Debt Hangover

While analysts, pundits and government quants all cheer the American consumer, rising retail sales that are not accompanied by a rise in industrial production are highly questionable as an indicator for the domestic economy. In fact, they are a far better indicator for the strength of the Chinese economy.

Consider the following. The U.S. housing industry is booming. However, U.S. production of appliances is flat to moderately down compared to a year ago. Or take the home furnishings industry, which should be a prime beneficiary of strong home-building activity. However, furniture imports into the U.S. have jumped 71% since 1999 in three years and now comprise between 40% and 50% of all sales as of the second quarter of this year.

For wood and metal furniture, principally bedroom furniture, chairs, tables, and cabinets, import penetration has increased even faster. The imports of such items now account for 80% of sales by domestic manufacturers, compared to 20% a decade ago. According to an economist who has studied how U.S. industries have been affected by rising imports, half a million workers lost their jobs in the furniture industry between 1979 and 1999. This is in stark contrast to China, which has become one of the world’s largest manufacturers and exporters of furniture, claiming 10% of the global market share.

In the first seven months of this year, furniture exports – principally to the U.S. – rose 35% to more than US $3 billion.

Ben Bernanke: The Value of a Dollar

Perhaps Fed governor Ben S. Bernanke should consider this point when advocating an ultra-easy monetary policy. In his now famous “printing press” speech at the National Economists’ Club in Washington, Bernanke suggested that: “By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services. We conclude that, under a paper- money system, a determined government can always generate higher spending and hence positive inflation.”

What Mr. Bernanke said in his speech was already evident to market observers, since M3 has gone up almost vertically since October 7, rising at an annual rate of 22.5%. (Please also note that, for Mr. Bernanke, the Fed, which is supposed to be an independent institution, and the government are one and the same.)

I would concede that the government can generate temporarily higher “spending” – but overseas!

If we look at the increase in U.S. retail sales over the last three years and compare it to the increase in the U.S. trade deficit, we note that practically all additional retail sales originated from the import of additional overseas products.

Mr. Bernanke’s U.S. printing press seems to have an extremely limited effect in stimulating domestic economic activity, while being very effective in stimulating foreign direct investments and industrial production in China and, increasingly, Vietnam.

A similar situation to the U.S. furniture industry is evident in its auto industry. While overall auto sales are robust, sales of the three domestic producers are currently lower than they were in the 1990 recession, while sales of imported cars and light trucks are at a record. Ford announced recently that it will boost its purchases of auto parts in China to as much as US$1 billion annually starting in mid-2003.

Ben Bernanke: Back to 1961

The shifting U.S. economy is reflected in the jobs picture, too. The “goods-producing” sector lost 332,000 jobs in the last eight months, while at the same time the service- producing sector has added 506,000 jobs. Mortgage brokers, most notably, were up 47,000…health services employment was up 178,000, education up 92,000, and government up 158,000. In the meantime, the number of manufacturing jobs is back to the 1961 level.

Rising import penetration aside, there is another reason to be skeptical about the durability of strong U.S. consumption growth. For one thing, it should be obvious that there is at present no pent-up demand in the U.S., as consumers have not yet retrenched and rebuilt their liquidity, as was the case in previous recessions. In addition, until recently, U.S. consumption was boosted above the trend-line by a decline in the savings rate. In the absence of strong stock market gains in the near future, it is likely that the savings rate will increase somewhat in the next 12 to 18 months and, therefore, contain consumption growth.

Finally, and this seems to me to be the crux of the matter, the consumer has become highly leveraged and his consumption may finally succumb to his debt load. Now, I am aware that many analysts and strategists will dismiss this concern, arguing that the consumer has been highly leveraged for a long time and has so far continued to spend and will therefore continue to spend in the future. To my mind, this line of argument is reminiscent of U.S. strategists who, in the spring of 2000, predicted that the stock market would continue to rise, based on the fact that it had been going up for 18 years in a row.

Responding to a piece by Gene Epstein, who writes a weekly column about economic issues for Barron’s, which stated, “Over the 56 years since 1946, consumer borrowing habits don’t appear to have changed at all,” The Prudent Bear’s Doug Noland recently produced the following figures: In 1946, as a percentage of national income, total personal sector liabilities were 31%, non-farm mortgages 13%, and consumer credit 5%.

At the end of 2001, however, total personal sector liabilities were 133% of national income, non-farm mortgages 70%, and consumer credit 21%.

Non-farm corporate liabilities stood at 44% of national income in 1946, compared to 101% at the end of 2001; total mortgage debt was 23% compared to 93%; security credit 3% versus 10%; state and local government debt 7% versus 17%; and total credit market debt 192% versus 359%.

In addition, in 1946, the personal savings rate stood at 9%, compared to around 2% now.

Ben Bernanke: Crises and Cycles

Noland points out that, in what has become a historic boost, it has taken less than nine years for the money supply to double. Noland concludes: “The service/consumption-based U.S. system is becoming only more monetary in nature – only progressively dependent on rampant money, credit, and speculative excess.” The economist William Ropke explained in his book Crises and Cycles (London, 1936) that the “qualitative” distribution of the money stream may become a factor of instability. Referring to the 1920s and the factors which led to the Depression, he wrote:

“This period, which has been followed by the severest crisis in history, shows, on the whole, a price level which was slightly sagging rather than rising. [The same as in the 1990s – ed. note] How, then, can there have been inflation? Owing to decreasing costs following on technical progress, prices would have fallen if an amount of additional credit had not been pumped into the economic system. Hence there was inflation, even if only of the relative kind. But it can be perfectly well argued that the quantitative effect of the inflationary credit expansion was considerably aggravated by an abnormal qualitative distribution of credits. One case is the great expansion of installment credits, which gives the impression that the Federal System was trying to administer the heroin not only per os but also per rectum.

“Another example is the real estate market, which was grossly oversupplied with credits. The worst and most conspicuous case, however, was the stock market speculation, which was the leader on the road to disaster. For purpose of illustration, it may be mentioned that the volume of brokers’ loans rose from 1921 to 1929 by about 900 per cent. We may conclude, then, that the last American boom is a striking example of how the disequilibrating effects of variations in the volume of credit may possibly be greatly aggravated by peculiarities in the qualitative composition of the stream.”

I have reproduced Ropke’s explanation of the 1920s’ boom and the following depression, because it immediately becomes obvious that we have a very similar situation today – only with far worse credit excesses and far more “abnormal qualitative distributions of credit”.

This time, however, the problem is not so much the expansion of brokers’ loans, but consumer and real estate credits as well as the leverage that was built up through government-sponsored enterprises – Fannie Mae, Freddie Mac, etc. – the derivatives markets, and corporations’ special- purpose entities.

I hope the reader will understand that the current mortgage financing boom and consumer credit explosion is simply not sustainable in the long run and that, at some point, credit expansion in the consumer and mortgage sector will slow down, as it has in the last two years in the corporate sector. The consequences of such a slowdown will obviously be that consumer spending will have to slow down very considerably, which will inevitably hurt the economy, but hopefully will redress some of the external imbalances.

So, whereas economists who point out that the consumer is in great shape may be correct now, sometime in the future the consumer may wake up with a terrific “debt hangover,” which will force him to retrench.


Marc Faber,
for The Daily Reckoning
January 14, 2008


“You would have to be crazy to be bullish on the U.S. economy,” Daily Reckoning contributor Marc Faber told Barron’s this week, “…you would have to be Fed chairman…!”

“This post-bubble environment is the most exciting environment of the past 20 years,” Faber continues.

Money flows from one illusion to the next, he believes. From oil in the ’70s to Japanese stocks in the ’80s to U.S. stocks in the ’90s….

“Once the bubble bursts, there is a change in leadership,” Faber explains.

After the bubble in stocks – particularly in dreamy tech stocks – capital turned to things it could see, touch and feel. Home prices in England have almost doubled in the last couple of years. In California, they’ve risen 20% in the last 12 months.

Commodities, says Faber, “fell to their lowest level in the history of capitalism” in February 2002. Now, they’re booming. Gold has risen $100 in the last 2 years.

Faber’s advice: “Be long commodities, stocks that relate to commodities and countries that relate to commodities.”

“And get out of the dollar,” we add from the Paris headquarters.

“While President Bush talked this week of a stimulative package to propel the U.S. out of its downturn,” reports the Financial Times, “Europe yesterday embarked on a different course. “Pedro Solbes, the European Union’s monetary affairs commissioner, yesterday told Germany, France and Italy – the three biggest economies in the eurozone – to focus on cutting their deficits. So while President Bush cuts taxes and lets the U.S. deficit take the strain, the EU’s stability and growth pact requires that Germany, flirting with deflation, has to boost taxes or reduce spending.

“Mr. Solbes smiled yesterday when asked what he made of President Bush’s approach, then launched into a staunch defense of the fiscal discipline imposed by the pact. ‘Sound public finances are a condition for durable growth and rising employment in Europe. Sound public finances are part of the solution, not part of the problem. We can’t spend our way out a downturn in Europe.'”

When the European Union began, American commentators disparaged it. The frog would never be able to get along with a hun, they said. They speak different languages…they have different cultures…and they hate each other. The Union would never be able to develop a strong, centralized government, or to undertake major programs.

“A man should thank his faults,” said Emerson. Europe’s weakness turned out to be its greatest strength. For it cannot do anything really important – neither foreign wars nor domestic inflation.

Here at the Daily Reckoning, we recall criticizing the euro as an “Esperanto currency.” We saw the lack of a single country backing the currency as a weakness. We were wrong. European member countries find it hard to agree on anything – even destroying their own currency.

Over to you, Eric…


Eric Fry in New York…

– The U.S. financial markets idled in neutral yesterday. Bonds barely budged and the gold price didn’t budge at all. Over on Wall Street, the Dow gained one meager point to 8,788, while the Nasdaq slipped one point to 1,446.

– The old Wall Street saw, “Never sell a dull market short,” would seem to pertain to yesterday’s sleepy market action. In other words, markets tend to become very quiet immediately before explosive moves. The pyrotechnics may begin very shortly, as several high-profile companies are due to report their earnings this week. Microsoft, IBM and GE – to name a few – will report quarterly earnings over the next few days.

– “We may just have rung in 2003, but Wall Street can’t seem to tear itself away from the mania of years gone by,” writes the ever-bearish Bill Fleckenstein. “Hype and hope still trump the fundamentals that warrant neither.” The principal “fundamental” that troubles Fleckenstein is a familiar one: stocks are too expensive. “Values in the aggregate don’t exist,” he says. An expensive stock market wouldn’t be so worrisome, were it not for the fact that the economy shows little sign of improvement. Rather, unemployment is rising and factory use is falling.

– Even so, investors do not lack for flimsy rationales to buy stocks. “Some of the reasons the bulls are touting to predict better times ahead are mind-boggling,” observes Reuters’ Pierre Belac. “They cite historical market patterns, such as years ending in ‘3s’ and the third year of a presidential term, which have often been good for stocks. Then there’s the famous ‘January Barometer,’ a prognosticating tool that has helped investors anticipate how the market will perform during the rest of the year.”

– Belac scoffs at the idea that any of these touchy-feely “seasonal” stock market tendencies will propel stocks higher for long. In the absence of a genuine and substantial economic recovery, he says, stocks are headed for a fourth straight losing year.

– “People swear that Wall Street has been penalized enough for its excesses in the 1990s, Belac concludes. “The market has fallen so much over the past three years, they say, that it should turn higher, no matter how bad the economic script. But the smart money says: “Just because the market has racked up four straight years of losses only once from 1929 to 1932, doesn’t mean it can’t do it again.”

– The lumpeninvestoriat will have none of Belac’s skepticism. They know that stocks excel “over the long run” and they are understandably delighted that stocks have been excelling over the very short run of 2003-to-date. They know, above all else, that stocks are the preeminent asset class and that they needn’t concern themselves with “fringy” investments like gold.

– In the eyes of the lumpeninvestoriat, the yellow metal is a two-headed goat. An attention-grabbing curiosity to be sure, but certainly not the sort of creature one would want to have roaming loose in a barnyard. Most investors continue to shun gold, dismissing its year-long rally as an aberration. Even so, the yellow metal is on almost everyone’s lips these days. (In fact, gold is also THROUGH almost everyone’s lips these days…and through their eyebrows, ears, tongues and navels…but maybe that’s just the style in Manhattan).

– The precious metal simply refuses to roll over and die. Fleckenstein offers a partial explanation: “The money that you carry around in your wallet or use via your credit card obviously is created at warp speed by the government. The Fed has told you in no uncertain terms that it will do everything to fight deflation…So, while credit cards and cash may be good mediums of exchange, they are pretty pathetic stores of value…It’s pretty tough to find a paper currency regime that has lasted for more than 50 years, and that’s giving some of them the benefit of the doubt.”

– “The dollar-centric global monetary regime is finally starting to fray around the edges,” says Fleckenstein. “What stands behind the recent move in gold is the recognition by many investors around the world that all this paper – whether one is speaking of paper currencies or paper stock certificates – is not what it was cracked up to be.”

– “Gold has a long way to go, both in time and price, before it’s time to take the other side of the gold market in a major way. When people start bragging to you about the gold stocks they own (the way they bragged about Internet stocks, or stocks in general, or the way they talk about their real-estate holdings), then it will be time, perhaps, to leave the party. But we’re certainly not there yet.”

– It’s true, your editors have yet to hear a New York City cab driver say, “My buddy was telling me about a red-hot stock called Newmont Mining…”


Back in Paris…

*** The percentage of workers who run out of jobless benefits before they find work is at a 30-year high. What’s more, for the first time in many years, labor market participation is dropping…people are deciding not to seek jobs. They’re going into retirement…or staying home.

*** The mortgage refinancing boom put $172 billion in homeowners’ pockets in ’02, up from $44 billion in 2000. That was the amount of cash taken out in refi transactions.

“This helps explain the miracle of consumer spending growth amid declining income levels,” says a Moody’s economist.

*** It also helps explain how the U.S. economy continues to defy gravity. It ought to fall into serious recession. But as long as consumers are willing to spend money they don’t have…putting their homes at risk in the process…the recession remains something to look forward to.

The purpose of a recession is to clean up the mistakes of a boom. Businesses need to go bankrupt from time to time. Consumers need to cut back on spending, pay off debts, save some money and tidy up their balance sheets. The recession of 2001 was just not up to the task. It followed the biggest boom in history, with more mistakes to correct than ever before. But instead of getting out the broom and scouring pads, it merely went around with a feather duster so soft that most people never even felt it brush their ears.

Yes, the corporate sector got rinsed. But consumers are as greasy as ever – and getting even more sullied, thanks to real estate lending.

“In the 3rd quarter of ’02,” Marc Faber points out, “mortgage debt was growing at an annual rate in excess of $900 billion, in a $10.5 trillion economy.”

It can’t last, of course. Sooner or later, the consumer will get scrubbed. Then, we will have the recession the country needs. More from Dr. Faber, below…

*** California is far in the lead among in state-level budget deficits. The Golden State faces a shortfall of $35 billion. Runners up include New York and Texas – each with about $10 billion deficits. Where’s the money going to come from? Too bad the states cannot print money…

The Daily Reckoning