Zbigniew Piekarski On how Americans have kept the World economy afloat

"Spending beyond your means does not produce economic perfection but an economic dead end, just as might have been predicted by a moral philosopher but missed by an economist."

- Bill Bonner & Addison Wiggin "Financial Reckoning Day" October 2003

The next time you want an explanation as to why the market is going up, consider this sequence of events. A high-profile stock reports "positive earnings" after the close of trading; its share price soars in after hours trading and establishes a "bullish tone" for the next day. All evening the Jabberwockies on the television gush enthusiastically about the positive earnings and investment fund managers go to sleep congratulating themselves on just how wise they are - as they know the individual investor is bound to pile in. When the market opens the next day, a flood of buy orders propels the market higher until one or two of the more sceptical analysts decipher a few hidden clues to the actual state of affairs and the next day some prudent investors begin to sell.

The stockbrokers and stock exchanges make money either way. When the stock moves up, it can be turned over quickly and generates commissions and when the stock falls, it can be turned over quickly and generates commissions. Analysts recommend individual shares, not necessarily on sound research, but because they are showing signs of momentum as other analysts reached a similar conclusion a while back. And fund managers are forced by the system into buying shares in sectors that they know are overvalued, but which will, as they soar, provide returns similar to those of other managers. The System rules and profits and the money of the many is channelled into the hands of the few.

At present, optimism still prevails and the glass is seen as "half-full", whereas only six months ago it was "half empty".

Until now, the American consumer has kept the World economy afloat.

In the 60s, Americans borrowed about $1 for every $3 of extra income they earned. By the 80s, they were up to borrowing $1.50. As the something-for-nothing mentality really took hold of the country in the late 90s, the ratio rose to the point where Americans were borrowing $4 for every $3 in new income. In the last couple of years, Americans borrowed even more - about $4.50 for every $3 of extra income. Most recently, according to Kurt Richebächer, for every $3 increase in income, debt was clocked running at nearly $9.

The consumer didn't worry about it, because interest rates fell so much he was able to refinance his house, reschedule his debts and buy a new car at zero-percent interest.

House prices in America have increased at about the same rate as increases in money supply, eight percent a year. Since 1997, total housing values have risen from $8.8 trillion to around $14 trillion, most of the increase occurring in the past two years. A property bubble invariably forms after a stock market bubble is pricked and lasts for around two to three years before it collapses.

The increase in house prices and the low level of interest rates have made it possible to keep the spending frenzy going. Consumers 'take out equity', while actually reducing their monthly payments. Unfortunately, the boost to consumer spending provided by the Bush tax rebate has already run its course and retail sales petered out completely in September, according to the Commerce Department.

Even though business lending rates are at their lowest level in 20 years, a U.S. Federal Reserve report shows that the dollar value of commercial and industrial loans dropped to its lowest level in five years. Intel, for example, beat their own earnings estimates by 20 percent but reported that they do not intend to increase their capital spending budget for the year.

With rising interest rates, the nation's massive financial sector is heading into its own private recession. As soon as mortgage interest rates were raised, re-financing dramatically declined. Financial services jobs are starting to disappear, even as other industries begin adding a stray job or two and could offset employment gains elsewhere in the economy.

Finance companies are not the only corporations vulnerable to rising interest rates. Closet finance companies like General Motors are also vulnerable. GM reported a profit of $425 million in the third quarter. But GM's global automotive operations contributed only $34 million to the bottom line, down dramatically from $368 million a year ago. GM's finance operations, especially its mortgage finance arm, contributed essentially all of the company's third-quarter profit.

Mortgage debt is larger than government debt and this debt bubble dwarfs even the U.S. stock market bubble that burst in 2000. In addition, there is a huge difference in the consequences for equity and property investments when the bubble finally bursts.

If you lose on the stock market, you lose your surplus cash and somebody gains. In the collapse of a property market there are no winners. Both the borrower and the lender lose and a property is usually the largest investment that the individual has.

During the fourth year of the Great Depression, 1933, the U.S. found itself in the midst of a housing crisis. Roughly half of all mortgage debt was in default and house prices collapsed nationwide by roughly 80 percent.

Highly priced stock markets are ill prepared for the trauma of rising interest rates and the average time taken for a market to collapse is about 30 percent of the time taken for it to rise.

We are today in the midst of an historic debt bubble and, regrettably, there is absolutely nothing that we can do about it. This is a traders market and not one for the buy and hold brigade. Few assets will remain unscathed in the deluge to come. We believe we may have an answer. Come and join us on www.gpmanagement.com.

On the WSE: The WIG 20 chart is forming into a pattern dreaded by all Chartists and Market Technicians. It's either the Devils Horn's or the ears of a smirking Cheshire Cat. Whichever it morphs to, the final outcome will be the same. The Santa Claus rally this year will probably be muted, as the best is behind us for a few years to come.