An economy needs a correction - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 18 January 2013
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Baltimore, Maryland

Enough of this zombie talk...at least for today.

You're probably ready for some economic insights. Maybe even some financial advice?

Yesterday, the stock market was up by a healthy 84 points on the Dow. Gold rose again to close at $1,690.

All is well, right? The Great Correction ...is it over?

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Well, let's look at where we are. In 2007, the private sector hit a wall. It couldn't go any further. It had too much debt. Lenders and investors were beginning to realize that the debt wouldn't be repaid.

Billions...maybe trillions...of dollars had been lent to people who were not really creditworthy...on the basis of collateral that wasn't worth what they thought it was worth. Housing was in a bubble. It had doubled in the previous 10 years...after only tracking inflation over the 100 years before that. Houses had become so over-priced that the average house was far out of range for the average buyer. And the housing industry was turning out millions more of them!

The leveraging up process had run for 60 years. It began at the close of WWII. It would have come to an end long before, but the feds and their pet economists had a theory. When an economy began to 'correct'...that is, to lay off the BS debt and BS businesses and the BS speculations - the feds thought they should step in to stop it. They thought that a healthy economy always grows. Recessions - or corrections - were things that needed to be eliminated, like lice.

And their theory told them how to do it. When businessmen and investors started to come to their senses and correct their mistakes, the feds would give them more of the elixir that got them so giddy in the first place - cash and credit.

This approach 'worked" for many years - in the sense that the feds were able to stymie corrections and keep the economy in growth mode. More jobs. More spending. More output. More debt.

Until now.

Is the theory sound? No. If you don't correct a child for saying nasty things to his grandmother sooner or later he'll rob a bank. That's our counter-theory. An economy needs a correction from time to time. Mistakes are always made, even by the smartest entrepreneur and the most mathematically-gifted speculator. If these mistakes are not corrected...they compound. The mistakes don't go away. And people don't learn from them. Instead, they continue making the same mistake until the thing blows up.

Take forests. Nature has a way of clearing out the dead underbrush. Forest fires. Stop the little forest fires and you get a much bigger conflagration later.

Nassim Taleb uses the example of restaurants. Imagine a world in which bad restaurants never went out of business. The food would be horrible in all restaurants...because it's easier and cheaper to prepare bad food than good food...and there would be no penalty for bad cooking.

Or, what about airline pilots? Suppose they get drunk in the cockpit. Do you fire them? Or put them at the controls of a new Dreamliner?

Without corrections, the dead wood...the bad food...the incompetent, lazy, stupid, and disastrous things people do... would not be systematically eliminated. We'd have a zombie world....waiting for the Zombie Apocalypse.

Little corrections prevent big ones.

But the feds are trying to put a stop to the debt correction. They want to do it in the worst possible way...by adding more debt!

Will this stop the private sector from correcting?

Here's Gary Shilling:

    We're In For Another 5 Years Of Painful Deleveraging

    The current domestic and global investing environment is dominated by deleveraging, according to Gary Shilling.

    In other words, households and institutions are slashing the debt on their balance sheets.

    And according to Shilling, we still have some way to go:

    "The deleveraging process for both these sectors has commenced, but it has a long way to go to return to the long run flat trends and we are strong believers in reversions to well-established trend. If we simply extend the downward slopes, it will take the Financial sector 9.5 more years to return to trend as bank assets continue to be dumped and capital raised, and 8.3 more years for the Household sector as debts are repaid or written off and assets are rebuilt through a rising saving rate

    ...We continue to suggest about five more years of deleveraging, however, since adding that to the 2008-2012 initial span would bring the total to about 10 years. That's the normal length of deleveraging after major financial bubbles, according to Carmen Reinhardt and Kenneth Rogoff's book, This Time Is Different: Eight Centuries of Financial Folly."

    And the power of deleveraging according to Shilling is "gigantic", because it is offsetting tremendous amounts of stimulus:

    "Witness the fact that despite all the fiscal and monetary stimuli here and abroad since 2008, economic growth remains slow at best.
But the feds will have some success. They will dangle debt in front of people. Some will take the bait. Some sectors will go into bubble mode because of it. Some speculators will bet heavily on it...and win.

No one...not Gary Shilling...not no one...knows what will happen exactly. But we do know something: debt is dangerous. It makes the debtor vulnerable to shocks. And the way it is distributed by the feds - to industries, a financial sector, and households - makes them vulnerable too. All depend on a fantasy: that you can continue borrowing and spending...practically forever.

The feds are printing money -- $84 billion a month. Fed asset holdings - the nation's monetary foundation - are going up 5 times in 5 years. And the real GAAP accounting US deficit is growing 20 times as fast as US GDP.

Warning: The feds are making a big mistake. Just wait until it is corrected!

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

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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2 Responses to "An economy needs a correction"

LOVEPAREEK

Jan 18, 2013

ZOMBIE....ZOMBIE....ZOMBIE.......BILL BONNER, I LUV THIS ZOMBIE SERIES. THE ZOMBIE ROCKS, N PLS KEEP IT GOIN.
HEY, U ALSO ROCK.
RGDS
PAREEK.

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Prakash Baxi

Jan 18, 2013

I perfectly agree with your point of view and quite impressed and influenced by your newsletters Mr. Bonner
. I have some comments as below.
Can prosperity be built with relentless debt ?
Can the problems be solved by relentless printing of money ?
Can an overleveraged economy and lifestyle be sustainable ?
How can there be any alternative to reducing unsustainable expences ? How any meaningful deal on fiscal cliff can avoid impact on US economy ?

I learnt in science the law of conservation of mass and energy . It says ..."The mass can niether be created nor distroyeed . It only changes its form." Also " The energy can neighter be created nor distroyeed . It only changes its form " . Does this law not impact GDP growth ? To put it in simple words, if you excessively exploit the envionment ( water, forests and other natural resources ) to achive higher GDP , will it not ultimately increase inflation by impacting rains and lowering agriculture produce ? Will the increased inflation not further dampen the GDP growth ? Since the whole universe is closely integrated , is GDP ( which count only certain tangible items ) growth an illusion ? Does it make sense to aim to achive excessively higher GPD growth Will it be sustainable ? Can the excesses be continued for ever ?
All the above questions lead to one general fundamental principle and i.e. the nature and world operates in cycles. This has already been told in Bhagvadgita as "Utpatii , Sthithi and laya " i.e. creation and sustenance is followed by distruction. Do the same not applicable to economic progress ? Then why there are such over expectations from the global world that fiscal cliff be resolved , when in realitty the US politicians are enjoying holidays ? Is it not expecting too much ? ds\
With Regards
Prakash Baxi

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