Products of the past are doomed

Jan 17, 2011

Paris, France

Products of the past...doomed...

Chinese President Hu Jintao: the US dollar-based monetary system is a "product of the past."

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He is right about that. And last week two major US credit agencies - Moody's and Standard and Poor's - underlined the point. They said America's triple A credit rating would be lost if the nation continues to borrow so much money.

Amen to that, brother...

But how can the US borrow less?

Ben Bernanke says the US economy will probably grow between 3% and 4% this year.

Pretty good, huh? We can stop worrying, huh?

Wait a minute. We don't know if the US economy will grow this year...and neither does Ben Bernanke. But even if it were to grow at 3% to 4%...would that mean we were enjoying a genuine recovery? Could the US dollar-based monetary system hold up after all? Could it surprise the Chinese and be a product of the future as well as of the past?

Let's see how the present economic model works. You spend $10 trillion on bailouts and stimulus. This puts the whole country on course for bankruptcy...where the Chinese are telling you that your money is history...and the rating agencies are threatening to take you down a notch or two. But for your trouble you get, say, 4% growth.

Hmmmm...4% growth is equal to about $560 billion more GDP. But don't look too closely. Much of this extra GDP is debt-fueled government boondoggling which add nothing real to the nation's wealth.

But in order to keep this "growth" going, you have to continue to run deficits - of about a trillion dollars a year. Hold on...what kind of business is Ben Bernanke running?

It costs more in deficit spending than you get in positive GDP growth.

Well, maybe you lose money every year...but you can make it up in the long run!

Hold on...the deficits are expected to run 5% to 10% of GDP for years. Maybe forever. If the growth rate is only in the 3% - 4% range, it will mean that debt always outgrows growth. In fact, that is exactly what almost every economist projects.

Then, what's the point? Well, maybe deficits can be cut...and the growth rate will pick up? Hey, anything is possible. And since we're starting out in 2011 with a positive attitude...we're ready to believe anything.

And maybe that's what gold speculators were thinking on Friday. They sold gold - taking the price down $26 an ounce. Gold rises as confidence in the financial system falls. If gold is falling, it must mean the confidence in the Bernanke, Geithner team is increasing.

Based on the evidence so far, we'd have to take the other side of that bet. If Bernanke & Co. have any idea what they are doing it is not apparent from the public record. Even now, in the 5th year of the Great Correction, they still seem unable to see what is going on.


"We got in trouble in the first place by making too many bad loans, right. So you've got to make good loans. We've got to have credit worthy borrowers."

It may be that, in private, Bernanke has a clearer view of things. But we cannot tap his phone or channel his dreams. All we have to go on is what he says...and does. So far, he has said or done nothing that gives us confidence in the man.

He's right: we got into trouble by making too many bad loans. But why did 'we' do that? Because the Fed lent money too cheaply! It encouraged speculation and risk taking - especially by the banks, who must have known that they would be bailed out if they got into trouble.

And how could the Fed remedy the situation? Easy. It could raise rates - just as Paul Volcker did. It could put the squeeze on speculators. It could raise reserve requirements. It could allow the banks to go bust...send them a message they wouldn't forget.

But what has Bernanke done? Just the opposite. He has rewarded the reckless speculators by buying up their bad bets (adding $1.7 trillion in trashy mortgage backed securities to the Fed's core holdings). He has cut rates even more...bringing the effective rate down to zero for privileged borrowers. And he has created the illusion of 'recovery' - by goosing up prices of stocks and commodities.

Bad policies. Bad in the short run. Worse in the long run.

*** You know what else is a product of the past? Solar panel manufacturing in Massachussetts. The state gave Evergreen Solar at least $45 million in subsidies. "Green" technologies got help from the federal government too - in the form of tax breaks. But last week, the company said it was moving its manufacturing business to.....China!

*** And guess what else is a product of the past - Paul Krugman. The New York Times columnist tries to explain the division in US politics as a split between Republicans, who want less government and more liberty, and Democrats, who want more government and more fairness.

Yeah, yeah...

In Krugman's simpleminded is a struggle between good and and dumb...progress and backsliding. He sees the democrats as the good guys. The republicans are bad guys.

Such a simpleton's world must be a comfort. You don't really have to do much thinking. Everything is black. Or it is white.

Too bad for Krugman, but most of the world is actually gray. If the republicans were so squarely in favor of limited government and liberty, how come they didn't actually cut government spending when they had the chance? They ran the show for years. And during those years government spending went up faster than it did under the democrats.

A look back over the last 100 years finds trends that go way beyond republican or democratic administrations. Almost every year, the reach of the federal government expanded. More people were covered by more programs...with more debt and spending obligations pushed farther into the foggy future. Now, according to Prof. Laurence Kotlikoff, the full measure of that unfunded, largely off-the-books, debt is over $200 trillion - making the US government, effectively, insolvent. And that didn't get there just because of democrats.

Nor will electing a republican make it go away.

And guess what else. If you look at the situation here in France, you see much the same thing. The cultural references are different. The debaters use different words and different concepts. There are no democrats. And yet...except for the fact that France no longer has imperial aspirations...the situation is much the same. The government has promised everything to everybody.

Look...according to our new Daily Reckoning theme...political parties, voting, the blah, blah of partisan well as Paul Krugman...

...they are all almost irrelevant...all 'products of the past'...


...full of sound and fury, but signifying nothing.

The real trends are bigger than that. What is at stake here is a model of government that began with Otto von Bismarck. It is a model in which the state supposedly serves the interests of the citizens. (Under the previous model, there were no citizens...just subjects who owed a duty of obedience to the sovereign...and in exchange received protection.) In Bismarck's model, citizens give up a portion of their output...and stand ready to protect the state with their lives. In return, the state gives them the right to participate (through elections etc)...provides protection from foreign states and domestic outlaws...and makes sure that their physical needs are taken care of.

This model seems to be headed for bankruptcy. The big question is: when the state is unable to provide the benefits it has promised...what will happen? Will the masses accept less? Or will they revolt? Or will a new model evolve...peacefully?

Stay tuned.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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1 Responses to "Products of the past are doomed"


Jan 18, 2011

Wasn't the bismark model of govt. evolved in britain?? parliamentary system of govt??

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