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Today’s Daily Reckoning had a good piece (as usual) from Bill Bonner.  He had an imaginary conversation with Tim Geithner about how to handle the debt bubble.  I wish I would have thought of that, but I’m not known for being original.    Here’s part of the conversation where Tim calls up Bill and asks for Bill’s advice:

“We need to recognize, first, that this is not just a regular recession. So you can forget the usual recession remedies – a few points off the Fed funds rate…a little counter-cyclical fiscal spending. This is much more serious.

“What we have here is a depression. It’s a depression because it requires a fundamental restructuring of the international financial model. You know how it worked during the Bubble Epoch; Asians made things…Americans bought them. Asians made money; Americans spent it. Asians saved; Americans borrowed. And now the Asians have money; and Americans have debts. Not really very complicated, is it?

“Well, these programs of trying to bailout businesses…and the banks…and the economy…you can see how they are all a waste of money. All of these efforts are trying to revive the old model. They’re trying to free up credit so that Americans can buy more! Now, we don’t really have to explain why that won’t work, do we? More debt won’t do Americans any good; more IOUs from Americans won’t do China any good.

“Instead, the model has to be taken apart and reconstructed. China needs to sell more to people with money – its own people, mainly. Americans need to pay down their debts before they can take up serious consumption again.”

“But wait, Bill,” Mr. Geithner interrupted. “Won’t that cause serious disruptions? When Americans save, in order to reduce their debts, they take away the single primary source of demand for the world economy. If they don’t begin buying soon, businesses all over the world will go broke. That’s why I’ve spent so much money trying to bail out the banks. Americans have no money. So the only way they can spend is if the banks provide credit. So, we have to save the banks first…then they’ll begin lending…and then the economy can begin growing again.”

“Uh…no. That’s not how it works. Even if you make all the banks solvent, whom are they going to lend to? Who’s going to borrow? Americans have too much debt already. Right now, if they get any money, they’re holding onto it…and using it to pay down their debts. They’re not going to start spending just because a bank offers them a loan.

Good stuff!  One thing that Bill left out is the power of savings.  Americans don’t have any savings to speak of, that’s why our government needs to borrow from China and Japan.  When the government ran up huge debts during the Depression and WWII, American citizens were the people who provided that money.  They provided it from savings, and we don’t have the money to do that today.

So when we purchase something made in China (or Germany) we have to effectively borrow that money in order to buy it.  That’s what a trade deficit does over time.  Wealth is extracted from the country with the deficit, and it flows into the country with the surplus.  It’s not rocket science.

Note – I am NOT suggesting that we pass protectionist measures to combat the trade deficit.  The fix to that is to simply live within our means and only purchase what we can afford.  That means paying as you go.  No new debt.  Pay down the old debt and save actual money.  When the debt is gone, people can once again buy more things – as long as they pay for it.

Robert Heinlein wasn’t the first to say it, but he said TANSTAAFL in a way that I remember it.  “There Ain’t No Such Thing As A Free Lunch”.  He’s right, and we’re finding that out in the US now.

I’m currently re-reading volume one of The Story of Civilization. “Our Oriental Heritage” and it’s amazing how many times throughout history that government (and people) think they can rewrite the laws of nature.  Supply and demand is one of those laws, and no amount of wishful thinking and no amount of new regulations is going to change it.  The countries that have tried it in the past are gone.

I fear we’re following rapidly down that well trodden path.  I wish that weren’t the case, but idiots keep voting for bread and circuses.  Unless that changes, we’re going downhill.

gk

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This is a hilarious article – with a serious message – from Bill Bonner of The Daily Reckoning.  I received it in their daily email, but I cannot find it on the Daily Reckoning site right now.  I’ll post a link to the article if I find it later.

Mr. Bonner -  I’m going to post a copy of the the article here.  Please let me know if you’d prefer if I excerpted it – which I’d do now if I could find a link to the full article. 

Enjoy the article – it’s Bill Bonner at his sarcastic best!

gk

Yes We Can’t!
By Bill Bonner
Paris, France

Free market capitalism is the “god that failed,” writes Martin Wolf. Thus does Financial Times lead off a feeble chorus of lament in its “Future of Capitalism” series. What do we do now? is the question. Can capitalism be tamed? Can it be harnessed? “Yes we can!” says America’s president.

Richard Layard from the London School of Economics, offered a way forward:

“We should stop the worship of money and create a more human society,” he writes. “Happiness has not risen since the 1950s in the US or Britain,” he points out, despite big increases in wealth. “Modern happiness research can help find answers,” he believes.

“Old fashioned socialist planning is the only coherent alternative to a collapsing capitalist economy,” an alert FT reader added.

Given the depth of these insights, we decided not to dive into this discussion headfirst. Instead, we will simply mock the swimmers from the bank. Brazil’s president, Lula da Silva, for example, could only come up with a campaign slogan: “The future of human beings is what really matters.” But who can blame them? They want a capitalism that makes people happy…fairer, gentler, greener… they want to reform it…to housebreak it…to cut its balls off so they can safely put it on a leash and introduce it to their daughters.

But they miss the point of it altogether: we can’t reform capitalism; it reforms us. Capitalism punishes mistakes and rewards virtue (or good luck) – not necessarily quickly or gently…but roughly and imperfectly, like a hanging judge in a frontier town. On paper, of course, we can do better. Imagine a world where public employees are saints and geniuses who do such a swell job of allocating capital we want for nothing. But then, when we get a chance to see them in action, we find that they are bigger rascals than the capitalists themselves.

This week, under pressure from its new proprietor – the U.S. government – AIG released a list showing who had gotten more than $100 billion of its bailout money. At the top of the list of recipients was a familiar name – Goldman Sachs. In a truly astonishing co-incidence, Goldman is the firm that had been run by the very person who headed up the AIG rescue – former Treasury Secretary Hank Paulson. And what serendipity! Lloyd Bankfein – Goldman’s top man now – was actually in the room with the feds when the AIG rescue plan was put together.

In the room; in the deal. But the big scalawags ducked out of the press almost immediately. Instead, the headlines focused on the small fry. AIG paid bonuses of $450 million – some charged it was $1 billion – to its executives. These guys shouldn’t get bonuses, came the popular outcry; they should get a firing squad.

You’ll recall the story. The insurance giant AIG lost money on a series of gambles. For example, it gambled that it could insure the mortgage payments of people who couldn’t afford to buy a house. During the bubble years, people bought houses at outrageous prices. They could borrow 80% of the purchase price from government-backed debt mongers Fannie Mae and Freddie Mac. Buyers were supposed to put up the other 20% themselves, giving lenders a margin of safety in case the transactions didn’t work out as planned. But, if an insurance company would guarantee the other 20%, Fannie could cover 100% of this “enhanced” mortgage loan. AIG found that insuring this part of the loan was profitable – as long as nobody asked questions. But then the market price for the collateral dropped – by as much as 50% in some areas. Suddenly, people were walking away from their houses. Defaults on these “enhanced” loans ran at 5 times the rates on normal Fannie-backed mortgages.

An ordinary person would look at these facts and pronounce the same judgment as the capitalist market: AIG and Fannie both deserve to go broke. But give him enough higher education in the economics department, or a job in government, and the fool rushes in –with someone else’s money.

In the theory of bailouts, an ailing firm is given a helping hand when it needs it. This gives it time to get back on its feet, and prevents it from dragging down its employees, lenders, investors and counterparties. But what actually happens is much simpler. Money is goes from the pocket of the person who earned it…to the pocket of someone who didn’t…from the innocent bystander to the fellow who caused the accident. Capitalism takes money away from erring capitalists; the capitalism improvers give it back to them.

And who decides who gets the loot? Ah…as soon as you hold them up to the light, the angels’ wings fall off. By and large, these are the same cherubim and seraphim – such as Hank Paulson – who were supposed to be leading…regulating…and controlling capitalism when it ran into a ditch. Not a single one raised a warning. Instead, they whooped for the free market and passed the whiskey bottle to the driver! And now, thanks to their bailouts, AIG continues writing insurance against mortgage loans. Seventy-three AIG executives continue getting $1 million bonuses. A long line of reckless counterparties goes unpunished. And Hank Paulson offers advice to Financial Times readers on how to make capitalism work better.

But that is always the problem with improving capitalism…even in the slapstick American way. The reformers promise a ‘new deal,’ but they’ve always got an ace up their sleeve somewhere.

Enjoy your weekend,

Bill Bonner
The Daily Reckoning

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It’s a cool rainy day in Knoxville, so I’ve been catching up on my reading.  Yesterday’s Daily Reckoning had a great article titled “How to Save the World” and I want to post a bit of it here with some comments, because it sums up the cause – and the solution – to the economic train wreck we’re all watching.

I like this line: It is not often that we are called upon to advise the world’s government. In fact, we can’t remember a single time. But we can’t resist a lost cause. So, we offer the Daily Reckoning Plan to Save the World, or DRPtStW for short.

Humor like that always make Bill Bonner’s articles a great read.

Just read the Financial Times. This week it has a windy series on the “Future of Capitalism,” inviting readers to imagine how the decaying old creed might be reformed. Alas, for capitalism, it’s out of the frying pan, into the toilet. Larry Summers, Obama’s number one financial advisor, voiced the prevailing view: “This notion that the economy is self-stabilizing is usually right, but it is wrong a few times a century. And this is one of those times…there’s a need for extraordinary public action at those times.”

Larry Summers is wrong.  The economy is self stabilizing – if only government would get the hell out of the way and let the stabilization happen.

The gist of his program can be expressed in another wistful absurdity: The consumer economy died because of too much spending; now we will revive it by spending more. “Give me your cunning bankers, your hopeless CEOs, your huddled masses of chiselers, spendthrifts and boondogglers,” says the Obama team, “and we’ll give them other peoples’ money!”

This is Keynesian economic theory in action.  It’s just as wrong now as it was in the 1930’s, but the government feels it has to do “something” even it it doesn’t makes sense.

Note – government spending in times of economic slowdown can help alleviate the suffering, but only the government has money to spend.  We’re $11 trillion in debt. Too much debt caused the problem – does anyone really think borrowing more is going to fix it?

“There’s no place that should be reducing its contribution to global demand right now,” explained Summers. “The world needs more demand.” But it was demand that the world recently had too much of. English speakers took on too much debt to create it…and built too many houses and too many shopping malls to satiate it. And despite the ready cash offered by Bush, Bernanke, and Paulson, demand has sunk, because the real problem is not an absence of spending, but a surfeit of debt. In America, for example, total debt went from 150% of GDP in the ’80s to 350% in 2007. The financial markets panicked when it became clear that debtors didn’t have the cash flow to pay off the debt…and that an entire world economy had been fizzed up to supply products to people who couldn’t afford them. Investors have been discounting debt-soaked assets ever since.

The fix is obvious – reduce the level of debt. About $20 trillion worth of debt, in the United States alone, needs to disappear. Then, consumers can go back to doing what they do best – consuming. But how do you reduce the debt level? Former Treasury Secretary Andrew Mellon had the right idea in 1929: ‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate…It will purge the rottenness out of the system…Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”

It really is that simple.  That’s capitalism.  People who make bad decisions go broke, and people who make good decisions get wealthy.  Government interference only gums up the process and keeps it from working.  Which is about the only thing governments do well.

What’s the cure for a depression? It’s a depression. Let willing buyers and sellers mark debt down to what it is really worth. Mellon’s plan was not followed by the Hoover or Roosevelt administrations. Instead, they introduced elaborate bailouts, stimulus programs, and boondoggles. That is why the depression is known as the Great Depression, rather than the So-so Depression. By the end of the 30s, the US economy was almost exactly the same size it had been at the beginning. Likewise, in Japan, holding off liquidation brought a “lost decade” in the ’90s. Bush followed in Hoover’s footsteps. And now, the Obama administration follows in Roosevelt’s and Miyazawa’s.

Here’s our advice: forget it. Let the depression do its work. Let the bad times roll!

Great article Mr. Bonner.

gk

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