The New Empire of Debt: The Rise and Fall of an Epic Financial Bubble (38 page)

What Levey and Brown were trying to tell us is that we had nothing to worry about.Yes, it was true that we Americans spent 6 percent more every day than we earned.Yes, $11.5 trillion worth of U.S. assets were in foreign hands and our net international investment position had gone negative at more than 3 trillion. And yes, it was true that we saved nearly nothing. But we could still feel good about ourselves, they said.

The numbers obscure “the United States’ institutional, technological and demographic advantages,” they said. What were those advantages? The two never quite said. But what could they say? Other countries have different institutions. Others have different demographics. Others use different technologies.Who knows which are an advantage and which are a hindrance? You only know—and then, only by inference—after the fact. At the height of its bubble in 1989, it was widely presumed that Japan had all the advantages. Hardly a single issue of the business press failed to mention them. Now, 15 years and a major slump later, Japan seemed to have all the disadvantages, while the advantages somehow crossed the Bering Strait into North America.

The mainstream press told us how dynamic, flexible, and open the U.S. economy was. At the end of their article, Messrs. Levey and Brown told us that the only real threat was that “protectionism and isolationism at home will put an end to the dynamism, openness and flexibility that power the U.S.”
¹¹

We can’t help but remember French military policy after the Franco-Prussian War. Led by Colonel Grandmaison, the French allowed words to replace tactics and strategy.
Élan
was the word. It meant “spirit” or “force of will.” When World War I began, the French attacked on horseback, swords glittering. What élan! What style! What blockheads. The German machine guns opened up and soon the ground was covered by handsome young soldiers. Élan proved great for poets but bad for France’s military.

One hundred years later, Americans put on their own gaudy tunics—so proud of their “dynamism,” their “flexibility,” their “openness.” Who cared that they spent more than they could afford? Who worried that we had no savings and now depended on the kindness of strangers to maintain our standards of living? Who realized that the Chinese or Japanese could bring the U.S. economy to its knees with a single word?

But so what if the Chinese and Japanese sold our bonds, we still had our houses!

The two economists noted that “when you include capital gains, 401 (k) retirement plans, and home values, U.S. domestic saving is around 20 percent of GDP, the same as in most other developed nations.”
¹²

They should have talked to Mr. Hill. They didn’t seem to realize that home values are “inactive.” We have yet to hear of a factory built with increases in house prices.We have yet to see a debt paid from a rising house price—without an equal debt arising somewhere else.

“Much of our meager savings and massive borrowing has gone into housing,” said the Monroe County banker. “How convenient it would be now if mansions and subdivisions could be exported, to improve our foreign trade balance. Since they cannot be exported, perhaps the foreigners who own our massive debts can be repaid by coming to live in our McMansions, with homeowners serving as houseboys and house maids to the visiting Japanese and Chinese owners of our debt.”

“The United States economy is growing,” said PaulVolcker,“on the savings of poor people.” Or, as Marshall Auerback put it, we had become a “Blanche Dubois” economy—we had delusions of grandeur, and yet, we were completely dependent on the kindness of strangers just to keep going. Poor people made things, and then financed the consumption of them by rich people.

Americans deceived themselves with the fanciful notion that people who live in hovels, eat disgusting animals, and earn less than 1/20 as much per hour would be willing to finance our new houses and new wars forever. Why? Our economy is so “dynamic” . . . so “flexible” . . . so “open”—the poor peasants can’t resist!

As the gusts of credit, debt, borrowing, and spending blew across the nation, very few of the old attitudes and institutions were left standing. Apart from Vernon Hill and a few others, lenders stopped worrying about the quality of their borrowers. Savings and loan businesses might as well have dropped the word
savings
from their names. And calling lenders
thrifts
was practically a lie; the whole industry bent to a new task—to load up consumers with as much debt as possible.

There was a time when thrift was a virtue. “A penny saved is a penny earned,” dead people whisper. Accountants with sharp pencils even noticed that a penny saved was more than a penny earned, 40 to 50 percent more; it was not subject to state, local, and federal income taxes.

But in America, circa 2005, thrift came to be regarded no longer as a virtue, but as a mental disorder.

Evidence came from a magazine spotted on Long Island, again through the ever-observant
Grant’s Interest Rate Observer.
The publication, entitled
Real Simple,
told the story of a poor woman named Morning Naughton, 34 years old in the flesh, hundreds of years old in spirit.

If the phone didn’t ring at an expensive jewelry store, it was Ms. Naughton who wasn’t calling. If no one was admiring the new SUVs in a North Carolina showroom, it was Ms. Naughton who stayed at home. If you were to check the credit card records for sales of expensive vacations, fancy hotel rooms, extravagant fur coats, or top restaurants, you would not find Ms. Naughton’s name.

Alas, said
Real Simple,
the woman had a real problem; she was “frugal to a fault.”

“She has never had credit card debt, she pays all her bills on time and she typically saves $500 each month—on a salary of about $30,000,” we are told.

“Her husband, Jason Michaels . . . worries about her inability to indulge herself... or him.” The plot thickens. “And he wonders if her scrimping sends the wrong message to their child.” “I realize she can’t help herself,” says Jason. “But her obsession with saving can drive me nuts.”

But never was there a problem under the bright sun of America that didn’t have some sort of fraud creeping in the shadows behind it. Reading about Ms. Naughton, economists saw a threat; if other consumers were to do the same, the whole shebang would be in trouble. Psychologists, on the other hand, saw an opportunity; some would prepare 12-step programs to help overcome it. Others would offer drugs and counseling.

Both economists and psychologists could relax. If frugality is a disorder, it was too rare to worry about. The odds of coming down with it were as remote as integrity in public office. Besides, thrift—even if it were a disorder—is one that comes and goes. If people are saving too much, or too little, just wait; it will go away.

Ms. Naughton—through no fault of her own—tumbled into an unusual situation. One generation creates; the next dissipates. One generation earns; the next burns. One generation composes, the next disposes. Morning Naughton was merely born at the wrong time.

“In the 1970s,” began a recent letter from a reader of our daily e-mail, the Daily Reckoning, “I recall seeing many people, children of the Depression, ravaged by inflation. They remembered the ‘bad times’ and were loath to take on debt—even if it would have been prudent to borrow and pay back in cheaper dollars. In the face of rising prices, they would slam their wallets shut or buy used, rather than new—‘I’d never pay that much for a new car!’ They held their dollars, steadfastly refusing inflation hedges, and watched, even increased their dollar position, as the inflation storm ravaged their holdings.”

“When Morning was 9,” continues the
Real Simple
analysis,“her parents divorced, and she moved with her father to Cape Cod. Her dad did some construction work to make money, but he was an artist at heart . . . . She worked at a multitude of odd jobs, including baby sitting, to make money. At age 10, she opened her first savings account. At 13, she started paying all the bills by filling out the information and having her dad sign the checks . . . . ‘My childhood left me with this extreme anxiety about parting with money. I always need a safety net.’”

She may have been the only American on two legs who still worried about falling. But she could always try therapy. “Were it not for her husband and child, Morning . . . might not be motivated to change,”
Real Simple
explained.

“After more than 20 years of belt-tightening, Morning knows she needs to relax. ‘I don’t want [my son] Spencer to grow up with the same money anxieties I have,’ she says. ‘Being so frugal has become a burden, and I want to change. But it’s hard after a lifetime of being this way.’”

We wished her luck. But we offered advice: Don’t change too much. Old habits might turn out to be useful.Who knows? Frugality could make a comeback.

A great empire can be viewed as a vast public spectacle. It begins with a bold crime, develops into a farce, with petty acts of tomfoolery and fraud along the way, and ends in shame, regret, and disaster.

The Medicare Drug Benefit program, enacted during Bush’s first term, was meant to cost $400 billion during its first 10 years. Turns out, the official estimates included 2004 and 2005, that is, two years before the program existed.The real 10-year cost of the program floated through the news months later at $720 billion. Americans voted for their representatives in Congress and the White House; the politicians voted for the free drugs. Thus, was the divine right of the majority—the brute power of the more to tell the few what to do—purified by the ballot box. The polite forms of the old republic were respected. But the essential act was a sin and a crime. Why should some Americans get drugs at other Americans’ expense? Is it not larceny on the part of one and complicity on the part of the other? And how will those “others” pay for it; were they not already on the hook for $44 trillion in unfunded federal obligations?

But now the scam is the law of the land.

George W. Bush wanted to create an “ownership society.” But it was a strange form of ownership. Much of what Americans believed they had title to actually belonged to someone else. Their retirements and health benefits, for example, must be stolen from other people before they could be handed out. Even things they thought they paid for were actually on the balance sheet of other people. More and more houses were really owned by mortgage finance companies. Cars were owned by GMAC and other auto financers. People expected to retire on the equity locked up in their houses. But they owned less of their own houses than ever before. And Social Security? A forensic accountant could pore over the books for a thousand years and never find a trace of the cash supposedly stashed away for Americans’ retirement. It doesn’t exist.

Mr. Bush said he wanted to change that. He wanted Americans to own their own retirement funds—with private accounts invested in stocks. The young had wised up to Social Security.There was no way they could get a decent return on investment in Social Security; they wanted out. The old were alarmed too; they were afraid that the something for nothing they’d grown to expect would turn out to be more nothing than something. And the Bush administration wanted votes from both groups. So, it did what you would expect: It deceived and dissembled.

It doesn’t matter what we think about it. Empires—like history—have thoughts of their own, and a will toward their own end.

11

Modern Imperial Finance

A
new piece of research from Princeton’s Center for the study of the brain was reported in the press in April 2005.
¹
Poking around, the scientists thought they found something new that would explain Americans’ reluctance to save money.

Decisions are made in two parts of the brain, the researchers told us. The first part is the lateral prefrontal cortex. This is where advanced, logical thinking is supposed to happen, such as when a person decides which investment to make or which automobile offers the most value for the money. Deeper down in the gray matter is another decision center, the more primitive limbic system, where he actually decides which car to buy—usually the one that best suits his own prejudice. If he thinks he is a manly man, he buys a big American-made truck, or maybe a Hummer. If he prefers to think of himself as an intellectual, he goes for a foreign make, maybe an Audi or a Volkswagen. Behind the wheel of a German car, he feels at one with Hegel and Schopenhauer. Or, if he is a hip environmentalist, he will want to advertise that, too; in a sleek hybrid he will feel as smug as a teetotaler in a beer hall.

Researchers believe that the limbic system decides our likes and dislikes, and tells us how to react to immediate stimuli. When a dump truck cuts you off in traffic, the limbic system almost automatically wants to cock your right arm and middle finger in the traditional salute, before your lateral prefrontal cortex can warn you against the gesture.

In the upper part of the brain, Americans realized that they needed to save for their retirement. But the limbic system insisted on buying a new wide-screen TV instead. Though the researchers’ report was circulated in the media as though it meant something, it left us only more puzzled than before.When did Americans acquire this limbic system, we wondered? Up until 1980, American savings rates were around 10 percent of incomes. Did some kind of evolutionary mutation occur in the early years of the Reagan administration?

And how come the Chinese didn’t seem to have the same problem? They saved 25 percent of their incomes, while Americans saved less than 1 percent. Someone ought to pry open a Chinese skull and take a peek to verify this, but our guess is that the Chinese have limbic systems, too.

At least the scientists were wise enough to realize that not every thought that passes through the human brain makes any logical sense. The most powerful thoughts—strong enough to put the average American’s retirement financing, and even his life, in jeopardy—are not logical at all, but instinctive, atavistic, and primordial.