The New Empire of Debt: The Rise and Fall of an Epic Financial Bubble (34 page)

Pensions were out. Free people could look out for themselves. They could set up their own 401(k) plans and make money in common stocks. All you had to do was buy the companies you liked, said Peter Lynch.

And the companies themselves no longer had to worry about their employees. Managers could focus on cooking the books to give the impression of maximizing shareholder value. America soon became “Shareholder Nation”—a whole country of capitalists, all getting rich in the freest, most dynamic economy the world had ever seen.

Now we see that the whole thing was a huge swindle. Supply-side policies never really increased the supply side. Government never actually lightened up to let people live their own lives in their own ways. Employees never quite got around to putting money into their 401(k) plans; they were too busy trying to keep up with the credit card bills.And managers soon realized that maximizing their own incomes with stock options, bonuses, and rich retirement plans was more rewarding than looking out for shareholders.

The shareholders themselves—the millions of lumpen pseudoinvestors who owned mutual funds—couldn’t tell the difference. They had neither the time, the money, nor the training to be real capitalists; they were merely chumps for Wall Street.

And now, here we are, nearly three decades since Reagan won the White House. In real terms, the average man earns less per hour worked than he did in the Carter years. And the typical household approaches retirement poorer than it would have been in 1980.

America was the world’s biggest creditor when Ike was president. By Ronald Reagan’s second term, about 15 years into the pax dollarium era, the nation slipped to net-debtor status. In the following 20 years, it broke all records—becoming the world’s biggest debtor and the greatest debtor of all time.

But Thomas Gale Moore, then a member of President Reagan’s Council of Economic Advisors, must have anticipated Ben Bernanke when he noticed the United States crossing the creditor/debtor threshold in the mid-1980s. Not to worry, said he,“We can pay off anybody by running a press.”

In 1980, people still held parties when they paid off their mortgages. Paul Volcker said that he would bring down inflation rates, and he meant it. You could buy a stock for six times earnings and lend your money to the U.S. government for a 15 percent yield. Lenders demanded that much because they remembered the inflation of the 1970s. They knew that not every investment story had a happy ending.

Back then, the United States still made things. General Motors was our biggest employer; you could tell what year a car was made by looking at the tail fins.When Eisenhower was in the White House and William McChesney Martin was at the Fed, the United States had most of the world’s gold and most of the world’s credit.This happy state of affairs persisted until the reign of Ronald Reagan and Alan Greenspan, when Wal-Mart—a retailer, not a manufacturer—became its biggest employer.

SUNRISE, SUNSET

Under Ronald Reagan, Americans thought they had rediscovered their youth.They couldn’t remember ever feeling more confident or more optimistic. Then, 20 years later, in George W. Bush, Republicans thought they saw their hero reincarnate, with another 20 years of prosperity ahead.

And why shouldn’t it be morning in America again?

We answer the question directly. It was not morning in America because it was evening. There was no bull market because there was a bear market. People were not getting richer because they were getting poorer. It was not 1981 because it was 2001.

Readers who find this an unsatisfying explanation are reminded that it is not your authors who set the planets in motion around the sun and created man—such as he is—out of the dust of the earth. Morning often looks a lot like evening—if you face the wrong way at the right time. But it is the opposite end of the day’s cycle.

In 1982, interest rates were high and stock prices were low. In 1982, there were a few people who wanted to buy stocks, and many who didn’t. In 1982, America, Inc., looked like a has-been economy. Its currency was widely considered near-trash and its bonds were described as “certificates of guaranteed confiscation.”

You could buy nearly the entire Dow for just one ounce of gold. In 2000 it took 43 ounces. The trend of the time, in 1982, was down. Then smart people considered it eternal.
BusinessWeek
proclaimed that equities were not just in a cyclical downturn, not just sick, but dead.

As the moon looked down in the summer of 1982, it shone on a wall of worry so high that only a knuckleheaded contrarian would think of climbing it. Every headline seemed to give another reason the bear market would last forever. Every poll showed that consumers expected it. Every price seemed to confirm the everlasting trend; the sun had set forever; the black of night was permanent.

And yet, at that very moment, had an investor turned around, he would have noticed a brightening in the eastern sky. Over the next 18 years, the sun rose higher and higher, until investors were so encouraged by the favorable growing conditions that they scattered their seed like confetti at a parade. Did anyone doubt that it would take root in the hard concrete of lower Manhattan’s financial hothouse or the thin soils of the technology sector?

But the year 2000 was everything the year 1980 was not. In 2000, there were many people who wanted to buy stocks and few who didn’t. Interest rates were nearly as low as they have been in half a century and stocks were as high as they have ever been. Consumers—who were relatively reluctant to spend in 1982—picked their own pockets at the end of the century. Consumer spending was increasing at five times the increase in wages and salaries.

“Estimates vary,” Pete Peterson points out in
Running On Empty,
his vast inquiry into the impending bankruptcy of the U.S. government, “depending on methodology, but the numbers are all vast.” Peterson points to studies done on the future obligations of the Social Security and Medicare trust fund alone. In 2003, the American Enterprise Institute projected a $45 trillion shortfall; $47 trillion countered the International Monetary Fund in 2004; the National Center for Policy Analysis and the Brookings Institution came up with $50 trillion and $60 trillion, respectively, in their own research reports published in 2003.

Those are all incomprehensibly large numbers, of course, but the biggest of the projections came in 2004 from Social Security and Medicare trustees themselves.They estimated the unfunded benefit liabilities to have a current value of $74 trillion dollars.

As an empire matures, the imperial citizens believe more and more extravagant things. By the opening of the twenty-first century, Americans were spending more than they earned. Each day brought more new debt than real new wealth. Yet, almost every quarter showed growth in GDP. Americans mistook this growth for progress. They knew they had the world’s best economy, its best system of government, and its finest culture. They could not imagine that they were growing poorer. But here we turn again to the living and the dead for elucidation. Supply-sider Jude Wanniski admitted that real growth had come almost to a halt:

In the United States, my own work shows that between 1945 and 1971, when the dollar was fixed to gold at $35 oz under the 1944 Bretton Woods arrangement, the real economy in the US grew by 4 percent per year. From 1971 when the dollar was floated to 2004, real growth of the US economy has only a pitiful 0.3 percent per year.
⁷

The growth, such as it was, in the American economy, came about by virtue of increased emphasis on the present tense. Americans came to despise the past and neglect the future. The lessons of the dead and the desires of the unborn were both ignored. Instead, all that seemed to matter was consumption in the here and now.

A dead man, F. A. Hayek, explained the consequences:

The economy in its entirety must continue to decline so long as more is being consumed than produced, and some part of consumption therefore takes place at the expense of the existing capital stock.

Without a theory, Hayek might have said, the facts are as mute. But by the year 2005, both facts and theories had become blabbermouths. The trouble was that the facts had been corrupted so they no longer told the truth. And the old theories that might have been used to interpret the facts had been abandoned in favor of new, more convenient delusions. Americans could now run up as much debt as they wanted, said the new theorists.

The American economy may or may not have been “growing” in the G. W. Bush years. But if traditional, time-tested theories about how wealth and poverty are correct, thank God it was not growing more. Every step it took moved it deeper into debt and closer to bankruptcy.

10

America’s Glorious Empire of Debt

Let us take a moment to stand back and gaze at America’s great Empire of Debt. It is the largest edifice of debt ever put up. It sustains the most magnificent world economy ever assembled. It supports more people in better style than any system ever before devised.

Not only is it incomparably effective, it is also immeasurably entertaining. For it has its burnished helmets and flying banners; its intellectuals and its gladiators; its Caesars, Antonys, Neros, and Caligulas. It has its temples, its forum, its Capitol, its senators; its praetorian guards; its via Appia; its proconsuls, centurions, and legions all over the world as well as its bread and its circuses in the homeland; and its costly wars in periphery areas.

The Roman Empire rested on a classical model of imperial finance. Beneath a complex and nuanced pyramid of relationships was a foundation of tribute formed with the hard rock of brute force. America’s Empire of Debt, on the other hand, stands not as a solid pyramid of trust, authority, and power relationships but as a rickety slum of delusion, fraud, and misapprehension.

“My tax guy has been bugging me . . . . You know, real estate is where it is at.” In June 2005, NBC quoted a young woman who had bought a second home at a Colorado resort. According to the report, more than a third of the houses sold in the previous 12 months were not primary residences, but second homes or investments.

Down at the bottom of the pyramid were petty agents spreading deceit and misinformation—such as the aforementioned “tax guy.” You would think a young woman could trust her certified tax advisor to give her sound counsel. Instead, he urged her to speculate on the most bubbly property market in American history. Naturally, she went for it, aided no doubt by a whole industry of professional dissemblers. Press reports told us that appraisers routinely stretched valuations to help close a deal. Mortgage lenders knew perfectly well the appraisals were lies, but they winked at them with one eye while winking at the borrower’s phony income declaration with the other. Again, according to the press reports, lenders no longer verified income claims.They had gone blind!

In California, house prices raced so far ahead of incomes that barely one in ten buyers could afford the median house. Yet thanks to “creative finance,” more houses were being sold than ever before.

Thus the foundation of the debt pyramid was laid down in a bed of mutual deceit and cupidity, and covered with another level of fabrications. Lenders did not stick around to see how the loans worked out. Instead, they pretended the credits were good, and packaged the mortgages into convenient units so that investors could buy them. The financiers knew damned well that many buyers couldn’t really afford to pay for the houses they bought, but they saw no point in mentioning it. Nor did the investors want to know. They were in on the scam, too. The smartest of them even figured out how it worked.The Fed held down short-term rates below the inflation rate so that investors in long-term mortgage financing and buyers of U.S.Treasury obligations could make an easy profit.

Further up the steps of imperial debt were whole legions of analysts, economists, and full-time obfuscators whose role was to make us all believe six impossible things before breakfast and a dozen more before dinner. Economists at the Bureau of Labor Statistics did to numbers what guards at Guantanamo did to prisoners. They roughed them up so badly, they were ready to say anything. In June 2005, it was reported that productivity was increasing at a 2.9 percent rate—the fastest pace in nine months. Productivity was supposed to measure output per unit of time. But the yardstick was bent by the government’s statistical brownshirts, who said that if a computer this year can process information 10 times as fast as one produced last year, the worker who assembled it has multiplied his output 1,000 percent. This abuse of statistics is part of what allowed Americans to deceive themselves about their own economy. It was healthy, they said. It was growing. It was stable.

Economists, commentators, and policymakers took up these distortions and added their own twists. It was obvious to anyone who bothered to think about it that an economy that spends more than it earns is in decline. But try to find an economist willing to say so! They’d all become like rich notables in the time of Trajan, doing the emperor’s work whether they are on his payroll or not.They would tell you the economy is expanding, but it was an expansion similar to what happens when a compulsive eater escapes from a fat farm; the longer he is on the loose, the worse off he becomes. It was an expansion of consumption, not wealth-producing, job-creating investment.

On the issue of the trade deficit, they said what the senators and consuls wanted to hear, as Levey and Brown did in
Foreign Affairs
magazine: “The United States’ current account deficit and foreign debt are not dire threats to its global position, as would-be Cassandras warn. U.S. power is firmly grounded on economic superiority and financial stability that will not end soon.”
¹
In fact, the story of international trade, circa 2005, was the most preposterous tale economists ever told. One nation bought things that it couldn’t afford and didn’t need with money it didn’t have. Another sold on credit to people who already couldn’t pay . .. and then built more factories to increase output.