Candy to Stop America’s Blubbering
|Sep 3, 2007|
Between them, President George W. Bush and Federal Reserve Chairman Ben Bernanke last week summed up much that is worst about America’s baby boom generation. Those who dodged the draft for Vietnam are now trying to dodge the consequences of a generation’s belief that the world owes them a living. If the US carries on with this course it can only result in a collapse of a value of the dollar greater than that of the late 1960s and early 1970s when the bills came due for the Great Society and Vietnam War.
Asia needs to beware. It has been welcoming the short-term relief provided by the latest bout of money-printing in Washington. More money from the Fed adds to the global supply and hence keeps asset markets at inflated levels in Asia as everywhere. But ultimately, as the owner of the bulk of America’s vast foreign debt, Asia will be the loser. Hard earned – often enforced -- savings will devalue, exposing the folly of providing the Americans with candy at give-away prices while spending too little at home.
At the first sign of nervousness on Wall Street -- relatively small falls in asset prices which might threaten oversized bonuses -- Bernanke was quick to offer cheap money from the Federal Reserve for banks that lacked the credit standing to borrow in the marketplace. All this is done in the name of financial sector stability, code words for bailing out greedy and incompetent financial market players.
Next up was President Bush, kindly offering government-supported relief for vast numbers of sub-prime borrowers who are unable, or soon will be, to pay rising interest rates on their loans. This was presented not only as a way of helping distressed, lower-income home-owners but of preventing mortgage problems from having a knock-on effect on the wider economy. Of course, it is also another way of bailing out those who persuaded borrowers to take out unaffordable loans in the first place – Wall Street.
Of course these bailout efforts were accompanied by suitably responsible-sounding messages about the need to avoid moral hazard, to let a few of the more dodgy players suffer the consequences of their greed and stupidity. But the mainstream message is bailout, bailout, bailout.
As if Bernanke was not being sufficiently accommodating, other Federal Reserve governors were on hand to push him. Frederic Mishkin chimed in with a demand that prompt Fed action was essential to stop house prices from falling. Bill Gross of Pimco, the world’s largest bond fund, said much the same thing even though one would have thought bond market vigilantes would be up in arms over such obvious measures to induce inflation.
The financial media have been full of exhortations from so-called experts urging similar action. “He would, wouldn’t he” – to use the phrase of the call-girl about a prominent client denying a relationship.
What is astonishing, particularly in Asia, is that this surge in the supply of cheap money is deemed necessary after a decline of less than 10 percent in major US stock indices and only a few percent in house prices. Even after prices had risen by 50 percent in five years, 100 percent in a decade and 300 percent since 1980, it is deemed unacceptable to Americans to see a fall of even 10 percent. This would drive the economy into recession, it is claimed.
Indeed it might. But why not? The US economy has avoided a much-needed recession through a level of self-indulgence and hubris that makes 1990s east Asia look positively puritanical. Cheap money drove up house prices and enabled existing homeowners to borrow against the value of their properties, thus sustaining consumer demand. But the suckers who paid for this indulgence were the foreign lenders underwriting the US current account deficit, now running at a stunning US$700 billion a year.
Every effort to sustain house prices through cheap money may in turn sustain consumer demand for a while – but it will also sustain or even add to the current account deficit. The last serious Fed governor, Paul Volcker, has warned often enough that current account deficit of 6 percent cannot be sustained for long, even by a country that thinks the international system allows it free rein to print money and assumes that Asia must save “excessively” to enable an aging America to save very little.
Meanwhile America’s own (few) savers are penalized by low interest rates which barely exceed a consumer price index, even one manipulated by hedonic pricing and chain links to deflate the index and hence pensions.
The Wall Street wizards convinced Volcker’s pliable successor, Alan Greenspan, and other central bankers that they had discovered new ways of using money more efficiently, pushing up asset prices without endangering any other aspect of the economy. Unfortunately central bankers almost everywhere are far too close to the people they are supposed to regulate. They have obviously forgotten the remarks of that most worldly-wide of economists, J.K. Galbraith: “Financial operations do not lend themselves to innovation… The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version”.
If the US was not a spoiled brat it would realize that the only way to get out of this bind and preserve the value of the dollar is to accept the inevitability of a consumer-led recession. Households would consume less and start saving. Consumption would fall, the economy would go into recession, interest rates and the dollar would fall gradually and balance would eventually return to the US current account.
But the baby boomers seem to imagine that recessions and business cycles have been abolished, that they do not need to save for retirement, close as it is now, and that they deserve that second home and third car.
Of course the entitlement society, the reliance on the narcotic of debt, is not unique to America. But the US through the role of the dollar is for now uniquely positioned to indulge it on a grand scale. This is the global equivalent of the bumiputra policy in Malaysia providing an apparently endless, god-given subsidy to a favored elite.
Just as non-Malays reluctantly accept this for fear of something worse, so Asia is accepting of the US debt for fear of something which would bring them some short term pain too. But what they fail to appreciate is that the longer this goes on the greater the likelihood of never being repaid. In his last newsletter in February this year the late Austrian-school economist Kurt Richebacher noted “much of the credit now being borrowed can never be repaid because debt service relies on capitalizing unpaid interest”.
That is a comment which could apply to the whole of the US, not just some homeowners and mortgage lenders.
The last few weeks have seen foreign lenders from China to Germany lose huge amounts from the sub-prime mess and the financial vehicles that turned sub-prime into AAA ratings. Now Bernanke & co are suggesting that their easy money will stop the rot so the foreign owners of US paper will not suffer so much. But this is like pushing a drowning man into shallower water farther from the shore.
It is a strategy which might both be acceptable to creditors and work for the longer term if the US did not need to continue to borrow vast amounts to sustain consumption. But it does. So will east Asia and the oil exporters continue to buy non-government US debt in massive amounts regardless of both the credit and currency risk? Are they prepared to sacrifice the future value of their savings for an easy life now, just as the US has been failing to save to sustain consumption today?
Asia went through a great trauma a decade ago when lenders pulled the rug from under them. But the cathartic effect was such that they recovered remarkably quickly. In a way, the western bankers who pulled that rug so abruptly did the region a favour by bringing back a sense of realism to the region. Asia could do itself as lender and the US as borrower a similar favour by stopping buying US debt until such time as that debt stopped growing.