The Kindness of Strangers

The United States has broken a lot of records recently…unfortunately, they aren’t the kind that will win us any gold medals. How long will our neighbors in the Far East continue to bail us out? Dr. Richebächer investigates…

Renewed weakness in the U.S. economy has hardly come as a surprise to us. It is the inexorable outgrowth of an economic recovery that has been of highly dubious quality right from the start. The U.S. economy is plagued by an extraordinary array of growth-impairing imbalances: a record-high trade deficit, a record-high budget deficit, record-high household indebtedness, record-low national saving and asset price bubbles supporting record-high consumer spending.

Any other country faced with these monstrous domestic and external imbalances would have endured panicky capital flight and a collapsing currency, forcing its central bank to drastic monetary tightening. But the U.S. central bank and the dollar were spared this fate because the central banks of the Asian surplus countries stepped in, accumulating any amount of dollars needed to avoid an undesired rise of their currencies.

In 2003, such dollar purchases by foreign central banks amounted to a stunning $616.6 billion, after $351.9 billion the year before. The total reserves of emerging Asia rose by over $350 billion between the beginning of 2003 and March 2004. Over the same time, Japan’s central bank purchased $316 billion worth of U.S. assets. The biggest buyer in emerging Asia was the central bank of China.

US Economic Weakness: Ultra-Loose, Ultra-Low

These huge and soaring dollar purchases by foreign central banks were crucial in allowing the U.S. Federal Reserve to pursue its ultra-loose monetary policy with ultra-low interest rates. As we have often stressed, this in combination with equally loose fiscal policy has prevented a deeper recession, but the question is whether or not these policies have laid the foundation for sustained economic growth in the longer run.

In our view, it is bad policy on both sides. The Asian central banks accommodate the credit excesses in the United States, and in doing so, fuel rampant credit excesses in their own countries. Japan’s horrible aftermath over more than a decade after its credit excesses in the late 1980s does not seem to deter anybody. The United States, on the other hand, is losing jobs to Asia.

Both are courting extraordinary credit excess, but with a crucial difference: In the United States, the credit excess went and continues to go overwhelmingly into asset prices and personal consumption; in Asia, it goes overwhelmingly into capital investment and production, essentially creating a mass of overcapacity and malinvestments. The result is an unprecedented symbiosis between the two continents: The Americans borrow and consume, and the Asians produce.

The U.S. economy has abruptly weakened. Is this weakness just a short-lived "soft patch" caused by higher oil prices, as emphasized by Fed Chairman Alan Greenspan and readily believed by the eternally bullish consensus? Or does it represent the beginning of a more severe downshift to subpar corporate and economic performance, if not worse?

An issue in particular is a slowdown in consumer spending. From the start of 2004 through July, real consumer spending rose by $122.2 billion. That is $209.5 billion, or 2.8% at annual rate, and compares with an overall increase of $232.2 billion (3.3%) in 2003 and of $213 billion (3.1%) in 2002. For perspective, during the boom years 1999-2000, it had growth rates of 5.1% and 4.7%.

US Economic Weakness: Lower Spending on Consumer Durables

Though this deterioration is not dramatic, it also does not suggest an ongoing recovery. Yet the aggregates hide one rather dramatic change in the current year, namely, sharply lower growth in spending on consumer durables. At annual rate, it was down to $23.5 billion in the first seven months of 2004, after $71 billion in 2003 and $58 billion in 2002.

Still, there has been a dramatic change for the worse in the consumer’s earning power. Since January 2004, the three-month annualized growth rate for real disposable personal income has literally collapsed: 5.7%, 4.6%, 4.5%, 3.7%, 2.5% and 0.8% for July. Over the seven months to July 2004, real disposable income was up a mere $77.4 billion, or $132.7 billion at annual rate. It grew by $174.3 billion in 2003 and by $226.2 billion in 2002.

Presenting these numbers, we have to mention that they have been jolted by tremendous revisions. Earlier data showed a pronounced rise in personal saving. Now there is a steep plunge. The crucial fact to see is that the consumer stepped up his borrowing to compensate for slowing income growth. The rise since 2000 is 74%. Yet the net effect has been gradual retrenchment in spending.

The success or failure of the massive monetary and fiscal stimuli over the past few years is one of the most controversial questions about the U.S. economy. Using the much slower economic growth in the Eurozone as a yardstick, as is the general American practice, U.S. policies look most successful. But using the previous six postwar U.S. business cycles as a measure of success, the U.S. economy’s performance during the last two to three years has been by far the poorest ever, despite the unprecedented amount of fiscal and monetary stimuli.

Annualized growth of real GDP has averaged 3.4% over the first 10 quarters of this upturn, far below the 5.4% norm of the recoveries in the previous business cycles. Real wage and salary disbursements – the grist of healthy, sustainable economic growth – over the same period have recorded a cumulative increase of just 2.2%. This compares with an average cumulative increase of 10.6% over the same period in past postwar business cycles.

Even more important is the further question of whether or not the economy has gained the "traction" it needs for the recovery to become self-sustaining and self-reinforcing without further artificial monetary and fiscal stimuli. It would have to show particularly in much faster employment and income growth than it has so far.

US Economic Weakness: Less than Full Traction

In his congressional testimony, Mr. Greenspan stated, "The expansion has regained some traction" after having gone through an oil price-induced "soft patch" last spring. In general, this has been interpreted as an upbeat statement. To us, the word "some" is strictly diminutive, implying less than full traction, which is realized when an economic recovery has gained self-sustaining, if not self-reinforcing, dynamism.

As a matter of fact, there was a very different reading about consumer spending in the Fed’s Sept. 8 Beige Book: "Household spending was reported to have softened in many parts of the nation, reflecting lackluster retail sales and some cooling in new and existing home sales." They certainly knew what happened in August.

In past cycles, the usual vigorous traction used to come mainly from pent-up demand that, due to prior monetary tightness, had accumulated during the recession mainly in residential building, consumer durables and business investment in equipment. Key to the present subpar recovery has been the exact opposite – heavy consumer borrowing from the future.

During the three years 2000-03, disposable incomes of private households grew, in current dollars, a cumulative $965.9 billion. They increased their spending by $1,023.7 billion and their debts by a stunning $2,726.9 billion. In this regard, the monetary and fiscal stimuli appear to have worked so far. But the problem is that a growing part of domestic spending exits to foreign producers, fueling the U.S. trade deficit, instead of U.S. domestic production.


Kurt Richebacher,
for The Daily Reckoning
October 13, 2004

"Imagine a place where you could spend far more than you earned for years without consequence," writes Gary Duncan in the Times of London. "Imagine a place where you could pay your way by writing cheques that nobody would bother to cash. Welcome to America, today."

Americans have never had it so good. But Nature has her ways of keeping things in balance. Like fat little lemmings rushing into the sea, Americans seem to have an urge for mass financial suicide; they couldn’t wait to put themselves in deep water.

"Over the past decade or more," Duncan continues, "the United States has been living far beyond even the vast means commanded by the world’s largest economy. America’s households have spent far more than they earn, borrowing extravagantly against the rising value of their homes and other assets. The U.S. government has been no less profligate, dramatically increasing spending while making hefty cuts in taxes. "

In the last five years, for every dollar Americans earned, they’ve spent $1.20. In barely a decade, the United States became the world’s biggest debtor, with the percentage of U.S. government debt in foreign hands rising from 20% to nearly half. Foreign lending – the kindness of strangers – is what keeps the U.S. economy going.

Many economists see this relationship as flattering…or symbiotic. They make; we take. They save; we borrow. They sweat; we think. We print dollars and Treasury bonds; they buy them. Who can complain about that?

It looks like "the biggest free lunch in modern economic history," says Niall Ferguson.

But there’s no meal quite as expensive as a free lunch, we riposte.

The Fed cut rates 13 times after the 2001 recession began. With the key rate as low as 1%, the Fed was willing to lend money at a negative real rate of interest. This ultra-cheap money is what stimulated a consumer-spending binge in the United States and a capital-spending binge in Asia. The effect on Americans is simple: They ruined themselves by spending money they didn’t have on things they didn’t need. Asians, on the other hand, built factories to produce things for people who didn’t have the money to pay for them.

Both trends are doomed, but not exactly in the same way.
Americans’ standard of living was bound to fall, compared to the rest of the world’s, anyway. Wealth still comes, mostly, from producing things. Asians can now produce things more quickly and less expensively. The Fed’s artificially low rates merely accelerate the process, giving Americans one last spending spree – like a condemned man’s last meal – before the credit card is taken away.

The industrialization of Asia was bound to happen, too. That, too, merely got a boost from the Fed. Many Asian companies will probably go bust when American demand slumps. But the Asians want things also; eventually, domestic demand should take up the slack.

When will the "free lunch" come to an end?

"No one can predict with certainty," writes Duncan. But a revaluation of the yuan might be the dessert course…or the coffee. Then, the bill is sure to come – denominated in yuan!

"It is a tantalizing prospect, although one that will depend on China’s ability to preserve political stability as its prosperity grows," Duncan concludes. "However, it is not impossible that, in our lifetimes, markets will hang, not on the words of Alan Greenspan or his successor, but on those of the chairman of China’s central bank."

More news, from Tom Dyson in Baltimore:


"From 1985 through 1987, the dollar index fell from 140 to below 90, and the yen soared, but the deficit still doubled in the same period. Even if the Chinese revalue – and it may not even be anytime soon – it could take years for the deficit to return to balance, just like in the early 1990s. The same policies that depress the dollar make American consumers feel like spending money, and they spend it on Chinese goods…"


Bill Bonner, back in London:

*** London housing prices are outrageous.

"Since 1996, London led a worldwide boom in big city property prices," says Yale economist Robert Shiller.
New York, Los Angeles, Paris, Shanghai, Vancouver – the world’s great cities became like luxury brands. When you said you lived in London, people knew what it meant – it was as if you carried a Gucci bag or wore a Hermes tie. You edged up the snob scale a little bit simply because you lived in a fashionable place. By contrast, if you said you lived in Chicago, you slipped a little. And if you admitted that you lived in Baltimore, they felt sorry for you.

"The trend towards metropolitan chic is unlikely to end soon," says Shiller. But the bubble in housing prices may be peaking out. Here in London, the papers tell us that prices in the center of town are already beginning to stabilize…or sag.

*** Meanwhile, from Dallas comes news that house resales fell for the second month in a row.

And from Baltimore, the Sun reports that prices in the region rose 20.5% in the last year – and still seem to be going up!

*** "One out of four Americans struggles to pay his bills," says a new study. The researchers wondered how families of four, living on less than $36,784 per year, got by. "Just barely," was the answer.

The Houston Chronicle:

"’One emergency – a broken-down car, rent increase or serious illness – can disrupt the families’ precarious equilibrium and plunge them into financial chaos,’ the report states.

"The nonpartisan report spotlights a growing disparity between low-wage earners and the educated skilled workers that U.S. businesses increasingly demand.

"Its release comes in the final weeks of a heated presidential campaign in which issues concerning low-income families largely have taken a back seat to those of the middle class and to worries about terrorism and the war in Iraq.

"’What we haven’t come to grips with is how large this number of working low-income families is,’ said Brandon Roberts, co-author of Working Hard, Falling Short.

*** We went out to a guitar store to buy Henry a birthday present last weekend. Henry turned 14 in July, but we have been traveling so much we had not had time to buy him the guitar he wanted.

The music stores all seem to be located over by Place Pigalle, an area of bars and prostitutes. But besides those, there is little of interest. Last weekend, there must have been an important rugby or soccer match pitting the French against the Irish. By 5 p.m. on Friday evening, the bars were already overflowing with drunken Irish fans. They wore green jerseys and were singing, "Sail, bonny boat…"as we walked by.

Guitars come with many different brand names at the end of the neck. But inside the box, we noticed that almost all guitars under $400 were made in China. We bought an Ibanez acoustic for 189 euros. Made in China, of course. Nice instrument

*** Our Pittsburgh correspondent, Byron King, comments on Jacques Derrida’s passing:

"Of course, Derrida and his philosophic snake oil was/is a pseudointellectual byproduct of an elastic currency and lack of a gold standard. (Whoops…there I go, showing my inherent bias. Damn. I hate it when that happens…) But I shall go on…

"In a hard-money world where people had to work at a real job and earn a living by being productive, no one would have time for Derrida’s nihilistic deconstructionism. The nation would be at peace, because it could not afford to go to war. The citizens would be at work, because they could not afford to be idle. The children would be in school and learning real subjects, because they could not afford to grow up and be stupid. And the politicians would be in Washington and London, Harrisburg and Annapolis, making sure that things stayed that way, because they could not afford to get voted out of office for screwing it all up."