Zombified Government Spending

The huge rally on Wednesday of last week fizzled by the end of the week.

What a week. Full of sound and fury…signifying nothing.

Wednesday’s rally was the “seventh best day for the DJIA in 110 years,” reports our Bonner Family Office analyst, Chris Hunter. “And sure, this sounds pretty impressive. But it’s useful to bear in mind that the best day in history for the DJIA was on October 13, 2008 (when the index shot up 936 points). In the next few days the DJIA was down 11%. Then it shot up again by 15%. Then it nosedived by 25%. The next best day after that for the index was October 28, 2008. And the sixth best day came six days after the top of the Nasdaq bubble, on March 16, 2000.”

Yes, dear reader, the pride of a big rally is what goeth before the fall of a big dip. Or worse.

House prices were down again for another month — making 15 out of the last 16 with falling prices.

But last week’s news was mostly good. Unemployment went down. House sales went up. Manufacturing data was mostly good…unless you looked at the trends in Europe, which were all bad.

And the shopping news was mostly good too… Auto sales were healthy, said the papers. Gasoline was selling for under $3 a gallon.

All of which could lead a determined hallucinator to imagine that the whole Great Correction thing had been called off.

Wouldn’t that be something, dear reader? What if we weren’t just wrong about the details but about the whole shebang? What if the number of new job offers continued to increase? What if consumers continued to buy things? What if Europe got control of its debt problem…and America’s economy began to really grow again?

But wait…the growth of the last 30 years came from spending money we didn’t have. In Europe, the government spent it. In America, households spent it. In Britain, both spent it.

Could that happen again? Certainly, that’s what the feds are aiming for…by reducing rates in Europe and lending at zero in the US. And bailing out big debtors. Heck, we won’t rule out anything.

But there must be limits on how much debt an economy can take. And by all indications, we blew by those limits long ago. Take the whole developed world. Put together its debts. Those debts grew at an 11% rate throughout the last decade, nearly 3 times faster than GDP. Now, they’re 310% of GDP.

You’d think that would be enough to sink the planet into a global depression. At a 5% interest rate, the carrying cost of that debt equals 15.5% of total output. That’s zombie finance — paying for toys for children who are now grown up…and trips for people who are now dead. It’s as if the average working stiff were putting in nearly one day a week just to pay the costs of the past.

Government finances are the most zombified of all — as you would expect. In the US, for example, taxpayers pony up about $2.1 trillion per year. But the feds owe $15 trillion. This puts the ratio of revenue to debt at about 1 to 7. At 5% carrying costs, it would cost the feds $750,000,000,000 per year in interest — or about a third of tax revenues. That would leave only about $1.35 trillion to cover the costs of federal spending — which is now at $3.5 trillion per year.

And it’s worse. Because the feds also have to roll over about 40% of their debt in the next three years.

Of course, the rest of government spending is zombified too. Into our office on Friday walked a dear reader. It turned out he was a doctor, author of many textbooks on natural remedies and alternative cures and once a very high-ranking official at the National Institution of Health.

“Zombified?” he began. “You don’t know the half of it. Just drive up that corridor north of Washington. It’s filled with gleaming office buildings. Many of them are bio-tech businesses.

“What a business! Their research is done at taxpayer expense by the NIH…or funded by it. They come out with these shock and awe new drugs. And then, investors think they’ve got an Aspirin, Motrin or Viagra on their hands. So they go into the marketplace and sell billions in shares to investors. And then, they sell the patented drugs back to the government. The US government is the biggest drug buyer in the world. And it doesn’t quibble on prices. Because a lot of the people who work at NIH and other health bureaucracies know that if they want to make real money they’ll move up the road to the bio-tech companies…and with the salary and options they have a chance of making beaucoup money. It’s all very cozy.

“And the real story is that the pharmaceutical industry rarely comes out with a really effective and safe drug. When I go to the doctors I ask for a prescription for drugs that were developed in the ’70s. Not just because they’re much cheaper…but because they now have 40 years of experience with them. We know which ones are reliable and which are dangerous. We don’t know that with the new drugs. And most really aren’t very effective anyway.”

Not to be distracted…we return to our theme. Can such a corrupt, zombified and heavily-indebted world suddenly sprint ahead?

Normally, it would have to shuck off its burden of debt. Normally, the zombies would have to find honest employment first. We will keep an open mind, but our guess is that the smart money is still selling stocks on rallies…and buying gold on dips, not the other way around.

Our new friend mentioned the I-70 corridor from Washington, DC to Gaithersburg and Frederick, Maryland. It is a center of the “bio-tech” industry — very near the source of its funding, regulators, and market, in Bethesda.

You drive up towards Frederick. You pass shiny new buildings. Whole new suburbs. Bright foreign-made cars full of people who look like they might be Pakistanis, with PhDs in molecular science.

But keep going and the world changes. Once you pass by Hagerstown you are out of commuting range. Soon, you are in what could be the ‘real’ America. People drive pick-up trucks. There are few new houses. Few fancy restaurants. In fact, there may not be a single one between Hagerstown and Pittsburgh.

Some of Southwestern Pennsylvania’s mill towns are practically zombietowns. We used to visit Charleroi as a child, because our father’s brother lived there. That was in the 1950s and early ’60s. Coming from the Maryland tobacco fields, it seemed as is we had entered into the hub of sophisticated urban life. There were shops, bars, movie theatres. There were young people on the streets. Children playing in the alleys. There was music coming out of open windows…union hall dances…bars on practically every street corner…diners…new cars… And the place hummed to the rhythm of the steel mill by the river.

Today, everything has changed. We went up last week for our aunt’s funeral. The steel mills have shut down. Production has long since moved to Korea, India…the countries where the bio-tech engineers come from. We heard no whistles calling the workers to their posts. We saw no houses that looked as though they had been built in the last 4 decades. We saw no children. We saw almost no people at all, save those using walkers and canes.

The only industries seemed to cater to zombies.

“Did your doctor miss your cancer?” asked one billboard for a shyster lawyer.

“Injured on the job?” asked another…which seemed like an unlikely thing. We’d be surprised if anyone in town had a job.

It looked as though government had misallocated resources to the town, in an effort to make it appear that it wasn’t dead. A central pedestrian street had been tarted up. But there were no pedestrians. A modernesque building houses a local “development” authority, but there was no development to authorize.

You need a cheap place to live, dear reader? One house had a hand-painted sign on the door:

“House for sale. $1,000 down. $346 a month.”

How about that? You could buy the house next to it too…and open a Cappucino Bar. Don’t bother with the free Wi-Fi. Or the cappuccino for that matter.

We wondered: will the bio-tech corridor someday pack up and move to India too? Then, will Gaithersburg be as derelict as Charleroi?

Bill Bonner
for The Daily Reckoning

The Daily Reckoning