America's Reality

Did Hurricane Katrina strike a robust or a fragile and vulnerable U.S. economy? According to many, the economy was expanding strongly – however, Dr. Richebächer thinks otherwise…

Corroboration was seen in particular in recent job gains that were fast enough to lower the unemployment rate to a four-year low of 4.9%.

In our view, the plethora of statistical data was overwhelmingly pointing to slowing economic growth.

Consumer spending may have remained surprisingly resilient, but considering its feeble underpinnings in the housing bubble, the time before a marked pullback is, in any case, rather limited. All that is needed to stop the consumer borrowing-and-spending spree in its tracks is a halt to the rise in house prices, implicitly finishing the provision of increasing collateral for higher borrowing.

Reported payroll growth over the first eight months of 2005 has been 1,506,000, averaging 188,000 per month. To those who are impressed, we have to say that this gain is 40% below the average job growth at this stage in past business cycles. Apparently, most economists have jumped to the happy conclusion that ample construction efforts will soon more than offset the initial hit to economic growth. Devastations are not subtracted from growth, while reconstruction is added to it. Such damage has, therefore, generally tended to boost economic growth.

But this time there is a big difference. Past hurricanes have generally hit resort and retirement areas. Katrina has shut down significant regional economic production and port facilities. The Gulf of Mexico accounts for 30% of U.S. oil production and 23% of natural gas production. Economic activity will be significantly constrained from the supply side. In 2004, Louisiana and Mississippi produced 1.2% and 0.6% of U.S. GDP growth.

To quote John Williams’ Shadow Government Statistics: "The U.S. statistical bureaus face a reporting nightmare in the months ahead. Door-to-door surveying, telephone surveying and company reporting from the storm-damaged area will not be possible for a month or two, perhaps longer. Many businesses no longer exist. That means that employment and unemployment data, in particular, will have to be guesstimated, and those guesses mean that the Bureau of Labor Statistics can come up with any numbers it desires."

Bond Bulls: A House of Cards

With great interest and attention, we are pursuing the struggle in the U.S. bond market between a large bearish community apparently betting on an impending recession or a period of slow growth triggering the accustomed "Greenspan put" – and a Federal Reserve displaying unprecedented determination to enforce higher long-term rates, so as to slow the housing bubble, increasingly fueled by speculative fervor.

In our view, the bond bulls are right about the economy’s weakness. The U.S. recovery is grossly ill-natured, depending fatally on continuous strong support from "asset-driven" consumer spending. Stopping the housing bubble is sure to stop the mortgage refinancing bubble. To us, this seems like pulling the rug from under the table.

While the bond bulls appear perfectly right in their dire assessment of the economy, we think they are playing a dangerous game. Under apparently tremendous pressure to produce profits, they risk a clash with the Fed. For the Fed people, on the other hand, their credibility is at stake.

This might well force them to go further with their rate hikes than they intended.

Further, it has to be realized that today’s U.S. bond market is a house of cards. Maintaining long-term interest rates at their present level needs a steady, huge stream of carry trade creating artificial demand for assets.

Financial credit soared in the second quarter to $1.124.8 billion at an annual rate, from $648.8 billion in the prior quarter.

If the Fed cracks this trade by inverting the yield curve, this would send long-term rates steeply up. A fire sale of unimaginable proportions could begin, with bond prices crashing. Comparing the credit explosion with the savings implosion and also with a consumer inflation rate now up 3.6% year over year, U.S. interest rates are, in any case, ridiculously low.

Lately, another conundrum has caught our attention: the unprecedented huge and growing wedge between soaring credit growth and dwindling money growth. Our investigations identified two main culprits: the U.S. trade deficit and escalating Ponzi financing of unpaid interest.

The best-known fact about the U.S. economy’s recession in 2001 is its extraordinary mildness. There were only two quarters with negative growth. For the year as a whole, real GDP increased 0.8%. This compares with an average decline of real GDP by 2% during previous postwar recessions.

An economy’s performance during recession, generally lasting one year, is certainly an interesting aspect. Yet far more important are the strength and pattern of the ensuing recovery over three, four or more years. In essence, it lays the foundation for future longer-term growth. Its composition between consumption, investment, net exports and government spending is, therefore, of utmost importance.

Bond Bulls: The Odd Pattern of the 2001 Recession

In actual fact, the 2001 recession already had a totally unusual pattern. Prior recessions were triggered by monetary tightening responding to rising inflation rates. Essentially, this put a sharp curb on all credit-financed spending. In practice, these were mainly business investment, both fixed and inventories; residential building; and consumer durables.

Unlike all prior experience, the economic downturn that developed in 2001 clearly had its cause not in tight money and credit. True, during the first half of 2000 the Fed had hiked its federal funds rate in three steps to 6.5%. Yet with a generous provision of bank liquidity, it accommodated a credit expansion of record pace. For the first time ever, the U.S. economy went with roaring money and credit growth into recession – a mild one, though.

Business fixed investment plunged over two years virtually in splendid isolation. Measured in real terms, it fell by 4.2% in 2001 and by 9.2% in 2002, followed by unusually weak growth of 1.3% in 2003. It was by far its worst performance in any postwar business cycle. This investment slump unequivocally broke the boom.

What followed the unique 2001 recession pattern was an equally unique pattern of economic recovery. Still, the unusually fast and aggressive easing had its spectacular immediate and widely trumpeted success in the mildest postwar recession.

Consumer spending never paused, increasing by 2.5% in 2001 and 2.7% in 2002. Its largely credit-financed component of spending on durable consumer goods raced ahead by 4.3% in 2001 and 11.7% in 2002. Equally exceptional was the behavior of residential building. After a slow start, it took off into the famous housing bubble.

Business fixed investment, normally a main driver of recoveries, refused to respond at all. Rather, it accelerated its decline during 2002. And this, in fact, has become and remains America’s central structural problem. Though it has recovered from its lows, it is no higher than in 2000.

As the recovery developed, American publicity kept hammering into people’s heads that the U.S. economy is greatly outperforming Japan and Europe. This conveniently diverted attention from the fact that in reality America had its most anemic recovery in the whole postwar period by any measure.

Still, different measures show very different results. By the reported productivity growth, this recovery resembles a "new paradigm" miracle. By the real GDP numbers, the economy appeared to be doing quite well, though much worse than in past cycles. But in terms of employment and wage and salary growth, this recovery has been and remains a disaster.


Dr. Kurt Richebächer
for The Daily Reckoning

October 25, 2005

The Fed has remained irrationally confident in the U.S economy – because they can’t afford from American consumers to see the truth – that the basis for this confidence is a shamelessly fraudulent farce of trumped-up statistics.

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."

Just as there are always ways to make money…so are there always ways to spend it. Nature, with her majestic sense of mischief, provides that for every dollar made there arises a dollar’s worth of spending that otherwise would not exist. The man who invented double-entry bookkeeping was a genius. For just as you bring nothing into this life, so must you take nothing out. The sum of energy and mass in the universe is always constant. Credits must equal debits; everything must balance out.
These thoughts brought a smile to our face as we wandered around the Lion d’Angers yesterday. Lion d’Angers is a place in the Loire Valley. It is also a great sports attraction – a Super Bowl of sorts for the horse world – where people do "three-day eventing," the sport that cost Christopher Reeves his life. The first day, the riders do dressage. The second, they compete at cross-country. On the third day, the horses jump over a series of obstacles.

We are not fans of spectator sports, among which we would rank three-day eventing somewhere between golf and tennis; that is, not as boring as golf and less exciting than tennis. But at least there is always the hope that a rider will take a fall and be carried off on a stretcher.

Lion d’Angers is an international competition. Riders come from all over the world to compete. There were teams from Italy, Germany, New Zealand, Russia, Sweden, and even the Ukraine. But there were no American riders for some reason. The closest thing to a U.S. presence was one horse on the French team named Key West, owned by none other than Madame Bonner. So, yes, we had a dog in this race. Even so, your editor couldn’t work up much enthusiasm for it. Like baseball, there are long stretches when nothing much happens. And then when something does happen, it is a bit of a letdown. A horse gallops up and jumps over a few bars. Bravo! That is what he is expected to do. The excitement only comes in small units, when something unexpected happens, such as when the horse stumbles and falls, crushing the rider beneath him. This doesn’t happen very often, and did not happen yesterday. But when it does, the crowd feels vaguely guilty for wishing it on him. It’s very much like a group of gawkers at a hanging, eagerly waiting for the trap door to open and the rope to stretch…and then they feel a bit sorry for the man at the end of it.

The most serious teams, the English especially, came with lavish equipment and entourages. They drove over with several horses in enormous vans, equipped with small apartments. Elizabeth explained how the business works:

"These are horse breeders. They know that if their horses do well they’ll be able to sell either these horses or their offspring for a lot of money."

"How much money?"

"Well, a decent performer will go for about $50,000. A real winner with the characteristics that people are looking for, such as a good Anglo-Arab with plenty of Arabian blood, can go for $150,000 or more. People spend a lot of money on this sport."

But Elizabeth proves that the sport is open to amateurs, too. She bought a horse fairly cheaply and found a rider to mount him (she rides well herself, but not quite at that level). If the horse did well, she figured, she could sell him or put him at stud and at least double her investment.

The final event, yesterday, was the jumping. Poor Key West seemed a bit tired. He knocked down one of the poles. This alone would not be too damaging, but it was a tight race, and the defending champion had just done the course without touching a single one.

The next rider, an Italian, also cleared all the hurdles, despite the fact that a white and black dog had gotten loose and chased him all around the track yelping at his horse’s hooves.

"That happened at another competition I attended," Elizabeth noted. "A dog got away from one of the trainers and chased someone around. The horse spooked and the rider fell off; he broke his shoulder and was disqualified. You can imagine how the poor dog owner felt."

We never found out how yesterday’s dog owner felt, but we could imagine. At the end of the day, a girl came up to us with the dog on a leash. "Do you know whose dog this is?" she asked. She had been going all over the field trying to match the dog with its owner. No one admitted ownership. Evidently, the owner was too mortified to claim him. (More on this below…)

Now for the news, from our team at The Rude Awakening…


Eric Fry, reporting from Wall Street:

"I’m a faithful reader of your monthly newsletter," your editor began his recent half-day discussion with Dr. Richebacher in Cannes, France. "And I accept your grim diagnosis for the U.S. economy. But I don’t want to accept your equally grim prognosis. I understand, for example, that our economic imbalances are considerable. But I don’t want to believe that they are insurmountable. Isn’t there some way for us Americans to tip-toe away from the precipice of disaster?"


Bill Bonner, back in Paris…

*** In the last weekend edition of The Daily Reckoning, we asked for you to write in and voice your opinions on America’s impending oil shock. The responses have been clogging up our inbox here at the DR HQ, so we will make a point to publish one or two reader comments each day…

"Well, there’s the easy way and the hard way. The problem is that the energy industry wants us to believe that the easy way is the hard way and vice versa. As Inigo Montoya said, ‘Let me ‘splain. No that will take too long. Let me sum up.’

"The easy way starts with a tube of caulk. You put it in the cracks around your doors and windows. You can either put in more effective windows or put up plastic with double-faced tape each winter. (Investment in new storm windows beat the Dow in returns over the past 30-odd years.) In the summer, close the curtains on the sunny side during the day. Open them to let the breeze blow through at night. Use a fan. Take the money you save and invest it in a few inches of insulation in your attic or crawl space. Wrap your hot water pipes with foam. Get a timer that will turn your hot water heater off for a few hours every night. Set the thermostat on the hot water heater so the water coming out of the tap is just right and you don’t have to temper it with cold water. But no, that’s HARD! Too much work! Just crank the thermostat, will you?

"OK, lets take the next easy step: buying or building a house? Make sure the long side faces south and the biggest windows are on that side. There’s a simple calculation you can do to figure out how wide the eaves have to be so that you will get maximum solar gain in the winter, when the sun rides lower in the sky, and have the entire window shaded in the summer when the sun is higher. Heck, builders could even work this into the design of developments and use it as a selling point.

"Lets take an even bigger step here, and look at how our cities and towns are laid out. Is there a store you can walk to? Should a portion of each residential neighborhood be zoned commercial? Are there any unused railroad tracks? Would it be possible to renovate them and create small commercial centers served by a rail transit line? WHAT! Not in MY neighborhood!

"Gee, let’s look at the Federal level. Transit is the biggest burner of petro products. How about increasing fuel efficiency standards? Improving public transit? And violate the Sacred Constitutional right to own a Hummer? How DARE you! Commie.

"Then there’s the easy way. Just keep living your life as you have, paying more and more to support it. When you run out of money, you still have plenty of alternatives. You can make the right moves (and only the right moves) in the stock market. Moonlight. Join a multilevel marketing organization. Win the lottery. Failing that, you can run up your credit cards, burglarize your neighbors, embezzle a little at work, sell pot or cocaine, whatever it takes to bravely continue the American Way of Life, so the sacrifices of our brave boys in the Middle East will not be in vain.

What could be easier?"

*** The winners were finally announced, late in the day. By then, we had found a bar and managed to spend a few happy hours discussing the business with a friend.

"It’s a terrible business," he explained. "It costs a fortune to buy, train, feed, and transport these horses. But people like it. It’s a bit like the restaurant business. I had a restaurant. It was fun…for about two weeks. Then, it was a nightmare. The horse breeding business it a bit like that. But maybe not…people love to get plaques and trophies that they can put on their wall."

The winner of the six-year-olds (horses, not riders) was a young German woman, while the local favorite, last year’s champion, a Frenchman with considerable élan, won the prize for the seven-year-olds. He had style, taking a nice victory lap around the course, raising his hat in the air. He reminded us of one of Colonel Grandmaison’s cavalry, who looked so handsome and so elegant just before the German machine-gunners cut them to pieces.

But the list of prizes was as long as the ceremony. Elizabeth’s horse, Key West, was at the very end of them – number 14. He didn’t win. But at least he placed; he is "classe," as they say.

Elizabeth got an oval, blue plaque about the size of a hot plate. "Did you win any money?" we asked.

"Yes, about $150."

The Daily Reckoning