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The American Way


Where it stops, nobody knows.

The markets are acting just like Karl Rove wants them to right before the elections. Oil and gas prices are down significantly, stocks are way up (being led by huge index buying), interest rates have been generally falling and the dollar is stable. Not only that, but new data "out of the blue" show an additional 800,000 jobs were created that the BLS must have missed. It was the largest revision in history and it was like pulling a rabbit out of a hat: was it always there or was it put there later? It certainly is all serendipitous, but is it coincidence?

I don't really know, although I don't really believe in coincidence. So let's just talk about why all this is so important, especially for stocks to be higher and higher. It is because the U.S. economy is in actuality not stable at all, as our politicians preach, but very unstable and very dependent on the ability of the consumer to borrow cheap "money."

Globalization is touted as free trade, but that does not describe the process of income re-distribution that occurs as a result of free trade between countries with vastly disparate standards of living.

What do we import from China that we cannot make better here in the U.S.? Do they have some special metal that we need? Do they have a skill or technology that we cannot reproduce? No. The only thing they have is cheap labor, slave labor basically. In fact, China just instituted new labor laws today to reduce their own disparity of income between rich and poor for fear of revolution. This should increase the cost of production but reduce sweat shop labor. How do U.S. companies respond to that? Do we praise such action as humanitarian? No. U.S. companies are in an uproar and quickly threaten to not build as many factories there.

Imagine back when Edison created the light bulb. I bet the U.S. exported a lot of light bulbs to other countries. Other countries bought them because they wanted to increase their standard of living and could do so at a marginal cost. So we sent them light bulbs and they sent us gold (essentially). This shifted income to the U.S. where it created new jobs and wealth. So production created income.

The U.S. is now exporting jobs solely because of cheap labor. China doesn't make anything we can't and they don't make what we can better, they just make it cheaper. The job lost here as a result of a job created there shifts income generation away from the U.S. to China in the same way as the light bulb shifted income to the U.S. from abroad. But we don't send them anything as quaint as gold anymore. We send them credit; we borrow the "money" to buy their cheap labor. This is all China has to offer us and we are taking the bait.

This is why income is stagnating in the U.S, at least for blue collar workers. Wages are under pressure because our workers are competing with Chinese workers who work for much less.

Sanguine economists say there are other sources of income for the U.S. economy and that is semantically true. High skilled workers (whatever that is; let's just say it's people that make a lot of money) still generate income. This is why median income growth is below mean income growth: the wealthy are doing OK in generating income.

But most of consumption is being driven by borrowing. You can see that in the trade deficit yesterday ballooning to a record $70 billion. The US now owes foreigners trillions of dollars from buying their cheaper labor.

With income generation lagging (a stable and growing economy produces income through production), income normally used for spending and investment, we have replaced it with borrowing for spending and investment. In order to borrow money, you need collateral. Collateral comes in the form of assets pledged; assets like houses, cars, and yes, stocks. To borrow more, the price of those things needs to go ever higher; stagnant prices do not allow more borrowing. This is called an asset based economy and this is not lost on the FED. It is not stable because growth does not depend on production, but rising asset prices and borrowing. The Fed inauspiciously indicates that they are very cognizant of this need by saying things like "targeting asset prices."

The irony is that the Fed must induce the very thing that is the problem: more borrowing and less saving to generate consumption. Almost all of U.S. GDP growth is consumption.

So the U.S. government continues to offer cheap credit through the Fed's creation of credit and more foreign borrowing because they have to: that credit is used to bid up nominal asset prices so that more borrowing can continue. But when it stops, for whatever reason (like lower corporate profits or higher interest rates or just risk reduction by markets), it will be dangerous because the debt will remain (the high risk I talk about). Where it stops, nobody knows.
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