A Good Deception

Nobody loves a good deception more than investors…unless it is voters. The Dow shot up more than a hundred points the other day.

And would you believe it? Consumer spending also shot up last month! Retail sales just posted their biggest increase since May of 2004. As a consequence, China is bringing in so much U.S. cash that they’re running out of space to store it. Merchants cart it over to the bank, where it is exchanged for local currency. So much new money has been created to keep up with the inflow of dollars that M2 — a measure of money supply — is rising at nearly 20% per year in China. No wonder the place is booming.

Oh, what a tangled web we weave. The U.S. Fed practices to deceive consumers with cheap money and then, consumers deceive their own retailers. These retailers then deceive their suppliers, who deceive their bankers, who deceive their borrowers. The borrowers build factories and office towers all over China. Whew! It makes your head spin and your skin crawl.

How do we untangle this web? We begin by wondering where consumers get the money to spend. After all, the Fed is now on a tightening cycle…threatening to raise short-term rates to 4.75% just to assert Ben Bernanke’s bona fides. And the house price bubble that was responsible for so much consumer spending since 2003 seems to be leaking. The number of unsold houses on the market in November was the highest in 20 years. Nearly three million houses were awaiting buyers on Thanksgiving Day, 2005.

And those houses that are already in homeowners’ hands are getting more expensive to own. The teaser rates under which they were purchased are expiring. Now, they’re paying interest at higher rates. According to Barron’s, there is a huge quantity of sub-prime mortgages that must be reset. How can these people continue spending more than they earn?

Maybe the January figure is a fluke. Or, maybe consumers are just pressing the pedal to the metal, as they say. They’re already flying along at breakneck speed. Why not give the old engine a little more debt juice and enjoy the ride? You’re dead at 60 MPH anyway, so why not go 80? Wheee!

Here in Britain, inflation is disappointing central bankers. As in America, they wanted to deceive the public at a fixed and controlled rate — a minimum of 2% per year. But in the latest 12 months, only 1.9% of the pound’s purchasing power fell off. Last month, prices actually fell (the pound grew larger). What does this mean? It means the economy is slowing down.

“It’s hard not to conclude that recession is on the way in the U.K.,” says our friend James Ferguson. “Growth has never before been as low as it is now (1.7%) without continuing on into recession. We know…that there is a close relationship between house prices and retail spending because of the mortgage-equity withdrawal (MEW), and we know that MEW in the last 12 months has dropped by an amount equivalent to 3% of GDP. You can’t just walk away from a hit like that, not when consumption makes up two-thirds of GDP.”

Oh, woe is us…woe is us. Whither will you go, Britain? And whither, dear America? The British currency is almost stable; the economy is slipping. Quick, start up the printing presses! Get Bernanke on the phone; ask him what to do. Gently remind him about those “unconventional methods” he favors — destroying a currency to incite a boom. Remind him that if he can weaken the value of the currency, people will be only too eager to get rid of it. Spending will sizzle again. The consumer economy will flourish. At least, that is the simple-minded reasoning that undergirds his oeuvre. It never seems to have occurred to him that people might catch on and dump their dollars before he gets a chance to cheapen them. But in the Bernanke Weltanschauung, he and his central bankers pals are fleet a’foot and sharp a’brain; they’ll always stay one step ahead of the people they’re trying to fleece.

Historically, no national bank, by purely conventional means, has ever failed to ruin its money, but not necessarily when or how it was planned. Bernanke’s obsession, say the experts, is neither with protecting the dollar nor with destroying it, but merely with controlling the rate of disintegration. There, we think the central banker is asking for too much. He is like a killer who asks him victim to stand still so he can stab him slowly. Imagine his surprise if the victim stabs first.

• Don’t worry, says David Brooks in the NY Times. The U.S. Empire is not in decline, it’s still the rising power, he says. We’re the biggest, best, brightest, most bumptious race in the entire world, he points out. By almost every measure, we’re on top…and we are still investing vast sums in research and engineering to make sure we stay on top.

Of course, that is what can be said at the top of any bull market or the top of any civilization. In the Fin de Bubble period, it appears to almost everyone that you are the best people God ever created; you can’t see any reason why you shouldn’t just get better.

What about falling consumer incomes, you ask? What about the trade deficits? What about government and consumer debt? Oh, don’t worry your little head about them; it’s a New Era. What about squandering the imperial military forces on costly and insignificant wars? Don’t worry about that either. We’re an empire, after all; we have to act like one.

We doubt Brooks is right, but wouldn’t it be nice to think so?

• For Valentine’s Day, we went out to see Walk the Line. We sat next to another couple, whose romantic evening must have gotten off on the wrong foot. We guess it started with an argument about nothing, but you never know about arguments. You never know what they’re really about. Sometimes they seem important and are really about nothing. Sometimes they seem like nothing, but are really important.

We leave to St. Valentine, the labor of sorting out distressed couples. But as we heave our shoulder to the wheel of economics and finance, we cannot help but notice that there is always a lot more going on than meets the eye or ear. And walking the line in central banking, as in marriage, can be harder than it looks.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis.