KEEPING UP WITH THE JONES
Submitted by Charleston Voice
Oct. 26, 2004
Let me tell you a story about a young man.
Call him Jim.
As a child, Jim had shown promise. He had opened a $4 savings account.
But something was nagging at Jim, even as a child. It seemed to him that all his friends always had money to spend, and they always had the things he wanted but didn't have. When he was young, they had nice bicycles, new baseball gloves and bats, radio-controlled model airplanes, an assortment of snakes and fish and hamsters as pets - and always they had money to buy things at convenience stores.
Upon entering his first year in high school, Jim had just over $1,000 in the savings account he started as a child. But the pressures of running with the right crowd, dressing the right way and having the right gadgets were too much for him. One day, Jim went to the bank and emptied his savings account. He felt a little funny about it, but that feeling passed as soon as he had a pocketful of cash.
Jump forward several years. Jim is 28 years old. He's been out of college for three years. After graduation, he got a job making $50,000 a year. Not bad for a young guy fresh out of college.
So Jim did something genuinely stupid. He filled out every credit card offer that came in the mail. Banks like to offer credit cards to college grads because they know college grads are probably working full time at a job that pays much better than minimum wage.
Jim assumed the banks wouldn't give him more credit than he could handle. He took all they threw at him. Soon he had three Visa cards and two MasterCards. Jim used his credit cards almost daily, buying furniture for his new apartment and taking his girlfriend to fancy restaurants. He figured that as long as he could make those monthly payments, he was OK.
The trouble in Jim's life - the trouble that was there all along if only he'd seen it - began when he lost his job suddenly and unexpectedly. Jim was in charge of the customer service call center for a small software company. They gave Jim a small severance check of $1,500, wished him well and sent him on his way.
To Jim, credit card debt was some far-off obligation, just another monthly payment, like the electric bill or the phone bill. He just knew that he needed money right away, so he borrowed it and didn't worry about the consequences. He figured that's how life was. You couldn't really have much of a life unless you borrowed money. Everybody else seemed to be doing it, and they were all OK, he thought.
After being out of work for just two months, the credit card companies started calling him. Jim did the only thing he could. He ate his pride and took a job working hourly at the convenience store he had worked for in college.
Jim moved back to his parents' house. He sold his stereo and his furniture to try to make a dent in the massive debts he had run up - over $35,000 on credit cards bearing interest as high as 19% for numerous cash advances. Jim's interest payments were more than his parents' interest payments on their house. That's to say nothing of principal payments. It's hard to make a dent in a $35,000 loan when you're paying $6,500 a year in interest.
Jim works two hourly jobs today, averaging $9 an hour. So he makes about $37,000 a year before taxes, instead of the big money he made fresh out of college. He's lucky, though. His parents don't charge him rent. So he's able to put a large percentage of each paycheck into his debts. He's making progress. It'll take Jim another few years to pay it all off, if he keeps putting about 75% of his paychecks into it. At that point, he'll be about 35, and he won't have one thin dime to his name. But he won't have any debt, either. Financially, he'll be back at zero, as though he'd just graduated from college.
In the midst of his crisis, Jim realized a horrible truth: He borrowed money because he wanted to own more things. In the process, he committed a significant portion of his future earnings to the banks. Now he has sold his possessions for a fraction of what he paid for them, and the banks own him. They will continue to own him until he's paid them off. Jim consumed more than he produced...then the bottom dropped out of his productive output, and it pulled the rug out from under his life.
If Jim's foolish behavior were an isolated case, this story would end here. But Jim's behavior is typical of many individuals in the United States. Right now, there's about $8,000 worth of credit card debt outstanding for every man, woman and child in the United States. But unlike Jim, every man, woman and child in the country can't move back in with their parents and live rent free.
Like Jim, the United States as a whole is consuming much more than it is producing. But instead of transferring its wealth to banks the way Jim did, the United States is transferring its wealth overseas, to other countries.
So far, the United States has transferred about $2.5 trillion of wealth to other countries. Now, most of this is simply debt money lent to us by investors living in other countries. In July 2004, U.S. government debt stood at over $7 trillion. About 40% of that is owed to investors based outside the United States. That's almost $10,000 in federal debt for every man, woman and child in America owed to foreign investors. We get their goods. They get our debt, our IOUs.
This would be perfectly fine if there weren't such a thing as legal tender laws. Legal tender laws in the United States say that we have to accept U.S. dollars as payment for all debts and transactions, public and private. It follows that there's a real risk that someday - and likely someday soon - a lot of those dollars are going to come flooding back into the United States. Suddenly, you're going to have a lot more dollars chasing the same amount of goods and services around the U.S. economy. The word for that is inflation. The rate at which our wealth is being shipped overseas is at a staggering all-time high. According to the latest figures from the U.S. Department of Commerce, the United States transferred $541.8 billion of its wealth overseas in 2003, up 13% from $480.9 billion in 2002. At that rate, U.S. wealth will transfer into foreign hands at a rate of over $1 trillion per year in less than seven years.
The U.S. Department of Commerce's Bureau of Economic Analysis refers to the annual transfer of wealth we're talking about as the current account deficit. You might know it as the trade deficit.
You've probably heard about the trade deficit before. But perhaps you never thought it was that important. After all, you might say, the trade deficit just means that we import more than we export. It just means that we enjoy a higher standard of living. If someone is confident that you'll keep producing goods and services in the future, they might be willing to lend you money against that future production. The banks thought Jim was young, intelligent and highly employable, and probably reliable. So they lent him a small fortune. That's what the United States is doing today. It's borrowing more than $500 billion a year to buy goods and services from foreign countries. That's how foreign investors have amassed claims on $2.5 trillion more of U.S. wealth than the United States has on theirs.
Now, it really doesn't matter where all this paper money is floating around, whether it's held by the Sultan of Brunei or in a hole in your neighbor's backyard. The simple fact is that there are a lot of dollars out there - trillions - and if they come back into the United States, we're going to experience sudden, severe inflation. That will have a horrible effect on stocks, bonds...just about any financial asset you can name.
On the other hand, hard assets like gold, silver, copper and other commodities will suddenly require a whole lot more U.S. dollars to purchase. We've all heard the stories about Weimar Germany and the wheelbarrows full of money needed to buy a loaf of bread. That's hyperinflation. We're not predicting anything like that, but the point is we don't need anything like that in order for things to get quite ugly.
Why would all these dollars come flooding back into the United States? The short, simple answer is because they have no place else to go. Since dollars are only "legal tender" within the United States, whether foreigners continue holding them depends on whether they have confidence in the soundness of the dollar. Confidence, of course, can vanish like a pile of feathers during a hurricane. Based on recent market action, it is clear that foreigners are becoming increasingly aware that the dollar is, in fact, an "IOU Nothing" issued by a bankrupt U.S. government.
for The Daily Reckoning
Doug Casey is the author of Crisis Investing, which spent 26 weeks as No. 1 on the New York Times best seller list. He is also editor and publisher of International Speculator, one of the nation's most established and highly respected publications on gold, silver and other natural resource investments.
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