The Daily Reckoning PRESENTS: All asset bubbles and bubble
economies have their highly visible and also compelling
trademark in exploding credit.
HOW TO IDENTIFY A BUBBLE
by Kurt Richebächer
In the old days, central bankers were always mindful of the
necessary balance between available domestic savings and
credit expansion. For them an early indicator of a
developing imbalance between the two aggregates was a
deteriorating trade balance, responding typically long
before prices.
It is, as a matter of fact, the central axiom of the
Austrian school of economics that the movements in the
price level can be a misleading guide to monetary policy.
What crucially matters is the inflation of credit, exerting
a much deeper and fundamental influence on the whole
economy through distortions and dislocations in its whole
demand and output structure.
From a policy perspective, to stress the key point, the
decisive evil thing is the credit expansion that exceeds
available domestic savings. That is the regular, cardinal
culprit behind all dangerous economic and financial
imbalances, and also behind all inflations. What the
Greenspan Federal Reserve refuses to accept is that their
beloved wealth-creation reflects incredibly dangerous
inflation in the asset markets.
Putting it differently, in a balanced economy, credit
expansion is fully matched by available domestic savings.
This used to belong to the elementary knowledge of
economists. Mr. Greenspan shocked us with his public remark
that an asset bubble can only be recognized after it has
burst. Outrageous credit inflation was the infallible and
most spectacular hallmark of America's equity bubble in the
late 1990s. But instead of feeding into the price indexes
of goods and services, which continued to fall, it fed into
soaring imports and soaring stock prices.
To repeat: All asset bubbles and bubble economies have
their highly visible and also compelling trademark in
exploding credit. The distinction between the two is
important. An asset bubble simply reflects a rise in asset
prices out of proportion to underlying yields. A bubble
economy is an economy where soaring asset prices fuel a
borrowing/spending binge that may be concentrated in real
estate, business fixed investment or consumption.
At year's end, during the discussion about the U.S.
economy, it has been repeatedly mentioned that interest
rates are at their lowest in 45 years. It made us curious
about differences in the underlying conditions in the two
periods.
Comparing the two eras was a most interesting exercise.
The common feature between them is low inflation rates. But
in every other respect, the comparison reveals radically
different economic and financial universes, and also
radically different causes for the record-low rates.
In 1959, the private sector's total net savings amounted to
$44 billion, of which personal saving accounted for $26.5
billion and business saving (undistributed profits) for
$17.5 billion. With the government sector in surplus by $21
billion, the three components added up to net national
savings of $61.1 billion, or 12% of GDP.
Imagine: In 1959, the business saving rate net of
depreciation - undistributed profits, in other words - was
3.4% of GDP. Compared to today's GDP, that would amount to
undistributed profits of around well over $350 billion.
And today? The reality during the third quarter in the case
of the nonfinancial sector was $49 billion in the negative.
American businesses are dissaving, and so, of course, is
the government sector with the soaring federal deficits.
According to National Income and Product Accounts
statistics, private households are running a savings
surplus, but looking at the rampant housing and mortgage
refinancing bubble and considering that saving represents
in essence unspent income, we wonder how that surplus comes
about.
All in all, it seems a fair guess that today's America has
gotten rid of any savings.
If the difference in savings between the two periods is
ludicrous, the difference between credit growth defies
description. In 1959, total net borrowing in the United
States increased by $56.8 billion, perfectly in line with
available net national savings of $61.1 billion. For
perspective, nominal GDP increased by $39.5 billion to
$507.4 billion.
Now to the credit horrors of the present. Keep in mind: Net
national savings are at best close to zero, if not
negative. Nonfinancial borrowings ballooned in 2002 by
$1,374.6 billion, of which $771.8 billion was on account of
the consumer. For perspective, this was about seven times
the simultaneous GDP growth of $364 billion.
We have drawn this comparison between the two periods not
just by impulse. We think it is most important to realize
the incredible difference that exists between today's
financial conditions in the United States and those of the
past.
In the late 1950s, America's record-low interest rates were
clearly and soundly founded in high domestic savings and
moderate credit growth. Today's record-low interest rates
are just as clearly founded in unprecedented monetary
looseness accommodating unprecedented financial leverage.
The relevant issue, however, is not the bubble as such, but
what happens in its wake to the real economy and the
financial system. In general, policymakers have become
fearful of asset bubbles.
America is the only country in the world where asset
bubbles have become the panacea of monetary policy.
Regards,
Kurt Richebächer,
for the Daily Reckoning
P.S. A few days after the release of the much vaunted 3rd
quarter GDP data, Treasury Secretary John Snow gave an
enthusiastic address to the Economic Club in Washington. He
said, "It seems clear that we have entered a new phase of
economic expansion... This is not a fleeting glimmer - there
is real muscle behind the growth trend."
The fact is that multiple one-off stimuli were converging
on the U.S. economy - the housing bubble, the mortgage
refinancing bubble, tax cuts, auto sales promotions and the
rallying stock market.
The main drivers, measured in real terms, were personal
consumption, business investment in computers, residential
building and purchases of autos both by consumers and
businesses.
But on closer look, the GDP growth in the third quarter had
one overwhelming source, and that was consumer spending on
two counts: consumption and homebuilding, accounting
together for 76.3% of the recorded overall GDP growth.
Editor's note: Dr. Kurt Richebächer's articles appear
regularly in The Wall Street Journal, the U.S. edition of
The Fleet Street Letter and other respected financial
publications. France's Le Figaro magazine did a feature
story on him as "the man who predicted the Asian crisis."
Dr. Richebächer is currently doing quite well in showing
readers of his letter how to profit from Greenspan's
mistakes.