From a brilliant observer writing from Javea, Spain. An essay from someone well worth listening to. I strongly recommend reading it, carefully. The November electons are coming, and they might be the last exit off the road we’re traveling.
“Summer Holiday? I wish it were…”, Raoul Pal, GMI, August 2008 — Excerpt:
The World’s biggest mess
Firstly, the assumption is that the US is going into a nasty recession followed by the UK, Australia, New Zealand, Spain, Germany and most of Europe. We are also going to see big dents to growth in Asia, but will probably be avoiding stall speed.
It’s the Magic Cycle
And let’s be clear why we are in this mess. The business cycle is heading towards its lows. This “Magic Cycle” moves all asset prices and uncovers the excesses of the preceding upcycle. It is a “magic” cycle because it has been going on for thousands of years in one form or another, and it alone allows for the long-term functioning of the economic system. (Trust me, recessions do a much better job of managing the economy than central banks do!)
The Fed thinks they look good… hmmm
However in recent years, overly rapid and aggressive use of interest rates by the Federal Reserve to cushion the economic blow of the downside of the business cycle, has led to an avoided recession in 1987, a mild recession in 1990, an avoided recession in 1996, another avoided one in 1998 and a very mild one in 2002. It looks on paper that it has been a very successful policy for the USA and economic commentators; the Fed themselves and investors have been high-fiving.
But it’s appalling economic mismanagement
The dark side of the policy, whilst blindingly obvious to many, seems to be a complete surprise to the Fed, the US Government and households in general. Essentially the Fed has underwritten the risk in the financial system and not allowed the system to purge itself of excessive borrowing/lending. It is a system that rewards risk-taking through the use of leverage.
Leading to the biggest credit bubble in World history
Cut to the biggest equity bubble in US history, then the biggest housing bubble in US history… all financed by the biggest credit bubble in global history. Borrow money and invest it to get rich! Who needs to save money when I can make capital gains so easily to fund my retirement? That was the plan, anyway.
My god, it’s going horribly, horrifically wrong. Equities in the US, in real terms have now produced zero returns since July 1997. Eleven years. And there is no end in sight. We are into the second lost decade.
Broken.
The system has been so abused that it stretched to breaking point. It has now broken. Forever. Banks are falling by the wayside on a daily basis. As I have written previously, I have never seen anything like this in history.
The total stupidity of the US getting to the point where they are 100% of World GDP in debt is unfathomable and shameful. It is economic mismanagement on an incomprehensible scale. Essentially they have borrowed one year’s income from every man, woman, government and corporation on earth to fund this lunacy.
I’ll say it again… debt is the inverse of wealth… it’s all false ego-flattering. And for what? To pretend that its economy grows faster than it does? To pretend to be richer than it is? To paper over the cracks that it is not globally competitive or productive enough to sell any product that the world actually wants to buy, except maybe the iPod?
Blind arrogance in their system
It should never have been allowed to happen and they have sown the seeds of their own demise through blind arrogance. The system has now been pushed so far beyond its limits that it is completely broken as a model. Well done the USA. Total genius.
This is going to take decades to sort out
Arguably no developed country has ever made such an economic error of this scale. It is so large that the ramifications are going to take multiple decades to sort out. People in corporations get jailed for running companies like this. In a nutshell, it is the beginning of the long decline of the Anglo-Saxon debt-based, central bank-managed, economic model.
Game Over. {end excerpt}
Please share your comments by posting below (brief and relevant, please), or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).
Other posts in this series about America, how we got here and how we can recover it
- Forecast: Death of the American Constitution, 4 July 2006
- Diagnosing the Eagle, Chapter III – reclaiming the Constitution, 3 January 2008
- A report card for the Republic: are we still capable of self-government?, 3 July 2008
- Americans, now a subservient people (listen to the Founders sigh in disappointment), 20 July 2008
- de Tocqueville warns us not to become weak and servile, 21 July 2008
- A soft despotism for America?, 22 July 2008
- The American spirit speaks: “Baa, Baa, Baa”, 5 August 2008
- We’re Americans, hear us yell: “baa, baa, baa”, 6 August 2008
- Obama describes the first step to America’s renewal, 8 August 2008
- Let’s look at America in the mirror, the first step to reform, 14 August 2008
- Fixing America: elections, revolt, or passivity?, 16 August 2008
- Fixing American: taking responsibility is the first step, 17 August 2008
- Fixing America: solutions — elections, revolt, passivity, 18 August 2008
- The intelligentsia takes easy steps to abandoning America, 19 August 2008
For all posts on this subject see America – how can we reform it?.
President Hoover wrote in his Memoirs that Mellon, as Secretary of the Treasury, had
“… only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people. ”
Advice that Hoover chose to ignore. From the Wikipedia article on the Great Depression.
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Fabius Maximus replies: A powerful and relevant quote. Here is my comment on this from “A happy ending to the current economic recession“, 12 February 2008:
We already hear similar recommendations. Are they correct? Ask God for when you see him, for the question is irrelevant in this world. Politicos adopting such views will find themselves unemployed after the elections of 2008 and 2010, in the dustbin of history alongside the Republican politicos defeated in 1932.
Nor will find allies at the Federal Reserve. Chairman Bernanke is an interventionist and Statist. He see these things through the prism of the Fed’s failures during the Great Depression. If he fails, it will NOT be for lack of large bold actions. Since I believe the Democrats will sweep the 2008 elections, those calling for strong solutions will have both Executive and Congressional Support. The Supreme Court will also change composition during the next eight years, with at least three Justices expected to retire quickly — giving the activists a strong majority on the Bench.
Besides withdrawing our military from everywhere, how exactly would the foreign debt be reduced? Tariffs are usually considered detrimental for all countries. China is unwilling to float their currency or spend their dollars.
The second most obvious fix would be to attack oil imports. We have private railroads, and public roads. This leads to the promotion of less efficient transportation. Railroads pay property taxes, while the roads pay none. This causes the promotion of both the automobile and trucking. If we spent the highway expenditures on high speed rail instead we might reduce air traffic as well. Basically the US has chosen oil imports over capital expenditures on the infrastructure. If capital property is taxed, but fuel is not, why not go with less efficiency?
Before the great depression their were many interurban railroads in my mother’s home state of Indiana. The decision in the New Deal was to go with oil, and essentially outlaw the ownership of the railroads by the utilities, due to utility bankruptcies. It was then that Aramco was founded. There really has been no change in public policy since, though the federal law against utilities owning unregulated business was recently repealed. Once the interstate highways were built, there was no private ability to do anything else except airlines, because of the subsidy of the highways and the taxation of private railroads. Those politicians who say they believe in free markets ignore the influence of the roads and airports. It should have been obvious during the Arab embargo that this was bad public policy, but besides drawing up a few plans for railroad electrification, nothing was done.
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Fabius Maximus replies: We can pay off our foreign debts thru a two-step process.
(1) Stop borrowing. This means a drop in our national spending of aprox 5%.
(2) Continue to allow the US Dollar to decrease vs. other currencies (esp. emerging nation currencies) until the trade deficit zeros out, as imports become too expensive and exports increase. This process is well along already. This is, of course, in effect a decrease in national income. But is probably the only viable solution.
To John Klug : COMPLACENCY, INDIFFERENCE & SLOTH. 3 things that’ll kill any nation. Not just in the U.S. of A. this is happenin’.
Hard to argue with this kind of argument. Everyone’s afraid of debt, because we think of it in personal terms. We know what it feels like when we’ve squandered all our money at the gaming tables. This argument appeals to that feeling.
But there’s a lot about buying and selling that we don’t understand, especially on the scale of trade between nations. Trade and investment on the international scale are a complex web binding creditors and debtors into a weird form of mutual dependency. The whole web mahy sink and bend, but it can also rebound.
This writer really only makes one statement — that we’ve badly mismanaged our economy and the consequences will be disastrous. He doesnt analyse it or prove it; he just repeats the same claim.
By contrast, we can see with our eyes that the dollar has deprecriated against other currencies — this is a form of inflation which lowers our standard of living. But lately, the trend has reversed itself, as Europe’s economies don’t look so strong. So that one wasn’t the end of the world after all — we may yet again be able to travel to Spain again!
There’s a vast pool of accumulated capital in the globe that has to go somewhere. It cfan’t all go to China and India. Investors may have to accept a slightly lower rate of return. Safety and stability may come to be prized more than high rates of profit. No doubt a recession is in store for the US, but that doesn’t mean the sky has fallen.
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Fabius Maximus replies: I disagree with most of this.
“This writer really only makes one statement”
This is one of the most common critiques against blog posts (It appears often in the FM comments), and misunderstands the nature of this medium. Blog posts are more like chapters in a book — like Dickens published his books, appearing serially. Not stand-alone works.
“But lately, the trend has reversed itself”
This is a common error when looking at long-term macroeconomic trends, noting action over short time periods (in this case, since July 14) and announcing that the trend has changed. Economic and financial metrics are almost never linear. There are always counter-moves along the way. The US dollar has been dropping in value since late 2001, but with several rallies along the way down. Such as almost a full year from mid-2004 – mid-2005.
“There’s a vast pool of accumulated capital in the globe that has to go somewhere.”
True, but it need not come here.
This is a commonplace view when looking at unsustainable economic processes, believing that they must continue. For example, in the late 1980’s many said that the Japanese stock market boom would continue. After all, the Japanese people had a high savings rate — the money had to go somewhere, and much would inevitably go into Japanese stocks. In fact, Japan’s savers abandoned their stocks and have been happey with fixed income returns of under 1%.
“Safety and and stability may come to be prized more than high rates of profit.”
Most foreign investors buying our “safe” bonds have had massive losses since 2001 , due to the decline of the US dollar. Which is why capital flows into the US are largely from a small number of governments. They loans money to us for political reasons; the flows will stop when their politial calculus changes. We are highly dependent on their decisions, as a sudden stop of these flows would be highly disruptive to the US economy.
“but that doesn’t mean the sky has fallen.”
He is not saying that the “sky is falling.” A large US dollar depreciation will represent a loss of wealth and income vs. the rest of the world, as did for the UK (in their case, via a long and painful process from after WWI to aprox 1980). That is just life, as consequences of our past actions.
I have written several posts about this process, of which this is the key one:
Geopolitical implications of the current economic downturn (24 January 2008) — How will this recession end? With re-balancing of the global economy — and a decline of the US dollar so that the US goods and services are again competitive. No more trade deficit, and we can pay our debts.
Just read somethin’ funny : What if US Collapses? Soviet Collapse Lessons Every American Needs to Know. ( madconomist.com )
I doubt things are ever gonna be THAT BAD in the US…just more worried ’bout the godforsaken region where I’m stayin’. The corruption & incompetence in the region is STAGGERIN’.
The lesson we are learning is nothing new.
In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: “If you don’t work you die.
— “The Gods of the Copybook Headings” by Rudyard Kipling
We are finding the limits of pushing money around to make money. Our manufacturing is roughly only 20% of our economy and a good percentage of that is in deep trouble. State and Federal taxes and regulations stand in the way of any growth in this segment of the economy and helps justify sending production overseas. Free trade the end all be all has yet to produce any real benefit to those in the lower half of our economy and then we expect them to compete with illegal immigrants with an education system that on a good day is bad and then send the work oversea’s too! And we wonder why so many people are unhappy when the numbers look so good.
Despair is a sin but it’s hard not to.
Fabius Maximus replies: We can pay off our foreign debts thru a two-step process.
(1) “Stop borrowing. This means a drop in our national spending of aprox 5%.”
This could increase the value of the dollar and further drop exports, with foreign investors buying in the private capital markets in the US. What is needed is less consumption and more US investment. Recently politicians have suggested decreasing the gas tax and using a windfall profits tax to be fed back to consumers. Both are increasing consumption. The first lowers the amount of money available for highway construction (conceivably a good thing if they will outlive their usefulness) and increases consumption, the 2nd results in less investment in the US oil business as well as increasing consumption. A direct tax on oil while holding the line on spending is politically impossible in the US.
(2) “Continue to allow the US Dollar to decrease vs. other currencies (esp. emerging nation currencies) until the trade deficit zeros out, as imports become too expensive and exports increase. This process is well along already. This is, of course, in effect a decrease in national income. But is probably the only viable solution.”
This won’t happen until the foreigners (particularly China) start spending dollars instead of saving dollars. This is largely out of US control in the long run.
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Fabius Maximus replies: These things are complex; here are some rough comments.
(1) Less consumption and more saving by US households — agreed. Note however that the combination means a substantial drop in US consumer spending. Since consumer spending is aprox 70% of GDP, the transition likely will be painful.
A direct tax on oil is also unlikely for another reason. These were easy during the first age of oil – the oil glut (supplies were developed far in advance of consumption, as the world’s giant fields were discovered first). Durign this time western nations profited more from oil (via taxes and oil company profits) than the producing nations. During this, the second age, consumer nations can no longer feast off oil taxes. If we believe oil prices are too low, the producing nations will be happy to adjust prices.
(2) Yes, the US dollar has depreciated against a wide range of currencies — but not the Asian emerging nations and Middle East oil producers. As a result of their below-market currencies, they are inevitably experiencing severe and accellerating inflation. This will eventually force them to raise rates and allow their currencies to appreciate.
“This is largely out of US control in the long run.”
Not at all. Interest rates and capital controls are powerful tools to manage currencies. We could easily raise rates to stabilize — or even increase — the value of the dollar. Raising rates would also increase domestic savings rates. Of course, the effect on the economy would be … unpleasant.
We could return to the pre-1970’s era and install capital controls. If our economic situation goes sour, as folks like Prof Nouriel Roubini believe (he is a Polyanna compared to me), we might do so. Economists will protest, but capital controls offer easy and painless solutions — however imaginary. Just what desperate politicos want. Perhaps just what desperate Americans will demand.
Could be interesting times ahead.
The most interesting point is the decades long clean-up process. That will be a true test of the US political system.
Can the Republicans & Democrats work together and formulate reasonably consistent policies to address the problems. The key here is “work together”. It seem from the other side of the Atlantic that you have had a rather confrontational political culture the last two decades. That will have to change and quite fast. Else one only have to look at Latin America to see what situation one can end up with.
RE #7. Seems to me that for too many decades, if not past 1.5 centuries, been far too much emphasis on profit versus actual productivity which has to be defined not only in monetary but community/ethical/spiritual terms, i.e. that one’s work is of benefit in some way, and also a source of daily discipline, learning and dignity. I don’t have the economic smarts of many on this board, but remain convinced that the emphasis on capital and returns etc. remains a pernicious cancer undermining the health of the body politic, i.e. all of us.
The root problem is the general materialistic mindset which took root with the overthrow of western land/place-based feudal culture and then took wing with the advent of the industrial revolution along with, basically, the merchant classes assuming leadership of nearly all aspects of societal governance. This is a huge, glaring and doomed-to-be-tragic flaw. Indeed, the definition of tragedy includes the notion that it is inevitable because of inherent flaws, despite the desires and intentions of those undergoing the torture such tragedies inevitably involve.
So what I meant to say was: it will take more than currency valuations to fix what ails us!
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Fabius Maximus replies: You are right, of course. There is no one magic bullet cure.
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The world is awash with cash, and not enough places to put it. The US, supposedly in crises, was paid to take money in its latest Treasury offering. The US is an underpopulated, growing continental power surrounded by oceans and friendly governments.
We are but in the first few generations, in the history of mankind, of mass education, albeit poorly done. This new, mass tapping of human intelletual abilities will radically change, for the better, mankind.
Problems are how we learn, what is and what is coming is natural.
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Fabius Maximus replies: Death is natural. So are plagues, floods, and famine. I do not understand what you are attempting to say.