|You can't wish away the bad debt
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"Data raise fears over faltering economy," says this morning's Financial Times.
What a surprise! What happened to the recovery?
The Dow fell another 41 points. Gold got hammered for a $39 loss.
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Why would gold go down so much? Because people are finally realizing that deflation is the real risk, not inflation. Gold could continue to slip and slide for a long time now... It's hard to say. It can rise in a deflation. But it depends on how volatile and uncertain the markets appear. In a stable, Japanese-style slump, gold could go down and stay down for many years.
But you know our thoughts on the subject. We'll see all kinds of 'flation' before this crisis is over. Deflation. Inflation. Stagflation. Hyperinflation. You name it!
The latest news tells us that jobs are down. Treasury bonds are trading at their highest point in 14 months. A 10-year Treasury note yields just 2.93%.
As dear readers know, the feds can't really make bad debt go away. All they can do is move it around. The parties to the transaction - creditors and debtors - usually decide among themselves who bears the losses. Typically, if the debtor can't pay the creditor loses his money. But when the feds step in almost anything can happen. But nothing good.
The general government plan is to collectivize losses - either by moving them onto the taxpayers or by moving them onto the general public. When the government borrows money to fund its bailouts and boondoggles, for example, it is taking losses away from the people who deserve them and sticking them on the taxpayer.
If they can manage to boil up a little consumer price inflation that is even better. Then losses seem to disappear into the air...like noxious fumes. The entire public breathes them in and gets a little light headed. It doesn't know what to think or who to blame.
In the present case, some economists favor sticking taxpayers with the losses. Others are squarely against it, preferring to force the losses on the general public by means of inflation.
The trouble is, these cockamamie plans tend to have unanticipated consequences.
The Japanese feds really pulled a fast one, in this regard. They borrowed from their own people in order to fund a 20-years bailout/boondoggle program. The idea was to provide "counter-cyclical stimulus."
Naturally, the stimulus never seemed to stimulate anything but more stimulus. The program went on for two decades...and, as far as we know, the Japanese economy is still limping along.
The effect economists did not anticipate was that the economy did not take off. Instead, there followed two decades of on-again, off-again slump. Which is why it would have been better to let the creditor and debtors work out their problems on their on...let them take their losses back in 1990...and be done with it!
Another unanticipated result has not yet been fully realized. The government took savings from Japanese households and spent it. Now, a whole generation of Japanese old people looks to government bonds as the source of its retirement wealth. Trouble is, there is no wealth there. The feds took credits and turned them into debits. They took the surplus wealth of an entire generation and squandered it. Now, instead of looking to stored-up wealth for their retirements, the Japanese have to hope that the next generation will be kind enough - and able -- to keep up with the debts laid upon them.
Trouble is, the next generation has too much debt to carry. Government bonds outstanding equal nearly 200% of GDP. At zero interest rate, it's not too hard to keep up with the interest payments. But even the Prime Minister is beginning to wonder how those debts will ever be repaid. And interest rates will not stay low forever.
Imagine that inflation rose...and that investors got nervous. Imagine that the carrying cost of that debt rose in Japan as it did in the '70s in the US. At 10% interest, the cost would be one fifth of GDP - or about as much as the entire government budget.
Obviously, the system will fall apart first...leaving Japanese retirees with a lot less money than they thought they had.
*** Here's a thought. The G20 meeting ended with a call to reduce deficits. The Obama team, on the other hand, warned that cutting deficits might undermine a very fragile recovery.
There seems to be no understanding of what is really going on. We are in a spell of debt de-leveraging in the private sector. There is no way to make the problem disappear. The only real question is who will bear the losses. We've seen what happened in Japan. That's the alternative that most economists are urging (only they claim that this time the stimulus will work...if we keep at it).
But what if governments really take the path signaled by the G20? What if they cut spending? What then?
Well, then you'd have de-leveraging in the private sector. And de-leveraging in the public sector. At the same time. There would probably be hell to pay for a while. But it would at least cure the real problem rather than just disguising the losses and collectivizing the costs.
But don't worry, dear reader. There is almost no chance that governments will follow through on their promises to de-leverage. Instead, they will reduce the rate at which they are adding debt. The private sector will continue to de-leverage. Government 'austerity' measures will be blamed.
And then? Well...who knows? But that's probably when the printing presses get turned on...and gold enters the third and final stage of its bull market.
Who pays bad debts?
A front page photo in Tuesday's Financial Times shows lightning striking near the Parthenon. Zeus must be reading the paper.
Greece is supposed to cut its public spending by an amount equal to 10% of its GDP. Even so, its public debt is expected to rise to nearly 150% of GDP by 2016 - or three times the level of Argentina when it defaulted in 2001.
It should be obvious that the Greeks owe too much . But so does almost everyone. Every kind of debt is so heroic it poses an affront to nature and a challenge to the gods. Much of it is unpayable. Private debt. Public debt. Short term. Long term. US. England. Europe. All kinds of debt in all kinds of places. In America's private sector, for example, debt exploded 6 times faster than GDP since 1950. And today, the whole world staggers under debt, with more than $3.50 of debt for every dollar of GDP.
Today's global economic problem is breathtakingly obvious: too much debt. The solution is obvious too; debt that cannot be repaid must be destroyed - by defaults, foreclosures, bankruptcies, write-downs, and restructurings.
Nouriel Roubini, writing in the Financial Times this week, is on the right track. Greece cannot bear the weight of all its debt, he says. Since it will default sooner or later, better to restructure the debt now...reducing it to a level the Greeks can actually pay. Fair enough. Creditors would take their losses in an orderly way.
When the debtor cannot pay, the creditor should take the loss. But practically the entire burden of modern economics over the last 3 years has been a scammy effort to shift the losses to someone else.
To bring the readers fully into the picture, the great debt build-up began with Reagan in the White House and Thatcher at #10. Reagan added to deficits. Thatcher cut them. On the west side of the Atlantic, economists called on Reagan to stop spending. On the east side, 346 economists implored Maggie Thatcher to spend more.
Reagan's young budget director, David Stockman, resigned in protest when the Republicans wouldn't bring deficits under control. Meanwhile, Maggie Thatcher was told that her austerity policies would "deepen the depression, erode the industrial base and threaten social stability." She should do a U-turn immediately, said the august economists. "This lady's not for turning," she replied.
It didn't seem to matter what anyone thought or did. Markets do what they want. Back then, interest rates were coming down. The US 10-year Treasury yield fell from 15% in 1980 down to under 3% today. In that tender, delightful world, debt was no problem for anyone. Even if you wanted to default, the banks wouldn't let you. They offered to refinance your debt at a lower rate. Both Britain and America grew; their debts grew too.
Private sector debt peaked out in 2007. Households and corporations have been de-leveraging ever since. But as the private sector taketh away, the public sector giveth more debt. And again, markets are doing what they want. Interest rates are already at the lowest levels in a generation. This time, economies cannot cut rates and grow their way out of debt. Instead, someone will have to pay. Who?
The world's economists have no better idea what was happening in the 21st century than they had in the 20th. They neither saw the crisis coming, nor knew what to do when it arrived. Their panicky 'rescue' attempts wasted $10 trillion. They claimed they had put the world on the road to 'recovery' and claimed victory over the credit cycle. They might just as well have claimed to have conquered sin or exterminated cockroaches.
Neither governments nor their economic advisors can make bad debt disappear. They know that as well as we do. All their sweating and grunting has another purpose - to decide who gets stuck holding the bag.
Taxpayers, for example. That is the general drift of the Germano-Anglo-Canadian proposal. 'Austerity,' as they call it, means higher taxes, fewer services, and bailouts of the financial sector. The big banks won't pay for their mistakes. The public will. Martin Wolf and Paul Krugman are wrong about many things, but they're probably right that the side effects of this bitter medicine; it will probably deepen and prolong the slump. It will cause a 'third depression,' says Krugman..
On the other hand, Krugman, Wolf and the other neo-Keynesians have a bad proposal of their own.
"..governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending," writes Krugman.
If too little spending were the real problem, it would invite the most agreeable fix since sex therapy. Every government would lend a hand. Alas, the real problem is the opposite. It is the consequence of too much spending - debt. More government spending means more debt.
Who will pay it?
Taxpayers? Consumers? Savers? Investors? Lenders? The young? The old? Nobody knows for sure. But everybody is surely going to find out.
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.
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