America: Boom or Doom?
(Will We Always Prosper?)
Part III
By Dene McGriff
Introduction
America: Boom or Bust? Is the economy robust and growing as the administration and most analysts insist? They say the fundamentals are good – inflation is under control, economic growth is steady and unemployment is low! Doesn’t the government have it all under control? They say America is the capital manager of the world. It is so big and powerful that deficits and trade imbalances don’t matter. The world needs us. They need our dollars! They need our genius.
History is on the side of the experts. There has been no repeat of the Great Depression. America seems to be more prosperous than ever as our own modern day “Wizard of Oz”, the Chairman of the Federal Reserve sits at the complicated controls of the economy and tweaks the interest rates, reserve requirements and money supply.
Few understand how the economy works. We sit back and think and consume. We don’t make much anymore. Others work and make things for us and loan us money so we can buy the things they make. You don’t need a Ph.D. in economics to sense something may be wrong with this picture. How can you be wealthy by consuming alone? Few can cut through the technical jargon, spin and misleading and conflicting views. I’m going to try and lay it out for you in simple layman’s terms.
There are two basic schools of thought: classical economists of the Austrian School, insist that American can’t go in debt indefinitely. The piper (debt) has to be paid. The Keynsian economists say, “hogwash”! Economies can be managed and we have done it successfully. So which scenario is true? You can’t have it both ways. We need to look at the big picture in order to understand what is happening. It is mainly common sense. The most important thing is to not get lost in the detail.
You may have heard the story about the King who brought all of his learned scholars together and asked them to condense economics down to its essence in terms he could understand. In return, the king offered a great reward. The scholars went out and compiled all the great works of the day – from Adam Smith to Karl Marx to John Maynard Keynes, Greenspan and Bernanke to Lou Dobbs and Suzie Orman. So the scholars condensed economics to a single book which is quite a feat you must admit. The King couldn’t understand it so he sent them back to the drawing boards. The story goes on and on. “Way too complicated,” said the king! They broke it down to a chapter and the King still didn’t get it. He urged them to boil it down a little more or off with their heads! The great scholars thought they had done it in just one page. The great King still didn’t get it and sent them off to the guillotine. Finally, a young student passed the King a note with a single phrase on it – and I’m sure you know the rest of the story…It read, “There is no free lunch”. The King was delighted. He got it! That is the question facing 21st Century America. Can we continue to be the most prosperous nation in the world by doing little more than consume?
America In Decline? The Sky is Falling?
For
the past thirty or forty years, prophets of doom have been warning of an
impending economic crash and lost credibility because it just didn’t come
about. Years ago, they based their gloomy prediction on the growing national
debt which they said was unsustainable but since WWII, the national debt has
grown from $200 billion to nearly $8 trillion and the sky hasn’t fallen yet.
More recently they point to the trade and budget deficits and the resulting
bubbles which they claim are unsustainable. So why do things just keep
rocking along the upward path to ever greater prosperity?
Recently, Treasury Secretary John
Snow said on Good Morning America that the fundamentals of the economy are
good: employment, business profits, inflation, economic growth, etc.
President Bush touts the success of the economy in speeches across the
nation. Although some may argue with their rosy scenario, the fact of the
matter is that since the tech crash in 2001,
America seems to be recovering nicely and the
world has been on an unprecedented growth spurt. The naysayers predicting
gloom and doom appear to be wrong. What is going on? Is there no end in
sight to unprecedented growth, full employment and our house ATM machines?
Rather than look at all of the mini-trends, let’s look at the big picture. What is happening at the global level? We need to understand why the U.S. and the world seem to be experiencing such growth and prosperity. The real reasons will astound and alarm you. Contrary to what you have been led to believe, it isn’t that hard to understand and you will be amazed that your government, the Federal Reserve and others know exactly what they are doing. You can look at their reports. It’s all there in black and white in their own words! We are pawns in a high stakes game and although it appears that things are getting better and better, it is an illusion. In the first chapter, we discussed the government manipulation of statistics (Lies, Damned Lies and Statistics) and in the second we looked at the Federal Reserve and how fiat money is created (Modern Alchemy: the Money Illusion). In this chapter we are going to look at post war America and what has happened in the world economy since 1948.
Once
you understand what happened and why, you will understand why America is able
to thrive even with trillion dollar deficits - $700 billion trade deficits and
$300 billion budget deficits. You will understand why the stock market keeps
going up, why housing prices keep going up even with the Fed raising interest
rates. The graph shows the debt load as a percent of GDP of the United States
from 1915 to the present. We are currently way above the 1929 crash levels,
and yet the huge debt load doesn’t seem to matter! There is no depression,
not even a recession!
You will understand why the nations of the earth continue to support America. You will see why the Fed wants the dollar devalued. And finally, in the last chapter, you will see how it all will end for America and for you and your family.
History Repeats Itself
Governments never have enough money. Even the Roman Emperor Nero needed more money to expand the empire. How did he do it? He started cutting the coins. “Cutting” was a practice of adding cheap metals and decreasing the amount of gold and silver in coins. The Roman Government had an insatiable appetite for more money. The increase in the money supply nearly ruined the economy. This went on until near the end of the empire when the Roman coins ended up with only 2 percent precious metal! Rome also ran a huge trade deficit with the nations on the periphery of its empire as Rome consumed its life away. Sound familiar?
It is a well known fact of history that the gold bullion the Spanish brought to Spain ended up ruining their economy by expanding the money supply and leading to runaway inflation – an empire based on consumption rather than production. Sound familiar?
It may surprise many of you but by 1885, America was the world’s leading manufacturer, ahead of Britain and Germany and it maintained that lead for over a century. After WWI, the U.S. balance of trade with Europe was way out of quilter and put a strain on the gold standard. From 1914 to 1924, gold flowed in waves into the U.S. causing the boom of the roaring twenties. This allowed us to lend money to Germany and a boom that ended in hyperinflation, the complete ruin of the German mark, and the rise of Adolf Hitler.
This is what happened in 1929. The boom in America caused by this surplus allowed for a period of dizzying growth, the financing of speculative ventures that could not be repaid, the money supply collapsed and banks failed. After the Depression, policy makers and economists became convinced that rising interest rates and a decreasing money supply exacerbated the situation and led to the prolonging of the Depression and that in the future, the Fed should take steps to prevent this from happening by printing money and lowering interest rates. Historically, asset bubbles are caused by inflation of the money supply which ultimately leads to a bust.
By the end of WWII, America had again accumulated most of the world’s gold reserves. It was the great producer nation. In 1944, the Bretton Woods Conference established a system of fixed exchange rates designed to balance the uneven gold reserves in the world which was fixed at $35 an ounce. After the War there wasn’t enough money to support the economic recovery of Europe and Japan so there was a quasi-gold standard based on gold and the U.S. dollar. Originally, unlimited deficits were not to be allowed. The British economist, John Maynard Keynes, proposed that both deficit and surplus countries be fined until both countries took measures to balance their payments. His plan was rejected by the Americans.
The Growth in Money Supply
After
World War II, we see the beginnings of globalization.
America encouraged other countries to
manufacture goods that we would buy them. Rather than just give money away
through the Marshall Plan, America opened her markets to the world. By the
late 60’s and early 70’s our gold reserves began to dwindle as we bought more
and more goods from abroad. Economists felt that world growth was hindered by
the gold standard. In 1971, President Nixon suspended dollar convertibility
to gold to protect U.S. reserves. The Bretton Woods system ended and a system
of floating exchange rates emerged based on the U.S. dollar. From that time
forth, the dollar became the standard reserve currency for the entire world.
Since there was no mechanism to adjust for trade imbalances, America began to
think that maybe there is such a thing as a “free lunch” after all as dollars
began to pour back into the country. As we shall see, trade imbalances are
responsible for the tremendous disequilibrium we see in the world today. The
Chart above shows the growth in the U.S. money supply and the chart to the
left shows the growth of the trade deficit.
Global money supply, fueled by American dollars, does not begin to go off the chart until after 1971. The dollar standard stimulated growth world wide because the money supply can be increased without any constraints. The dollar standard has resulted in increased liquidity for growth but results in a huge disequilibrium between nations. It has also caused disruptions around the world: depressions, recessions, inflation and deflation. Notice in the chart above the correlation between the growth of money supply and our current account (trade) deficit. In other words, we printed dollars or created bonds – we inflated the supply in order to pay our debts
The Dollar Rules!
Gold was a discipline to Central Banks and governments. It prevented them from just printing money and overheating economies. It forced the trading nations to adjust for trade imbalances, and restore equilibrium. Huge budget and trade deficits would have been impossible under the gold standard or the Keynesian Bretton Woods system. So much gold would have left America that America would have been forced to reestablish a balance of trade or suffer a credit contraction and depression. With gold out of the way, governments were free to let deficits go uncontrolled. The nations of the world trade with the U.S. causing an increase in not only the American dollar but their own money supply as the charts above show.
The dollar standard worked. It led to unlimited capital creation, investment and growth. Under the gold standard, countries would have to devalue their currencies, export more and begin to accumulate more gold reserves. Now, they just create money as we discussed in the last chapter. But, there are problems with the dollar standard. First, the surplus countries suffer from too much money just as Spain did during the colonial era and America during the depression, and more recently Japan and other Asian countries (and China in the next few years). The surplus threatens the economic health of surplus countries by causing boom and bust cycles. Second, as we shall see, because the debt of the United States never needs to be settled, it just keeps growing. This is the flip side of the surplus countries. Neither position is sustainable. Eventually, balance must be restored but no one and I mean no one knows when that will happen. This has been going on now for over 30 years but continues to grow more and more every year. Lionel Robbins wrote in 1934 in his book titled The Great Depression, “It is agreed that to prevent the depression the only effective method is to prevent the boom.” We note that whether we are talking about America, Japan, Thailand or wherever, booms are ALWAYS followed by a bust. Today, booms are caused by flooding the world with dollars which causes overinvestment, excess production capacity which is followed by falling prices, business failures and deflation.
Oh Wonderful Inflation!
Today, Alan Greenspan and Ben Bernanke are convinced that the problem is the dollar is too valuable and they want to see it lose value. Is this good? I don’t think so. Inflation means devaluation or loss in value of the dollar.
“The United States counts on a steady devaluation of its money. It buys from overseas and pays in dollars. Then, in effect, it prints up more dollars to replace those it has shipped overseas. The resulting inflation of the currency –reflected in the increase in prices of oil, gold and other internationally traded goods-is a form of imperial tribute. It is America’s only way of making the empire pay. As the dollar goes down, the trillions of dollars held in foreign accounts become less valuable.” (Empire of Debt by Bill Bonner and Addison Wiggin, 2006, p.37)
People don’t understand what inflation is. Most people think that inflation is an increase in the prices of goods, but in fact, it is the increase in the amount of currency and decrease in value. It is the greatest hidden tax we all pay and the government wants to keep it up. Is a house built in the 50’s that sold for $5,000 worth a half million today – a thousand percent increase? Is the roof any better, the plumbing, or electrical any better? Is the 25 cent haircut when I was a kid any better than the $25 haircut today? No, the only difference is the currency is worth less.
The government tells us that inflation is low so they take out food and fuel, count housing as rent and play a bunch of other games to understate it. As we covered in the first part of this series, Lies, Damned Lies and Statistics, the inflation figures given by the government are grossly understated. A quick trip to the grocery store to buy bananas on sale for 99 cents a pound when we used to get them for 29 cents a pound two years ago, knows what inflation is. The new Federal Reserve Chairman Bernanke has declared that he wants to program 2 to 3 percent into the economy – a sure formula for disaster! But inflation is a wonderful thing to the average brain dead American who sees his house increasing at double digits every year, often surpassing his salary!
“The problem goes back to the Fed and its ill-advised monetary policies. Driving down interest rates has, more than anything else, caused the shift in jobs. We want to buy from foreign countries and we’re content to do so with debt, especially as long as interest rates are low. Unfortunately, this has created real inflation throughout our economy, at least on the cost side. But on the wage side, we’ve seen no growth at all. And eventually, this disparity is going to backfire on the Fed and on the American Consumer.” (The Demise of the Dollar by Addison Wiggin, 2005, p. 167)
Eventually, inflation causes the dollar to fall and interest rates to rise which tightens consumer and business credit, ends home equity loans, reduces purchasing power and makes the U.S. more vulnerable to Asian debt holders. The economy slows down, consumption is curtailed and workers are laid off.
Globalization
is one reason inflation is low. It’s not that we are so efficient but other
countries are cheap producers. Take China for example. There is tremendous
downward pressure on the price of manufactured goods. They have ultra low
wages, ultra low costs and even subsidized industries. Another aspect of
globalization are the billions of dollars (about 2 billion a day) that come
back into the economy to keep it pumped up so we can buy more foreign goods.
Foreign money came into bonds which kept interest rates low so people could
continue to extract equity from their houses at low rates. Why does inflation
seem to be controlled? Two reasons: dishonest governmental reporting and ever
cheaper imports from China and other countries.
But what does inflation mean to us? It means we earn less in real dollar terms – just as we have since 1970. It means that if you are “baby boomer” and living on a fixed income, pretty soon that retirement may cover either your food, housing or medical expense – take your pick. You get only one choice! If you don’t have a house already, you may never afford one. If you are just starting out, you will never see the standard of living you grew up with. Unless you are part of the lucky elites, you and your husband will have to hold down multiple jobs just to survive.
Japan’s Experience
Let’s talk about Japan for a moment, the world’s second largest economy thanks to the U.S. opening their markets to them after the war. Between 1971 and 1985, Japan began to accumulate dollar reserves and asset bubbles began to grow as new currency was pumped into the economy. Their stock market rose 500 percent and then went up another 500 percent in the next ten years. Their stock market hit all time highs by 1989 a high of 38,915 on the Nikkei. Property values grew incredibly fast in the late 80’s and early 90’s until the Japanese royal palace grounds were worth the value of all land in Canada. The commercial land tripled in value from 1986 to 1990. Families were making more on their stock portfolios and home appreciation than they were from their jobs. Sound familiar? In 1989, after black Monday and a 30 percent one day drop in the American stock market, imports from Japan began to drop off and their bubbles began to burst. Over the next ten years, even with a few rallies, the Nikkei continued to fall, eventually losing almost 70 percent of its value. Money shifted to real estate which continued up for a few years just as it h as in the U.S.
The Central Bank of Japan tried to correct by raising discount rates initially to six percent but by 1995 it was down to .05 percent, eventually falling to zero. With free money, consumer debt skyrocketed to 130 percent of income. Domestic credit eventually grew to 270 percent of GDP. Consumer credit companies increased lending by 700 percent from 1985 to 1990. The illusion of wealth was fueled by huge increases in real estate fueled by free money, 100 year multi-generational loans. The bubble popped and values dropped by 80 percent! For those who say it can’t happen here, they should note that it happened in Japan – a surplus trading partner, as well as other Asian countries. Even Argentina saw a 90 percent drop in real estate values. There is, however, a very good reason why the bubble hasn’t burst in the United States and it is critical to understand why because it is an example of the problem we are describing. We will come back to this in a moment.
Too much money and too much debt are twin evils. Too much money is just as dangerous since it creates credit bubbles that lead to more and more investment in production capacity. As supply increases, price falls and businesses fail. A surge in money supply and credit helps in the short run by increased capital investment, share prices and property values. Asset prices increase and there is a positive wealth effect that spurs even more investment and production. The cycle then goes to over production, falling prices and bankruptcy.
So we should be careful if we think that the short term gains we have had since 2001 will last. Besides, we are on the debt side of the equation (in contrast to say the Chinese). We are living on money loaned to us by others. There is a time when it looks like jobs are being created, production is growing and things are getting better and better… but we must be careful. Remember what Lionel Robbins said in 1934. The only way to avoid the bust is to not have the boom to begin with. In our case, the next bust will not be because we have a huge trade surplus as we did in 1929, but because we are the greatest debtor nation the world has ever seen.
Every law of human behavior, physics, economics or any other discipline tells us that any trend will eventually regress to the mean. When? We don’t know. But we do know that the longer it drags out, the more difficult the adjustment will be. Adjust it will.
The Federal Reserve and Inflation
What happened in Japan is the Fed’s worst fear
– deflation which is just another term for another more severe term called
“depression”. Remember in the last chapter when we talked about the fact that
“debt” is what is used to create money? American 
debt
is bought up in many ways by foreign governments, foreign central banks and
foreign investors. All of this debt, helps create fresh new money in their
own countries (causing the dislocations we talked about above) and in the
U.S. We are swimming in dollars and we will look at money supply at the world
and national levels in a moment. At any rate, this debt results in money
creation both here and abroad. Now, if you double the supply of money, what
happens to its value? It goes down.
The chart shows the growth of the money supply in 2001. This is a time when the Bush Administration reversed the Clinton surplus, cut taxes resulting in a 700 million dollar deficit. The chart to the right shows the growth in M2 money supply which includes cash and short term assets from June 2004 to the present.
Our part in this economic charade is that we
continue to borrow and buy. We max out our credit cards, refinance our houses
thanks to the benevolence of Greenspan and Asia to make money available on the
cheap. Month after month, we spend more than we earn and we keep up the game
as if there were no end. We look at the house that cost only $5,000 when it
was new in 1950’s selling 
today
for half a million and are so glad for our neighbor’s fortune. We somehow
don’t get it. The house isn’t really worth any more in real terms than it was
fifty years ago. Our dollar is worth that much less! Were it not for
Greenspan’s cheap money (below the inflation rate the past 55 years), we
wouldn’t have been lured into giving up our savings and home equity. Were it
not for all those inexpensive products from
China,
we may not have bought so much. And the price we pay? Jobs lost forever.
Production lost forever. And debt that will haunt us forever! A trade
deficit reflects an excess of domestic spending over domestic production. The
chart to the left shows the relationship between the trade deficit and the
dollar.
Inflation is caused by increasing money supply. Higher prices are just a symptom of debasing the currency. If you look at why prices go up, it isn’t because of greed, foreign competition, taxes or inefficiency. It is the loss of purchasing power and the need for more dollars to purchase the same thing – whether housing, fuel or food. Behind everything is fiat money and the fact that the government can’t stop the Fed from creating more and more money – inflating not only our economy but the entire world’s. Fiat money is just too tempting for governments to not use it as a political tool.
There is some question how much control the Federal Reserve has over the economy these days. The flows of capital from creditor nations is so great the central bank can no longer control interest rates. There is so much credit available from credit and debit cards, and house refinancing, the Fed controls no longer have the effect they once had.
This is not a pretty picture – falling income, and increased spending. This year alone, $600 billion in equity was extracted from home equity to spend on more things! But the chart to the right tells the picture. Inflation is the most insidious hidden tax of all. As the purchasing power of the dollar goes, income never keeps up. Thirty years ago, a house cost 1/20th of what it costs today and a car about 1/10th. During the same period wages certainly did not increase ten or twenty fold!
Stephen Roach, chief economist at Morgan Stanley said recently,
“During the Greenspan era, the
U.S. economy pushed the envelope in sustaining
an increasingly dangerous strain of unbalanced growth. In doing so, it
experienced an equity bubble, a housing bubble, a record current account
deficit and a monstrous overhang of household debt. The U.S. has gotten away
with these imbalances because of the "kindness of strangers" — the willingness
of foreigners to keep investing in dollar-based assets.
But the confidence that underpins foreign funding of the U.S. is a very
fragile commodity. Fed transition time usually unmasks that fragility. Like
the chairmen who preceded him, Bernanke could quickly find himself dealing
with a confidence crisis. And suddenly, the inflation targeter will be staring
at a far more intractable set of problems than his research and training
prepared him for.
History warns us to expect the unexpected when the nation's second-toughest
job changes hands.”
The Great Debtor Nation
America has become the greatest debtor nation
in the history of the world. Currently it is running a trade deficit of
nearly $800 billion a year, 7% of the GDP. This is unheard of in history.
The Chart to the left shows the U.S. 
trade
deficit. In 2005, the numbers are even larger, especially with the increase in
the price of crude oil.
Now let’s see where the money comes from. It comes from countries that may or may not be our “friends” – from Muslim countries, China, Russia, etc.
Now where does the money go? Foreigners are
purchasing American assets – everything from Sony Pictures, to Greyhound Bus
Lines to land, farms and oil. But even more significant is the fact that they
are buying Treasury notes and bonds as we see in the figure below. This is
merely paper held by foreigners. As long as they have confidence in the
dollar,
no problem. We get to recycle, use and spend it. But like the loan shark who
keeps extending more and more credit, the creditor nations may one day lose
confidence in our ability to repay the loan. If
China or Japan were to suddenly stop buying
dollars, we would be in trouble. In fact, they are beginning to diversify
into other currencies. They have a big incentive to keep buying dollars so we
will buy their goods. But can this go on indefinitely? We already absorb
over 80 percent of the world’s savings. So far, the dollar is indispensable
to world trade. Oil is traded in dollars. Other accounts are settled in
dollars but there is a push to switch to the Euro or an oil/gold based Middle
Eastern currency. The dollar may be king today, but there are those who would
knock it off its lofty throne.
Budget Deficits
Five successive years of tax cuts by the Bush administration along with the wars in Afghanistan and Iraq, disasters around the world and at home have led to huge Government deficits. The $8 trillion is what they always want us to focus on, but the unfunded deficits of Social Security, Medicare, Medicaid, are much larger. The total debt amounts to about $40 trillion, nearly four times our GDP! The government has been taking that money and spending it without accounting for the losses. Some argue that at least the money is spent, but government spending produces nothing and generates no revenues adding nothing to the economy. Calloused old politicians, academics and salesmen/analysts of the new world order would ignore these deficits and say they don’t matter but it all adds up. The fact that we understate the problem and fail to face the facts, does not bode well for those about to retire or the next generation who will support them.
Most private pension plans are in deep trouble. Our infrastructure is falling apart. Once proud California now has the worst roads, the worst schools and the worst debt of any state in the country. Once the economy begins to crumble, the burden on federal, state and local government will become unbearable.
Globalization
Let’s talk about globalization for a moment. We all recognize that we are in a global market. Our huge trade deficits do two things: they allow foreigners to buy U.S. assets and they allow money to be circulated back into the country by purchasing bonds.
But globalization has another face and that is the permanent loss of key manufacturing and other productive jobs to other countries. The chart to below shows the loss of jobs since the recession of 2001.
The loss of air transportation, computer,
telecommunications, wholesaling and manufacturing jobs, especially represent
basic productive capacity that is gone from America forever!! 
The current account (trade) deficit is very serious no matter what you may hear the experts say. It will ultimately destroy the dollar and our spending power. Other countries such as Mexico, Argentina, Brazil and many other countries have seen their currencies destroyed by far less – a 2 to 3 percent deficit instead of the nearly 8 percent which we currently have. When administrative officials or pundits point to the strength and resilience of the American economy, they are only partly correct. No country in the history of the world has ever survived such deficits unscathed. But one fact economists and analysts like to ignore is that these deficits will adjust eventually. America is being sold off right from underneath us and we don’t even realize it. The difference between debt, say during World War II and now is that then 90 percent of the debt was owned by Americans. Today, half of it is owned by foreigners. We have gone from the largest producer and creditor in the world to the largest consumer and debtor nation. You tell me, can that continue forever?
In our distorted view of the world, we see the fact that everyone invests in dollars as a sign of our superiority and the inflation in housing and stock prices as the creation of true wealth. At one time the dollar was strong and to be desired. For a hundred years, America led the world as the most productive country in the world, but we have become a victim of our own conceit, thinking that our borrowing and consumption represents real wealth. The day of reckoning will be the day when the nations discover our dirty little game and stop playing it. They stop buying our dollars and our bonds and giving us their savings so we can in turn buy more of their products. Right now, America consumes most of the world’s savings – another sustainable trend for decades to come???
The perverse nature of it all is that the $4 trillion in trade deficits flooded the world with dollars became the reserves that the world needed to carry out their own economic development. As you may remember from the last article, the Money Illusion, fractional banking makes money out of debt, thus the massive increase in global money supply.
The Great Consumer Nation
Government figures tell us that the economy is growing at 4.5 percent, but is it real or has it occurred simply because consumers replaced lost income with home equity borrowing? An economy based on consumption rather than production is not very sound. Income-driven spending slumped while borrowing fueled bubble-driven spending. Credit-financed spending made business money, but is it really real and sustainable? What happens when we can borrow no more? We are not consuming based on our income, but debt. Month after month we have less than zero savings and spend more than we earn. How many more years can this continue? Indefinitely?
During the WTO demonstrations in Seattle, a reporter was interviewing a woman and asked about the job situation. The woman said, “Sure there are plenty of jobs up here. I have three and my husband has two jobs.” Go back to the chart above and look at the kind of service, house keeping, temp jobs, etc. that are being created. In California, a third of the jobs created recently are related to the boom in the housing industry (construction, mortgage banking, real estate, etc). What will happen to them as the air goes out of the bubble? November 2005 alone saw the biggest decrease in new home purchases in California in eleven years.
There is a big difference between wealth “created” through savings and investment and wealth gained from asset or credit bubbles – from borrowing in the case of our houses. In recent years, asset bubbles in the forms of stocks, bonds and housing were the source of economic growth. The Federal Reserve cushioned the bursting of the stock market bubble by lowering interest rates creating the housing bubble. That shouldn’t detract from the fact that $7 trillion in people’s money disappeared permanently in the stock market!
Excessive credit expansion has led to excess manufacturing capacity in the U.S. and abroad, especially China and China is in the American position in 1929. This is the anatomy of a cycle:
“Initially, as the global money supply expanded on the back of surging dollar liquidity, a great deal of profits were generated and deposited into the banks around the world. Those deposits enabled banks to extend new loans that further stimulated the economic expansion. This expansionary cycle continued until asset price bubbles formed and excessive industrial capacity came into existence. At that point, a large portion of the loans that had fueled the boom could not be repaid, and a large portion of the deposits were lost.” (The Dollar Crisis by Richard Duncan, 2005, p. 167)
This is what happened to America in 1929, to Japan in 1990 and to China very soon. China is another story – an economic miracle yes, but flawed by government intervention and banking problems. Excess liquidity (too much money) leads to excess production which can only be balanced by retraction or bankruptcy, recession or depression. On the other side, excess credit leads to mountains of debt and a disequilibrium that can’t continue indefinitely. The United States continues to set records month after month, but this can’t go on forever.
“If the U.S. economy has been the engine of economic growth in the world in recent years, it has been because the American consumer has been in the driving seat…and speeding.
The household sector’s credit market debt amounted to US$7.9 trillion at the end of the second quarter of 2002, making it the second-heaviest borrower in the credit markets after the financial sector. As a percentage of the GDP, this sector’s debt (i.e. the individual consumer) has risen rapidly to 77% from 50% in 1980, enabling the American consumer to fuel the global economy.”
Record low interest rates and wildly aggressive lending practices by creditors have allowed households to continue increasing their debt and their consumption. However, the deflation of the New Paradigm economic bubble has caused unemployment to rise, while knocking down the rate of increase in personal income to the lowest level in more than a generation. (Richard Duncan, The Dollar Crisis, pg 111)
As 2005 comes to an end, we are about to see a collapse in consumer spending. The property bubble has begun to deflate. Interest rates are rising, and we are just beginning to see the infamous “inverted yield curve” where short term bond rates (2 year) are higher than long term (10 year) – always a sign of recession in the past. During the last major recession/correction in 1987, the trade deficit peaked at 3.4% of GDP and the DOW fell 23% in one day. Now deficits are over 7% and housing is still near the peak and the Dow just short of four year highs but all are poised for a fall.
Ben Bernanke plans to fire up the printing presses and drop money from helicopters if necessary as he once quipped. Japan tried that, along with lowering interest rates, massive government spending and could not prevent a 14 year slide – a loss of 80 percent of their value in stocks and real estate. The Federal Reserve has already been increasing the money supply at record rates. History should tell us that this doesn’t work long run but we don’t seem to learn.
The Housing Bubble
I have Google flag articles on the housing bubble every day. It is interesting that about nine out of ten say that no bubble exists. The blindness of the American public is incredible, even the so-called experts are in denial. One would have to be blind to not recognize the importance of a prime rate of one percent and real estate loans as low as four to five percent in driving up the price of real estate.
As a real estate broker, it is obvious that if
interest rates go down, prices go down and vice versa. Is a market tenable
where only 15 percent of the potential buyers can afford to buy an average
home? The Center for Economic and Policy Research warned in July that "The
collapse of the housing bubble will throw the economy into a recession, and
quite likely a severe recession." Lehman Brothers said the effects of a fall
would be severe since a third of the past years growth was due to 
the
housing boom.
The fact is that nearly half of the recent buyers were either “sub-prime” (bottom of the barrel borrowers who have no business getting an adjustable rate mortgage or zero interest mortgage) or speculators flipping, speculating, renting or buying second homes. Inventory has risen in Sacramento by 500 percent. Nationwide, inventory is at 19 year highs.
The run up in mortgage values created 5 trillion dollars in “wealth”, much of which was spent while the rest could evaporate quickly. In states like California about a quarter of the economic growth has been in the housing related industry. Once interest rates increase and foreclosures begin, who knows what the effect will be on the mortgage, S&L, and secondary markets of Fannie Mae and Freddie Mac. The most revealing chart is the one below that shows the growth of the GDP the past ten years with and without mortgage equity. This proves conclusively that our so-called economic growth did not come from productivity but from taking equity out of our homes and spend it!
Once
rates rise, lending tightens and the “house” ATM is shut down. Spending
cools. The chart above graphically shows the increases in home equity loans.
The one to the left shows the GDP Growth with and without mortgage equity.
Since our economy is seventy percent consumer driven, where will the money come from once the housing well runs dry? This isn’t to mention the fact that people with adjustable rate mortgages could see their payments increase by 20 or 30 percent.
The fall out in lost jobs, lost spending; lost consumption, not to mention foreclosures will ripple through the economy for years to come. According to the Contrary Investor, homeowner equity is at the lowest point since 1945 and mortgage debt as a percentage of GDP is also at the highest since 1945 too. And those who bought houses they can’t afford with adjustable rate and zero down, interest only mortgages have no cushion. The Center for Economic and Policy Research predicts the bursting bubble will cost from 5 to 6.3 million jobs and end in a Federal bailout of the mortgage market. (Ellen Simon, Associated Press, 11/14/05)
The War/Disaster Factor
War historically has always been a huge driver of American debt. Today we have the endless War on Terror with major theaters in Iraq and Afghanistan and possible conflicts coming up in Iran and Syria. Not only does America account for half the military spending in the entire world, most of it is debt. I’m not going to go into a lot of detail here since it was covered in another chapter on the American Military. At the dawn of the 20th Century, Teddy Roosevelt began to flex American power around the world. Wilson entered WWI for no real national interest other than to “save the world for democracy.” Since 1945, the U.S. has engaged in 111 military actions around the world. Today, we divide the world into four major regions and have bases in 120 countries. We have shown a willingness and ability to project power wherever we desire, no matter what the cost. Who know the true cost of the American empire?
At to the wars, the tsunami in Indonesia and Sri Lanka, earthquakes in Pakistan and hurricanes in the gulf, including the flooding of New Orleans, and you have hundreds of billions of additional dollars being spent for relief and development. How much money is there to go around to meet all these needs as well as wage war against our faceless enemies?
Oil & Other Commodities
I only mention oil because of its affect on the economy. The rising prices are certainly a concern about inflation and rising costs for everything that requires transportation. The major factor is rising world demand and the inability to refine the product. We are just about as close as you can get to 100 percent capacity here in the states. Refineries are aging and damaged by hurricanes. A refinery hasn’t been built in the last 30 years in America. Worldwide, there is no excess capacity and demand in China, India and other developing countries is increasing rapidly. This will keep upward pressure on the price of all petroleum products.
I mention other commodities because we see increased demand for all commodities – steel, copper, silver, tungsten, etc. as well as food, oil, natural gas and other natural resources by China, India and other developing nations. The increased demand and limited supply will lead to tremendous price pressure which is bound to impact the United States in the coming year.
Concluding Comments
What surprises me is that most people are in denial – from policy makers, the so-called expert economists and market makers to the average American. Most live under the delusion that we are the richest and most powerful country the world has ever known and that we will always remain so. The first statement is absolutely true, but the second is very questionable.
The fact of the matter is the government, the Federal Reserve and even other nations know exactly what they are doing. They are playing the charade, keeping the dollar artfully and artificially propped up, protecting themselves from the inevitable bust. Why do they know? Because they created it. The data in the charts in this article comes from the government and the Federal Reserve! They know exactly what is going on, but want to keep it going as long as possible. It is in everyone’s best interest – America and the world to keep the status quo. That is why we haven’t seen a crash. We know it will – maybe next year, maybe later… but it will happen. The gloom and doomers understand what is happening but are amazed at the ability of the powers that be to keep America propped up.
We are talking about trends that have been building for the past 35 years – not something that just happened over night. The problem isn’t the real estate bubble. The problem is the whole global financial system and its dependency on the dollar and the continued growth in currency, debt and credit. The problem is with central banking and the lack of discipline in the monetary system. We may not see the sky falling this year, but the end is coming. We just don’t know when but we do know it will greatly affect the average American so stay tuned for the next chapter. The economy could just trend down for the next 15 years as Japan’s has or there could be a precipitating event such as another war, a major terrorist event that could, a natural crisis such as an earthquake or hurricane, oil shortages, etc. which would cause a sudden crash. We just don’t know.
Much more could be said on the subject. Some of the books quoted here do a far better job than I do in laying out the case and they are all essentially in complete agreement on the facts which we will summarize here:
· Inflation destroys the value of currency. In fact, no fiat (paper) currency has ever failed to eventually arrive at its true value – zero, as mere paper.
· The dollar has fueled the world’s money supply which is growing geometrically and will eventually lead to the ruin of nearly all world currency.
· No nation, no matter how strong can support the tremendous double debt load (government and trade deficits) of a trillion dollars a year (compared to an $11 trillion economy) year after year.
· The nations of the world, especially Asian are supporting the dollar by continually buying dollars, bonds and assets to the tune of $2 billion a day or nearly $700 billion a year. This will go on as long as they feel confident in America and the dollar.
· The idea that a country can consume rather than produce is not sustainable. The very thing that made America great to begin with is what we have lost.
· The idea that an individual, company or nation can go into debt without an accounting just doesn’t happen.
· In statistics and in life, probabilities will eventually adjust to the mean. In time, there will be an equalization of wealth.
· The exploding global money supply will lead to the worst financial crisis ever experienced in the world and set us up for “solutions” we may not want.
In the concluding chapter we will examine what I call “the prophetic imperative”. Probably the most amazing thing is that America is still the largest economy in the world and the only military super power. The fact that America is still the standard for world trade and the dollar rules is most incredible. Will America decline while others take her place? Is her day in the sun over? Her empire in decline? Or is something else going on? The answer may surprise you.
We will also see what this means to us Americans. You will see the two Americas and the fate that awaits each. So, what do we have? Boom or doom? The answer is a bunch of both…