There are many ways to tell the tale of the "Great Unwind." ‘We told you it would never work,’ say the old leftists. The system is broke, say the politicians; we’ll fix it. The press, meanwhile, is in full pursuit of desperadoes – Madoff…Wall Street…the bankers and their henchmen.
Here at The Daily Reckoning, we turn to Shakespeare for a more poetic view of the financial collapse: "Let Rome in Tiber melt, and the wide arch Of the ranged empire fall!"
So said Marc Antony as he drew the Queen of the Nile into his embrace. This is another way to look at the crisis of ’08. You begin by noticing that it is centered in just two countries – Britain and America. Not coincidentally, those two countries are the twin capitals of the world’s only surviving empire, an empire built on a foundation of industry, technology and trade…but lately richly redecorated in an elaborate rococo style of modern debt and finance.
Beginning in the 19th century, factories in England and New England transformed the value of a working man. Instead of being equal to his counterpart in China or India – as he had been for a thousand years – he suddenly was superior; he could produce more. By the 21st century, the average day laborer in Britain and America earned 10 to 20 times more than his confrere in Asia.
Of course, the English speakers had rivals. They were challenged by other Europeans…and the Japanese. All learned that the same machines that produced wealth could destroy it even faster. The Germans were particularly tenacious competitors. By 1910, their factory output was greater than that of the UK. By 1940, they were trying to blow up England’s factories. But England and America ganged up against them. In a couple costly wars in the first half of the 20th century, the Teuton threat was finally crushed.
By 1945, The Anglo-American empire had only one challenger still standing – the Union of Soviet Socialist Republics. Militarily, the USSR was a real menace. But commercially, it was no more than a comic footnote in economic history. At first, the weakness in the Soviet’s system was not obvious…especially not to economists. The figures – put out by the USSR – showed rapid growth. But nobody flew to Moscow to buy the latest fashions nor bragged about his Soviet auto. Nor did people hasten to open accounts in Russian banks or seek heart transplants in Soviet hospitals. The Soviets had managed to create a rare thing – a value-subtracting economy. They took valuable raw materials out of the ground and turned them into worthless finished products. If he had a choice, no one would buy soviet-made goods. Every sale made the seller poorer. And the longer this went on, the poorer the Russians got. Finally, the whole system caved in – in 1989, leaving the Anglo-Americans masters of earth, sky and the seven seas.
This next era, 1989-2007, was remarkably pleasing to almost everyone. Even former enemies rushed to stock the empire’s shelves and lend it money.
Overstretched, over-indebted and over-there… it had military bases all over the world. No swallow could fall nowhere in the world without it being captured and interrogated by the Pentagon or its proxies. Back in the homeland, the imperial race went a little mad. People spent too much money…distracted themselves with bread and circuses…and flattered themselves with delusions of mediocrity. It seemed perfectly normal to them that they consumed while the foreigners produced…and that they spent what the foreigners saved. Central banks encouraged the plebes to consume; the more they consumed, the poorer they got, but as long as they had someone else’s money to spend, they didn’t complain. The imperial youth studied gender sensitivity at school; rivals studied engineering. And as for the foreigners themselves, like gigolos complimenting an aging heiress, they barely suppressed a snicker: "Your hair is beautiful," they remarked. "Have another drink of sherry." And while the poor woman admired herself in the mirror, they rewrote her will.
Soon, competitors had more modern factories, more savings, better-trained workers – as well as lower costs. Then, the empire turned to a colossal conceit; that it could make its way in the world by financing things, rather than making them. Gradually, the Anglo Americans developed a value-subtracting society too – financing, derivatizing, borrowing, flipping, consuming – all at the expense of real production. Russians recognized the symptoms: the leadership was largely delusional, industrial capacity was largely archaic and dysfunctional, and the working class was largely broke.
The old Bolsheviks recognized the rot too. What the Romans called "consuetude fraudium" became business as usual…in the Soviet Union…and then in England and America. By 2006, practically every transaction was tainted with swindle. Banks sold each other packages of scammy debt, composed of mortgage contracts on houses sold to people who couldn’t afford them, fraudulently rated Triple A by the rating agencies, based on quack formulae invented by Nobel-prizing winning economists. This took place in a party atmosphere created by central bankers, who had put something in the water; they spiked the entire economy by under-pricing credit and then urged consumers to drink up, by buying SUVs (Fed governor Tier, 2002) and using sub-prime loans (Fed chairman Greenspan, 2005). The Russians would recognize the next stage too. After the collapse, the ruins are liquidated, picked over, and parceled out to the politically well-connected.
"Kingdoms are of clay," said Antony, before killing himself.
The Daily Reckoning
December 30, 2008 — Ouzilly, France
Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of the national best sellers Financial Reckoning Day: Surviving the Soft Depression of the 21st Century and Empire of Debt: The Rise of an Epic Financial Crisis.
Bill’s latest book, Mobs, Messiahs and Markets: Surviving the Public Spectacle in Finance and Politics, written with co-author Lila Rajiva, is available now.
"What an awful year. And 2009 doesn’t look like it’s going to be any better."
Our neighbor, Pierre, was describing the state of the agricultural industry in Europe…and, indirectly, why he couldn’t pay the rent. He leases some land from us at a price of about $150 per acre. He’s now far behind on his rent payments. Elizabeth had asked for a meeting to try to collect. Your editor sat off to the side, listening.
"Of course, I’d like to pay," Pierre explained. "And I’m sorry I’m so far behind. But this is just a terrible time for us. I have to feed the cows. That’s the first priority. I have to feed them…and buy medicines and fertilizers…even though nobody is buying them. The meter turns over pretty fast – even though I’m not going anywhere. I’m not a meat producer. I’m a breeder. We’ve been breeding Limousine cattle here for more than a hundred years. These cows can trace their ancestry better than most people. But when farm prices fall, people stop investing in the quality of their herds.
"Normally, I sell about 20 top breeding bulls per year. This year, I’ve sold 5. There are many people who want to buy, but they don’t have any money. They don’t have any money because they can’t get good prices for their cows…and can’t get credit from the bank. So they don’t buy my bulls…so I can’t pay you."
"Well, the publishing business is no picnic either," Elizabeth replied. "Your customers don’t have any money…you don’t have any money…and now I don’t have any money either," she added with a laugh.
We wondered how many conversations like this were taking place all over the world. The world’s money machine has broken down.
Yesterday, the Dow fell 31 points. Oil rose to $40. The dollar held steady at $1.40 to the euro. Gold rose $4 – giving it a nice gain of about 6% for the year.
Everything else is losing money. This will go down in history as the worst year for investors of all time. Oil, copper, and most financial stocks are down 2/3 from their highs. Stock markets generally are down 40% to 60% all over the world. Housing markets are down in most places too – with prices in Britain and America off about 20%.
Bloomberg reports that holiday sales were so bad it will "force store closings, bankruptcies."
And USA Today reports that global trade is expected to shrink by 2% in ’09, after rising at nearly 10% per year for the last decade. Smoot? Hawley? Who needs those knuckleheads? Global trade is collapsing without trade barriers. Because Americans aren’t buying.
And here, we can trace the breakdown in the entire world money machine…from the pistons that don’t fire to the crankshaft that doesn’t turn. Like the farming business in France, one man doesn’t have any money…so the next man is a little short…and so on all up and down the line.
And here, for the benefit of new readers, we offer a simple schema of the machinery of the Bubble Epoch: Americans bought stuff from the Chinese. The Chinese printed up yuan to buy dollars from Chinese merchants. Then, the nice Chinese financial authorities lent the money back to America. What else could they do with it?
So, you see, everyone had plenty of money. And the more Americans bought…the more money they had to spend. And the more they spent, the more the Chinese had to lend!
Of course, it didn’t take a genius to see that a system that depended on people buying things they didn’t need with money they didn’t really have couldn’t last long. In the event, it lasted longer than we expected. But still, not forever.
It broke down under the strain of its own absurdity.
But wait a minute. How come all of a sudden Americans don’t have any money? Won’t anyone lend any money to them? And why not?
Oh dear reader, throw us a bone!
The financial authorities are clumsily turning screws and tightening valves. They think they can fix the machine by simply getting more credit into consumers’ hands. But this machine is not that simple. In fact, it’s not a machine at all…but a living, organic thing. It has emotions as well as a brain. It is capable of self-delusion, deceit, corruption, wishful thinking, and extravagance.
Investors, businessmen, householders and consumers are all now reacting to the madness of the Bubble Epoch. They lent, spent, speculated and borrowed wildly – as if there were no tomorrow. Now, every day is tomorrow. And they’re afraid. After the sub-prime bubble popped, all the bubble delusions began to fall from their eyes. While once they looked through the glass rosily, not they look darkly:
Wall Street was not making them rich, after all – it was ripping them off! Houses didn’t go up forever – sometimes they went down! Things didn’t get better and better all the time; often, they got worse! Prominent analysts and economists often have no idea what they’re talking about! Alan Greenspan wasn’t such a genius after all!
Suddenly, they looked at their balance sheets and realized that they were in danger. Investors have lost half their money in 2008. Homeowners have lost about $4 trillion in America alone. They read the news. They talk. They know the whole thing is imploding. How are they going to pay their bills? How are they going to keep up their standards of living? How are they going to be able to retire?
Instinctively, reflexively, they cut back their spending. And when the pistons stop pumping, the drive shaft stops spinning, and the wheels stop turning. Americans don’t go to the stores, the stores don’t order more stuff, the ships don’t bring more stuff, the Chinese merchants don’t make money, the Chinese central bank doesn’t have to buy it from them, and then the Chinese have less money to lend back to Americans – who aren’t borrowing in any case.
The machine is busted. It can’t be fixed.
*** "The Undeniable Shift to Keynes," begins a piece in the Financial Times.
Why the shift? Because Friedman has let us down. The Fed kept the supply of money and credit fairly constant, just as it was supposed to. Then, when credit got tight, it cut rates…all the way down to zero, just as it was supposed to.
Did that solve the problem? Nope. Because the economy is not a simple machine. It’s a complex, organic system. It cannot be controlled. It can only be survived. Tolerated. Enjoyed.
Let’s imagine that the Fed’s key lending rate was zero all year long. Even so, if you’d borrowed money directly from the Fed and used it to buy stocks, your rate of return would be about MINUS 50%. Or suppose you bought a house with a zero-interest mortgage? Your rate of return would be about MINUS 20%. Or, it could have been worse. You might have invested your money with Bernie Madoff, in which case your rate of return would be MINUS 100%.
What business…what investment…what durable consumer item is worth borrowing for under those conditions? Not many.
Besides, once the Fed gives away money at zero interest, what more can it do? Well, it still has some tricks up its sleeve, but its main monetary tool is worthless. It can’t cut rates further.
So, it turns to another great economist – Keynes. Instead of colluding to fix the price of money, Keynes said governments should make up for the lack of private spending with public spending. That is, instead of allowing consumers to use their resources as they wished, politicians should divert resources to their own pet projects. In its idealized form, if the private sector found no use for a working man, for example, the feds should put him to work on some socially-useful project – such as building a bridge or picking up trash.
Of course, if there are idle hands in an economy it’s because the feds have already distorted it. Typically, various government rules and safety nets make it difficult to adjust the price of labor downwards. So, when prices fall, labor rates become disproportionately high. Who’s going to pay a man $25 to make a gadget that sells for $15? No one. That is what causes unemployment. But rather than allow labor prices to fall, Keynes came up with a trick. Government should spend money, thus causing inflation. The rising prices will make labor seem relatively affordable again.
But like all the tricks and quick-fixes in economics, Keynesianism causes more problems than it solves. Governments rarely have any genuine savings. So, in order to spend, they either have to take money away from other spenders …or print it up. If they take it from other uses, the net gain, in theory, is zero. In practice, it is much less than zero, since most government spending is wasted. If it prints up the money, on the other hand, the inflationary effect is much greater…and ultimately ruinous. As we shall see…as the reckoning continues.