Wednesday, June 23, 2010

Double or Nothing

I wrote this post in 3 pieces on Mish Shedlocks Blog. is a daily read for me and a brilliant writer. Needless to say, I agree with about 80% of his reasoning, but I do disagree in part. This current economic collapse is one of paradoxes and I believe one that is going to need some real maneuvering by government to not turn into a total collapse. What government is doing at the present in the US is courting disaster. It is nothing less than what was done in Japan, which has lead to a near destruction of their economy in a time when the world at large had sustained sizable growth. There was a reluctance to call a spade a spade and declare much of the financial system in Japan insolvent. Debt could have been wiped out in bankruptcy, the losses taken and the economy started anew, while the US was inflating a huge debt bubble of its own. There isn't a country that can counterbalance the US deflating and it appears Europe is joining the US in this deflation, while China, Australia, Canada and a few others have created their own deb bubbles. I believe I covered some good bases in this series of posts (series because the software at Mish's doesn't accomodate my novels), though I didn't go into detail. In short, I fell we need a plan, not a plan to throw money at the problem, but a plan to clear out the debt, take the losses and in the meantime buy time. The governments of the world are trying to spend us to prosperity and that isn't going to work, as it will destroy the private sector, where all the ideas that work are. But, I believe government could buy some time and it is clear we are looking at economic disaster of epic proportions which will need assistance, else hundreds of thousands or even millions starve in countries where starvation is currently almost non-existant. The situation is so paradoxical that very few understand it. Here is the post.

“I am amazed how little vision most involved have in what causes depressions. Even the guys I read like Mish and Denninger get off track and to say I don't get off track myself would be a lie. The entire matter is so paradoxical that no party is 100% wrong and I doubt any are more then 75% right. I even read where Robert Prechter said that banks had loaned out every penny of deposits, which is in fact true, but only in the reverse, as all deposits are created by lending this day and time. The problem is they have loaned more than deposits and since deposits and currency is all the money there is in the system, as liquid assets, the excess over deposits can't be collected.

In a commercial banking system, all growth that is measured by the nonsense measurements they call GDP is created out of new debt. Absent new debt to create new money, the compound interest equattion swallows itself. With this action, the market value of all marginal assets goes in the tank and with it the credit for these outfits to exist. GM blew a fuse in a hurry. So did some outfits that didn't appear on the face to be marginal and now the countries that are marginal are blowing fuses as well.

Krugman can make his case because he fails to see that the stimulus doesn't fix anything, but is more akin to putting makeup on skin cancer. The cancer is still there, but it is covered up. The fallacy is the cancer is gone and comes back with the removal of the makeup, but if you keep the makeup on long enough, the patient still dies.

Great care has been used to cover up the fact that the problem revolves around debt. Why is it the Rockefeller controlled education system failed to teach anything about debt in the field of economics? The U of Chicago was JDR's baby and who should arise out of this outfit but Samuelson and Friedman? Both of these lines of reasoning run down the line of give the patient another drink and his hangover will go away. They fail to recognize that the organs inside will continue to rot.

The current system is more akin to the gambling game where the loser gets to go double or nothing until he wins. Except only 1 loser gets to do this, while the other pays up. How do we up the ante and go double or nothing again? In the case of the banks, they are insolvent and can't really produce the money to pay the depositors. In the case of the borrowers, they can't pay the banks, because the banks can't produce the money. Both of these outfits are being supported at the expense or benefit, which there are 2 sides of this equation of the depositors and other holders of financial assets. The game of double or nothing has to go on or everyone loses, as the losers of the bets, the debtors can't pay and the creditors can ride on as long as the pretense is they can pay.

The best we can do is buy time and that is what stimulus does. But, stimulus can't be the plan and neither can the actions of the Fed, because the plan leads to more debt and more pretend double or nothing. Anyone who has ever done double or nothing on a bet knows it was done because the loser couldn't pay in the first place after the second or third loss. The problem here is the loser isn't ever going to win to clear the debt.

There are too many things that the establishment needs to happen which can't. One is that prices remain high. We are looking at a pension system that is based on the stock market. Pull out the stimulus and the numbers attached to stocks goes down and with it the pension model collapses. Manufacturers and retailers need price supports to maintain profits, banks need additional credit to keep the system at least appearing to be solvent. The counter side of this is if the debt is reduced, prices go down, not up. Also, the backbone of the political and monetary structures go away.

The Goldman report is flawed as well, not because it can't be true, but because what they studied has never been done at the end of a bubble. Never as in their history. What this tells me is Goldman has probably already set up a trade to make a killing out of a collapse, as I have not read where they put out an honest report to the public for nothing. Again, I am not supporting stimulus, because at this point it is at best rearranging the chairs on the deck of a sinking ship. I would venture that private credit has always pulled the economy out of a spin and the result has been more government revenues and falling expenses related to recession

The point of all of this is what is the final solution. Regardless of the flaws of government stimulus and monetary policy, the question arises as to how we collapse and survive? I happen to believe that the history of keynesian and monetarism solutions has placed us on this edge of disaster where we sit today. The plan has to have an exit that doesn't contain the delusion we are going to have a normal recovery. We won't and it won't be because they quit doing the flawed ideas taught in the Chicago school. It will be because it is just time for a depression. The only way we go forward is if China raises wages 1000% and we give Chinese consumers credit cards and thus collateralize the future earnings of a billion new people. Even then, it would be necessary for the rest of the world to reduce their debt by a corresponding amount. This isn't going to happen, because the compound interest equation won't allow it.

It is hard to get new debt out there when the people with brains know there is going to be a haircut against cash. If people understood that failing to take the tax credit for buying a house would allow them to buy the same house maybe $20,000 cheaper in 2 years, while taking the credit puts them in debt by a like amount, the tax credit would have never been utillized. But, the asset bubble is the end game of a debt bubble that has lost its capacity to drive commodity and labor prices, because so much of the new debt is geared, not to consumption as assumed, but toward servicing the compound interest equation itself. This system of double or nothing cannot amount to a real gain, only the delusion one is going to collect what they already own and the other person cannot pay.

The real solution is that FNMA paper is worth maybe 50 cents on the dollar. The stock market is maybe worth a dime on the dollar. I am using these 2 as examples for the broad field of assets. This shows the real depth of the problem, as those in favor of austerity might change their minds when they see their pensions, their financial holdings, the price of their homes and other things go down the drain. They fail to see that collecting on these assets at anywhere near par is impossible, but they are going to insist government make an effort. Most have already compounded double or nothing several times and spent the change. But, remember the debtors can't pay

1 comment:

Blurtman said...

When the market and homes are worth pennies on the dollar, relatively speaking, the dollar will be worth 10-100x more.

So hold both assets and dollars to hedge. Being long in only one and guessing wrong can be disastrous, no?