Geithner preached the lessons of the emergency banking support provided by the Treasury and Federal Reserve in reaction to the collapse of Lehman Brothers Holdings Inc., mixing it with criticism of Europe’s crisis-management coordination.
Uh huh. And those lessons are? Has our economy recovered? Has debt contracted to appropriate and manageable levels? Has the federal government’s “temporary” support program of borrowing and blowing 12% of GDP concluded?
Or is the truth, Timmy, that fraud as a business model has now been extended to government and you’re smugly patting yourself on the back for preventing an explosion by pulling the burning wick out of the box a bit further, forgetting that (1) you’re still carrying the box and (2) there’s a dozen pounds of TNT in there and the wick still goes inside!
The imagery that comes to mind when Turbo speaks of such things reminds one of Wile-E-Coyote and his inveterate attempts to blow up, smash and otherwise kill the Roadrunner. But like the cartoon although Wile-E is often seen with dining apparel in hand nobody every explains how he’s going to actually eat a blown up, smashed to dust, or buried under tons of rock Roadrunner, should he some day succeed despite his repeated display of “genius.”
Europe projects an image of “ongoing conflict” between national governments and the central bank, hampering efforts to put the economy on a sounder footing, Geithner said at a banking conference in between euro meetings.
“Your financial challenges in Europe are eminently in your capacity to manage financially, you just have to choose to do it,” he said.
And how would that be? See, this is the problem – Germany exports lots of hard goods (like cars, for example) to Europe which then consumes them. But Europe has consumed them by borrowing, not by producing. Greece, for example, has a monstrous welfare state, as does the United States. But consumption in those European nations is how Germany manages to put up the numbers it has economically.
Unfortunately Germany has stoked it’s “growth” with false expectations, as has most of the rest of the western world. Rather than build a sustainable model in which people produce, pay taxes from that production for government services (that’s redistribution – let’s call it what it is), spend however much of the rest they wish on consumption and save some part of the remainder (that’s called “capital formation“) the entire European continent joined the rest of the western world in believing that we could continually borrow more and more money to sustain consumption!
The economic term for this is malinvestment. That is, rather than invest from saved capital (the economic surplus from produced goods and services) people were provided incentives to instead borrow on the promise of producing more tomorrow.
The problem is that not everyone can produce more tomorrow and nobody can do so on a compounded growth rate into the indefinite future.
Consider the athlete. He runs a 4:10 mile. He might be able to improve his time by 4% or so in the next year with training, and in doing so cross the “magical” 4 minute mile barrier. But he cannot continue to improve at a rate of 4% a year forever; that is a physical impossibility.
This, however, is what we’ve been sold. We’ve been sold it in investments (the “8% annual return” meme that is still being run today) we’ve been sold it in terms of economic growth (the mythical “5% GDP”) and we’ve been sold it in virtually every other phase of our life.
This cannot continue for the simple reason that it’s physically impossible. Yes, there will be major improvements from time to time in productivity. We know of many throughout the last couple hundred years – first the introduction of large-scale steam power into industry, then electrification, then communications (e.g. telephone and telegraph), mechanization of farming and transport (e.g. the development of practical internal combustion engines of various sorts) and data processing (e.g. first large-scale computing through several iterations, then combining that with communications via the Internet.)
These have all “shrunk” the apparent size of our world. This is good, not bad.
Have you ever noticed that the worst credit bubbles tend to come at the same time as we experience these improvements in productivity? There’s a simple reason for this, of course: The growth in output occurs and people are led to believe that’s a durable change and will continue – not in fits and starts, but on a continual and annual basis.
They’re wrong, of course, because that’s not how the physical world works. The monster growth spurt in the Internet occurred with the release of Windows 95 in August of that year. The “monster” part was over within 12 months. It then tapered off, but that was sufficient to produce a bubble in stocks that took nearly four years to pop, and when it did it destroyed the apparent wealth of millions.
I say “apparent” because that “wealth” was never real. Oh sure, there were people who did produce durable wealth from that time, myself among them. But MCSNet never took a nickel in forward financing of any sort. Saul (the bank President where we did business) kept lamenting the fact that I refused to borrow money from him, choosing instead to grow the company from retained earnings – that is, excess capital after all costs of producing the services we sold were paid. That growth was real, it was durable, and it was “mathematically” less than it would have were we to have employed massive leverage – if I had been wise enough to know exactly when the bubble would pop and get out first.
Ah, there’s the problem grasshopper – are you smart enough to know with certainty when that is? No you’re not, and the wise man recognizes this fact and therefore chooses not to play. The inveterate speculator on the other hand risks blowing up everything he built every day by entering that casino and it is luck, rather than skill, that allows him out before his head takes its turn in the economic guillotine.
The real problem that the Eurozone faces is that it has allowed banks to lie about the value of bonds on their balance sheet, just as we have. It has not forced them to mark those instruments to the market nightly, just as we have not. The market has correctly deduced that in the event these “temporary” and “market-based” losses represented by current offered price crystallizes into actual economic loss, such as through a Greek default, many of these financial institutions will be rendered instantly insolvent.
The error is not in failing to bail out Greece, or bailing out Greece. The error is in a continued promotion of economic policy that violates the laws of the physical world we live upon. The premise of borrowing to consume and speculate must always end badly, because continued compounded growth is mathematically impossible on a sustainable basis, and yet this is what the system requires to operate perpetually when it is allowed to run in this fashion. Rather than build economic progress on capital formation – that is, the economic surplus of individuals after they pay the expenses of their lives, we have instead turned the world on its ear and bought into the bankster’s siren song that one can have today and produce tomorrow.
Without explicit government support of fraud these excesses cannot happen over an extended period of time. If you force honest accounting and reporting to take place under penalty of criminal sanction and deny these firms the ability to claim their assets are “covered” when there is no proof of ability to pay all of the gamesmanship disappears and the bubbles cannot expand to dangerous levels.
Oh sure, there will always be speculation, and people will make or lose money predicated on that speculation. There’s nothing wrong with that in the general sense.
But there’s plenty wrong with Geithner’s claims that we can keep playing this game on an indefinite forward basis and never have to pay the check engendered by doing so. That has never worked over time because it mathematically cannot, and yet our government refuses to accept and acknowledge that fact.
It appears that Europe is starting to “get it.” They’ve come to the conclusion that nations cannot run deficits on a perpetual basis that exceed economic growth. The “3%” rule appears reasonable assuming that economic growth can reach 3%, and it probably can over material periods of time. While a better rule is “0%”, simply because the natural evolution of all economies is a mild deflation (due to productivity improvements) this is certainly better than our situation today – or theirs. Such a rule would limit the United States to a $450 billion deficit inclusive of financing costs, which means that functionally our operating deficit limit would be about $200 billion today, dwindling toward zero the longer we kept it up.
Greece, for its part, appears to know the gig is up too. Papandreou has apparently decided not to meet with the IMF and Geithner this weekend, choosing instead to return to Greece.
The pyramid that has sustained the “rally” in risk-asset prices over the last two years appears to be about to have its legs cut out from under it. A couple of weeks ago I said that I expected you’d have one more chance to get out of the market if you were stuck long risk assets.
That opportunity may in fact be about to expire.