10/30/09 Gualfin, Argentina – Regular readers of this space will recognize this as the third in a series. Irregular readers will not recognize it at all. They will look at us as though we had come from Mars. Earthlings are all convinced that a financial crisis of cosmic proportions befell the planet last fall. Had the authorities failed to act with determination and speed, it would have been the end of the world. In the popular mind the politicians have saved capitalism from its own excesses.
Our views are different, but not extra-terrestrial. Once upon a time, not so long ago, they were even respectable. The gist of our message two weeks ago was that debt is dangerous. It feels good at first. But give a society too much debt – either in its private sector or the public sphere – and someone’s going to get killed. That’s why the present situation is such a delight to serious economists; it offers more data points. We get to see how much straw the feds can add before the poor camel’s back breaks.
What’s the best way to get through a debt crisis? Straight through was our advice last week. For at least a thousand years, the business cycle went round and round without help from central bankers or economists. It is only since these geniuses have been on the case that really serious problems have arisen. The Panic of 1920 – in which the US government did nothing but cut taxes and spending – was quickly forgotten. The Panic of 1929, on the other hand, was followed by massive rigging and jiving by the authorities. It took 20 years and a world war to overcome; today it is still remembered today as the Great Depression.
Martin Wolf, speaking, gravely, for the world’s intelligentsia in The Financial Times last week, proclaimed that: “the only thing worse than rescuing the system would have been not rescuing it.” But he is wrong; of all the many blessings economists may bestow upon a grateful people, improving the economy is not one of them. An economy is a natural thing. It can be improved by the striving of entrepreneurs, the prudence of bankers, and the sweating of field hands. But when it comes to the macro-economic policy, forbearance is the quality that pays. Any initiative on the feds’ part inevitably makes things worse.
The Bubble Era, like the Great Depression, was largely –but not completely – the result of government initiative. Artificially low interest rates – intended to counter the modest downturn of 2001 – sent the wrong message. Consumers – notably those in Britain and America – bought things they couldn’t afford. Producers – notably those in Asia – made things for which there was no real market. Debt piled up. Mountains of it.
As consumers bought more and producers made more the economy grew. But much of the economic “growth” of the 2001-2007 period was fraudulent. It was based on debt spending, not on genuine increases in purchasing power. Debt pretends to be real money. It looks like the real thing, but it is not. It stimulates the economy like counterfeit money. It causes production and consumption, but of the wrong sort. Former Reagan era Office of Management and Budget director David Stockman estimates the level of “counterfeit GDP” at $4 trillion in the US alone.
The fraud was discovered, though misunderstood, when sub-prime debt began to implode. The economy had been kissed hard; millions of houses had been built, bought and sold. Now, owners couldn’t pay for them. All of sudden, the counterfeit money began to shrivel up. Lenders, investors, and householders all began to de-leverage; paying down the debts as fast as they could, defaulting on those they couldn’t.
Rather than come to the obvious conclusion, that they should never have meddled with the economy in the first place, the feds began rescue operations on a breathtaking scale. The British government increased spending to 140% of revenues. America now runs a stimulus program nearly equivalent, in economic impact, to WWII. Not since 1945 have the two pages of its ledgers – debits and credits – told such different stories, with almost $2 of spending for ever $1 in tax receipts. Britain will add almost 50% to its government debt in the next three years. David Stockman expects the publicly held US national debt to almost double in the next five years.
Even at those levels, many economists think the government should do more. Nobel Prize winner, Paul Krugman is one. Richard Koo is another. They’ve warned that the US (and by extension much of the rest of the world) could suffer a Lost Decade, like Japan, if the government slacks off before consumers have finished de-leveraging. At least they understand what is going on. Too bad they missed the point of it. The problem is too much debt, not too little spending. Leveraging up the public sector doesn’t help. Even government debts must be paid – if not by the borrower, then by the lender. The feds are smooching more ardently than any debt lover in history; next, we get to see who dies…or at least who defaults.
Until next time,
Bill Bonner,
for The Daily Reckoning
Bill Bonner
Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind The Daily Reckoning. Dice Have No Memory: Big Bets & Bad Economics from Paris to the Pampas, the newest book from Bill Bonner, is the definitive compendium of Bill’s daily reckonings from more than a decade: 1999-2010.
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I’m happy for BONNER if he truly thinks this is just a big miscalculation. I doubt he does. Keep your eyes peeled as this monumental crisis unfolds. After all of the pain and misery, the answer to our problems is going to be increased standarization and centralization.
No, what this essay is saying is that the government is going to shoulder a ton of debt to allow the economy to continue while the private sector deleverages. So, the government hopes to alleviate unemployment, a drop in equity investments and other consequences of the lack of consumer spending by itself into oblivion. And, we have yet to see the ultimate result–will the government give up and allow nature to run its course at some point? Will the government continue to stimulate until it drowns in debt? Will bondholders at some point cut up our national credit card? Or will the US just default on all of it?
Bill:
Economies are dynamic; so is stupidity. Just as there is a natural tension between supply and demand, creativity and destruction, so too in whom society appoints to be the agents of idiocy. One of the things this crisis showed, I think, is that if you just stand back and let people engage in commerce, pursuing their own self-interest and don’t set up a regulatory and corporate governance framework to properly align incentives, bad things happen. What we may someday see is that democracy and the politicians are not the best means of designing a good incentive scheme, not only because most congressmen are stupid and morally vacuous, but also because they are properly responding to their own, already existing incentive system, in the form of campaign contributions and lobbyists. So the irony is that society keeps lurching back and forth between different agent-principal problems: managers fail shareholders, and then the government fails them, and everybody else.
Cheers!
The path to a default of US Gov. isn´t in the long term, next year we will see another wave of foreclosures in Alt-A mortgage sector. That will cause the financial black hole swallow the big banks like Wells Fargo, and will ignite the meltdown of the world financial sistem. Then US economy will be wiped out.
Bill: But how much of the debt is owed to Martians and other extra-terrestrials??
And how much was actually borrowed from unborn earthlings?
Did the earth as a whole, really consume more than it produced?
What are the implications of the answers to these questions?
I love capitalism. It cost a lot of money it save capitalism from destroying itself. But considering the alternative, its well worth it.
Scott, I recommend you go to charles hugh smith, oftwominds website, he has a great piece today on how the govt is turning into a giant Kleptocracy and as it grows more and more desperate for money, it is using harsh police state tactics to extract fees and fines from citizens.
As one who had lived through the miseries of Soviet “liberation” in 1945, a hyper-inflation in 1945-46, communist dominated socialism (as opposed to the West European falvor) and voted with my feet in 1956, I think a collaps will be serious, painful but not the end of the world. The USA will have to relearn to be self sufficient, to create wealth instead of phony wealth in fiat money and to be more prudent with her military power. The “tuition fee” the best teacher, whose name is NEED, demands will be high but we’ll survive it (unless we tear each other to pieces in the process).
Mr. Bonner,
Seldom explored in discussions of our present debt splurge and government’s response to solve all our fiscal problems, is the effect of government’s actions upon its citizens.
Specifically, its senior citizens.
Presently, yours truly has reached the magnificent age of 78 years with a plan to fund a prosperous retirement through a successful series of working, saving, investing and living underneath our means.
Now that we are largely income investors, we are treated, once again, to Federal Reserve interest rate policies of low to nonexistent return on our carefully nurtured savings.
It seems that government is once again more interested in saving an economy of spenders than encouraging its citizens to build a productive pool of savings from which a healthy economy can emerge and a stronger society prosper as a result.
Finally, is this the scourge of democracy? Where a nonproductive society votes for benefits they have not earned—only achieved through the fraudulent use of the ballot box?
Best regards and thank you for your brilliant and insightful essays.
Bruce Hemmings—Modesto, California
No, no one is saving capitalism from itself.
No, we do not need more regulation on anything. We have laws.
We have not had capitalism but a command economy with the FED dictating the price of our most precious commodity. Money.
We have not had capitalism with the Banks able to print money through the ‘Fractional Banking System’. Fiat money, not tied to anything.
No, we have not had capitalism when fraud is sanctioned & mandated by the governments forcing banks to lend to people that WILL NOT pay. 8 million times, 5+ trillion dollars worth.
No, we’re on the edge of an abyss. The ‘Derivatives’ Market this week is 544 trillion dollars. How did this get up there ?
“The economy had been kissed hard…”
_______________________________________
and she’s not responding well
Joe….The bankers lobbied for deregulation and they got what they wished for. Free and unfettered they made huge bets on bank loans to people who didn’t have the means to make their payments. Bankers were blinded by their own greed.
The moral of the story, capitalist don`t know what`s good for them. What is good for capitalism is not always good for everything else or even themselves. They have no vision. No master plan. Just next quarters earnings, which are getting increasing more difficult to sustain.
You can blame the rest of the world for that as well.
When the US consumer stops spending, the whole world stops spinning, it seems.
What has been spending in the red for the average American since the 70s wasn’t going to happen forever and the Chinese will eventually get tired of welfaring (paying us to buy their stuff) us as well.
Unfortunately, the rest of the world watches idly.
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It seems that government is once again more interested in saving an economy of spenders than encouraging its citizens to build a productive pool of savings from which a healthy economy can emerge and a stronger society prosper as a result.
I don’t think I can get through another day without Bonner’s commentary! I hope he didn’t escape to a secret bunker with Mr. Mogambo!
Think of the interest on that government debt and think of the taxes to be paid just to cover interest. Then think of the opportunity foregone by all that spending on bad debt acquisition.
The only consolation is that the US – and then the world – has probably avoided deflation. That bogey must have worried Bernanke a lot more than he has publicly admitted.