Friday, November 6, 2009
The Great Collapse
| The current economic crisis is considered a recession, on the verge of depression. The reality is that we are not entering another great depression and the more proper term is "The Great Collapse". What has happened in the past, usually will happen in the future. I approach this problem not with the fuzzy mathematics of the economist but with the certainty and empirical evidence of the historian. Recessions and Depressions are trying times for the citizens of a nation. Collapses are a completely different situation. An economic collapse is followed by exponential increases in misery. The more comfortable the population at the time of the collapse, the more violent the retribution. In the United States all but two of the recessions since the Great Depression of the 1930's have been precipitated by the government and specifically the Federal Reserve Bank. These recessions were designed to slow down economic growth, and thus prevent a more serious down turn. Real recessions are usually tied to inventory adjustments. Real economic depressions are usually tied to the popping of a specific bubble, that ultimately spreads throughout the economy at large. The current and continuing crisis could correctly be tied to the bubble in housing prices, but only to a point. And we must look at a few other issues surrounding the collapse in prices to find the underlying cause of the Great Collapse. I should digress for a moment and explain my labeling as a collapse. The Great Collapse is not just a collapse in the price of houses, rather it is a collapse in residential and commercial property, a collapse in credit, and a collapse in the faith of the dollar. The Obama administration has incorrectly blamed former President Bush for this economic mess. The real culprit is the congress with the complicity of the Federal Reserve Bank and several other government agencies. All of these government entities worked in concert to expand not just credit, but credit aimed at increasing home ownership. Purchasing a home always creates a stimulative effect on the economy at large. Homeowners must have lawn movers, washing machines, painting and other maintenance supplies. When the government pushed home ownership on to people who could barely afford the payment and taxes, they failed to consider all of the other associated costs. This was compounded because from the casual outside observer it looked for awhile like every segment of the economy was growing. On closer inspection, we were spending like crazy to make a house payment, pay the new higher utility bill, and buy all the things that are required of the home owner. It was a lofty goal to be sure, but the corresponding effects ran up prices, and greatly increased the risk model of the lenders. Had the risk been naturally mitigated (through higher interest rates) much of the collapse could have been avoided. Alas government stepped in to "secure" the loans and the Mortgage Backed Securities industry exploded. Let's put this in plain English. Banks were not only encouraged, but were in many cases forced in to making very risky loans. The full faith and credit of the U.S. government was enjoined to back these loans through Fannie Mae and Freddie Mac. The loans were then packaged in to very simple (yes, they were simple) instruments and resold. When the peddlers of these packages realized how risky they actually were, they brought in mathematicians to hide the simplicity of the risk through ridiculous equations that were supposed to "balance the risk". They way they did this was by assigning arbitrary scores to the loans, and then mixing up the packages with some high scores and some low scores. While this was a brilliant marketing and sales strategy, it of course lacked any historical pretext or economic validity. Once a small number of the loans went in to default, behaviors changed and all of the loans were now at greater risk. Which loans were risky was anyone's guess. When the tipping point was reached, and a certain number of loans went in to default, the entire package of loans was worth less than what it was purchased for. In short,the balance sheet was ruined and there was no easy fix. Now any financial institution holding these devices found itself unable to lend money, and in some cases unable even to operate its business. Cash flow was negative. This negative cash flow spread throughout the economy. Companies like General Motors were not able to pay the monthly bills and service their debt load. Universities throughout the country had been training business leaders for years that business was no longer business, it was all finance. The manipulation of debt was regarded as some kind of holy grail for business success. Any small businessman or business owner from thirty years ago could have told you this was not sustainable. The collapse in real estate thus precipitated a collapse in credit, and the house of cards collapsed. The government and the Federal Reserve worked together to try to fix the balance sheets. What they did was in its most basic form enter new numbers in to the balance sheets of the banks, and removed the failed mortgages putting them on the balance sheet of the American taxpayer. They did this by printing money. Money is kind of like apples, oranges and computers, the more you have, the less it is worth. ****Why the Great Collapse is potentially so dangerous**** The credit collapse is not rebounding it is in its infancy. When the world comes to the realization that all of the new credit is being offered with newly printed money, the dollar will collapse. Once again the economists and politicians believe that we will see this coming. History tells us clearly that we will not. Currencies collapse not over a period of years or even months, but often in the span of a few days. If just one or two holders of dollars decides that they must reduce their risk the collapse will accelerate and become a final tipping point in to anarchy not just in the financial markets, but in all aspects of life. The scenario is not difficult to imagine. Suppose China were to realize that they have 1 trillion dollars at risk. They do not wish to cause a panic, but do realize that they must unload half a trillion dollars quickly and convert them to gold or Euros. At the same time Russia, or another country sees what is happening and also unloads a few hundred billion dollars. Over a single weekend the speculators world wide see what is happening and panic. They begin to sell dollars. Suddenly millions of people are trying to get rid of dollars and convert them to gold, silver, or other currencies. In the span of three days the dollar would fall to a fraction of its current value, and could conceivably collapse entirely. If the United States government follows the historical lead of Gideon Gono in Zimbabwe, Hjalmar Schacht in Weimar Germany, or countless other financial power brokers since the days of the Roman empire they will attempt to fix the short term problem by printing more dollars. This will ensure the finality of the collapse. *************************** How do we fix it? I've always like the analogy of an economy to a building. It must be built on a solid foundation. The foundation of a strong economy for more than two thousand years has been consistent. A stable currency is the bedrock of not only stability but growth. You can grow your economy only when the currency is stable. Over the past fifty years we've built an economy not on a foundation of reinforced concrete, but ballons. Balloons are more fun to use as a foundation because you just pump more air in to them, and the structure rises. The problem of course is that when one or two of the balloons pops, the rest cannot support the weight of the structure. The way we fixed problems like this in the 1800s was to let the debt be reckoned. Investors lose money, families lose homes and lending is limited to only those with sound credit, and a realistic ability to pay the money back. Families restrain their spending, businesses only borrow that which can be serviced out of positive cash flow. Those who have lost become wiser in the future. The businesses that were built on the old fashioned foundation of positive cash flow begin to prosper and grow, and within a year or two we return to prosperity. So am I advocating a return to the gold standard? No. There are two reasons that a return to the gold standard isn't the fix. First, it won't work. We simply don't have enough gold in reserve. The price of gold would jump to something on the order of $100,000 per ounce. Secondly, and this is most important, empirically there is no need for a gold standard. When we get to the core of the gold standard, gold becomes a yard stick. We don't print more money than we can back with gold at the current worldwide price. If we try to print more money we must simply pay more money to our creditors so the exercise is futile. But we can accomplish a sound currency by simply stopping the printing presses and addressing the damage that has already been done. The expansion of credit should be based on the ability to repay the loan and the profit motive. Many economists and a few politicians tie monetary policy to fiscal policy. The rest of the politicians (and I mean most of them) have no understanding at all of monetary policy or history. But this correlation to fiscal policy is not right. Monetary policy is dependent on regulatory policy much more than fiscal policy. The expansion in money supply will cause inflation once the currency begins to circulate. There is no way around it. But we can lessen the effect of inflation by decreasing regulation and thus increasing productivity. Productivity is the only antidote to inflation when money supply is increasing. Friedman and the rest of the Monetarist may have been correct in suggesting that money supply determines economic performance. Today, far too many people leave it at that. They neglect to study the underlying issues surrounding the manipulation of money supply. When it is considered, they simply tell you we must contract the money supply when the economy rebounds. To date no nation has been able to manage the contraction without causing damage somewhere else. I believe one of the biggest reasons for this is that the monetarist don't have any power over the politics. Current Fed chairman Ben Bernanke is a student of the Great Depression. I think that most of the things he espoused in the before he became chairman were correct. When he became chairman he seems to have lost his religion, much like his predecessor Alan Greenspan. Greenspan was a former Ayn Rand acolyte who became a big spending, money printing monetarist shortly after assuming his position. Bernanke once believed that if the government was to increase the money supply it should do so through tax cuts. This would have been a better approach than the targeted stimulus. The trillion dollars in stimulus money have led to an unemployment rate now well over 10% and it shows no signs of shrinking. This is because there is no computer in the world big enough to tell you how people are going to respond to the recession. Everyone acts in his own interest, and his actions are based on what he believes to be a logical outcome to the act. ****The first step is to fix the foundation***** To fix the problem, we first need to fix the currency. The best way to do this at this point is to increase productivity. We can easily increase productivity by lowering the cost of doing business. The only way for government to do this is by de-regulating. We could also increase productivity and reduce business cost by lower the cost of oil. Oil effects everything. It is the golden commodity that magically effects the cost of every other commodity. The government need do nothing but get out of the way and let the oil companies drill for oil. Stop the expansion of the money supply, and increase productivity through every means possible. ****The second step is to fix the risk model**** To do this we must slow down the spending and regulatory machine congress is creating. We need look no further than the currently proposed health care regulation. Republicans have been shouting to all who will listen that Medicare is 40 trillion dollars in debt, by which they mean underfunded, and thus we cannot pile on additional government spending or we will destroy Medicare. Very sober economists tell us that if the government were using real accounting methods, we would expose this debt and it would be "on the books". This is not true at all. Health care is much like any other industry in the modern world. Its future costs will be largely determined by technological innovation. While the promised outlays are real, the cost itself is unknown until we get closer to the date which the money will actually be spent. If innovations proceeds unfettered the cost will go down. Congress in its infinite wisdom has decided to do everything in its power to halt that innovation. THERE IS NOTHING MORE DANGEROUS IN THE CURRENT HEALTH CARE PLAN THAN THE 2.5% TAX ON MEDICAL DEVICES. This tax will create an instant barrier to investment in health care technology. To fix this problem congress should remove the tax, and lower the capital gains tax on health care related technology to a big fat 0. This is the kind of policy that lowers risk and encourages nvestment and innovation. To lower costs and increase productivity and investment throughout the rest of the economy, the capital gains tax rate should cut in half. On the health care side we would see much of the money currently sitting on the sidelines go to work finding a cure of cancer, more efficient and affordable design of medical devices, and lower cost treatment for diabetes. Imagine for just a minute how cheap health care would be if MRI machines were like computers and the cost fell by 70% or more. Health care costs would plummet. **** The third step is to prime the pump**** This is largely at odds with what I have suggested previously, and I get that. But we have so screwed up the initial stimulus spending that it has actually been counter productive. Congress and the president have been trying to prime individual pumps, or segments of the economy. The cold hard truth is that fixing roads and repairing potholes does nothing to increase productivity. Thus it has no mechanism to create real jobs. In an economic downturn today, small business creates all of the jobs. We need to prime the pump of the entire economy. Everyone needs to benefit, because we have no way of predicting the actions of people. Here is the only stimulus plan that will work. It should be paid for by cutting spending, and if congress cannot agree where to cut, it should be cut across the board at the federal level. There are more than 1 million small businesses in the United States of America. Those of you that work for a large business are still entirely dependent on small business. General Motors and General Electric cannot survive without the employees of small business buying their products and services. The stimulus price tag for one year would be three hundred billion dollars. Yes, it is big money. The money should be returned to small business. This sounds like Obama's current plan to offer tax incentives to small businesses that hire new employees. That plan will fail spectacularly. This is because small busines A, may not need more employees, it may need to purchase a new fleet of trucks, or new computers, or machine tools. If he cannot keep his current employees busy, why would he hire more, and how would that grow the economy? It will not. If on the other hand he receives a check for then thousand dollars for every employee up to ten employees, he can buy what he needs. Then the small business owner at company B who sells and installs equipment will hire people.This is Keynesianism at its finest. We cut spending and government does what it does best, gets out of the way. But we cannot simply print the money to do this. We must cut spending to pay for it. In less than three months unemployment would be falling, GDP would rise, and real productivity would be increased. If we couple this with regulatory changes, and increased incentive on investment we can fix many of the problems that confront us. Why is this so simple? Because the truth is economics is simple. Supply and demand are always dependent on productivity and cost. Today is not the day for cap and trade, new environmental regulations, and massive expansion of health care spending. Tomorrow may be that day. Today is the day to rebuild the foundation of the economy. We must do it the same way that it has been done successfully for thousands of years. From Queen Elizabeth to Ronald Reagan, we must return to the things that work. History has delivered to us the gift of a clearly lighted path. But that path has a fork in the road which is just as clearly lit. On one path our future is secure, and we enjoy our lives as we have. The other path leads to misery the likes of which we have not seen in centuries. During the Great Depression, the faith in the dollar was never in serious jeopardy. Today, this is not the case. When currencies and credit collapses, governments collapse. Nations with a history of representative government do not tend to devolve in to tyrannical and repressive governments. This is however slim consolation. A broken government does lead to persecution of those the populace believes to be at blame. It is never satisfying to blame an individual, the masses prefer to blame smaller groups. The biggest problem our nation faces has little to do with economic policy or politics in general. It has to do with our mistaken belief that stability and comfort are the norm and that freedom and liberty are generally protected. They are not. The lesson of history is not that those who fail to learn from it are destined to repeat. This nothing more than an obvious bromide used by politicians to scare you in to buying their policies. The real lesson of history is that citizens who are not diligent in protecting their freedoms will lose those freedoms, and in many cases their very lives. History shows us clearly that the natural progression of man and government is a short burst of prosperity followed by a Hobbesian existence, nasty brutish and short. We are at the historical tipping point. There is no time left. Those on the left of the political spectrum must now come to the realization that there is no money left for big government programs. There may be in the future, but you must live to fight another day. Those on the right must realize that the Republican politician in Washington does not have a good track record of over turning laws or eliminating programs. They may de-regulate, but if they return to power they will face the same pressure to print money. If you want to know if the politician is on the right track, his words should not be comforting, but honest and quite frankly a bit frightening. There is always hope for tomorrow, but hope runs thin with time. Now is the time to rally around the words of former president Bill Clinton, "It's the economy stupid." When the economy is growing and the treasury is flush with cash all things seem possible and many are possible. When the currency is devalued, the debt burden is overwhelming and businesses are regulated to the point of stifling the entire economy, nothing is possible and misery is on the only thing on the menu. Before we begin the arguments of the future, we must fix the foundation. |
| |
<< Home