Diary of a Rogue Economist

Mar 11, 2015

- By Bill Bonner

Bill Bonner
Gualfin, End of the Road, Argentina

Dear Diary,

We're glad we brought out our old "Crash Alert" flag last week. It looks like we might need it. The Dow was down 338 points yesterday.

Back to that in a minute...

"Jorge," we asked our farm manager. "When was the last time you visited Marta Sandoval at Tacana?"

"Oh...maybe two years ago. She was okay then. A little crazy, maybe."

"Don't you have to go every year to count the animals?"

"Not up there. It's not worth it. She only has about 5 goats."

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The farm is a marvel of ambiguity. We own it. On paper. But about 100 people live on it...work it...and use it. In fact, they control some of the best parts of it. They pay us 'rent' in the form of a percentage of their animals - about one in twenty. But since their animals aren't worth anything, we count, but we don't bother to collect. And so, they pay nothing...and they can stay as long as they - or any of their descendants - want.

How long they will want to live in such harsh and lonely conditions is a subject of much conversation and speculation. But most show no signs of wanting to come down.

"They were born there," says Jorge. "They want to die there too."

"Can I ride up to Tacana some time?"

"Yes. The trail is very rough. And you'd never find it on your own. I'll take you."

Back in the world of money, GDP, yields, Kardashian videos, Netanyahu speeches and market crashes...

...to fully understand this strange world we live in...and the strange events that brought us to negative yields, a phony recovery and multiple bubbles, we must go back - once more - ab ovo...from the egg...whence today's curious money system was hatched. For that, we begin with two economists, one living, one dead.

Economist Richard Duncan maintains that a new system replaced capitalism in the Post-War period. This new system no long works with capital, he says, but with credit. "Creditism," he calls it.

In free market capitalism, private companies and private persons own capital and decide how to invest it. Typically, they invest in new projects - factories, industries, housing, technologies - which they hope will produce enough profit to repay the cost of capital, and then some. When they are successful, this results in more capital. Thus does a society get rich.

The old system was limited - shackled to a golden ball and chain. You could only lend money if you had saved it. (Or a multiple of it.) And you could only spend what you had earned or what you could pay back. On a national basis, if a country spent more than it earned, its currency ended up in foreign hands. Then, when accounts were settled, the over spender had to ship its gold abroad, to its creditors, leaving it with less money (gold) to spend and invest. As the money supply went down, the economy contracted...thus restoring balance.

In WWI, the US became the largest holder of gold in world. It sold food, clothing and weapons to the Allies and collected money (gold) in payment. Arguably, America entered the war on the side of the allies largely because they owed her so much money; the US wanted to be sure to get paid. This increase in America's money supply led to a big expansion of credit in the "Roaring Twenties," followed by a credit crunch and depression in the '30s.

By the '60s, the US was no longer collecting gold, but disbursing it. It was over-spending in a big way, on the Great Society at home and the Vietnam war overseas. By 1971, half of its trove of gold was called away by foreigners. This is why the US Treasury "closed the gold window," and changed the whole world's money system.

People didn't know what that change meant then; they still don't. We meditate. We pray. We drink heavily. And still, we struggle to understand it.

The obvious consequence of the new system was that it removed the restraints on lending. Total US credit hit the $1 trillion mark in 1964. Today, it is near $60 trillion. During that half century, total US GDP summed to $477 trillion, in 2009 dollars. So, you may infer that one out of every eight shopping malls, highways, wars, health care costs, university football teams - all were bought on this new and expanded credit.

Real, traditional money disappeared with automobile fins and drive-in movie theatres, in the early '70s. The new money was very different. You didn't have to earn it by the sweat of your brow or the diligence of your enterprise. It could be created, out of thin air, by the banking system, which was led by the Federal Reserve in the US, operating under the terms of a charter granted by the US government.

Unlike capital which was earned by, saved by, and directed by the private sector, this new credit was largely directed by the government. And gradually more and more of it was sent in a new direction, towards consumption, rather than production. The old capitalists might have built a factory; they knew they had to make a profit to pay back the loan. The new creditists would more like finance housing, more automobiles, more student loans, or more payments to old people. And when the bills came due, they could re-finance.

Economists of the era had it all wrong. They thought consumer spending was the key to boosting GDP and increasing prosperity. Actually, it is production that gives consumers the wherewithal to spend, not the other way around. Consumption does not create wealth; it consumes it. And as the economy switched from capital to credit, and from production to consumption, growth rates declined. From about 5% per annum in the '60s, GDP growth has declined to under 2%, and seems likely to sink to only 1% this year. That is the reason that household income growth has been stalled for the last quarter of a century and why the typical family actually has less real income than it did in 2007. And that's also the reason that there are 2 million fewer real, full-time "breadwinner" jobs today than there were in December 2007.

But it is how the new credit system reacts to stress that is our subject for tomorrow...

And for insight into that we draw on one of our favorite dead economists, Milton Friedman.

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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