The Great Deformation (69 page)

In fact, by promising to keep nominal interest rates on low-risk money market funds at zero for six years, from December 2008 until mid-2015,
Bubbles Ben Bernanke threatened to confiscate the real wealth of Main Street America unless it cooperated and chased after high-risk asset classes. Nor would this confiscation be trivial. The CPI will have averaged 2.5 percent per year during the Fed's “era of ZIRP (zero-interest-rate policy)” while no-risk and liquid money market funds will have yielded essentially zero after taxes.

The math implies a 15 percent reduction in real wealth during Bernanke's six-year experiment in savings destruction. It is not surprising at all, therefore, that the bubble-vision financial news networks are able to find an endless string of money managers who expect the stock market to go up because “the Fed is forcing you to buy equities.” They will be proven right—until the third bust materializes from the Fed-sponsored speculations now under way.

Whatever the longevity of the Fed's third equity bubble, it cannot be gainsaid that the historical thrift habits of the American middle class have been kept dormant for another decade. Even after a devastating housing crash and another equity market meltdown, the household savings rate rebounded only tepidly, and stood at just 3.5 percent near year-end 2012.

Consequently, after a decade in which American households saved out of current income in a niggardly manner, and chased the illusion of instant riches from financial speculation instead, they are deeper in the hole than ever before. The violent inflation and crash of the Greenspan stock market bubble in 2000–2002 proved to be not a warning bell, but just the catalyst for another dose of monetary heroin, which under the Bernanke Fed became an addiction.

HOW THE $11 TRILLION HOUSING BUBBLE BLOATED MAIN STREET CONSUMPTION

The greatest housing bubble in history obscured this underlying impoverishment for a time. Indeed, when the Fed slashed interest rates down to 1 percent by June 2003, thereby igniting a ferocious housing price escalation, Greenspan, Bernanke, and the rest of the monetary politburo professed not to notice the bubble. Nor did they acknowledge that it was compounding the problem of low savings.

Someday historians will surely wonder how it was that the Fed herded the nation's aging population to nearly a zero savings rate by 2007, when it was evident that the soaring gains on household real estate were artificial and unsustainable. According to the national balance sheet data that the Fed itself publishes every quarter in the “Flow of Funds” report, the market value of household real estate actually surged from $11.8 trillion at the end of 1999 to $20.2 trillion at the end of 2004.

Only a willfully oblivious central bank could have viewed a 75 percent increase in the value of real estate holdings in just five years as anything except a dangerous deformation. After all, these soaring home prices did not represent a snap back from a deep housing depression. The value of household real estate had been rising for decades and, in the more recent past, had already clocked in at a robust 5.3 percent annually during the long 1987–1999 span of the first Greenspan stock market bubble.

In the end, the national balance sheet entry for household real estate experienced the same Lucy and Charlie Brown syndrome as did equities. Housing asset values kept climbing until they peaked at $23.2 trillion in 2006. The bubble makers at the Fed duly published that number in early 2007, but could they possibly have believed that the value of household real estate in the United States had risen by $11.4 trillion in just seven years? Or that this represented anything other than a vast accident waiting to happen?

In the event, the accident did happen and it was a doozy—the largest financial catastrophe in American history in terms of the breadth and depth of losses on Main Street. Household real estate values plunged for five consecutive years to just $18.0 trillion at the end 2011. So another $5 trillion bubble had vanished.

In all, the Fed's serial bubble making during the years after the dot-com peak kept Main Street distracted by hype and hopium, even as overall net worth stagnated. After the flashy bubbles in equities and real estate were liquidated, the gain in total household assets barely kept up with inflation, while the household debt burden doubled over the twelve-year period.

Accordingly, the net worth of American households rose by just 2.5 percent in constant dollars during the entire first decade of the 21
^st
century, yet even that miserly figure obscured the reality that the median household net worth actually declined by 27 percent in real terms, from $106,000 to $77,000. Since the after-inflation net worth of the top 10 percent of households actually rose by 17 percent, all other households experienced steep declines.

This perverse skew can be laid directly on the doorstep of the Fed. The net worth of the bottom 90 percent of households is heavily concentrated in residential property. In its wisdom, the nation's central bank encouraged households to massively increase their mortgage debt, but then proved incapable of preventing the collapse of the resulting housing asset bubble. In the crunch resulting from a 35 percent housing price decline versus mortgage debt obligations which remained contractually fixed, the net worth of Main Street households was hammered like never before.

LIVING HIGH ON THE HOG: $1.3 TRILLION PER YEAR IN BORROWED CONSUMPTION

If a decade of real wealth setback was the only adverse effect of the Fed's incessant juicing of Wall Street speculators, it might be argued that only limited harm has been done and baby boomers would be destined for a far more frugal retirement than they now imagine. In fact, however, irremediable damage has been done to the very foundation of the American economy because a two-decade-long holiday from a normal savings rate has come at a steep price.

Specifically, the excess consumption enabled by subnormal household savings resulted in year after year of recorded GDP growth that amounted to little more than theft from future generations. Compared to the historic benchmark savings rate of 8.5 percent, the actual rate of 3 percent registered over much of the last decade means that nearly 6 percent of the nation's disposable personal income, or about $600 billion per year, has been released for extra consumption expenditures.

Unfortunately, Professor Friedman's floating money contraption blocked the negative offsets that would normally boomerang back to an economy living too high on the hog. The classic effect of a savings drought under a régime of honest money is that interest rates soar. In the first instance, investment in productive assets is sharply suppressed, but eventually consumption falls and the savings rate rises in response to an increased reward for deferred gratification. Thus, free lunch economics tended to have a short-dated shelf life, at least until Camp David.

But under the dollar's “exorbitant privilege” conferred by the post-1971 T-bill standard, most of this excess consumption has been funded by means of borrowing from abroad, mainly from mercantilist central banks and their domestic financial wards and servitors. To date, the nation's cumulative domestic savings shortfall has been covered by $8 trillion of such foreign borrowings, thereby obviating the ill effects that would otherwise impact domestic interest rates and investment.

Those rising debts to the rest of the world will weigh heavily on American households when one day the Fed's con job on the price of government debt comes to an end. Its financial repression policies have crushed yields, but only because speculators believe that the Fed and other central banks will keep buying enough treasuries on the margin to keep the price propped-up far above market-clearing levels. When that confidence breaks, speculators and foreign central banks too will begin to sell and then to desperately stampede toward the exit as bond prices plummet and dollar interest rates soar.

In turn, the excess consumption of heavily indebted American households will drop with a thud in response to a surging interest due bill. The magnitude of the collapse will not only be startling, but will dramatically expose the phony GDP growth of the Greenspan-Bernanke era.

During the Eisenhower-Martin golden age of 1954–1965, for example, personal consumption expenditures averaged about 62.5 percent of GDP. This trend level was indicative of what might be expected in a reasonably healthy, steadily growing, noninflationary economy.

After traditional financial discipline was abandoned by Richard Nixon in August 1971, the consumption share rose steadily and reached about 65 percent of GDP by 1986. When the Greenspan money-printing era commenced in earnest, however, the personal consumption share of GDP headed resolutely upward and never looked back. By 1993, it stood at 67.3 percent and then rose above 69 percent after the turn of the century, finally hitting 71 percent of GDP at the peak of the credit bubble in 2007.

Moreover, during the subsequent fiscal “stimulus” régime, under which household spending has been heavily medicated by massive deficit-financed transfer payments and tax cuts, the consumption share of national income has risen even further. In fact, it reached an all-time high of 71.5 percent in 2010, a figure which far exceeds that for every other major nation on the planet.

The nation's bloated consumption ratio is among the principle deformations which now afflict the American economy. Its sheer magnitude is stunning. At the current level of 71.5 percent, the consumption share of GDP is 9 percentage points higher than the 62.5 percent ratio which prevailed during the 1954–1965 golden era.

At the GDP level recorded in 2010, this upward shift amounts to $1.3 trillion of extra annual consumption. Self-evidently, when this unsustainable ratio unwinds, the drag on GDP growth will be a harsh echo of the munificent boost which was realized on the way up.

Yet the actual story is even worse. While private residential construction is recorded in the GDP accounts as “investment” rather than consumption, the housing services actually provided by owner-occupied units amount to consumption no less than do purchases of sneakers or pizza; the GDP accounts just pretend that households “invest” in shelter and then “rent” it back to themselves.

So during the great housing boom new home square footage rose from an average of 1400 to 2400, spending on interior appointments soared, and McMansions sprang up on suburban tracts across the land. “Residential fixed investment” thus became more opulent, but it should never be confused with investment in productive business assets.

The true extent of the deformation brought on by the Greenspan bubble, therefore, can be more accurately measured by the sum of personal consumption expenditure (PCE) plus owner-occupied housing investment. The figures for peak-to-peak growth between the Greenspan bubble peaks of 1999 and 2007 leave no doubt that the US economy was being warped by a consumption spree of epic proportions.

During that eight-year period, the nation's nominal GDP expanded by 50 percent, or $4.7 trillion. Yet $3.9 trillion, or fully 82 percent, of the entire gain in reported GDP was attributable to the increase in personal consumption plus residential investment. By contrast, the benchmark standard for these two sources of consumption spending during the golden era of 1954–1965 averaged just 67 percent of national income.

Household consumption spending during the Greenspan bubble era was thus extended so far out on the limb that it defied all historical experience. And this deformation was enabled by a parabolic rise of debt.

Not surprisingly, the Fed exhibited no cognizance whatsoever of the role of debt in fueling the nation's consumption spree. Indeed, during the same 1999–2007 period total credit market debt outstanding doubled, rising from $25 trillion to $50 trillion, but the minutes of FOMC meetings during that era have almost nothing to say about this stunning eruption of borrowing by households, business, and governments alike.

This was the elephant in the room and it was also growing at an elephantine pace. During this same seven-year interval, nominal GDP grew by only $4.5 trillion, meaning that total debt on the nation's balance sheet had grown five times faster than national income. While the FOMC apparently never noticed this freakish development, there is no doubt that it was this debt explosion which fueled the Greenspan consumption bubble.

THE FED'S THIRD MONEY-PRINTING PANIC AND THE $25 TRILLION DEBT ERUPTION

So during the span between the end of 1999 and the final quarter of 2007, the deformations and contradictions of Greenspan bubble finance reached their apogee. Above all else, this meant that the central events of the period were not what they were cracked up to be.

The Fed claimed to be engineering a fulsome cyclical recovery and rising national prosperity, and the stock market and real estate sector pretended to be pricing it in. In fact, these trends were really all about the $25 trillion in new debt the Fed pumped into the American economy after launching its third money printing panic in December 2000.

Its hand-over–fist buying of government debt was unconscionable, especially given the fact that there was no crisis whatsoever in the Main
Street economy. Yet in the four years ending in December 2004 the Fed bought $200 billion of the public debt, causing its balance sheet to expand at a blistering 8 percent annual rate.

Needless to say, the data make a mockery of the Fed's claim that all of this wild money printing was necessary because the economy needed a supersized jolt of monetary stimulus, including an aberrationally low 1 percent interest rate, to avoid tumbling into the drink. In fact, the “recession” of 2001 was so faint that in later versions of the data it was essentially “revised” out of the government's own statistical record.