The Nation that Debt Built
America has become a country of risk-takers – and it’s not solely homeowners and investors taking these chances…"trusted" government officials have made promises they can’t – and never intended to – keep. So what happens when this all comes to a head? Dan Denning takes a look…
"America may be the dominant force in the global economy because we’re a nation made of somewhat Crazy Eddies-gonzo businessmen and women who may be genetically predisposed to take big-time risks," says Daniel Gross in his review of a new book, The Hypomanic Edge: The Link Between (a Little) Craziness and (a Lot) of Success in America.
Gross writes a great review of what sounds like an interesting book. But today we wonder if American’s might be a little too crazy for their own pocketbooks. The book by John D. Gartner concludes that, "many of the components of the archetypal American character-optimism, entrepreneurial energy, religious zeal-fit the hypomanic profile." Gartner says writes that because America began as a nation of immigrants, Americans may be "culturally and genetically predisposed to economic risk."
Whether it’s genetic or not, Americans are taking on more risk than ever. Here a risk, there a risk, everywhere we look we find a whole nation at risk. Investors, new homeowners, and would-be retirees take on big risks with Puritanical zeal.
What a moment in financial history we observe, dear reader. A quick scan of today’s headlines show all the large themes of globalization and history picking up speed and converging. Americans are getting older, and realizing they can’t pay for rising health care costs, or for the comfortable retirement of the Baby Boomers.
China has overtaken the United States in consumption of basic agricultural and industrial goods. It’s pushing OPEC to max its output. The competition for the world’s oil gets more intense with every passing day. But China itself must compete for oil with India and Japan. All this competition is one reason why buying long-dated oil calls is so appealing.
Impending Economic Crises: The Crisis In America’s Retirement Resources
But the flip side of the contest for the world’s energy resources is the impending crisis in America’s retirement resources. American policymakers are finding out, quite plainly, that State-sponsored retirement schemes are unsustainable. Alan Greenspan said it yesterday in his prepared remarks to the Senate Banking Committee. The Chairman came out swinging for personal retirement accounts. He told Senators that "the existing structure is not working," and that personal accounts were "a good thing to do over the long run."
The nitty gritty of it is that the near future will find too few workers paying too many retirees too much money. Or, if you prefer Fed speak, the "benefits promised to a burgeoning retirement-age population under mandatory entitlement programs, most notably Social Security and Medicare, threaten to strain the resources of the working-age population in the years ahead…the demographics are inexorable, and call for action before the leading edge of baby boomer retirement becomes evident in 2008."
Greenspan also warned that if the problem isn’t dealt with now, it might drive long-term bond yields up. Perhaps the Chairman has been following the great bond debate between the at-odds editors of the Rude Awakening. Short-term rates have risen, but long-term rates haven’t, even as America racks up a $600 billion trade deficit. Even Greenspan is befuddled. "For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience."
We will save you the wait and point out that recent experience aside, when a nation becomes a credit risk, bond yields go up. There may be many small reasons to explain why yields are not rising today. But tomorrow, we find it hard to imagine a scenario where it gets cheaper for the indebted American government to borrow for increasingly expensive social welfare plans, not to mention global warfare plans.
Alarmingly, it’s not even Social Security that may blow up the yield curve on the long end. It’s Medicare. A new Harvard study reports that since 1990, medical spending in America has gone up from $696 billion to $1.7 trillion last year, or about 15% of GDP. The Bush Administration’s prescription drug benefit is going to end up adding another $1 trillion to the Medicare burden in the next ten years.
Not only is Medicare going to eclipse Social Security in terms of Federal spending, it might go bankrupt even sooner. The Harvard study projects that if the Medicare hospitalization trust fund will run out in 2019, well before the Social Security trust fund.
How do stocks react to all this gloomy sociopolitical forecasting? They go up, of course. A new Merrill Lynch survey shows that global fund managers are bullish on stocks and pouring cash in. The survey of 320 fund managers found that one in more had over 65% of their assets in stocks and that the average stock allocation was 55%.
Impending Economic Crises: Bad News For the Dollar
Yet foreigners actually bought $27.8 billion less in U.S. financial assets in November, according to Treasury Department figures released yesterday. Foreigners still bought about $61.3 billion in financial assets. But analyst Peter Frank at ABN Amro said, "It was a steep drop, but the market had already been expecting a much smaller number. If that’s the start of a pattern, it’s bad news for the dollar."
That sounds familiar. Bad news for the dollar. Bad news for interest rates, eventually. And bad news for anyone who depends on the American consumer for economic growth. But even that may be changing.
China has overtaken the United States in the consumption of basic agricultural and industrial goods, according to a survey from the eccentrically named Earth Policy Institute. According to the survey, China consumed 64 tons of meat in 2004, while McDonald’s gorging Americans only choked down 38m tons of red meat. China used up 258m tons of steel, compared to 104m in America. And China burned 40% more coal than America.
Granted, on a per capita basis, Americans are probably not cheating themselves at the dinner table (or at the breakfast table, or at the lunch counter, or at the snack bar, or at the desert cart.) And granted, China gets more energy from coal than America because China has a lot of coal. With oil above $45 it is cheaper to burn what you own than buy what you don’t.
But don’t think the Chinese are backing away from the oil sweepstakes. OPEC said yesterday that rising Chinese demand would force the cartel to boost global output to 30.1 mbpd. OPEC’s capacity, by the way, according to the OECD is about 31.5m bpd. Not much slack is there?
In two stories we see two proofs of the same idea. Everyone knows Social Security is going bankrupt, but pretends otherwise. Everyone knows there are more competing for oil that’s already being pumped at peak capacity. Prices have risen, but geopolitical temperatures haven’t, at least not yet.
Here’s the question: at what point does a future inevitability become a clear and present force on asset prices? When will the lurking knowledge that the American government has made promises it can’t (and has no intention of keeping) propel U.S. bond yields into double digits? And when will the nervous struggle for the world’s oil, conducted politely and with fake smiles and behind the scenes deals for access, turn into an ugly public spectacle? Or are we already watching the opening act?
for The Daily Reckoning
February 17, 2005 — London, England
P.S. We scarcely mentioned Fannie Mae and Freddie Mac. They have exited stage right in the mind of investors as the oil and bond stories take center stage. But if there is an unassuming villain in this drama, it’s the GSEs. A sharp and unexpected spike in long-term yields would be just the plot twist to rip the mask off of America’s financial economy and begin the sudden popping of its many bubbles.
Kind of reminds you of Hamlet at the end when all the main chracters die on stage. Fortinbras, the King of Norway arrives on scene and speaks the final lines of the play:
"Take up the bodies. Such a sight as this becomes the field, but here shows much amiss. Go bid the soldiers shoot."
It’s no secret that sub-prime borrowers have gone out on a limb to purchase houses that they can’t – and never will be able to – afford. They are living in houses that they don’t really own, spending money that they don’t really have…and to top it all off, Dan Denning, editor of Strategic Investment, warns that the "fool’s paradise" of low interest rates can’t last forever…and even a 1% interest rate increase will cause more damage than you can imagine.
The force of a correction is directly proportional to the deception that preceded it.
We repeat our dictum for no apparent reason. We just like the sound of it.
You may quote it any time you like, dear reader.
As a practical formula, it does little to help us. We still do not know when or how the correction will come. And, to borrow a phrase 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.
The source of the proximate deception is the U.S. Federal Reserve, America’s own, dear central bank. Setting its key-lending rate below the current "inflation" rate, the Fed misled almost everyone.
Yesterday, the Great Deceiver himself, Alan Greenspan, appeared before the U.S. Senate and dissembled.
"The economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well anchored," he told the nodding heads on the Senate Banking Committee. "The evidence broadly supports the view that economic fundamentals have steadied."
As to the mystery of why long-dated bond yields have failed to increase, the free world’s leading financial expert said he had no idea: "For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum."
The dollar fell on the news, the euro rising above $1.30.
We are not going to criticize the maestro this morning. You must be getting as tired of it as we, dear reader. But we are connoisseurs of absurdity here at The Daily Reckoning and we can’t help but appreciate a good vintage. And Mr. Alan Greenspan must be the 1986 Petrus of economists – the most absurd of all. For on the very same news, Mr. Greenspan had only to read the headlines to see that inflation was far from "anchored." Instead, inflation and inflation expectations – notably in the housing market – were under full sail in hurricane-force winds.
"January housing starts at 21-year high," said one headline.
"8-figure homes sales soar," added CNN.
"No Stopping Housing Boom,’ concluded TheStreet.com.
The cost of housing, in many areas of the country, is not just inflating – it is puffing up like a front-seat air bag. As reported here yesterday, in Alan Greenspan’s hometown, prices are rising six times faster than GDP growth. Buyers are not looking for a place to live; they are speculating – betting that their neighbor, the Fed chairman, will continue giving away enough money to make them rich.
There was little movement in major markets yesterday. The Dow, gold, bonds, and the dollar – all ended the day not far from where they began it. So, we stop, draw breath, and wonder.
As Alan Greenspan raises short rates, the gap between short rates and long ones narrows. The financial industry – which is the leading source of profits and economic expansion in America today – is squeezed. It typically makes money by borrowing at low short rates and lending at higher ones long-term. If long rates sink and short ones rise, the trade is out of business. This is normally when a recession begins. Mr. Greenspan knows that just as well as we do. But Greenspan needn’t keep the deception going forever, just until next January, when he steps down from the Fed.
Whatever happens after is someone else’s fault.
What kind of correction will it be? We have guessed that it will be long, slow, and soft – like a lazy snake. But what do we know?
And yet, 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, but not the only one.
The promise of American capitalism is that it makes people richer, freer and more independent. But since the introduction of the Fed, 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. But it also has far more debts on the other side of the ledger. Their house is worth more dollars, for example, but it owes more dollars on it. Mortgage debt has doubled since 1996. Real wages, on the other hand, have barely budged. People also tend to owe a lot of money on their cars. And today, online, we were asked if we wanted to mortgage our house to pay for college tuition. How many people do that? Statistically, quite a few. While there are many people who have accumulated a pile of real money, savings, and wealth, there are many more people who have nothing at all. They have been gradually, and silently, ruined. They have more gadgets and better cars, but they own only a few rooms of their houses…and their bank accounts are empty. Every week is a race to keep up with credit card bills, mortgage and auto payments, taxes, tuition and health care expenses.
Socrates despised democracy (see reader’s letter below). Most people are fools, he said. So anything approved by the majority was bound to be foolish. Is it any wonder America’s majority insists on more health care benefits…more Social Security benefits…more this and more that? The poor stiffs live hand to mouth; they’ve shackled themselves with chains of debt. Now they’re dependent on handouts from the government and low lending rates from the central bank.
And so, the absurdity darkens. The Fed provides the credit – misleading them further into debt and dependence. And the feds provide the bread and pubic circuses, which cost more money. In addition to their private debts, Americans are now on the hook, one way or another, for their share of America’s vast public debt. The present value of federal-level unfunded liabilities is said to be about $55 trillion. That’s about half a million dollars per household.
[Correction: The numbers we crunched on Fannie Mae yesterday contained an error. The statement should have read: "Citigroup recently admitted to a 6.3% stake in Fannie Mae. Given that Fannie Mae has a $60 billion market cap, Citigroup’s stake is worth $3.78 billion. Since December 31, 2004, Fannie’s stock has declined by 11.2%, handing Citigroup an unrealized mark-to-market loss of $423 million year-to-date."]
How this will all be corrected, we don’t know.
More news, from our team at The Rude Awakening:
Eric Fry, reporting from Manhattan…
"You’d never have thought a scrap metal company could become a stock market darling. Scrap metal prices have doubled and, in some cases, tripled. The companies that render this stuff are doing very nicely…but, this could be just the beginning…"
Bill Bonner, back in London with more bits of opinion…
*** Poor Japan! The country just can’t seem to break out if it’s long, slow, soft, on-again, off-again recession. The 4th quarter of last year was not a good one for Japan. Consumer spending went down; the economy contracted.
What must Mr. Asakawa think? The poor man has been sleeping with his infernal currency market monitor next to his bed, his slumber disturbed every time the dollar falls…and for what? Japan holds more than $700 billion worth of U.S. treasury bonds. Sure, Japan lost more than $100 billion last year (compared to holding the euro), but buying the U.S. debt was supposed to guarantee that Americans would continue buying (which they did)…and supposed to guarantee that Japan’s exports, and its economy, kept growing. Something is very wrong with this formula. Mr. Asakawa must be thinking that he should throw the damned currency monitor away…dump the bonds…and get a good night’s sleep.
*** A great day for the macro guys…Dan Denning sends us this:
"Yesterday was one of those days, like hitting for the cycle…or batting around in an inning. The U.S. government finds itself on the edge of the social welfare crisis everyone has been predicting for 30 years. The chairman is befuddled that long yields aren’t rising, as if he wonders why the rest of the world doesn’t see the ugly truth behind the dollar. And China is pushing OPEC to max out oil production. At the same time she’s eating more red meat and using more steel than America.
"It’s not often you find a country that consumes more than U.S. Too bad it’s driving the price of oil up!"
*** "I spent two years in Houston," said a Frenchman in the oil business. "It was amazing. We loved it. We traveled around. You know, America is so cheap. And there’s so much to see. But what was amazing was the way Americans are so uncurious. As I say, we were there for two years. We lived in one of those newish, upscale communities. Supposedly our neighbors were well-educated, upper-middle class people. But in the entire two years not one person ever asked a single question about France…or what people thought in France…or what we thought. We found it very strange. There’s a lack of conversation that is remarkable. People don’t seem to entertain very much. At least, they didn’t seem to want to entertain us. They were friendly, but just not interested. We ended up spending our social time with foreigners. It was easy to make friends with the Germans, other French people of course, but also with people from the Middle East and North Africa. We had a lively social life, but not with Americans.
"I think Americans have a deep inferiority complex. They’re ill at ease with Europeans on cultural matters. They don’t know much about history or art or philosophy. They don’t know how to make dinner conversation. At least, that is what we think we saw in the Houston area.
"Of course, the French have an inferiority complex too. We envy America’s energy, its commercial dynamism. Even its excesses are liberating to us.
"You know, we Europeans are much more careful. We don’t spend our money quite as readily. We don’t take to new ideas or new things easily. But there’s a good reason for that. We know that it’s very hard to recover from mistakes. Things are expensive in Europe…and take a lot of time. So you have to be careful. If you innovate…it can take a long time to make any money from it. And it can ruin you. And if you’re ruined, you probably won’t be able to recover from it. So there’s a lot to lose and not a lot to gain.
"But in America, if you come up with some crazy new idea, you can make a fortune quickly. So why not take the chance? Besides, if you’re wrong, you can try something else. You have time to recover. The people who make the big successes seem to be those who take big chances.
"That attitude carries over into foreign policy, I think. We Europeans saw the war in Iraq as a lot of risk and not much gain. We have small armies now. And we distrust military campaigns of all sorts. We had enough of that in WWI and WWII. But you Americans have a big army. You can afford to try all sorts of things – even things we would consider foolhardy. If you’re wrong, you can recover. You can try something else. A mistake is not fatal."
*** A thoughtful comment from a reader:
"Regarding your 10:1 negative email, take heart. It is reported that Socrates once proposed that, because there were far more fools than wise men in the world, any majority decision must be worthless. His peers agreed and approved his proposition by a large majority."