Hope and hype are again triumphing over reality.
The primary preoccupation in economics worldwide is the U.S. economys "recovery", presently hyping the markets. We note three different views. First, a cocksure bullish consensus; second, doubtful voices, among them the Federal Reserve, stressing the lack of conclusive evidence; and third, a few lonely voices, ours among them, who flatly repudiate the possibility of a full-scale, self-sustaining economic recovery in the United States.
We see years of Japanese-style sluggish growth for America, if not worse.
Yet, the latest American Association of Individual Investors poll showed 71.4% bulls and a miniscule 8.6% bears. The gap between the two is the highest since August 1987, just weeks before the crash. Merrill Lynch surveys show institutional investors more fully invested than at any time in the past two years, and heavily overweight high tech.
The case of the bullish community rests crucially on the assumption that the U.S. economy is basically in excellent shape. Fed Chairman Alan Greenspan, and with him the large bullish community, have actually never seen anything seriously wrong with it.
In their view, its failure to return to normal economic growth is mainly due to a series of exogenous shocks inflicted one after the other on the economy: the stock market crash, the September 11 terrorist attack, the corporate governance scandals and the Iraq war. Rather, they consider it a sign of health that the economy has not weakened more in the face of this unusual sequence of shocks.
Yet compared to the extraordinary exuberance prevailing in the markets, the Fed has been remarkably hesitant in declaring the economy's impending recovery. In his testimony to Congress, Greenspan acknowledged that the "economy is not yet showing convincing signs of a sustained pickup in growth." In the same vein, Richmond Fed President Alfred Broaddus said a bit later in an interview, "We still don't have a critical mass of hard evidence that the economy is accelerating," defining "hard evidence" as increases in employment, production and capital spending.
Now to our own opinion: after careful analysis both of recent economic data and also of basic micro- and macroeconomic conditions for the resumption of strong economic growth, we have come to two conclusions:
* First, the U.S. economy neither improved nor accelerated in the second quarter. The reported GDP growth of 2.4% is grossly misleading. From the perspective of quality, it has distinctly deteriorated.
* Second, as we shall explain in detail, the crucial macro- and microeconomic conditions for a self-sustaining and self-reinforcing economic recovery remain flatly missing. Necessary economic and financial adjustments of past economic and financial excesses implicitly involve pain. But pain is not accepted in the United States. In essence, policymakers are trying to cure past borrowing excesses by more of the same and new excesses.
Trying to assess the U.S. economy's prospects, the first thing to realize is that past cyclical experience offers no guidance to the present downturn because it has completely different causes and also a completely different pattern.
All past recessions had their main cause in monetary tightening. As soon as the Federal Reserve loosened its shackles, the economy promptly took off again, propelled by pent-up demand. For the first time in history, the U.S. economy went into recession against the backdrop of most rampant money and credit growth.
Manifestly, the forces depressing the economy this time are radically different from past experience. The typical, major imbalance in post-war business cycles has usually been in inventories. To correct it, retailers and manufacturers temporarily sold from stock, depressing production. Once the stocks were down to desired levels, production came into its right again. At the heart of the regular V-shaped business cycles was the inventory cycle.
In contrast, the present downturn has its brunt in the combination of a profit and capital-spending crisis. At the same time, there has accumulated an array of economic and financial dislocations that tend to depress the economy in many ways, such as extremely poor profits, badly ravaged balance sheets, a variety of asset bubbles in different stages of development, excessive leverage in the whole financial system and shrinking cash flow. There is nothing normal anymore in the U.S. economy and its financial system.
For the old economists, investment in tangible assets - factories, commercial buildings and machinery - was paramount in creating both economic growth and wealth. It creates demand, employment and income as the capital goods are produced. And with their installment, all these new buildings, plant and equipment create increased supply along with increasing employment and income with increased productivity.
The United States has always been a low-savings and low-investment economy. Putting it in reverse: a high-consumption economy. But all three went to unprecedented extremes over the past several years. Savings and investment have been run down to atrociously low levels that are typical for underdeveloped countries.
To repeat: Investment in tangible assets is paramount in creating everything that is decisive in generating our wealth and raising our living standards. Given the low levels of saving and investment in the United States, American policymakers and economists in recent years have elevated productivity growth to the single most important achievement of an economy. But just by itself, productivity growth creates only unemployment. It is the normally associated capital spending that makes for the necessary, simultaneous demand and employment growth.
This simple recognition - gross lack of saving and capital formation - is really at the root of our controversial and highly critical view of the U.S. economy's sanity and vitality. True, its growth rate has been the highest among the industrial countries for years. But it has all the time been economic growth of the most miserable quality. The striking hallmarks of this extremely poor quality were collapsing savings, low rates of business fixed investment, a profit carnage that began at the height of the boom, exploding consumer and business debts and an exploding trade deficit.
Today's economists have at their disposal information in quantity and speed as never before. But reading numerous reports, we have the impression that very few are making use of it.
Particularly shocking in this respect were the immediate euphoric reports about growth acceleration in the second quarter.
During the 1960-70s, by the way, the U.S. accumulated on average about 1.5 dollars of additional debt for each dollar of additional GDP. Just extrapolate this escalating relationship between the use of debt and economic activity. And think of it: the GDP growth of today is tomorrow a thing of the past, while the debts incurred remain.
Plainly, Greenspan's policy has collapsed into uncontrolled money and debt creation that has rapidly diminishing returns on economic activity. The late economist Hyman P. Mynsky would call this a Ponzi economy, where debt payments on outstanding and soaring indebtedness are no longer met out of current income, but through new borrowing. Soaring unpaid interests become capitalized.
P.S. We keep asking the question of the American economists: Are they providing deliberate misinformation or simply performing slipshod work? In our view, as usual, the latter rings true.
The whole economic discussion today is fixated on the next economic data with one single question in mind: is it better than expected? Careful, more detailed analysis with a longer-term perspective is completely missing. Obviously, most economists and journalists read no more than the brief summaries provided by agencies, like Bloomberg and Reuters, that only rehash the summaries preceding the official releases.
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."
In the September issue of his newsletter, Dr. Richebächer aggressively dissected the data economists are interpreting as a miracle 'recovery' - including a critical look at defense spending and its aggregate effect on the revised GDP numbers for Q2. His conclusion: the recovery is hokum. If you are not already a subscriber, you can't afford to miss this special report:
Greenspan Is Robbing You Blind! http://www.agora-inc.com/reports/RCH/RighteousGains