So Far Not So Good

Last week, following my appearance on CNBC's "Squawk Box" Steve Liesman dismissed my warnings of dire consequences resulting from America's growing current account deficit, by arguing that 20 years of consistent deficits have failed to slow the US economy. In fact, the belief that the U.S. economy has faired better than those of surplus nations and that our current account deficits actually result from our superior growth is now widely accepted in both academia and on Wall Street. Excuse me folks, but I beg to differ.

In 1982, the last year in which the U.S. enjoyed a current account surplus, America was the world's richest creditor nation. Today, we are the world's greatest debtor. How can such a transformation be interpreted as being positive? Can someone really say with a straight face that being a debtor is better than being a creditor? In 1982, America still flooded the world with high-quality, low cost manufactured goods. Today we flood the world with our IOUs. How can the disintegration of American industry be seen as anything other than a colossal economic failure?

It is not as if American manufacturing has become so efficient that it has made room for other industries, as was the case when improvements in farming productivity gave way to the industrial revolution. When factories supplanted farms, America did not begin running massive trade deficits as a result of imported food. It was simply that farming became so efficient that capital was freed up for manufacturing. However, there is nothing creative about today's destruction.

This "so-far, so-good" attitude not only reflects a lack of understanding of basic economic principles, but of simple common sense as well. It is easy to have a good time while squandering an inheritance. However, the "good times" are not indicative that all is well; it is just that the consequences are postponed until the credit runs out. Americans, much like philandering playboys, have squandered away the mother of all inheritances. The process of blowing all that wealth may have been fun while it lasted, but it should not be confused with economic success. The ability to blow an inheritance reflects the achievements of our ancestors, not ourselves.

We all know that as individuals, going into debt is a sign of failure, while paying it off is evidence of success. When individuals are asked what they would do it they won the lottery, the most common response is to pay off debts, not run up bigger ones. Given that nations are nothing more than the sum of their individual citizens, why do we not understand that what is bad individually is also bad collectively?

Think about it this way, if you were to ask a relative, perhaps your Uncle Sam, how he was doing, and he answered with the following; "I just took out a second mortgage on my house, maxed out all my credit cards, cashed out all my retirement funds, and raided my kids college funds", would you assume that he was doing well? Would you congratulate him on his success? What if you asked a friend how he was doing and he replied "I just paid off my mortgage and all of my credit cards, fully funded my retirement accounts, and pre-paid all my kids college tuitions." Would you feel sorry for this individual? Would you assume that paying off his debts was somehow a sign of economic distress? Would you refer him to your Uncle Sam for financial advice?

Proving that truth is stranger than fiction, on a recent trip to China, an American delegation actually gave economic advice to the Chinese. This is analogous to an F-student advising an honor student on how to improve his grades. Our recommendation; save less and spend more, is akin to what the F-student might advise an honor student: study less and party more. I'm sure the Chinese will give our advice all the consideration it deserves.

Of course, not all debt is bad. Debt used to finance investments is good, to the extent that it produces superior positive cash flows. In addition, investment debt is self-liquidating, as it provides the means not only to pay the interest but retire the principle. However, consumer debt, used to pay for basic necessities, luxury goods, take vacations, or remodel kitchens, produces no income at all, and merely works to ultimately bankrupt the debtor. In actuality, current consumption financed by debt, ultimately leads to far less future consumption. Ironically, it is savings, the deliberate act of under-consumption, that maximize lifetime consumption, as savers, rather than struggling to repay debts, enjoy the extra consumption financed by compound interest.

Rather than evidencing superior economic performance, American consumption actually reflects the reverse. The party was fun while it lasted, but unfortunately it is time to pay the piper. When the music stops, the world will finally see America's false prosperity for the illusion that it is, and the so-called gloom and doomers will finally be vindicated.

November 4, 2005

Peter D. Schiff

President/Chief Global Strategist

Euro Pacific Capital, Inc.

www.europac.net