Panacea Du Jour von Richebächer / The Daily Reckoning

verfasst von - ELLI -, 21.01.2003, 22:28

-->Panacea Du Jour

The Daily Reckoning

Paris, France

Tuesday, 21 January 2003

-------------------

*** Debt...debt...debt...how much is too much?

*** Destroying the dollar...gold to rise...
Japanese turning to the euro...

*** Unwinding the mania...terminating illusions...Chinese
empire...and more!


"Personal consumption has been going up in the U.S. for the
last 20 years. Instead of solving the problems of
underinvestment and rebalancing the economy, which would be
painful for a while, the central bank just throws money at
the system and entices consumers to take on more debt."

Felix Zulauf had interrupted Barron's Annual Roundtable
discussion to say something important.

"At best," he continued,"the U.S. is in for a long period
of stagflation, very low growth or worse. At some point,
the world will begin to understand that the U.S. economy is
fundamentally much weaker than generally believed."

Americans enjoy a level of consumption they cannot really
afford. If they had invested more of their money in new
plants and equipment - capital improvements that increase
income and profits - the situation would be different. But
they didn't; rather than save and invest, they consumed.

And now the world's only superpower depends on the kindness
of strangers in order to keep its citizens living in the
style to which they have become accustomed. But the
strangers are becoming less kind...or less stupid. Last
year, foreigners bought $45 billion of U.S. equities,
Zulauf tells us,"but that will change at some point. When
people realize there are fundamental problems in the U.S.
economy, the dollar will begin to decline in a major way."

The dollar has already lost 20% of its value against the
euro. But Zulauf thinks the biggest drop in the dollar will
come against gold.

"Other central banks will at some point then try to support
the dollar, because if it declines too much, it hurts their
exports. They will be forced to adopt the same policy as
the U.S. central bank, and you will have the whole world
creating more fiat currencies. That's when gold will really
run."

How far? In 2000, the ratio of an ounce of gold compared to
the Dow stocks was 45 to 1. It took 45 ounces of gold to
buy the Dow. Now, the ratio is down to 25 to 1.

"I don't know exactly how low it will go," admits Zulauf,
taking the words right out of our mouths,"but I'd guess
somewhere between 1 to 1 and 1 to 3. We'll see in 10-12
years."

Let's check in on Eric in New York...

-----------

Eric Fry, reporting from Manhattan...

- The U.S. financial markets took a break from the action
yesterday in honor of Martin Luther King Day. But America's
growing debt burden never takes a break. We Americans can
borrow and spend better than anyone. In fact, borrowing
money from foreigners and spending it on CD players and
all-you-can-eat shrimp dinners is one of our greatest
national talents.

- Better still, we get to repay our foreign debts with
money that we print ourselves. That's a pretty sweet deal,
all in all. Unfortunately, we don't always have a lot to
show for all of our borrowing and spending. That's because
we tend to spend far more money consuming things than
building things.

- This week's issue of Barron's quantifies America's
growing debt burden from several different angles. Herewith
a sampler:

**"Total U.S. debt...an aggregate of the borrowings of all
households, businesses and governments (federal, state and
local), zoomed up from about $4 trillion at the beginning
of 1980 to $31 trillion as of 2002's third quarter.

**"Credit-market debt now equals 295% of gross domestic
product, compared with 160% in 1980 and less than 150%
during much of the 1960s.

**"Debt as a percentage of GDP exceeds the previous record
reading of 264% from early in the Great Depression.

**"Corporate revenues, the raw material of debt service,
have fallen to just 113% of corporate debt levels - the
second worst reading in debt-repayment capacity since the
Great Depression."

- Meanwhile, default rates are on the rise everywhere.
Corporations as well as consumers are defaulting in record
numbers.

-"At what level does debt turn lethal?" Barron's asks
provocatively."No one knows for sure." As long as our
foreign creditors eagerly accept the dollars we print, our
foreign debts could remain manageable for years to come.
Unfortunately, it's looking like a few foreigners have
already become less enthusiastic about accepting our
"Benjamins,""Andrews" and"Abrahams."

- Many foreign creditors, especially the Japanese, are
shifting assets out of dollars into euros. As Barron's Vito
J. Racanelli remarks,"Investors in the Land of the Rising
Sun are increasingly disaffected with U.S. assets and have
suddenly warmed up to the allures of Europe. Data from
Japan's Ministry of Finance show that Japanese residents
invested $9.1 billion in eurozone assets in November,
primarily bonds, compared to $5.3 billion in U.S.
securities, while selling $600 million in U.K. assets.

-"For the fiscal year (which begins in April in Japan)
through November," Racanelli continues,"[Japanese]
investment in the U.S. was double that of [their investment
in the] eurozone, but in August, October and particularly
November, more cash went to Europe than America."

- Is it any wonder the dollar is stumbling? If the Japanese
stop plugging the foreign exchange leaks springing from
America's massive current account deficit, the dollar's
problems will become very severe very quickly.

- The dollar is but the latest victim of America's post-
bubble economy. Given the fact that our economy is beset by
the twin evils of excess capacity and feeble demand for
goods and services, the near-term investment prospects
aren't terrific. And that means that foreign capital will
flee the U.S. looking for better opportunities elsewhere.

-"The key factor to remember in assessing the economic and
stock market outlook is that this is not a typical post-war
bear market, but the unwinding of the mania that occurred
in the late 1990s," Comstock Partners reminds us,"and we
are now suffering from the consequences. That is why
mainstream economists and strategists who ignore the bubble
and continue to use the post-war period as their framework
are missing the big picture and making so many erroneous
forecasts. We believe that the unwinding of the bubble is
far from complete and that the market still has a long way
to go on the downside."

------------

Back in Paris...

*** We are unwinding the '90s mania, as the Comstock
Partners remind us. But we can't help but think that there
is more to it. The stock market mania climaxed from a more
important spectacle: the information revolution and the
democratization (in both markets and politics) of amplified
mob sentiments. Suddenly, there was a fool on every TV and
computer screen urging people to believe what couldn't be
true - that they could all get rich together in stocks (15%
annual returns forever!)...that paper money would go up
against real money (gold) until Hell froze...and that
consumers could borrow and spend their way to wealth.

The lumpeninvestoriat have been bruised and abused. They've
lost half their money in stocks...and are deeper in debt
than at any time in history. Will they suddenly come to
their senses? Or will they cling to their illusions, like
die-hard German soldiers defending Berlin in '45, until
they are completely and utterly crushed?

***"The policy of the U.S. central bank is going to
destroy the dollar," Felix Zulauf continued, speaking to
the Barron's Roundtable."Confidence in the U.S. currency
at some point will collapse, and you'll have a run on
dollars. Money can't go to other currencies, because they
have to support the dollar. Gold will act as a monetary
currency - a currency without the liabilities of ill-guided
central bankers. Another way of looking at it is to say the
U.S. has underinvested in capital investment to supply the
goods that U.S. consumers are demanding. You have spent
your money by buying on credit instead of investing. The
Chinese are investing. They are building an empire."

*** Oh là là...Elizabeth returned from a parent-teacher
meeting with a worried look on her face.

"It was horrible," she reported."They said he never pays
attention...that he turns around and talks to his
friends...that he won't sit still...that he's way behind
the other children..."

"It sounds like he acts at school just as he does at home,"
replied his father."At least he's consistent."

"And he's going to fail. We'll have to find another school
for him."

Poor Edward, a failure at age 9. If he is kicked out of the
best primary schools, he will not get in the best high
schools...and then, no Andover...no Harvard or Yale...What
will become of him, his mother wondered?

"He's pretty good at helping me on the stone walls," said
the father, still trying to look on the bright side,"maybe
he could become a stonemason. It's more fun than sitting at
a desk and you can talk all you want."


PANACEA DU JOUR
by Kurt Richebächer

It used to be elementary knowledge among economists that
rising investment in tangible assets - factories, offices,
machinery and other forms of equipment - is paramount for
economic growth and general prosperity.

First, it generates demand, employment, incomes and
tangible wealth while the factories and the equipment are
built and produced. Once the capital goods are installed,
they increase supply, employment, incomes and productivity.
The key point to see is that investment is the one and only
GDP component that adds both to demand and supply.

But mainstream American economic thought seems to overlook
this reality. It places, first of all, an unusual emphasis
on consumption as the prime mover of economic growth, and
there is furthermore a general disregard of what is
happening to saving and capital accumulation.
Alternatively, the emphasis is on autonomous changes in
productivity growth through new technologies as the root
cause of economic growth and profitability.

This is a radical departure from the thinking of the old
economists. Measured by the rate of productivity growth,
the U.S. economy appears to be in excellent shape,
definitely better than the whole rest of the world. But
measured by its record-low rates of saving and capital
accumulation, it is in most miserable shape. What is the
right interpretation?

For America's policymakers and economists, productivity
growth seems to be that great magic that solves all
problems and that will sustain an economic recovery. It
appears to be a widespread view that the measured stellar
productivity growth is the main warrant of a mild recession
and of an impending recovery.

The crucial point to see about productivity growth is that,
by itself, it only means that hours worked have risen less
than real GDP. But there is nil economic merit in this
effect unless it is accompanied by an improvement in some
other kind of the economy's performance such as growth of
output, profits or investment. In the case of the United
States, in actual fact, everything else is deteriorating.
That is probably the main reason for the general, singular
focus on productivity growth.

Looking at the whole postwar period, the United States
actually experienced its most vigorous and definitely its
most healthy economic performance in the 1960s. Its rates
of national saving and of capital investment were then at
their highest in the whole postwar period, and so were its
rates of business profits. The main purpose of moderate
borrowing on the part of the consumer at the time was the
financing of new homes, and the main purpose on the part of
businesses was the financing of new investment in plant and
equipment, that is, in tangible assets. In essence, it was
overwhelmingly borrowing for capital formation.

This pattern of borrowing began to change gradually in the
1970s and rather dramatically in the 1980s. From then on,
debt growth went exponential. Consumer debts have since
skyrocketed by 473% and business debts by 382%. These
numbers compare with simultaneous GDP growth by 283%.

A drastic change in the use of the new debts was the other
striking new feature of the developing borrowing binge.
Exploding credit quantity implied plunging credit quality.

Consumers started to borrow like crazy to finance increased
current spending, and businesses borrowed like crazy no
longer to invest in plant and equipment, but to finance
financial transactions - mainly leveraged stock buyouts,
mergers, acquisitions and stock repurchases - that were
thought to be more appropriate for quickly raising
shareholder value.

Ever since firms and retailers invented consumer
installment credit in the 1920s, U.S. economic growth has
become heavily geared to consumer spending and borrowing.
But this traditional consumption bias took a big leap in
the 1980s and in particular in the late 1990s. The most
striking characteristic of both periods were exploding
consumer debts and collapsing national saving.

In the 1980s, in actual fact, the hemorrhage of national
saving had caused great and widespread concern. Many
American economists expressed their strong misgivings about
the implicit negative effects on capital investment. This
time, in diametric contrast, nobody seems to care or even
take notice.

There seems to prevail a widely accepted view that credit
creation makes old-fashioned saving from current income
superfluous. As to the equal utter lack of interest in
capital formation, the apparent explanation is a singular
focus on productivity growth. Why are saving and investing
even necessary, if the U.S. economy is enjoying stellar
productivity growth without them?

What's wrong with this view? In short, everything. It's
macroeconomic nonsense.

Productivity growth is not the panacea for which American
policymakers and most economists seem to take it. If there
is insufficient demand, as today, increasing productivity
can only result in increasing numbers of unemployed
workers, declining capacity utilization and, ultimately,
slower growth.

What really induced generations of economists of all
schools of thought to elevate saving to an indispensable,
key condition for economic growth? The basic reason is that
it is the limiting factor for capital investment. Short of
nirvana, all resources are scarce. Due to this elementary
wisdom, new capital investment can only come about to the
extent that somebody makes the resources for the production
of the capital goods available. That somebody happens to be
mainly the consumer. By saving, that is, by spending less
than he earns, he effectively releases the necessary
productive resources for investment.

But this necessary release of productive resources is true
only for saving from current income, coming implicitly from
current production. The attendant release of resources is
what makes this kind of saving indispensable for investment
and economic growth.

In essence, capital formation represents the surplus of
production over consumption, and that has to be made
possible by saving. To quote Friedrich Hayek on the
subject:"Saving is not synonymous with the formation of
capital, but merely the most important cause which normally
leads to this result."

A lot of energy has been devoted to whether there will be a
double-dip into recession. This is the wrong question. What
really matters, instead, is whether capital spending will
rebound after its steepest decline in the whole postwar
period. This is also a question that can be answered with
reasonable foundation from the available data.

If yes, the U.S. economy has a chance for a sustained
recovery. If not, it will be Japanese-style near-stagnation
and sub-par growth for years to come. We think the
prevailing conditions speak overwhelmingly for the latter.


Regards,

Kurt Richebächer
for the Daily Reckoning

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• Panacea Du Jour von Richebächer / The Daily Reckoning - - ELLI -, 21.01.2003, 22:28