So Jason Schwarz thinks that we will have some great laughs around the bonfire a few months from now recalling the anxiety caused to the market by “Greek debt concerns.” Well I hope that Jason has some nitrous oxide laid in for his beach party because I think he may need it.
Greece may be geographically far away from the US, with a population of about 11 million and relatively insignificant, when compared to the US, GDP of 357 billion, but here is why Greece is more like the US than some people seem to think. Simply put, the citizens and the governments of both countries spend well beyond their means. It looks like Greece may get a bailout of some form this time but the US is another matter; who will bail it out when the time comes? Roger Nusbaum has argued on this site that while the US has some serious long-term economic problems it is just too big for the rest of the world to allow it to fail. But I don’t see how a bunch of teetering dominoes, the western economies, are going to hold each other up, let alone support the weight of the biggest domino of them all.
But enough of analogies – here are some specifics. The US simply can no longer hope to grow its way out of its ever-expanding consumer and government debt. True, there is some deleveraging taking place in consumer debt, but government tax breaks and stimulus packages are only really another form of credit extension to the American consumer – and government debt ultimately becomes the citizens’ debt. Besides that, consumer deleveraging is unlikely to be able to keep up with the declining earning power and property values in the US – this relationship being much more important than the amount of debt in itself. In the same way GDP growth in the US no longer has any hope of catching up to the ballooning government debt. I will demonstrate why this is so in both cases.
It was once believed that the US could afford to lose its manufacturing base to foreign countries because all these lost factory jobs were going to be replaced with clean, high paying jobs in the high tech service industry. I was never really sure though how all those assembly line workers were going to be retrained as computer programmers. But even if these people, the factory workers, were considered expendable in this scenario (and believe me they are to the big corporations who out-source) and it was the new wave of university graduates who were supposed to get these jobs, what percentage of the population really have the innate skills to be computer programmers? And much more importantly, now that America has sent its hard won know-how and technology overseas, and there are millions of smart, well-trained young people graduating from Chinese and Indian universities, how will Americans compete? Just look at IBM, an American company. Where do they recruit the vast majority of their talent? Overseas, of course. Companies like IBM are the future. They were born of American ingenuity, but they have no loyalty to America. Right or wrong this is the reality.
There is presently a vast redistribution of wealth going on in the world. Both factory workers and well-educated IT people overseas are willing to work for much less than Americans. Multinational Corporations, even those based in the US, have clearly demonstrated that they will hire where labor costs are cheapest. This means essentially that there will be a gradual leveling of wages toward a worldwide mean among industrialized nations, and this will hurt the US and other Western economies badly. GDP in the US will grow at a snail’s pace at best but more likely reverse for years at a time. The standard of living that Americans are used to will decline drastically.
Sure, there will still be innovators who will do well in the US. But their ideas will quickly be sent out for development and exploitation overseas. This is the trend.
Three years ago when I said that a depression was possible in the US most people thought I was crazy. Now people are saying that we almost had a depression but Bernanke saved us. Well, it looks like he bought us some time. But Ben Bernake, student of the Great Depression, is like a general fighting the last war instead of the one that he is in. The Depression of the thirties was much more of a pure financial crisis; there were no gigantic foreign competitors bleeding away American jobs on this scale. This time the financial crisis is only a symptom of deep displacements that began years ago. Incomes, except for the upper percentile, have not risen in the US for at least a decade. People were merely given the illusion of increasing wealth through the expansion of credit. The collapse of the real estate market was again only a symptom of a deeper problem, the overextension of credit to a population whose real income was not increasing.
Virtually all of the GDP growth of the last decade can be accounted for by the growth of credit, private and public. If the US economy were to actually grow by a very optimistic 5% this year and it cost the equivalent of almost 10% of GDP in government deficit spending (1.3 trillion is the conservative estimate now) to get it there, then how is that real growth? This is before accounting for the 1.4 trillion deficit the year before, a year of negative growth. Keeping Americans employed selling Chinese-made goods to each other, while the government keeps borrowing money for consumers to spend, cannot sustain the US economy. I exaggerate, but you get the point.
GDP = private consumption + gross investment + government spending + (exports - imports)
GDP will always remain misleading as long as government spending is added to the plus side of the ledger while government deficit is not accounted for in some way. I realize that this is difficult to do, as there is there is stimulus momentum from deficit spending done in one year that carries forward into following years and that this is hard measure. But it seems to me though, looking over stats, that it has been costing the government more and more over the period of the last eight years to stimulate the economy for comparatively less and less result.
And there are no forecasts that show GDP growth out pacing the deficit in the foreseeable future. When you add to this scenario the entitlements owed to an aging population then it is obvious that the expanding US debt is a real time bomb. Ben Bernake himself, under questioning regarding the subject of deficit spending outrunning GDP growth, during his confirmation hearing in December, essentially confirmed that the US government was headed for insolvency and that there was no solution in sight. What he said more precisely, for the record, was that the Fed’s estimates showed that within 15 years the entire US government budget would be devoted to servicing the debt and paying for entitlements with nothing left over for anything else. It was obvious that even he believes that his polices are only buying time in the long run. It was interesting that the committee immediately dropped this line of questioning after this response. I happened to be watching his testimony live and was astonished that I found no reports of his statement in the media, and that the stock market hit a new high for the year a few days later. I am not reading any conspiracy theory into this; only that maybe I’m turning over a rock here that no one really wants to look under.
The US government is now the banker of last resort attempting to keep the credit bubble inflating in lieu of real economic growth. But I see no purpose to this other than to try to maintain the illusion of prosperity as long as possible. This is what the Greek government did and this is what the American government is doing now. Americans would not be any more willing to confront the reality of their situation than the Greeks are today. There would be rioting in the streets as there is in Greece if the truth were made clear.
Many Americans are now out of work; if they find new jobs many take ones that pay far lower wages than what they were used to. Judging by income tax stats on the State and Federal level this is having a huge impact on government revenues. There seems to be no end in sight now to a future of declining wages, lower tax revenues, and larger deficits. Although I believe that inflation is still a ways off, it may inevitably be the only way to deal with the debt.
It seems to me that the economic decline of the US, and basically the Western economies with it, is baked in now. I do not see the political will, consensus, insight, or courage to change the outcome anymore. All the Washington based solutions, Democratic or Republican, are futile because the true causes of growing government debt have metastasized beyond what any spending cuts alone could possibly remedy.
Companies like IBM may still thrive in this scenario and maybe even the Vampire Squid, GS, will survive. As for the rest, well, I am not going to try to call the timing of the end of this rally but there will be money made by some who are on the short side when the music stops.
Author’s note: I do not in any way relish the dark outcomes that I have described here; they are merely the conclusions that disinterested analysis has led me to. Several years ago the same kind of analysis convinced me that an inevitable pullback in the real estate market would set off a chain of events that would lead to a financial catastrophe. However, since I am not formally trained in economics it is my hope that this time some readers, more educated than I, will find flaws in my logic and blow my arguments out of the water. Then I can have a good night’s sleep.
Disclosure: Short SPY
