As I will explain in this report, Alan Greenspan and the Federal Reserve System have now created a unique opportunity for tens of millions of Americans to reduce their debt load. Most Americans won’t do this, but maybe you will, assuming you have debt. Here’s how: refinance your credit card debt, including any revolving credit accounts with retail sellers.
The big consumer news for the past two years has been on mortgage refinancing. Falling mortgage rates have offered a tremendous opportunity. I hope you took advantage of this before July 1: a fixed-rate mortgage (not an ARM). But what most Americans don’t understand is that another savings opportunity has been made available to American debtors: a quiet, almost invisible refinancing boom in credit cards.
You may have seen TV ads for non-profit organizations that intervene to persuade credit card companies to reduce the interest rate extracted from borrowers. These non-profit outfits do well enough to pay for TV ads. What few Americans know is this: you can skip the middleman.
The banks that issue credit cards are in a price war. But only one card company, Capital One, advertises heavily. “What’s in your wallet?” is a great slogan. It’s working. Capital One also claims to offer the lowest fixed rate: under 6%. This is far better than the 18% or 24% that millions of Americans are paying.
The presence of Capital One offers you a tremendous bargaining chip. Sit down and write a letter to your credit card company. Request a reduction in your interest rate. Explain to the credit card company or the revolving-credit issuing company that you have seen Capital One’s ads on TV, and you are thinking of switching. You’re thinking of consolidating your debt with a Capital One card. This, I assure you, will get the attention of the creditor. The creditor is profiting at your expense. Ask for a new contract: a lower fixed rate for all of your existing debt on the card.
Here is his new option: he can get 0% from you after you switch cards and pay off your debt to him, or he can earn a much lower rate by offering you a permanent reduction. A creditor would rather receive something than nothing. He will offer you a much better deal. In the meantime, keep shopping on the Internet for low fixed-rate cards that offer loan consolidation for your existing debt. The ads are all over Google.
Get this in writing: a permanent reduction to a fixed rate on all existing debt on the card. The longer you have to repay at the new rate, the better. If you don’t get the rate and time frame you want, negotiate in writing or on the phone with the person who signs the response letter.
The companies are relying on the ignorance of existing borrowers who don’t know that the companies are ready to negotiate lower rates with people who threaten to pay off their loans by borrowing on a new card. You are no longer ignorant. While rates are low, negotiate a better deal.
Do not do what so many Americans do; namely, expand your existing debt burden because you can afford to after you receive lower rates. As I will explain, Greenspan has created what I call a creepy recovery. You can use it to reduce your overall debt obligation in preparation for the great reversal in the economy.
THE CREEP FACTOR
Thirty years ago, a pair of reporters with the Washington Post were given a strategy by a tipster they called Deep Throat: “Follow the money.” The tipster was inside Nixon’s White House.
Woodward and Bernstein followed the money that had been used to pay G. Gordon Liddy and the other Watergate burglars. The money trail led them to the organization that had the most ill-selected yet fitting acronym in American political history: CREEP (Committee to Re-Elect the President).
As to why CREEP spent the money on the break-in, no one is quite sure, except for Liddy, whose lips are sealed on this issue (but no others). Jeb Magruder recently stated that he heard Nixon over the phone tell Attorney General John Mitchell to allocate the money, but this has been denied by other Watergate researchers. If the break-in was part of Nixon’s election-year strategy, it was wasted. Six weeks later, the Democrats nominated George McGovern, who was hopelessly behind right from the beginning.
There was another political factor in 1972: the economy. In fiscal 1970 and 1971, the government had run back-to-back deficits of $25 billion, which back then were regarded as huge. (The good old days!) The recession had led to a change in Federal Reserve policy under Arthur Burns: monetary expansion. On Aug. 15, 1971, Nixon had suspended gold payments to foreign central banks, i.e., “closed the gold window.” This enabled the Fed to continue to expand the money supply without being bothered by the outflow of gold. Nixon also unilaterally froze prices and wages, thereby creating massive shortages, which no one in the administration blamed on the controls. In short, he was exercising tyrannical powers familiar in wartime. The Democrats in Congress rolled over and played dead.
Because 1972 was an election year, Federal spending soared. Every incumbent president asks the Federal Reserve to make available sufficient credit to sustain this spending and thereby stimulate the economy. This is the Keynesian prescription for curing recessions. Nixon had already announced on national television, “I am a Keynesian.” He was, indeed. But every president is a Keynesian in an election year if he is running for re-election. He may call himself a supply-sider, but the formula is the same: “deficits don’t matter” + “sufficient liquidity” = re-election in November.
We are coming into an election year. The candidates are lining up. The Democrats would prefer to run on the issue of the economy, since they fell in line regarding Afghanistan and Iraq. Bush must go into the election with a booming economy if he wants to be re-elected. The war is not over, its expenses are soaring, and so is the government’s deficit. But he, unlike our troops, can still dodge the bullet if the economy is booming. Most voters are pocketbook voters.
Greenspan, like all Federal Reserve chairmen, knows where his bread is buttered in an election year. The Fed knows what it has to do: inflate. The Fed always becomes CREEP: the Committee to Re-Elect the President.
Because the Fed was facing recession in mid-2001, followed by 9/11, it inflated like mad. When the economy survived 9/11, the Fed put on the brakes to avoid serious price inflation. But it has continued to expand the money supply in the 6% to 8% range ever since.
Greenspan announced and then got a series of reductions in the Federal funds rate, the rate at which banks loan overnight money to each other. It went from about 6% to 1%. But the economy still sputtered. That’s because, as I have repeatedly said, the fall in the rate was due more to the fall in demand for commercial and industrial loans than it was to Fed monetary policy. Businesses reduced the demand for credit. This has not changed.
Take a look at two charts published by the Federal Reserve Bank of St. Louis. The top chart shows overall bank lending. The figure is rising sharply. The bottom chart shows commercial and industrial loans. It is still falling.
If banks are lending more money overall, yet loans to businesses are falling, the conclusion is obvious: banks are lending to consumers.
Because interest rates are falling, consumers are able to expand their overall debt burden: principal owed. They are buying new cars and homes. They are adding to their total debt obligation because they can afford to carry this debt in their monthly budgets. All they care about is the monthly budget. They assume that present rates will stay low. They also assume that they will not get fired.
In this phase of the business cycle — recovery — monetary inflation is not producing much price inflation. Unemployment remains above 6%. Utilized industrial capacity is in the 75% range — low. Price increases are unlikely with foreign competition high — officially, about $500 billion a year in the red.
(I’m not convinced that the payments deficit really is this large, or at least very significant. This is because Americans actually bring in slightly more money from their investments abroad than foreigners take out from their investments in America. Each group will receive about $280 billion this year. (See Table 1.9, “Income receipts from the rest of the world” vs. “Income payments to the rest of the world.”) This “balance of extracted earnings” has been true for more than a decade. This seems to indicate equality between foreign capital invested in the United States and Americans’ capital invested abroad, since arbitrage tends to equalize the rate of return. Warren Brookes wrote about this inconvenient and unexplained fact back in 1991, just before he died. The balance has remained amazingly steady ever since. He concluded that the Bureau of Economic Analysis was supplying incorrect figures regarding the value of capital invested abroad. I am open to any other explanation. I assure you that the BEA has not explained the anomaly, at least not to me. I have tried, unsuccessfully, to get an explanation that is in English.)
We are seeing something unique in the history of America’s business cycles. In the past, Fed monetary inflation has led businessmen into the same forecasting error at the same time; namely, the illusion that low interest rates were the result of increased thrift on the part of investors. Businessmen then borrowed from banks and started new projects. This was malinvested capital, given the fact of the lack of additional thrift. Then, when interest rates rose in response to price inflation, these projects became visibly unprofitable, and businesses cut back, causing a recession.
This time, businessmen are not deceived. They are reducing their borrowing. They are laying off workers. It is consumers who are taking the money and running. Businessmen look at the economy and say “I’ll pass” to Greenspan. Consumers, concerned only about next month’s payments, are gobbling up the new credit. They are adding to their long-term liabilities because of the lure of short-term rates.
Consumers forget about rising taxes and rising interest rates. They assume, like the drunkards in Isaiah’s day, that things will always get better. “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” (Isa. 56:12). They not only refuse to save for a rainy day, they in effect sell the shingles off the roof and spend the money.
Presidential election years are traditionally sunshine years. The Fed makes it so. The question then arises: “What happens in the year following the election?” Will the Fed put on the monetary brakes? If it does, the economy will fall into recession. But if the Fed doesn’t put on the brakes, it risks the return of serious price inflation.
DEBT AND PRODUCTIVITY
If you are borrowing for something that will probably increase your output, then debt may be legitimate. For example, a debt for college education might be wise if you are majoring in civil engineering (not much competition from China or India), but not if you’re majoring in sociology. But if you are borrowing to buy a consumer good that will decline in value, debt is a lot riskier. The market value of the asset may not be — probably will not be — as high as the principal remaining on the loan. If you lose your job, you could get trapped. You might even have to violate your contracts and declare bankruptcy.
The economy seems to be improving. Productivity is rising. But the reason for the increase in productivity is not an increase in the supply of capital. On the contrary, businesses are reducing their debt. They are not borrowing to add to the supply of capital. Then where does the additional productivity come from? Simple: from layoffs. Businesses are firing marginal employees. This increases business productivity, but at the expense of workers’ income.
The ISM (formerly the National Association of Purchasing Managers) monitors manufacturing. Things have picked up over the last two months. Previously, the index was under 50 — recession level. Now it’s in the mid-50s. But one negative statistic remains: employment.
But there is an anomaly in the unemployment figures. It was revealed by the figures for August, when businesses laid off 93,000 people, yet unemployment dropped from 6.2% to 6.1%. How can this be?
Because of how the Bureau of Labor Statistics defines “unemployment.” You might think that unemployment means “not having a job.” You would be incorrect. The term is officially defined as follows:
Unemployed persons are all persons who had no employment during the reference week, were available for work, except for temporary illness, and had made specific efforts to find employment some time during the 4-week period ending with the reference week. Persons who were waiting to be recalled to a job from which they had been laid off need not have been looking for work to be classified as unemployed.
If the number of people, net, who get fired is lower than the number of people who quit looking for work, then the unemployment rate falls.
The estimate for August is that, while 93,000 workers got fired, 566,000 officially unemployed workers stopped looking for work, July/August, thereby removing themselves from the ranks of the officially unemployed.
Thus, the unemployment rate dropped. Whoopie!
Even with a little help from 566,000 people who quit looking for work in July/August, the unemployment chart from the final month of Bush I’s term (7.3%) to August, 2003, looks bad for Republicans. This chart is likely to be the center piece of the Democrats’ campaign next year unless the figure drops substantially. Take a look at the chart. It makes the Clinton era look good.
So, we find that in the midst of a poor labor market, American consumers are loading up on debt. Their employers, in contrast, are repaying debt and not replacing it. Psychologists call this phenomenon “cognitive dissonance.” I call it high-risk behavior: grasshopper syndrome. The ants know better.
Here is my point: debt should be a function of expected productivity. If a person does not expect to increase his productivity, he should not add to his debt except in cases of emergency. Adding to personal debt in response to the interest rate-effects of a combination of the Fed’s expansionist monetary policy and businessmen’s refusal to borrow in order to add to plant capacity is what is sometimes called “driving beyond your headlights.” Millions of Americans are doing this. They are putting the pedal to the metal.
To this scenario add the resource-consuming effects of a war. This is Keynesianism in operation: an attempted economic recovery based on (1) increased government spending, (2) increased Federal deficits, and (3) increased consumer spending by means of an increase in personal debt.
The grasshoppers are out there, banjos on their knees. The ants are burrowing deeper. The people who provide the tools of production that enable workers to increase their output and therefore their real income have decided that now is not a good time to invest. They look at the American economy, even in an election year, and conclude:
“Not yet.” They not see ways of increasing business income by using debt to add to productive capacity. Meanwhile, their employees are running up personal debt.
It seems to me that the decisions of businessmen whose capital is on the line, and who are afraid to increase their indebtedness to the banks, are more reliable indicators of the future of the economy than people who borrow to buy new cars, even at a 0% rate.
It is no surprise to me that the new book, The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke, has reached best-seller status in recent weeks. If I could buy futures in just one book, that book would be my choice for the next decade or two. The market for that book will increase inexorably during my lifetime.
We are about to enter an election year, November to November. This will be the year of the CREEP. Greenspan & Co. will supply liquidity to this economy, keeping rates down. Consumers will therefore continue to malinvest their resources.
It is possible that businessmen will get caught up in the credit-induced prosperity. If they start to borrow, then the nearly free ride for consumers will end. Rates will start back up: more demand. The Fed will then have to decide: keep the boom going by increasing the rate of monetary inflation (increase the supply of loanable funds) or else allow rates to rise and thereby cut short the recovery. Greenspan will cross that bridge when he comes to it. I think it is safe to say that he will keep the boom going long enough for statistics to remain as good as possible through November 2004.
The Keynesian places faith in consumer spending, however this spending is motivated. The monetarist places faith in the steady increase in the money supply. The Austrian places faith in capitalists who put their money on the line.
Right now, corporate insiders are selling their shares to the mutual fund managers who are acting on behalf of fund shareholders. Insider sales exceed insider purchases by close to eight to one.
This tells me that the present recovery is CREEPy. I am content to place my excess funds elsewhere than the U.S. stock market.
September 24, 2003
Copyright © 2003 LewRockwell.com