Make It Stop Hurting!

From the world’s largest creditors, Americans have become the world’s most profligate spendthrifts. Worse, they’re now dependent on the nanny state – and the central bank’s printing presses – for funding. "This story is not going to end well for most people," predicts Gary North, below…

Americans live in a fantasy world. This fantasy world is going to be destroyed by economic forces that are already well established.

It is easy for readers to think, "He’s talking about the other guy." Maybe I am, but if you are doing essentially what the other guy is doing, then I’m talking about you.

Americans no longer save. They spend. You have read this over and over, but has it registered? Really? What percentage of your after-tax income do you save each month? Do you have an automatic thrift plan with your employer? Do you ever touch the money?

Unfortunately, saving does not come naturally for most people; it must be learned. A young man doesn’t emotionally know that if he doesn’t save for his old age, he will be in dire straits. Children are not future-oriented. Present-orientation is one of the primary marks of a child. Children are also not independent; others make their decisions for them. That is the primary mark of a child.

Americans today are a nation of children. We can see this in their savings habits. We can also see it in their voting habits.

Keynesian Economics: Recessions Scare People

In recessions, the rate of thrift rises. People get scared. They worry about losing their jobs. They recognize that they are vulnerable. Like the overweight person who finds that his clothes are too tight and who thinks, "I must start dieting today," so is the spendthrift in a recession. He can no longer put off a savings program, he thinks. He must begin saving. So, he does.

But, like the overweight person who loses 20 pounds and whose clothes again fit, the saver is tempted to go off his budgetary diet. The money seems good. The job seems safe. He stops saving.

You can chart recession years by looking at the sharp increase in the national savings rate. You can also mark the period of the recovery. The savings rate drops.

In the most recent recession of 2001, the savings rate never went over 4%. In previous recessions, it has gone over 8%. Today, it has fallen back into the 1% to 2% range. The recession has had no lasting effect on people’s willingness to sacrifice present enjoyment for the sake of future security and income.

From the point of view of the return on savings, I can hardly blame the American public. The Federal Reserve System pumped in so much money in 2001 that it drove the short-term interest rate from over 6% to about 1%. Meanwhile, the rate of price increases was over 2%. After income taxes and the decline of purchasing power, a person with a passbook savings account or money market fund went in the hole. He had a negative return on his money. That means that his sacrifice of present enjoyment of spending the money left him poorer. Then why save?

Here’s why. When someone loses the willingness to save, this affects his outlook regarding the future. He consciously decides that the payoff of self-denial today is a losing proposition. He concludes that the system is rigged against him in his capacity as a saver. He is correct: the system really is rigged in favor of the spender and the debtor.

When a recession hits, Keynesian policies of deficit financing are adopted by the Federal government. The central bank starts buying government debt with newly created fiat money. The government and the central bank adopt policies that are disastrous for individuals to adopt: reduced saving, more spending, more borrowing.

The public is so utterly ill informed today – as ill informed as Keynesian economists – that people mimic the state. They spend. They take on consumer debt. In the 2001 recession, they bought homes and new cars. This, we are assured by government economists, was a good thing. The consumer did not falter. The consumer spent the country into prosperity.

Keynesian Economics: Spend Your Way to Prosperity

This is the essence of the Keynesian economic solution to recession: spend yourself (and the nation) into prosperity. Keynesians apply this principle to government spending because they believe that consumers are slackers when it comes to spending during a recession. There is insufficient demand. Demand – spending – is the key to recovery…not thrift (a negative), not reduced wage rates (a negative), but spending. So, the government must pick up the slack. It must also encourage the public to follow the leader.

This is a child’s universe. The child falls down and scrapes his knee. He runs to his mother to get her to make the pain go away. His mother will fix it! Two minutes before he fell down, he may have resented his dependence on his mother. He wanted to be a big boy. But when big boys fall down, they don’t run to their mothers…and so he finds he is not ready to be a big boy after all.

Americans have bought the Keynesian party line. They believe that self-discipline is not the way to success. They believe in the state as mother. So, we live under the watchful eye of the nanny state. That is what most Americans want. They vote for politicians who refuse to cut back on government spending. The state grows ever larger, and so do its promises.

We have again seen the rate of thrift fall to about 1%. We have seen the Federal government’s percentage of the economy rise to 25%. These phenomena are the result of the same mind-set. As surely as the determination to save is related to the determination to become independent economically, so is the determination to take on consumer debt to buy depreciating assets linked to the determination to find someone else to solve life’s economic problems. "Make it stop hurting!"

When the economy falls down and goes un-boom, the voters run to the government. "It hurts. Make it better." What snookums needs is a cotton swab drenched in alcohol. "This is going to hurt." Response: "No! Don’t!" The child wants the hurt to go away now. He doesn’t want what is necessary to solve his problem – his real problem. He doesn’t know anything about infection. He knows only that his knee hurts and he wants mommy to make it stop hurting.

In politics, however, mommy has to be re-elected at regular intervals. Mommy is not secure in her high office. So, she promises never to use that nasty old alcohol. She will kiss the wound and make it well. In doing so, she will increase the risk of infection.

Keynesian Economics: Increase Spending but Not Taxes

Ever since John Maynard Keynes persuaded politicians that what they wanted to do – increase spending without raising taxes, and therefore increase the national deficit – is economically sound policy, the politicians have become incorrigible spendthrifts. They want to be re-elected, and a slack economy is their own scraped knee. So, they run to the central bank. "Kiss it and make the pain go away." The central bank obliges. It creates money. The supply of money goes up. This tends to lower the price of money – the interest rate – in the recession phase. The result: the destruction of a positive economic return for savers, after taxes and price inflation.

Keynes taught that what is rational for the individual during a recession – increased thrift – is bad for the economy as a whole. To cut expenses personally is self-defeating nationally, says the Keynesian, even if he calls himself a supply-side economist, a monetarist, or an Austrian economist. If his argument is that thrift and cost-cutting are good for the individual but bad for the economy, he is a Keynesian. He is denying the heart of free market economics, from Adam Smith to the present. He is saying that rational individual self-interest not only fails to coordinate the economy, it is bad for the economy.

This is the child’s universe. The West has become dependent on government to provide fiat money. If the world’s central banks were ever to stop creating money, the malinvestments which their low interest rate policies have created would be exposed by the capital markets as misused capital…and the capital markets would fall like a stone.

The West is now in its second childhood. It refuses to do what is necessary to grow up: reduce taxes, increase thrift, pay off the national debt, and stop creating new money. This can be done, but it won’t be done. To do it would hurt. "Make it stop hurting!"

Meanwhile, the nanny state continues to look for injuries to kiss. The voters need to tell the state exactly what it can kiss…but they never do.

This story is not going to end well for most people. I hope it ends well for you.


Gary North
for The Daily Reckoning
March 16, 2004

Editor’s Note: Gary North is the author of "Mises on Money" and the editor of Reality Check, his free e-letter. At the age of 25, Gary North became the youngest elected member of the Economists’ National Committee on Monetary Policy. He has also held such posts as research assistant to U.S. Congressman Ron Paul and senior staff member of the Foundation for Economic Education.

The U.S. stock market seems to have rolled over into Phase II of the Great Bear Market we’ve been worrying you about for the past 5 years.

The Dow lost nearly 500 points in the last 6 days of trading (based on the numbers at 4pm yesterday). Hardly anyone noticed.

The national character was well prepared for Phase I. It was blasé, insouciant…congenitally relaxed. The thought occurred to us on the metro last night as we entered a loud car full of slouching American teenagers on a class trip. The woman sitting across from us had once been pretty. But she had not bothered to put on make-up. She wore what looked like an exercise outfit…ready to absorb the sweat from her pudgy body as she made her way around Paris. She must have been a teacher or an accompanying parent. But she carried herself like one of her charges – lazily, stupidly, casually. On another bench was a young man who had not bothered to tie his shoes or comb his hair.

In America, no one notices. Everyone is as relaxed as jello. The French are uptight by comparison; here, there is a residual respect for culture, class and style. The British, by contrast, tend to vulgarity, hooliganism or self-conscious anti-culture – at least, that is the impression you get from reading the newspapers, going to an art show or walking down Oxford Street. Americans used to be known for their vulgarity. But it was a naïve, energetic, baroque vulgarity…innocent and almost attractive. Now, Americans are too soft and limp to be vulgar. They go along with anything…for they can’t be bothered to think about it.


On the train this morning, en route to London, a fat young man in a T-shirt sat down across the aisle with a skinny woman at his side. He took off his shoes and put his smelly feet up on the seat. When he opened his mouth we discovered that he, too, was one of us…an American…a slob. We studied him at length. Did he have any idea of how repulsive he seemed, we wondered? Oh no…he began stroking and kissing the grumpy-looking French woman, who must have been his wife. Yech…And then, she reached under his T-shirt to rub his back. Uh oh…they looked deeply into each other’s eyes…they must have been newlyweds, or else they were both blind…they embraced…We thought we might be getting sick.

These are our own people. We want to think well of them. Besides, what possible difference does it make what people look like, or how they dress? And yet, as Aristotle might have said had he thought of it, in the breath of our national character we smell, faintly, our decaying national fate.

Four years into the 21st century, the Great Bear Market Americans are so at ease with themselves and life in general…so deeply asleep to the rigors of life…that they have nearly lost consciousness. Back in the ’70s, the national current account deficit rose to nearly 1% of GDP. Economists were alarmed. The dollar fell. Stocks fell. The nation was so strapped and the dollar so weak that the Carter Administration planned to borrow $10 billion in foreign currency to tide itself over. By the time the period was over, you could have earned 15% interest yield from a U.S. Treasury bond. A typical stock – which you could have bought at an average of 6 times earnings – would have paid dividends of more than 5%.

Today, the current account deficit is above 5% and economists see no problem. For the moment, the U.S. government still borrows in a currency it alone controls. And foreign central banks still seem so happy to lend that over the last 3 months, their holdings of U.S. government securities rose at more than 50% annual rate to more than $1 trillion.

Stocks, real estate, employment, interest rates, government spending…all the things we count upon to maintain our fat and happy lives depend on foreigners…who may be less relaxed that we are. The Japanese alone spent nearly $70 billion of their own money in the month of January trying to keep alive Americans’ fantasy economy. Even this was not enough; the dollar fell anyway. In the same month, Japanese finance minister Sadakazu Tanigaki said right out loud that he thought Japan might be overdoing it. Maybe Japan would be better served with other assets in its central vault other than just U.S. Treasury bonds he suggested.

The menace to Americans’ way of life went – like so many other threats – unmentioned in the Land of the Free Lunch. And today, the International Herald Tribune was again silent on what the Dow’s latest downturn might portend. Once in motion, a stock market continues to fall until it falls too much. It only comes to a halt at levels that make stocks not only decent deals…but attractive ones. A currency, too, falls not to a point of equilibrium…but far beyond. There, once again, it is out of balance with the rest of the world, but this time, in the opposite sense.

In Phase I, the retreat was orderly and calm. But Phase II may be less calm and more disturbing. It may even unsettle
Americans from their carefree reverie…

Over to Eric for more news…


Eric Fry on the scene in New York…

– Terrorism claimed another victim Monday…The S&P 500’s gain for 2004. Last week, the terrorist bombings in Madrid knocked the Dow and the Nasdaq into the red for the year. But the S&P still clung tenaciously to its 1% gain…until yesterday.

– The U.S. stock market resumed its slide Monday, as word surfaced that al-Qaida became the lead suspect in last week’s horrific bombings. Also weighing on stocks was the Socialist party’s upset victory in Spain’s general election over the weekend. "The Socialist victory deals a blow to President Bush’s global support for the war in Iraq," CBS Marketwatch explains, "as the prime minister-elect promises to bring Spain’s troops home from Iraq by the end of June."

– In Monday’s trading, the Dow fell 137 points to 10,102, while the Nasdaq tumbled 2.3% to 1,939. The stock market’s selloff spooked investors into the gold market, where the safe-haven metal jumped $4.00 to $399.60 an ounce.

– Despite the ever-present threat of terrorism – or maybe BECAUSE of the ever-present threat of terrorism – Americans continue to "live for today." They continue to borrow money they don’t really have to buy things they probably don’t need. Meanwhile, the Chairman of the Federal Reserve urges the populace, "Borrow, spend and be merry, for tomorrow we die!"…or something like that. The same guy who once cautioned against "irrational exuberance" now advocates reckless consumption…based on interest rate speculation.

– Greenspan is urging Americans to swap out of their "expensive" fix-rate mortgages into "inexpensive" floating rate mortgages. Never mind that rising rates would make this a very expensive trade. "Alan Greenspan, mater of muffled speech," writes Jim Grant, editor of Grant’s Interest Rate Observer, "issued a clarion call [recently] to the nation’s homeowners. ‘Float,’ he advised them, in so many words."

– It’s true: two weeks ago, Greenspan remarked before the Credit Union Nation Association in Washington, "Recent research within the Federal Reserve suggests that homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward."

– To which Grant’s quips: "To be sure. And recent research conducted by this office suggests that many investors might have earned tens of thousands of dollars had they bought the Nasdaq Composite in early 1991 and sold about 10 years later (though they would have lost money, of course, had the stock market gone down instead of up)."

– While Greenspan urges the lumpeninvestoriat to extract and spend every last cent of equity "locked up" in their homes, America’s Big-3 automakers entice the lumps to borrow as much money as possible in order to buy cars they can’t really afford.

– "Thanks to ultra-low interest rates and lengthening auto-loan maturities, Americans in rising numbers owe more on their cars than their cars are worth," Jim Grant observes. "In vehicular lingo, they are ‘upside down.’

– "’About 30% of all customers walk into showrooms upside down, according to one estimate,’ reports the Feb. 16 Automotive News. ‘And that means that the nation’s multiyear string of strong auto sales is being propped up increasingly by longer loans and staggering consumer debt.’

– "The data shows that, since 1984, household debt as a percentage of household net worth has climbed to 29.4% from 22.7%," Grant continues, "while the maturity of the average new-car loan has jumped to 61.3 months from 46.3 months. As recently as 2001, new-car buyers borrowed, on average, for just 55 months…Automotive News, quoting the Consumer Banker’s Association, reports that banks last year crossed a kind of prudential Rubicon, financing 100.9% of the invoice price of cars and trucks. In 1997, there were lending a mere 89%.

– "When one is upside down, what does the world look like?" asks Grant. "Automotive News reported on the case of a certain Grand Prairie, Texas, Chevrolet dealership, which ‘signed a customer last month to a $46,911 loan over 96 months, $18,136 over the invoice price of a Chevrolet suburban.’ Why? Because the consumer owed more on the trade-in than it was worth; the excess of debt over equity was rolled into the loan…

"Wowing Gov. [Ben] Bernanke, and sustaining the U.S. economy, North American vehicle sales have averaged about 17 million a year for the past four years. Owing to rebates, low interest rates and E-Z finance terms, car and truck sales scarcely pulled back even during the nine-month recession of 2001-2. Thanks be to the consumer to borrow, the creditors to lend – and foreign central banks that helped to make it all possible."


Bill Bonner, back on the train…

*** We reported adjustable rate mortgages of 3.71% recently – a new record. But the word from Grant’s Interest Rate Observer, which Eric cites above, is that even lower rates have been observed. A $1 million house in Atlanta was recently advertised for sale with an interest-only mortgage on which the monthly payments were only $2,291.67. This works out to a rate of 2.25%.

*** We are tempted to borrow. Lenders are giving money away. The day will come when 2.25% mortgages look like at $400 – a gift from the market gods. The smart thing to do was not to buy Amazon at the offer price…but to sell it. Better yet, start your own Amazon and sell shares to the public. Investors were giving away money. But instead of spending the money on a goofy of your own…the thing to do was simply to save it. After the crash, you could have bought one of the survivors.

But how to take advantage of today’s lenders – who seem bent on giving away their money? Take it? Maybe. But don’t forget: don’t spend it.

*** Train travel isn’t as easy as it used to be. Suspicious packages interrupted our journey this morning…we spent an hour outside Brixton waiting for the bomb squad to disarm someone’s dirty laundry.

*** From our unpaid correspondent in Pittsburgh, Byron King, a confession:

"Did I ever tell you that I ran for U.S. Congress back in 1992? I probably did not mention it. I usually do not bring it up in polite company. It is just not all that important to me, in retrospect. I even left it out of my Harvard 20th and 25th reunion class report because it seemed so unremarkable. But, yes. Nolo contendere. That was me on the campaign trail, my otherwise good name on the election ballot for Pennsylvania 14th District.

"Back in 1992, nobody was going to run against the long-term incumbent liberal Democrat who represented Pittsburgh. I was talking with someone from the Republican Party, and I said ‘He’s going to run unopposed? What is this, East Germany?’ So the Republican bubba called my bluff and said, ‘Why don’t you run?’ Me? Hey, I never ran for any political office in my life, not even high school class treasurer. Me and my big mouth…Next thing I knew, I was the candidate. Campaigned ‘on the issues,’ of course. Raised a bunch of money. Received a bunch of votes on election day. Did not win the election, but I met my wife along the way. That was the best part.

"One of the most important things about running for office was that I ran. In a sense, win or lose, you win by running, and not necessarily by winning. Heck, if I had won, I would have had to break the bad news to everyone that their federal government is broke, has to cut spending and shrink the nanny state, and that people have to save, invest and work harder to grow the economy. Who wants to hear that kind of noise from their politicians?"