THE COMING CORRECTION
By Bill Bonner and Addison Wiggin
Oct 13, 2006

Tout passé, tout casse say the French. Everything goes away. Everything breaks down. Nothing is born that does not die. Nothing begins that does not end. There is no morning without an evening, and no silver lining without a cloud. Empires come. Empires go.

In the financial markets, the "going" phase is called a correction. It is intended to correct the excesses and mistakes of the expansion phase. In a bull market, there are corrections that bring extraordinary gains down to more modest ones. In a bear market, corrections - which soften extraordinary losses into more ordinary ones - are known as rallies.

Generally, the force of a correction is equal and opposite to the trend that precedes it. And the pain it causes is directly proportional to the pleasant deception that went before it.

As a practical formula, this does little to help us. We still do not know when or how the correction will come. And, to borrow an idea from Lord Keynes, the deception can last a lot longer than you can remain solvent betting against it. And yet, it is even more dangerous to bet on it.

America's empire of debt rests on many huge deceptions that we have described in this book:

• That one generation can consume - and stick the next with the bill.
• That you can get something for nothing.
• That the rest of the world will take American IOUs forever - no questions asked.
• That house prices will forever go up.
• That American labor is inherently more valuable than foreign labor.
• That the American capitalist system is freer, more dynamic, and more productive than other systems.
• That other countries want to be more like America, even if it is forced on them.
• That the virtues that made America rich and powerful are no longer required to keep it rich and powerful.
• That domestic savings and capital investment are no longer necessary.
• That the United States no longer needs to make things for export.

The deception that sent credit expansion soaring between 2001 and 2005 came eagerly from America's own central bank. By setting its key lending rate below the current inflation rate, the Fed misled almost everyone.

Throughout the boom years of 2002 to 2005, the Great Deceiver, Alan Greenspan, appeared before the U.S. Senate and dissembled. Not only did inflation present no clear and present danger, neither did Americans' debt loads, nor did the negative numbers in the current account. Mr. Greenspan, who surely must have known better, found nothing to dislike and nothing to worry about.

So, we stop, draw breath, and wonder.

The deception is so large, we wonder how it could ever be fully corrected. We speak not merely of Mr. Greenspan's perjury before Congress, but of the larger deception, in which Mr. Greenspan plays a leading role.

The promise of American capitalism is that it makes people richer, freer, and more independent. But since the introduction of the Fed and the rise of the empire, the currency in which Americans keep score has so addled the figures, we scarcely know if we are winning or losing. The dollar we knew as a child - in the 1950s - is only worth a tenth as much today.

The average household today has far more of them than we did. In 1950, U.S. household debt to disposable income, which is basically after-tax income, was 34 percent (if disposable income was $10,000, households had $3,400 in outstanding debt). Today, the average American household has learned to live large - on an imperial scale. Its house is worth more dollars.

It has a bigger car. It eats out more often. It has a wider TV screen with a clearer picture. It has more employment insurance. More health insurance. More Social Security Insurance. More protection offered by more government employees than ever before. It has many more credit cards, with much larger lines of credit. It has more clothes. More toys.

More gadgets, gizmos, and whatchmacallits. It has more debt. More obligations. More chains.

Almost every American believes he is richer. Certainly, compared with the Old World, Americans have no doubt that the rise of their empire improved every subject's life. Is it true?

We pause to deliver a shocking update.

People love myth, fraud, and claptrap - especially when it flatters them. Maybe their food, life expectancy, crime rates, transportation, liquor, women, and architecture are nothing to brag about, say Americans to each other, but when they grub for money, they grub good. "Old Europe," they say, making a comparison, "is too rigid, fossilized, hidebound...a museum."

And yet, even this is a fraud. Despite Laffer's curve, Greenspan's Bubbles and Reagan's revolution, the U.S. economy has done no better than Europe.

The Economist examined the evidence. Everybody believes that America grew a lot faster than Europe over the past 10 years. But the figures, in terms of GDP/person are very close - 2.1 percent per year for America against 1.8 percent for Europe. Take out Germany - which has struggled with absorbing its formerly communist cousins from the East - and the two regions are exactly the same.

And productivity? A study by Kevin Daly, an economist at Goldman Sachs, finds that, after adjusting for differences in their economic cycles, trend productivity growth in the euro area has been slightly faster than that in America over the past 10 years.

What about jobs? America is the greatest jobs machine on the planet, right? Again, excluding Germany, jobs in the rest of Europe grew at the same pace as in America. And more jobs have been created in the euro.

It's true that Americans earn more and spend more than Europeans...but they work a lot more hours. Europeans simply enjoy leisure more.

But what about the post-2001 "recovery?" Hasn't it been much more vigorous in America than in Europe? Well, only on the surface. Spiked up by the biggest dose of fiscal and monetary juice in history, America's economy has slightly outpaced Europe's.

But the figures are hard to compare. Europe calculates GDP growth more conservatively than America...and understates the truth, rather than overstates it, as they do at the Labor Department. More importantly, America's jolt of growth has come at great cost. While Europe got no net stimulus, America has gotten enough to give it the shakes.

"Super-lax policies of the past few years have left behind large economic and financial imbalances that cast doubt on the sustainability of America's growth," says the Economist. "From a position of surplus before 2000, the structural budget deficit (including state and local governments) now stands at almost 5 percent of GDP, three times as big as that in the euro area.

America has a current-account deficit of 5 percent of GDP, while the euro area has a small surplus. American households now save less than 2 percent of their disposable income; the savings rate in the euro area stands at a comfortable 12 percent. Total household debt in America mounts to 84 percent of GDP, compared with only 50 percent in the euro zone."

Barely has the twenty-first century begun and America finds itself in a remarkable position. It has, what it believes is, the world's most powerful economy . . . and the world's most powerful military force. Like the defunct Soviet Union, it has a sickle in one hand and a hammer in the other. The sickle, alas, has an awkward bend in it.

Since 1990, income for the average American household has risen only 11 percent while average household spending has jumped 30 percent. How could people spend so much more money without earning more?

Outstanding household debt doubled to more than $10 trillion between 1992 and 2004, even adjusted for inflation. And in Utah last year, 28 of every 1,000 households declared bankruptcy, almost three times the rate of a decade earlier.

People are determined to live large and live better than they can afford. They do this by what economists call smoothing income. Anticipating higher incomes in the future, young families spend the money now (e.g., buying bigger houses than they can afford). Nationwide, house sizes have grown 30 percent since 1980, says Cornell economist Robert Frank.

And now even people in their 50s and 60s look forward to either higher incomes or miracles. Some economists refer to the whole phenomenon as the "democratization of credit." "Innovation and deregulation have vastly expanded credit availability to virtually all income classes," says the Fed chief. He did not mention his own role in this democratic revolution. He is too modest. He is a Danton and Robespierre put together.

The Fed chairman accomplished more than all the nation's innovators and deregulators put together. Dropping the price of credit below the inflation rate, he offered the entire world something for nothing. Now, every man could get himself into financial trouble, not just kings, speculators, and financiers. He made it possible for lending institutions to extend such a long rope of credit to the common man that millions are sure to hang themselves.

We don't know what to make of it, so we turn to the dead for an opinion. But it is hopeless, the corpses know even less than we do. They can't even imagine what is happening. Borrow against your house when you don't have to? Buy a house as an "investment?" Take out "equity?" "Depend on foreigners to balance your budget?" "Live beyond your means and expect Third World wage earners to make up the difference?"

The ideas that Americans once took for absurd, they now take for granted.

What was wrong with our parents, grandparents, and long-dead ancestors? Why weren't they smart enough to realize that they could have a brand-new house with all the modern conveniences without paying for it? Why didn't they figure out that they could all get rich by buying each others' houses? But now, thank God, we are all geniuses.

The baby born when the empire began in 1913 came into the world with nothing. But he owed nothing. Now, he comes into the world owing his share of 37 trillion; that's about $128,560 with his name on it. Is he richer? Is he better off? What would the dead say? That doesn't include his share of Federal obligations and commitments that he'll have to pay, which could add $100,000 more.


Related Story:
Why Gold ...Grows More Precious Every Day By Bill Bonner, DailyReckoning.com, Nov. 22, 2005

Related Special Offer:
"2006: The Rule of Gold" with book review of "Empire of Debt".

Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).

In Bonner and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Empire of Debt has just been released in paperback - and RMP readers can buy their copy at a discount - just click HERE for "The Most Feared Book in Washington!"


DISCLAIMER: All of the provided information is believed to be accurate, however errors are possible. The opinions in the Commentary section do not necessarily reflect the opinions of Swiss America. Past performance of any investment is no guarantee of future performance. All investments have risk.

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