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| Friday, July 10, 2009 - Capitalism rewards those who save their money…
- Get ready for the long, slow slump…
- China's 'new dig' at the dollar…
- Bill Bonner on the world's great bubble deniers…and more!
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The Great Credit Contraction Cometh
by Bill Bonner
London, England
"In a fundamental shift, consumers are saving rather than spending," notes the
Los Angeles Times.
This is the shift we've been talking about for months. The great credit
expansion of 1945-2007 is over. Now cometh the great credit contraction.
During the bubble years, more and more credit produced less and less real
prosperity. It was as if you were borrowing more and more, to invest in your
business or merely to increase your standard of living, but your income didn't
rise fast enough to keep up with the interest payments.
In 2005, Americans saved nothing. Not even aluminum foil or string. Now,
the savings rate is approaching 5% of disposable income – a big
turnaround.
We know from logic and experience that saving money – not spending it – is
the key to getting wealthier. Saving money gives you capital. And it's capital
accumulation – in the form of factories, roads, ships, buildings,
machines...and raw savings – that gives people the ability to produce more. It
may take a man with a shovel a whole day to dig a decent grave. Give him
capital – in the form of a backhoe – and he can bury everyone in town. That's
why capitalism works. It rewards the fellow who saves his money.
Yet every yahoo economist in the year of our Lord 2009 takes news of rising
savings rates like the death of Michael Jackson. If households don't consume,
they reason, how can a consumer economy grow?
The problem is that you can't really grow an economy by borrowing and
spending.
Recent history proves it. Despite the biggest splurge of borrowing and
spending in history, the US consumer economy barely grew at all.
"In the five years to December 2007," reports Grant's Interest Rate Observer,
"America's credit market debt climbed by nearly 57%, to $18 trillion.
However, in the same half-decade, nominal GDP was up by only $3.3
trillion."
For every five dollars people borrowed, they only increased their incomes by
$1. Imagine that the borrowing had an average effective interest rate of 10%
(credit card debt can be much more expensive). At that rate half of the
additional income earned between 2002 and 2007 had to be used just to pay
the interest.
This was not the kind of growth that was likely to last. In fact, it didn't.
The whole thing came crashing down in '07 and '08. And now, the consumer
has had a cup of coffee. He's looked at himself in the mirror. He's sorted
through his pile of bills. And he's made up his mind: that's enough of that!
"The ratio of cash held by households as compared with assets has been rising
sharply," says James Saft in The New York Times.
"Companies, households and banks all want to pay down debt and...prefer to
hold cash rather than assets, partly because the outlook for those assets is poor
and partly because after a decade of excess, everyone now looks a bit over-
extended.
"This is exactly what happened in Japan during its lost decade, when a
balance sheet recession, one characterized by the paying down of debt and
liquidations of assets, was self-reinforcing and very difficult to stem."
And now this from David Rosenberg:
"The ultimate question is where all this cash is going to be deployed, and
we believe it will ultimately be diverted toward debt repayment."
Let's see. We can figure this out from the numbers above. American
consumers must have added about $7 trillion in extra debt during the Bubble
Epoque, 2002-2007. Now, instead of buying things, they use their money to
pay it down. The average household has about $43,000 worth of income. Let's
keep the math simple by saying there are 100 million households in the United
States...and that they save 5% of their income. And let's say they use every
penny of savings to pay down debt. Hey...it will only take about 30 years to
pay it off! Get ready for a long, long slump.
To read more about the drag the lack of consumer spending will have on the
US economy, see The Richebacher Letter's latest report here.
More news from The 5 Min. Forecast:
"Every once in a while we stumble upon a chart or table that says it all,"
writes Ian Mathias in today's issue of The 5. "Here's one hot off the press:
"Oh my, where do we begin? This beast calls for bullet points. - Obviously, Wal-Mart is no longer No. 1. That title now goes to Royal
Dutch Shell. The American consumer is out, and a global oil
conglomerate is in… 'nuff said
- There's a clear sea-change in American business. AIG, Lehman and
Bear Stearns fell off the list from 2008-2009. Nike, Google and
Amazon moved up.
- The world is increasingly less Amero-centric. An American company
is not No. 1 for the first time in over a decade. In the whole list for
2009, 140 companies are American, the lowest number on record
- The world is increasingly more Sino-centric. Look at China National
Petroleum and Sinopec. Both Chinese companies are by far the biggest
movers up from 2008-2009. Sinopec, an oil and gas company, also
marks China's first foray into Fortunes' Top 10. China now has 37
companies in the list of 500, its largest presence ever
- Oil is still where it's at. In spite of all the price drama over the last
year, seven of the top 10 firms are oil companies.
- In the face of the worst global economic environment of our lifetimes,
the world's biggest companies are still making lots of money. The
2008 top 25 pulled in $4.88 trillion in revenue. This year they made
$5.38 trillion.
- And freakin' GE… what a black box. The world's producer of
everything was one of very few companies to retain the same position
from 2008 to 2009. And despite the infamous GE Capital, the finance
arm that apparently threatened to torpedo the whole company, GE
ended up increasing revenues by nearly $7 billion. "Hmmm…"
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And back to Bill, with more thoughts:
Yesterday, stocks went nowhere. Oil went nowhere. And the dollar went
down as gold went up.
The reason for the dollar's decline and gold's rise was given in the front-page
headline of today's Financial Times. China launched a "new dig" at the dollar,
it says. As near as we could tell, China merely stated the obvious – that the
world is going to have to find a better monetary system. The US dollar won't
be king of the hill forever. And China, which is up to its neck in dollars,
would like to find a solution sooner rather than later – that is, before the dollar
goes the way of all paper.
The dollar will eventually give way to inflation and devaluation, but probably
not soon.
"I'm absolutely worried about inflation," says John B. Taylor.
But here at The Daily Reckoning, it is not inflation that worries us...it's the
lack of it. Making a long story short, as long as the feds see no inflation they
will continue trying to create it. In the end, they will get more than they
wanted.
And where will investors flock when that day comes? You guessed it – to our
favorite yellow metal. Beat the rush…pad your portfolio with gold now.
Though, right now, instead of inflation, we have deflation. Today's New
York Times tells us that deflation in Ireland has reached 5.4% — the highest
since the Great Depression of the '30s.
You know the reasons for deflation as well as we do. The world suddenly has
too many people who borrowed too much money buy too many things they
really didn't need and really couldn't afford. This caused the world's
producers to greatly over-estimate the 'real' demand. Their customers began
to disappear in 2007. Their factories are still standing.
"Is it always so cold in July?" asked an American visitor yesterday. London
has been cold, windy and rainy for the last week. It comes as a shock to
American tourists, who inevitably show up in shorts and t-shirts.
Europe has a milder climate than North America. Our guest comes from
Ottawa, Canada.
"Everybody thinks it is so cold in Canada. But it's much hotter there than it is
here. A lot of houses in Ottawa have air conditioning. Here, almost no one has
it. And I guess they don't need it."
But in the winter, the streets of North American cities turn bitter cold and
bums freeze up on the sidewalks. That doesn't happen in Europe. It rarely
gets cold enough to freeze a bum here. Maybe that's why there are so
many of them.
Around the corner from our office is something we had never seen before. A
mother-daughter team of 'street persons.' Dressed in black rags, they sit with
their bags and talk. They are there when we get to the office in the morning.
They are there when we leave in the evening.
The daughter appears to be in her 20s or early 30s. She is a pretty girl, as near
as we can tell. The mother must be in her 50s...maybe 60s. The two look very
similar – like the mother/daughter combinations you see in skin cream
advertisements. They dress the same. They have the same very English faces.
They have the same expressions and same postures...sitting on the sidewalk
with the backs to the wall. Whenever we pass, they are chatting with each
other – happily, it appears.
Keep reading for today's essay, below…
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| The Daily Reckoning PRESENTS: Why do smart people do such stupid
things? Why couldn't the crème de la crème of the economic world see the
runaway train that was the credit and consumption bubble racing toward them
at warp speed? Bill Bonner examines these questions – and more – in today's
essay, below…
Bubble Deniers
by Bill Bonner
London, England
"War Criminal says Sorry, Sobs," was the headline in the Nation on February
9th, 2004. Robert McNamara had just done something extraordinary for
Secretaries of War: with tear in his eyes, he apologized for his role in the
Vietnam War. The war made ghosts out of 58,000 American soldiers. On the
Vietnamese side, the total was over a million. This week, McNamara went to
meet them.
Why do smart people do such stupid things? The French had already shown
what Western powers were up against in Indochina. De Gaulle had warned
Kennedy that it was a "rotten" country. Still, the United States sent in
troops...and McNamara, to his credit, spent the last 40 years of his life
regretting it.
We do not disrespect the shades here on the back page. But once they are
down, we can hardly wait for the autopsy report. We want to know what was
wrong with them. McNamara had a brain "like a computer," say the
morticians. Too bad. He needed more than that.
Robert McNamara was described in the obituaries as the "architect" of
the Vietnam War. This is libelous to real architects; as near as we could tell,
the war went on without plans or blueprints. Instead, Robert McNamara took
an economist's approach to war. His formula had only three numbers: how
much damage he could inflict on the enemy; at what price; and how much
pain the Vietcong/North Vietnamese could stand. Later, he discovered that the
enemy wasn't even counting.
Long gone are the days when economists thought deeply about how life
actually works. Adam Smith, Adam Ferguson, Anne-Robert Turgot – the
great "moral philosophers" – all died hundreds of years ago. Since then, the
trade has gone bad. They're all numbers guys now. An economist, of the
modern variety, is a statistician...an extrapolator...and a mountebank. If
numbers go up two months in a row, he predicts they will go up another one.
He rarely stops to ask whether his numbers really make any sense.
Instead, he merely adds them up and rolls them out. Thus – at the bubbly top
in 2006 – he was he able to describe the likelihood of default on a certain
derivative instrument as a "Six Sigma event" without laughing. A Six Sigma
event happens once every 2,500,000 days. Then again, when the Bubble of
2002-2007 popped, they happened once a week.
| "Do these setbacks cause economists to stop and wonder if their theories are bogus and their numbers are nonsense? Nope, they do what McNamara did. They turn up the heat.
They propose to spend more money they don’t have on more programs that don't work." | | The blogs are full of chatter on the subject. What good is the economics
profession, asks Paul Samuelson, if it cannot foresee the biggest single
economic event in at least a quarter-century?
Yet, those same economists – who had failed so miserably at diagnosis and
prevention – they barely hesitated. Rather than spend months in drunken
shame, contemplating their own incompetence, and wondering what a bubble
really is, they denied the wild bubble side of life altogether...and tried
their hands at prescription. President Obama's economics advisors went to
Congress last autumn to predict that without the stimulus measure joblessness
in the United States could rise to 8%! Bernanke made it seem that if the bill
wasn't passed that day, the economy may cease to exist all together. How he
could know the future, when he demonstrably knew so little about the recent
past, was a mystery. Still, the politicians responded by enacting the biggest
bank bailout boondoggle in history.
What would have happened had the legislators failed to jump when
economists threw them a bone? We don't know. But we know what happened
after the stimulus measures were passed – they failed to stimulate. The
employment numbers for June showed that economists had misjudged both
the direction and the speed of the oncoming bus. Instead of shifting down, the
rate of job losses increased to 9.5% in the United States. Instead of going
forward, the economy was backing up!
Do these setbacks cause economists to stop and wonder if their theories
are bogus and their numbers are nonsense? Nope, they do what McNamara
did. They turn up the heat. They propose to spend more money they don't
have on more programs that don't work. Predictably, Obama advisor Laura
Tyson now suggests that the stimulus thus far is "too small." Other
economists too are talking about a "son of stimulus," that will offer even more
credit to the debt-saturated consumer. Only trouble is, neither consumers,
businesses nor banks cooperate. Despite trillions in cash and credit to the
financial system, lending is still going down.
Robert McNamara was as smart as any of today's number crunchers. A
Harvard "whiz kid' with a 'can do' attitude, he was one of the 'brightest and
the best,' the kind of American that makes you proud to be one. He was an
efficiency expert. But everything has its place. Poetry is not much in demand
from bridge builders. In love, war and bubbles, on the other hand, rational
efficiency is at best a second tier concern. When asked to take the job at the Defense Department, McNamara replied to
John Kennedy that he was "not qualified." That was the last thing he was right
about. As to everything else, he missed the point completely.
Sometimes it is the brain that fails. Sometimes, it is something else.
Enjoy your weekend,
Bill Bonner
The Daily Reckoning
P.S. Our annual Agora Financial Investment Symposium in Vancouver,
British Columbia is rapidly approaching…and this year marks the 10th
anniversary of The Daily Reckoning. So, this July, the Symposium will be
focused around a "Decade of Reckoning"…four days that will help you to
gain greater insight on how to turn investment ideas into the profit
opportunities of the next decade.
This event is already 70% sold out…secure your spot now. Click here for all
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The Agora Financial Investment Symposium: July 21-24
Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning.
He is also the author, with Addison Wiggin, of the national best sellers
Financial Reckoning Day: Surviving the Soft Depression of the 21st Century
and Empire of Debt: The Rise of an Epic Financial Crisis.
Bill's latest book, Mobs, Messiahs and Markets: Surviving the Public
Spectacle in Finance and Politics, written with co-author Lila Rajiva, is
available now by clicking here: Mobs, Messiahs and Markets
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