BEST OF KURT RICHEBACHER
U.S. ECONOMIC WRECKAGE EXPOSED
The financial markets are typically considered leading indicators of the economy, and with good reason. They form an important transmission mechanism through which monetary policy impacts the economy. Typically, at the dawn of a new economic cycle, rising stock and bond prices allow companies to replenish cash holdings and strengthen balance sheets.
Yet this time it is different. Despite a flood of money and credit creation, and despite widespread predictions of recovery, the markets refuse to cooperate.
Why? In short, because we are not experiencing a cyclical recession, and therefore a cyclical recovery is not on the way. Instead, the U.S. economy is sick to the bone.
Unprecedented excesses in consumption and financial speculation have devastated the growth fundamentals of the U.S. economy, as evidenced by the deplorable state of savings, capital investment and profits.
Worse, the gross macro- and microeconomic mismanagement that caused the current economic sickness was sold to the public as a new paradigm economy that would deliver unprecedented miracles of productivity growth and profits. Yet it only delivered unprecedented fraud and abuse in various forms – from manipulated government statistics to rigged corporate profit reports.
Yet deception and mismanagement have apparently lost their power to sustain the illusion of economic health. Loose monetary policy is having no impact, major corporations have been caught committing egregious fraud and no amount of government massaging of the numbers can patch up widespread deteriorating profits.
The markets are not rallying… the recovery is not under way. Instead, the bear market and a major recession are only just beginning.
THE MOST OUTRAGEOUS BUBBLE IN HISTORY…
The first thing to get straight is that this was – and still is – the most outrageous bubble economy in history, far worse than the U.S. bubble of the 1920s and Japan’s bubble of the late 1980s. This term implies that rising asset prices fuel an extraordinary burst in spending, either through soaring wealth effects on consumption or through sliding capital costs on investment. In the U.S. case, the bubble-related spending went fully into private consumption.
Effectively, Mr. Greenspan’s prolonged, extreme monetary looseness created multiple bubbles both in the U.S. economy and in its financial system. The most obvious and spectacular among them was certainly the Nasdaq bubble. But the biggest and most terrifying bubbles are the consumer bubble, the bond bubble and the dollar bubble.
All three have yet to pop, and when they do, they will wreak unprecedented havoc on the whole U.S. financial system because all three of them are addicted to permanent, limitless debt creation. Eventually, a point is reached where the financial system is unable to create the ever-greater credit requirements to keep these bubbles expanding.
…AND A CRISIS IN CAPITAL FORMATION
Our earlier central contention was that in the end the economic growth process is all about capital investment. The same, as just explained, is true for profit creation. For the reasons explained, net investment is the most important profit source. Yet there is always a circular causation. High capital investment breeds high profits, and high profits, in turn, breed high capital investment.
Pondering the prolonged, poor profit performance in America, we see its decisive, primary cause in gross corporate mismanagement. In their frenzied pursuit to enrich themselves and their stockholders in the quickest way possible, American corporations in the past few years have massively resorted to mergers, acquisitions, stock buybacks and cost-cutting, sold to the public as measures providing new paradigm synergy effects.
While the effect on stock prices couldn’t have been more spectacular, the inherent erosion of the economy’s growth fundamentals, showing in the dismal development of savings, capital investment, profits and the trade balance, was flatly ignored or discarded as economically irrelevant in comparison to the alleged profit and productivity miracle. It was economic intelligence at its lowest in two centuries.
The big short-run gains in share prices were, in reality, achieved at the expense of capital investment. Instead of new factories, the enlightened CEOs built in the course of their financial wizardry unprecedented mountains of new debt. Knowing the crucial importance of net new capital investment, it was clear to us right from the beginning that the strategies implicit to this new "equity culture" would devastate profitability in the long run.
Capital investment, as elucidated, is the key strategic variable in the economic growth process. But its realization depends on two indispensable preconditions: an expectation of reasonable profits; and command of sufficient financial resources through saving from current income.
The intriguing thing about the U.S. economy is that both requisite conditions for capital formation have been systematically destroyed in the past few years. Savings have been wiped out by gross macro-mismanagement, more precisely, by the preposterous credit excesses fuelling consumption and speculation; and profits have been depressed by gross micro-mismanagement, favoring financial manipulation to sound capital investment.
The crucial thing to see about the U.S. economy is that its growth during the past few years was driven by uncontrolled debt creation for consumption and financial speculation, while in the process domestic savings and the potential for capital investment have been devastated as never before.
CONCLUSIONS:
Very few people so far have realized that the U.S. economy is sick to the bone. In the past few years it has been grossly mismanaged, on the macro level through unprecedented monetary looseness on the part of the Greenspan Fed, and on the micro level through corporate strategies that built only mountains of financial leveraging but no factories.
Healthy, long-term economic growth depends on three key fundamentals: savings, profits and capital investment. During the past few years in the United States, all three have been devastated in favor of debt-fuelled consumption and financial speculation. It is becoming evident that the new paradigm economy was a new paradigm sham.
Looking at the plunging stock market, it seems that the moment of truth for the economy and the markets is rapidly approaching. Yet, we still have the impression that there is more confusion than serious worry about what is happening in the economy and the stock market. Inevitably, the consumer, too, will have to retrench. This recognition will pull the rug from under the economy, the markets and the dollar.
The dangers that loom on the currency front are immense. Virtually, the grossly overleveraged U.S. financial system is hostage to a strong dollar and permanent, huge capital inflows. The U.S. trade deficit and the accumulated foreign indebtedness have reached a scale that defies any possible action by central banks. The fate of the dollar is out of any control. |
