Friday, January 27, 2006

US Consumer Spending: Consuming America
A Daily Reckoning White Paper Report

By Dr. Kurt Richebacher
One has to realize that all the increase in US consumer spending is borrowed. And it is borrowed against rising house prices. In 2001, Greenspan replaced the bursting stock market bubble with the housing bubble. But soon he’ll be faced with a bursting housing bubble. The only question is when.

Asset prices are the key to the US economy. As long as asset prices are high, there seems to be ample liquidity in the economy. But as asset prices fall, the liquidity disappears. Americans think they are liquid. They aren’t liquid. Liquid is a person who has savings. We must realize that the appearance of great liquidity is merely the result of highly leveraged asset prices. And those can collapse.

Excess credit is the only thing supporting asset prices...Greenspan recently observed that American consumers have weathered the energy price hikes very well. But that’s only because they borrowed crazier and crazier. That’s not the kind of resilience you should applaud. It’s as if he said, “We succeeded in helping the consumer to borrow more and more.”

US Consumer Spending: The Noose Tightens

It would be desirable, of course, if the consumer would retrench a bit. Not that he would continue to increase his borrowing.

The thing to realize, of course, is that the housing bubble is many times more dangerous than the stock market bubble, because it involves the whole banking system. Greenspan has replaced one bubble with an even bigger and more dangerous bubble.

American monetary policy is out of control. Greenspan has created a debt Colossus. This debt Colossus needs permanent new credit. In an economy that needs four dollars in credit to produce one dollar of GDP, simply reducing credit could be disastrous. Even a slight reduction of credit could create enormous negative repercussions in the asset markets and financial markets.

The level of credit excess in America has reached such a level of absurdity that no return to normalcy is possible without a disastrous effect on the economy.

US Consumer Spending: America the “Ponzi unit”

America has become what Hyman Minsky calls a “Ponzi unit.” In other words, there sometimes comes a point where an economic unit has to rely upon asset sales to satisfy its interest payments and debt repayment. That’s America!

The writings of Hyman P. Minksy, particularly his 1986 book, ‘Stabilizing and Unstable Economy,’ ...identify three distinct income-debt relations for economic units: hedge, speculative and Ponzi finance:

1) Hedge-financing units can fulfill all of their contractual payment obligations by their cash flow.

2) Speculative units can meet the interest bill on their liabilities from their income, but are unable to repay the principal out of cash flow from operations. They need to roll over their liabilities.

3) Ponzi units are unable to fulfill repayment of principal and to pay the interest due on outstanding debts by their cash flow from operations. They depend on borrowing or selling assets even to meet their interest bill.

It is a reasonable conclusion that the U.S. economy and its financial system on the whole have become one huge Ponzi financing unit.”]

US Consumer Spending: The Abolition of Saving

What the Americans have done is that they have simply abolished savings. And that means that more and more of GDP goes into consumption at the expense of investment and at the expense of the trade balance...

What I often hear is that there's so much liquidity in the US economy and US financial markets. But this liquidity is not from cash. It is credit. There is huge liquidity in the asset markets that could turn into a savage deflation tomorrow. This is an illusion, this liquidity argument. It works as long as the system of inflating asset prices functions. But when it stops, liquidity is gone. If there is a lot of leverage in the market, it can collapse.

It has not yet happened...But it will, as soon as credit becomes more expensive or difficult to obtain...

The crucial support for the American financial infrastructure is the massive purchases of U.S. Treasury bonds by foreign central banks. The Americans think that this is to their advantage. But this only means that they have a longer rope with which to hang themselves. To have too much credit is never good, not for a country and not for an individual and not for a company.

America as the Empire of Debt

This is the problem: America has too much international credit. Not from private investors, but from central banks. Central banks are the marginal key influence. And therefore, when you consider the American fundamentals, America is certainly the most backward country in the world, among industrialized nations.

From a fundamental point of view, the American economy is in incomparably worst condition today than in 2000. Income growth for the individual is stagnating. It is negative. And there is no savings. America has no reserves to protect itself against the next recession.

The fact is, Americans are trapped. And worse, there comes a point where they are unable to sell any assets to raise capital, a point where the markets become completely illiquid...because there's no buyer left. The buyers of today are all leveraged buyers. They need new credit. But when you get declining prices, there is no buyer left. America's super-liquidity all comes from borrowing. Credit has played a major role in all U.S. financial markets...

There are many who say that deficit spending by the government is bad. But they don't say that deficit spending by the consumer is equally bad, or worse. The American idea that everything good comes from consumer spending is preposterous. And that is the key fallacy in America today.

But the key question is whether America has finally reached the inflection point where its disastrous economic policies will begin to undermine its prosperity. I think she has.

There is no way out. The excesses are much too big to be treated with conventional methods.

US Consumer Spending: The Great Ideological Divide

Anglo-Saxons know no limits at all! And no one complains about it. Europeans impose fiscal limits on ourselves and have difficulty keeping them under control, which is understandable. But when Americans double and treble their deficits, that is okay, because there are not limits. The Anglo-Saxons have two different sets of rules: One for the Europeans and one for the Anglo-Saxons. The Anglo-Saxons can do whatever they like.

The normal economic condition for a developed industrial country is to have an export surplus, and this surplus becomes the basis of its capital formation...That was basic macroeconomics.

All of a sudden, the virtue of an industrial country is not to export, but to save the world through over-consumption.

The European economies, for example, always had investment and export as a key driver of growth. And that is what you would expect from an industrialized economy, that is invests and that it exports...But Americans just borrow and consume.

Because consumption has grown so far out of proportion to production, capitalist America relies on the generosity of communist China. Americans don’t even realize how ridiculous and absurd this is. It’s so absurd I can’t believe it. I think this is the worst sign that I could imagine. It means that net investment is collapsing.

Consumption produces the least desirable kind of growth. And the simple thing to know is that it is unsustainable. It is unsustainable because real incomes are not growing. In America you're having a fiasco in employment and income growth. The average income of the American middle-class is declining in real terms. And they have debts and debts and debts and zero savings. They have no reserves.

US Consumer Spending: Manufacturing Disaster

In America, it is no secret, the manufacturing sector is shrinking. That's THE big problem. In every economy, the manufacturing sector has the biggest multiplier effect.

Manufacturing is a sector that uses all the intermediate goods. That's part of its multiplying effect. The growth of financial services is fine, but not when the manufacturing sector is disappearing at the same time...When you look at capital goods production in the United States, you can see what has collapsed is investment. And with the collapse of investment you have a collapse of employment in the manufacturing sector...

There are two kinds of assets; those that you produce, and those that you simply trade. In America today, you have an inflated service sector trading inflated assets. The assets that you trade do not produce any widespread wealth. They simply produce wealth for the individuals who trade them. The great failure in America is in investment, employment and income growth...and that is tied to manufacturing.

we're living in a world where Greenspan and his associates have told the world that all of America's massive imbalances do not matter. But for any economist who has a little something in his head, the structure of the American economy is one of the most alarming of all time. For a developed economy it is scandalous.

The American economists think this is perfectly acceptable. But I find it unbelievable. Like Ben Bernanke blaming the rest of the world for what he calls a “savings glut.” This is crazy. Why isn’t he, instead, urging Americans to save and to invest? Are the Fed governors really as stupid as they appear? Or are they deliberately stupid?

There are, of course, people in America, including many of my readers, who are old-fashioned, economically speaking. Paul Volcker, for example, who is an old friend of mine. But he held these basic economic concepts that I write about in his gut. All these things that I write about used to be in the gut of every economist.

The Americans I knew thirty years ago saved money. They didn’t save as much as the Europeans, but they held the same attitude, at least. The fundamentals were never questioned. No economist questioned the idea that a nation needs savings. They never questioned that investment is crucial for prosperity. It was never questioned that a developed country should have a surplus in its current account. This was never questioned! It was never a topic of discussion!

But all of a sudden, the Americans have rewritten economics...because it suits them...Saving money used to be instinctive in people, even without any economic theories. Classic economic theory is absent in America. It does not exist.

US Consumer Spending: More popular the Quaint

Anachronism of Saving.

We are at an inflection point in thinking...The big change begun in the 1980s. In the '80s, Americans continued to save, but it was the government that began to dis-save. And at the time, there was a lively debate among economists about the wisdom and benefits of deficit-spending by the government. There was a very lively debate about this topic. Today there is no debate. There is no longer any economic discussion. American economists are silent, deeply silent.

Do you know why they are quiet? Because academic America, like all of America, believes that consumer spending is the key to prosperity. The high esteem of consumer spending is implanted in every American, including its academics.

There are many who say that deficit spending by the government is bad. But they don't say that deficit spending by the consumer is equally bad, or worse. The American idea that everything good comes from consumer spending is preposterous. And that is the key fallacy in America today.

And so I wonder, is it possible that next year we will see the great denouement of the American economy?