The strong, compelling evidence of an economy that is as far away from a recovery as its disastrous job numbers.
There has been much talk to the effect that America has just had its slightest recession in the whole postwar period. That is measured in real GDP growth, being bolstered by many statistical tricks. Measured, however, by job losses, which certainly are the far more important gauge, it is already America’s worst recession by far.
In June it was declared that the recession had ended in November 2001. Yet in the 20 months since, payroll employment has declined by a total of about 1 million jobs, or about 8%. In not one of the seven or eight postwar recoveries has there been any employment decline. Immediate strong job growth has been the regular characteristic of all business cycle recoveries. On average, payroll jobs increased 3.8% in the 20 months following the end of recession.
What’s more, no letup in job losses is in sight. During the second quarter, widely hailed for its better-than-expected GDP growth, the household measure of employment slumped by 260,000. However, this figure concealed an even greater number of workers – 556,000 – who statistically quit the workforce because they have given up looking for nonexisting jobs.
This rapidly growing group of people no longer count as unemployed. What American job statistics really measure are not changes in unemployment, but changes in job seekers. Including the frustrated job seekers, the U.S. unemployment rate is hardly lower than in Europe. Certainly, it is rising much faster.
2001 Recession: Payroll Decline
In addition, the Labor Department is employing month for month the same two practices that camouflage the horrible reality. In July, for example, it reported a decline in payrolls by 44,000, while job losses for June were revised upward from 30,000 to 72,000. For May, the retrospective upward revision was even from 17,000 to 70,000. As such upward revisions of job losses in the prior month have become a regular feature, this practice has the convenient effect of producing correspondingly lower new numbers every month. The same happens, at more moderate scale, with weekly reported claims.
There is still more spinning involved. The government adds every month some 30,000-50,000 imaginary workers to the job total. It is based on the assumption that in an economic recovery a lot of people start their own business. In normal recoveries, they have done so, indeed.
All it needs to activate this statistical job creation is a unilateral decision by the government that the economy is in recovery. Once a year, the statisticians reconcile their assumption with reality by a revision. When they did this in May of this year, 400,000 new jobs that had been reported earlier simply vanished. Such revisions, of course, take place outside the monthly reported job losses. Together, we presume, these statistical casuistries have reduced the reported job losses in the past two years by well over 100,000 per month.
It rather abruptly became the consensus view that in America the great recovery from protracted, sluggish growth is finally on its way. Record-low interest rates, runaway money and credit growth, new big tax cuts, record-high cash-outs by consumers through mortgage refinancing, increasing house and stock prices, and rising profits are cited as the compelling reasons for this optimism.
2001 Recession: Grossly Disappointing Effects
We are more than skeptical about the true impact of all these influences on the economy primarily for one reason: Most of them, if not all of them, have been at work for some time already, but with grossly disappointing overall effects on the whole economy, and now some of these influences are weakening or even reversing.
Think of the sharp rise in long-term interest rates that is most assuredly stopping the mortgage-refinancing bubble dead in its tracks. That, in our view, will not only abort any recovery but will also mean the economy’s relapse into new recession.
As for fiscal policy, it clearly gave its biggest boost to the economy between the fourth quarter of 2000 and the second quarter of 2002. That is a period of six quarters during which the federal budget gyrated from a quarterly surplus of $306.1 billion to a deficit of $526 billion, both at annual rate. This year, the deficit is supposed to hit $455 billion. Most probably, it will come out much higher. But this follows a deficit in the last year of $257.5 billion. The fiscal stimulus is waning, not increasing.
In any case, actual, historical experience in the 1970-80s with large-scale government deficit spending has been anything but encouraging. It created more inflation than economic growth. Over time, rising deficits were rather recognized as impediments to economic growth. Japan’s recent experience makes frightening reading. Since 1997, government debt has skyrocketed from 92% to 150% of GDP, rising every year by more than 10% of GDP. Yet nominal GDP keeps shrinking.
As to monetary policy, we have very much the same doubts about its efficacy in generating economic growth under current economic and financial conditions. It is the traditional American consensus view that monetary policy is omnipotent if properly handled. In this view, any recession, or worse, always has its decisive cause in the failure of the central bank to ease its reins fast enough. In this view whatever happened in the economy during the prior boom is irrelevant.
2001 Recession: Growth Rate Slump
This time, both monetary and fiscal policies in America have acted with unprecedented speed and vigor. To people’s general surprise, the economy’s rate of growth abruptly slumped during 2000 from 3.7% in the first half to 0.8% in the second.
Starting on Jan. 3, 2001, the Fed slashed its short-term rate in unusually quick succession. Within just 12 months, its federal funds rate was down from 5.98 to 1.82.
Assessing the development, the first thing that struck us as most unusual was that this sudden, sharp economic downturn occurred against the backdrop of most rampant money and credit growth. Total nonfederal, nonfinancial credit grew by $1,144.3 billion in 2000, after $1,102.6 billion in the year before. This compared with nominal GDP growth during the year by $437.2 billion. The first important conclusion to draw therefore was that this sudden economic downturn had obviously nothing to do with money or credit tightness.
Ever since, nonfinancial credit growth has sharply accelerated. In the fourth quarter of 2002, it hit a record of $1,612.8 billion, at annual rate, followed in the first quarter of 2003 by $1,338.3 billion. This coincided with simultaneous nominal growth of $388.4 billion and real GDP growth of $224.4 billion, both also at annual rate. For each dollar added to real GDP, there were thus six dollars added to the indebtedness of the nonfinancial sector.
for The Daily Reckoning
September 24, 2003
P.S. During the 1960-70s, by the way, there was on average about 1.5 dollars of debt added for each dollar of additional GDP. Just extrapolate this escalating relationship between the use of debt and economic activity. And think of it: the GDP growth of today is tomorrow a thing of the past, while the debts incurred remain. Plainly, Greenspan’s policy has collapsed into uncontrolled money and debt creation that has rapidly diminishing returns on economic activity.
As we noted in these pages last week, the late economist Hyman P. Mynsky would call this a Ponzi economy where debt payments on outstanding and soaring indebtedness are no longer met out of current income but through new borrowing. Soaring unpaid interests become capitalized.
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."
In the September issue of his newsletter, Dr. Richebächer aggressively dissected the data economists are interpreting as a miracle ‘recovery’ – including a critical look at defense spending and its aggregate effect on the revised GDP numbers for Q2.
"Economic optimism is widespread," begins an article in yesterday’s Financial Times. "Merrill Lynch’s global survey of fund managers, published last week, showed that 87 per cent of those polled expected the global economy to grow over the next 12 months with most in favor of ‘much’ stronger growth."
Unemployment is low. Inflation poses no obvious threat. The Fed is free to hold rates down "a considerable period" to make sure the economy gets underway. The U.S. government is ready to help, too – as long as someone will lend it the money – with a $500 billion deficit spending program.
"The growth rate is widely expected to reach 5%, annualized, in the third quarter," continues the FT.
You have read our scoffs before, dear reader. Every time the ‘recovery’ appears before us, we feel like yanking on his beard, for we are sure he is an imposter. Today, we pull down his pants and check for birthmarks.
To hear the popular press tell it, the nation’s factories and malls are in full up-swing. GDP rose 3.1% in the 2nd quarter – twice as fast as expected.
"Consumer spending accelerated to its fastest pace since the fall; business investment grew at its fastest rate in 3 years and construction was stronger than thought," concluded the Wall Street Journal.
We have already pointed out that more than half the GDP growth of the 2nd quarter was the result of military spending. Without it, GDP would have grown scarcely more in the 2nd quarter than it in the first. We also mentioned the curious effect of crunched and tortured numbers on computer spending. Information technology, it turns out, "accounted for more than the overall increase in business fixed investment," writes Dr. Kurt Richebächer, snitching. "This investment component soared by $38.4 billion, or 12%, from $319.1 billion to $357.5 billion. This clearly looked like a new boom."
But it was a boom that no one heard…for it never happened. The real increase in spending on computers barely squeaked; it was only $6.3 billion. Still, using its quality-enhancement jets, government statisticians were able to blow the number up by more than 600%.
If you let the numbers take their natural shapes, you get a very different impression of the first quarter. GDP grew by a paltry 0.27%. "Even including the huge amount of defense spending, this is hardly better than the growth rates in the rest of the world," Richebächer concludes.
Pulling down the recovery’s pants, we discover the disgusting truth. It is right there in the unemployment numbers. Not one of the 7 or 8 postwar recoveries failed to produce jobs, Dr. Richebächer tells us. But in the 20 months following the official end of the most recent recession, about 1 million jobs have been lost. In the 2nd quarter, 260,000 is the number given for jobs lost. Even this is a bit of a lie. It doesn’t measure the number of people who’ve given up looking for work – a number said to be twice as large.
Plus, with his trousers down, we find an even bigger disappointment in Mr. Recovery. "The government adds every month some 30,000 – 50,000 imaginary workers to the job total," Richebächer tells us. "It is based on the assumption that in an economic recovery, people start their own businesses…Once a year, the statisticians reconcile their assumption with reality by a revision. When they did this in May of this year, 400,000 new jobs that have been reported earlier simply vanished. Such revisions, of course, take place outside the monthly reported job losses. Together, we presume, these statistical casuistries have reduced the reported job losses in the past two years by well over 100,000 per month." More from the good doctor below…
Addison Wiggin, writing from Paris…
– When it rains it pours, goes the saying…we have been rather excited by the launch of our book "Financial Reckoning Day" through bn.com. Last weekend, after the announcement we mailed to you, we raced past John Grisham and The South Beach Diet in the sales rankings on the site. Then, we knocked "Dr. Phil" off the #1 slot on the bn.com best-seller list – and stayed there all weekend. It was all very exciting, indeed. But unfortunately, for whatever reason, bn.com hasn’t stocked enough copies to keep up with the demand.
– Briefly, last night, while we were nervously refreshing the screen to check the best-seller page, we noticed that they had received a second shipment. And for a brief moment, we were back in the game! Alas, it only lasted an hour; the shipment was already spoken for. Now, the book has been sidelined again…de-listed: "Not Yet Released", as if we had not launched at all. We have subsequently dropped to #9 on the list…even the pair of loud-mouths Bill O’Reilly and Al Franken have passed us by…quelle tristesse!
In the meantime, we’ll keep you posted, as the "Financial Reckoning Day" drama unfolds.
– Secondly, one of our French colleagues, responsible for the distribution of La Chronique Agora, the French-language edition of the Daily Reckoning, has taken an abrupt leave of absence. Consequently, his colleagues here in the Paris office were faced with the challenge broadcasting using the American broadcast system, whose instructions are written in English. The result was…as you may have noticed…a three-fold broadcast of La Chronique Agora to your e-mail address yesterday. We’d like to apologize profusely. With any luck, it won’t happen again.
– Back to the markets…the dollar plunged to a near 3-year low yesterday…Treasury Secretary John Snow warned "other nations" as he was leaving the G7 shindig in Dubai that they had better not count on the U.S. consumer to continuing buying imports…and Koffi Anan, head honcho at the U.N., warned the general assembly that "we have come to a fork in the road…a moment no less decisive than 1945 itself, when the United Nations was Founded."
– Meanwhile, gold staved off selling pressure from Goldman Sachs and Morgan Stanley, closing the day down only one dollar at $385.
– What do all these events have in common? Dave Lewis, writing on his Chaos-onomics website, summed it up nicely: "Economic policy makers around the world appear to have finally decided to try to restore equilibrium. This is never a painless effort as it involves behavioral change on a mass scale, most recently experienced here in the U.S. in the 70s. Whether the political will can be found to stay the course remains to be seen…As Arthur Miller describes so well in Death of a Salesman, it is the illusions of greatness which come back to haunt."
– "If you don’t think it can happen here," writes Dan Denning in the opening salvo of Strategic Investment this month, referring to collapse of the U.S. dollar, "you might be surprised to find out that it already has, twice. And both times, the crumbling currency has taken the financial markets with it, but left investors in hard assets comparatively safe.
– "It wasn’t the end of the world either of those two previous times…[and contrary to the opinions of your editors,] it won’t be this time either. But it will be a period of painful adjustment for most." [You can read more about the two previous collapses of the U.S. dollar in the October issue of Strategic Investment, currently available to paying subscribers.
– What will a painful period of adjustment look like? Perhaps this is an indication. The AARP released a report yesterday saying a survey of its members finds "most" plan to keep working well into their 70s. "Higher healthcare costs," says a review of the report posted at CNN.com, "insufficient retirement funds and recent investment losses feed the need to keep earning."
– Given Kurt Richebächer’s comments below, one wonders, what jobs will they continue to work in? The day of financial reckoning has more and deepening consequences than even we, who watch with the awe of a witness to train wreck each day, are aware…
Bill Bonner, back in Bonn…
*** We have come to Germany to see Robert P. Miles, a Warren Buffett worshipper. We say ‘worshipper’ because his comments on Mr. Buffett last night brought him dangerously close to mortal sin.
Mr. Miles explained Warren Buffett’s investment secrets. Our train was held up, so we arrived late, but we pass long the secrets we heard:
"Don’t buy a little of a lot of stocks, like Wall Street tells you," Miles explains. "Buy a lot of just a few. Buffett says he knows of no outstanding super-investor who owns more than 4 or 5 stocks."
"Don’t diversify," he went on; "concentrate on a few companies and make sure you choose them very, very well."
What companies should you buy? "Those that you can buy at their intrinsic value or less [based on discounting the stream of earnings over the life of the franchise]…which have in place good management and a durable franchise with a moat around it."
What do you look for in managers? "Buffett looks for three things: integrity, energy and intelligence. Of those, the most important by far is integrity. If they don’t have integrity, Buffett would rather have managers who are lazy and stupid. And he doesn’t want to buy businesses from people who just want money. He wants managers who love the business and will stick with it. Buffett has no vice presidents. He has fewer than 15 employees. He can’t send out anyone to supervise or trouble-shoot these businesses. He leaves them alone. One CEO of a Buffett-owned company told me that he hadn’t seen Buffett in 20 years.
"Don’t trade in and out of stocks. Buy just a few and hold them for a long, long time. Warren Buffett’s favorite trading period is forever," continued Miles. "Did you know what the average holding period for Nasdaq stocks is? It’s just 6 months. And stocks on the NYSE? Just one year. But the average share of Warren Buffett’s Berkshire Hathaway only changes hands once every 17 years. And Buffett himself holds its shares for an average of 20 years."
There you have it, dear reader. All you need to know to become a billionaire. Of course, you may need the biggest bull market in world history too, but Mr. Miles didn’t mention it.
Here at the Daily Reckoning, we have mixed feelings about Mr. Buffett. We appreciate his sage advice, but we find his example both noble and pathetic. Mr. Miles showed a photo of Buffett’s plain house in Omaha. We were supposed to applaud the simplicity of it and admire Mr. Buffett’s devotion to his métier. Like Hannibal, the leading general of American shareholders shares his soldiers’ hard life…and only slips away occasionally, to his $6 million California condo.
But, looking at the Omaha photo, we can’t help but wonder: if you have to live in a barrack like that, you might as well be poor.
More on Warren Buffett…Abraham Lincoln….Johnny Cash…and other unrelated subjects…on Friday.
*** An alert Daily Reckoning reader, still on the trail of Il Duce:
"Earlier, I emailed you with some more detail about Mussolini. This level of background is what John Flynn does not tell you (he probably did not know this much history about Il Duce back in 1943-44), when he says that absent the War some other person might have come to power in Italy, and governed with a different form of ‘fascism.’ Absent the War, Mussolini would have remained a Socialist crank on the fringes of power.
"But the keel of the fascist ship had been laid in Italy over the 60 years previous to Mussolini’s rise to power. Mussolini was a war hero who used the disaffected arditi to consolidate his rise to power. The instrumentalities of fascist power were already in place. Mussolini took over the throttles of this power. But could any other captain have taken the helm of the Italian ship of state? Would the history of Italy, if not Germany, if not the world be any different? Thus Flynn wrote part III of ‘Marching,’ all about FDR and his New Deals.
"This, I think, is the key point of John Flynn’s ‘Marching.’ When the roots of fascism grow in the cultural and political soil of any nation, it takes only a man with a certain kind of vision to bring out a certain kind of result. When the apparatus of state planning and government spending via massive public debt are in place, these items can be used for better or worse (and usually, for worse). Flynn spent decades writing and criticizing FDR, and he did not need to take time out of his schedule just to write a book of Italian-German history. ‘Marching’ is a book about how things similar to what occurred in Italy and Germany, giving rise respectively to Signor Mussolini and Herr Hitler, were occurring and had occurred in the USA, circa 1930’s-40’s.
"The U.S. republic bought a reprieve from the apparatus of fascism in 1936 when the Supreme Court struck down two of the key early New Deal agencies, the National Recovery Act and the Agricultural Adjustment Act. But after FDR began to place ‘his’ justices behind the high bench, the ‘general welfare’ and ‘interstate commerce’ clauses of the U.S. Constitution took on new meanings that legitimized the growth of the central government’s powers according to FDR’s schemes. Interestingly, FDR’s new justices found things written and or implied in the U.S. Constitution that no Supreme Court justice had seen in the previous 150 years of the nation’s history. Supreme Court jurisprudence began its decades-long drift away from black-letter law and Gold-standard moorings. In 1955 John Flynn proposed that the States adopt a Constitutional amendment to the effect that no Supreme Court decision from 1937 onwards stand for any precedent, or have any controlling power in the law. But that is another story for another time.
"Still in shock and awe, I remain… BWK"