The road to a long, soft, slow depression is paved with the illusion of wealth...
THE WORLD HE LIVES IN
Bill Bonner
Today we approach a serious and disturbing paradox: how could it be possible for an economy to slow down just when its central bankers and its central government push harder than ever on the accelerator?
If you would prefer something more light-hearted, you could read Alan Greenspan's address to Congress on Tuesday. More and more, we find we share the sentiments of Rep. Bernie Sanders, who remarked following a previous testimony by the Fed chairman:
"Mr. Greenspan, I always enjoy your presentation because, frankly, I wonder what world you live in."
We wonder too.
As near as we can tell, it is a strange one. For in Mr. Greenspan's world, there are no paradoxes. It is a world as clean and dull as an actuarial table with only whole numbers. The Fed chairman is surrounded by such positive thinkers, the poor man must not get a chance to voice a doubt or doubt a voice. Ben Bernanke thinks he can make the dollar worth as much or as little as he wants, just by controlling the speed of the printing press. Robert McTeer says he can hardly wait to fight deflation; he thinks it will be fun. Alfred Broadus is probably the most cautious of the bunch...but still delusional. He says the Fed has proven that it can fight inflation, and now it has to prove it can fight deflation.
It is to this last point that we are drawn...as if to a crime scene. The Fed claims it came along just in time and chased off the miscreant. We look at Al Broadus and the rest of his gang and wonder: who do they take us for, complete morons?
And yet, Americans' can-do optimism seems to depend on the ability of its central bankers to do what the Japanese could not - successfully wage war on deflation. All right, so the war on inflation was not the great success that Broadus thinks it was. (The dollar ended the year 1913 about where it was 100 years before. In that year, the Fed took up its mission - to protect the value of the nation's currency. Over the next 90 years, the dollar lost 95% of its value.) What the Fed has proven is not that it is a good inflation fighter, but that it is good at stabbing the dollar in the back. And since destroying the dollar is just what the times seem to call for, what are we worrying about?
If only there were not so many paradoxes, dear reader. Wouldn't life be much better if women meant what they said? Wouldn't it be nice if you could be happy by thinking of yourself and only doing what makes you happy? Wouldn't it be grand if the investments that made people rich last year would make you rich this year?
Or, more to the point, wouldn't it be just peachy if the Fed really could control the money supply...so that people would have money to spend when the Fed wanted them to spend? But therein hangs a tale, which is the subject of today's letter.
But here, hardly having moved forward a single inch, we must arrest our progress. Alert readers may already be looking ahead, with an objection:
"Hey, I know where you're going with this. You're going to say that the Fed will be as incompetent at destroying the dollar's value as they were at protecting it. But haven't you been saying that the dollar was going to collapse? (And sotto voce: I've been buying gold and euros thanks to you...the dollar damned well better collapse!)"
Ah...but you expect too much, dear reader. If you want consistency or simplicity, you will have to pay for it. Dearly.
Many, if not most, of our friends have taken the Fed at its word, and on its record. If there is one thing the Fed can do, they say, it is inflate the currency.
"Buy gold," they say. Consumer price inflation is on the way...with higher interest rates and falling bond prices.
But an odd thing: even as the dollar lost value...and the trade deficit hit 5% of GDP...and federal deficits soared...long T bonds, recently, went up. Why would people lend money for 30 years, at paltry rates of interest, to a government openly declaring that it intends to inflate?
We don't know. Perhaps people need the income, as small as it is. But, whatever the reason, the bond market is unconcerned about inflation. Not only did long T bonds go up, the differential between regular treasury bonds and those whose return is adjusted for inflation narrowed. (We would give you the figures, but we don't have them at hand; you will have to take our word for it.) [Editor's note: Bill is lost in the wilds of his château in Ouzilly, taking advantage of the long May-Day weekend in France.]
The bond market seems to anticipate not a rerun of the inflationary '70s...but something else; perhaps America will follow in Japan's footsteps after all. For the last 8 years or so, the U.S. economy and its stock market have done a fair imitation of the Japanese trendsetter...with a 10-year time lag. When the Japanese economy boomed, so did the U.S. economy - 10 years later. Then, Japan entered its bubble phase, followed by the U.S., 10 years later. Then came the bear market in Japan, again trailed a decade later by a bear market in America.
At first, no one paid any attention to the Japanese situation. It was just a blip, said economists; Japan will come back fast.
That was 14 years ago. And last week, the Nikkei Dow sank to new lows - down 80% from a high set back in the final year of the Reagan Administration. After Reagan, Bush the Elder took over in America, up-chucked on Japan's Prime Minister...and it has been downhill for the Japanese ever since.
But the Japanese did not go gently into that good night. They fought the dying light just as the Greenspan Fed would do - 10 years later. Rates were cut...and cut...and cut some more, until they reached zero. Nor did the Japanese shirk from government spending...public works projects of all manner and description were begun. Never before has so much concrete been mixed and poured in such a small place.
But it didn't work. The money supply fell anyway...and Japan became the first major nation to experience outright consumer price deflation since the Great Depression. Twenty years of stock market gains have been wiped out. Unemployment edges up as the economy experiences multiple recessions. Consumers seem unwilling to spend - guessing that they will get more for their money next week than they would this one.
How could it be, we ask ourselves? How could a central bank be unable to do what central banks do best?
We remind readers that when the Fed creates money 'out of thin air' it does not create any corresponding wealth. The world's supply of services or swimming pools does not magically increase when Ben Bernanke turns up the dial on the printing press. What it does create is an illusion of wealth; people with more 'dollars' imagine that they are richer...and begin to act the part.
Kurt Richebächer describes this as "pseudo or phantom wealth", whose effect is, paradoxically, to make people poorer. In the boom phase of an economy, the phony money goes into stocks, or real estate, or some other asset.
"What the rising asset values effectively create," Richebächer explains, "is a corresponding rise in claims on the economy at the expense of those who do not own such assets. But this is wealth redistribution, not wealth creation. More importantly, this kind of wealth creation involves no gain in current incomes and productive capacity. To the extent that it actually boosts consumption at the expense of investment and foreign trade balance, the net result from a macro perspective is overall impoverishment." [See: "Phantom Wealth", a DR essay from 1 April 2003. http://www.dailyreckoning.com/body_index3.cfm?id=5334&tp=a ]
Poor people have less money to spend...and less money to repay their debts. Unless the central bank delivers the new cash along with the daily paper, money creation takes place through credit. The new money is lent out. If the borrower cannot repay, the cash disappears.
Curiously, money 'created out of thin air' tends to disappear even when the loans are paid back. As explained in a recent issue of the Mogambo Guru's, which we would quote if we could find it, when a man lends out his savings, he can expect to get paid back, with interest, and all is well. No change to the money supply.
When money is created 'out of thin air', on the other hand, the money supply is enlarged when it is lent out. It didn't exist before it was borrowed. Then, when it is paid back, naturally enough, the money supply shrinks! The money goes back to its maker; it exists no more. Thus, the more new credit the Fed has created...the greater the measure by which the money supply will eventually fall.
The only way to avoid this inevitable deflation would be to either to give the cash away on the streets...or to keep the supply of credit expanding forever. The first solution would be worse than the problem it was meant to solve; the second is impossible.
Meanwhile, the world's apparent wealth - and implied spending power - expands and contracts as the assets, bought on credit, go up and down in value. About 7 trillion dollars were wiped out so far in the stock market decline of the last 3 years. If U.S. stocks follow the Japanese plan - falling 80% over 14 years - another $8 trillion or so, in America alone, will disappear.
Is it any wonder that cash and 'wealth' created 'out of thin air' returns whence it came - no matter what its creators would like? There is some elegant justice to it, we think, reminding us once again that we do not get what we want from life, nor what we expect...but what we deserve.
Bill Bonner
5 May 2003
Editor's Note: Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter publishing companies, and the author of the free daily e-mail The Daily Reckoning (www.dailyreckoning
