The Role of Consumer Spending in Phony Economic Growth

Good mornin' captain... Good mornin' shine.

- Jimmie Rodgers

Bet you don't know what a "shine" is. See below...

On Friday, everything went down. Well, almost everything. The Dow fell 261 points. Gold dropped $22. Copper. Oil. The dollar. You name it; it went down.

Unless you name US Treasury bonds - which were up!

What does this mean? Maybe nothing. But since it accords with the direction we think the markets ought to be taking, we'll say it's a trend. It's a Great Correction. Asset prices go down. Cash goes up.

Let's go back and see where we've come from. Then, maybe we'll see more clearly where we're going.

In 1999, the US stock market - led by the NASDAQ - clearly topped out. The bubble in the tech sector blew up. Equities started down.

This happened after 50 years of credit expansion. And after much of the "growth" in the economy had begun to look suspiciously like borrowing from the future rather than real growth, debt in the private sector had reached record levels.

It was time for a bear market/credit contraction. That is, it was time for a correction.

The correction began in January 2000. The NASDAQ collapsed. And in 2001, the economy entered a recession.

But this recession was phony. Consumer spending didn't go down; it went up. Consumers kept borrowing money. It wasn't correcting the debt problem, in other words, it was making it worse.

Why? Who knows? Maybe the consumer wasn't ready for a correction. Or, perhaps it was because the feds began the biggest countercyclical stimulus program in history. The prime interest rate was dropped to below the rate of consumer price inflation. The federal budget went from about $300 billion in surplus to $500 billion in deficit (from memory).

For the rest of the decade, the big banks could borrow at less than the inflation rate. And the deficits averaged about $1 trillion every two years.

The correction of 2001 had been held up and made much worse by the feds' efforts to stop it. At least $10 trillion of additional debt was added to the system in the decade of the '00s.

And guess what? It was soon the Bubble Époque!

Stocks boomed. Spending boomed. Real estate boomed. Finance in all its formed boomed.

Growth was positive. But it was phony. Because it was almost all based on debt. It was a debt-fueled bubble - particularly in real estate.

If you take on debt in order to expand production, the extra output can make it possible to pay off the debt later, and you come out ahead. But when you borrow to increase consumption, all you're doing is taking output from the future and consuming it now. You'll have to settle up later - by taking your future output and using it to pay off your debt. Then, you're no longer borrowing from the future; you're paying off the past. And nobody likes it very much. Because it means living below your means rather than above them.

The bill came due in 2007. Subprime crashed. Then, the whole financial sector crashed, followed by the economy itself.

There are a number of ways to look at it, but we think it is most accurate to look at 2000 as the beginning of the present correction. That's when stocks hit their peak in real terms. Since then, stocks have gone nowhere. And probably 90% of the "growth" since then was phony. Certainly, the average person did not get richer; he got poorer.

But having learned nothing in the '00s, the feds set to work in '08-'09 repeating and magnifying their mistakes. Instead of running $500 billion deficits, they ran deficits of $1.5 trillion. Instead of dropping rates below inflation, they took them down as far as they could go - to effectively zero. In addition, they nationalized whole industries, bailed out big businesses, and proceeded to add immense new financial obligations that nobody really understood.

You have to hand it to the Obama administration. We didn't think anyone could be worse than Bill Clinton's bunch...but then along came George W. Bush. In comparison, Clinton seemed like a great president. And then, just when we thought we'd seen the worst administration ever, here comes Barack Obama and his team. Obama has continued all of Bush's programs (save torturing people). The war in Iraq continues. The war in Afghanistan continues. And the war on the correction continues. And Obama even added a new front - a health care initiative that is almost sure to be a financial and administrative disaster.

Not that we're complaining. To the contrary, we find it all very entertaining. But we don't think people are going to like the consequences.

The economy has been trying to correct since 1999. Every effort to stop it merely increases the size of the eventual correction. In round numbers, the US economy currently has debt equal to 350% of GDP. It averaged about half that much in the '50-'80 period. If it were to go back to that level, it would have to eliminate about $25 trillion in debt. According to the last number we saw, the private sector was currently writing off, defaulting on, or paying down about $2 trillion per year. Not bad. But that would mean another 12 years of correction.

It would go a lot faster. But, remember, the government is helping.

And more thoughts...

"Good mornin' captain, good mornin' shine..." is how "Mule Skinner Blues" begins.

A "shine" is what we call today an "African American." We don't know whether it is on the list of forbidden words or not. Rodgers uses it affectionately. It's a song about a fellow who just shows up on the job site and asks for work. Those were the days! Now, it's practically against the law to hire someone unless you have his birth certificate and social security number.

We have to be a lot more careful now than we used to be. It's not a good idea to drive past a police station without your seat belt fastened. And it's probably not a good idea to refer to Barack Obama as a "shine." It may even be against the law!

But heck, everything is against the law now. There are so many laws on the books it's inevitable that you break them from time to time. We had a couple of Henry's friends out for the weekend, helping with the work. We paid them 10 euros an hour. That is surely illegal. (If the gendarmes show up at our door, we'll know you ratted us out, dear reader. And we'll deny everything.)

We must have broken a few dozen traffic laws driving out here. We gave Henry wine with dinner. We dodged the census takers...we burnt our tree-limbs and branches in an open blaze...we installed a bathroom without a permit...and who knows what!

There are so many laws it makes us want to break them. We never felt like smoking until they made it illegal. We look for a "No Parking Zone" where we can put the car. And when Baltimore proclaimed a "No Killing Day," we didn't pop anyone that day. But we bought a handgun so we'll be ready for the next time.

*** It's a bright morning here in Normandy. We spent the weekend painting doors and windows. What a pleasure it is to work...at least when you're not getting paid for it.

The nice thing about having money is that you can afford to do honest work. You don't have to get a job and pretend. You can buy a piece of property and fix it up. Then, when the work is finished, you can buy another one. Or, you can start a business. You never run out of work!

The boys don't feel that way, though. They're redoing the joints in stone walls...and painting a fence...for money! Well, they won't actually get any cash. Instead, they're paying back their dad for expensive tickets. Henry (19) and Edward (16) said they wanted to go with us to Vancouver this week.

"Are you interested in investing?" we asked.

"Yeah...I want to make money. And I want to make money without working," Edward replied.

"That's not the way it works," we told them.

Bill Bonner
for The Daily Reckoning Australia

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