Friday, January 19, 2007

Why Money is Sick

by John Sharpe




"America has no better than a 10% chance of avoiding economic Armageddon."
-Stephen Roach, chief economist at banking giant Morgan Stanley



Common sense reveals the silliness of what today's economy is about. Is it necessary that basic tools and consumables be manufactured thousands of miles from where they will be used and consumed? Should it be that for Americans to become home "owners" they must pay money back to a lender two, three, or four times over, when the lender did no work and sacrificed no capital to loan the money into existence? Is it the case (using G.K. Chesterton's example) that milk should come out of a "clean shop" and not a "dirty cow" and that the average American dinner should travel 1500 miles before being consumed? Are things "normal" in the "world's breadbasket" when we've lost five million family farms since 1930, only 1% of Americans still live on a farm (compared to 50% a half-century ago), 62% of our agricultural output is produced by just 3% of our farms, 42% of produce is retailed by only five different concerns, 71% of government subsidies to keep the system running went (over the last seven years) to only 10% of the farms, and farmers are only getting nine cents worth of every dollar spent on food, while the rest goes to suppliers, processors, middlemen, and marketers?

The insanity doesn't stop here. All of the above is the result of what Bob Precher, writing recently for The Daily Reckoning, has termed the "credit-bubble" that has been "70 years in the making." The bulletin's editors note:

"the rise of consumer-credit capitalism [in which] people switched their attention from assets to cash flow... from balance sheets to monthly operating statements... from long-term wealth building to paycheck-to-paycheck financing... from saving to spending... and from "just in case" to "just in time."


Many sneered at Hilaire Belloc's prediction that capitalism would break down of its own accord, but these observations in fact imply that, absent the creation of huge volumes of credit, the breakdown would have occurred long ago.... Let's consider here.

First, there is US Government debt. Two years ago, Uncle Sam was in $6.12 trillion of debt [see "How Big Is a Trillion?" on p.35 -Ed.]. America's treasurers left that limit in the dust on November 18, 2004, passing a limit-increase to $8.18 trillion. Morgan Stanley's chief economist, Stephen S. Roach, said that this "open-ended license for fiscal irresponsibility is a recipe for disaster."


Second is mortgage debt. In the last two years mortgage debt has risen $2 trillion. This "funny money," rather than savings and real wealth, is what's keeping the economy running. As Richard Benson, President of the Specialty Finance Group, noted recently, the "increase in mortgage debt represents the spending that the Bush Administration needed to keep a $12 trillion economy moving forward." There's a bright spot: home "ownership" rose 2% to an all time record of 67.2%. Benson says:

The bad news is what had to be done to get it there while the labor force participation rate has dropped two percent!... [Easy credit and record low interest rates have boosted home sales. In previous economic cycles, the boost... came from rising incomes and more jobs!


The home-sale fantasy doesn't end there. The engines that drive housing finance, that is, government-sponsored enterprises Fannie Mae and Freddie Mac, are both under investigation for accounting irregularities that might impact earnings and losses by several billion dollars.

Third is corporate debt. Corporations being "in the hole" is not news; what is, though, is their increasing inability just to stay afloat. Beyond their total debt of some $7 trillion, major corporations can no longer keep up their end of the bargain as participants in the Servile State. Committed to caring for employees, cradle-to-grave, automakers and airlines find it impossible to meet their pension commitments. Doing so puts them further in debt, until the "realists" admit the process is unsustainable. Thus US Airways refused to continue making pension-plan payments, declaring at a recent bankruptcy filing: "It would be 'irrational' to make pension contributions (reported by Jim Jubak in MSN Money] because it provides no benefit to the estate." The alternative, Jubak explained, is for "senior pilots [to file] for early retirement by the hundreds and then [take] their pension in a lump-sum payout." He summarized the upshot thus:

Welcome to the bankruptcy economy, where companies and governments walk away from long-standing promises to workers, and where workers scramble to collect as much as they can now in fear that even less will be available tomorrow.

Bankruptcy, either formally declared in the case of troubled companies or informal in the case of cities or the U.S. government, will restructure the entire economy in coming decades.


Fourth: consumer debt. In 2003 it was $1.98 trillion. Americans consume more than they can pay for. The assessment from Tamara Draut, a director at a public policy institute that looked into credit card debt recently, is not pretty.

Too many Americans are drowning in credit card debt as a way to deal with the rise in the cost of living as their incomes have stagnated or dropped. It's... the band-aid holding the family budget together....

With savings at their lowest level since 1959, credit cards must pick up the slack. As Marshal Auerback's International Perspective reported, "the savings rate has averaged below 1% for the first nine months of 2004- the first time this has happened in seven decades." How else, then, to keep consumption going than by credit?

Fifth and finally: deficits. Continuously adding to much of our debt, the deficits in America's budget and current account reflect another denial of reality: they presume a limitless ability to get more than we can pay for. While the budget was balanced until President George W. Bush unbalanced it by nearly $500 billion, the current account-reflecting trade and other financial flows across American borders-remains in the red by $660 billion. A remarkable paper by Nouriel Roubini and Brad Sester calls this deficit "the defining feature of the global economy right now," pointing out that the US, "the world's largest economy-and the world's pre-eminent military and geo-strategic power-is also the world's largest debtor." This deficit also "looks set to expand significantly in 2005 and 2006," for our massive consumption of Asian-produced goods is not poised to decrease any time soon. With money flowing overseas and goods coming in, it's not American manufacturers, businesses, and laborers who are being remunerated. As James Gipson, manager of the Clipper Fund, wrote in his shareholder letter: "A slowly and likely growing share of our output of goods and services will go to provide comfortable retirements for the residents of Tokyo, not Topeka."

To make up for money leaving the US, the Treasury must sell its debt paper to the tune of some $4.5 billion dollars per month. Jim Sinclair, a veteran commodities and foreign currency trader, noted how precarious this is:

It is not necessary for major nations to sell US debt in order to un-float the boat of the US dollar...not buying as significantly as before will do the exact same thing. As the inflow to the US falls below $46 billion per month, the need per month rises, and so begins the process of drowning in debt (emphasis mine).


China's recent announcement "that it is considering the sale of US dollar-denominated Federal Debt," coming on the heels of "Russia's decision to consider doing the same thing [to shift] to Euro-based items," means that the system could unravel sooner than many think.

Fantasy finance is thus a "virtue" covering a multitude of sins. Critics forget this when saying Belloc erred in predicting capitalism's demise. With total debt over 400% of the Gross Domestic Product [i.e., the GDP, the total value of products made in the country where the factory or mine is located whether that value stays in the country or not -Ed.], $48 trillion dollars worth (four times the GDP) of the economic wealth in our nation still has to be paid for. What use is the capitalist wealth-creation engine if it only loans things to us at compound interest? Though a few can make great sums of money with unreal financial tools that postpone the inevitable, it's of no use for those aspiring to be owners of more than just debt.

Finance exists to facilitate production, and production to meet the material needs of man; it's that simple. Submission to that principle would initiate a "return to the real," opposing the profound unreality of credit and money-breeding, so characteristic of modern economic life.

Economics for Helen offers a true and simple sketch of economic principles to help our minds to return to reality. Then we can disconnect in practice from the unreality of modern economic life, to recover the contact with nature and real property that was once mankind's "natural state." Being productive will then mean not conducting on-line stock trades, but growing vegetables, learning a craft or trade, and mastering the basics of economic reality: food, shelter, clothing. Where two or three families unite to pursue this end, as many already have, there's no limit to what can be achieved.

The gadgets of our "comfortable" lives have profound social costs and, if we want to escape the unreal world of wage slavery, mass production, and debt speculation, must be sacrificed.

There are rough times ahead for credit-and-finance capitalism. Pundits are now predicting de-flation from an inevitable interest-rate hike as the Asians lose interest in bankrolling the dollar; this means "depression." Belloc said that "things will not get right again... until society becomes as simple as it used to be," and on that way back to reality there will no doubt be suffering: "We shall have to go through a pretty bad time before we get back to that." However, if the future brings suffering, it will also bring wisdom, even about things economic.


This is the Preface to Economics for Helen, the book reviewed starting on p.38 in this issue, published by IHS Press. Its author, John Sharpe, is founder and editor of IHS Press, based in Virginia. He and his wife Randa and their two children attend the Latin Mass at St. Athanasius Catholic Church in Vienna, Virginia.

Interview with Thomas Storck

On Cooperative Ownership

John Médaille Interview in Romania

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