The Beginning of the End

After the downfall of communism, the USA warned Russia not to attempt to solve its financial problems by printing money as this would simply cause inflation. This is common held view point, in fact it is established economic wisdom. If you simply print money then the value of the money goes down and inflation sets in. What isn't pointed out in any of the media is that today the 'wealth' of the USA is built on printing money.

The increase in money supply is partly due to the actual printing of notes but is also due to increased lending. If banks lend money out that hasn't been invested in the bank in the form of savings then this has exactly the same effect as printing the money. So how can the USA get away with it? Well to a certain extent they aren't as the value of the US dollar is declining. The value of a product, and this includes a currency, is, to some extent, what people are prepared to pay for it. I say to some extent because if the value is not built on reality then sooner or later a crash will come about. As Abraham Lincoln said 'you can fool some of the people all the time or all the people some of the time', The current share market is symptomatic of this. People are paying for shares well above their earning potential as they were during the 'tech boom' of the late 1990s and as they were in the 1920s before the 1929 Wall St crash.

This is from The Daily Reckoning (http://www.dailyreckoning.com/) 17 Nov 2003:

It all seems so calm. So ordinary.

Like Europe before WWI, everything seems to be going so well...

.. but just 4 short years after the Archduke went down, practically everything else had fallen, too. Millions of soldiers and civilians... currencies... manners... architecture... and all the major governments of Europe. Gone were the Hohenzollerns from Germany, the Hapsburgs from Austria, and the Romanoffs from Russia. The Ottoman Empire collapsed in Turkey. The British Empire was badly damaged; it would fall, too... but it would take another World War to bring it down.

Even more remarkable, hardly a single, solitary, sentient human being saw it coming.

For what it is worth, here we are. Not quite single. Not exactly solitary. And more or less sentient. And what we see coming is not the equivalent of the Great War... but a Great Disappointment.

Americans are in the process of ruining themselves. They are transforming assets into liabilities, trading the real wealth that was built up over generations for the quick fix of debt. The 'equity' they own in their homes has fallen to its lowest level since the government began tracking it in 1965. The asset - the home - has been replaced by mortgage debt.

While new houses are going up on every empty lot, new factories and office buildings are rarely built in America. Instead, consumers borrow from foreigners in order to buy foreign-made goods... thus stimulating a boom in factories and offices overseas. Even the cash in our pockets has been replaced - first with paper money of no real value, then with credit cards, which allow the spender to pay for his hamburger for the rest of his life.

You will recall, dear reader, that at the beginning of this new millennium, it looked as though things were going to change. The bubble on Wall Street had blown up. Americans would be forced to cut back on spending... and save money, we thought.

The consumer economy would have to do a little less consuming and a little more producing, we hoped. But along came the heroes at the Federal Reserve and U.S. Federal government; with even easier credit terms, tax cuts and billions more in new spending, the Feds managed to avoid sanity for a while longer.

How much longer, we don't know. But for the moment at least, frugality, prudence, and good sense have been staved off. The perverse economy of Squanderville seems to be recovering; its residents are squandering their assets at the fastest pace in history.

Debt increases at the rate of 10% of GDP per year. Wal-Mart, where Americans do much of their squandering, reports that sales are not growing as well as expected. Buyers seem to be shopping for cheaper alternatives and "timing their expenditures around the receipt of their paychecks, indicating liquidity issues."

Consumer sentiment rose in November. Consumer sentience continued its decline.

The situation is no different in Australia, which has en even higher rate of borrowing than the USA and the recent interest rate rise is causing the beginnings of a crash in the housing bubble. The problem could be devastating. If people borrow $120,000 at, say, 4% and interest rates go up they obviously have to pay more back each month. If there is a corresponding downturn in the economy then people lose their jobs and are unable to pay back the mortgage so the house gets repossessed by the bank, which then sells it at below cost simply in order to cut their losses on a bad loan. This, in turn, causes house prices to decline, which means that the mortgage of $120,000 is on a house worth only $100,000 and the owners can't even sell the house to repay the loan. This is the trap that awaits many people who at the moment are congratulating themselves on the financial acumen for investing in property which, as everybody knows, can only go up in value. After all, everyone needs a house to live in, don't they?