Take It Away, Maestro

The Daily Reckoning PRESENTS: As a country, we are at record-breaking levels of foreign and domestic debt…and who can be held responsible for our borrowing binge? Most fingers are pointing in the same place – toward the man at the helm of the Federal Reserve for the past 18 years…


In the spring of 2005, the American economy had been in “recovery” for over 24 year months. It was an odd recovery. No one was quite sure what it was recovering from. There had been a recession in 2001 and 2002. But it was a curious recession. GDP growth went negative. Yet consumer spending and credit continued to expand. If recessions were meant to correct the mistakes of the previous expansion, this one was a failure. Consumers should have spent less and increased savings. Then, after the recession was over, they should have had money to spend in the following expansion and a pent-up desire to buy what they had not bought during the recession.

The expansion was doomed from the beginning. Consumers had never stopped spending. So, when the economy turned around, they had saved no money. The only way they could continue spending was by borrowing more. The Fed helpfully dumped more alcohol in the bowl – lowering rates to make it easy for them. But by this time, the whole economy had become so woozy that the extra consumer spending had a much less positive effect on the real economy than had been hoped. Americans borrowed and spent. But, in the new globalized economy, much of what they bought came from Asia, particularly China, which could turn out consumer goods at a lower cost than the United States.

What America really needed was not a consumer binge, but a capital-spending boom. It needed to invest in new factories, new plants, and new jobs. The jobs would have given consumers real new income, with which to buy more goods and services and sustain the expansion. But gross investment – which had averaged 18.8 percent in the pre-Reagan years – had begun dropping the year Reagan entered the White House. By 2004, it had fallen to 1.6 percent – even dipping below zero periodically. People were spending, but on consumption, not future production. The gewgaws and gadgets bought from China merely put Americans further into debt.

Neither jobs nor incomes improved. Typically, at this stage of a recovery (June 2005), 10 million more new jobs should have been created. Likewise, incomes went up $300 billion less than they should have, based on the pattern of previous recoveries.

Many economists – including Alan Greenspan – maintained that the lack of jobs was a sign of something good happening. “Productivity,” they said, “accounts for most job losses, not outsourcing.”

“Over the long sweep of American generations and waves of economic change,” explained the maestro, “we simply have not experienced a net drain of jobs to advancing technology or to other nations.” Could something be different this time? Could this be a kind of “new era” in American economic history? The answer we give is “yes”but we will give it later. Here, our burden is more modest, and our proof comes more readily to hand. For here, we argue only that America’s leading economic and political policymakers are either rascals or numskulls.

Major tops in the credit cycle seem to correspond with major bottoms in economic thinking. From high off ices all over the nation come the explanations, excuses, rationales, and obiter dicta; we don’t know whether they are corrupt or merely stupid. But when the guardians of the public financial mores begin urging people to acts of recklessness, we cannot help but notice. Buy more, says one Fed governor. Borrow more, says another.

Don’t worry about debt, interest rates, or the loss of jobs, says the captain of them all. It is as though the National Council of Bishops had come out with a public statement, urging wife swapping. The experience may not be unpleasant, but it is unseemly of them to say so. “Go out and buy an SUV,” urged Fed governor Robert McTeer. Seventeen million people heeded his call each year, from 2001 to 2005.

On February 23, 2004, the Fed chief urged Americans to switch from fixed rate mortgages to ARMs – mortgages with adjustable rates, which left them much more exposed to interest rate increases, at the very moment when the Fed was increasing them.

If anyone could be held directly and immediately responsible for the record level of America’s foreign and domestic debts, it was Alan Greenspan. He had brought about a binge of borrowing by lowering interest rates down to Eisenhower-era levels. But spiking the punch was not enough; he was urging consumers to have another drink. Even the press was beginning to notice.

“Alan Greenspan is essentially lending money at a loss,” began a surprising editorial in the International Herald Tribune. “This cannot go on indefinitely, and it should not go on much longer…It increased corporate profits and prompted consumers to refinance their mortgages and to spend their way into plenty of other debt…Many homeowners, and consumers in general, are borrowing recklessly, betting that rising housing prices and easy credit are here to stay…Americans may be in for a rude shock when the real estate market levels offs, and when millions discover that the adjustable rates of their mortgages and other loans can be adjusted upward.”

The Fed chairman had an uncanny way of arriving at ideas at a time when they would be of most benefit to his own career and of most danger to everyone else. To Greenspan, the conservative economist, the stock market looked “irrationally exuberant” in the mid-1990s, until a member of Congress pointed out to him that he would be better off keeping his mouth shut. A goldbug in the 1970s, Greenspan has now become the biggest purveyor of paper money the world has ever seen. Similarly, large federal deficits seemed at odds with his creed until it suited him to think otherwise. The new American empire needed easy money and almost unlimited credit: Alan Greenspan made sure they got it.

Markets make opinions, say old-time investors. Mr. Greenspan’s opinions neatly corresponded with the market for his services. As the debts and deficits mounted up, Greenspan underwent an intellectual metamorphosis. An article in the New York Times explained:

“Many mainstream economists are worried about these trends, but Alan Greenspan, arguably the most powerful and influential economist in the land, is not as concerned:

“In speeches and testimony, Mr. Greenspan, chairman of the Federal Reserve Board, is piecing together a theory about debt that departs from traditional views and even from fears he has himself expressed in the past. In the 1990s, Mr. Greenspan implored President Bill Clinton to lower the budget deficit and tacitly condoned tax increases in doing so. Today, with the deficit heading toward a record of $500 billion, he warns more emphatically about the risks of raising taxes than about shortfalls over the next few years.

“Mr. Greenspan’s thesis, which is not accepted by all traditional economists, is that increases in personal wealth and the growing sophistication of financial markets have allowed Americans – individually and as a nation – to borrow much more today than might have seemed manageable 20 years ago.”

And here the article strikes gold:

“This view is good news for President Bush’s re-election prospects. It increases the likelihood that the Federal Reserve will keep short-term interest rates low. And it could defuse Democratic criticism that the White House has added greatly to the nation’s record indebtedness.”

Out of convenience, rather than ideology, Mr. Greenspan came to see goodness in all manner of credit. Since he became head of the Federal Reserve system, debt levels rose from $28,892 for the average family in 1987 to $101,386 in 2005. Mortgage foreclosure rates, personal bankruptcies, and credit card delinquencies rose steadily and are now at record levels. Mortgage debt rose $6.2 trillion during his tenure at the Fed. By January 2005, it had reached $8.5 trillion, or approximately $80,849 per household.

But none of this seemed to bother the chief of America’s central bank, nor its chief politicians.


Bill Bonner
The Daily Reckoning
London, England
January 26, 2006

Editor’s Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin’s follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is – an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount.

We return to the Five Big E’s

1.) Energy is no longer cheap. We were appalled when we got the latest heating bills from our house in France. And we’re not even really heating the place; we’re just trying to keep the pipes from bursting.

2.) The Exodus of wealth and power continues…from West to East. Reuters tells us today that “China Roars into the New Year.” Experts expect the sino-economy to produce another year of near-double digit growth.

We interrupt with a note about the homeland economy. Employment is still disappointing. It’s up only 2.7% in the 49 months of this expansion. That compares to 8% during a similar period in the ’90s…and 13% in the ’80s.

Where are all those missing jobs? Look East. The United States’ trade balance is running at a negative $60 billion per month. That is money that goes to foreign-based suppliers and foreign-based workers – notably in Asia. Yes, a substantial part of the U.S. payroll is packing up and leaving for the East, too. Recent reports even tell of Westerners who have gone to the Far East in search of better paying jobs.

In America, meanwhile, the jobs that are left show little or no wage growth. Except for the very top earners, real wages are lower today than they were two years ago.

3.) Hot on the heels of this exodus of wealth, power and income marches Pharaoh’s army. Yes, the U.S. Empire is peaking out. And its crack troops are drowning in a Red Ink Sea …or wasting away in far-flung, godforsaken outposts of the empire. A new report commissioned by the Pentagon warns that the imperial army is getting worn out by frequent deployment to the Middle East. In 2005, recruiting agents missed their targets for the first time since 1999. The empire may soon have to turn to barbarian troops; the homeland boys would rather go to work as mortgage brokers and enjoy new granite countertops at home.

4.) The Grand Experiment with paper money is running its inevitable course, too…like a fever or a hangover. Yesterday’s trading pushed an ounce of gold up over $560. The problem with central banking is the problem with running an empire: You can control some things, but not everything. And when you try to control one thing, you throw the other things out of whack. You get your yin right, but the yang goes haywire. Or just at the moment you have the flim down pat, the flam starts acting up.

In the Fed’s case, it can control the quantity of money or the quality of it, but not both at the same time. Having vastly increased the quantity during the Greenspan years, Ben Bernanke is going to be plagued by quality issues. The dollar only lost half its purchasing power during Greenspan’s reign. It is only a matter of time until it loses the rest.

5.) And then, there is the old Economic cycle. For nearly a quarter of a century credit expanded, asset prices rose, and bond yields fell. The rich got richer; the poor went further into debt, and everyone was happy. Things just couldn’t be better, said Bill Clinton near the peak. He was right. Now they will be worse. In real terms – matched against gold, that is – almost all asset classes are going down. They have been since July of 1999. Then, you would have had to put 43 ounces of gold on the table in order to buy the Dow stocks. As of this week, you need only 19 ounces. And by the time this cycle runs to its ineluctable conclusion, a single ounce of gold will buy every stock on the Dow…with change left over.

Remember the 5 E’s, dear reader. Remember the 5 E’s.

More news from Aussie Joel and The Rude Awakening team…

Bill Bonner, back in London with more thoughts…

*** A reader explains what may happen to the oil price as Iran gets targeted in the War on Terror:

“The Iranians are in no mood for another regime change and will exact a tremendous toll on the U.S. Empire, which will ultimately lead to its demise. Quite frankly, the high price of oil and our addiction to it is a blessing because it is the only deterrent that the dogs of war will pay attention to.

“As someone who has worked in the oil industry, I fully expect to see oil at $100 a barrel after sanctions are imposed. Once hostilities occur, I could see prices between $300-500, especially if tanker traffic is slowed or targeted. The worst scenario would be if a sunken tanker blocks the narrow Strait of Hormuz. This will bring about a global economic meltdown. I cannot fathom how developing countries are able to cope with the present price of oil let alone when it skyrockets.”

“So what?” we wonder. An Iranian debacle would do no one any good, but things can always get more out of whack than you expect. The neo-cons wanted “creative destruction” in the Middle East…they may get more of it than they wanted.

[Ed. Note: There is so little leeway between supply and demand that even minor disruptions can domino into terminal overload…imagine what kind of disruption the possible situation with Iran will cause. Someone won’t be getting all the oil it needs…and it will most likely be the United States.

*** “After reading Empire of Debt, I was inspired into wanting a Hollywood satire/thriller (based on the book) about a German-style hyperinflation scenario hitting the United States economy,” one reader writes.

“I would love to see the macabre enactment of Federal helicopters dumping currency on cities, mob scenes at gas stations charging $50 per gallon, frenzied depositors mobbing banks and jumping over teller counters to make forced ‘withdrawals’… The movie could showcase the ‘worse case scenario’ of runaway hyperinflation, crashing markets and the Chinese on a spending spree in the U.S. buying up real estate and driving the average home into the tens of millions.”

How do you picture the Empire of Debt documentary? Any thoughts, suggestions, or comments on this project are welcomed. Send Kate your ideas: kincontrera@dailyreckoning.com

*** Things always last longer than we expect, and get further out of whack than we can imagine.

Today’s news tells us that “Vegas Condos Grow Cold.” Three high-profile projects have been canceled in the last seven months, the article tells us. Maybe the madness is correcting…maybe not yet.

The Fed funds rate could soon reach 5%. This will give Ben Bernanke some room. There is not much margin for error, it is true. With credit market debt about twice the level it was when Alan Greenspan nestled into in the cushiest chair at the Fed, Bernanke will find his own seat a little harder and less comfortable. But as the economy starts to sober up and come to its senses, Bernanke will also have a little more gin to add to the punch. He’ll be able to cut the prime rate back down to 1%. Who know what madness will follow?

House prices could continue to go up. Stocks could rise. People might spend even more recklessly, and add to their debts even more imprudently. About the only thing you can count on is that the price of gold will go up. We say that, fully aware that we can’t read tomorrow’s newspapers any sooner than anyone else. It’s just that we have a deep and abiding faith in central banking; we know it is a swindle. The more brazen it becomes, the more brightly good old honest gold shines in comparison. (More on this below…)

*** How mad has the real estate bubble become? A service called “101 dumbest moments in business: Real estate” tells us that there is a booming business in converting insane asylums into up-market housing. Of the “seven priceless moments of real estate insanity,” this one tops the list, say the authors. They go on to say, “the nuthouse-to-yuppie-house trend currently sweeping North America, with such conversions also planned in Detroit, New York, Vancouver, and Columbia, S. C., where the centerpiece of the development is an original brick building with the word ‘asylum’ chiseled into the facade.”

Also on the list: “Vail’s Board of Realtors announces that it’s moving back in with its mom.

“Unable to buy office space in a community where the average home price recently headed north of $4 million, the Aspen Board of Realtors heads north too – to Basalt, Colo., a town of 3,000 residents 20 miles away.”

In San Francisco during the month of March: “The median price of a single-family detached home in the San Francisco Bay Area rises more than $1,000 per day. By month’s end, it swells to $106,000 above the previous year’s median – 43 percent more than the area’s estimated average household income of about $74,000.”

And here in England: “A house in the Shepherds Bush area of London measuring less than 10 feet across at its widest goes on the market for $933,000. Listing agent Winkworths describes the anorexic structure as ‘utterly amazing and almost certainly unique.'”

The Daily Reckoning