There was good news for the American economy yesterday. Revised estimates for third quarter GDP numbers showed a very nice up-tick, showing a 4.3% increase. But, “Uh-oh,” you’re saying, “Isn’t this the guy who can’t bear to see a modern work of art or good news without taking an ax to it in true 80s slasher film style?” That’s rank slander, and no this is not an ax behind my back. It’s a chainsaw I’ll have you know!

There are of course worrying elements right there in the numbers. Note the weight of personal consumption, federal government spending and real estate as contributing factors to the rise. More on this later. But there’s bigger game afoot.

You see GDP doesn’t really measure what most people think it does. Most people use the word as synonymous for growth. But what it in fact measures is economic activity. Can you see where I’m going with this here chainsaw? If I were to find a bank willing to lend me one million schmolians, and I proceeded to go on a one month bender, burning money like Montgomery Brewster, I would have added 1 million schmolians in economic activity and GDP. But would it be sustainable economic activity?

True growth, and I know I’m being a stick in the mud here, comes from producing goods and services other people are willing to buy, thereby increasing your income, which gives you room to expand your savings or expenditures. You can’t borrow your way to wealth, unless that borrowed capital is invested in future money making assets. Simply put, you can’t get rich by taking out a loan to buy a Chinese stereo and a Japanese car. You’ll only feel rich, for a while.

There are four salient facts about contemporary American economy:

  1. The economy has delivered good to very good GDP number for the last couple of years.
  2. The consumer now accounts for 76% of all economic activity in The US.
  3. Median income for US workers, when inflation (which for the middle class at least is understated in the first place) is factored in, has been falling for the last couple of years.
  4. The personal savings rate, that is the aggregate of what every American saves and owes in debt, has fallen below zero during that time.

Now like a computer program goto 1 and see if you can spot where those GDP number stem from.
The engine of this debt fueled growth has been the booming property market, its pistons the economic relationship with the Asian countries, mainly China. Americans go Wal-Mart to buy cheap Asian made goods. The Asian central banks then recycle that money back into US debt instruments, like federal treasuries, helping the Federal Reserve keep interest rates so low it’s been profitable to borrow money in real terms (while their cheap exports help keep inflation in check, both by driving prices down, and by putting pressure on the wages of American workers at a competitive disadvantage).

Those low interest rates and floods of liquidity sloshing through the financial system fed a booming property market, with houses doubling, tripling even quadrupling in price some places. This in turn allowed house owners to refinance their property, getting the same, or lower, monthly payments through adjustable rate mortgages, and “extract” a solid chunk of the value as cash. They then take that money and go to Wal-Mart to buy cheap Asian made goods. And the cycle repeats.

Now there are those, like the ones tooting the horn of the “New Economy” and the DOW at 36,000 during the boom, who are now blowing the same rusty trombone, claiming the economy is now so sophisticated, and the credit instruments so fine tuned, that debt levels no longer matter as a practical consideration. They are skilled at what they do, but like the often equally skilled serialists and atonalists of avant-garde classical music, what they are doing is not very productive.

Just because something is more complicated, doesn’t make it more sophisticated, or advanced, or true. Indeed, making things complicated is at the heart of flim-flam, it is the smoke-screen behind which the rabbit is stuffed into the financial, or artistic, magician’s hat.

At the end of the day the growth is built on the spending power of a middle class whose wages have just barely, or not at all, kept up with inflation, that has largely burned through their savings and are in the process of burning through credit, and spending by a federal government financed mainly through taxing that middle class.

And how long can such an unsustainable trend continue? General answer; far longer than you’d ever expect. It is in the very nature of irrational trends that they defy logic. Otherwise, would they be irrational trends? In fact such trends do have a sort of logic backing them up. The combined foolishness of a large part of the actors in a system will create conditions that favours irrationality, for a time at least. That is why many intelligent investors have ended up losing their shirts betting against irrationally exuberant booms. They were correct in thinking that something had to give. But unwise in trying to use straight forward logic to suss out an event which by its very nature is irrational. It’s the old saw, that the market can stay irrational far longer than you can stay solvent.

The more specific answer of course is for as long as there is enough cheap credit available on both the macro and micro level. As long as the bank is willing to lend you the cash, and you’re able to keep up with the monthly payments or roll them over into new loans, you could be living high on the hog. As long as the Asian central banks are willing to recycle their earnings into US treasuries, allowing US interest rates to skim at or just above the level of inflation, the party goes on.

And as a past master in the game of excess, I know that you can postpone crashing though the judicious application of stimulus of various and increasingly extreme forms for a surprisingly long time. But when that day of reckoning comes, when no matter what powders, liquids or pills you try to administer, the body just gives out, that hangover you’ve been kicking down the road, it’s waiting for you, with interest, and pink elephants, and alligators in the ceiling, and a mariachi band.

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