A Failed Confidence Trick

Consumers don't lack 'confidence'. They lack money...

TWO NEWSPAPERS – The International Herald Tribune and The Financial Times – said this week that the American economy has hit a bad patch, writes Bill Bonner, founder of the Daily Reckoning.

Both refer to consumer confidence as a cause of the problem. Consumers aren't willing to borrow or spend...say the papers...because they lack confidence.

What they really lack, of course, is money. They don't have enough money to continue spending at the bubble era rate...and they have little hope of getting any.

"Gloom holds back the US economy," says the FT.

The Conference Board does an index of consumer sentiment. It's at its lowest point in 40 years.

And no wonder. More Americans are unemployed now than there were 40 years ago, or any time in between. And never have house prices fallen so much. The Case-Shiller index puts house prices nearly 4% lower than they were 12 months ago. If all of America's housing stock has a value of around $20 trillion...this represents a loss of about $800 billion over the last year.

"It was all on paper anyway," you might say. But that was the paper that the baby boomers had hoped to use to finance their retirements. Seventy million of them are supposed to retire over the next 15 years. Few have actually saved enough money. Some looked to the stock market for the money they needed. Others counted on selling their houses.

Now, they're in a jamb. Stocks and houses have gone nowhere in the last 10 years. These years should have been the "peak retirement savings" years for the boomers...when their earnings were peaking out and the beaches of sunny Florida beckoned to them like Lorelei on the banks of the Rhine.

But they blew it. They took their peak earnings...invested in stocks or real estate...or simply spent the money. Now, what have they got?

They've got to do a lot of saving!

The trouble with saving money is that it is incompatible with a debt-soaked economy. If your earnings are increasing you can pay back your loans with your extra money. It doesn't take anything away from the economy. But if your earnings aren't increasing, you have to reach into your pocket and take out money that was earmarked for other things. This has the inconvenient consequence of reducing consumer spending...which sends the economy into a funk.

But now, the feds pump furiously, still raising debt levels in the public sector, but the tide goes out for almost everyone else. It sweeps millions of households out to sea with it. They are now drowning in debt, 'underwater,' with little hope of ever getting back to the surface. The best they can do is to let go the burden of mortgages, student loans, credit cards...all the debt that is dragging them down.

Then what? Then, they have to cut back...and save real money for retirement.

And you already know what this does to the economy.

"Well, Mr. Smarty Pants," said our better half, "What's your solution?"

"I don't have a solution. I only have a resolution."

"What's that?"

"Let the markets sort it out. Let the chips fall where they may. Give bankruptcy a chance."

"But it was the markets that got us into this mess. It was the markets that got people into so much debt. It was the markets that made them think houses would go up forever. It was the markets that rewarded Wall Street for its financial engineering."

"Well...yes...it was the markets reacting to a lot of bad cues and misinformation supplied by the feds."

"Maybe...but if the markets could make such huge mistakes...how do you know they won't make more of them?"

"Hey, the markets never know what anything is worth. They always make mistakes. But they are always finding out what things are worth. And when they realize they've been suckered into a bad position, they correct. They're always correcting their mistakes. And that's why we have a Great Correction on our hands today."

"But how do you know the correction will be any better than the mistake?"

"You're asking tough questions. I thought we were on a vacation."

"You're the one who is always talking about these things..."

"Of course, we never know anything for sure. That's why we have markets. They don't know anything either. But they're always discovering. It's sloppy. It's painful. But that's just the way it works.

"And what's the alternative? The Soviets tried to eliminate markets. They got smart people together and let them decide how capital was to be allocated, who got what...and at what price. It was the greatest economic experiment ever conducted. And they stuck to it. Over a 70-year period. If people objected, they sent them to Siberia. Some tried to get out of it by jumping over the Berlin Wall; many were shot by the guards. 

"We really should erect some monument to the Soviets for such steadfast zeal and earnest commitment to economic experimentation. Maybe they should get a Nobel Prize. They certainly have done much more than Keynes or Krugman to help us understand how markets work. Sensible people would have dropped the experiment after a few months. But the Soviets kept going.

"And now we know. Seven decades after it began, Russia was poorer than when it began.

"But that's the problem with a command economy. It corrects too, but only very reluctantly. Usually after a revolution.

"And that's what we see right now. The private sector — a market economy — is correcting the errors made in the bubble years. It is correcting its debt. It is de-leveraging. But the public sector? Government is a command economy. Decisions are made by bureaucrats, lobbyists and glad-handers. Capital is allocated according to political considerations; they are not guided by the invisible hand of the market. So they don't correct. They just keep making the same mistake — running up debt — until a correction is forced upon them."

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Bill Bonner is founder and owner of Agora Inc., one of America's largest consumer newsletter publishers. Best-selling author and globe-trotting correspondent since 1999 for the Daily Reckoning email, he is chairman of family-wealth advisory Bonner & Partners, and co-author with his son Will of Family Fortunes: How to Build Family Wealth and Hold Onto It for 100 Years (Wiley, 2012).

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