Economic Reckoning Coming 06.12.06

How the U.S. Discouraged Personal Savings in a Generation

Richard Russell

1.2 billion foreigners that save are destined to come out ahead of 190 million Americans that continue to spend on the good life, all the while going deeper and deeper into debt. The housing market is about to reverse, taking the U.S. economy with it. It will be quite a show.

The US today is a land of spenders. My 25 year old daughter, Lauren, lives with three other girls, all of them in the 20-25 age bracket, and, I think, all typical of the youths of today. These young ladies go out dancing, they drink Starbucks coffee, they eat out a lot, they do pretty much what they want. The other day I asked Lauren, "How do they do it? How can they spend so much in view of what they earn? Do they save anything?" Lauren didn't have to give me the answer. I know that these young ladies don't save a nickel. I don't know whether saving even occurs to them. This is a different world than the one I grew up in.

In my generation, people despised debt and avoided it like the plague. If they had any debt, it was in a mortgage, but then they couldn't wait to pay that "damned mortgage" off. They would give "mortgage parties" to celebrate when their mortgage was finally paid off. Credit cards? Who ever heard of a credit card?

I've tried to teach my own kids to save. I've drilled into their heads the power of saving and compounding. I've shown them how saving $75 or $100 a month and compounding their savings can bring in important income over the years. But there's something in the air, something in the generational thing, that makes the kids and the boomers of today disdain savings. "Why save? How bad can things get? Besides, why should we worry, at worst the government will come up with something? And we have to live, don't we?"

And then I think, what about savings? How safe are our savings? The government takes away the purchasing power of anything we save through inflation. The government also taxes what we earn. And when we die the government taxes a certain amount of what's left with the "death tax." Maybe, just maybe -- the government has broken people's desire to save. You might as well spend it now, have a good time with it now, because the government will dig its claws into whatever you earn and whatever you manage to save.

Personally, I think it's ominous, and it's going to sent this nation into a spiral of decline. The Chinese and most Asians are big savers. The Chinese save a huge 23% of what they earn, while Americans continue to go deeper into debt. The final outcome has to be a disaster for this country. After all, we live in a global, competitive world. I don't see how 1.2 billion people that save cannot come out ahead of 190 million people that continue to spend on the good life, all the while going deeper and deeper into debt.

[Editor's Note: In the month of April 2006, U.S. consumers borrowed at the fastest
pace in 10 months. The increase in dollar terms was $10.6 billion, pushing
total consumer borrowing to a record $2.17 trillion. This does not include
mortgages or other loans secured by real estate.]

The basis for all the US prosperity of the last five years has been the phenomenal rise in home prices. Remember, 69% of all American families own their own home (that is, if you can call it "owned" if you still have a mortgage). Home prices have surged month after month, year after year, particularly on the two heavily populated coasts.

But since 2004 inventories of homes have been rising. Now existing home inventories are near 6 million and rising rapidly. Home-sales turnover is lengthening -- it's taking longer and longer to sell a house. In some places, such as Las Vegas, condos have been sold from floor plans before ground has even been broken for new construction. Now people are beginning to cancel, and some projects have been called off with deposits returned.

Here in La Jolla I see new construction going up on every other block. And I wonder what these people are thinking. Rather I know what they are thinking -- tear it down, add on rooms, rebuild, you can't go wrong. Prices will just keep rising and rising.

Orders for new homes are starting to drop drastically for many of the major home-builders. This includes Pulte, Standard Pacific and Toll Brothers. Builders and flippers and speculators are starting to reduce prices or they are tossing in extras in order to tempt new buyers.

The median price of homes in certain areas is now declining. Soon I think we'll be reading about the price of homes actually dropping on a year-over-year basis. That will cause a major rise in fear among home owners, particularly those who have to deal with rising rates on their rate-adjusted mortgages. Those who have borrowed to buy speculative second homes will be in a panic to sell and hopefully get their money back.

The fact is that the whole housing boom (built on manipulated low interest rates) has saved this nation from recession following the 2002 stock market collapse. A third or more of all the jobs created since 2002 have been housing related. Last year home owners took $750 billion out of the value of their homes through refinancing. Where'd the money go? Vacations, new rooms on their homes, college expenses, new cars, all sorts of unneeded nonsense. Now the money is spent -- it's gone.

I don't think investors realize what is happening. If it turns out that housing prices are slipping below last year's prices, we could see the stock market "fall out of bed." Suddenly, all the fun and games could turn into "let me out of here." The Fed has been playing with the idea of raising short rates another notch to 5.25%. That may be the boost that breaks the stock market's back.

Much of the capitalist world has been having a jolly old time selling goods and services to the US. But over the last month or so, sophisticated investors have realized that "something is wrong" in the US. And they've started to unload stocks. I use the weekly chart below as evidence. Here we see the Dow Jones World Stock Index. Today the Index declined to sit right on its long-term trendline. The bloom is off the global rose. From what I see, the stock markets of the world are preparing for trouble.

At the same time, everybody is worried about inflation. Fed Chairman Bernanke has announced that inflation is "unwelcome." Central banks all over the world have been sopping up liquidity and raising their interest rates. Evidently, they have decided to fight inflation. But the markets, which discount the future, are not worried about inflation. In fact, if I had to guess, I'd say that the markets were discounting deflation, particularly deflation in that key area -- US housing.

Once it's perceived that US housing is in trouble, and that this is deflationary, I expect the Bernanke Fed to do a turnaround. The Fed is mortally afraid of deflation. Bernanke built his reputation on his studies of the Great Depression and the painful results of deflation.

During 1995 to 2000 we saw wild inflation in the prices of tech stocks. The "marvel of tech" plus rising productivity was supposed to usher in a new era for America. Then, following the 2000 top, we saw the tech stocks deflate. The losses were catastrophic, and as of now the Nasdaq stock average is still more than 50% below its year 2000 high.

And I'm wondering whether the same sequence may happen to housing. If housing starts to collapse, as it did in Japan during the '90s, the Fed will oppose those deflationary trends with all the power it can muster. The move to re-inflate will be huge. It should be quite a show.

Anyway, that's the way Richard Russell sees it.

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