The Coming Correction

The Daily Reckoning PRESENTS: Now that the housing market, which has been propping up the U.S. economy for quite some time now, has gone soft, what’s next? Well, despite a stock market rally and high consumer confidence, Bill Bonner and Addison Wiggin warn that a correction is headed our way – and it won’t be pretty. Read on…


Tout passé, tout casse say the French. Everything goes away. Everything breaks down. Nothing is born that does not die. Nothing begins that does not end. There is no morning without an evening, and no silver lining without a cloud. Empires come. Empires go.

In the financial markets, the “going” phase is called a correction. It is intended to correct the excesses and mistakes of the expansion phase. In a bull market, there are corrections that bring extraordinary gains down to more modest ones. In a bear market, corrections – which soften extraordinary losses into more ordinary ones – are known as rallies.

Generally, the force of a correction is equal and opposite to the trend that precedes it. And the pain it causes is directly proportional to the pleasant deception that went before it.

As a practical formula, this does little to help us. We still do not know when or how the correction will come. And, to borrow an idea from Lord Keynes, the deception can last a lot longer than you can remain solvent betting against it. And yet, it is even more dangerous to bet on it.

America’s empire of debt rests on many huge deceptions that we have described in this book:

? That one generation can consume – and stick the next with the bill.
? That you can get something for nothing.
? That the rest of the world will take American IOUs forever – no
questions asked.
? That house prices will forever go up.
? That American labor is inherently more valuable than foreign labor.
? That the American capitalist system is freer, more dynamic, and
more productive than other systems.
? That other countries want to be more like America, even if it is
forced on them.
? That the virtues that made America rich and powerful are no
longer required to keep it rich and powerful.
? That domestic savings and capital investment are no longer necessary.
? That the United States no longer needs to make things for export.

The deception that sent credit expansion soaring between 2001 and 2005 came eagerly from America’s own central bank. By setting its key lending rate below the current inflation rate, the Fed misled almost everyone.

Throughout the boom years of 2002 to 2005, the Great Deceiver, Alan Greenspan, appeared before the U.S. Senate and dissembled. Not only did inflation present no clear and present danger, neither did Americans’ debt loads, nor did the negative numbers in the current account. Mr. Greenspan, who surely must have known better, found nothing to dislike and nothing to worry about.

So, we stop, draw breath, and wonder.

The deception is so large, we wonder how it could ever be fully corrected. We speak not merely of Mr. Greenspan’s perjury before Congress, but of the larger deception, in which Mr. Greenspan plays a leading role.

The promise of American capitalism is that it makes people richer, freer, and more independent. But since the introduction of the Fed and the rise of the empire, the currency in which Americans keep score has so addled the figures, we scarcely know if we are winning or losing. The dollar we knew as a child – in the 1950s – is only worth a tenth as much today.

The average household today has far more of them than we did. In 1950, U.S. household debt to disposable income, which is basically after-tax income, was 34 percent (if disposable income was $10,000, households had $3,400 in outstanding debt). Today, the average American household has learned to live large – on an imperial scale. Its house is worth more dollars.

It has a bigger car. It eats out more often. It has a wider TV screen with a clearer picture. It has more employment insurance. More health insurance. More Social Security Insurance. More protection offered by more government employees than ever before. It has many more credit cards, with much larger lines of credit. It has more clothes. More toys.

More gadgets, gizmos, and whatchmacallits. It has more debt. More obligations. More chains.

Almost every American believes he is richer. Certainly, compared with the Old World, Americans have no doubt that the rise of their empire improved every subject’s life. Is it true?

We pause to deliver a shocking update.

People love myth, fraud, and claptrap – especially when it flatters them. Maybe their food, life expectancy, crime rates, transportation, liquor, women, and architecture are nothing to brag about, say Americans to each other, but when they grub for money, they grub good. “Old Europe,” they say, making a comparison, “is too rigid, fossilized, hidebound…a museum.”

And yet, even this is a fraud. Despite Laffer’s curve, Greenspan’s Bubbles and Reagan’s revolution, the U.S. economy has done no better than Europe.

The Economist examined the evidence. Everybody believes that America grew a lot faster than Europe over the past 10 years. But the figures, in terms of GDP/person are very close – 2.1 percent per year for America against 1.8 percent for Europe. Take out Germany – which has struggled with absorbing its formerly communist cousins from the East – and the two regions are exactly the same.

And productivity? A study by Kevin Daly, an economist at Goldman Sachs, finds that, after adjusting for differences in their economic cycles, trend productivity growth in the euro area has been slightly faster than that in America over the past 10 years.

What about jobs? America is the greatest jobs machine on the planet, right? Again, excluding Germany, jobs in the rest of Europe grew at the same pace as in America. And more jobs have been created in the euro.

It’s true that Americans earn more and spend more than Europeans…but they work a lot more hours. Europeans simply enjoy leisure more.

But what about the post-2001 “recovery?” Hasn’t it been much more vigorous in America than in Europe? Well, only on the surface. Spiked up by the biggest dose of fiscal and monetary juice in history, America’s economy has slightly outpaced Europe’s.

But the figures are hard to compare. Europe calculates GDP growth more conservatively than America…and understates the truth, rather than overstates it, as they do at the Labor Department. More importantly, America’s jolt of growth has come at great cost. While Europe got no net stimulus, America has gotten enough to give it the shakes.

“Super-lax policies of the past few years have left behind large economic and financial imbalances that cast doubt on the sustainability of America’s growth,” says the Economist. “From a position of surplus before 2000, the structural budget deficit (including state and local governments) now stands at almost 5 percent of GDP, three times as big as that in the euro area.

America has a current-account deficit of 5 percent of GDP, while the euro area has a small surplus. American households now save less than 2 percent of their disposable income; the savings rate in the euro area stands at a comfortable 12 percent. Total household debt in America mounts to 84 percent of GDP, compared with only 50 percent in the euro zone.”

Barely has the twenty-first century begun and America finds itself in a remarkable position. It has, what it believes is, the world’s most powerful economy . . . and the world’s most powerful military force. Like the defunct Soviet Union, it has a sickle in one hand and a hammer in the other. The sickle, alas, has an awkward bend in it.

Since 1990, income for the average American household has risen only 11 percent while average household spending has jumped 30 percent. How could people spend so much more money without earning more?

Outstanding household debt doubled to more than $10 trillion between 1992 and 2004, even adjusted for inflation. And in Utah last year, 28 of every 1,000 households declared bankruptcy, almost three times the rate of a decade earlier.

People are determined to live large and live better than they can afford. They do this by what economists call smoothing income. Anticipating higher incomes in the future, young families spend the money now (e.g., buying bigger houses than they can afford). Nationwide, house sizes have grown 30 percent since 1980, says Cornell economist Robert Frank.

And now even people in their 50s and 60s look forward to either higher incomes or miracles. Some economists refer to the whole phenomenon as the “democratization of credit.” “Innovation and deregulation have vastly expanded credit availability to virtually all income classes,” says the Fed chief. He did not mention his own role in this democratic revolution. He is too modest. He is a Danton and Robespierre put together.

The Fed chairman accomplished more than all the nation’s innovators and deregulators put together. Dropping the price of credit below the inf lation rate, he offered the entire world something for nothing. Now, everyman could get himself into financial trouble, not just kings, speculators, and financiers. He made it possible for lending institutions to extend such a long rope of credit to the common man that millions are sure to hang themselves.

We don’t know what to make of it, so we turn to the dead for an opinion. But it is hopeless, the corpses know even less than we do. They can’t even imagine what is happening. Borrow against your house when you don’t have to? Buy a house as an “investment?” Take out “equity?” “Depend on foreigners to balance your budget?” “Live beyond your means and expect Third World wage earners to make up the difference?”
The ideas that Americans once took for absurd, they now take for granted.

What was wrong with our parents, grandparents, and long-dead ancestors?
Why weren’t they smart enough to realize that they could have a brand-new house with all the modern conveniences without paying for it? Why didn’t they figure out that they could all get rich by buying each others’ houses? But now, thank God, we are all geniuses.

The baby born when the empire began in 1913 came into the world with nothing. But he owed nothing. Now, he comes into the world owing his share of 37 trillion; that’s about $128,560 with his name on it. Is he richer? Is he better off? What would the dead say? That doesn’t include his share of Federal obligations and commitments that he’ll have to pay, which could add $100,000 more.

Bill Bonner and Addison Wiggin
The Daily Reckoning
October 11, 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.

Empire of Debt has just been released in paperback – and Daily Reckoning readers can buy their copy at a discount – just click on the link below:

The Most Feared Book in Washington!

Let us step back for a minute.

Stock market investors are giddy because the Dow has hit new highs, even though the broader market has been going down. And even though in real terms, the Dow is 20% below its peak set six years ago.

Speculators, meanwhile, are said to be shifting into Dow stocks and out of gold in order to increase their short-term results, which are the only results they are interested in.

Trillions of dollars are being gambled on spliced and diced derivatives whose real risks are both unknown and probably unknowable.

Meanwhile, house prices in America are going down. House sales are falling sharply; inventories of unsold houses are now twice average levels. And housing costs are now higher than they been for nearly a generation. Which has an obvious and almost immediate effect on the purchasing power of the people who live in them. With no further equity to extract…and a “wealth effect” that has turned either ineffective…or actually negative…the poor householder cannot keep spending. And since 70% of the U.S. economy – the highest percentage in history – depends on consumer spending…and since the world economy still depends on the U.S. economy… the whole world now turns its weary eyes to the poor U.S. householder:

“Please keep spending money you don’t have on things you don’t need,” they say to him.

“How about a newer, faster automobile…so you will look rich and powerful as you crawl through rush hour traffic?”

“What you need is a bigger television set…think how your family will applaud when you bring it home!”

“Go ahead, buy a new house…this little setback in the housing market is only temporary…everybody knows houses always go up in the long run. Besides, this new house has granite countertops…end the embarrassment of Formica forever.”

What a pity, the poor man is willing to spend. He is ready to spend. He is psychologically, sociologically, and pathologically ready to part with his last dime. But when he reaches for his billfold…what a pity, his pockets are empty!

What a marvelous contraption this modern financial system is!

Investors are paying record prices for companies with record earnings. And whence cometh these record earnings? From the spending by the same consumers who derive their purchasing power from the aforementioned rickety houses!

But not to worry. The National Association of Realtors joins Alan Greenspan in saying “we think housing has now hit bottom.” Why do they think it has hit bottom already? What kind of bottom is it that is less than 2% below the all-time high? What kind of world is that allows consumers, homeowners and speculators to go on the biggest, debt-fueled binge of all time…

…pushing up housing so much that the typical house went up more than 50% in the last five years…and permitting Americans to ‘take out’ $1.3 trillion from their houses over a two-year period…

…and then, when the bubble finally pops, punishes them with a decline of less than 2%? The median house in August was worth precisely 1.7% less than it was worth the year before.

Is it not a great world, dear reader? Is it not a wonderful world? Is it not a guilt-free, sinless, all-forgiving, gain-without-pain, two-steps-forward-none-back kind of world?

Is it not a world that doesn’t exist?

More news…


Mike Shedlock, reporting from Illinois:

“…Pondering the latest birth/death revisions once again, I see construction jobs are being added by the model. 157,000 construction jobs were added between February-September, in the face of the massive housing slowdown…”

For the rest of this story, and for more market insights, see today’s issue of

Whiskey & Gunpowder


More thoughts…

*** Long term, Asia is almost certainly a better bet for your investments than the United States, says our old friend Mark Faber. Speaking to the magazine Wirtschaftswoche, he noted that while real incomes in North America are stagnant, those in Asia are rising sharply. In China, for example, income per capita has doubled each of last two decades.

What’s more, Asia is becoming less and less dependent on the United States. Instead, of selling things to people who don’t need them and can’t pay for them, Asia will soon be selling to its own rising consumer class. In China, for example, 84% of car buyers are first time buyers. They’ve never had a car before. And think how many people in China still go through their entire lives without the benefit of granite countertops! It takes our breath away.

A “massive transfer of wealth” from West to East is underway, he says. Not only will this make Asia richer…it will also doom people in the West to lower standards of living, simply because, for the first time since the advent of the Industrial Revolution, Westerners must now compete with Easterners for scarce resources. All of Asia now only uses 22 million barrels of oil per day…the same amount as the United States. But Asia has more than 12 times the population.

China consumes only 1.7 barrels of oil per capita…an amount scarcely greater than the United States before the Industrial Revolution began. Asia has a lot of catching up to do, but it’s doing it quickly. And it will mean much higher prices for oil…and other natural resources critical to modern development. Look for oil at $100 to $200 a barrel…and higher gold prices too, says Faber.

[Ed. Note: If – and when – the price of oil soars again, the impact is felt all throughout the economy. The dollar gets destroyed. Energy-dependent industry goes bust. Many stocks go down.

That’s the bad news. The good news is when energy is under the gun, the rising oil price itself opens you up to all kinds of soaring investments. And just on energy shares alone, Outstanding Investments’ have helped their readers do extremely well…you can read all about it here:

There is Still Money to Be Made

*** BBC News tells us that the latest Nobel Prize winner in economics has merely explained a point we have made many times in The Daily Reckoning. Once investors, consumers and businessmen catch onto the Fed’s trick – introducing ‘liquidity’ as though it were additional purchasing power – the jig is up. They anticipate inflation and cease expanding the economy. Instead, prices rise while the economy stagnates. The Fed’s job now is managing inflation expectations so that they continue to inflate without anyone catching on. Otherwise, stagflation results.

The BBC:

“Professor Phelps has been concerned with explaining the relationship between unemployment and inflation, which had been described by some economists as a trade-off.

“He argued that inflation expectations could become embedded in the economy, leading to stagflation despite high unemployment.

“This also meant that if inflation expectations were kept in check, the economy could run at a lower level of unemployment than would otherwise be the case.

“Such views helped influence central banks to try and curb inflationary expectations promptly.

“Professor Phelps said of his work:

“‘I tried to put the people back into our economic model and in particular to take into account their expectations about what other economic actors are doing at the same time and in the future.'”

*** Oh…and here’s another bell ringing; this one for the hedge fund industry:

From MarketWatch: “When TV commentator Ron Insana starts getting into hedge fund management, it’s probably time for everyone else to get out. This isn’t to slight Insana, who is among the most sober and intelligent thinkers on that channel, if he still is on that channel.

“But when people who make their living as TV pundits eschew their given profession in the hopes of corralling some easy hedge fund money, it’s irrational exuberance time.”

The signs are everywhere that the glory days of hedge funds are over.

*** On Friday, we wrote:

“The trouble with these bums,’ we complained to Maria the other day, ‘is that they’re not up at dawn…and they’re not very inventive or industrious.’

“We began by outlining what we would do if we were ever down and out. The first thing would be to get out of town. You can live well on nothing in Arkansas, maybe, but not in Paris or London.

“But even in a major city, a bum could improve his lot. What we’d do, we said warming to our ideas, would be to rig up a hammock in one of the trees in the park. Using a system of pulleys, we would then be able to get in and out easily…and stash the whole affair in the daytime so that no one would bother it.”

And here, an earnest dear reader writes in response to our little brainstorming session:

“While I realize that your last few sentences about the homeless were written just to illustrate your point, they are so poor and sloppily thought out that they end up reinforcing it in a way you obviously didn’t intend. Please consider the following:

“New York has a much bigger economy than Arkansas, more money, more food, more places to shelter, more work. If you are homeless, you are breaking the law just by sleeping in public so the anonymity that a big city confers is a major advantage. Besides which, if Arkansas were a bum mecca, wouldn’t there be homeless flocking there? Do the homeless insist on living in the big coastal cities just out of a stubborn love for the scenery and cultural climate?

“Your tree house idea doesn’t consider the most basic needs for shelter or safety. What’s to stop other bums from climbing up the tree and grabbing your stuff the second that you leave? Won’t your tree house be rather obvious come wintertime? Do you think the police might take exception to your commandeering of city property for permanent habitation and storage? Will you want to live in a hammock in a tree during a snow or thunderstorm?

“A portion of people on the streets are just bums, but many of them are very industrious people, who are handicapped with mental and/or physical defects that prevent them from working within the mainstream. Another lot of them were perhaps just never made to function in an industrial society, period. The bums just happen to be the most visible.

“Just wondering if any of that had occurred to you?”

*** Editor’s reply: no.

The Daily Reckoning