Wealth International, Limited

Finance Digest: The Theme of Empire of Debt in a Nutshell

Note:  The rest of this week’s W.I.L. Finance Digest may be found here.


[Ed: This summary of the synopsis of Bill Bonner and Addison Wiggin’s thesis outlined in their new book, Empire of Debt: The Rise of an Epic Financial Crisis, was too long to include on our regular Finance Digest page. It is still considerably more condensed than the orignal piece!]

Watching the news is a bit like watching a bad opera. You can tell from all the shrieking that something very important is supposed to be happening, but you do not quite know what it is. What you are missing is the plot.

Let us begin by noticing that this is a comic opera that seems as though it might veer into tragedy at any moment. The characters on stage are familiar to us – consumers, economists, politicians, investors, and businessmen. They are the same hustlers, clowns, rubes, and dumbbells that we always see before us. But in today’s performance they are doing something extraordinary, they are the richest people on the planet, but they have come to rely on the savings of the world’s poorest people just to pay their bills. They routinely spend more than they make – and think they can continue doing so indefinitely. They go deeper and deeper in debt, believing they will never have to settle up. They buy houses and then mortgage them out – room by room, until they have almost nothing left. They invade foreign countries in the belief that they are spreading freedom and democracy, and depend on lending from Communist China to pay for it.

But people come to believe whatever they must believe when they must believe it. All these conceits and illusions that we find so amusing in the Daily Reckoning, come not from thinking, but from circumstances. As they say on Wall Street, “markets make opinions”, not the other way around. The circumstance that makes sense of this Strange performance is that the United States is an empire – whether we like it or not.

It must play a well-known role on the world stage, just as you and I must play our roles, not because we have thought our way to them, but simply because of who we are, where we are, and when we are. Primitive people play primitive roles. They are no less intelligent than the rest of us, but they would be out of character if they began doing calculus. They have their parts to play just as we do. Sophisticated people play sophisticated roles. They are no smarter than anyone else, but you still don’t expect them to wear bones through their noses. We, citizens of the last great empire, have our roles to play too, and the empire itself, must do what an empire must do.

Institutions have a way of evolving over time – after a few years, they no longer resemble the originals. Early in the 21st century, the U.S. is no more like the America of 1776 than the Vatican under the Borgia popes was like Christianity at the time of the Last Supper, or Microsoft in 2005 is like the company Bill Gates started in his garage. Still, while the institutions evolve, the ideas and theories about them tend to remain fixed; it is as if people had not noticed. In America, all the restraints, inhibitions, and modesty of the Old Republic have been blown away by the prevailing winds of the new empire. In their place has emerged a vainglorious system of conceit, deceit, debt, and delusion.

The U.S. Constitution is almost exactly the same document with exactly the same words it had when it was written, but the words that used to bind and chaff have been turned into soft elastic. The government that could not tax, could spend, or regulate, can now do anything it wants. The executive has all the power he needs to do practically anything. Congress goes along, like a simpleminded stooge, insisting only that the spoils be spread around. The whole process works so well that a member of Congress has to be found in bed “with a live boy or a dead girl” before he risks losing public office.

American businesses are still capitalistic. They operate, as everyone knows, in the most dynamic, free, and open economy in the world. A recent press item reports, that General Motors will never be able to compete unless it ditches its crushing health care costs. Why does it not just cut the costs? It seems to lack either the nerve or the right, but the journalist proposed a solution: Nationalize health care! Meanwhile, CEO pay has soared to the point where the average chief executive in 2000 earned compensation equal to 500 times the average hourly wage. Stockholders, whose money was being squandered, barely said a word. They were still under the illusion that the companies were working for them. They had not noticed that the whole capitalist institution had been trussed up with so many chains, wires, red tape, and complications, it no longer functioned like the freewheeling, moneymaking corporations of the 19th century. Meanwhile, corporations in China – a communist country – had their hands and feet free to eat our lunches and kick our derrieres.

The entire homeland economy now depends on the savings of poor people on the periphery to keep it from falling apart. Americans consume more than they earn. The difference is made up by the kindness of strangers – thrifty Asians whose savings glut is recycled into granite countertops and flat-screen TVs all over the U.S. But these ironies, contradictions, and paradoxes hardly disturb the sleep of the imperial race. They have permitted themselves to believe so many absurd things that they will now believe anything. In the fall of 2001, people in Des Moines and Duluth were buying duct tape to protect themselves from terrorist “sleeper cells ready to attack the Midwest.” In the fall of 2004, they believed the Chinese were manipulating their currency by pegging it to the dollar for nearly 10 years!

Like Alice, they were expected to believe six impossible things before breakfast and another half dozen before tea:

Real estate never goes down!
You can get rich by spending!
Savings don’t matter!
Deficits don’t matter!
Let them sweat, we’ll think!

We cannot help but wonder how it will turn out.

If you deny that the United States is now an empire, you are as big a fool as we were. For a very long time we resisted the concept. We did not want the United States to be an empire. We thought it was a political choice. We liked the old republic of Jefferson, Washington, the U.S. Constitution … the humble nation of hard money and soft heads; we did not want to give it up. We thought that if the United States acted as though it were an empire it was making an error. What morons we were. We missed the point completely. It did not matter what we wanted. There was no more choice in the matter than a caterpillar has a choice about whether to become a butterfly.

This was an important insight for us. Until then, all of the blustering and slapstick pratfalls on stage seemed like “mistakes”. Why would the U.S. run such huge trade deficits, we wondered. It was obviously a bad idea, the nation was ruining itself. And why would it launch an invasion of Iraq or begin a war on terror – both of which were almost certain to be costly blunders. It was as if the U.S. wanted to destroy itself – first by bankrupting its economy, and second by creating enemies all over the globe. Then, we realized, that of course, that is exactly what it must do.

We repeat, people come to believe what they need to believe when they need to believe it. America is an empire; its people must think like imperialists. In order to fulf ill their mission, the homeland citizens had to become what George Orwell called “hollow dummies”. Soon, it has set in motion a whole system of shiny vanities and illusions as distant from the truth as Pluto and as bizarre as Saturn. Americans believe they can get rich by spending someone else’s money. They believe that foreign countries actually want to be invaded and taken over. They believe they can run up debt forever, and that their debt-laden houses are as good as money in the bank. That is what makes the study of contemporary economics so entertaining. We sit at our telescopes and laugh like a divorce lawyer looking at photos of a rich man in flagrante delicto; we know there is money to be made.

Things that are unusual usually return to normal. If they did not, there would be no “normal” to return to. That is why you can expect stocks to become more expensive when they are cheap and cheaper when they are expensive. Stocks today are expensive; so are houses. These simple reversions to mean are hardly controversial. We do not know when they will happen or how, but that they will come about is practically guaranteed. More interesting to us are the reversions to other, bigger means. An empire itself is a rare thing. It is normal, but unusual. Nature abhors a monopoly. An empire is a monopoly on force. Nature will tolerate it for a while, but sooner or later, the imperial people must revert to being normal people, and the preposterous beliefs that the imperial people cherish, also must pass away.

The dollar is an extraordinary thing too. Do you know what the long term mean value of paper currency is? Well, it is zero. That is what the average paper currency is worth most of the time … and it is the black hole into which all paper currencies in the past have gone. There could be something magic about the dollar that makes it unlike any paper currency in the past – that is, something that makes it non-mean reverting. But if anyone knows what it is he is not working on this book.

Beliefs give us a clue to the larger cycles. People must play the roles that have been thrust upon them. They are bullish near the end of a bull market; they are bearish near the end of the bear market. If it were otherwise, the market could never fully express itself. If investors grew suddenly cautious while nearing an epic bull market peak, they would sell their stocks, and the peak would never be reached. Or suppose that after several years of soaring house prices homeowners came to believe that housing prices would fall? How could you have a proper housing bubble? How can you have a rip-roaring party without anyone getting drunk, in other words? How can people make fools of themselves if they are unwilling to get up on the tables and dance?

These are deep philosophical questions. But they help us recognize where we may be in the cycle. As prices reach a loony excess, peoples’ ideas grow loony too. Ergo, the loonier the ideas the more likely it is that a turning point is near; the wilder the party, the more likely someone will call the gendarmes. We also suspect that attitudes evolve similarly in an imperial cycle, during which a country’s economic, financial, and military power runs up over several generations and then declines. At the peak, the imperial people come to believe that their system is superior, that their values are universal, and that their way of life will inevitably dominate the entire world. Readers will recognize these attitudes in a famous article by Francis Fukayama, written after the fall of the Soviet Union, in which he suggested that the world may have reached the “End of History”. It was the end of history because the American system had triumphed – no improvement seemed possible. Fukayama’s idea was not original. Hegel and Marxist intellectuals had proposed the same thing more than a 100 years earlier: With the victory of the proletariat, no further advance could be made.

Hegel stopped ticking. Marx died, too. History continued. But when people feel they are on top of the world, they begin to take things for granted that they previously thought absurd. As we mentioned earlier, Americans now depend on the savings of Communist China in order to pay for their lifestyles … and their wars to make the world safe for democracy. They do so without thinking. Subconsciously, they have come to believe what imperial people always seem to believe – that their society is so superior, that the rest of the world longs to be just like them or is inevitably drawn to become like them, whether they like it or not. That is the premise behind the billions of dollars Americans are investing in China. A few years ago if someone had suggested that they invest in a communist country they would have thought the person mad. China is still run by veterans of various “great leaps forward”, but Americans are convinced that they are all leaping to become just like us – capitalists and democrats at heart! So vain are we that we cannot imagine anyone wanting to be anything else.

How did America become an empire? There was never a debate on the subject. There was never a national referendum. People do not choose to have an empire; it chooses them. Gradually and unconsciously, their thoughts, beliefs, and institutions are refashioned to the imperial agenda. While no one noticed, the imperial weed put down roots deep in the soil of North America. By the early 21st century, hardly anything else grew; it had completely crowded out the delicate flowers planted by the Founding Fathers. The debate surrounding the invasion of Iraq was an imperial debate – about means and methods, not about right and wrong or national interest. No one from either major political party bothered to suggest that the U.S. had no business nosing around in other peoples’ business. Once the nation had become an empire – with a homeland and wide-ranging interests beyond it – almost all wars seemed appropriate.

A landmark in the history of the American empire came on August 15, 1971. That was the day that Richard Nixon severed the link between the imperial currency and gold. Thitherto, empire or no, the U.S. had to settle its debts like other nations – in a currency it could not manufacture. Henceforth, the way was clear for a vast increase in empire spending … and debt. Thus we arrive at the real problem for the American empire. It has by far the strongest military in the world. It has no serious challengers beyond its borders. Hence, it had to become its own worst enemy. All empires must pass away. All must find a way to destroy themselves. America found debt. The traditional method of empire finance is so simple even a Mongol barbarian could master it. Nations are conquered and forced to pay tribute. The homeland is supposed to make a profit; it is supposed to grow richer compared to the vassal states. But here, America fell victim of its own scam. Pretending to make the world a better place, the U.S. could not very well require the poor nations it conquered to pay up. Instead, it had to borrow from them.

This was not a problem in the early days. But in the 1970s, the U.S. trade balance turned negative. By the year Alan Greenspan took over at the Fed, foreigners owned more U.S. assets than Americans owned foreign ones. American factories had grown old and expensive. American workers were paid too much. American businessmen invested too little in training and new capital equipment. The whole nation developed an attitude more in harmony with an empire on the decline than one that was still rising. The imperial people chose to spend rather than to save, and to hallucinate, rather than think hard. They demanded bread and circuses at home; let the Asians sweat abroad.

There are 3 billion people in Asia. And almost every one of them is willing to work for a fraction of the average American wage. Not only that, they tend to save their money, rather than spend it. The savings rate in China, for example, is said to be nearly 25%. In America, it is near zero. Globalization and artificially low interest rates in America have allowed Asian industries to flourish. But for every dollar earned by an Asian exporter, 6 cents in debt is added to America’s heavy balance sheet.

Things happen that no one particularly wants or especially encourages, and the average man goes along with whatever humbug is popular – with no real idea where it leads or why he favors it. Each person plays the role given to him; everyone believes what he needs to believe to play the part. Alan Greenspan was famously against paper money that was not backed by gold when he was a libertarian intellectual. When he became a government functionary, his views conveniently changed. He came to believe what he had to believe in order to be the head of the American empire’s central bank: the Federal Reserve. The empire needs almost unlimited amounts of credit to carry out its foreign wars, while making bread and circuses available at home. Alan Greenspan makes sure it gets it. Expensive foreign wars, expensive bread, expensive circuses … these are, of course, what bankrupted almost every empire from Rome to London. But that is just the point: institutions play their roles, too.

Americans could cut their military budget by 75% and still have the biggest, most advanced army in the world. They could trim their household spending by half, and still live well. They could drive less in smaller cars, they could cease mortgaging their houses, they could “make do” with last year’s clothes and yesterday’s laptop, but how could they ruin themselves if they put on the brakes before getting to where they are going? Alan Greenspan’s easy money policies – the Fed has been lending money at a rate at or below the level of consumer price inflation for more than two years – do not merely lure Americans to borrow and spend, they also grease the skids of history, permitting one empire to slip away while another slides in to take its place.

Were it not for Greenspans low rates, Americans would not have found it so alluring to spend. Were it not for Greenspan’s low rates, they would not have bought so much from Asian manufacturers, the Asians would have made less money and would have built fewer new factories and trained fewer new workers. Were it not for Greenspan’s lending policies, in other words, Asia would not have grown so quickly and would not now pose such a competitive threat to the rest of the world’s industries. In today’s paper for example, a headline tells the tale: “China joins global race for fastest computers: Beijing and Tokyo aim at a new barrier to overtake U.S. lead”.

And Americans would not owe Asians so much money. Asians now own enough U.S. dollar assets to buy a controlling interest in every company on the Dow. They have enough T-bonds to destroy the U.S. economy on a whim. Their economic power is growing at 3-5 times the GDP rate of Western nations. So far, they have shown little interest in political power; that is for a later stage of the cycle … another role for another time. None of these insights are new or original. Most Americans have heard these things. Longtime readers of our Daily Reckoning have heard them so often they look for exits when they see your authors coming.

But while people know these things to be true, they do not really believe them. They believe what they need to believe in this late, degenerate stage of the empire. That is, they believe in sloppy fantasies. “The U.S. economy is still the most dynamic and flexible in the world,” they tell each other. “We’re the most creative, inventive people on the planet,” they congratulate themselves. “We’ll invent new businesses. We’ll think of something!” These vague expressions of faith are probably typical for an advanced empire. The Romans, even to the time of the last emperor, when the Barbarians appeared before the city walls, most likely told each other: “We’ll beat them again this time; we always do!”

You never know where you are in the cycle until it is too late to do anything about it. For all we know, we could be facing merely a temporary pullback in what is still a long-term bullish period for the American empire. We have mentioned how present American attitudes seem more in keeping with the end of a great empire than the beginning of one. In addition to that, the math of it makes us think we are closer to the end than the debut. The U.S. military budget and the indirect costs of its own consumerist excesses – another $700 billion or so per year in trade deficit – together represent a cost of empire of more than 10% of GDP … more than $1 trillion each year. Instead of collecting tribute, the U.S. finances these costs by borrowing.

Here, Alan Greenspan and the paper dollar were immensely helpful. There is no theoretical limit to the amount of debt that can be taken on. The problem is a practical one. The dollar must maintain a reasonable value or lenders will be unwilling to lend. Dollar loans must also pay a reasonable amount of interest. With $36 trillion in loans outstanding, even at 5% interest, that represents annual debt service payments of $1.8 trillion. Who has got that kind of money? Not Americans. They are already spending every penny. And the more they spend, the less money they have left to pay interest. All they can do is to refinance – taking on new debt in order to pay the interest on the old debt. We will not dwell on this, as it is obvious even to an economist that it cannot go on for very long.

Real estate prices in Rome began a downturn in the year AD 300 or so (this we do not know for a fact, it is just a good guess). They did not stop going down until 1,000 years later … in the Renaissance … or maybe later. Even as late as the 18th century, sheep were grazing where the Forum used to be. The belief in the American empire – in American cultural, political, social, and economic superiority – must also be crushed out somehow. That is the likely next phase … the degenerate stage of empire … which could last 100 years or more.

We do not know what stage the American empire has reached, but we look around and see so many degenerate and absurd things, we guess: We must be nearer the end than the beginning. How will it end? What will happen next? We do not know, but we note that people do not give up their self-serving conceits and illusions readily. They hold on to them as long as possible. “America still has the greatest, most dynamic economy on earth,” they tell themselves, even as the nation loses money (its income is less than its expenses). This kind of madness is hard not to like; it is like an aging woman who thinks she becomes more fetching with each passing year. The gap between perception and reality grows wider every day, until finally, the mirror cracks.

What will shatter America’s confidence is probably a combination of financial crises. The dollar is vulnerable. So are Treasury bonds. So are stocks and house prices. Which one will crack the mirror is anyone’s guess. Our guess is that house prices will stop rising, causing a cutback in consumer spending. This will send the U.S. economy into recession … probably a long, soft slump that will take down house prices and the stock market, but leave the dollar and bonds with little damage. Long suffering readers will find this forecast familiar. It is the same one we made two years ago in another book called Financial Reckoning Day. We thought then that the tech bubble would blow up, resulting in a long, soft slow slump, à la Japan. Whether we were wrong, or just early, only tomorrow’s newspapers will tell. Instead of a real slump, the United States has had a 9-month phony recession (in which consumer debt actually expanded) and a phony boom since (in which consumer debt actually expanded).

If we were sure of this forecast we would buy bonds. Since we are unsure, we buy gold. In the coming real slump, assets of all sorts are likely to be marked down – especially those with a debtor on the other side of the transaction. Gold is what people will buy when they start to wonder about the empire … and its money. We guess that they will begin to wonder more and more.

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