Do You Believe Borrowing Leads to Prosperity? (Part 1)

Includes: DIA, SPY
by: James Quinn

Mott the Hoople and the Game of Life. Yeah, yeah, yeah, yeah
Andy Kaufman in the wrestling match. Yeah, yeah, yeah, yeah
Monopoly, twenty one, checkers, and chess. Yeah, yeah, yeah, yeah
Mister Fred Blassie in a breakfast mess. Yeah, yeah, yeah, yeah
Let's play Twister, let's play Risk. Yeah, yeah, yeah, yeah
See you in heaven if you make the list. Yeah, yeah, yeah, yeah

Man on the Moon – REM

The 1970’s were a simpler time. As kids, we listened to All The Young Dudes by Mott the Hoople on our portable record players. We would cut Monkees’ .98s from the back of our Raisin Bran cereal boxes. There were maybe ten TV stations we could watch. For entertainment we would play board games like The Game of Life, Monopoly, and Risk. I remember having a two day Risk match with friends from our neighborhood. Our parents didn’t smother us with attention. We created our own fun. We organized our own roller hockey league with games played in our back alley and on the side streets of our neighborhood. We played half-ball against the back of our row homes. We organized our own pickup basketball games on the playground, running for three hours and refereeing the games ourselves. There were five baseball fields within a mile of our house where we could play for hours with our friends. When we played organized sports there were winners and losers. We routinely would leave the house in the morning and not return until dark. I was allowed to ride my bike the three miles to school through the cemetery and across highways and trolley tracks. Money didn’t matter at all in generating happiness. We had enough for two weeks in Wildwood. That was more than enough for me. Between then and now, something has gone terribly astray.

Today, we can download Mott the Hoople songs in an instant, for $.99 onto our $250 iPods and then play them on our $100 iPod speaker system. For a mere $200 a month we can have the Comcast HD triple play bundle of 1,000 stations, HBO, Showtime, Cinemax, Starz, Sports packages, internet service and VOIP. Why play a board game and interact with other human beings when you can turn on your $399 PS3 console and kill as many fake human beings in 3 hours as possible. When you are tired of that game, just whip out the credit card and download a new game for $39.99.

Our kids today are over scheduled, over indulged, over protected, and under prepared for the future we are leaving them. Today, we pay $200 per sport to sign our kids up at the age of 5 for little league baseball, ice hockey, soccer, football, and basketball. Kids get trophies for just playing. Everyone is a winner in the politically correct world of today. Kids don’t have the time or inclination to organize their own pickup games. Kids catch a bus to a school that is two blocks way. A $10,000 vacation in Disney World or Cancun is now the standard family vacation. We’re raising marshmallows and we are handing them a country that is in the midst of a debt induced death spiral. How did we get here?

Brain Gets Smart but Your Head Gets Dumb

The National Debt is currently $11.2 trillion or 80% of GDP for the 1st time since Harry Truman was President. Based on the usually underestimated CBO deficit estimates, the National Debt will exceed $14 trillion in 2012. The National Debt will be close to 100% of GDP for the 1st time since WWII. In the 1940’s we were engaged in a war of survival and needed to borrow to produce the tanks, planes, ships and guns to win the war. There are a couple small differences between the 1940’s and today. The government borrowed all the funds from its patriotic citizens through the issuance of war bonds. The Personal Savings Rate was 25% during the war.

Today, we are attempting to borrow hundreds of billions from China, Japan, and the Middle East. The Personal Savings Rate has risen from below 0% to 4% today. At the end of the war, the United States dictated the economic future of the world, producing the goods the rest of the world needed. Today, we are the biggest debtor nation in the world. We no longer dictate the economic terms to the rest of the world. Our government and citizens have fallen for the same misguided advice. Live for today and don’t worry about tomorrow.

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Well the years start coming and they don't stop coming
Back to the rule and I hit the ground running
Didn't make sense not to live for fun
Your brain gets smart but your head gets dumb

The ice we skate is getting pretty thin
The waters getting warm so you might as well swim
My world's on fire how about yours
That's the way I like it and I never get bored

All Star – Smash Mouth

Based on the chart below it is clear that our heads got dumb starting in the early 1970s and with the onslaught of our “smart” MBA brains to Wall Street in the early 1990s, securitization led the charge to our ultimate destruction. Consumer credit outstanding grew from $169 billion in 1975 to $2.6 trillion in 2008, a 1,400% increase in 33 years. Over this same time frame US GDP grew from $1.6 trillion to $14 trillion, a 800% increase. Personal consumption expenditures rose from $1.0 trillion to $10 trillion, a 900% increase. Consumer expenditures accounted for 63% of GDP in 1975 versus 70.5% in 2008. Houston, we’ve got a problem.

When Nixon closed the gold window in 1971, the Federal Reserve was free to print as many dollars as they desired with no constraints. It took a little while to get going, but once consumers and politicians realized they could spend whatever they wanted today with no adverse consequences, they were off to the races. I find it amusing that with consumers owing $2.6 trillion in consumer debt (approx. $23,000 per household), unemployment soaring, wages stagnant, home prices plummeting, and retirement savings obliterated, the talking heads on CNBC are calling for a consumer led recovery in 2009. An unsustainable trend will not be sustained. Regression to the mean has commenced.

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The most revealing aspect of the consumer debt outstanding statistics between 1975 and 2008 is the fact that up until 1990 consumer borrowing was done through traditional outlets of commercial banks, finance companies and credit unions. The wizards of Wall Street took consumer debt to a new level in the early 1990s. These geniuses figured out with their financial models they could package consumer debt into pools and sell it to pension funds, mutual funds, little towns in Norway, and anyone who wanted a great return with “no risk”. This new financial product led to a surge in credit card issuance by the major players in the industry. The MBAs assured everyone that even debt from subprime borrowers could be turned into gold by packaging it just so. Like any Ponzi scheme, this consumer debt scheme needed more and more debt issuance to cover the increasing bad debt in the portfolios. Once the market for buying the pools of toxic debt seized up in 2008, the game was over.

Another interesting aspect is that while the coming crisis was clearly seen by smart analysts like John Hussman, John Mauldin, and Jeremy Grantham in 2005, Commercial Banks and the Government ramped up their lending by 24% between 2005 and 2008. Credit unions, savings institutions and non-financial businesses decreased their risk exposure. The biggest and brightest made the riskiest bets at the exact wrong time. Did they do this because they knew the Fed would bail them out? I think the proof has been borne out.

Consumer Credit Outstanding1

(in billions of dollars)

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