The Upcoming Depression Explained: The Path Downward Outlined

Many of us scrutinize the economy[1][2], 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[3] 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[4] in France. Few dictators ever willingly step down with the notable exception of the Roman Sulla. [5] 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[8] 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’[9] 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.’[10]  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[11] 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[12] 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.[13] 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.[14]

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.[15] 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[16] 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.[17] 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[18] 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."][19]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[21] 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”[22], 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. [23] 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 Tax[24],Global Warming[25] 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[26] 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[27] 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[28] 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. [29] 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 Chile where “1 current Chilean Peso = 1,000 Escudos” or when the Russian Ruble “… devalued from about 40 r/$ in 1991 to about 30,000 r/$ in 1999.” This could happen to us.

 Now, we have to look at the new money injected into the banks: If the banking currency multiplier is about 10, then printing money by the Fed amounting to 4.29 trillion for the bank bailouts and credit swaps and such, and adding in the spending of 1-3 trillion in freshly printed money leads to the assumption that we will have about 6 trillion dollars in circulation that will soar to 10 x 6 = 60 trillion dollars in less than two years and that is more than 10 times the current GDP, which will fall to 14 trillion or less in 2009. For a multiplier of only 7 it becomes 42 trillion, which is just about as fatal.  We are looking at the prospect of watching a ten dollar bill becoming worth about a dime.  A Starbucks Latte then might cost $500 to $300 dollars.

The government is fighting debt-deflation with massive debt, an essay in lunacy and desperation. There is nothing more foolish than this. [31] We are headed down the road to both depression and socialism unless we quit wasting money and begin forcing corporations and states to enter bankruptcy. The population will not stand for a depression and a vacated lifestyle for too long so we should expect tax revolts, civil disobedience and other actions until the government can restore some reasonable financial and economic future to the middle and upper classes.

Things we Must and Must Not Do:

[1] The mindless foray into ‘green’ products is based on politics and not science or logic. We should inspect current technology and fund research in new energy systems, but not simply halt coal and oil usage as this will provide huge costs to businesses and create more bankruptcy and unemployment. We need to drill and offset foreign oil imports until we transition to better energy systems.

[2] Bailing out Detroit or any other businesses that have failed and have no way t0 recover [GM is 60 bln in debt and can never recover] must be halted. This is throwing money away to keep mostly union employees in jobs. We face the absurd notion that we will subsidize the non production of cars at $75 per hour.

[3] We should lower the corporate tax rate to zero for 3 years so as the give job creation a chance to bring back our economy.

[4] We must stop printing money as the potential for economy-crushing inflation 0r hyperinflation is too dangerous.

[5] We need to force failed states like California, New York and New Jersey into bankruptcy courts and let a judge adjust spending and state employee levels. There is no way California will cut spending so they will beg for federal handouts and just add to the inflation and depression.

[6] We need to vote out every member of Congress who voted for the bailout as they have no concept of what they are getting us into. We need to see what Obama will do, but he appears to be some form of ideological socialist and may lead us into depression, probably revolution and hyperinflation.

From Obama today:

“Calling for investments in priorities such as energy, education, healthcare and the nation's infrastructure, Obama says, "there is no doubt that the cost of this plan will be considerable. It will certainly add to the budget deficit in the short-term. But equally certain are the consequences of doing too little or nothing at all, for that will lead to an even greater deficit of jobs, incomes, and confidence in our economy."[32]

This is lunacy, but this is also politics in action from a dedicated leftist. The depression is at hand.

rycK

Comments: ryckki@gmail.com