Wednesday, August 10, 2005

August 9, 2005

$oaring or Running on Fumes?

Is this the best economy in years or a ticking time bomb? Confused? I'm not surprised. If you just read the daily papers and listened to economists on TV you would have to believe America's economic skies are clear, flowers are sprouting nourished by warm, gentle rains and American workers are busy spreading picnic blankets in verdant pastures of thickening clover.

It must be true. The New York Times, Washington Post and Wall Street Journal say so. The mainstream media has dutifully reported that the US economy is growing at a healthy 3.2%, and just last quarter created over 200,000 new jobs.

Reading all that reassuring economic news has boosted consumer confidence too.

"Consumer confidence has clearly turned up," Terry Jones, associate editor at Investor's Business Daily said. "Despite the spurt in oil prices above $60 a barrel, a rising number of people believe their own personal financial situation will improve over the next six months."

Hope springs eternal. It can also create mirages, like visions of a sustainable economic recovery. We want it to be so, so when a piece of good news seems to support that wish we embrace it. Everyone, including the media, seem willing to live the old reporter's joke that goes, "Never investigate a good story too far."

"Television has an inexhaustible supply of optimistic economists," said Paul Craig Roberts, a senior fellow at the conservative Hoover Institute. "CNN had John Rutledge explaining that the strength of the US economy was (being driven by) 'mom and pop businesses.' The college student with whom I was watching the program broke out laughing. What mom and pop businesses? Everything that used to be mom and pop businesses has been replaced with chains and discount retailers. Auto parts stores are chains, pharmacies are chains, restaurants are chains. Wal-Mart, Home Depot, and Lowes, have destroyed hardware stores, clothing stores, appliance stores, building supply stores, gardening shops, whatever — you name it."

So if it's not small businesses creating these positive economic numbers, what is? For the last three years the driver has been dirt-cheap credit. Credit fueled consumer spending has been remained at record levels for an unprecedented 54 straight quarters – 216 uninterrupted months of profligate spending. Credit cards and low-interest home equity loans fueled the lion's share of that spending. Is that good news? Is that a sustainable economic model?

A growing number of experts think not.

David Rosenberg, chief North American economist for Merrill Lynch, is one of them. He looked at the Bush administration's June and July growth figures and saw something just behind the curtain that troubles him.

"It always seems as if a three per cent or lower number is going to be in store the next quarter and then what happens is we get sideswiped by some unexpected 'event' that provides a significant lift. If it's not the housing boom, it's a bonanza of auto sales incentives or a surge in capital spending or purchases of transportation equipment. Outside of the events that are non-recurring but always seem to find a replacement ... the economy has actually been growing at a sub-three-per-cent pace for the past six quarters, or almost a full percentage point below the posted rates."

See, there you go. Rosenberg just had to investigate that good story too far. And when he did he discovered it was those one-time auto company employee discount promotions that sent consumers into another borrowing and spending frenzy that propped up the positive growth numbers for the last quarter. And why where auto companies ready to take such a drastic hit to their profit margins? Because their in-house economists told them the US consumer was tapped out and unlikely to buy cars and trucks unless they got one hell of a deal. And, they were right.

But is that a sustainable economic model? Not so much.

"It won't be long before a credit-fatigued and energy-price-pinched U.S. consumer eases off," writes Avery Shenfeld of CIBC World Markets, arguing that many data watchers are seeing the world through rose-colored reading glasses.

Consumer credit-fatigue may be just now setting in. A report from the International Council of Shopping Centers and UBS showed sales at U.S. chain stores fell 0.8 percent last week, after a 0.9 percent gain in the previous week. Year-on-year sales also dropped nearly 1 full percent the same period a year before.

Even Shylock credit card companies won't extend credit to working stiffs forever. Sooner or later those working stiffs reach the highest minimum monthly payment they can handle – and then some. That's when the credit gravy train stops. We may be there now, and if not now, we will be very soon.

Okay Mr. Doomsday, whatya say about those great job numbers, huh? Huh?

Well, yes, 207,000 is a very pretty number -- as long as you don't look too closely at it.

* 26,000 (about 13%) are tax-supported government jobs.
* 177,000, or 98%, are in the domestic service sector, such as,
* 30,000 food servers and bartenders,
* 28,000 health care and social assistance,
* 12,000 real estate, 6,000 credit collection agencies,
* 8,000 transit and ground passenger transportation,
* 50,000 retail trade and 8,000 wholesale trade.
* 7,000 were manual construction jobs, most of which were filled by Mexican immigrants,

"Not a single one of these jobs produces a tradable good or service that can be exported or serve as an import substitute to help reduce the massive and growing US trade deficit. The US economy is employing people to sell things, to move people around, and to serve them fast food and alcoholic beverages. The items may have an American brand name, but mainly made off shore. (For example, 70% of Wal-Mart’s goods are made in China.)" Paul Craig Roberts, Hoover Institute Senior Fellow

But there's the boom in housing prices. What about housing?

If you're a homeowner you have seen the market value of your home soar over the past couple of years. On paper anyway, you're rolling in it, right? Yes and no.

Yes, if you had the sense to leave your equity right where was was, in your home. Home equity is like blood, lose too much of it and you're in deep shit. While it can be a good thing to give a little blood now and then, it's not a good idea to just open and artery and let if flow.

So, if you are one of America's many equity eaters the rise in your home's value is all but meaningless, or worse. You sucked the equity out and spent it, didn't you? Nice. Now what?

"Shut up Pizzo, we spent it on home improvements that will increase the value of our home," you respond.

Big deal. Now you have a giant-ass mortgage, likely an adjustable rate mortgage at that. Rather than looking forward to the day you own your home free and clear you have monthly payments stretching deep into your retirement years – maybe beyond. And, when this housing bubble deflates – as they all eventually do -- your improvements will deflate right along with it. (Rule: Real estate speculation is fine. But for christ sake, never speculate with the equity in your family's home.)

Yesterday oil prices surged to over $64 a barrel. Diesel fuel is not more expensive per gallon at the pump than gasoline. That will drive up prices of everything moved by ships or trucks.

The Fed will boost rates again today. That will result in higher credit card bills and larger home mortgage payments in the months ahead, and the Fed ain't done raising rates.

Finally this. We had to really work at it, but as of this writing American's have finally achieved a zero savings rate, meaning most families have no economic cushion, no rainy day fund, a zero margin for error. Amazing. Terrifying.

I warned some months ago that the US economy was heading back to the late 1970s, not just inflation, not just recession, but both – stagflation.

"Stagflation is thought to occur when there is an adverse shock (a sudden increase, say in the price of oil) in a country's aggregate supply curve. The effects of rising inflation and unemployment is especially hard to counteract for the central bank. The bank has one of two choices to make, each with negative outcomes. First, the bank can choose to pursue a loose money policy to stimulate the economy and create jobs by increasing the money supply (by lowering interest rates) and exacerbate the inflation problem further. Or second, pursue a tight money policy (by increasing interest rates) to try and rein in inflation at the cost of perhaps increasing unemployment further." (

I was a in real estate back then and remember it well. It was ugly. Several things caused it and they are all with us again today. Back then it was the impact of a decade of guns-and-butter deficit spending during the Vietnam War. When that chicken came home to roost interest rates soared.

Those who were lucky enough to have accumulatedunencumbered hard assets made a bundle. Gold soared to $800 a ounce. Money market funds, for example, were paying as much as 16% annually.

Those without assets were screwed as prices on everything, including housing, soared.

Considering the total US debt today, at over 305% of GDP, is more than twice the debt level of the 1970s, raising interest rates now will have a devastating impact as they trickle through our over leveraged commercial and consumer economy.

So, this is a good time to ask -- what's in your wallet?

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