The End of the Economy As We Know It?

I am often reminded of Locke's Two Treatises of Government. In it, John Locke first refutes the basis of the then-existing seventeenth-century political order (primogeniture), and then goes on to develop a new basis for a political system. First, however, he asks all the hard questions.

Economics is like that, or it should be. In times of crisis, it is appropriate to ask the hard questions. If we examine our lives closely, we realize that most of our interactions with other people on this planet are economic in nature. We sell our labor and buy the things we need and want from other people, even from people we never meet from across the globe. How did the government come to be “in charge” of the economy? How well are they doing? Is our economy “free”? On what should a modern economy be based? 

For any “free market” economic system, the single most important underpinning is TRUST. We buy things on trust; trust that the products will perform as promised and not harm us, trust that the food is not toxic, trust that if there is a problem that we can reasonably expect the seller to make good. We also sell things on trust: trust that we will be paid as promised in some useful unit of exchange. When financial arrangements become complicated or long term, performance requirements are spelled out in written contracts. We trust the system to grant us access to valid information that we can use to make an informed choice about the ability of our counterparty to perform. We trust that, if any party fails to perform, those parties can be held to account in a courtroom. We trust that the judicial system will protect us from force and fraud, and that our contracts will be upheld. A functioning and reliable judicial system is central to the existence of a free market economy.

Destroying trust would be fatal.

And yet, that is exactly what the government has done, and what they continue to do, and that is exactly why the economy continues to crumble:

1. By encouraging banks to hide their insolvency, turning them into walking dead. Who would trust a zombie to pay you back?
2. By refusing to reveal recipients of trillions of dollars of loans and largesse, with money extracted from taxpayers under threat of force; by refusing to reveal what these recipients have offered as collateral.
3. By smashing companies, unannounced, with random and inconsistent wipeouts and haircuts for various investor classes.
4. By selectively protecting certain companies through more taxpayer plunder. One can only speculate about the selection process involved.
5. By flooding the system with brand new money, calling it "capital", while everyone intuitively knows it is no such thing at all.
6. By tinkering with market rules in a constant effort to push up the stock market.
7. By threatening to empower and encourage courts to "adjust" en masse the terms of existing contracts, starting with home mortgages.

And now, the hard questions:

In such an environment, who would want to "invest"?   Why does the system wonder why there is no appetite for risk? Who would loan money when it might not be paid back, when you cannot adequately determine the financial condition of your counterparty, when banks are encouraged to lie, when regulators look the other way, and when the courts might not uphold your contract anyway?

Who would borrow money when the "value" of that money is being grossly manipulated by its issuer, in concert with foreign governments and foreign central banks? 

Who would buy stock when the company could be wiped out by the government at any moment, or when the rules might be changed at any time trapping your investment? 

Who knows what their currency will really be worth in a year? Two years? Ten?

Will abrogating home mortgage contracts make it easier to value MBS and the CDOs based on them? How about if this abrogation drags out over many years? Will it restore trust in the institutions that hold them as "assets"? 

Will appointing another Wall Street insider as Treasury Secretary restore the trust of the man on the street? 

Will coordinated global currency debasement restore trust in currency?

Given the above questions, who in their right mind would borrow real capital, build a factory, buy equipment, hire and train staff, and start making a product?

I will finish with a really easy question:

Did we learn anything at all from the Soviet experiment?

Comments

[socrateazz:]

Quite a few good questions. I am inclined to believe few people realize the serfs of the middle ages were socialistic communities. The problem came about in later years when the leaders (royalty) took greater shares of that produced causing little incentive to produce. Slavery comes from socialism and socialism requires others to produce for the good of the many. Know the difference between the carrot (Capitalism) and the stick (Socialism) Wealth is the reward for production under Capitalism. Shortage and want is the reward for Socialist. For of the two the real greed is from those who want equal goods while giving less effort because they deserve it I went off track. The problem I see is too many socially acceptable decisions and not enough capitalistic decisions. The means will cause the next crisis, Change is coming and few will like the coming results. When The crisis becomes the next opportunity then the economy will again improve.

2008 Nov 11 06:25 AM

[Smarty_Pants:]

Great article. Raises the core points that undermine the gub'mint's efforts to "save" us.

When the gub'mint changes the rules in the middle of the game only insiders want to play, everyone else will avoid the game entirely if possible.

socrateazz: Great analogy with carrot and stick for capitalism and socialism.

2008 Nov 11 09:39 AM

[axelrod608:]

Excellent article. The questions you pose are where the "bailout" should have started.

It is crystal clear that the unlimited cheap credit bubble provided us by Alan Greenspin was unsustainable. It is also clear that it provided a bunch of casino gamblers masquerading as investors to try all sorts of arcane and risky - and as it turns out, stupid - ways to try to make obscene profits.

The financials grew fat and the consumer purveyors grew fat. The sheer volume of free money corrupted every system. My unemployed student kids get credit card solicitations weekly. Unemployed folks got mortgages. Are we really so stupid to think it could last ?

And now Hank and Ben are doing everything possible to keep the bubble inflated. Can they not see that industries grown fat cannot survive lean times ? They remind me of two guys with garden hoses "protecting" their house from the oncoming forest fire.

This will end badly. The only bottom line question is, will we throw a few more $trillions into the fire. And the answer from DC is .....YES !!

2008 Nov 11 09:39 AM

[investor88:]

SW's article is insightful. Trust and confidence has been lost, and the government is not helping here with bailing out this and that in trigger happy fashion. Let the cancer spread [can't be helped], do its job and at the end of it all we get to the other side of a new life. First tighten belts for a rough ride through the bottom before looking up.

2008 Nov 11 10:13 AM

[Jason Rines...:]

I would say a salient point is if the monetary stewards whom created this mess should have had ANY decision making ability of this magnitude!

I can see how I would respond as the CEO of my own business if a few employees cooked the books bankrupting the company. Would I keep these employees around AT ALL? Would it matter if they had studied historical texts of how to fix malfeasonce and incompetence? If it were your business would you? Oh, never mind that 300 M lives will now have a very diminished quality of life for the next five to ten years.

My advice to President Bush in March was to declare the economy a national emergency and begin investing $150 B into energy then using the SBA to help underwrite loans for small businesses and lent by responsible regional banks. When trickle down isn't trickling down it's time for something new and dramatic. Other then that there should have been NO bailouts of any kind for any organization. Yes, we would have had a temporary route of the dollar and stocks would have tanked to this same level we are at today. 200 people would have been hastily ousted from Washington by the citizenship and investor confidence globally would have also returned hastily. Instead, it is quite a possibility the USA will lose it's international monetary peg status. Investor confidence indeed is destroyed on a global level and I hear my colleagues constantly talk of 'being all in cash'.

So to restore trust at this point will be a slow, grinding and painful process for America IF we can avoid other catastrophes. Future spending on stimulus for the consumer is a nice thought, but people I talk to daily would rather have a full time job without the fear of being next in the layoff realms. Perhaps surveying the American public would be a good start to begin ASKING what the citizenship wants in these decisions.


On Nov 11 09:39 AM axelrod608 wrote:

> Excellent article. The questions you pose are where the "bailout"
> should have started.
>
> It is crystal clear that the unlimited cheap credit bubble provided
> us by Alan Greenspin was unsustainable. It is also clear that it
> provided a bunch of casino gamblers masquerading as investors to
> try all sorts of arcane and risky - and as it turns out, stupid -
> ways to try to make obscene profits.
>
> The financials grew fat and the consumer purveyors grew fat. The
> sheer volume of free money corrupted every system. My unemployed
> student kids get credit card solicitations weekly. Unemployed folks
> got mortgages. Are we really so stupid to think it could last ?
>
>
> And now Hank and Ben are doing everything possible to keep the bubble
> inflated. Can they not see that industries grown fat cannot survive
> lean times ? They remind me of two guys with garden hoses "protecting"
> their house from the oncoming forest fire.
>
> This will end badly. The only bottom line question is, will we throw
> a few more $trillions into the fire. And the answer from DC is .....YES
> !!

2008 Nov 11 10:26 AM

[contraxism:]

Until a society is willing to except a limitation on individual wealth, the boom bust cycle will continue to repeat itself. Trust cannot be achieved in a society that worships its wealthy class.

2008 Nov 11 11:37 AM

[mdmrjsds:]

On Nov 11 11:37 AM stoneweapon wrote:

> Until a society is willing to except a limitation on individual wealth,
> the boom bust cycle will continue to repeat itself. Trust cannot
> be achieved in a society that worships its wealthy class.
>
I suggest that it is a limitation of *inherited* wealth that is required. Let everyone make as much money as they can during their life. And let them give their children as much education and life training as they desire. But tax any wealth passed to their children at 95% or 99% so that the children have to make it on their own. This removes the concentration of wealth, and the formation of webs of corruption that we see so prevalent in our culture today. I don't think we worship the wealthy, it is the wealth that everyone is worshiping, the lifestyle it buys.

Of course, this also requires that corporations be isolated from the political process, as it is easy for the officers to subvert them to their own ends. They need to be forbidden from any participation in the political process. That doesn't mean their officers can't participate with their own money and on their own behalf, just that resources of the corporation can't be used.

What SW Richmond has described above is owed partly to the influence of these two factors on our political economy.

Would their lack fix all the problems with our system? No, there are other factors that need to be fixed as well.

Governance of corporations is out of the control of their shareholders, and they are no longer under control.

Our congress has become unresponsive to the voter. We have taxation without representation.

Our money supply is managed to the benefit of the financial class. The mechanism needs to be redesigned.

We have an unsustainable entitlement system. We have to learn to live within our means.

Our legal system is a morass, incapable of being navigated. We need twighlight clauses on all laws so they have to be reexamined periodically for relevance. And laws should be enforced to intent, not letter. The job of congress should be to debate the intent of a law and state it plainly. Let the legalese be written by subcontracted lawyers.

And many more. Just because the founding fathers had the vision to create a system that lasted this long doesn't mean it is perfect and doesn't need revision as society and technology change. We've come to worship things the way they are, as if they are sacrosanct. That way lies decay and stagnation.

Our misfortune stems from the fact that the people who should lead that effort, our congress, is decadent and incompetent and subverted. We need some sort of plebiscite process to force congress to act when enough of the populace are aroused enough to demand it through petition.
Currently our alternatives are to continue as things are or armed insurrection. The plebiscite allows middle ground.

2008 Nov 11 12:49 PM

[goldstriker:]

Truer words were never spoken! --- In the 1920's all dollars were convertable to gold. That in itself limited the power of the feds to expand their central government. Then when we went off the gold standard in 1935, fiat money was created and grossly expanded. Then the final act of the creation of fiat money was the removal of the dollar backed by silver in 1964.

Now the bottom has fell out and they have totally lost the confidence of the American people as well as the rest of the world. We are on a track that will lead us over the edge of the cliff, and who knows if we will survive the true capitalist system.

2008 Nov 11 12:53 PM

[carey_jim:]

"For any “free market” economic system, the single most important underpinning is TRUST"

In the twentieth century, at least 40 million people were killed in wars and 175 million were KILLED BY THEIR OWN GOVERNMENTS: Hitler, Stalin, Rwanda, the Killing Fields of Cambodia ....

You are surprised that you can't always trust the government?

At least 1.35 million children are homeless during a year’s time in America. I doubt if those children trust anyone, let alone the the government.

This year, the top 1% of Americans received almost 60% of all income from capital gains, dividends, interest, and rents.

THE BOTTOM 80% OF AMERICANS received a little more than 10% of all income from capital gains, dividends, interest, and rents.

The sad truth is that most Americans don't trust anyone and for good reason:

Just about everyone is lying to them and trying to take their money.

Buy more snake oil but caveat emptor.

2008 Nov 11 01:09 PM

[Moon Kil Woong:]

Anytime everyone including the government thinks the solution is continued fiscal irresponsibility by consumers and how to encourage it, I see only shameful behavior. People should be applauding Americans are finally beginning to curb spending and start saving. If economic growth suffers that is in the long run better than running the US into bankruptcy.

Unfortunately, when the consumer get's fiscally responsible, the government gets even more irresponsible and thinks the baks should too. Shameful....

2008 Nov 11 01:24 PM

[billp37:]

Einstein's comment

"The problems of today will not be solved by the same thinking that produced the problems in the first place."

may be particularly relevant in the current economic messes and attempted fixes?

2008 Nov 11 03:11 PM

[Teutonic Kn...:]

Excellent article and artistically written fit for Pulitzer.

I don't mean to be regressive and throwing gasoline on fire, let alone pouring salt on wounds.

Trust, boy, there isn't any. When we see this guy collecting his honors and titles including an honorary knighthood ready to pack it in for his "peaceful" retirement, (hold thy peace in retirement now, please) we know it is like the third and last movement of the symphony. The conductor is pulling his hair and the tempo is louder and louder. Suddenly the music stops as the conductor strikes his baton with the final blow. Of course the curtain went down. No encore please!

The problem is these guys are closeted in their marble floor offices. How do they really know what else to do to make a living?

I guess what occurred is what my pastor called sins. We are all sinners.

2008 Nov 11 03:11 PM

[doubleguns:]

Repent ye sinners, repent. Now comes the wailing and gnashing of teeth chewing on dollars. Congress will chew through so many this and next year that forests will need to be cut down to keep the presses at the mint going.

Soooooo let me get the present fiscal problem and correction clearly.

--- Problem--- everything is deflating because it was over inflated. ---

---Solution---- reinflate it back with trillions of dollars---

These unrepentent attempts to restore previous order will fail.

I say it again. Repent ye sinners repent. For you are damned to financial hell and there is no turning back if you are taking this road. The road to hell is obliterated with stocks, bonds, dirivatives, CDO's, CDS's and fiat money.

Seek out the golden path for your financial redemption.

2008 Nov 11 05:50 PM

[contraxism:]

On Nov 11 12:49 PM mdmrjsds wrote:

“Let everyone make as much money as they can during their life”

I say that one mans wealth shall be no greater than 10 times that of the average man.

My God! I have reached my limit, what shall I do now?

Every man, woman and child is not without food, shelter, health care and education.

2008 Nov 11 07:38 PM

[danmcl:]

On the contrary, trust cannot be achieved in a society that worships crooked politicians and views the government as savior. The boom bust cycle will continue until we remove the power to make artificial credit and demand deposits from the Federal Reserve and the fraudulent fractional reserve banking system. The bubble was directly caused by the low interest rates and expanding money supply, controlled by the central bank. America's productivity has been hamstrung by massive and incredibly stupid regulation. I challenge anyone to name a time in the last 100 years when there were actually free markets, totally free of regulation.

There wasn't any.


On Nov 11 11:37 AM stoneweapon wrote:

> Until a society is willing to except a limitation on individual wealth,
> the boom bust cycle will continue to repeat itself. Trust cannot
> be achieved in a society that worships its wealthy class.
>

2008 Nov 11 09:31 PM

[zanardm:]

Can one fully deleverage without ALL bubbles deflating? As mentioned by others, is the ultimate bubble, the treasury bubble coming? Was foreigners' markedly decreased purchase of Fannie Mae and Freddie Mac securities, a harbinger of the future for treasuries? Would the resultant lack of government ability to borrow be what is required to deleverage politicians? Possible dual currencies here, like for Europe, since there is greater faith in ECB than our Fed? Possibly an attempt by U.S. to borrow in eurodollar and yen denomination securities overseas? Is this the worse case scenario? Would a U.S. budget deficit less than $1 trillion+, and other fiscal conservative measures, send the right message to creditors, both domestic and foreign? Or is it the same old spend and spend (code word for debt); what did the vote on bail out indicate? The private sector is deleveraging; but not the public sector. A generation (25 yrs) for the excesses of the last 25 yrs, to be deleveraged? Good luck to all of us.

2008 Nov 11 11:41 PM

[Mark, UK:]

Okay, let's clear one thing up, if the US Government revealed who it was lending money too, that would SHATTER market confidence in that institution, creating a run on its stock and most likely its collapse. This in turn would feed into the wider economy and further deflate market confidence causing the perpetuation of stock losses which is driving the recession. This is precisely what happened over here with Northern Rock, that the Bank of England loaned it money and publishes that fact led to a wealth of mis-informed newspaper reportage (Northern Rock did very little that the majority of others in the market didn't except that most of them operate internationally and so were able to go to the European Central Bank for money, which crucially does NOT reveal who it loans to). To reveal who they were lending to would fundamentally undermine the point of the loan, which is to try to re-establish market confidence, would prolong the economic distress and would result in tax payers never recouping their money. I'm not saying that the American tax payer definately will recoup any way, but just that if it was known which companies were taking loans would definately prevent this.

Also there needs to be the realisation that the money being taken is not always because the institution is in trouble, but becasue the government is offering money at a cheaper rate in an effor to lower LIBOR. This is not a new strategy, and one that fundamentally makes sense, and is why LIBOR is now beginning to stabilise.

You're seeing the effects in the real economy now because historically therte has always been about a six month lag between money markets and the real world economy.

2008 Nov 12 12:05 PM