How To Identify A Bubble

January 7, 2004

*** More thoughts on the year ahead - what OUGHT to happen...

*** Consumer debt rises...mortgage debt too! U.S. heads to Third World status...who will love us then?!

*** Falling dollar is prelude to stock market collapse...what really happens in a presidential election year...and more...including flying aspidistra!

What will happen in 2004? We won't even try to tell you. The best we can do is try to figure out what OUGHT to happen.

And even then, we are appalled by our own arrogance. We cannot know what the gods intend. All we can do is try to make out - dimly - the right and wrong of it. As we mentioned yesterday, then...at least we can deserve what we get.

We begin today's remarks with a disturbing question: why ought an American earn 10 times as much as a Chinese laborer? Does he work that much harder? Is he so much smarter? Does he have some unseen virtue blessed by the gods with extra spending power?

He earns more only because his parents and grandparents and great grandparents worked hard...saved their money...built machines and factories...accumulated wealth and know- how...and avoided blowing themselves up in wars, hyper- inflation, revolution, and socialist delusions.

But now he squanders his savings...mortgages his children' s future...and willingly participates in extravagant mass hallucinations (we will borrow and spend until we all get rich...we will build an American-style democracy in ancient Nineveh...our kind friends the Chinese will pay our bills...) Ought such a man prosper?

The remarkable thing, says a report from the Rocky Mountain News, is that despite the furious pace of home refinancing, other forms of consumer debt did not go down. You will remember, dear reader, that no less of an authority than Alan Greenspan (and, if there is less of an authority, we can't think of whom he might be) told us what a great thing mortgage debt was. It allowed homeowners, he explained, to switch from expensive credit card debt to less expensive mortgage debt. With their balance sheets thus reinforced, they could add another few pounds of spending...without the whole thing giving way.

Well, the Fed chief was as wrong about this as he was about everything else. While the average household added to its mortgage debt, it added to its other debts, too. Credit card debt per household has grown to $7,000. Leaving out mortgages, consumer debt has doubled in the last 10 years...to $18,700 per household. Millions of families live 'paycheck to paycheck,' says the news item, with no provision for risk.

Of course, these families see no risk to provide for. As long as the money keeps flowing, they ask no questions. How can a nation with a half-trillion dollar government deficit add expensive new programs - such as providing patent medicines to old Americans...and new roads to young Iraqis? How can a country with a falling currency continue to attract foreign investment? How can a people who save less than 2% of their income build the machinery, the systems, the technology needed to compete in the modern, globalized economy? The questions never seem to occur to anyone.

Reckless spending, massive deficits, collective fantasies - if this continues, warns Paul Krugman in the New York Times, the U.S. will soon be regarded as a Third World nation. It has happened before. At the beginning of the 20th century, Argentina had living standards nearly equal to those in Europe and America. Then came the mass delusions of socialism, Peronism, paper moneyism, and debt. Hyper inflation and recession wasted Argentina's economy...to the point where it sunk down to near-Third World levels.

Here at the Daily Reckoning, this does not scare us. We like Third World countries. The weather is often good. And the cost of living is usually low. But we doubt that many Americans will welcome a drop in their wages, or a decline in their living standards. And even as a Third World country, the winter weather is not likely to improve.

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