Chapter 5 Borrowing against the American Dream
U. S. Economy in a Self-Made Vise
June 16, 2010—Delray Beach, Florida Stocks rallied yesterday. The Dow rose 213 points. Gold went up too—plus $9. So many people are buying gold coins that the storage vaults are getting crowded, says a Bloomberg report.
But since we don’t trust the numbers anyway . . . let’s return to words.
Vise is a funny word. It looks like it should be pronounced like vies . . . but it is actually pronounced like vice.
Whatever. The New York Times says it has a grip on Congress.
On the one side, the pols are pressured to cut deficits. On the other, they are pushed to create jobs.
Of course, the Times misses the point. It makes it sound as though Congressmen
were just innocent, well-meaning schmucks, trying to do their best to resolve conflicting pressures.
Not at all. They’re the ones who built the vise. On the one hand, they passed hugely expensive programs. They didn’t have the money to pay for all the boondoggles and bailouts, so they had to borrow. The deficits, in other words, are a problem they brought on themselves. The pressure to cut deficit spending is merely reality raising a boot with which to kick them in the derriere.
On the other side of the vise is the pressure to create jobs. The idea is preposterous flattery. Congress never actually created a single additional job in all its history. Jobs come from productive effort. From making things or providing services—at a profit.
One person pays another to cut his lawn. Another pays a person to fix his teeth. Both the lawn mower and the dentist have jobs. The government, on the other hand, is a job destroyer. It takes away resources that might have been used to hire a dentist or buy a lawnmower. It can put people to work . . . but only by taking away resources, and real jobs, from the wealth-producing economy.
If it wanted to, government could force everyone to work digging holes or counting each other. It could increase salaries and report full employment. But no one would have a real job. And we’d all go broke.
American politicians are facing up to the phony challenge in a phony way. That is, they are pretending to create jobs. The Europeans, on the other hand, say they are cutting deficits. They have to; lenders said they wouldn’t give them any more money.
As Nouriel Roubini put it, in the Old World, “austerity is not optional.”
Here at the Daily Reckoning, we’re with the Germans. The euro feds are beginning to correct a mistake, albeit dishonestly. Americans are just adding on a new one.
Neither Americans nor Europeans are happy with each other’s response. The U.S.
Treasury Secretary accused the Europeans of threatening the recovery by withdrawing demand at a critical juncture. He insinuated that if there were another Great Depression, it would be the Europeans’ fault. Claude Trichet, meanwhile, head of the European Central Bank, says it’s the Americans who are to blame. It was they who came up with subprime mortgages and it was they who permitted Wall Street’s reckless and greedy speculations.
At this point, most responsible journalists and economists would say something such as: “Both sides should put aside their differences, work together, and put the economy back in order.” But you won’t get that kind of earnest drivel from us! It’s just mealy-mouthy nonsense. The Europeans should stop bailing out French and German banks (by guaranteeing the debts of Greece and the other PIIGS). The Americans should stop trying to bail out everyone. Both should stop bailing and merely get out of the way so the economy can collapse if it wants to.
Dear readers may find our opinions too radical. Everyone else does. But the evidence shows that collapse is actually a good thing. Free market economies are remarkably robust. They don’t require the genius of politicians and bureaucrats in order to operate. And when they occasionally stumble and fall, it’s actually healthy for them. It’s how they shake off parasites. Bloomberg reports:
Currency collapses tend to spur a resumption of economic growth rather than
fueling a decline in gross domestic product, according to the Bank for International Settlements.
Currency collapses are associated with permanent output losses of about 6 percent of GDP, on average, though the drop tends to appear beforehand, the Basel, Switzerland–based BIS said in its quarterly review yesterday.
“This suggests that it may not be the currency collapse that reduces output, but rather the factors that led to the depreciation,” Camilo E. Tovar wrote in the study. “To gain a full understanding of the implications of currency collapses on economic activity it is important to carefully examine the full circle of events surrounding the episode.”
The positive effects of a weaker currency on GDP, including making local products cheaper than imported goods, may outweigh the negative ones, such as rising inflation. Currency collapses occur when the annual exchange rate drops by about 22 percent, according to the BIS, which identified 79 such episodes, “more commonly in Africa than in Asia or Latin America,” since 1960, Tovar said.
Why Debt Does Matter
July 6, 2010—Baltimore, Maryland On Sunday, we celebrated America’s independence from Britain.
Having just come from London, it’s hard to see what the fuss was all about. The English seem like decent people. The queen still has her dignity. The British government seems no worse than its American counterpart. And David Cameron appears to have a much better idea of what he is doing than the Obama team.
Cameron is calling for austerity. He wants the British public to make sacrifices so that British public finances can be brought back under control. We have some doubt that he will succeed. As far as we know, no democratically elected government has ever been able to reduce its debt burden during a credit contraction. A number of governments—including the United States and Britain—managed to reduce their debt in the 1980s and 1990s. But that was when their economies were booming. As long as the economy is growing faster than the debt, the burden of debt will decline as a percentage of GDP. The 1980s and 1990s were boom years. Credit was expanding.
People were buying more and more things they didn’t need with more and more money they didn’t have.
Obviously, that kind of boom can’t go on forever. And when it came to an end in 2007, it changed the financial picture for governments as well as households and businesses. Tax revenues went down. Expenses went up. And so did the bailouts and boondoggles that they call stimulus spending.
As deficits rise, so does debt. And so do the voices who tell us that debt is nothing to worry about. Those voices—led by Paul Krugman at the New York Times—mention the debt decline of the 1980s and 1990s. They say we can “grow our way” out of debt this time, just like we did the last time.
Here at the Daily Reckoning, we don’t rule out anything. The day is long past when we said anything with absolute, unshakable conviction. Today, even when someone
asks us our name, we check the initials on our undershirt just to be sure.
Might the United States and Britain grow their way out? Well, anything is possible.
But two things make it unlikely. As we said before, we’re in a credit contraction. It’s part of what we call the Great Correction. Growth rates are going to be low . . . and occasionally negative. U.S. government deficits, on the other hand, are scheduled to be over 5 percent of GDP from here to Kingdom Come. And if David Stockman is right, they could stay over 10 percent of GDP for the foreseeable future. Stockman is the former head of OMB during the Reagan Administration. He predicts deficits as high as $2 trillion per year, thanks to a weak economy and strong spending by the feds.
The second thing that makes it unlikely that we will be able to grow our way out of debt is the composition of the economy. More and more of it is under the control of government. Growth in this economy is largely phony. It reflects activity. But not prosperity. The activity, therefore, is not the sort that you can tap to pay down your debt. Instead, it adds to the debt.
You can see how this works just by imagining what would happen if the feds hired a million census takers. The economy would appear to grow—maybe even faster than the debt. But the economy itself would be hollow and less able to sustain the debt burden.
The other example used by Krugman et al. is World War II. At the end of the war, U.S. debt was equivalent to what it is today, as a percentage of GDP. “Hey, what’s the big deal? It didn’t do us any harm then,” they say.
But the federal government was actually in a much stronger financial position back then. While it had about the same official national debt, it faced almost no off-the- books unfunded liabilities, financial guarantees, and open-ended commitments. The last time we looked, these off-balance-sheet debt items—such as for health care programs—totaled more than $50 trillion.
And then, there’s the private sector debt, too. That’s about $50 trillion, too.
How much net private debt was there in 1950? Almost none.
In the post-war period we were in a different stage of the credit cycle. People were just beginning to spend. They didn’t have a mountain of debt. They had a mountain of savings!
Yes, dear reader, people made sacrifices during the war years. They had put off consuming. Then, soldiers came back from Europe and the South Pacific with pent- up demand, and real savings that they could put to work. So, the economy was ready for a credit expansion, not a contraction. People had lived through the lean years.
Now they were ready for some fat ones. The economy too was ready to rock and roll.
It had been converted to a war footing. Now it was ready to meet consumer demand.
This is the opposite of the picture today. Few sacrifices were made over the last 50 years. Instead, the last five decades were a time of increasing extravagance. That’s why sacrifices are necessary today.
Households are only now beginning to cut back. Governments in Europe are cutting back too—or so they say. And under the sway of Krugman and other neo-Keynesians, the U.S. government continues to run huge deficits . . . hoping that the debt will be
refinanced and repaid, as it was after World War II.
But probably the nicest thing about after World War II was that there was an after World War II. The war had a beginning and an end. When it was over, people were finally able to get on with their lives. The economy was ready to switch to a new phase, too—from making tanks to making hot water heaters. And, finally, governments could stop borrowing and begin repaying their debt.
The major trouble with today’s struggle is that there is no end in sight.
Chapter 6