Deleverage the World

Capitalism is supposed to be a system of profit and loss, but in recent years, central bankers and central planners seem to have forgotten the part about losses. The push and pull every lever on the control board to try to make losses for the big players go away, which can be a bit like trying to stop a receding tide. The strategy cannot work over the long term. Economic law, eventually, prevails.

For this reason, the news that American Airlines has filed for bankruptcy — an actual large company that is finally throwing in the towel — comes like a blast from the past of the way things used to work (remember the failure of Lehman?). The tide receded, and nothing could stop it.

Not that the company didn’t try. But its capacity to adapt to new realities was hindered by its own hectoring unions, rising fuel prices, mounting debt and a blizzard of mandates and restrictions imposed by federal regulators. Whatever the reason, the company could no longer deny reality, as much its stockholders, managers and even paid-for politicians would like it to be otherwise.

The blessed power of economic law! It operates without anyone pulling levers. It imposes itself, even against the determined will of the world’s princes and potentates. It is what keeps the world honest and truthful about what is and is not possible. It keeps the material world on track, so that fallible people cannot do stupid things forever. It’s no wonder the political class hates it.

As goes American Airlines, so goes the whole of Europe. A credit crunch not unlike what the U.S. faced in 2008 is now threatening the Continent. Banks are looking at their own portfolios of toxic government debt, and they are concerned about their own liquidity going forward. They have begun calling in loans and cutting credit lines, even from big players. This is starting to send the first signs of panic through the land. Given the U.S. precedent here, all stemming from the housing crisis, the problems can only get worse.

Think back to those days of 2008, when the reality began to surface, housing prices went into tailspin and Lehman fell. We had not seen a financial hysteria, on this level, in our lifetimes. The political class, the banking class and the financial pundit class all seemed to agree that if we let the credit crunch continue, the next step could be mass starvation.

Just look at the boats filled with goods that can’t even leave harbor because of cut credit lines! Look at Iceland, with its empty grocery-store shelves! Imagine a future in which people might have to actually save money to buy things, rather than relying on the fictitious prosperity as created by the fiat-money machine!

We could have gone one of two directions. We could have recognized that the failure of Lehman represented a reassertion of reality. We could have let the deleveraging continue, so that the signs of false prosperity could be washed from the system. We could have let housing prices fall to their market level, and let the same market have its way with banks and financial institutions that had built their houses on the sand of bad debt, rather than the hard rock of real savings.

But that is not what we did. The addiction to credit had been permitted to permeate too deeply, and hardly anyone could even imagine a world in detox. One in prosperity was rebuilt on real things and not illusions. So while even President Obama admitted the sheer size and scale of the financial bubble, no one in power had the guts to sit back and let the deleveraging take its toll. Had we done that, say many economists, we would already be back on the road to building a reality-based civilization.

Instead, what did we see? Many trillions in real resources were sucked out of the the private economy and dumped onto companies that should have but did not enter bankruptcy. Interest rates were driven down to zero and negative levels, a move designed to inspire borrowing but which only ended up punishing savings and guaranteeing that banks could no longer make a profit from its lending operations. (The grim details are all reported here.)

Three years later, what good did it do? The latest news on housing is rather devastating. Prices are still falling. Year-to-year unadjusted September prices declined 3.3% for the 10 major markets. The 20-city index dropped 3.6%, to levels not seen since 2003. Some commentators tried to find a silver lining, noting that the pace of falling prices has actually slowed.

Let’s just admit something: This is one of the most gigantic failures of Keynesian-style economic policy in human history. The central planners started with the theory that the whole mess was caused by falling housing prices, so clearly the fix was to bring them back up again. They pulled out every contraption in the grab bag of tricks but nothing worked. And why? It turns out that prices are determined by agreement between buyer and seller. The planners have a lot of power but not yet the ability to tap into our brains and force us to do stupid things like buy and sell at a loss.

Every new report on housing prices is like a stern rebuke to the Fed, the Treasury Department, to Congress and to two successive presidential administrations. There is nothing wrong with protesting their policies and lobbying against them, but in the end, nothing speaks as loudly and plainly to their failure than the dazzling and bracing forces of the price system and the balance sheet. This is where we find the undisputed speaker of truth in a world of lies.

If they had to do it again, would the establishment react differently? Probably not, because in the end, it really isn’t about creating or protecting the conditions of prosperity for the rest of us. It is about protecting their own power and the profits of their friends. We will soon see the whole scenario repeated against throughout Europe: hysteria followed by folly followed by failure.

This is why the bankruptcy of American is really an occasion to celebrate, not because a once-great company was taken down by stultifying regulations, union demands or poor management; rather, it is a victory for the forces of supply and demand, which, contrary to the claims of dictators from time immemorial, are the best friends that the common man ever had. It’s proof that the politicians only pretend to rule the world.


Jeffrey Tucker