-->Forget Iraq

The Daily Reckoning

Paris, France

Monday, 17 March 2003

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*** War jitters still disturbing the economy...Bush has to
do something!

*** Mortgage borrowings soaring...Americans use 80% of the
world's savings...

*** Would war really fix the economy? Bubbles and sharp
objects. And more!

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"US seen contracting unless Iraq situation resolved soon,"
says an MSNBC headline.

"War jitters," say news reports, are hurting consumer
spending and business investment. Instead of beginning new
projects, American businesses keep eliminating old ones -
and getting rid of the employees who ran them. For their
part, consumers are still mortgaging their homes -
heroically or desperately - but growing more and more
uneasy about spending money. Retail sales just showed the
sharpest decline in a year and a half. (More from Kurt
Richebächer, below...)

That George Bush is a great statesman, we have no doubt.
But neither do we doubt he noticed that it was the
recession of '93 which made his father a one-term
president.

Having inspired the war jitters, Bush now has to calm
them...by getting the war underway and over with, we would
guess. In a matter of days...or maybe weeks...we can
reasonably expect 'regime change' will be a matter of fact
in Iraq. We're less sure that it will have the desired
economic effects on the homeland front.

The thing that unites both supporters of Bush's war and its
opponents, we wrote on Friday, is dollars. Both sides have
them.

Twenty three percent of U.S. corporate bonds are held
overseas...13% of equities and 35% of treasuries. There are
also trillions worth of U.S. cash in central bank vaults,
merchants' registers, and individuals' piggy banks all over
the world.

Victory against Saddam may inspire foreigners to hold more
of the winners' currency. Then again, it might not. Even a
short, sweet war may not make the world a safer place...nor
a happier one. It will not make U.S. goods more competitive
on world markets. It will not reduce the supply of
dollars...nor the demand for them.

"A costly war could drive more foreign investors away from
the U.S.," explains an article on MSNBC,"hurting living
standards and our influence abroad."

"As risks increase, expenditure declines," Max Fraad Wolff
elaborates on the Prudent Bear website."Funds advanced
shift toward safer havens. We are positioning to receive
declining portions of a shrinking pie. The airline industry
suffers as Airbus replaces Boeing and Mecca Cola replaces
Coke. The dollar slides as foreigners fear reckless
spending, military conflict and xenophobic campaigns. U.S.
positions are sold as global equity markets plunge and bond
prices fall, forcing up rates. There is no lasting recovery
in such an environment.

"...Tens of billions will be spent on a lengthy, unpopular
occupation. At home and abroad opposition will form and
strengthen. Protests, boycotts and whisper campaigns will
rage. Conflicts overseas echo at home. Terrorists and
competitors seize opportunities to attack. Even if war goes
well militarily, it generates massive and enduring costs.
The Council on Foreign Relations estimates occupation costs
at $20 billion per year. Taxes and revenues are projected
to decline. Where will the billions come from? Fear of the
answer burdens us.

"American-led global cooperation is being displaced by
division. 'Old Europe' and world opinion impact our
exports, treasuries, equities and prosperity. As we
struggle with the challenges posed by massive indebtedness,
anemic earnings, declining budgetary health - state and
federal, negative wealth effects and global economic
weakness, unity and cooperation are essential. If the world
is to continue to fund our multibillion-dollar current
account deficits and budget shortfalls, harmony is
required. Our fiat dollar floats, in part, on good
will..."

Floating on good will is fine when the tide is running in
your favor. But eventually...the tide always turns.

In the meantime, Eric's back on the job, if not in the
office:

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Eric Fry, reporting from Sir John Templeton's backyard...

- Your co-editor is still marooned in the Bahamas. He
arrived in this sunny tropical locale late last week to
attend a meeting of the Supper Club, an interesting event
about which you may learn more in tomorrow's Daily
Reckoning.

- But your co-editor has not yet returned to New York
because he is in no hurry to trade a balmy beach for an icy
metropolis. Your co-editor fancies himself something of a
beach aficionado, and has lounged on many of the world's
finest. He was prepared, therefore, to be underwhelmed by
the beach at the Atlantis Resort here in the Bahamas.
Instead, it impressed him greatly.

- The resort's massive, Disneyland-style trappings and
swarms of overweight vacationers detract from its natural
beauty. (Your co-editor found himself longing for the stark
isolation and raw beauty of Rancho Santana in Nicaragua).
But, physically, the beach at Atlantis is gorgeous. Less
gorgeous by far were the beach-goers. If you spend any time
strolling along the beach at Atlantis - or wondering around
almost any American resort - one particular observation
becomes inescapable: Americans eat...and eat and eat and
eat...They never miss a meal, and rarely miss a between-
meal snacks. We Americans know how to consume, and nobody
does it better.

- But are American feeding habits any different than
American financial habits? Or is the tendency to over-
indulge - whether in credit cards or carbohydrates - simply
part of our national DNA? We gorge ourselves on debt and
donuts alike. Predictably, our financial profile is as
unsightly as our physical profile. And getting back into
shape is difficult and"like so un-fun". We shouldn't
expect either profile to improve any time soon, if ever. To
the contrary, the way that our debts are expanding, we'll
soon need to loosen our financial belts several notches.

-"During the fourth quarter, total (Federal and Non-fed,
but excluding financial sector) debt increased at an
annualized $1.563 Trillion, or 7.7%, to $20.7 Trillion,"
the Prudent Bear's Doug Noland observes,"with Total
Household borrowings increasing at a 10.7% annualized rate.
The Household sector has not experienced a year of double-
digit debt growth since 1987. And we're now compounding on
top of a base that has seen Household sector debt surge 52%
in five years."

- A big part of the reason household debt is soaring is
that mortgage borrowings are expanding at a blistering pace
and now total more than $6.05 Trillion."Take a close look
at truly historic developments within the Great Mortgage
Finance Bubble," says Noland."Household Mortgage debt
growth is fully 60% greater than 2001's record $530.9
billion...The fourth quarter saw a lending frenzy at almost
four times the pace of only five years ago...Total
outstanding Mortgage Debt is up $1.59 Trillion over two
years (23%) and $3.3 Trillion (64%) over five years..."

- One of Noland's most alarming observations is that
consumption-based borrowings have been increasing
dramatically over the last five years. (Noland refers to
consumption-based lending as"cheesecake" - i.e. tastes
great, but very unhealthy). To illustrate the unhealthy
trend, Noland calculates that the total dollar value of
mortgage-backed securities and asset-backed securities,
together with the total value of Fannie Mae and Freddie Mac
loans outstanding, has soared over the last five years from
48% of GDP to 77% of GDP. In other words, the economy may
be slowing, but debt-financed consumption never slows.

-"Could our deranged Credit system offer a less wholesome
regimen?" Noland asks rhetorically. We suspect not. Our
consumption-driven debt boom seems as unhealthy
as...well...a dinner of cheese pizza and French
fries...(For a follow-up on the troubles plaguing the U.S.
credit system - and notably Fannie and Freddie - see his
latest article:"A Parallel Central Bank"
http://www.dailyreckoning.com/body_headline.cfm?id=3012).

-"Extra cheese on the pizza, please! We'll all be wearing
swim suits in the Bahamas next week!"

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Back in Paris...

*** We spent the weekend laying up a stone wall...and
cogitating on the nature of things.

Americans"do not go abroad in search of monsters to
destroy", wrote John Adams early in the 19th century. But
by early in the 21st, American troops were stationed all
over the world, looking for monsters under every rock.

It is progress, of a sort. And perhaps it is inevitable.
Now that America is the world's only super-power, maybe it
has responsibilities that it didn't have when it was merely
a decent republic. Some argue that the nation has a duty to
throw its weight around - even if it doesn't want to do so.
After all, policing the world may be dirty work, but
someone has to do it, right?

But is that the way the world works, dear reader? Do
people...and much less, entire nations...respond reasonably
to the rational duties and responsibilities thrust upon
them? Or do they merely go a little mad from time to time?

Crowds of people develop a particular thought about
themselves, which Gustave le Bon called the General Belief.
The thought may be harmless...(such as 'The sun never sets
on the British Empire...') or it may be very dangerous
(such as Hitler's idea that Germans were a superior race
needing more lebensraum [living room]!). At certain points
in history, people come to think that they are so
special...so superior...so firmly in God's grace...that the
usual rules no longer apply to them.

In bubble markets, investors come to believe that"this
time it is different", so they can ignore P/E ratios, the
threat of bear markets, dividend yield, and so forth. And
in politics, they come to think that they can get away with
practically anything.

And maybe they can. History shows that a country can
maintain a military advantage and a General Belief about
itself for generations.

But nature abhors monopolies and vacuums. When a vacuum
develops, she fills it. When a monopoly occurs, she
destroys it. And when a bubble appears, it is soon
surrounded by sharp objects.

*** A program note: if you're not too busy boycotting
French products, and in fact, would like to get a taste of
La Vie Française, while learning a new trade, International
Living will soon be conducting it's annual Travel Writer's
Workshop, right here in gay Paree...

For details, please click on the following link:

The Ultimate Travel Writer's Workshop
Paris, France
April 29-May 3, 2003
http://www.ildiscoverytours.com/conf/tw04032/dr


The Daily Reckoning PRESENTS: Today, the day Bush calls the
"Day of Truth" for the West, Dr. Kurt Richebächer offers an
alternative suggestion...


FORGET IRAQ
By Kurt Richebächer

From what we read about the U.S. economy, we have to
conclude that its enormous bubble-related, structural
problems are still little understood.

Too many economists in America possess an extraordinary
ingenuity to discard the greatest imbalances in the economy
as irrelevant. Record-high trade deficits, record-low
savings and record-low profits do not matter in their eyes.
It is, by definition, an economy that cannot have serious
problems.

We like the statement that Rep. Bernard Sanders recently
made to Fed Chairman Alan Greenspan after a testimony:"Mr.
Greenspan, I always enjoy your presentation because,
frankly, I wonder what world you live in." It is a question
that we would like to ask numerous Wall Street economists
and analysts.

Not only Mr. Greenspan, but indeed most economists are
clearly overstating the role of the Iraq"jitters" in
slowing the economy. In the same vein, they flatly ignore
the implications of the severe economic and financial
maladjustments that the bubble-related borrowing and
spending excesses have inflicted on the economy, among them
in particular the profit implosion. There is no debate, no
discussion, no questioning about this unprecedented profit
calamity - just lamenting that increasing oil prices and
the looming war with Iraq are causing companies and
consumers to postpone big spending decisions. This
explanation has, of course, the great virtue to make
believe that the economy and the markets will resume
booming as soon as this uncertainty is lifted, war or no
war.

For the great economic thinkers of the past, it was
uniformly apodictic that healthy economic growth depends on
three key attributes: a high share of saving, a high share
of investment and a high share of profits. But the U.S.
economy's strong growth during last year badly lacked all
three attributes.

Looking for the effective quality of the U.S. economy's
strong growth in recent years, we noted the following
facts: In 2002, consumption accounted for 87% and
government spending for 32% of GDP growth in current
dollars. On the other hand, business fixed investment
diminished GDP growth by 23.6%. Another sizable cut by
20.2% derived from the further worsening trade deficit. In
the fourth quarter of 2002, by the way, government spending
accounted for 39.4% of GDP growth. If this was a recovery,
it was a very sick one that lacked everything for
sustainability.

During the preceding four years, 1997-2001, nominal GDP
grew altogether by $1,763.8 billion, or 21%. Consumption
accounted for $1,457.7 billion, or 82.6%, of the total.
That share was about 15 percentage points above the long-
term average. Government spending provided $370 billion, or
20.9%. An unusually small contribution came from business
fixed investment, with $202.2 billion, or 11.4%, of the
total. The soaring import surplus diverted a huge $259.6
billion of domestic spending abroad.

According to official interpretation and general
perception, the U.S. economy's growth during these years
was led by strong investment and productivity growth. The
ugly reality was that growth was consumption-led growth as
usual, with one important difference: this time, the
consumer borrowing binge went to an unprecedented extreme.
Just as clear was its decisive propellant: the skyrocketing
wealth effects of the booming stock market.

By definition, it is the essence of a bubble economy that
rising asset prices fuel specific borrowing and spending
excesses. In the case of Japan, these went mainly into
commercial construction and business fixed investment.
America's bubble economy had its decisive, big structural
distortion in the borrowing and spending orgy of the
consumer.

Consumption's steeply rising share in GDP was the manifest
hallmark of the U.S. bubble economy that developed in the
late 1990s. Essentially, a sharp rise in one GDP component
implies the looting of other components. In the U.S. case,
these victims were fixed investment and foreign trade.

There is a widespread, hopeful view that the bubble-related
imbalances and distortions are being rapidly corrected. In
this view, the U.S. economy's main problem from the past
boom years has been a protracted excess in business
spending on fixed investment that has resulted in vastly
excessive production capacity. Boosting potential supply in
relation to slower demand growth, it is also supposed to be
the main cause behind the profit carnage by destroying
pricing power. From this perspective, the drastic
retrenchment of business fixed investment represents a
highly desirable correction of the prior investment
excesses.

It is the consensus view. Yet it is absolutely ludicrous.

Overinvestment may, indeed, be true for Asia, but
definitely not for the United States. As explained and
documented, America's overwhelming structural maladjustment
in the past few years has been bubble-driven
overconsumption that plainly bombed out business investment
and the trade balance.

What the slide in business fixed investment truly reflects
from this perspective - our perspective - is not at all a
desirable and necessary correction of a prior
maladjustment, but a dramatic worsening of chronic
corporate underinvestment in the United States. The profit
carnage is the obvious culprit.

What saved the U.S. economy from a crushing recession was
the housing and mortgage refinancing bubble that developed
with consumer debt growth beating record after record. In
the third quarter of 2002, it ran at an annual rate of
$770.7 billion, as against $661.3 billion in the same
quarter a year ago, and $571.4 billion another year back.

Everybody is hailing this acceleration of the consumer
borrowing binge because it has prevented a deeper
recession. But in essence, this, too, represents an
increasing maladjustment in consumer spending.


Regards,


Kurt Richebächer,
for The Daily Reckoning