An Even Better Trade of the Decade, Part II

Part II of our speech in Las Vegas, in which we explain why the US will go broke:

What does it mean when the financial intelligentsia seems to have no idea what is going on? It means they’ve got the wrong idea about the way things work…and probably no incentive to have the right one.

Goldman Sachs had 21 billion reasons to think it was a good idea to bail out AIG. The bankers who hold Greek debt have 146 billion reasons to like the bailout announced yesterday. And the US government has about 2 trillion reasons to believe the economy is growing.

[As we explained yesterday], there were 8,000 billion numbers between Hank Paulson’s estimate of how much taxpayers’ money would be put at risk rescuing Wall Street and the actual fact. But Hank Paulson is by no means the only major authority or financial celebrity to be wrong. The folks running money for Harvard and Yale – the crème de la crème of financial managers – were spectacularly wrong too.

And so were the people running major banks. But today I will mention just one of them…someone who had already settled up when the financial crisis of ’07-09 arrived. Walter Wriston was the Chairman of Citibank…the bank that eventually got taken over the federal government in the general panic of 2008…he remarked that:

“Governments can’t go broke.”

And here I’ll do a little speculation – I bet that Citibank would NOT have had to seek government support if it had been run by a historian.

Financial history is full of government bankruptcies. The first modern nation to go broke was Spain – which did so 4 times in the 16th century.

The book by Ken Rogoff and Carmen Reinhardt has a nice list of these state bankruptcies. You’ll see there are dozens of them. Some countries seem to be bankrupt all the time. Greece, for example. According to Rogoff and Reinhardt, Greece has been in default about every other year since it gained its independence in the 1820s.

And I’ll offer you a prediction, before this decade is over…or perhaps the next one…dozens of countries will go broke, including the United States of America.

I don’t mean they will close down and go out of business. But they will default on their debts – either by ceasing payment, by forced restructuring, or by intentional inflation.

How do I know that? Well, I don’t. It’s just a guess. And it’s a guess that comes from reading history…not from doing mathematics.

Generally, as I told an audience in India, we seem to be at some major inflation point. I call this period the Great Correction, because it appears that there are several things that are in the process…or perhaps only the very beginning…of being corrected.

1. There is the 50+ year credit expansion – centered in the US…largely a product of the modern, numbers-oriented way of looking at economics
2. There is the bull market in stocks, begun in 1982…correction began in 2000 and still is not fully realized. That bull market too owed a lot to modern financial thinking
3. There is the 28-year-old bull market in bonds, which apparently came to an end in the fall of 2008…but has not yet been completed. Again, this was made possible and sustained by the financial ideas of the mid-20th century
4. There is even a 400-year boom in Anglo-Saxon culture – backed by military and economic force – which may be beginning a correction too. And it wouldn’t surprise you to know that these new, modern financial theories are almost entirely the product of Anglo-Saxon academics…

All of these things are connected. The common thread is the 5th thing that needs to be corrected…and the thing I’m going to focus on here today. It’s the rise of a body of thought concerning the way the world works – at least the world of money – which began in England and then was developed in the United States…

…on Friday, I called it “Fab Finance” after the Frenchman who got charged with fraud by the SEC. The idea is to put together slimy packages of debt and sell them to people who don’t know what’s in them. “Lumps for Chumps,” you might call it.

Poor Fabulous Fab got stuck in the hot seat, but he was only following the logical development of a whole body of thinking that dates back almost 100 years….

…and which now seems to be leading the world to something much bigger and much more dangerous than just blowing up a few hedge funds and German banks…

Now, practically all the world’s countries are using Fab Finance. They’re gradually absorbing all the world’s financial risks and putting them on the public accounts…ultimately backed by the full faith and credit of the United States of America.

This year, governments around the globe will issue $4.5 trillion in debt – three times the average over the last 5 years. About $2 trillion of that will be issued by the US.

What’s more, there is NO EXIT from this debt build up. Only about 10% of these deficits is really caused by the financial downturn. Most of it is structural. That is, it is the result of programs that have been in place for years…

These programs just grow and grow…year after year…until they become unsupportable. And most of these programs are sold as Fab Finance…they transfer small, individual risks onto the balance sheet of the whole country.

In fact, if you had to sum up the entire effect of Fab Finance – the whole body of ideas and theories of modern, anglo-saxon economics in the 20th century – you could say that they took small problems and turned them into big ones.

Instead of running the risk that a few people will retire without sufficient funds, we now face the risk that the whole country will run out of money.

Instead of taking the risk that some people will not be able to afford health care, we now run the risk that the whole nation will be bankrupted by public health care costs.

Instead of allowing a few badly managed financial institutions to go under, the feds have put the entire credit of the United States of America at risk.

And in Europe, we see the same thing. Instead of allowing tiny little Greece to go bust, the Europeans are spreading the risks out all over the Eurozone.

I’m sure other speakers will talk about this, so I won’t go into details. It’s the most important economic event of our time. After a huge run up in debt in the private sector, now the public sector is having a go at it…and rolling it up into bigger and heavier balls.

And what happens when the government spends too much and borrows too much? History tells us what happened in the past. Philosophy tells us what should happen. Governments go broke. Always have. Always will.

But I’d like to share with you a headline from The Washington Post on Wednesday. The Post is the paper the politicians and bureaucrats read. So you can imagine how penetrating its insights are.

Well, the headline that made me laugh was this:

“Task force to tackle National Debt.”

Not many things are certain in this life. But I can guarantee you that the bipartisan task force will not get close enough to the National Debt to read the number on its jersey, let alone tackle it.

The Great Depression convinced economists that they needed to be more activist. Now, our economy is responding to economic activism. And it will be destroyed by these modern ideas…and then, and only then, will new ideas arise.

We’re going to see a correction…a regression to the mean of a number of things…including the way people think.

It is not normal to think you can spend your way out of debt.

It’s not normal to think you can consume capital and get richer.

It’s not normal to believe that central economic planning will make the world a better place. The Soviets proved that central planning doesn’t work. We got to see that experiment. But instead of learning from it…we seem destined to repeat it.

More tomorrow…


Bill Bonner
for The Daily Reckoning