DOSE OF RICHEBACHER

**(see also my friends how my use of 20EMA has kept us on sidelines with bonds, they have broken out large today. Commercial traders, smart money near record LONG.stay tuned)


The Daily Reckoning PRESENTS: Did Hurricane Katrina strike a robust or a fragile and vulnerable U.S. economy? According to many, the economy was expanding strongly - however, Dr. Richebächer thinks otherwise...

AMERICA'S REALITY
by Dr. Kurt Richebächer

Corroboration was seen in particular in recent job gains that were fast enough to lower the unemployment rate to a four-year low of 4.9%. In our view, the plethora of statistical data was overwhelmingly pointing to slowing economic growth.
Consumer spending may have remained surprisingly resilient, but considering its feeble underpinnings in the housing bubble, the time before a marked pullback is, in any case, rather limited. All that is needed to stop the consumer borrowing-and-spending spree in its tracks is a halt to the rise in house prices, implicitly finishing the provision of increasing collateral for higher borrowing.
Reported payroll growth over the first eight months of 2005 has been 1,506,000, averaging 188,000 per month. To those who are impressed, we have to say that this gain is 40% below the average job growth at this stage in past business cycles. Apparently, most economists have jumped to the happy conclusion that ample construction efforts will soon more than offset the initial hit to economic growth. Devastations are not subtracted from growth, while reconstruction is added to it. Such damage has, therefore, generally tended to boost economic growth.
But this time there is a big difference. Past hurricanes have generally hit resort and retirement areas. Katrina has shut down significant regional economic production and port facilities. The Gulf of Mexico accounts for 30% of U.S. oil production and 23% of natural gas production. Economic activity will be significantly constrained from the supply side. In 2004, Louisiana and Mississippi produced 1.2% and 0.6% of U.S. GDP growth.
To quote John Williams' Shadow Government Statistics: "The U.S. statistical bureaus face a reporting nightmare in the months ahead. Door-to-door surveying, telephone surveying and company reporting from the storm-damaged area will not be possible for a month or two, perhaps longer. Many businesses no longer exist. That means that employment and unemployment data, in particular, will have to be guesstimated, and those guesses mean that the Bureau of Labor Statistics can come up with any numbers it desires."
With great interest and attention, we are pursuing the struggle in the U.S. bond market between a large bearish community apparently betting on an impending recession or a period of slow growth triggering the accustomed "Greenspan put" - and a Federal Reserve displaying unprecedented determination to enforce higher long-term rates, so as to slow the housing bubble, increasingly fueled by speculative fervor.
In our view, the bond bulls are right about the economy's weakness. The U.S. recovery is grossly ill-natured, depending fatally on continuous strong support from "asset-driven" consumer spending. Stopping the housing bubble is sure to stop the mortgage refinancing bubble. To us, this seems like pulling the rug from under the table.
While the bond bulls appear perfectly right in their dire assessment of the economy, we think they are playing a dangerous game. Under apparently tremendous pressure to produce profits, they risk a clash with the Fed. For the Fed people, on the other hand, their credibility is at stake.
This might well force them to go further with their rate hikes than they intended.
Further, it has to be realized that today's U.S. bond market is a house of cards. Maintaining long-term interest rates at their present level needs a steady, huge stream of carry trade creating artificial demand for assets. Financial credit soared in the second quarter to $1.124.8 billion at an annual rate, from $648.8 billion in the prior quarter.
If the Fed cracks this trade by inverting the yield curve, this would send long-term rates steeply up. A fire sale of unimaginable proportions could begin, with bond prices crashing. Comparing the credit explosion with the savings implosion and also with a consumer inflation rate now up 3.6% year over year, U.S. interest rates are, in any case, ridiculously low.
Lately, another conundrum has caught our attention: the unprecedented huge and growing wedge between soaring credit growth and dwindling money growth. Our investigations identified two main culprits: the U.S. trade deficit and escalating Ponzi financing of unpaid interest.
The best-known fact about the U.S. economy's recession in 2001 is its extraordinary mildness. There were only two quarters with negative growth. For the year as a whole, real GDP increased 0.8%. This compares with an average decline of real GDP by 2% during previous postwar recessions.
An economy's performance during recession, generally lasting one year, is certainly an interesting aspect. Yet far more important are the strength and pattern of the ensuing recovery over three, four or more years. In essence, it lays the foundation for future longer-term growth. Its composition between consumption, investment, net exports and government spending is, therefore, of utmost importance.
In actual fact, the 2001 recession already had a totally unusual pattern. Prior recessions were triggered by monetary tightening responding to rising inflation rates. Essentially, this put a sharp curb on all credit-financed spending. In practice, these were mainly business investment, both fixed and inventories; residential building; and consumer durables.
Unlike all prior experience, the economic downturn that developed in 2001 clearly had its cause not in tight money and credit. True, during the first half of 2000 the Fed had hiked its federal funds rate in three steps to 6.5%. Yet with a generous provision of bank liquidity, it accommodated a credit expansion of record pace. For the first time ever, the U.S. economy went with roaring money and credit growth into recession - a mild one, though.
Business fixed investment plunged over two years virtually in splendid isolation. Measured in real terms, it fell by 4.2% in 2001 and by 9.2% in 2002, followed by unusually weak growth of 1.3% in 2003. It was by far its worst performance in any postwar business cycle. This investment slump unequivocally broke the boom.
What followed the unique 2001 recession pattern was an equally unique pattern of economic recovery. Still, the unusually fast and aggressive easing had its spectacular immediate and widely trumpeted success in the mildest postwar recession.
Consumer spending never paused, increasing by 2.5% in 2001 and 2.7% in 2002. Its largely credit-financed component of spending on durable consumer goods raced ahead by 4.3% in 2001 and 11.7% in 2002. Equally exceptional was the behavior of residential building. After a slow start, it took off into the famous housing bubble.
Business fixed investment, normally a main driver of recoveries, refused to respond at all. Rather, it accelerated its decline during 2002. And this, in fact, has become and remains America's central structural problem. Though it has recovered from its lows, it is no higher than in 2000. As the recovery developed, American publicity kept hammering into people's heads that the U.S. economy is greatly outperforming Japan and Europe. This conveniently diverted attention from the fact that in reality America had its most anemic recovery in the whole postwar period by any measure.
Still, different measures show very different results. By the reported productivity growth, this recovery resembles a "new paradigm" miracle. By the real GDP numbers, the economy appeared to be doing quite well, though much worse than in past cycles. But in terms of employment and wage and salary growth, this recovery has been and remains a disaster.
Regards,
Dr. Kurt Richebächer
for The Daily Reckoning