Extraordinary Popular Debt

Debt was never meant to extend so far. But a little bit here and there quickly became a lot all over the place. As Bill Bonner explains, debt has taken a strong hold on a great number of people, and sets out to find the culprit.

Despite the Thatcher and Reagan revolutions…deficits still matter.

Consumer credit came into the world as a simple act of kindness:

“Don’t worry, Mrs. McMurphy, you can pay me next week.”

But consumer credit grew up and debt grew mean. As mentioned in this column previously, until 1980, total credit market debt in America never exceeded 130% of GDP. Now, it is more than 330%. (What happened in 1980? Ah, more about that below…) And derivative contracts, based on credit, have grown even faster. There are now $45 trillion worth of credit default swaps, for example, up nine-fold in the past three years.

So heavy is the burden of this debt that householders at the bottom of the financial pyramid are being crushed like Egyptian slaves. “Mortgage Meltdown,” is easily the most popular headline in the U.S. financial press. Under its banner, the Chicago Sun-Times reports that there is about one house in foreclosure on every block of the Windy City. What’s astonishing is that well-heeled areas are affected too – with foreclosures running 100% ahead of last year in one middle class neighborhood…and up 193% in an area thought to be ‘wealthy.’

What has happened? Credit, it turns out, soon reaches the point of diminishing returns. During the entire period up until 1980, it took about $1.40 worth of extra credit to produce a single extra dollar of GDP. Since then, the ratio has deteriorated…with recent figures showing as much as $7 in new credit per additional buck of output.

And now…we seem to have passed the top of the credit cycle – with the credit industry unwilling to pony up more cash…and output falling. John Crudele, perhaps jumping the gun, says the U.S. economy may already be in recession.

Who is the culprit? You could blame central bankers…or the City…or Gordon Brown and George W. Bush. Or, you could blame the entire human race.

Man cannot leave well enough alone, we conclude. He gets ahold of an idea and he cannot help himself. He takes it up clumsily, as he would a new wrench. Then he begins twisting it…hammering it…stretching it out…sharpening it…until he can use it to cut his own throat.

Every innovation turns against him. His television brings him reality shows. His automobiles lead him into traffic jams. And scarcely a single generation after he invented them, his airplanes are dropping bombs on London.

These credit mushrooms were no exception. They grew in a hothouse – nurtured by extraordinary popular delusions…fertilized by the rich manure of politics…and abundantly watered by liquidity from central banks. People ate them; their debts grew as large as their hallucinations.

Forget about the central banks; their role is so obvious. But think about the New Era that came in the 1980s – thanks to the revolutions wrought by Mrs. Thatcher and Mr. Reagan. They brought in a fresh idea – that capitalism could be unleashed…and that it would serve man as obediently as a cocker spaniel. We don’t dispute that there was some truth in it. But it wasn’t quite as true as people came to believe. Especially in its grotesque new form.

Where in capitalism is the idea that you can spend more than you earn? Where in the vision of Adam Smith is the idea that foreigners will subsidize your standard of living – indefinitely? Where in laissez-faire is the notion that central bankers will prevent corrections by controlling the price of money? What had happened to the old sturm and drang? Where was Schumpeter’s ‘creative destructive?’ The new capitalists offered creation without destruction… resurrection without crucifixion! They offered not only to hold harmless investors in the face of their own bad judgment…but to revive booms before they ever expired and to cut short corrections before anything has been corrected.

This was not the old capitalism of our grandfathers. The old-timers had been wary of it…they knew that the free market was dangerous and unpredictable. The old capitalism was a jungle…red in tooth and claw. You had to watch your back. This new capitalism was a zoo; all the dangerous beasts were supposed to be behind bars. It was almost too wonderful.

The culture of zoo-capitalism spread to all levels of society. At the top, such was faith in this new doctrine that tax rates were reduced…in the belief that more capitalism would enlarge the tax base (unfortunately, spending increased faster). But don’t worry, “Deficits don’t matter,” said Dick Cheney. In other words, our dynamic capitalistic economy will grow itself out of any problems. And at the bottom, too, people fell victim to the same delusion. Householders borrowed and spent money they hadn’t made yet. Why not? Their houses, their stocks and their incomes would always go up, wouldn’t they? And savings? Who needs savings when you live in the strongest, most flexible, most globalized, most technology-enhanced, most tax-enlightened economy in history?

That is the trouble with man. First, he does. Then he overdoes. His progress takes him backwards. Every blessing evolves into a curse…and every revolution leaves him mounting the scaffold.

Have a nice weekend,

Bill Bonner
The Daily Reckoning
December 7, 2007

We are on a plane again. This time, we are making our passage to India.

Johannesburg was more dynamic than we remembered from our visit last year. More shopping malls. More new restaurants. The place is booming.

“Yes it is very nice…very full of life,” says the pretty South African woman, now sitting to our left. “But crime hangs over your head all the time. You always have to be careful. That part of it is not so nice. I have never been a victim of it…but you are always reminded. You don’t walk down the street. You don’t leave the doors of your car unlocked. You always have security guards and electric fences.”

“Do you have a Plan B?” we wanted to know.

“Well, we’re leaving South Africa next year. I love the place. My family’s been there for hundreds of years. We’re Africaaners, not English…we feel we are part of the country. I had to learn English in school; almost no one spoke it in the town where I grew up. We feel it really is our country. And it’s beautiful. But my husband is a pilot. He’s 50 years old, so he was a pilot in the South African Air Force before the Blacks took over. So, they call him an ‘apartheid pilot.’ They’re trying to get rid of the ‘apartheid pilots’ and replace them with Blacks. The trouble is, there aren’t many qualified Black pilots…so they’re training them in Australia. But it takes years.

“My husband and the other ‘apartheid pilots’ are probably the best in the country. But they’ve got to leave to find work elsewhere. We’re going to China. A new airline is hiring a lot of them. Jade Airlines, I think it is called. We’re going to live in Shenzhen, China. It’s going to be very exciting. But I will miss South Africa.”

*** One thought has been lurking around: that this whole era marks the end of an era.

At a minimum, we suspect we’re coming to the end of the credit bubble…and an end to the asset speculation bubble it wrought. We’re probably coming to the end of the Dollar Era of the world monetary system. The American empire, too, seems to be peaking out; it is squandering its resources at such a rapid pace, it is hard to see where it will get the money to expand.

“We are all freakin’ doomed.” Our friend the Mogambo puts a fine point on it. But grosso modo, it seems that we are doomed in many ways…or one big way, depending on how you look at it.

One of the themes of these Daily Reckonings for the last eight years has been what might be called the ‘topping out’ of Western Civilization. Power and money is on the move, from West to East, like the South African pilot mentioned above.

“You wouldn’t believe it,” says a friend just returned from a visit to Shanghai. “The buildings…the people…it’s like a city from the future …and so incredibly big. It took my breath away.”

We feel it too…whenever we travel to the East. So many people…so much energy.

The West triumphed over the rest of the world only recently – in the 18th, 19th and 20th centuries. Before that, a person in India or China had about the same standard of living – or maybe higher – than a person in France or in Britain. But then, the West took off. What, exactly, was the source of the West’s success? No one knows. But one innovation was perhaps paramount – the West converted matter to energy…and back to matter again…at a much faster rate than ever before. In the East, only Japan was able to come even close – and not before U.S. warships showed the island nation how far behind the curve it had fallen. Then, after a breathtaking period of imitation and growth, in the early 20th century, Japan’s military machine was able to challenge the Russians, successfully, and the Americans, unsuccessfully.

Japan’s failure in WWII was largely a matter of energy. The United States had it in abundance. Japan barely had any at all. At the crucial battle of Leyte Gulf, Japan’s ships were practically immobilized by a lack of fuel.

Yes, dear reader, our civilization…and our hegemonic power…depends on energy. A colleague sent us a chart. It shows the connection between energy and GDP. The more energy you use, the higher the standard of living. Naturally, at the very top of the living standards is the United States of America…which is also at the very top of the world in energy consumption. That it is also on top of the world in terms of military power is, perhaps, no coincidence.

We showed this chart to our intrepid correspondent, Byron King.

“Hmmm,” he said. “Looks like if there’s no energy, there’s no GDP. Correlation is not always causality. But sometimes…wow.”

Of course, it makes sense. It takes energy to make things…to move them around…to farm…to manufacture…to cook …to travel. And to carry a big stick. We remember from our brief encounter with physics that the total of energy is constant…and that energy and matter are interchangeable. Oil is black goo. It exists as matter, which we transform into energy…and use the energy to transform other things into other kinds of matter – trucks and cars, for example. Then, we put more energy into our fuel tanks to move matter around.

We have no quarrel with this program. And it salves our conscience to know that we will leave the earth no worse off – in a purely energy sense. Somehow, there has to be as much energy when we shuffle off as when we came kicking and screaming in.

The problem is not at the macro-philosophical level. The problem is a practical one. People want more stuff. It takes energy – notably in the form of that black goo we mentioned above – to make stuff. So, they’re going to want more energy to make. That is, they’re going to require more energy to raise their standards of living.

Trouble is, the supply of oil is somewhat limited. It’s not as easy to produce new oil as it is to produce new dollars. So, you can expect the price to rise. Even in real terms, the price is likely to go up, simply because more and more people want it…and the easy goo, close to the surface, in hospitable regions, has already been burnt up.

Back to the chart. While the United States, Britain, France and other rich, developed countries are at the top – both in terms of GDP/capita and energy consumption/capita – down at the bottom are countries without much stuff – but with a lot of people. China, for example. It will take a lot of energy to push China from the bottom of the chart to the top of it. But that’s exactly where China aims to go. And from what we hear, she probably will get there…which means, the Chinese have to use a lot of energy that might otherwise be used by people in the rich nations. Barring some technological breakthrough, you’d expect that people in the rich nations are going to pay a lot more for each barrel of oil they use. But current standards of living depend on oil at $20 a barrel…maybe $40 a barrel…maybe even $80. At $200 a barrel, the stuff of civilization is much more expensive…and the cost of being on top of the world is higher. The cost of being rich is going up, in other words. Ceteris paribus, that means that the rich nations aren’t going to be as rich as they used to be. It also means that the cost of operating a military machine is increasing. The American military is the biggest consumer of oil in the world.

And one other thing. There are those who think that burning fossil fuel is already much more costly than we realize. The theory is this: along with all that potential energy, locked up in the black goo, was an ocean of carbon dioxide. When you convert that matter to energy, you can’t help but release the carbon dioxide, which then floats into the atmosphere. Al Gore says that humans have never lived in a world with so much carbon dioxide in the atmosphere. The last time there was so much was millions of years ago, when it was a very different world from the one we evolved in. According to Gore, we have inadvertently recreated the conditions of the dinosaur age. And as a consequence we are going to have to live through a period of severe climate change – to which we will have to adapt, at great expense – if we can adapt at all.

Whether this is true or not, we couldn’t say. It seems believable. But so many prestigious scientists, leading statesmen and university professors believe it…the idea must be bogus in some way.

The Daily Reckoning