The Consumer Spending Surge is a Giant Mirage

"If one understands that socialism is not a share-the-wealth programme, but is in reality a method to consolidate and control the wealth, then the seeming paradox of super-rich men promoting socialism becomes no paradox at all. Instead, it becomes logical, even the perfect tool of power-seeking megalomaniacs. Communism or, more accurately, socialism is not a movement of the downtrodden masses, but of the economic elite." - Gary Allen, None Dare Call It Conspiracy, Concord Press, 1971

Is America’s Economic Recovery on the Whole Based on a Rotten Sham?

By Justice Litle, Daily Markets
April 20, 2010

The economic “recovery” we are now witnessing is based on theft, greed and deceit. It’s a giant rip-off, a rotten sham. In this sleazy imitation of a free market economy, liars, cheats and deadbeats are the ones getting rewarded.

And as for the savers, the hard workers, the ones who chose to honor their debts and live within their means? Nothing but a bunch of suckers. (They’re the ones paying for it all.)

If you’re one of those “suckers,” at least you’ve got company. I’m a sucker too.

All this time, I thought working hard for my money and staying debt free was wise. I thought sticking with one credit card -- paying down the balance every month, no exceptions -- was prudent. I thought driving a five-year-old car -- fully paid off, nothing flashy -- was a sensible thing to do.

Nope. Turns out those were sucker moves. What I should have done, to be in synch with this economy, was to have bought a 3,000-square-foot McMansion at the peak of the bubble… pulled out a cool hundred thousand in home equity loans… and then defaulted on the place.

That way I could have had the cash for a jet ski and a new convertible and a Hawaiian vacation ---- you know, the means of living in style -- without having to worry about a thing.

No Morals Is the New Normal

Apologies for my cranky tone today. I hope I’m not messing up your Monday. It’s just that, heading into the weekend, I read something that absolutely made me sick. More on that in a moment…

Two weeks ago your humble editor asked, “Did the Housing Bust Fuel the Consumer Spending Binge?” In that piece, it was explained step by step how the phenomenon of “strategic defaults,” i.e. homeowners walking away from their mortgages, may have fueled a surge in retail spending by way of freeing up cash.

As it turns out, it looks like the strategic default thesis was correct. And this helps show why those who were expecting a “new normal” got it wrong.

See, guys like Mohamed El-Erian at Pimco (and yours truly) at first thought the “new normal” meant consumers tightening up and living within their means. What we failed to realize is that “new normal” actually translated to “NO MORALS,” as in “deadbeats ripping off the banks with abandon” (while the banks in turn screw the taxpayers).

In the piece two weeks ago, I hat-tipped a blog called Credit Writedowns for helping me solve the strategic default puzzle. The main blogger there, Edward Harrison, continues to do solid investigative work. Below are some of the anecdotes he recently reported. After reading them, I think you’ll understand my mood:

My 25 year old niece had $10,000 of outstanding credit card debt. Recently, she told the bank she couldn’t pay. She is not unemployed so the ‘hardship’ is all relative. Nevertheless, the bank offered her a concession which she refused. They offered another concession, she refused again. Finally, they told her if she paid $150/month for 2 years (total of only $3600 with no interest), they would call it paid in full! She accepted in a heartbeat. It is less than a month later, and she celebrated her good fortune by going on a cruise to Hawaii.

A friend owns a small manufacturing co. He tells me of one of his female employees who was saddled with a $450,000 home she purchased almost five years ago with no down pmt. One year after her purchase she pulled $75,000 home equity and purchased ‘fun stuff’ including a boat. She recently walked away from the house (now saddled with $525K mortgage), purchased a new house for $200,000 (in her sister’s name) and kept all the goodies purchased from the home equity withdrawal. With the much lower mortgage payment she just bought a new car.

Almost everyone in my “survey” is aware of, or knows someone living rent free in their home for an extended period of time, having stopped paying their mortgage. Many of these free boarders are spending lavishly on non-essentials. My hard-working part-time assistant knows two different 35+ yr olds who have enjoyed over 9 months (one is up to month eleven) of rent-free living in very nice homes they purchased in 2004/2005! Both are employed and both enjoy a non-frugal lifestyle. My assistant wonders if he should do the same or have me pay him more so that he too can enjoy the ‘good life’.

My sister is a nurse with 25+ years on the job. She told me of a young couple that she is good friends with that both work at her hospital making a decent joint income. They didn’t like the fact that they grossly overpaid for their 3000 sq ft home in 2006. They stopped making hefty monthly payments six months ago and haven’t yet been contacted by the bank. They have decided to wait until contacted and then walk away. In the meantime, they just returned from NYC from a week vacation in the Big Apple.

My brother-in-law wanted to know if he should stop making payments on everything. He lives in Virginia and his carpentry skills are not as marketable as they were in the height of the boom. He and his wife’s best friend have lived close-by for many years. For the past 13 months since they strategically decided to stop paying their mortgage, they had yet to be contacted by their bank. Not even one letter! My brother-in-law doesn’t understand how they get to pocket the mortgage and spend carefree, including a 10-day Caribbean vacation.

Apparently there are lots more anecdotes of this type -- potentially “millions of similar stories across the country.”

I thought I was about as cynical as I could get. I thought that, after the initial outrage of the bailouts, my anger was all but spent. But this makes me feel righteously ticked off all over again.

The Revolutionary Rip-Off Machine

Why be furious? A few reasons.

First of all, because these happy-go-lucky knuckleheads spending strategic default “mad money” like water have the attitudes of fiscal dope fiends. They are likely going to go broke again en masse, or otherwise need bailing out, and someone else will have to pay. AGAIN.

Second of all, because it’s just damn disgusting that those people who scrimped and saved to own their homes and pay their debts -- i.e. the “suckers” who lived by a moral code of personal obligation and free market ethics -- have to see such blatant debauchery not just flaunted, but rewarded by the system. It’s a breakdown of ethics and common sense that threatens the future of the country as a whole.

And third, because even though the banks are the ones eating strategic default losses, they aren’t the ones getting screwed in this deal. TAXPAYERS and SAVERS are the ones getting shafted -- people like you and me. (Oh, and your kids too. They’re going to pay out the nose for all this. Big time.)

To understand why the banks don’t really care about strategic default losses -- why they can let defaulters go a year or more without so much as a slap on the wrist -- take a look at the following chart from Gluskin Sheff.

The chart shows the financial sector’s profits as a percentage of all corporate profits in total.

Before the crisis hit, the financial sector had worked its way up to more than a third of all corporate profits at the peak -- an obscene number in itself. Thirty-three cents out of every dollar earned by way of financial engineering? You don’t see that kind of imbalance in a healthy economy… only in a paper casino “phinance” economy, where the “ph” is for phony.

As the financial crisis took hold, the financial sector’s profits plummeted, which the chart shows. But then, post crisis, they bounced back with a vertical vengeance. See that rocket ride on the right side of the chart? It comes courtesy of the Federal Reserve and U.S. Treasury finding any way they can to shovel huge profits into Wall Street’s pockets. At the taxpayer’s and saver’s expense.

Here is how the revolutionary rip-off machine functions:

• Lavish-spending “strategic defaulters” feel justified in ripping off the banks.
• The lawless deadbeat culture spreads -- as sparked by the banks’ own example.
• The banks don’t care because they are in the rip-off game too, on a larger scale.
• The banks can ignore strategic defaults by way of taxpayer-funded profits.

The whole thing winds up being a backdoor political transfer. Washington pumps torrents of money into the rotten banks. The banks look the other way as strategic defaulters catch on that “the way to play the game” is to defraud, deny and spend. And politicians get to enjoy the illusion of recovery.

A License to Print

So how are the banks ripping off the taxpayer, you ask? By way of the record steep yield curve. In keeping short-term rates near zero, the Federal Reserve has given the banks a license to print money.

Thanks to Ben Bernanke, banks can borrow as much as they want for practically nothing… plow that cash into longer-dated U.S. Treasuries… and make perpetually huge profits with little to no risk. It’s like a permanent backdoor bailout subsidy.

Meanwhile, again, the powers that be, to the extent they truly know what is going on, are happy about the strategic default situation. They see the defaults and rampant spending binges as a good thing. Why? Because all that “mad money” creates the illusion of a healthy consumer!

All these jokers going out to buy new cars and Hawaiian vacations and whatnot are fueling a new spending surge, which in turn boosts corporate earnings, which in turn gets Wall Street cheering and the average citizen thinking “hey, things are okay.”

And as for the banks -- why should they trip over pennies on their way to dollars? The big banks have far more money coming in by way of the Federal Reserve’s magic gift (zero interest rate policy) than they do going out.

A Criminal Disaster

The whole thing is a criminal disaster. Here’s why:

• Zero interest rates are a cruel punishment for savers, especially elderly savers.



• Backdoor inflation (via the creation of excess reserves) is a means of rewarding profligate debtors and punishing savers harshly (making “suckers” of them).



• Businesses are gearing up based on the notion that this consumer spending surge is sustainable, when in actuality it’s a giant mirage.



• The massive profits being accrued by the banks are pooling disproportionately in the pockets of fat cats and deeply connected investment players (as usual).



• The real backbone of America’s economy -- small business -- is still being neglected. So are genuine savers.



• The up-and-coming generations -- the children that will inherit all the debt being created -- are in some ways the most voiceless victims of all in this scheme.

Small Business Pain

Meanwhile, even as corporate America rejoices, small business continues to starve. According to a recent survey from the National Federation of Independent Business (NFIB), the credit picture is worsening for small business now. Despite all the hoopla, the employers of more than half of America’s workforce have reason for pessimism, not optimism, in the quarters ahead.

But who cares, right? The economic recovery, or at least the illusion of it, will be carried on by the revolutionary rip-off machine. The Federal Reserve has found a neat new way to funnel cash into the hands of those who least deserve it, just as it did with AIG.

And taxpayers and savers -- the few of them left that is -- will just keep getting squeezed on both sides. An estimated 47% of Americans pay no taxes at all… and the fat cats at the top of the oligarchy ladder certainly get a lot more out of the system than they put in.

So that leaves the “suckers” in the middle (i.e. you and me) to pay the final tab. For all of it. The whole rotten thing.

To be honest, I don’t really know what to think of my country any more. This ridiculous, debauchery-ridden, quasi-socialist Ponzi-scheme of a recovery is going to end in absolute disaster. Crushing deflation, hyperinflation, heck, maybe even martial law… it could all be coming down the pike, in wave after debilitating wave, when the music finally stops.

Maybe we’re just fulfilling the old prophecy:

A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship.

Insights Into America's Disneyland and Our "Neo-Feudalistic, Gulag Casino Economy"

Mike Krieger, formerly a macro analyst at Bernstein, and currently running his own fund, KAM LP, summarizies the pretend reality we are all caught in now, knowing full well America is set on a crash course with reality at some point, yet sticking our collective heads in the sand, as the collapse will be some time in the "indefinite" future. In the meantime, banks will continue to boost US GDP by peddling "financial innovation" and restructuring advice to countries like Greece... and nothing else. - Zero Hedge

'Goodbye Disneyland' by Mike Krieger
April 22, 2010

A government big enough to give you everything you want is a government big enough to take from you everything you have. - Thomas Jefferson

We Must Move to a Free Market and Shun the Welfare-Warfare State or all will be Lost

Unfortunately for all of us, the primary economic policy of the U.S. government, as well as many others around the world, is an 'extend and pretend' strategy that is economic suicide -- primarily in that it keeps the irresponsible in their assets and makes the responsible shudder and shun productive investments.

Whether it be a homeowner that is subsidized to stay in a home that he cannot afford or a bank that doesn’t want to come clean on the extent of its bad assets, the result is the same -- complete economic inertia.

Now of course there has been a rebound in demand, but my argument has been and continues to be that this is the most unproductive rebound in aggregate demand that perhaps the world has ever seen. Whether it be in the U.S. or China, the demand is taking away spare capacity in many areas, indeed, but we must question the methods. This is where the whole idea of inflation comes into play.

The whole reason why printing a million dollars and giving it to everyone doesn’t work is because this “liquidity” is not created through a productive process. It is purely an injection of new dollars into the economy. The basic rule of supply/demand kicks in. In the average person’s pocket, this money is unlikely to be “invested” in productive capital endeavors; rather, the vast majority of it will simply be spent to consume the resources of that which can be supplied by the already existing capital stock.

So in many ways it isn’t that the creation of the money itself that is the biggest problem, it is the distribution channel of that money. Only a small percentage of the population that receives the million dollars has the ability, drive and discipline to invest the money into something that will create economic value for the society at large rather than just blow it on a flat screen television. This is the entire premise of why a free market economy works when it is allowed to work, which I would argue is not possible under the current Federal Reserve system.

The Fed is a socialist organization that SETS the most important price in the economy, the price of money. Even worse, when they set that price at say 0%, as is basically the case today, that 0% (or anything close to it) is not offered to all the small businessmen or potential entrepreneurs out there.

It might not even be so bad if the low interest rates weren’t simply being used to gamble or play a carry trade with treasuries. Of course, the banks, or anyone else for that matter, playing a spread by borrowing at near zero to buy long-term treasuries is doing irreparable harm to this nation. They are complicit in the gross misallocation of capital to the government, capital that can then be doled out at will to favored interests.

So all we have today is essentially a creation of money and credit out of thin air that is allocated to two major constituents. First, it has primarily been used to maintain the people of wealth, power and political connections (on both sides of the isle) before the crash entrenched in their socioeconomic roles. Second, is to pay off political favors. Those who supported the President in his campaign have been paid back handsomely and are today much more powerful and secure than before, whether we are talking unions or the oligopoly banks.

If we wish to have any hope of a sustainable recovery preventing the inevitable social unrest to come from truly getting dangerous, we must restore the free market and end the union of big business and government, which historically has presented an extremely dangerous situation.

For those that are in big business and think they have made a great move by joining forces with the state, I suggest you go back and read your history. You never will possess the ultimate power; you will be seduced into thinking you do; and then, when the time is right, government can eliminate you and your fortune with the stroke of a pen. Power is granted to you by this authority when you engage in this unholy union, and it can be taken away on whim and your wealth confiscated. Selling out freedom and your fellow citizens for some extra money or government contracts will come back to haunt you. Your legacy to the United States will be a neo-feudalistic, gulag casino economy that has already begun.

Here is a link to an excellent interview with Bill Moyers on PBS about our financial oligarchy (I believe many industries here are becoming oligarchies, but the financial one is the most powerful) and the need to stop its cancerous growth.

There Will be Surplus...In 2050!

The above paragraph is meant to reach those that are actually faced with important decisions every day which can have a meaningful impact on our future -- decisions on whether to sacrifice their country’s and their children’s futures for an extra buck or to stop the game, stand up for freedom and make a positive difference in this world.

This paragraph is meant for a much more broad based audience. Key to the entrenched elite strategy (whether in government or business) is to keep the public in an infantile state. What I mean by this is to keep the notion alive that big daddy government is going to be there to provide for you and protect you. Taking it one step further, they really want the public to believe the government’s existence is in fact necessary for the realization of all one’s hopes and dreams, whether it be economically or with regard to security.

If you remember from Orwell’s 1984, there is never-ending war in Oceania. Think about how useful a never ending “war on terrorism” is to those in positions of power. All this said, while I am a small government person, I am no anarchist. I think government can do a lot of good. I merely think government must be used a tool, a complement to the freedom, independence and individuality. Once the government becomes so big that it is the primary driver of capital and investment, we are in big trouble. This is where the individual’s economic creativity becomes stifled and things shut down.

One of the key strategies being used by insolvent governments around the world right now are fantasy long-term budget projections. They basically read something like, “Well we expect deficits to GDP to be elevated for the next several years, but there will be a surplus by 2020.” Sadly, many people actually believe this nonsense.

As I have said before, the biggest wealth destruction in the next 1-2 years will be, in my opinion, without a doubt, in the sovereign/municipal debt markets. Whether it be through inflation or deflation, this stuff can’t possibly be paid back in real money or anything close to it. The biggest fallacy I hear from people I know that own government or municipal paper is they say they are “comfortable just collecting the yield.” Ok, they may be comfortable with that now, but what if inflation escalates in a major way, which is, in my opinion, one of the more likely outcomes to all this. It means that clipping 3.7% per year on a 10-year note will not be so comforting.

The only reason people think it sounds good is because of what they just experienced in 2007-2009. Use some common sense and there is nothing comforting about it. In fact, it is downright scary. Here’s why. As inflation escalates, the overall price of these securities will trend lower and then, one day, whether in two months from now or a year from now, yields are really going to spike and you will be sitting on a pretty hefty capital loss. By the time an owner actually comes to the admission that there is big inflation in the system (remember the big holders of long-term treasuries will be the LAST to admit this) there will be a major principal loss on the securities, and the decision to sell or hold at that point will not be a pleasant one. Clipping the coupons wasn’t such a good idea after all…

Why Extending Unemployment Benefits is Inflationary and Why Food Stamps = Bread Lines

One theme I have focused on for years now is how the government and the establishment relies on disinformation and propaganda to keep this phony economy alive and to keepp the populace distracted with “bread and circuses” (as the Romans called it) or, as we can say in the modern United States, “food stamps and American Idol.”

Before I get into some of the “bread” tactics used by politicians on both sides of the isle, I want to make something clear. I am not saying we should get rid of food stamps and unemployment benefits. In the current world where we allow corporate oligarchies to control all aspects of the country, this would be unhelpful and immoral. However, I would be in favor of reducing them AFTER the oligarchy problem is dealt with. To do so before would lead to social chaos and would, as I said earlier, be entirely immoral.

Ok, so first with regard to food stamps. The latest data shows that 39.4 million Americans are receiving food stamps. One of the biggest spins you have heard on the media since 2008 is that this is nowhere near as bad as the Depression; after all, where are the bread lines? Well of course there are no bread lines, this is 2010. Food stamps are the modern equivalent. It is a convenient way to keep the suffering and plight of 13% of the American citizenry out of sight and out of mind. That way those that are benefitting from the corrupt crony capitalism of the current system can feel better about themselves. How about you join reality instead.

Next, there is the issue of unemployment benefit extensions. This situation is very similar to the simplistic scenario of printing money and giving it to everyone. Except this is worse. In that situation, at least some percent of those getting the money will be in a position to put that money to productive uses. Someone that is struggling with the severe trauma that is unemployed is going to basically use that money to pay the bills, pay down some debt, and if there is a little left over…well that IPAD sure looks nifty. All the while this is an unused asset of the economy.

This unutilized economic asset is consuming on the taxpayer dime while not adding to the productive capacity of the economy. This is pure inflation. Again, I want to reiterate that dealing with this problem is not the first order of business -- dismantling the oligarchies and restoring a free market is. Then the welfare issue can be dealt with.

Next, to those that continue along this irrational line of thinking -- that without wage inflation there is no inflation (2+2=5) -- I see the first signs of it appearing despite U6 employment at near 20%. Let me give you an example. Here in New York City we were just faced with a prospect of a doorman’s strike. At the last minute a deal was reached with the union which calls for a four year contract with a nearly 10% pay raise and no cuts in benefits for workers. First Wall Street bonuses rebound and now the unions. Entirely coincidental I am sure.

Say Goodbye to Disneyland

One of my old colleagues when I was at Bernstein, and who is from another country, described America to me with the following statement: “it’s like “Disneyland.” I never fully understood what he meant until the last couple of years. However, what I have also realized is this sense of delusional entitlement is extremely manifest in most other OECD nations as well. In case you missed it, earlier this week the European Union declared traveling a “human right” and is “launching a scheme to subsidize vacations with taxpayers’ dollars for those too poor to afford their own trips.”

A friend quipped to me after I sent him that article: “I just realized that there no longer exists any need for political parody. The Onion is a short.” Indeed.

Euro down on Greek jitters, banks dent U.S. stocks
Reuters - The euro fell and Greek debt came under intense pressure on April 26, 2010, on renewed jitters over Greece's bailout, while U.S. stocks mainly edged lower on fears that the financial reform making its way through Congress will curb bank profits.
Euro hits 1-year low on Greece, Portugal downgrade
Reuters - The euro hit a one-year low against the dollar on April 28, 2010, and some traders saw scope for a further drop in the near term, after downgrades of Greece and Portugal's credit ratings raised fears the euro zone's debt problems were spreading.
Battered euro, U.S. stocks get lift from Fed
Reuters - The euro rallied from one-year lows on April 28, 2010, and U.S. share prices gained after the U.S. Federal Reserve left interest rates near zero and gave an upbeat assessment of the U.S. economy.
Oil rises towards $86, up for third month on recovery
Reuters - Oil rose on April 30, 2010, heading for a third straight monthly gain, driven by expectations of global economic recovery and hopes of a bailout package to help Greece avoid debt default.
Consumers step up spending, bolstering growth
Reuters - The U.S. economy expanded at a 3.2 percent annual rate in the first quarter as consumers stepped up spending, the strongest sign yet a sustainable recovery is taking hold.
Instant View: U.S. economy grows 3.2 percent in 1Q 2010
Reuters - The U.S. economy grew at a slightly slower-than-expected pace in the first quarter of 2010, held back by inventories and exports, but resurgent consumer spending offered evidence of a sustainable recovery, a government report showed on April 30, 2010.
U.S. Economy Grew at a 3.2% Pace in First Quarter as Consumers Spent More
Bloomberg - The U.S. economy expanded at a 3.2 percent annual rate in the first quarter as households spent more freely, setting the stage for gains in employment that may help the recovery broaden and accelerate.