APRIL2005BANKNOTES R.

NelsonNash,Editor

InfiniteBankingConceptswillbeconductingtheTenHourSeminarandThink TanksessionintheFallofthisyear.Thedatewillbeannouncedlaterandwill bepostedonthewebsiteontheSEMINARSbutton.Weareconsideringthe locationonthewebsitewww.rossbridgeresort.com .Thiswillbecontingenton enrollingenoughparticipantswhowanttocombinebusinesswithsomepleasure. Theresortisadjacenttoafabulousgolfcourse,apartoftheRobertTrentJones GolfTrail. Ifyouareinterestedinthispossibility,pleasecontactusassoonaspossibleso thatadequateplanscanbemade.
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Experiencehathshewn,thatevenunderthebestforms[ofgovernment]those entrustedwithpowerhave,intime,andbyslowoperations,perverteditinto tyranny. ThomasJefferson Jeffersonsobservationisstillineffect,ofcourse!Inviewofthisfact tellme something whywouldanyoneevertrustthosefolkswiththeirfinancialfuture(401K plans,pensionplans,IRAs,etal)? Whengovernmentcausesaproblem(oneroustaxation)andthenturnsaroundandgrants youanexceptiontotheproblemtheycreated(pensionplans,healthplans,etal) arent youjustalittlebitsuspiciousthatyouarebeingmanipulated? Ifgovernmentreallywantedtohelpyouout whydonttheyjustreducetaxes?Do youreally thinktheywilleverdothat? R.NelsonNash _______________________________________________________________________

ToSavetheDollar,SaveaDollar
byGaryNorth
byGaryNorth

"Apennysavedisapennyearned."~BenjaminFranklin "Apennysavedis1.39centsearnedifyoureinthetopU.S.taxbracket." ~GaryNorth MostAmericansappeartobemiddleclasspeople.Inthebellshapedcurveoflife,thisis asitshouldbe.Thatswhatmakesthecurvebellshaped.

Therewasadaywhentobemiddleclassmeanttobethrifty.Thisisnolongertrue. Therearebasichabitsthatprebabyboomersacquired.Theyarehabitsassociatedwith the1950s:mygeneration.Somebabyboomersacquiredthem,too,butsomeonebornin 1946reachedage19intheeraofthecounterculture.Formillionsofthesepeople,the habitsofyouthwerescrapedaway,likeafryingpansgreaseinasandstorm. Grandchildrentendtorepeattheerrorsoftheirgrandparentsbecausetheyrebelagainst theerrorsoftheirparents.Thegenerationbornin196570tendsnottowearlonghair. Platformshoesareout.Afrohaircutsareout.Butthechildrenborntothebabyboomers arenotechoesofmygeneration.ToomuchofthefryingpansTeflonsurfacegotscraped awayinthesandstorm.Badhabitsnowstick. Americansaretodayintheprocessofmovingfromthemiddleclasstothelowerclass. Here,IusethebrilliantinsightofHarvardspoliticalscientist,EdwardBanfield.Inhis 1970book, TheUnheavenlyCity,hearguedthatclasspositionistiedmoretoapersons assessmentofthefuturethantothesizeofhisbankaccount.Afutureorientedpersonis upperclass,heargued.Apresentorientedpersonislowerclass. Nothingbetterrevealstheclasspositionofapersonorasocietythanthecommitmentto thrift. THRIFTANDECONOMICGROWTH Thriftisaproductoffutureorientation.Peopleforegospendingtodayinordertoachieve evengreaterspendingtomorrow.Itisthisattitudethatcharacterizesupperclassculture: "Spendyourdividends,neveryourprincipal."Toalesserextent,itcharacterizedthe middleclassofthepreBeatlesera.Butforthemiddleclass,thestakesarehigherandthe requireddisciplinegreater.Unliketherich,whohaveamassedsufficientcapitaltobe abletoavoidenteringthejobmarket,themiddleclassmustamasscapitaloutoftheir wages.Theymustlearntoavoidspending100%ofthefruitsoftheirlabor.Thistakes educationandselfdiscipline.Itdoesnotcomenaturally. Habitsofonegenerationmaynotpersevereinthenext.Thisisespeciallytrueofgood habits.Childrenwhoweretaughttosay"Yes,sir,"donotseemtohavetransferredthis habittothebabyboomers,whoneglectedteachingittotheirchildren.Myquestionis this:Isthrifttheequivalentof"yes,sir"? Thisleadsustothequestionofdeficits:trade,federal,andpersonal.Letsconsiderthem inreverseorder. Statisticallyspeaking,personaldeficitsappeartobetheleastofoureconomicworries. Theratioofdebtservicerepaymentinrelationtodisposablepersonalincomehasvaried littleovertheyears19802003:between13.4%to16.2%.Itsinthehigh15stoday.

ThisindicatesthatindividualAmericanspaycloseattentiontotheirabilitytorepaytheir debts.Theyarenotwildspendthrifts.Butwhattheyalsoarenotthesedaysiswildthrifts. Thepersonalsavingsratetodayiscloseto0:about0.2%. Sociallyspeaking,however,personalbudgetarydeficitsreallyaretheheartofour economicworries.Butwhyisthistrue,if,statisticallyspeaking,personaldebtis restrained?Becausethedifferencebetweenpersonalthriftandpersonaldebtisthe definingmarkofeconomicsuccessandeconomicfailure,longterm.Thedifference individuallybetweenanetannualdeficitandanetannualsurplusadifferenceatthe margin markstheUnitedStatesasanemergingdebtornation. Americaisadebtornationbecauseofthemindsetofitscommonpeople.Thismindsetis increasinglypresentoriented.Itisthereforelowerclass.TheAmericanmiddleclassis steadilybecominglowerclass,despiteitspresentlevelofwealth. Therecanbedebtthatisfutureoriented.Debtusedtobuytoolsoreducationisfuture oriented,upperclassdebt.Butdebtincurredtopurchasedepreciatingassetsisamarkof personalcapitalconsumption:lowerclass.If,atthemargin,theindividualsbudgetisin thered,yearafteryear,thenheisconsuminghisseedcorn.Becauseofbudgetary restraints,thisconsumptionmaybemarginalannually,butitisnonethelesspartofa patternofbehavior.Thispattern ofbehaviorispresentorientedandantieconomic growth.Multipliedacrossanation,itbecomestheindicatoroffutureimpoverishment. THRIFTANDGOVERNMENTDEBT UnliketheindividualAmerican,theU.S.governmentisnotundermuchrestraintwith respecttoitsdebt.Thegovernmentisunquestionablyaspendthrift.Ifitwerenotforthe accountingtrickofcountingSocialSecuritysnetrevenueasincome,ratherthanasa futureliability(debt),theUnitedStatesgovernmentwouldnothavehadasingleon budgetsurplusyearinmygeneration.Nixonstinysurplusin1969wastheresultof LyndonJohnsonsrecommendedaccountingtrickregardingSocialSecurity taking SocialSecurityoffbudgetwhichwentintoeffectinfiscalyear1969. TheunfundedoffbudgetliabilityofSocialSecurityandMedicarecombinedisnowover $45trillion.(Table1scrolldown) Theestimatedonbudgetdeficitforfiscal2005isintherangeof$520billion.Without SocialSecurityssurplusofincomeoverpayments,itwouldbe$675billion. WehaveenteredaneraofmassiveFederaldeficits.ThegrowthoftheFederaldeficitis about5%ofgrossdomesticproduct.Thegrowthoftheeconomyisunder4%.Thedeficit isgrowingfasterthantheeconomy.Weareincancermode. Thereareonlytwowaysoutofcancermode:(1)encouragemoreeconomicgrowthby freeinguptheeconomy(2)cutgovernmentspending.Ofspendingcuts,weseenone.As forfreeinguptheeconomy,wealsoseenone.

Everyyearforthelast11years,TheWallStreetJournalandtheHeritageFoundation havepublishedtheEconomicFreedomIndex.Thisbooklongstudyranks161nationsin termsofeconomicfreedomin50differentareas:tradepolicy,fiscalpolicy,government intervention,monetarypolicy,etc.In2004,forthefirsttime,theUnitedStatesdidnot makethetopten.Itfellto#12. Dr.EdFuelner,thepresidentofHeritage,explainswhy. Othersareovertakingus.Wearetreadingwater. Inrecentyears,theU.S.hasallowedhighergovernmentspendingand protectionistmeasurestodragoureconomyintoatrap.Werenowchoosingtodo whatiseasyandshortsighted,ratherthandoingthehardworkneededtoexpand economicfreedom. But,astheIndexshowsyearafteryear,withoutpersistentcommitment,economic freedomfades.Luckily,ithasntcometothathere.Yet. Oureconomicfreedomisntfading,itsmerelyholdingsteadyasothernations improve.Thatswhywevebeenslidingdownthelistofeconomicallyfree countries.Thisyear,Iceland,AustraliaandChileallforgedpastus. Hightaxrates especiallyhighcorporatetaxlevelsareamajordragonthe U.S.economy.Increasinggovernmentspending,nowat35.9percentofGDP,is alsoaproblem. THRIFTANDTHETRADEDEFICIT Thetradedeficitisacombinedproduct:lowcostforeigngoodsandawillingnessof foreignerstoinvestintheUnitedStates.Foraslongasforeignersarewillingandableto providethemoneytobuygoodsofferedforsaleintheircurrencies,thetradedeficitwill continue.Ofcourse,ifAmericanconsumerssaid,"Letssave,"spendingonforeign consumergoodswoulddecline.Butitislikelythatlowcostimportedcapitalgoods wouldreplacethem.Ifforeignerscanproducecheapconsumergoodstoexport,itis likelythattheycanproducelowcostcapitalgoods,too.Americanslookforbargains,and thisisevenmoretrueofcapitalgoodsbuyersthanconsumers.Businessmenpayclose attentiontothebottomline. Now,ifAmericansstartedsavingatratescomparabletoforeignerswhoinvestindollar denominatedassets,foreignerswouldbuyfewerassets.Thiswouldhaveaneffectonthe distributionoffuturepayments,Americansvs.foreigners.Americanswouldearnhigher incomesthaniftheyhadrefusedtosave.Outputherewouldrise:morecapital.American industrywouldgrowmorecompetitive.WecouldcompetebetterwithAsian manufacturers.ButitwouldtakeanenormousincreaseinthriftbyAmericanstooutbid foreignersforownershipofcapitalusedindomesticfirms. Basically,thetradedeficitisaproductofAmericanswhoarelookingforbargainsand foreignerswhoarelookingtobuyassetsownedbyAmericans:bargains.Americansbuy

consumergoods.Foreignersbuyproducergoodsanddebtinstruments.Forthis arrangementtochange,itwouldtakeatransformationofthinkingonbothsides:by foreigners,whowoulddecidetoinvestlessmoneyhere,andAmericans,whowould decidetoinvestabroadorintheU.S.,therebyraisingthepriceofAmericancapital assets.Americanswouldoutbidforeigninvestors. Thelikelihood ofthischangingdramaticallyonbothsidesisminimal.Therearebasic habitsofmindalreadyfirmlyingrained.Americansdontliketosave.Foreignersdo.So, anymajorreductionofthetradedeficitmustcomefromcapitalssupplyside,i.e.,foreign investors.Theykeepbuyingdollars,whichraisesthepriceofthedollar,whichenables Americanstobuyimportslessexpensively. Inotherwords,thefateofthedollarisnowinthehandsofforeigners:privateinvestors andcentralbankers.Theinitiativecomesfromforeigners,whoinvesthere.Theymake foreigncurrenciesavailableattodayslowbutclimbingprices.Americansareinfull consumptionmode.TheyaretakingtoheartthedemandsideeconomicsofJohn MaynardKeynes:"Spendourselvesrich." FEARANDGREED WeknownowthatintheU.S.capitalmarkets,Americanshavedecidedtoforegogreed futureincomeforpresentenjoyment.Thelureofgreedisnowminimalinthethinking ofmostAmericans.Theyarecontentnottogetrich. Thenwhatoffear?JohnMauldin,inhisJanuary7letter,predictsthatfearwillbethe greatmotivator. Afallingdollarwillnotbeenoughtocurethetradedeficit.Itwillalsotakea risingsavingsratefromtheconsumer.Whatwillbringthatabout?Whenthenext recessioncomesin2006or2007,thestockmarketwilldrop.Averagedrops duringarecessionare43%.TheBabyBoomergenerationwillrealizethatthe stockmarketisnotgoingtobailouttheirretirementhopes.Theywillstop spendingandstartsavingwithavengeance. ThatsJohn:evertheoptimist.Heisalwaysreadytodrawtoaninsidestraight. Ithinkthehabitofthriftissofarremovedfromthethinkingofbabyboomersthatitsnot worthconsideringasamacroeconomicfactor.Whynot?Becausetheboomershaveso littletimetopreparefortheirloomingretirement.Theslogan,"Itsnevertolateto begin,"istrue.Buttheunstatedassumption "Youcanstilllivecomfortablyin retirementifyoustartsavingnow"ispoppycock.Thirtyyearsgonebycannotbe recoveredinadecadeofthrift.Thereisnowayforhighratesofthrifttomakeupfor threedecadesof"MeDecade"investingbythegenerationthatreachedadulthoodinthe 1970s.Theydidnotchangeinthe1980s.

ThoseofuswhoreachedadulthoodbeforetheBeatlesarrivedin1964vaguely recognizedthatthriftisvital.But,afterFebruary,1964,thecounterculturecapturedthe mindsofAmericasyouth.Thecountercultureasaninyourfacephenomenonlasted onlyfrom1964totherecessionof1970,butthatwassufficient.TheMeDecadebeganin 1970,andthe70sgenerationdidnothavethriftinitsagenda. NowthoseMeDecadepeoplearereachingtheendoftheircareers.Whywilltheychange theirspendinghabitsatthislatedate?Wehavealreadygonethrougharecession:2001. Consumersdidntmissabeat.Thehousingmarketboomed.TheFederalReserveSystem pumpedinmoneytokeeptheconsumerboomfromfaltering.Thisreconfirmedthe worldviewoftheMeDecadescohorts:"Therearenosignificantnegativesanctionsfor bigspenders."TheFEDforceddowninterestrates,whichallowedhouseholdstoincrease theirspendingwithouthittingthedebtrepaymentceiling.Theyborrowedmorebecause moneywascheaper.TheFEDofferedthebaittheconsumersbit. TheMeDecadescohortshavealwaysbelievedthat,withrespecttotheirretirement years,somethingwillturnup,thatthegovernmentwillprovidethegoodlife,thatdeficits dontmatter.Theyarewillingtocutspendingwhen theyfearthattheycantmaketheir monthlypayments,butthisisnotthesameassayingthattheyarewillingtocutspending sufficientlytopayofftheirdebtsandnottakeonnewones.Onthecontrary,theideaof payingoffdebtsandbecomingnetsaversissofaroutsidetheboxfortheMeDecade brigadethatitisnotworthconsideringasawaytosavethedollarfromacontinuingfall. Thenwhatwillreversethefall?This:theindividualdecisionsofforeigninvestorsto ceasefinancingAmericansbuyingspree.Howdotheyfinancethis?Bytheirpurchaseof dollardenominatedassets,therebyincreasingdemandfordollars.Thedollarwillfall whentheyquitinvestinghere. Youshouldinvestintermsofthisunderstanding.ThriftbyAmericanswillnotreappear asifbymagicduringthenextrecession.Thedollarwillfall.Americanswillthenof necessitybuyfewerforeignmadegoods.Thetradedeficitwillshrink.Thisstateof affairswillbeimposedonAmericanconsumers.Itwillnotbeinitiatedbythem. OTHERSCENARIOS Therecouldbeachangeinattitudeifthebenefitswerehighenough.IftheUnitedStates governmentceasedtotaxprofitsanddividendsuntilthemoneyistakenaspersonal income,thatwouldincreasethedomesticsavingsrate. Butitwouldalsoincreasethe savingsrateofforeignbuyersofdollardenominatedassets.Thiswouldincreasethe valueofthedollarinternationally,makingimportedgoodscheaper.Thetradedeficit wouldcontinueuntilsuchtimeasimprovedAmericanproductivitybegantomakeitself feltintheworldsmarketsoruntilforeigninvestmentmarketsandlegalsystemsbecame competitivewithAmericas.Thiswouldnotbeanovernightphenomenon.Ithinkit wouldtakewelloveradecade.Wecannotmakeupforlostinvestinginonedecade, eitherpersonallyornationally.

Thepossibilityofamajoroverhaulofthetaxcodetodayisminimal.Togetridofthe corporatetaxandthetaxationofretainedearningswouldtakeanideologicalrevolution. Itsnotgoingtohappensoon. Stablemoneywouldstopthefallofthedollar,butthatwouldnotnecessarilyendthe tradedeficit.Stablemoneywouldgiveforeignersanotherreasontoinvesthere.The dollarwouldthenrise.Itwouldbuymoreforeigngoods.Thetradedeficitwould increase. Mauldinwrites:"Afallingdollarwillnotbeenoughtocurethetradedeficit."Ithinkto myself,"enough,pluswhat?"WiththetradedeficitforthemonthofNovemberat$60 billion,whatkindofmotivationwouldbeabletoreversethetrend?Icanthinkofnone thatwillcomefromAmericassideoftheequation. IcanthinkofonlyoneAmericaninitiatedfactorthatmightconceivablycurethetrade deficitoverthenextdecade:thereturnofthecommitmenttothriftbyAmericansa levelofcommitmentonascalenotseeninmygeneration.Nevertheless,this commitmentmustnotlureAmericanmanufacturerstobuyimportedcapitalequipment. Thetroubleis,itwould.Americanswantabargain.Americascapitalgoodsindustries arenotsufficientlycompetitive. WhatAmericaseconomyneedsmostisincreasedproductivity.Weneedtobeableto competeinworldmarkets.Weneedmoreinvestment,especiallyineducation,butnotthe educationprovidedbytaxfundedbureaucrats,i.e.,classroomteachers.Weneed educationinentrepreneurship.Weneededucationbymarkettestedmasters. Weneedareturntoapprenticeship.Thisisnotgoingtohappen.Thiscountryspendsover $270billionayearoneducation,andmostofthismoneygoesforclassroominstruction intaxfunded,tenuregovernedinstitutions.Theseinstitutionsarewellorganized politically.Theyarenotgoingtoturnlooseofthemoneytree. WouldyouratherspendayearasanapprenticetoDonaldTrumporasanapprenticetoa tenuredprofessorofmarketingwhohasneverworkedinprivateindustry?GivemeThe Donald!Americansinstinctivelyknowthis.NobodywouldwatchTheApprenticeifthe mentorwereProfessorAnyone.NobodywouldtuneintohearProfessorAnyonesay, "Youflunked!" Thestatetoutseducationasacureall.Butittoutsonlystatefundededucation.Itseeksto featheritsownbureaucraticnest.Theresult:asoilednest.Therearetoomanydegree holdersandnotenoughentrepreneurs.Therearetoomanylawyersandnotenough engineers. Twothingscanreversethetradedeficit:(1)vastlyincreasedthriftbyAmericans (unlikely),whowillinvestincompaniesthatinsistonbuyingAmericanmadecapital goods(2)arefusalofforeignerstobuyAmericaninvestmentassets.Thefirstisntgoing tohappenuntilthedollarfallssolowthatAmericancapitalistscantaffordtobuy

foreignmadecapitalgoods.Idontknowwhenthesecondwillhappen.Iknowonlythat itwill. DEBTASATOOLOFDOMINION Somedebtsmakesenseforthedebtor.Ijustboughta4bedroom,2bathhomefor $90,000.(Note:notinCalifornia.)Ipaid5%downandgota30yearloanat5.375%.My totalmortgagepaymentisunder$540amonth.Thehomeislocatedinthemiddleofa boomareawith growinginmigration. (HoorayfortheWeb,withitspublishedmortgageratesites.Iwillsavetotal paymentsof$17,200overtheratequotedtomelocally.Ittooklessthan20 minutesoftollfreephonetimetogettheloan.) WasIfoolishtoborrow?NotwhenIcanrentthehomeformorethanIpaytothelender. WhycanIdothis?BecauseIhaveanalmostflawlesscreditrating.Also,becauselenders trustthedollarsfuture. Ievaluateahousingbubblethusly:CanIrentthehomeformorethanImustpaytorepay themortgage?IfIcan,itsnotabubble.Itsmerelyaboom.Ilikebooms. Forme,thriftisawayoflife.Italwayshasbeen.So,Icannowborrowcheapmoney. Thepersonwhospendswhatheearnsandrunsupdebtsdoesnthavethecreditratingto enablehimtobuy.Hemustrent. Somepoorschnookisgoingtospendmymonthlymortgagepaymenttobuyafew groceriesbeforeitspaidoff.Illprobablybeinoneofthosestatelyetherealmansions, butmywifewillhaveminimalmonthlypaymentstomakeintermsofpurchasingpower. Shewillhavearoofoverherhead. Iinvestinhardassets,suchasapieceofcommercialrealestatethatwillproduce20% perannum,probablyappreciate,andletmeearna$50,000salarywhileImatit. (http://www.demischools.org) Thisiswhyweshouldteachourchildrentosave.Savingrequiresbudgeting.Iprobably didnotdoagreatjobteachingmychildrenmostofwhatIknow,butthislessonthey learned.Theyarefrugal.Thiswontmakethemrich,butitwillkeepthemfrombeing poor.Theymayrenttoday,but,atsomepoint,theywillhavetheabilitytosecurea mortgagebecauseoftheirgoodcredit. Imayhaveoverdoneit.Theyshouldborrowshorttermmoneytobuytoolsorget meaningfuleducations/licenses,andthenpayoffthedebt,fast.Thisway,theywillbuild acredithistory.Thatsthewiseststrategy.Butifthereisatemptationtogointo consumerdebt,thenitsbestnottoborrowatall.Likeotheraddictions,thefirstsnort shouldbeavoided.

Borrowingisnotanevil.Itdependsofwhatyouareborrowingfor.Ifyourdebtsupplies tools,education,oracomfortablebutmodestplacetolive,thenitsatoolofdominion. Butifdebtisusedtobuy depreciatingassets,itisacurse.Mostassetsdepreciate.Buy themusedforcashfromsomeonewhoisstrappedforcash. CONCLUSION Patternsofthoughtandbehaviortakeyearstoacquire.Theycanbelostinone generation.ThisiswhathappenedtotheidealofthriftintheUnitedStates.Joe Lunchbucketisdeadorretired.Hischildrenareinhock.Hisgrandchildrenwanttobe liketheirparents.Debtiseasierthanthrift.Asthesayinggoes,"Thingsareeasierto getintothanoutof." Thehabitofthriftforthewealthyupper20%isstillwithus,althoughdeclining,butthis habitiscompromisedbythetwinassumptionsofastabledollarandtrustingovernment promises.Thus,thecreditorswhobuygovernmentdebtthinktheywillberepaid.Itwill takeauniversaldefaulttodisabusethemofthisconfidence.Thatdefaultiscoming,in oneformoranother. Fact:therearemoredebtorswhovotethancreditorswhovote.Andthebiggestdebtoron earthistheU.S.government.ItwonttakeanythingnewtopersuadeCongresstoruna deficit.Thevotersareontheirside. Therewillbetensofmillionsofvictimsofgovernmentpromises.Therearetwovarieties ofvictims:(1)governmenttrustingdebtorswhoneversave,and(2)governmenttrusting creditorswhodo.Don'tbeineithercamp. ________________________________________________________________________

GreenspansWhopper
byBillBonner
byBillBonner

"YouarewastingyourlifeandyourtalentswritingaboutAlanGreenspaneveryday," saidanoldfriend. Foryears,wehavebeenworkingonGreenspansobituary.Asfarasweknow,themanis stillinexcellenthealth.Butwedonotwanttobecaughtoffguard.Maybewecouldeven rushoutaquickiebiography,explainingtothemassesthemeaningofMr.Greenspans lifeandwork. Perhapsourfriendisright.Butthenagain,wewerentdoinganythingspecialbeforewe startedkeepingupwiththeFedchairman.Besides,weseesomethinginAlan Greenspanscareerhiscomportmenthisbetrayalofhisoldideashispactwiththe

DevilinWashingtonandhisattempttoholdoffnaturesrevengeatleastuntilheleaves theFedthatisbothentertainingandeducational.ItsmacksofGreektragedywithout theboringmonologuesorbloodyintrigues.EventhelanguageofitisGreektomost people.ThoughtheFedchairmanspeaksEnglish,ofcourse,hiswordsoftenneed translationandhistoricalannotation.Rarelydoesthemaestromakeastatementthatis comprehensibletotheordinarymortal.Somuchthebetter,weguess.Iftheaverage fellowreallyknewwhathewastalkingabout,hewouldbealarmed.Andwehaveno illusions.Whoeverattemptstoexplainittohimwillgetnothankshemightaswelltell histeenagedaughterwhatisinherhotdog. Wepersevereanyway,moreinmischiefthaninearnest. Thebackground:TheU.S.economyfacedamajorrecessionin2001andhadaminor one.Thenecessaryslumpheheldoffbyadramaticresorttocentralplanning.The "invisiblehand"isfineforlumberandpoultryprices.Butattheshortendofthemarket indebt,AlanGreenspanspawpressesdown,likeabutchersthumbonthemeatscale. TheFedquicklycutratestoheadofftherecession.Indeed,neverbeforehadratesbeen cutsomuch,sofast.GeorgeW.Bush,meanwhile,boostedspending.Theresultantshock ofrenewed,ersatzdemandnotonlypostponedtherecessionitmisledconsumers, investorsandbusinessmentomakeevenmoreegregiouserrors.Investorsboughtstock withlowearningsyields.Consumerswentfurtherintodebt.Governmentliabilitiesrose. Thetradedeficitgrewlarger.Evenontheothersideoftheglobe,foreignbusinessmen geareduptomeetthephonynewdemandChinaenjoyedacapitalspendingboomas excessiveasanytheworldhaseverseen. WhattheGreenspanFedhadaccomplishedwastoputoffanatural,cyclicalcorrection andtransmogrifyanentireeconomyintoamonstrousECONOMICbubble.Abubblein stockpricesmaydolittlerealeconomicdamage.Eventually,thebubblepopsandthe phonymoneypeoplethoughttheyhaddisappearslikeapuffofmarijuanasmoke.There arewinnersandlosers.Butintheend,theeconomyisaboutwhereitbegan unharmed andunhelped.Thehouseholdsarestillthereandstillspendingmoneyastheydid beforeandthecompaniesstillinbusiness.Onlythosethatleveragedthemselvestoo highlyinthebubbleyearsareinanytroubleandtheyprobablydeservetogooutof business. Evenapropertybubblemaycomeandgowithlittleeffectontheoveralleconomy. HousepriceshavebeenrunningupinFrance,forexample,atnearlythesameratesasin America.ButinFrancethereisverylittlemortgagerefinancingor"takingout"of equity.TheEuropeanCentralBankwasrepeatedlyurgedtolowerratesinlinewiththose inAmerica.Itrefusedtobudge.Withoutfallingrates,therewasno"refiboom."Nor wereEuropeanbanksoffering"homeequitylinesofcredit."Propertycouldrunupand rundownandtheonly peoplewhocaredwouldbetheactualbuyersorsellers,who eithercursedthemselvesorfeltlikegeniuses,dependingontheirluck. ButinGreenspansbubbleeconomysomethingremarkablyawfulhappened. Householderswereluredto"takeout"theequityin theirhomes.Theybelievedthatthe

bubbleinrealestatepricedcreated"wealth"thattheycouldspend.Manydidnothesitate. Mortgagedebtballoonedintheearlyyearsofthe21stcentury fromabout$6trillionin 1999tonearly$9trillionattheendof2004.Threetrilliondollarsmaynotseemlike muchtoyou,dearreader.Butitincreasedtheaveragehouseholdsdebtby$30,000. Americansstilllivedinmoreorlessthesamehouses.Buttheyowedfarmoreonthem. WehadgivenupallhopeofevergettinganhonestwordoutoftheFedchairmanonthis subjectwhen,inearlyFebruary,intheyearofourLord2005,themaestroslippedup.His speechwasentitled"CurrentAccount."Jetlagged,hisdefensesdown,thepoorman seemstohavecommittedtruth. "Thegrowthofhomemortgagedebthasbeenthemajorcontributortothedeclineinthe personalsavingrateintheUnitedStatesfromalmost6percentin1993toitscurrentlevel of1percent,"headmitted.Thus,hedidbringupthesubject.Then,hebegana confession:Therapidgrowthinhomemortgagedebtoverthepastfiveyearshasbeen "drivenlargelybyequityextraction,"saidthemanmostresponsibleforit.Bythistime, listenerswerebeginningtoputMr.Greenspanatthesceneofthecrime.Andprettysoon, eventhedullesteconomistintheroomwasadding2and2.Mr.Greenspanlowered lendingratesfarbelowwhereafreemarketincreditwouldhaveputthem.Withlittleto begainedbyputtingmoneyinsavingsaccountsandalottobegainedby borrowinghouseholdsdidwhatyouwouldexpecttheyceasedsavingandbegan borrowing.Whatdidtheyborrowagainst?Therisingvalueoftheirhomes"extracting equity,"touseMr.Greenspansownjargon.TheFedchairmanhadmisledtheminto believingthathousepricesincreaseswerethesameasnew,disposablewealth. Buttheworldsmostfamousandmostreveredeconomistdidntstopthere.Hemusthave hadtheaudienceontheedgeofitschairs.Heconfessednotonlytohavingdonethe thingbutalsotohavinghiswitsabouthimwhenhedidit.Thiswasnoaccident.No negligence.Thiswasintentional. "Approximatelyhalfofequityextractionshowsupinadditionalhouseholdexpenditures, reducingsavingscommensuratelyandtherebypresumablycontributingtothecurrent accountdeficit.ThefallinU.S.interestratessincetheearly1980shassupportedhome priceincreases,"continuesAmericasanswertoAdamSmith. Peopletakemoneyoutoftheirhomes.Withthissourceofspendingpoweravailableto them,theyseenoreasontosave.Instead,theyspendoftenonforeignmadegoods. Withnosavingsavailabledomestically,Americamustlookoverseasforcredit. "TheobviousandmostimportantpointisthatrapidgrowthofU.S.mortgagedebtdidnot comeoutofthinair,"commentsStephenRoach."Itwas,ofcourse,adirectoutgrowthof theFedshyperaccommodationofthepostbubbleeranamely,shortterminterestrates thathavebeennegativeinrealtermsforlongerthanatanypointsincethe1970s.". ThecrimeofwhichMr.Greenspanisguiltyisfraud.Puttinginterestratesatan artificiallylowlevel,theFedchairmanintentionallymisledAmericans.Wereitnotfor

theFedslowratesandeasylendingpolicies,Americanswouldnthavethought themselvessorich.Theirhouseswouldnthavegoneupsomuchtheywouldnthave takenoutsomuchequity,becausetheywouldnthavehadanyequitytotakeout.They wouldhavehadtospendless,whichwouldhavereducedtheU.S.currentaccountdeficit anddiminishedhouseholdindebtedness. "Lackinginjobcreationandrealwagegrowth,"explainsRoach,"privatesectorreal wageandsalarydisbursementshaveincreasedamere4%overthefirst37monthsofthis recovery fullytenpercentagepointsshortoftheaveragegainsofmorethan14%that occurredoverthefiveprecedingcyclicalupturns.Yetconsumersdidntflinchintheface ofwhatinthepastwouldhavebeenamajorimpedimenttospending.Spurredonby homeequityextractionandBushAdministrationtaxcuts,incomeshorthouseholds pushedtheconsumptionshareofUSGDPuptoarecord71.1%inearly2003(andstill 70.7%in4Q04)anunprecedentedbreakoutfromthe67%normthathadprevailedover the1975to2000period.Atlonglast,ChairmanGreenspanownsuptothecentralrole heandhiscolleaguesattheFederalReservehaveplayedinfosteringthese developments." OurownFedchairman,guardian ofthenationsmoneycustodianofits economynightwatchmanofitswealth Howcouldhedosuchathing?Andyethehasdoneit.Heturnedafinancialbubbleinto aneconomicbubble.Notonlywerethepricesoffinancialassetsballoonedtoexcessso werethepricesofhousesandsowerethedebtsoftheaveragehousehold. Wheredoesitlead?Theforceofacorrectionisequaltothedeceptionthatprecededit. Mr.Greenspanswhoppermustbefollowedbyawhopperofaslump. . ________________________________________________________________________

MortgagingtheFarm
byBillBonner "Whatisprudenceintheconductofeveryprivatefamily,canscarcebefollyinthatofa greatkingdom,"wroteAdamSmith.Wewonderaboutthecontrary...whatisfollyin privateconduct,ifitisnotfollyforthegreatkingdom? Volatilityisata12yearlow.Peopledonotexpectmuchmovementinthestockmarket. Theyarenotgettingmuch.Investorsarecalm,bullish,anddelusional.Nothinghappens. Andnothingisjustfine.

Becausewhiletheyaremakingnothingfromtheirstocks themarketisnohighertoday thanitwas6yearsago theyaregettingrichinrealestate.Seventypercentof Americansowntheirownhouses.Inroundnumbers,theaveragehouseisworth $200,000.Andtheaveragehousegoesup10%peryear.Thisgivestheaverage household$20,000more"wealth"eachyear.What'snottolike? Insomeareas,housesaregoingupfive,six,even10timesfasterthanconsumerprice inflation. Wait,howcouldhousepricesberisingsofastandconsumerpriceinflationsoslowly? Isn'thousingthebiggestsingleiteminprivateexpenseaccounts?Well,thestatisticians whocompilethefigurestakecaretoputintotheCPIonlyitemsthatpeopledon'tliketo seegoup.Morethantwooutofthreehousesareownedbytheiroccupants,butwho amongthemcomplainswhenhousepricesrise?Thecomplainersarerenters.Soitisthe rentalfiguresthatgointotheCPI. Forthehomeowner,theriseinhousepricescomeslikefreeboozeonanemptystomach. Heputsthecuptohislipinhardlyanytime,he'salittlegiddy.Theaveragehomeowner thinkshehas$20,000moretospend.Howishesupposedtoknowthatthe"wealth"isa figmentofAlanGreenspan'sfinancialfiddle,andnottherealthing? Whocanblamehimforwantingtotakeadvantageofafreedrink? Multipliedovermillionsofhouseholds,thealcoholeatsawayatthenation'sbalance sheetasifitwereliver.Everyday,asWarrenBuffettputsit,thenationspends5%more thanitearns.Wearelikeaverywealthyfamily,hesays,withaverybigfarm.Wedon't earnthemoneyweusedto,sowekeepmortgagingmoreandmoreofittopaycurrent expenses.Intheend,wewillstillbeafamily,butwewillnotbewealthy.