The Daily Reckoning PRESENTS: Wealth creation used to be a
factor of sweat, blisters, and clock-time. Not in
Greenspan's new world order... to get rich nowadays, you
simply have to use your credit card and refinance your
house occasionally.
The Daily Reckoning
London, England
Tuesday, 25 May 2004
A GROTESQUE MISNOMER
by Dr. Kurt Richebächer
Economic growth now depends crucially on the strength of
wealth and profit creation. Mr. Greenspan and the bullish
consensus economists claim that America is enjoying its
highest rate of wealth creation in history - through rising
asset prices.
Fed members are claiming that this is a perfectly normal
transmission mechanism of monetary policy. This is an
outright lie. Never before have inflating asset prices been
a key driver of real economic activity.
To be sure, asset prices have always risen in the early
stages of a cyclical economic recovery in response to
monetary easing. But such increases do little or nothing to
boost economic growth.
First of all, in past recoveries, price rises were
generally very limited in size, particularly for housing;
and secondly, there was no way to convert the asset
inflation into cash, because the reckless lenders of today
did not exist. Besides, Americans of the 1960 - 1970s would
have been too proud to practice inflated-asset liquidation
and too intelligent to mistake it for wealth creation.
There is no precedent for such profligate behavior of
private households.
Worst of all, asset-price inflation is not wealth at all.
That is strikingly obvious from the macro perspective. The
best way to realize this, we think, is a comparison against
the true wealth creation that generations before us have
experienced and that generations of economists have
regarded as the one and only way to greater, lasting
prosperity. It comes from investment spending on income-
creating buildings, plant and equipment.
Investment spending creates demand, employment and incomes
in the first instance through the production of the
necessary capital goods. When finished and installed, the
new capital goods go into production, creating further
employment, incomes and demand. And most importantly, debts
incurred in connection with this wealth creation are self-
liquidating through the underlying income creation.
And what really happens to incomes and debts in the case of
so-called wealth creation through appreciating asset
prices? Nothing at all. Generations before us never thought
of it as wealth creation. This new attitude arises
principally from a general convention to consider total
outstanding assets of a certain category as being worth the
price of the last trade, however small that trade may have
been. Clearly, small trades have tremendous capitalization
effects. For good reasons, such so-called wealth creation
is not practiced in most countries.
In Japan's case, the principal beneficiaries of the asset
bubbles in the late 1980s were industrial and real estate
businesses. In the U.S. case, it is the consumer. But in
order to enjoy the wealth effects of rising stock and
housing prices, the American consumer had to encumber
himself with soaring debts in order to afford the price-
driving asset purchases.
For Mr. Greenspan and the bullish consensus it is a
virtuous circle, as the overall gains in capitalized asset
prices have outpaced the rise in debt levels. Implicitly,
the big net gain in asset values can be used as collateral
for borrowing, which funds higher spending for consumption.
In their economic effects, these two patterns of wealth
creation have nothing in common. The key feature of the
capital investment model is correlated increases in current
and future incomes. It boosts economic growth both in the
short and long run. What's more, the associated initial
rise in corporate debt amortizes itself through the
following depreciations.
The striking key feature of so-called wealth creation
through asset bubbles in favor of the consumer is, first of
all, the associated record production of debt, set against
the total absence of income creation. To maintain demand
creation through this kind of wealth creation, ever more
debt creation is needed - first, to keep the asset prices
inflating; and second, to fund the spending on consumption.
Thinking it over, one realizes that "wealth creation" is
really a grotesque misnomer for asset prices that are
rising out of proportion to current income. The economic
reality is not wealth creation, but impoverishment. We
repeatedly hear from Americans that they are living in
houses or apartments they cannot afford to buy with their
present incomes. But many years ago, with incomes and
prices as they were at the time, they could afford the
houses. That says it all.
The writing has been on the wall for years. In 1996 the
American consumer increased his spending on current goods
and services by $281 billion, with debt growth of $345.7
billion. In 2000 he spent $456.9 and borrowed $566.9
billion. And in 2003 spending of $367.9 compared with debt
growth of $879.9 billion.
But consumer borrowing was not alone in escalating to
unprecedented extremes. Government borrowing also soared,
in particular borrowing for boundless financial
speculation.
In 1997, the U.S. economy grew by $487.4 billion in current
dollars, with an overall credit expansion of $1,406.8
billion. That was already an unusually high borrowing
ratio. In 2003, it took $2,717.5 billion of new credit to
generate nominal GDP growth of $504.7 billion.
Credit excess - always due to artificially low interest
rates - implicitly means spending excess. But the problem
is that these spending excesses tend to distribute very
unevenly across the economy. In the United States, for
years, the spending excesses have been overwhelmingly
directed towards the whole range of asset markets - stocks,
bonds, housing - and in the economy towards consumption.
Given the enormity of these credit and spending excesses,
it goes without saying that they have involved tremendous
distortions in the economy's whole structure, being
typically located in three areas: first, they misdirect
output; second, they distort relative prices, costs and
profits; and third, they strain balance sheets.
It used to be true among policymakers and economists that
for an economy ailing from such structural distortions, a
return to sustained growth is only possible after these
have been significantly moderated, if not removed. Mr.
Greenspan has plainly opted for the diametrically opposite
strategy of fighting economic weakness, regardless of
existing maladjustments, through more and more credit
excess.
Pointing to the U.S. economy's rates of real GDP growth,
Mr. Greenspan claims full success for his policy. Compared
with the far higher rates of growth of past cyclical
recoveries, his policy has grossly failed, even by that
measure. But considering the horrible development of
employment, it has been a policy disaster.
Regards,
Kurt Richebächer
for The Daily Reckoning