'It's time for the United States to collapse", said the good doctor, "The world needs to heal.'"

BY FAR THE WEAKEST RECOVERY --
by Dr. Kurt Richebächer --

Trying to assess the situation and further growth prospects of the U.S.
economy, the first important fact to see is that the U.S. economic
recovery since November 2001 has been by far the weakest in the whole
postwar period. Just a few tidings composed by the Economic Policy
Institute in Washington:

First, inflation-adjusted hourly and weekly wages today are below where
they were at the start of the recovery in November 2001; second, median
household income (inflation adjusted) has fallen five years in a row
and
was 4% lower in 2004 than in 1999; third, total jobs since March 2001
(the
start of the recession) are up 1.9% and private jobs 1.5% (at this
stage
of previous business cycles, jobs had grown 8.8%); fourth, the
unemployment rate is low only because several million people have given
up
to look for a job.

And here are some cursory remarks on our part: First, job growth has
steeply fallen during the last three months, from 200,000 in February
to
75,000 in May; second, all the job growth has come from the artificial
net
birth/death model, implying that it is booming among small new firms
not
captured by the payroll survey, while slumping in existing firms;
third,
private household indebtedness since 2000 has soared by 70%. This
compares
with an overall increase in real disposable personal income by 12%.

According to the popular GDP accounts, consumer spending in the first
quarter has burst by a record rate of 5.2%. That is the fact on which
everybody happily focuses. Few people realize, first of all, that this
is
an annualized figure. The true increase against the prior quarter was
1.3%.

In any case, though, it is a grossly distorted figure. The ugly reality
of
the first five months of 2006 is that the consumer-spending boom of the
past few years has effectively broken down. But to realize this, it is
necessary to look at the sequence of monthly data. Here they are, from
the
same source as the GDP numbers, the Bureau of Economic Analysis (BEA):

By these figures, measuring spending and income growth from month to
month, consumer spending in the first quarter has increased 0.6%, or
2.4%
annualized, less than half the 5.2% as reported in the GDP accounts. As
we
have stressed several times before, the big difference between the
figures
arises from the fact that the GDP measures changes in averages. The big
increase in consumer spending happened in reality in November/December
2005, resulting in a large "overhang" for the following quarter.

To detect a recent change in trend, it is necessary to focus on the
changes from month to month, as above. For May, reported retail figures
showed an increase by 0.1% before inflation. With a monthly inflation
rate
of 0.3%, total real spending should be at a minus.

This sudden weakness in consumer spending has an obvious reason. The
spending bubble on consumer durables - that is, on autos and housing
durables - is going bust. It was largely spending borrowed from the
future
to be implicitly followed by payback time.

For us, this rapid, steep decline in the growth of consumer spending is
the first decisive consideration to expect in the United States'
impending
serious recession; and remarkably, this is happening with record credit
growth and even before the housing bubble is truly bursting.

That this most important fact goes completely unnoticed says something
about the depth of research. Moreover, this sharp slowdown in consumer
spending strikingly conforms to the downward shift in the growth of
real
disposable personal incomes. In 2005, it was already down to 1.3%. So
far
in 2006, it is zero.

Under these miserable income conditions, the strength of future
consumer
spending manifestly depends on the possibilities of ever-higher
cash-out
mortgage refinancing against rising house prices. It hardly requires
any
intelligence to have realized by now that this is flatly impossible.

Looking at the accelerating credit expansion, we are, as a matter of
fact,
more than doubtful that the slowdown in the economy and the housing
bubble
has anything to do with the Fed's rate hikes. What crucially matters
for
both is the current credit expansion, and that keeps accelerating. But
the
problem is that more and more credit creates less and less economic
activity, as measured by GDP.

The unrecognized problem in the United States is that economic growth
driven by a housing bubble is extremely credit and debt intensive. It
needs, firstly, heavy borrowing to drive up the house prices and,
secondly, further heavy borrowing to turn the resulting capital gains
into
cash. Put this together with minimal or now zero real disposable income
growth and you have something like a credit Moloch devouring credit and
leaving less and less for economic growth.

Yet we are sure that the U.S. economy's extraordinary debt addiction
has
other reasons unrelated to the housing bubble. One is the huge trade
deficit, and the other is extensive and rapidly increasing Ponzi
finance.

The American consensus view holds that the trade deficit, however
large,
does not matter because foreigners easily finance it. This view reveals
the total absence of any serious analysis of related domestic income
and
debt effects. The obvious first major harmful economic effect is that
domestic producers lose an equal amount of domestic spending and income
creation to foreign producers, and that today in a staggering annual
amount of more than $800 billion, equal to about 7% of nominal GDP.

Such persistently large and growing income losses from the trade
deficit
would have pulled the U.S. economy into recession long ago. It has not
happened because the Greenspan Fed, by way of loose and cheap money,
provided for a compensating increase in domestic demand through
additional
credit creation. It succeeded, true, but the thing to see is the
additional credit and debt creation. This was justified with low
inflation
rates. Ironically, the import boom in the trade deficit has been very
helpful in suppressing U.S. inflation.

Yet there is still a second major harmful effect to the trade deficit
that
American economists completely ignore. Implicitly, the alternative
demand
created by the looser U.S. monetary policy is different from the demand
that emigrates to foreign producers. The big loser is the export
industries in manufacturing. The gains, via the surrogate demand, have
been in consumer services and goods.

In essence, the trade deficit alters the economy's structure in a
negative
way. The losing manufacturing area is the sector with the highest rate
of
capital formation, and therefore also the highest rate of productivity
growth. For good reasons, it also pays the highest wages. Consider that
U.S. manufacturing lost 3 million jobs in the past few years. To be
sure,
the trade deficit is not its only reason, but unquestionably a major
one.

Pondering the U.S. economy's unusually high addiction to credit and
debt
growth in relation to GDP growth, we are sure of another evil factor -
Ponzi finance. Principally, every increase in spending brings about an
equivalent increase in incomes. But this is not true in three cases of
spending: first, spending on existing assets; second, spending on
imports;
and third, Ponzi finance.

Ponzi finance means that lenders simply capitalize unpaid interest
rates.
Ponzi finance creates credit, but it is bare of any demand and spending
effects in the economy. In the conventional American view, balance
sheets
of private households are in their very best shape because increases in
asset values have vastly outpaced the sharp increases in debts. So
Americans see no problem.

With such great optimism about the U.S. economy still prevailing, it is
a
safe assumption that lenders have been more than happy to capitalize
unpaid interest rates as new loans, at least until recently. As widely
reported, lending standards have been extremely lax for years.
Nevertheless, there is bound to come a point where Ponzi lending stops.

The crucial difference is in the ghastly difference between runaway
debt
growth and nonexistant real disposable income growth as the income
component from which debt service has to be paid. In 2000, consumer
debt
growth of 8.6% compared with real disposable income growth of 4.8%.
During
the first quarter of 2006, private household debt growth of 11.6%,
annualized, compared with zero real disposable income growth.

These numbers suggest that, in the aggregate, all debt service occurs
through Ponzi finance. Essentially, borrowing against existing assets
is
required to service debt. Another striking evidence of extensive Ponzi
finance is the unusually large difference between rampant credit growth
and much slower money growth. Capitalizing unpaid interest rates adds
to
outstanding credit and debt while adding nothing to bank deposits
(money
supply).

To get an idea of the actual extent of Ponzi finance, we make a simple
calculation. Total outstanding debts in the United States amount to
$41.8
trillion. Assuming an average interest rate of 5%, this implies an
annual
debt service of about $2 trillion. This compares with an increase in
national income before taxes of $616 billion in 2005. Consumer incomes
are
even stagnant.

Under these conditions, the only question is the severity of the
impending
U.S. recession. In this respect, we are a great believer in the axiom
of
Austrian theory that every crisis is broadly proportionate to the size
of
the excesses and imbalances that have accumulated during the prior
boom.
Our basic assumption is that the American consumer is bankrupt when
house
prices fall 20 - 30%.

The most important thing to realize is that the spending and debt
excesses
that have accumulated in the U.S. economy and its financial system on
the
part of the consumer during the past 10 years are altogether of a size
that vastly exceeds the potential for debt service from current income.


With stagnant real disposable income and double-digit debt growth, the
American consumer is caught in a vicious debt trap. What, then, makes
most
people so optimistic of further economic growth? Apparently, there is a
widespread view that households have sufficient equity cushions in
their
balance sheets to not only weather any storm ahead, but also to
continue
higher spending.

In our view, the most important thing to see is the fact that the
consumer
has accumulated debts at a level vastly exceeding his abilities of debt
service from current income. Probably many never had any intention of
such
kind of debt service. The general idea, certainly, has been to settle
debt
and debt service problems simply by selling later to the highly
appreciated greater fool. That is what most economists take for
granted.

What all these people overlook is, first of all, the vicious dynamics
of
Ponzi finance through compound interest on unproductive indebtedness.
During 2000, total financial and nonfinancial credit and debt growth
amounted to $1,605.6 billion. In 2005, it had accelerated to $3,335.9
billion; and in the first quarter of 2006, it has run at an annual rate
of
$4,392.8 billion, and this now with zero income growth. Note that this
debt explosion has happened with little change in GDP growth.

Given this precarious income situation on the one hand and the debt
explosion on the other, it should be clear that at some point in the
foreseeable future, there will be heavy selling of houses, with prices
crashing for lack of buyers.

As to the level of asset prices in the United States, an additional
comment is probably needed. Normally, the money for asset purchases
comes
from the savings out of current income. In the U.S. economy, with
savings
in negative territory, all asset purchases essentially depend on
available
domestic credit and capital inflows. Buying assets on credit used to be
the exception. In America today, it is the rule. For good reasons, the
Fed
is fearful to make money truly tight; it would crush the markets.

A study by the International Monetary Fund published in 2003 under the
title "When Bubbles Burst" examined the differences in economic effects
between bursting equity bubbles and bursting housing bubbles. It left
no
doubt that the latter are the far more dangerous specimen:

Housing price crashes differ from equity price busts also in three
other
important dimensions. First, the price corrections during house price
busts averaged 30%, reflecting the lower volatility of housing prices
and
the lower liquidity in housing markets. Second, housing price crashes
lasted about four years, about 1 1/2 years longer than equity price
busts.
Third, the association between booms and busts was stronger for housing
than for equity prices.

The situation today in the United States reminds us strongly of late
December 2000. At its previous meeting in November, the Federal Open
Market Committee directive had called future inflation the economy's
greatest risk. But then, all of a sudden, the bottom fell out of the
economy. At its next meeting, on December 19, the FOMC changed the
bias,
declaring that the risk of economic weakness was outweighing the risk
of
inflation.

Two weeks later, Jan. 3, 2001, shocked by worsening economic news, the
Fed
dropped its funds rate, through a conference call, by 0.5% - twice the
usual rate.

As we have stressed many times, the U.S. economy today is incomparably
more vulnerable than in 2000. All the growth-impairing imbalances in
the
economy - the trade deficit, the savings and incomes shortage and the
debt
levels - have dramatically worsened.

Very rapid interest rate cuts and prompt massive government deficit
spending succeeded in containing the recession. The phony "wealth
effects"
derived from the escalating housing bubble became the key source of
demand
creation in the United States. But the unpleasant longer-term result of
the new policies was an unusually weak and lopsided economic recovery,
particularly seeing drastic shortfalls in employment and income growth.


Regards,

Dr. Kurt Richebächer
for The Daily Reckoning

Editor's Note: The clock is ticking - and three SHOCKING events
threaten to wipe out investors by Dec. 31, 2006.

Former Fed Chairman Paul Volcker once said: "Sometimes I think that the
job of central bankers is to prove Kurt Richebächer wrong." A regular
contributor to The Wall Street Journal, Strategic Investment and
several
other respected financial publications, Dr. Richebächer's insightful
analysis stems from the Austrian School of economics. France's Le
Figaro
magazine has done a feature story on him as "the man who predicted the
Asian crisis."

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