Keeping Up With the Jones

Millions of Americans are spending more that they’re earning…buying gas-guzzling SUVs, plasma screen TVs…just so they can appear to be wealthy. Doug Casey explores overwhelming debt the United States incurs as a whole…

Let me tell you a story about a young man.

Call him Jim.

As a child, Jim had shown promise. He had opened a $4 savings account.

But something was nagging at Jim, even as a child. It seemed to him that all his friends always had money to spend, and they always had the things he wanted but didn’t have. When he was young, they had nice bicycles, new baseball gloves and bats, radio-controlled model airplanes, an assortment of snakes and fish and hamsters as pets – and always they had money to buy things at convenience stores.

Upon entering his first year in high school, Jim had just over $1,000 in the savings account he started as a child. But the pressures of running with the right crowd, dressing the right way and having the right gadgets were too much for him. One day, Jim went to the bank and emptied his savings account. He felt a little funny about it, but that feeling passed as soon as he had a pocketful of cash.

Jump forward several years. Jim is 28 years old. He’s been out of college for three years. After graduation, he got a job making $50,000 a year. Not bad for a young guy fresh out of college.

So Jim did something genuinely stupid. He filled out every credit card offer that came in the mail. Banks like to offer credit cards to college grads because they know college grads are probably working full time at a job that pays much better than minimum wage.

Legal Tender Laws: More Credit than You can Handle

Jim assumed the banks wouldn’t give him more credit than he could handle. He took all they threw at him. Soon he had three Visa cards and two MasterCards. Jim used his credit cards almost daily, buying furniture for his new apartment and taking his girlfriend to fancy restaurants. He figured that as long as he could make those monthly payments, he was OK.

The trouble in Jim’s life – the trouble that was there all along if only he’d seen it – began when he lost his job suddenly and unexpectedly. Jim was in charge of the customer service call center for a small software company. They gave Jim a small severance check of $1,500, wished him well and sent him on his way.

To Jim, credit card debt was some far-off obligation, just another monthly payment, like the electric bill or the phone bill. He just knew that he needed money right away, so he borrowed it and didn’t worry about the consequences. He figured that’s how life was. You couldn’t really have much of a life unless you borrowed money. Everybody else seemed to be doing it, and they were all OK, he thought.

After being out of work for just two months, the credit card companies started calling him. Jim did the only thing he could. He ate his pride and took a job working hourly at the convenience store he had worked for in college.

Jim moved back to his parents’ house. He sold his stereo and his furniture to try to make a dent in the massive debts he had run up – over $35,000 on credit cards bearing interest as high as 19% for numerous cash advances. Jim’s interest payments were more than his parents’ interest payments on their house. That’s to say nothing of principal payments. It’s hard to make a dent in a $35,000 loan when you’re paying $6,500 a year in interest.

Legal Tender Laws: A Horrible truth

Jim works two hourly jobs today, averaging $9 an hour. So he makes about $37,000 a year before taxes, instead of the big money he made fresh out of college. He’s lucky, though. His parents don’t charge him rent. So he’s able to put a large percentage of each paycheck into his debts. He’s making progress. It’ll take Jim another few years to pay it all off, if he keeps putting about 75% of his paychecks into it. At that point, he’ll be about 35, and he won’t have one thin dime to his name. But he won’t have any debt, either. Financially, he’ll be back at zero, as though he’d just graduated from college.

In the midst of his crisis, Jim realized a horrible truth: He borrowed money because he wanted to own more things. In the process, he committed a significant portion of his future earnings to the banks. Now he has sold his possessions for a fraction of what he paid for them, and the banks own him. They will continue to own him until he’s paid them off. Jim consumed more than he produced…then the bottom dropped out of his productive output, and it pulled the rug out from under his life.

If Jim’s foolish behavior were an isolated case, this story would end here. But Jim’s behavior is typical of many individuals in the United States. Right now, there’s about $8,000 worth of credit card debt outstanding for every man, woman and child in the United States. But unlike Jim, every man, woman and child in the country can’t move back in with their parents and live rent free.

Like Jim, the United States as a whole is consuming much more than it is producing. But instead of transferring its wealth to banks the way Jim did, the United States is transferring its wealth overseas, to other countries.

So far, the United States has transferred about $2.5 trillion of wealth to other countries. Now, most of this is simply debt money lent to us by investors living in other countries. In July 2004, U.S. government debt stood at over $7 trillion. About 40% of that is owed to investors based outside the United States. That’s almost $10,000 in federal debt for every man, woman and child in America owed to foreign investors. We get their goods. They get our debt, our IOUs.

This would be perfectly fine if there weren’t such a thing as legal tender laws. Legal tender laws in the United States say that we have to accept U.S. dollars as payment for all debts and transactions, public and private. It follows that there’s a real risk that someday – and likely someday soon – a lot of those dollars are going to come flooding back into the United States. Suddenly, you’re going to have a lot more dollars chasing the same amount of goods and services around the U.S. economy. The word for that is inflation. The rate at which our wealth is being shipped overseas is at a staggering all-time high. According to the latest figures from the U.S. Department of Commerce, the United States transferred $541.8 billion of its wealth overseas in 2003, up 13% from $480.9 billion in 2002. At that rate, U.S. wealth will transfer into foreign hands at a rate of over $1 trillion per year in less than seven years.

Legal Tender Laws: The Trade Deficit

The U.S. Department of Commerce’s Bureau of Economic Analysis refers to the annual transfer of wealth we’re talking about as the current account deficit. You might know it as the trade deficit.

You’ve probably heard about the trade deficit before. But perhaps you never thought it was that important. After all, you might say, the trade deficit just means that we import more than we export. It just means that we enjoy a higher standard of living. If someone is confident that you’ll keep producing goods and services in the future, they might be willing to lend you money against that future production. The banks thought Jim was young, intelligent and highly employable, and probably reliable. So they lent him a small fortune. That’s what the United States is doing today. It’s borrowing more than $500 billion a year to buy goods and services from foreign countries. That’s how foreign investors have amassed claims on $2.5 trillion more of U.S. wealth than the United States has on theirs.

Now, it really doesn’t matter where all this paper money is floating around, whether it’s held by the Sultan of Brunei or in a hole in your neighbor’s backyard. The simple fact is that there are a lot of dollars out there – trillions – and if they come back into the United States, we’re going to experience sudden, severe inflation. That will have a horrible effect on stocks, bonds…just about any financial asset you can name.

On the other hand, hard assets like gold, silver, copper and other commodities will suddenly require a whole lot more U.S. dollars to purchase. We’ve all heard the stories about Weimar Germany and the wheelbarrows full of money needed to buy a loaf of bread. That’s hyperinflation. We’re not predicting anything like that, but the point is we don’t need anything like that in order for things to get quite ugly.

Why would all these dollars come flooding back into the United States? The short, simple answer is because they have no place else to go. Since dollars are only “legal tender” within the United States, whether foreigners continue holding them depends on whether they have confidence in the soundness of the dollar. Confidence, of course, can vanish like a pile of feathers during a hurricane. Based on recent market action, it is clear that foreigners are becoming increasingly aware that the dollar is, in fact, an “IOU Nothing” issued by a bankrupt U.S. government.

Regards,

Doug Casey
for The Daily Reckoning
October 26, 2004

It is only “a drop in the bucket,” says Stephen Roach. He is talking about the dollar’s decline so far. Since January 2002, the dollar has fallen almost 50% against the euro. Which makes us wonder how big the bucket is…and how many drops are left.

Yes, dear reader, things are now happening. Oh joy! How bored we have been all summer. Nothing happened. But now…ooh la la…the fan is turning, and the you-know-what is hitting it.

A week before the election, and the Dow fell to a new low for the year yesterday. No president has ever won re-election with the Dow off so much for the year. But we’ll see.

And gold? Yes, the GUDD times are back. Gold is up, the dollar is down. Gold rose to nearly $430 yesterday.

And now you may be wondering what is going on. We will tell you…at least, we will give you a theory.

First, the Internet, the strong dollar and EZ credit from the Fed created the huge bull market of 1975-2000. Remember Alan Greenspan’s warning of an “irrational exuberance.” That was when the Dow was well below 5,000. He was promptly called before Congress, where the politicians reminded him what business he was in; irrational exuberance was just what they wanted!

So the Fed chairman stopped worrying about a stock crash and began talking up the New Economy. Stocks ran all the way above 12,000, before finally peaking out in January 2000.

The experience left Americans with a taste for bubbles. They had gotten something for nothing for many years; they wanted more of it.

So rather than let the bear market run its course, the Greenspan Fed cut rates – down to below the rate of inflation. In effect, the central bank of the world’s biggest economy was giving away money. Never before had the world seen such EZ credit. And never before had they liked it so much.

This had two major consequences. It caused a worldwide bubble in real estate prices. In America, house prices had risen along with the inflation rate for many decades, but all of a sudden, they shot up two to three times as fast. In certain areas, the rate of increase was nearly 10 times the inflation rate.

Householders thought they were getting rich. They “took out” some of the equity and spent it – notably on products from Asia. This created a new bubble in Asian manufacturing. Asia was industrializing at breakneck speed anyway. But this new EZ credit deluded Americans into believing they had money to spend that they really didn’t have. So while Americans bought things they really didn’t need with money they didn’t really have, the Asians built factories to meet a demand that really wasn’t there. Even now, the U.S. economy slows down…but the ships keep coming from Asia, loaded with goods; so many ships are spread out in front of West Coast ports that it looks “like D-Day,” said one observer. And in Houston, the railroads are handling so much traffic they barely keep up with it.

It is an unsustainable situation. But it works…as long as nothing happens to disturb it.

Now things are starting to happen.

Ooh la la…

More news from New York:

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Eric Fry, on the scene in Lower Manhattan…

Greenspan’s oil price expectations…what the Fed chairman has to say about this “schizophrenic security” in today’s issue of
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Bill Bonner, back in Ouzilly (enjoying a semiholiday for All Saints)…

*** We drove up to Utrecht in the Netherlands over the weekend, charging through Belgium like a Panzer division. It was our first visit to the Low Countries.

The Low Countries – Belgium, Flanders, Holland – are not especially pretty. The land is flat, as you might expect. Many of the roads are nicely bordered by trees, but the buildings tend to be unattractive agglomerations of brick, metal and glass.

The people are not very fetching, either. At least those we saw dressed without much style and had sloppy, mushy bodies. They lacked definition and élan. That is the trouble with Northern Europe. People seem to prefer convenience over elegance, economy over elaboration and comfort over charm. In that sense, it is much more like America than the Latin countries of Europe. Missing is the rigor of Paris or Rome. Missing, too, is the allure.

“The Dutch present themselves as the most open-minded and tolerant people in the world,” said a cousin. “And in some sense, they are. But they are also very cold and closed off from the rest of the world. They all speak English, but unless you speak Dutch perfectly, you will never, ever be fully accepted or integrated into Dutch life.”

*** Gold went up yesterday…but so did bonds. One day does not a summer make, but gold and bonds usually go in opposite directions. Yet for the last few months they have been walking along, practically holding hands. What to make of it? Our guess is that the economy is still sinking into a Japan-style slump. When it ends…bonds will collapse. And gold will soar [Ed. Note: Resident gold expert, Paul van Eeden, explores the forces driving the gold market and explains how the dollar could still fall even if interest rates are rising. Accurate gold predictions will not be possible without an understanding of this dynamic…