Spenders versus Savers

Consumer spending is the holy grail of the American economy, especially in the last two weeks of the holiday season.

But the main reason we still have money to spend is because foreigners still have money theyre willing to lend us.

Heres how it works:

Step 1. We overspend and overbuy, especially from overseas.
Step 2. Foreigners collect the money from us.
Step 3. Foreigners lend the money back to us.
Step 4. We overspend and overbuy still MORE from overseas.

This perverse cycle has helped to sustain the holiday shopping season … prevent our unemployment from skyrocketing … hold down our mortgage rates … drive up our real estate values … prolong our stock market rally … and create a grand, but entirely false, sense of prosperity.

Wall Street pundits would have you believe its all OK.

Its OK, say they, to overspend and live high on the hog. Its OK to borrow from abroad to sustain the spending habit. They even think its OK to finance most of our governments budget deficit with foreign money.

The metaphor they want you to visualize:

Two kids on a sidewalk,
trading marbles. As long as theyre
willing to play, the game goes on.

The true image that comes to mind:

An addict on a street corner,
shopping for his next fix,
sinking deeper into his habit,
sliding deeper into debt.

How Bad Is It?
Consider the Facts:

Fact. In October, the U.S. trade deficit ballooned to nearly $69 billion, the worst in history.

Fact. Octobers shocking trade deficit came on the heels of a $66 billion deficit in September, also the worst in history.

Fact. Our trade deficit is breaking new records against nearly all of our largest trading partners, the 25-nation European Union, Canada, Mexico, and of course China.

Fact. For the year, our trade deficit will surpass the $700 billion mark by a mile, double the already-huge deficit of just four years ago.

Fact. The accumulation of deficits in recent years has sunk our nation into the deepest dependence on foreign debt since Benjamin Franklin begged the French for a loan to finance the Revolutionary War.

Question: When will the spend-and-borrow cycle start coming to an end?

Answer: When the dollar begins to collapse.

That will be the signal for our foreign creditors to slow down the flow of money to the United States.

Worse, it could also be the trigger for many foreigners to pull out the money they have already sent our way.

Why This Situation
Is Now So Unstable

When a mountain of debt piles up inside the United States strictly between American lenders and American borrowers its relatively rare for lenders to call back a loan.

But when we pile up a mountain of debt to foreigners, they can pull out their money at the drop of a hat. All they have to do is pick up a phone, call their bankers, and give instructions to shift their accounts from dollars to another currency. Instantly, their loan to America is terminated. No remorse. No protests.

Question: When is the dollar collapse going to begin?

Answer: It may already have begun!

The dollar started falling last month and has been tumbling ever since. Last week in particular, the dollar got smacked hard against all major currencies.

Dollar investors were scared away by the announcement of the record-smashing U.S. trade deficit.

Dollar investors were discouraged by the Feds lack of resolve in raising U.S. interest rates.

And some may finally be waking up to the danger of feeding Americas insatiable spending habit.

Even on Friday, a relatively quiet day in most other markets, the dollar continued to decline against the euro, the Japanese yen, and the British pound.

This is not good.

If the dollar decline were strictly against certain currencies, it wouldnt be as big of an issue. But right now, the dollar is falling not only against the currencies of major economies, but also against those of smaller, emerging nations.

If the dollar were falling strictly in foreign exchange markets, it would be less worrisome. But the fact is, the dollar is also falling against major commodities like energy, copper, gold, and other natural resources.

If the dollar decline were just a temporary dip in a stable dollar market overall, it would not be of such great concern. But thats not the case. The dollar plunge youre witnessing now is the resumption of a long-term decline that began years ago.

If this dollar decline were slow and gradual, it would also not be too alarming. But that, too, is not the way things are shaping up. It looks like this second phase of the dollars decline could be steeper and deeper than the last one.

What Happens When Money
From Abroad Starts to Dry Up?

The U.S. will face chronic capital shortages.

Indeed, ultimately, what drives any economy of the modern world is capital. And the only lasting way to build that capital is by saving not by spending and borrowing.

The money saved in banks, insurance companies or money market funds goes into a national savings pool. That national pool, in turn, is the primary source for the capital that healthy companies need for growth … or that unhealthy companies need for survival.

But in recent generations, the habit of saving has simply not been a part of the prevailing American ethic.

Scrooge capitalists are relics of the past. Penny-pinching bureaucrats were gone even earlier. Only lavish spenders are societys super-heroes.

All this spending does seem to fuel the economic engine for a while. But consider the true, lasting impact on each major sector of the economy:

Consumers: The overwhelming majority of American families have no stash of cash. To embark on a holiday shopping spree, theyve got to get a fat bonus from work … a big tax refund check from Uncle Sam … a chunk of change from an equity loan … or a cash advance from a credit card. And each of these is available mostly thanks to money from abroad.

As long as the funny money is flowing, fine. Consumer confidence rises, and everyone is happy. But woe on us and the entire economy when the money dries up, as may happen if the dollar collapses.

Industry: The dearth of savings creates a chronic shortage of capital. So when capital rushes into certain sectors, it leaves other sectors with virtually none.

Example: Technology companies in the tech boom of the late 1990s. They sucked up capital like a giant twister sucks up cows and pigs … only to dump it in a heap of bankruptcies and broken portfolios.

Another example: Mortgages. As long as interest rates continued to fall, trillions in new capital flooded into the mortgage market. As soon as interest rates stopped falling, the boom ended, with still-untold consequences.

Governments: In recent years, capital shortages have struck cities and states like a Category-5 hurricane. Even in the wake of 9/11, budgets were cut for law enforcement, security and 911 emergency staff. In the West, even after dire warnings of California fires, new funding dried up for firefighters in virtually every state. Throughout the nation, money for libraries, schools and clinics was slashed.

Now, local governments are beginning to collect more revenues. But their revenues could easily dry up again if foreigners pull their money out of the U.S.

Despite the appearance of wealth and prosperity created by the abundance of foreign money flowing into America, the fact is our country suffers from a fundamental, long-term, chronic shortage of capital.

Why? Because Washington, Wall Street and most of America have transformed spending and the borrowing needed to support it into our only national religion. Meanwhile, saving, the only enduring fountainhead of capital, is frowned upon as an outdated cult.

Spenders are continually lauded by the president, the financial press, and, of course, by the advertising media. Savers, meanwhile, are punished with interest rates that remain lower than inflation.

Indeed, the mass proselytizing of the spending religion is so powerful and so overwhelming, that most people have forgotten what it was like to save. And at least two generations of Americans never knew it to begin with.

The Family Fortune

In my fathers time, it was very different.

When he was born in Manhattan, eight years after the turn of the last century, his parents had recently arrived from Romania, virtually penniless.

His father didnt earn enough as a tailor to pay rent for an apartment. Nor did his mother as a seamstress. So when they had a chance to live rent free as janitors in an East Harlem tenement, they grabbed it.

By the time he was seven, Dad and his older brother would regularly invest in a case of matches and spend the entire day hawking them on the busiest street corner they could find. They didnt go home until the last match box was sold.

But keeping any of the money for themselves was tantamount to thievery. Every single dime went back to their mother.

Once, my father found a small injured bird on the roof of their building and began nursing it back to health. But it happened to be a particularly tough month, with no income and no extra money for meat.

One afternoon, when he came home from school, he learned that the chicken soup for dinner was not exactly made from chicken.

He promptly lost his appetite. But he also learned, again, the hard lesson of just how precious the family savings really was.

They had so little. And, yet, strangely, they managed to save so much several times more, in fact, than many better-off families save today.

The Tokyo Subway and Kozukai

This is not an isolated phenomenon. Nor is it just a custom you can attribute to tough times. In fact, in most growing and vibrant societies whether modern or traditional family savings are typically the main pillar of the economy.

In 1980, I worked as an analyst in a Japanese brokerage firm, and at the end of each month, there were invariably four circumstances coming together at the same time that left me spellbound.

First, all monthly salaries were distributed in cash. Not checks. Not direct bank transfers. Just cold, hard cash in brown, two-by-six-inch envelopes.

Second, nearly everyone stuffed their thin or fat money envelopes into the inside pocket of their suit jacket, and so did I.

Third, nearly all of us went home by subway or national railway, joining the army of salariman returning home that evening, all with their own money envelopes tucked into their inside jacket pocket.

Once I tried to calculate how many billions of yen in cash were flowing through Japans public transportation system on payday each month. I started with an estimate for Tokyo and Osaka, the two largest business centers.

But long before I could tally up the equivalent sums at dozens of other large cities across Japan, I gave up; and my mind drifted to the fourth factoid that many Americans might find even harder to understand:

With rare exceptions, the Japanese custom both then and, to a lesser extent, today as well is to hand the entire pay envelope over to the woman of the household.

The man is still the primary wage-earner. But in exchange for his labor, he often gets little more than kozukai a small allowance of spending money. All the rest goes to cover basic living expenses plus one final destination savings!

The Japanese arent the only ones. Savings are revered in China, India and much of the Middle East. In inflation-ridden countries, the savings goes into silver, gold and jewels. In some of the poorest countries, it goes into stashes of grain and other non-perishable foods.

No, the United States is not necessarily unique in its spending ways. There are other countries that have mimicked our habits. But the way we borrow and spend in the United States today is certainly not the norm. Nor is it a stable situation.

Inevitable Consequences

When the nations pool of savings has shrunk to a puddle … when capital is in such chronic short supply that we must get it abroad … and when the nations debt habit is so ingrained that borrowing heavily from future generations is a constant … then big trouble is surely the consequence.

Expect a new world war between …

(a) big spenders seeking to sustain their habit any way they can, and

(b) big savers threatening to withdraw their money at a moments notice.

The battle lines are being drawn right now. And the first shots are being fired at the U.S. dollar, which is falling sharply. Plus, along with the falling dollar, youre bound to see:

A renewed flight to gold. Friday night, gold retreated to below $500 per ounce. But as Larry told you the day before, that kind of volatility is normal in a roaring bull market for the yellow metal. It doesnt change the big trend: Up.
A surge in mining shares. Despite the sharp correction in bullion, mining shares have held up remarkably well and even rose firmly on Friday. Dont be surprised if they retreat temporarily, as early as today. But if they do, welcome the opportunity to buy at better prices.
Higher interest rates. Wall Street is again salivating with the hope that the Fed will stop raising interest rates sometime soon. But beyond a few word changes in the Feds most recent statement, they have no evidence to support this hope. I think theyre going to be sorely disappointed, again. Reason: Its the market and not the Fed that controls interest rates overall. And when foreign capital pulls out of the U.S., our interest rates must rise to keep the money here … or try to get it back.

My Recommendations:

1. Keep a big chunk of your money in a Treasury-only money fund, aiming for safety, liquidity and rising yield.

2. Hedge against a falling dollar with gold and gold mining shares.

3. For money you can afford to invest more aggressively and would like to see multiply rapidly, go for the three undervalued mining companies that Sean has picked out for his subscribers.

Hes sending out his recommendations tomorrow morning. If you want to join him, the deadline is midnight tonight. Call 800-400-6916.

Good luck and God bless!

Martin

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Christine Johnston, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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