07/19/10 Normandy, France – On Friday, everything went down. Well, almost everything. The Dow fell 261 points. Gold dropped $22. Copper. Oil. The dollar. You name it; it went down.
Unless you name US Treasury bonds – which were up!
What does this mean? Maybe nothing. But since it accords with the direction we think the markets ought to be taking, we’ll say it’s a trend. It’s a Great Correction. Asset prices go down. Cash goes up.
Let’s go back and see where we’ve come from. Then, maybe we’ll see more clearly where we’re going.
In 1999, the US stock market – led by the NASDAQ – clearly topped out. The bubble in the tech sector blew up. Equities started down.
This happened after 50 years of credit expansion. And after much of the “growth” in the economy had begun to look suspiciously like borrowing from the future rather than real growth, debt in the private sector had reached record levels.
It was time for a bear market/credit contraction. That is, it was time for a correction.
The correction began in January 2000. The NASDAQ collapsed. And in 2001, the economy entered a recession.
But this recession was phony. Consumer spending didn’t go down; it went up. Consumers kept borrowing money. It wasn’t correcting the debt problem, in other words, it was making it worse.
Why? Who knows? Maybe the consumer wasn’t ready for a correction. Or, perhaps it was because the feds began the biggest countercyclical stimulus program in history. The prime interest rate was dropped to below the rate of consumer price inflation. The federal budget went from about $300 billion in surplus to $500 billion in deficit (from memory).
For the rest of the decade, the big banks could borrow at less than the inflation rate. And the deficits averaged about $1 trillion every two years.
The correction of 2001 had been held up and made much worse by the feds’ efforts to stop it. At least $10 trillion of additional debt was added to the system in the decade of the ’00s.
And guess what? It was soon the Bubble Époque!
Stocks boomed. Spending boomed. Real estate boomed. Finance in all its formed boomed.
Growth was positive. But it was phony. Because it was almost all based on debt. It was a debt-fueled bubble – particularly in real estate.
If you take on debt in order to expand production, the extra output can make it possible to pay off the debt later, and you come out ahead. But when you borrow to increase consumption, all you’re doing is taking output from the future and consuming it now. You’ll have to settle up later – by taking your future output and using it to pay off your debt. Then, you’re no longer borrowing from the future; you’re paying off the past. And nobody likes it very much. Because it means living below your means rather than above them.
The bill came due in 2007. Subprime crashed. Then, the whole financial sector crashed, followed by the economy itself.
There are a number of ways to look at it, but we think it is most accurate to look at 2000 as the beginning of the present correction. That’s when stocks hit their peak in real terms. Since then, stocks have gone nowhere. And probably 90% of the “growth” since then was phony. Certainly, the average person did not get richer; he got poorer.
But having learned nothing in the ’00s, the feds set to work in ’08-’09 repeating and magnifying their mistakes. Instead of running $500 billion deficits, they ran deficits of $1.5 trillion. Instead of dropping rates below inflation, they took them down as far as they could go – to effectively zero. In addition, they nationalized whole industries, bailed out big businesses, and proceeded to add immense new financial obligations that nobody really understood.
You have to hand it to the Obama administration. We didn’t think anyone could be worse than Bill Clinton’s bunch…but then along came George W. Bush. In comparison, Clinton seemed like a great president. And then, just when we thought we’d seen the worst administration ever, here comes Barack Obama and his team. Obama has continued all of Bush’s programs (save torturing people). The war in Iraq continues. The war in Afghanistan continues. And the war on the correction continues. And Obama even added a new front – a health care initiative that is almost sure to be a financial and administrative disaster.
Not that we’re complaining. To the contrary, we find it all very entertaining. But we don’t think people are going to like the consequences.
The economy has been trying to correct since 1999. Every effort to stop it merely increases the size of the eventual correction. In round numbers, the US economy currently has debt equal to 350% of GDP. It averaged about half that much in the ’50-’80 period. If it were to go back to that level, it would have to eliminate about $25 trillion in debt. According to the last number we saw, the private sector was currently writing off, defaulting on, or paying down about $2 trillion per year. Not bad. But that would mean another 12 years of correction.
It would go a lot faster. But, remember, the government is helping.
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.
The Daily Reckoning is your premier source for making sense of the news Washington and Wall Street generate. Each business day, The Daily Reckoning calls on its stable of world-class writers and thinkers to show you how to get ahead.
Start your 100% FREE subscription to The Daily Reckoning today and you’ll get a free research report, “How to Survive the Fall of Social Security.” Simply enter your email address below to get your free report and join over 495,000 worldwide Daily Reckoning subscribers!
We Respect Your Privacy and We will
Never Share or Sell Your Email Address
indonesian citizen obama has not stopped the torture program – he is as evil as his predecessor.
Kenyan citizen.
Obama is torturing all of us.
Herr Bonner:
2 $Trillion/year provides 0.5$T more black ink than the feds’ 1.5 $Trill predicted anuual overdraft. Throw in the handouts that foreign central banks use to maintain their dollar pegs and this could go on a lot longer than 10 years.
Austrian economics is always corect, but your application of it in terms of government spending at all levels may be incomplete.
Non-financial debt destruction is new found cash flow for the feds. It obviously wasn’t there for their taking in the 00′s, when private debt was going through the roof. It is now.
Minimizing what Obama is doing in Iraq has nothing to do with your main point and reveals that your article as a whole is suspect because it is designed to bolster your political views, not on economic logic.
Not sure what your actual point is about the comparison of consumer debt to the national debt and annual federal budget deficits. So I assume since you crave the good old 50′s to the 80′s you are for huge tax increases on the wealthy? The top marginal rate during that entire 3 decade period never dropped below 70%, of course the federal budget was balanced. Not sure what that has to do with consumer credit card habits though.