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Money Coach

March 2007 - Posts

  • Scared Straight -- Why The Powers That Be Won't Come Clean

    I don't know who I'm more upset with -- the U.S. Government or the national media. Because when it comes to coming cloean with the American people on the economy, both fall way short of the mark.

    For example, both Uncle Sam and the US media uses the trade deficit as an economic bogeyman – or an economic boon – depending on their agenda.

    Under presidential administrations they prefer, trade deficits are either “manageable” or “unsustainable”. It just depends on which way the political winds are blowing.

    What’s beyond dispute is that, all along, the mainstream media, taking its cues from the government elite, has messed up the trade picture for Americans, who now don’t know what to think about the economy as it relates to our trading partners.

    For decades, economists, politicians and the mainstream media have maintained that the rise of foreign indebtedness was a trivial issue. But at $900 billion, even the most cockeyed optimist would have to admit that the emperor has no clothes.

    Certainly, the status quo is not acceptable. The consequences of more debt are huge and should be alarming to the American public. But apologists in the media and in politics don’t want to scare the public. They say that timely policy adjustments will cure our trade problems. If the public knew the truth about the impact of records trade deficits, they’d be up in arms. And that’s the last thing that the powers-that-be want.

    America's awesome economic problem is instead portrayed as something else – for example, an esoteric technical dispute about currency values, the dollar versus the Chinese yuan. The debate is guaranteed to baffle the average US citizens. A few brave dissenters have stated the matter plainly and called for significant policy shifts to stop the hemorrhaging. Warren Buffett, the legendary investor, says the United States is destined to become not an ''ownership society,'' but a ''sharecropper society.'' But his analysis, and others like it, are brushed aside and never see the light of day in the public arena.

    An authentic debate might start by asking heretical questions such as: Why is the United States one of the few advanced economies that suffers from perennial trade deficits? Why do new economic policies, despite official promises, always leave the United States with a deeper deficit hole, with another wave of jobs moving overseas? How do the economic wizards creating these policies explain the 30-year stagnation of working-class wages that is peculiar to America? Are we supposed to believe that everyone else is simply more competitive or slyly breaking the rules?

    The American predicament is shaped by economic policies grounded in the global system, singularly embraced by Washington because Washington originated most of them. At the outset, these practices were both virtuous and self-interested for the United States – designed to encouraging industrialization in poor countries, binding Cold War allies together with trade and investment, furthering the global advance of American business and finance. With its wide-open market, America played and still plays the role of buyer of last resort for world exports. Its leading companies and banks gained access to developing new markets, often by sharing jobs, production and technology with others. And, as a side benefit, American policymakers also got to run the world.

    The utopian expectations behind this arrangement turned out to be wrong, however, if you take a good long look at the empirical evidence rather than theory. Why wrong? American political debate is enveloped by the ideology of free trade, but ''free trade'' does not actually describe the global economic system. A more accurate description would be ''managed trade'' - a dense web of bargaining and deal-making among governments and multinational corporations, all with self-interested objectives that the marketplace doesn't determine or deliver.


    Every sovereign nation, the United States included, uses its vast arsenal of policies to pursue its national interest. But on the crucial question of how policy makers define ''national interest,'' Washington stands alone. Western Europe, whatever its problems, manages economic policy to maintain modest trade surpluses. China strives to acquire a larger, more advanced industrial base at the expense of worker incomes and bank profits. Germany and Japan, despite vast differences, both manage to keep advanced manufacturing sectors anchored at home and to defend domestic wage levels and social guarantees. When they do disperse production and jobs overseas, as they must, they do so strategically.

    Is Debt Really Such a Bad Thing?

    Keep in mind that the White House Council of Economic Advisers is not generally known for its sense of humor. But in the annual 2006 Economic Report of the President, the CEA decided to have a bit of fun with the record $726 billion trade deficit.

    At nearly 6 percent of gross domestic product, a deficit that large would in be treated in most other countries like the economic equivalent of a nuclear meltdown. But rather than dwell on the negative, the academics that make up the CEA framed their analysis not as consumption exceeding production (the so-called current account deficit), but as a consequence of cheap foreign capital financing our decadence (the capital account surplus, which by definition is its mirror image). Sort of like General Motors ending a disastrous sales month but declaring what a good period it had been for inventory.

    This upbeat view of the trade deficit reflects current American economic thinking that holds that the root cause of the world's massive economic imbalances is that the rest of the world is producing and saving too much, not that Americans are producing and saving too little. And what makes it possible for these trade deficits -- or capital account surpluses to the truly optimistic -- to continue year after year is that foreigners have decided that the best place to stash all the cash they earn from selling us sneakers,
    computers and oil is right back in the United States.

    There is certainly a good deal of truth in the idea of a global "savings glut." When excessive saving in Asia and Europe leads to too much capital flowing into the United States, it has the effect of bidding up the price of real estate and stocks while lowering interest rates. In turn, Americans respond by borrowing more against their newfound paper wealth, using the money to buy more stuff from overseas, creating a self-reinforcing cycle.

    Viewed in this way, it is the capital surplus that drives the trade deficit, rather than the other way around. Or, as the government, media and Wall Street would have us believe, it's their fault, not ours.

    I would argue that the "savings glut" is, to a large extent, really a "liquidity glut" caused by central banks, primarily those of China and Japan. For reasons that made sense in the context of sustaining growth and stabilizing prices at home, these central banks wound up printing too much money -- money that is now sloshing around the globe looking for some place to be invested.

    Some of this excess liquidity has gone into bidding up the price of stocks, particularly outside the United States. Some of it has gone into real estate, particularly inside the United States. Some of it has been used to bid up the global price of commodities, such as gold or oil futures. But a big portion of that money has gone into government bonds everywhere, creating a bond market bubble, which has the effect of lowering inflation-adjusted interest rates to ridiculously low levels.

    The problem is that these asset-market "bubbles" now have the potential to spill over into the real economy, generating excess growth and, eventually, unacceptable levels of inflation. Rather than wait for the full measure of inflation to show up in the official numbers, when it becomes much harder to deal with, they suggest that the Fed and other central banks should consider the economic equivalent of the policy of preemption. The idea is that raising rates earlier to slow the economy and take some air out of asset prices will reduce economic pain later.

    Excluding food and energy, the closely watched index of "core" consumer prices was up 1.8 percent in 2005, near the top of what the Fed considers its acceptable range. And with labor markets relatively tight, and health, energy and commodity costs putting upward pressure on prices, and a falling dollar likely to raise the price of all those imports, it's likely that the Fed will soon have to break the news that it won't be able to stop raising rates as financial markets now expect.

    This confluence of circumstances has disaster written all over it. And if you’re not prepared for the inevitable, I hope you, too, have a good a sense of humor.

    Posted Mar 26 2007, 04:20 PM by moneycoach with no comments
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  • This is the last in my series on American and its burgeoning debt crisis. I'll touch on it some more from time to time, but the last three blogs have given me the time and room needed to amplify this critical problem that can impact every one of us.

    As I've said, the consumer debt crisis is akin to termites eating away at the foundations of our economy. As a result, we’re already beginning to see pillars crumbling.

    And that has long term ramifications that are serious, if not critical.

    Allow me an example. What if you knew that, due to our poor financial health, the U.S. couldn’t save one of its most prized cities?

    That’s what’s happening with the city of New Orleans. The Crescent City, laid low by Hurricane Katrina in 2005, may or may not rise again to its once-prominent stature as one of America’s genuine destination spots. If it does not, it will not be Katrina that causes New Orleans’ demise, but rather America’s imbalanced, savings-starved economy, that left it so vulnerable to such a disaster in the first place.

    Why? Because Katrina struck the American economy at a particularly vulnerable time. By assuming that the sun would shine indefinitely, and that our economic levees (such as rising home values), would protect us from ruin, Americans have saved nothing for a rainy day. That explains the new all time record savings rate I brought up earlier in this series of blogs.

    Of course, as is always the case, many naïve “economists” look for the silver lining in the Hurricane’s cloud, pointing to the spending necessary to replace what Katrina destroyed as being a benefit to the economy. What such simplistic analysis overlooks is that resources devoted to replacing destroyed wealth are no longer available to create new wealth. Americans will either have to reduce spending in other areas, or postpone such reductions through borrowing.

    Since America lacks the domestic savings necessary to rebuild the infrastructure destroyed by Katrina, the money required to do so will have to come from abroad. Not only will America likely go even deeper into debt to rebuild the Gulf Coast, but the extra costs associated with more expensive imported oil will only exacerbate our growing current account deficit. If over-leveraged American consumers finally buckle under the strain of rising energy and debt service costs, causing the Fed to hold off on further rate hikes, the dollar could tumble, causing an economic hurricane far more damaging than Katrina.

    In the immediate aftermath of Katrina, as oil prices pierced the $70 per barrel level, there was no shortage of commentators expressing amazement at how well the U.S. economy had performed despite the increase. Such false assumptions have lead to fallacious conclusions of another “new era” in which America is no longer vulnerable to “oil shocks.”

    What such observations overlook is the tremendous increase in debt which has accompanied rising oil prices. Rather than curtailing consumption, Americans have merely responded to higher gas prices by borrowing more money. Therefore, the immediate damage isn’t reduced consumption but increased debt. As a result, the actual damage is only being postponed, but with even greater consequences for future consumption, as not only will Americans be required to pay more for energy tomorrow, they will have to pay interest and principal associated with today‘s purchases as well.

    A good analogy would be a man losing his job but maintaining his lifestyle by raiding his kids’ college fund, plundering his retirement account, taking out a second mortgage on his house, and maxing out his credit cards. A Wall Street “economist” might conclude that his job was really unnecessary, as consumption was not reduced as a result of its loss. However, such a simplistic observation ignores the tremendous accumulation of debt and dissipation of savings. Such has been the case with the entire American economy.

    What America has succeeded in creating is not an economy impervious to “shocks,” but merely one which enables their consequences to be postponed to a later date.

    Posted Mar 19 2007, 06:22 PM by moneycoach with no comments
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  • This is the last in my series on American and its burgeoning debt crisis. I'll touch on it some more from time to time, but the last three blogs have given me the time and room needed to amplify this critical problem that can impact every one of us.

    As I've said, the consumer debt crisis is akin to termites eating away at the foundations of our economy. As a result, we’re already beginning to see pillars crumbling.

    And that has long term ramifications that are serious, if not critical.

    Allow me an example. What if you knew that, due to our poor financial health, the U.S. couldn’t save one of its most prized cities?

    That’s what’s happening with the city of New Orleans. The Crescent City, laid low by Hurricane Katrina in 2005, may or may not rise again to its once-prominent stature as one of America’s genuine destination spots. If it does not, it will not be Katrina that causes New Orleans’ demise, but rather America’s imbalanced, savings-starved economy, that left it so vulnerable to such a disaster in the first place.

    Why? Because Katrina struck the American economy at a particularly vulnerable time. By assuming that the sun would shine indefinitely, and that our economic levees (such as rising home values), would protect us from ruin, Americans have saved nothing for a rainy day. That explains the new all time record savings rate I brought up earlier in this series of blogs.

    Of course, as is always the case, many naïve “economists” look for the silver lining in the Hurricane’s cloud, pointing to the spending necessary to replace what Katrina destroyed as being a benefit to the economy. What such simplistic analysis overlooks is that resources devoted to replacing destroyed wealth are no longer available to create new wealth. Americans will either have to reduce spending in other areas, or postpone such reductions through borrowing.

    Since America lacks the domestic savings necessary to rebuild the infrastructure destroyed by Katrina, the money required to do so will have to come from abroad. Not only will America likely go even deeper into debt to rebuild the Gulf Coast, but the extra costs associated with more expensive imported oil will only exacerbate our growing current account deficit. If over-leveraged American consumers finally buckle under the strain of rising energy and debt service costs, causing the Fed to hold off on further rate hikes, the dollar could tumble, causing an economic hurricane far more damaging than Katrina.

    In the immediate aftermath of Katrina, as oil prices pierced the $70 per barrel level, there was no shortage of commentators expressing amazement at how well the U.S. economy had performed despite the increase. Such false assumptions have lead to fallacious conclusions of another “new era” in which America is no longer vulnerable to “oil shocks.”

    What such observations overlook is the tremendous increase in debt which has accompanied rising oil prices. Rather than curtailing consumption, Americans have merely responded to higher gas prices by borrowing more money. Therefore, the immediate damage isn’t reduced consumption but increased debt. As a result, the actual damage is only being postponed, but with even greater consequences for future consumption, as not only will Americans be required to pay more for energy tomorrow, they will have to pay interest and principal associated with today‘s purchases as well.

    A good analogy would be a man losing his job but maintaining his lifestyle by raiding his kids’ college fund, plundering his retirement account, taking out a second mortgage on his house, and maxing out his credit cards. A Wall Street “economist” might conclude that his job was really unnecessary, as consumption was not reduced as a result of its loss. However, such a simplistic observation ignores the tremendous accumulation of debt and dissipation of savings. Such has been the case with the entire American economy.

    What America has succeeded in creating is not an economy impervious to “shocks,” but merely one which enables their consequences to be postponed to a later date.

    Posted Mar 19 2007, 06:22 PM by moneycoach with no comments
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  • More on America and Its Crushing Debt Load

    In the last few blogs I've talked about America's growing debt problem -- a situation which could seriously deteriorate our collective quality of life if we don't address it.

    That's why it’s important to recognize our debt problem, and what it means to the future of our great country. A future where we may have to churn our own butter sounds severe, but it’s symptomatic of the price we’ll pay for our rampant consumerism and high-debt culture that has grown out of control over the past few decades. The decade of 2010-20 will be much different and much harder, than what Americans have grown accustomed to.

    How did America stop becoming a producing economy and slide into a consumer economy? What led to the economic conditions that has led to America becoming one of the most highly debt-leveraged countries in global history?

    To get a grip on our debt problem, it’s important to understand the origins of our consumer culture; to understand how low-inflation, low interest rates that led to easy credit triggered the debt explosion that we’re reeling from today.

    If you can begin to understand that you can begin to understand America’s transition from a producing culture to a consumer culture, and why that bodes ill for the American economy over the next 10-20 years.

    Our Problem with Debt

    2006 was a record year for US consumers, but not the kind of record you’d want to brag about.

    By year-end, the average savings rate for Americans was for 2006 was negative 0.5 percent, the worst savings rate since the Great Depression.

    But could the savings rate numbers be worse than the US government is letting on? Not surprisingly, yes.

    I see instance after instance where the government is using faulty data to conjure up faulty financial numbers that they pawn off on the Americans public as being the genuine article.

    With the savings rate numbers, the scam works like this:

    The Commerce Department's Bureau of Economic Analysis calculates the savings rate by taking a household's after-tax income (wages,salaries, interest income, rental income, dividends, social security, unemployment benefits, etc.) and subtracts spending on consumer goods and services (food, clothing, entertainment, etc). Whatever's left over is savings. But the government doesn't figure housing expenses into the spending-saving calculation since it views housing as an investment.

    Consequently, anything a home-owning consumer spends on the quality and upkeep of that house, like a $20,000 finished basement that they may have had to take a home equity line of credit out to pay for, is not really spending, but an investment – for the betterment of the home’s value.

    While the last point is defensible, the idea that spending $20,000 on a new basement really isn’t spending is not. Factor in all the household improvement spending – about $233 billion on home improvements and repairs, according to Harvard University's Joint Center for Housing Studies,
    that Uncle Sam doesn’t include in its savings/spending calculus – and the savings rate dives even deeper than the negative 5% that it reported in 2005.

    According to Paul Kasriel, director of economic research at Northern Trust in Chicago, if the government factored in a line item called "residential investment." Americans would have shelled out roughly $472 billion more than they earned after taxes. That bumps up the government’s negative savings rate of 5.2 percent.

    Worse, that trend of negative savings on the part of Americans seems to be gathering speed during the past 10 years. Kasriel has looked back to 1929 in gathering his calculations. In that time he has found only 12 years (through 2005) where Americans spent more money than they earned on a year-to-year basis. Understandably, two of those years were in themidst of the Great Depression and three more were right after World War II, where war veterans and their families unleashed a buying spree of huge proportions (and a baby-producing spree of equal proportions).

    Take the worst economic depression and the worst World War of the last 100 years out of the equation, and Kasriel’s statistics show that Americans were paragons of savings virtue during the 20th century.

    But of the 12 years where Americans did spend more they earned, the other seven years came from 1999-2005.

    "What's amazing is that my generation, the rapidly aging Baby Boomers, are entering their prime saving years," Kasriel tells Yahoo.com in a 2006 article entitled American’s Debt: Worse Than You Think?”. “Most of the Boomers, representing nearly a quarter of the population, are in their peak earning years (42 to 60). Many are becoming empty nesters, so their expenses should be declining. They already own the durable goods one acquires in the early stages of adult life. "But however you slice or dice it, we aren't saving," Kasriel says.”

    The Savings Quandary

    To emphasize this reality of life, let me introduce you to two hard-working farmers.

    Farmer Chang only grows oranges. Farmer Jones only grows apples. Each grows only the fruit that he produces most efficiently, trading his surplus for the fruit grown by the other. Both farmers benefit from comparative advantage and free trade. The sole reason that Farmer Chang “exports” oranges is so he can afford to “import” apples, and vise-versa.

    Suppose that one year a flood wipes out farmer Jones’ apple crop. Not having any fruit to trade, but hungry nevertheless, he proposes to trade apple IOUs for Farmer Chang’s oranges. Since Farmer Chang can not eat all the oranges he grows anyway, and since Farmer Jones’ IOUs will pay 10% interest (in extra apples of course), he accepts.

    Farmer Chang only accepts farmer Jones’ offer because of the apples that Farmer Jones’ IOUs promise to pay. By themselves, the IOUs have no intrinsic value. Farmer Chang cannot eat them. It is the promise to pay additional apples that gives the IOU its value.

    Now suppose that the following year Farmer Jones’ crop is again destroyed, this time by a hurricane. He and Farmer Chang once again make the same deal, with Farmer Jones getting more of Farmer Chang’s oranges, and Farmer Chang accepting more of Farmer Jones’ IOUs.

    Further suppose that similar natural disasters continue to besiege Farmer Jones for several more years, until it finally dawns on him that he is eating pretty well, without actually farming. He therefore decides to turn his apple orchard into a golf course, and simply play golf all day while enjoying Farmer Chang’s oranges. In other words, Farmer Jones now operates as a “service economy.”

    Farmer Chang on the other hand is so busy growing all those oranges that he never gets a chance to play Farmer Jones’ course. In fact, he has been accepting Farmer Jones’ IOU’s for so long that he no longer remembers his original reason for doing so. He now counts his wealth based solely on his accumulation of Farmer Jones’ IOU’s. In fact, Farmer Jones had such a good reputation within the farming community that Farmer Chang is able to trade some of Farmer Jones’ IOU’s for goods and services provided by other farmers and local merchants. However, as a result of Farmer Jones’ good reputation, no one notices that his apple orchard has been turned into a golf course. His IOUs are now worthless since farmer Jones no longer possesses the ability to redeem them with actual apples.

    Some might argue that the entire community now depends on Farmer Jones and his worthless IOUs. Farmer Chang and the others will simply accept them indifferently to avoid acknowledging the reality of their folly. Sure, were these circumstancesto transpire, any unfortunate holders of Farmer Jones’ IOUs would officially be forced to write down the value of those IOUs on paper and write them off as bad debt. But their true financial situations would improve, as any further accumulation of worthless IOUs would cease. As far a Farmer Chang is concerned, he would once again literally enjoy all the fruits of his own labor.

    Farmer Jones however would not be as fortunate. Without a viable apple orchard or the ability to buy oranges on credit, he would starve. It would take years to turn his golf course back into an orchard, any equipment he once had is either obsolete, dilapidated, or was traded in for a golf cart and titanium clubs. It has been so long since he ran a farm that he no longer remembers how to do it anyway. In the end, his only alternative might be to sell his golf course to Farmer Chang and take a job picking fruit in his orange grove.

    Do not wait for all the Farmer Changs to come to their senses and end up picking fruit on someone else’s orange grove. Protect your wealth before it’s too late.


    Posted Mar 13 2007, 12:23 AM by moneycoach with no comments
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  • Seeds of an Economic Tsunami

    In last week's blog, I offered up the opinion that, from a financial point of view, the U.S. is in big trouble. Make no mistake, this slide toward economic chaos has already begun.

    The U.S. is the world’s biggest debtor nation, printing money with abandon to sustain the illusion of prosperity. And we’ve been doing this for years.

    In 2006, the US government owed $7 trillion and that number is climbing every day.

    For decades, Americans have been told by government, by Wall Street, and by mass media that the economy is just fine, even as the cancer grows below the surface. My singular goal here is to make you aware of the stakes; aware enough to take action to survive the carnage.

    Key themes that bear discussion in the coming blogs include:

    The Deficit – A slew of government and private analysts put the actual U.S. "fiscal gap," (which means all future receipts minus all future obligations,) at $40 trillion (Government Accountability Office) to $72 trillion (Social Security Board of Trustees). The International Monetary Fund estimates the gap at $47 trillion; the Brookings Institution at $60 trillion. To solve the deficit problem the US government would have to stick taxpayers with an immediate and permanent 78 percent hike in the federal income tax.
    In fact, the huge US budget deficit is the single biggest driver of US economic woes.

    The Dollar – The story of the weakening dollar—and how it’s the loosened lynchpin in the coming economic collapse—is a key, bearish theme. The U.S. dollar is in a major long-term bear market, and investors would do well to keep their exposure to the dollar at an absolute minimum.

    The Stock Market -- I believe that, in general, U.S. equities remain substantially over-valued, and that the major U.S. stock indexes are in the early stages of long-term bear markets. In fact, economic policy decisions by the U.S. Federal Reserve is greasing the skids for the stock market’s demise, primarily by flooding the world with dollars and credit. Since 1995, the amount of money in the world has increased almost exponentially, growing an average of $525 billion a year. (For comparison, between 1990 and 1995, the money supply rose a total of $468 billion.)

    Most of that money is in the stock market, buying up stocks with no earnings and companies with no prospects. That cash will disappear once stocks start dropping -- while investors still have big debts to pay. Meanwhile, a cash flood is also washing overseas. Foreigners are holding nearly nine trillion U.S. dollars. That is a vicious cycle. Less profits means lower stock prices. Just like Americans, foreign investors have watched their stock market wealth disappear. Overseas, American investments are becoming less and less attractive, and foreigners may soon abandon the dollar altogether. Exhibit A? One of the big reasons for last week's stock market collapse is that China, our biggest creditor, is tightening its lending practices.

    Real Estate – There’s no great trick to understanding the current status of the US real estate market. If it looks like a bubble, walks like a bubble, and quacks like a bubble, it's a bubble. The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only, and negative-amortization mortgages, has produced the "mother of all bubbles." As the real estate bubble finally bursts, it's not just real estate speculators and home owners who will suffer, but the entire U.S. economy, its banking and financial systems, and anyone with U.S. dollar denominated savings.

    Interest Rates – The alarming interest rate environment is identified as another destructive force to the U.S, economy.

    As stated earlier, the U.S. dollar has dropped precipitously in the late 1990's and early 2000's. In response, the Federal Reserve had to drop interest rates to a 46-year low. In an effort to push the collapse off into the future, the dropping of interest rates to practically near zero-levels has created a frenzy of lending, as people rushed out to continue to live beyond their means. With loan interest near five percent, those burned in the stock market went out and invested in real estate. Overleveraged, many of them are now paying the price.

    Consumer Debt (and Bad Economic Calculations) – The typical debt carried by the average middle-class family in America today is between $10,000-$13,000 in credit card debt and a minimum of ten times that amount on their home mortgage. Unfortunately, most Americans don't even realize the danger they're in. Instead, they celebrate the “strengthening economy”, unaware the numbers supporting it are misleading... if not outright lies.

    Foreign Debt – Many economic observers give credence to the notion that America’s unique status makes it immune from suffering the economic consequences that have historically crippled smaller economies. However, the U.S. may soon wake up to the fact that it is not a special case—just an extreme one. Toeing the standard line that the U.S. is “too big to fail” some economists say that foreign creditors will never tire of loaning America enormous amounts of money at low interest rates, even as it becomes clear that they can never be repaid with real purchasing power. Although this game has gone on for some time, to paraphrase P.T. Barnum, "you can't fool all the Asian central bankers all the time." Once Asian governments and businesses realize the only thing standing between their citizens and sharply higher standards of living, is their continued subsidy of American consumers, the game will end.

    Is there a way out of this mess? Actually, yes. In next week's blog, I'll begin to explain how.



    Posted Mar 05 2007, 07:24 PM by moneycoach with no comments
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