As Dick Tuck put it, after losing a California State Senate election:
“The people have spoken…the bastards.”
America’s voters spoke yesterday. And they said, “Give us Obama.”
And it came to pass that the man called Obama was given unto them.
“America is a place where all things are possible,” said the man himself in his victory speech.
And yes, it is possible for a half-black man to be elected. But no, all things are not possible. It is not still not possible to get rich by spending money. Nor is it possible to save a man from too much debt by giving him more credit. And you still can’t trust a politician…or his money.
The election “changed everything,” shouts the headline on today’s International Herald Tribune. But the eternal verities still apply; Barack Obama is not going to change them.
And that means that a slump caused by too much debt cannot be made to disappear. You can disguise it. You can delay it. You can push the losses onto someone else. But you can’t escape it.
And now, thanks to an economist with the Nomura Research Institute in Tokyo, we think we have a clearer idea of how this downturn is likely to turn out.
We’ll get to that in a minute. First, a quick look at what is going on the world of money.
The Dow rose 305 points on Election Day. Investors are looking for any bit of flotsam or jetsam they can find to buoy them up. Anticipating an Obama victory, they thought things might change. The price of gold shot up $39. Gold buyers have their suspicions too.
“Post election rallies” are more myth than reality. Stocks rose strongly following Reagan’s first election to the White House…and again when Bill Clinton was elected. But neither Bush, pere nor fils, boosted stock prices.
Still, an Obama rally is probably on its way. Investors are ready for it. Practically every major investment guru is calling for it. “Stocks are cheap,” they say. “This may be the greatest investment opportunity of our lifetimes,” they add. Even the ‘contrarians’ are getting aboard. “Investors are frightened,” they point out. “Confidence is down,” they explain. “There’s blood in the street,” they clinch the argument.
All over the world, people look to Washington with hope in their hearts…and humbug in their heads.
“A New World Dawns” proclaims Britain’s Daily Mirror.
People look at Obama and think they see a young Kennedy…they think they’ll be about to rerun the tape and do a little editing – a New Frontier without the Vietnam War…a Camelot without Lee Harvey Oswald.
But it’s not a New Frontier that America faces…it’s an old, worn out flimflam. It’s not a new dawn at all – a dark night is falling.
Our old friend Adrian Day, originally from London, England, now from Annapolis, Maryland, explains:
“The position of the United States today is approaching that of Britain at the end of World War II. Britain had been the world’s dominant economic, political and military power, with the world’s reserve currency. But by 1946 it was militarily stretched beyond its capacity, and highly indebted. The U.S. took over the #1 spot and the dollar became the world’s reserve currency, with the pound falling from five-to-one in 1946, down to parity four decades later.
“The problem with being the world’s reserve currency is that more money is created than is necessary for the domestic economy’s needs. For decades, the United States has created far more dollars than it needs, but it didn’t matter so long as other countries were prepared to buy and hold those dollars. But those dollars still exist. As other countries lose confidence and diversity, those dollars eventually come back…”
Yes, dear reader…a man must always compensate for his strengths. The U.S. had the world’s strongest and most reliable currency for half a century. It was our greatest strength and our biggest export. But this much IS changing: the dollar is no longer our biggest strength; it is becoming our biggest weakness.
*** Yes, we are figuring it out, dear reader. And the clearer the picture becomes, the more we realize we were right all along – almost.
“You really got the Japan story right,” said Theo Casey, a London-based colleague yesterday.
Theo had just read our book, Financial Reckoning Day, written in 2002. In it, we suggested that America was following in Japan’s footsteps. At the time, we wrote so much about it in Markets and Money that readers begged us to change the subject. And then…the subject changed on its own. Instead of beginning a Japan-style correction, the U.S. economy took off in an American-style bubble.
But now the bubble has popped. What now? Want to know? Just look at Japan!
Richard C. Koo has prepared a remarkable report: “The Age of Balance Sheet Recessions – What Post-2008 US, Europe and Japan Can Learn from Japan 1990-2005.”
His argument is not far from the one we made six years ago. In the 1980s, Japan ran up stock and property prices in a spree of debt and leverage. Then, when the bubble popped, the usual monetary stimulus didn’t work. The Bank of Japan cut rates to almost zero…still, few people were willing to borrow.
The economy did not recover; instead, it got worse and worse until 2005 – 15 years later – when stocks had lost 72% of their value, land was down 81%, and golf course memberships had sunk 95% from their peak.
The problem, he explains, was that it was a “balance sheet recession,” not a typical business cycle downturn.
Companies, banks, and individuals had to pay down the debt that they had accumulated in the boom; they did not want to borrow more money, even at zero interest rates. For 7 years, from 1998 to 2005, net business borrowing went negative – meaning, businesses were paying off more debt than they were taking on.
This came as a shock to modern economists. Japanese officials were flummoxed. U.S. economists accused them of not acting swiftly enough…or not having the stomach to let the big banks fail. But almost no one seemed to understand what was really going on. They should have. Irving Fisher described it back in 1933, observing that when people who are deeply in debt get into trouble they usually sell assets. He called it a “stampede to liquidity.” Investors dump stocks and property for any price they can get – desperate to pay off their debts before they are dragged into bankruptcy.
This is the phenomenon known to economists as the “fallacy of composition.” What is good for every individual investor – cutting expenses, paying off debt – turns out to be bad for the economy itself. Asset prices fall. Sales fall. Unemployment rises. The slump deepens.
In Japan’s case, combined capital losses from land and stocks grew from 1990 until 2002, at which time they reached $15 trillion – or 3 years worth of Japan’s GDP.
You can do the math yourself, dear reader. America’s GDP is about $14 trillion. Multiply that times three and you get $42 trillion. So far, the U.S. has lost about $4 or $5 trillion in housing prices…and maybe another $6 trillion in stocks, for a total of about $11 trillion, maximum. A long way to go…
Tomorrow, we’ll explain why the U.S. will follow Japan’s lead – but only to a point. In short, Japan didn’t have the world’s reserve currency. And Japan also had savings – mountains of savings. The initial conditions are very different in the United States; the outcome will be different too. More tomorrow…
*** “The Joy of Thrift” is the cover story on this weekend’s Sunday Times Style supplement. As predicted, suddenly, thrift has become stylish.
“It dawned on me that nothing was going to change unless I made fundamental changes in my life,” writes India Knight, describing her close encounter with bankruptcy. And then…the damascene conversion:
“Five years ago, buying stuff I didn’t need was my idea of bliss. But these days my treat of choice comes from a yarn shop in north London…and if I want to give someone I really care about a present, I may actually – gasp! – make them something. And here’s the clincher: I would consider the something as chic and stylish as anything a department store could have produced. Chicer, sometimes…
“There is something really gross about wanting something and buying it, just like that…thank you, AMEX.”
*** Thrift has not exactly become chic in the Bonner household, but it is perhaps less out-of-style than it was a few months ago.
We are all skyping, rather than using the telephone. Our gardener has been given notice: no more overtime. No more fancy restaurants either; the Italian dive across the street will do just fine. And hold the $50 bottles of wine; we can’t tell the difference anyway.
So you see, we are roughing it. In this time of national hardship, everyone has to make sacrifices.
Your editor has dramatically reduced his commuting expense. Rather than buy a subway ticket for 1.6 euros, he rides a bicycle. These two-wheeled, unmotorized, non-electronic vehicles are big moneysavers.
To begin with, we don’t have to buy gasoline. And a bicycle costs you almost nothing to maintain – just adjust the brakes yourself; it’s easy. And you don’t need expensive auto-insurance.
Best of all, there are no costly repairs to make after a fender-bender – especially if you’ve fixed the brakes yourself. You’ll have no lawyers to pay. No points on your license. Almost all encounters between delivery vans and bicycles are fatal to the fellow on the bicycle. What a savings!