A Quicksand of Debt

"Nobody can ever gauge the full impact of a great intellectual in the development of culture," writes Lew Rockwell. "His influence spreads like waves in a lake; by the time the waves hit the shore, few are in a position to remember the source. But this much I’m sure of. We are in Hans Sennholz’s debt far more than we know." Here is his latest work…

"Out of debt out of danger" is an old proverb that says it all. It applies to personal debt as well as to the liabilities of business and government. It may even pertain to the world monetary order and the U.S. dollar standard that rests on mountains of debt. They cast dark shadows not only on the dollar itself but also on American economic conditions.

The world monetary order consists of a large assortment of national currencies all of which are fiat money. They are made legal tender by the decree, or fiat, of their governments. The U.S. dollars we know are money because the courts say they are legal tender and we accept them. Internationally, they have no legal status but are readily used because of their relative prominence and good repute.

As the world’s most popular money, they have become"standard" money. Unfortunately, it is a precarious standard that may soon sink in the quicksand of debt.The Federal Reserve manages the standard in utter disregard of basic principles and laws of economics. It blithely and routinely ignores market rates of interest that limit the demand for loan funds to the supply of savings. It prints money and creates credit at will, allowing member banks to borrow new funds at one percent and then relend them happily at 4, 5 or even 6 percent. Its bargain rate induces financial institutions to extend new credits not only to the federal government itself but also to business and consumers. Guided by popular notions of the benefits of money creation and driven by political concerns, Federal Reserve governors take pleasure in keeping their interest rates far below market rates in order to stimulate and activate the economy, thereby creating bubbles of debt.

During the great stock market bubble of the 1990s, growing current-account trade deficits signaled a rapid flow of American funds abroad. Between 1992 and the first quarter of 2002 they moved in payment of the annual excess of imports over exports of goods and services actually rose to some $500 billion or five percent of gross national product. Other countries obviously run trade surpluses that cover these deficits, acquiring masses of U.S. dollars or U.S. Treasury obligations. Japan is by far the largest American creditor country, followed by China and the newly-industrialized and developing countries in Asia. In recent months they were joined by the oil-exporting countries, including Russia and Norway, which are the temporary beneficiaries of soaring oil prices.

A world economy that labors under such chronic imbalances with goods and services flowing to the biggest and richest economy and its fiat money drifting to poorer countries is highly unstable. Some foreign observers even call it "perverse;" for this reason, they are searching for new ways to sustain global activity that does not rest on a growing mountain of U.S. debt. But they need not search far; inexorable economic principles are bound to force a correction.

According to an optimistic view of global readjustment, a gradual fall of the U.S. dollar relative to the Euro and other currencies would facilitate a smooth correction. In the United States, goods prices would rise gradually thus boosting industrial output and reducing unemployment – provided the costs of labor do not rise as rapidly as goods prices. In creditor countries with floating exchange rates, currencies would appreciate toward the dollar and thus facilitate trade readjustments. In creditor countries with fixed or tightly managed exchange rates, such as China, the imbalance is likely to continue as long as they retain their rigid attachment to the U.S. dollar. If China should ever sever its connection to the dollar, the rest of Asia undoubtedly would follow suit and facilitate the readjustment.

There are other noteworthy scenarios. One is a sudden rather than smooth decline of the dollar. It would not take much to upset an international configuration in such imbalance. An abrupt fall of the dollar would trigger sharp rises in long-term interest rates and steep falls in American asset prices. They in turn would reduce household spending, which would aggravate the economic slowdown. In reaction, the Fed may accelerate its debt-monetization and dollar depreciation.

Yet another possibility is that China and its Asian partners will resist exchange-rate adjustment to the bitter end. It would delay the correction in the short run, but would aggravate the accumulation of bad debts and worsen the inevitable adjustment in the long run.

The worst conceivable scenario would be a combination of present monetary and fiscal policies together with an explosion of American protectionism. Present policies alone may lead to an abrupt fall of the dollar and all its dire consequences. To block readjustment by sheltering domestic industries from foreign competition would make matters worse. To exclude certain imports or impose new duties on imports from creditor countries undoubtedly would be popular with protected industries but highly contentious in creditor countries. For a debtor to strike at his creditors always is ill advised and unwise; it may spell the end of the world dollar standard.

A mountain of debt casts a shadow on the brightest place. American current-account trade deficits and foreign debts are casting a dark shadow on the U.S. dollar.


Dr. Hans F. Sennholz
for The Daily Reckoning
July 8, 2004

Dr. Hans Sennholz is president emeritus of The Foundation for Economic Education (FEE) in Irvington, NY. Lew Rockwell has recently posted an essay on the Life of Hans Sennholz.

His essays and articles have appeared in over thirty- six major German journals and newspapers, and 500 more that reach American audiences. Dr. Sennholz is also the author of 17 books covering the Great Depression, Gold, Central Banking and Monetary Policy. You can write to him by sending an e-mail to this address: hans@sennholz.com.

Who’s crying now?"

It was late at night and someone was crying…your editor didn’t know who. He had been reading about gold rising back over $400. About total credit market debt rising to 299% of GDP – higher than the 270% reached in ’29. About CEO’s and corporate directors whose pay rises 5 to 10 times faster than the rest of the economy…and rising mortgage demand, caused by falling rates.

But he is on vacation, trying to not pay attention to the markets. Besides, he has a large family…and other things to worry about. More notes from a small cabin, below…

But first, here’s Addison Wiggin in Baltimore:


Addison Wiggin, from ‘Mobtown’…

– The votes are in. The confederacy of dunces has spoken: 2004 GDP growth is predicted to reach a new 20-year high of 4.7%.

– "We are moving into a sweet spot for the economy," said the appropriately named Diane Swonk, chief economist at Bank One, "with interest rates not too high, jobs coming back and business investment providing strength."

– The Bond Market Association’s economic advisory committee, too, expects the strongest annual growth since Reagan was running for re-election in 1984. (At that time, Reagan managed to conjure up a stunning 7.2% growth rate.)

– The ‘sweet spot’ won’t be accompanied by inflation either, says a survey of analysts and economists published by the AP. Last month’s high inflation rate is "unsustainable." They predict the CPI will settle down to a more palatable 3.1% for the year as a whole. Next stop: Economic nirvana!

– But that’s not all…when you buy now, you get a free six months of employment growth thrown in… free! These boffins expect at least 200,000 jobs to be added each month for the next six months (discarding June’s weak number as an aberration in the trend). Wouldn’t that be spectacular?

– Just in time, we hesitate to add, Mr. Bush needs exactly 1.2 million new jobs before he escapes the distinction of being the "first president since Herbert Hoover in the great Depression to have lost jobs while in office.

– "We are looking for a darn good year" chimed another optimistic chief economist to the AP, "despite the fact that we had a big jump in oil prices and interest rates are going higher than people thought would occur," Hmmmm…

– Heady stuff indeed, but here at the Daily Reckoning, your editors are reluctant to swallow the consensus predictions without, at the very least, a small measure of due diligence; we turn to the markets for help…

– The Dow yesterday closed down 214 for the year. The S&P 500 is only up six points this year. Nasdaq is now down 47 points in 2004, equivalent to 2.3%. Despite the flush patina on yesterday’s headlines, none of the three major indices moved significantly yesterday.

– "So what else is new?" Alan Abelson, Barron’s master craftsman asks. Predictions such as those that litter yesterday’s press only provide one thing: "solid confirmation of the errant nature of forecasting… especially that genre of the black art that traffics in financial and economic auguries."

– Mr. Abelson is referring specifically to a study he received from one Pierre Lussier, of the Investment Information Provider. Having gone back to 1982 and analyzed the Street’s forecasts and predictions, Mr. Lussier concludes that the savants are awful – as in really BAD – at predicting GDP and inflation…although they seem to be relatively successful at predicting unemployment.

– One-year predictions for nominal GDP were 102% wrong, for example. Two-year forecasts? They were off by 109%. Their inflation targets were out by 29% over one year and 41% over two. As for unemployment predictions, the street performed much better…they were off by only 5% on a one-year forecast and 12% on a two-year.

– Never fear. "Rather than worry about whether [analysts] get it right or not," says our intrepid analyst Dan Denning, "recognize that the world is built on randomness and your financial security with it…why not take Pascal’s wager instead…hoping you’re wrong, but hedging your bets in case you’re right?"

– The biggest problem you face may in fact be well beyond your control. "The Federal Reserve and the Federal government have betrayed the American people," Dan writes, "They’ve robbed savers by destroying yields in the money market. They’ve issued debt that will either destroy America’s credit rating when the government defaults, or take Americans generations to pay back…"

– Dan, as you may be aware, is on an 11-week sojourn

through the wilds of Asia and Australasia. At the moment he’s in Perth, Australia. Yesterday, he reports, he was checking out the Perth Mint. While there, he had three gold-plated silver coins minted – each coin is worth 1 Bill Bonner, and stamped with the Reckoning Day Reserve, July 4 2004 DDGU (dollar down, gold up).


Bill Bonner, back in Canada…

*** "Currently investors’ attention is focused on the threat of inflation – rising prices – rather than deflation," writes old friend, Martin Spring.

But inflation may be less of a threat than deflation. Because of…

– The spread of the Internet…slashing costs and boosting productivity.

– The competitive pressure from Asian countries, becoming stronger manufacturers with the rise of China, and emerging in services with the international outsourcing of back-office administration, customer services, programming, engineering and research.

– The intensifying competition as a consequence of deregulation, liberalization of world trade, privatisation, and the spread of market capitalism in the developing world. This has produced global excess capacity for all manner of goods and services, old and new…

– The emergence of an international monetary system hostile to inflation. Central bankers share a commitment to keep prices stable. In any case, they have no choice. At the first signs of an inflation problem, global capital will flee the currency while bond investors will drive up interest rates – both producing immediate unpleasant political consequences for governments.

Most reputable economists believe that if falling prices were to become a problem, all the authorities have to do is print more money. As Ben Bernanke, a governor of the US central bank and an expert on the Great Depression, has argued: "Under a paper money system, a determined government can always generate higher spending and hence positive inflation."

One objection to this comforting view is that in Japan, the world’s second biggest economy, they’ve been trying such a policy for years, since the bursting of its property and stock market bubble, without success. (Although it may be argued that without such measures, Japan would have suffered a depression rather than just low growth).

The Japanese government has introduced such huge spending packages, financed with borrowed money, that its bonds have acquired a Third World credit rating. And for the past five years the Bank of Japan, the central bank, has been "printing" money by offering credit at virtually zero interest to the commercial banks.

Nevertheless, prices have continued to fall."

*** "F***!" Just as Eskimos have something like 60 ways to describe snow, so do Americans use the word "f***" in a multitude of contexts," Byron King elucidates the mother tongue. "Most of the uses are inappropriate, to the point of being offensive. On that aspect, Elizabeth is entirely correct in her critique of Yankee argot. But not all uses are out of bounds.

Back in Navy Aviation Officer Candidate School in Pensacola, our Marine Corps Drill Instructor must have had 308 different uses for the word…noun, pronoun, verb, adverb, adjective, gerund, connector. You name it, he could "f***" it. He could take that one ancient, four-letter word and insert it into English, Spanish, Russian, Korean and Vietnamese, and even do it in all those languages in the same sentence.

Somehow or another, when that short collection of letters of the alphabet left the mouth of that Gunnery Sergeant, it made perfect linguistic sense and you knew exactly what he was trying to communicate. It was a prefix, a suffix, a modifier. It was a description of high praise, of insult, of respect, even of affection.

It served as a substitute for numbers, for colors, for times, for speeds, for distances. It was a word with one syllable, spoken quickly.

Or it was a word with one syllable, spoken slowly. Or it was a word with two or sometimes three or even four syllables. While the word may not be epic poetry in the Homeric tradition (but since Homer was communicated orally for centuries until his tales were written down, how would we know?) However, properly spoken, the word is a key element of modern military oral communications.

When I think back on it, I do not believe that my Drill Instructor ever used the word in reference to anything having to do with sex."

*** Our friend in Paris, Michel, writes to tell us that, in American movies, the use of the word ‘F***’ is controlled by Hollywood’s censorship system. He explains that ‘the U.S.A. is the only country in the western world that exercises such a censure on the language in films (especially in the last 7 or 8 years)…for reasons that a sociologist would have to analyze…and that escape the French altogether. In this respect, the French are freer than Americans."

*** And another old friend:

"I could not agree with Elisabeth more. It is appalling that the word is used so casually, not just in rated-R movies by the villains, as you say, but all over, in places one would not expect (Disney movies, The Economist, FT, Spectator etc.) It used to be that no movie was complete without a bedroom scene; now it needs at least one f*** to be a real movie. (I am also astonished at the movies that are often shown on the screens in airlines. Even without with headphones, they are not suitable for the entire planeload.)

*** Notes from a small cabin…

The Northwoods of Canada are immense. But the cabin on Milford Lake is tiny. It is not the place for secrets.

Someone was crying. We could hear the whimpering sobs. But we couldn’t tell which bedroom they came from. In one, Jules was upset following a discussion of college plans. His mother wants him to approach the matter more resolutely. She wants him to apply to her alma mater, Harvard. Jules is not sure he wants to go to college at all.

In another bedroom, Edward has been banished, after being rude to his mother. We don’t know what the 10-year-old had said, but we can imagine. His mother has been trying to get him to keep up with his french schoolwork, even on his summer vacation. The boy thinks he deserves a break.

Another bedroom is shared by two teenage girls; one can’t stop thinking of her weight, the other can’t stop thinking of her boyfriend.

Henry was in the clear, reading quietly in the corner.

There are advantages to having a large family, dear reader.

Families are humbling. And here at the Daily Reckoning, we appreciate humility more than any other quality. With us, humility is not a virtue; it is a conceit.

A large family humbles parents; there is a crisis every day, and not many of them can you do anything about. That is why you should never trust a politician or an economist who doesn’t have a large family. In the first place, he will not be humble enough. In the second, he will have time on his hands.

A politician with a small brood is likely to think he can feed the multitudes; a man with a large family knows he cannot even get his own model-thin daughter to eat. A bachelor economist is susceptible to the delusion that he can change the behavior of whole nations; a man with a large family knows he cannot even get his own children to straighten up.

"What’s wrong?"

Your editor had finally located the source of the sobs and asked the appropriate question. He thought he already knew the answer.

"I’m just thinking about John," said Sophia. "I miss him. And I know…sniff, sniff…I’ve broken up with him before. But this time it’s final. I went to see him just before coming up here. I explained that I just wasn’t ready for the kind of commitment he wanted from me."

"Honey, don’t worry about it," said Pater Familias. "I’m sure you’re doing the right thing. Cheer up. Remember, tomorrow is your birthday."

"I’m sure I’m doing the right thing too… but I already feel lonely. He may not have been the perfect boyfriend, but he was nice to me…and it was nice to have him around.

"And that birthday thing…well, it makes it worse. I feel like I’m getting older. I’m not a kid anymore… I’m an adult. And I’m already making a mess of my life…"

"Oh, c’mon Sophia, you’re only 22. You’ve still got a lot of life to make a mess of," said her father, comfortingly.

The next morning at breakfast…

"Shhh…Mom, not so loud."

Jules was embarrassed. His mother was explaining to the family how Galileo got in dutch with the church in the 17th century.

We were sitting in the dining room at our guesthouse in Milford, NS. Oddly, the room was deserted at 8:30 pm. Almost all the diners had finished and left. But we lingered. We could barely believe they expected us to eat before 8PM. Jules figured they expected us to keep quiet too.

"Mom, not everyone wants to hear you talk about Galileo," Jules explained.

"Other families talk about normal things," Maria took up the issue. "Like the weather…and how we’re doing in school and so forth. You talk about the strangest things.

"Also, in America people don’t sit around and have long dinners talking about all kinds of things, not like they do in Paris anyway. They eat and get on with it."

"Well, I’m going to tell you about Galileo anyway…because it’s important.

"Galileo had bought a rudimentary eye-glass from Holland. And then he improved it so he could see the planets with it. He noticed, among other things, that the moon was not a perfect sphere…and that Copernicus was right, the Earth was not the center of the universe, but just another planet.

"He explained this to the pope, Urban I think, who seemed genuinely interested. The church really had no opinion about how the planets worked. The planets are not even mentioned in the Bible, and Galileo believed there was nothing in his observations that ran counter to revealed truth. The Bible showed people how to get into heaven; it did not pretend to instruct man on how the heavens themselves were arranged. Still, he had enemies in the church as well as supporters.

"When he pointed out that the moon was not a perfect sphere, it ran counter to the idea that churchmen had of the cosmos. They believed that while the Earth itself was full of woe, the heavens were perfect. Aristotle himself – whom Thomas Aquinas had squared with church thinking – maintained that the all the planetary bodies were perfect spheres. Galileo seemed to be calling into question their whole idea…

"The big difference was that, before Galileo, people had various ideas about things and more or less took it for granted that their ideas were correct. But Galileo actually looked. He began what we know as the ‘scientific method’ – by developing a body of observations and then figuring out when they might mean."

Galileo got in dutch with the papal authorities not because he challenged its view of the cosmos…but merely because he challenged it at all.

"The church thought it had a monopoly on the truth," Elizabeth explained. It didn’t appreciated others muscling into its territory.

"But how did the church know that what it thought wastrue," asked Henry. "And it turned out it was wrong, didn’t it?"

Elizabeth was reading a book entitled "Galileo’s Daughter." Like Henry, she has a remarkable ability to shut out distraction and concentrate her attention on an idea…a book…or a conversation.

But by the end of the evening…even she was in tears…

To be continued…

The Daily Reckoning