The Party Is Over: The Crisis We Borrowed & Spent Our Way Into

More than just a mere liquidity or credit crisis, the current financial storm represents the death throes of the old global economic order, and perhaps the birth pains of a new one. The sun is setting on the borrow and spend culture that has defined us for a generation. Our long ride on the global gravy train is finally coming to an end, and once it does, nothing will be the same. The sooner we come to grips with this the better.

Despite the myriad of proposals that are coming from Washington and other world capitals, we must understand that this crisis cannot be cured by governments. In the United States, credit is gone because savings are gone. Our shallow pool of savings has been depleted through bad loans, and we can no longer entice foreigners to lend us their available savings. Given that we are already too loaded up on existing debt that we cannot realistically repay, who can blame them for not wanting to lend us more?

As a result, the free market is trying to put an end to our spending spree. Without savings or home equity to fall back on, Americans struggling with rising prices are finally being forced to cut back. This has terrified our leaders and is causing them to dismantle the remaining structure of our free enterprise-based economic system.

The intention of all these daily federal interventions is to keep the credit spigots open so Americans can go even deeper into debt to buy more stuff they can't actually afford. This should be clear enough to anyone who listens to what our leaders are actually saying.

When speaking about the need for an even larger fiscal stimulus package, Barney Frank, chairman of the House Financial Services Committee, said, "We have to prop up consumption." He has it backwards. The government has been propping up consumption for far too long, and the best thing they can do now is remove the props so spending can be replaced by savings.

The sad reality is that we borrowed and spent our way into this crisis, and we are not going to borrow and spend our way out of it. Legitimate credit can only be supplied if there are genuine savings to finance it. Savings can't be magically concocted into existence by a printing press, but can only be created by consumers who spend less than they earn. Efforts to fool the market will not work and will ultimately lead to a monetary disaster and runaway inflation.

Were the government to allow market forces to work, Americans would now have to pay cash for their consumption. That would mean no instant credit for new cars, plasma TVs, appliances, consumer electronics, clothing, furniture, etc. Unless buyers actually had the cash in their checking accounts these purchases would have to be deferred. From an economic perspective this is precisely what the doctor ordered. But for an economy based 72 percent on consumer spending, the medicine will go down hard.

Ultimately, a serious reduction in consumer and mortgage credit, combined with an increase in personal savings, would again provide a pool of needed capital for businesses to produce products and provide employment opportunities. However, the danger is that this potential credit could be completely crowded out by massive borrowing by the Federal Government. In addition, prices for such things as houses and college tuition will fall sharply, as the credit artificially propping them up disappears. People would still be able to buy houses and send their kids to college, only they would pay much lower prices when they do.

However, if the government keeps creating inflation to artificially sustain consumer borrowing and spending, there will be no savings left to fund anything and prices will be so high that despite massive consumer spending there will be few goods that Americans could actually afford to buy.

For a more in depth analysis of our financial problems and the inherent dangers they pose for the U.S. economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse."

For an updated look at my investment strategy read my just released book 'The Little Book of Bull Moves in Bear markets.'

Comments

[ain't no fortunate son]

Peter, great article... unfortunately it'll go down about as easy as the idea that Americans may benefit by losing a few (dozen) pounds apiece... we're big, Peter, and we like it that way... why, its our birthright!

At least until we're on the gurney.

2008 Oct 12 08:33 AM

[venividivici]

Very good article. The reason Americans get politicians like this is because the only way to get elected to office in America is to promise lower taxes and enhanced services.
This will work only for as long as foreigners are prepared to lend America greater and greater amounts of money.
The only thing holding up this skyscraper built out of playing cards is the principle that America is simply too big to fail and will bring everyone else down with them. But it is now crystal clear that this rotting edifice is no longer sustainable. There's serious pain acoming so brace yourself.

2008 Oct 12 08:40 AM

[investor88]

Good article. We have to brace for a period of pain.

2008 Oct 12 10:31 AM

[Jimmy Lathrop]

Crisis? Pain? Only if you were about to retire and you had your investments in equities (Hint: bad idea)

Crisis? Pain? Only if you are a money manager or your fortunes rise and fall with trading strategies which can be charted and planned.

For the rest of America who were prudent, who didn't borrow and took on low risk, we say, see you at the auction! How low can the prices go? Where is Crazy Eddie Antar when we need him - these prices are INSANE!!!!

2008 Oct 12 11:00 AM

[skysleuth]

Peter,

I read Crash Proof back in December and thoroughly enjoyed it. I promptly put your advice to work and got my investments out of the dollar into non-denominated assets such as foreign funds, commodities and gold. Well needless to say my investments were hammered. I would have been better off selling all my stocks and putting it all in cash in the dollar! The only argument in your book that I had trouble swallowing was that emerging markets were going to be able de-couple from the US. I think it is well proven that at this point the de-coupling theory is dead. Foreign stocks are failing worse than US stocks. The dollar is surging at the expense of most other currencies except the Yen. It's not that I disagree with your premise because your arguments are logical and make sense, they just haven't materialized. All countries are making a coordinated effort to print more money to unfreeze the credit markets, not just the US. I have no idea how this will end up for the US and the dollar. Maybe in the end you will be proven correct.

2008 Oct 12 02:54 PM

[Emerald]

Decoupling is a myth. The U.S. dollar is the only currency people want in a financial crisis. Maybe inflation will follow in two years, but now we are seeing massive debt destruction. This is necesary to get the excesses out of the system.We also need to raise taxes to pay down our massive debt load. The worst part of all this is Osama bin Laden is laughing at us. He said he couldn't defeat us militarily, but could do so financially. He sucked us into an endless land war in the middle east and is causing us to go broke! Also, our main banker is a communist country (China)! Throw the bums out in November and live within your means.

2008 Oct 12 03:11 PM

[henarl]

Yep, the parties over and the wake wont be nearly as much fun. The super rich will still be super rich (of course), the slightly rich will become the middle class, the middle class will become the poor, and the poor will become the lawless rioters. Who you are in this scenario will determine your best course of action but guns and ammo will probably be universally desireable assets.

2008 Oct 12 06:02 PM

[Jack Walker]

How are we going to sell the concept of austerity to a generation that only knows consumption? Our entire economy has been driven by, and encouraged by, our government to consume not produce. The real question is who will provide the leadership to change this deplorable state of affairs? Who has the courage to stand up and tell the “want it now generation” how to proceed?

2008 Oct 12 08:33 PM

[Dean Striker]

This goes back to a part of the cause, in this case inflation. When people see that inflation exceeds the expected return on savings/investment, as they have seen for darn near forever, their incentive is to spend, not to save.

Outlawing manipulation of the money supply by the Fed and Congress would go a very long way back toward encouraging savings. The worst non-saver of all is Gov with it's national debt now past $10trillion.

Too late now, but leading by example?

2008 Oct 13 11:22 AM

[Econ 101]

Pain? How about Dow 3000?

2008 Oct 13 11:23 AM