Anatomy of a Disaster: The Next Stop 11 comments
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These past few weeks we have laid the groundwork for the upcoming economic and financial mess. Lacking a textbook definition of a depression and outright refusal by the media and government to even admit we’re in a recession, I will use the unscientific and arbitrary term ‘mess’ to describe both the current and upcoming realities. After all, ‘mess’ is a scalable term.
We are currently in the eye of the hurricane. While it certainly doesn’t seem like it, this is the best things are going to be for quite some time. With job losses leading the way, the US economy slides into the clutches of irrelevance with those in charge unwilling to acknowledge the magnitude of the situation. We’ve hit the iceberg, bulkheads 1,4,7, and 11 are flooded, and our leaders are on the Promenade handing out free water. Where do we go from here?
RIP US Consumer
One month a trend does not make, but given all that is going on, it seems increasingly likely that August’s decrease in consumer credit outstanding is not an aberration. In August, consumers actually began to repay debts faster than they accumulated new ones. It is about time. Of course, this reality has led to political spin, particuarly from Condoleeza Rice about how we need to be ‘leaders in the world economy’.
Worried about consumption? You ought to be. The dirty secret is that without debt accumulation, there is no growth. Period. The second dirty secret is that without the abandonment of credit standards and pedal to the metal monetary policy, this day of reckoning for consumers would have come back in 2001. By the Fed’s count, that was $1.6 trillion ago in outstanding consumer debt. The pump was housing and now the pump is irreparably broken. This reality leaves our leaders frantically trying to figure out how to maintain debt growth in the absence of a handy asset bubble.
Maybe they will start allowing banks to lend to people against the ‘equity’ in their retirement account next? I bite my tongue. Contrary to the politicalspeak, consumers overall did the right thing in August. Keep doing it. Pay your bills. Trim your budgetary excesses and streamline. When your next stimulus check arrives in the mail, pay down your debt some more. Money is the least of the government’s problems; the Fed is really good at creating it from nothing and the Treasury is the 21st century version of Daddy Warbucks on steroids. No, money isn’t the problem. Creating endless amounts of it while trying to keep the public convinced that it is actually worth something is the problem.
Avalanche of Obligations
Somewhere in all the turmoil the fact that we have a demographic tsunami headed for the Federal balance sheet has been forgotten. True, with a stock market crash, dizzying losses in almost all asset classes, bailouts, and bank failures, it is hard to remember everything. None of what has happened though in the past 6 months changes the fact that both Social Security and Medicare are heading for outright insolvency. A recession (or worse) will cause inflows to these programs to drop even more, thereby exacerbating the problem.
Baby boomers headed towards retirement have seen the value of their savings chopped by a third or more. This will cause them to rely even more on Social Security and seriously hamper their ability to spend. These programs will need trillions moving forward. At this time those trillions don’t exist. We have an immovable object and an irresistible force. Either we’re going to have to create the money or else we’re going to have to cut the benefits.
To this point there has been no talk of cutting benefits. An interesting observation to make here is that a year ago, bailing out Social Security with printed funny money would have seemed far-fetched to the average person. Not so anymore. The bailout mentality is firmly in place, and in fact, the scope of monetary magnitude has been lost. We used to say millions and it was a lot of money. Then it was billions. Now we discuss trillions of dollars like it is pocket change. This is a hyper inflationary mindset. Get used to it.
The Battle of the Backstop
More than ever, it will be necessary to be able to discern between nominal and real. Our website has dozens of articles, and the focus of a good many of them has been to differentiate between nominal and real. It’s not the numbers of dollars, it’s what they buy. It will be critical for individuals to understand what your money buys. If you fully grasp this, you will know when the tide changes. You will not need the Sunday paper.
Right now we are focused on falling asset prices, and in the case of energy, consumer prices. While falling consumer prices are a welcome breath of relief, do not get too used to it. Enjoy it while it lasts and watch for signs that the trend is reversing. The biggest problem is the scale of the monetary creation to date that the Fed is willing to admit. Monetary inflation leads to consumer price inflation and when those spining wheels hit the road and get traction, look out. Things will change quickly. It is imperative to be up on the wheel here so to speak.
Make no mistake, your wealth is in harm’s way unlike any other time in history. While the assault has been ongoing since we decoupled from the backing of real money, for a time, our money was backed by some degree of common sense. However, common sense dictates that you do not create trillions upon trillions of dollars to rescue the financial economy while leaving the foundations of the real economy to reap the whirlwind. Common sense dictates that your money supply growth should not exceed the growth of your underlying producing economy.
Common sense should tell you that you don’t allow financial institutions to leverage their portfolios at 100:1. Common sense should tell you that you don’t allow a bank to lend out $10 for every $1 in deposits. Common sense tells you that FDIC is insolvent. It also tells you that California and New York are going to need a bailout. It might even suggest that many of the remaining 48 will require one at some point in the near future along with every pension fund and entitlement program currently in force.
The magnitude of the final quantity of money that must be created is astronomical. From the standpoint of the authorities, it would be best if we continued to go into never ending debt. This way money could be multiplied through the banking system in an ‘orderly’ fashion. The next choices are handouts (think ‘stimulus’ packages), and direct monetization of debt (think outright purchase of new Treasury issues). The multiplier method leads to a ‘slow burn’ inflation such as what we’ve experienced to this point.
However, there is an actual moment in time when the population cannot continue to accumulate debt at a level that will perpetuate the fiat system. Then we move to the latter two options which have a much greater likelihood of creating hyperinflation and the eventual end of the paper currency. We have now reached the tipping point where debt accumulation on a meaningful scale cannot continue. Therefore, we are left to watch the remains of the current liquidation of assets then reap the whirlwind of rampant, undisciplined monetary creation.
Disclosure: None
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This article has 11 comments:
Some of us "gold bugs" have seen this coming for decades. A little bit of common sense should have told us that uncontrolled borrowing made possible by the unprecedented creation of fiat currency would eventually lead to an economic nightmare. The party is over and the hangover will be punishing and long lasting. We have no one to blame but ourselves. We voted in the political hacks who, with their banker friends, lead us down the primrose paths of materialism, wealth and opulence. We have been deluded by the advertisers who have ingrained into the American psych the need to buy that which we do not need nor that which we can reasonably afford.
Unfortunately, our unchecked avarice has created an economic derailment which can no longer be mitigated by yesterday's solution: more debt creation. The dance is over and It's time to pay the fiddler and pay we shall.
This should be a wake up call for people to get out of debt, have an emergency savings account, and be very careful of the stock market. It could fall another 30 to 50% to get in line with a bear market P/E.
Your hypothesis that there is no growth without debt accumulation has to be the most enlightening theory I have heard in a long time.
In relation to this brilliant thesis, It is both frightening yet intriguingly insightful that our global economies (well the US and UK at least) have only been so prosperous due to massive debt, accumulated by relentlessly naive consumers,financiers and governments, all in the name of pursuing grotesque personal "wealth" with no foresight or forethought of the consequences of falling asset prices upon which all of that wealth (or should I say debt) was built.
How ridiculously stupid and ignorant of our capitalist societies to be so blinded by the mesmerizing stench of money that nobody ever stopped to consider that this faux wealth accumulation was build on a rickety mountain of trillions and trillions of debt.
Now we are all paying the price, yet still no lessons have been learned.
I am still astounded that the US, UK and European governments are trying to solve this problem by issuing more debt to pay off the existing debt!
Er, hello?! Has nobody told these fatcat politicians that simply throwing more money onto the fire ain't going to extinguish it?
Has anybody noticed how the conceited action of our useless governments in their response to the global credit crisis (i.e issuing more debt to pay off the existing debt) is an exact replication of society as a whole where peolpe "paid off" their credit card debts using other credit cards - merely transferring the debt, not actually reducing it.
The only way we can solve this crisis is to end this crazy credit obsession and go back to a debit system of hard cash in bank accounts. That is why I only have a debit card - I can only spend what I ACTUALLY have. Now there's a thought, eh?
What a mounumental task; replacing the consumer debt driven economy .......and with what? For the better part of 50 years the rampant building of the viral machine of "MORE" has invaded every pore, every facet of "developed" nations human interactions.....from macro ecomonics and the associated foriegn and domestic "policies" to the micro economics of the household, and the resultant social interactions and value systems.
It is a very sad time, made more so by the fleeting hindsight realization of the wonderous possibilties of what "we" could have "become" as a nation, as a world.
Andy Sutton wrote:
... The dirty secret is that without debt accumulation, there is no growth. Period. ...
HowDan wrote:
... How ridiculously stupid and ignorant of our capitalist societies to be so blinded by the mesmerizing stench of money that nobody ever stopped to consider that this faux wealth accumulation was build on a rickety mountain of trillions and trillions of debt. ...
Most people in developed countries shudder when they read or hear about parents in third world countries selling their children into slavery or indentured servitude. And yet we have done the same thing. The reasons were different. In the case of the impoverished parents, the fact they had more children than they could afford meant they had to sacrifice one in order to provide subsistence to the rest. For us, we have sold our descendants into indentured servitude so we could consume in the present, so that we could live the high life we have not earned. And the means were much more sophisticated, shielding our sensibilities from what we were doing. We didn't do the deed directly, but sold debt to creditors that our descendants will have to repay.
Andy Sutton wrote:
... These programs will need trillions moving forward. ...
FDR set us on the path to the current crises when he set up the ponzi scheme of social security. Because the attention span of the public is as short as that of congress, no one sees that this isn't a sudden crisis, that it has been building since the thirties (LBJ through more wood on the fire in the sixties). A ponzi scheme has to collapse. The demographics are just a coincidence, it has to happen sometime because a monotonically increasing series tends to infinity. The more insidious thing that FDR did was to put into the political arena that the public had a 'right' to the fruits of the economy, whether they had earned it or not. That became the pandering that dominates politics today, like people aren't intelligent or mature enough to be told the truth. Like a spoiled child they cry, and our codependent congress provides. That is the true rot at the bottom of this crisis. No polity can survive that attitude.
At this point, we are still selling our descendants into servitude. There are still lenders out there willing to lend us money for future promises. So the trillions are financed. As you say, eventually these lenders are going to see the writing on the wall and stop lending to us. At that point, we become like Zimbabwe, printing money without any backing whatsoever, tacking on zeros as the inflation rages. Or we live within our means, consume only as much as we produce. I wonder which our politicians and voters will choose? ;-)
One of the revelations that really surprises me in the detritus of this crisis is how cheap it is to purchase a congressman. Barney Frank and Chris Dodd were purchased by campaign contributions and personal favors from Fannie Mae and Freddie Mac in the thousands (yes, you read that right, the thousands) and they defended them and their unsustainable model against the public good like pit bulls. It just doesn't fit. Like a 50 cent whore at an executive retreat. The executives at those institutions were making millions in bonuses as their companies made billions and Barney and Chris had to know that. These two men were part of congressional deliberations on billions of dollars of spending. I know that congress has made its job cushy, full pay for life in retirement, no income tax, 100% no cost health care, vote yourself a pay raise every year, restrict any challenge to your reelection as much as possible. But even that isn't enough to justify their tenacity in my mind. Are they really 50 cent whores? I think there must be offshore accounts involved somehow, some off the record payment.
Some like Rep. Randy "Duke" Cunningham are corrupted by money. Most are corrupted by power. It's like an addiction; once one tastes it, one needs more and more and nothing will stop the pursuit of it. Ethics, integrity and the ability to do the right thing take a back seat and are no longer important other than for appearance sake. The seniority system insures preservation of power. Term limits would certainly go a long way in cleaning up Congress.
Of course, the inflation being unleashed now is probably seen as a medium term cure-all. Get those mortgages, credit card and social security debts down without taking unpopular decisions. Best of all cut the government debt to manageable proportions and.... off we go again.
In 5, 10 years or whenever we can sort out the inflation problems. No worries.
Sadly, history is not on the side of this Panglossian approach. The social and geopolitical fall out will complicate our futures and the economy....?! Yikes.
You forgot to mention that Ponzi is talking about adding a new element to the social security pyramid scheme: single payer health care.
Politicians talk of "affordable" health care. Modern health care is a Cadillac, not a Volkswagen. 1950s health care couldn't do a lot for you but it was "affordable". No country is rich enough to provide free Cadillac health care to everyone. In Canada which has single payer health care, services are rationed via many months long waiting lists, and still health care is approaching 50% of the ENTIRE budget of many provinces who have to pay for it. Just replace the IRS with the AMA, give 100% of your income to the medical system, and they will give you all the 'free' health care you want. There may even be a few bucks left over to return to you to buy food. But don't count on it.
These welfare entitlement schemes were born in desperation in the Depression and massively expanded after WWII when baby boom demographics made them look fiscally painless. Now the demographic is becoming inverted, with few on the bottom paying and many on the top collecting. Meanwhile politicians "bringing good news" have the public believing that all these schemes are realistically possible. They are not. But what politician could get elected by telling this truth rather than reciting the fairy tales?
2) Investments within the US, e.g. healthcare, domestic energy and infrastructure, do not create any net cost to the US, unlike the war in Iraq, oil imports and everything made in China. The government can and should invest heavily in these activities and they will boost the US economy. Boosting healthcare may reduce the labor available for nail salons but will not have any other negative effects.
3) Companies can't make profits if the majority of the public cannot buy their products. So yes, we do need to stor the money around. This seems to escape McCain. Obama has a plan - McCain does not.