Fake Fixes for the Real US Debt Problem

Not much market movement yesterday. Dow basically flat. Gold rose $30. Gold investors don’t seem to be able to decide. Is the economy good for gold…or bad?

Here’s our opinion: This is a good time to own gold. But it won’t seem like a good time. Not now. Because the Great Correction just gets worse and worse. And as the correction bites the economy, the dollar goes up against almost everything.

“Gold is not going down,” says David Rosenberg. But we’re not so sure. Gold investors bought gold to protect themselves against the dollar. But in the short and medium term, they won’t need protection against the dollar. They’ll need protection against everything else! They’re likely to be disappointed with gold and drop it as this period of de-leveraging drags on.

Yesterday, we promised to explain what was really behind what Tyler Cowen calls “The Great Stagnation.” We haven’t forgotten. We’ll come back to it. Just hold on.

First, let’s look at how this world economy is slipping into a worldwide depression.

Just check out the container shipping volumes at California ports. They’re down nearly 10% from a year ago. That’s a big drop in world trade. What happened? Did Americans finally get enough gadgets and gizmos from Asia? And what does it mean for the Asian exporters? Their economies depend on buying from overseas. They’re export economies. Of course, it is true that local demand is increasing. Eventually they’ll adjust to fewer exports and more domestic consumption. But adjustments take time…and are usually linked to major financial crises. What will happen?

Here’s an answer from Britain’s Telegraph newspaper:

China ‘faces subprime credit bubble crisis’

Monetary tightening in China threatens to pop the $1.7 trillion (£1.07 trillion) credit bubble in local government finance and expose the country’s simmering “subprime” crisis, according to the Communist Party’s economic guru.

Mr. Cheng said China is entering a “very tough period” as growth runs into the inflation buffers, threatening the sort of incipient stagflation seen in the West in the 1970s and leaving the central bank with an unpleasant choice.

“The tightening policy is creating a lot of difficulties for local governments trying to repay debt, and is causing defaults,” he told a meeting at the World Economic Forum in Dalian. “Our version of subprime in the US is lending to local authorities and the government is taking this very seriously.”

“Everybody assumes that they will be bailed out by the central government if they default, but I disagree with this. It means that the people will ultimately pay the bill for it all, at a cost to the broader welfare.”

Meanwhile, in Europe, Italy got downgraded by S&P. Angela Merkel lost a critical vote. And Greek bankruptcy is right around the corner.

And back in the US the typical American is suffering. He had equity of 61% in his house back in 2001. Now, he’s got a paltry 38%. And he’s lucky to have that. There are 11 million homeowners who have less than zero equity. They’re ‘under water’ and still sinking.

One in four young people is jobless…with sentiment among the youth at a record low. The old people may be optimistic, but not the young.

And 15% of the population — a record number — is now below the poverty line. That’s 46.2 million people living in poverty in the richest nation on earth.

But don’t worry, dear reader, president Obama is on the case. He says he has a solution to the US debt problem. He says he’ll cut expenses and raise revenue. Why didn’t we think of that!

A quarter of the cuts are supposed to come from the military budget. But they’re totally fraudulent. The feds don’t really know how much their wars will cost. So when they talk about ‘cuts’ and ‘savings’ they are talking about reductions in projected costs, not real costs. They’re made-up numbers, in other words. Even they admit that the savings are “illustrative” — rather than real. And there’s no way these illustrative savings will turn real — not as long as America stays on the imperial path.

Obama also wants the rich to pay more in taxes. Heck, Warren Buffett is on board. And so are most of the voters.

Of course, most of the voters don’t pay taxes at all! Not net. About half of the people eligible to vote get more from the feds than they pay in taxes. That leaves the “rich” shouldering an outsize burden. Already, the top 1% pays 30% of the taxes.

But if you’re rich, don’t expect any sympathy from us or anyone else. The rich have rigged the system in their favor. Everyone else has gotten poorer while they’ve gotten richer. Voters will be happy to soak the rich. Heck, they’d drown them if they could get away with it.

But let’s go back to the big picture. Tyler Cowen thinks the US enjoyed the low-hanging fruit. Fertile farmland, cheap energy, abundant water, easy credit…getting rich was a piece of cake.

He mentions too that investments in health care and education seem to have reached points of diminishing returns. The US spends far more on both than other countries…and gets no extra benefit. Our schools are not better. And Americans don’t live as long as people who spend only half as much on health care.

Can we fix this problem, asks Mr. Cowen? Wasting no time answering his own question, he responds that we just need to boost the prestige of scientists…and count on human ingenuity and innovation to come up with a solution. Heck, even Thomas Friedman could have come up with that! In other words, he thinks the system can heal itself.

But the real problem is not a ‘low hanging fruit’ problem. It’s a declining marginal utility problem. And a zombie problem.

As a society ages its institutions become brittle and inefficient. They are no longer dynamic and productive. And, they become nests for dead-head zombies. The two things go hand in hand. On the one hand, declining marginal utility undermines the productivity of future inputs. And the zombies take over…making it impossible to direct inputs elsewhere. The zombies protect their turf; they make sure they get more resources, not less.

Take education, for example. A little of it goes a long way. When a person learns to read and write, the whole world of ideas and information opens up to him. Whether more inputs of formal education actually pay off or not is open to question. Clearly, beyond some point, they don’t. Americans spend twice as much per student as they did 40 years ago. The educational attainment results are about the same. Which suggests that the marginal utility of investment in the education industry declined to zero 4 decades ago.

Most the world’s great ideas…great books…and great inventions were produced by people who spent relatively little time in formal school settings. But now, every goofball and half-wit is expected to have a college degree. What do you expect? A college degree isn’t really worth very much.

But the zombies want their children to go to college. And the zombies want cushy jobs as ‘educators’ and educational administrators. (They don’t want to teach…that’s too hard!) And children are no dopes either; they know it’s a lot more fun to spend 4 years at Party U., at someone else’s expense, than 4 years out in the real world. Especially now, when it’s hard to get a job. That’s part of the reason student loans have quadrupled since ’07.

Obama promised to bring ‘change’ to the nation. But change is the last thing the zombies want. And it’s the last thing that Obama would want to give. The voters wouldn’t stand for it.

Instead, we have a Great Stagnation…an economic deadend…where further inputs into traditional, zombie-controlled institutions no longer pay. More credit? More military spending? More Medicaid? More Social Security? More education? More consumer spending? More hiring? More capital investment? More energy consumption? More programs? More unemployment compensation? More taxes? More laws? More regulations? More lawyers? More educators? More security guards?

Will they pay off?

Not a chance.

Tune into tomorrow to find out how to really fix the problem.


Bill Bonner,
for The Daily Reckoning

The Daily Reckoning