An Evasive Recovery

The Daily Reckoning PRESENTS: We live in a bubble economy. And eventually all bubbles run out of steam – the United States economy included. The big question here is: are we in for a hard or a soft landing? Dr. Kurt Richebächer explores…


In the early 2000s, Mr. Greenspan earned himself the honorable title of “serial bubble blower.” Fearful of a painful burst of the equity bubble, he aided and abetted a bond bubble in order to boost the housing bubble. Measured by the mildest postwar recession, it appeared a smashing success. But taking measure of the following anemic recovery, and particularly the following dismal employment and income performance, into account, it was an utter policy failure.

Any assessment has to further take into account that the government and Federal Reserve have supported this recovery with unprecedented fiscal and monetary lavishness. Tax cuts reduced government revenue by $870 billion, while the Federal Reserve slashed its fed funds rate to 1%, its lowest level since the Great Depression.

The decisive failures of these policies have been in business fixed investment and in employment, both displaying a drastic shortfall in relation to reported GDP growth.

Historical experience and economic theory leave no doubt that business fixed investment and employment play the crucial role in providing economic growth with the necessary traction to become self-sustaining. Even in its fifth year, the present U.S. economic recovery remains fully dependent on the housing bubble to drive the consumption bubble.

The same, by the way, applies more or less to all Anglo-Saxon countries. Over the past few years, all of them have hung on the steroid of inflating house prices providing the collateral for outsized consumer borrowing-and-spending binges. Their further common features are large budget deficits (except Australia), very low savings and large trade deficits (except Canada).

All of these economies have, in essence, become bubble economies. This means that monetary policy impacts the economy primarily through inflating asset prices, which in turn stimulate and facilitate credit-financed consumer spending.

An important adverse feature of all asset and credit bubbles is that they inherently break an economy’s pattern of growth. In all the English-speaking countries, the credit excesses have primarily inflated house prices. Using these as rising collateral, consumers have enjoyed unprecedented borrowing facilities to spend as never before in excess of their current income. What resulted were extremely unbalanced economies.

Distorted demand over time invariably also distorts the economy’s supply side. What has actually happened in all these countries is that domestic spending has increasingly outpaced domestic output. On the other hand, low domestic saving and capital investment keep a brake on output growth. The infallible result in all these countries, except Canada, is large, chronic trade deficits. Evidently, all this is structural, not cyclical.

Essentially, the low savings, the low capital investment and the soaring trade deficits act as major drags on economic growth. Over the past few years, these drags have been offset by the rampant demand creation through the housing bubbles. But the trouble with this recipe is that it worsens the structural distortions and imbalances.

Nevertheless, all asset and credit bubbles eventually run out of steam. Plainly, this is going on in all these bubble economies, the United States included. For us, the key question about whether there will be a hard or soft landing is the extent of the prior excesses. They are the worst in history.

The consensus sees new momentum in the U.S. economy from strong retail sales. We focus on the inflation-adjusted monthly figures for overall consumer outlays and observe the opposite. There are sharp fluctuations in spending on durables, but with a distinct downward trend.

As everybody knows, or ought to know, the strong monthly changes in consumer spending have their main cause in the sharp ups and downs of auto promotions. In the quarterly GDP reports, they are even annualized. But comparing the above figures, it strikes the eye that the recovery in the last three months was very much weaker than in the prior downturn.

Any assessment of the U.S. economy’s further course has to start with the recognition that the housing bubble is doomed, and in its wake the consumption bubble. Only the vigor of their slowdown is in question. Given this virtual certainty, the U.S. economy urgently needs an alternative source of growth.

Unfortunately, there is but one possible alternative source, and that is sharply rising business fixed investment and exports. The consensus, apparently, takes a strong revival of business fixed investment for granted.

Assessing the relevant figures, including profits, we take for granted that business investment and hiring are going to fail in the future even more than in the past. First of all, the record-sized fiscal and monetary stimulus of all times has been exhausted; second, business fixed investment in the United States, even though heavily bloated by hedonic pricing of computers, recently accounts for a record low of 11.5% of GDP, as against more than 70% for consumer spending; third, consumer demand is weakening; and fourth, nonresidential investment has slumped from double-digit growth rates in 2004 to just 2.6% in the fourth quarter of 2005, after 10% in the first half.

Common arguments in favor of a comeback of capital investment are high business liquidity and high profits. Plainly, they have recovered from their lows, but growth has sharply slowed from 2004, when tax incentives gave a strong impetus.

New orders for machinery are up over the year, but by far not enough to suggest a developing investment boom. Given for many years a preponderance of short-lived investments, it needs moreover large and ever-higher capital investments just to replace worn-out plant and equipment, as reflected in rising depreciations. There is every reason to assume that the rise in new orders of capital goods barely reflects rising depreciations.

Most impressive is definitely the following chart reflecting the U.S. economy’s profit performance. Since 2000, it is the greatest profit boom in the whole postwar period. Strikingly, it even compares most favorably with the profit performance during the “New Paradigm” boom years, from 1995-2000.

Profits of the whole nonfinancial sector were $401 billion in 1995 and $413.4 billion in 2000. But from 2001 to late 2005, they have almost trebled, from $322 billion to $868.5 billion. Wall Street, of course, eagerly seizes them. For us, these numbers are so absurd as to require investigation.

First of all, it was an extremely imbalanced profit boom reflecting an extremely imbalanced economic recovery. This recovery had literally nothing in common with the business cycle pattern of the past. Intrinsically, this shows in a radically divergent profit pattern.

The profit boom of the last few years was narrowly centered in the category “other.” The fact is that the housing bubble has been crucial not only in creating demand and GDP growth, but also in creating employment and profits.

Most astonishing is, of course, the steep jump in profits from $534.2 billion in 2004 to $863.3 billion in 2005. Two phony causes are easily identified. One is a sharp decline in depreciations, from $804.3 billion to $668 billion. Depreciations are a business expense, of course. If a firm stops investment, it increases its profits. But this is hardly a desirable way toward higher profits. The second major cause of the sudden profit surge was a tax incentive that induced companies to repatriate a large amount of foreign profits into domestic profits.

Leaving aside the grossly distorted profit figures for 2005, we focus on the period from 1997-2004, the former marking the U.S. economy’s prior profit peak in the postwar period. Over these seven years, including the “New Paradigm” boom years, overall profits barely rose.

The next thing to recognize is the tremendous differences in profit performance between sectors. For all sectors producing or moving goods, manufacturing and transportation, it has been seven years of profit disaster, and moreover of steady deterioration.

In contrast, it has been seven years of profit bonanza for retail trade, wholesale trade and in particular for the branches captured under “Other.” Here construction and real estate agents have been the main contributors.

We would say that overall this is a dismal profit performance, definitely giving no reason for a booming stock market. Measured against nominal GDP, which has risen 41% between 1997-2004, it is a profit collapse.

Very poor profits in the aggregate are the one big problem. An extremely lopsided pattern between sectors is the other. Manifestly, this lopsidedness in the profit pattern perfectly reflects the extraordinary lopsidedness of the U.S. economy’s growth pattern during these years. The housing and consumption bubbles rule.

It always amuses us when Mr. Greenspan and Mr. Bernanke criticize the government for its budget deficits. The irony is that the chronic deficit spending by the consumer, induced by their monetary looseness, is doing far greater structural damage to the economy.


Dr. Kurt Richebächer
for The Daily Reckoning
April 18, 2006

Editor’s Note: The Good Doctor has found the only five investments you’ll need in 2006 – and one of them is a mighty hedge against the forces of dollar weakness and inevitable inflation. At the very least, it will help protect your money from the boneheaded inflationary policies and programs of the Federal Reserve – especially under new Fed Chief Ben “Printing Press” Bernanke.

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.”

Everything changes, ages and transforms itself.

We think of our own life.

We got married in the 1970s. We had nothing but an old rusted-out sports car and a job that paid about $39,000 a year. One day, driving home from work, we went over a bump; the floor of the car gave way and the seat fell through to the road.

We were young and energetic. We bought an old farmhouse and fixed it up ourselves. Building materials were expensive, so we often went to the dump to find things we could recycle. We saved our pennies. We worked hard.

By the early 80s, we were probably entering the basement of the middle class. But then, misfortune! We got divorced and were broke again.

That didn’t set us back for long. We remarried and started again. At the time, the assets page of the Bonner family accounts could be reduced to an index card: one blue Datsun pickup truck with the door falling off, and one very small publishing business that lost money every year.

Baltimore was cheap back then. The city was so desperate for taxpayers, it gave away buildings to anyone who was fool enough to move into them. Our office was bought for $1. Our house cost $27,000, purchased on credit from the seller. Ignoring the gunshots and crack dealers, we went to work.

Once again, we did everything ourselves, by hand, scavenging materials wherever we could find them. And once again, our fortunes improved. But as life grew more comfortable, gradually the habits of thrift were cast off.

We were appalled when Elizabeth wanted another car…used, of course. But now, we have four new ones.

We were indignant when she wanted to call in a professional cabinetmaker. Weren’t our homemade cabinets good enough for her?

We were actually alarmed when she wanted to move into a real house, in a good neighborhood – it would cost real money. Where would we get it, we wondered? But, we soon yielded, and then we had a bigger house to heat. This new house required more serious – more expensive – furniture.

It also required more insurance.

There was a boom in America throughout the 80’s and 90’s, and we boomed along with it. By the mid-90s, we were ready to head for new challenges. We pulled up our roots, moved to Europe, and found them. But, we had to leave at home, like an old pet, a whole new set of thrifty inhibitions. In our new life, we needed more new furniture, more expenses, and more help. We bought a large house in the country, but we discovered that we needed to rent an apartment in the city, too.

The children had to go to a proper school and we had to work in a proper office. Proper school? What was wrong with the public school? It had been good enough for us, hadn’t it?

“Times have changed,” we were told. Now the public schools – even in France – are said to be violent and incompetent.

And since we now had two residences, we needed help to take care of them. We needed a cleaning lady. Oh, and a gardener, too. One thing leads to another. One old habit falls like a Baltimore row house. The next thing you know, the whole block has been taken down and replaced with upscale condos and coffee shops. Jobs that used to be done out of happy necessity are taken up grudgingly…out of a lingering sense of duty or nostalgia.

“Why do we have to do this?” groan the boys, when we get them out to fix a wall or clear some brush. “Why don’t you just call someone who knows what he is doing?”

On family vacations, we remember, we used to crowd everyone into the van and drive up to Canada. In the early 90s, we rented a house on a small lake in Nova Scotia. Mice ran around in the corners; the place smelled like kerosene. But, it was $230 for a week. We couldn’t beat it.

“This is horrible,” said Elizabeth.

And it was horrible, but we enjoyed it just the same.

Now, the news from our currency counselor…


Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis:

“As I always tell you when a currency makes the first run at a line in the sand (resistance), it will fail to break through. But, that won’t be the only attempt at 1.2370, and once the euro breaks through…look out!”

For the rest of this story, and for more insights into the currency markets, see today’s issue of The Daily Pfennig


And over to Addison and Short Fuse in Baltimore…

*** has recently ranked Baltimore, home to the DR HQ, as one of the top ten cities in the United States whose real estate bubble is going to burst.

Reports show that the market is overpriced and homes are over-valued by as much as 17 percent.

“Seventeen percent?!” chortled Addison. “Try 50 or 60 percent.”

He described a “shell” that he looked in Charm City’s historic Fells Point. The row home was four stories and as he and the real estate agent approached the fourth floor, she warned Addison to not go all the way up – the rotting floorboards may not hold.

And how much was being asked for this non-heated dilapidated castle?


Overvalued? That might be the understatement of the year…especially, as Bill pointed out, above, since the same home could have been purchased for literally one dollar a couple of decades ago.

These ridiculous prices are finally starting to make an impact on prospective buyers, when last year, people wouldn’t have batted an eye at these prices.

“I am guessing that a growing crisis in consumer confidence will hurt both the economy and the real estate market,” writes one Realtor on a blog.

“With public fits over war, the economy and other global and local maladies, the mood to spend big money to nest may be dwarfed by hesitation, fear and financial mania. War’s end may inspire optimism in some but cynicism in others. The point: we are in the middle of something, not the beginning, not the end. Stuck in the middle, a place where fretting thrives.”

In anonymous postings, the famously tightlipped and ever-optimistic real estate professionals spill their secret worries on a real estate blog, created to get a handle on what’s really going on with this bubble.

CNN Money reports: “When Brad Inman of Inman News, which tracks the real estate industry and is widely read by industry insiders, recently gave real estate agents the opportunity to blog about market conditions, they almost uniformly described them as bad – and getting worse.”

Here is a sampling of their comments:

“Portland, Oregon is mixed…more inventory, sitting longer…sellers no longer king.”

“Minneapolis/St.Paul…15 houses per buyer. If we had buyers. Huge inventory in every price range. More foreclosure properties coming on daily.”

“Northern Ca. Let’s not beat around the bush here. There is a slow down!! Home prices are not going up. Sales are down.”

So, there you have it, straight from the horse’s mouth…

*** “You sir…are the scourge of the earth.”

Markets make opinions; we’re fond of saying here at The Daily Reckoning. Oil hitting an all-time high is making some pretty strange opinions, indeed. Yesterday, while doing a call-in radio show with Andy Johnson in Jacksonville, Florida, a caller suggested we were “evil” for helping readers make money by investing in oil.

Would they have been as perversely upset if oil were still hovering around $30 a barrel? $50 bucks? Not likely.

But times are changing. It hasn’t happened yet, but historically high oil prices are bound to slow consumption and demand in the U.S. economy sooner or later. And there’s a chance we could see a ‘fat tail’ spike up above $100 bucks a barrel soon. Think of the evil profits you could make then…Heh. Heh.

[Ed note: ‘Scourge of the earth’ or no, we’re of the opinion you should try to live as well as possible despite economic trends that are beyond your control. In fact, that’s the focus of our 6th Annual Agora Wealth Symposium in Vancouver, July 25-29th, 2006.

This year’s theme? Investing in the Age of Empire.

If you join us, you’ll learn how to make ‘evil’ profits from all kinds of exogenous events in the economy, from such diverse experts as Steve Forbes, Doug Casey, Dr. Mark Skousen, Bill Bonner, Kevin Kerr, Dennis Gartman and many, many more. Call 1-800-926-6575 to reserve your spot today. Space is already filling up, so call right away.]

*** A reader poses an interesting question: “I work with an author who is writing a novel taking place in the near future where there is a second economic depression, which by definition would be worse than the first because I believe people were more self-reliant back then.

“I would like to ask what you believe this country would be like during this time of an economic upheaval. Some have informed me that Martial Law would have to be declared in order to maintain order. One person even suggested that people would bid on available jobs, with the people offering the lowest salary being awarded the position.

“What do you think would happen in the day-to-day life of people?”

We’re going to turn this question over to you, dear reader. What do you think the Great Depression, Part Deux would be like for this country? What do you imagine? Send your thoughts, drawings, or ramblings to Short Fuse at

The Daily Reckoning