New Year's Resolutions, Part II
The Daily Reckoning PRESENTS : What if America can’t pay its staggering debts? Mr. Bonner digs through history and uncovers and alarming answer.
Americans, at the beginning of Anno Domini 2004, were a happy and contented race – but in Revolt against Fate.
Their paper money – unbacked by anything more than promises from the world’s biggest debtor – was destined to go bad; all paper money always did. Their economy was doomed to slow down – debtors cannot increase their spending forever. Their stocks were sure to fall, victims of an excess of enthusiasm and a paucity of real profits. Their bonds were living on borrowed time, too – for it was amazing that foreign lenders continued to buy a 5% bond when the currency in which they were denominated was losing 20% of its value in a single year.
But as the snow fell in the winter of 2004, they hardly suspected. For they believed their position in the world must reflect some kind of innate grace, or must be a product of their own invention. Since they had invented it themselves…surely they could control it.
Little did they realize that there was nothing really new to their system. But no fantasy is so hard to destroy as a man’s good opinion of himself…and in January of 2004, Americans’ opinion of themselves had not yet been bruised by a falling dollar…nor hardly even touched by the recent recession and bear market. Americans still could not describe their special gift…but they were sure it put them on top of the world. For they had invaded Iraq…not the other way around. Their economy was racing ahead of their European competitors (they ignored the effect of the dollar)…and they alone could still issue pieces of paper that the whole world called ‘money.’
Benito Mussolini: The Great American Debt Bull Market
If a bull market can turn a schmuck into a genius, The Great American Bull Market in Debt created a whole nation of them…all somehow sure that the end of history had come…and its final chapter had them as the big winners. They ignored the hard work of their fathers and grandfathers in the chapters ahead of them. They dismissed the virtues of thrift, sound money, limited government and collective modesty that made their forebears so successful. They flipped through the pages of American history and paid no attention to the dead. And the young…the unborn? It was as if they thought the book had no sequel…as if it were the last oeuvre ever…the last word…the final, culminating perfection of all Western civilization. The young are on their own…they will have to pay off our debts as best they can!
We can almost hear Fate snickering. Not that we know what he has in store for us. But since it is the beginning of a new year, we guess and wonder…
We wonder how Americans can avoid a drop in their standards of living. In global terms, wage rates have fallen in the U.S. for the last 2 years – and are down 40% in euro terms. A few more years of this, and the average American factory worker will be competitive with a Bengali!
We wonder when stocks will begin to fall. Soon is our guess. The Feds reloaded the bubble in 2003. But what ammunition do they have left? Lower interest rates? Bigger deficits and more government spending? Another tax cut? None of this is very likely anyway.
We wonder when the Chinese and other lenders will come to their senses and stop lending to Americans at such low interest rates. We don’t know. But eventually.
Benito Mussolini: No Constructive Advice
But all of these wonders and guesses you have heard before. Readers say they are getting tired of our ‘gloom and doom’ and would welcome some ‘constructive suggestions’ for surviving 2004.
Alas, we have no constructive advice. The best we can do is to continue digging down…day by day. Our resolution for the New Year is the same as for the old; we are still trying to get to the foundation…the hard meaning of it all. It is slow going, for we are digging into the bedrock of the modern consumer economy…trying to understand what it rests upon. When does it give way, we wonder? What happens when the proud tower of debt and paper money finally becomes too high, too heavy for the earth beneath it? What happens when the wind blows? Which direction will it fall?
"Republican hearts are all aflutter over one quarter of strong GDP numbers," writes Robert Freeman. "But the 8.2% third quarter growth was purchased on credit – the $374 billion budget deficit that was the largest in the country’s history. All indications are that next year’s deficit will be even larger, exceeding half a trillion dollars.
"There is simply no magic to ‘growth’ under these conditions. Any idiot with a hand full of credit cards charged to the next generation’s children can gin up the short term illusion of prosperity. Until, that is, the bills come due.
"George W. Bush inherited a $127 billion fiscal surplus but ran through all of that and more in his first year. He has turned a $5.6 trillion 10 year forecast surplus into a $3+ trillion forecast loss – an almost unimaginable reversal of $9 trillion in only three years. And this, in an economy that has grown for ten of the last twelve quarters.
"How, then, does a nation deal with debts that so greatly outrun its ability to pay?" There are only a few ways, says Freeman. "All are unappealing. Most are calamitous."
Over the past 4 and a half years, here at the Daily Reckoning we have chronicled the build-up of debt…and the extravagant delusions that support it. Now, we look ahead and wonder what happens next. When the tower of debt falls…where does it land? Who gets hurt?
Benito Mussolini: Talking to Dead People
But we find no answers staring blankly into the space of the future. Instead, we get our clues and hints by sifting through the sediment of years past…and talking to dead people.
We have dug down through the Bush years…and past the Clinton and Reagan eras. We sliced our spade right through the sordid debris of Nixon’s time…and kept going through the Great Society, WWII, the New Deal, the Great Depression, and Roaring Twenties…and even down to the founding of the Federal Reserve and WWI.
Of course, we’ve collected many entertaining nuggets in our sifter: "We’re all Keynesians now," said Nixon. Beware "irrational exuberance," warned Greenspan. We will "make the world safe for democracy," said Wilson. We stop and giggle.
And then, we take up our tools and dig a little deeper. We have reached the 19th century…and have wandered over to sunny Italy. There, after the "risorgimento," or renaissance of the Italian state under Mazzini and Garibaldi, Italy joined the modern, democratic world.
There was a time when kings, princes, and emperors ruled the world. Back then, "the people" knew their place. But in this new, modern world it became necessary for rulers to appease the masses with various programs designed to fool them into obedience. Armed with ballots, everything seemed possible.
Ortega y Gasset describes the scene:
"Whereas in past time life for the average man meant finding all around him difficulties, dangers, want, limitations of his destiny, dependence, the new world appears as a sphere of practically limitless possibilities, safe and independent of anyone…and if the traditional sentiment whispered: ‘To live is to feel oneself limited, and therefore to have to count with that which limits us,’ the newest voice shouts: ‘To live is to meet with no limitation whatever and, consequently, nothing is impossible, nothing is dangerous…’"
He might have been describing the mindset of the contemporary American investor, who sees no limit to stock prices and no risk anywhere. And so he was…but 70 years ahead of his time.
Voting cannot really increase the masses’ well-being. It brings no more hogs to market…builds no more gadgets…improves no meals…nor does it increase the efficiency of the internal combustion engine. But the masses will believe anything…and after Bismark and Garibaldi came to believe that this new world of assemblies, parliaments and election fraud offered a better world. It then became the job of politicians to find a way to appeal to these fantasies. This they did, in 19th century Italy as in 21st century America, by borrowing money – thus creating the illusion of spending power, out of thin air.
Benito Mussolini: 46 Deficits in 66 Years
From 1859 to 1925, the Italian government ran deficits over 46 years. In only 20 years was the budget balanced. The lire was not a reserve currency; Italian politicos had to do the best they could.
But the debts continued…and led, according to John T. Flynn in his excellent book, "As We Go Marching," to war. Not because anyone in particular wanted war…or debt for that matter. It was just that one was an evolutionary consequence of the other…and both were consequences of the natural urges of democratic society.
"Out of the condition of Italian society sprang certain streams of opinion and of desire that governments acted on and people accepted or at least surrendered to with little resistance, even though they may have not approved or even understood them. Bewildered statesmen turned to government debt as a device for creating purchasing power. No one approved it in principle. But there was no effective resistance because people demanded the fruits it brought. Another was the ever-growing reliance of social-welfare measures to mitigate the privations of the indigent, the unemployeed, the sick, the aged. The instruments of debt and spending became standard equipment of politicians. And this need for spending opened the door to an easy surrender to the elements most interested in militarism and its handmaiden, imperialism."
"Out of Italy," he continues, "had gone definitely any important party committed to the theory that the economic system should be free."
Whenever the debts threatened to overwhelm the nation, inventive politicians found new enemies to distract the people and quiet opponents.
"If the country had no natural enemy to be cultivated, then an enemy had to be invented," wrote Flynn.
In September of 1911, Italy went to war with Turkey. Then, WWI provided fresh diversions. But after the war, the debts mounted even higher. The pre-war debt was 15 billion lire. When the war ended it was 4 times as much. But after the war came new promises…and old-age pension system…unemployment insurance…a national heath care plan. The deficit reached 11 billion lire in 1919..then rose to 17 billion in 1921. How could the debts possibly be paid? Was there anyway out, people wondered?
It was at this point that a scoundrel worthy of the crisis arrived on the scene – and proceeded to make things worse. Benito Mussolini was the man for the job – energetic, opportunistic…with no scruples or fixed positions to hamper his movements. Mussolini, like Roosevelt, Bush, and practically every politician elected to any office in the entire 20th century, denounced the loose spending policies of his predecessors…and then spent even more. He decried the unbalanced budgets that had brought Italy to the brink of ruin…and then piled new debt on the heavy end of the scale. Taking office in 1921, he found himself with a debt of 93 billion lire. By 1943, the New York Times estimated that his debt had risen to 405 billion lire, with a deficit for the year of 83 billion lire.
"Spending had become a settled part of the policy of fascism to create national income," concluded Flynn, "except that the fascist state spent upon a scale unimaginable to the old premiers."
"We were able to give a new turn to financial policy," explained an Italian pamphlet from the period, "which aimed at improving the public services and at the same time securing a more effective action on the part of the state in promoting and facilitating national progress."
The policy ended in disaster.
Spending on domestic programs shifted to spending on military ones. Soon, Italy was at war again. In blood, steel, shame, disgrace, and financial ruin…it settled its accounts.
The Daily Reckoning
January 9, 2004
Editor’s note: Bill Bonner is the author, with Addison Wiggin, of the #1 NYTimes Business bestseller "Financial Reckoning Day".
"Financial Reckoning Day is in the category of scintillating sex or good vision," writes our friend Jim Davidson, author of best-selling The Sovereign Individual, "something to be savored and enjoyed. Before it is too late."
"Soak the Stupid!"
We propose the slogan to the Republican party…for they seem bent on an original method of government finance. They cut taxes…but increase expenses. Who then will pay for their programs of guns and drugs? Rather than soaking the rich or wringing out the poor, the Republicans want to hose anyone dumb enough to lend money to the Bush Administration at Eisenhower-era rates. They borrow…and then degrade the currency in which the debt is calibrated.
It is chicanery…but an elegant chicanery; nearly half the lending comes from foreigners…and the poor foreigners don’t vote!
But what’s this? The dollar fell again…after a one-day rally. Gold rose $2.10. And now it appears that the kindness of strangers has reached its limit. They are voting with their feet.
"An ominous harbinger for U.S. financial assets," writes our friend Terry Reik of Clapboard Hill Partners, "has been the stunning collapse in foreign-capital flows…From a peak of $110.4 billion in May, net foreign flows have fallen to $90.6 billion in June, to $73.4 billion in July, to $49.9 billion in August, to $4.2 billion in September."
September’s net inflow, Terry explains, is only 10% of the monthly minimum required to fund our $500 billion current account gap. Private interests overseas have forsaken the dollar in favor of other assets.
So far, only central bank buying of dollars – or, buying U.S. dollar assets, such as Treasury bonds, thus lending money to the Bush administration – has kept the dollar from destruction. In September, for example, while the rest of the world was dumping dollar assets, the Bank of Japan was spending $40 billion to support the dollar. "Without this Herculean effort by Japanese authorities," Terry continues, "foreign flows would have been an unthinkable negative $35.8 billion."
This apparent bout of sanity among foreigners comes at a bad time. For every passing day, Americans seem to need more credit just to stay in the same place. Again, Terry reminds of the numbers: credit grew at a $2.2 trillion annual rate in the first quarter of 2003…and then exploded at a $3.3 trillion rate in the second quarter. Debt has reached $33 trillion, with annual interest of nearly $2 trillion – even at today’s Eisenhower rates – and it’s growing seven times as fast as the economy itself.
What is debt on America’s balance sheet is a credit (albeit of uncertain value) overseas. In the first 200 years of the republic, Americans managed to build up net assets with foreigners equal to about 5% of GDP. But then Reagan’s "Supply Side" folderol took hold in Washington, followed by Clinton’s "Anything Goes" years, which was in turn followed by George Bush the younger’s program of "Soak the Stupid." By the beginning of Reagan’s second term, net foreign assets had fallen to zero and over the following 17 and 3/4 years, foreigners owned more and more U.S. assets while Americans owned, net, less and less foreign ones.
By April of 2003, foreigners owned $3.301 trillion more than the Americans owned of foreign assets. And then, in the following 90 days, the number shot up 21.5% to over $4 trillion.
Whew! Our head spins.
Here’s Addison with more details…
Addison Wiggin confused over the day’s financial news…
– The refi boom has busted…and with it financial reckoning day – the deleveraging of America – begins in earnest. This much, we think we understand…
– "Credit crunch coming?" CNNMoney alliteratively asks, covering a report released by the American Bankers Association yesterday. "The refinancing boom, triggered as mortgage rates fell to the lowest level in a generation, offered home owners a ready source of cash. Most consumers plowed that cash back into their houses, for new washers and dryers, carpeting or to build that new deck…shut off the refi spigot, and you may have shut off the ability of some cardholders to pay."
– Credit card delinquencies shot to record levels in the 3rd quarter. "Even if there’s a pick-up in job creation," says the ABA, "we should not see real improvement in delinquencies until later this year – there’s about a six to nine month lag."
– But now we begin to wonder. Yesterday’s new jobless claims report came in at an unexpectedly high 14,000 – the first increase since the beginning of December. The Dow reacted positively to the news – up 63 to close at a bewildering 10,592 – because, so the story goes, the jobs picture is slowly recovering from a three-year slump. Unemployment claims have remained below 400,000 for 13 weeks, which feel-good economists feel is a good number. Still, without the support of rising housing prices, or refinancing, the ‘recovery’ rests squarely on the creation of new jobs. Or debt.
– "The economy is doing well because people are going into debt," Samuel Gardano, head of the American Bankruptcy Institute, told the Kansas City Star yesterday. Leaving us wondering further still: what does he mean by ‘well’? During the year that ended September 30, 2003, the institute recorded 1.66 million bankruptcies…the highest number ever recorded in the nation’s history.
– Gardano suggests that credit card delinquencies and personal bankruptcies are "a natural outgrowth" of a $10 trillion economy driven almost totally by consumer spending. And quite happily adds that the more the "economy improves, the more people will grow deeper in debt and bankruptcies will grow." Now we’re completely baffled. Orwell couldn’t have improved on this one: Increasing debt and bankruptcies rising from an already staggering historical level = an "improving economy." Color me confused…
– "It’s a conundrum," says Roger Whelan, a former bankruptcy judge now in the employ of the institute. "Credit fuels the improvement, but overspending can result in debt and losses to the credit industry." Hmmmn…that helps. "We’re living in a society where living within our means is not the thing to do." Okay, now we’re starting to see. "Keeping up with the Joneses has a greater meaning today than it ever has." Aha! We need these kinds of "debt = wealth" explications…because the lumps just can’t suffer the embarrassment of looking shoddy to their neighbors. (Is it just a tasty bit of irony, as we pointed out in these pages a few weeks back, that Wyndclyffe, the house in upstate New York that is believed to have given rise to the term "Keeping Up With The Joneses" has fallen into decrepit ruin? [See: The Mystery of Wyndclyffe])
– But it ain’t just the Joneses and their hapless admirers that should be concerned. According to a report released by the IMF yesterday, the U.S. government’s got another think coming, too. According to the NY Times, the report warns "that the U.S. net financial obligations to the rest of the world could skyrocket to 40% of the entire economy within the next couple of years. That represents ‘an unprecedented level of external debt for a large industrial country’ and could raise havoc with the value of the dollar and international exchange rates."
– "The IMF is right," says Fred Bergsten, an economist with Institute for International Economics, as though he were prone to imbibing wine with your Daily Reckoning editors. "If those twin deficits – of the federal budget and the trade deficit – continue you are increasing the risk of a day of reckoning when things can get pretty nasty."
– How can the government owe 40% of an economy, we wonder, beginning to get bamboozled by the logic again, fuelled largely by consumers who are going bankrupt at historically rapid rates? This question outlines the Great Disconnect, suggests Dr. Richebächer.
– "For us, the greatest uncertainties [in the global economy]," writes the good doctor on the Daily Reckoning website, "are about the U.S. economy, its financial system and its currency. The great issue not only for America but also for the global economy is whether the U.S. economy has definitely reached the stage where economic growth has become self-sustaining. Or whether it may relapse into sluggish growth next year, if not recession. Looking at the markets, we have the impression that many people [foreigners especially] are struggling with this question…"
See: The Great Disconnect
[Editor’s note: Readers who have been following the trades in the Richebächer Letter would have had several nice hits lately: 425% last May…292% again in June…100% in December. Not only is the good doctor rather insightful and a good read, but his advice can be rather profitable, too.]
Bill Bonner, back in Paris…
*** As alarming as the failure to attract money from overseas is the drop in the U.S. money supply. M3 is collapsing. From August to November, M3 fell at its fastest rate since they began collecting statistics back in 1960.
*** If there is anyone who knows exactly why M3 is falling, he doesn’t work at the Daily Reckoning. Well, Addison might, but he’s not telling. Still, without knowing the cause, we can still guess at the effect: Instead of a real recovery…a real recession lies ahead. Again, we quote our friend Terry Reik:
"We view recent monetary and fiscal stimulus and the consumption and borrowing it has fostered, as merely delaying an inevitable process of rationalization, debt- reduction and deferral of consumption to rebuild national savings. A sustainable economic recovery has never occurred in the U.S. with its current account in such disarray and savings rates so low. We do not expect it to happen this time either."
*** "Big financial firms, including Enron, become Bush’s top donors," says a headline in today’s International Herald Tribune. Here we offer an explanation.
We are living in a degenerate age, we conclude, when both our economy and our government have been corrupted by easy money. Why go to all the trouble of making things, when you can make money out of thin air? Companies no longer make money by hustling to make things and sell them, but by hustling money itself. As a proportion of total corporate profits, those that come from "financial" firms have risen from under 10% during the Eisenhower years to nearly 40% during the reign of George W. Bush. Why are financial firms giving so much money to Bush? Because they are the only companies that have any money left to give.
They are also the companies with the motive as well as the opportunity. Who has more at stake in seeing the reckless spending and borrowing of the Bush years continue? Who most benefits from the credit bubble? Who hustles the stocks and bonds in the "Soak the Stupid" era? Whose clients are going to be soaked?
It is decadent. It is disgusting. But it is America, 2004…It is the New Babylon we offer so generously, so selflessly to the desert tribes of the old one…
*** A note from a dear reader:
"Yesterday Amazon.com sent some recommendations to me which included your book. If you scroll down the page you’ll see that "Customers interested in this title may also be interested in: Next Day Antidepressants and Prozac!
*** And another:
Please settle an argument for me! My friend and fellow DR junkie believes that if you were forced to have to vote for a political party it would be democrat. I say it would be republican. Now, before you say they are the same, I am talking about what they CLAIM to stand for, not what they actually do. The fact that you last voted for Carter is too long ago to make a judgement today. I said that you scorn all politicians and since a Republican happens to be in office, it sounds like you dislike what Republicans claim to believe in. But if a democrat were in office, you would be mocking him also.
WHO IS RIGHT?
*** Your editor dodges: We learned our lesson in the Carter campaign. We voted…were deeply embarrassed…and vowed never to do it again. Since then, we have liked every politician we ever met personally…and despised them all professionally. Republicans as well as democrats; we have no prejudices.
Democrats favor boondoggles for the poor. Republicans favor boondoggles for the rich. Moderates favor boondoggles for everyone. A pox on them all!