Who will tell the US to drop dead?
12 JULY 2011
Dow down 151 points yesterday. Asian markets down again this morning...
"Panic in markets caused by debt crisis," says the headline in the French newspaper, Le Figaro.
Which debt crisis, we wondered?
In Europe, no sooner was one can kicked down the road than another one showed up. Greece disappeared from the headlines. Italy took its place.
We haven't studied the Italian problem in any detail. It may not be a problem at all. But the amounts are larger - too big to bailout, according to one report.
Europe seems to be taking a tried and true approach to its debt crises. It kicks the can down the road a few times. Then, when it has exhausted bad choices, it turns to a good one. Having run out of foolish and phony solutions, in other words, the authorities are taking up one that works. They're telling Greece to drop dead. The latest news: Greece will be allowed to default.
Of course, you knew that was the thing to do from the get-go. Remember Gerald Ford's famous reply to New York City in the '70s? New York was on the verge of bankruptcy. So it appealed to Washington for a bailout. Ford, who had more sense than any major politician since, responded: Drop dead. And if he didn't actually say that, he should have. For those were "les mots justes" - exactly the reply that the occasion called for.
Having no other recourse, NYC had to shape up. Which it did. It got rid of many of its unionized zombies...cut expenses....and the Big Apple was a better place for it. (It didn't hurt that New York was also the center of America's financial industry, which began a historic boom a few years later.)
Greece would be a better place too if its politicians would stop spending more than the people can afford.
But now we turn to the other part of the world with a debt crisis - that part of the world which sits between the world's two large oceans, and between the 49th parallel and the Rio Grande. Yes, dear reader, we are talking about the USA.
Yes, the USA still has plenty of bad choices to make before it is finally forced to make a good one. Sometimes a great empire goes broke. Sometimes it is defeated militarily. Usually, it suffers both calamities before coming to its senses.
So, dear reader, make sure you put yourself and your wealth out of harm's way. And lay up a good supply of alcohol and anything else you might need to enjoy the show. It's going to be exciting.
The problem for the USA, in a nutshell, is that there is no one to say 'drop dead.' New York had Washington. Greece has Germany. Philip II had Sir Francis Drake. Custer had Sitting Bull. But who does the USA have? Abroad, its armies meet no effective opposition. At home, its spendthrifts run wild.
Perhaps most important, it has a printing press with no lock on the door.
Eventually, bond investors will have their say. But that could be far in the future...long after the nation has done itself irreparable harm.
Yesterday, we reported that people are coming around to our point of view. They're beginning to realize that these are not ordinary times. The recession was not ordinary...and we have no ordinary recovery. What's more, the slump looks like it will last for years. Even the Secretary of the Treasury seems to see it that way.
Investors are still bullish. They're heavily invested in stocks at very high prices. They see high earnings and no reason for the bull market to falter. What they don't realize is that those high earnings are part of the problem. First, because earnings are 'mean reverting.' When they are low, they are likely to go higher; when they are low, they are likely to go higher. And second, because the earnings represent efficiencies which actually herald a weaker economy. A business increases its earnings by spending less on labor, for example. The result: working people find fewer jobs and earn less income.
Investors still don't realize what is going on. They have largely recovered their stock market losses from the '07-'09 crisis. But the economy has not recovered. Working households - especially those in the middle - still have huge losses on their houses. More than $7 trillion has been lost so far...and the losses continue to grow.
And it is harder than ever to find a good job. Two years after the recovery supposedly began, and real unemployment is going up.
Can QE 3 be far away?
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*** The Wall Street Journal/Marketwatch reports:
If losing half your meager life savings weren't bad enough, the middle class has also been falling behind in terms of income for decades. Families in the middle make most of their money the old-fashioned way: Working their fingers to the bone for 40 years for wages and a modest pension.
*** If the real cause of the slowdown is consumer debt, then you obviously can't make the problem go away by lending consumers more money. That's why all the feds' efforts have failed.
The middle class has been getting a smaller and smaller share of the pie over the past 40 years. Their wages have been flat after adjusting for inflation. In the late 1960s, the 20% of families right in the middle were earning almost their full share of the pie: they had 17.5% of total income. Their share has been falling steadily ever since. Now, that 20% is earning just 14.6% of all income. Meanwhile, the top 5% captured a growing share, going from 17% in the late 1960s to 22% today.
The housing bubble was the last chance most middle-class families saw for grasping the brass ring. Working hard didn't pay off. Investing in the stock market was a sucker's bet. But the housing bubble allowed middle-class families to dream again and more importantly to keep spending as if they were getting a big fat raise every year.
During the last expansion from 2003 to 2007, according to an analysis by Fed economists, American homeowners took $2.3 trillion in equity out of their homes through cash-out refinancing and home-equity loans, and they spent about $1.3 trillion of it on cars, boats, vacations, flat-screen televisions and shoes for the kids.
All that spending circulated through the economy, creating millions of jobs here and in China, where they make those TVs and shoes.
During that period, the economy grew at an annual average rate of 2.7%, which is about Now that the bubble has burst, homeowners are putting money INTO their homes, not taking it out. The impulse to pay down the mortgage and the credit card is reducing the amount of money we're spending on other things. Since 2007, instead of taking $2 trillion out of their house, homeowners have put $1.3 trillion into them.
You think that might be having an impact on consumer spending?
The slow growth in the economy is no mystery: Most families don't have any extra money to spend. It will take a long time for the middle class to rebuild its wealth, especially if we don't find some work.
The crazy thing is that our leaders aren't even talking about this crisis. ...
So, what happens?
Consumers need to pay down what they can pay ...and default on what they can't. Right?
When the crisis began, we estimated that it would take 5 to 10 years for the downswing in the credit cycle to run its course. We're already in year 5. Debt to disposable income was 130% at the height of the bubble. Now, it's 115%. Hmmm. Not much progress. Consumers dragged their feet on debt consolidation. Because they believed the feds when they said recovery was right around the corner...and because the feds continued to lend them money.
Felix Zulauf says he thinks the world economy will begin an inflationary depression over the next 3-5 years. That would speed up the process. Inflation would lighten the debt load, generally. Depression would cause much debt to be written off, defaulted, foreclosed and so forth.
But if things keep limping along as they are now - a la Japan - this slump could last for decades. In 1976, debt was only 60% of disposable income. At the present rate, it will take 18 more years to get to that level.
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