The Wealth Illusion

by Bill Bonner

Mr. Vernon W. Hill, a Monroe County banker, considers the “wealth” accumulated in the housing market an illusion, as we do.He believes it will lead to big problems among both borrowers and lenders.To avoid the big problems personally, Mr. Hill, like Warren Buffett, lives in the same house he bought nearly 40 years ago.Avoiding the big problem professions, Mr. Hill requires prospective borrowers to show him their finances without considering the house they live in.Whatever value there is in the lived-in house, he says, is “inactive.”It doesn’t really earn any money for you; if you were to sell it, you’d just have to buy another one.And you can’t ship it to China to pay for your flat-screen TVs or to Japan to pay for your SUV.

This point brings us back to today’s news and to the duo appearing in today’s International Herald Tribune.Mr. David H. Levey was formerly managing director of Moody’s Sovereign Ratings Service.His sidekick, Stuart S. Brown, is a professor of economics and international relations at Syracuse University.The two argue, “U.S. Hegemony Has a Strong Foundation.”The two are talking big.They are talking macroeconomics, with no trace of Mr. Hill’s modest insights, or his private knowledge, nor his 37 years of experience lending money, nor the keen and immediate attention of having his own money at stake.Instead, the two economists merely play their role in the public spectacle.

What Levey and Brown are trying to tell us is that we have nothing to worry about.Yes, it is true that we Americans spend 6% more every day than we earn.Yes, that $8.1 trillion worth of U.S. assets are in foreign hands…and that our net international investment position has gone negative at more than $3 trillion.And yes, it is true that we save nearly nothing.But we can still feel good about ourselves, they say.

The numbers obscure “the United States’ institutional, technological and demographic advantages,” they say.What are those advantages?The two never quite say.But what could they say?Other countries have different institutions.Others have different demographics.Others use different technologies.Who knows which is an advantage and which is a hindrance?You only know – and then, only by inference – after the fact.At the height of its bubble in 1989, it was widely presumed that Japan had the all the advantages.Hardly a single issue of the business press failed to mention them.Now, 15 years and a major slump later, Japan seems to have all the disadvantages…while the advantages somehow crossed the Bering Strait into North America.

Today, the mainstream press tells us how dynamic, flexible or open the U.S. economy is.Yesterday was no exception.At the end of their article, Levey and Brown tell us that nothing we are doing now is a problem.The only real threat is that “protectionism and isolationism at home will put an end to the dynamism, openness and flexibility that power the U.S.”

We can’t help but remember French military policy after the Franco-Prussian war.Led by Colonel Grandmaison, the French allowed words to replace tactics and strategy.“Élan’ was the word.It meant – “spirit” or “force of will.”When WWI began, the French attacked…on horseback…swords glittering…What élan!What style!What blockheads.The German machine guns opened up and soon handsome young soldiers covered the ground.Élan proved great for poets, but bad for war.

And now, Americans put on their own gaudy tunics – so proud of their “dynamism,” their “flexibility,” their “openness.”Who cares that they spend more than they can afford?Who worries that we have no savings…and now depend on the kindness of strangers in order to maintain our standards of living?Who realizes that the Chinese or Japanese could bring the United States economy to its knees with a single word?

But, what about our houses?Aren’t we rich?So what if the Chinese and Japanese sell our bonds, we still have our houses!

The two economists note, “when you include capital gains, 401(k) retirement plans, and home values, U.S. domestic saving is around 20 percent of GDP, the same as in most other developed nations.”

They should talk to Mr. Hill.They don’t seem to realize that home values are “inactive.”We have yet to hear of a factory built with increases in house prices.We have yet to see a debt paid from a rising house price – without an equal debt arising somewhere else.

“Much of our meager savings and massive borrowing has gone into housing,” says the Monroe County banker.“How convenient it would be now if mansions and subdivisions could be exported, to improve our foreign trade balance.Since they cannot be exported, perhaps the foreigners who own our massive debts can be repaid by coming to live in our McMansions, with homeowners serving as houseboys and house maids to the visiting Japanese and Chinese owners of our debt.”