 Imbalances and Dislocations
The Daily Reckoning PRESENTS:
The Fed
issued a 'deflation scare' to harness Wall Street's awesome speculative
firepower. The E-Z credit gushed. But if you play with fire,
sooner or later, you'll get burned...
By Kurt Richebächer
The Daily
Reckoning
May 15, 2004
Attempting to assess the U.S. economy's further outlook, one
should first ponder the main causes that have been thwarting
a stronger and healthier recovery, even though the Fed's monetary
and fiscal policy has achieved an aggressiveness without precedent
in history.
For most American
economists, sufficiently easy money is of infallible efficacy.
The few instances in history when record-low interest rates persistently
failed to work, like recently in Japan and during the 1930s in
the United States, are summarily discarded with the argument
that central banks failed to act fast enough.
During the
whole postwar period, it has, in fact, been typical that depressed
economies promptly took off once central banks eased. Yet for
us, this was never proof of the efficacy of monetary policy.
Since all postwar recessions had their cause in monetary tightening,
it was only natural that economies promptly jump-started when
central banks loosened their brakes.
But the situation
today is radically different. For the first time in the whole
postwar period, the U.S. economy slumped against the backdrop
of rampant money and credit growth. But if tight money or credit
did not break the boom in 2000, it is hard to see how easy money
can be the cure.
Identifying
the true causes of the U.S. economy's poor economic performance
in recent years is certainly a most important task. During 2003,
leading Fed members propagated the idea that the U.S. economy
was mainly suffering from an "unwelcome fall in inflation"
- according to the title of a speech by Fed Governor Ben S. Bernanke,
on July 23, 2003, at the University of California, San Diego.
In more detail, Bernanke said that lack of pricing power was
seriously impinging upon corporate profits, which in turn had
strangled business capital investment.
Considering
that the U.S. economy had been booming with the most rapid money
and credit growth in history, this was an absurd conclusion.
But several Fed members managed to exploit the temporary deflation
scare they had raised, the better to implant expectations for
sharply lower long-term interest rates into the markets - with
the desired effect that the financial community, with its huge
speculative firepower, quickly obliged with prodigious carry
trade.
What, then,
brought the U.S. economy down in 2000? In short, several years
of unprecedented credit excess. We realize this is unthinkable
for many people, yet it is a notorious historic fact that serious
depressions are always preceded by extremely loose money and
extraordinary credit excess. Tight money is too easily reversible
to cause a deeper crisis. Ironically, it was always low inflation
rates that misled central banks to excessive credit accommodation.
The two worst
cases of this kind in history are, of course, the U.S. boom-bust
from 1927 to the 1930s and Japan's boom-bust since 1987. In both
cases, extraordinary asset bubbles played a key role in escalating
credit excess. The third, and probably worst, case of a "bubble
economy" is the United States for the past several years.
Credit excess
thwarts economic growth even in the absence of monetary tightening,
through effects ambiguously known in Austrian theory under different
labels: structural maladjustments, distortions, and imbalances
and dislocations.
The imbalances
most often cited are a rock-bottom national savings rate of 1%
of GDP, record levels of personal indebtedness, a record current
account deficit, a record-high budget deficit, a record ratio
of household indebtedness and an unprecedented shortfall of employment
growth and labor income generation.
But there are
important other imbalances that are totally ignored. One of them
is the tremendous gap that has developed in the United States
between virtually stagnating production of goods and soaring
demand, as measured in retail sales. While the latter have been
going from record to record, manufacturing production, which
should deliver most of the goods sold in the shops, has been
badly lagging. The soaring difference went, of course, into the
soaring trade deficit.
For more than
two years, the Fed has been holding its short-term rate at 1%.
That is, below inflation. But instead of spurring economic growth
directly, it stimulated sharply rising prices in almost all major
asset classes, which in turn stimulated spending, mainly consumer
spending. Rising property values and the increasing ability and
willingness of homeowners to tap accumulated housing wealth became
the major pillars of support both for the economy and also -
given minimal personal savings - for the asset markets.
The all-important
question now, of course, is whether this ultra-loose monetary
policy and the associated development of asset prices have laid
the foundation for a normal, self-sustaining economic recovery.
Good luck,
Dr. Greenspan.
Regards,
Kurt
Richebächer
for The
Daily Reckoning
Editor's note:
Former Fed Chairman Paul Volcker once said: "Sometimes I
think that the job of central bankers is to prove Kurt Richebächer
wrong." A regular contributor to The Wall Street Journal,
Strategic Investment and several other respected financial publications,
Dr. Richebächer's insightful analysis stems from the Austrian
School of economics. France's Le Figaro magazine has done a feature
story on him as "the man who predicted the Asian crisis."
Dr. Richebächer
is currently warning readers to beware the wiles of Alan Greenspan
- for unchecked, they can sabotage your investments. To learn
how to avoid them, read the good doctor's latest report:
Don't Get Caught in the Greenspan Trap!
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321gold Inc
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