History’s biggest credit bubble will collapse
Financial Times, Dec 19, 2000, LETTERS TO THE EDITOR

Sir, Prof Rudi Dornbusch has it half right (”A rendezvous with bankruptcy”, December 15). The US does matter - and he glosses over the extent of our problems. Yes, Japan is in parlous circumstances and yes, unless they let their debts liquidate and markets clear, there is no solution on the horizon.

US indebtedness is a much bigger problem. It now exceeds Dollars 2,600bn. The vaunted US surplus is a chimera, as the Federal budget is in deep deficit. Why? The unfunded Social Security and Medicare obligations of the US, coupled with unfunded government workers’ retirement, are a black hole. If there were an actuarial requirement to provide for these obligations, the US budget would show a deficit by one reckoning that pushed Dollars 1,000bn a year.

The purported ”surplus” is due primarily to capital gains taxes and exercise of options by the US’s senior executives. The gap between average worker and CEO has never been greater, at a ratio of 475 times, as a result of options.

Before 1995, Nasdaq and personal consumption in the US had a weak correlation of 0.24. Since 1995, this correlation has increased to 0.74. As the Nasdaq bubble further collapses, a negative wealth effect will occur, lowering corporate profits, wage gains and capital gains.

The US savings rate will increase from a negative rate currently, resulting in diminished US profitability. Rising joblessness means more government payments. Presto! Lo and behold, the deficit reappears.

Since 1995, broad money in the US expanded by Dollars 2,600bn and total credit by Dollars 9,300bn, yet nominal GDP was up only Dollars 2,700bn. In the second quarter of 2000, credit expanded by Dollars 1,400bn, a record pace.

Credit has been growing at 4-5 times the rate of GDP growth. Consumer credit has never been greater, mortgage indebtedness as a percentage of total housing value has never been greater and US corporate indebtedness has exploded as US executives have bought back shares to make their options profitable. Downgrades by credit agencies, rising personal and corporate bankruptcies and wide credit spreads indicate a systemic credit problem. Pimco’s Bill Gross said to avoid corporates ”at any cost”. Profit downgrades increase daily.

The US debt situation and credit bubble make Japan look prudent fiscally. No amount of Fed legerdemain can overcome the collapse of the greatest credit bubble in history.