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The So-Called Recovery
And Other Gloomy New Year Musings
by Mark M. Rostenko
Editor, The Sovereign Strategist
January 28, 2004

You hear it all around you. The U.S. economy is in recovery; stimulus efforts are finally paying off. The stock market is ripping and roaring and happy days are here again. But ignoring the headlines, the spin-doctoring and Fed jawboning and calmly looking at the facts reveals a different story than do the bubbleheads of the mainstream media.

Our first clue that something may in fact be amiss comes from the cheerleaders at the Fed. While most of us were still mistakenly writing “2003” on our checks early in the year, the Fedheads were out in full force giving an unprecedented number of speeches (for such a short time period).

Have you heard Shakespeare’s quote “methinks the lady doth protest too much”? Truth is generally obvious. You don’t need to harp on it over and over to convince anyone. So when someone’s working overtime to convince you of the “truth”, you know something is awry.

While the CRB Index of commodities surged to new 15-year highs, Alan Greenspan took advantage of new year optimism to remind us that the risk of inflation is quite low. While the dollar plunged, Fed governor Bernanke belabored the point that the “risk of a dollar crisis is quite low.” 

Methinks the ladies have been protesting far too much and I worry more than ever about a dollar crisis and rising inflation. Especially given that Alan Greenspan’s tenure at the Fed has resulted in an absolutely unprecedented 45% increase in the global supply of dollars.

Greenspan recently gave himself quite the pat on the back by stating that “there appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful.” If by “addressing” he means “to create a series of other bubbles”, then indeed Mr. Fedhead deserves a pat on the back.

By dramatically dropping rates and expending gobs of effort in reassuring markets that rates will remain low, the Fed has created obvious bubbles in the housing and credit markets. In the 90s stock market bubble, the favorite subject of cocktail hour banter was the latest hot tech stock. Today it’s who got the biggest cash-out on their refi.

Exceptionally low interest rates, surging real estate prices, an insatiable hunger for debt and a massive expansion of dollars: these are all imbalances that must be addressed. And it’s very clear that our powers that be consistently refuse to address anything, so long as the “gettin’ is good.”

(For example, paraphrasing Mr. Greenspan’s comments about the 90s stock market: “I didn’t know it was a bubble and even if I did, I couldn’t have done anything about it.”)

Imbalances must eventually be dealt with and the longer the wait, the more painful it is. Housing and credit are just such imbalances and they threaten the flimsy basis for sustainable economic growth.

The twin deficit are even bigger imbalances putting a massive strain on our economy. But as long as the “gettin’ is good”, no one cares. After all, the trade deficit has been expanding for years without much consequence (as long as we ignore that pesky 30% decline in the dollar, like most folks do.)

And so what about the budget deficit? We’ll make that up during the forthcoming economic boom. “If it doesn’t hurt right now, it’ll never hurt” is the philosophy too many of those in power live and legislate by.

But the piper must always be paid. We don’t get something for nothing in this world. It’s simple, natural law. Cause and effect. 

Structurally, the consumer, the foundation for 2/3 of GDP, is also unsound. The national savings rate is at a historical low. Folks don’t save money anymore. They simply read in the newspaper that housing and stock prices are going up. They feel good and borrow more money, buy more junk and feel rich. The so-called wealth-effect in action.

It’s called the wealth effect to differentiate it from real wealth. Wealth is what happens when you work, save, invest and build net worth. The wealth-effect is what happens when you have little, borrow more, spend still more and feel the “effect” of someone else’s (your banker’s) wealth. Temporarily. 

This “wealth-effect” that has Americans feel good, borrow and spend is fundamentally uprooting the foundation of all real progress and growth. The proof lies in the unprecedented level of bankruptcies in this country: 1.66 million in the year to 30 September, 2003, according to the American Bankruptcy Institute.

If the recession ended a couple of years ago, how come so many folks are going bankrupt? It’s the wealth-effect! Americans are living the effects of wealth without actually creating any.

Fed data shows that consumer debt has exceeded a whopping $2 trillion for the first time in history. That’s a 100% increase in less than ten years. This IS a bubble, folks. The Fed has convinced the American consumer that it’s ok to increase debt because interest rates are low.  This keeps the consumer shopping (and digging a financial grave), without regard for long-term consequences. That’s the essence of bubble psychology.

Sure, as long as rates are low debt is affordable. But with rates at 45-year lows, where’s the next big move? Up or down? With the dollar plunging, it’s only a matter of time before rates rise rendering “easy to manage debt” unserviceable. In the words of credit industry expert Robert D. Manning “That’s one of the trends that’s really going to kill the American consumer in the next downturn. It’s just impossible to keep interest rates this low for much longer.”

And by the way, these “easy to afford” credit terms are an illusion. Manning concludes that the cost of borrowing has actually tripled in real terms since the 1980s. 

The consumer is also losing jobs. Forget the headlines, folks. The real job story is far less glamorous.  Media pundits and politicians point to trivial decreases in the headline unemployment rate as evidence of economic recovery. Never mind that the headline figures exclude frustrated workers who have given up looking for jobs. The real unemployment rate is closer to 10% according to recent research by the LA Times as well as others.

Oh sure, low-paying “hamburger-flipper” jobs are being created.  According to Stephen Roach most job growth is limited to temporary staffing, education and health care. A total of 286,000 of these jobs were added between August and December. Impressive? Hardly. Manufacturing continued to bleed jobs during the same period, shedding employees for 41 consecutive months so far.

The so-called recovery began two years ago. Yet the number of jobs is 1% below where it stood during the official recession. According to Stephen Roach, we should be up 6% at this stage of the game.  But the mainstream media and politicos jump all over that 286,000 figure, don’t they?!  That’s 1/27th, a mere 3.7% of how many new jobs we should have by now.  Wow!  And to think that all it took was thirteen rate cuts, three tax cuts and a veritable explosion in money supply!

Nonetheless, popular spin says there’s no need to worry. With profits rising, productivity strong and the cost of borrowing low, job growth is inevitable. Think so? Think again.

It’s been TWO YEARS since the recession and the job growth isn’t happening. Part of the reason lies in an emerging trend that is not likely to abate: U.S. corporations are outsourcing many jobs to foreign labor pools. Indian call centers, for example. The Chinese have taken over the manufacturing of many common products. Levi Strauss recently shut down the last of its U.S. factories. Blue jeans will no longer be as American as apple pie. And most of my apples come from New Zealand, by the way. 

You don’t get a sustainable economic recovery without jobs because unemployed folks don’t make any money.  Simple, really.  No money = no consumer spending.  In fact, household purchasing power has fallen 1% during this so-called recovery. 

But wait a minute! Isn’t consumption still high? Aren’t profits rising? Yep. See the earlier section about the so-called wealth-effect. Consumers have less money to spend but continue to spend by borrowing against over-inflated assets like housing. Imbalance. A big one. In the words of Stephen Roach:

Lacking in such internally generated income, saving-short American consumers have had to draw support from secondary sources of purchasing power - namely massive tax cuts, an outsized build-up of debt, and the extraction of cash from over-valued assets such as homes. This is a tenuous foundation of support for any economy...A persistence of this jobless recovery will only up the ante on these imbalances - raising serious questions about the ultimate sustainability of the current upturn...

The massive imbalances in the U.S. economy are routinely downplayed by government spin-doctors. The folks at the Fed tell us there’s nothing to worry about. We’re not some third world nation that has to worry about trade imbalances, after all. We’re the U.S. of A. Too big to fail. Our dollars make the world go ‘round so we can pretty much get away with anything.

But money and natural economic law don’t give a flying flip to who’s who and where the money is printed. Imbalances always get balanced in the long run, one way or another, and the bigger the imbalance, the larger and more painful the inevitable adjustment.

In the 90s many Asian countries were making best friends with the double-edged sword of credit. Thai consumers, for example, were buying up everything in sight and the trade deficit surged, financed by foreigners gobbling up their debt.  Sounds very much like the U.S. today, no?  The end result? The 1997 Asian financial crisis that almost pushed the global economy to its knees.

But that can’t happen here, right?  Keep dreaming.

In ten years, the U.S. current account has gone from a greater than $80 billion surplus to a more than a $500 billion deficit. That’s a record.  But the gig can only continue so long as foreigners are convinced that the dollar is under control and that the government can make good on its obligations. 

The dollar has thus far declined in an “orderly” fashion. But any crisis of confidence could change that right quick. The result would be a dollar crash and an upsurge in interest rates that would stop any and all hopes of recovery dead in their tracks.

Former Treasury secretary Rubin recently warned of the potential for disaster resulting from our huge twin deficits. His conclusion: 

Substantial ongoing deficits may severely and adversely affect expectations and confidence, which in turn can generate a self-reinforcing negative cycle among the underlying fiscal deficit, financial markets and the real economy...

In layman’s terms: if we don’t get our act together, a third-world type of crisis in confidence is very possible.

A rational examination of the big picture, the facts free of government spin-doctoring and media hype leads to a very simple conclusion. The so-called recovery may in fact exist in certain terms but is being pulled at and strained on all sides by severe imbalances that are basically ticking time-bombs, waiting to explode. The consumer is overstretched in debt, the nation is drowning in debt and the employment picture is not improving to any significant degree. We may be in recovery, but we’re not in a sustainable recovery.

Unless the powers that be have stumbled upon a formula for perpetually inflating economic bubbles with no long-term costs, the other shoe will inevitably drop. It’s only a matter of time...

© 2004 Mark M. Rostenko
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