Finance Digest for Week of November 21, 2005

DANGERS OF A RUNAWAY MORTGAGE MARKET

The long-awaited slowdown in the U.S. housing market is upon us. So far the deceleration is a long way from a car wreck. Housing sales and housing prices are still projected to climb in 2006, just not as fast as in 2005. But over-revved markets generally crack up rather than slow down gracefully: They have built up too much momentum to handle a change in direction without at least a bang against the guardrail.

Adding to the odds of a crackup is the very peculiar nature of the investment market for mortgages. Right now, there is a huge disconnect between the folks who are making the mortgage loans and the investors who ultimately wind up owning the mortgages. The mortgage lenders who know individual mortgage borrowers the best – and the risk they do or do not represent – are selling their riskiest mortgages. The investors who buy them know nothing about individual borrowers and are relying upon the magic of the Wall Street derivative market for risk protection. Sound like a car wreck waiting to happen? Let me explain how the wonders of Wall Street financial engineering have put conservative financial institutions such as insurance companies and pension funds in the path of the runaway mortgage market.

First, the obvious: The signs of a slowdown in the U.S. housing market are everywhere. You do not have to work too hard to figure out why the housing market is slowing down. The supply of home buyers is not infinite, and every time housing prices go up, the supply of buyers shrinks a bit. But mortgage rates for a 30-year fixed loan hit 5.2% in June 2003, expanding the pool of potential buyers who, at such a low rate, could afford to buy houses even at inflated prices. But mortgage rates have been on the rise lately, climbing to 6.5% on average, the highest level in more than two years. And rates are expected to keep climbing into 2006.

Mortgage lenders have fought back against rising prices and rising mortgage rates with all kinds of mortgage products designed to make it possible for more buyers to take on more debt and still, hopefully, meet their monthly payments. One of the riskiest mortgage types, the option adjustable-rate mortgage, was among the fastest-growing type of mortgage in the first half of 2005. Option-adjustable-rate mortgages give the borrower the option of making payments that pay interest and principal, that pay just interest, or that pay less than the interest due each month. That last option actually increases the amount the borrower owes on the mortgage.

And, most recently, the mortgage industry has promoted low- or no-documentation mortgages for buyers who might not qualify for a mortgage if they had to reveal information such as the size of their income or the level of outstanding debt. Low- and no- documentation mortgages made up 46% of all non-Fannie Mae and Freddie Mac mortgages in the first eight months of 2005, according to LoanPerformance, a mortgage industry risk analysis company. In 2000, such loans made up 28% of that market.

All the risky mortgage schemes are not a problem as long as home prices keep climbing and as long as interest rates are steady or falling. But that has all changed recently. Home prices have started to level off and some industry experts predict that prices will fall in 2006. Interest rates on the 10-year Treasury note, the benchmark for many adjustable mortgages, have climbed to 4.6% from 4% in June 2005. Higher energy prices make any increase in monthly mortgage payments even more of a strain on the family budget.

All this creates a ladder of risk that begins with the individual home buyer/mortgage holder on the lowest rung and climbs toward the top rungs of the global income markets. The risk for the individual homeowner, of course, is default on that mortgage because higher interest rates lead to higher mortgage payments. Add enough individual mortgage defaults, and the mortgage banks that made the riskiest mortgages start to feel the pain.

But recently the risk has not stayed with the mortgage banks making the loans. Countrywide Financial (NYSE: CFC) sold 80% of the option- adjustable-rate mortgages it originated in the third quarter to other parties. Countrywide Financial is not alone in this policy. These mortgages are being sold to institutional investors in the form of a derivative called a collateralized debt obligation, or CDO. CDOs, managed by Wall Street investment shops, include a mix of bonds and other fixed-income assets. Increasingly those pools include mortgage-backed securities, which are batches of mortgages originated by a lender and then purchased and packaged for resale by Fannie Mae. In theory, these pools of mortgages are less risky than the individual mortgages themselves. But in practice, that almost certainly is not true today. Lenders that know these mortgages best are packaging and selling their riskiest mortgages. Worse, these are exactly the products that the mortgage lenders know the least about because most are new products with very limited track records. No one knows very much about how they will behave if times get tougher for borrowers.

It is hard to predict the behavior of a pool of any kind of mortgages when interest rates are moving - in either direction. If rates go down, mortgage holders refinance and prepay their mortgages. If interest rates go up then the default rate for these adjustable mortgages will rise. As you might expect, hedge funds have been among the main buyers of these packaged risky mortgages. But they have not been the biggest players. That honor goes to European and Asian insurance companies, pension funds, and banks. With yields so low in Europe, the lure of the U.S. mortgage market has been impossible to resist. Those higher yields will be little comfort if the risk in this market turns out to be higher than the buyers of these pools of mortgages expect. It is never a good sign when the folks that know an asset best are selling.

With real estate, this time it really is different.

As evidence mounts that the real estate boom has finally peaked, most economists, analysts, and industry professionals continue to predict simply a slowing of price increases, or perhaps, modest price dips. Apparently they have taken comfort from the irrelevant fact other than during the “Great Depression” there has never been a year in which national real estate prices declined. While this ignores significant national price declines in other wealthy nations, as well as several noteworthy regional declines in the U.S. itself, it ignores the unprecedented run up in prices and credit excesses of the last six years. In fact, when it comes to real estate, this is one of the rare examples where this time it really is different.

Historically, national housing prices have increased no faster than the annual rate of inflation, as measured by the CPI. Though recent changes to that index, and several short-term anomalies, have resulted in the CPI underestimating inflation, the recent run up in real estate prices is still unprecedented even if one assumes inflation is double the official estimates. To expect the pendulum to swing so far in one direction, without completing a equal move in the opposite, is a leap of faith as extraordinary as the bubble itself.

To understand why the current real estate market is different, one must examine the unique circumstances that produced the bubble in the first place. Historically, many factors have combined to keep national real estate prices in check. However, due to a confluence of events, those traditional restraints have been temporarily removed, making the unprecedented price increases experienced during the last six years possible. To their own hazard, the public has largely accepted arguments from partisan real estate boosters justifying absurd prices as resulting from legitimate market fundamentals. However, as those restraints gradually return, and true market fundamentals reassert themselves, a price collapse is inevitable.

The recent run-up in home prices began during the latter stages of the 1990s stock market bubble, and kicked into high gear almost precisely when that bubble began to deflate. It is not without coincidence that the speculative fever born in the stock market mania seamlessly found new life in real estate. However, were it not for the irresponsible actions and omissions of the Federal Reserve, the Federal Government, Wall Street, and the mortgage industry itself, such speculation never could have produced the unprecedented national bubble just experienced. The following is a list of those traditional safeguards that prevented national real estate bubbles from forming in the past, the abandonment of which has made this historically unprecedented bubble possible.

In the final analysis the temporary factors artificially elevating real estate prices will subside. Rising interest rates and inflation, and a resumption of savings as home equity fades, will combine to suppress consumer spending, leading to recession, job losses, and reduced demand for housing. The supply of unsold houses will continue to rise as higher interest rates, tighter lending standards, and higher down payments price more potential buyers out of the market. Without the expectation of routine cash-out refinancing, homebuyers will no longer be willing to devote staggering percentages of their incomes to mortgage payments. In addition, the expectation of lower prices will bring more sellers to the market, just as buyers are backing away.

Once the trend reverses, falling prices will purge speculative demand from the market. Once speculators become sellers, supply will overwhelm demand. As lenders see housing prices fall and inventories rise, increased default risk will result in tighter lending standards, restricting access to mortgage credit. As more mortgages go into default, the secondary market for mortgage backed securities will dry up as well. This will act as a self-perpetuating, vicious cycle, as tighter lending standards reduce housing demand, leading to lower home prices, more defaults, fewer qualified buyers, lower prices, tighter standards, ad infinitum. In addition, the collapse of consumer spending associated with higher mortgage payments and vanishing home equity, will plunge the economy into a severe recession, further exacerbating the collapse in real estate prices, worsening the recession, and continuing the vicious cycle.

The housing mania, like all manias that have preceded it, is finally coming to a long overdue end. Time tested principles of prudent mortgage lending will inevitability return, and houses will once again be regarded merely as places to live. However, the country will be a lot poorer as a result of the unprecedented dissipation of wealth and accumulation of consumer and mortgage debt which occurred during the bubble years. Before real estate prices can return to normal levels, they will first have to get dirt cheep. It has been a wild party, but in the end all that will remain is a giant hang-over.

Housing speculators retreat.

Lisa Tershak is offering to pay $5,500 in cash to anyone who buys her 3-bedroom house in Leesburg, Virginia, near Washington. She has reduced the investment property’s asking price five times since July to $464,900, not far from the $450,000 she paid for it in March. “There’s too much inventory,” says Ms. Tershak, 35. “Everyone felt the bust coming and decided to dump their properties at the same time.” Investors who helped fuel the U.S. housing boom by bidding up prices are now so desperate for buyers that some are offering cash bonuses in such markets as Washington.

Inventories of unsold single-family homes are near a 17-year high as demand from speculators has waned and mortgage rates have risen from a four-decade low reached in 2003. “We’re at the turning point,” says Susan Wachter, professor of real estate at the University of Pennsylvania in Philadelphia. “We’re all hoping for a flat market, and not a plummeting market.” That would be welcomed by Federal Reserve policy-makers as a sign that they are succeeding in slowing the economy to a sustainable pace of growth, said Dean Maki, chief U.S. economist at Barclays Capital in New York. “We have seen a 65 basis-point rise in mortgage rates over the last nine weeks, and this does appear to be starting to slow mortgage purchase applications,” Mr. Maki says. The Fed has raised interest rates 12 times in the past year and a half.

The average rate for a 30-year fixed mortgage, at 6.37%, has risen for 10 straight weeks, according to Freddie Mac, the second-biggest purchaser of U.S. mortgages. Applications for loans to purchase real estate are down 12% from the record set in June, the Mortgage Bankers Association reports.

Investment buying accounted for almost a quarter of U.S. home transactions last year, according to the National Association of Realtors. Investment-home purchases rose 14% to 1.8 million in 2004 from 1.57 million in 2003. The group does not have 2005 figures. David Berson, chief economist at Fannie Mae, said declining demand from speculators will help slow home sales to an annualized 6.77 million this quarter from a record 7.24 million in the third quarter. The falloff in demand is already being felt in regions such as Las Vegas, the fastest-growing housing market in the U.S. a year earlier. “The mom-and-pop investors are unloading their properties,” says Greg Sullivan, a partner in Cash Now Vegas LLC, a Las Vegas company that buys homes from investors and resells them. “When home values were going up $10,000 a month, everyone wanted in. Now, all those properties are sitting empty.” Nationwide, home sales probably will decline in every quarter of 2006, Mr. Berson said.

Lyle Gramley, a former Fed governor who is now senior economic adviser at Stanford Washington Research Group in Washington, says market forces played a larger role than speculation in pushing up home prices. Prices rose because of economic growth, low interest rates and a shortage of building lots in some markets, he says. “When fundamental factors drive prices up, it certainly does encourage speculation and more buying by investors,” Mr. Gramley says. “And when the froth begins to come out of the market, those are the first people who run for the hills.”

October housing starts fell to 2.01 million at an annual rate, from 2.13 million the previous month. Some experts say home prices in previously hot markets such as Boston and Washington will fall in 2006. Mr. Gramley foresees “declines in home prices of maybe 10, 15 or 20 percent on both coasts on a year-over-year basis. … The economy can take that. It won’t cause a major problem, but we don’t know if it will stop there.”

Housing Market “Street Smarts”

As you mull over the MapQuest printout detailing how to get to grandma’s house this Thanksgiving Holiday, do not be surprised if part of the directions read as follows: Go north 9.6 miles on “To Be Announced Lane”, turn right onto “Still Sitting On The Fence Drive”, travel approximately 1.7 miles, road intersects with “It’s Down To Three Avenue”, turn left and travel 0.18 miles to final address. The 5-year long housing boom in America has also brought about a boom in the building of byways and back ways – new streets paved to reach the new subdivisions made, turning the surface of the U.S. into a virtual plate of spaghetti.

As it were – those in charge of such a task are running out of names for the noodles. A November 19 Wall Street Journal fills in the details: According to the U.S. Postal Service, the real estate explosion has “created more than 200,000 new streets in the past two years, and developers deciding what to call them are running into some road blocks.” Aside from having to be pronounceable, original, memorable, and tasteful – now, county planners are under added pressure from real-estate agents to create names that are also “psychologically” pleasing.

According to the little research that has been done on the matter, a “phenomenon” exists whereby a more “prestigious”, or “sweet” sounding street can “sell a home even if it sits near a busy interstate.” Constant blaring horns and screeching brakes? So what so long as you live off “Bubbling Brook Boulevard”. In the words of one Florida real estate agent: “There is a lot at stake. Street names affect home prices.” And, as the telltale signs of a cooling housing market pop up across the country, the importance of having a street name that “reflects the value” (or at the very least, embellishes the true value) of the homes lining that street has become a number one priority among planning commissioners, developers, and residents alike.

Call it what you want, though – High On The Hog Road OR Hard Up Circle – the only name that will affect real change in the housing market is the pattern unfolding in mass social mood. Point of fact, in the March 2005 Elliott Wave Financial Forecast, we noticed a downturn in collective psychology as reflected in the wave pattern underway in stocks and various housing indexes. Because of this, we foresaw the following events for the next phase of the housing market: “Demand wavers, supply spikes higher and sellers hold out for higher prices and sell at lower prices.” Sound familiar?

Bottom line: the real “street” smarts involving the long-term trend changes in store for the U.S. housing market ARE not in the name.

ASIAN COMPLACENCY

Back in Asia for the second time in a month, I have heard two recurring (and related) themes – amazement at the ever-resilient American consumer and astonishment over the dollar’s strength. This fixation only reinforces my conviction that an externally focused Asian economy remains very much a levered play on U.S. demand. Consequently, it would be a big deal out here in Asia should the terms of engagement with the U.S. change – through either a shift in demand or a swing in relative prices (i.e., currencies). In my view, that is precisely the risk that looms in 2006.

Currency fluctuations have long been one of Asia’s biggest wildcards. That is very much the case again in 2005 – largely due to the surprising strength of the U.S. dollar. After nearly three years of declines from early 2002 through late 2004, the greenback reversed course this year. Many of Asia’s dollar-pegged currencies have followed suit – especially the Chinese renminbi (RMB) but also the currencies of Korea, Thailand, Malaysia, Singapore, and India. The Japanese yen has been a striking exception to this trend, having weakened by 14% against the U.S. dollar since early 2005. A continuation of this counter-trend rally by the dollar could pose a serious problem for Asia. Lacking in solid support from internal demand, Asia needs super-competitive currencies to keep its export machine running. To the extent the dollar’s surprising strength drags Asian currencies along for the ride, that could prove troubling for the region’s growth outlook.

In recent years, China’s increasingly powerful export machine has turned the Chinese economy into an engine of pan-Asian trade. China draws heavily on imports from its neighbors to provide inputs into Asia’s increasingly China-centric export platform. A dollar-led strengthening of the RMB actually boosts China’s purchasing power of such foreign made components. In the end, however, China’s export prowess is balanced on the head of a pin – a pin made in America. Fully 35% of all Chinese exports go to the U.S. Should U.S. domestic demand falter – hardly idle conjecture for an over-extended American consumer that looks exceedingly vulnerable to the twin pressures of an energy shock and a possible bursting of the housing bubble – China would quickly be in trouble. A faltering of Chinese export demand would deal a serious blow to the rest of Asia. That would be especially the case in Japan, Asia’s newest and possibly most exciting recovery story.

While the U.S. dollar has continued to strengthen in recent weeks, Asia should not count on a continuation of this trend. A weaker dollar and higher interest rates should finally allow the U.S. to turn the corner on its massive current-account imbalance. A renewed decline in the dollar underscores another risk that Japan could face – a reversal of the recent depreciation of the yen. A decoupling of the yen from other Asian currencies in 2005 has provided an important prop to the nascent recovery of the Japanese economy. Yet if Japan’s recovery is for real, then there is no overriding reason why its currency should continue to sag. That is especially the case given Japan’s outsize current-account surplus.

Asia is the most currency-sensitive segment of the global economy. That was a painful lesson from the Asian financial crisis of 1997-98 and is still very much the case today. And it is especially the case for the region’s two export powerhouses – China and Japan. If the U.S. dollar strengthens further and Asia’s dollar-linked currencies continue to follow suit, the region’s export-led growth dynamic could be in trouble. If the dollar resumes its decline, as I suspect it will, those pressures would be tempered. China, however, could be an important exception. If its currency stays tightly linked to a weaker dollar, an increasingly competitive RMB may well be the breaking point for Washington’s protectionist-prone politicians. That slippery slope should be avoided at all costs.

Asia is relatively carefree these days – riding the waves of U.S.-centric global growth and benefiting from the strength of China and a nascent recovery in Japan. It is as if nothing could go wrong. Such complacency is always worrisome – especially for a region that remains so heavily dependent on others for its economic sustenance.

Hardly a Flat World

I always travel a lot, but recently it has been off my charts. I am just winding up the second of two spins around the world in the past month. I long ago decided that you cannot do global economics by sitting at your desk in New York and reading the FT. There is no substitute for the first-hand impression – in this case, globalization by immersion. I give Friedman a lot of credit for bringing globalization to the masses (see his The World Is Flat: A Brief History of the Twenty-first Century, 2005). But to me, “flat” just does not cut it in today’s world. Yes, IT-enabled connectivity has shrunk the world in many new and important respects. But the world is struggling mightily with what this connectivity has brought.

China and India are reshaping the global economy as never before. The 40% of the world’s population that lives in these two countries is only just getting a taste of economic prosperity. Not surprisingly, these two behemoths have big appetites and are pushing ahead rapidly with very different development models. China has done it the manufacturing way catering to external demand, whereas in India it has been more of a services and internal consumption story. The theory of globalization teaches us that this is a “win-win” development. As the Chinas and Indias enter the global economy, they provide cheap goods and now services for the rest of the world, while, at the same time, they create a new class of consumers that will buy things made in developed countries. Who could ask for more?

My travels tell me that the theory is not working as advertised. Globalization may well be win-win in the long run, but in the here and now it is profoundly asymmetrical. It has given rise to a multitude of new entrants on the supply side of the global equation but very few new consumers on the demand side. With the important exception of India, Asia remains very much an external demand story – aiming its rapidly growing production platform at providing stuff for the overly-indulgent American consumer. Two numbers say it all: In 2004, Chinese consumption fell to a record low of 42% of its GDP, whereas America’s consumption share held near a record 71%. With 35-40% of Chinese exports going directly to the U.S., there can be no mistaking the dichotomy of the roles played by the rich and the wannabes. With the rest of Asia now increasingly integrated into a China-centric supply chain, the region remains far more skewed toward U.S.-centric external demand than internal consumption. With per capita spending of only about $400 per year, India’s global impact remains trivial at this point in time.

But the asymmetries of globalization have an equally profound effect on the other side of the ledger – on workers in the rich, developed world. Over the past five years, industrial world labor markets have suffered from both jobless and now wageless recoveries. The U.S., with the world’s most flexible labor market, has been on the leading edge of these trends. While hiring has picked up over the past 24 months, the private sector job count remains more than 10.5 million workers below the profile that would have been generated by a more typical hiring cycle. Moreover, the inflation-adjusted hourly pay rate is virtually unchanged over the 46 months of this recovery – underscoring the rare confluence of surging productivity growth and stagnant real wages. At the same time, structural unemployment remains a serious problem elsewhere in the developed world – especially in both Europe and Japan. And make no mistake – workers in the developed world are far from pleased over this outcome and the global context in which it has arisen.

The Internet has not only revolutionized the logistics of supply-chain management in manufacturing but has also transformed once non-tradable, information-based activities such as software programming, engineering, design, accounting, lawyers, medical, and financial analysis into tradables. In an era increasingly dominated by the ultimate disruptive technology, the distinction between tradables and nontradables has become blurred. Employment and real wage compression in the developed world is a direct outgrowth of this blurring – and so is the politics of the labor backlash it has spawned. The hyper-speed of an increasingly asymmetrical globalization is hardly the stuff of a flat world.

I have not come to this critique of globalization casually. It fits all too well with the intelligence gathering that occurs on these global jaunts. As I speak with businesspeople, government officials, investors, and political leaders around the world, I am struck by one thing these seemingly diverse groups all seem to have in common – they recognize the unexpected pitfalls of globalization but they have no plan as to how to repair the damage.

Meanwhile in the Mid-East: Unlike the oil shocks of the past, which gave rise to the concept of the “petro-dollar” – a recycling of windfall oil revenues into dollar-denominated assets – the current windfall accrues to a Middle East that is much better prepared for inward re-investment. Take a look at year-to-date returns in the stock markets of the region’s major oil producers – Saudi Arabia (+96%), UAE (+179% in Dubai and +85% in Abu Dhabi), Kuwait (+84%), Qatar (+77%), and Bahrain (+32%). Also take a look also at the urban construction boom – Dubai is starting to look Singaporean in scale. Unlike the 1970s when petro-dollar recycling was a necessity for a region that had few internal options, today there is a far richer menu of inward options to absorb the current surge of oil revenues – a conclusion that should not be lost on dollar bulls. And make no mistake, the asset allocators in the region are also very nervous about the dollar implications of America’s gaping current account deficit.

Meanwhile, back on the home front, China bashing still has considerable support in the U.S. Congress. President Bush’s just completed mission to Beijing did not change that one bit, in my view. If anything, it served as a very vivid reminder of the wide gulf between the two major engines of the world economy – the Chinese producer on the supply side and the American consumer on the demand side. In a flat world, these two engines would be working together in near perfect harmony. In today’s world, they are like passing ships in the night – cruising full speed ahead on their own journeys in increasingly choppy seas. Globalization at this point in time is far more about disparities between nations than the assimilation of a flat world.

ETERNAL SUNSHINE OF THE THOUGHTLESS MIND

Under Ronald Reagan, Americans thought they had rediscovered their youth. They could not remember ever feeling more confident or more optimistic. Then, 12 years later, in George W. Bush, Republicans thought they saw their hero reincarnate, with another 20 years of prosperity ahead. And why should it not be morning in America again?

We answer the question directly. It is not morning in America because it is evening. There is no bull market because there is a bear market. People are not getting richer because they are getting poorer. It is not 1981 because it is 2005. Readers who find this an unsatisfying explanation are reminded that it is not your authors who set the planets in motion around the sun and created man – such as he is – out of the dust of the earth. Morning often looks a lot like evening – if you face the wrong way at the right time. But it is the opposite end of the day’s cycle.

In 1982, interest rates were high and stock prices were low. In 1982, there were a few people who wanted to buy stocks, and many who did not. In 1982, America, Inc., looked like a has-been economy. Its currency was widely considered near-trash and its bonds were described as “certificates of guaranteed confiscation”. You could buy nearly the entire Dow for just one ounce of gold. Now it takes 22 ounces. The trend of the time, in 1982, was down. Then, as now, smart people considered it eternal. BusinessWeek proclaimed that equities were not just in a cyclical downturn, not just sick, but dead. As the moon looked down in the summer of 1982, it shone on a wall of worry so high that only a knuckleheaded contrarian would think of climbing it. Every headline seemed to give another reason the bear market would last forever. Every poll showed that consumers expected it. Every price seemed to confirm the everlasting trend; the sun had set forever; the black of night was permanent.

And yet, at that very moment, had an investor turned around, he would have noticed a brightening in the eastern sky. Over the next 18 years, the sun rose higher and higher, until investors were so encouraged by the favorable growing conditions that they scattered their seed like confetti at a parade. Did anyone doubt that it would take root in the hard concrete of lower Manhattan’s financial hothouse or the thin soils of the technology sector?

But the year 2005 is everything the year 1982 was not. Today, there are many people who want to buy stocks and few who do not. Interest rates are nearly as low as they have been in half a century and stocks are as high as they have ever been. Consumers – who were relatively reluctant to spend in 1982 – pick their own pockets today. The latest figures show consumer spending increasing at five times the increase in wages and salaries.

Can these sunny trends continue forever? They never have before. And no theory of economics explains how they might. Instead, the typical pattern is for night to follow day. It is also typical for the dumb things people did when they were feeling flush to be corrected by recession and bear markets. There is one more big difference. … Foreigners have been hot for U.S. assets for years – an attitude we have come to count on, because we need $2 billion in capital inflows every day to cover our foreign-trade deficit. What happens as they cool off again? Of course, they will cool off. Americans cannot expect foreigners to support them indefinitely. Someday, perhaps soon, they will realize that their main customers cannot pay their debts; they will get tired of lending to them. Then, the long, dark night will begin. It will not last forever…

Let us take a moment to stand back and gaze at America’s great Empire of Debt. It is the largest edifice of debt ever put up. It sustains the most magnificent world economy ever assembled It supports more people in better style than any system ever before devised… By the opening of the 21st century, Americans were spending more than they earned. Each day brought more new debt than real new wealth. Yet, between 2002 and 2005, every quarter showed growth in GDP. Americans mistook this growth for progress.

Without a theory, F. A. Hayek might have said, the facts are as mute. But by the year 2005, both facts and theories had become blabbermouths. The trouble was that the facts had been corrupted so they no longer told the truth. And the old theories that might have been used to interpret the facts had been abandoned in favor of new, more convenient delusions. Americans could now run up as much debt as they wanted, said the new theorists. The American economy may or may not be “growing” in 2005. But if traditional, time-tested theories about how wealth and poverty are correct, thank God it is not growing more. Every step it takes moves it deeper into debt and closer to bankruptcy.

Torture, Abuse and Deception

Let us take a moment to stand back and gaze at America’s great Empire of Debt. It is the largest edifice of debt ever put up. It sustains the most magnificent world economy ever assembled. It brings more wealth to more people than any system ever before devised. Not only is it incomparably effective, it is also immeasurably entertaining. … The Roman Empire rested on a classical model of imperial finance. Beneath a complex and nuanced pyramid of relationships was a foundation of tribute formed with the hard rock of brute force. America’s empire of debt, on the other hand, stands not as a solid pyramid of trust, authority, and power relationships but as a rickety slum of delusion, fraud, and misapprehension.

Thus the foundation of the debt pyramid is laid down in a bed of mutual deceit and cupidity, and covered with another level of fabrications. Lenders do not stick around to see how the loans work out. Instead, they pretend the credits are good, and package the mortgages into convenient units so that investors can buy them. The financiers know damned well that many buyers cannot really afford to pay for the houses they buy, but they see no point in mentioning it. Nor do the investors want to know. They are in on the scam, too. The smartest of them even have figured out how it works: The Fed holds down short-term rates below the inflation rate so that investors in long-term mortgage financing and buyers of U.S. Treasury obligations can make an easy profit.

Further up the steps of imperial debt are whole legions of analysts, economists, and full-time obfuscators whose role is to make us all believe six impossible things before breakfast and a dozen more before dinner. Quack economists at the Bureau of Labor Statistics do to numbers what guards at Guantanamo did to prisoners. They rough them up so badly, they are ready to say anything. This abuse of statistics is what allows Americans to deceive themselves about their own economy. It is healthy, they say. It is growing. It is stable. All these so-called facts are little more than elaborate prevarications.

Economists, commentators, and policymakers take up these distortions and add their own twists. It is obvious to anyone who bothers to think about it that an economy that spends more than it earns is in decline. But try to find an economist willing to say so! … They will tell you the economy is expanding, but it is an expansion similar to what happens when a compulsive eater escapes from a fat farm. The longer he is on the loose, the worse off he becomes. In fact, the story of international trade, circa 2005, is the most preposterous tale economists have ever heard. One nation buys things that it cannot afford and does not need with money it does not have. Another sells on credit to people who already cannot pay and builds more factories to increase output.

Every level colludes with every other level to keep the flimflam going. From the center to the furthest garrisons on the periphery, from the lowest rank to the highest – everyone, everywhere willingly, happily, and proudly participates in one of the greatest deceits of all time. At the bottom of the empire are wage slaves squandering borrowed money on imported doodads. The plebes gamble on adjustable rate mortgages (ARMs). The patricians gamble on hedge funds that speculate on huge swaths of mortgage debt. Near the top are Fed economists urging them to do it! The spectacle is breathtaking. And endlessly entertaining. We are humbled by the majesty of it.

Everywhere we look, we see an exquisite but precarious balance between things that are equally and oppositely absurd. On the one side of the globe – in the Anglo-Saxon countries in general, but the United States in particular – are the consumers. On the other side – principally in Asia – are the producers. One side makes, the other takes. One saves, the other borrows. One produces, the other consumes. That is not the way it was meant to be.

WHAT HATH ALAN WROUGHT?

For years, we have been working on Greenspan’s obituary. As far as we know, the man is still in excellent health. We do not look forward to the event; we just do not want to be caught off guard. Maybe we could even rush out a quickie biography, explaining to the masses the meaning of Mr. Greenspan’s life and work.

We see something in Alan Greenspan’s career – his comportment, his betrayal of his old ideas, his pact with the Devil in Washington, and his attempt to hold off nature’s revenge at least until he leaves the Fed – that is both entertaining and educational. It smacks of Greek tragedy without the boring monologues or bloody intrigues. Even the language used is Greek to most people. Though the Fed chairman speaks English, his words often need translation and historical annotation. Rarely does the maestro make a statement that is comprehensible to the ordinary mortal. So much the better, we guess. If the average fellow really knew what was being said, he would be alarmed. And we have no illusions. Whoever attempts to explain it to him will get no thanks; he might as well tell his teenage daughter what is in her hotdog.

Alan Greenspan is the most famous bureaucrat since Pontius Pilate. Like Pilate, he hesitated, but ultimately gave the mob what it wanted. Not blood, but bubbles. Greenspan’s role in the empire is more than that of a Consul or a Proconsul. He is the Prefect. He is the quartermaster who makes sure empire has the financial resources it needs to ruin itself. We do not know how heaven will judge him. According to the central bankers’ code, Greenspan has committed neither sin nor crime. He is seen as a paragon of virtue, not vice. Yet, as Talleyrand once remarked to Napoleon, “Sire, worse than a crime, you have committed an error.”

When the winds of imperial debt-finance blew, Mr. Volcker planted his feet and stuck out his jaw. His successor, Mr. Greenspan, tumbled over. The Fed chairman’s error was to offer more credit on easier terms to people who already had too much. What the Greenspan Fed had accomplished was to put off a natural, cyclical correction and transmogrify an entire economy into a monstrous economic bubble. A bubble in stock prices may do little real economic damage. Eventually, the bubble pops and the phony money people thought they had disappears like a puff of marijuana smoke. Only those who leveraged themselves too highly in the bubble years are in any trouble. But in Greenspan’s bubble economy, something awful happened. Householders were lured to take out the equity in their homes. They believed that the bubble in real estate priced created wealth that they could spend. Many did not hesitate.

We had given up all hope of ever getting an honest word out of the Fed chairman on this subject when, in early February 2005, the maestro slipped up. He gave a speech in Scotland entitled “Current Account”. Jet-lagged, his defenses down, the poor man seems to have committed truth. “The growth of home mortgage debt has been the major contributor to the decline in the personal saving rate in the United States from almost six percent in 1993 to its current level of one percent,” he admitted. Thus, did he bring up the subject. Then, he began a confession: The rapid growth in home mortgage debt over the past five years has been “driven largely by equity extraction,” said the man most responsible for it. The Fed chairman had misled them into believing that the increases in house prices were the same as new, disposable wealth. But the world’s most famous and most revered economist did not stop there. He confessed not only to having done the thing but also to having his wits about him when he did it. This was no accident. No negligence. This was intentional.

Since the fall of the Berlin Wall, nearly everyone seems to agree that central planning is bad for an economy. The central planners, as any Economics 101 student can tell you, do a poorer job of delivering the goods than the “invisible hand” of Mr. Market. The U.S. economy faced a major recession in 2001 and had a minor one. The newborn slump was strangled in its crib by of the most central planners who ever lived. Alan Greenspan cut lending rates. George W. Bush boosted spending. The resultant shock of renewed, ersatz demand not only postponed the recession, it pushed consumers, investors, and businesspeople to make even more egregious errors. Investors bought stock with low earnings yields. Consumers went further into debt. Government liabilities rose. The trade deficit grew larger. On the other side of the globe, foreign businessmen worked overtime to meet the phony new demand; China has enjoyed a capital spending boom as excessive as any the world has ever seen.

Our own Fed chairman, guardian of the nation’s money, custodian of its economy, night watchman of its wealth, turned a financial bubble into an economic bubble.

THE GREAT DEBATE

The entire investment community seems to be obsessed with the appointment of Ben “Helicopter” Bernanke as the new chairman of the Federal Reserve. “What will the new maestro do? Will he continue to raise interest- rates? Will he target inflation? How will the markets react?” Such questions have been popping up almost everywhere. I am going to address some of these issues but first, let me explain the key concepts of inflation and deflation.

The widespread belief is that the Federal Reserve is currently increasing interest-rates to “control” inflation. This misconception stems from the fact that most people do not really understand inflation. The great majority thinks that inflation is an increase in the prices of goods and services, which is totally incorrect. In actual fact, inflation is defined as an increase in the quantity of money. A general increase in prices is merely a consequence of inflation. An over-supply of money (inflation) causes its value to drop and it takes more money to buy the same quantity of goods and services, causing prices to go up.

In addition to this, the consensus is that deflation is a fall in the prices of goods and services, which is also inaccurate. It is crucial to understand that deflation is in fact a decrease or contraction in the quantity of money. A general decline in prices is merely a consequence of deflation. A reduction in the supply of money (deflation) causes its value to rise and it takes less money to buy the same quantity of goods and services, resulting in lower price levels. The fact that the public does not understand inflation or deflation allows the central banks to carry on with their money printing agenda. All the while, the public remains oblivious.

When the Federal Reserve was established in December 1913, its objective was to “control” inflation. Well, I hate to break this to you, but the Federal Reserve has failed in its task of “controlling” inflation. In fact, the U.S. dollar has lost 95% of its purchasing power through money printing (inflation) since the Federal Reserve came into power. In other words, the $1 your ancestors saved for you in 1913 is only worth five cents today! This is an outright confiscation of hard-earned savings. Consumer prices only started to go up after the Federal Reserve came into power in 1913. It is interesting to note that money lost most of its purchasing power after gold was removed from the monetary system in 1971. The grim reality is that the modern day central banking IS inflation … and the quicker we get used to this idea, the better. The deflation scare is nothing more than a decoy, which the central banks use in order to continue with their money-printing (inflationary) program. Still not convinced? Then, consider the greatest fabrication, the Japanese “deflation” scare.

For years now, we have been told repeatedly that the root cause of Japan’s economic problems is deflation. Allow me to share a secret – the central banks want you to believe that deflation is a total disaster so that they can freely print more money, thereby creating inflation. Despite all the brainwashing, close inspection reveals that Japan never really had any deflation! The truth is that throughout the past 15 years, Japan’s money supply has continued to grow (inflation). Japan has witnessed inflation, and not deflation, since 1980. Sure, Japanese asset prices have fallen since 1990, but the cause is not deflation, as advertised by the establishment. In fact, a sharp rise in interest-rates was the trigger, which caused the Japanese stock and property bubbles to burst.

These days, we are being told that the Federal Reserve is raising interest- rates to “control” inflation. If the Federal Reserve were really curbing inflation, why would the American money supply continue to surge despite recent interest-rate hikes? Despite all the noise about inflation, the Federal Reserve has added roughly $1 trillion to the system over the last year. The U.S. economy is in a mess, and a true contraction in the money supply (deflation) would send the whole world into a severe recession. Under this scenario, millions of companies and individuals would go bust and the entire financial system may collapse. Therefore, you can rest assured that the Federal Reserve will continue to inflate for as long as possible.

I believe the Federal Reserve is raising interest-rates to prevent an outright collapse of the U.S. dollar. A weak currency needs to offer a high yield (interest) in order to attract capital. Today, the U.S. is the world’s largest debtor nation. It must be obvious to both Greenspan and Bernanke that the U.S. dollar is skating on very thin ice. In my view, interest-rates in the United States will rise much higher than most people expect at this time. If history is any guide, Mr. Bernanke will continue to inflate the money supply while increasing interest-rates over the coming months. Already, he has talked about dropping dollar bills from helicopters. Well, at least the guy is honest!

THE ECONOMY: “DOESN’T GET BETTER THAN THIS”?

If you like stories of how one small insight can gain a person lasting fame, you may know of Arthur Laffer. His notoriety dates from the late 1970s, when he argued that income taxes rates were too high, and that cutting those rates could increase tax revenues. Specifically, Laffer illustrated his idea with a simple domed curve inside a vertical and a horizontal axis. His “Laffer Curve” assumed that the peak of the dome was the optimum point for tax revenues (vertical axis) and tax rates (horizontal axis). He said rates were beyond this optimum, which meant less revenue: cut rates back toward the optimum, and – presto – revenues increase.

This transformed the debate over income tax rates, a debate that continues to this day. So it may seem grudging of me to call the Laffer Curve a “small insight”. But in truth all Laffer did was apply the law of diminishing returns to tax revenues/tax rates. Use “fertilizer” for the vertical axis and “crop yield” for the horizontal axis and you will see what I mean (too much fertilizer will reduce crop yield).

Laffer served as an economic advisor in the Reagan White House, yet the inconvenient fact is this: the Reagan administration cut income taxes, but saw a slower rate of increase in income tax revenues than did the Clinton administration, which raised income taxes. (Do not even THINK that I am arguing for higher income taxes.) Still, his notoriety merits the occasional prominent op-ed piece, as was the case in a large financial daily this past October 26. I read it at the time, and decided that the remark quoted below rendered it too silly to discuss: “I have never witnessed or even read about an economy that comes close to the excellence of the current U.S. economy. In spite of all the rhetoric to the contrary, it just doesn’t get any better.”

I will not offer “rhetoric” to the contrary, mainly because facts are better criteria to judge whether “excellence” is the right word to describe the economy. And the fact is, the current business cycle is weaker by EVERY standard measure than ANY of the previous six major post-WWII business cycles were at a similar stage (54 months after the previous cycle peak). Why raise this now? Because Laffer’s op-ed piece was mainly about soon-to-be Fed Chairman Ben Bernanke – and because Bob Prechter says Laffer’s opinion reflects a much larger psychology that is about to turn. As Bob explains, “Public figureheads have a way of representing eras;” and he spells out in full what “Chairman Bernanke” will likely be remembered for.

A GREAT PICTURE TELLS SEVERAL STORIES AT ONCE

Good pictures often tell good stories, and a great picture can tell several stories at once. This is why the “Stock Mutual Funds Cash/Assets Ratio vs. Aggregate Stock Prices” is one of my very favorite financial charts. When it comes to exploding myths and establishing facts, I can not think of another like it.

The chart shows that: 1.) Cash levels in stock mutual funds have been tracked for more than 40 years, long enough to see trends in those levels during major bull and bear markets. 2.) During most of those four decades, it was nearly unheard of for the average fund manager’s portfolio to have as little as 6% cash; instead it was common for that level to hover at 10% or greater. 3.) Cash levels actually stayed above 6% from about 1976 until – you guessed it – the late 1990s. 4.) At market lows fund managers hold larger percentages of assets in cash, while at market highs they hold smaller percentages of assets in cash. Thus at times of major opportunity and of great danger, fund managers are the least prepared. 5.) Financial professionals exhibit the same herding behavior that governs private investors, and the notion that fund managers are “less emotional” or “more rational” than shareholders is complete rubbish. 6.) The smallest-ever percentage of mutual fund assets in cash was less than 4%, right at the stock market peak in 2000. Yes, fund managers were more than 96% invested in stocks at the all time highs.

That final point may be the most important, because in truth it is no longer accurate; cash levels recently broke beneath the 4% level, and today stand at a new smallest-ever percentage – 3.8%, to be precise. Even though this chart is a great picture that tells several stories, it is only part of a still-larger story. The “Stock Mutual Funds Cash/Assets Ratio vs. Aggregate Stock Prices” chart AND that larger story are included in the November issue of The Elliott Wave Theorist.

DOW WOW! WILL THE GENERAL MARKET FOLLOW THE TRANSPORTS?

If you plan to travel this Thanksgiving Holiday, know this: the only thing moving faster than the plain, train, or well, utility truck you take to get from A to B is the share price of these stocks as listed on the Dow Jones Transportation Average (DJTA) index. That is speed. As for direction – a giraffe on stilts could not crane its neck to see that high up. In case you have not checked out a Trannie chart lately, think vertical horizon. To wit, from its March 2003 low, the DJTA has rocketed 114% to set a new, all-time record high on November 21, 2005.

In the words of November 22 USA Today: “Forget about the 4½ year highs in some major stock market indexes. The real action is in humdrum transportation stocks. [These guys] have emerged as unlikely Wall Street champions.” Whether the sustained rising tide will “lift all boats”, as the saying goes, is a question the “experts” are approaching with cautious optimism. Thing is, according to one of the oldest economic ‘isms out there, two scenarios signal the onset of a bullish trend in the overall market: Both the DJTA and the Dow Jones Industrial Average (DJIA) soar to new highs together – OR – A brief divergence occurs whereby the DJTA reaches record levels first AND the DJIA soon follows suit.

Reality check: So far this year, Trannies are up 9.4% while the industrials have gained a mere 0.3% – not to mention the fact that the latter index is still a thousand points below its all-time high. Which leaves the door open for scenario number two – at least for the many. In the words of one chief strategist cited in a November 18 Dow Jones MarketWatch story: “A window now exists in which the Industrials can confirm to the Transportation Average’s new high. The DJTA has started the clock running on a process in which the DJIA must prove itself.”

Problem is, investors who wait-and-see whether the Dow Industrials do in fact catch up to the Transports are missing out on opportunities underway in both markets right now. In the November 21 Short Term Update, we presented readers with a labeled price chart of the DJTA, along with this commentary: Trannies are at an interesting juncture. The rise from October fooled us but the pattern remains clear. The sharp advance from March to October is best considered a classic wedge pattern – one whose signature suggests dramatic change ahead for every major U.S. average.

Bottom line: As far as objective analysis of the short-term trend unfolding in the DJTA – there is absolutely no time to kill.

STATES’ COFFERS SWELLING AGAIN AFTER STRUGGLES

After four years of tight budgets and deepening debt, most states from California to Maine are experiencing a marked turnaround in their fiscal fortunes, with billions of dollars more in tax receipts than had been projected pouring into coffers around the country. The windfall is a result of both a general upturn in the economy and conservative budgeting by state officials in recent years, and it is leading to the restoration of school funding, investments in long-neglected roads and bridges, debt reduction, and the return of money borrowed from cities and counties.

One sign of the improved fiscal health, according to the National Association of State Budget Officers, is that only five states were forced to make midyear budget cuts, totaling $634 million, in the fiscal year that ended, for most states, on June 30. In 2003, by contrast, 37 states cut spending in the middle of the budget year, by a total of $12.6 billion, the association said.

But the good news is not universal and may prove short-lived. The Great Lakes States continue to be hammered by the loss of manufacturing jobs, and full recovery from the hurricanes in the Gulf Coast States will take years. And experts warn that even though tax revenues are rising in most of the country, demands on state budgets – particularly for education, health care and pensions – are growing even faster.

TOYOTA QUICKENS QUEST TO UNSEAT GM

Toyota Motor Corp. is quickening its quest to unseat ailing rival General Motors as the world’s biggest automaker with reported plans to start manufacturing up to 100,000 Toyota vehicles at a Subaru factory in Indiana. Word of Toyota’s ramped-up production schedule comes just days after money-losing GM said it will close 12 facilities by 2008 in a move that will slash the number of vehicles it is able to build in North America by about 1 million a year. The combined developments could help Toyota surpass GM in worldwide production, although it is unclear if that could happen because Detroit-based GM is growing rapidly in Asia.

Toyota expects to produce 8.1 million vehicles this year, while GM expects 9 million, according to Greg Gardner of Harbour Consulting, a manufacturing consulting firm. Chipping away at GM’s lead will also be a new Toyota pickup truck plant scheduled to open next year in San Antonio, Texas, that will add an additional 200,000 vehicles to Toyota’s annual capacity. The Japanese company’s output will be boosted by another 100,000 vehicles in 2008, when Toyota’s new RAV 4 plant comes online in Canada. Under the latest expansion plans, the world’s No. 2 automaker has asked Fuji Heavy Industries, maker of Subaru autos, to start building Toyotas in 2007 at a Lafayette, Indiana, factory operated by Fuji’s wholly owned subsidiary Subaru of Indiana Automotive, the Asahi newspaper reported.

THANKSGIVING

Today, America’s tables groan and its bellies gurgle. It is Thanksgiving – a day to gather together and count our blessings. This poses a challenge to many voters; they find they have more blessings than fingers.

While the rest of the nation takes the day off, here at The Daily Reckoning headquarters in London we continue our lonely vigil. Today, as every day, there are things to reckon with. But we, too, pause to reflect on the many things we have to be thankful for. We have not been drafted and sent to Iraq. We have not been rounded up and hustled off to a “black site”, where imperial lackeys do dark things. We do not work for GM or Wal-Mart. We earn a decent living, for a writer, doing what we want to do. We are as healthy as a locust stump. We have a happy, healthy family. We have a credit card … with a line of credit that has never been exhausted. We have not had all our money stolen by government … nor have we lost it in the investment markets. We are almost free (we pay taxes in the U.S., France, and Britain). We are almost white (of Irish extraction). And definitely over 21. What more could we ask for?

There must be a fixed sum of absurdity in the world. Let others count their blessings. Our job is to point out the preposterous … the calamitous … and the mendacious. In WWI it seemed as though all the world’s absurdity was concentrated in a single disastrous event – a war so lame brained and ruinous it practically destroyed Western civilization. Later, absurdity took a new form – “isms” that changed the map of the world. National socialism in Germany brought another war. Communism in Russia brought seven decades of misery. Colonialism became a bad thing and was replaced by nationalism, which turned Africa into a murderous dump. There were other isms too – in art … in philosophy … and in politics. Almost all were sordid or mad. But no one cares much about isms anymore. Che has become a T-shirt symbol; young people think he played the guitar in Elvis Presley’s band.

But if there is a fixed sum of absurdity in the world … where has it gone? There is a “glut of savings,” says Fed chief-dauphin Ben Bernanke. “We think, they sweat,” say the economist impersonators. “Prices are not rising,” say the Pinocchios over at the Labor Department. We note that the world’s richest people now depend on the savings of the world's poorest. Is that not absurd, dear reader? We note also, that the world’s greatest military power throws its weight around all over the world – making the world “freer” and more democratic, we are told – and expects the still-Red Chinese to finance it. Is that not mad, dear reader?

“It’s unbelievable,” said Kurt Richebacher last night. We dined with Dr. Richebacher, who made one of his rare trips to London. “I’ll tell you what is really crazy,” he began. “Everybody says that the U.S. economy is the most flexible in the world. They must be dreaming. The U.S. economy is completely inflexible. It suffers from huge problems that are obvious to any serious economy, mainly the lack of savings and the current account deficit. But the economy is so inflexible; it can’t do anything about them. And, even worse, no one can even talk about them. Well, I shouldn’t say no one. There are a few of us. But we are outsiders. We are marginal. The people on the inside do not even seem to recognize that there is a problem.

“… What they did was to stimulate the economy more than any government had ever done. The tax cuts were worth about $860 billion. And the low interest rates brought $3 trillion of new credit into the system. But even all that didn’t create a boom. Take out all the lies and measurement nonsense and you see an economy that has never recovered. Talk about jobs? America has 1.2 million real estate agents. It’s all a housing boom … caused by the credit expansion.

“And you know why profits are up in the United States? It has nothing to do with healthy, growing businesses. Just the opposite. These businesses have stopped investing in new plant and equipment. So they have much less capital equipment to depreciate. As depreciation collapses, profitability goes up – especially when they’re making money from financing activities. But this can’t last.

“It’s unbelievable. I grew up in a time when you wanted to save so that your children would have a better life than you had. Now, in all the Anglo-Saxon economies, people don’t seem to want to help the next generation, they want to cheat it, by leaving a legacy of worn-out capital … and debt.

“I tell you the whole thing is a monumental fraud. And Mr. Alan Greenspan is merely an extraordinary criminal. Here is something for Americans to think about as they celebrate their Thanksgiving Day. Why is it that we Europeans have a higher standard of living than they do? Yes, it’s true. My son works in America. He barely gets any time off. He has hardly any vacation to come to visit me. In Europe, we get at least 6 weeks, sometimes much more. And people don’t have so much debt. Property prices have risen in France, for example. But they rise on savings, not debt. And everybody is always saying what a mess the German economy is in. But when I look at it carefully, I see that it is solid. And growing. It has a positive balance of trade. And the Germans’ saving rate is going up – above 10%. I like the European model much better.”

LAND OF THE DEADHEADS

We searched the newspapers on Thursday. We could find hardly a mention of it. Who are we supposed to thank? For what? No one addressed the questions. Perhaps Thanksgiving comes too hard on the heels of Veterans Day. Maybe the gratitude had been all squeezed out. But you would think a nation as lucky as America would have at least two days’ worth of thanks in it. But here, we offer not a panegyric to all our dead ancestors but an interrogatory to the living: what will the next generations thank them for?

“I shall begin with our ancestors,” said Pericles, in his speech for the dead soldiers. This was 431-430BC, the first year of the Peloponnesian War. The custom was to give a public eulogy – a kind of Thanksgiving and Veterans’ Day rolled into one – each year. “They dwelt in the country without break in the succession from generation to generation, and handed it down free to the present time. … And if our remote ancestors deserve praise, much more do our own fathers, who added to their inheritance the empire which we now possess, and spared no pains to be able to leave their acquisitions to the present generation.”

Pericles begins as George W. Bush might, honoring the achievements of the nation’s fighting men. An unsentimental historian might wonder what those achievements were worth. Athens, like other city-states, seemed prone to go to war with its neighbors for no particular reason and no particular advantage. Athens was more successful than most and was able to build up its own little empire. Then, it was brought low by plague, treachery, and other empire builders; all the sturm and drang seemed to get it nowhere. Then, Pericles makes equally dubious remarks about Athens itself. These, too, might have come from the mouth of America’s current president, if someone would write them out for him in short words. This little insight should put to rest forever the idea of Athens as a center of serious thinking. Pericles was a better humbugger than Bush, but the flatteries were the same. Athens’ government was better than its rivals, he said. Its people were more courageous and better organized. Even its artists flourished in Athens as nowhere else. With such men as this, Athens could not lose.

Pericles had urged Athenians to war, like George W. Bush. But the war did not go well. Twice, the Spartans invaded and laid waste to Athenian lands. A year later, the same people who praised Pericles were at his throat. The great orator held them off – urging them to stay the course. Yes, he pointed out, your lands and houses might have been ruined, but this is a fight for something much more – liberty! “You cannot decline the burdens of empire and still expect to share its honors,” he says. The Athenians did stay the course; it led them to total defeat. Pericles died of plague. We know what thanks Pericles’ generation owed its predecessors. But what thanks did the next generation of Athenians owe to them? Athens was destroyed. Their parents’ empire building had cost them dearly: their wealth, their independence, even the empire itself.

25 centuries later, Thanksgiving Day went by without much notice. A few people probably did pause before turning to the turkey to thank their dead ancestors. The dead men had worked, and saved, so that their descendants would have life … and have it more abundantly, just like the “remote ancestors”. But did anyone stop to wonder about the generation to follow? We recall Dr. Kurt Richebacher’s comment: “I grew up in a time when you wanted to save so that your children would have a better life than you had. Now, in all the Anglo-Saxon economies, people don’t seem to want to help the next generation, they want to cheat it, by leaving a legacy of worn-out capital … and debt.”

Each year, America’s dollar declines … Americans own less of their own national debt … less of their own houses … and less of their own future earnings. Little by little the patrimony of future voters slips away, replaced by obligations. So great has the debt load become that it cannot be settled in a single generation – even if that generation were willing. Instead, the blessings that one generation enjoys are passed onto the next generation as a curse. A child born in America in 1900 came into the world naked and free of debt. Today, he pops into the world and is immediately swaddled in chains of debts. All his life he will have to pay them – debts from bonuses paid to government employees in 1986 … from bombs dropped in 2003 … from boondoggles built in 1995 … checks written in 1974 … promises made to old people in 2002 … the expenses of hurricanes in 2005 – and so on. The poor child will have to drag around with him the entire pathetic history of America’s financial decline.

“Stay the course,” says Bernanke in 2005. “We cannot stop now,” adds Bush. “Damned b**tards,” the next generation is likely to grumble.