An Ominous Parallel
The air of general unconcern over the current state of the U.S. economy is mystifying – especially with the unstable housing market and sky-high consumer debts. Dr. Richebächer explores…
It can no longer be doubted that the world economy is heading into a new downturn following a recovery that has been unusually short and weak among the industrial countries. The loss of momentum during the second half of last year was especially pronounced in Japan and several Far Eastern countries. In Europe, the major eurozone economies have been making headlines for some time with very unpleasant growth and employment numbers.
There seemed to be two great exceptions to this unfolding general economic slowdown: the United States and China. That, at least, has been the overwhelming perception. A strengthening dollar largely reflected the consensus view that the growth spread between the United States and the eurozone would considerably widen again, as the U.S. economy maintained its strong growth.
At a conference of the Federal Reserve Bank of San Francisco on April 14, Fed Governor Donald L. Kohn presented a cheerful picture of the U.S. economy, starting his speech: "The economy has been performing well of late. Economic activity has shown a good bit of forward momentum as businesses have stepped up their purchases of capital equipment and households have continued to increase their spending on consumer goods and services and on houses."
Further fuel for the new dollar bullishness arose from the expectation that gradually accelerating inflation would induce the Fed to step up its rate hikes further. In its earlier comments, the Fed’s Federal Open Market Committee has done its best to confirm these high-riding expectations about the economy.
Complacency with the US Economy: Stellar Growth Masks a Dramatic Deteriorization
As we have explained in detail many times, we radically disagree with this general unconcern about the U.S. economy. Its stellar aggregate growth rates, particularly since 2000, have masked a dramatic deterioration in the four key fundamental determinants of long-term economic growth: national and personal savings, productive capital investment, profits and the current account of the balance of payments. All four are in shambles.
In essence, recessions are the phase in the business cycle in which consumers and businesses unwind the borrowing and spending excesses of the prior boom. In the U.S. case, the ugly reality is that the excesses and imbalances of the boom years in the late 1990s have grown in the past few years to extremes unprecedented in history.
The big question now is whether the rosy assessment of the U.S. economy is right or wrong. In our view, it is dead wrong, for two main reasons: First, contrary to perception, the flow of economic data since the beginning of the year suggests the exact opposite; and second, and more important, the U.S. economy’s recovery from its recession in 2001 has a precarious foundation in the unsustainable housing bubble and exploding consumer debts, while employment and income growth are calamitously lagging.
While scrutinizing the economic data, we first noted a sharp slowdown in consumer spending. Inflation adjusted, it declined slightly in January, by 0.1%. An increase of 0.3% followed in February. Meanwhile, sluggish retail trade figures for March suggest little more than stagnation. With these weak numbers before our eyes, we have been following the public discussion and the Fed’s statements about the strong economy with amazement.
All this has reminded us of a similar experience in 2000. For us, there is an ominous parallel. In the consensus view, the U.S. economy continued to boom. Taking everybody – including the Fed – completely by surprise, the share market and the economy went into a sudden sharp slump, while the Fed kept raising interest rates in order to fight inflation.
We see today the very same uncritical complacency about the U.S. economy. Although its recovery from the 2001 recession has been, by any measure, the weakest by far in the whole postwar period, people are beguiled by juxtaposing the apparent strong U.S. economic growth with a sluggish Japan and Europe. At the same time, we are pondering a question that is, unquestionably, the most important of all: Is today’s U.S. economy in better or worse shape than in 2000?
Complacency with the US Economy: A Parallel from 2000
First, though, back to 2000. On the morning of Feb. 2, the Fed’s senior economists started a meeting of the FOMC with a review of recent developments, which confirmed that the economy was still growing strongly. During the policy discussion, the only issue of contention was how far to raise the federal funds rate. Some members of the committee wanted an immediate half-point increase in order to signal the Fed’s determination to get a grip on the booming economy.
After lunch, the Fed announced a rate hike from 5.5-5.75%. In a statement, the FOMC said it remained "concerned that over time, increases in demand will continue to exceed the growth in potential supply, even after taking account of the pronounced rise in productivity growth. Such trends would foster inflationary imbalances that would undermine the economy’s record economic expansion."
On March 21, 2000, the FOMC discussed another rate hike. The consensus saw no sign of an economic slowdown. Consumer spending remained particularly strong. Again, there was a unanimous vote to increase the federal funds rate to 6%. Repeating the formula used after its previous meeting, the committee said, "The economic risks weighed mainly toward conditions that may generate heightened inflation pressure in the future."
The third rate hike followed on May 16, 2000. According to the published minutes, the economy was still seen to be powering ahead. Even though stock prices were sliding, the Fed raised its federal funds rate by 50 basis points, from 6% to 6.5%.
In fact, real GDP inched up during the first quarter by just 1% at annual rate, following a 7.3% jump in the prior quarter. While the second quarter sparkled again with a high growth rate, an abrupt slump of fixed residential and nonresidential investment pushed real GDP growth in the third quarter into negative territory at minus 0.5%. In hindsight, the boom clearly broke in early 2000, when the Fed still saw nothing but a continuous boom requiring higher interest rates. Just look at the data on the previous page.
Just seven months after its 50-basis-point rate hike in mid-May 2000, the Fed started its most rapid and drastic rate-cutting binge in history to prevent a slumping economy and a collapsing stock market from hurtling the economy into a dreaded deep and long recession.
Looking at the very weak first quarter of 2000, the third rate hike by 50 basis points in mid-May is particularly hard to understand. Moreover, the equity market had been sliding since March. That a central bank would tighten the reins in the face of a crashing stock market was definitely unusual. But in its associated statement, the FOMC justified its decision with "extraordinary and persistent strength of overall demand ."
In other words, they had no inkling of the rapidly spreading weakness in the economy. It reminds us of a famous remark by Joseph Schumpeter about events in 1929: "People stood their ground firmly. But that ground itself was about to give way."
Yet the Fed had one apparent excuse for its false optimism in early 2000. It is apparent in the following table. According to Bureau of Economic Analysis data available at the time, real GDP growth had soared by 5.4% at annual rate in the first quarter, as against the later downward-revised rate of just 1%. Still, the early slide in the stock market, which started in March 2000, suggests on its part a far better "smell":
We have recalled this episode because it seems to us a striking parallel to the present experience. In contrast to the bullish consensus view, we see many signs and problems in the U.S. economy that suggest an impending sharp slowdown.
For most economists, economic analysis today is little more than the simple extrapolation of the economy’s most recent growth rates. Economic growth in 2005 must be strong, because it was strong until late 2004. There is literally zero public discussion about the future implications of rock-bottom savings, skyrocketing levels of unproductive debt, a massive budget deficit and a soaring trade and current account gap.
Regards,
Kurt Richebächer
for The Daily Reckoning
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."
We mentioned last week that our small ideas had been getting together behind our back. We turned around yesterday to discover such a huge, awkward monster of an idea that we didn’t know what to make of it. It was a moment in which we recalled that not everything under heaven and earth is contained in our philosophy – and gave a sigh of relief.
No one else seems to have noticed…but something fundamental has change. Whether it is meaningful or not, we don’t know. But we thought we ought to mention it, just in case.
We must give credit to our favorite columnist, Thomas L. Friedman, for the insight. Of course, he did not think of it. But he had an idea so preposterously simpleminded, it triggered a thought in us.
We are not going to criticize Friedman. There is no sport in it. The man is evidently handicapped. He only sees things in two dimensions, like a drawing by a five-year-old with only one eye. There is no depth to it…no historical perceptive…no trace of irony or subtlety. When he describes something, it is like a child coming back from the playground, with traces of dark chocolate around his mouth and a tale on his lips.
"A big white thing came out of the sky," says the boy. "It had blue fairies in it who handed out ice cream."
You don’t know what really happened, but you’re tempted to go out and have a look.
Thus, when Friedman writes: "What’s wrong with Kansas?" we can’t help but wonder what is really going on.
What Friedman is worried about is "the disappearance of an internationalist, pro-American business elite." He wonders why business leaders are not out in front on issues such as free trade agreements and federal deficits. Predictably, he comes to the wrong conclusions. Business has "its head in the clouds," he writes.
"If we Americans don’t get our act together, this will affect not just our economy, but also our power," he goes on. Thus does the New York Times thinker reduce the entire mad world of political economy to a matter of collective will. If we want to be winners in the 21st century as we were in the 20th, he implies, we just have to get off our duffs and do something.
Looking at the issue with two eyes…and rounding on it a bit to get a better view…we see that things are not nearly as simple as Friedman must imagine. And here, we think we see something no else has noticed.
What we see is America’s rolly-polly empire – of consumer capitalism, "Pax Dollarum," Airborne diplomacy and debt. It has established order throughout most of the world. That order was immensely helpful to Americans in the first 60 years of the U.S. imperium. We made things that we could sell throughout the world – at a profit. But since the trade balance went negative, and since the United States now owes the rest of the world – net – an amount equivalent to nearly a third of its GDP, order no longer pays. Our industries cannot compete with those on the periphery. Neither our citizens, nor our government, can pay its debts to foreigners. And every day that the present system continues, the homeland gets poorer, relative to the rest of the world, by about $2 billion. To look at it another way, the entire economy produces about $12 trillion worth of output – in goods and services – each year. Yet, it consumes about $12.6 trillion…. each and every day that the present order remains…the U.S. goes further in the hole.
There is no question that order – especially order imposed by a civilized country – benefits "everyone." People are able to trade freely. The division of labor expands. People, generally, are better off.
But there is a dark side to the human character. After they have enough to eat and a roof over their heads, people care more about their relative wealth than their absolute wealth; they care more about their status than their souls. In absolute terms, a continuation of the present imperial order will benefit Americans, most likely. But it benefits foreigners more. Real wages are rising in Asia. In the United States, they are stagnant. In relative terms, Americans will continue to get poorer, again most likely, even if they eliminate their trade deficit.
The logic of human jealousy…and imperial finance…has now shifted. The United States should not be willing to continue providing a public good – order – for no other return than the opportunity to compete on a level playing field. U.S. industries are now losing that competition. Americans, too, gain nothing from it. Either we retire from the empire business; or we take it up in way that impedes globalized economic progress.
Looked at this way, the Bush Administration’s actions make more sense. Why invade Iraq? Because it creates disorder. Military adventures are risky and destabilizing. And they are a shift from civilized means of getting what you want to political means, which are not only inherently disorderly, but also favor America’s military strengths while minimizing her commercial weaknesses. Why pressure China to revalue the yuan? Because not does it create disorder, it puts the Chinese in a worse position commercially. The yuan has been stable for 10 years – pegged to the U.S. imperial dollar at a fixed rate. The United States now insists that the yuan move up. Why impose tariffs and trade barriers? Because they directly interfere with the orderly give and take of commerce…and slow our competitors’ growth. Why run up huge federal deficits? Why keep giving away money rate the cost of consumer price inflation? All these things are deeply disturbing to the world financial system; they breed disorder.
We are not quite sure what to make of this…so we will say no more…until we’ve had an opportunity to think about it more…
More news, from our team at The Rude Awakening:
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Tom Dyson, reporting from a freight train, somewhere in Canada…
"Your junior Baltimore-based editor is on a two-week joyride through the unforgiving wilderness of Northwestern Canada, sent by Addison Wiggin and Eric Fry to explore the Athabasca tar sands for investment opportunity. My journey begins here…"
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Bill Bonner, with more views:
*** Consumer confidence is going down. But April house sales hit a new record. Prices, year to year, are rising at a 15% rate.
*** Buy the rumor, sell the news. Polls show the vote on the European Union constitution is going to be close. Our guess is that the French will vote "yes," because they won’t want to have to worry about what a "no" might mean. Our guess also is that buying the euro now might be a good speculation. The price of euros has been driven down by fears that the French will say "non." So even a negative outcome for the constitution might yield a bounce in the euro. A "oui" on the other hand, will almost certainly produce a rise in the euro. Speculate on the euro if you’re feeling lucky. Buy gold if you’re not.
*** Jonathan Kolber, with an update on the Nordic pharma-tech company he’s been tracking:
"In a nutshell, this small company has developed a one-of-a-kind-on-Earth method for pinpointing genetic factors involved in a person’s predisposition to disease. Basically, it’s cracked the codes in the human genome that make people more likely to develop 50 of the most common diseases on Earth. Exactly HOW it did this is a story that’s equal parts pure high-tech perseverance, innovative vision in information collection and analysis, and a twist of simple cosmic luck…
"But I digress. The most important part is this: Cracking this genome ‘code’ allows this company to develop drugs targeted specifically to the genetic defect that causes a disease, instead of ‘shotgunning’ an entire bodily system the disease affects – often doing more harm than good, like a lot of mainstream drugs.
"The results: Super effective drugs with vastly fewer side effects than current treatments – and – incredible profits – likely 10,000% or more – for stockholders as these drugs surpass current treatments in efficacy, safety and cost."
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