|The perils of debt financing
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The Europeans are trying to find a way out of their debt mess.
"Paris and Berlin in last-ditch Greek talks," says this morning's headline at the Financial Times.
Americans are studying maps and watching the stars too.
Meanwhile, over on the other side of the globe, the Chinese seem to be checking the trees for moss.
All the authorities are lost. They wandered into a swamp and forgot to drop bread crumbs. The poor little lambs. What can we do to help them?
This morning we were struck by the illusion of comprehension. That is, for a brief moment, we thought we could see what is going on. For the benefit of central bankers, policymakers and dear readers everywhere, here is what we saw:
It looked a bit like a rhinoceros. But dressed in a pink evening gown. It seemed to have had too much to drink. Or maybe it was just stupid. Every time someone approached, it said: 'Put the bunny back in the box.'
What does this strange vision mean? Well, it's obvious, isn't it?
Let us explain.
In the 18th century, part of the world began an epic growth spurt - made possible largely by harnessing stored up energy in coal, and more importantly, in oil.
By the late 20th century, the developed economies were far ahead of the rest of the world. But it was also at the point where they could no longer deliver high rates of growth. First, the marginal utility of further energy inputs - increasingly expensive ones - declined. Then, after the crises of the '70s, in order to continue making material progress, households and governments leveraged their balance sheets. That is, they switched to debt financing, effectively consuming goods and services that should have been left to future generations. In 1949, when debt expansion in the US began, the private sector held only about 30 cents of debt per dollar of GDP. By 2007, it had risen to $2.60 to every dollar of GDP. And for every dollar of extra GDP in the '50s, it took only about $1.40 in credit. By the end of the cycle it took more than $5 in credit to do the same job. In other words, the marginal utility of further inputs of debt had declined ...to the point where more debt was unwelcome as well as ineffective.
As demonstrated by Reinhart and Rogoff, when government debt hits 90% of GDP growth rates fall by 1%. This is just what has happened in the US and elsewhere. The US used to run at about 3% GDP growth per year. Now it is at 2%.
Meanwhile, the un-developed countries, those that have not fully taken up the energy-guzzling ways of their more advanced brethren, are able to grow at rates the US and Europe haven't seen in years. China, India and Brazil are all growing at more than 5% per year.
And while the middle class in the US is threatened with extinction, in other places it is booming. The Financial Times:
"In the past 10 years, the income of the poorest 50% of the [Brazilian]
population grew 68% in real per capita terms, while the income of the richest 10% grew 10%.
The trouble with 2% is that it isn't enough. Especially when much of it is phony, government-driven 'growth.' Today, one of 6 Americans is on Medicaid. One of 4 children is on food stamps. A record 44 million all together get food stamps. And 59% of Americans now get some of their money - one way or another - from the government.
Two percent GDP growth is not enough to absorb population growth and bring idle workers back into the active labor force. And it isn't enough to keep the US economy from dipping into recession from time to time; it is too near 'stall speed.'
More important, it is too low to allow the feds to 'grow their way' out of debt. Au contraire, the debt gets worse and worse...until the system blows up. The US deficit is about 10% of GDP. At 2% GDP growth, the debt is growing - net - by about 8% per year. Not getting this debt under control is 'suicide,' wrote Glenn Hubbard, former chairman of the Council of Economic Advisors to George W. Bush.
He's right. But so what? The present version of the US economy is going to die anyway. With growth depressed, the only thing that can be done is cut spending and raise taxes. Those things - if you could do them politically -- would further depress growth rates...making the situation worse, and probably tipping the US into a Second Great Depression.
There. Is that clear? Hope so.
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*** In Europe or America, the situation is basically the same. The central authorities can rescue anyone they want. They have printing presses. But there are costs to money printing.
America's conservatives are afraid the nation will be driven to bankruptcy...unless they are able to get control of the situation now. Or, they are merely afraid that Obama will be re-elected. They don't know which result they like less.
And this just in...Germany has its own 'Tea Party.' These people definitely don't want to see Germany's credit besmirched and sullied by the irresponsible politicians who places like Greece.
So, yes dear reader...politics has caused the problem - spending more than people can afford to pay in taxes. But now politicians seem to be coming out with their hammers and wrenches, offering to fix it.
Will they succeed?
We doubt it. We learned years ago that it really doesn't matter what anyone says...or thinks. History has a mind of her own. She goes whither she will.
Have you noticed how all the major developed nations are more or less in the same boat? Ja, some barks are more seaworthy than others, especially Germany's sturdy vessel. But all are shipping water...and all are headed in the same direction.
How come? Wouldn't you expect one country to have radically different ideas from another? Wouldn't you expect that one country would have capable, intelligent leadership, even if the others were led by morons?
And yet, with the possible exception of those people whose native language is German, we are all in this together. Higher and higher debt. More and more zombies. No end in sight.
Why? Because History is calling the shots. Not us as individual, thinking, responsible, rational human beings.
Humans, you will recall, are neither good nor bad, but subject to influence. Under the influence of popular democracy, oil driven machinery, and the social welfare nation state, almost every developed nation has made the same choice - to go broke.
In this the US was exceptional too. Only America had imperial pretensions. Only she not only ruined herself with zombified social welfare spending ...but also with zombified spending dressed in khakis. Military bases were kept open and operating only because they were in particular congressional districts. Weapons were ordered only because they made jobs available in others. And all around the US Capitol Beltway, trillions were spent on consulting, software, manufacturing, and furnishing the biggest, fattest, softest, best supplied, most high tech, and least productive armed forces in history.
Scratch a military man and you will often find a zombie. Or you'll get punched in the mouth.
*** Of all the dumbbells in all the world, Larry Summers is in a category by himself.
The former US Treasury Secretary and Harvard President must be a man of action; thought is not his thing.
In Monday's Financial Times he does a fair job of laying out the problem. In short, you can't continue giving money to governments that have no way of paying it back. Lending at below market rates to these borrowers only makes the eventual restructuring that much more painful.
Okay so far...
Then, the poor man shifts from sharp description to dead-head prescription. Like all meddlers, his meddles are only sensible if you assume the world will stand still for them. It won't.
"European authorities must restate their commitment to solidarity and recognize that the failure of any European economy is unacceptable."
Hmmm....why? Aren't their some that deserve to fail?
Then, "there must be a clear commitment that, whatever else happens, no big financial institution in any country will be allowed to fail."
Holy cow! What kind of advice is this? Just tell the big banks that they won't be allowed to fail. And don't forget to tell Greece too.
Then, try to get the bonus-driven traders to be more careful! And try to get Greek unions to agree to wage cuts...when they know full well they don't have to do so. You might just as well give the key to your liquor cabinet to your alcoholic brother in law and introduce your daughter to Dominique Strauss-Kahn.
Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.
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