Extracts from The Richebächer Letter – May 2006
THE NEW U.S. ECONOMY
The policy dilemma currently facing the United States can be simply stated. Economic growth has become completely dependent on consumer spending, and this, in turn, has become completely dependent on rising house prices providing the collateral for the most profligate consumer borrowing.
This borrowing has become a necessity because income growth has abruptly caved in. Rock-bottom short-term interest rates and utter monetary looseness were the key conditions fostering altogether four bubbles: bonds, house prices, residential building and mortgage refinancing.
What developed is an economic recovery with an unprecedented array of escalating imbalances: ever-declining personal savings; an ever-widening current deficit; exploding government and consumer debts; and, on the other hand, a protracted shortfall in business fixed investment, employment and available incomes.
We must admit that the staying power of this extremely ill-structured and debt-laden recovery and the stubborn buoyancy of the financial markets have rather surprised us.
But this only lengthens the rope with which to hang oneself. What American policymakers and most economists studiously keep overlooking is that the credit bubbles are doing tremendous structural damage to their economy. The longer the bubbles last, the greater the damage.
DEBT EXPLOSION VS. INCOME IMPLOSION
This time, we want to focus on the dramatic shortfall of employment and income growth that radically distinguishes this recovery from all its precedents in the postwar period. It must have a particular cause, but where is it? In search of its causes, we contrast, first of all, credit and debt growth with income growth.
Over the five years from 2000–2005, total debt, nonfinancial and financial, has increased $12.7 trillion in the United States. This compares with a simultaneous rise in national income by $2.1 trillion. For each dollar added to income, there were $6 added to indebtedness.
In real terms, national income increased little more than $1 trillion. Last year, U.S. private households added $374.4 billion to their disposable income and $1,204.7 billion to their outstanding debts. Inflation-adjusted disposable income grew $115.7 billion. It is a growth pattern with exploding debts and imploding income growth.
To make our point perfectly clear: The present U.S. economic recovery has never gained the traction that it needs for self-sustaining economic growth with commensurate employment and income growth. As to its main cause, all considerations lead to the conclusion that it must reside in the protracted, appalling shortfall in business fixed investment. Investment spending is, really, the essence of economic growth.
Our own considerations begin with the recognition that the U.S. economy is, in every single respect, in far worse shape today than it was in 2000, and also that there is no other bubble in sight to replace the housing bubble. Everything depends on the housing bubble to rapidly reflate once the Fed eases again.
Our strongly held assumption that the U.S. economy is in a most precarious condition basically has two reasons. One is the extravagant size of the housing bubble, involving the whole financial system to an unprecedented extent. The other is the grossly ill-structured economy, replete with imbalances inhibiting sustained economic growth.
Forecasts for the world economy are generally optimistic in the expectation that the U.S. economy will continue its global pull with continuous strong growth. We think the anemic and extremely unbalanced U.S. economic recovery is in its last gasp.
Our key consideration is that the U.S. economy has become perilously addicted to asset inflation in general and the housing bubble in particular. Both rising asset prices and the rising dollar had their foundation in carry trade of astronomic scale. While interest rates may still appear rather low compared with the inflation rates, the Fed’s rate hikes have pulled the rug from under the dollar-based carry trade.
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.