Cartoon Capitalism

The "consumer economy" was always a mockery. The more people consumed, the more GDP went up. Of course, GDP measures output, not wealth creation; but in a cartoon economy, who can tell the difference? Bill Bonner explains…

Last week, purely in the spirit of mischief, we brought up a sore subject: America’s largest mortgage finance companies, Fannie and Freddie. The two have so much water in their lungs it will take at least $25 billion of the public’s money to save them. Possibly $300 billion. Were it up to us, we’d leave them on the beach.

But, last week, the U.S. Senate bent down and pressed its large mouth onto those gaping traps of the mortgage twins – gurgling into them a corrupt breath of life. Since the two hold one out of every two mortgages in the nation, in effect, Congress is nationalizing the U.S. housing stock itself. Henceforth, citizens will pay not only their taxes to the government, but their mortgage payments too.

In America itself, how this came to be is the subject of little concern. But despite the lack of interest, it is the subject of the next 500 words or so.

At a speech in Vancouver, James Kunstler seemed positively delighted. Finally, gasoline over $4 a gallon was going to do what generations of artistic scorn could not – destroy Fannie and Freddie’s collateral. Kunstler’s critique of American suburban vernacular architecture is that its products are not real houses at all – but "cartoon houses." They have porches that look like real porches from a distance, but they are too narrow to sit on. They have shutters too – nailed to the wall, making them completely useless. They may have "picture" windows…looking out on nothing…or no windows at all. And they wouldn’t exist at all were it not for cheap credit and cheap gasoline.

Of course, the same may be said of America’s – and Britain’s – entire economies during the last 20 years. The loose credit that built cartoon houses also constructed cartoon economies; they look like real economies, but they are essentially perverse, consuming wealth rather than creating it.

For proof, we return to Fannie and Freddie. Here were two companies that appeared to be helping Americans own houses. But since they were created, homeowners’ equity – that portion of the house actually owned and paid for by the homeowner – fell from 70% to below 50%. Currently, Americans’ total equity is lower than their mortgage debt. As a whole, the nation’s homeowners are "upside down," in other words. Nearly 9 million Americans have zero or negative equity already – and house prices are still falling.

How comes this to be? The answer is simple: lenders lent more than the houses were worth to people who couldn’t pay it back anyway. This Looney Tune approach to finance radiated to all points of the economy. People pretended that they earned more – spending more and more money to buy more and more goods and services – but wages did not really increase. Then, they bought houses – believing the roofs over their heads were investments, rather than consumer items. With no down payment, no proof of income, and zero interest loans – for most of the new buyers, home ownership was merely a dangerous conceit. Now that the roofs have caved in, it is a staggering burden.

The "consumer economy" was always a mockery. No serious economist ever suggested that you could get richer by consuming wealth. But that didn’t make consumerism unpopular. The more people consumed, the more GDP went up. GDP measures output, not wealth creation; but who could tell the difference? In a cartoon economy – no one. Besides, spending made people feel as though they were getting richer.

Then, whenever the consumer threatened to come to his senses, the feds rushed to "stimulate" him – by giving him more of what he least needed, more credit. More spending kept the cartoon economy running – allowing the consumer, the businessman and the speculator to add to his burden of debt. In 1971, when the United States went off the gold wagon, household debt was less than 50% of GDP. Now, it is more than 100%. And now, the poor consumer’s knees buckle; he will be forced to work the rest of his life just to keep up with his debt burden, let alone pay it off.

Even the rentiers were bamboozled by their own claptrap. Stocks rose from ’82 to 2000…fell heavily to 2002 and bounced back. For the last 10 years, shareholders have gotten little for their effort. In July of ’98, the FTSE hit a high of 5,458. This month, it has reached 5,625. And in America, if stock prices were quoted in gallons of gasoline, the Dow would take the driver no further in 2008 than it did 40 years ago.

The cartoon capitalists did it all backwards; they are supposed to exploit the workers, not be exploited by them. But while consumers and investors were going nowhere, corporate managers and Wall Street hustlers were getting rich. The two Bozos running Fannie and Freddie, for example, pocketed about $32 million between them last year – during a period in which the companies lost almost $5.2 billion – not to mention the losses to shareholders. And on Wall Street, managers paid out $250 billion in bonuses in the 4 years leading up to the credit crunch. The firms declared a profit and paid bonuses when the bets were made; they didn’t wait to see how they turned out. Thus did the big banks and big brokers become capitalists without capital, dependent on the gullibility of investors to keep them in business. And when investors began to wise up, they turned to the public for capital support.

What kind of scam is this? It may look like capitalism from a distance. But this is not real capitalism; this is cartoon capitalism – run by clowns, who sell freak investments to chump investors, and encourage the lumpen householder to ruin himself.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

August 01, 2008 — Ouzilly, France

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.

Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.

There is important news. And there is entertaining news.

Today’s most important story comes to us from the Financial Times:

"Biggest dive for commodities in 28 years," says the headline. It is important because it is likely to give people the wrong idea.

Oil dropped another $2.74. Clearly, the peak has come and gone. The black goo hit $147 and has been in retreat ever since.

Gold is down too. It rose $10 yesterday, bringing the price back to $922. For a moment, it looked as though we’d have a chance to buy below $900. But the yellow metal is fighting hard to stay above the $900 mark.

All across the archipelago of commodities prices are falling – from the base metals to the precious metals, from the softs to the hards, with all the mushy in between.

"All these gold bugs are back where they started 28 years ago," said our colleague Karim Rahemtulla in Vancouver. "The price of gold is barely higher today than it was in 1980. They haven’t made any money at all."

After gold hit a peak of $850 in 1980, it promptly fell back…and kept falling for the next 20 years. Oil had a similar trajectory. It hit a high in the early ’70s…and it, too, fell for about two decades.

Karim, and a lot of others, expect a replay.

They may be disappointed. The biggest dive in commodities in 28 years could be just a splash, not a sinking.

What marked the end of the last commodity boom was a major change in the monetary picture. Paul Volcker strode onto the scene and decided it was time for something different. Inflation rates were hitting 10%. And a relaxed monetary policy – allowing easy credit and more cash – was making the situation worse. "Stagflation" had become public enemy number one. When the feds tried to stimulate the economy out of the ‘stag’ part…they ended up contributing to the ‘flation’ part.

Of course, that is a big part of the picture today too. The feds are desperate to avoid any further bank failures or economic weakness. There are too many voters, too many Wall Street firms, and too many businesses in danger of failing. They’re nationalizing the nation’s housing…bailing out Wall Street…and holding the key lending rate at less than half the rate of consumer price inflation.

What can you expect? Well…stagflation!

Already, one estimate is that 144,000 retailers are expected to close their doors this year. Each time one goes broke, more people are dumped onto the job market. The latest figures show jobless claims reaching a 5-year high. Each month for the last 7, unemployment has gone up.

The ‘stag’ part is hitting the nation’s eateries especially hard. Restaurants expanded too fast, say the experts. Now, they’re contracting – releasing more low-income employees from taking orders and scrubbing pots and pans. And the airlines and automakers are suffering too. General Motors plans to lay off 15% of its work force too. GMAC, its credit arm, just reported a $2.5 billion loss.

Naturally, tax receipts are falling too. Net corporate tax receipts are expected to fall by $100 billion in 2009. Net individual tax receipts should fall by $100 billion too. Hey, a billion here…a billion there…pretty soon, the government is running a trillion-dollar deficit…

The economy is growing at a 1.9% rate, according to yesterday’s report. That’s less than economists had expected. The Commerce Departmen says it believes a recession may have begun in the last quarter of last year. (More below…)

Won’t recession mean lower commodity prices…and the end of the bull market in gold and oil? Is this the end of the trend begun only a few years ago…the trend that took oil from $20 to $147…and gold from $260 to $1,000? Probably not.

Commodity cycles usually last 15-20 years. It takes a long time to open a gold mine or an oil field. At first, people in the business are reluctant to invest the money. They’ve just been through a long down-cycle, in which all their investments during the previous boom phase blew up on them. They’ve still got the powder on their faces and the burn marks on their fingers. When prices turn up, they’re convinced that the upturn is merely temporary. Their models still project low prices. Their hedge books are still crowded with forward sales well below spot prices. And in their garages are still parked the same old cars they bought in the last boom.

But prices climb a "wall of worry," say the old timers. Then, after they have scaled the worries, they are sans soucis on top…and then so cocksure that they can’t wait for the hand-grenade to explode on its own; they pull the pin themselves – investing and spending recklessly, sure that prices will continue to rise forever. It’s when that last stage comes that you really have to watch out… That’s when gold, oil, and the whole commodity complex comes crashing down…and doesn’t revive for another 20 years.

We doubt we’re there yet. But please don’t confuse us with someone who knows what is going on. If we told you we knew for sure when this bull market would end – you should start reading some other commentary. Because your Daily Reckoning editor would be an even bigger fool than he thinks he is.

All we can do is guess. And our guess is that we are looking at a correction, not a fundamental change of direction. Not only has the cycle not lasted long enough to draw forth substantial increases in most basic commodities (with the exception of the farm commodities), the monetary cycle remains decidedly expansive. There is no Paul Volcker in the picture. Instead, there are Ben Bernanke and Hank Paulson. There are bailouts, deficits, and cheap credit…as far as the eye can see. Plenty of ‘flation’, that is, to go with the ‘stag.’ An article in the Economist, for example, says consumer price inflation will rise to 6% before the end of this year…

*** Yesterday’s news told us that the U.S. economy is still growing. But GDP growth rates are mostly a fraud. They measure economic activity – but do so clumsily; you don’t really know what is going on. When the feds give back "tax rebates," for example, the money goes into the economy as people spend it. GDP rates go up. But how could there actually be more net spending? Since there are no savings in the U.S. economy, every penny is spent, no matter what. If it had not been given back to its rightful owners, the feds would have spent every penny of that money themselves.

There are only so many hours in the day…and only so many resources to work with. The real question is what is done with them. If they are used to produce things, to build factories, and to add to the nation’s capital, people become wealthier. If they are squandered – using up capital instead of adding to it – people become poorer. GDP figures don’t tell you want is really going on. But when an economy becomes too dependent on credit and consumer spending, GDP figures actually become perverse; they measure the rate at which the nation impoverishes itself.

*** Oh yes, the entertaining news:

The sovereign state of Connecticut has filed suit against the rating agencies – making the usual charge, that they knew or should’ve known that those freak investments Connecticut bought from Wall Street weren’t as solid as they thought they were.

That’s what happens at the end of a bubble. The crybabies and whiners come out.

Meanwhile, Merrill Lynch is dumping its CDOs (collateralized debt obligations)… After telling clients – and itself – that they were worth $1, it’s selling them for 22 cents.

And pity the poor Singapore government. It thought is scored a coup when it bought Merrill stock for $48 a share. Now, Merrill is forced to raise capital again. But this time it’s selling $8.5 billion worth of shares at only $22.50.

No doubt, attorneys are looking at Merrill too, trying to find an incriminating email – proving that Merrill knew or should have known that its own shares and CDOs were trash.

What is amazing to us is how there could have been any doubt about it. We said so often in these Daily Reckonings. The state of Connecticut…or nation of Singapore…could have found out for free. If they didn’t, it’s their own damned fault.

Or, as George W. Bush put it, the financial industry had "gotten drunk." Everyone knew it had been one helluva party. Then, as the financiers fumbled for their keys, and got in their cars, could there have been any doubt that there would be accidents on the way home?

But now that the crack-ups are in the headlines, the lawyers, police and insurance companies are coming out. Like all major accidents, these will end in disgrace, chapter 11, and jail.

*** We came back from Vancouver with two $20 gold pieces in our pocket. Actually, the idea came from Jim Rogers, who gave us one. We bought another to give to Henry for his 18th birthday.

"Hey…what’s this?" Henry wanted to know.

"It’s a gold coin… A Canadian maple leaf…"

"Oh…is it worth anything? It says it’s worth $20…kind of a measly birthday present, wouldn’t you say, Dad?"

"Well, it’s worth a lot more than that. It’s gold. An ounce of gold…"

"What’s that worth? Two hundred dollars?"

"A lot more than that…"

"But it says it’s worth $20. I guess at one time it was worth $20…"


"Can you still use these for money? I mean, can you go into a shop in Canada and pay for things?"

"Well, maybe, but I don’t think it would be a good idea…"

"Or maybe you can say to your boss that you want to be paid in these coins? And then, when the IRS asks you how much you made, you can say $20?"

"I don’t know Henry, but I think that’s the sort of thing that people go to jail for."

"Well, it’s their fault the coin is worth more than $20, isn’t it? You should be able to use it as $20. I mean, what’s going on, anyway? Something funny about this…"

"Oh Henry…this is a very long story…but you’re right. It’s very funny."

The Daily Reckoning