The ugly truth about the West's balance-sheet recession...
THE BIG STORY in markets everywhere today is that US GDP number, reports Dan Denning for the Daily Reckoning Australia in Melbourne.
It was up 3.5% in the third quarter, annualized, according to the US Ministry of Commerce. We predict that everyone is going to use it to claim that the recovery is upon us and that stock markets did not get too far ahead of themselves after all. That's just what happened overnight in the States. And stocks rallied smartly.
Don't believe the hype is our advice. The big problems in the economy – too much debt, too much leverage, too much government – are still there. They didn't go anywhere overnight. We'd suggest that getting sucked back into stocks now because of the US GDP figure is a very bad idea.
Of course we could be wrong. Maybe stocks will go up another 20% from here. Or 30%. Or 50%. But it's not likely. It's more likely that the recession is over, and that the Depression has just begun.
Depression has begun, we think, because what the US GDP numbers actually show is a private sector in full retreat. Its income is shrinking, its assets fallen in value, and the cost of servicing debt is rising. Into that terrible breach steps the public sector (i.e. the taxpayer), armed with an arsenal of inefficient and stupid programs that give the illusion of economic activity but actually prevent the economy from liquidating excess capacity and bad debt – the two conditions required for a real recovery.
So we're sorry to have to ruin your weekend, but the US GDP rebound is not as benign as you might think. Just the opposite really.
The GDP figures presage a massive increase in government spending in America and elsewhere. This debt binge is driving the public sector ever closer to its own reckoning with Ponzi Finance – where new debt barely covers the cost of interest and principal payments on old debt.
Why so serious? Shouldn't we celebrate? US GDP has contracted each of the last four quarters, and we are not going to rain on the parade by trying to prove that it didn't grow. But the real question is whether the GDP figures show that the economy is recovering, or whether a quarter or two of government intervention can give the economy a healthy looking flush, while concealing the disease that is eating away at its insides.
It all depends on what kind of recession we had. In a garden variety recession, businesses build up too much capacity in anticipation of consumer demand that never materializes or suddenly vanishes. Think of the US housing boom. Its seeds were sown when homebuilders built way too many units in places like Nevada, California, and Florida. They failed to realize that soaring demand for these units was driven by the supply of cheap credit. When the credit dried up, so did the demand. And the homebuilders were left a massive over-supply of housing.
The ones that survived had to liquidate inventory (land as well) at bargain prices. And such excess productive capacity is exactly what gets liquidated in a normal recession. Inefficient producers of goods and services get booted from the marketplace. Inventories are worked down until they are in line with a lower level of demand. And then, maybe, the economy starts a new cycle.
But what we have here, dear reader, is not your common or garden variety recession. While it's true that there is a huge amount of excess capacity in the world economy (hence wage deflation in the West), there is also another, more serious problem: too much private and household debt.
That is what makes this, as others have written before, a balance sheet recession.
You get a balance sheet recession when households and businesses must reduce the amount of debt they have.
Households "must" do this because cash flows aren't robust enough to service accumulated debt AND send little Timmy to private school. People have to cut back until expenses are less than income. In the case of a business, they must cut back because the cash flow isn't robust enough to cover the interest and principal payments on existing debt AND finance the operating expenses of the business. Businesses have to shift back to investing in capital goods and new growth, rather than speculating in financial assets and paper wealth.
There is, in short, no escaping a generation of accumulated debt. When the cost of debt begins to consume most of your free cash flow, then...well...sooner or later you have no free cash flow. There's nothing left. You're spending every last Dollar maintaining your household, paying your mortgage, and putting gas in the car. This doesn't leave room for much else – unless someone gives you money to spend...
For the last four quarters, American households have been reducing debt in order to get their financial house back in order. They are no longer borrowing against the equity in their house (because that equity is vanishing or has vanished) or spending their capital gains in stocks on a new TV (because those capital gains are smaller too). Instead, they have been de-leveraging.
Did all that really change in just one short quarter? No. What happened in the last quarter is that the US government gave people money, albeit indirectly. The Commerce Department reported that real personal consumption expenditures increased 3.4% in the quarter. They had declined by nearly one percent in the second quarter. So people spent money.
But whose money, and on what?
According to the Commerce Department, "Durable goods increased 22.3%, in contrast to a decrease of 5.6% in the second quarter. The third-quarter increase largely reflected motor vehicle purchases under the Consumer Assistance to Recycle and Save Act of 2009 (popularly called the 'Cash for Clunkers' program)."
All up, the feds tells us that (see page seven) the "Cash for Clunkers" program added about 1.7% to third quarter GDP. Keep in mind that in September, car sales fell 40% from August levels. Either the program will have to be extended, or it's shot its one-time stimulus bolt. But what a bolt it was!
Unless we're mistaken, however, about half the GDP growth came from one government program that's expiring and stopped working in September. Chuck in another half a percentage point due to the tax credit for new house buyers (sound familiar Aussie readers?), and another half point from the 7.9% increase in government spending – and you get your 3.5% GDP growth.
So that's it, then? The government pours billions of Dollars into the real economy and trillions into the financial sector to support bankers, and all we get is more cars and more houses bought by people with credit provided by a government that doesn't have any?
That's a recovery? That's the tipping point?
Excuse our skepticism. But it's not like household balance sheets improved that much in the last three months. Because in the very same glowing press release that announced the 3.5% growth, we learn that people had less disposable income in September, despite the rosy growth number.
"Disposable personal income decreased $20.4 billion (0.7%) in the third quarter, in contrast to an increase of $138.2 billion (5.2%) in the second. Real disposable personal income decreased 3.4%, in contrast to an increase of 3.8%."
That sounds like households – when they are not spending government money on houses and cars – are still cutting back. They're cutting back because there's no wage growth in the economy and no job growth. But there is still a lot of debt!
"What destroys individuals, ruins families, and fells nations is debt – or rather the inability to service debt, and the cultural ramifications that follow," writes Victor Davis Hanson. Attitudes to debt are both private and collective. And they tell you something about the people you are, or are becoming.
Take classical Greece. Hanson writes that, "The difference between the 5th century BC and late 4th century BC Athens is debt – and not caused just by military expenditures or war.
"The claims on Athenian entitlements grew by the 350s even as forced liturgies on the productive classes increased, even as the treasury emptied.
"At Rome by the mid-3rd century AD the state was essentially bribing its own citizens to behave by expanding the bread and circuses dole, while tax avoidance became an art form, while the Roman state tried everything from price controls to inflating the coinage to meet services and pay public debts."
Speaking of Rome, Barack Obama's pick to run America's National Endowent for the Arts has recently said that, "Barack Obama is the most powerful writer since Julius Caesar." If that's the case, we suggest a new slogan to replace "Hope and Change" for the President:
We came, we saw, we spent!
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