* * * * * * * * * * * * REMINDER * * * * * * * * * * * * *
On the days that I don't publish, like today, you will
receive Bill Bonner's DAILY RECKONING. This will help you
to keep pace with the changes in the markets. Bonner and
I agree on most things in the field of economics, so the
two letters will reinforce each other.
* * * * * * * * * * * * * * * * * * * * * * * * * * * * *
The Kindness of Strangers
The Daily Reckoning
London, England
Wednesday, October 13, 2004
---------------------
*** The land of the free - and of no consequences...
*** And we'll have fun, fun, fun, 'til Daddy takes the
credit card away...
*** Designer cities... large families barely squeaking
by... a nice dose of philosophic snake oil... and more!
---------------------
"Imagine a place where you could spend far more than you
earned for years without consequence," writes Gary Duncan
in the Times of London. "Imagine a place where you could
pay your way by writing cheques that nobody would bother to
cash. Welcome to America, today."
Americans have never had it so good. But Nature has her
ways of keeping things in balance. Like fat little lemmings
rushing into the sea, Americans seem to have an urge for
mass financial suicide; they couldn't wait to put
themselves in deep water.
"Over the past decade or more," Duncan continues, "the
United States has been living far beyond even the vast
means commanded by the world's largest economy. America's
households have spent far more than they earn, borrowing
extravagantly against the rising value of their homes and
other assets. The U.S. government has been no less
profligate, dramatically increasing spending while making
hefty cuts in taxes. "
In the last five years, for every dollar Americans earned,
they've spent $1.20. In barely a decade, the United States
became the world's biggest debtor, with the percentage of
U.S. government debt in foreign hands rising from 20% to
nearly half. Foreign lending - the kindness of strangers -
is what keeps the U.S. economy going.
Many economists see this relationship as flattering... or
symbiotic. They make; we take. They save; we borrow. They
sweat; we think. We print dollars and Treasury bonds; they
buy them. Who can complain about that?
It looks like "the biggest free lunch in modern economic
history," says Niall Ferguson.
But there's no meal quite as expensive as a free lunch, we
riposte.
The Fed cut rates 13 times after the 2001 recession began.
With the key rate as low as 1%, the Fed was willing to lend
money at a negative real rate of interest. This ultra-cheap
money is what stimulated a consumer-spending binge in the
United States and a capital-spending binge in Asia. The
effect on Americans is simple: They ruined themselves by
spending money they didn't have on things they didn't need.
Asians, on the other hand, built factories to produce
things for people who didn't have the money to pay for
them.
Both trends are doomed, but not exactly in the same way.
Americans' standard of living was bound to fall, compared
to the rest of the world's, anyway. Wealth still comes,
mostly, from producing things. Asians can now produce
things more quickly and less expensively. The Fed's
artificially low rates merely accelerate the process,
giving Americans one last spending spree - like a condemned
man's last meal - before the credit card is taken away.
The industrialization of Asia was bound to happen, too.
That, too, merely got a boost from the Fed. Many Asian
companies will probably go bust when American demand
slumps. But the Asians want things also; eventually,
domestic demand should take up the slack.
When will the "free lunch" come to an end?
"No one can predict with certainty," writes Duncan. But a
revaluation of the yuan might be the dessert course... or
the coffee. Then, the bill is sure to come - denominated in
yuan!
"It is a tantalizing prospect, although one that will
depend on China's ability to preserve political stability
as its prosperity grows," Duncan concludes. "However, it is
not impossible that, in our lifetimes, markets will hang,
not on the words of Alan Greenspan or his successor, but on
those of the chairman of China's central bank."
More news, from Tom Dyson in Baltimore:
---------------------
"From 1985 through 1987, the dollar index fell from 140 to
below 90, and the yen soared, but the deficit still doubled
in the same period. Even if the Chinese revalue - and it
may not even be anytime soon - it could take years for the
deficit to return to balance, just like in the early 1990s.
The same policies that depress the dollar make American
consumers feel like spending money, and they spend it on
Chinese goods... "
Like what you see? Want to read more? Check out The Rude
Awakening:
http://www.dailyreckoning.com/home.cfm?loc=/body_headline.cf
m&qs=id=4169
---------------------
Bill Bonner, back in London:
*** London housing prices are outrageous.
"Since 1996, London led a worldwide boom in big city
property prices," says Yale economist Robert Shiller.
New York, Los Angeles, Paris, Shanghai, Vancouver - the
world's great cities became like luxury brands. When you
said you lived in London, people knew what it meant - it
was as if you carried a Gucci bag or wore a Hermes tie. You
edged up the snob scale a little bit simply because you
lived in a fashionable place. By contrast, if you said you
lived in Chicago, you slipped a little. And if you admitted
that you lived in Baltimore, they felt sorry for you.
"The trend towards metropolitan chic is unlikely to end
soon," says Shiller. But the bubble in housing prices may
be peaking out. Here in London, the papers tell us that
prices in the center of town are already beginning to
stabilize... or sag.
*** Meanwhile, from Dallas comes news that house resales
fell for the second month in a row.
And from Baltimore, the Sun reports that prices in the
region rose 20.5% in the last year - and still seem to be
going up!
*** "One out of four Americans struggles to pay his bills,"
says a new study. The researchers wondered how families of
four, living on less than $36,784 per year, got by. "Just
barely," was the answer.
The Houston Chronicle:
"'One emergency - a broken-down car, rent increase or
serious illness - can disrupt the families' precarious
equilibrium and plunge them into financial chaos,' the
report states.
"The nonpartisan report spotlights a growing disparity
between low-wage earners and the educated skilled workers
that U.S. businesses increasingly demand.
"Its release comes in the final weeks of a heated
presidential campaign in which issues concerning low-income
families largely have taken a back seat to those of the
middle class and to worries about terrorism and the war in
Iraq.
"'What we haven't come to grips with is how large this
number of working low-income families is,' said Brandon
Roberts, co-author of Working Hard, Falling Short.
*** We went out to a guitar store to buy Henry a birthday
present last weekend. Henry turned 14 in July, but we have
been traveling so much we had not had time to buy him the
guitar he wanted.
The music stores all seem to be located over by Place
Pigalle, an area of bars and prostitutes. But besides
those, there is little of interest. Last weekend, there
must have been an important rugby or soccer match pitting
the French against the Irish. By 5 p.m. on Friday evening,
the bars were already overflowing with drunken Irish fans.
They wore green jerseys and were singing, "Sail, bonny
boat... "as we walked by.
Guitars come with many different brand names at the end of
the neck. But inside the box, we noticed that almost all
guitars under $400 were made in China. We bought an Ibanez
acoustic for 189 euros. Made in China, of course. Nice
instrument
*** Our Pittsburgh correspondent, Byron King, comments on
Jacques Derrida's passing:
"Of course, Derrida and his philosophic snake oil was/is a
pseudointellectual byproduct of an elastic currency and
lack of a gold standard. (Whoops... there I go, showing my
inherent bias. Damn. I hate it when that happens... ) But I
shall go on...
"In a hard-money world where people had to work at a real
job and earn a living by being productive, no one would
have time for Derrida's nihilistic deconstructionism. The
nation would be at peace, because it could not afford to go
to war. The citizens would be at work, because they could
not afford to be idle. The children would be in school and
learning real subjects, because they could not afford to
grow up and be stupid. And the politicians would be in
Washington and London, Harrisburg and Annapolis, making
sure that things stayed that way, because they could not
afford to get voted out of office for screwing it all up."
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The Daily Reckoning PRESENTS: The United States has broken
a lot of records recently... unfortunately, they aren't the
kind that will win us any gold medals. How long will our
neighbors in the Far East continue to bail us out? Dr.
Richeb�cher investigates...
THE KINDNESS OF STRANGERS
By Kurt Richeb�cher
Renewed weakness in the U.S. economy has hardly come as a
surprise to us. It is the inexorable outgrowth of an
economic recovery that has been of highly dubious quality
right from the start. The U.S. economy is plagued by an
extraordinary array of growth-impairing imbalances: a
record-high trade deficit, a record-high budget deficit,
record-high household indebtedness, record-low national
saving and asset price bubbles supporting record-high
consumer spending.
Any other country faced with these monstrous domestic and
external imbalances would have endured panicky capital
flight and a collapsing currency, forcing its central bank
to drastic monetary tightening. But the U.S. central bank
and the dollar were spared this fate because the central
banks of the Asian surplus countries stepped in,
accumulating any amount of dollars needed to avoid an
undesired rise of their currencies.
In 2003, such dollar purchases by foreign central banks
amounted to a stunning $616.6 billion, after $351.9 billion
the year before. The total reserves of emerging Asia rose
by over $350 billion between the beginning of 2003 and
March 2004. Over the same time, Japan's central bank
purchased $316 billion worth of U.S. assets. The biggest
buyer in emerging Asia was the central bank of China.
These huge and soaring dollar purchases by foreign central
banks were crucial in allowing the U.S. Federal Reserve to
pursue its ultra-loose monetary policy with ultra-low
interest rates. As we have often stressed, this in
combination with equally loose fiscal policy has prevented
a deeper recession, but the question is whether or not
these policies have laid the foundation for sustained
economic growth in the longer run.
In our view, it is bad policy on both sides. The Asian
central banks accommodate the credit excesses in the United
States, and in doing so, fuel rampant credit excesses in
their own countries. Japan's horrible aftermath over more
than a decade after its credit excesses in the late 1980s
does not seem to deter anybody. The United States, on the
other hand, is losing jobs to Asia.
Both are courting extraordinary credit excess, but with a
crucial difference: In the United States, the credit excess
went and continues to go overwhelmingly into asset prices
and personal consumption; in Asia, it goes overwhelmingly
into capital investment and production, essentially
creating a mass of overcapacity and malinvestments. The
result is an unprecedented symbiosis between the two
continents: The Americans borrow and consume, and the
Asians produce.
The U.S. economy has abruptly weakened. Is this weakness
just a short-lived "soft patch" caused by higher oil
prices, as emphasized by Fed Chairman Alan Greenspan and
readily believed by the eternally bullish consensus? Or
does it represent the beginning of a more severe downshift
to subpar corporate and economic performance, if not
worse?
An issue in particular is a slowdown in consumer spending.
>From the start of 2004 through July, real consumer spending
rose by $122.2 billion. That is $209.5 billion, or 2.8% at
annual rate, and compares with an overall increase of
$232.2 billion (3.3%) in 2003 and of $213 billion (3.1%) in
2002. For perspective, during the boom years 1999-2000, it
had growth rates of 5.1% and 4.7%.
Though this deterioration is not dramatic, it also does not
suggest an ongoing recovery. Yet the aggregates hide one
rather dramatic change in the current year, namely, sharply
lower growth in spending on consumer durables. At annual
rate, it was down to $23.5 billion in the first seven
months of 2004, after $71 billion in 2003 and $58 billion
in 2002.
Still, there has been a dramatic change for the worse in
the consumer's earning power. Since January 2004, the
three-month annualized growth rate for real disposable
personal income has literally collapsed: 5.7%, 4.6%, 4.5%,
3.7%, 2.5% and 0.8% for July. Over the seven months to July
2004, real disposable income was up a mere $77.4 billion,
or $132.7 billion at annual rate. It grew by $174.3 billion
in 2003 and by $226.2 billion in 2002.
Presenting these numbers, we have to mention that they have
been jolted by tremendous revisions. Earlier data showed a
pronounced rise in personal saving. Now there is a steep
plunge. The crucial fact to see is that the consumer
stepped up his borrowing to compensate for slowing income
growth. The rise since 2000 is 74%. Yet the net effect has
been gradual retrenchment in spending.
The success or failure of the massive monetary and fiscal
stimuli over the past few years is one of the most
controversial questions about the U.S. economy. Using the
much slower economic growth in the Eurozone as a yardstick,
as is the general American practice, U.S. policies look
most successful. But using the previous six postwar U.S.
business cycles as a measure of success, the U.S. economy's
performance during the last two to three years has been by
far the poorest ever, despite the unprecedented amount of
fiscal and monetary stimuli.
Annualized growth of real GDP has averaged 3.4% over the
first 10 quarters of this upturn, far below the 5.4% norm
of the recoveries in the previous business cycles. Real
wage and salary disbursements - the grist of healthy,
sustainable economic growth - over the same period have
recorded a cumulative increase of just 2.2%. This compares
with an average cumulative increase of 10.6% over the same
period in past postwar business cycles.
Even more important is the further question of whether or
not the economy has gained the "traction" it needs for the
recovery to become self-sustaining and self-reinforcing
without further artificial monetary and fiscal stimuli. It
would have to show particularly in much faster employment
and income growth than it has so far.
In his congressional testimony, Mr. Greenspan stated, "The
expansion has regained some traction" after having gone
through an oil price-induced "soft patch" last spring. In
general, this has been interpreted as an upbeat statement.
To us, the word "some" is strictly diminutive, implying
less than full traction, which is realized when an economic
recovery has gained self-sustaining, if not
self-reinforcing, dynamism.
As a matter of fact, there was a very different reading
about consumer spending in the Fed's Sept. 8 Beige Book:
"Household spending was reported to have softened in many
parts of the nation, reflecting lackluster retail sales and
some cooling in new and existing home sales." They
certainly knew what happened in August.
In past cycles, the usual vigorous traction used to come
mainly from pent-up demand that, due to prior monetary
tightness, had accumulated during the recession mainly in
residential building, consumer durables and business
investment in equipment. Key to the present subpar recovery
has been the exact opposite - heavy consumer borrowing from
the future.
During the three years 2000-03, disposable incomes of
private households grew, in current dollars, a cumulative
$965.9 billion. They increased their spending by $1,023.7
billion and their debts by a stunning $2,726.9 billion. In
this regard, the monetary and fiscal stimuli appear to have
worked so far. But the problem is that a growing part of
domestic spending exits to foreign producers, fueling the
U.S. trade deficit, instead of U.S. domestic production.
Regards, Kurt Richebacher, for The Daily Reckoning
Editor's note: Former Fed Chairman Paul Volcker once said:
"Sometimes I think that the job of central bankers is to
prove Kurt Richeb�cher wrong." A regular contributor to The
Wall Street Journal, Strategic Investment and several other
respected financial publications, Dr. Richeb�cher's
insightful analysis stems from the Austrian School of
economics. France's Le Figaro magazine has done a feature
story on him as "the man who predicted the Asian crisis."
This essay was adapted from an article in the October
edition of: The Richeb�cher Letter
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