America's Glorious Empire of Debt, Part II

Editor’s note: America’s economic recovery may seem like it is built on solid ground. But scratch the surface and a very different reality emerges. In their book, “The New Empire of Debt”, Bill Bonner and co-author Addison Wiggin, reveal the faulty foundations on which the US economy rests. 

Through his widely followed e-letters and his bestselling books, Bill has made it his mission to warn readers about the dangers posed to them by America’s debt-fueled and heavily manipulated economic model.  He believes that the debt crisis of 2008 was just the first wave of a much bigger crisis still on the horizon – one he believes could wipe out all the stock market gains of the last five years… crash the dollar… and radically transform your way of life. As a result, he recommends avoiding over investing in US stocks… and instead holding plenty of gold… and non-US assets. 

In today’s Weekend Edition – excerpted from Bill and Addison’s book – Bill looks at how the US has squandered its wealth… and built its imperial ambitions on what he calls a “cartoon economy.”

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by Bill Bonner and Addison Wiggin

“The citizens of Squanderville, as Warren Buffett called the United States, were a happy bunch. They believed happy things; it didn’t bother them that the things they believed were impossible. After 20 years of mostly falling interest rates, mostly falling inflation rates, and mostly rising asset prices (stocks and real estate), people had come to believe that this is the way the world works: Interest rates mostly go down, and house prices mostly go up; it goes on forever. 

Even the professionals in Squanderville had never been more certain: A 2005 poll of economists working for major brokerage houses found that 100% of them expected rising stocks prices over the next 12 months. And real estate? Who believed house prices would fall? Almost no one. 

While it is all very well to think happy thoughts and spend happy money, it is savings and investments that produce real jobs and real earnings. As the years go by, Squandervillians make less and less that they can sell abroad, and consume more and more from overseas. So, when they spend money, much of it goes to buy products from Thriftville. (Buffett’s term; perhaps he had Asia in mind.) The industrious people of Thriftville used the money to hire more workers, build more factories, import more technology, and improve their products. Thus, the authorities in Squanderville found themselves in a remarkable position: They could still use monetary and fiscal policy to create a boom, but that boom happened in Thriftville! 

America’s Imperial Backbone: Meanwhile, the corpus of the world financial system became even more grotesque than it had been the day before. Connecting the thigh bone of bond yields… to the hip bone of Asian purchases of US bonds… to the vertebra of credit expansion… we stood back in awe and wondered: What kind of monster was this? It looked like a creation of Frankenstein. 

The best way to understand America’s economic predicament is to look at it as a system of imperial finance. The US is an odd reluctant empire. Its body parts fit together, but only in an absurd and comical way; it’s the imperial backbone that gives it shape. Only an empire can run such a trade deficit for many years. Only an empire can maintain so many expensive outposts all over the world. Only an empire’s money will be accepted by so many people in so many different places. 

The American empire still sets the trends in fashion, arts, style and manners – but it neglects engineering, science and homeland-bound industries. And it depends on periphery states for its savings and its consumer goods. As an empire matures, its center weakens and its backbone bends. Eventually it either passes its imperial burden to a friendly power to which it becomes beholden – as Britain did to America between 1917 and 1959 – or its back breaks. 

The Mighty Fallen: The merde began hitting the fan in the summer of 2007. “We are seeing things that were 25-standard deviation events, several days in a row,” said David Viniar, CFO of the smartest financial firm in the world, Goldman Sachs. According to Goldman’s mathematical models, August, Year of Our Lord 2007, was a very special month. Things happened that were only supposed to happen about once in a blue moon. 

What went wrong? The business model seemed so pure and simple. You simply bought up subprime loans from the knaves who made them, and then you cut them up, slicing and dicing them into a kind of mortgage spam. You got the ratings agencies to bless them… and then you sold them off to naive investors. When the going was good, it looked as though no business could be better. You were providing a valuable public service, helping people buy houses they couldn’t afford by redistributing the risk from the people who incurred it to the people who had no idea it was there. And in the process you earned such large feed you would get your picture in the paper, build a huge mansion in Greenwich, Connecticut, and acquire some abominable, but very expensive, paintings to put on the walls. 

Cartoon Economies: What could go wrong? Everything… America’s largest mortgage finance companies, Fannie and Freddie, had so much water in their lungs it was announced that it would take at least $24 billion of the public’s money to save them. Were it up to us, we would have left them on the beach. Kunstler’s critique of American suburban vernacular architecture is that its produce are not real houses at all, but “cartoon houses.” They have porches that look like real porches from a distance, but they are too narrow to sit on. They have shutters, too, nailed to the wall, making them completely useless. They may have “picture” windows – looking out on nothing – or no windows at all. And they wouldn’t exist if it were not for cheap credit and cheap gasoline. 

Of course, the same may be said of America’s – and Britain’s – entire economies during the previous 20 years. The loose credit that built the houses also constructed the cartoon economies; they looked like real economies, but they were essentially perverse, consuming wealth rather than creating it.” 

- http://www.thedailyreckoning.com

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