The Daily Reckoning PRESENTS: From time immemorial, busted bubbles have wreaked havoc on the economy which gave rise to them. The U.S.' current malaise, suggests Kurt Richebächer, traces its roots as far back as 1970s - when corporations first started undergoing the "profit carnage" so prevalent in late, degenerate capitalism.
A CRITICAL JUNCTURE
By Kurt Richebächer
March 3, 2003
Economic downturns are generally caused by monetary
tightening responding to rising inflation rates. Clearly,
this has not been true for the U.S. economy's present
slowdown. Instead, the current slump happened against the backdrop of runaway money and credit growth and plunging interest rates.
This economic downturn had very different causes. The
single most striking cause was the profit carnage, which
acted as a savage depressant on business fixed investment.
It is now fully two years since the U.S. economy went into
recession. And for the first time ever, business fixed
investment - the key to economic growth - has continued to
decline through the recession, with the growth of net fixed
investment at an historic low.
The mainstream explains today's persistent investment
drought is generally explained by referring to low demand
and existing idle capacities in business inventories. But
its obvious, original cause was the profit carnage that
started in 1997, at the height of the U.S. economy's boom.
This apparent explanation, however, only raises a
subsequent question: what has been ravaging profits?
America's profit malaise is nothing new; it started in the
late 1970s. Until then, profits of non-financial
corporations had fluctuated around 8% of GDP. A steep
plunge in the following years slashed it to half that
level. From then on, there were only feeble recoveries. In
hindsight, the 1980s clearly emerge as the critical
juncture in the development of the U.S. post-war economy.
But what explains that sudden, drastic rupture in the
profit performance? The fact is that the U.S. economy
experienced a variety of changes to its structure in the
1980s that significantly altered its whole growth pattern,
some of which were highly detrimental to business profits.
The most striking and hotly disputed novelty in the U.S.
economy's new pattern of growth was, of course, the surging
trade deficit. It started in 1982 at $11.4 billion, after a
surplus of $5 billion in the prior year, and peaked in 1987
at $167.4 billion, equal to 3.5% of GDP.
Just as striking and also hotly disputed was the equally
soaring federal budget deficit. After a steep jump in 1982 to
$161.3 billion, from $85.5 billion the year before, it peaked
in 1985 at $225.7 billion, equal to 5.3% of GDP.
While the twin deficits almost monopolized the public
attention, rather dramatic changes occurred simultaneously
in the financial behavior of both the consumer and
businesses. Both suddenly discovered the joys of
unrestrained borrowing. Over the three post-war decades
until 1980, the consumer ran up an overall indebtedness of
$1,404 billion. He boosted that in the following 10 years
by 158% to $3,624 billion. Business debts soared over the
same time almost in lockstep by 153% from $1,474 billion to
$3,735 billion.
The consumer's new borrowing binge essentially had two
important macroeconomic effects. In the late 1980s,
consumption had accounted for 70% of GDP growth, a record
high that compared with a share of 63% in the late 1970s.
Its flip side was a decline in the consumer savings rate
over the decade, from 10% to 7.5% of disposable income. But
given the bursting budget deficit, the net national savings
rate - domestic funds and resources available for net new
investment - dropped to an unprecedented low of a little
over 2%, less than one-third of its historical average of
7.5%.
In the case of businesses, the new proclivity to reckless
borrowing went together with a drastic change in the use of
the proceeds of borrowing. Businesses borrowed increasingly
for financial transactions - including mergers,
acquisitions, leveraged buyouts and stock repurchases - and
decreasingly for growth through investment in new plant and
equipment. As net new investment of the nonfinancial
corporate sector progressively lagged GDP growth, the
economy's capital stock fell sharply as a percent of GDP.
Nonfinancial profits increased between 1981 (a recession
year) and 1991 by 37.6%, from $159.6 billion to $219.6
billion. Measured as a share of GDP, they declined from
5.1% to 3.7%. It was a profitless expansion.
In hindsight, the U.S. economy in the 1980s already had the
key features of a bubble economy, though at a much more
modest scale than in the late 1990s. While profit margins
fell, stock prices on average more than trebled. Yet
American economists preferred to focus their attention on
the "productivity miracle" and other fictitious
explanations for America's boom-time economy.
It has always utterly amazed us how anybody with some
knowledge about the essence of economic prosperity could
ever have hailed this pronounced shift in American
corporate strategies away from investment in tangible
assets towards investment and speculation in financial
assets as an expression of superior, new corporate
governance.
Regards,
Kurt Richebächer
for The Daily Reckoning
P.S. Cynically, one might say that the changes of the 1980s
reflected a managerial revolution. They did, of course, but
the changes were all of the worst possible kind from the
perspective of long-term growth.
Editor's Note: Dr. Kurt Richebächer's articles appear
regularly in The Wall Street Journal, Barron's, the U.S.
edition of The Fleet Street Letter and other respected
financial publications. France's Le Figaro magazine has also
done a feature story on him as 'the man who predicted the
Asian crisis.' Dr. Richebächer is currently advising
investors on how to profit from Greenspan's mistakes