We call it the housing bubble but really it was the greatest money and credit excess in the history of the world. The immense damage to our economy from the bursting of this bubble continues to haunt us. How is it that a calamity of this magnitude could not be foreseen by our political leadership, our economists, our so-called wizards of Wall Street and all the other experts?
A few people saw it coming. Twenty years ago in 1991, I had been writing about the perils of credit excess and big government for almost two decades. However, what I warned about never seemed to happen. I sounded like a broken record. So few people were interested in gold and silver I gave serious thought to closing my company, Investment Rarities, and doing something else.
Not long after, I came across an interview in a newsletter with a German economist by the name of Kurt Richebacher. He was a financial forecaster who was influenced by Austrian School economics. I called him on the phone and over time we became friends. At that time Kurt was the only significant economist that predicted a dire financial outcome.
As far back as 1996 he was warning about a stock market crash.
“The bullish wave threatens to come crashing down on the hordes of analysts and investors who bet so heavily – and so foolishly – on their dreams of a perpetual ‘stock market boom.’”
In 1999 he wrote,
“The U.S. financial system today hangs in an increasingly precarious position, a house of cards literally built on nothing but financial leverage, speculation and derivatives.” As the Nasdaq bubble deflated he wrote in June of 2000, “The decisive cause of every single, serious economic and currency crisis are credit and debt excesses. Apparently, we cannot repeat it often enough: the U.S. credit and debt excesses of the past few years are beyond past experience in history, essentially leaving behind a totally vulnerable economy and financial system.”
One of his sternest warnings came in 1999 when he criticized Alan Greenspan for his speech endorsing derivatives.
“To be the leading Central banker of the world, it really ought to be obvious that the overriding consequences of widespread derivatives use is excessive leverage and risk taking... derivatives markets encourage a dangerous shifting of risk to parties with less wherewithal to shoulder potential losses. This is particularly the case during an acute financial crisis precisely when derivative ‘insurance’ is called for. We see. . .massive shifting of market risk to the highly leveraged and exposed U.S. banking industry and Wall Street firms.”
In 2002 he warned about the collapse of national savings, “The total carnage of national savings is the U.S. economy’s most important – but also most widely ignored predicament. . .national savings have been squandered to pay for spending that the consumer cannot afford from his current income.”
He continued with a crucial economics lesson, one that the Keynesians have totally failed to grasp. “Ever since Adam Smith, savings has meant exactly one and the same thing in all languages: it is the part of current income that is not spent on consumption. And the key point of this definition is that such savings, and such savings only, make it possible to divert real resources from the production of consumption goods to the production of capital goods.
“To pin down and emphasize the key point: savings from current income represent the economy’s supply of capital. Thus, it definitely sets the limits to the financial funds and the real resources that are available for new capital investment. Any increase in consumer spending as a share of GDP correspondingly decreases the economy’s capacity for capital formation. It is, of course, easy to replace missing savings with credit creation. But there is no substitute for missing real resources.”
“In the end it is all about capital investment. It is the critical mass in the process of economic growth that generates all the things that make for rising wealth and living standards. Capital investment creates demand, growing supply, employment, productivity, income, profits and tangible wealth.”
“The crucial thing to see about the U.S. economy is that its growth during the past few years was driven by uncontrolled debt creation for consumption and financial speculation, while in the process domestic savings and the potential for capital investment have been devastated as never before. . .The first thing to get straight is that this was – and still is – the most outrageous bubble economy in history, far worse than the U.S. bubble of the 1920s and Japan’s bubble of the late 1980s.” (Remember, this was 2002.)
“Very few people so far have realized that the U.S. economy is sick to the bone. In the past few years it has been grossly mismanaged, on the macro level through unprecedented monetary looseness on the part of the Greenspan Fed, and on the micro level through corporate strategies that built only mountains of financial leveraging but no factories.”
In 2005, he delivered this indictment of the U.S. economy.
“The ongoing credit explosion is financing a lot of different things, except production and tangible capital formation. Debt growth is almost entirely used for unproductive purposes, such as consumption, imports, government deficits, purchases of existing assets and financial speculation.”
He continued, “Credit growth in the United States has gone completely insane. This is sheer Ponzi financing – and like all Ponzi schemes someone will end up holding the bag. At the same time, the diversion of credit into bonds, stock and housing has created an illusion of bulging wealth.
“This so called wealth creation has its quack origins in loose money and artificially low interest rates; it boosts consumption at the expense of saving and investment. Strictly speaking, this is the exact opposite of wealth creation – impoverishment.”
By 2006 Kurt Richebacher was warning about a pending downturn. “The U.S. economy is in danger of a recession that will prove unusually severe and long. . .The great question is what will happen to the variety of financial asset bubbles in the United States when the housing bubble bursts and the economy slumps.”
In the spring of 2007 Kurt Richebacher suddenly lost his eyesight. In our last conversation I could hear the anguish in his voice as he explained to me that he had gone permanently blind. To someone who spent much of their time reading financial reports and economic statistics this was devastating beyond measure. Soon afterwards Kurt Richebacher passed away.
In one of his final newsletters in January of 2007 he wrote with amazing prescience,
“In our view, the obvious major risk is in the impending bust of the gigantic housing bubble. Home ownership is broadly spread among the population, in contrast to owning stocks. So the breaking of the housing bubble will hurt the American people far more than did the collapse in stock prices in 2000 – 2002. . .Some day, the same will happen to the bond and stock market... Another big risk is the dollar.”
It’s sad that Kurt Richenbacher did not live to see the sorry outcome of the monetary excesses he warned about. The accuracy of his predictions makes him the soothsayer of the century. The economist Paul Krugman argued in 2002 that the Federal Reserve should do what it could to create a housing bubble; yet, he received a Nobel Prize. Nobody paid much attention to Kurt Richebacher and his accurate forecasts. In a rational world Kurt Richebacher would have won the Nobel and Krugman would have been fired.
Were he alive I’m sure Kurt Richebacher would agree with my view that Paul Krugman, from his influential post at the New York Times is the most dangerous and wrong thinking economist since Karl Marx. Kurt would also have pilloried Mr. Bernanke just as he did Mr. Greenspan. He would argue that the politicians and monetary authorities in charge today suffer a profound economic ignorance. He would agree, they are leading us into catastrophe. He would be warning us about a falling dollar, a bursting bond bubble, a gathering recession and wrong-headed policy prescriptions coming from Washington. He would agree we could not be in worse hands.