Increasing Government Debt to Produce Economic Growth

Is the Great Correction over? Not quite!

Nothing much in the markets yesterday. Dow and gold both essentially flat.

So, let’s rehearse what we’ve learned so far.

Government’s main business is protection. Always and everywhere, its chief responsibility is the security of the nation’s borders and the safety of its own officers. As a secondary matter, it is concerned with the protection of the people it governs.

Of course, it protects, first and foremost, the interests of the people who control it.

A modern democracy is controlled by competing groups. In a combination of larceny and bribery, almost everyone gets something. Elite and powerful groups get a lot. The less powerful masses get a little.

In the crisis of ’07-’09, for example, government moved fast to protect elite interests – with trillion-dollar transfers to the banks and their bondholders.

Then, as the economy weakened, the masses of voters needed bribes too – food-stamps, unemployment relief, shovel-ready jobs, etc.

These measures do not produce genuine prosperity. How could they? They are just boondoggles and bailouts. But they give the appearance of stability and they help keep everything under control.

But how can the feds pay for all this larceny and bribery? They have to borrow…effectively shifting the cost to the next generation. Debts are incurred now. Money is spent now. It is meant to be repaid sometime in the future, by people who benefit from neither the bribes nor the thefts.

The private sector unloaded debt as quickly as it could in ’08 and ’09. Savings rates went from 2% of disposable income to 7%. We called it a “Great Correction.”

But now the process of correcting seems to have stalled. While the private sector threw off debt, the public sector picked it up. And now, it looks like the private economy is beginning to borrow again too.

Savings rates have fallen back to around 5%. Credit card debt has increased for the first time since the crisis began. Non-revolving credit is reported to be at a record high.

Government debt, meanwhile, is soaring. The US deficit last year was greater than all the money borrowed by the US government from its founding until 1986. And the Obama administration will borrow more than all previous administrations put together.

Is the Great Correction over?

Where will this end? Bankruptcy? Hyperinflation? Or revolution?

Maybe all of the above.

But wait. What if the peoples’ representatives “see the light”? What if they turn the situation around, forcing the US government to de-leverage along with the private sector?

Well, anything is possible. But we wouldn’t count on it.

Meanwhile, there’s another part to our hypothesis. Over time, stable societies become more and more rigid as elites get a tighter grip on them. They become “zombified,” with more and more of the society dependent on giveaways, bribes, boondoggles, protected markets and redistributed income. In a democracy, that means that the numbers begin to work against evolution. Against change. Against natural correction.

More and voters get more from the government than they pay for it. They will not permit any change to the system, because any change would be harmful to them.

So, over time, governments become less and less able to produce wealth…less dynamic…less responsive to evolutionary adjustment.

How does that work, exactly?

Well, it works in many, many different ways. But here’s a simple example. If the crisis of ’07- ’09 had happened back in the 19th century the big banks involved would have gone broke. Not only that, the bankers involved would have lost everything – including their personal mansions in the Hamptons. Because back then, typically, a banker was personally responsible for his losses. Neither banks nor investment houses had the advantage of corporate protection.

Today, the failures remain in business. The failed executives continue to receive bonuses. Their losses are socialized…picked up by feds and spread to people who don’t deserve them – notably, the next generation.

Most people think this process will last forever…with the costs pushed infinitely into the future. But it won’t.

“Stability leads to instability,” said Hyman Minsky. We see it coming. Stability makes people think that the system is eternal. They lend to the government at low interest rates…or even accept its new, paper money as though it was the real thing. This permits the government to run up far more debt than it could in an “unstable” era. The debt then becomes unsustainable…and the system collapses.

When? Who knows? But sooner or later, the lenders revolt. Or the next generation does.

Bill Bonner
for The Daily Reckoning

The Daily Reckoning