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Responses to the Doomsayers

 
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PostPosted: Tue Oct 16, 2007 3:11 pm    Post subject: Responses to the Doomsayers Reply with quote

http://www.bls.gov/opub/uscs/report991.pdf

The rise in U.S. living standards is understated, because quality isn't taken into account. For example, the median house today is newer, bigger, and better than the median house in 1901 (also, median household size has shrunk to less than 2.5 people, while the homeownership rate rose to about 70%, which increased the number of houses). Moreover, there's no comparison in median automobile quality (few autos existed in 1901), etc. Furthermore, there are many products that exist today that didn't exist in 1901, which raised living standards.

A sense of proportion is needed. U.S. income (equals output equals GDP) over the next 10 years will be $160 trillion and U.S. assets may be over $100 trillion. So, the National Debt, which is the Federal debt accumulated over the entire history of the U.S., is only 70% of one-year's GDP. Moreover, the Federal government financed the Federal debt at lower interest rates, i.e. sold Treasury bonds at lower rates. Furthermore, I may add, assets and consumer surplus of U.S. households increased faster than liabilities, which is why debt rose and saving fell. Bargains induced U.S. demand.

Just like the volume of production in itself will cause declining prices and induce demand, the volume of capital will in itself cause interest rates to fall and induce demand. Export-led economies are willing to accept small gains of trade (which imply the U.S. accepts large gains of trade) to achieve and maintain acceptable levels of employment and output. However, the U.S. economy can expand with huge negative net exports. Obviously, the U.S. economy is relatively stronger and becoming stronger, through international trade. The U.S. can be viewed as a Black Hole attracting imports and capital. Now, it's also attracting the foreigners who own that capital.

The U.S. with less than 5% of the world's population, produces about one-third of the world's output. Yet, the U.S. consumes more than it produces. In 2007, the U.S. will consume over $800 billion more than produce. Obviously, U.S. living standards have risen substantially on both the production and consumption sides.

In 2006, U.S. per capita income reached $43,000, which is over $10,000 a year more than E.U. per capita income, while Americans continued to consume more than produce. Consequently, Americans, in general, live in newer, bigger, and better houses, drive newer, bigger, and better cars, buy many durable and non-durable goods at low prices and with low interest rates, etc. Most of the increase in U.S. debt was by U.S. households.

However, U.S. firms had 18 consecutive quarters of double-digit earnings growth resulting in strong balance sheets. The U.S. government deficit is projected to be only $150 billion in 2007 (or a little more than 1% of 2007 U.S. GDP), in part, because of low rates on Treasury bonds. U.S. firms and the U.S. government have became stronger.

Low prices and low interest rates, along with high incomes, induced U.S. household demand. U.S. households will work longer to pay-down debt and build-up saving, which will add to future U.S. economic growth. Also, U.S. exports will accelerate faster than U.S. imports, which will add even more to U.S. economic growth. Less slack in the U.S. economy (to close the output gap) will cause wage growth to accelerate and profit growth to slow. U.S. households are adept at maintaining autonomous consumption or a higher living standard. Those who've underestimated the U.S. economy were very sorry they did.

Is the U.S. moving in the right direction? Forget the fact that the U.S. leads the rest of the world combined in the Information and Biotech Revolutions (in both revenues and profits). Look at the goods & services produced by U.S. Agricultural and Industrial Revolution firms, e.g. Boeing, Caterpillar, Gillette, Coca Cola, Pepsi, Johnson & Johnson, GE, McDonalds, Disney, DuPont, Hilton, Harley Davidson, Paccar, Heinz, Hersheys, Ingersoll Rand, International Paper, Kellogg, 3M, Alcoa, etc. They have a great deal of market power focusing on higher quality "core" products. Also, the efficiencies of U.S. retail and finance are the envy of the world. Moreover, U.S. oil firms (energy firms are roughly 15% of the S&P 500) make more money refining oil than oil producers make selling oil, while U.S. gold, copper, steel, etc. firms make huge profits. The only way to move from one economic revolution into the next is through efficiencies, which free up limited resources. It's all interrelated, and inevitable, which is why the U.S. leads the world in the Agricultural, Industrial, Information, and Biotech Revolutions.

What the Doomsayers fail to understand is U.S. household assets increased faster than U.S. household liabilities, which raised U.S. living standards. For example, the median U.S. home price fell in 2007 for the first time in 29 years (houses tend to be appreciating assets), while interest rates fell throughout the '80s and '90s, which lowered monthly payments and increased equity (e.g. for massive expenditures on home improvements that reached over $230 billion in 2004). Ignoring assets and focusing on liabilities will lead to biased negative conclusions, similar to ignoring the increases in U.S. output far exceeded the rise in U.S. inflation or the losses in U.S. purchasing power.

There's little comparison between the U.S. economy of the 1920s and the 2000s. The U.S. economy is much more diversified now. Margin requirements were 10% in the '20s (compared to 50% today), i.e. an investor could borrow $10,000 on $1,000 for the stock market. The U.S. economy was overproducing in the '20s, which created a short-run economic boom/bust cycle. Moreover, the Great Depression was the result of a long-wave economic boom/bust cycle (based on uneven labor supply). However, the U.S. economy has been underproducing throughout the 2000s. The U.S. was on a fixed-exchange rate system in the '20s. So, when gold outflows increased, the U.S. money supply was tightened. The U.S. is on a flexible-exchange rate system.

Buying a house causes debt to increase substantially, and when the value of a house falls, debt may also increase. Nonetheless, the real value of the house doesn't disappear. U.S. export growth has already increased more than U.S. import growth and it will accelerate. I've stated before low prices, low interest rates, and high incomes induced U.S. demand causing high household debt and low household saving. Americans are still consuming more than producing, because the gains in consumption and assets outweigh the losses in saving and debt (see "opportunity cost"). Most Americans will at least maintain their higher living standards, while some will decrease and some will increase their living standards, e.g. through shifts in homeownership.

Global imbalances will correct either slowly or suddenly. Either economic growth of export-led economies will slow gradually, or a crisis will cause one or more of those economies to fall into recession or collapse. If the imbalances correct slowly, U.S. economic growth will accelerate. If they correct suddenly, U.S. economic growth will remain positive.

The imbalances were created by export-led economics. However, the U.S. responded to capture the greatest gains of trade, which raised U.S. living standards much more than export-led economies. No matter what happens, U.S. living standards will continue to rise more than export-led economies, because the imbalances are not a U.S. problem.

What Peter Schiff fails to understand is export-led economies needed to accept smaller gains of trade to spur export growth (so, U.S. gains of trade were larger). Also, while the U.S. dollar depreciated, export-led economies accepted even smaller gains of trade to maintain export-led growth. That's why many of Peter Schiff's predictions didn't materialize or the magnitudes were small. It may be best for U.S. living standards if the U.S. dollar remains near its all time low, until imbalances correct enough (which will benefit the U.S. more on the production side than the consumption side rather than benefit the U.S. more on the consumption side than the production side, although the net benefits will remain large, because of economic policy differences between the U.S. and export-led economies). A precipitous fall in the dollar would harm export-led economies much more than the U.S. economy. A stronger dollar implies the imbalances are correcting. So, the U.S. is in a win/win economic situation no matter what happens.

Global imbalances will correct either slowly or suddenly. Either economic growth of export-led economies will slow gradually, or a crisis will cause one or more of those economies to fall into recession or collapse. If the imbalances correct slowly, U.S. economic growth will accelerate. If they correct suddenly, U.S. economic growth will remain positive.

The imbalances were created by export-led economics. However, the U.S. responded to capture the greatest gains of trade, which raised U.S. living standards much more than export-led economies. No matter what happens, U.S. living standards will continue to rise more than export-led economies, because the imbalances are not a U.S. problem.

The Doomsayers may say that the U.S. money supply is increasing over 10%. However, U.S. nominal GDP isn't increasing over 10% (in part), because those dollars are being absorbed by export-led economies.

U.S. assets have risen faster than U.S. liabilities. Americans aren't stupid. When they see bargains, they'll spend, including using their savings and going into debt. China, India, etc. sell much of their goods below true costs (e.g. when social costs are included). They're making the U.S. wealthier. Americans don't work for free. I don't blame the Federal government for selling as many Treasury bonds as possible. It's paying such a low interest rate, and the depreciating dollar makes the rate even lower, that foreigners are more than financing Operation Iraqi Freedom.

The global share of U.S. manufacturing has remained constant for over 20 years, although the U.S. lost millions of manufacturing jobs. How is that possible? The U.S. made up in value what it lost in volume. E.U. and Japan manufacturing global share fell substantially, while China's share increased substantially. One reason China's share increased is because the U.S. bought a lot more Chinese goods (while the U.S. exported little to China). U.S. manufacturing is much stronger, not only because of higher productivity, but also because of shifting into higher-quality and higher-profitable goods, with market power, while offshoring low profitable goods to Third World countries, rather than discontinue operations, to increase U.S. profits.

Some believe abundant U.S. capital came from the U.S. money supply. However, the U.S. money supply has been restrictive throughout most of the 2000s, which is why U.S. actual output has been below potential output almost throughout the entire 2000s. Abundant U.S. capital came from huge foreign capital inflows (capital account surpluses offset current account deficits to keep the balance of payments balanced), productivity gains (or capital creation of U.S. firms), market power (e.g. improving terms-of-trade), etc. The excess capital accelerated the housing boom, which allowed Americans to buy newer, bigger, and better houses, raised the homeownership rate to about 70%, and increased expenditures on home improvements to over $200 billion a year. The excess capital allowed many Americans who really couldn't afford to buy homes to become homeowners, and many other Amercians to buy more expensive homes they really couldn't afford. However, one American's loss is another's gain, because of lower prices and low mortgage rates. To paraphrase Shakespeare: Is it better to have owned and lost or to have never owned? The fact is the real increases in U.S. living standards won't disappear. Many Americans will maintain their higher living standards, while some will decrease and some will increase their living standards through shifts in homeownership.

The Fed works in the future economy, because of lags in the adjustment process. Given the Fed's excellent track record of smoothing-out the business cycle, particularly over the past 25 years, the Fed believes inflation will remain low, and the U.S. can close the output gap without accelerating inflation. U.S. actual output was slightly above potential output in the mid and late '90s. However, U.S. actual output has been slightly below potential output throughout the '00s. What's remarkable is the U.S. economy needed 17.6 million new jobs from 1993-98 to expand real GDP slightly over 3% a year. However, the U.S. needed only 3.7 million new jobs from 2001-06 to expand real GDP slightly below 3% a year. The U.S. became much more productive in the 2000s, using fewer inputs for a given level of output, which helped raise U.S. living standards (on the production side). Consequently, U.S. per capita income reached $43,000 in 2006, over $10,000 a year more than E.U. per capita income.

Also, I may add, it's appropriate for the Fed to increase the money supply to somewhat offset negative net exports. Y = C + I + G + NX. The negative $800 billion in NX this year has a negative effect on Y (output). So, the Fed increased the money supply (or adopted an accommodative policy) to somewhat close the output gap, i.e. raise actual output towards potential output. Also, note, the increase in the U.S. money supply causes export-led economies to overproduce even more, i.e. move further away from their equilibriums, while the U.S. moves closer to equilibrium.

Doomsayers shouldn't ignore the real economy, because that's what's really driving the stock market. More capital and low prices allow the economy to expand. U.S. firms are the best in the world at capital creation, U.S. households can afford to consume more than produce, and the U.S. government is able to borrow at low rates. Americans have been able to increase their assets faster than their liabilities, which has increased their wealth, and can afford to increase consumption more than production, to raise their living standards (American living standards rose from both consumption and production). The U.S. is the only economy that can expand with huge negative net exports. It's the engine of world growth. Rising incomes, low interest rates, and low prices are the results of sound U.S. economic policies.

Now, I know, what the doomsayers will say. Housing prices are falling. So, the value of those assets are lower and people's net worth may be negative. However, the fact is even if housing prices fell to zero, people are living in bigger and better houses (including the massive expenditures in home improvements). Mortgage rates are lower. Houses tend to be appreciating assets. So, the depreciation is temporary. The U.S. homeownership rate rose to about 70%. Yet, there are too many houses (i.e. assets).

Take China. The U.S. exports little to China. Most of what the U.S. exports to China are the inputs to produce the output that are exported to the U.S. However, the U.S. buys lots of Chinese goods, much at below true costs, when social costs are taken into account (which induce U.S. demand). Chinese consumers don't benefit much from trade with the U.S. However, American consumers benefit enormously. China is forced to invest those dollars from trade back to the U.S. So, it can keep overproducing and maintain acceptable levels of employment. U.S. exports (to the rest of the world) may be higher than China's consumption. Basically, China is a slave country, similar to Japan before it, working to raise U.S. living standards. China makes huge profits for U.S. multinationals, and the Communist elite gain from a larger tax base. However, Chinese workers are exploited. Nonetheless, the Fed doesn't want to kill the goose that lays the golden eggs. So, it doesn't ease the money supply enough to where China's economy overproduces to the point of collapsing, which means the U.S. has to underproduce somewhat. However, Chinese investment in the U.S. raises U.S. income. So, Americans can buy more Chinese goods, while China receives low rates of returns on those investments (and eventually even lower rates when dollars are exchanged for Yuans, because China will receive fewer and fewer Yuans per dollar). If China wanted to buy U.S. equities, for higher returns, it would have to pay premiums (similar to any corporate takeover). Also, China could buy U.S. real estate (although, Japan lost big buying U.S. real estate in the '80s).

Also, I may add, the E.U. cannot come close to replacing the U.S. as the main engine of world growth, because it cannot expand with huge negative net exports. It has too many anti-growth/anti-business policies. The E.U. is falling further behind North America and Asia.

Moreover, we heard in the '80s how Japan was going to overtake the U.S. However, the Nikkei topped in 1990 and fell about 80% over the next 15 years. A very slow "Creative-Destruction" process. Nonetheless, Japan is still firmly in the Industrial Revolution, producing even better old industry goods rather than shifting faster into the Information and Biotech Revolutions. Yet, Japanese still live in small million dollar houses (with 100 year mortgages), drive small cars, were paying $10 for a glass of orange juice and over $20 a pound for average steak over 10 years ago, etc. Japan has little consumer surplus.
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