The End of Money

[Note: I begin today with a short bit from where we left off last week. Also today’s title is the same as the economic seminar series I give to ever growing audiences]

The greatest shortcoming of the human race is our inability to understand the exponential function. ~Dr. Albert Bartlett

I have a question for you.  Let’s say you’re driving down the road, at night, along a busy highway, 10 miles from the next exit, and the oil warning light suddenly blinks on.   What do you do?  Are you the sort that pulls over or keeps on driving?  If you’re the sort that keeps on driving, upset mainly because you don’t have any black tape to put over that pesky red light, then you might as well stop reading right now because we’re about to pull over.

First a set of definitions; when liabilities exceed assets by an amount that cannot be serviced by any conceivable future revenue stream, then one is said to be ‘insolvent’.  When current cash flow cannot service current debt payments, then we say an entity is technically bankrupt.  And finally, when a debt payment is missed, then a default has occurred, the entity is actually bankrupt and all sorts of legal machinery kicks into high gear.

In my last article I wrote about the fact that United States budgetary and fiscal officials revealed to us that in order for the United States government books to net out to zero there would need to be $53 trillion in the bank, today, earning interest.  Of course there isn’t any public money of that sort, or any sort, in the bank.

SCREEEECH!  <-- That’s the sound of this article pulling over to the side of the road

Stop.  Why is this not our #1 topic of debate in Washington DC?  If we suspect that we are insolvent as the Comptroller and Treasury Secretary have indicated, then it’s questionable as to whether it does us any good to debate, say, the finer points of federal education reform or a new flag burning amendment.  As noted above, insolvency precedes bankruptcy and bankrupt nations cannot afford to do anything so why talk about anything else?  We have a bright red oil light lit up on our national dashboard yet the Democratic and Republican leadership continue to drive on bickering about who should have brought the black tape to put over the warning light.

What would it mean if our nation went bankrupt?  A good analogy would be New Orleans.  The city is bankrupt; it’s a mess, and can only rebuild with federal (outside) assistance.  New Orleans completely lacks the ability to rebuild on its own because it doesn’t have the funds and its economy is pretty much destroyed.  But if the US goes bankrupt, who will help us rebuild?  If the answer is ‘nobody’, then you might want to take a trip down to The Big Easy to see for yourself what this country is going to look like in a few years.

The good news is that because the problem only grows more intractable with every passing day, our dithering politicians will have fewer options to chose from when the crisis hits thereby making their jobs that much easier.  The bad news is that the more time we spend in denial, the less time remains for us to get busy and do something about it.   There is even the danger that if we wait too long, we will face a potentially unfixable problem on the scale of what the Soviet Union experienced - catastrophic economic failure.

During my time as a consultant, I had ample opportunity to witness a very clear phenomenon.  If the person at the top of an organization was ethical, for the most part so were all the rungs and layers beneath them.  Conversely, an unethical leader usually presided over an unethical organization.  As a social animal, we tend to take our cues from above.

Our federal government is now several decades into a reckless love affair with unrestrained profligacy.  Because we’ve lacked any clear, moral leadership for so long, it is easy to find reflections of this behavior peering back from every corner of society.

Consider the evidence:

1)     State pension shortfalls running towards a trillion dollars

2)     Municipal pension shortfalls in the hundreds of billions of dollars

3)     Corporate pension and healthcare deficits of one-and-a-half trillion dollars

4)     401K savings of only $53k per 55 year old worker

5) A national savings rate that has steadily eroded since the early 1990’s falling from 10% to negative 1.5%, a condition last seen at the depths of the great depression in 1933

In summary, the list above indicates that at the federal, state, municipal, corporate, and personal levels nobody is saving for the future.  I could probably tick off a few more but since I’m out of fingers on my non-typing hand let’s agree that pretty much covers it.  We are not saving for our future, we are all in this together, but it will take leadership to get us out. 

It is imperative that we return to our heritage of saving and investing for the future.   Somehow we’ve forgotten that a period of living beyond your means must always be balanced by an equal amount of living below your means.   The belief that debts can be compounded forever is dangerously naive as it merely shuffles the bills off to the future as though they could be forever hidden by time.

Leaving aside the obvious moral parallel between this behavior and the fable about The Ant and the Grasshopper, this insolvency issue, large though it appears, is merely a symptom; an effect rather than a cause.  At the root of it all is our monetary system, which we need to understand before we can begin to posit solutions.

Let me be clear - I think that while it was operating well, our monetary system was a great system, one that fostered incredible technological innovation and advances in standards of living.   But every system has its pros and its cons and our monetary system has a doozy of a flaw.

It is run by humans.

Oh, wait, that’s a valid complaint but not the one I was looking for. 

Here it is:  Our monetary system must continually expand, forever.

Which means it has a math problem in the same way that a beached whale has a breathing problem.  In each case we have a massive organism that was optimized for a very different set of conditions than those in which it currently finds itself.

This will be the topic of our next article.

In the meantime, be on the lookout for DC politicians seeking to buy black tape.

All the best,

Copyright, C. Martenson, 2006©

I’d like to wish everyone the happiest of holidays.

Also, I’d like to let you know that the normal weekly update has been deferred to next week as I attend to my family and especially my three young children for whom Christmas is pure magic.

The next posting will expand upon the math problem that lies at the  base of the banking system.

All the best,
Chris

Prepare to be shocked.

The US is insolvent. There is simply no way for our national bills to be paid under current levels of taxation and promised benefits. Our combined federal deficits now total more than 400% of GDP.

That is the conclusion of a recent Treasury/OMB report entitled Financial Report of the United States Government that was quietly slipped out on a Friday (12/15/06), deep in the holiday season, with little fanfare. Sometimes I wonder why the Treasury Department doesn’t just pay somebody to come in at 4:30 am Christmas morning to release the report. Additionally, I’ve yet to read a single account of this report in any of the major news media outlets but that is another matter.

But, hey, I understand. A report is this bad requires all the muffling it can get.

In his accompanying statement to the report, David Walker, Comptroller of the US, warmed up his audience by stating that the GAO had found so many significant material deficiencies in the government’s accounting systems that the GAO was “unable to express an opinion” on the financial statements. Ha ha! He really knows how to play an audience!

In accounting parlance, that’s the same as telling your spouse “Our checkbook is such an out of control mess I can’t tell if we’re broke or rich!” The next time you have an unexplained rash of checking withdrawals from that fishing trip with your buddies, just tell her that you are “unable to express an opinion” and see how that flies. Let us know how it goes!

Then Walker went on to deliver the really bad news:

Despite improvement in both the fiscal year 2006 reported net operating cost and the cash-based budget deficit, the U.S. government’s total reported liabilities, net social insurance commitments, and other fiscal exposures continue to grow and now total approximately $50 trillion, representing approximately four times the Nation’s total output (GDP) in fiscal year 2006, up from about $20 trillion, or two times GDP in fiscal year 2000.

As this long-term fiscal imbalance continues to grow, the retirement of the “baby boom” generation is closer to becoming a reality with the first wave of boomers eligible for early retirement under Social Security in 2008.

Given these and other factors, it seems clear that the nation’s current fiscal path is unsustainable and that tough choices by the President and the Congress are necessary in order to address the nation’s large and growing long-term fiscal imbalance.

Wow! I know David Walker’s been vocal lately about his concern over our economic future but it seems almost impossible to ignore the implications of his statements above. From $20 trillion in fiscal exposures in 2000 to over $50 trillion in only six years? What shall we do for an encore…shoot for $100 trillion?

And how about the fact that boomers begin retiring in 2008…that always seemed to be waaaay out in the future. However, beginning January 1st we can start referring to 2008 as ‘next year’ instead of ‘some point in the future too distant to get concerned about now’. Our economic problems need to be classified as growing, imminent, and unsustainable.

And let me clarify something. The $53 trillion shortfall is expressed as a ‘net present value’. That means that in order to make the shortfall disappear we’d have to have that amount of cash in the bank – today - earning interest (the GAO uses 5.7% & 5.8% as the assumed long-term rate of return). I’ll say it again - $53 trillion, in the bank, today. Heck, I don’t even know how much a trillion is let alone fifty-three of ‘em.

And next year we’d have to put even more into this mythical interest bearing account simply because we didn’t collect any interest on money we didn’t put in the bank account this year. For the record, 5.7% on $53 trillion is a bit more than $3 trillion dollars so you can see how the math is working against us here. This means the deficit will swell by at least another $3 trillion plus whatever other shortfalls the government can rack up in the meantime. So call it another $4 trillion as an early guess for next year.

Given how studiously our nation is avoiding this topic both in the major media outlets and during our last election cycle, I sometimes feel as if I live in a small mountain town that has decided to ignore an avalanche that has already let loose above in favor of holding the annual kindergarten ski sale.

The Treasury department soft-pedaled the whole unsustainable gigantic deficit thingy in last year’s report but they have taken a quite different approach this year. From page 10 of the report:

The net social insurance responsibilities scheduled benefits in excess of estimated revenues) indicate that those programs are on an unsustainable fiscal path and difficult choices will be necessary in order to address their large and growing long-term fiscal imbalance.

Delay is costly and choices will be more difficult as the retirement of the ‘baby boom’ gets closer to becoming a reality with the first wave of boomers eligible for retirement under Social Security in 2008.

I don’t know how that could be any clearer. The US Treasury department has issued a public report warning that we are on an unsustainable path and that we face difficult choices that will only become more costly the longer we delay.

Perhaps the reason US bonds and the dollar have held up so well is that we are far from alone in our predicament. In a recent article detailing why the UK Pound Sterling may fall, we read this dreadful evidence:

Officially, [UK] public sector net debt stands at £486.7bn. That’s equal to US$953.9bn and represents a little under 38% of annual GDP. Add the state’s “off balance sheet” debt, however – including its pension promises to state-paid employees – and the total shoots nearly three times higher. Research by the Centre for Policy Studies in London says it would put UK government deficits at a staggering 103% of GDP.

If we perform the same calculations for the US, however, we find that the official debt stands at $8.507 trillion or 65% of (nominal) GDP but when we add in our “off balance sheet” items the national debt stands at $53 trillion or 403% of GDP.

Now that’s horrifying. Staggering. Whatever you wish to call it. More than four hundred percent of GDP(!). And that’s just at the federal level. We could easily make this story a bit more ominous by including state, municipal and corporate shortfalls. But let’s not do that.

Here’s what the federal shortfall means in the simplest terms.

1) There is no way to ‘grow out of this problem’. What really jumps out is that the US financial position has deteriorated by over $22 trillion in only 4 years and $4.5 trillion in the last 12 months (see table below, from page 10 of the report). The problem did not ‘get better’ as a result of the excellent economic growth over the past 3 years but rather got worse and is apparently accelerating to the downside.

Any economic weakness will only exacerbate the problem. You should be aware that the budgetary assumptions of the US government are for greater than 5% nominal GDP growth through at least 2011. In other words, because no economic weakness is included in any of the deficit projections presented, $53 trillion could be on the low side. Further, none of the long-term costs associated with the Iraq and Afghanistan wars are factored in any of the numbers presented (thought to be upwards of $2 trillion more).

2) The future will be defined by lowered standards of living. As Lawrence Kotlikoff pointed out in his paper titled “Is the US Bankrupt?” posted to the St. Louis Federal Reserve website, the insolvency of the US will minimally require some combination of lowered entitlement payouts and higher taxes. Both of those represent less money in the taxpayer’s pockets and, last time I checked, less money meant a lower standard of living.

3) Every government facing this position has opted to “print its way out of trouble”. That’s an historical fact and our country shows no indications, unfortunately, of possessing the unique brand of political courage required to take a different route. In the simplest terms this means you & I will face a future of uncomfortably high inflation, possibly hyperinflation if the US dollar loses its reserve currency status somewhere along the way.

Of course, it is impossible to print our way out of this particular pickle because printing money is inflationary and therefore a ‘hidden tax’ on everyone. Consider, what’s the difference between having half of your money directly taken (taxed) by the government and having half of its value disappear due to inflation? Nothing. Except that the former is political suicide while the latter is conveniently never discussed by the US financial mainstream press (for some reason) and therefore goes undetected by a majority of people as the thoroughly predictable outcome of deficit spending. All printing can realistically accomplish is the preservation of some DC jobs and the decimation of the middle and lower classes.

In summary, I am wondering how long we can pretend this problem does not exist. How long can we continue to buy stocks and flip houses, forget to save, pile up debt, import Chinese made goods, and export debt? Are these useful activities to perform while there’s an economic avalanche bearing down upon us?

Unfortunately, I am not smart enough to know the answer. I only know that hoping a significant and mounting problem will go away is not a winning strategy.

I know that we, as a nation, owe it to ourselves to have the hard conversation about our financial future sooner rather than later. And I suspect that conversation will have to begin right here, between you and me because I cannot detect even the faintest glimmer that our current crop of leaders can distinguish between urgent and expedient.

What we need is a good, old-fashioned grassroots campaign.

In the meantime, I simply do not know of any way to fully protect oneself against the economic ravages resulting from poorly managed monetary and fiscal institutions. For what it’s worth, I am heavily invested in gold and silver and will remain that way until the aforementioned institutions choose to confront “what is” rather than “what’s expedient”. This could be a very long-term investment.

Are you shocked?

All the best.

Chris

All rights reserved, Copyright, 2006 Dr. Chris Martenson

While the US stock market blithely ambled about last week, unable to decide if it should blast higher or maybe give up some of its outlandish recent gains, ominous clouds of data darkened the sky. Here’s a sampling:

• US manufacturing shrank for the first time in 3 ½ years
• Consumer confidence slipped
• A sharp increase in initial claims for unemployment benefits was registered
• Weak holiday sales, and the first yr/yr decline in monthly sales for Wal-Mart in a decade, spoke to a flagging consumer mentality
• Durable goods orders and corporate investment fell sharply
• New home sales tanked
• A very sharp pullback in construction spending (both residential and non-residential), the most since September 2001, was recorded
• Mortgage applications declined
• Slumping auto sales signaled an auto recession (at the least)

How the stock market is able to remain elevated at, or above, all time highs (depending on which index is being considered) is simply beyond me. Massive flows of liquidity are blasting into the stock market from somewhere, somehow.

Meanwhile, back at the ranch, the US press was, as usual, furiously trying to soft-pedal the now worrisome weakness in the US dollar. Here’s the spin Business Week applied to the ugliness:

Europe calmly looks at sliding dollar

With the European economy on the upswing, companies and governments are shrugging off the dollar’s renewed slide against the euro this week — a phenomenon once dreaded as potential poison for the continent’s many exporters.

Companies appear to have made their peace with a stronger currency for the time being, especially in export champion Germany, helped by stronger growth at home, currency hedging and increasingly globalized production practices.

Don’t worry! Europe isn’t! That seems to be the opinion of this particular Business Week writer and his editors. Meanwhile, this is how it was being played over in the UK press:

Plunging dollar will set world markets reeling

The slowdown in the US economy, which has sent the dollar into freefall over the past fortnight, will have devastating knock-on effects in markets around the world, analysts warn.

It could just be me but I think I can detect a slight difference between the two articles.

So let’s take another look at that USD chart we viewed last week and decide for ourselves how Old Uncle Buckie is doing. When viewing the chart below keep in mind that ‘everybody’ was expecting the dollar to rebound after that horrible 2-day slide from Thanksgiving week. It did not. Things got worse.

[note: This is a daily chart so each bar, or candle, is a day.  Last week is represented by the last five bars, two white and three red]

Ugly. That’s some bad action right there. No recovery at all.  We’re still a couple of points away from the ‘danger zone’ at 80.50 but this past week did nothing but confirm that the dollar is under severe strain.

What we don’t know, out here in the cheap seats, is what’s really driving this decline. The US news does its best to ‘explain’ such movements by linking the dollar movements to recent happenings like weak US manufacturing data or weak holiday sales but in my experience such news has nearly zero predictive power for actual movements in the US dollar.

For example, it is not uncommon for the US press to report that the dollar went down because of weakness in some reported data set one month, only to state the opposite the next month. The point is that the US press feels an obligation to provide ‘an explanation’ but usually never does.

I believe that for the past several years the US dollar has gone up or down for one primary reason and one reason only; foreign central bank activity. Which foreign central bank is number one on that list? That’s right, China. And have there been any recent news reports that might help us understand why the dollar has been stumbling?

I’m glad you asked:

Paulson reaching out to China

Hank Paulson, US treasury secretary, will on Monday begin a series of discussions with industry leaders to hammer out the Bush administration’s policy towards China ahead of a high-level delegation to Beijing next week.

Monday you say? You mean this Monday after two weeks of dollar hell? Geez, it’s not like the US is planning to approach its largest creditor with a huge list of demands that might cause that creditor to ‘send a little message’ in advance of that meeting, right?

What? That is the case? That doesn’t seem too smart:

WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke will accompany Treasury Secretary Henry Paulson and other cabinet officials to Beijing next month to try to persuade China to alter its economic policies, senior U.S. government officials said on Thursday.

The 1-1/2-day visit in mid-December has an ambitious agenda to push, from urging China to let its Yuan currency to appreciate further to persuading it to reduce barriers to foreign investment and crack down on piracy and theft of intellectual property.

When I read the above, I think about the US hemorrhaging in every possible way in a dreadful Middle East conflict, a debtor nation without parallel that has squandered massive amounts of international prestige but now sees fit to ‘pre-sell’ a trip to it’s largest creditor trading partner with an exhaustive, if not petulant, list of demands. Search though you might, you will not find a corresponding list from the Chinese side. Why? Because that would be bad diplomacy and the Chinese are careful diplomats. I can only imagine how steamed they are over there right now. Oh to be a fly on the wall at those negotiations.

In the face of all of this, the stock markets continue to trundle along as if there wasn’t a care in the world. One area the stock market has allegedly drawn some comfort from is the government inflation data, which shows inflation backing off pretty sharply. The twisted logic of the stock market today is this; lower inflation will lead the Fed to reduce interest rates, which will translate into cheaper borrowing costs, which will lead to even more consumer borrowing which is ultimately good for the stock market.

It’s a logic train that only Rube Goldberg could love, but that’s what we’ve become as a nation…everything hinges on our ability to borrow ever more at ever cheaper rates.

However, as you know I am a huge critic of the way that our government collects and reports inflation numbers and I think the stock market is making a huge mistake in believing the ‘official inflation numbers’. For example, in the most recent GDP announcement it was reported that food costs are up 2.4% over the past year.

Hmmmm. Could they have forgotten to include the cost of orange juice which is up not 2.8%, not 3.9% not even a horrendous 9.2% but rather 66.0%(!!) over the past year?

In fact, this is not an isolated example. The following links to charts of all the major grain types reveals similar patterns. I wonder how food costs can be said to be up 2.4% when the actual price increases are up over 15 to 30 times that amount? A fair question, to be sure.

Corn (up 87% over the last year)

Wheat (up 58%)

Oats (up 44%)

Continuing into other basic materials I cannot find any that even remotely correspond to the government’s numbers

Oil (Unchanged)

Copper (up 60%)

Silver (up 75%)

Aluminum (up 39%)

These charts show, in frightening and graphic detail, that inflation is running at anything but the ~3.3% that the government recently reported.

The bottom line to these charts is that inflation is actually raging along quite nicely, thank you very much, and I sincerely doubt that the Fed is going to be able to reduce interest rates because of low inflation.

Instead the Fed may be forced to combat a severe economic slump initiated by a housing crash by slashing interest rates but that would then cause the dollar to decline even more sharply (since high interest rates support a stronger dollar and vice versa).

Hence the Fed is stuck between the proverbial rock and a hard place. Lower interest rates risk a severe dollar decline, but higher interest rates assure a recession with American citizens as poorly positioned for a recession as they can possibly be. What to do…what to do?

I predict the Fed will display their stupendous bureaucratic sclerosis and employ the vaunted ‘deer in the headlights’ strategy, which will manifest as a non-decision at their next meeting. Interest rates will remain unchanged.

As for stocks…look out below!

Best,
Chris

To subscribe for the free delivery of this weekly missive by email, please register over at DRMSS.COM
All rights reserved, Copyright, 2006  Dr. Chris Martenson 

I will have to make this very short this week. I blame turkey induced napping.

The US markets were shortened this week with Thursday being entirely closed and Friday a half-day.

However, the rest of the world was open and boy (!) did they have something to say about the US dollar.

In the chart below the red ‘candles’ (as they are called in financial chart-speak) indicate times when the US dollar is falling against a basket of foreign currencies, and the white candles indicate times when it is strengthening.

The basket has a number of different currencies within it but the ‘big three’ are the Euro, the Pound Sterling, and the Yen.

What this chart tells us is that the dollar had a really bad two-day losing streak on Thursday and Friday (Nov. 23rd & 24th). One of the worst in recent years.

I am keeping my eye glued to the dollar this week for several reasons:

1. If the dollar breaks ~80 on the scale above, there is suddenly a very real possibility that it will lose up to half of its international value. And pretty quickly too.
2. Gold, oil, and a significant proportion of our imported items will double in price (including oil).
3. The worldwide derivative tower, or colossus (or nightmare) rests on a stable dollar value. Upset one, and you upset both.

In fact, the dollar has gained and lost a lot of ‘value’ compared to other currencies in the past and this has largely gone unnoticed by the average American.

What could make it different this time?

1. America owes more to the rest of the world than ever before. In fact, the total amount has roughly doubled over the past six years.
2. Derivatives grew over 30% in size over the first six months of this year from $285 trillion to $370 trillion. Yikes! In six months! Let’s not trivialize this number. Let’s draw it out. That’s $370,000,000,000,000 … or more than 5 times the total yearly world economic output.
3. America now imports a much larger proportion of its basic needs. Stuff we either cannot produce (oil) or no longer produce (clothes, shoes, electronics, etc). If the dollar falls a lot, and quickly, we will simply have to adjust to higher prices.
4. Interest rates are very low but debt levels are very high. If the dollar starts to fall and our fiscal & monetary authorities want to stem those losses, the only tool in their tool kit (besides the gunboats I mean) is raising interest rates. What would happen to our economy if interest rates doubled? Nothing good.

If the dollar reaches and then breaches the key technical level of 80.50 I will be sending out my first ever email alert. What you do with that information is up to you, but I will be converting more of my dollars into foreign currencies, gold, and oil.

And now, for some random articles of import.

First, the USA imports a bunch of oil from Mexico. Mexico has a single ‘super-field’, the second largest in the world, as well as a number of less notable oil fields. The largest is called Cantarell and, as mentioned in this missive nearly a year ago, Mexican officials are now admitting that it is declining far faster than originally stated. There are some pretty serious implications behind this data.

PEMEX CEO Sees Cantarell Field Declining 14% Per Year

26 November 2006

In testimony before the Energy Committee of the Mexican Senate, PEMEX CEO Luis Ramirez Corzo said that production at the giant Cantarell offshore field will decline by an average of 14% per year between 2007 and 2015. The Cantarell complex currently produces about 1.8 million barrels of oil per day (bpd)—about 55% of the total 3.3 mbpd PEMEX estimates it will produce this year.

Next, why is the housing bubble going to be so painful? Because some people are going to be asked to pay over $1 million in interest and more than $450,000 in principle on a house they originally bought for $97,500. Confused? Read on:

Ana Martinez has repeatedly remortgaged her three-storey home since buying it in 1994 for $97,500, moving down the chain from bank lenders to sub-prime mortgage companies. In all, she has taken more than $300,000 that she says went for major house repairs and trips to Honduras to visit her ailing mother.

Most recently, she refinanced through a California sub-prime lender in October 2005. She ended up with two loans, one for $427,500 and another for $28,500.

The interest rate on the larger loan was fixed for two years at 7.35 per cent. After that, the rate is to ratchet up every six months until it hits a maximum of 13.35 per cent, said Virginia Pratt, a counselor at an community group called ESAC that is working to save Martinez’s house.

Documents show her monthly payment is to rise from $2,766 to $3,612 beginning June 1, 2008. After paying that amount for 27 years she will still owe a lump-sum “balloon payment” of $276,938. In all, she is scheduled to pay $1.14 million in interest over 30 years.

Can you imagine? This woman, who is not unique in the American experience, somehow convinced herself that lying about her income in order to obtain a mortgage the she could not afford, so that she could extract $300,000 in spending power from a house that she originally bought for $97,500 but is now going to pay $1.14 million in interest cost for…somehow she convinced herself that this made good fiscal sense. If Santa cares about this country, this year he will distribute a few million pocket calculators, plus instruction booklets.

And finally, Wall Street is starting to seriously fret about the outsourcing of jobs. It has finally dawned upon the financial masters of the universe that America losing it’s most important job categories is a terrible thing.

How and when did they come to this conclusion? After the data showed that their own “irreplaceable positions” as creative paper pushers, er, I meant ‘the center of financial innovation’, is rapidly slipping away:

Whatever the causes, the numbers bear out America’s slippage. It is still well ahead of Europe in hedge-fund and mutual-fund assets, securitisation, syndicated loans, and turnover in equities and exchange-traded derivatives. In all but one of these, however, the gap narrowed in 2005. Europe’s corporate-debt market overtook America’s last year (see chart 1), although America still leads in high-yield “junk” bonds, a distinction less dubious than it once was.

The loudest sucking sound has been in the market for initial public offerings, a crucial barometer of financial wellbeing. America’s share (measured by proceeds) has collapsed since the late 1990s (see chart 2). Five years ago the New York Stock Exchange dwarfed London and Hong Kong. This year it is being beaten by both.

This is shocking data because it means that we flubbed our most basic assumption about the future. We (and by “we” I mean congress and their lobbyists) gave up our manufacturing base under the assumption that our financial economy would then service the needs of the rest of the world. You know, along the lines of we’re the brains and they’re the muscle. That sort of thinking.

Ha ha ha America! It turns out, shockingly, that the rest of the world can creatively push paper around just as well as we can. Who knew?

At any rate, it sort of begs the question – if we no longer manufacturing things and we are no longer the financial center of the universe, what exactly are we? And how will we earn a living at it?

I need to go take a nap.

All the best,
Chris

All rights reserved, Copyright, 2006 Dr. Chris Martenson

Since there’s nothing really new to report on the markets this week – stocks remained mysteriously levitated despite a bevy of harsh news on the housing front; bonds, gold, the dollar and oil seem to be in holding patterns – I will use our time this week to round out a topic that we covered in some detail in the lecture series. And, no, that topic is not my waistline.

What I’m talking about is debt.

Here’s what we know about debt. Debt comes in two forms. The first is called, in banker parlance, ‘self-liquidating debt’ and represents borrowing that will boost economic activity and therefore stands an excellent chance of ‘paying itself back’. The simplest example would be a case where you could borrow money at 5% but loan it out, risk free, at 7%. If I had the opportunity to conduct such a trade I would go into as much debt as possible, sit back, and watch the money roll in. More broadly, self-liquidating debt typically has a productive asset tied to it, such as a utility company, an apartment building or a factory which generates the income to pay off the debt.

The other type is ‘non self-liquidating’ debt which, as you have already guessed, does not ‘pay for itself’ and is used for consumption, not investment. An example would be borrowing $40,000 to buy a car which does not get you to work any faster than your old beater. Or the construction of a shiny new town hall. Or a war of choice in the Middle East. All of these represent debt taken on today in order to purchase and consume something today but the purchases do not then lead to new economic earnings. The money is spent, but the debt remains.

Since 2001, our national level of debt has very nearly doubled. Almost all of this mountain of new debt has been of the non self-liquidating variety.

And here’s the one thing we need to remember about this kind of debt; it represents future consumption taken today. Sometimes people find this statement confusing so let me flesh this out. In the case of the auto purchase given above, $40k was borrowed and the car purchased. But later, the loan has to be paid back, with interest. And every one of those future payments are made with real cash that is not available to spend on something else (or even save). Cash that you can’t spend in the future represents consumption that you must forgo. In other words, a preference for a car today acquired via debt is really just another way of saying that having the car NOW has a higher ‘value’ than having a car’s worth of purchasing power in the FUTURE.

And finally, remember that there are only 2 ways to make a debt go away:

1) Pay it back

2) Default on it

Unless you are the federal government in which case you can always go for the third option:

3) Print money to pay the debt.

The federal government always favors this last option because so very few people correctly perceive the (inevitable) resulting inflation for what it really is, a hidden tax that erodes the value of all existing money, whereas everybody understands that raising taxes directly takes their money away. But, having sat through the seminar series, and having the buttocks calluses to prove it, you understand this mechanism and know that inflation is everywhere and always a monetary phenomenon. Excess printing by government always, always, always leads to inflation. End of story.

So what does any of this have to do with the title? What does any of this have to do with morality?

Well, we can rotate the topic slightly and see that there are two other ways to view debt. On the one hand there’s debt taken on with the intent of paying it back, and on the other hand there’s debt taken on with the intent that it will not be paid back.

To pass judgment on these two approaches, the former is moral, the latter is immoral (and usually illegal). To really understand this judgment we’ll need to take look at this in greater detail.

Certainly we can all agree that taking out a loan with the intent of never paying it back runs afoul of a variety of civil and criminal laws. But what about a situation where one generation borrows with the intent that a future generation will be the one paying off the loan? Further, what if the loans were of the non self-liquidating (consumptive) variety and zero benefit would accrue to the future generation? Would we call that immoral as well?

Well, the 6,000-pound elephant in the room is that is exactly how the US has been operating for the past 20 years or so. This is not to point a finger of blame, or to create victims and victimizers. We have all been equal, eager and willing participants in this game. We have been robbing Peter to pay Paul. Unfortunately, Peter has not yet even been born, which means what we’ve done is even easier than taking candy from a baby. Babies cry a lot when you take their candy, which I find troubling. Earmuffs help, but even then…

At any rate, we can observe the phenomenon of generational theft in the negative $65 trillion net worth of the US at the federal level, the $8.6 trillion in direct federal debt, and the negative $1 trillion in unfunded pension obligations at the state level. Each of these represents borrowed promises that the current generation has opted to lay upon future generations. In every case it has also meant that current and past generations have been able to enjoy both high consumption and low taxes.

Need more proof? Observe the record-breaking 97% pass rate of state bond issuances in the November 2006 elections. This Bloomberg article explains, and is worth your time to read:

Welcome to the Golden Age of Public Finance — Nov. 8 (Bloomberg)

That’s the message voters sent to the municipal market yesterday, as they approved the majority of the record $78.6 billion in bonds placed on the ballot this year.

Of the $56.5 billion in bond issues totaling $200 million or more being considered nationwide, Bloomberg News this morning calculated that 97 percent had passed. The majority appear to be for education, the remainder, money to be used for infrastructure construction and maintenance.

The election of 2006 marks a watershed for the municipal market. Never before have voters had to consider so many bond issues. Never before had they approved so many.

What’s going on here? The easiest answer would be to blame California, where voters were asked to approve that outlandish package of $43 billion for transportation, water, and school construction, and did.

That’s the easy answer. It would be harder to prove, but it wouldn’t be overstating the case to attribute the big election to generational change.

Stay with me here. The people who approved these bond issues, most of them, I’d bet, grew up in the 1970s.

What does that have to do with it? These are people who are used to having nice things. By comparison, those who grew up in the Great Depression and the 1940s were used to making do. They were suspicious of government, and of debt.

When they entered their 30s and 40s, it was the 1970s. The approval ratio for the 1970s, the entire decade, was 49 percent. There were years when this frugal generation approved 9.5 percent (1975), 18 percent (1971) and 33 percent (1973) of the bonds put before them for consideration.

Those who grew up in the 1950s and 1960s, certainly a happier group, approved marginally more borrowing 30 years later, when they started raising their families. The average approval ratio during the 1990s was 69 percent.

Now we’re talking about people who were born in the 1970s. These are the people who enjoyed air-conditioned schools and comfortable college dorms and coffee that tastes good, and they want the same things for their children, as well as things like smooth roads that aren’t too crowded, and new sidewalks, and nice parks, and roomy stadiums. They grew up cosseted, and squeamish about things that are less than just so.

These are the people who have moved to the suburbs and the exurbs and they see no reason why they shouldn’t borrow millions and billions of dollars for things that are going to have a useful life of, oh, when it comes to bridges and highways and sewers and the like, of 50 years to forever. The approval ratio for bonds put up for the vote in the 2000s is 80 percent, according to the Bond Buyer.

So welcome to the Golden Age of Public Finance. Now that this bunch has seen how easy it is to get a whole barge load of bonds passed, look for election ballots to swell to even more unseemly sizes in the years ahead.

I think the author, above, has made a very good set of observations. Namely that the current generation has lost all compunction about borrowing long-term to finance near-term consumption.

And this has come about because Greenspan’s “easy money 4-ever policy” of 1995 through 2005 has lulled us all into thinking that easy, cheap borrowing is a permanent condition. It is not. The piper always must be paid.

But more importantly, I have serious moral reservations about one generation saddling the next with its debts. How can this be right? At the federal level we’ve decided, as a nation, to make all sorts of promises that cannot possibly ever be kept at current levels of taxation. So either future senior citizens are going to be sorely disappointed by meager entitlement payments or future taxpayers (my kids) are going to have to shoulder crushing employment tax burdens.

For the senior citizens this is patently unfair since they paid more than their fair share into these retirement programs all their working lives. Should it be their fault that our leaders decided to use those ‘excess funds’ for current spending on hapless wars, bridges to nowhere, and other exotic examples of pork barrel spending of every conceivable stripe?

On the other hand, should it be the responsibility of subsequent generations to shoulder the burden of paying for all that past consumption and our collective decision to ‘fund’ past societal excess with future promises to pay?

In this skirmish, I must side with the future generations. I think it is incumbent on each generation to figure out how to pay for whatever levels of consumptive spending it deems fit.

I think that racking up huge debts with the intent of pushing their repayments off to future generations is morally equivalent to loan fraud. It would not surprise me in the least if future generations decide that they have no legal or moral obligations to make good on that debt.

In the meantime, we each must ask of ourselves where we stand on this issue, how we’ve benefited, and whether we have any sort of an obligation to correct the situation.

I hope you have found my logic to be even more expansive than my waistline.

All the best,

Chris

Copyright 2006, all rights reserved.

I’m leaving later today for a long weekend adventure, which means I’m going to have to put this out in record time. Which is an oblique way of saying my normally shoddy quality control is headed right out the window. So brace yourself for a rough ride as I arrange the typos and grammatical blunders in a tight washboard pattern on a horribly constructed metaphorical road.

Market action: This week saw the stock market start to yield some of its recent outsized gains as the reality of an impending recession started to force its way into an irrationally exuberant market. Retail sales were softer than expected, auto sales rebounded compared to last year but were hardly spectacular and the steady trickle of bad news on the housing situation continued unabated. Worse, productivity dropped while labor costs rose which was a double whammy for the stock market bulls who were hoping for another round of interest rate easing by the Fed.

Isn’t it odd that our stock market would care more about interest rates than actual economic activity? Wouldn’t this imply that the stock market cares more about people’s ability to go deeper into debt (low interest rates = cheap money = more debt at a faster rate) than it does about the actual growth of our productive enterprises?

Yes it does, and that is sad. It means that somewhere along the line US citizens slipped from a position of adding value via productive enterprise(s) to the shallow occupation of being consumptive borrowers. As always, if anyone out there can find any country, any persons, any businesses that managed to borrow and consume their way to wealth, please call me at any hour of the day or night.

Robert Rubin, former Treasury Secretary under Clinton, recently put it this way:

“I think there’s been a curious phenomenon in the equity markets, at least in the last few months: When there is news that the U.S. economy is slowing, the market often gets stronger because investors figure the Fed will stop raising rates, or maybe lower rates — or maybe they think bond yields will decline. For some reason, they don’t seem to say to themselves that earnings may be lower. I think it’s very strange.”

He’s right, it is very strange. Unless you’ve been through The Straight Story seminar series, then you understand that for a late-stage, debt based, fiat money system (such as ours) nothing is more important than additional, new credit (debt) creation. If the credit machine ever fails to create enough new debt (money) to pay off the old interest (uh oh!) the US economy will resemble a failed Saturn-V rocket launch, tipping slowly to the side as it’s forward momentum fails. The stock market understands this very well.

What the stock market doesn’t understand very well, anymore, is risk. With all the indexes perched near their five-year highs one would be hard-pressed to find any indication that a recession is even a remote possibility. Here’s Rubin again on risk:

“Sandy Weill (the former Citigroup chairman) made a good comment to me. Nobody’s going to ring a bell to tell you, but someday you may wake up and find out that these risks have materialized.”

Rubin observed that many people seem to think the risks that do exist won’t matter in the short run. Therefore, they’re fully invested — “because that’s not their time horizon in calculating an expected value. … Also, some assume that they can get off before the music stops. You know, not everybody is going to get off before the music stops.”

Which raises a set of important points. First, all the market participants seem to be assuming that the Fed, or the government, or whomever is going to ‘save’ the market should it start to decline. Second, if this turns out not be the case, everyone assumes that they’ll be able to get out “before the music stops”. These are both very, very dangerous assumptions. In the first case because the market is waaaaaay bigger than the Fed and the government combined and second because more than 60% of the market is now traded by computers with sub-millisecond execution times.

By the time you or I, or most market participants, find out that something is amiss in the markets most of the important trading will have been over a long, long time ago. Many hundreds of thousands of milliseconds ago.

Lastly, Rubin said this on the dollar:

“You have to figure out some way — which I have not done, I might add — to protect yourself should we have a real currency problem here. I’m not saying what the odds are. I have no idea. Maybe the odds are very low. But that is one concern.”

I have managed to figure out a way to protect from a falling dollar and that is to buy gold, silver, or any other commodity priced in dollars. What Rubin meant was he couldn’t find a way to protect the gigantic bank he works for from a fall in the dollar. That, truly, is a very significant problem because they have tens of billions under management. But for you or I, gold would work very well.

Moving on…if you like hypocritical, self-serving statements by powerful people you’re going to love this recent comment by Ben Bernanke, the Fed Chairman regarding ARMs:

“Some evidence, including recent Federal Reserve research on consumers holding adjustable-rate mortgages, suggests that awareness could be improved, particularly among borrowers with lower incomes and education levels,” Bernanke said in prepared remarks to a conference here on community development.”

Uh, earth to Ben? You do recall that it was your predecessor Greenspan who advised consumers to use ARMs back when interest rates were low in 2004? And you are also aware that it is at least in part up to the Fed to set lending standards? I could go on and on deconstructing Bernanke’s dismissive attitude towards “low income and education” borrowers, but I’m sure you get the idea.
Next up, USA Today continues to shine a bright light on the economy and actually points out how distorted the official inflation measures actually are in this remarkably revealing article:

Low inflation rate? Some consumers beg to differ 11/1/2006 11:05 AM ET by John Waggoner

Ask most economists about inflation, and they’ll tell you it’s low. Ask the average consumer, and you might get a very different answer.

Sean Taylor, 34, an information technology consultant in Trenton, N.J., ticks off the changes in his bills in the past nine years: property taxes, now $9,000 a year, up 105%; heating oil, $238, up 109%. His wife, Carrie, a state employee, pays $87 a month for health care; nine years ago, it was free. His income varies from year to year. Her salary is $75,000, up from $45,000, or 67%.

The consumer price index, including food and energy, has risen 2.1% in the past 12 months, according to the Bureau of Labor Statistics (BLS). By most measures, that’s low inflation. At that rate, it would take about 35 years for prices to double.

Somehow, though, it doesn’t sound quite right to Stacy Harris, editor of Stacy’s Music Row Report, a country music news website based in Nashville. “I feel the bite every time I go to a grocery store,” Harris says. Food prices have gained 2.6% the past 12 months, according to the BLS.

“The CPI is somewhat of a plutocratic measurement,” says Mark Zandi, chief economist for Moody’s economy.com. “Spending is dominated by wealthier households.”

The index also adjusts for the increased value of goods, which critics argue understates inflation. For example, if you buy a laptop computer today, you’ll pay roughly the same amount you would have three years ago. But your computer will be faster, have more storage and probably a Wi-Fi card, too.

Using the BLS methodology means that personal computer prices have fallen about 61% in five years and about 85% since September 1998 — a discount most consumers haven’t actually experienced.

I love that the practice of hedonic adjusting is finally being exposed in print. However, the article missed a golden opportunity to point out that property taxes, which were flagged as problematic by the persons they interviewed, are not actually included as a component of the CPI measure. All in all though, a great article.

And finally, I got a bit of a kick out of this report in Fortune on recent auto purchases by US consumers which showed a big spike in SUV sales:

NEW YORK (Fortune) — Who can remember all the way back to last summer, when we had daylight-saving-time, baseball and $3 a gallon gasoline prices?

Not American car buyers, apparently, and you can see the evidence in the results of October auto sales.

Sales of big pickup trucks and SUVs went through the roof - doubling from the year before in some cases. Sales of small, fuel-efficient cars, meanwhile, remained stagnant. It is as if all that moaning and groaning about price gouging by oil companies never happened.

Actually, it is worse than that. American consumers have reinforced all the stereotypes they are labeled with: short attention spans, lack of social consciousness and thinking with their wallets.

Does anyone seriously believe that having once spiked up to $3 with very little provocation, gasoline prices won’t do it again? Have they forgotten about the ongoing instability in the Middle East? And have they stopped caring about traffic density, scarce resources or global warming? And if they haven’t, why aren’t they exercising better sense in their vehicle preferences?

For SUV sales to tank when gas is $3 but come roaring back at $2.30 merely shows that the American consumer assumes that whatever is happening at the moment is a permanent condition.

Not at all unlike a 1 year-old that has not yet developed a sense of object permanence.

I mean, good gracious! An SUV purchase is a 7-10 year capital purchase but somehow the last 4 years of rising energy costs is meaningless to the average US consumer. All that matters is the last two weeks of gasoline prices at the pumps. Such intellectual rigor usually gets everything it deserves.

In closing, now more than ever would be a good time to remain alert. I would be especially leery of any government numbers regarding housing, employment, the GDP, etc. The stakes involved in this election are simply too high to ignore.

And I hope that your long, endless trip to get this far into the missive wasn’t overly bumpy.

All the best,

Chris

Copyright 2006, all rights reserved.

This was a big week for economic numbers. Those of you who have attended the Straight Talk seminar series know that most of the economic numbers come from either the government or trade associations and that both sources have conflicts of interest when it comes to presenting unbiased data.

Unfortunately, the numbers released this week were no exception.

Let’s start with the headline Gross Domestic Product, or GDP, number that was released on Thursday morning and came in at a disappointing 1.6%.

Growth rate is weakest since first quarter of 2003

By Greg Robb, MarketWatch
Last Update: 12:38 PM ET Oct 27, 2006

WASHINGTON (MarketWatch) — U.S. economic growth slowed sharply in the third quarter, increasing at a real seasonally adjusted annual rate of 1.6% after a 2.6% increase in the second quarter, the Commerce Department said Friday.

Investments in housing fell 17.4% in the third quarter, the largest decline since the first quarter of 1991. Housing subtracted 1.1 percentage points from third-quarter growth.

In nominal terms, GDP increased 3.4% to an annualized $13.3 trillion.

Inflation at the consumer level eased in the July-through-September period. The personal consumption-expenditure-price index increased at a 2.5% annual rate, down from 4% in the second quarter. The core PCE price index — which removes food and energy costs — increased at a 2.3% rate, down from 2.7% in the second quarter.

But the core PCE price index has increased 2.4% in the past year, up from 2.2% year-over-year growth in the second quarter. That’s the fastest pace since the second quarter of 1995.

Government spending increased 2%. Federal spending increased 1.7%, including a 6.9% rise in nondefense spending. State and local government spending increased at a 2.1% rate.

There was little evidence of the weak auto sector in the GDP report. Motor-vehicle output added 0.7 percentage point to growth and consumer spending on cars added 0.4 percentage point

There are a number of very odd things about this GDP release. First of all, the basic numbers do not add up. The Real GDP is what is left after nominal GDP has inflation (using the notorious ‘implicit price deflator’) subtracted. After 4 quarters of stating that inflation was 3.3%, this time around the BEA announced that inflation was only 1.8% - or that it had been cut nearly in half. Inflation is not usually so volatile but, unfortunately, no explanation was given for why/how this number suddenly plunged.

Next we might take note of the rather rapid collapse in residential real estate investment and ponder how many economists persist in claiming that collapsing real estate will have no impact on the economy (see the post from 3 weeks ago for an answer).

Lastly, we find the immensely bizarre claim in the report that the automobile industry expanded by a full 26% over last year leading, all on its own, to an incremental addition of 0.7% to the nation’s GDP. Here we have to note a few things…last year was a record year for auto sales and this year was not. So how did auto sales manage to expand? Next, the big three auto manufacturers all reported significant cutbacks in production this past quarter. So how do such cuts sum up to a hefty expansion?

Again, we are simply dealing with extremely fuzzy government numbers. I wasn’t the only one scratching my head at that one. This article points out that much of the financial world was shocked at the great pre-election auto-revival miracle:

U.S. Data Fluke Exaggerated Growth, Will Be Reversed

By Carlos Torres

Oct. 27 (Bloomberg) — An unexpected increase in auto production last quarter was a statistical fluke that will be reversed, making current U.S. economic growth even weaker, according to a former Commerce Department economist.

Last quarter’s annualized 26 percent increase in auto production shocked Joe Carson, now director of economic research at AllianceBernstein LP in New York. Without the gain, the economy would have grown at an annual rate of 0.9 percent, not the 1.6 percent the Commerce Department reported today.

The reported increase in output came despite cutbacks announced by General Motors Corp., Ford Motor Co. and others. A drop in the wholesale price of SUVs and light trucks as the automakers cleared leftover 2006 models made production look stronger than it actually was, said Carson. The economic fallout from the auto-industry cutbacks will instead come this quarter, he said.

“Last quarter was weak even with the benefit of this mismatch and the fourth quarter will now also be weak because it’s going the other way,'’ Carson said. “Whatever output you have this quarter, which will probably be down, will be discounted by a likely rebound in prices.'’

The mismatch can be explained by looking at how the government adjusts the figures for price changes.

Commerce Department economists use wholesale light truck prices, from the Labor Department’s producer price report, to eliminate the influence of inflation on investment and inventories for that category. A 5.5 percent drop in price of SUVs and other light trucks last quarter made output look stronger when adjusted for inflation.

Did you follow that? I’m not sure I did but basically it seems that the government interpreted lowered truck prices as the same, statistically speaking, as a gigantic increase in output. Confused? Don’t worry! That’s normal. If you’re not confused, you may want to apply down at the Commerce Department for a very satisfying career in number torturing. The job of water-boarding the auto data is clearly well staffed, but perhaps there are other opportunities.

And so, as expected (by me) the great auto-revival of 2006 has been revealed to be nothing more than garden-variety statistical fakery. Also not surprising is that the statistical ‘fluke’ had a positive bias. In fact, I cannot recall the last time a government statistic had a negative bias…

Prediction time. When the next quarterly GDP report is released watch for two things; this quarter’s amazing increase in auto production will be quietly revised down (heavily) and then next quarter’s auto data will handily beat that number allowing our DC denizens to point to yet another expansion in auto sales. Wash, rinse, repeat.

That’s how the game is played. Spin every number to the upside, quietly revise it later to the downside, then beat that new lower number on the next pass trusting that nobody will care about a huge downward revision of ‘old data’. I’ve seen this done with ever increasing frequency over the past 5 years to the point that it is now standard operating procedure. Wash, rinse, repeat.

Why do we care about such arcane minutia as fraudulent auto sales in a quarterly GDP report? Because bad data can lead to bad decisions which often leads to malinvestment. [I wonder how many stockbrokers are advising buying or holding auto shares based on the GDP ‘strength’?]

Nobody is doing us any favors by misreporting this data – nobody gains except the incumbent politicians. So consider the latest GDP report to be the national equivalent of a nice, gigantic happy face carpet laid over a field of withered crops.

Next I’d like to refer you to this article about David Walker, Comptroller of the USA (head of the GAO) detailing his efforts to make our current political establishment take notice of our nation’s precarious economic situation. Here are a few snippets from the article:

GAO Chief Takes to Road, Warns Economic Disaster Looms Even As Many Candidates Avoid Issue

AUSTIN, Texas (AP) — David M. Walker sure talks like he’s running for office. “This is about the future of our country, our kids and grandkids,” the comptroller general of the United States warns a packed hall at Austin’s historic Driskill Hotel. “We the people have to rise up to make sure things get changed.”

From the hustings and the airwaves this campaign season, America’s political class can be heard debating Capitol Hill sex scandals, the wisdom of the war in Iraq and which party is tougher on terror. Democrats and Republicans talk of cutting taxes to make life easier for the American people.

What they don’t talk about is a dirty little secret everyone in Washington knows, or at least should. The vast majority of economists and budget analysts agree: The ship of state is on a disastrous course, and will founder on the reefs of economic disaster if nothing is done to correct it.

This year Walker has spoken to the Union League Club of Chicago and the Rotary Club of Atlanta, the Sons of the American Revolution and the World Future Society. But the backbone of his campaign has been the Fiscal Wake-up Tour, a traveling roadshow of economists and budget analysts who share Walker’s concern for the nation’s budgetary future.

Wow! It turns out that David Walker and I are running about giving substantially the same lecture. Only he’s got a supporting cast of big-name economists whereas I have two good shirts, one without gravy stains on it. At any rate, I consider this article important enough that I have given it a permanent home over on our discussion forum. David Walker points out that every year we fail to deal with this issue means an additional $3 trillion of additional liabilities pile up on all of us. How much is $3 trillion? Beats me. But it’s a very, very big number.

I take this article to be further confirmation that our ‘leaders’ are not going to do anything about our fiscal situation until there’s an emergency. If you too wait for that moment to attend to your fiscal preparations you may find the situation chaotic and uncomfortable.

Housing: Finally, we need to keep our eye on the nation’s housing situation as this holds the key to our near-term economic future. Besides the usual litany of rapidly rising inventory and slumping sales, we had a real shocker on Wednesday with this news:

The Commerce Department reported yesterday that the median price of a new home plunged 9.7 percent last month, compared with September 2005, falling to $217,100, the biggest such drop since December 1970.

Holey smokes! This means that (on average) everybody who bought a new house over the past 9 months now finds that their house is worth less than what they bought it for. Is 9.7% decline a lot? Well, it’s the biggest decline ever recorded. So yes, it’s a lot.

However, even the 9.7% is known to be under reported due to some quirks in how that number is derived by the Census Department. From the same article as linked above:

The home builders’ association reported that 45 percent of builders and developers said they cut prices in September to maintain sales volume. That was up from only 19 percent a year earlier. Similarly, the association reported that 55 percent offered amenities like granite counters or upgraded kitchen cabinets for no additional cost. Only 19 percent did so a year earlier.

The cost of those incentives was not reflected in the new-home price data, which suggested that builders were making even less money from each sale than the shrinking official prices would indicate.

I could show you dozens of articles from this past week revealing the myriad of builder incentives that are now a normal part of the sales pitch ranging from free trips to warm locales, granite counter tops, pools, money towards closing costs, and even to the entire first year of mortgage payments being picked up by the builder. None of those incentives are counted against the sales price by the government which serves to (surprise!) bias the data positively.

However, suppose you paid $250k for a nice house and that your new neighbor bought a similar house 6 months later for $250k but their house had a pool, nicer amenities, and more square footage. You’d likely consider the sales prices to have been unequal. The government would not. If you find yourself in this particular situation, I recommend selling your house to a government official.

Why are we seeing such a rapid decline in new home prices? An excerpt from the San Francisco Chronicle explains:

If you are interested in reading more about the current state of housing I highly recommend that you visit this site: http://thehousingbubbleblog.com/

There you will find:
· Rapidly climbing inventory levels virtually everywhere in the country
· Falling house prices
· Rising foreclosures
· Tales of appraisal fraud
· Tales of woe from unwary ‘flippers’ (people buying and rapidly selling houses hoping for a gain).

As I read it, the correction in the housing market is picking up speed, and shows no signs of getting close to a bottom. Based on the behavior of 4 past housing booms, I would expect a bottom sometime between 2008 and 2010.

In the meantime, I’ll do what I can to keep you apprised of the various fuzzy numbers that you may encounter and which may cloud your vision.

Signed, your very fuzzy economist,

Chris

All rights reserved, Copyright 2006, C. Martenson