Pondering Post-Bubble America

Where is the faltering U.S. economy headed? For starters, it is not clear to us that the consequence of the U.S. Credit Bubble is a predestined “deflation”. Indeed, we can look to the disparate environments in post-Bubble Japan and post-Bubble Argentina as evidence that collapsing Bubbles may end in a long, draw-out mild deflation or, in the case of Argentina, rapid financial implosion and devastating inflation. From the standpoint of attempting to analyze which of these polar extremes may best apply to Post-Bubble America, we are increasingly convinced that the dollar’s performance will play an instrumental role.

Post-Bubble Economies: Japan

Consider first Japan. Before succumbing to extreme financial excess in the late eighties, Japan made truly incredible economic progress for several decades. Sadly, the Japanese “drank the poison” and basically destroyed their financial system in a few short years. Yet, post- Bubble Japan remained endowed with great wealth-creating manufacturing capacity. The Japanese multinationals have not only survived; they have prospered. With enormous trade surpluses, the economy has been able to muddle through a wrenching decade-long financial quagmire.

The related trade surplus and household saving attributes (Japan as a creditor nation) played an instrumental role in supporting the Japanese currency. The yen today trades at about 120 to the dollar, just off its 10-year average and above where it began the nineties. Importantly, and especially for retirees, the frugal Japanese saver has maintained her purchasing power. There has been no run on Japanese financial assets.

The Japanese Credit Bubble was a severe domestic debt problem, but international investors and speculators played a relatively insignificant role. The fate of the financial system and economy did not rest tenuously on yen confidence. The post-Bubble banking system has been an unmitigated disaster, but the Japanese economy’s debt structures – supported by decades of sound investment and enormous household savings – proved resilient.

Stagnant private sector credit growth was partially offset by large government borrowing, playing a critical role in tempering financial fragility and stabilizing the system. Excesses, both real and financial, had not reached the point where contracting private-sector debt growth would lead to unmanageable collapse. Fortunately, I would argue, the Japanese government used its fiscal and monetary powers to ease an arduous post-Bubble transition, rather than to sustain the Bubble.

While certainly encumbered, Japanese society has remained cohesive through a protracted and difficult adjustment period. The general population has not rioted or spent much time in protest, but rather fell back on financial discipline and its hard-work ethic. There has been too much (typical post-Bubble) talk of policy incompetence and not enough recognition of a most impressive performance by the Japanese people.

Post-Bubble Economies: Argentina

At the other extreme, an arguably much less formidable and pervasive Bubble in Argentina has left the financial system and economy in absolute tatters. Many savers have been completely wiped out, and the social fabric has been severely frayed. Argentine citizens have lost confidence in the government and the country’s institutions. Sadly, bank runs have become commonplace.

The Argentine peso has lost 70% of its value, with inflation running rampant. Foreign bankers, investors and speculators have abandoned the country, with international institutions (and “globalization”) under justifiable attack from Argentine citizens, politicians, and monetary authorities. The economy has sunk into deep depression, with little benefit from a collapsing currency. Indeed, the sinking Argentine peso has been a major hindrance, in stark contrast to the experiences of post-Bubble South Korea, Thailand, Russia and Brazil.

The boom-time Argentine economy came to depend on foreign-sourced finance, much of it of a speculative character. Once addicted, all involved were steadfast in refusing to recognize the sickness. Foreign borrowings financed too much consumption and too little of the type of sound investment capable of creating the necessary economic wealth to repay creditors. Once this course was chosen, it was only a question of the dimensions of the inevitable financial and economic dislocation.

Reliance on foreign borrowings in combination with economic maladjustments over time combined to create acutely fragile debt structures. Indeed, it was precisely the nature of the speculative capital flows fostering non-productive credit excess that proved fatal to the Argentine financial system. Frail debt structures and economic maladjustment left the currency, credit system, and economy hopelessly vulnerable to both the inevitable reversal of speculative flows and attendant capital flight.

Confidence in the peso’s peg to the dollar became of momentous consequence. Almost overnight, Argentine financial assets were no longer an acceptable medium for international exchange. Significantly, none of these types of issues have played a role in post-Bubble Japan.

Post-Bubble Economies: America

Considering these two post-bubble scenarios, we have very difficult and complex questions to contemplate in our pursuit of What Will Be Post-Bubble America. Most regrettably, the Greenspan Fed, Wall Street, the GSEs and Washington politicians are resolute in their determination to stonewall the adjustment process. This dangerous course of prolonging the Bubble is categorically based on continued credit excess – inflating dollar financial claims. This should not today be in dispute, and incessant credit inflation is why we remain fixated on dollar vulnerability and devaluation.

There may certainly come a day when faltering confidence and a run on dollar financial assets wreaks (Argentine- style) havoc on the U.S. credit system – especially its acutely fragile “Structured Finance” parallel “banking” system. However, the system today still retains its capacity for unchecked and rampant inflation of dollar claims (credit inflation).

The inescapable consequences of the U.S. Credit Bubble Dilemma include only more credit and speculative excess, heightened financial fragility, deeper economic maladjustment and impairment, and a further debasement of our currency. It is not at all outrageous to assert that the U.S. system has set a perilous course toward the collapse of the world’s reserve currency. No amount of inflation will change the facts of economic life.

There are no available shortcuts but many risky gimmicks to prolong the Bubble, making the inevitable day of reckoning all the more painful and Balkanizing. Nowadays, the call for stimulating and “reflating” grows ever louder, but there is absolutely no discussion of the consequences. Yet there is so much at stake. It is our view that the longer the U.S. travels down this dangerous course, the more rapidly the Post-Bubble America pendulum swings away from a Japanese scenario in the direction of Argentina.

Warm regards,

Doug Noland
for The Daily Reckoning
February 5, 2003


Watch Fannie Mae! As she goes, so goes the whole world economy.

Stability is destabilizing, warned economist Hyman Minsky. Because the financial intermediaries – notably banks and mortgage lenders – take advantage of the perceived low-risk conditions in order to lure investors to destruction.

Alan Greenspan has been the most successful Fed chief in history. For nearly 15 years, it seemed that he could make water run uphill! Paper money – unbacked by gold – typically loses its value compared to real money (that is, gold itself). There are no counter examples in all of history; sooner or later, paper disappears and gold remains.

But Greenspan did the impossible. He made gold go down while the dollar went up. It looked as though he had created a perfectly stable economy – with high growth, low unemployment, and little inflation; people thought it would last forever.

But like wolves at a pigs’ picnic, along came the “innovative financial intermediaries” to take advantage of the situation. Since the good times are here forever, Fannie Mae and other lenders seemed to whisper in the little piggies’ ears, why not take advantage of them? Why not take out some of the equity from your house and live a little? Go on…why not…the house will just keep going up in price…jobs will always be plentiful…what have you got to worry about?

And so, the poor saps took the bait, and borrowed more and more…to the point where the whole system is dangerously destabilized by an excess of credit. Lenders can still lend…but only to weaker and weaker customers. Borrowers can still borrow…but only by weakening the balance sheets of those they borrow from. Fannie Mae’s book of loans expands, in other words, but it is less and less sure of getting paid back.

Sooner or later, the trend that can’t go on doesn’t. Borrowing stops. Regretting begins.

“This is the harsh reality that we should recognize as a nation as we contemplate Post-Bubble America,” writes Doug Noland. “And no amount of inflation will change the facts of economic life. There are no available shortcuts but many risky gimmicks to prolong the Bubble, hence only making the inevitable day of reckoning all the more painful and Balkanizing. There is nowadays only louder call for stimulating and ‘reflating,’ but there is absolutely no discussion of the consequences.”

Consequences are shouting from every news report. Yesterday’s gold price (April contracts) came within 10 cents of $380. Bankruptcies continue to rise. Unemployment edges up. Car sales went down last month. The dollar falls almost every day.

“There is so much at stake,” Noland continues. “It is our view that the longer we travel down this dangerous course, the more rapidly the Post-Bubble America pendulum swings away from a Japanese scenario in the direction of Argentina.” (More on Post Bubble America from Noland below…)

Eric is having surgery this morning. We don’t know what they are cutting out, but we hope it’s nothing important. In the meantime, Addison covers the markets for us…Addison?


Addison Wiggin, also reporting from London…

– The markets don’t seem to like waiting for Colin Powell’s appearance before the U.N. Security Council later today. Stocks and the dollar sank yesterday, while bonds rebounded. The Dow fell 96 points to 8,013; the Nasdaq lost 18 points to 1,306. War jitters pumped up oil prices almost $1.

– But there seems to be only one word on the lips of investors these days…and I believe Klondike said it best: “GOOOLLLD!!!” New highs, record volumes…gold’s in the news around the world.

“There’s nothing traders like to see more,” says veteran FOREX trader and the Daily Reckoning’s man-on-the-scene here in London, Sean Corrigan, “than the new lot of buyers and sellers that accompany the move to a new price range. In gold’s case – where that range is being extended to a new 11-year high and exchange-traded volume records are being set – you couldn’t find a better signal.”

This is exactly what is happening in Japan, where the surging price of gold in terms of yen is doing all of the above, attracting frantic interest in the metal – which does, after all, yield more than the home-grown paper money. Reuters reported panic buying, but also opportunistic selling, though the latter shouldn’t be taken as a bad sign – better to get the selling over in a rising, rather than a falling market.

The most-active December gold contract was up 28 yen in mid-afternoon yesterday at 1,489 yen per gram, a level not seen since August 1992, before it eased back to Y1469 at the close. Turnover hit unprecedented volumes, with trade in the December contract alone topping 397,714 lots (400 tons), and all six contracts reaching a massive 525-ton equivalent.

Osamu Ikeda, general manager of precious metals at Japan’s biggest bullion house, Tanaka Kikinzoku Kogyo K.K., told Reuters that ordinary Japanese were turning up in droves to buy gold bars and coins. Even so, Ikeda warned that there were sellers among people who bought back in 1999 – when gold prices hit a low of 917 yen per gram – who were now taking advantage of the high price.

Kikinzoku reported that its bullion sales for investment purposes soared 54% in calendar 2002, as investors funneled money to gold from stocks and other assets.

“Many individuals have recently come to us to purchase gold in chunks of 2 or 3 kilograms,” a dealer from the company told the Kyodo News. “It appears that gold possession is regarded as a good method for preserving the security of one’s assets from a long-term standpoint, as people have come to develop anxieties about the course of Japanese society.”

In Australia – where gold has hit a 15-year high in terms of the local dollar – it seems a veritable gold rush is underway. Reuters reports that “gold prospectors eager to peg new ground made a run on heavy mining equipment.” “This morning, we tried to hire a diamond-tipped drill, but were told there was none available,” said Ron Manners, chairman of Croesus Mining NL, Australia’s third-biggest gold producer. “Such a thing was unheard of until now.”

Hmm…we’re guessing they’ll be hearing it more and more in the coming months…


Meanwhile…back in London…

*** China and Russia are buying gold, too. Put yourself in the shoes of one of these export-driven foreign countries. They send goods to the U.S. and get paid in dollars. The U.S. doesn’t seem to produce much that they want…so what do they do with the dollars? They used to buy U.S. assets…but with the dollar falling and Wall Street taking a beating…they have to think twice.

Gold, meanwhile, is streaking up so dramatically that even the financial press has noticed. Wouldn’t you be tempted to replace a little of your dollar reserves with real money?

Gradually…or suddenly…the extra dollars of cash and credit squeezed into the system by the Fed, Fannie, and other financial intermediaries lose their appeal. Who wants them? Who can borrow…and pay back? The system has become destabilized…and must collapse. But how? Will it implode – like Japan? Or explode – like Argentina?

*** “I guess they wanted people to take them more seriously.” Elizabeth was trying to explain the shift in the economics profession from the ‘moral philosophers’ of the 18th century to the econometricians of the 20th.

The question at hand was: why hadn’t economists noticed the destabilizing effects of Greenspan’s policies?

“Because they forgot what business they are in,” was your editor’s response. “They so admired physicists and other hard scientists that they began to imagine that economics was a hard science too. Like astro-physicists, they thought they could come up with quarks, anti-matter, and black holes…they thought they could come up with ideas that were unbelievable…counter-intuitive…fantastic.

“In the hard sciences, you can heat water, for example, and every time it reaches 212 degrees Fahrenheit it will boil, other things being equal. Neither steel, water, nor dice have any memory or any feelings…they do what they do every time.

“But economics is not a hard science at all. It’s a human science. And humans react differently depending on their experiences, expectations and so forth. If they think they can get rich buying stocks…they rush into the stock market, and bid up prices to the point where there is no way they can get rich. A company only produces so much profit. If you pay too much for it, you don’t get rich, you get poor.

“Plus, humans are not machines; they’re not mechanical. They do wild and crazy things…make fools of themselves from time to time…that is what makes them so much more amusing than steel or silly putty…

“And when you put them in a group, it is even worse…they seem to go mad regularly…and only come to their senses after they’ve nearly destroyed themselves…”

Well, most humans are that way…not Daily Reckoning readers, of course.

The Daily Reckoning