Monday, April 18, 2005

US Economy at brink of meltdown - nobody cares

Last week, the Dow Jones Index fell by triple-digit amounts for three consecutive days and just last night, the Nikkei fell to a four-month low. This does not bode well, that's for certain. Economists like me are adherents to a dismal science and are always wary of the doom on the horizon. You know it's bad when the Times basically comes out and says that the Empire has no clothes:

"The key players in this game are the Asian nations, led by China, which have pegged their currencies to the dollar. These countries’ central banks have continued to acquire billions in US Treasury bonds as they act to prevent their own currencies rising against the greenback. The resulting strong Asian demand for Treasury bonds keeps US market interest rates low, even as America’s debts spiral upwards. So Americans can carry on borrowing and spending, while Asia can carry on selling them its goods at artificially competitive exchange rates.

What worries the IMF, Mr Volcker and many others is that, as this situation persists, and the resulting current account imbalances grow ever wider, something has to give. The US cannot live on borrowed funds for ever and payback time will arrive. And as the pile of foreign claims against American assets grows ever larger, Asian and other creditor countries may lose their willingness for ever more dollar holdings.

Economists acknowledge that the Asian-American quid pro quo could perhaps carry on indefinitely. But the nagging fear is that it could unravel abruptly, with grave repercussions. If markets were to decide that the situation were unsustainable, triggering a collapse in the dollar, Wall Street would be hit hard, and US Treasury bond prices would tumble, driving US market interest rates upwards. The result would almost certainly be an American recession, and perhaps an outbreak of protectionism."

In America, the Lifetime Income Hypothesis does not seem to hold. The LIH basically maintains that low taxes and high expenditures today implies budget cuts and high taxes in the future. The US is racking up some huge debt numbers and plenty of economists are getting edgy. But a lame duck president does not care about the future - it's best to milk the Beast for all she's worth, damn the torpedoes and let some future Presidential Candidate deal with it.

The Plunge Protection Team

One of the best analyses of the US situation was written by Robert Bell where he details the "Hidden Hand in Financial Markets" - the Plunge Protection Team, which basically maintains faith in the market through intervention. Check out the nuggets of insight in his conclusion:

"All who imagine that the mythical market forces will prevail seem to deliberately avoid actually looking at what the so called markets really are, including their concentrations, Plunge Protection mechanisms, and Plunge Protection’s extensive access to a variety of pools of other people’s money. The mechanisms and the market concentrations permit the Bush administration to systematically sell off U.S. assets to pay for its more wars/less taxes policies. The Bush administration is comparable to a group of corrupt trustees for the family fortune of a lazy and incompetent heir. They siphon the money out by selling off the inheritance while the heir is too stupid or drunk to notice. He still has his mansion, his fleet of big cars and his monthly check, and he doesn’t notice that the assets are shrinking. He may not for a while. This family’s fortune is big and there are a lot of assets still to sell off."

Something's on the horizon, and it ain't pretty.