 A Grotesque Misnomer
The Daily Reckoning PRESENTS:
Wealth
creation used to be a factor of sweat, blisters, and clock-time.
Not in Greenspan's new world order... to get rich nowadays, you
simply have to use your credit card and refinance your house
occasionally.
Kurt Richebächer
Jun 1, 2004
Economic growth
now depends crucially on the strength of wealth and profit creation.
Mr. Greenspan and the bullish consensus economists claim that
America is enjoying its highest rate of wealth creation in history
- through rising asset prices.
Fed members
are claiming that this is a perfectly normal transmission mechanism
of monetary policy. This is an outright lie. Never before have
inflating asset prices been a key driver of real economic activity.
To be sure,
asset prices have always risen in the early stages of a cyclical
economic recovery in response to monetary easing. But such increases
do little or nothing to boost economic growth.
First of all,
in past recoveries, price rises were generally very limited in
size, particularly for housing; and secondly, there was no way
to convert the asset inflation into cash, because the reckless
lenders of today did not exist. Besides, Americans of the 1960
- 1970s would have been too proud to practice inflated-asset
liquidation and too intelligent to mistake it for wealth creation.
There is no precedent for such profligate behavior of private
households.
Worst of all,
asset-price inflation is not wealth at all. That is strikingly
obvious from the macro perspective. The best way to realize this,
we think, is a comparison against the true wealth creation that
generations before us have experienced and that generations of
economists have regarded as the one and only way to greater,
lasting prosperity. It comes from investment spending on income-creating
buildings, plant and equipment.
Investment
spending creates demand, employment and incomes in the first
instance through the production of the necessary capital goods.
When finished and installed, the new capital goods go into production,
creating further employment, incomes and demand. And most importantly,
debts incurred in connection with this wealth creation are self-liquidating
through the underlying income creation.
And what really
happens to incomes and debts in the case of so-called wealth
creation through appreciating asset prices? Nothing at all. Generations
before us never thought of it as wealth creation. This new attitude
arises principally from a general convention to consider total
outstanding assets of a certain category as being worth the price
of the last trade, however small that trade may have been. Clearly,
small trades have tremendous capitalization effects. For good
reasons, such so-called wealth creation is not practiced in most
countries.
In Japan's
case, the principal beneficiaries of the asset bubbles in the
late 1980s were industrial and real estate businesses. In the
U.S. case, it is the consumer. But in order to enjoy the wealth
effects of rising stock and housing prices, the American consumer
had to encumber himself with soaring debts in order to afford
the price-driving asset purchases.
For Mr. Greenspan
and the bullish consensus it is a virtuous circle, as the overall
gains in capitalized asset prices have outpaced the rise in debt
levels. Implicitly, the big net gain in asset values can be used
as collateral for borrowing, which funds higher spending for
consumption.
In their economic
effects, these two patterns of wealth creation have nothing in
common. The key feature of the capital investment model is correlated
increases in current and future incomes. It boosts economic growth
both in the short and long run. What's more, the associated initial
rise in corporate debt amortizes itself through the following
depreciations.
The striking
key feature of so-called wealth creation through asset bubbles
in favor of the consumer is, first of all, the associated record
production of debt, set against the total absence of income creation.
To maintain demand creation through this kind of wealth creation,
ever more debt creation is needed - first, to keep the asset
prices inflating; and second, to fund the spending on consumption.
Thinking it
over, one realizes that "wealth creation" is really
a grotesque misnomer for asset prices that are rising out of
proportion to current income. The economic reality is not wealth
creation, but impoverishment. We repeatedly hear from Americans
that they are living in houses or apartments they cannot afford
to buy with their present incomes. But many years ago, with incomes
and prices as they were at the time, they could afford the houses.
That says it all.
The writing
has been on the wall for years. In 1996 the American consumer
increased his spending on current goods and services by $281
billion, with debt growth of $345.7 billion. In 2000 he spent
$456.9 and borrowed $566.9 billion. And in 2003 spending of $367.9
compared with debt growth of $879.9 billion.
But consumer
borrowing was not alone in escalating to unprecedented extremes.
Government borrowing also soared, in particular borrowing for
boundless financial speculation.
In 1997, the
U.S. economy grew by $487.4 billion in current dollars, with
an overall credit expansion of $1,406.8 billion. That was already
an unusually high borrowing ratio. In 2003, it took $2,717.5
billion of new credit to generate nominal GDP growth of $504.7
billion.
Credit excess
- always due to artificially low interest rates - implicitly
means spending excess. But the problem is that these spending
excesses tend to distribute very unevenly across the economy.
In the United States, for years, the spending excesses have been
overwhelmingly directed towards the whole range of asset markets
- stocks, bonds, housing - and in the economy towards consumption.
Given the enormity
of these credit and spending excesses, it goes without saying
that they have involved tremendous distortions in the economy's
whole structure, being typically located in three areas: first,
they misdirect output; second, they distort relative prices,
costs and profits; and third, they strain balance sheets.
It used to
be true among policymakers and economists that for an economy
ailing from such structural distortions, a return to sustained
growth is only possible after these have been significantly moderated,
if not removed. Mr. Greenspan has plainly opted for the diametrically
opposite strategy of fighting economic weakness, regardless of
existing maladjustments, through more and more credit excess.
Pointing to
the U.S. economy's rates of real GDP growth, Mr. Greenspan claims
full success for his policy. Compared with the far higher rates
of growth of past cyclical recoveries, his policy has grossly
failed, even by that measure. But considering the horrible development
of employment, it has been a policy disaster.
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!
______________
321gold Inc
|
