Same As It Ever Was

For the past few weeks we have looked at the argument for the case "This time it’s different," made eloquently in a 130-page book called "Our Brave New World" by the very bright minds behind GaveKal Research. The trade deficit of the United States does not matter, they aver. For the next few weeks we turn to look at the opposite view, made by Bill Bonner and Addison Wiggin in their new 370-page book, Empire of Debt. Not only do they tell us that things are not different, but that the end result will be the same as it has always been. And for the curious, the end result is not a pleasant thing.

Where GaveKal sees a rising dollar, Bonner and Wiggin see The Demise of the Dollar (the title of a separate book by Wiggin). Where GaveKal sees promise and positive benefit in a negative balance of trade, Bonner and Wiggin see hubris and peril. Is it an Empire of Debt about to go the way of all empires, or into a Brave New World? Let us make no mistake, these are polar opposite views. And where you come down makes a large difference in how you manage your investment portfolio, not to mention how you order your future. This will make for an interesting, if not altogether fun, letter. Warning: you are about to enter a major doom and gloom zone.

There are two stories in Empire of Debt. The first is the traditional argument of the Austrian economic school. You cannot forever run trade deficits. Eventually your currency will collapse, as people will not want any more of it.

"The economy in its entirety must continue to decline so long as more is being consumed than produced, and some part of consumption therefore takes place at the expense of the existing capital stock." – Friedrich August von Hayek (Nobel Laureate, 1974)

But the evidence of that decline is not yet present. America and its currency seem to continue to prosper, even when no other nation has ever run such huge deficits without seeing a major, if not disastrous, currency revaluation. How can this be?

Empire of Debt: Can We Borrow Our Way To Success?

Can we in fact borrow our way to success? Rather than save and invest in new capital production, we ship production of our goods and now even our services offshore, and hope other nations will finance our debt.

"As the Anglo-Saxon economies lost their competitive edge in manufacturing, they tried to make up for it by encouraging consumption. This is the biggest fraud of all," write the duo in Empire of Debt.

"At first, higher consumption feels good. It is like burning the furniture to keep warm; it feels good for a moment. But the sense of well-being is extremely short-lived. When people borrow and spend, they feel as though they are getting richer – especially when their houses are rising in price. The increased consumption even shows up, indirectly, in the GDP figures as growth. But you don’t really become wealthier by consuming. You become wealthier by making things you can sell to others – at a profit. The point is obvious but, at this stage of imperial finance, it was inconvenient."

You cannot borrow and consume your way to riches. Yet our national debt – private, corporate and public – just keeps soaring. However you want to measure it, in absolute terms or as a percentage of GDP or income, debt is up and continues to climb. The low interest rates engineered by the Federal Reserve has only encouraged consumers to take on more debt.

So, one of the main themes in the book details how the increase in debt in America, combined with both trade and government deficits, must end in tears. One cannot spend oneself into riches, whether as an individual or as a country.

This is a fairly straightforward subject, and one with which many readers will find themselves nodding in agreement. It has been the way of the world since the Medes were trading with the Persians. If you do not produce more than you consume, eventually you will end up in poverty, or at the very least, in lesser economic circumstances.

But how did we get here? How did we get to a place where we run $700 billion(!) trade deficits? How did we arrive at a time when foreigners own an ever-increasing percentage of U.S. debt, where savings in the United States is negligible and we consume some 70-80% of the rest of the world’s saving so that we can continue to consume? We are beholden to the kindness of strangers – specifically China and Japan. The authors contend that if they pull the plug – if they stop buying our debt – our currency will collapse, our interest rates soar and our housing market collapse, sending us into a deep recession.

Empire of Debt: Seeing Ourselves As an Empire

And thus we arrive at the second, and far more troubling theme in the book. It pricks at our national conceits, at the very value and beliefs that we as Americans hold about ourselves. We (or most of us) see ourselves as the good guys. Bonner and Wiggin see that view.

Bonner sees the United States as an empire. That in and of itself is not exactly a new thought. Many hold that line of thinking, and do so proudly. Pax Americana makes the world a better place. Niall Ferguson contends that it is all that holds the world back from another Dark Ages. Someone has to order the world and make people and countries play nice. If there is a real problem, who you gonna call? The French? Get real.

For Bonner, being an empire is not a good thing, even though he readily admits that America is not the traditional empire of old. All empires must come to an end. So how will the American Empire end? For Bonner, it is in debt.

Full disclosure: Bonner and Wiggin are libertarians. They are advocates of a minimalist government. And they also do not believe in nation building. They believe that government intervention into problems causes more problems, rather than solves them. And that specifically includes military and central bank intervention.

"… If you deny that the United States is now an empire, you are as big a fool as we were. For a very long time we resisted the concept," write Bonner and Wiggin in their introduction. "We did not want the United States to be an empire. We thought it was a political choice. We liked the old republic of Jefferson, Washington, the U.S. Constitution…the humble nation of hard money and soft heads; we didn’t want to give it up. We thought that if the United States acted as though it were an empire it was making an error.

"What morons we were. We missed the point completely. It didn’t matter what we wanted. There was no more choice in the matter than a caterpillar has a choice about whether to become a butterfly.

"This was an important insight for us. Until then, all of the blustering and slapstick pratfalls on stage seemed like "mistakes." Why would the United States run such huge trade deficits, we wondered. It was obviously a bad idea, the nation was ruining itself. And why would it launch an invasion of Iraq or begin a war on terror–both of which were almost certain to be costly blunders. It was as if the United States wanted to destroy itself – first by bankrupting its economy, and second by creating enemies all over the globe.

"Then, we realized, that of course, that is exactly what it must do. We repeat, people come to believe what they need to believe when they need to believe it. America is an empire; its people must think like imperialists. In order to fulfill their mission, the homeland citizens had to become what George Orwell called ‘hollow dummies.’ An imperial people must believe that they deserve to be the imperial power – that is, they must believe they have the right to tell other people what to do. In order to do so, they must believe what isn’t true – that their own culture, society, economy, political system, or they themselves are superior to others.

"It is a vain conceit, but it is so bright and so big it exercises a kind of gravitational pull over the entire society. Soon, it has set in motion a whole system of shiny vanities and illusions as distant from the truth as Pluto and as bizarre as Saturn. Americans believe they can get rich by spending someone else’s money. They believe that foreign countries actually want to be invaded and taken over. They believe they can run up debt forever, and that their debt-laden houses are as good as money in the bank. That is what makes the study of contemporary economics so entertaining. We sit at our telescopes and laugh like a divorce lawyer looking at photos of a rich man in flagrante delicto; we know there’s money to be made."

But America is not an empire in the traditional sense. The Mongols or Romans conquered and demanded taxes, (a rapacious 10% or so). The British and French took commodities and cheap goods. Americans send an army and then pay hundreds of billions to the conquered.

Empire of Debt: How We Became an Empire

How did we become an empire? Bonner points to its beginning in 1913, when both the income tax and the Federal Reserve were created. These were the building tools, which could finance an empire. What tribute does the American Empire require? If you use our dollars, you have had a depreciating asset over time. The dollar will buy a mere nickel’s worth of what it did in 1913.

The second major event on the road to empire was Nixon closing the gold window, allowing the Fed and the government room to manipulate the currency as they saw fit. And of course, the New Deal, deficit financing and a host of other government solutions all contribute.

In the same way that investors thought that tech stocks would only go up in 1999, or gold in 1979, Bonner and Wiggin see a country that thinks that its stock can only rise. Since that has been the case for 225 years, why should it be different now?

Yet, they quote, "The U.S. suffers from…structural deficits that will limit the effectiveness and duration of its crypto-imperial role in the world," explains Niall Ferguson. "The first is the nation’s growing dependence on foreign capital to finance excessive private and public consumption. It is difficult to recall any empire that has long endured after becoming so dependent on lending from abroad." (Niall Ferguson, "The End of Power: Without American Hegemony the World Would Likely Return to the Dark Ages," Wall Street Journal, June 21, 2004.)

And thus we come to it. To Bonner and Wiggin, America is on a course to a soft depression brought on by debt precisely because we have become an empire. We have spent the income of future generations in order to consume today, amassing a staggering debt that grows ever larger. We have obligated our children to pay a Social Security and Medicare burden that they simply will not have the means to pay as things currently stand. The generational contract will be broken because it cannot be paid.

This is not your ordinary run of the mill doom and gloom. It captures a whole new level, for it is an inevitable doom. We are slouching toward an evening in America, unaware of our own fate. Thus have all empires ended, either with a whimper or a bang. They make a good case. The question is, can we ignore it? Are they wrong, or will somehow things be different?

John Mauldin
for The Daily Reckoning

December 06, 2005

P.S. Next week, we will look at the numbers surrounding our debt, and the not surprising answer that Empire of Debt offers: buy gold. Plus, they have a few more thoughts on ways to profit and enjoy the ride.

Not much happened in yesterday’s markets. Of course, not much has happened for a long time. This leaves most people thinking that not much will ever happen. The Dow will be over 10,000 forever. The dollar seems stable at 1.18 versus the euro. And why would you ever have to pay more than 6% for a mortgage loan?

But two things happened yesterday that might be significant. First, oil seemed to end its correction with a move back towards $60 a barrel. Second, the price of gold went up again to over $512 per ounce (Feb. contracts).

These things are significant because in the happy picture of America’s finances and the world economy, they shouldn’t be there. It would be like a man with a turban on his head saying mass at Notre Dame, or a sour smell from a bowl of yogurt. Something is rotten, they tell us.

The accepted view of America’s economic situation is that it is enjoying strong growth that – thanks to its dynamic economy and enlightened central bank – is not merely sustainable, but eternal. People expect GDP growth of 2% to 5% annually…with inflation between 2% and 3%, and property prices rising somewhat faster.

Gold points an old, gnarled finger at this pleasant scene and mutters, "It ain’t necessarily so."

Oil, too, seems unwilling to go along with the Fed’s gag. When the price seemed to peak out a month or so ago, economists breathed a sign of relief. "At last," they said, "the crisis is over. Oil will go back down to where it is supposed to be: under $50 a barrel." But yesterday, it looked more like the correction was over. Instead of continuing to go down, oil turned around and headed back up. "It ain’t necessarily so," says oil.

Of course, if you look carefully you will see a lot of other things saying the same thing.

The Bush Administration is puzzled as to why it doesn’t get more credit for such a healthy economy, writes Paul Krugman in the New York Times. You already know why it doesn’t, dear reader: the economy’s health is largely a statistical illusion.

"The president made an appearance in the Rose Garden," explains Krugman, "to hail the latest jobs report, yet a gain of 215,000 jobs would have been considered nothing special – in fact, a bit subpar – during the Clinton years. And because the average workweek shrank a bit, the total number of hours worked actually fell last month."

"Back in August the Census bureau released family income data for 2004," he continues, "It should have been a good year…the economy grew at 4.2 percent, its best performance since 1999. Yet most families actually lost economic ground. Real median household income – the income of households in the middle of the income distribution, adjusted for inflation – fell for the fifth year in a row. And on key source of economic insecurity got worse, as the number of Americans without health insurance continued to rise."

"Never mind the GDP numbers," Krugman concludes. "Most people are falling behind."

The numbers are not in for 2005, but we are sure they will show the same thing: for the sixth year in a row, real median household incomes are going down.

And yet, the economy is supposed to be healthy, dynamic and growing.

It ain’t necessarily so, is it?

More news from the pundits at The Rude Awakening…


Eric Fry, reporting from Manhattan:

"’The bull market in gold is still young,’ declared Michael Martin late last week. ‘I would be buying every dip on the way up…just like tech stock investors did throughout the 1990s.’"


Bill Bonner, back in London with more flotsam and jetsam…

"Outsourcing. Offshoring. That’s all we hear about in the mainstream media. And they are all falling over each other to report news of the bigwigs outsourcing and offshoring to India," Sala Kannan tells us.

"J.P. Morgan announced yesterday that it plans to have nearly one-third of its investment banking back office and support staff offshore by the end of 2007, and would achieve this by doubling its head count in India. That means that by 2007, J.P Morgan will have hired nearly 9,000 people in India.

"BusinessWeek recently published an enthusiastic article titled, ‘Intel’s Eager Passage to India.’ According to the article, Intel, the world’s largest semiconductor maker, has 2,800 employees in India and will spend $800 million over the next five years to expand its Indian operations.

"Makes you want to run out and buy an Indian outsourcing play, doesn’t it? DON’T!

"Indian outsourcing plays won’t make you a dime. They are overvalued. The average Indian IT company has a lofty 40 P/E. And the very fact that the mainstream media are all over these stories is enough proof to be bearish on Indian outsourcing.

"The IT sector is no doubt generating income, paying taxes and spending its profits on cars, houses, etc. Essentially, money is flowing out of IT and into other sectors of the economy. So instead of investing in IT, follow the money out of Indian IT and into other sectors.

"Think of it as a champagne tower. Just like champagne overflows from the first glass and fills the others below it in a champagne tower, money overflows from the IT sector and fills the other sectors below it."

*** All assets – except stocks – seem to be rising, especially at the top end. Christies reports that art prices have hit new records, after rising as much as 40% over the lat year. Diamonds are also soaring in price – particularly big ones…mansions, too.

We have no data on this, but our guess is that while inventories of "McMansions" are backing up, the real mansions are selling quite well. The difference is that the McMansions are bought with debt. Real mansions are bought without mortgages. Bonuses on Wall Street, and in London’s "City," are huge. Everyone who works in finance or the shelter trades is making money. A friend here in London tells us that he was staggered when he went to put a new kitchen in his country house:

"Well, one thing led to another. We have to fix up an apartment over the garage so we’d have somewhere to stay while they were redoing the kitchen. And then, when we got into it we decided to update the plumbing…and why not do this and that. But in the end, the new kitchen is costing me about $400,000!"

Now the plumber has more money, and the people who put in granite countertops, and the builders. All over town, the money oozes out. GDP rises. Everyone is richer, right?

Well, our friend has a nice kitchen, but he has $400,000 less in savings. The money has been converted into a consumer item: a better kitchen. And then consumed by plumbers, masons, electricians and so forth.

Is this how people get rich? Nope.

*** And now for something really interesting. We have always wondered what happens when you get your head cut off. Do you black out immediately? Or, do you have some brief time to reflect on life without a body? Do you have time to curse the executioner? Thankfully, the Daily Mail provides answers:

"Generally…it appears to take around 30 seconds to lose consciousness after decapitation. We know this from the French Revolution and the liberal use of the guillotine. The condemned were asked to blink if they were still alert after their heads have been removed from their body. Records show that it took between 20 and 30 seconds for the heads to stop blinking."