BEST OF KURT RICHEBACHER
August 17, 2004
Focusing on the enormous imbalances and structural distortions in the U.S. economy, its generally trumpeted, sustained recovery was stillborn from the start. Inflating asset prices, propelled by a limitless supply of credit at Fed-orchestrated, "pegged" rock-bottom interest rates, created a deceptive recovery through a protracted consumer borrowing-and-spending binge. There was no break with the dismal saving-investment pattern.
Speaking of rate hikes, Mr. Greenspan is soft in words and even softer in action. For sure, he has not the slightest intention to impose true credit restraint. Nevertheless, consumer credit has been drastically tightened, not through the Fed, but through the bond market. The rise in yields of 10-year Treasury bonds has driven mortgage rates to a level where they act as a drastic brake on new mortgage borrowing.
Consumer spending has sharply weakened, and the expected strong and broad rebound in business investment never materialized. Contrary to Mr. Greenspanús reassuring testimony to Congress, there should be no doubt that the economic weakness is a new trend, and not a brief blip.
For two or three months already, economic news across the board is weaker than expected. Nevertheless, the markets, particularly the currency market, are trading on Greenspanús credibility, rather than on the flow of weak economic data.
Our main consideration about the U.S. economyús prospects is that the asset and credit bubbles have exhausted their economic impetus. In order to sustain bubble-driven spending, asset bubbles have to be kept inflating. Thatús Americaús new biggest problem.
Though they have lost their economic impetus, the bubbles still exist, and that is Americaús other new big problem. It lies in the fact that the highly leveraged bond carry trade is unsustainable in the long run. Further modest rises in the long-term rate would prick it. Consider that with leverage of 20-to-1, a 5% fall in bond prices, reflecting an increase in rates by just 50 basis points in 10-year bond yields, would wipe out 100% of investor equity.
But there is only one way to forestall this tremendous looming risk, and that is to sell the bonds held in carry trade. Essentially, the highly leveraged carry traders are on edge to sell whenever the market situation allows. For us, this guarantees that U.S. long-term interest rates have a long way to rise, even if the economy weakens. The counterparts to absorb the potential massive selling of bonds simply do not exist.
At some point in the very near future there will be a sea change in the outlook for the U.S. economy. The shock of recognition will rock its asset markets.
The reported weak GDP growth in the second quarter was centered in consumer spending. Its growth rate plunged to 1%, from 4.1% in the prior quarter (both numbers annualized). Again, the weakness was across all three components: durable goods, minus 2.6% after +2.2%; nondurable goods, minus 0.1%, after +6.7%; and services +2.6% after +3.3%.
Actually, consumer spending rose in real terms by a mere $19.5 billion, an increase by $76.2 billion in the prior quarter. That is a virtual collapse in comparison to the earlier spending levels in 2002û03. Its cause is, of course, the next most important question. There were no great changes in disposable income. In chained dollars, its growth rate slowed to 2.9% from 3.2% in the prior quarter. Income from wages and salaries in the private sector made only a minimal gain, despite the reported record gains in employment.
What, then, was the main culprit of this drastic curb in consumer spending? Sharply higher personal saving! It shot up to $142 billion, up from $103.4 billion in the prior quarter and an incredible $79.5 billion year-over-year.
investmentrarities.com |
