How many more bubbles can the US economy throw up before it sinks?

"Statistics showing sharply rising stock sales by corporate insiders over the past couple of months," Dr Kurt Richebächer writes in his July 2003 Letter, "suggest that the bosses of Corporate America regard the current stock rally as a great selling opportunity. We happen to share this view."

In this, there are hints of rats and sinking ships. When I asked Dr Richebächer when he expected the ship to sink, he said: "By the end of calendar year 2003."

So, when the northern hemisphere returns from its summer holidays in September, not only will the "ridiculous euphoria" of the "new paradigm" economy of a few years ago be a mere distant memory, but even the present "striking aura of optimism" in the United States might already be behind us.

That optimism, which has kept the bull count at 58.7 per cent and the bear count at only 16.3 per cent, has been founded - or to maintain our metaphor, should we say has been buoyed up to the heights? - by a series of bubbles. The stockmarket bubble has been followed, largely thanks to the guiding genius of Fed Chairman Alan Greenspan, by a housing bubble, a mortgage refinancing bubble and a bond bubble.

Sustained only by that "striking aura of optimism," the stockmarket bubble, which lost $4,880 billion, or 54 per cent of its peak value between 1999 and 2001, is now only waiting - if bubbles wear shoes - for the second one to drop.

The housing bubble increased the marketable value of tangible assets from 1999 to 2002 by almost $3,500 billion; but builders are now said already to be holding several months of past production; and inventories continue to rise.

The mortgage-refinancing bubble must also have just about run its course, if only because mortgage rates can probably not fall much further - or at least significantly below their present all-time-record lows.

Looming above all is the fearsome bond bubble whose "influences," Richebächer says, "are pervading the whole economy and the whole financial system, and its bursting may have apocalyptic consequences".

Will the bond bubble indeed burst? "All that is needed to prick the bubble is for new buying to cease because long-term rates have become too low. Soon, more and more players will close their position, driving long-term rates upward."

That must be a gravely worrying - indeed, terrifying - forecast.
Is there some other bubble to sustain the American - and, ultimately, the world economy?

The boosts to the American economy have already been huge, with cuts from 6.5 per cent to 1.25 per cent in the Federal funds rate in just two years; and the conversion of a Federal surplus of $295 billion in 2000 to a DEFICIT of between $400 and 500 billion this year. Stimuli of these enormous dimensions, including financial and non-financial credit totalling $4.4 trillion, have scarcely been enough to hold up consumer spending - which has been almost the sole support of U.S. GDP growth in recent years.

The fundamental problems of the United States economy remain: Low savings and low fixed-capital public and private investment; miserable profits; and what is probably the single biggest drag on the US economy, the huge external trade deficit, now between $400 and $500 billion.

How did this massive obstacle to growth - and now, recovery - of the United States economy, come about?

If we take a quick look at its causes, we can see that the raising of interest rates to "fight inflation" after 1969 brought, not lower inflation, but stagflation, that is, higher inflation with unemployment, lower productivity and lower production. As time passed, this domestic inflation was shifted to external trade deficits as overseas suppliers, such as the Asian Tigers and, later, China, emerged to meet supply shortfalls. Domestic industry was gutted and moved offshore. This shift occurred particularly after the dramatic inflation and huge interest-rate hikes under Fed Chairman Volcker in the late 1970s and early 1980s and the supply-side Reagonomics of the 1980s.

Imports damped down inflation, interest rates fell; but money flowed not into enhanced production - and a return of "offshored" industry - so much as into speculation, especially stockmarket (including bonds and derivatives) and real estate, resulting largely in asset-price inflation. The latter caused interest rates to be lifted again, economic growth and employment to slow, the trade deficit to persist or move still higher, and so on. There was thus a vicious circle, leading from domestic inflation to the gutting of domestic industry, to financial speculation rather than real, fixed-capital investment, to asset-price inflation, to a resumption of higher interest rates and then the whole vicious circle started again.

(This vicious circle or cycle was not and is not unique to the United States. Australia has been plagued with it too; and its viciousness has been as marked for us as it has been for our big brother - our big brother in misguided economic policies. Our external-trade deficit now seems to be running at about $40 billion a year.)

Mainstream economic thinking, at the theoretical/academic, banking and business, and political level remains dedicated to the policies which have produced this vicious circle of instability and misuse of resources.

However, in its latest annual report, the Bank for International Settlements (BIS) effectively pulls the rug from under monetarism, draws attention to the ineffectiveness of monetary policy, questions the wisdom of the inflation-target policy of central banks, and the wisdom even of the independence of the central banks themselves.

BIS warns of the liquidity trap and advocates demand stimulation.
Are we entering a new era? So far, national political, business and academic "leaders" have not aligned themselves with the report of the BIS. Perhaps they never will. In the past, we have had brave statements from institutions which have not been followed by effective action. There is no sign that the International Monetary Fund, for example, which remains always under the effective command of the United States Treasury, has changed its spots.

What is certain however is that we face a crisis of unusual dimensions - economic, social, political and, indeed, strategic. One of the world's most prestigious international financial institutions, the BIS says in its report that:

Unless the leading industrial countries get their act together and pursue compatible economic policies, the world economy may be threatened by 1930s-style competitive devaluation and an outbreak of protectionism.

Although the BIS has drawn attention to the shortcomings of present policies, it has not identified, at least with any clarity or precision, the lines of policy, beyond demand stimulation, that national governments and international institutions should follow.

What is clear, as Dr Richebaecher puts it, is that "the obvious indispensable further condition for sustained, stronger economic growth is higher business fixed investment" and he quotes Greenspan as saying that "the central question about the outlook remains whether business firms will quicken the pace of investment".

Richebächer concludes that "there are no reasonable signs of an imminent pickup in U.S. economic growth in general and of business fixed investment in particular."

What then are we to do? Is there a lifeboat on the sinking ship into which we can clamber?

The only real prospect is that of increased business fixed investment and that can now be achieved only under the stimulus of public fixed-capital investment. There is no other means of rescue for the American economy and, through and alongside it, of the world economy. In the short- and probably in the medium-term, that rescue is now likely to be at best partial, since it has already been too long delayed; but it is essential that we embark on such a rescue without any further hesitation.

The BIS has suggested that "the leading industrial countries should get their act together and pursue compatible economic policies." They should do more than this and look to models and processes that have succeeded in the past, in particular, those of the kind of the Marshall Plan for reconstruction after World War Two.

If governments will not do it, we should try to stimulate them to act through our own direct democratic action. That is the purpose of VOW and the need for action within it grows ever more urgent.