The Daily Reckoning
London, England
Tuesday, July 19, 2005
The Daily Reckoning PRESENTS: The Fed continues to stand by their claim that
the U.S. economy is just experiencing a "soft patch" that will surely be
followed by high rates of economic growth. Dr. Richebächer stands firm in his
belief, too - that the worse has yet to come...DEBT, DELUSION, DECEPTIONby Dr. Kurt Richebächer
The skyrocketing wedge between debt growth and GDP growth is definitely the
most spectacular and most frightening phenomenon of the economic and financial
development in the United States. In relation to lagging income growth, the
wedge is considerably bigger. Yet it receives zero attention by the Federal
Reserve and the permanently bullish consensus.
Due to higher inflation, higher short-term rates and compound interest,
ever-increasing amounts of credit are required to maintain their effects on
spending and asset prices. Signs of a slowing global economy are abounding, led
everywhere by the manufacturing sector. Downward surprises are chronic. The
U.S. economy is no exception.
Our highly critical assessment of the U.S. economy is mainly determined by two
extremely negative considerations: First, its chronic structural imbalances
between consumption, saving, investment and debt creation have dramatically
worsened since 2000; and second, both monetary and fiscal policies have
virtually exhausted their stimulatory potential. There is little or nothing
left for them to do when the economy slides back into recession.
It is the particular feature of U.S. economic growth since the late 1990s that
consumer spending has increasingly outpaced the growth of production. Its
counterparts are a collapse of saving out of current income, weak business
fixed investment and the soaring trade deficit. Actually, business borrowing
goes mostly into mergers, acquisitions and dividend payments.
The most striking hallmark of this escalating divergence between consumption
and output in the U.S. economy has been the exploding U.S. current account
deficit, presently running at an annual rate of close to $800 billion. This is
more than six times its amount of $109.5 billion in 1995.
It seems that U.S. policymakers and economists have yet to realize that this
deficit is the economy's great income and profit killer. To offset the implicit
huge drag on U.S. domestic production, employment and incomes, the Federal
Reserve has kept its money and credit spigots wide open to create alternative
domestic demand.
In his congressional testimony on June 9, 2005, Federal Reserve Chairman Alan
Greenspan described the U.S. economic situation to be "on a reasonably firm
footing." Looking at the following monthly figures from the Bureau of Economic
Analysis' (BEA) Personal Income and Outlays report, we note a dramatic
deterioration in income growth and spending growth.
This table finds very little attention. In reality, it is of eminent importance
because it shows changes in consumer incomes and spending on a monthly basis.
Given the high share of consumption in GDP, it is the best proxy for current
GDP growth. For the first two months of the second quarter, April - May,
consumption is up 1.2% at annual rate.
The published numbers for the gains in real disposable income are actually so
disastrous that we hesitate to take them at face value. Real disposable income
in May 2005 was $8,211.6 billion, down sharply from $8,473 billion in December
2004.
Assuming a big distortion from December to January, we focus on the four months
February - May. Over these four months, the real disposable income of private
households edged up a miserable $37.7 billion, equal to an annual growth rate
of 1.5%. For comparison, real disposable income grew 3.7% in 2004 and 2.3% in
2003. It seems reasonable to describe this as an income collapse.
Over the same four months, consumer spending in chained dollars surged by $75.7
billion, but with a steep downtrend: February, $32 billion; March $28.6
billion; April, $18.1 billion, May - $3 billion.
There is no secret as to how the American consumer has been pulling this off.
It is all about an economy in which demand growth through income creation has
been increasingly replaced through inflating asset prices providing the
collateral for ever-higher spending on credit. But income creation is not
catching up; it is in dramatic decline.
We are looking for the deeper macroeconomic causes behind this rapidly widening
gap between consumer spending and consumer incomes. These reside in the two
major structural imbalances, which policymakers and economists in the United
States stubbornly refuse to regard as a problem.
The paramount reason is the soaring deficit in the U.S. economy's current
account, reported at $195 billion for the first quarter of 2005. This sum
reflects current spending of many different kinds in the United States. The
recipients of this huge amount, however, are foreigners enjoying a
corresponding rise in their current incomes.
These big income gains on the part of the surplus countries implicitly have
their counterpart in a commensurately big income leakage on the part of the
U.S. deficit economy. With its soaring current account deficit now close to
$800 billion, or well over 6% of GDP, it would long be in deep recession.
To offset this enormous trade-related income drag cogently requires
compensating credit and debt creation to generate alternative demand. That is
what the Fed has done with its persistent extreme monetary looseness. Thus the
monstrous trade deficit has trapped the U.S. economy in a vicious circle of
growing credit excess.
But as the demand for manufactured goods is increasingly met by foreign
producers, the alternate domestic credit creation increasingly feeds service
jobs, of which a large part is low-paying. Another point to consider is that
different types of expenditures have very different aftereffects. Just compare
in this respect the difference in income creation between spending for health
service and spending for building a new factory. In short, easy money replaces
the good jobs that emigrate by bad service jobs.
In our view, gross lack of investment spending with high multiplier effects is
America's second biggest macroeconomic deficiency.
In line with Austrian theory, we regard capital spending as the critical mass
in the capitalist process, generating all the things that make for true
prosperity. First of all, it creates employment, income and tangible wealth
from the demand side while the plant and equipment are produced. Then, upon
their installment, all these capital goods create employment, productivity and
income from the supply side.
And there is still a third point to be considered. First, capital investment is
self-financing; and second , depreciations and their reinvestment create an
endless stream of recurrent employment and income without any additions to
debt. Investment-driven economic growth, therefore, has a very low debt
propensity. In contrast, unproductive government and consumer debt
automatically feed on themselves through compound interest.
There was a drastic break in the U.S. economy's debt propensity from the early
1980s, similar to the late 1920s, but considerably worse. In both cases, it had
the same two causes: booming consumption and financial speculation.
Earlier, we emphasized that the U.S. economy's prospects is presently the
all-important question for the global economy. The popular spin, trumpeted by
Mr. Greenspan in particular, is that the U.S. economy possesses such
extraordinary resilience and flexibility "that its imbalances are likely to be
adjusted well before they become potentially destabilizing."
It is an absurd statement; because flexibility is the last thing the U.S.
economy has shown in the past few years. Its one and only flexibility has been
in the creation of a housing bubble and the associated credit bubble, while all
the structural imbalances - rock-bottom savings, asset inflation and the
monstrous trade deficit - have soared to new extremes.
Duly, the U.S. pattern of the economy's downturn in 2000-01 has diametrically
differed from the typical, cyclical kind. All past recessions were triggered by
monetary tightening, the Fed's response to rising inflation rates. Consistent
with tight credit, consumers and businesses slashed their credit-financed
expenditures. These were the same components in all economic downturns -
consumer durables, business investment and residential building.
This downturn has been unlike anything ever experienced in the annals of the
business cycle. While the Fed undid its 1998 rate cuts in the first half of
2000 - raising its federal funds rate in three steps by a total of 1%, to 6.5%
- credit flows to businesses and consumers escalated as never before. Yet real
GDP growth slowed sharply from 3.7% in 2000 to 0.8% in 2001. It was the first
recession to happen under conditions of rampant credit expansion.
But what distinguished the 2001 recession most radically from all past
experience was its pattern. The downturn had centered on one single demand
component - business fixed investment. With a plunge of 13.1% in 2001-02, it
experienced its sharpest fall of all postwar business cycles. In an equally
unusual fashion, consumer spending simultaneously surged by 5.8%. Clearly, the
extraordinary developing consumer borrowing-and-spending binge moderated the
economy's downturn.
The following recovery has been just as diametrically different from past
experience. With the lowest interest rates in half a century and the biggest
fiscal stimulus in history, the U.S. economy's recovery from its 2001 low has
nevertheless been its weakest by far in the whole postwar period by any
measure. The broadest popular measure is real GDP growth. It increased during
the three years 2001-04 by 9.6%, as against an average of 14% growth over the
same period for previous cyclical recoveries in the postwar period.
But there is a second utterly unusual feature in this U.S. economic recovery.
Just as in the case of the prior downturn, its pattern differs diametrically
from past experience. The normal V-shaped recovery remains grossly missing.
Three aggregates of crucial importance for sustained strong economic growth
show persistent, drastic shortfalls. These are business fixed investment,
employment and real wage and salary income.
It should be clear that a recovery's composition crucially matters for its
vigor and sustainability. Typically, past cyclical recoveries got their
immediate, strong traction from pent-up demand for business fixed investment,
consumer durables and housing generated by the prior tight money. This time,
two critical components went badly wrong: Business fixed investment recovered
meekly, and foreign trade went into an exploding deficit.
Regards,
Kurt Richebächer
for The Daily Reckoning
P.S. This U.S. economic recovery has been unique in that it rests on one single
pillar - the housing bubble, which the Fed systematically engineered to boost
consumer spending through easy consumer borrowing against rising house prices.
Ominously, this is occurring against the backdrop of unusual weakness in the
growth of employment and wage and salary income.
Editor's Note: Consumer spending (or rather, consumer borrowing and spending)
remains high for one reason only: An irrational confidence in the economy. What
our friends at the Fed don't want you to know is that the basis for this
confidence is a shamelessly fraudulent farce of trumped-up statistics.