K. Richebacher, A Dangerous Addiction

A Dangerous Addiction
By Dr. Kurt Richebacher

It has become customary in the United States to speak of
"asset-driven" economic growth. "Asset-driven" is, of
course, a euphemism for bubble-driven, because it requires
particularly large rises in asset prices.

Many modern economists consider asset-driven growth a valid
alternative to the traditional growth pattern, nowadays
called "income-driven" economic growth.

Mr. Greenspan gained high regard in the late 1990s for
nourishing the rising stock values that provided such a
massive "wealth effect" and, therefore, such a massive
boost to consumer spending. Plainly, this inspired him to
subsequently nourish the housing bubble. A new, indirect
and apparently more efficient method of stimulating
consumer spending through intermediation of an asset bubble
was invented.

It seems to have two great advantages. Rising asset prices
can boost "wealth" much more quickly than income growth,
while also providing facilities with high leverage. But if
these are advantages, they cannot be regarded in isolation.
For obvious reasons, the bullish publicity concentrates on
the two best-looking statistical aggregates as the key
measures of economic performance. That is, real GDP and
productivity growth. As a rule, they are in line with what
people actually experience in the incomes they earn and the
prices they pay in the shops. But this time, there is an
unprecedented gross discrepancy between the very good looks
of these two aggregates and what they experience in actual
life. It is an open secret there is extensive statistical
spin.

Frankly speaking, we liken asset bubbles and associated
credit bubbles with drugs. Just like human bodies can
become dangerously addicted to drugs, economies can become
dangerously addicted to these bubbles. Of course, drugs
cause severe damage to body and soul, and so do asset and
credit bubbles to the economy and its financial system. In
the U.S. case, these damages are highly visible. See the
collapse of saving, the monstrous trade deficit, the
capital spending crisis, miserable employment and income
growth and, on top of that, the debt explosion devastating
balance sheets.

These are definitely the attributes of pathological,
unstable and unsustainable economic growth. These are more
than just symptoms, because they exert their own malign
effects. The decisive problem is that credit bubbles do not
evenly distribute their effects across the economy. They
concentrate on one or two areas, which expand out of
proportion to normal trend growth. In the U.S. case, the
latest credit excess has centered on durable goods, housing
and financial speculation.

Put differently, asset and credit bubbles distort the
economy's demand and output structure in an unsustainable
way. At some point in the future, the related spending
excesses flag, either under the pressure of credit
tightening or on their own accord. Depending on their size,
the bubble economy slides into recession.

Have the borrowing-and-spending excesses of the past years
in the United States been of a size to make a severe
adjustment crisis and deeper recession possible or
probable? That is today's most important question, not only
for the U.S. economy, but for the world economy. A crucial
related question, of course, is the U.S. economy's
resilience and flexibility to resist the coming adjustment
shocks.

According to forecasts, the consensus economists expect the
U.S. economy to see little more than a brief and minor
economic slowdown from the housing blow. Basically, it is
still in their eyes a "Goldilocks" economy, its outstanding
emblem being low inflation interest rates.

For American economists, it is dogmatic that low inflation
rates are the infallible indicator of economic health. The
Great Depression of the 1930s, and also Japan's prolonged
economic malaise, both having followed many years of a
stable price level, should have taught a lesson about the
inadequacy of this aggregate as a measure of health and a
guide for policy.

The key point about the U.S. economy, really, is that the
forces that caused the 2001 recession never went away. They
went from bad to worse. Business fixed investment has not
really recovered from its slump in 2000–02. Its recovery in
the following years has been far too weak to offset the
prior loss. The counterpart and implicit cause of this
capital spending crisis are the spending excesses on
consumption and housing absorbing a growing share of GDP.

In 2005, consumer spending and the housing bubble accounted
for 90.1% of real GDP growth. Now consider the following
two figures: Real disposable income of private households
grew 1.2%. This compared with an increase in real consumer
spending by 3.5%. That is, spending rose three times as
fast as disposable income!

It is no secret what made this incredible discrepancy
between the two aggregates possible: equity extraction
against inflating house prices. Over the four years 2001–
05, outstanding mortgages of private households have jumped
from $5,292.9 billion to $8,888.1 billion, or 68%.
Apparently, the housing bubble was not only the icing on
the cake. It was the cake.

While U.S. real economic data overwhelmingly keep
surprising on the downside, comments by economists and the
media keep surprising on the upside. According to a count
by Kleinwort Benson (Dresdner Bank), the frequency with
which the word "Goldilocks" is mentioned in the financial
press has risen to its highest level since the word came
into vogue as a description of the ideal U.S. economic
environment.

This is grotesque. Compared with 2000, when the last
downturn started, the U.S. economy's growth fundamentals —
savings, investment and the trade balance — have
dramatically worsened. Debts, in particular of private
households, have escalated as never before.

And now comes the housing bust – a bust that has barely
started. The housing-driven wealth effect that Americans
have been enjoying has disappeared. And now that home
prices are falling, the wealth effects will become anti-
wealth effects.

Rising home values have been supporting the U.S. economy's
recovery. Any significant fall in home values will abort
it.

[Joel's Note: The housing bubble wasn't the only thing the
world's most notable classical economist predicted way
ahead of time – the wilting U.S. dollar and a plummeting
savings rate has lead Dr. Richebacher to some other ghastly
conclusions regarding current U.S. economic trajectory. The
following report outlines the coming crisis and, more
importantly, details exactly how you can prepare yourself
and your portfolio for it. Greenspan fans need not apply.

The Coming Crisis and How You Can Best Prepare
http://www.isecureonline.com/Reports/RCH/ERCHG813