From The Daily Reckoning
April Fool's Day, 2004.

This is the day people admit what they've been all year long.

Perhaps Alan "Bubbles" Greenspan... Zembei "Mr. Dollar" Mizoguchi... and all the world's most prominent central bankers will wake up this morning, look themselves in the mirror and say to themselves: ah, what fools we have been!

The U.S. economy appears to thrive by consuming what it cannot afford. The Asian economies appear to thrive by selling to Americans what they cannot pay for. And almost everyone everywhere appears to like the foolishness so much, they ask only that it continue.

And why not? Americans are happy to spend money they haven't got; their economy depends on it. And Asians are happy exporting products to them; their economies depend on it, too. Who wants to change? Who wants to enter the long, dark passage to a new economic order? No one. So it goes on - based on lies, fraud and foolishness.

But the present situation is ruinous for everyone, as near as we can tell. Each year sends Americans deeper into the hole... and makes them less competitive on world markets. Meanwhile, Asian economies add to their productive capacity based on demand that really isn't there. If Americans spent only what they could afford, buying would suddenly go down... and cobwebs would form on Asian assembly lines. China, with its hundreds of millions of barely-employed people, would probably erupt into war, revolution... or some other form of upheaval.

The whole thing will blow up in our faces. But when? How? "There is a lot of ruin in a nation," Keynes pointed out. But how much?

"The problem is debt," said Robert Catto at our Roundtable discussion on Tuesday. "Somehow, debt levels have to go down."

But couldn't debt levels go down gradually, asked another fund manager? We know the present situation is unsustainable... but couldn't there be a 'soft landing'? Couldn't the transition to a more balanced and healthy world economy be accomplished without anyone slashing his wrists?

We considered the question. Certainly, we'd like to believe it. But imagine a man with $100 to spend every week. He believes things will always get better, so he mortgages his house and uses credit cards in order to enjoy some of tomorrow's good things today. He spends $110 a week... and the economy booms. Multiplied by millions of fellows just like him, the spending power of the entire nation seems to have been magnified by 10%.

After a year, however, he owes 5 times his weekly disposable income. No one will lend him more. Instead, his creditors are demanding repayment. Can he gradually reduce his debt without pain?

Alas, no. In order to reduce his debt, he must spend less than $100 a week. His living standard must go down 10%... at least. And even if he cut back by a single dollar - his living standard must go down. Plus, the economy has come to rely on him spending $110 every week. If he spends less than that, sales go down... which sends a shock wave through the entire system. Business profits fall. People are laid off. The effect is amplified... because then incomes fall, too. Pretty soon, the man no longer earns $100, but $95 or $85. He has to cut back his spending even more, just to keep his head above water.

Sir John Templeton was quoted last week saying that in the coming downturn, 20% of people with mortgages are likely to lose their homes. At the margin, the two-income, no-savings household cannot afford even a slight cut in income or credit. They will lose their house. And who will buy it? And what price?

*** Editors note.
The upcoming mortgage foreclosure rate in Canada will be similar to that of their American neighbors to the south.