It's the Paradigm

Bankia, one of Spain’s largest banks, is needing a €23 billion bailout, to compensate for their over-zealous investments in the country’s late real estate boom gone bust. Throw in a few other teetering banks and the price tag rises to €50. The only way to thrive or even survive in a scenario of irrationally exuberant lending is to borrow more to keep the growth paradigm going. In other words, as long as the value of property is expanding, it’s not necessary to be rational in your investments. But then, as always happens with bubbles, they burst - it is a part of their nature, after all.

There are two ways that happens, though they’re often intertwined. One is inflated prices. At a certain point, prices have to reflect reality. The other is larger economic movements. The general economic malaise that pervades the country depresses optimism and growth. Either way, the loan is defaulted and somebody is going to have to pay.

Spain wants the European Central Bank to bailout the banks directly. That makes sense, since it’s the system, the paradigm, which encourages, almost demands imprudent lending. Used to be you had to put 20% down to buy a house. A buyer who’s accumulated that much cash will generally be a low level risk. However that would also constrict the market and slow down construction so we can’t have any of that. Instead the establishment wisdom is to push the economy to the limit, go for broke, the more growth the better.

The country is also at fault since it could’ve established rules and policies designed more for stability and prudence than growth at any cost. That would not be an easy task in today’s financial environment. There are only so many Hugo Chavez’s in the world who could ignore the dictates of the establishment view.

The borrower, of course, must take a substantial portion of the blame for the broken contract, but ultimately is has to rest with the bank to assume responsibility and take the loss. Banking is about risk; banksters know the level of risk they are undertaking. If you aren’t smart about lending your money, who else is supposed to compensate for your inadequacy?

Actually it’s the taxpayer who coughs up since some type of deposit insurance is essential to a functioning banking system. (But not in Cambodia, here you’re on your own.) There should be no question or hesitation when a bank gets into trouble; it should be shut down and small depositors paid off. There’s no good reason to keep a stupidly or irresponsibly run bank alive. Also as long as the taxpayer is on the hook to insure depositors the government has responsibility to properly regulate to prevent speculation that has the potential to get the bank into trouble. However, since the banksters own the government, at least in the US, we know there can be no changes on that front.

In Europe it may be different, since they have a more socialist, egalitarian political outlook and the people are hopping mad. Still, there’s a very powerful push on the part of the financial establishment for European countries to ‘take their medicine’, that is, to strip any benefits that might aid the 99% so that they’d have the money to feed the banksters.

Still, can you imagine, Spain coughs up €50 to protect the banks at the same time they’re slashing safety net funds in an economy with 25% unemployment? In fact, latest news is that the Spanish government has accepted a $125 billion loan to bailout its banks… anything to protect the banksters.

The European establishment may be forced to change the paradigm but Americans will never get it together if the recent recall result in Wisconsin is any indicator. Governor Scott Walker, who was elected in a Tea Party surge in 2010, started off giving $180 million in tax breaks to business and then discovered there wasn’t enough money to pay public employees. His ultimate goal, unstated in the campaign, was to break the public unions, which he proceeded to do by virtue of Repug control of both houses of state government.

This didn’t sit well with the unions or the progressive community so they fought back with a signature gathering campaign to recall the governor. The got the necessary signatures, all right, but lost badly in the election with Walker sustained in office by a 53% to 46% vote. There are two immediate reasons why the Repug won. The most important was the flood of money from right-wing billionaire assholes. According to the US Supreme Court - which today garners the support of only 44% of the people - money has the right of free speech. The other reason was that Obama gave the campaign neither financial or moral support. The feckless wonder did not stand by the people. The Dem running against Walker had $4 million and was outspent 8 to 1. Obama made $3.5 million in one fundraising event but couldn’t see his way to helping a fellow Dem.

The fundamental reason for the Dem’s defeat is that Americans, at least a lot of them, are political morons. It’s called the Fox News effect: A recent study showed people who watched Fox were less informed than people who watched no news at all. It’s people who rail against socialism at the same time they love their Medicare, that socialist program that would save the country $400 billion a year if it applied to everyone. It isn’t just the average low IQ wingnut dolt that doesn’t know their ass from a hole in the ground. You’ve got Romney and the Repugs insisting on programs of slashing public services to pay for tax cuts for the wealthy as a path to economic recovery when that’s been an abject failure since Reagan.

Once again Americans face a disheartening lack of choice this November, though the country will slide downhill a little slower with Obama at the helm. In the end result, the people get the politics they deserve… unfortunately.

  

Athens Enflamed

The crisis in Greece is multifaceted both in its sources and portents. In addition to the inability of many governments – which includes UK, US and Japan, to name a few - to get serious about taxing sufficiently to maintain a reasonably balanced budget (it’s too easy spending money you don’t have) Greece is faced with corruption at the top and featherbedding on the bottom.

As to the former, wealthy weasels collude with corrupt bureaucrats to avoid paying taxes, which seriously truncates tax revenue.

The latter involves lots of ghost workers and jobs that are way too cushy. Ghost workers are those that only make their presence known when it’s time to collect their paychecks. Featherbedding is best described by an experience I had working on the NY subway system back in 1964. It was World’s Fair time and I got a temporary 6-month job as a car cleaner for the line that served the fair.

It was graveyard shift, 10 pm to 6 am. We had a quota of 8 cars to sweep a night, but most nights it didn’t take much more than an hour to do the work. We’d punch in at 10, sit around the lunch table till after 11, go out and sweep 4 cars and then sleep in one of the cars till lunch at 2. After lunch we’d go back and sweep 4 more cars then take another nap till punch out time at 6. If anybody hadn’t shown up for work, there’d be overtime, 2 hours for 2 additional cars.

If you had a puke to clean up that could take extra time but the cars were new with smooth floors and hard plastic seats so very easy to clean. They also had only lateral seating, that is, against the sides of the car. It was on the city’s IRT line, the oldest of the three subway systems and the cars were narrower and shorter than in the other two newer systems. Since the cars on the newer lines were wider there was room for perpendicular seating so the two types of seats, lateral and perpendicular, alternated, making lots of little corners to sweep. And being older than the new cars I worked on, the floors were kind of rough. Those cars actually took some time to sweep, though still nowhere near one hour per car.

It was union work rules that created lots of easy jobs. I’m somewhat conflicted on the subject. On the one hand I like the idea of jobs not being excessively stressful and frantic. On the other, well, it does get boring not having anything to do and besides there’s always productivity to consider. Breaking down costly and unproductive work rules was part of the Reagan legacy. In some ways it was good, but the industrial world has carried it way too far in the constant drive to push workers harder and harder to eke out every penny of profit. Every downsizing involves forcing the remaining staff to work harder.

In order for Greece to maintain its bloated civil service in the face of inability to raise revenue, compounded by the economic downturn, the country was forced to borrow at unprecedented levels. Their borrowing, by the way, was aided by Goldman Sachs, the investment bank most of us like to hate, which provided ‘innovative financial instruments’ that allowed the country to hide its true debt level.

Now its annual deficit is running at nearly 14% of GDP and total debt is about 115% of GDP. The country can no longer finance its debt, since investors are now asking for very high interest on Greek government bonds out of the very real concern that the country may default. It cannot afford the interest. If it had its own currency instead of using the Euro, it could just print money, thus devaluing the currency and lessening the debt burden. It can’t print Euros so it’s either got to pay or default.

The only way Greece can pay is if it gets bailed out, and the only way it’ll get bailed is if it changes its profligate ways, otherwise no other country will be willing to risk their taxpayer’s money on a country that can’t figure out how to live within its means. In order to get that help they must either end the tax evasion at the top, or severely reduce benefits and cut back on its bloated civil service, the latter much easier to do than the former. They will also be raising value added taxes, which is equivalent to sales taxes, that will hit everybody. The workers are understandably balking. Nobody wants to lose benefits or suffer drastic pay cuts, they will naturally fight. Some workers are suggesting the alternative, defaulting, saying let the fat cats pay.

The high rollers would pay for sure in a default scenario, that’s why European countries and the IMF are frantically putting together a trillion dollars worth of guarantees and bailout money to keep their troubled economies afloat, otherwise their banksters will take a deep hit and they’ll wind up bailing the banks out directly. The Greek bailout is in the form of debt which, though it will be on favorable terms and save the country from default, will seriously add to its total debt burden… so maybe only a temporary fix.

Default, on the other hand, is also no bed of roses. If the deficit is 14% of GDP then the country is getting 40 to 50% of its budget from borrowing. In a default scenario, that source of money instantly dries up so the result is cutbacks far more drastic than proposed in a bailout scenario. Moreover, instantly removing 14% from the economy would throw it into a tailspin with unemployment spiking and economic hardship across the board.

Argentina defaulted about ten years ago. The country was immediately transformed from a middle income country to 60% living in poverty. Much of the economy turned to barter as their only means of exchange. In some cases workers took over shuttered factories. Today, the country seems to be doing ok but it still has not returned to its former economic status.

The root of the debt problem, it seems to me, is the mania for growth. In that scenario, some level of budget deficit is considered a good thing because money is being injected into the economy. According to the theory, borrowing that stimulates the economy is not a problem because the resulting growth lessens the impact of the debt. However, problems arise because governments tend to get hooked on debt – it’s so much easier to borrow than tax – and they become unable to rein in spending to match income. Eventually, as we see in Greece, debt can become so large it is unsustainable and requires drastic retrenching to return to balance.

The debt/deficit situation in the US is actually not far from that of Greece. Total debt is about 100% of GDP. Deficit spending at $1.4 trillion is now about 10% of GDP and that borrowing represents 40% of the budget. The only thing that saves America from Greece’s fate is the use of the dollar as an international currency. For instance, here in Cambodia about 80% of all transactions are in dollars. When Cambodia needs dollars it has to pay for them, which in effect provides interest free loans to the US.

The dollar is temporarily riding high against the Euro because of the Greek problem but Greece is a very small part of the Eurozone and the main countries in it are in fine financial health so unless the US starts to get serious about reducing its deficit the dollar at some point will reverse present course and crash. Meanwhile the idea that America will at any point in the near future begin to bring its finances into balance is risible, unthinkable, almost unimaginable.

However, if the US keeps merrily ignoring fundamental fiscal reality, believing it can be the world’s only exception it will be merrily waltzing over a cliff. The catalyst will be a rise in interest rates. At some point, and in the not too distant future, resource depletion will cause a spike in inflation which will trigger an increase in interest rates (not that raising interest rates in that scenario makes any sense but that’s how the economic establishment thinks about those things) which will sharply increase debt service… and thus begins the downward spiral. You know, yourself, when you get too far into debt, and have to start taking money out of daily life to pay down that debt, it’s very painful living without your usual amenities until you get back on an even keel.

In any case the prognosis isn’t pretty.

Reservoir Going Dry

Regarding the ‘reservoir of wealth’ statement I made in my last article a reader asked a question via email which I will respond to.

There is a positive aspect to the immense reservoir of wealth I referred to in the sense of their being a large tranche of money in the hands of many Americans to help keep the economy afloat (even if just barely). However, on the negative side it will merely prolong the day of reckoning.

Another point that maybe wasn’t clear was that the mother of all bubbles refers to inflation and the crash of the dollar.

The US has been living way beyond its means because the dollar’s status as the world’s reserve currency exempts it from the hard choices that every other country has to make under the same spendthrift conditions. Every other country has to raise taxes, cut expenditures and generally tighten its belt. The US only has to print more dollars.

That exemption is soon to be sorely tested since the other countries who’ve been financing America’s debt are beginning to balk. China in particular has begun to fear for the safety of its trillion and a half dollars worth of US investments and rightly so since America’s debt binge is only intensifying in the desperate attempt to restore the old economy.

What a travesty, an embarrassment to see Obama and Geithner obsequiously reassuring China that it’s investments were safe, that America was interested in a strong dollar.

A lot of countries are talking of switching their assets, or parts of them, to more stable and possibly more universal currencies, once again presenting a great challenge to the dollar and the American economy.

A big part of the run up of oil prices last summer was the corresponding fall in the dollar, it hit a low of $1.60 to the Euro. The dollar then, almost counterintuitively, rose in value last winter. With economies crashing everywhere, the dollar seemed a relatively safe bet to many people and it went up to 1.25 to the Euro. That also corresponded to a fall in oil prices down to a low of about $35 per barrel.

Now the dollar is back down to $1.40 against the Euro and still falling and oil prices have surged back to near $70 per barrel. Oil’s rise is based on two other basic reasons besides the fall in the dollar.

One is the inexorable decline in reserves. The fact that oil is currently being used up at a slower pace than during the boom doesn’t change the reality that it’s being used up. China is still growing at 8%, India at 6%. Added together they have about 40% of world population. Since transitioning to a sustainable energy world is today 99% words and 1% deeds, they are doing their best to take up the slack in consumption (and resource depletion) created by the fall in demand in the developed world.

Finally the matter of speculation rears its ugly head. As long as the wealthy are flush they have to find somewhere to play with their money. As long as those types of transactions aren’t taxed, they can play to their heart’s content: to no one’s benefit but their own. If taxed, they would be more cautious and circumspect.

The stage is set for a steep rise in oil prices in the next two or three years.

First a very short description of monetarism; the guiding principal of American economic governance for decades now. Simply put: Inflation means the economy is growing too fast so you raise interest rates to slow it down and thus dampen inflation. High unemployment, which means the economy is in the doldrums, is countered by lowering rates.

The fact that the theory has failed miserably to describe actual events has not deterred its proponents one iota. The Clinton years were characterized by low inflation and low unemployment – wasn’t supposed to happen that way.

Before that during the Carter years there was high inflation and high unemployment, but that 1970’s inflation was caused by a spike in oil prices, not a roaring economy. One way the theory falls down is not recognizing that scarcity completely changes the price paradigm. If a time of inflation is not based in any way on an overheated economy, then raising interest rates can only make it worse.

Interest rates under Carter went up to 17% to counter soaring inflation, but the high rates were themselves fueling same. Maybe interest rates fluctuating between 2 and 6% would not have an effect on underlying inflation, but 17%, for sure.

So here’s the scenario: oil prices spike, triggering inflation, which in turn calls for high interest rates to counter it, which in turn batters the economy further. Meanwhile, the US government will need to raise fantastic amounts of money on the bond market to pay for monster deficits, as well as raise large amounts for bonds that have to be redeemed and refinanced.

To do that it will have to raise the rates it pays in order to entice buyers. They are already wary, so the rates may have to go relatively high. Higher rates also mean a lot more of the budget will need to be devoted to servicing debt. The only other alternative is to print money; either way a surefire recipe for inflation.

To begin to right the budget and the nation’s priorities, the first step has to be higher taxes, including heavy taxes on the wealthy and corporations. This will curb speculation and get the debt onto a manageable level.

It’d be perfectly ok to increase debt if it were going for alternative energies, electric vehicles and fast trains because those types of investments would shield the nation somewhat from higher fossil fuel prices to come.

Raising taxes as high as necessary to insure food, shelter and health care for all should also be a no-brainer. In real life the bankers get their trillions while homeowners facing bankruptcy get almost nothing.

So sorry, but America is addicted to the cheap fix of devil-may-care debt. There’s literally no chance the political establishment would even understand the imperative of raising taxes to tackle the budget deficit, let alone actually make it happen.

So what’s the prognosis? The US will muddle along doing its best to avoid reality until the next crisis, which will be of mega proportions. It will haughtily, arrogantly depend on belief in its own exceptionalism to imagine that it has a cosmic dispensation to be irresponsible without the burden of consequences. Bumpy ride ahead, folks.

The Mother of All Bubbles

Back in the heady days of the 1990’s dot-com bubble there was a TV clip, on Nation Public Broadcasting I believe, that profiled a couple who were what I’d describe as extreme, or more appropriately mindless, investors. They had gambled their entire stash on a company they knew only by its stock market code. They had no idea what it actually did. That was four or five years before the crash, so they might well have cleaned up.



This was also about the time a true economic idiot made a bundle of money writing a book called DOW 36,000 that argued the market was actually way underpriced and was bound to triple in value even when in reality it was already seriously overpriced. It’s a new paradigm! Now the market only goes up! The boom and bust cycle is finished! Most depressing for the state of the world and the state of the American media is that that fellow, who’s name I can’t bother to remember, is still seen on TV doing his punditry thing, in spite of making one of the worst predictions of all time.



That was also about the time Greenspan made his too-smart-for-himself irrational exuberance comment. Too smart because after properly identifying a grave danger to the economy he did nothing to counteract or mitigate the certain crash to come.



You can be exuberantly irrational for limited periods of time but it defies logic, reason and common sense that you could carry on irrational behavior for very long before it results in a very rational smackdown.



I kept predicting the crash year after year; a good friend kept responding by saying, You’ve been saying that for years and it’s still going up. Well, no matter how much one might wish it otherwise, there’s no defying gravity. It’s in the nature of bubbles to burst, that’s what they do at their anointed time.



One bubble per decade seems to be America’s current pattern or need so it was important to create a housing bubble for the double oughts. In the great fear that the economy wouldn’t barrel ahead after 9-11, interest rates - for the bankers, that is - were taken down to near nothing. It’s worth pointing out that low interest rates are not good for everyone. For the savers, the people and their lifestyle that under normal circumstances - thinking of a rational world, that is - you want to encourage, low interest rates are a disaster.



In the midst of the housing insanity I pointed out to the same friend that in a market like Southern California it cost twice as much per month to own a house than it did to rent an equivalent one. An average $500,000 house might cost $5000 per month to own, but only $2500 to rent: in other words paying a $30,000 per year premium to own it. She then pointed out that property values were rising at 15% per year so that half million dollar house added $75,000 to its value and you’d still be way out ahead.



But rising values that were way out of line with reality were pricing people out of the market so mortgages had to be invented for people who couldn’t afford to pay them. NINJA loans – no income, no job, no assets – became the rage. It didn’t matter since the borrowers could always draw equity out of their houses’ rising value… until values stopped rising.



The enabler, I would argue, of both bubbles was/is the excessive wealth held by the powerful of society and the corollary belief that prosperity for the greatest number would be facilitated by placing the least restraints on those wealthy controllers. In reality, whenever they have too much money on their hands the certain result will be dangerous, and eventually destabilizing, speculation and asset bubbles.



Now, in the desperate, frantic, but also wistful and futile attempt to revive the old economy, or even a semblance of it, America is creating another bubble: this time it’s the dollar’s turn to bubbleize. It’s akin to a Reno loser story I once heard. When a gambler’s losses reach too high they feel they have to try anything to win the money back. After they max out the cash limits on their credit cards they go to a furniture store, buy a TV – the cards are still good for purchases – then turn around and hock it at the nearest pawn shop, getting probably 25 cents on the dollar.



America has already sold the farm – trillions of dollars are owed to foreign governments (China is the biggest creditor… If that doesn’t put a chill down your back, it should) – now it’s selling the furniture in the rented farmhouse; all to revive an unsustainable economy that should have been retired long ago.



Eleven trillion dollar national debt, 1.9 trillion dollar budget deficit for this year, 600 or 700 billion dollar trade deficits on an annual basis for years, one trillion dollars of personal credit card debt and now thirteen trillion dollars gambled on the big banks in the form of giveaways, loans and guarantees.



America’s the only country that could run massive trade deficits because the dollar is the world’s currency – people around the globe use dollars for things totally unrelated to the US. Eighty percent of transactions in Cambodia where I live, for instance, are in dollars. Every other country that tried to run those kinds of deficits would have been brought short pretty quickly and paid a heavy economic and social price for their spendthrift ways. Not America. At least not yet.



You know what they say; something that can’t go on indefinitely, won’t. Let me add my own postscript to that; the longer you wait to correct the imbalance the greater the impact when judgment day comes. For America comeuppance will bring catastrophe.



While all the aforementioned mentioned debts and liabilities will contribute to the crash of the dollar, the one most important factor has to be the attempt to save failed too-big-to-fail banks. Even after 13 trillion dollars of support, the Fed’s stress tests showed about half the nation’s 19 big banks will need another 70 billion dollars in new capital.



Moreover when you look at how unstressful the tests were, that 70 billion is a joke. The banks got to decide for themselves how healthy they were – doing their own pricing of their toxic assets, for instance - and their supposed solvency was based on extremely rosy economic predictions for the near future.



America’s on a years-long binge, challenging the gods, as it were, to bring it low. It’s ok to go into debt if it’s for something that has lasting value. It’s also good to go into debt if it’s used for something that brings in revenue and pays itself off. That’s sort of the thinking behind bailing out the banks: healthy banks = healthy economy = high tax revenues = debt no problem. But it’s a tremendous gamble on the order of the sad cases in Reno whose addictions result in them losing everything.



The big problem with going so deeply into debt so nonchalantly is that it has to eventually be paid back. At some point the joy ride must end and the price paid. Under any but the most benign circumstances, retiring debt is painful. It means taking from today’s advancement to pay for yesterday’s indulgence.



The only alternative to paying off the debt, which would require steep tax rises and social sacrifice – impossible to imagine in spoiled-child America - is running the money printing presses full speed ahead and hoping that doesn’t result in worst case scenarios.



There remains an immense reservoir of wealth in America in spite of the current hard times and great respect and trust in America’s strength around the world so I wouldn’t look for this dollar crash to happen tomorrow, but it’s as inevitable as the last two bursted bubbles were.