 The Great Wealth
Deception
Dr. Kurt Richebächer
The
Daily Reckoning
April 25, 2005
The Daily Reckoning PRESENTS: The U.S.'s economic recovery since
2001, despite what others may say, is practically non-existent.
Dr. Richebächer wonders if this quest for an economic rebound
has been abandoned - or simply delayed...
This is the most important
economic question in and for the world: Has the U.S. economy's
rebound since 2001 been aborted, or is it only delayed? Our rigorous
disagreement with the global optimistic consensus over this question
begins with four observations that we regard as crucial:
1. In the past four years, the U.S. economy has received the
most prodigious monetary and fiscal stimulus in history. Yet
by any measure, its rebound from the 2001 recession is by far
the weakest on record in the post-World War II period.
2. Record-low interest rates boosted asset prices and, in their
wake, an unprecedented debt-and-spending binge on the part of
the consumer.
3. What resulted was a badly structured economic recovery, which
- due to grossly lacking growth in capital investment, employment
and wage and salary income - never gained the necessary traction
to become self-sustainable.
4. Sustained and sufficiently strong economic growth implicitly
requires a return to strong business fixed capital spending.
We see no chance of this happening. Above all, the outlook for
business profits is dismal from the macro perspective.
This takes us to the enormous structural changes that the Fed's
new monetary "bubble policy" has imparted to the U.S.
economy over the years. While consumption, residential building
and government spending soared, unprecedented imbalances developed
in the economy - record-low saving; a record-high trade deficit;
a vertical surge of household indebtedness; anemic employment
and income growth from wages and salaries; outsized government
deficits; and protracted, unusual weakness in business fixed
investment.
None of these shortfalls is a typical feature of the business
cycle. Instead, they are all of unusual structural nature. Yet
the bullish U.S. consensus simply ignores them, bragging instead
about the U.S. economy's resilience and its ability to outperform
most industrialized countries.
To be sure, all these structural deformations tend to impede
economic growth. Some, like the trade deficit and slumping investment,
do so with immediate effect; others become repressive only gradually
and in the longer run. Budget deficits stimulate demand as long
as they rise. An existing budget deficit, however large, loses
this effect. Rather, it tends to become a drag on the economy.
In the past few years, clearly, the massive monetary and fiscal
pump-priming policies have more than offset all these growth-impairing
influences.
Assessing the U.S. economy's future performance, it is necessary
to distinguish between two opposite macro forces: One is the
drag on the economy exerted by the various structural distortions;
the other is the enormous demand-pull fostered by the housing
bubble and the associated rampant credit creation.
Measured by real GDP growth, the demand-pull driven by the housing
bubble has, so far, overpowered the structural drags, provided
you believe in the accuracy of the GDP numbers. We do not. Yet
even by this measure, as repeatedly explained, it is actually
by far the U.S. economy's weakest recovery on record in the postwar
period. In fact, measuring the growth of employment and wage
and salary income, there has been no recovery at all.
Our stance has always been and remains simple. Asset bubbles
and their demand effects invariably fade over time; structural
effects invariably worsen over time if not attended to. It is
our strong assumption that the negative structural effects are
overtaking the positive bubble effects.
We come to another feature of economic recoveries that American
policymakers and economists flatly ignore. That is its pattern
or composition.
Past cyclical recoveries were spearheaded by three demand components:
durable consumer goods, residential building and business fixed
investment, regularly following prior sharp downturns caused
by tight money during the recession. Importantly, the tight money
had always created pent-up demand in these three categories,
which promptly catapulted the economy upward when monetary policy
eased. For sure, the pent-up demand played a key role in the
recovery dynamics.
With its rapid and drastic rate cuts, the Fed rewrote the rules
of the traditional business cycle and related policies. It managed
a seamless transition from equity bubble to housing bubble. Consumer
spending on durable goods continued to forge ahead during the
2001 recession at an annual rate of 4.3%. Residential building
never retreated, while business fixed investment took an unusual
plunge.
From 2000-04, consumer spending soared by 27.3% on durable goods
and 25.4% on residential building. Government spending, too,
rose sharply, by 13.9%. Together, the three components accounted
for 123% of real GDP growth.
But in the rest of the economy, it was all misery. Despite a
modest rebound, business nonfinancial fixed investment in 2004
was still down 0.2% from 2000. Exports of goods posted a minimal
gain of 0.1%, whereas imports of goods shot up by 16.5%.
Thanks to the sharp decline in interest rates over the last few
years, sharply inflating house prices have been a rather common
feature around the world. Still, there is one crucial difference
among the countries concerned. There are countries in which the
rising house prices have fueled borrowing-and-spending binges
by private households, and there are others where these binges
are completely absent. Typical for the first pattern are all
Anglo-Saxon countries; typical for the latter are most eurozone
countries.
Even among the Anglo-Saxon bubble economies - meaning countries
where the house-price inflation led to borrowing-and-spending
sprees - the United States is a unique case. It concerns the
official and public attitude to such bubble-driven economic growth.
The United States is the one and only country in the world where
monetary policy was systematically designed toward the goal of
inflating the market value of assets - stocks, houses and bonds
- virtually making wealth creation through inflating asset prices
their explicit goal.
In Britain and Australia, the associated borrowing-and-spending
binges are even worse than in the United States. Yet there is
a general apparent reluctance to embrace this growth model as
an unmixed blessing. Central bankers who celebrate this as "wealth
creation" and even explicitly animate people to exploit
the possibilities of easy credit to lift their spending on consumption
are unique to America.
For generations of economists, it used to be a truism that "wealth
creation" implies capital formation in terms of generating
income-creating tangible assets. The emphasis was on capital
formation and the associated income creation. To indiscriminately
put this label of "wealth creation" on rising asset
prices in the absence of any income creation is plainly a novel
usurpation of this concept. It is in essence wealth creation
through a stroke of the pen.
Measured by their net worth (market value of household assets
minus debts), American households have amassed unprecedented
riches in the past few years, despite spending in excess of their
current income as never before.
The first question springing to mind in the face of this "wealth
miracle" is its cause or causes, leading immediately to
the next question: whether or not this drastic increase of house
prices relative to the consumer price index has to be seen as
a "bubble," which sooner or later have the habit of
bursting.
In old textbooks, you would read that higher saving increases
capital value. But in the U.S. case, capital values have soared
while personal and national saving has collapsed. What else,
then, has the power to lift asset prices?
Everybody knows the answer, but few want to admit it: Lured by
artificially low interest rates and easily available credit,
private households have stampeded as never before into the purchase
of homes, boosting their prices. Artificially low interest rates
and easily available credit are, actually, the key features that
specifically qualify an asset bubble.
The growth of home mortgages exploded from an annual rate of
$368.3 billion in 2000 to an annual rate of $884.9 billion in
2004, compared with a simultaneous increase in residential building
from $446.9 billion to $662.3 billion. Altogether, the United
States experienced a credit expansion of close to $10 trillion
during these four years. This equates with simultaneous nominal
GDP growth of $1.9 trillion. America's financial system is really
one gigantic credit-and-debt bubble.
Our general misgivings about "wealth creation" simply
through rising house prices has still another reason, however,
and that is the way housing values are calculated. The conventional
practice in America is to treat the whole existing housing stock
as being worth the last trade. We do not think this makes sense,
considering that current sales are always marginal to the whole
capital stock.
This way of calculating wealth creation naturally explains the
extraordinary rapidity with which it can deluge an economy, creating
trillions of dollars of such wealth in no time. For sure, this
contrasts wondrously with the tedious process of generating prosperity
through saving, investment and production.
In earlier studies published by the International Monetary Fund
about asset bubbles in general, and Japan's bubble economy in
particular, the authors repeatedly asked why policymakers failed
to recognize the rising prices in the asset markets as asset
inflation. Their general answer was that the absence of conventional
inflation in consumer and producer prices confused most people,
traditionally accustomed to taking rises in the CPI as the decisive
token for inflation.
It seems to us that today this very same confusion is blinding
policymakers and citizens in the United States and other bubble
economies, like England and Australia, to the unmistakable circumstance
of existing rampant housing bubbles in their countries.
Thinking about inflation, it is necessary to separate its cause
and its effects or symptoms. There is always one and the same
cause, and that is credit creation in excess of current saving
leading to demand growth in excess of output. But this common
cause may produce an extremely different pattern of effects in
the economy and its financial system. This pattern of effects
is entirely contingent upon the use of the credit excess - whether
it primarily finances consumption, investment, imports or asset
purchases.
A credit expansion in the United States of close to $10 trillion
- in relation to nominal GDP growth of barely $2 trillion over
the last four years since 2000 - definitely represents more than
the usual dose of inflationary credit excess. This is really
hyperinflation in terms of credit creation.
In other words, there is tremendous inflationary pressure at
work, but it has impacted the economy and the price system very
unevenly. The credit deluge has three obvious main outlets: imports,
housing and the carry trade in bonds. On the other hand, the
absence of strong consumer price inflation is taken as evidence
that inflationary pressures are generally absent. Everybody feels
comfortable with this (mis)judgment.
Regards,
Kurt Richebächer
for The
Daily Reckoning
 email: richebacher@agorafinancial.com
Dr. Kurt
Richebächer
is the editor of The Richebächer Letter. Former Fed Chairman
Paul Volcker once said: "Sometimes I think that the job of
central bankers is to prove Kurt Richebächer wrong."
A regular contributor
to The Wall Street Journal, Strategic Investment and several other
respected financial publications, Dr. Richebächer's insightful
analysis stems from the Austrian School of economics. France's
Le Figaro magazine has done a feature story on him as "the
man who predicted the Asian crisis."
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