The Great American Bull Market in Debt
Americans, at the beginning of Anno Domini 2004, were a happy and contented race - but in Revolt against Fate.
Their paper money - unbacked by anything more than promises from the world's biggest debtor - was destined to go bad; all paper money always did. Their economy was doomed to slow down - debtors cannot increase their spending forever. Their stocks were sure to fall, victims of an excess of enthusiasm and a paucity of real profits. Their bonds were living on borrowed time, too - for it was amazing that foreign lenders continued to buy a 5% bond when the currency in which they were denominated was losing 20% of its value in a single year.
But as the snow fell in the winter of 2004, they hardly suspected. For they believed their position in the world must reflect some kind of innate grace, or must be a product of their own invention. Since they had invented it themselves...surely they could control it.
Little did they realize that there was nothing really new to their system. But no fantasy is so hard to destroy as a man's good opinion of himself...and in January of 2004, Americans' opinion of themselves had not yet been bruised by a falling dollar...nor hardly even touched by the recent recession and bear market. Americans still could not describe their special gift...but they were sure it put them on top of the world. For they had invaded Iraq...not the other way around. Their economy was racing ahead of their European competitors (they ignored the effect of the dollar)...and they alone could still issue pieces of paper that the whole world called 'money.'
If a bull market can turn a schmuck into a genius, The Great American Bull Market in Debt created a whole nation of them...all somehow sure that the end of history had come...and its final chapter had them as the big winners. They ignored the hard work of their fathers and grandfathers in the chapters ahead of them. They dismissed the virtues of thrift, sound money, limited government and collective modesty that made their forebears so successful. They flipped through the pages of American history and paid no attention to the dead. And the young...the unborn? It was as if they thought the book had no sequel...as if it were the last oeuvre ever...the last word...the final, culminating perfection of all Western civilization. The young are on their own...they will have to pay off our debts as best they can!
We can almost hear Fate snickering. Not that we know what he has in store for us. But since it is the beginning of a new year, we guess and wonder...
We wonder how Americans can avoid a drop in their standards of living. In global terms, wage rates have fallen in the U.S. for the last 2 years - and are down 40% in euro terms. A few more years of this, and the average American factory worker will be competitive with a Bengali!
We wonder when stocks will begin to fall. Soon is our guess. The Feds reloaded the bubble in 2003. But what ammunition do they have left? Lower interest rates? Bigger deficits and more government spending? Another tax cut? None of this is very likely anyway.
We wonder when the Chinese and other lenders will come to their senses and stop lending to Americans at such low interest rates. We don't know. But eventually.
But all of these wonders and guesses you have heard before. Readers say they are getting tired of our 'gloom and doom' and would welcome some 'constructive suggestions' for surviving 2004.
Alas, we have no constructive advice. The best we can do is to continue digging down...day by day. Our resolution for the New Year is the same as for the old; we are still trying to get to the foundation...the hard meaning of it all. It is slow going, for we are digging into the bedrock of the modern consumer economy...trying to understand what it rests upon. When does it give way, we wonder? What happens when the proud tower of debt and paper money finally becomes too high, too heavy for the earth beneath it? What happens when the wind blows? Which direction will it fall?
"Republican hearts are all aflutter over one quarter of strong GDP numbers," writes Robert Freeman. "But the 8.2% third quarter growth was purchased on credit - the $374 billion budget deficit that was the largest in the country's history. All indications are that next year's deficit will be even larger, exceeding half a trillion dollars.
"There is simply no magic to 'growth' under these conditions. Any idiot with a hand full of credit cards charged to the next generation's children can gin up the short term illusion of prosperity. Until, that is, the bills come due.
"George W. Bush inherited a $127 billion fiscal surplus but ran through all of that and more in his first year. He has turned a $5.6 trillion 10 year forecast surplus into a $3+ trillion forecast loss - an almost unimaginable reversal of $9 trillion in only three years. And this, in an economy that has grown for ten of the last twelve quarters.
"How, then, does a nation deal with debts that so greatly outrun its ability to pay?" There are only a few ways, says Freeman. "All are unappealing. Most are calamitous."
Over the past 4 and a half years, here at the Daily Reckoning we have chronicled the build-up of debt...and the extravagant delusions that support it. Now, we look ahead and wonder what happens next. When the tower of debt falls...where does it land? Who gets hurt?
But we find no answers staring blankly into the space of the future. Instead, we get our clues and hints by sifting through the sediment of years past...and talking to dead people.
We have dug down through the Bush years...and past the Clinton and Reagan eras. We sliced our spade right through the sordid debris of Nixon's time...and kept going through the Great Society, WWII, the New Deal, the Great Depression, and Roaring Twenties...and even down to the founding of the Federal Reserve and WWI.
Of course, we've collected many entertaining nuggets in our sifter: "We're all Keynesians now," said Nixon. Beware "irrational exuberance," warned Greenspan. We will "make the world safe for democracy," said Wilson. We stop and giggle.
And then, we take up our tools and dig a little deeper. We have reached the 19th century...and have wandered over to sunny Italy. There, after the "risorgimento," or renaissance of the Italian state under Mazzini and Garibaldi, Italy joined the modern, democratic world.
There was a time when kings, princes, and emperors ruled the world. Back then, "the people" knew their place. But in this new, modern world it became necessary for rulers to appease the masses with various programs designed to fool them into obedience. Armed with ballots, everything seemed possible.
Ortega y Gasset describes the scene:
"Whereas in past time life for the average man meant finding all around him difficulties, dangers, want, limitations of his destiny, dependence, the new world appears as a sphere of practically limitless possibilities, safe and independent of anyone...and if the traditional sentiment whispered: 'To live is to feel oneself limited, and therefore to have to count with that which limits us,' the newest voice shouts: 'To live is to meet with no limitation whatever and, consequently, nothing is impossible, nothing is dangerous...'"
He might have been describing the mindset of the contemporary American investor, who sees no limit to stock prices and no risk anywhere. And so he was...but 70 years ahead of his time.
Voting cannot really increase the masses' well-being. It brings no more hogs to market...builds no more gadgets...improves no meals...nor does it increase the efficiency of the internal combustion engine. But the masses will believe anything...and after Bismark and Garibaldi came to believe that this new world of assemblies, parliaments and election fraud offered a better world. It then became the job of politicians to find a way to appeal to these fantasies. This they did, in 19th century Italy as in 21st century America, by borrowing money - thus creating the illusion of spending power, out of thin air.
From 1859 to 1925, the Italian government ran deficits over 46 years. In only 20 years was the budget balanced. The lire was not a reserve currency; Italian politicos had to do the best they could.
But the debts continued...and led, according to John T. Flynn in his excellent book, "As We Go Marching," to war. Not because anyone in particular wanted war...or debt for that matter. It was just that one was an evolutionary consequence of the other...and both were consequences of the natural urges of democratic society.
"Out of the condition of Italian society sprang certain streams of opinion and of desire that governments acted on and people accepted or at least surrendered to with little resistance, even though they may have not approved or even understood them. Bewildered statesmen turned to government debt as a device for creating purchasing power. No one approved it in principle. But there was no effective resistance because people demanded the fruits it brought. Another was the ever-growing reliance of social-welfare measures to mitigate the privations of the indigent, the unemployeed, the sick, the aged. The instruments of debt and spending became standard equipment of politicians. And this need for spending opened the door to an easy surrender to the elements most interested in militarism and its handmaiden, imperialism."
"Out of Italy," he continues, "had gone definitely any important party committed to the theory that the economic system should be free."
Whenever the debts threatened to overwhelm the nation, inventive politicians found new enemies to distract the people and quiet opponents.
"If the country had no natural enemy to be cultivated, then an enemy had to be invented," wrote Flynn.
In September of 1911, Italy went to war with Turkey. Then, WWI provided fresh diversions. But after the war, the debts mounted even higher. The pre-war debt was 15 billion lire. When the war ended it was 4 times as much. But after the war came new promises...and old-age pension system...unemployment insurance...a national heath care plan. The deficit reached 11 billion lire in 1919..then rose to 17 billion in 1921. How could the debts possibly be paid? Was there anyway out, people wondered?
It was at this point that a scoundrel worthy of the crisis arrived on the scene - and proceeded to make things worse. Benito Mussolini was the man for the job - energetic, opportunistic...with no scruples or fixed positions to hamper his movements. Mussolini, like Roosevelt, Bush, and practically every politician elected to any office in the entire 20th century, denounced the loose spending policies of his predecessors...and then spent even more. He decried the unbalanced budgets that had brought Italy to the brink of ruin...and then piled new debt on the heavy end of the scale. Taking office in 1921, he found himself with a debt of 93 billion lire. By 1943, the New York Times estimated that his debt had risen to 405 billion lire, with a deficit for the year of 83 billion lire.
"Spending had become a settled part of the policy of fascism to create national income," concluded Flynn, "except that the fascist state spent upon a scale unimaginable to the old premiers."
"We were able to give a new turn to financial policy," explained an Italian pamphlet from the period, "which aimed at improving the public services and at the same time securing a more effective action on the part of the state in promoting and facilitating national progress."
The policy ended in disaster.
Spending on domestic programs shifted to spending on military ones. Soon, Italy was at war again. In blood, steel, shame, disgrace, and financial ruin...it settled its accounts.
Bill Bonner, The Daily Reckoning |
