- Excerpt

EMPIRE OF DEBT:
The Rise of an Epic Financial Crisis

by Bill Bonner and Addison Wiggin

INTRODUCTION

Bill Bonner and Addison Wiggin are the team behind the enormously popular contrarian financial newsletter, The Daily Reckoning. In Empire of Debt, Bonner and Wiggin deliver a lively, entertaining and critical look at our debt-powered economy. They predict a dramatic economic crisis for the U.S. when the country's over-stimulated economy gets the hangover from so much debt-fueled consumption.

In Empire of Debt, Bonner and Wiggin weave current events and history into a highly readable account of exactly why our economy runs the way it does -- and the dangers of running it into the ground. In their eyes, our precarious economic state is driven by a complex but fragile system that connects trade deficits to the speculative real estate market. The best way to prepare for the inevitable crash? Learn where real values can be found.

The excerpt, below, administers an upbraiding to both liberals and conservatives for their ridiculous overstatements of U.S. economic prowess. "Every business day puts America $2 billion further beholden to its mostly- Asian creditors," say Bonner & Wiggins. This excerpt is a classic reckoning.

An Absurd Balance

by Bill Bonner and Addison Wiggin

Let us take a moment to stand back and gaze at America's great Empire of Debt. It is the largest edifice of debt ever put up. It sustains the most magnificent world economy ever assembled. It supports more people in better style than any system ever before devised.

Not only is it comparably effective, it is also immeasurably entertaining. For it has its burnished helmets and flying banners; its intellectuals and its gladiators; its Caesars, Antonys, Neros, and Caligulas. It has its temples, its forum, its Capitol, its senators; its praetorian guards; its via Appia; its proconsuls, centurions, and legions all over the world as well as its bread and its circuses in the homeland, and its costly wars in periphery areas.

The Roman Empire rested on a classical model of imperial finance. Beneath a complex and nuanced pyramid of relationships was a foundation of tribute formed with the hard rock of brute force. America's Empire of Debt, on the other hand, stands not as a solid pyramid of trust, authority, and power relationships but as a rickety slum of delusion, fraud, and misapprehension.

"My tax guy has been bugging me... You know, real estate is where it is at." In June 2005, NBC quoted a young woman who had bought a second home at a Colorado resort. According to the report, more than a third of the houses sold in the previous 12 months were not primary residences, but second homes or investments.

Down at the bottom of the pyramid are petty agents spreading deceit and misinformation -- such as the aforementioned "tax guy." You would think a young woman could trust her certified tax advisor to give her sound counsel. Instead, he urges her to speculate on the most bubbly property market in American history. Naturally, she went for it, aided no doubt by a whole industry of professional dissemblers. Press reports tell us that appraisers routinely stretch valuations to help close a deal. Mortgage lenders know perfectly well the appraisals are lies, but they wink at them with one eye while winking at the borrowers phony income declaration with the other. Again, according to the press reports, lenders no longer verify income claims. They have gone blind!

In California, house prices have raced so far ahead of incomes that barely one in ten buyers can afford the median house. Yet thanks to "creative finance," more houses are being sold than ever before.

Thus the foundation of the debt pyramid is laid down in a bed of mutual deceit and cupidity, and covered with another level of fabrications. Lenders do not stick around to see how the loans work out. Instead, they pretend the credits are good, and package the mortgages into convenient units so that investors can buy them. The financiers know damned well that many buyers can't really afford to pay for the houses they buy, but they see no point in mentioning it. Nor do the investors want to know. They're in on the scam, too. The smartest of them even have figured out how it works: The Fed holds down short-term rates below the inflation rate so that investors in long-term mortgage financing and buyers of U.S. Treasury obligations can make an easy profit.

Further up the steps of imperial debt are whole legions of analysts, economists, and full-time obfuscators whose role is to make us all believe six impossible things before breakfast and a dozen more before dinner. Economists at the Bureau of Labor Statistics do to numbers what guards at Guantanamo did to prisoners. They rough them up so badly, they are ready to say anything. In June 2005, it was reported that productivity was increasing at 2.9 percent rate -- the fastest pace in nine months. Productivity is supposed to measure output per unit of time. But the yardstick was bent by the government's statistical brownshirts, who said that if a computer this year can process information 10 times as fast as one produced last year, the worker who assembled it has multiplied his output 1,000 percent. This abuse of statistics is what allows Americans to deceive themselves about their economy. It is healthy, they say. It is growing. It is stable.

Economists, commentators, and policymakers take up these distortions and add their own twists. It is obvious to anyone who bothers to think about it that an economy that spends more than it earns is in decline. But they to find an economist will to say so! They've all become like rich notables in the time of Trajan, doing the emperor's work whether they are on his payroll or not. They will tell you the economy is expanding, but it is an expansion similar to what happens when a compulsive eater escapes from a fat farm. The longer he is on the loose, the worse off he becomes. It is an expansion of consumption, not wealth- producing, job-creating investment.

On the issue of the trade deficit, they will say what the senators and consuls want to hear, as David H. Levey and Stuart S. Brown did in the March/April 2005 issue of Foreign Affairs magazine: "The United States' current account deficit and foreign debt are not dire threats to its global position, as would-be Cassandras warn. U.S. power is firmly grounded on economic superiority and financial stability that will not end soon." In fact, the story of international trade, circa 2005, is the most preposterous tale economists have ever heard. One nation buys things that it cannot afford and doesn't need with money it doesn't have. Another sells on credit to people who already cannot pay and then builds more factories to increase output.

Every level colludes with every other level to keep the flimflam going. On the banks of the Potomac, people of all classes, rank, and station are pleased to believe that all is well. And there, at the Federal Reserve headquarters, is another caste of loyal liars. Alan Greenspan and his fellow connivers not only urge citizens to mortgage their houses, buy SUVs, and commit other acts of wanton recklessness, they also control the nation's money and make sure that it plays along with the fraud.

From the center to the furthest garrisons on the periphery, from the lowest rank to the highest -- everyone, everywhere willingly, happily, and proudly participates in one of the greatest deceits of all time. At the bottom of the empire are wage slaves squandering borrowed money on imported doodads. The plebes gamble on adjustable rate mortgages (ARMs). The patricians gamble on hedge funds that speculate on huge swaths of mortgage debt. Near the top are Fed economists urging them to do it! And at the very pinnacle is a chief executive, modeled after whom... Augustus or Commodus?... who cuts taxes while increasing spending on bread, circuses, and peripheral wars.

The spectacle is breathtaking. And endlessly entertaining. We are humbled by the majesty of it. Everywhere we look, we see an exquisite but precarious balance between things that are equally and oppositely absurd.

On the one side of the globe -- in the Anglo-Saxon countries in general, but the United States in particular - - are the consumers. On the other side -- principally in Asia -- are the producers. One side makes, the other takes. One saves, the other borrows. One produces, the other consumes.

This is not the way it was meant to be. When America first stooped to Empire, she was a rising, robust, energetic, innovative young economy. And for the first six decades of her imperium -- roughly from 1913 until 1977 -- she profited from her competitive position. Every country to which she was able to extend her pax dollarum became a customer. Her businesses made a profit.

But gradually, her commercial advantage faded and her industries aged. The very process of spreading the soft warmth of her protection over the earth seemed to make it more fertile. Tough, weedy competitors sprouted all over the periphery of the empire -- first in Europe, then in Japan, and later, throughout Asia, even areas she had never been able to dominate.

By the early twenty-first century, the costs of maintaining her role as the world's only superpower, and its only imperial power, had risen in excess of 5 percent of her GDP, or $558 billion per year. Not only had she never figured out a good way to charge for providing the world with order, now order was working against her. The periphery economies grew faster. They had new and better industries. They had higher savings levels and much lower labor rates. They had few of the costs of bread or circuses and none of the costs of policing the empire. They were freer, lighter, faster. Every day, the competitors took more of America's businesses, assets, and money. If the empire were an operating business, accountants would say it was losing money.

The empire no longer pays because the entire Western world -- including Japan -- has lost its competitive edge. Globalization of the pax dollarum served the United States well after World War II. America was the world's leading exporter. But Europe also thrived in the 30 years after the war -- les tente glorieuses, as the French call them. Then, in the 1980s, the Japanese took over as the leading economy of the advanced world.

And now, the pax wrought by the American empire works against America. Asian factories are newer and more modern. Asian factories are newer and more modern. Asian workers are younger and cheaper. Now, every business day that passes, the Asians grab a little more of the U.S. market. And every business day puts Americans $2 billion further beholden to its mostly-Asian creditors.

"GM plans to cut 25,000 jobs in the U.S." The headline appeared on the front page of the International Herald Tribune in mid-June 2005. Elsewhere in the paper was a status report explaining that China's Chery Automobiles plans to begin exporting the first of 250,000 Chery Crossovers to the United States in 2007. For every job lost by America's preeminent industrial company, China was planning to export 10 new cars.

It was not just manufacturing that was moving to periphery states. The advent of high-speed, inexpensive communications, along with cheap computing power, has allowed Asians to compete in service sectors as well. Anything that can be digitized can be globalized -- architecture, law, accounting, administration, data processing of all sorts, call centers, record keeping, marketing, publishing, finance, and so forth.

What is left for the developed economies? What could they do? Here is where European and Anglo-Saxon economies part company. The Europeans emphasize high value-added products such as luxury goods and precision tools. They cling rigidly to the wisdom of the old economists, refusing to expand consumer credit and refusing to use massive doses of fiscal stimuli to increase overall demand. House prices rise sharply in Paris, Madrid, and Rome. But there have been few signs of speculation. Houses are not refinanced readily. They are not "flipped." There is little creative finance. Nor has there been a big run-up in consumer debt, or a big run-down in savings rates. Credit cards are still comparatively rare. Unemployment is high, for Europe's policy managers have tolerated neither marginal credits. Europe is rigid and dull, economically, but relatively solid, with a positive balance of trade.

The Anglo-Saxon countries took a different route. During a time when the Bank of England has regularly moved interest rates up and down to deal with changes in economic conditions, the ECB sat on its hands.

The general consensus was that Europe would be better off if it acted a bit more like the Anglo-Saxons, by manipulating interest rates to encourage consumer debt. American economists imagined themselves carefully analyzing the data and coming to a logical conclusion. What they did not realize was that their numbers, conclusions and views of the world had become nothing more than stones in the immense pyramid of consuetude fraudium of the advanced empire.

The numbers were frauds. If you were to look at the percentages fairly, the European economy actually looked no worse than its Anglo-Saxon competitor -- with a similar rate of growth, higher unemployment, but better productivity and less debt.

As the Anglo-Saxon economies lost their competitive edge in manufacturing, they tried to make up for it by encouraging consumption. This is the biggest fraud of all. At first, higher consumption feels good. It is like burning the furniture to keep warm; it feels good for a moment. But the sense of well-being is extremely short-lived. When people borrow and spend, they feel as though they are getting richer -- especially when their houses are rising in price. The increased consumption even shows up, indirectly, in the GDP figures as growth. But you don't really become wealthier by making things you can sell to others -- at a profit. The point is obvious but, at this stage of imperial finance, it was inconvenient.

The homeland's losses -- measured by a negative balance of trade -- began in the mid-1970s. Less than 30 years later, both government and consumers were running up debts at an alarming rate. What else could they do? The only way Americans could continue their imperial role -- which meant more to them than ever, since it was now the only source of national pride left to them -- was to borrow.

The global economic system in the pax dollarium era was perfectly balanced. For every credit in Asia, there was an equal and opposite debit in the United States. And for every dollar's worth of demand from the United States, there was a dollar's worth of supply already waiting in a container in Hong Kong.

But while the imperial finance system was flawless, its perfections were devastating.

For the moment, in mid-2005, Americans salute their imperial standards. They gratefully paste the flag to their car windows, their jackets, their hats, their beer mugs, their shirts, and even their underwear (never once in Europe have we seen anyone with a national flag anywhere except at a parade or a public building). Americans are proud of their empire -- and should be. Without it, they could never have gotten so far in debt. What central banker would fill his vault with Argentine pesos or Zimbabwe dollars? What drug dealer or arms seller would want Polish zlotys in payment? What insurance company would want to buy Bolivian or Kyrgzstan bonds to cover its long-dated liabilities? The dollar has not been convertible into gold for 34 years. Yet, people still take it as though it were as good as the yellow metal -- only better. Ultimately, lending money to a foreign government is a bet that the government will put the squeeze on its own citizens to make sure you get paid. The United States doesn't even have to squeeze. When one foreign loan comes due, other foreigners practically line up to refinance it; it is as if they were drinks to a street bum, just to gawk and wonder when he might pass out.