The Emperor Has No Clothes

Four strong reasons why the recovery is bogus and cannot last.

"The deficit country is absorbing more, taking consumption and investment together, than its own production; in this sense, it is drawing upon savings made abroad. Whether this is a good bargain or not depends upon the nature of the use to which the funds are put. If they merely permit an excess of consumption over production, the economy is on the road to ruin. If they permit an excess of investment over home savings, the result depends on the nature of the investment."

– Joan Robinson, "Reconsideration of the Theory of Free Trade," Collected Economic Papers, Volume IV, 1973

America’s economic recovery and its likely strength have been and remain the central preoccupation in economics around the world.

In the consensus view, the U.S. economy will record in this year’s second half its strongest pace of growth since the late 1990s. According to a monthly survey of 53 economic forecasters conducted by the Wall Street Journal Online, its seasonally adjusted annual growth rate during the current quarter will be 4.7% and 4% in the fourth quarter.

American Economic Recovery: Completely Deceptive

While a few economists have been warning that this recovery’s actual pace may disappoint, our own view is that the U.S. economy’s higher growth rate in the second quarter was totally deceptive. Focusing strictly on the hard economic data, like employment, personal income, production, business fixed investment and profits, we completely fail to see any recovery at all in the United States.

Ever since 2001, the United States has been running monetary and fiscal stimulus of unprecedented largess. In July, the government’s tax cut and rebate checks turned an income gain of $19 billion into a $120 billion gain in disposable income.

In the bullish consensus view, the medicine is finally working. Above all the upward revision of the second- quarter real GDP growth rate from 2.4% to 3.1%, following 1.4% each in the two prior quarters, has caused virtual euphoria.

Knowing these are annualized growth rates is the first reason why we are still unable to see a sustained, let alone a self-sustaining, economic recovery in the United States. When American economists speak of 4% growth in the coming quarters, they really mean 1%, and that is a far cry from what used to rank as a cyclical recovery. Growth rates of postwar recoveries in the United States averaged 5.4% over the first two years after recession – and that needed very little monetary and fiscal stimulus, as against less than 3% growth currently.

The second reason for our disbelief is that U.S. GDP has been heavily bolstered by government spending. In the fourth quarter of 2002, it accounted for 24.5% of nominal GDP growth, in the first quarter of 2003 for 40.7% and in the second quarter for 38.2%.

American Economic Recovery: More Slowdown than Acceleration

A third reason is that the recovery completely fails to show in the current-dollar data. In these dollars in which all economic activity takes place, GDP grew 0.99%, after 0.94% in the first quarter, an acceleration hardly worth mentioning. But measured in chained dollars, it more than doubled from 0.35% to 0.775%. Taking the big boost from government spending into account, it was more slowdown than acceleration.

The fourth and most important negative point is that the trumpeted recovery in business fixed investment, in particular in high tech, is just another statistical mirage. In the second quarter of 2003, overall business fixed investment in structures, equipment and software, measured in current dollars, amounted to $1,119.9 billion, slightly down in comparison with $1,126.8 billion in the first quarter of 2002.

Measured in real terms, chained dollars, it was up $64 billion, or 0.5%.

I hardly need remind you that a true economic recovery essentially must come from a balanced rise in consumer spending and business investment spending. But what really happened to the two during the first half of 2003, being generally hailed as the start of the U.S. economy’s final recovery?

Let us look at the changes in aggregate GDP. Measured in current dollars, it grew by $99.6 billion in the first quarter and by $105.5 billion in the second quarter, hardly an acceleration.

Looking at the demand components, growth of consumer spending, its biggest component, slowed between the two quarters from $87.1 billion to $83.1 billion. Nonresidential fixed investment dipped in the first quarter, but recovered in the second quarter to its earlier level. From first to second quarter, the growth of government spending slowed from $40.7 billion to $33.6 billion, and that of residential investment from $21 billion to $6 billion. Not one single GDP component rose. The sharply rising trade deficit subtracted $11.1 billion from GDP growth in the first quarter and $23.8 billion in the second.

American Economic Recovery: computer Price Deflator

But this dismal picture, measured in current dollars, radically changed for the better after the statisticians had treated the numbers with their price indexes. GDP growth, measured in chained dollars, surged from $33.8 billion to $73.5 billion. Growth in consumer spending, down in current dollars, went steeply up from $33 billion to $62.4 billion, and growth in government spending even shot up from $1.7 billion to $31.7 billion.

Yet by far the single biggest contributor to this sudden surge in real GDP growth from the first to second quarter came from the calculation of the price deflator for computers. Measured in current dollars, this investment inched up by $0.8 billion in the first quarter and by $6.3 billion in the second quarter, but the hedonic deflator boosted the two numbers in real terms to $15.3 billion and $38.4 billion. Hedonic pricing of computers in the first quarter accounted for 43% of real GDP growth and for 44% in the second.

The bullish consensus, flatly disregarding the overwhelming hedonic component, immediately hailed the sharp rise in computer investment as the rapid comeback of high-tech investment. Wall Street celebrated with the NASDAQ up 56% since March.

In its absence, nonresidential investment remained dead in the water across the board.

Warm regards,

Kurt Richebächer,
for The Daily Reckoning

November 06, 2003

Dr. Kurt Richebächer’s articles appear regularly in The Wall Street Journal, Barron’s, the U.S. edition of The Fleet Street Letter and other respected financial publications. France’s Le Figaro magazine did a feature story on him as ‘the man who predicted the Asian crisis.’ Dr. Richebächer is currently advising investors on how to profit from Greenspan’s mistakes.

Our souls are being tested, dear reader.

Our convictions…our guesswork…even our sense of right and wrong.

What if we’re wrong, we ask ourselves? What if the world doesn’t work the way we think it does?

Not that we can presume to ever know how the world really works. That is something not granted to us humans. All we can do is to look through the glass darkly and try to make out general patterns…the rules and principles…that help us understand it.

When a man drinks too much, we expect him to fall down. And frankly, we’re a little disappointed when he doesn’t; it is as if he has cheated nature in some way.

When a man cheats on his wife or his business partners…we don’t know, but we suspect there is a price to be paid somewhere…somehow…sometime. If not in this world, perhaps in the next! And if that’s not the way it is…well, that’s the way it ought to be.

And now we have before us the spectacle of millions of people who think they can get richer – neither by the sweat of their brows…nor the discipline of saving…but by merely by buying a house or a stock. The price of purchase doesn’t seem to matter; the secret is just to ‘be in the market.’

And since they believe they have found the lazy man’s way to wealth…they see no need for the usual precautions. Why not mortgage up your house…if you know the price will rise? America’s savings rate has fallen to one half of one percent of GDP…or less than 3% of personal income. By contrast, the Chinese typically work longer hours, under worse conditions, for 1/10th the pay…and save 35% of their money!

Not only do they not save money, collectively, Americans spend a half-trillion more than they make…and borrow another half-trillion – much of it from third-world, communist nations – to finance their national government.

But don’t worry about it, we are told: ‘America is the biggest, most dynamic economy in the world. We’re growing twice as fast as Europe. Our stock market is booming. Our real estate is rising. We have Alan Greenspan at the Fed and George W. Bush in the White House. What could go wrong?’

So far, the Dow has recovered 57% of its losses from the bear market of 2000-2002. The last quarter showed the strongest economic growth in 19 years. Investors are more bullish than ever. Margin buying is at its highest level since ’99. And even the dollar is going up – yesterday, it climbed, again, against the euro.

Can it be, dear reader? Is this the real thing? A real recovery? Will the bill never come?

We wait…and wonder…

In the meantime, here’s Addison with more news:


Addison Wiggin writing from Paris…

– "Bears, bears, bears…" begins an all-too-typical message from a faithful reader, "the market has been going up for 8 months – don’t you think it’s time you changed your tune?"

– Even our editor at Wiley has her reservations: "We checked with your publicist and our contacts – the media is disinterested in your ‘reckoning day’ doomsday philosophy. Especially since the market is going up. Producers [of TV and radio programs] clearly recognized you and Bill but feel the ‘message’ was off…"

– Fact is, as Jim Rogers points out in the foreword he wrote to Financial Reckoning Day, "…artificially low interest rates and rapid credit creation policies set by Alan Greenspan and the Federal Reserve caused the bubble in U.S. stocks of the late 90s…Now, policies being pursued at the Fed are making the bubble worse. They are changing it from a stock market bubble to a consumption and housing bubble. When those bubbles burst, it’s going to worse than the stock market bubble…

– "No one, of course, wants to hear it," continues Rogers, getting to the point we want to make today, "They want the quick fix. They want to buy the stock and watch it go up 25% because that’s what happened [in the last bubble] and that’s what they saw on TV."

– Indeed, the rally in the market has been remarkable. Remarkable enough to shake the very bedrock of the principles your editors here at the Daily Reckoning strive in vain to follow. Yesterday, the market, showing signs of fatigue, did take a breather. The Dow lost 18 points, settling in for the evening at 9820. The S&P 500 lost a couple points to 1051. The Nasdaq limped ahead two points to close at 1959. But you’ve got to hand it to them…since the rally began, the Dow is up 32% and the Nasdaq a whopping 56%.

– And all over the news we find raving madmen (mostly politicians or policy wonks, it seems) talking up that tart ‘productivity’…cooing over the estimated 7.2% growth rates for Q3…and whispering coyly about the 4% growth rate for the fourth quarter… – Even if the numbers were true – which we have our reservations about, as the good doctor Richebächer points out below – the ‘recovery’ can’t last. Even our new pal Paul Krugman is on the case. He appears to have taken a gander at out book: "Such explosive growth in debt can’t go on forever, and it won’t. Yet our current leaders and their apologists insist that the problem will magically solve itself. Last year’s deficit came in slightly below forecasts, and we’ve had one quarter of good economic growth – see, we’ll grow out of the deficit! But we won’t, and there will eventually be a day of reckoning…

– Krugman continues: "As Bill Gross of Pimco, the giant bond manager, says, ‘Sooner, perhaps later, our Asian creditors will wake up and smell the coffee.’ (Yes, the federal budget and the value of the dollar now depend on huge purchases of Treasury bills by the governments of Japan and China.) When they do, he predicts ‘higher import costs, a cutback in spending on cheap foreign goods, rising inflation, perhaps chaotic financial markets, a lower standard of living.’ Something to look forward to…[and] the day of reckoning seems closer…"

– We’re sure the NY Times editorialist, and fellow best- selling author, has some crazy policy proposal for stopping the Day of Reckoning from wreaking its righteous havoc.

– Your Parisian editors don’t even pretend to know enough to construct such a policy. We simply sit down to write with a smile…like a fatigued mother who has finally gotten the kids to bed might sit down with a good mystery, trying like the dickens to enjoy the read. We also try to pinpoint the clues…and see if we can’t guess the ending before we reach the final chapters.

– What types of clues have we spotted today? Well, a headline in the NY Post reads "Grim News: NYC loses 47,000 jobs." Ouch. The jobs picture received negative reviews across the country in October.

– "The easiest way to gain an understanding of the U.S. economy," writes our friend and colleague Jim Puplava, "is to think in terms of four words: debt, consumption, speculation and illusion. When looking at the U.S. economy from the perspective of these four words, it becomes easier to understand why the recovery isn’t shaping up like cyclical recoveries of the past.

– "It has become a start and stop economy for the last two years," Puplava continues. "The economy picks up steam after stimulus is applied, then it begins to fizzle once the stimulus has been exhausted. Without the constant input of new stimulus – either through interest rates or tax cuts or deficit spending – the economy rolls over. It is a bubble economy where real economic growth has been anemic, job growth has been nonexistent, and business fixed investment has been absent."

– And what’s this? Another clue comes over the wire as we write. The BBC reports that the Bank of England voted this morning to raise rates to 3.75%. The BoE has been the faithful hand-servant of the Federal Reserve, cutting rates in England at an equally rapid pace on this side of the pond. Now, apparently, they’ve voted to bite the bullet and begin the hard work of digging at the wound…

Jim, by the way, is the host of Financial Sense Newshour, a two-hour weekly Internet radio broadcast. Bill Bonner will be his guest a week from Saturday. We’ll fill you in on the details as the time nears.]


Bill Bonner, back in Baltimore…

*** Against all the bullish news are the tell-tale signs that the end of the world is coming.

While investors have never been more bullish, the investors who know what they are doing – the insiders – are pulling out. The latest research shows them selling 34 shares for every one they buy.

*** The greatest investors, too, are warning investors. In recent weeks, the big three – Buffett, Soros, and Templeton – have all told investors to watch out.

*** While the Dow has recovered so much that almost all investors are sure this is the real thing – a real bull market, Richard Russell reminds us that the stocks market recovered almost as much following the ’29 crash. While the Dow has bounced back 57% – following the greatest jolt of stimulus ever administered – the Dow bounced back 52% in the early ’30s, even with little stimulation.

*** Darn. Gold went back up. It had fallen sharply at the beginning of the week. We hoped that it would drop to our current buying target – $370 – so we could buy more. Alas, the real money slipped to $377 and then recovered…marching back to $382 yesterday.

*** When the real recovery comes, we will know it. People will find real jobs paying real money. So far, that hasn’t happened. This from the Prudent Bear:

"Layoff tracker John Challenger was quoted as saying, ‘We put so much stimulus into the economy in the third quarter that the economy grew at its fastest pace since 1984…And yet there was a net job loss of 50,000 jobs in the third quarter.’"

*** "How’s Edward doing," your editor asked his wife, trying to keep up with the family by phone.

His father had spoken to him in grave tones. He confessed his crime…and now the poor little boy regrets ever having laid eyes on the b-b pistol or the friend who sold it to him.

"I talked to his teacher yesterday. She said he was being very well behaved, which is so unusual…it is very noticeable, she pointed out."

The Daily Reckoning