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Everybody Needs Money

"Everybody needs money. That's why they call it money!" - Danny DeVito as Mickey Bergman in "Heist" 2001

Danny DeVito had a lot of fun doing the movie "Heist" playing a jewellery fence that stiffs a gang of robbers led by Gene Hackman. All of them of course just want to make some money. As the film wore on the double crosses and double, double crosses grew with the body count at the end. No one today has to go to the lengths they did just to get some money. We can all do it quite legally. All you need is a credit card(s).

Even today when I am already up to my eyeballs in credit cards new marketing campaigns show up in the mail almost every month. "Transfer your balances today". "Special low interest rates". "Use our money" "Get our credit card and get an extra one for your spouse or loved one". And then after the credit cards come what follows are the special cheques. "Wouldn't you like to take a break from higher rates?" "Use our special cheques for just about anything - pay the groceries, take a holiday, pay the babysitter, cover your rent....." It goes on. I mean pay the babysitter!!!!! Yes it's real.

One doesn't have to steal the money from the financial institutions they shovel it at you. And it never goes down. Consumer debt in the US grew by $92.4 billion last year or $7.7 billion per month and now stands at $2.1 trillion. This was actually slow up only 4.6%. In Canada it was even faster as it was up over 10%. But what really continues to explode is mortgage debt. In the US this rose 11.5% on the year. And it is not as if the money is going into new houses as most certainly some of it is but there is a continuance of refinancings where the funds are then spent on consumer goods. Live the good life today for tomorrow who knows.

Household debt as a % of disposable income now sits at around 120% in the US (2003 figures). 10 years ago in 1993 it was about 85%. And it is no better here in Canada as we also sit at around 120%. The worst one though are Britain and Japan where in 2003 it was about 140%. Of the G7 countries the Italians are spendthrifts with household debt only around 40% of disposable income. What's the matter with them? Can't they spend? But then the Italian economy only grew around 1.3% last year. Imagine if they spent the levels the US, Canadians, Brits and Japanese did, they might catch up to the lofty numbers in Canada and the United States of 3.3% and 3.7% respectively.

What is driving all of this of course is the ongoing slackest monetary policy ever known. For the past four years or certainly since 2001 the real Fed Funds rate in the US has been as high as negative 2% and despite six successive interest rate hikes it is still negative 0.8%. Rarely in the past four years has it been a positive spread let alone the more historical spread of a positive 2%. Accompanying the low interest rates has been the development of a culture of debt. Not surprisingly even buying a burger at MacDonald's is more likely to be paid for with a credit card then with cash.

Some economists are sounding alarms over the rapid growth of credit. According to a report by the Toronto-Dominion Bank it is creating a "culture of complacency" (odd coming from one of the financial institutions responsible for shovelling money at people as if it were monopoly money). But then in a bold about face they say there is less than a 10% chance of the loose money policy creating a crisis. In soothing tones it was felt that there could be gradual reduction (the Fed uses measured) in financial liquidity through a series of central bank rate hikes and that this will deflate financial excesses. The Bank of Canada released a report at the same time playing down any risks there might be to household finances in Canada.

The Economist is not quite as confident. They said in the February 5, 2005 issue (Still gushing forth) that "there are plenty of other signs that easy money has led to excess, from rapid growth in credit and house prices to tight credit spreads and widespread willingness to take greater risk". Ah therein lies the clue. If one believes that the interest rate hike will at worst only take us back to a neutral spread and that low interest rates and an accommodative central bank is here to stay then not only do the institutions (banks, investment dealers, hedge funds) assume greater levels of risk but so does the individual.

You throw in derivatives and the leveraged games of hedge funds, banks and investment dealers than it might only take a small financial accident somewhere to start a run similar to what happened in 1998 when the Russian rouble collapsed and hedge fund Long Term Capital Management (LTCM) collapsed almost bringing down the financial system. It took the Federal Reserve and a cadre of banks to bail them out in order to prevent a potential bigger collapse. The Fed of course lowered interest rates rapidly and flooded the system with liquidity. But that was back in 1998 and then the interest rates had a positive spread. Today there is no room to do the same thing because we have been in the mode of constant low interest rates now for four years.

Trouble with the exceptionally loose monetary policy in the US is that everyone does it now effectively exporting the easiness world with liquidity ejections and low interest rates. Helping this export of liquidity is the fall in the US Dollar. In order to help keep a lid on their own currencies the other G7 nations are also keeping interest rates low and usually negative for periods longer than they may really care to. Mortgage lending, consumer credit and money supply are growing at dangerous rates everywhere.

And the falling US Dollar creates other dislocations besides playing havoc with monetary policy as they buy US Treasuries, Agency paper and US corporate bonds to again stem the rise in their own currencies which in turn helps keep interest rates low in the US thus fuelling a continuance of the low interest rates in the US which spurs on the consumer borrowing, mortgages etc. All of this is akin to a fire and everyone is standing around pouring gasoline on it to make it bigger and believing "what a great time we are having".

The excess liquidity finds itself poured into a host of assets including houses, stocks and other speculative ventures. Inflation does not have to mean that prices are rising (which clearly they are not as inflation remains low and even artificially low in the US in particular) but instead it is asset inflation. But ultimately it is a complete misallocation of resources as The Economist notes. As the asset prices rise consumers think they have even more to spend and rush out to fill the void by buying even more consumer goods. Personal Spending on the whole has exceeded personal income. In December personal income rose 0.6% not counting the Microsoft dividend but personal spending rose .8%. Most every month that is the situation as consumers spend more than they earn. The savings rate meanwhile continues to hover at extremely low levels barely above zero both in Canada and the US. Who needs to save when foreigners are providing all the savings to protect their currencies and all you have to do is go click click to get what you want now.

Despite the high level of consumer debt it is not consumer debt per se that causes the ongoing record level of bankruptcies. Surprisingly in America it is getting sick (researchers say 50% of US bankruptcies are caused by soaring medical bills) even though apparently 75% of those going bankrupt have medical insurance. Just not enough it seems and if medical bills pile up bankruptcy looms (Note: In Canada because of public health insurance you can not go bankrupt if you get sick). But all that being said, if a financial accident were to happen and there was a sharp downturn in the economy, then the level of debt could cause a credit collapse and defaults would rise.

To date we have not had a credit crunch in this particular cycle. What we are doing is putting off the inevitable because at some point in time in the future the ability to play this game runs out. And none of this is being helped by the easy fiscal policy of the Bush administration. Easy spending by the Federal Government just adds to the culture of spend today and worry about the debts tomorrow. US budget deficits are now projected to exceed $400 billion and some numbers show it could already be as high $600 billion.

Even the recent budget presentation showing that they plan to cut the deficit in half by the end of the Bush term appears to be in trouble even before it starts. The budget assumes that all spending will be frozen or cut except for homeland security and the military where expenditures will go up. But the new budget does not include spending for the wars in Iraq and Afghanistan nor anything in the event another war started such as Iran. The war in Iraq costs upwards of $5 billion a month. There is no allowance for the cost of the Social Security plan that could be as high as $1.5 trillion over the next decade nor the new Medicaid at a cost of about $750 billion over ten years. Even the administration admits Social Security could cost $754 billion over the next decade. Many of the cuts are in areas that have entrenched interests including in congress and the senate such as farmers, veterans and education programs. Slash the farmers and veterans and up the expenditures on security and foreign wars. This won't fly.

While the announcement that the budget might be cut was initially positive for the US$ the trade deficit numbers announced earlier this week ended the recent US$ rally. The massive deficits and debts of the US hang over them like a sword. If they were a third world country the IMF would already be calling. And massive deficits hang over the world. We can't help but notice that Alan Greenspan, effectively the Chairman of the Central Bank of the World will retire next year. Given that his successor may very well face an economic hangover as The Economist says "Does anybody really want the job". In the interim use those special cheques sent to you by your bank. The babysitter will appreciate it. After all she/he like everybody needs money.

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