Send in the Clowns: Bush Administration Pursues Economic Policy of Benign Neglect

By Peter D. Schiff
Guest Columnist

Four leading members of the Bush administration's economic team, including Ed Lazear, chairman of the Council of Economic Advisors, U.S. Commerce Secretary Carlos Gutierrez, Al Hubbard, director of the National Economic Council, and Jim Nussle, director of the Office of Management and Budget, convened on a CNBC TV panel last week and confidently predicted that the U.S. economy would avoid a recession.

As they uttered their platitudes, we learned that housing sales plunged again – with national inventories of unsold homes hitting a new record high – and that Merrill Lynch & Co. Inc. (MER) had disclosed nearly $8 billion in write-offs. Set against this backdrop of deteriorating economic news, it would have been more honest – and perhaps more effective – if the administration team came on stage in clown makeup and oversized shoes.

The Weak Dollar Dance

The group's most entertaining routine could be described as the "falling dollar hot potato."  It is a testament to the professionalism of CNBC host Dylan Ratigan that he was able to suppress howls of laughter while the economists scrambled to avoid any discussion of the dollar by claiming that only the president and the secretary of the treasury were allowed to comment.

How can the leading economic policymakers in government refuse to discuss the value of our money, which is arguably the single most important part of our economic system?  Why is the subject taboo?  Perhaps they feel that anything they say will only inspire less confidence in the dollar?

In reality, the administration is pursuing a policy of benign neglect.

In addition to the dollar dance, the wacky economists also provided some laughs on a variety of other subjects. Regarding the California wildfires, the panel reassured us that the resilient U.S. economy would weather the storm, much as it did with Hurricane Katrina.  However, as state and federal officials promise unlimited funds to rebuild thousands of burned homes, they conveniently ignore the fact that we must put the tab on our national charge card.  The ability to postpone pain by borrowing from abroad is evidence of economic vulnerability, not economic resilience.  A truly resilient economy has ample domestic savings to cover these vicissitudes itself.  America has yet to pay the costs associated with a string of natural disasters, the bills for which will likely come due much sooner than anyone seems to realize.

The administration gang also told us that the American economy will benefit once China moves to an economy based on consumption, rather than savings (in other words, more like our economy), as that country would finally begin buying more of our products.

U.S. Creditor Concerns

Although it is reasonable to expect that China will inevitably start spending more, it is ridiculous to assume that this spending will benefit the United States. When the Chinese begin spending, they will simply snap up their own abundant production and send fewer goods to America.  As the Chinese reduce their savings to begin enjoying the fruits of their labor, American borrowers will lose access to their largest source of credit.  The two-pronged effect on the American economy will be substantial increases in both consumer prices and interest rates – hardly the benign outcome all the president’s men expect.

None of them seemed too concerned about the cost of funding the war in Iraq (already more costly than either Korea or Vietnam in inflation-adjusted terms), which on the day of this “summit” we learned is now projected to be almost $2 trillion.  Their lack of concern likely reflects their belief that Americans are not the ones picking up the tab.

But I’m sure there is a much different reaction among our foreign creditors, as they contemplate the prospect of “loaning” us that much more money – knowing that a declining dollar guarantees they will never be repaid in full.  Perhaps the thought of loaning us endless sums to cope with natural disasters at home and man-made ones abroad will shock foreigners to their collective senses, and prompt them to finally cut us off.

The Mounting Mortgage Debacle

On housing we were once again told the problems would be contained. Such upbeat pronouncements should be wearing thin in the face of mounting evidence to the contrary.  When will people begin to grasp that the trillions of dollars of mortgage loans financed by Wall Street will never be repaid in full and that the losses for lenders will be staggering? 

Homeowners have lenders over a barrel, and soon all will know it.  Once the government exempts forgiven mortgage debt from being treated as taxable income, defaults will become a national trend.

Under normal circumstances, lenders have all the power, as 20% down payments and an ample supply of qualified buyers makes foreclosure a real threat.  However, under current circumstances, that threat is completely empty.  Lenders cannot foreclose, as there are no buyers and no equity.  If homeowners choose not to pay, lenders really have no choice but to renegotiate the loans.

Once homeowners understand this, no one will make a mortgage payment until their loan is reduced to an amount more consistent with the actual value of their home.

While homeowners themselves will experience mere paper losses, the losses that lenders incur will be all too real.  However, even with less mortgage debt, homeowners will finally wake up to the fact that their home equity is gone.  Without that cushion, Americans will be much more like the Chinese of today – consuming a whole lot less, and hopefully saving a whole lot more.

Money Morning Guest Columnist Peter D. Schiff is president of Euro Pacific Capital Inc., a Darien, Conn.-based broker/dealer known for its foreign-market expertise. A well-known financial author and commentator, Schiff has a reputation for making calls that conflict with the conventional Wall Street wisdom – and being right. In mid-August, when analysts were touting beaten-down financial shares, Schiff said the stocks were “toxic,” were destined  “to get hit hard,” and advised investors to “stay away.” Investors who heeded that advice, and avoided such shares as Merrill Lynch, also avoided some stressful losses. Schiff’s first book,“Crash Proof: How to Profit from the Coming Economic Collapse,” was published by Wiley & Sons in February.

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