The Daily Reckoning
Buenos Aires, Argentina
Wednesday, April 19, 2006
The Daily Reckoning PRESENTS: We live in a bubble economy. And eventually
all bubbles run out of steam - the United States economy included. The big
question here is: are we in for a hard or a soft landing? Dr. Kurt
Richebächer explores...AN EVASIVE RECOVERYby Dr. Kurt Richebächer
In the early 2000s, Mr. Greenspan earned himself the honorable title of
"serial bubble blower." Fearful of a painful burst of the equity bubble,
he aided and abetted a bond bubble in order to boost the housing bubble.
Measured by the mildest postwar recession, it appeared a smashing success.
But taking measure of the following anemic recovery, and particularly the
following dismal employment and income performance, into account, it was
an utter policy failure.
Any assessment has to further take into account that the government and
Federal Reserve have supported this recovery with unprecedented fiscal and
monetary lavishness. Tax cuts reduced government revenue by $870 billion,
while the Federal Reserve slashed its fed funds rate to 1%, its lowest
level since the Great Depression.
The decisive failures of these policies have been in business fixed
investment and in employment, both displaying a drastic shortfall in
relation to reported GDP growth.
Historical experience and economic theory leave no doubt that business
fixed investment and employment play the crucial role in providing
economic growth with the necessary traction to become self-sustaining.
Even in its fifth year, the present U.S. economic recovery remains fully
dependent on the housing bubble to drive the consumption bubble.
The same, by the way, applies more or less to all Anglo-Saxon countries.
Over the past few years, all of them have hung on the steroid of inflating
house prices providing the collateral for outsized consumer
borrowing-and-spending binges. Their further common features are large
budget deficits (except Australia), very low savings and large trade
deficits (except Canada).
All of these economies have, in essence, become bubble economies. This
means that monetary policy impacts the economy primarily through inflating
asset prices, which in turn stimulate and facilitate credit-financed
consumer spending.
An important adverse feature of all asset and credit bubbles is that they
inherently break an economy's pattern of growth. In all the
English-speaking countries, the credit excesses have primarily inflated
house prices. Using these as rising collateral, consumers have enjoyed
unprecedented borrowing facilities to spend as never before in excess of
their current income. What resulted were extremely unbalanced economies.
Distorted demand over time invariably also distorts the economy's supply
side. What has actually happened in all these countries is that domestic
spending has increasingly outpaced domestic output. On the other hand, low
domestic saving and capital investment keep a brake on output growth. The
infallible result in all these countries, except Canada, is large, chronic
trade deficits. Evidently, all this is structural, not cyclical.
Essentially, the low savings, the low capital investment and the soaring
trade deficits act as major drags on economic growth. Over the past few
years, these drags have been offset by the rampant demand creation through
the housing bubbles. But the trouble with this recipe is that it worsens
the structural distortions and imbalances.
Nevertheless, all asset and credit bubbles eventually run out of steam.
Plainly, this is going on in all these bubble economies, the United States
included. For us, the key question about whether there will be a hard or
soft landing is the extent of the prior excesses. They are the worst in
history.
The consensus sees new momentum in the U.S. economy from strong retail
sales. We focus on the inflation-adjusted monthly figures for overall
consumer outlays and observe the opposite. There are sharp fluctuations in
spending on durables, but with a distinct downward trend.
As everybody knows, or ought to know, the strong monthly changes in
consumer spending have their main cause in the sharp ups and downs of auto
promotions. In the quarterly GDP reports, they are even annualized. But
comparing the above figures, it strikes the eye that the recovery in the
last three months was very much weaker than in the prior downturn.
Any assessment of the U.S. economy's further course has to start with the
recognition that the housing bubble is doomed, and in its wake the
consumption bubble. Only the vigor of their slowdown is in question. Given
this virtual certainty, the U.S. economy urgently needs an alternative
source of growth.
Unfortunately, there is but one possible alternative source, and that is
sharply rising business fixed investment and exports. The consensus,
apparently, takes a strong revival of business fixed investment for
granted.
Assessing the relevant figures, including profits, we take for granted
that business investment and hiring are going to fail in the future even
more than in the past. First of all, the record-sized fiscal and monetary
stimulus of all times has been exhausted; second, business fixed
investment in the United States, even though heavily bloated by hedonic
pricing of computers, recently accounts for a record low of 11.5% of GDP,
as against more than 70% for consumer spending; third, consumer demand is
weakening; and fourth, nonresidential investment has slumped from
double-digit growth rates in 2004 to just 2.6% in the fourth quarter of
2005, after 10% in the first half.
Common arguments in favor of a comeback of capital investment are high
business liquidity and high profits. Plainly, they have recovered from
their lows, but growth has sharply slowed from 2004, when tax incentives
gave a strong impetus.
New orders for machinery are up over the year, but by far not enough to
suggest a developing investment boom. Given for many years a preponderance
of short-lived investments, it needs moreover large and ever-higher
capital investments just to replace worn-out plant and equipment, as
reflected in rising depreciations. There is every reason to assume that
the rise in new orders of capital goods barely reflects rising
depreciations.
Most impressive is definitely the following chart reflecting the U.S.
economy's profit performance. Since 2000, it is the greatest profit boom
in the whole postwar period. Strikingly, it even compares most favorably
with the profit performance during the "New Paradigm" boom years, from
1995-2000.
Profits of the whole nonfinancial sector were $401 billion in 1995 and
$413.4 billion in 2000. But from 2001 to late 2005, they have almost
trebled, from $322 billion to $868.5 billion. Wall Street, of course,
eagerly seizes them. For us, these numbers are so absurd as to require
investigation.
First of all, it was an extremely imbalanced profit boom reflecting an
extremely imbalanced economic recovery. This recovery had literally
nothing in common with the business cycle pattern of the past.
Intrinsically, this shows in a radically divergent profit pattern.
The profit boom of the last few years was narrowly centered in the
category "other." The fact is that the housing bubble has been crucial not
only in creating demand and GDP growth, but also in creating employment
and profits.
Most astonishing is, of course, the steep jump in profits from $534.2
billion in 2004 to $863.3 billion in 2005. Two phony causes are easily
identified. One is a sharp decline in depreciations, from $804.3 billion
to $668 billion. Depreciations are a business expense, of course. If a
firm stops investment, it increases its profits. But this is hardly a
desirable way toward higher profits. The second major cause of the sudden
profit surge was a tax incentive that induced companies to repatriate a
large amount of foreign profits into domestic profits.
Leaving aside the grossly distorted profit figures for 2005, we focus on
the period from 1997-2004, the former marking the U.S. economy's prior
profit peak in the postwar period. Over these seven years, including the
"New Paradigm" boom years, overall profits barely rose.
The next thing to recognize is the tremendous differences in profit
performance between sectors. For all sectors producing or moving goods,
manufacturing and transportation, it has been seven years of profit
disaster, and moreover of steady deterioration.
In contrast, it has been seven years of profit bonanza for retail trade,
wholesale trade and in particular for the branches captured under "Other."
Here construction and real estate agents have been the main contributors.
We would say that overall this is a dismal profit performance, definitely
giving no reason for a booming stock market. Measured against nominal GDP,
which has risen 41% between 1997-2004, it is a profit collapse.
Very poor profits in the aggregate are the one big problem. An extremely
lopsided pattern between sectors is the other. Manifestly, this
lopsidedness in the profit pattern perfectly reflects the extraordinary
lopsidedness of the U.S. economy's growth pattern during these years. The
housing and consumption bubbles rule.
It always amuses us when Mr. Greenspan and Mr. Bernanke criticize the
government for its budget deficits. The irony is that the chronic deficit
spending by the consumer, induced by their monetary looseness, is doing
far greater structural damage to the economy.
Regards,
Dr. Kurt Richebächer
for The Daily Reckoning