The U.S. has too Much Credit

*** “The real story is the decline of America,” said David Fuller yesterday at lunch. David has been writing his Fuller Money , a careful analysis of global money trends, for as long as we can remember.

The rest of the world is in pretty good shape, economically, says David, adding that if he had to make one “buy-it and forget-it” investment for the next 10 years he’d buy stocks in India .

India (Asia generally) and much of the rest of the world have expanding economies, rising incomes, and plenty of room for growth, he says. The problems, on the other hand, are mostly concentrated in the United States.

Martin Hutchinson adds this:

“The US is currently in the position of General Motors in about 1970, splendid in its possession of a majority share of the US automobile market, and apparently invulnerable to competitive threat, yet in reality burdened with impossible welfare programs that a foolish management had negotiated during the good years. For General Motors, the future after 1970 was one of steadily slipping market share, from 60% of the US market to about 25%, of a steadily aging workforce, and of a retiree health benefit obligation that if valued appropriately is today worth far more than the value of the company itself. Had GM not undertaken its excessive pension and healthcare obligations, it would have had more capital to compete effectively, would have been less likely to lose oodles of money in every downturn, and might still retain primacy in the world automobile market today, albeit by a lesser margin than in 1970.

“For the US, the position is the same. Its workforce will be older than its competitors’ and entitled to benefits that absorb an increasing share of the national income as its relative earnings decline.”

We probably all had the same thought. Yesterday, if you were to buy a 30-year Treasury bond you would have gotten a 4.28% yield. That yield is only a few basis points from the current U.S. consumer price inflation level, as announced by the government’s own number torturers. Assuming the number is more-or-less honest, and assuming things don’t change, this means that a person who buys a long Treasury bond gives up money now for the right to receive zero return over the next 30 years. Of course, things do change. But the changes that are most likely are those that make this investment even worse. The inflation rate is likely to go up. At 10% inflation, the investor loses 5.72% per year. If the dollar falls against other major currencies, he is out even more.

The only way the bet on long bonds could work out for investors would be if the United States were to sink into such a fear-driven recession that inflation and interest rates fell substantially. Nominal prices could actually go down, for example, as they did in Japan. Real yields could rise...for a while.

But the United States of America controls the value of the currency in which the United States of America’s debts and obligations are calibrated. Even before a slump has begun, the Fed has panicked...and Washington has rushed to get the checks in the mail. A serious downturn would produce even more desperate attempts to bring prices up and the dollar down. It is the only way the feds can service their enormous debts and obligations. One way or another, they will find a way to keep inflation rates high...and sooner or later, certainly sometime with the next 30 years...they are almost sure to lose control altogether. Holders of long U.S. treasury bonds will continue receiving their coupon payments. Perhaps they will be able to buy a cup of coffee with them.

*** Colleague Horacio Pozzo in Argentina thinks investors may have gone too far in driving down prices on financial stocks. In the United States, he notes that you can buy Bank of America at prices 26% below its high...giving it a P/E of only 11. The bank has been recapitalized with $12 billion in bonds. He thinks the worst is behind it.

Citigroup, too, looks like a buy to Horacio. Its price has been cut in half and now trades at only a fraction above book value.

We were more convinced by Horacio’s pick in his own Argentina. The United States already has plenty of credit – too much of it. We can easily imagine that these U.S. financial firms will lose ground for years – like GM. We don’t see much growth...but plenty of room on the downside.

But South of the Rio Plata, the picture is upside down. North is where the sun shines. South is where the snow flies. And credit has plenty of room to expand. Nobody has much credit in Argentina. The ratio of private credit to GDP is only 12.5%...(compared to over 150% in the U.S.)...and it’s growing at 42% per year. There is not much room on the downside...and clear skies overhead.

The banking sector in Argentina has none of the threats and problems of its U.S. peers, but banking stocks have taken a beating anyway. As a result, you can now buy Banco Macro at a P/E just above 11...and its deposits are growing at 23% annually. You can read Horacio, in Spanish of course, at Moneyweekes.com.

Bill Bonner
The Daily Reckoning Australia

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