Banana Republic, Without the Bananas...Or the Republic

The U.S. economy is under a lot of scrutiny these days – and rightly so. But some of the name-calling it has undergone has been unwarranted…or at least inaccurate. Bill Bonner explains…

The dollar is falling against almost everything…even against Iraq’s dinar.

Both Bernanke’s rate cuts and Bush’s ‘tax rebate’ plan have a fruity odor to them. The tax ‘rebates,’ for example, will not return any money to its rightful owners. The U.S. government can’t afford it. Instead, they’ll send out checks to 117 million people – including many who never paid any tax in the first place, encouraging people who have already spent too much to spend even more. Where will the money come from?

The Bernanke/Bush team isn’t saying. They’re so eager to avoid a serious correction that they are throwing caution to the wind – and the dollar too. Let it fly wheresoever it wouldst – as long as it goes down. Besides, who cares? Most of the world’s dollar reserves are held by foreigners. And foreigners don’t vote in U.S. primary elections. "It may be our dollar," Treasury Secretary John Connelly once shrewdly observed, "but it’s your problem."

But overseas dollar holders are beginning to notice the tropical flavor of U.S. finances. The dollar has lost 30% of its purchasing power during the last 7 years. Against gold, oil and other key commodities – and other major currencies – it is down much more. In many sunny places with shady finances, this must seem all-too familiar. The ‘banana republics’ did business this way themselves – running up huge debts to overseas lenders…selling off their capital assets to foreign savers…printing money by the boatload…and generally making themselves look ridiculous. Now, the kvetchers are labeling the United States as "the world’s largest banana republic." One calls the dollar a "Bernanke peso." Another says the United States is following "Zimbabwe economics."

Here at The Daily Reckoning, we have been critical of the U.S. economy in the past. But today, we rise not to carp and criticize, but to defend it: The United States has little in common with a banana republic. It has no bananas. It is not a republic. And its weather is not as good.

That said, there are similarities. Real wages for men are lower today than they were 37 years ago. Robert Reich, former Secretary of Labor, writing in the Financial Times, explains that Americans were only able to increase their standards of living by putting their wives to work, putting in more hours on the job, and finally, going deeply into debt.

In the last seven years of the Bush administration, the federal debt increased by two-thirds while U.S. household debt doubled. Despite all this extra spending, median real incomes have continued to go down. Practically all new jobs have been created either by government, or in housing, health care, bars or restaurants. Jobs in manufacturing are now at levels not seen since just after WWII.

"This is the profile of a third world economy," says former Under Secretary of the Treasury Paul Craig Roberts.

How does an economy like this keep going? It depends on the kindness of strangers and the stupidity of friends. Who but a fool or a friend would buy a U.S. 30-year treasury bond at a 4.28% yield? This number is only a few basis points from the number for annual increases in consumer prices. Which means, if all goes well, investors can expect to make a return of zero on their investment over the next 30 years. And if all this talk of Zimbabwe economics and banana republic finances turns out to be true, they can expect to suffer another round of losses – measured in the trillions. And why shouldn’t it be true? The American Empire is a bit like General Motors, says Martin Hutchinson. It has heavy fixed costs, an aging workforce, worn-out equipment, mammoth debts, and it is losing market share. At immense cost, America maintains its legions in more than 100 overseas garrisons. At home, the mobs call for bread. And every candidate for office – save the forgotten man, Dr. Ron Paul – offers more of it. "We cannot afford another year without decent wages because our leaders could not come together and get it done," said Barack Obama in South Carolina.

GM, of course, cannot print money. But as Ben Bernanke himself put it, the United States, like Zimbabwe where inflation is running at 150,000%, "has a technology called the printing press." What can you expect? We would modestly predict that those 30-year T-bonds, sometime between now and 2048 when they mature, will become worthless.

Maybe sooner rather than later. Because both friends and strangers are wising up. The Gulf Sates have the largest foreign currency reserves in the world. But at the end of November, Sultan Nasser al-Suweidi, governor of the central bank of the UAE told The Wall Street Journal, "the connection to the dollar has contributed much to our economy…in the past. Nevertheless, we come to a bifurcation…" Kuwait already switched away from the dollar; for its reserves it now uses a basket of currencies.

Meanwhile, China is said to have about 70% of its $1.53 trillion pile in U.S. dollars. Cheng Siwei, Vice President of the Popular National Congress: "In terms of the structure of our international reserves, we must take advantage of the appreciation of strong currencies in order to offset the depreciation of weak currencies." ‘Sell the buck,’ he must have whispered to his broker.

And in even the formerly weak currency zone of Latin America – the home of the real ‘banana republics’ – the dollar is wilting. Central banks in Argentina, Peru and Colombia have had to intervene to hold up the greenback. According to Mario Bodersohn, in the Buenos Aires paper, La Nacion, there’s "no precedent for such an intense sell-off of a reserve currency." Usually, it’s their own pesos, reals, colons, and australs that people are laughing at. Now, it’s the gringo notes that get the punch lines.

Until next week,

Bill Bonner
The Daily Reckoning

February 01, 2008 — London, England

Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.

David Fuller is right. What we are really watching is the decline of the United States of America…its currency…its capital base…and its competitiveness in the world economy.

The feds can try to play out more lines of credit to strapped families, but what they are really doing is giving them more rope with which to hang themselves. The real problem is that American wages have not kept pace with inflation…which means, the average American is not as rich as he used to be. He can only pretend to be rich…by exchanging more of his leisure time for dollars…and by borrowing. Both of those "coping mechanisms," as Robert Reich called them, are now exhausted. Now, he’s going to swing.

Over the last 30 years, Americans believed they were on top of the world. Everybody said so. And, logically, they should have been. It was post Reagan Revolution, with the most modern, most capitalistic economy in the world…with the latest technology, with the world’s best brains, with the top schools, and with Wall Street to "allocate capital" in the best possible way. If workers couldn’t get ahead in this economy, they couldn’t get ahead anywhere. At least, that was what people believed.

But capitalism is a jungle, we keep saying, not a zoo. It lets animals get fat, but only so they can be eaten by hungrier beasts.

To us here at The Daily Reckoning, it was fun listening to the conceits and pretensions of the zookeepers. At the end of the ’80s, they announced their triumph over communism, apparently unaware that their biggest potential rivals had just cut themselves loose from a ball and chain. It is not even 20 years later, and both Russia and China are already formidable competitors. China’s reserves of foreign currency, for example, are nearly 20 times those of the USA. And now, if the Red Giant decides to dump dollars, America’s economy will be hit by a major crisis…and possibly paralyzed.

Then, near the end of the ’90s, the dreamers thought they had found some magic formula. America no longer needs savings, said the pundits, because now our information technology allows us to create wealth using ‘virtual’ capital…brain capital. "They sweat; we think," said one genius, as if the Chinese and Russians couldn’t think too. If this insight weren’t hilarious enough, Ed Yardeni went on to say that there was a whole new species of human – those who understood this important new truth…those who "got it." Those who "didn’t get it," were destined to be left in the dust, he said. We were happy to remain in the camp that was left behind.

Later, after the dotcoms blew up, another hallucination developed. One that sophisticated financial engineering, combined with enlightened macroeconomic management, had made market crashes and recessions obsolete. The geniuses went to work with computers, proving that those fancy derivative contracts (which they were selling) were completely foolproof. They were supposed to run into problems only once in a blue moon. "You’re talking about sigma 25 events," they said, as if they had a clue. Scarcely three years later, the moon was blue.

It was all great fun. Watching the show, that is. And it’s not over.

Yesterday, the Dow rose more than 200 points. Richard Russell, the keeper of Dow Theory flame, says the stock market is no longer pointing to deflation…but to inflation.

Of course, the price of gold has been pointing to inflation for a long time. It rose again yesterday – up to nearly $930. In Europe, too, inflation is making headlines – it’s at a 14-year high. Many people in France, for example, think the euro (EUR) was a plot to increase prices; they want the franc back. Painted on the wall of a Paris building yesterday, we saw the citoyens’ complaint: "Euroshima" it said.

And consumer inflation in China, at nearly 7%, is said to be "China’s latest export."

But we are not writing today about the war between inflation and deflation. Today, we’re focusing our attention on a bigger story.

*** The headlines rarely tell you much about what is really happening. They are like dispatches from the front. Inflation scored a victory in the oil market. Deflation advanced on the retail stocks. One company got killed. One trader blew himself up. A trendline broke through resistance.

Behind these news stories is the story so big that scarcely anyone notices it. The United States is losing ground. Its people are getting poorer. Why? Because now, it’s America that drags around the ball and chain.

How much do Russia and China owe the rest of the world? How big are their trade deficits? How many trillions have they promised their retirees? Their sick? Their former employees? How high are their taxes? How much do their people save?

On almost every score, the former communist hellholes have a huge advantage over their North American competitor. The Chinese save nearly 50% of their incomes; Americans save nothing. Russian tax rates are less than half those of the United States. Both have positive trade balances. Even in high tech, America has a negative trade balance with the rest of the world.

Like Europe, America is chained to an aging population and democracy. Both are bad for business. The baby boomers are beginning to retire. They’ve already been promised the sun and the moon… And, once they’re retired, they’re going to vote for the stars too.

That’s why Republican strategists are telling their candidates: No more tax cuts! The voters want to be sure there’s money available for them when they retire.

A little late for that. The government didn’t really set aside money in a ‘lock box,’ as Al Gore used to put it, for Americans’ retirement. It just took the money out of the general fund and put an I.O.U. in the retirement fund. Now, those I.O.U.s are coming due. And what politician is going to stand up to the biggest block of voters in the country and suggest that they be cut back?

And unlike Europe, America has low savings rates…a negative trade balance with the rest of the world, and few industries that can stand the challenge of competition. Germany is still making cars at a profit; the United States is not. France has its luxury products. Switzerland has its precision tools.

In addition to the social charges, there is the big, leaden ball of military expenses. The U.S. military budget is half of the entire world’s military spending, and represents 80% of the increase in world military spending since 2005. The whole point of having such a big military is to be able to push people around. But you have to make it pay. Empires traditionally demanded tribute from the peoples they conquered and/or protected. But the U.S. never got the hang of it. It maintains garrisons of troops all over the world – at its own expense. It thinks it is doing the world a favor; and it thinks it is rich enough to afford it.

The biggest U.S. outposts are in Afghanistan and Iraq, which aren’t even in the military budget. When the war in Iraq began, we estimated that it would end up costing a trillion dollars. And now that the numbers are coming in, we have to admit that we were wrong. Instead of $1 trillion, the Congressional Budget Office estimates that the war will cost $1.7 trillion; the National Bureau of Economic Research puts the tab at $2.2 trillion; and the Congressional Joint Economic Committee thinks it will come to $3.5 trillion.

A trillion here…a trillion there…pretty soon, you’re out of money.

But this is a story only the invisible man of the U.S. presidential election, Ron Paul, is willing to tell.

*** Who ever heard of a stock market without corrections? Don’t prices go up as well as down? And isn’t it normal from economies to take a breather every once in a while? Why the panic at a slight market pullback and first signs of a coming slump?

What is most astonishing about the situation is that there is so little astonishing about it. Bear markets and recessions – like the poor – will always be with us. It’s not the end of the world when they come…because they go, too. Why then the feds’ desperate attempts to avoid them? As we pointed out yesterday, the stock market was barely down 15% from its all-time high and already the Bernanke Fed was taking emergency measures. And hardly has a slowdown begun, and both the House and the Senate have rushed through proposals to send out checks. What kind of economics is this? What theory tells you that you should send out $1,000 checks as soon as GDP growth rates fall to 2%? And if $1,000 checks are supposed to make things better, why not send out $2,000 checks…and make them wonderful again?

As we point out above, the United States is in danger. But the danger cometh not from a bear market in stocks or a recession. Those things are normal, natural and inevitable. Even if you could prevent them by sending people money…you wouldn’t want to. You’d just be making the situation worse.

Americans’ problem is that they’ve spent too much, borrowed too much, and saved too little. That problem will not go away. It needs to be corrected.

*** "That guy they nabbed in the Societe Generale scandal. He’s just a fall guy," explained a friend yesterday. "A sacrificial lamb. They made a deal with him to cover up the bank’s losses elsewhere. At least, that’s the rumor going around town. And it’s probably true. You can’t believe anything the banks say. "

The Daily Reckoning