International Precious Metals & Commodities Fair - Munich, Germany
Transcript of Dr. Kurt Richebächer's Lecture
November 19, 2005
Ladies and Gentlemen,
My first journey to the United States occurred in the year 1962. (By the way, I stayed in the Moritz Hotel at South Central Park and it only cost me ten dollars.) I had a recommendation from the German Central Bank to the US Secretary of Treasury, who asked me when I approached him, "Would you like us to meet together?" I said "Well ok, - yes please". Immediately, he called somebody and there came a very tall, young man and it turned out to be Paul Volcker.
Now, Paul Volcker had arranged my appointments with the other economists and from that time forward we kept in close contact. It was also through him that I was able to meet with leading economists. I had been in contact with leading economists in America for about 40 years, but that practically ended in the 80-ies. The discussion in the 90-ies became so crazy, that I stopped wanting to speak with any American economists. In particular, it was the time of the "new paradigm economy".
If I may, I would like to begin with a quote from Paul Volcker from his - Washington Post Letter, which appeared about two or three months ago. He wrote: "I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand now, it is more likely than not that it will be a financial crises rather than a policy foresight that will force the change."
I am looking at the world economy and I can identify three groups among the industrialized nations. The first group are the Asians, led by China, and a group with very high investment savings and investment ratios. China is the leading country of this group, and is running a big surplus with America while having a big deficit with other Asian countries. So far, China is the economic and financial leader of Asia.
What I am most interested in is the difference between the two other groups. The first group are the Anglo-Saxon countries; in particular, the United States and the other group are the European countries. During the past years, we have read a lot from the Anglo-Saxon community, boasting of their superior growth, efficiency and flexibility compared to the inflexible, stupid Europeans, i.e., Germany as an example.
I have a very strong disagreement with this statement. In fact, I would say the most inflexible countries in the world are the Anglo-Saxon countries. I wouldn't say the Europeans are very flexible, but they are certainly, in my opinion, more flexible than the Anglo-Saxons.
What exactly is the particularity of the Anglo-Saxons? Well, they all have asset bubbles. I mean economic growth in the Anglo-Saxon countries during the past years has been, without exception, fuelled by asset bubbles, notably, the housing bubble. Then the housing bubble translated into a credit bubble which in turn led to the bubble in mortgage refinancing and equity extraction. The striking symptoms of this economic growth are big deficits in foreign trade. All of the Anglo-Saxon countries, except for Canada, have huge trade deficits and collapsing savings. These countries are booming on the back of consumption and they are in a pure consumption boom.
It is the opposite of Europe. They have had higher growth than in Europe, but the quality of the growth in these countries is the worst ever. Actually, I will explain later more about the development in detail but I do want to make a remark about flexibility, at this time. The general explanation is that Europe is completely flexible. We are flexible and therefore we have higher growth and they have lower growth. But that premise has nothing to do with flexibility.
First of all, I would define flexibility of a country to be the ability of coping with imbalances in the sense of improving them. If you look at the Anglo-Saxon countries, you see no flexibility in the sense of adjustment. To the contrary, you see only imbalances ever growing and growing. I mean they are completely incapable of making the slightest adjustment. It is true of all of them and America is certainly among the worst because they even glorify this anomaly.
On the other side of the coin, we see Europe with its unique problem. That problem is high saving ratios. America and the Anglo-Saxons have collapsing savings ratios but Germany has an 11% savings ratio. France and Italy are likewise in the same category, i.e., very high saving ratios and these ratios have remained high despite the weakening economy.
What has actually happened is this: we have a sharp decline in investment in all of the industrialized countries but investment in Europe is higher than in the Anglo-Saxon countries. However, it is still low to the still very high level of savings. In this regard, I am astonished that the Europeans have never explained this. The European savings ratio is the main reason for their slow growth.
In the global economy, America, of course, has played the leading role. It has played the leading role because it's running a trade deficit that has increased since year 2000 from about USD 400 billion to an approaching USD 800 billion. Now, USD 800 billion is a large amount even for an economy like the United States. The main beneficiary of this American spending and consumption boom has been China. China with a surplus of about USD 180 billion - more than half of that is lost again to the other Asian countries.
But the key point to remember is that China with its fixed exchange rate runs an export surplus. The problem is now, or better put, the key question is what happens to the export surplus? You know, when you think of our own experience in Germany we used to have an export surplus. The export surplus in turn liquefied the banking system which in turn led to booming investments and those booming investments even add to an export surplus. This was the general development at that time.
I now see the same development in China and China is going to succeed in my opinion. China is turning the export surplus into a credit bubble. By buying dollars, they liquefy the banking system. Then the liquefied banking system expands credit and the expanding credit forms an investment and real estate bubble. This is the development in China now. But China has an enormous savings ratio and an enormous investment ratio. Moreover, China is really going the way Japan is going. What you see in China is very much a repetition of what has happened in Japan. Both countries have bought dollars, liquefied their banking systems which in turn have created a credit bubble that has fed into an investment and real estate bubble. My question therefore is: how long can this go well for China?
Okay, let's turn back to the United States. The United States has the worst credit bubble in history. It is simply unprecedented, unimaginable, as regards to what's been happening there. When Greenspan took over, total indebtedness of the United States was USD 10,000 billion. Today, total indebtedness is 37 trillion dollars and something. I mean indebtedness has more than tripled in the United States and the question is: where did all this money go?
It didn't go into the price indexes. The Americans only really look at the price index. A stable price index means financial stability and with regard to this stability, we have strong growth. Well, for me I check the numbers. Credit expansion is always a key component to look at in an economy. When you look at the credit expansion in America from the late 70-ies and over these past decades, America has had a credit expansion of 1.4 dollars credit for 1 dollar additional GDP. The relationship was 1.4 to 1. Recently, the relationship is 4 to 1. For every dollar added to GDP, there are now 4 dollars added to indebtedness. This is the worst performance in terms of credit expansion in history and of course in comparison to any other country.
The question is: how is this possible? Well, one problem is that you have to question where does this credit go to? In the past and until the late 70-ies, I said there was 1.4 dollars additional debt for 1 dollar additional GDP. At that time, credit expansion borrowing went completely into spending by firms or consumers. Consumers and firms borrowed practically for one single reason and that was to spend money in the real economy. This changed in the 80-ies. There were two developments that ensued. Firstly, more and more borrowing went into financial markets. This led to the first beginnings of a stock market bubble. This all developed gradually but the connection between credit and income creation and spending loosened, thus, it became interrupted.
There was a gradual development in the sense that more and more credit expansion went into other channels, into other outlets, than GDP. And this turned wild in 1998. You remember in 1998, there was the Asian crisis, the Russian crisis and the LTCM crisis and that was a period when the Federal Reserve intervened to save LTCM. Also, since 1998 there has been an explosion of financial credit. In other words, more and more credit went into the buying of assets which drove up asset prices and in particular the stock market.
Secondly, another development/outlet was the trade deficit. The trade deficit means a contraction of domestic income. What happened in particular is that consumer spending no longer went to domestic producers where it creates income. Instead, it's going to foreign producers and is creating income for Asia. The end result means a complete loss of income. A trade deficit means dollar for dollar an equal loss of spending and income for the country with the deficit. America is now loosing every year about USD 800 billion to foreign producers and of course that has an undesirable effect.
The usual argumentation in America goes something like this: "Oh, the trade deficit plays no role. We even have higher growth than the Europeans with a trade deficit, so therefore it can't be a problem." There is not even a brush of an analysis regarding how a trade deficit affects their economy. In essence, what happens is that America has had a big drain in its big income and spending stream, hence, a trade deficit that would drive the economy into recession if not depression. However, in order to prevent the weakening of the economy, it needs easy money. The trade deficit forces the Federal Reserve to create alternative credit allowing for alternative spending that creates income, and, by the way, this has happened all the time.
So the fact is this alternative credit creation must go on. That means, ultimately, a deficit country needs easy money. Let's say it like this: a deficit arises from easy money and then the Federal Reserve reacts/responds by printing easy money in the effort to compensate for the income losses. So, the result of course is, that the trade deficit has been growing and growing and has needed more and more credit to compensate for the losses.
So, at the moment the key question is: how weak or strong is the American economy? I am thinking of the press releases regarding the various rate hikes. In these press releases, the FED explains how it sees the economic situation. It says we have temporary weakening influences, i.e., hurricanes and rising oil prices which are only temporary influences. On the other hand, we still have an accommodative monetary policy and robust productivity growth and when we think of the rebuilding of the devastated areas, the economy will be stronger. And that is obviously the general expectation in America: the economy is strong and it can only become stronger, because of the building in the devastated areas.
Well, I have made my own calculations. What is my opinion? For the time being the last number that interested me very much was the retail trade numbers which were published on Tuesday. It indicated - 0.1. At the same time they announced a 4.3 % inflation rate. If you take that together you have a declining number in retail sales in real terms of about 0.5 %. But the market took it positive by saying, "We expected - 0.7 and instead we have - 0.1 which means the economy is better than expected." You know, this is a trick which they use all the time. Bad news is buried by saying, "better than expected." You can turn the worst news into the way of the best news.
I did my own calculation and was curious of what's happening because automobile sales have collapsed. The collapse began in August. July was very strong, but it fell steeply in August and it fell further in September and still further in October. And I made my calculation and it says that consumer spending fell in these three months to October by an annual rate of 7 %. The fact is that the BEA - (Bureau of Economic Analysis) publishes every month very detailed figures about consumer spending and I use these monthly figures which are different. The quarterly figures are averages where you compare average to average. However, I find it more important to look month to month and according to these numbers, consumer spending has been in a deep slump during these three months.
My question at the moment is: will this slump in consumer spending continue or not? Let me make some remarks about the whole recovery. This recovery has been praised as a great success or a successful policy. The fact is it's the weakest recovery of all times in the United States. It is by far the weakest in every single aggregate. However, it differs according to various aggregates and I shall explain from where it comes. This impression of a successful policy and a successful recovery is created by comparing it with Germany, Europe and Japan. They say: "Look there, they are weak when we are strong."
The fact is, like I said, it's the weakest recovery of all times in the United States. When you draw this comparison you have to take into consideration that America has had the biggest fiscal and monetary stimulus of all times. The tax reductions were USD 860 billion from 2001 to 2003 - the biggest tax cuts of all time. In addition, you had the rate cuts leading to the 1 % interest rate of several years. With this entire stimulus they still had the weakest recovery of all times. No, when you compare all the different components, you see that there was a catastrophe in two areas. The first one was in unemployment and the second one was in investment. The fact is they were not satisfied with the recovery until 2003 and they decided that they had to do more.
End of Part I
(The Transcript was done Richard H. Mayr - Argentuminvest.de and the final revision by our friend Jim Messenger)
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