The Upcoming
Depression Explained: The Path Downward Outlined
Many of us
scrutinize the economy, world wide, and have for decades
and some of us have lived through rough economic times such as the Carter
Malaise Era. We can ignore economics and
money management only at our peril. The economic spheres of influence on the
planet are roughly divided into three categories: [1] places dominated by third world political
corruption, [2] socialist camps of varying degree of success with the future of
most of their citizens barred from making a lot of wealth and [3]
quasi-capitalism in a few places where success is observed and many are quite
well off in economic terms. Each sphere
is controlled by some kind of ‘government’ that may or may not attempt to
provide [or indirectly assist in producing] a supply of essential goods and
services to its citizens or, at least, perform the parlor tricks that might
convince some observers that they are doing so.
The fact is that out of 190 countries half are now in horrible economic
shape and, not unexpectedly, this is actually a better position for the world’s
people than it was 100 or 1000 years ago.
The Roman system worked out better than what we now see in Africa, parts
of Asia, just about anywhere in the Middle East and in Eastern Europe under the
74 years of the age of the USSR. The
Roman Era lasted 1000 years and worked fairly well for Roman citizens. The
Romans had a better life than Russians, Africans or Chinese since 1900.
Government, in
general, cannot solve economic problems.
But, economic failure, starvation and war are not very serious problems
for government leaders given the thousands of examples of these
government-induced disasters since 1900. Marxism, the biggest failure in
society ever recorded, rivaled only by tribalism when counting dead bodies in Africa or the Middle East, has failed to produce acceptable
living standards for some several billion people and has murdered 100 million
and starved several times that number. Marxism is anti-capitalism.
Nevertheless, the quest for Marxian solutions to society is still a hot and
exciting current topic with enthusiastic advocates waving flags and making
speeches about Marxist dictators as they attack capitalism. The Marxists want
to keep trying until they ‘get it right.’ Socialist societies are a middle case
that features limited future economic opportunities for its citizens along with
high taxes and high prices with intrinsic shortages of many important items
such as housing and automobiles. The 2009 global recession will challenge many
socialist countries and it will be interesting to see how or if they can
recover from what looks like a probable impending depression.
These problems
are intrinsically rooted in the theory and practice of politics. Politics is
the process of making decisions in groups and some form of coercion is
necessary to enforce these decisions.
Absent any prodding, the polis will generally ignore the decisions. This
political process always leads to a quest for ultimate power and power leads to
inevitable corruption. People naturally fall into opposition camps for just
about every potential decision to be made and thus create chaos by disagreement
on how to choose options for the economy, society and other matters. People frequently switch to other groups when
the category or variety of the decision changes and do so without the use
reason. Emotion is the principal driving force in politics. Those that
stubbornly rest on certain special interest issues become ideological rubber
stamps for politicians and degenerate the decision-making process.
There are rational
‘rules’ or qualified mechanisms for political reasoning:
[1] Nobody knows everything. [2] Few people
know anything about politics. [3] Most people form strong political opinions
from a few factoids. [4] Politics causes more problems than it solves.
This unmanageable
process, driven mostly by ignorance or indifference, leads to economic and
social stagnation or disintegration and the incapacity to pool resources to
provide essentials for the citizenry.
Frequently, those who survive the political struggles are not adept in
making satisfactory financial, military, scientific or economic decisions. The
political process then acts as a filter that identifies and promotes those who
can excel in persuasion but posses few skills with truth or leadership.
Competency is frequently filtered out.
Dictators are even voted into full power that later destroy their
societies such as Hitler and Marshal Pétain in France. Few dictators ever willingly step
down with the notable exception of the Roman Sulla. Douglas MacArthur was a middle case.
It should be
clear, given a study of history or the current world environment, that wealth
is generated by but a very few in a pyramid system. People with business
talent appear spontaneously, attract investors and create goods, services and
wealth without the ‘assistance’ of government.
The notion of Laissez-faire [“hands off”] capitalism is a myth[6] and has never existed with the possible
exception of the current narcotics trade in Mexico. The socialist Merkel of Germany and
French President Nicolas Sarkozy have recently called for the UN to ‘regulate’
capitalism. [7]Talented business leaders ascend to
the top of the pyramid and the inept fall to the bottom. Governments seem to
operate in the opposite fashion where the least skilled persons rise to power
in political systems. Once in government, it is almost impossible to get rid of
the inept or corrupt politicians. Governments fade away and change but capitalism
stubbornly returns despite government in its original format. Those who can
create wealth seem to often avoid political organizations and conversely except
where bribery becomes a business option.
Thus as political systems and governments collapse ultimately the
capitalistic pyramids reappear using the same, ancient and accepted business
practices while new governments tend to exploit social situations with ‘novel’
solutions. Governments change
spontaneously; business practices remain largely invariant. For politicians
there is always some new theme; for business there is always production and
profit. Business and government are in opposite economic camps as governments
tend to tax and spend their resources into oblivion and capitalism tends to
rebuild society. Business and government cooperate only when business selects
and funds politicians who support capitalism. Leftist governments are
antagonists of capitalism and believe that they can confiscate wealth and
‘redistribute’ it indefinitely to the ‘masses.’ Such phony theories are
highlighted by the Soviet system, the PRC under Mao, Argentina under Peron and anywhere in Africa since 1950 under Marxism. Thus there
is a cycle of firstly degeneration and alternately spontaneous regeneration of
capitalist society wherever government is powerless to prevent this from
happening. Modern mercantilism as demonstrated by the People’s Republic of China is an accommodation of far leftist
government and leading-edge capitalist mechanisms where each sector retains
their own identity and controls what is important to their own group. The
returns of capitalism are thus shared with the government and military and this
sharing appears to be highly successful.
Wealth brings up
the necessary and highly political nostrum of distribution of that wealth.
Some, like the socialists, believe that some process is necessary to ‘spread
the wealth around’ The difficulty here is that
socialist ‘leaders,’ such as the phony Bolsheviks and Soviets, placed the seized
wealth in their hands and failed to provide even the basic elements of a stable
society. The Communists, like the fascists and Nazis, restricted membership in
their ‘parties’ to 5% or less so they did not have to share power and wealth.
Robert Mugabe is currently the best example of how not to run a
government. For the way the world and
politics work, the pyramid system provides the best possible allocation of
minimal wealth to all citizens even though it is based on strict notions of
‘equality.’ There is no hope of equality and such a quest is merely a
crass license for political types to grab wealth and squander it on their
political constituents. Equality generates
inequality in every form it has been tried. We are not equal citizens in cognitive terms, industry and work ethics,
physical attributes and many other parameters.
Our country was a
novel experiment in methods and ways to decentralize the power and thus
minimize the ultimate corruption of government by giving the citizens options
for restricting government’s quest for wealth. This worked until we came to the
point where somewhat more than half of the citizens believed that the
government could provide wealth for the citizens. The belief that wealth can be equitably redistributed
is an old, stale leftist euphemism that diverts money and power to those who
cannot reinvest in the society. This result allowed the government to trade ‘affordable housing’ and other perks like free medical care and ‘retirement’ systems
to buy votes and the government spent
too much money and went into massive debt. A severe depression is usually the
ultimate result of massive government debt. The process of giving away credit
to credit-unworthy persons caused a consumer spending spree that we now cannot
recover from. Now, the incoming Obama
government is promising trillion dollar deficits for ‘years to come.’
Many people think they will get something for nothing in this ‘offer’ to trade votes for wealth and
will be the first victims of the upcoming depression.
The current
recession/depression is driven by debt deflation and this happens when people
accumulate wealth and a credit basis for spending nested in their real estate
and then the price of housing falls thus wealth is lost. The market forces are
actually operating normally and commodities and such that are priced too high
are correcting by falling. This happens to oil, cars, jewels, gold and
everything else. Government may try to control prices, but this always fails.
Prices may only be stabilized when there are many buyers and sellers who are
happy and willing to trade openly. Attempts to fix prices always result in
either surplus or scarcity.
The Gross Domestic Product
The gross
domestic product [GDP] is the algebraic sum of consumption
[C], investment [I] and government spending [G]. This is the sum of the goods and
services for a year.
GDP = C + I + G
Consumption[C] driven by consumer’s domestic or
foreign constitutes about 68% of the GDP and nearly all this money comes from
salaries from businesses. Investment is very low since savings are near
zero. Investment [I] should be about 5% for a healthy economy. The low classes do not
save and this is known as the marginal propensity to consume, which is 100% or
so below the median income levels. The
rest is government spending which includes deficit spending. The government
usually taxes about 26% of the GDP, historically, and pays its
employees with taxes from business. Part of G is interest on debt [debt service] and is supposedly paid for in
a balanced budget, when that happens. France spends 51% of their GDP.
The Money Supply
The government
controls the money supply [M1,2,3] by the use of banking laws and regulations.
Here is how the banking system increases the money supply: If a new dollar appears
in the system then it may be spent and that new dollar is deposited by some
business in bank #1. The banking laws requires a reserve be held, say 5% for argument
purposes, and this means that bank #1
can loan out 95 cents. The person or business that gets the loan from this new
dollar spends this sum and somebody deposits it in bank #2. The second bank
must have a reserve too and thus can loan out about 90 cents. The third and
successive banks can loan out the difference between the deposit and the
reserve and this process, called permutation, continues until the participating
banks hold a fraction of the original dollar in reserve near a total value of
one dollar. In 6-15 months of normal
business, the amount of money in circulation from this single dollar is the
reciprocal of the reserve ratio [1/.05] or 20. Thus, a single dollar can
generate 20 dollars in money if it travels thru a chain of banks in the usual
manner. The current reserve varies from 3 to
10 % depending on how much money the institution has. The first 10.3 million
dollars has no reserve. For more than $44.4 million the ratio rises to 10%. The
average is somewhere near 3-5 %. The multiplier is thus about 20-30. However, money held in banks that does NOT
move in terms of loans does not have a multiplier effect.
Inflation, Deflation and the Money Supply.
Suppose there are
only 100 people in the system and that everybody has, on average, 100 dollars
to spend in a given time period. Prices,
controlled by market forces, are limited by the fact that a given individual
has only 100 dollars to spend. This is complicated when people can borrow a few
dollars and then they can spend more.
Money balances thus shift around and as long as the money supply
averages 100 dollars per person in this example then inflation and deflation is
essentially zero. For growth purposes, the money supply is slowly increased and
is appropriate at about a 1-2% increase per year. If the money supply increases
for any and all reasons, the demand for goods and services increase as the
individual has more money to spend and inflation occurs from excess demand. The
opposite happens during deflation. With fewer than 100 dollars using the
current model prices fall from lower demand.
Inflation can be
controlled by interest rates. The bank interest rate is the price of money so borrowing
at various rates forces the borrower to pay a higher cost at higher rates. High
inflation rates can be controlled by raising borrowing interest rates by both
the fed and member banks to, say, 20% as
what happened during the Jimmy Carter Malaise and the double digit inflation
fell to a few percent. This makes new
home ownership very expensive.
Deflation is our
current problem and it is much more serious than inflation. Here, when demand for goods and
services drops because people who were previously borrowing from their home
equity for spending saw their credit go down because their home values
declined. With lower demand, the prices of most goods and services are seen to
fall. Falling prices means smaller profits for business so they tend to lower
prices in the h0pe that people will buy at the lower price. Buyers tend to wait until prices fall even
lower and this reduces demand and forces prices to fall still farther. This
lower profit triggers business to fire employees and the spiral continues. England’s firms now face a 45% drop in
business earnings activity in 2009 and the British government is trying
to increase the money supply to combat this. This is not working very well. The
US is doing the same thing with
measures like a ‘stimulus’ and some bailouts and more. This is also not working
as people and banks are hoarding money so that the money expansion process from
a serial transit through several banks is stalled. The money supply can only increase when loans
are made and new deposits made in different banks. Consumers refuse to spend in
fear for their jobs and debt and this fuels deflation. Europe and Asia haves a similar problem. Why loan out money at risk when
deflation makes the currency more valuable over with no risk? Why should banks trust the governments or
other banks?
The Budgets
F.D.R. put Social
Security ‘off budget’ in 1935 and this social program was set up to raise
‘taxes’ from employees and to work separately from the federal budget.
Unfortunately, Congress ‘borrowed’ 1 trillion dollars of the SS surplus, spent
it and that is gone. The unfunded tax liability of SS is 34 trillion dollars at this time. Social Security will hit a zero
level of revenues and payouts about 2014 or so and will then need to raise this
tax to higher levels. Medicare is another matter with another 20 trillion or so unfunded.
The regular
budget has line items for government spending in numerous departments like Defense, HHS, Dept of Education and such. This
budget has a current national debt liability
of 10.5 trillion dollars. The debt service is about .3 trillion dollars, the current deficit is .45 trillion for 2008 and with the Obama spending of 1-2 trillion dollars on new social programs, at least, the debt
liability will soar to about 13 trillion dollars until the end of
2009.
Before the
financial crisis, the Fed had certain powers to make loans and such and now prints money ‘off budget.’ This practice is now labeled as ‘quantitative
easing,’ a euphemism for simply running the printing presses. The stimulus of 130 billion came off the Fed balance sheets and also the 4.29 trillion in credit swaps and other such things and also the 700 billion bailout measure
voted on by Congress, of which half is spent rescuing banks and insurance
companies and now Detroit.
The states have
various budgets, but cannot, for now, print their own money. They can borrow
from private lenders and spend that. Most of the states have deficit budgets
with California, New York and New Jersey in severe financial troubles and are
headed for bankruptcy. Some 45 state governors now beg for bailouts totaling 1 trillion dollars from the federal government.
The Beginning of the End
What we fear now
is that we will pass Gladwell’s Tipping Point ["…the levels at which the
momentum for change becomes unstoppable."]and face a situation where the world
cannot thwart a general depression. Such a collapse destroys international
commerce and exports from all countries will fall toward zero. 11.6% of the US GDP is derived from exports according to
the Commerce Department and is running at $1.05 trillion, in 2007.[20] A global economic meltdown could easily lower
the GDP by half this value for a contraction
level of -6%. That would translate into
something like a 2-3% unemployment level for that economic metric factor
alone. We started deflating in July
2008 and the data are not sufficient to tell us how the deflation rate is
running but it appears to be running a -5% or more. We are close to a national
8% unemployment rate now [out of 130 million workers] and that loss of exports
alone would bring us up to double digits—near depression levels. The Great
Depression had unemployment levels for 12 to 25 % over a span of 11 years from
1929 to 1940. The fear is that we will pass the boundary of the tipping point
and fall into a deflationary liquidly
trap where lowering interest rates to
near zero and printing money does not help the problem. The inability to lower interest rates below
zero is called the zero bound. Presumably, the government is addressing this
problem.
Government, of
course, will always react in a way that [1] favors the government leaders and
the party in control and [2] places blame on others including the opposition
party and the business community. In our case, raising taxes and deficit
spending, offered in the pretext of obtaining some ‘redistribution of wealth”, was the driving force to gain a
majority of votes in 2008. Once the low
class surpasses the 50% maj0rity at the polls they will tend to continue to
vote money toward them selves. Why not? They don’t have to pay
taxes and these ‘income tax credits’ are a negative form of income tax and is
free money. This political effect causes an avalanche in spending and taxation
until the economy crashes and continues until more than half the population
votes to end this madness. We are fast approaching this vanishing point—the
point where the future of the middle and upper classes tend to vanish in a swamp
of socialism. Many political operatives
view this as an opportunity to reject capitalism and institute socialism.
Other Taxes and Programs
Propaganda and
phony science designs also drive the voters to vote in programs that are costly
and counter productive. Such programs as the Carbon Cap TaxGlobal Warming and other leftist adventures have the
potential of devastating the economy of many countries and achieving nothing in
return for the voters or the environment. Such programs only favor frauds, science
types that need funding for research, new ‘green’ industries and businesses and
certain politicians. The English have recently voted [645 to 5 in Parliament]
to put enormous taxes on their economy, a process that
will sink their society. There is no evidence for global warming so the tax is
synthetic and provides no return for money spent.
This is a
political opportunity for many and we should realize that corporations pay 99%
of the economic freight in this country and the rest of the world and that corporations
provide the revenues for all government jobs. We now face the prospect of
experiencing the highest corporate tax rate in the world after we raise our
corporate tax rates from 35% to 39% during the Obama Administration and that
will discourage business starts and will force corporations to shut down
operations and discharge their employees. The government cannot replace these
lost jobs with meaningful employment as they only pay employee salaries with
taxed or printed money. Thus, the G
[government spending] will advance to a higher fraction because of the
necessity of the federal government to spend more. France’s 2007 GDP was 51% government spending and this
caused the government to fall. The efficiency of the economy is always related
inversely to the fraction of government employees. When too many people work
for the government the system fails.
Corporations
produce goods and services for profit and taxes are part of the cost
structure. When the economy starts to
descend then costs tend to squeeze profits and inhibit expansion and job
creation. Governments tend to increase taxes whenever they can and this causes
businesses to critically examine their business plans, which is easy to do in
our modern world of communication and computers. Corporate profit projections over the short
and long term mush then accommodate a new 4% tax and this is not good for
business. Thus, jobs will be lost and the government will be tempted
to increase taxes even more and create more unemployment. The temptation by
government is to then hire the unemployed using the nostrum that the government
is the ‘employer of last resort.’ This
cycle destroys the business community and leads to socialism and inflation.
Transition from Deflation to Hyperinflation and the Risks
Our current
federal 2008 budget is about 3 trillion dollars with a .45 trillion dollar deficit and we spend about .3 trillion on debt service on our 10.5 trillion debts, half of which occurred in the last 5 years. The
bailout is not small compared to this debt number, it is an astonishing 4.29 trillion dollars at this time and this must be added to the some 5 trillion dollars in bad mortgage debt held by Fannie Mae and
Freddie Mac. The GDP for 2008 was about 16 trillion dollars.
The total debt is
now close to 20 trillion dollars. The sum of all household wealth in the US is about 57 trillion so we are getting close to destroying 40% of our
entire wealth in 2008.
Only half of the
130 million workers in the US pay taxes so a trillion dollars
winds up to be $16,000 in tax liability for each
worker. Note that 20 trillion in debt becomes $320,000 in tax liability per
worker who makes over $50,000. That means that the total equity
[and more] of the homes of the average worker is in jeopardy. The only people who can pay high taxes are
those with wealth and property and they will be asked, or forced, to pay for
most the new spending, debt service and new social programs. This debt is so
large that it impacts the 401(k)s now so popular since Social Security is a
grim joke. The temptation by government
is to seize the 401(k)s and blend this money into some federal retirement
system patterned along the same lines as the USSR plan. All that wealth vanished in
inflation by 1990.
President elect
Obama wants to keep the deficit at a trillion dollars for ‘a few years’ so we
are now looking at this for 2009:
[1] The federal
government will spend more than 4 trillion dollars or probably 30% of the GDP in 2009. The states will spend another trillion.
[2] Taxes
revenues will plummet from mass unemployment and business loses and money will be printed in Washington for bailouts. The debt will increase probably to 22 trillion by the end of 2009.
[3] Business and
unions are crying for bailout money. The states are in the same chorus.
[4] The money
supply is now spring-loaded and could explode sometime in 2009 or 2010 as it surges trough
the banks and will cause massive inflation or, worse, hyperinflation.
Inflation is
controlled only by high interest
rates and that causes more unemployment and stifles business. That poor
business climate causes lower tax revenues and lower profits and a contraction
in business activity. Inflation, running at perhaps 1-2% per month for years,
will have the singular and questionable ‘benefit’ of lowering our federal debt
at the expense of loss of wealth. Hyperinflation kicks in at a arbitrarily
defined rate of 50% per month. [30]Examples [see link below] of this
calamity include Argentina where “1 (1992) peso =
100,000,000,000 [or 100 billion fold inflation]. pre-1983 pesos” or