Fundamental Truth: You Can’t Spend More Than You Take In

OK, now I’m getting a bit spooked — Bloomberg ran this:

America has a terrible saving problem and a slumping economy. But our national mantra, underscored by last week’s payroll-tax cut, is spend, spend, spend.

Countries can’t spend their way to prosperity. This demand- side voodoo-economics approach is driving us further into hock. The right mantra should be save, save, save.

Hoh hoh hoh…

Back to fundamental truths, my friends:

  • Nobody ever lends anyone money at an intentional loss.
  • Due to the mathematical essence of exponents two compound functions will always run away from each other over time.

That’s the beginning and end of it economically.  “Spend spend spend” can never work because capital formation requires saving and when you replace capital formation with debt you are guaranteed, in aggregate, to lose.

Noodle on those two basic principles above a bit and it will snap into focus: A lender of capital will always seek to charge more than the growth rate in the economy (otherwise he’d rather do something with the capital other than lend it to you) which means that when capital formation as the predicate for business formation and investment is replaced by debt — what banks and the financial industry calls “credit” — the spread guarantees that eventually the amount of debt will rise hyperbolically compared to output.

I know I’ve shown this chart dozens of times, but until we break this cycle we will never have actual economic prosperity.

That will always happen.

There’s only one way to stop it — don’t do that.  Don’t rely on “credit” for economic expansion.  Economically force expansion to be funded by economic surplus — that is, capital formation.

People recoil in horror when I say “force”, but in point of fact the government doesn’t have to force anything.  The “force” in question are natural economic forces and they act all on their own if the government stops backstopping and subsidizing the use of debt instead of capital.

Fannie, Freddie, the rescue of AIG, Student Loans, Medicare/Medicaid, the bailout of GM and Chrysler, backstopping Citibank as many times as you have fingers in the last 30 years, refusal to instantly jail all the officers of MF Global when the missing segfunds were discovered and more — all come down to one thing: Government’s intentional distortion of the markets.

This should not surprise — after all, if government was to use capital instead of debt it would have to tax more and spend less!  That is, the same “basic” principle applies at the government level.  It’s not quite identical in that government doesn’t produce (directly) and thus there is no “economic surplus” per-se, but in general it can either fund its programs with economic surplus (which it taxes from the people — by definition economic surplus since if you can’t pay and survive you cease to be a taxpayer) or it can replace economic surplus with debt.

The cessation of these policies beings with government.

We either do it now or we’ll do it the hard way.  Both paths suck — we’re only choosing which sucks less, and the longer we wait to do the right thing the worse it’s going to be.

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