Debt vs. Income: At the Point of No Return
Debt vs. Income: At the Point of No Return
Sat Feb 21 16:31:31 2004

(1) American Debt Bubble problem already past the Point of No Return
(2) Is Alan Greenspan Behind China's Bubble Too?
(3) SIGNS OF A HURRICANE, by Marc Faber
(4) Calvi murder linked to missing $70m
(5) Fourth-highest concentration of US debt at Caribbean banking centers

(1) American Debt Bubble problem already past the Point of No Return

Date: Mon, 16 Feb 2004 22:04:28 -0500 From: "David Chiang"

Debt vs. Income: At the Point of No Return February 16, 2004

Richard Benson February 12, 2004
Richard Benson is president of Specialty Finance Group, LLC , offering
diversified investment banking services.

At the beginning of 2003, the level of debt that Americans owed as an
absolute amount, and as a ratio of income, was already approaching
levels never seen before. Debt can be handled in a number of ways:

1) earn enough money to pay it off; 2) default; 3) borrow even more; or,
4) pray for inflation so you can earn more dollars (but really pay back

Where are we now?

Last year, personal income increased about 2%. Individual debt increased
about 10%. Personal debt for autos, credit cards, etc., topped $2
Trillion - up about $120 Billion despite massive debt consolidation and
mortgage refinancing. Mortgage debt rose about $800 Billion, and total
individual debt rose over $925 Billion, while wages and salaries rose
only $190 Billion. Retirees and savers saw their interest income shrink,
as interest paid on savings dropped by $30 Billion. Indeed, given the
Fed's low interest rate policies, it doesn't pay to save.

In December, the savings rate dropped to a new low of 1.5% and in the
3rd quarter of 2003, the only reason financial assets were acquired is
because they were bought with borrowed money. The low savings rate is
even more astounding when you consider the increase in Disposable
Personal Income of around $200 Billion from the tax cut. The economy
needs $500 Billion in government stimulus from tax cuts and increased
spending just to keep employment from falling and to help consumers roll
over their credit cards for another month.

The savings rate is actually materially overstated. Personal Income,
according to the Bureau of Economic Analysis, includes a few hundred
billion dollars in "imputed income" for owning your own home and
receiving value for other "non-cash services." Imputed income is
significantly greater than the 1.5% savings rate! Unfortunately, debt
can only be repaid with actual cash flow. In January, Personal Income
rose at about a 2% annual rate and very few jobs were created. Consumers
are spending every last penny to live, and many are "tapped out."

What is perfectly clear from simple arithmetic is that without a sudden
increase in the number of jobs and the wages they pay, individual debt
can not be serviced by personal income. Worse yet, not only are people
not saving, but their financial reserves are not in real cash. The only
thing keeping the "national ponzi scheme" going is the illusion of
wealth created by the Federal Reserve's low interest rates and liquidity
that has allowed stock market valuations and housing prices to
artificially inflate.

The market value of homes in 2003 rose about $1 Trillion and stock
market values rose about $1.5 Trillion. The rising asset prices look
like they balance rising debt on household balance sheets. Tragically,
the increase in asset prices will vanish the day that interest rates
rise, but the debts will still remain. Indeed, not only will the debt
remain, but the cost of servicing it will go up dramatically. As
interest rates rise, wages and salaries must increase or massive debt
defaults will follow.

Income and job growth are so low that we have certainly passed "The
Point of No Return." There cannot be an easy resolution to the debt
bubble and resolution will only come when a crisis forces change.
Perhaps, for this election year, crisis can be postponed by continuing
to facilitate an increase in borrowing so that debts can be rolled over,
but increased. By 2005, the ultimate outcome to resolve the debt problem
looks like it will be a combination of inflation, rising interest rates
and debt default.

The reason we do not believe that job and income growth will save the
day for the American worker is we have never before seen in history such
increases in government spending, tax cuts, federal budget deficits,
consumer spending and borrowing, with so little job growth. The massive
fiscal and monetary stimulus has mostly been spent. There will be some
nice tax refunds this spring, and that's it! The peak of mortgage
refinancing is already past. Construction spending is at a peak and the
percentage of people who own their homes is at a record 69%. Mortgage
underwriting shows that 5% of homebuyers in 2003 really couldn't afford
to buy a home, and another 5% could lose their home if one spouse
becomes unemployed.

While the industrial sector is recovering, employment in the
manufacturing sector has not increased since the start of the recession
- there has been job loss in manufacturing for the past 42 months in a
row. The United States has been in an economic recovery for over a year
and a half and continues to lose manufacturing jobs every month! This is

Capacity utilization in the US remains about 76%, while massive new
investments in production capacity are being made in Asia. The drop in
the dollar has primarily affected trade with Europe, and Europe isn't
stealing our jobs. As long as Asia buys our dollar debt and continues to
hold their currencies down against the dollar, job growth will happen
there, but not here. Even when China and the rest of Asia "finally
float" their currencies, few jobs will come back to America.

In the United States, we only produce 45% of the manufactured goods we
consume and much of that production is in electricity, petroleum
refining, chemicals etc., that are capital intensive, with few workers
required. Critically, many of the workers listed as employed in
manufacturing are not engaged in manufacturing at all but in design,
marketing, and distribution. Even if the Chinese currency doubled in
value, the labor cost for a worker in China would still only be a
fraction of the cost for an American in America. The sad fact remains
that Personal Income growth will not happen because of job growth.
Personal Income remains under pressure as higher "valued added"
manufacturing jobs are exchanged for lower paying part-time and service
jobs. America is losing manufacturing jobs paying $45,000 - $60,000 a
year so it needs three new service jobs paying $15,000 - $20,000 a year
just to replace the one manufacturing job that was lost.

So, where are Americans and their mountain of debt headed?

If the days of borrowing more - courtesy of both the Federal Reserve and
Asia's Central Banks - are winding down later this year when Asia
revalues its currency, it looks like there will only be two ways out:
increased inflation and debt default. Both are likely. When those
Chinese goods at Wal-Mart go up 30% in price, Americans will see
inflation. The Fed will accommodate most of the inflation, but there
will be a rise in interest rates. Inflation, if allowed and encouraged,
will save the wage earner so he can continue to service his consumer
debts. Rising interest rates will smash into housing prices like a
tornado in Kansas. Homeowners who have a 30-year fixed rate mortgage
will come out in the end, if they don't have to sell their home for at
least 10 years. Anyone who wants to sell their home will see some "asset
deflation," and financial institutions will experience substantial "debt
default." The Federal Reserve will "print money like crazy" to fight
asset deflation and encourage inflation. Sometime before or after the
Presidential election, the financial markets will be interesting, but
painful to many.

(2) Is Alan Greenspan Behind China's Bubble Too?

Date: Tue, 17 Feb 2004 17:28:44 +1000 From: "makichris"

Is Alan Greenspan Behind China's Bubble Too?

William Pesek Jr. Feb. 11 (Bloomberg) --

Globalization is globalizing the Federal Reserve.

It has 12 districts and acts based on U.S. events, but its influence has
never been greater. It isn't far-fetched to think of Latin America as
the 13th district, Southeast Asia the 14th, Russia the 15th, China the
16th, and so on.

Perhaps it's not surprising, then, that some observers are blaming the
Fed for problems in one of its de facto, satellite districts. China,
Asia's second-largest economy, is experiencing a dangerous asset bubble,
one that's making investors antsy.

It seems a reach to blame Fed Chairman Alan Greenspan and his colleagues
here in Washington. After all, Asia isn't a huge blip on the Fed's radar
screen these days. The Fed also has taken its share of flack for the
U.S. bubble of the late 1990s. But the U.S. central bank's global reach
is being felt in Asia.

``The Fed commitment to keeping interest rates low for a considerable
period of time fueled speculation in high-risk assets,'' says Andy Xie,
Hong Kong-based chief economist at Morgan Stanley Asia Ltd.

``The byproducts of this speculation,'' Xie explains, ``are the wealth
effect on consumption in the U.S. and the cheap capital-fueled
investment boom in China -- the twin engines or bubbles, depending on
your perspective, for the global economy today.''

The cycle, Xie says, will end with either the Fed reversing its policy
or with a financial accident caused by the leverage building up in
high-risk assets around the world. ``History would not be kind to the
Fed,'' Xie says. ``Its accommodation and even encouragement of
speculative excesses would be viewed as the primary cause of the massive
bubble in the global economy today, the consequences of which are yet to

The Fed's culpability is debatable. What's not is that speculative
capital flows into Asia reached a record high last year, surpassing the
previous peak in 1996.

The big recipients of capital in 1996 were Hong Kong, South Korea and
Southeast Asia. This time, it's China. Just like the capital flow
destinations of the 1990s, China is experiencing an investment bubble.

In 2003, East Asia's foreign-exchange reserves rose $234 billion more
than the region's trade surpluses. That compares with an average of $26
billion in the 1990s and $8.3 billion in the 1980s. China and Japan were
the main capital recipients in Asia last year.

The increase began in 2001, when the Fed cut interest rates aggressively
to boost U.S. growth. Like clockwork, China's foreign-exchange reserves
rose by more than its trade surplus for the first time since 1996. The
inflows picked up speed and reached record levels last year.

What can be done about all this? China needs to tighten capital controls
to slow the inflow, Xie argues.

Such a step would be anathema to free-market aficionados and to the
Group of Seven nations, which last weekend renewed its call for flexible
exchange rates. But the longer Beijing allows such rapid inflows of
speculative capital, the more difficult it will be to avoid a financial

Xie's views are contrarian, indeed, but it's hard to dismiss them. The
vast majority of world leaders, economists and investors think China's
currency is undervalued and that Beijing should let it rise. That was
certainly the thrust of the G-7's latest communique.

But ``the appreciation of China's currency, which many advocate as the
main means to cool the bubble, would only encourage more speculation, as
we saw in Southeast Asia,'' Xie says. ``The resulting bigger bubble
would make a hard landing inevitable.''

China may be presenting economists with a rare throw-away- the-textbooks
situation. Established macroeconomic models hold that more exchange-rate
flexibility will squeeze some air out of China's bubble and keep the
economy from overheating. Freeing the yuan may do exactly the opposite.

Beijing has taken steps to cool its economy. The central bank, for
example, increased reserve requirements on commercial banks to curb
money-supply growth. Higher interest rates in the U.S. could help temper
China's boom. Global investors are looking for hints on the subject when
Greenspan testifies in Congress this week.

``The massive swings in capital flows into Asia could only be explained
by the speculative drives that rise or ebb with some stimulus,'' Xie
says. ``The stimulus is usually Fed policy changes.''

It's doubtful Greenspan is preoccupied with all this. But those
speculating on China's rise should keep two things in mind. One, the
Fed's policy decisions here in Washington may have considerable
influence on China's outlook. Two, what markets think they know about
China's currency policy could be 100 percent wrong.

(3) SIGNS OF A HURRICANE, by Marc Faber

Date: Wed, 18 Feb 2004 23:04:18 -0500 From: "David Chiang"


The present "strong" recovery phase in the U.S. economy won't last for
long, as it is totally artificial. There are simply too many imbalances
in the system - as reflected by a record low national saving rate,
record household debts, and record trade and current account deficits -
for this recovery to lead to sustainable strong growth that would
justify the present stock valuations.

According to economic theorist Joseph Schumpeter, economic recoveries
that are purely a consequence of fiscal and monetary stimulus must
ultimately fail. Schumpeter writes: "Our analysis leads us to believe
that recovery is sound only if it does come from itself. For any revival
which is merely due to artificial stimulus leaves part of the work of
depression undone and adds, to an undigested remnant of maladjustments,
new maladjustments of its own."

My colleague Peter Bernstein correctly points out the complexity of the
issues involved: "Private sector saving, private sector investment,
household consumption, government spending, government revenues, capital
flows, and trade balance all react upon one another - often in
surprising fashion. We live in a complex system: each piece tends to
function as both symptom and cause." And while I cannot discuss here
Bernstein's entire analysis of economic data, which he himself admits is
"confusing," I would like to point out that he also is "certain" that
"current trends are not sustainable."

Bernstein writes: "The imbalances are now enormous, far more glaring
than at any point in the past. Furthermore, the linkage of the parts are
so tightly knit into the whole that reducing any one imbalance to zero,
or even compressing them all to a more manageable level, appears to be
impossible without a major upheaval. A hitch here or a tuck there has
little chance of success. When it hits, and whichever sector takes the
first blows, the restoration of balance will be a compelling force
roaring through the entire economy - globally in all likelihood. The
breeze will not be gentle. Hurricane may be the more appropriate

Part of the problem the United States is facing is the long-term decline
in the U.S. national saving rate (including household saving, corporate
cash flows, and the government's budget surplus or deficit). As a
percentage of GDP, there was an improvement in the national saving rate
between 1993 and 2000 due to higher taxes and a swing in the federal
budget toward surplus...but thereafter, the national saving rate
plunged. Over the same time period, real personal consumption
expenditures as a percentage of GDP declined modestly between 1988 and
1998, but soared between 2000 and 2003 to a record.

Now, in past recessionary periods (1973-74, 1981-82, and 1990), the
tendency has been for real personal consumption ex

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