T Nation

The Gravy Train Has Left the Station

http://www.safehaven.com/article-2810.htm

[i]March 29, 2005

[center]Even Stephen Roach Has It Wrong
by Peter Schiff[/center]

In his latest commentary, Morgan Stanley’s Stephen Roach, perhaps the only Wall Street economist who at least partially comprehends the looming economic danger, once again lamented that a “co-dependent global economy can’t live without the excess consumption of Americans.” This echoes the popular misconception that Americans are some how doing the world a favor by consuming the fruits of their labor.

The world no more depends on American’s consumption than medieval serfs depended on the consumption of their lords, who typically took 25% of what they produced. What a disaster it would have been for the serfs had their lords not exacted this tribute. Think of all the unemployment the serfs would have suffered had they not had to toil so hard for the benefit of their lords. What would they have done with all that extra free time?

According to modern day economists, if the lords had decided to increase their take, say to 35%, it would have been the equivalent of an economic boom for the serfs, who would have been insured more work. Too bad the serfs did not have economic advisers or central bankers to encourage such progressive policies!

I have written on this subject in the past (see my former commentaries entitled: “CNBC Redefines the Word ‘Sacrifice’,” Feb 10th 2005 and “The U.S. is Not a Special Case, Just an Extreme One,” Jan. 18th 2005). Both articles are archived in the commentary section on my web site at: http://www.europac.net/archives.asp. However, I would like to put the ridiculous assumption that the world benefits from America’s excess consumption, and has something to fear from its cessation, to rest once and for all. Consider the following analogy:

Suppose six castaways are stranded on a deserted island, five Asians and one American. Further, suppose that the castaways decide to divide the work load among them in the following manner: (for the purpose of simplicity, the only desire the castaways work to satisfy is hunger) one Asian is put in charge of hunting, an other in charge of fishing, and a third in charge of finding vegetation. A fourth is put in charge of preparing the meal, while a fifth is given the task of gathering firewood and tending to the fire. The American is given the job of eating.

So, on our island five Asians work all day to feed one American, who spends his day sunning himself of the beach. He is employed in the equivalent of the service sector, operating a tanning salon which none of the Asians on the island utilize. At the end of the day, the five Asians present a painstakingly prepared feast to the American, who sits at the head of a special table, built by the Asians specifically for this purpose.

Realizing that subsequent banquets will only be forthcoming if the Asians are alive to provide them, he allows them just enough scraps from his table to sustain their labor for the following day.

Modern day economists would say that this American is the lone engine of growth driving the island’s economy and that without his ravenous appetite, the Asians on the island would be unemployed. The reality, of course, is that the best thing the Asians could do to improve their lots would be to vote the American off the island. Without the American consuming all of their food, there would be a lot more available for them to eat.

Alternatively, they could spend less time on their food related tasks, devoting the extra time to greater leisure or to satisfying other needs, which previously went unfulfilled since much of their scarce resources are currently devoted to feeding the American.

Now some of you might be thinking that this analogy is flawed, as in the real world economy, Americans pay for their food, so real world Asians providing the meals receive value in exchange for their effort. O.K. lets assume that the American on our island pays for his food in the same manner real world American pay for theirs, buy issuing IOU’s. Let’s assume that at the end of the meal, the Asians present the American with a bill, which he pays by issuing IOU’s claiming to represent future payments of food.

However, all the castaways know that the IOU’s can never be collected, as the America has no food, or the means or even the intention, of providing any in the future. But the Asians accept them anyway, and each night add them to the piles of IOUs collected on previous days. Are the Asians better off as a result of this accumulation? Are they any less hungry? Of course not.

Now let’s assume another Asian castaway washes up onto the island, and assumes the role of central banker. Now each day the central banker taxes the other Asians on the island by confiscating a portion of the scraps of food the American throws them each day from his table. The central banker than agrees to return these morsels to the other Asians each day, in exchange for each Asian’s daily accumulation of the American’s IOU’s, less a small percentage for himself, because the central banker also has to eat.

Does the existence of a central banker change anything? Do the Asians have any more to eat because their own central banker gives them back a portion of the food he took from them in the first place? Do the American’s IOU’s have any more value because they can now be exchanged in this manner? Of course not.

Well, if it does not make sense for the six make-believe Asians to support one make-believe American, it does not make sense for billions of real world Asians to support millions of real world Americans. The fact that they do so in exchange for worthless IOU’s in no way alters this reality.

There is no question that in the short-run, by allowing the U.S. dollar to collapse (in effect voting millions of American’s off the island), there will be some temporary disruptions to Asian economies. Of course there will be some initial losers, particularly among those Asians who currently profit from this arrangement. However, these profits come only at the expense of far greater losses born by the broader Asian population.

In the end, the cessation of America’s excess consumption, which is a burden that the Asians now disproportionately bear, not a benefit that they enjoy, will be the best thing that can happen to the Asian people. Like the serfs being liberated from their lords, their scare resources will finally be freed to satisfy their own needs and desires, and their standards of living will rise accordingly. In addition, since their savings would then be available to finance additional capital investments, rather than being squandered by American consumers, their future standards of living will rise that much faster as well.

Unfortunately for Americans, being kicked off the Asian gravy train means its time to get back to work. In simple terms, this means a whole lot more hunting and fishing, and a whole lot less eating.[/i]

Compare that with this interview where Friedman says a few years back that Americas economy is strong and has nothing to fear from all this foreign debt unless of course the Fed started an inflation which it obviously never ever would.

Ahem…

http://video.google.com/videoplay?docid=-2963837673813979186&q=milton+friedman+rose

Interesting article. Those 5 Asians in the example may be providing goods and services for the single American who is sunning himself, but when the American is working he is exporting more to other islands then the 5 Asians combined due toefficeint use of capital and productivity and innovation.

Where Mr Schiff has missed the boat is productivity and innovation. American exported 1.1 Trillion dollars of exports in 2007. Real goods, commodities and services. Not simply IOU’s. His argument leaves that fact out. Those IOU’s simply facilitate global trade in the modern world. America could also enact protectionist strategy and use it’s capital solely for it’s own benefit. Like the Asian example in the article after a period of adjustment the economy would assimilate the change. Unlike Mr. schiff’s conclusion however, domestic markets are much smaller then global markets and the standard of living of an isolated nation would be limited at best and contracting at worst.

Mr Schiff is a risk averse adviser. Good for preserving wealth but not for creating it.

[quote]hedo wrote:
Mr Schiff is a risk averse adviser. Good for preserving wealth but not for creating it.
[/quote]
Is there no risk in saving? I only ask because you seem to be implying that credit based investment is the only way to take a risk. All investment decisions involve risk.

I believe the analogy is only used to show that there is a trade deficit between the 5 Asians and the American. The point being we export more debt than goods.

Theoretically, in this example, the American could trade his labor for food and there would be no trade deficit (provided it was a desired skill, etc.). The moment the American opts to use credit instead of his labor he has incurred a trade deficit.

The system of using savings (cash on hand) v. credit does have a downside in that it is not always possible immediately satisfy wants; on the other hand, using credit only temporarily shifts “saving” to a later date in the form of debt repayment.

Either way, consumption can only happen via production and production can only happen via saving. Credit only shifts when saving has to happen.

All investment decisions do involve risk to some degree. The higher the risk the more the return must be to reward the investor. Savings is considered risk free. Certainly that depends on what method you use to save but T-Bonds and Bills as well as savongs accounts are considered riskless by the investment community.

I do see the point the author was trying to make but to dismiss the largest export economy in the world as simply issuing IOU’s to pay for it’s indulgences was ignoring the most important point in that those IOU’s facilitate trade and they are backed by the world’s largest economy.

Going forward the US has always managed risk well and US corporations are experts in risk management. How about China? Is China’s growth rate sustainable and is the economic data from China accurate? Because once the growth slows in China, and it must at some point, and if the growth data was not accurate and tansparent, the the economic implications for China will be dire.

[quote]hedo wrote:
All investment decisions do involve risk to some degree. The higher the risk the more the return must be to reward the investor. Savings is considered risk free. Certainly that depends on what method you use to save but T-Bonds and Bills as well as savongs accounts are considered riskless by the investment community.
[/quote]

You have to be careful what you call a “risk” in terms of finances.

Risk is the measurable or expected deviance from the expected
return, so for a dollar investor t-bills might be without risk but he still could lose everything when it comes to a hyperinflation.

He does not have a risk in terms of dollars, because he will get them 100%, but they might not be worth anything.

For the foreign investor the situations is different for he obviously bears an exchange risk.

That is irrelevant because it does not matter how wealthy someone is when he defaults on his loans. Right now the US has a lot of short term revolving credits and they become increasingly unattractive because of the falling dollar.

So either the Fed raises interest rates to make up for that, which would be bad for the American economy, or they will no longer lend you money, which would lead to a massive inflation if they used all the dollars they have to go shopping in the US.

The last part is probably already happening.

[quote]
Going forward the US has always managed risk well and US corporations are experts in risk management. How about China? Is China’s growth rate sustainable and is the economic data from China accurate? Because once the growth slows in China, and it must at some point, and if the growth data was not accurate and tansparent, the the economic implications for China will be dire.[/quote]

Right now there is one government that definitely lies in its economic statistics and that is the US.

What will the economic consequences for the US be?

[quote]orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

[/quote]

Give me a break.

[quote]orion wrote:
hedo wrote:
All investment decisions do involve risk to some degree. The higher the risk the more the return must be to reward the investor. Savings is considered risk free. Certainly that depends on what method you use to save but T-Bonds and Bills as well as savongs accounts are considered riskless by the investment community.

You have to be careful what you call a “risk” in terms of finances.

Risk is the measurable or expected deviance from the expected
return, so for a dollar investor t-bills might be without risk but he still could lose everything when it comes to a hyperinflation.

He does not have a risk in terms of dollars, because he will get them 100%, but they might not be worth anything.

For the foreign investor the situations is different for he obviously bears an exchange risk.

I do see the point the author was trying to make but to dismiss the largest export economy in the world as simply issuing IOU’s to pay for it’s indulgences was ignoring the most important point in that those IOU’s facilitate trade and they are backed by the world’s largest economy.

That is irrelevant because it does not matter how wealthy someone is when he defaults on his loans. Right now the US has a lot of short term revolving credits and they become increasingly unattractive because of the falling dollar.

So either the Fed raises interest rates to make up for that, which would be bad for the American economy, or they will no longer lend you money, which would lead to a massive inflation if they used all the dollars they have to go shopping in the US.

The last part is probably already happening.

Going forward the US has always managed risk well and US corporations are experts in risk management. How about China? Is China’s growth rate sustainable and is the economic data from China accurate? Because once the growth slows in China, and it must at some point, and if the growth data was not accurate and tansparent, the the economic implications for China will be dire.

Right now there is one government that definitely lies in its economic statistics and that is the US.

What will the economic consequences for the US be?

[/quote]

Thats a tiersome argument. If all economies were as transparent as the US and the statistics were compiled the same way markets would be far more orderly. Do you have any evidence to the contrary? There will be no consequence because it isn’t happening. The Chinese don’t even believe the economic data they produce due to widespread corruption. Why would anyone else?

Why would a wealthy investor default on his loan? In as much as property rights are a cornerstone of the American legal and financial system (not so in China) and assuming the money was lent under agreement how would that happen?

Currency fluctuates in cycles. Always has. US exports are cheaper now and quality is high. The EU is already crowing that it is unfair to them. The market will be bring it back to equilibream and the Euro will fall. Markets move in cycles and this one is no different.

[quote]hedo wrote:
… Markets move in cycles and this one is no different.
[/quote]

The sky is falling.

[quote]Zap Branigan wrote:
orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

Give me a break.[/quote]

they do.

Is it my problem that you do not know it?

[quote]orion wrote:
Zap Branigan wrote:
orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

Give me a break.

they do.

Is it my problem that you do not know it?

[/quote]

And every other country is forthcoming and honest? You are full of shit.

[quote]hedo wrote:
orion wrote:
hedo wrote:
All investment decisions do involve risk to some degree. The higher the risk the more the return must be to reward the investor. Savings is considered risk free. Certainly that depends on what method you use to save but T-Bonds and Bills as well as savongs accounts are considered riskless by the investment community.

You have to be careful what you call a “risk” in terms of finances.

Risk is the measurable or expected deviance from the expected
return, so for a dollar investor t-bills might be without risk but he still could lose everything when it comes to a hyperinflation.

He does not have a risk in terms of dollars, because he will get them 100%, but they might not be worth anything.

For the foreign investor the situations is different for he obviously bears an exchange risk.

I do see the point the author was trying to make but to dismiss the largest export economy in the world as simply issuing IOU’s to pay for it’s indulgences was ignoring the most important point in that those IOU’s facilitate trade and they are backed by the world’s largest economy.

That is irrelevant because it does not matter how wealthy someone is when he defaults on his loans. Right now the US has a lot of short term revolving credits and they become increasingly unattractive because of the falling dollar.

So either the Fed raises interest rates to make up for that, which would be bad for the American economy, or they will no longer lend you money, which would lead to a massive inflation if they used all the dollars they have to go shopping in the US.

The last part is probably already happening.

Going forward the US has always managed risk well and US corporations are experts in risk management. How about China? Is China’s growth rate sustainable and is the economic data from China accurate? Because once the growth slows in China, and it must at some point, and if the growth data was not accurate and tansparent, the the economic implications for China will be dire.

Right now there is one government that definitely lies in its economic statistics and that is the US.

What will the economic consequences for the US be?

Thats a tiersome argument. If all economies were as transparent as the US and the statistics were compiled the same way markets would be far more orderly. Do you have any evidence to the contrary? There will be no consequence because it isn’t happening. The Chinese don’t even believe the economic data they produce due to widespread corruption. Why would anyone else?

Why would a wealthy investor default on his loan? In as much as property rights are a cornerstone of the American legal and financial system (not so in China) and assuming the money was lent under agreement how would that happen?

Currency fluctuates in cycles. Always has. US exports are cheaper now and quality is high. The EU is already crowing that it is unfair to them. The market will be bring it back to equilibream and the Euro will fall. Markets move in cycles and this one is no different.
[/quote]

The US is already defaulting on the US governments loans by printing dollars. Why do you think the oil prize rises? Answer, it doesn´t, the dollar drops. Is that technically defaulting? No. Will investors care what it technically is any longer? Highly improbable.

Then of course the Chinese lie. They also grow so fast that they have a measurable impact on commodity prizes so something is happening there.

The point is, they save and produce while the US takes loans to consume. The first one you can do forever, not so much the second. If the Chinese lie, they lie about unimportant things, how much you owe them is undisputable.

Finally, yes it all goes in circles. However, instead of shrinking and expanding the money supply with the economic cycle , Greenspan has constantly expanded the money supply to avoid a recession.

So, what went up, must come down, but instead of taking several small recessions every three years or so you will take one gíant big one now.

[quote]Zap Branigan wrote:
orion wrote:
Zap Branigan wrote:
orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

Give me a break.

they do.

Is it my problem that you do not know it?

And every other country is forthcoming and honest? You are full of shit. [/quote]

No, but no civilized country does lie when it comes to inflation and production statistics like the US.

The unique thing about the US system is that it is like US politics. No one really outright lies, it is just so much BS that noone can really know what is true anymore.

At least I can trust the Chinese not to lie to themselves, the US government does exactly that.

You can easily verify that by googling “hedonic statistics” and “food gas CPI”.

So, to bring this discussion back to your level of economic understanding, no, you´re full of shit.

[quote]orion wrote:
Zap Branigan wrote:
orion wrote:
Zap Branigan wrote:
orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

Give me a break.

they do.

Is it my problem that you do not know it?

And every other country is forthcoming and honest? You are full of shit.

No, but no civilized country does lie when it comes to inflation and production statistics like the US.

The unique thing about the US system is that it is like US politics. No one really outright lies, it is just so much BS that noone can really know what is true anymore.

At least I can trust the Chinese not to lie to themselves, the US government does exactly that.

You can easily verify that by googling “hedonic statistics” and “food gas CPI”.

So, to bring this discussion back to your level of economic understanding, no, you´re full of shit.[/quote]

You said the only country that lies is the US and now you are mealy mouthing it. You are full of shit which makes you the liar and discussion impossible. you have earned nothing more.

[quote]orion wrote:
hedo wrote:
orion wrote:
hedo wrote:
All investment decisions do involve risk to some degree. The higher the risk the more the return must be to reward the investor. Savings is considered risk free. Certainly that depends on what method you use to save but T-Bonds and Bills as well as savongs accounts are considered riskless by the investment community.

You have to be careful what you call a “risk” in terms of finances.

Risk is the measurable or expected deviance from the expected
return, so for a dollar investor t-bills might be without risk but he still could lose everything when it comes to a hyperinflation.

He does not have a risk in terms of dollars, because he will get them 100%, but they might not be worth anything.

For the foreign investor the situations is different for he obviously bears an exchange risk.

I do see the point the author was trying to make but to dismiss the largest export economy in the world as simply issuing IOU’s to pay for it’s indulgences was ignoring the most important point in that those IOU’s facilitate trade and they are backed by the world’s largest economy.

That is irrelevant because it does not matter how wealthy someone is when he defaults on his loans. Right now the US has a lot of short term revolving credits and they become increasingly unattractive because of the falling dollar.

So either the Fed raises interest rates to make up for that, which would be bad for the American economy, or they will no longer lend you money, which would lead to a massive inflation if they used all the dollars they have to go shopping in the US.

The last part is probably already happening.

Going forward the US has always managed risk well and US corporations are experts in risk management. How about China? Is China’s growth rate sustainable and is the economic data from China accurate? Because once the growth slows in China, and it must at some point, and if the growth data was not accurate and tansparent, the the economic implications for China will be dire.

Right now there is one government that definitely lies in its economic statistics and that is the US.

What will the economic consequences for the US be?

Thats a tiersome argument. If all economies were as transparent as the US and the statistics were compiled the same way markets would be far more orderly. Do you have any evidence to the contrary? There will be no consequence because it isn’t happening. The Chinese don’t even believe the economic data they produce due to widespread corruption. Why would anyone else?

Why would a wealthy investor default on his loan? In as much as property rights are a cornerstone of the American legal and financial system (not so in China) and assuming the money was lent under agreement how would that happen?

Currency fluctuates in cycles. Always has. US exports are cheaper now and quality is high. The EU is already crowing that it is unfair to them. The market will be bring it back to equilibream and the Euro will fall. Markets move in cycles and this one is no different.

The US is already defaulting on the US governments loans by printing dollars. Why do you think the oil prize rises? Answer, it doesn´t, the dollar drops. Is that technically defaulting? No. Will investors care what it technically is any longer? Highly improbable.

Then of course the Chinese lie. They also grow so fast that they have a measurable impact on commodity prizes so something is happening there.

The point is, they save and produce while the US takes loans to consume. The first one you can do forever, not so much the second. If the Chinese lie, they lie about unimportant things, how much you owe them is undisputable.

Finally, yes it all goes in circles. However, instead of shrinking and expanding the money supply with the economic cycle , Greenspan has constantly expanded the money supply to avoid a recession.

So, what went up, must come down, but instead of taking several small recessions every three years or so you will take one gíant big one now.

[/quote]

Much like the flaw in Mr. Schiff’s argument you assume that the world’s largest economy only consumes and doesn’t produce and that the dollar can only fluctuate down and not up. You do realize how big the export economy is don’t you and how much it will grow in 2008, despite a recession. It is very likely that the next expansion could eliminate all losses incurred during a recession. Centralized planning rarely does as well.

The sky is not falling. However if your perspective is limited by youth, inexperience or bias such as the journalism that much of the world, and in particular Europe, is exposed to then your conclusion is predetermined.

More astute investors are buying US companies and property on the cheap. Smart US companies are taking advantage of the weak US dollar to compete on cost against other export nations they couldn’t match before and are still offering higher quality and guaranteed delivery vs. payment. This is how world trade works for all. Hyperbole rarely holds up past the next percieved crisis.

[quote]orion wrote:
Zap Branigan wrote:
orion wrote:
Zap Branigan wrote:
orion wrote:

Right now there is one government that definitely lies in its economic statistics and that is the US.

Give me a break.

they do.

Is it my problem that you do not know it?

And every other country is forthcoming and honest? You are full of shit.

No, but no civilized country does lie when it comes to inflation and production statistics like the US.

The unique thing about the US system is that it is like US politics. No one really outright lies, it is just so much BS that noone can really know what is true anymore.

At least I can trust the Chinese not to lie to themselves, the US government does exactly that.

You can easily verify that by googling “hedonic statistics” and “food gas CPI”.

So, to bring this discussion back to your level of economic understanding, no, you´re full of shit.[/quote]

A vast conspiracy is not an answer. I a politcal system with opposing parties vast economic conspiracies are not likely or possible. Too many people involved with different agendas.

Economic statistics are compiled from hundreds of sources in the US as well as private investment firms. No single “ministry” or “minister” has the opportunity to fudge them.

[quote]hedo wrote:
Going forward the US has always managed risk well and US corporations are experts in risk management. How about China?[/quote]

How much does it matter how well risk is managed while accruing debt? This just shifts risk to the lender. To answer your question, China would be fool to keep lending to us. That is called risk management.

I am not trying to imply that debt isn’t useful. It most certainly is but eventually the bill becomes due and one would be careful to not accrue more than one can pay back. However, ones eventual death will be the “get out of jail free” card.

[quote]LIFTICVSMAXIMVS wrote:
hedo wrote:
Going forward the US has always managed risk well and US corporations are experts in risk management. How about China?

How much does it matter how well risk is managed while accruing debt? This just shifts risk to the lender. To answer your question, China would be fool to keep lending to us. That is called risk management.

I am not trying to imply that debt isn’t useful. It most certainly is but eventually the bill becomes due and one would be careful to not accrue more than one can pay back. However, ones eventual death will be the “get out of jail free” card.[/quote]

I think they would be foolish to invest it anywhere else. The US economy on a trend line of over 100 years is resiliant. The EU is a gamble and so are emerging economies. They may all develop into riskless economies in the future but they aren’t now and couldn’t support the sudden influx of investment. Besides US goods, services and properties are at bargain prices due to a falling dollar.

[quote]hedo wrote:
I think they would be foolish to invest it anywhere else.
[/quote]
Spoken like a trader who gets paid a commission.

Wouldn’t it be more prudent for foreign investors to diversify risk?

Resiliency doesn’t mean anything to a person who loses their entire investment on a single downswing.

This state of zero risk can only exist with perfect knowledge of the future. In other words, it doesn’t exist.

Let us distinguish between investment in consumer and capital goods. Right now we are seeing the effects of malinvestment in consumer goods – for example, the collapse of the housing market. Capital goods are STILL a good investment but it will be harder to get loans to grow them any further because of the aforementioned “crisis”.

We need to shift our consumptive habits to saving. Fortunately, the corrective forces are already at work bankrupting people – whether they consume less is doubtful but at least they will be kept from incurring more debt.

[quote]hedo wrote:
LIFTICVSMAXIMVS wrote:
hedo wrote:
Going forward the US has always managed risk well and US corporations are experts in risk management. How about China?

How much does it matter how well risk is managed while accruing debt? This just shifts risk to the lender. To answer your question, China would be fool to keep lending to us. That is called risk management.

I am not trying to imply that debt isn’t useful. It most certainly is but eventually the bill becomes due and one would be careful to not accrue more than one can pay back. However, ones eventual death will be the “get out of jail free” card.

I think they would be foolish to invest it anywhere else. The US economy on a trend line of over 100 years is resiliant. The EU is a gamble and so are emerging economies. They may all develop into riskless economies in the future but they aren’t now and couldn’t support the sudden influx of investment. Besides US goods, services and properties are at bargain prices due to a falling dollar.

[/quote]
are you saying i get to buy things cheaper with my crappy dollar? i dont follow.