"Debt sanity, insanity" (CITS Debt Watch)

**                                                              **
                    W. Curtiss Priest, Ph.D.
          Center for Information, Technology & Society
              466 Pleasant Street Melrose, MA  02176
  E-mail: BMSLIB@MIT.EDU, Voice: 781-662-4044, FAX: 781-662-6882


                           July 9, 2003

                        Public Issue #:108

                          CITS DEBT WATCH

                      "Debt sanity, insanity"

             Commentary by Dr. W. Curtiss Priest, Director:

Based on the record level of debts across all U.S. sectors,
and based on the serious trade deficit, one might sanely
expect this current economy to implode.

Indeed.  Dr. Kurt Richebacher was interviewed in December
of 2002, and his comments of concern about the U.S. economy
are included below.

Richebacher, an independent analyst and author of a newsletter,
describes all the factors that indicate the inevitable demise
of the U.S. economy.

Yet, as anyone has followed, there is yet another wave of
optimism as shown in both NASDAQ and Dow levels.

An attached AP article indicates that credit cards got "liberal
use in May."

We can only imagine homeowners folding such debt into yet
further real estate refinancings.  (attached is our letter to
the Boston Globe on this issue, unlikely to be published, as
it attacks the refinancing industry at too basic a level.)

I write this current newsletter, simply incredulous.  The
further rise in stock markets signal, yet further wishes
of the 401(k) crowd, etc., that they "deserve" a hugh return
on their "investments."  But, throwing money, either onto
a wheel at Monte Carlo or our stock market is a highly
suspect activity.  As Mr. Richebacher notes, everything
from company profits to U.S. deficits of trade are seriously
against any wager of stock market gain.

My advice?  Don't hold the U.S. dollar.  And sell short any
tech. dot-com with a P/E of over fifty (except, perhaps
eBay).

WCP

Editor, CITS Debt Watch

****
Letter to the Boston Globe:

Correspondent Grillo appropriately notes in "Bucking
the US trend, foreclosures fall in state," (July 5, 2003,
p. D1, a very peculiar event, indeed, where our state
rate of foreclosures has dropped.

However, there are various parts of his report that
distort the picture.

I must sorely question the use of the words "equity"
and "value."  If due to some quirk we have a 'boom' in house
prices, one cannot use either of these words to state the
present condition.  One may, only, use the word "price."

To use words that suggest some kind of permanency such
as "value" we must presume that home prices will persist
at these prices for, say, at least a decade.  But we do not know
that will be the case.

Also, there is a problem with the headline writer's interpretation
of the article.  He/she says, "High prices, low rates allow
homeowners to tap into equity to pay down debts."  Not only
does this writer commit the fault of using the word "equity"
instead of "price"  but the writer goes further to say that if one
trades other debts for further debt in one's home, this amounts
to "paying down" a debt.

But, certainly, anyone can recognize that this doesn't "pay
down" any debt, but only transfers it.  And, it transfers it
to an asset of larger collateral worth than, say, purchases
made via a credit card.  A house is an asset that bankers know is
"better" (more fungible) than, say, a stack of DVDs or an
SUV.  And, it is a fact, that every time a refinancing
occurs that 75% of those refinancing take at least an additional
$5000 for other purposes, and many purposes beyond paying off
existing debt.  Thus, these borrowings not only doesn't 'pay
down debts,' but increases the overall level of debt.

The article writer does then state that some are concerned
about a possible "dramatic rise in foreclosures" when prices
may fall.  However, the writer, carefully wishing to remain
neutral about this eventuality, manages to quote at the end
of the article that one economist sees nothing but roses
ahead.

Sincerely,

W. Curtiss Priest, Ph.D.
Economist
466 Pleasant Street
Melrose, MA  02176
781-662-4044
*****************************************************************

Interview with Dr. Kurt Richebacher Dec. 24/02 - 2002

http://www.minersmanual.com/news/KurtRichebacher.php

INTERVIEW WITH DR. KURT RICHEBACHER

Return to Mining News List

Dr. Kurt Richebacher has shown an uncanny ability to spot future
economic problems. This former chief economist of the Dresdner Bank
warned about the recession and the NASDAQ crash months before they
happened. He forecast the collapse of the Asian Tigers in 1998 and
blew the whistle on corporate profit tricks long before Enron. When
virtually everyone was certain of a V-shaped recovery, he argued that
it was impossible.

Master of classical economics, and perhaps, the best analytical
economic thinker in the world today, Dr. Richebacher writes a monthly
newsletter, "The Richebacher Letter." Given his impressive record of
accurate warnings and predictions in the face of almost unanimous
disagreement from establishment economists, we think the following
interview should be read with deep thought and reflection.

Back in March of 1997 you warned that serious problems loom in the
heavily indebted miracle economies of the Far East. What
caused you to spot this problem?

Their boom was credit induced. They went heavily into debt to
overbuild.

Same old story?

Yes, runaway money and credit growth and the typical symptoms
associated with overheating economies - inflation, speculation and
financial excess.

Then in June of 1998 you said, "Later this year the U.S. economy will
abruptly slow down." What did you see?

Earnings were faltering and corporations were favoring self-defeating
financial tricks and accounting ploys, including heavy speculation and
leveraging. I wrote that a few were immensely enriched by exploding
paper wealth, but savings and capital formation were deplorable.

Then you predicted the collapse of the stock market and the technology
bubble. How?

The great speculative manias in history were connected with
innovations that generated great popular excitement. That was the case
with the Internet and, along with it you had the ever-present deluge
of money and credit. Yes, I wrote that a bear market was inevitable.

Late in 1999 you were calling it a classic speculative blowoff. Why
you and nobody else? I mean, Lawrence Kudlow was saying the Internet
was more important than the Fed, and the Dow would be 30,000, then
50,000 and higher.

Yes, this kind of nonsense was helping to fuel the Wall Street boom.
We expected that a sharp decline in tech stocks would be a death blow
to the greater U.S. stock market bubble, and it was.

In the fall of 2000 the belief was widespread that the U.S. economy
would have a soft landing. What were your thoughts on that?

Well, I wrote hopes for a soft landing in the U.S. economy were
completely misplaced. The credit excesses of the late 1990s were many
times worse than those in the 1980s and even those of the 1920s. So
were the imbalances in the economy and the financial system. You only
needed to notice the zero personal savings rate and the stupendous
trade deficit. To speak of the U.S. economy's excellent fundamentals
in the face of these disastrous facts required a lot of stupidity.

Was it the worst credit bubble in history?

Absolutely.

What did you say about the V-shaped recovery that all the experts were
predicting back then?

I wrote that it will come as a great surprise how fast the U.S.
economy weakens in the near future.

What did you base the prediction on?

Profits were collapsing, heavily indebted corporations were slowing
their spending and new investment in capital goods had caved in.
Serious problems were everywhere.

That brings us up to today. Will we tip over into recession again?

Yes. Drastic weakness of the U.S. economy is the great shock waiting
to happen for the world. A slumping dollar will turn it into a
nightmare.

How can you be so certain? Most economists see a recovery.

I am dismayed at the low level of U.S. economic thinking. Elementary
insights into economic processes that have been accepted by all
schools of thought for more than 200 years are unknown, discarded or
even put on their head. The facts are that you have serious structural
problems that exclude any possibility of a sustained economic
recovery.

Such as?

A profits decline, a record savings shortfall, a capital spending
collapse, an unprecedented consumer borrowing and spending binge, a
massive current account deficit, ravaged balance sheets and record
high debt levels.

Sounds terrible. Is one just as bad as the other?

Tops among them are the depression of profits and capital spending.
They propel each other downward in a vicious spiral.

Why are there no mainstream economists saying anything like this?

Not only economists, but U.S. policymakers and the public are in
denial of the gravity of the economic and financial situation.

But why?

The main problem is a lack of understanding and blind faith in the
omnipotence of the Federal Reserve.

Well, the Fed has aggressively lowered rates. It's worked in the past
hasn't it?

This downturn differs dramatically from all previous postwar
recessions. It hasn't been brought about by tight money, but by
unsustainable spending excesses that have left behind an overextended
financial system.

You mean low interest rates aren't working?

For the first time in the whole postwar period, the U.S. economy and
even the stock market has slumped against a backdrop of the most
aggressive rate cuts by the Federal Reserve and the most rampant money
and credit growth ever. The forces depressing the U.S. economy this
time are radically different from those that fueled past recession.

In what respect?

The profits implosion is the most obvious and the most important.

The Fed has pushed down rates to prop up spending. You say low rates
aren't working, but people are taking advantage of the low rates to
keep spending, aren't they?

That's right. America is fighting the recession with still more
consumer spending excesses.

Could the consumer keep the ship afloat?

Consumer sentiment has been falling. More importantly, the economics
data for the past several months conclusively suggests that the
American consumer has started to retrench.

You never hear that.

Nobody wants to believe it. One reason may be that there is nothing
else in sight to prop up the U.S. economy.

But isn't the consumer's income still growing?

No, growth has stalled and a lot of the growth that there was came
from the tax cut.

So, consumer spending may stagnate?

Especially if the consumer continues to rebuild savings, which has
just recently been running at three to four percent of disposable
income. This will probably increase in the future. That's the kind of
thing that will end the borrowing and spending excesses of the boom.

Why?

Any rise in savings exerts a drag on economic growth and this squeezes
profits.

Well, so far the consumer hasn't slackened measurably.

They have postponed the day of reckoning by loading themselves with
more debt. Much of this debt can't be repaid.

As you say, people have faith in the monetary authorities. That's one
reason they keep spending.

This faith is utterly amazing. It overwhelms the facts. It's based on
the Federal Reserve creating money and credit with reckless abandon
and the consumer borrowing and spending with reckless abandon. Nobody
seems to understand the extraordinary excesses of these two and how
they have been responsible for the present economic and financial
mess.

I have to agree with you. People don't see anything foreboding in
these developments.

It's time they did. The economic news is going from bad to worse.
Never before has the world experienced such massive destruction of
stock market wealth and never before have business profits and
business capital spending suffered such steep declines.

You see business profits as key to the whole crisis don't you?

We have continually warned of the economy's unusually poor profit
performance during the prior boom years. As the economy sharply slowed
during 2001, it turned into a virtual profit implosion. Profit margins
are at their lowest since the Depression in the 1930s. Moreover, there
is nothing in sight that might reverse this progressive profit
erosion.

What are the consequences?

CEO's have capitulated to the profits disaster. Their solution has
been a savage curtailment of their investment spending.

Why are investment spending and capital formation so important?

In the end, it is all about capital investment. It is the critical
mass in the process of economic growth that generates all the things
that make for rising wealth and living standards. Capital investment
means the construction of new buildings, plants and equipment. This
creates demand, employment, income, profits and tangible wealth. The
installation of these capital goods creates growing supply,
productivity, employment, incomes and profits that, by the way, also
repay the debts. Always remember that capital formation is strategic
for generating general prosperity.

Okay. So, what's causing the profits decline that's ruining capital
investment?

First, let me say that when you consider the key role of profits in
shaping economic activity, it's puzzling how little attention this
exceptional profits carnage is getting. Especially since there is
nothing in sight that might improve U.S. corporate profitability and
stimulate business capital investment.

Give us the cause of the profits problem.

Corporate cost cutting, for one. The widespread measures that
individual firms take to improve their own profits have, in the
aggregate, the opposite effect on the profits of other firms. Business
spending is the key source of business revenues, not consumer
spending. A retrenchment in business spending cuts business revenues.
Higher profits and higher prosperity cannot possibly come out of
general cost cutting.

What else impacts profits?

Rising depreciation charges on plants and equipment are a drag on
profits.

And?

Corporations took on an enormous amount of new debt and the interest
charges are a record high expense. For example, in 1997, interest
expense accounted for 23% of manufacturing profits; in 2001 for almost
100%.

But this borrowed money went into productive assets that improved
profits, didn't it?

Very little went to net new investment. It's great bulk went into
mergers, acquisitions and stock repurchases, adding nothing to the
economy's productive capacity. Huge amounts were dissipated in
worthless goodwill, reflecting absurdly high payments for
acquisitions.

None of this borrowing helped profits?

No. As profits went down, corporations effectively devastated their
balance sheets and credit ratings. The deterioration in credit quality
has been unbelievable.

Let's get back to the discussion about the profits problem. Any other
big drags on profits?

The most important one of all. The U.S. trade deficit has ravaged U.S.
business profits. In four years this deficit has soared from $128
billion to $450 billion annually.

How does the trade deficit squeeze profits?

By directing current income and spending away from domestic producers
to foreign producers. The trade deficit implements a direct transfer
of profits from the United States to foreign countries. Considering
the deficits monstrous size, it massacres U.S. profits.

What does this profits decline imply for the stock market?

U.S. stocks today are still overvalued. The worst part of the bear
markets is still to come and it will result in the wholesale
destruction of the financial wealth derived from the bubble economy.

Only a few years ago we heard stories about an endless boom and a new
era. What went wrong?

Americans new brand of capitalism didn't work. Corporate managers
concentrated on creating shareholder value through stock buybacks,
cost cutting, mergers and acquisitions. This strategy helped drive
share price to absurdly high levels, but the effects on the economy
were destructive.

Why?

Mr. Cook, these strategies do not build factories. They do not
increase business revenue. To the extent that they curb new
investment, which they do, they reduce profits.

Could you elaborate?

Rising prosperity and rising living standards do not come from
existing factories, but from new factories. It's not productivity that
creates wealth. It's investment spending alone and not consumer
spending that propels economic growth. The wealth effects of free
enterprise have always accrued through the building of factories, not
through the stock market or reckless consumer borrowing and spending.

You mean these companies used their capital for financial engineering
and speculation rather than building productive facilities?

Absolutely. As an example, most of the profits in the high tech sector
came from huge gains in the stock market.

Are you saying the new information technology didn't deliver profits?

Yes, and it's the greatest irony that the worst profit numbers have
come from the high tech sector for which Wall Street was trumpeting
unprecedented miracles of productivity and profit growth. These poor
profits subsequently turned into a profits collapse.

What's your explanation for this failure?

The importance of information and information technology for
production and wealth creation was ridiculously overestimated.

Doesn't high tech have the greatest productivity gains?

Such productivity growth is statistical hot air.

I won't go there. I know you think hedonic pricing is statistical
nonsense.

When you see this statistical fudging, it makes us wonder if
systematic delusion lies behind these practices.

Okay, let's move on. You didn't mention the effect on corporate
balance sheets of the new era financing of mergers, acquisitions and
stock buybacks.

Corporate managers leveraged their balance sheets with the
recklessness of desperadoes who have everything to gain in the short
run and nothing to lose in the long run. They ruined their balance
sheets to conceal and offset the increasingly disappointing profit
performance.

Sounds ugly.

They substituted more expensive debt for equity. The trick was to fool
investors by shrinking the number of shares.

I have to say that you were blowing the whistle on these dubious
practices long before anyone else.

The sudden outbreak of profit chicanery was based on the common desire
to hide a disastrous profit performance. That's the key point to
recognize.

Some would argue that it lifted share prices?

Only temporarily. At best they are saddled with debt that depresses
profits and at worst they've ruined their reputations and their
future.

What are the ramifications of taking on so much debt?

Declining credit availability for corporations and the possibility of
a credit crunch. Badly ravaged, highly fragile balance sheets and very
poor profit performance have severely reduced corporate
creditworthiness. I cannot imagine a good outcome from this
predicament.

Let's talk for a moment about savings. What are your concerns about
the low savings rate?

Savings is the indispensable condition for economic growth. Without
savings out of current income there can't be an increase in productive
facilities or capital stock.

How come economists here don't see this as a problem?

There's a general refusal to see reality. The total carnage of
national savings is the U.S. economy's most important predicament.
This is the economy's supply of capital.

What's happened to the savings we've already accrued?

They've been squandered to pay for spending the consumers can't afford
from their current income. And corporations have been funding dividend
payments out of their retained earnings.

What happens to countries with low savings?

They have low investment, low wages and low profits.

But the government economists and the Fed are saying we don't have to
get it done with savings; we can do it with spending and credit. What
about that?

Ha! I don't think you can turn vice into virtue.

Why not?

Credit creates spending power out of nothing. Credit alone can't
sustain a growing economy for long. Today's soaring debt load has to
be repaid. I have little doubt that a debt crisis lies ahead. When
most of the debt is used for unproductive purposes like consuming and
speculation, it must eventually lead into a debt trap. The reckless
pursuit of debt is economic insanity.

A lot of this is mortgage refinancing isn't it?

One is tempted to say that the American public is monetizing their
homes.

And this alarms you?

I can only say that in Europe to use one's home as collateral is
something that neither homeowners nor bankers would consider, except
perhaps in the case of an emergency.

I've never heard any American economist or Wall Street spokesman speak
against it. In fact, they encourage it.

No doubt. Mortgage refinancing and home equity lending have been at
the epicenter of the credit explosion. I must admit to have grossly
underestimated this component of the American bubble. I can only say
it has removed any doubts that this is by far the greatest and the
worst credit bubble that the world has ever seen.

But only you and a small handful of critics make mention of it. The
public likes it and everybody in the mortgage business is making hay.

They should enjoy it while they can. The U.S. financial system today
hangs in a precarious position. It's a house of cards built on nothing
but financial leverage, credit excess, speculation and derivatives.

Are we going to fall down and go boom?

I would say prepare for much worse to come.

What's the nature of this recession you predict?

It will prove unusually severe and long.

Why?

The key to fathoming the severity of the future crisis lies in
appreciating the vulnerability of an economy and financial system that
have for years been exposed to the most reckless financial expansion
and speculation in history.

That's Austrian business cycle theory, right?

Yes, the length and severity of recessions or depressions depend
critically on the magnitude of the dislocations and imbalances that
have accumulated in the economy during the preceding boom.

And that's why you consistently predicted that the U.S. economy was in
for a hard landing?

Yes. Allow me to summarize. The U.S. economy of the 1990s ranks as the
worst bubble economy in history. The boom was built on nothing but
leverage upon leverage. A vanishing supply of domestic savings was
more than subsidized by boundless credit creation for leveraging asset
holdings.

And the Fed's the culprit?

The all-important thing to see is that the Federal Reserve abandoned
any control of money and credit creation. The power of the American
credit machine to create credit out of the blue is unique and
unprecedented.

Well, some would say it's saved the economy.

This excessive monetary looseness has only postponed and magnified the
coming inevitable crisis.

Let's talk about the dollar. You have said that it will weaken, and to
some extent, it has. Is there more weakness to come?

We regard it as an inescapable event. Growing disillusionment with the
U.S. economy is the trigger.

But doesn't the world like a strong dollar?

It suited the rest of the world because it boosted their exports and
it suited the United States as a boost to its financial markets. In
actual fact, the huge capital inflows have become the U.S. financial
markets' single most important pillar. Take this pillar away, and
those markets will instantly collapse with devastating effects for the
U.S. economy, turning quickly into a savage credit crunch.

Could it happen that fast?

The fact is that the exposure of the U.S. financial markets to foreign
investors and lenders has grown to such preposterous magnitude during
recent years that controlled, gradual dollar devaluation no longer
appears feasible. Under today's extreme circumstances, the alternative
is only between a strong and a collapsing dollar.

Is there any cure for that?

In order to avoid the worst, the Fed may be forced to drastically
raise interest rates?

My goodness!

The dangers that loom on the currency front are immense. The grossly
overleveraged U.S. financial system is hostage to a strong dollar and
permanent, huge capital inflows. The U.S. trade deficit and the
accumulated foreign indebtedness have reached a scale that defies any
possible action by central banks. The fate of the dollar is beyond any
control.

Thank you, sir.

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Credit cards get liberal use in May

Borrowing rises by $7.3 billion

By Associated Press, 7/9/2003

WASHINGTON -- Consumers were brisk borrowers in May as free-financing
deals and deep discounts motivated them to use their charge cards more
freely.

The Federal Reserve reported yesterday that consumer credit rose by a
seasonally adjusted $7.3 billion from April, an annual rate of 5
percent.

That followed a $7.9 billion borrowing increase in April from March,
or a 5.4 percent growth rate, a robust pace but not as strong as the
Fed had estimated a month ago.

May's increase in borrowing was larger than the $5 billion advance
economists had forecast and pushed up total consumer debt to $1.76
trillion.

Demand for revolving debt, such as credit cards, went up in May by
$3.1 billion, or at a 5.3 percent annual rate. That compared with a 2
percent growth rate in April and a $1.2 billion increase.

"Rebates and heavily discounted merchandise were simply too good for
consumers to refuse," said economist Richard Yamarone of Argus
Research Corp.

For nonrevolving credit, which includes loans for new cars and
vacations, borrowing rose by $4.2 billion, or a 4.9 percent rate in
May. While that remained robust, it was down slightly from April's
sizable $6.6 billion increase in nonrevolving credit, which
represented a 7.8 percent growth rate.

The Fed's report includes credit card debt and loans for cars, boats
and mobile homes. It does not include real estate loans such as home
mortgages or increasingly popular home equity loans.

Consumers are the main force keeping the economy going.

One factor supporting consumer spending is a refinancing boom, stoked
by low mortgage rates. Extra cash from refinancing combined with solid
home value appreciation help make consumers feel better about their
finances even amid the muddled economic climate.

So far, those positive forces are helping to offset the negative
forces of a sluggish job market, where unemployment in May rose to 6.1
percent. The situation worsened in June, with the nation's jobless
rate climbing to a nine-year high of 6.4 percent.

This story ran on page C5 of the Boston Globe on 7/9/2003. c Copyright
2003 Globe Newspaper Company.

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