Why it isn’t different this time

For the past few weeks we have looked at the argument for the case that 'This time it's different'. It's made eloquently in a 130-page book called 'Our Brave New World' by the very bright minds behind GaveKal Research.

The trade deficit of the United States does not matter, they aver. But now we turn to look at the opposite view, as made by Bill Bonner and Addison Wiggin in their new 370-page book, 'Empire of Debt'...

Not only do The Daily Reckoning's duo tell us that things are NOT different, but they say the end result will be the same as it has always been. For the curious who can't wait 'til the end, it is not a pleasant result.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Where GaveKal sees a rising dollar, Bonner and Wiggin see 'The Demise of the Dollar' - the title of a separate book by Wiggin...and where GaveKal sees promise and positive benefit in a negative balance of trade, Bonner and Wiggin see hubris and peril.

Is it an 'Empire of Debt' about to go the way of all empires, or into a 'Brave New World'? Let us make no mistake, these are polar opposite views. And where you come down makes a large difference in how you manage your investment portfolio, not to mention how you order your future.

So this will make for an interesting, if not altogether fun, letter. Warning: you are about to enter a major doom and gloom zone.

There are two stories in 'Empire of Debt'. The first is the traditional argument of the Austrian economic school. You cannot forever run trade deficits. Eventually your currency will collapse, as people will not want any more of it.

'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.'

- Friedrich August von Hayek (Nobel Laureate, 1974)

But the evidence of that decline is not yet present. America and its currency seem to continue to prosper, even when no other nation has ever run such huge deficits without seeing a major, if not disastrous, currency revaluation.

How can this be? Can we in fact borrow our way to success? Rather than save and invest in new capital production, we Americans ship production of our goods and now even our services offshore, and hope other nations will finance our debt.

'As the Anglo-Saxon economies lost their competitive edge in manufacturing, they tried to make up for it by encouraging consumption,' write the duo in 'Empire of Debt'. 'This is the biggest fraud of all...

'At first, higher consumption feels good. It is like burning the furniture to keep warm; it feels good for a moment. But the sense of well-being is extremely short-lived. When people borrow and spend, they feel as though they are getting richer - especially when their houses are rising in price. The increased consumption even shows up, indirectly, in the GDP figures as growth. But you don't really become wealthier by consuming. You become wealthier by making things you can sell to others

- at a profit. The point is obvious but, at this stage of imperial finance, it was inconvenient.'

You cannot borrow and consume your way to riches. Yet our national debt - private, corporate and public - just keeps soaring. However you want to measure it, in absolute terms or as a percentage of GDP or income, debt is up and continues to climb. The low interest rates engineered by the Federal Reserve have only encouraged consumers to take on more debt.

So, one of the main themes in the book details how the increase in debt, combined with both trade and government deficits, must end in tears. One cannot spend oneself into riches, whether as an individual or as a country.

This is a fairly straightforward subject, and one with which many readers will find themselves nodding in agreement. It has been the way of the world since the Medes were trading with the Persians. If you do not produce more than you consume, eventually you will end up in poverty, or at the very least, in lesser economic circumstances.

But how did we get here? How did we get to a place where America runs $700bn trade deficits? How did we arrive at a time when foreigners own an ever-increasing percentage of US debt, where savings in the United States is negligible and we consume some 70-80% of the rest of the world's saving so that we can continue to consume?

Well, we are beholden to the kindness of strangers - specifically China and Japan. The authors contend that if they pull the plug - if they stop buying our debt - our currency will collapse, our interest rates soar and our housing market collapse, sending us into a deep recession.

And thus we arrive at the second, and far more troubling theme in the book. It pricks at America's national conceits, at the very value and beliefs that we hold about ourselves. We - or most of us - see ourselves as the good guys. Bonner and Wiggin spear that view.

Bonner sees the United States as an empire. That in and of itself is not exactly a new thought. Many hold that line of thinking, and do so proudly. Pax Americana makes the world a better place. Niall Ferguson contends that it is all that holds the world back from another Dark Ages.

Someone has to order the world and make people and countries play nice. If there is a real problem, who you gonna call? The French? Get real.

But for Bonner, being an empire is not a good thing, even though he readily admits that America is not the traditional empire of old. All empires must come to an end. So how will the American Empire end? For Bonner, it is in debt.

Full disclosure: Bonner and Wiggin are libertarians. They are advocates of a minimalist government. And they also do not believe in nation building. They believe that government intervention into problems causes more problems, rather than solves them. And that specifically includes military and central bank intervention.

'...If you deny that the United States is now an empire, you are as big a fool as we were. For a very long time we resisted the concept,' they write in their introduction. 'We did not want the United States to be an empire. We thought it was a political choice. We liked the old republic of Jefferson, Washington, the US Constitution...the humble nation of hard money and soft heads; we didn't want to give it up. We thought that if the United States acted as though it were an empire it was making an error.

'What morons we were! We missed the point completely. It didn't matter what we wanted. There was no more choice in the matter than a caterpillar has a choice about whether to become a butterfly.

'This was an important insight for us. Until then, all of the blustering and slapstick pratfalls on stage seemed like 'mistakes'. Why would the United States run such huge trade deficits, we wondered. It was obviously a bad idea, the nation was ruining itself. And why would it launch an invasion of Iraq or begin a war on terror - both of which were almost certain to be costly blunders.

'It was as if the United States wanted to destroy itself - first by bankrupting its economy, and second by creating enemies all over the globe.

'Then, we realised, that of course, that is exactly what it must do. We repeat, people come to believe what they need to believe when they need to believe it. America is an empire; its people must think like imperialists. In order to fulfil their mission, the homeland citizens had to become what George Orwell called 'hollow dummies'. An imperial people must believe that they deserve to be the imperial power - that is, they must believe they have the right to tell other people what to do. In order to do so, they must believe what isn't true - that their own culture, society, economy, political system, or they themselves are superior to others.

'It is a vain conceit, but it is so bright and so big it exercises a kind of gravitational pull over the entire society. Soon, it has set in motion a whole system of shiny vanities and illusions as distant from the truth as Pluto and as bizarre as Saturn. Americans believe they can get rich by spending someone else's money. They believe that foreign countries actually want to be invaded and taken over. They believe they can run up debt forever, and that their debt-laden houses are as good as money in the bank. That is what makes the study of contemporary economics so entertaining. We sit at our telescopes and laugh like a divorce lawyer looking at photos of a rich man in flagrante delicto; we know there's money to be made.'

But America is not an empire in the traditional sense. The Mongols or Romans conquered and demanded taxes, a rapacious 10% or so. The British and French took commodities and cheap goods. Americans send an army and then pay hundreds of billions to the conquered.

How did we become an empire? Bonner points to its beginning in 1913, when both the US income tax and the Federal Reserve were created. These were the building tools which could finance an empire. What tribute does the American Empire require? If you use our dollars, you have had a depreciating asset over time. The dollar will buy a mere nickel's worth of what it did in 1913.

The second major event on the road to empire was Nixon closing the gold window, allowing the Fed and the government room to manipulate the world's No.1 currency as they saw fit. And of course, the New Deal, deficit financing, and a host of other government solutions all contributed.

In the same way that investors thought that tech stocks would only go up in 1999 - or gold could only go higher in 1979 - Bonner and Wiggin see a country that thinks its stock can only rise. Since that has been the case for 225 years, why should it be different now?

Yet, they add, quoting Niall Ferguson: 'The US suffers from...structural deficits that will limit the effectiveness and duration of its crypto-imperial role in the world. The first is the nation's growing dependence on foreign capital to finance excessive private and public consumption. It is difficult to recall any empire that has long endured after becoming so dependent on lending from abroad.'

And thus we come to it. To Bonner and Wiggin, America is on a course to a soft depression brought on by debt precisely because it has become an empire. We have spent the income of future generations in order to consume today, amassing a staggering debt that grows ever larger. We have obligated our children to pay a Social Security and Medicare burden that they simply will not have the means to pay as things currently stand. The generational contract will be broken because it cannot be paid.

This is not your ordinary run of the mill doom and gloom. It captures a whole new level, for it is an inevitable doom. We are slouching toward an evening in America, unaware of our own fate. Thus have all empires ended, either with a whimper or a bang.

They make a good case. The question is, can we ignore it? Are they wrong, or will somehow things be different?

By John Mauldin for The Daily Reckoning

John Mauldin is the creative force behind the Millennium Wave investment theory, author of the weekly economic e-mail Thoughts from the Frontline, and author of the best-selling 'Bull's Eye Investing: Making Real Returns in a Smoke & Mirrors Market' (John Wiley & Sons, 2004).

His latest book, 'Just One Thing', is due out in December. You can pre-order your copy at a 25% discount - here:

https://books.global-investor.com/books/22314.htm?ginPtrCode=21664

And you can click on the link below now to get your copy of 'Empire of Debt' at a 30% discount:

'Empire of Debt: The Rise of an Epic Financial Crisis'

https://www.wiley.com/trackthrough?urlcode=454858