by Gary North
Congress is in gridlock. We are told by financial analysts that America needs a stimulus package from Washington, but Congress cannot agree on what this package should look like. Congress is divided over who should be the beneficiaries. Each political party has its preferred groups of voters to pay off. Each Congressman's official goal is to "get the economy moving again." The unofficial goal — the one that really matters — is to "pay off the voters who supported me in the last election, and who probably will support me in the next election."
What kind of stimulus package should Congress pass if the goal really is to get the economy moving again? The package that there is no chance of getting passed. I discuss it at the end of this report.
The debate over any stimulus legislation is always conducted in terms of an assumption: certain consumers need a break. The divisive political question is: "Which consumers? Yours or mine?"
This is the wrong question in a recession. What the economy needs in a recession is not a shot in the arm by consumers. What it needs is a re-structuring of prices, especially the prices of capital goods. It never gets this. Instead, it gets the stimulus of new injections of credit money. That's why we keep having recessions.
A recession is the product of prior monetary inflation. The central bank has injected reserves into the commercial banking system by purchasing government debt with newly created money. The fractional reserve banking system then expanded the money supply in response to the new central bank reserves. This increase in bank credit money reduced the rate of interest: more money "for sale" was chasing borrowers. So, the "price of money" — interest rates — initially fell (just as short-term rates have fallen over the last year). Businessmen borrowed who should not have borrowed. They invested in capital equipment that should not have been purchased, given expected consumer demand apart from the new money. But the money was injected. Now the market is bringing these forecasting errors to light. Prices of capital goods are changing to reflect the true conditions of consumer supply and demand. The stock market is lower today than in early 2000 or early 2001.
The policy of the U.S. government should be to reduce taxes permanently and stabilize the money supply permanently. This should always be the goal of government, in good times and bad. But it isn't. The two political parties go into gridlock over which voters should get the tax cuts. All they ever agree on is that Alan Greenspan should provide more money.
In a recession, everyone cries for more money. The economists and the politicians join forces on this point. This is what the FED has been doing for over a year now: an 8% expansion of the adjusted monetary base. This started as soon as the inverted yield curve appeared in late 2000: short-term T-bill rates above 30 T-bond rates. That was when I began predicting a recession in 2001. Greenspan knew, too. He turned on the money spigot.
If the consumer ever gets a tax break, what should he do with the money? The free market answer is clear: "Whatever he wants to do with it." That is what freedom is all about.
In a recession, uncertainty increases. The rational thing to do is to reduce your debt if you think that you might lose your job. The other thing to do is to stay liquid: keep your money invested in a near-cash asset, such as a money market fund. Money is the most marketable commodity. If you don't know what is going to happen, but things look bad, then you can reduce your future uncertainty by increasing your reserves of the most marketable commodity: money.
The government and most economists recommend that consumers do neither. They recommend that consumers go on a spending binge. "Don't save: spend. Don't pay off debt: add to your debt." President Bush has told us that the patriotic thing to do is spend money.
This intellectual battle — the battle of economic theorists — is mostly about thrift. It is this issue: "What does America need now, more thrift or more consumer spending?
CONSUMER SOVEREIGNTY AND RECESSION
In modern free market economic theory, the consumer is king. What he does with his money is said to govern the economy. I'm all for this view of the free market. A defense of the free market should always begin with the right of private ownership, which ultimately means the authority of the consumer to do what he wants with his money. As we read in Jesus' parable of the employer who hired the ungrateful workers, "Is it not lawful for me to do what I will with mine own? Is thine eye evil, because I am good?" (Matthew 20:15).
But. . . .
The consumer has two options: spend on consumption goods or spend on production goods — if not directly, then by lending money to someone who will buy producer goods. "Consumption goods or production goods?" That is the question, day and night, night and day.
If you want long-term personal prosperity, the correct answer is: more producer goods. You should increase your rate of saving.
If residents of a nation want to live in a growing economy, the correct answer is: more producer goods. They should increase their rate of saving.
But most economists, when push comes to shove during a recession, want consumers to buy more consumption goods, not production goods, i.e., to reduce their rate of saving. Why? Because they think that consumer demand makes a nation rich. They are demand-side economists.
What makes us rich individually and nationally and internationally is our productivity. Consumer spending is possible only because there has been previous consumer productivity. Except for people who are being subsidized by others, such as children, imbeciles, and Congressmen, our authority as consumers is determined by our ability as producers. To increase our productivity as producers, we need better tools: more capital and better capital. This requires thrift on someone's part.
The American economy today is the victim of bad economic theory. The economists have pandered to our weakness: our proclivity to buy now, pay later. Our political leaders have told us that we should spend, not save. Our leaders are also demand-side economists.
Keynesian economics and democratic politics are now tied to the expansion of debt — for governments and for consumers. The consumer is king in the free market, but the experts have lured him into spending like an emperor. He has been told, "Buy now, pay later." He has become addicted to consumption first, repayment later. "Pleasure now, pain later." This has increased his present-orientation. So, Americans have stopped saving.
The American economy has been built on the idea that consumers will indebt themselves in order to keep buying — and should. Entrepreneurs have been lured into producing goods and services for the next fiscal year (or fiscal quarter) on the assumption of more FED-created credit money will be there for them, and more FED-funded credit will be there for consumers. Everyone assumes that Greenspan will see to it that the money is there. Greenspan has always delivered.
Only one school of economics opposes this: the Austrian School. All other schools of economic opinion cry for more money — more central bank money — whenever a recession appears.
THE ECONOMISTS' WAR AGAINST THRIFT
What if a consumer decides that he wants to become a saver? He does so, at least during a recession, under a heavy burden of criticism by academic economists. The Keynesian economic outlook, which has been dominant in American government policy-making circles for almost seven decades, teaches that the saver is a threat to the economy in times of recession. The saver supposedly undermines the economic recovery.
Economically speaking, the economists' hostile view of thrift is ridiculous. If we're in a recession, should the rational person cut spending and save money? Yes. Then why is this decision bad for the economy? Since when does increased thrift and capital spending hurt the economy? Why do better tools for workers produce economic disaster? Why do rational decisions by individual savers produce bad results for the national economy? Isn't the insight of Adam Smith true, that self-interested decisions by individuals produce benefits for the economy? Was Smith wrong? Are the socialists right?
The Keynesian argues that this situation in a recession — my saving makes other people poor — is an anomaly of the capitalist system. He calls this unique phenomenon "the paradox of thrift." What is good for the individual — saving — is bad for the economy in times of recession. The usual free market relationship between a person's economic self-interest and the common economic good breaks down in times of recession.
Conclusion: the government should run budget deficits, so that consumers will also run budget deficits.
This, too, is ridiculous. When the government runs a budget deficit, where does it get the money to cover this excess of spending over tax revenues? Answer: by borrowing the money. From whom? Answer: from savers. So, we are told that savers — dangerous, self-interested people — should loan their money to the government instead of lending to profit-seeking businesses. This means (follow me here) that savers who lend money to profit-seeking businesses hurt the economy, but savers who lend money to a huge, profit-losing bureaucracy (the government) that is run by Civil-Service-protected employees who can't be fired for dropping the money down fiscal ratholes are Doing The Right Thing.
There are only two ways for the government to run a deficit: borrow from savers or borrow from the nation's fully legal counterfeiter: the Federal Reserve System. If the government borrows from the central bank, the Treasury spends the newly created money into circulation, thereby giving full-time employment to government employees who work in the various rathole divisions. In other words, we are told, what the economy needs now is more inflation. It needs higher prices.
Why is monetary inflation good for an economy during recession? Because it produces price inflation! There is a perverse, though officially unstated, logic here. The economist knows that rising prices will reduce workers' real (after inflation) wages. He also knows that these lower real wages will encourage businesses to hire more people. This is an economic law: "At a lower price, more will be demanded." In short, government deficit spending through central bank counterfeiting is a program for full employment through monetary debasement. This program has been going on in America, year after year, ever since 1933.
The problem is, we keep getting more recessions. The boom that is created by the expansion of credit money fades when the rate of monetary expansion eventually becomes part of businessmen's plans and workers' plans. They learn to expect higher prices. They price themselves accordingly. Consumers stop buying, and the recession appears. Then it's the same old cry: "More government deficits! More central bank inflation!"
THE LOGIC OF THRIFT
The individual who saves money is transferring money to someone else. Credit money doesn't go to "money heaven," as Doug Casey calls it, unless the Federal Reserve System is selling its debt. The money is transferred.
If a man lends money, then the borrower thinks he has a way to earn a return on the money. If he didn't, he would not borrow the money. He gets temporary use of the money.
As "Deep Throat" told Ken Woodward, "follow the money." The money stays in the economy if it's in the financial markets. Only cash money is hoarded. There isn't much of it in circulation inside the United States these days. It circulates mostly in foreign countries. People in line at a Wal-Mart check-out counter rarely pay with cash. They may pay cash at a 7-11, but America's economy doesn't rest heavily on 7-11. Besides, the next morning, the 7-11 manager deposits the cash into a local bank.
Then why is saving hated and spending cheered? Because of existing inventories of consumer goods that should never have been produced in the first place. They go a-begging. It's a buyer's market. If businesses can't sell their inventories, they lose money.
My question is this: Should economists and policy-makers cheer a decision that (1) is based on faith in economic growth in the future (buy producer goods), or (2) says "let us eat, drink, and be merry, for tomorrow we die — or go belly-up" (buy consumer goods)?
What we need in a recession is more thrift. The money should go to future-oriented entrepreneurs who think they have ways of pulling their businesses out of the recession, not to entrepreneurs who guessed wrong and who produced goods that they can't sell at yesterday's prices.
What we have today in the United States is no net thrift by individuals and families. The nation's families are in negative savings mode, i.e., Americans are going into debt to pay for present consumption. This is present-oriented activity. It places a premium on today's expenditures at the expense of tomorrow's income.
ARE WE FACING A DEBT DISASTER?
There is considerable talk today in bearish circles that American consumers are overextended. Consumers are on a spending spree like no other in post-World War II history. They are not only not saving, they are going into debt.
Well, yes and no. What the statistics indicate is that total consumer debt is rising, but consumers' debt repayment debt burden is not rising. In fact, it seems to be falling.
Now, we all know that statistics can be wrong, or can be used to prove points that don't follow. I place only limited trust in official statistics. But when I am following the money, I wind up trudging down some unexpected highways. What I look for are patterns over time. Maybe a statistical index is based on cooked books, but the books are probably cooked by the same chef using the same recipe, year after year. So, I look for changes in statistics that indicate changes in people's behavior.
With commercial bank statistics, I have considerable confidence. Bankers can go to jail if they commit fraud in reporting.
Click on the following link. Here, the FED gives us two decades of statistics on the statistic that most debtors care about most: their monthly debt payments in relation to their disposable (after-tax) income. What you are about to see may amaze you.
In early 1980, the ratio of monthly debt payments to disposable personal income 13.12%. Now look at 3rd quarter, 2001. It's 13.81%. This is down from the second quarter: 14.22%. That 14.22% figure was the second highest in the whole period, just under the record of the 4th quarter, 1986: 14.38%.
It is true that there has recently been a high ratio. It is falling a bit, but it has been high. But when I say "high," I mean high in relation to twenty years of statistics. Over the period, the range is amazingly narrow. This ratio changes hardly at all. I don't think that most economic reporters understand this.
Take a look at the most recent low point: 1993-94. This was in the early stage of a recovery period: Clinton's first half of his first term. The public had been shaken by Bush-I's recession. The ratio had been in the mid-13's. Only after the recession was over did the ratio drop.
I am not saying that the monthly debt burden isn't at the high end of the scale. It is at the high end. But it seems to be coming down. We will know more when 4th quarter figures are released: 9-11 and its aftermath.
Look at the figures for the actual level of consumer debt, not counting mortgage debt. This has been rising. In early 1996, it was a little over $5 trillion. Two years later, it was $5.7 trillion. Two years later, in early 2000, it was $6.7 trillion. By the third quarter of 2001, it was $7.6 trillion.
This is a 50% increase in six years. What annual rate of increase in total debt was this? About 7% per year, compounded. This is approximately the rate of increase in the M-2 money supply. It is greater than the M-1 rate of increase, but lower than either M-3 or MZM.
But remember: as a percentage of disposable household income, the monthly repayment was not affected much: from 7.2% in 1996 to 7.7% in late 2001. It was 8.7% in 1980.
There has been one significant shift: the percentage due to mortgage debt. In 1980, it was in the low-to-mid-4% range. Today, it's in the low 6% range. But this increase is economically rational for debtors. The government allows us to take deductions of our mortgage interest payments from gross income when figuring our taxable income. In the mid-1980's, the government changed the rules for non-mortgage debt. No longer is interest on non-mortgage debt deductible. Debtors have been given a subsidy to shift from non-mortgage debt to housing debt. They have responded to this incentive.
Also, from the point of view of lenders, mortgage debt is safer unless interest rates rise. Rates have been declining. Lenders know they will be repaid. People will do almost anything to keep from getting evicted from their homes. This is why interest rates on mortgages are much lower than interest rates on credit cards. The loan is secured by an appreciating asset (except in Silicon Valley, where housing prices are falling).
I bring all this up because I don't want to overemphasize the debt threat to debtors. Borrowers are rational. They do pay attention to the level of their debts. They do budget for debt repayment at the beginning of the month. Major creditors know their customers' income and habits. Nobody gets a mortgage without filling out forms. People can go to jail for fraud if they lie on these forms and then default. They don't lie wildly on these forms.
There is no doubt in my mind that this level of debt repayment signals "top of the business cycle." But it doesn't signal a looming debt collapse. It tells us that consumers are likely to reign in their spending in the near future, especially if interest rates rise. They are likely to continue to reduce their debt/income ratio, as they seem to have been doing recently. This reduction has been the pattern in two previous recoveries from recessions. Look at 1981-84 and 1993-94. The ratio in both recovery periods was lower by more than a percentage point compared to today.
The consumer is overextended today, but not wildly overextended. We need to keep things in perspective. After all, the consumer does. Yes, consumers make mistakes, with the help of Alan Greenspan, but nowhere near the magnitude of mistakes made by the money center bankers who loaned Argentina $141 billion.
Now let's look at the situation facing the banks. First, delinquency rates, seasonally adjusted. These are loans whose payments are late, but not in default.
Look at the rate of credit card delinquencies in 1990. It was above 5%. That was in a recession year. The latest figure is also 5%. The last time it was below 4% was in 1995. It has not been much below 3.5% in the last decade. So, we are in a recession-level situation with respect to credit card delinquency rates. That is because — hold the presses! — we are in a recession.
Now look at total loans and leases — the far right-hand column. In 1985, during a recovery period, it was well above 4%. It went above 5% in 1987. Its high point was above 6% during the Bush-I recession: 1990. Then it dropped. The latest figure is under 3%. Not too bad. It did not go below 2% any time in the last 15 years.
Commercial real estate loans at commercial banks were in a disaster zone in 1991-92: above 11%. Today, it's under 2%. Notice residential real estate: it rarely goes above 2.5%. It's 2.25% today. Not too bad.
Now look at the charge-off rate. These are bad loans: loans in default. Banks hate these loans most of all.
In 1985, total loans and leases were at .80% — low. The high point was just before and during the Bush-I recession: above 1%. Today it's 0.97%. Not good, but not a disaster.
Commercial real estate charge-offs went above 2% in 1991 in the 4th quarter. The rate is down to .11% today — very low.
Residential real estate charge-offs have risen, but only to .43%. It's at the top end of the scale, but it's no big threat to banks. What I'm getting at is this: the U.S. banking system is not Japan's. It is not facing oblivion. The domestic saving rate is low. America's economy is dependent on foreign investors to fund our imports and keep our capital markets solvent. But, in the game of international capital roulette, we've got the largest casino in town. Remember, the U.S. sells financial services. That is our specialization in the international division of labor. If Japan goes into the tank — further into the tank, I should say — this will make America's financial markets look even more appealing to Asian investors. There could be a panic melt-down in the international futures markets, but that would not affect the comparative position of U.S. That would be an international disaster: everyone gets hit.
As for non-financial business debt, the level has fallen steadily since 1997. The peak was $3.806 trillion in September, 1997. The latest figure is for October, 2001: $3.373 trillion.
THEN WHAT'S THE PROBLEM?
The problem is the permanent symbiotic relationship of monetary expansion and the level of total indebtedness. Debt keeps rising with the expansion of the money supply. Debtors and creditors assume that the FED will never stabilize the money supply. So, consumers go into more debt whenever the money supply rises. The FED then accommodates the increase in total consumer debt. That is, the FED subsidizes it.
We are in a long-term debt/inflation cycle. Whenever the FED stops creating money, a recession appears. When the FED then makes the recession go away by monetary inflation, the capital and credit markets don't complete their adjustment to a world without monetary debasement. The inflation calculator on the Bureau of Labor Statistics' site tells us, year by year, just how much additional money income need just to stay even (before taxes).
The FED has been inflating at an 8% rate for a year. This, coupled with the recession, has pushed down short-term interest rates. But this expansion of money will eventually create rising prices. (I know; the deflationists predict otherwise. This is a major debate. I'm still in the inflation-predicting camp.) Price inflation will not end. The distortions in both the capital markets and debt markets that are created by the monetary inflation will continue.
We are now seeing an ominous development. The FED is inflating, but the economy is not recovering, or is recovering very slowly. The "kick" from the monetary inflation is fading. It looks as though a higher rate of monetary expansion is now required to "get the economy rolling again." Like a junkie who requires ever-larger doses of junk to get the same high, so is the U.S. economy. (So is the Japanese economy.)
WINNERS AND LOSERS
If the FED continues to inflate, then those debtors who have locked in a long-term interest rate, such as home buyers and businesses that have sold bonds to investors, will be winners. The losers will be their creditors, who will see the purchasing power of the dollar fall, and who will also see the market price of their bonds fall. (The price of a bond moves inversely to the appropriate interest rate for that length of bond.)
Debtors have looked at their monthly payments. That's what they all do, including businessmen who are ready to market corporate bonds. "How much will I have to pay each month to stay solvent?" When rates are low because of recessions, or because the FED is pumping in money during a recession, debtors lock in a fixed rate of interest. If prices fall, they can still win. When interest rates fall, they can go into the market and re-finance at a lower rate. That's what millions of homeowners have been doing, as you know. The creditors, betting on a stream of fixed monetary income, will learn all about re-financing: a lower monetary income stream. On the other hand, if prices rise, and rates rise, the debtor is also a winner. He stiffs his creditors with cheap money.
This is why bonds that can be "called" — refinanced on demand by the debtor — are such bad investments. The debtor says, "Heads (deflation) you lose; tails (inflation), I win." (Economists call this heads-tails long-term debt structure "asymmetric," because the slogan doesn't sound very scholarly.) And there is also this problem: the companies that sold the bonds may go bankrupt and stop paying. That's serious asymmetry!
A major problem for our economy in the future is too much long-term credit extended by naive investors who do not see what is going to happen to them. They will either get stiffed by early repayment (if rates are falling) or stiffed by cheap money (if rates are rising).
I am not particularly fearful about the inability of a relative handful of debtors to repay. I am fearful about the destruction of the capital markets by the mass expropriation of long-term creditors. This expropriation can take place in two ways: mass inflation (most likely politically) or an unexpected gridlock and shutdown of the world's capital markets. In the latter case, debtors will escape creditors through a legislated mass moratorium on debt repayment. Politicians will not defend the economic interests of creditors in a gridlock situation, assuming politicians are in a position to do anything at all. There are more debtors who vote than creditors who vote. "The expropriation of the expropriators." The phrase is Marx's. "The liquidation of the rentier." The phrase is Keynes's. There is a smoldering, envy-driven resentment against those people who provide the tools that make economic output possible. These people are the engines of wealth creation in a modern economy, along with entrepreneurs who put the creditors' investments to work. They are hated. When they fall, the world rejoices. Envy is a powerful emotion. It destroys victims and sinners alike.
CONSUMER SPENDING UPTURN AND THE V-RECOVERY
There is talk about a V-recovery based on consumer spending. If there is a V-recovery in sight, I don't see it. Surely, it will not be based on increased consumer spending. The consumer is tapped out, and he knows it. That's why consumers are reducing their monthly debt load, as of the 3rd quarter, 2001. They were paying a lower percentage of their disposable income to creditors than they did in the 2nd quarter.
Consumers are cutting back on their monthly debt payment burden. Rising interest rates — assuming there will soon be an economic recovery — will speed up this process. Consumers are carefully watching their monthly debt payments, even though they are spending on items with low interest rates — or zero interest rates, in the case of certain new cars. For the consumer, the key issue is his monthly debt load, not his total debt burden. This is why he uses a credit card to borrow money that may take 10 years to repay at 18% interest. He is present-oriented. He cares only about the bills coming due each month. He cares very little about how many months they will come due. He is perfectly content to monetize his future income by means of present debt, just so long as his monthly payments don't rise.
This is bad for economic growth, long-term. We need more thrift if we want more economic growth. We do not need more consumer debt. We need a revival of future-orientation: a nation of savers who are willing to forego consumption today in order to increase the likelihood that they will have greater consumption in the future. We need more tools and fewer fools — fools who believe that the Social Security/Medicare System is actuarially solvent. (For an instant mail-back refutation of that illusion, click here and then click SEND: mailto:[email protected].) We are becoming a nation of intoxicated dreamers. "Come ye, say they, I will fetch wine, and we will fill ourselves with strong drink; and to morrow shall be as this day, and much more abundant" (Isaiah 56:12).
The consumer is king. But he needs to sober up. He is becoming a alcoholic to debt as surely as the economy has become an alcoholic to Federal Reserve credit. I don't care whether he prefers Keynes Red Label, Chicago Deluxe, or Old Supply Side. He has got to lay off the sauce. So has the economy.
This gets me back to a point that Dr. Kurt Richesbächer keeps making: the reason for this recession is not a fall in consumer spending, but a fall in capital investment. Capital investment has fallen because expected profits have tanked.
Why have they tanked? Here, economists do not agree. Austrian economic theory tells us that businesses expanded production beyond what should have prevailed in a world of stable money and steadily falling consumer prices (more consumer goods chasing the same amount of money). The American economy is now in a level of credit money addiction that requires ever-higher rates of money expansion in order to sustain economic growth.
Foreign competitors are also making life tough on American manufacturers. They keep cutting prices. Ford's recent announcement of corporate tightening is the latest. A total of 20,000 people may be fired in 2002. This won't be cheap for Ford. Estimates as high as $4 billion are being floated in the financial press. About 12,000 of the terminated will blue-collar workers who will have to be given severance pay or early retirement bonuses. Ford lost almost a billion dollars in the 4th quarter. That followed $1.4 billion combined losses in 2nd and 3rd quarters. The company fired 5,000 people last summer. The 0% credit financing and booming auto sales did not solve Ford's problems. It just postponed them. The consumer bought, but only when he got a really good deal. He went into debt at 0% interest, which was not a long-term paying proposition for the lender. Next year, this year's car buyer will not buy another new car. Or the year after.
America's economic problem isn't the supposedly tight-fisted consumer. The problem is the FED's monetary policy, which is no longer either stable or predictable. Businessmen were been misled by low interest rate signals. They expanded some lines of business when they should have cut back. They also thought that the high-tech boom was forever. They thought that by installing a rapidly depreciating capital base — computers — they would make their firms profitable. Instead, they wound up giving the cost savings to consumers. This is as it should be. Producers work for consumers in a free market.
I think the V-recovery is a mirage. It surely needs some kind of analytic justification. If the consumer is not the likely source of the recovery, since he never has cut back much on spending, then who is going to pull the economy out of the tank? Republicans propose tax cuts, but will Democrats vote for this? It doesn't look like it. Gridlock has returned to Washington.
A NON-ENVIOUS IMMEDIATE SOLUTION
What is needed for a fast recovery is faster depreciation schedules for tax purposes and some sort of capital spending tax credit. That would get production back on track faster than anything else. We need more production, not more consumption.
Long-term, there is a more permanent answer. If the Republicans would call for the elimination of the capital gains tax, and pay off the Democrats politically by accepting full taxation of any personal income generated by the permanent sale of investments, we would see a capital spending and savings boom. If investors were allowed to let their paper profits accumulate tax-free until the day they took the money out of the investment markets as personal income, we would see rapid economic growth and a booming stock market. But that kind of tax cut would require a political order that is not influenced heavily by organized envy. That scenario is not in the cards.
January 14 , 2002
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