Has the correction process stalled?

Feb 10, 2011

Baltimore, Maryland

Is the Great Correction over? Not quite!

Nothing much in the markets yesterday. Dow and gold both essentially flat.

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So, let's rehearse what we've learned so far.

Government's main business is protection. Always and everywhere, its chief responsibility is the security of the nation's borders and the safety of its own officers. As a secondary matter, it is concerned with the protection of the people it governs.

Of course, it protects, first and foremost, the interests of the people who control it.

A modern democracy is controlled by competing groups. In a combination of larceny and bribery, almost everyone gets something. Elite and powerful groups get a lot. The less powerful masses get a little.

In the crisis of '07-'09, for example, government moved fast to protect elite interests - with trillion-dollar transfers to the banks and their bondholders.

Then, as the economy weakened, the masses of voters needed bribes too - food-stamps, unemployment relief, shovel-ready jobs, etc.

These measures do not produce genuine prosperity. How could they? They are just boondoggles and bailouts. But they give the appearance of stability and they help keep everything under control.

But how can the feds pay for all this larceny and bribery? They have to borrow...effectively shifting the cost to the next generation. Debts are incurred now. Money is spent now. It is meant to be repaid sometime in the future, by people who benefit from neither the bribes nor the thefts.

The private sector unloaded debt as quickly as it could in '08 and '09. Savings rates went from 2% of disposable income to 7%. We called it a "Great Correction.

But now the process of correcting seems to have stalled. While the private sector threw off debt, the public sector picked it up. And now, it looks like the private economy is beginning to borrow again too.

Savings rates have fallen back to around 5%. Credit card debt has increased for the first time since the crisis began. Non-revolving credit is reported to be at a record high.

Government debt, meanwhile, is soaring. The US deficit last year was greater than all the money borrowed by the US government from its founding until 1986. And the Obama administration will borrow more than all previous administrations put together.

Is the Great Correction over?

Where will this end? Bankruptcy? Hyperinflation? Or revolution?

Maybe all of the above.

But wait. What if the peoples' representatives 'see the light?' What if they turn the situation around, forcing the US government to de-leverage along with the private sector?

Well, anything is possible. But we wouldn't count on it.

Meanwhile, there's another part to our hypothesis. Over time, stable societies become more and more rigid as elites get a tighter grip on them. They become 'zombified,' with more and more of the society dependent on giveaways, bribes, boondoggles, protected markets and redistributed income. In a democracy, that means that the numbers begin to work against evolution. Against change. Against natural correction.

More and voters get more from the government than they pay for it. They will not permit any change to the system, because any change would be harmful to them.

So, over time, governments become less and less able to produce wealth...less dynamic...less responsive to evolutionary adjustment.

How does that work, exactly?

Well, it works in many, many different ways. But here's a simple example. If the crisis of '07- '09 had happened back in the 19th century the big banks involved would have gone broke. Not only that, the bankers involved would have lost everything - including their personal mansions in the Hamptons. Because back then, typically, a banker was personally responsible for his losses. Neither banks nor investment houses had the advantage of corporate protection.

Today, the failures remain in business. The failed executives continue to receive bonuses. Their losses are socialized...picked up by feds and spread to people who don't deserve them - notably, the next generation.

Most people think this process will last forever...with the costs pushed infinitely into the future. But it won't.

'Stability leads to instability,' said Hyman Minsky. We see it coming. Stability makes people think that the system is eternal. They lend to the government at low interest rates...or even accept its new, paper money as though it was the real thing. This permits the government to run up far more debt than it could in an 'unstable' era. The debt then becomes unsustainable...and the system collapses.

When? Who knows? But sooner or later, the lenders revolt. Or the next generation does.

*** As we reported yesterday, young people have extremely high rates of unemployment in most parts of the world. Why? It's explained by our hypothesis.

The older generation is taking advantage of the younger generation, shamelessly. Labor rules help protect existing jobs...but stand in the way of new ones. The cost of public pensions and health care too increase the price of taking on new employees - while rewarding almost exclusively older ones. Union labor contracts favor senior union members, not junior members. Minimum wages laws also pinch unskilled new workers more than their older, more experienced competitors.

We saw this phenomenon in France, which has the most protective labor laws in the world. Small artisans refused to hire young assistants or to teach them their trade. It was simply too expensive and there was too much paperwork involved. They preferred to retire...leaving their businesses to retire with them. In our small town, it became hard to find a plumber or a brick mason - even as the government paid welfare benefits to thousands of young people who "couldn't find work.

*** Poor Merced County, California. USA TODAY reports that things have changed. The Great Correction is still underway:

"Life has changed in ways big and small in this central California county, which is still trapped in the wreckage of a housing boom that went bust five years ago."

The median home price, $116,000, is down 68% from its peak in 2006. Three of five homeowners with a mortgage here owe more on their loans than their houses are worth, compared with about one in five nationally.

Socked by a sharp loss of property and sales tax revenue, Merced County and its cities have slashed budgets, workers and services. The grass is being mowed less often in city parks. A senior center is open fewer hours.

Families have adjusted, too. Forget dreams of making big bucks on California real estate. Many here now count the years - guessing, really - until they'll no longer owe more on their homes than they're worth.

"We're in survival mode, waiting for recovery," says Stephen Hammond, 42, pastor at Bethel Community Church in Los Banos, a Merced County town of 35,000 amid cotton and tomato fields.
More cuts are possible because of looming budget deficits, Merced government officials say. Dozens of other communities nationwide may face the same tough choices in the wake of huge drops in home values, which often lead to less property tax revenue. In Merced, the impacts have hit hard, and they hint at what may be to come for others.

For Merced County government, property taxes are the No. 1 source of general fund revenue, says Scott De Moss, deputy county executive officer. Property tax revenue has dropped 25% during the past three years. Almost 15% of the county's workforce has been slashed. Social and mental health service positions took the biggest hits, officials say.

In the city of Merced, sales tax revenue is down 24% and property tax collections, about 34%, from 2007 levels, city officials say. That's forced cuts in the police and fire departments. Police might not show up anymore to take fender bender reports and firetrucks may no longer always roll on the same calls as ambulances, says Merced City Manager John Bramble. The city's 80,000 trees now get pruned once every three years, instead of every two. The senior center is open 28, not 40, hours a week. Asphalt patches, not new concrete, are being used to repair sidewalks.

"People are used to a higher level of service," says Bill Spriggs, who serves as mayor for the city of 80,600. "But this is the new normal."

In Los Banos, the grass is now cut in city parks every 15 days. It used to be cut weekly. Vacant houses dot nearly every neighborhood. New roads end in cul-de-sacs surrounded by vacant lots. A weather-beaten billboard announces a 35,000-square-foot retail center that is "coming soon" but never has.

The double whammy of the recession and the real estate crash has forced changes in how consumers spend, plan for their futures and view their neighbors. Businesses also have suffered, because homeowners have less equity in their homes or none at all. Overlaying everything is a local economy in which one of five workers is jobless, in part because of the collapse of the area's once-fast-growing home construction industry.

The "last good year" was 2008, says Greg Parle, owner of the Branding Iron Restaurant in Merced. Business is off at least 20% since then, he says. He's adding lower-priced items to the menu.

The region's ability to foster such small businesses will suffer because of so much lost home equity. Almost one-quarter of small-business owners borrow against their homes or use them as collateral to fuel businesses, according to a 2009 Gallup survey of small-business owners. That'll likely be less now in Merced and other places with so many underwater homeowners. Start-ups will feel the greatest impact, says Mark Schweitzer, director of research for the Federal Reserve Bank of Cleveland.

Loreina Childress, 39, a county environmental health worker, has felt the impact of the new normal at home and work.

The previous work of 26 in her department is now done by 21. At home, a lot remains vacant, and there are more renters in her neighborhood than before the real estate bust.

Childress bought her Merced County home in 2006, when the market was still hot. She owes $241,000 on the 1,500-square-foot home that might sell for $140,000.

John Betham, 58, and his wife, Sandra, 55, are staying put. They owe $375,000 on their Los Banos home. They estimate it would sell now for $150,000.

*** We warned him. Former President George W. Bush might as well hand in his passport. Unless he travels to a country where the fix is in, he's likely to be arrested. Here's the report:
GENEVA, Feb 5 (Reuters) - Former U.S. President George W. Bush has cancelled a visit to Switzerland, where he was to address a Jewish charity gala, due to the risk of legal action against him for alleged torture, rights groups said on Saturday.

Bush was to be the keynote speaker at Keren Hayesod's annual dinner on Feb. 12 in Geneva. But pressure has been building on the Swiss government to arrest him and open a criminal investigation if he enters the Alpine country.

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

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2 Responses to "Has the correction process stalled?"


Feb 10, 2011

What a terrible situation.
A great writing of yours, Bill Bonner.
I am on appreciation.
When there is problem on hand, we try to manoeuvre it on a short term basis and ignore far-sighted vision. After all, short term crisis occurs because of non far-sighted approach.

Some of us know it. Others are ignorant or unconcerned as though it is happening in some unknown place.

I feel Boston Consulting Group should do an analysis of the country's economy as a whole ( cause and effect, regression analysis of the various factors etc) and come out with recommendations, as though it is doing it for an enterprise.
All the Governmental Economists roost as though everything is rosy and pleasurable.

With regards,



Feb 10, 2011

Due regards,
No doubt the rot of the past is getting more stingy and messy for the present. The clouds and dense and thick, but the more dark the night is, the bright will be the next morning. On the horizon, from behind does appear a silver lining of hope.. hope for the world to be a better place to live in. .. hope that administrators world over will behave more rationally. or they will be forced out of power. the people power.
Sir, there is limit to stretch. stretch of patience and perseverance and tolerance. The unseen boil going on inside public mind will erupt with venom like a volcano ready to blast.
Its time politicians and administrators realise it and realise it early. god save india and the world.
let hope and expect better times prevail than the despair of the present built up on the rot of the past and continuing present.

Dinesh Kotecha
chartered Accountant

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