A Gloomy Richebacher Was Prescient in 1999

[Dr. Kurt Richebächer was one of the most visible and vocal proponents of Austrian School economics at the time of his death in 2007.  Eight years earlier, at the height of the dot-com bubble, we interviewed him for the Sunday San Francisco Examiner.  In retrospect, the economic problems that he believed threatened the global economy were small and relatively manageable back then. The same problems are of course still with us, and Richebächer undoubtedly would be appalled by the extent to which they have metastasized.

Although he spoke of a deflationary collapse in the interview, a close reading of his monthly newsletter from 1997-2002 reveals that he was conflicted on the subject. He used the word “deflation” only rarely during that period, and when he did, his logic became uncharacteristically muddy. Perhaps this is because, in the Austrian scheme of things, spectacular credit blowouts are not supposed to beget deflation, but rather, inflation. Arguably, if he were around today, he would still be uncertain as to which is likely to prevail when the economy finally collapses, as it must.  The interview below appeared in November 1999 under the flippant headline — not my work, for sure — “Economic Basics Predict Apocalypse”.  RA]

The dismal science will never be the same if Dr. Kurt Richebächer’s dire predictions for the global economy should come to pass. The former chief economist and managing partner at Germany’s Dresdner Bank says a deflationary collapse lies ahead that will ravage the world’s bourses and usher in a dark period of austerity and financial discipline.

Probably not one economist in 50 shares his views, at least not publicly. Richebächer, now living in France, says many of his American colleagues have been seduced into ignorance and complicity by Wall Street’s billions as well as by their love affair with mathematical models that shun fundamental laws of economics. Where they see a New Era of productivity growth and industrial efficiency, he sees duplicitous bookkeeping and manufacturing’s steep decline. They talk of a booming U.S. economy; he sees a profitless mirage. They worship capitalism’s bold risk-takers; he scorns them for recklessly piling leverage to the sky. Someone’s going to be wrong, but judge for yourself who.

Like the theories of Copernicus 500 years ago, Dr. Richebächer’s logic strikes one as no less sound and compelling than the Polish scientist’s once-heretical notion that the earth revolves around the sun. Richebächer asserts that the U.S. investment boom in computers borders on statistical hoax. It began in 1995 with the government’s implementation of a “hedonic” price index designed to capture both the falling prices and the rapid rise of computational power of each new computer. This is akin to measuring GM’s auto sales by tallying the horsepower of all the engines in its cars, says Richebächer. Applied to the computer business, it has exaggerated investment levels exponentially. For example, during the 12-month period ended March 31 the business sector increased its net investment in computers from $91.8 billion to $97.2 billion, accounting for a paltry 1.3 percent of nominal GDP growth. But when government statisticians multiply that $5.4 billion increase by their hedonic supercharger, the figure swells to $146 billion.

Hedonic Illusions

This has worked wonders on America’s bottom line, boosting the computer sector’s nominal 1.3 percent contribution toward GDP growth for the period to 49 percent, and the 4 percent contribution for the years 1996-1998 to 38 percent. For the first half of 1999, the effect has been even more pronounced, giving the computer industry a whopping 93 percent share of GDP growth. Remove the computer industry from the ledger, however, and the vastly larger rest of the economy had actual growth of just 2.5 percent during the three-year period vs. a reported 4 percent. Meanwhile, last year’s expansion would have been a middling 2 percent, and the uptick in productivity that has recently cheered economists would fade to insignificance.

The obvious question is, how could the computer industry, with barely more than 1 percent of the total workforce and plunging product prices, be responsible for what most economists read as a dramatic improvement in America’s standard of living? The answer is that it could not. And has not. Hedonic accounting makes the computer sector look like an economic hero, but any statistically significant improvement in our standard of living would necessarily have to come from the spreading use of computers across the entire economy.

Greenspan Concurred

Computers are indeed everywhere, but evidence that they have substantially boosted U.S. productivity remains elusive to say the least, says Richebächer. In this assertion he has corroborating testimony from no less an authority than Fed Chairman Alan Greenspan. In a 1997 speech in Frankfurt, Germany, Greenspan acknowledged that a straightforward interpretation of certain service-economy data suggests that productivity output per man hour has actually been falling for more than two decades. Greenspan called this implausible, offering the explanation that prices may have been mismeasured. But whatever the reason for the anomaly, the Fed chairman is obviously at pains to convince us that he and his staff of Ph.D.s truly understand how to measure productivity accurately.

If productivity growth in recent years has been largely illusory, the spectacular expansion of credit during that same time has been all too real, warns Richebächer (pronounced REEK-a-beh-kur). It didn’t happen by accident. The economist says the Fed started the real orgy last fall with a series of rate cuts intended to shore up some hedge funds that had gotten in way over their heads by amassing huge positions in leveraged credit instruments. The Fed’s massive gift to debtors quickly found its way into the mortgage markets, where homeowners ran up new borrowings in 1998 to more than $1.5 trillion, nearly two-thirds of it in refinancings.

Four Classic Signs

The hot money spread like lava into the financial system. Fannie Mae and Freddie Mac, quasi-governmental agencies which buy up mortgage loans, expanded their balance sheets four times as quickly as they had the previous year, with $220 billion of growth vs. $61 billion in 1997. This put an estimated $15,000 into the pocket of each re-fi customer, kicking off a spending binge that pumped housing and stock prices to record heights. It also created a financial bubble whose collapse Richebächer says we will eventually have to reckon with. He says the four classic elements of a bubble are all present and most obvious: 1) money and credit have been expanding vastly in excess of both savings and GDP growth; 2) inflationary pressures are being channeled toward, and concentrated in, asset prices; 3) low inflation has kept monetary policy too loose; 4) soaring asset prices have overstimulated domestic borrowing and spending.

The Richebächer Letter, published by Baltimore-based Agora Publishing, circulates widely among top-level financial decision-makers, probably because it is so good at poking holes in the prevailing wisdom. What has he been saying lately? Just this: Profit performance in the U.S. economy has been appalling during the stock market’s steep rise of the last several years, but accounting gimmicks designed to please Wall Street have masked the weakness. Compared to a year ago, profits per share on the S&P 500 have declined from $39.72 to $37.71, and on the Industrial Index from $42.13 to $38.37. Over that time, as all investors know, share prices on the 500 have risen spectacularly.

Trade Deficit a Killer

Some other points noted by Richebächer:

  • The trade deficit, which sent $233.4 billion abroad last year, is the biggest profit-killer in the economy. It has been offset, albeit precariously, by a household sector that has consumed manically with borrowed dollars and dissavings. The bulls believe the Fed will keep the credit machine running full speed if the economy starts to falter. But full speed is not enough, since sustaining growth in the economy and the stock market will require ever-larger credit injections. With the personal savings rate already in negative territory, it is by now manifestly impossible to increase dissavings to the extent necessary to produce continued economic growth.
  • The “profit miracle” of the 1990s is nonsense. What kicked the stock market into high gear earlier in the decade was mainly the one-time effect of lower borrowing costs induced by a recklessly generous Fed. Profits have weakened since in absolute terms and egregiously relative to soaring share prices.
  • The widespread use of stock options to compensate employees has caused corporate earnings to be grossly overstated, since the options reduce the amount of wages charged against profits. If properly accounted for, stock options would have lowered aggregate published profits by 56 percent in 1997 and 50 percent in 1998, according to figures from Smithers Co., a London-based research institute.
  • Derivatives can insure individual market participants against risk, but not system as a whole. Ultimately they have spurred higher risk-taking through leverage, exposing the global financial system to the prospect of devastating failure.

Volcker a Friend

Richebächer, who counts former Fed Chairman Paul Volcker among his close friends, says U.S. economists of the 1960s would more readily have recognized these problems and acted stridently to counteract them. Public discussion was still influenced back then by staid economists who represented the banks and who knew their theory. The current crop, however, is “really a part of Wall Street’s sales force to sell shares,” he says.

In contrast with European economists, their theoretical thinking is “not too deep,” notes Richebächer, and in recent years has been completely eclipsed by mathematical models that fail miserably in reckoning with the crucial variable of human behavior.

The current level of thinking is “unbelievable,” he says. “How can you simply overlook a negative savings rate and mountainous trade deficit” in saying the economy is healthy and robust? “There is almost no one left in America to pose critical questions about economic fundamentals,” he laments. Meanwhile, “the only miracle about the American economy is the consumer’s amazing propensity to borrow,” a fact which Richebächer says has delayed a day of reckoning.

Even if there were someone raising such questions, would anyone be listening?

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  • nonplused June 13, 2011, 7:01 pm

    It seems strange that even though we (humanity) suposedly has known for 100 years what causes bubbles and how they end, the powers that be still intentionally cause them, and people still fall for it.

    But then again, I know people who believe the universe was created in 6 days about 6,000 years ago. I guess the light from distant galaxies was created already in place too so that we can see things more than 6,000 light years away. Or maybe all that stuff we see up there doesn’t really exist.

    We aren’t smart enough as a species to deal with what’s going on, especially money.

  • Marc Authier June 12, 2011, 4:32 am

    Thinking ? The present time is totally devoid of any thinking whatsoever. It’s like the food. Corn syrup, aspartane, MSG, GMO insecticide, silicon, amoniac MADE IN USA crap. Courtesy of Ronald McDonald Bernanke and Lady Gaga Greenspan. Is Obama still alive ?

  • Rich June 8, 2011, 1:54 am

    OT: Speaking of quadrupling down after losing money on the Vancouver Olympics, NBC just won the next four Olympic TV rights for $4.38 B.
    Mr Market seems to like it, targeting +27% LT…

  • John Jay June 7, 2011, 12:05 am

    The US Dollar has been backed by plutonium and tritium since Nixon closed the gold window back in the 70’s. No gold in Fort Knox is a given, but the plutonium and tritium, and the fact that the rest of the world knows we have the lunatics in power to use it seems to work even better.

    • michaels June 7, 2011, 4:42 am

      Exactly. It is funny though…

      You look at the most people, and they do find it somewhat logical that we should “probably” do something about Iraq and Iran. While it should be patently obvious, that if we should look at the argument of “Has the weapons of mass destruction”, then it is mostly us, and if we should also weigh the argument “and is known to use them”, then it is only us in a solitude. It is funny and scary at the same time to realize to what degree the people have been brainwashed, to repeat mindless mantra and not even notice that the reality is exactly opposite to the belief.

    • Rich June 8, 2011, 1:47 am

      Fukushima finance…

  • Rich June 6, 2011, 9:55 pm

    Agree with the notion of Marginal Productivity of Debt, reflected by declining money multipliers and velocities. The productivity of money market manipulation declined as the USA approached terminal velocity to insolvency and debt default deflation.
    The US dollar currently targets a new low at 60, the long Treasury Bond Yield 6.3%, Gold $1660 and Silver $29.
    Interesting times demanding asset reallocations, to be sure…

    • Rich June 8, 2011, 1:45 am

      SPX targeting 1200 and GDXJ 25 LT…

  • Ron Robins June 6, 2011, 5:55 pm

    This is quite a co-incidence! I authored a column today on a leading Mid-East business portal referencing Dr. Richebacher.

    See my post at: http://english.alrroya.com/content/economic-statistic-us-elites-keep-%E2%80%98hush-hush%E2%80%99

    • Rick June 8, 2011, 4:23 am

      Thanks, Ron. I wrote on this topic — the marginal productivity of debt — in Barron’s about 15 years ago, and even then the numbers looked atrocious. I’m going to post the link you’ve furnished on the Rick’s Picks home page, since it deserves the widest audience possible.

  • DG June 6, 2011, 5:23 pm

    I know it sounds trite, but it is amazing how genius “the love of money is the root of all evil” is.
    Pretty much every ill we have can be traced to one elevating the importance of creating more short-term money for oneself above long-term good.
    The Fed is nothing more than this and our current monetary system. Ditto stock options as income. Unfunded wars. Unfunded pensions.
    Ditto political campaign contributions. (Goldman was Obama’s largest sugar daddy. “Shocked, I’m shocked I tell you”).
    It is all the same.
    I’m all for making more money, but not all money is good money and is therefore not worth it.
    I believe we are all in a very long process of learning what money really is. “Red Will” challenged, “what are you gonna do about it?” Indeed.
    What MUST be done is that we all try to understand the fundamentals of our flawed system and spread this understanding widely. Otherwise, we will be given solutions which we really don’t want.
    Clearly, those have the mic are spouting nonsense -they never saw the problem coming and NOW, their solutions aren’t working. Why would they work? So why would any reasonable person accept their current ideas to solve the problems? This is Einstein’s definition of insanity!
    The Germans started down the road of monetary destruction during WW1. They spent money they didn’t have to finance a war that should not have been. Sound familiar? The folks never figured it out. Never. It wasn’t until foreigners kicked their ass into submission that they finally “figured it out.” This process took nearly 30 years and massive human cost! If you are disturbed by everything Nazi, then replace them with handfuls of examples South of our border, Argentina, for one. Or go back to third century Rome.
    What are you gonna do? We need to strongly dismiss the nonsense being spouted by our leadership as they are known failures, completely revolt against the existing banking structure, and demand solutions which are logical and sensible. BTW, these solution will be dramatically different from what you have become accustomed to. So become comfortable accepting uncomfortable solutions. I can guarantee you that what most find intellectually comfortable is absolutely wrong. This is logical. What we know is not working…
    How pathetic would it be if we completely ignore history and force our children to suffer an entire generation of mistakes which are completely avoidable?

    Which leads me to more biblical advice, “and a fool returneth to his folly”

    I’m no theologian……..just sayin’ don’t be a fool, fool!

    • michaels June 6, 2011, 8:43 pm

      “We need to strongly dismiss the nonsense being spouted by our leadership as they are known failures, completely revolt against the existing banking structure, and demand solutions which are logical and sensible.”

      Agree, very much, except for “demand the solutions”. This is the root of the problem, I think. They can not possibly offer solutions, and we should never ask for solutions from these clowns. Their only job is to protect us from each-other use of violence, that is it.

      Government should never be able to regulate, decide, promote, discourage or facilitate anything that has to do with exchanges, markets, economy and money. Money should be gold, specifically to deny any government any purchasing power they don’t need to have.

      This is a recipe on how to do it right.

    • warren June 7, 2011, 6:05 pm

      Eccl 1:9

    • Rich June 8, 2011, 1:47 am

      What has been will be again, what has been done will be done again; there is nothing new under the sun…

  • Rich June 6, 2011, 12:12 pm

    PS Did I post the testimony under oath from the Fed Counsel in Congress last week, that the Fed actually has no gold, having transferred it all to Uncle Sam, keeping the account entry as an historic record of that transfer?
    So the tradeable supply of gold (and silver) is too small to stash debt derivative money and hope to have the ability to buy and sell without any market landslide. Oh boy. Nothing like a liquidity trap to break hedge funds…

    • DG June 6, 2011, 6:51 pm

      Saw that. Odd. I don’t understand why every central bank in the world buys and sell gold, reports the activity, yet ours has none and claims it never has. Hmmmmmmm. Or so their Loy-ya says.
      Maybe that’s the rub. Legal-ese…

    • michaels June 6, 2011, 8:48 pm


      “A new report prepared for Prime Minister Putin by the Federal Security Service (FSB) says that former International Monetary Fund (IMF) Chief Dominique Strauss-Kahn was charged and jailed in the US for sex crimes on May 14th after his discovery that all of the gold held in the United States Bullion Depository located at Fort Knox was ‘missing and/or unaccounted’ for.”

      “tungsten connection” surfaces again…

  • Rich June 6, 2011, 12:05 pm

    Kurt Richebacher and Vern Myers:
    Does God make strong men like that anymore?
    Read below for my answer.
    It seems the Fed was constrained to stop and go policies of monetary inflation, in a flailing attempt to rob by usury the host economy without killing it, offset secular deflation brought about by too much debt and consequent default the really old-timers wrote of in Exodus and Leviticus, the two-generation Debt Jubilee, without the Fed and Treasury triggering dreaded hyperinflation, while denying the 11+% current inflation John Williams measures using 1980 methodology.
    While JW showed 15% inflation in 1980, which Volcker conquered raising short term rates to 21% to suck all cash out of the markets, killing anyone on leverage or margin, BB is dealing with a much larger derivative debt pyramid than 1980, that threatens to bring the world down like the Walls of Jericho. After all, we were the largest global creditor in 1980 and when Ronnie Raygun left office, we were the world’s largest debtor.
    As Ron Paul will tell anyone who will listen and report with integrity, BB and TG basically broke the economy with ZIRP and Primary Dealers feeding funds for market manipulation.
    And the IMF Strauss Con basically wanted to dethrone the dollar with Eurotrash, while the AngloAmericans still clung to it and took him out with the honey trap.
    So far this serious sturm und drang had precious little to do with the real American Main Street Economy or employment, killed by WTO agreements that exported jobs overseas, with obscene profits to elites at the expense of the economy on Main Street.
    Government agencies and Czars were willing mega corporate accomplices and subsequent hires like the head of DHS profiting selling lethal scanners, and the head of Defense and VP enriching themselves buying useless Tamiflu and no-bid anticompetive war contracts, agencies redefining economic measures so they became meaningless, examples including hedonic improvements, core inflation and seasonal adjustments.
    Most people with any common sense saw the Emperor had no clothes, so they put their assets in ammo, drugs, food, fuel, precious metals and webcams like government covert black ops, with the result there is precious little real productive enterprise, despite glowing export figures massaged by multinational accountants hiding money offshore and spouted by talking heads on the sell side of Wall Street.
    So where may that lead/leave US?
    Cyclonic bursts of deflation, one of which we appear to be in right now, with ever greater subsequent monetary creation, and ever smaller velocity, less bang for the buck.
    Thus the current Marxist President teleprompter cheerleader for economic death squads on Wall Street and Policy Wonk Hitmen emanating from the District of Criminals, while DHS, FDA, FEMA and TSA tighten their noose, with 200 M Americans armed and potentially dangerous if they are without clothes, employment, food or housing too long.
    Think Robin Hood.
    See The Road, with Viggo Mortenson, Cherize Theron, Robert Duvall, for the scenario, where E coli domestic bioterrorism and economic chaos without electronics become the fatal factor.
    At least one long-time financial observer/participant sees the 11% real CPI jumping to 15% late this year, then 50% within two years, as the Fed and Treasury go back to hidden QEIII on the QT.
    What may that do to interest rates after this deflationary burst is over sometime this fall?
    What could that do to equity markets?
    The flight out of debt and derivative markets 100 times larger than equity markets could break the debt derivative markets and easily create the 30,000 or higher Dow Bronson foresees.
    If the Dow had only kept its nominal 10% total return from 2000 to 2011, it would be over 31,000 now.
    If the Dow recovered it’s 10% nominal return by 2020, it would be north of 74,000.
    Food for thought.
    But in the meantime, Big4 are LT down on long bonds and stocks except RUS, and all currencies but the Dollar, Euro and Kiwi.
    The Fed up Market appears to require a casino trader navigator to survive, so I nominate Rick Ackerman as the Kurt Richebacher/Vern Myers of today.
    Love ya man…;

    • Rick June 8, 2011, 4:19 am

      Thanks, Rich, but I’m afraid Myers and Richebacher were the last of their kind. Concerning your Dow Average extrapolations: Amazing!

  • John Jay June 6, 2011, 4:55 am

    “Vodoo Economics” came to the fore more and more as the Dollar lost value and our manufacturing jobs and factories moved offshore. From the 1960’s forward we had less and less to sell to the outside world, so TPTB made up increasingly dubious economic scenarios to cover up what was being done to the US economy and workforce. It involved ever growing piles of debt, a debased Dollar, and a casino mentality that came to pervade America. Dot com, housing, you name it. The government still refuses to admit what has happened as they pretend to act puzzled by our comatose economy that requires ever cheaper money to even slow it’s descent, let alone make it robust. The government is preparing an attempt to reflate housing since I have read that they feel down payments and decent credit scores are dooming millions to “rental doom” or some such nonsense. FHA 3% or less downpayment mortgages are crowding out everything else. We have not even begun to recover from the last housing ponzi scheme and they are right back at it.

    Meanwhile, all the food prices (which Ben and the Feds say don’t count as inflation) sure seem to be inflating to me.
    Florida’s Natural OJ is north of $4 a half gallon when it is not on sale, up from $3 not too long ago. That is all fresh squeezed, not from concentrate, all domestic oranges, I use it as the gold standard of OJ out here in California. Gasoline prices have dropped back some but that is the game they have played for decades. I remember the first oil shock back in the 70’s, I think prices went from about $.35 to $1 a gallon. When the public got riled up, suddenly there was a shortage even at $1 a gallon. Long lines, odd/even days, flags when they were out of gas etc. Then prices dropped back to $.75 a gallon and there was plenty at that price, so everyone was happy for no more lines, they stopped complaining. Ever since, that has been the scheme, run it up till they scream, then drop it back a bit so it seems cheap again. I can’t keep up with all the “Rackets” being run on us anymore!

  • KURT June 6, 2011, 2:15 am

    “the only miracle about the American economy is the consumer’s amazing propensity to borrow,”

    …or, we can look at the fools trying to buy RE in California, even before the blade finishes it’s fall.

    Why do we see a behavior of increasing recklessness?

    As Austrian economics is more of a study of men behavior as it relates to economic matters, perhaps we should look at the behavior of an animal that resembles men the most?

    Take a bunch of Rats.

    Experiment One, call it pre-socialist America:

    Bunch of rats are mingling around, feeding on stuff, procreating, chasing each-other, fighting, etc. We approach them with a trap, in which we set a piece of cheese. Few most heroic rats are captured.

    Experiment Two, call it socialist America:

    Bunch of rats are mingling around, chasing each-other, fighting, etc. Except, there is nothing to feed on, we have removed everything around them, the only existing food is that in our trap. We approach them with that trap, in which we set a piece of cheese. Most rats are fighting for their entry into the trap, we might even say that they are “raising the price of admission to the trap cage”. Some rats are stomped and bitten to death, and lay at the door of the cage. In rat’s opinion, “the price of cheese in the trap always grows”.

  • KURT June 6, 2011, 1:53 am

    ” in the Austrian scheme of things, spectacular credit blowouts are not supposed to beget deflation, but rather, inflation”

    Funny how people take it this way. I think it would be foolish to say that after a boom, there might be no bust. Of course deflation is what awaits the economy after a boom, whether it is Austrian explanation or not.

    What Austrians are saying is that given that the government is able to issue new money (fiat money system), they must always try and counteract the oncoming deflation, by issuing that new money, i.e. inflating to counteract ongoing deflation. In doing so, they must attempt to judge how much is enough. However, their mistake on side of “not enough inflation” would be hundred times as painful as their mistake on the “too much inflation” side. Thus, they predictably will err on the side of issuing too much.

    So, while pure economics suggests necessary deflation, we will not see it as long as the government can issue money. It is not the same as to say deflation is impossible. It is instead to say that while deflation surely will be the result every time, it will not be observed, as it will be excessively masked out by politically caused inflation.

  • Ollywood June 6, 2011, 1:36 am

    Yo Rick

    What’s up with that “what’s a hidden pivot?” ad!?!?

    • Rick Ackerman June 6, 2011, 5:56 am

      Try clicking on it, Olly. You’ll figure it out …

  • redwilldanaher June 6, 2011, 1:23 am

    Great piece Rick. I spoke with him once while working on a project that I was involved with from 2002-2004. I listened to more truth in those 2 hours on the telephone with him than I had heard in the prior 15 years of financial/economic reporting by the MSM. The void he left behind remains to this day imo.