Dr Kurt Richebacher "The Kindness of Strangers"

Daily Reckoning PRESENTS:
The United States has broken a lot of records recently...unfortunately, they aren't the kind that will win us any gold medals. How long will our neighbors in the Far East continue to bail us out? Dr. Richebächer investigates...

THE KINDNESS OF STRANGERS By Kurt Richebächer
Renewed weakness in the U.S. economy has hardly come as a surprise to us. It is the inexorable outgrowth of an economic recovery that has been of highly dubious quality right from the start. The U.S. economy is plagued by an extraordinary array of growth-impairing imbalances: a record-high trade deficit, a record-high budget deficit, record-high household indebtedness, record-low national saving and asset price bubbles supporting record-high consumer spending.
Any other country faced with these monstrous domestic and external imbalances would have endured panicky capital flight and a collapsing currency, forcing its central bank to drastic monetary tightening. But the U.S. central bank and the dollar were spared this fate because the central banks of the Asian surplus countries stepped in, accumulating any amount of dollars needed to avoid an undesired rise of their currencies.
In 2003, such dollar purchases by foreign central banks amounted to a stunning $616.6 billion, after $351.9 billion the year before. The total reserves of emerging Asia rose by over $350 billion between the beginning of 2003 and March 2004. Over the same time, Japan's central bank purchased $316 billion worth of U.S. assets. The biggest buyer in emerging Asia was the central bank of China.
These huge and soaring dollar purchases by foreign central banks were crucial in allowing the U.S. Federal Reserve to pursue its ultra-loose monetary policy with ultra-low interest rates. As we have often stressed, this in combination with equally loose fiscal policy has prevented a deeper recession, but the question is whether or not these policies have laid the foundation for sustained economic growth in the longer run.
In our view, it is bad policy on both sides. The Asian central banks accommodate the credit excesses in the United States, and in doing so, fuel rampant credit excesses in their own countries. Japan's horrible aftermath over more than a decade after its credit excesses in the late 1980s does not seem to deter anybody. The United States, on the other hand, is losing jobs to Asia.
Both are courting extraordinary credit excess, but with a crucial difference: In the United States, the credit excess went and continues to go overwhelmingly into asset prices and personal consumption; in Asia, it goes overwhelmingly into capital investment and production, essentially creating a mass of overcapacity and malinvestments. The result is an unprecedented symbiosis between the two continents: The Americans borrow and consume, and the Asians produce.
The U.S. economy has abruptly weakened. Is this weakness just a short-lived "soft patch" caused by higher oil prices, as emphasized by Fed Chairman Alan Greenspan and readily believed by the eternally bullish consensus? Or does it represent the beginning of a more severe downshift to subpar corporate and economic performance, if not worse?
An issue in particular is a slowdown in consumer spending. From the start of 2004 through July, real consumer spending rose by $122.2 billion. That is $209.5 billion, or 2.8% at annual rate, and compares with an overall increase of $232.2 billion (3.3%) in 2003 and of $213 billion (3.1%) in 2002. For perspective, during the boom years 1999-2000, it had growth rates of 5.1% and 4.7%.
Though this deterioration is not dramatic, it also does not suggest an ongoing recovery. Yet the aggregates hide one rather dramatic change in the current year, namely, sharply lower growth in spending on consumer durables. At annual rate, it was down to $23.5 billion in the first seven months of 2004, after $71 billion in 2003 and $58 billion in 2002.
Still, there has been a dramatic change for the worse in the consumer's earning power. Since January 2004, the three-month annualized growth rate for real disposable personal income has literally collapsed: 5.7%, 4.6%, 4.5%, 3.7%, 2.5% and 0.8% for July. Over the seven months to July 2004, real disposable income was up a mere $77.4 billion, or $132.7 billion at annual rate. It grew by $174.3 billion in 2003 and by $226.2 billion in 2002.
Presenting these numbers, we have to mention that they have been jolted by tremendous revisions. Earlier data showed a pronounced rise in personal saving. Now there is a steep plunge. The crucial fact to see is that the consumer stepped up his borrowing to compensate for slowing income growth. The rise since 2000 is 74%. Yet the net effect has been gradual retrenchment in spending.
The success or failure of the massive monetary and fiscal stimuli over the past few years is one of the most controversial questions about the U.S. economy. Using the much slower economic growth in the Eurozone as a yardstick, as is the general American practice, U.S. policies look most successful. But using the previous six postwar U.S. business cycles as a measure of success, the U.S. economy's performance during the last two to three years has been by far the poorest ever, despite the unprecedented amount of fiscal and monetary stimuli.
Annualized growth of real GDP has averaged 3.4% over the first 10 quarters of this upturn, far below the 5.4% norm of the recoveries in the previous business cycles. Real wage and salary disbursements - the grist of healthy, sustainable economic growth - over the same period have recorded a cumulative increase of just 2.2%. This compares with an average cumulative increase of 10.6% over the same period in past postwar business cycles.
Even more important is the further question of whether or not the economy has gained the "traction" it needs for the recovery to become self-sustaining and self-reinforcing without further artificial monetary and fiscal stimuli. It would have to show particularly in much faster employment and income growth than it has so far.
In his congressional testimony, Mr. Greenspan stated, "The expansion has regained some traction" after having gone through an oil price-induced "soft patch" last spring. In general, this has been interpreted as an upbeat statement. To us, the word "some" is strictly diminutive, implying less than full traction, which is realized when an economic recovery has gained self-sustaining, if not self-reinforcing, dynamism.
As a matter of fact, there was a very different reading about consumer spending in the Fed's Sept. 8 Beige Book: "Household spending was reported to have softened in many parts of the nation, reflecting lackluster retail sales and some cooling in new and existing home sales." They certainly knew what happened in August.
In past cycles, the usual vigorous traction used to come mainly from pent-up demand that, due to prior monetary tightness, had accumulated during the recession mainly in residential building, consumer durables and business investment in equipment. Key to the present subpar recovery has been the exact opposite - heavy consumer borrowing from the future.
During the three years 2000-03, disposable incomes of private households grew, in current dollars, a cumulative $965.9 billion. They increased their spending by $1,023.7 billion and their debts by a stunning $2,726.9 billion. In this regard, the monetary and fiscal stimuli appear to have worked so far. But the problem is that a growing part of domestic spending exits to foreign producers, fueling the U.S. trade deficit, instead of U.S. domestic production.
Regards, Kurt Richebacher, for The Daily Reckoning
Editor's note: 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."
This essay was adapted from an article in the October edition of: The Richebächer Letter