The New Empire of Debt: The Rise and Fall of an Epic Financial Bubble (44 page)

This is the great comedy of the financial markets.They put a fool together with his money just so they can get a good laugh by taking it away from him. These “investors” thought they were geniuses.They thought their techniques and strategies were making them rich. Of course, tech stock speculators also thought they were getting rich. Then, they lost “a ton” of their portfolios. It is amazing that they had a ton left. But that would go soon.

As prices rose in 2005, Congress wanted to know if the Fed might raise rates faster than anticipated. It looked as though the bubble in real estate was getting out of hand. Don’t worry about it, said the world’s most famous economist; inflation was no problem.

“The economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well anchored,”Alan Greenspan told the nodding heads on the Senate Banking Committee. “The evidence broadly supports the view that economic fundamentals have steadied.”
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He must not have looked out the window that day. For the very same day, as headlines made clear, inflation and inflation expectations—notably in the housing market—were under full sail in hurricane-force winds.

The cost of housing, in many areas of the country, was not just inflating—it was blowing up like a front-seat air bag. In Alan Greenspan’s home-town, Washington, DC, prices were rising six times faster than GDP growth. Buyers were not looking for a place to live; they were speculating—betting that their neighbor, the Fed chairman, would continue giving away enough money to make them rich.

The house flippers were driving around in new Mercedes, making big money by buying and selling each other’s houses. One genius bought a condo before it was built. He flipped it to another investor, who held it until it was completed, making a bundle when he sold it to a professional couple who intended to stay for two years and then sell (at a huge profit) to other buyers. All of them were making the smart moves—buying with little money down and making minimum monthly payments on adjustable rate mortgages. And all of them were getting richer—or so they believed—as long as prices continued to rise. They talked about it at cocktail parties. They looked at their balance sheets with pride and pleasure, and if they needed cash, they “took out a little equity” as easily as calling for a pizza.

Pity the poor renter. He was the sort of man you wouldn’t want your daughter to date, let alone marry. He was the poor loser who forgot to buy tech stocks in the late 1990s and now was missing the real estate bubble. He was the quiet, lonely dork who never got invited to parties and had nothing to say—except an “I told you so” that he had been holding onto for years, waiting for the right moment.

AMERICANS GET POORER . . .

“This is the greatest crisis facing the country that people can do something about,” wrote Ben Stein in
Forbes.
Stein was talking about people who failed to save enough for retirement.

“With less than 20 percent of U.S. workers now in employer pension plans (many of those plans are on shaky financial footing) and with Social Security typically replacing less than 40 percent of pre-retirement income, personal saving has never been more important,” continued Stein. And yet, few people save any money.

“Savings rates have never been lower,” Stein explained. “In 1999, the national savings rate dipped below 3 percent for the first time since 1959, according to the U.S. Commerce Department. It has been declining further since then, and in 2004 it was at a mere 1 percent. The low savings rate, coupled with large deficit financing by Asian banks, is dangerous for the U.S. But it’s more dangerous for individuals.”

People are forever crying alarm about this or that. There is a crisis in health . . . a crisis in moral values . . . a crisis in the Middle East . . . or in the newspaper trade. For all the whining, there is usually little that can be done about the emergency, and if it is left alone, it generally takes care of itself in its own way.

“Nearly 28 million U.S. households—37 percent of the total—do not own a retirement savings account of any kind,” continued the
Forbes
article, “Among the households who owned a retirement savings account of any kind as of 2001, according to a 2004 report by the Congressional Research Service (CRS), the average value of all such accounts was $95,943. That number was distorted by the relatively few large accounts, and the median value of all accounts was just $27,000.

“The median value of the retirement accounts held by households headed by a worker between the ages of 55 and 64 was $55,000 in 2001,” the CRS says. To that, Stein added that “just 11 percent of all Americans have retirement savings of $250,000 or more.”
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You can jabber to people about saving money until your jaw falls off; they’re not going to put an extra dime in a savings account—not when property prices are going up at 10 percent per year and the Fed is still giving away money. Eventually, however, the things that must happen do happen. Of course, that’s when people wish they had saved money. That’s when they really need it. That’s when the whining really begins.

Saving—like manufacturing—is one of those early-empire virtues that was once an important part of the American economy . . . but seems to have gotten exported. The Chinese now make our products and do our saving for us. They save more than 25 percent of their income. According to Ben Bernanke, they had so much of savings, they were thankful to us for taking it off their hands.

But what goes around comes around.When the U.S. real estate bubble popped, some of that old virtue began to make its way back home. Americans started to save again.Whereas they put aside only a penny on the dollar in 2005, soon they are likely to set aside 10 cents or more.The savings crisis will be over. A new crisis can then begin: a depression.

In traditional economic theory, people save. Their savings are borrowed by entrepreneurs and businesspeople to build new enterprises, new factories, and new consumer items. This new output is then sold at a profit, which creates new jobs—and higher incomes—that give people more purchasing power, more savings, and so forth.

But in America’s fabulous twenty-first century bubble economy, things happened so much differently that we wondered. Is the theory mistaken . . . or are Americans? Hardly a dime was saved. But Americans spent more than ever.

Something was wrong. The picture was grotesque, unnatural . . . like a pretty wife who rotates her own tires—it is almost too good to be true.

The problem with not saving money is that you won’t have any. If you want to do anything beyond what you’re already doing, you have nothing saved up to do it with. Even current levels of consumption cannot be maintained. Factories wear out and need to be rebuilt. Competitors race ahead. There is no standing still.You are either going forward . . . or falling behind. “Day by day, all the earth ages, drooping unto death,” saith the old Anglo-Saxon poets.You need a reserve of “energy”—savings—to give it life again.

Tout passe, 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 deception that precedes it. And the pain it causes is directly proportional to the pleasant deception that went before 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.

In particular, 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 was so large, we wondered 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 played 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).

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, hide-bound . . . 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 in 2005:

Everybody believed that America grew a lot faster than Europe over the previous 10 years. But the figures, in terms of GDP/person were very close—2.1 percent per year for America against 1.8 percent for Europe. Take out Germany—which struggled with absorbing its formerly communist cousins from the East—and the two regions were exactly the same.

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

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.

It’s true that Americans earned more and spent more than Europeans . . . but they worked a lot more hours.

Europeans simply enjoyed more leisure.

But what about the post-2001 “recovery?”Wasn’t it 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 slightly outpaced Europe’s. But the figures are hard to compare. Europe calculated GDP growth more conservatively than America . . . and understated the truth, rather than overstated it, as they did at the Labor Department. More importantly, America’s jolt of growth came at great cost. While Europe got no net stimulus, America got 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,” said 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 had the twenty-first century begun and America found itself in a remarkable position. It had what it believed was the world’s most powerful economy . . . and the world’s most powerful military force. Like the defunct Soviet Union, it had a sickle in one hand and a hammer in the other. The sickle, alas, had an awkward bend in it.

Since 1990, income for the average American household rose only 11 percent while average household spending 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.