Part II

Well, as the facts turned out, they succeeded in bringing the 10 year long-term yield rate down to 3.1 %. That was the lowest yield in the whole period and it was achieved by encouraging yield curve playing. As a result, they had developed a whole composite bubble system. The first was the credit bubble. The second was the mortgage refinancing bubble which later led to the third bubble, i.e., the consumption bubble. Since then, all economic growth has been consumption led. One has to realize that this was an unusual development and it was all based on bubbles. The bond bubble emerged which ignited the carry trade bubble which later spawned the housing bubble. As you can see, one bubble is dependent on the other one and they all work in tandem with each other.

The question now is: "How does this continue to work further?" Making these comparisons with the past, one has to take into consideration, that American economists in the past years have undertaken great changes in the measurement of aggregates. These changes have taken place in those aggregates which have the most political expediency. For example, they changed the inflation rate. Then, a commission structure came along which invented all kinds of changes. The main proposals were: "We must channel product quality improvements into price reduction." That has already existed a long time for computers, but now they have extended it over the whole economic system. Price reductions were mainstay and another thing was the substitution effect.

With very expensive needs-and-wants, the Americans switched to cheaper things. They changed the whole pattern of items in the index. They made it flexible. Conservative estimates put these changes in the measurement of inflation at 1.5 % while others put it at 3 %. Jim Willie quoted somebody who spoke of the 3 % figure as the more accurate one. Well, whatever the exact rate really is, when you deduct that from the growth rates, there is nothing left. When you have 3 % growth while having a measurement change of 2 to 3 % that means there was no growth. Did you catch this point? I mean there is no growth. I shall explain that a little later.

The other thing of interest was that they changed the measurement of unemployment. Clinton, before his second election, wanted lower numbers for unemployment. In that regard, they drafted another question for calculating employment figures. Did you know for instance that they measure unemployment by asking 50.000 people every month about: "Have you lost your job?" "Are you unemployed?" And so on. Now, interestingly enough, they have added another question to the tableau which asks: "Have you been active in looking for a job?" Translation: "Have you written a letter for a new job - or have you been to a company asking for a new job?" And if the person says "Yes", guess what …, he is no longer unemployed. The sad fact of course is that there are many people who have been unemployed for so long, that they have just plain given up. Translation: By giving up, they are no longer unemployed. The Federal Reserve in Boston has made calculations and has published them. These so-called 'discouraged workers' count for more than 5 million people. If you count these folks in, the real American unemployment rate is at about 8 % to 9 % rather than the touted rate of 5 %.

Another point of interest has to do with employed people. The fact is, in a normal past recovery it took 21 months for total employment to recover from a recession. In the jobless recovery of the early 90-ies, it took 31 months, which, incidentally, shocked people because it took so long. This time, it has taken 46 months. In other words, the average of past economic down cycles, employment within the private sector grew by 8.6 % but this time it has only grown by 0.8 %. The growth of employment measured by the labour department is 1/10 of the average for past recessions. However, when you read these numbers, you have to be aware that they have a special method to calculate for employment. Government statisticians say: "When you have a recovery, you have a lot of employment statistics that go uncaptured by our inquiries." By the way they have a formula for this: namely, recovery equals 900,000 employed people per year.

So, they call it the net worth ratio. It's all been explained before in detail and is no secret. This recent recovery has seen 2 million people get jobs through this statistical model. If you take that away, employment is really lower than it was in the recession. The result is that you have minimal employment growth with minimal wage growth. Basically, one can say that for the American working population, there had never been a recovery and if you take the inflation rate into account, the incomes of the working population have been falling, year by year. So then, for these people, there had never been a recovery and I would say there had never been a recovery, all around.

So now, how do we account for these differences? The cheating methods that determine employment numbers are not the most reprehensible. You get tremendous inconsistencies for sure, i.e., GDP shows big growth while employment shows zero growth. To reiterate, how does this come about? Well, the fact is, you have the biggest cheating activity going on to determine the numbers for GDP and so, in consequence, the understatement of the inflation rate. It makes all the difference, whether you say, the inflation rate is 1 % or 2 % or 3 %. That explains everything.

In the case for employment, these tricks are also evident, but they don't play the same role. I personally would say the key for measuring economic performance is the income of people. The question is: "Why is that?" First of all, it's the weakest of all recoveries measured by various aggregates, but, depending on which aggregate you take, it was a disaster or mildly put: worse than in the past.

The other point is the pattern of growth was totally different from the past. In the past, recessions came from monetary tightening responding to inflation rates which reduced investment spending on housing. But that also created the pent-up in demand. This time, there was an easing without any tightening, so, I mean there was never any restraint in demand. What happened was, the investment collapsed for some reasons which have nothing to do with monetary tightening. The credit expansion was running at full steam in 2000, but investment suddenly collapsed faster than ever. So, I mean to say the unusual weakness in investment was the beginning. At the same time, however, the drastic monetary easing led to higher spending on Housing and Eurobonds. So there was never any pent- up demand issues to have countervailing force. The fact now is that business investment has never quite recovered. Business investment today is barely at the level of 2000. On the other hand, Housing and Eurobonds are up by 35 %. Consumption has taken an ever growing larger share of GDP. Measured again, GDP growth reached 81 % compared to the long term number of 67 %.

So that was the development in summary. But, this still begs the question: "Why does the poor employment growth still exist? I mean, measured by past employment performance, the recent round was a catastrophe. America needs every year more than a million new jobs because it has rising labour force. The general explanation is that productivity growth is a reason for the poor development of employment. That sounds plausible. But, if you look into the structural changes of the American economy, it is hard to understand, why there has been such spectacular productivity growth while, alternately, capital formation has collapsed. If you look at the details, the key looser in the economy is the manufacturing sector. The manufacturing sector has lost 3 million jobs out of 70 million since year 2000. The manufacturing sector is also the sector with the highest capital investment. Capital investment in this business sector has completely ceased; there is nothing left.

On the one hand, you have the shrinkage of the manufacturing sector and on the other hand you have the expansion of other sectors. The biggest job creator in the United States has been housing and associated things like Asians - you know: "real estate Asians". About 40 % of the poor job creation was associated with the housing bubble. You have an economy where the manufacturing sector shrinks rapidly; it has never ceased to shrink. Every month, the manufacturing sector continues to loose jobs, while on the other side, you have increases in jobs, as I said, in real estate and in services like health services and so on. These are all low paying jobs. Not all, but most of them are low paying jobs, compared to the high paying jobs in the manufacturing sector.

That still leaves the question: "Why is the net result in employment so terrible?" I would say, the reason is that the GDP numbers are fake. They are inflated by the understated inflation rate. I would say, you have to adjust the GDP numbers to the employment number and then you realize that there really was no economic recovery in the United States. The GDP numbers give a completely wrong picture of the true growth that has and is happening in the US economy.

No, the question now is: "what's next?" I told you, the thing to watch is consumer spending. "What is happening there?" That's the important question. But the Federal Reserve says: "Our monetary policy is still accommodative, it is still easy." If you look at the inflation rate compared to the federal funds rate and compared to the interest rate, monetary policy is indeed very easy. Real interest rates are close to zero. But the noteworthy thing is from this point on the economy should continue to grow and obviously, that is the assumption of the Federal Reserve.

But there is yet another problem and that relates to the asset and carry trade bubble. During those years, Greenspan (when you look over his 18 years) has twice used a carry trade bubble; a positive yield curve for his policy. He had a tremendously positive yield curve in the first half of the 90-ies and he lowered interest rates from 10 % to 3 % in connection with the recession of 1991. But the economy boomed in 1994 and he decided to raise rates. He raised them, but to the general astonishment of all, long term interest rates shot up in lock-step with short term rates. In the end, he had raised his short term rate by 3 percentage points and the long term rate by doing the same job. Today, it is exactly the opposite.

I think, the people at that time still took Greenspan, seriously. They saw his tightening and they liquidated their carry trade in bonds which had lowered the interest rates. But this time around, they have refused to do so. They no longer take him seriously. The long term rate is 4.5 % and that is even a little lower than when the short term rate was at 1 %. But the problem is that the yield curve is the most important monetary aggregate because the United States is a country without savings. A country without savings must have financial markets which depend on nothing but carry trades. The total US financial system is built on nothing but carry trades which is part of the huge credit explosion that has taken place.

The problem now is Greenspan obviously wanted a certain rise in the long term rates. He wanted a rise perhaps to 5 % in the hope that this would gradually slow consumer spending and the housing bubble. But the market didn't do that. The market kept the long term rate at 4.5 % and now, any further rise is not virtually flat. Any further rise means that the yield curve becomes inverted. And that is the worst thing that can happen to the US economy because it would force the yield curve players and the carry trade players to sell their bonds. In my opinion, the weakness of the Euro and the Yen has to do with the fact that these players have switched in some part to Euro and Yen to finance their carry trade. However, in the long run, it becomes difficult. For me personally, it's a mystery that these people continue to sit on their large carry trades, waiting and waiting.

In my opinion, the problem is that the FED considers the economy to be very strong. I say, they are the victims of their own propaganda. That is one point. The other point is even the understated inflation rate of more than 4 % forces them to raise the interest rate. They cannot allow short term rates to fall below the inflation rate. They are forced to raise the rates. But the question now is: "What will they do?" They have said that when the economy is weak they have to reduce interest rates. I had my doubts that a reduction in interest rates have the same effect as they had in the past.

It was a very complicated bubble system that they developed with their short term rates and propaganda to get some growth. It is impossible to re-establish this system. They may reduce their interest rates but the Federal Reserve is sure that when there is trouble they can lower the interest rates and everything will be "ok" again, because there is a blind faith in the ability of monetary policy to steer the economy. This blind faith also exists among the carry trade players. They think: "Greenspan will come into action again and then we'll continue, as always." It's really a mystery! I would say that a weakening would unleash forces that would lead to cracks in the whole system. I would expect a USD crash. The USD is also a component of the carry trade bubble. When this carry trade bubble collapses I wouldn't assume that they would reduce interest rates and everything would be fine again. I can't and won't believe this. No, I would say that there will be a change in perception. We have at the moment a perception that the US economy is in splendid shape. Interest rates make nothing and yet consider the bullishness in the stock market. I think the American economy is at its most critical situation point in the whole of the post-war period because all of the excesses have accumulated. There has never been a pause in this and the savings rates are in negative territory.

By the way, one word which is also unknown is "Incomes". The Americans have a word for this and it is called "Imputed Incomes". The statistics say that consumers and firms get a number of things for which they don't pay for which should count as income. For example, look at the homeowner in the United States. The statistics say: "He has a house, he doesn't pay for it (mortgaged property) so we attribute to him a rent." You have about USD 600 to USD 700 billion which is called 'imputed rent'. The FED publishes this in complete detail; itemising the specifics. They say: "This is imputed income which we calculate, because the consumer gets something for which he doesn't pay." He gets, for example, an imputed income because he doesn't pay for payment service. The banks in America don't charge payments. So, the statistics say, that is a gift of the bank for the consumer and they count this as income. Crazy? You bet!

By the way, for this statistic they calculate the savings rate without imputed income and that is - USD 500 billion. The fact is they detail everything but there is nobody who reads this; that is the point. In America, there is zero discussion about all of these imbalances. Why not? Well, the American is not trained to think about these things. In America basically, theory is non-existent. The Americans say: "We don't need theory, we have statistics." Now that has a history. The leading economist of America is a man named Wesley Mitchell. He was born in 1874 and lived until 1948. He said: "We know too little in order to develop a theory. All we can do is we must develop statistics. We must have as many statistics as possible and then we can judge what is happening."

The Americans have more statistics than anybody else and in particular they like to ask people. This is the substitute for theory. Hayek in 1927, when he made his first visit to America, he noticed this. He has written about it. He talked with Mitchell and he said: "They refuse to do any perceptional thinking. They only believe in statistics. He also said: "How can you obtain statistics if you don't have a theory that gives you the ability to distinguish between important and unimportant numbers?" That's why Americans are unable to distinguish between important and unimportant numbers. I personally think, that all those surveys are total nonsense because, in my opinion, what do those people give you? Asking 5.000 consumers is no substitute for doing your homework by analysis. I mean, what do these people say? They tell you what they read in the newspaper which frankly, is worthless. Undergirding this is the belief that expectations are the key determinant for spending. If everybody tells you that he is optimistic, that means we get a rising economy.

Further to this argument is they don't know what is important with consumer spending and investment spending. For Americans, consumer spending is the key to everything because it is the biggest component in GDP. On top of that they say: "Businesses invest only when they see consumer spending." That's even what leading economists - whom I appreciate - think. Stephen Roach writes about investment spending and derived demand. I mean, the consumer can only spend what businesses have given to him. The whole thing is so absolutely ridiculous because the consumer can only spend his income that business has already spent.

The beginning of recovery and economic growth is where there are businessmen who spend and where there are consumers who receive the money. But even these simple things are not understandable to the American economists. Basically, I would say that economic theory and macro-economic knowledge are completely absent. To make matters worse, is that the economic discussion in the United States today is dominated by Wall Street Economists. They know nothing about macro-economics because they are trained to look at a single economy as a micro-economy. With this view, mergers and acquisitions are the best substitute for investment, but that of course is micro-economics; it destroys the macro-economics. I would also say that Wall Street economists are corrupt; corrupt in the sense they are not allowed to say critical things. I know that some of the macro-economists write about this but it is very subdued. One economist even wrote that production is much weaker than GDP. They noticed that but they would never say what this statistic is for.

Thank you very much for your time and attention.

End of Part II

(The Transcript was done Richard H. Mayr - Argentuminvest.de and the final revision by our friend Jim Messenger)