Kasriel is head of economic research at Northern Trust Co. A version of this article appeared on Grantsinvestor.com on June 29, 2001.
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Two very interesting and ominous things happened yesterday.
First, “shoppers put the brake on borrowing” as the Seattle Times reports it. This could be the first sign that the consumer is finally coming to his senses. More details in Eric’s report.
“Refinancing of mortgages by homeowners is taken as a sign of optimism, and that things are improving,” says the Mogambo Guru. “They are, in fact, probably just the opposite. There are many good reasons why a person would want to trade equity in his house for a little ready cash. In this case, with the consumer saddled with record-breaking debt amid a faltering economy, it almost certainly means that the homeowner is on the verge of bankruptcy, and paying off some current short-term creditors with a long-term loan.”
The second important bit of news was that Singapore announced it was in recession – the first Asian economy to make it official. Singapore’s economy is not merely easing off – it is imploding, down 10% in the 2nd quarter. All over the world, an economic slowdown is developing, spreading as a sort of international flu epidemic.
Both of these items suggest the end of the American miracle economy. Year after year, Americans have bought more and more goods and services from abroad – on credit. Money is thus taken out of the U.S. consumer economy. But it comes back – as foreigners use it to buy U.S. stocks and bonds. It has been this marvelous circle – and not a productivity miracle – that helped to keep the dollar and U.S. stocks and bonds high…without causing consumer price inflation in the U.S.
But now it is coming to an end – and a dangerous one.
“Foreigners own a near-record 36.7% of all outstanding US Treasuries, a record 13.3% of federal agency bonds, and an unprecedented 22.7% of US corporate bonds,” reports James Grant. “Moreover, as of 2001’s first quarter, a record 12.2% of the market value of US equities accrued to foreign investors.”
What will happen as Americans stop spending…and foreigners stop investing in the U.S? Could it happen? We will see. But first, let’s hear from Eric, who is visiting me right here in Charm City, USA:
– The Nasdaq breaks 2,000! But not the way that Alan Greenspan, James Cramer, or Joe Battapaglia might have had in mind. The week-kneed index limped through another trading day and fell 64 points through to 1,963. The Dow fell 124 points.
– Isn’t the stock market supposed to rally when the Fed is cutting interest rates? It looks like Mr. Market is missing his cue, and he’s not alone. Neither are corporations nor consumers borrowing on cue.
– Instead, the more Greenspan lowers rates, the less folks are borrowing. For example, the amount of corporate bank loans and commercial paper outstanding has been falling. “In an unprecedented fashion, credit creation has turned negative at the same time that money growth has accelerated,” ISI observes.
– Likewise, the consumer may be losing his appetite for additional debt. Consumer credit rose by a seasonally adjusted 4.9% annual rate – the slowest rate in two and 1/2 years. May’s pace of borrowing was less than half the pace of April.
– Without rising employment, Greenspan’s magic interest rate will work no magic whatsoever. “The biggest risk facing the U.S. economy centers on a forthcoming loss of jobs that might eventually prompt another slowdown by household expenditures,” says Moody’s John Lonski. “The Challenger Layoff Report estimates that the number of announced job reductions shot higher by 248% year-over- year during 2001’s first-half.”
– Amazingly, manufacturing employment has now fallen all the way back to where it stood in 1965.
– “We continue to believe that the U.S. economy is on the mend and that the recent pullback in stock prices is part of an ongoing recovery process that will carry stock prices higher from here.” The “royal we” who uttered this prophecy is none other than Wall Street strategist and perma-bull, Joe Battapaglia. When the market was going up every day, folks like Joe took great delight in branding skeptics as “broken clocks.” Look in the mirror, Joe.
– “All but 5% of the stocks that crossed the analysts’ desks on Wall Street won a buy rating last year,” writes Lynn Carpenter, “And what do the analysts know? Whatever they learned in their last job… which was writing term papers for professors.”
– Yesterday, I rode the gleaming new Amtrak Acela train down to Baltimore. The speed train was designed to whisk its riders up and down the Eastern seaboard much faster than a conventional train. Instead, the Acela delivered me to my destination one hour late. Is there a parable here? Weren’t those sexy new-era Internet stocks supposed to whisk investors rapidly to the land of early retirement? Yet, as the “Internet Express” has derailed, only the tired old value stocks have been pulling into the station on time.
Back to Bill:
*** What is going on in France while we’re back in the U.S.?
*** Well, Laurent Fabius, France’s finance minister says the U.S. is at fault for the world economic slowdown. How the world turns! For the last 12 years, western finance ministers have been pounding on the Japanese…and U.S. economists routinely mock France’s economic “dirigisme.” Now, it is our turn to suffer the slings and arrows of foreign criticism and advice…
*** And from Ouzilly, my son sends the following report:
“Dad, Suzannah and I were checking our e-mail yesterday evening when there was a knock at the front door. Upon answering it, I discovered on the stoop an entire girl scout troop. It struck me as odd that they weren’t holding any cookies for sale as is the American custom. So, I was very shocked when I asked if I could help them and they replied that they needed a place to stay for the night! I looked confused, but they assured me that Pierre [a neighbor who looks after the place when we are gone] said it was OK… So, after getting used to the idea and sympathetic to their exhausted state, we took them in. So they stayed the night… We got some pictures…”