FedUpUSA

Archive for the ‘Gross Domestic Product’ Category

The U.S. economy is in effect a counterfeit economy, living on money created from thin air that is unbacked by an equivalent productive expansion of surplus value.

Yesterday we looked at counterfeiting and money printing and discovered they are one in the same: (Counterfeit Money, Counterfeit Policy.) If we apply the same analysis to the U.S. economy, we have to conclude the entire U.S. economy is also counterfeit.

The analysis is not as complicated as store-bought economists would have you think.Much of what passes for “economics and finance” is simply distraction, a sophisticated version of bread and circuses.

Let’s start with two basic concepts: productive value and surplus value.The classic example of a productive asset is a factory that produces goods that have a market value that exceed the input (production) costs. In other words, the factory produces surplus value.

We can measure value by any number of means: ounces of gold, quatloos, sea shells, etc. To keep things simple, let’s just measure value in units. If it costs 10 units to produce a good (including labor, materials, energy inputs, transportation, and a return on the investment to construct and maintain the factory), then the output (products manufactured by the factory) must fetch 11 units in the open market to create 1 unit of surplus that can be invested or spent on consuming other goods or services.

If it takes 10 units of input costs to make a product that is only worth 9 units, then the process generates a net loss. There is no surplus to spend; rather, there is a loss that must be covered by cash, borrowing or the selling of other assets. When the cash, ability to borrow and assets that can be sold all run out, then the enterprise is recognized as insolvent and it closes.

If the factory’s output has little to no market value, then the investment is what we call a mal-investment–an investment that only claimed to be valuable because it was speculative or protected from price discovery in a transparent market.

Our current economic theory holds that any good or service produced has value, which we measure in dollars of gross domestic product (GDP).The intrinsic flaw in this way of assessing value is that it doesn’t recognize mal-investments.

Here are some examples.

– If a military aircraft woefully underperforms and costs so much field commanders dare not risk its combat deployment, then what value was created by its manufacture?

– If it takes 10 units of input costs to produce a biofuel crop that is processed into fuel worth 9 units, then what value was created by the process of making that biofuel?

– If a subdivision of new homes is built in the middle of nowhere and finds no buyers, then what value was created by the construction of these houses?

– If a costly medicine is distributed at great expense in the millions of doses and is discovered to have little to no effect on longevity or other metrics of health, then what value was created by the immense cost squandered on this medication?

In all these cases, the mal-investment was added to the GDP as if it created productive value.The factory and the costly but essentially useless aircraft (think B-1B bomber) were added to the GDP, but they did not create useable military value. The biofuel production facilities were all added to the GDP, even though the process generated a net loss. The homes built in the middle of nowhere were also added to the GDP, along with the costs of the worthless medication.

Consider a financial sector that is declared “too big to fail” and trillions of units are borrowed on the taxpayers’ account to bail out the albatross banks. The bailout of banks created no productive value, even as it took money away from potentially productive investments.

Since surplus value is not limitless, the money squandered on these mal-investments was no longer available for productive investments.Rather, these mal-investments sucked up all the surplus generated by the entire economy. Now there is no money left for superior (and cost-effective) military aircraft, medications that actually cure diseases rather than reduce symptoms, homes that are in desirable, cost-effective locales, productive energy investments, and solvent banks.

Let’s say an economy required 1 million units of input costs to generate 2 million units of productive value, i.e. goods and services whose price has been discovered by a transparent market. That economy has 1 million units of surplus to spend on consumption, productive investments and mal-investments.

Since everything requires maintenance and infrastructure, then there is no such thing as a steady-state economy: for example, factory machines wear out and have to be replaced. If there is no surplus money left because it has been sunk into mal-investments, then the factory’s ability to create productive value and surplus value degrades.

If the mal-investments have been prodigious, at some point the factory is incapable of producing any surplus at all.

There is a “fix”: borrow money based on the future surplus.If the amount being borrowed is modest in comparison to the potential surplus created by a refurbished factory, and the borrowed money is productively invested, then this reliance on credit and leverage may pay off.

But if the borrowed money is spent on consumption and mal-investments rather than being invested in productive assets, then the only “fix” left is to borrow more money–not just mortgaging the future surplus of the factory, but leveraging it into a stupendous sum of borrowed money.

At some point the sums being borrowed far exceed the potential surplus generated by the factory, even if the factory amd market are running at optimum levels.If the factory requires 100 units of investment to generate 50 units of surplus, but 1,000 units of money have been borrowed against that future surplus, then the interest payments on that 1,000 will eventually exceed the modest potential surplus value.

Note that future surpluses are all imaginary; it could turn out that the market for the factory’s goods declines and there will be little to no surplus value created in the future.

Borrowing money based on imaginary future surpluses is a higher form of counterfeiting. And that is precisely what the U.S. is doing, borrowing immense sums at every level, private, corporate and State/Federal, all leveraged against phantom future surpluses, even as the economy requires some 10% of its supposed output (GDP) to be borrowed and spent on consumption each and every year just to run in place, i.e. the Red Queen’s Race (Bernanke, Goldilocks and The Red QueenJanuary 10, 2011).

In other words, the U.S. economy is running a massive deficit, and squandering the vast sums being borrowed on consumption and mal-investments.Once you rely on more borrowing against imaginary future surpluses to fund your current expenses, then eventually the costs of servicing that debt exceeds any possible future surplus.

The last-ditch “fix” is to simply print units of money (or borrow it into existence like the Federal Reserve)–counterfeiting, pure and simple– and deceive the market for a time via the illusion that the freshly printed units of money are actually backed by productive value or surplus.

As history has shown, eventually the market discovers the actual value of this counterfeit money, i.e. near-zero, and the system implodes.

Alternatively, the credit markets grasp that there is no way the economy can pay the interest on its monumental debts, never mind pay back the principal, and then the number of people willing to lend surplus capital to the economy declines to zero, as does the economy’s ability to sustain itself with leveraged debt.

The system then implodes as the “free money machine” of ever-expanding debt breaks down. Once there is no more “free money” to fund consumption and mal-investment, then the reality of systemic insolvency is revealed to all.

You cannot counterfeit actual surplus value generated by productive assets, you can only counterfeit proxy claims on future surplus. That is the U.S. economy in a nutshell: we are counterfeiting claims on our future surplus, even as we squander vast sums on horrifically obvious mal-investments and wasteful, cost-ineffective consumption.

Charles Hugh Smith – Of Two Minds

Things that make you chuckle in the morning…

European Union leaders gather for their first summit of 2012 as a deteriorating economy and struggle to complete a Greek debt writeoff risk sidetracking efforts to stamp out the financial crisis.

EU chiefs arrive in Brussels about 2 p.m. today to put the finishing touches on a German-led deficit-control treaty and endorse the statutes of a 500 billion-euro ($661 billion) rescue fund to be set up this year. Greece and its private creditors said Jan. 28 they expect to complete a deal in coming days after bondholders signaled they would accept European government demands for a bigger cut in their debt holdings.

Uh huh.  That’s not the problem.  The problem is that Germany is screaming that Greece must surrender its national sovereignty in order to continue to receive “help”, effectively becoming a vassal state of Germany. 

In the meantime Sarkozy says he’s going to unilaterally impose a financial transactions tax.  One wonders how he’s going to pull that off, given that I don’t think France re-installed a King.  Or did they?

Here in the US we still won’t face reality — although it’s at least being talked about in the media now.

The level of debt held now by governments, the financial industry and especially consumers remains a greater drag on the U.S. than in 1983, Reinhart said Jan. 27 in a radio interview from Davos on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt. In the third quarter of 2011, total household debt was 86 percent of GDP, compared with 47 percent in the third quarter of 1983, according to the U.S. Commerce Department.

“The capacity for households to carry on to be the engine of growth that they have been in past recoveries is simply not there,” said Reinhart, a senior fellow at the Peterson Institute for International Economics in Washington.

Until this is recognized and we adjust for it we cannot have the sort of “recovery” everyone wants to see.  That is, we never hit the bottom, we never purged the bad debt, and we never set the stage for a “recovery”, instead covering up the problems with more debt and fraud.

In the final three months of 1983, average after-tax personal income had risen 4.2 percent from a year earlier, adjusted for inflation, according to the Commerce Department. In the final quarter of last year, it had dropped 0.8 percent.

Now now, let’s stop the intentional misuse of statistics there Bloomberg, and instead look at what we had just started doing back in 1983….

So did personal income actually rise?  Hmmmm…. we added, in 1983, a bit more than $100 billion in GDP.  But we also added $176 billion in debt, which means we were borrowing the so-called “increase” in after-tax personal income, we were not earning it.  Indeed, here’s the debt and GDP addition numbers for the quarters from 1981 through 1989:

Growth?  Where? 

We didn’t grow at all — we borrowed from roughly 2x to nearly 5x the increase in output each and every quarter during Reagan’s so-called “recovery”!

This is the fundamental scam that we have run for the last 30 years and we’re still not talking about it honestly!  Until we do and we reconcile the overblown asset prices and costs that go into both business and personal life that have come with this debt there can be no durable recovery — only further attempts to blow more Ponzi-style bubbles.

The problem is that in order to blow another asset bubble you need to find an asset where leverage is reasonably low and can be cranked up so as to support it, at least for a while. 

But we seem to be all out of those unencumbered assets……

So what to make of the GDP release Friday?

Real gross domestic product — the output of goods and services produced by labor and property located in the United States — increased at an annual rate of 2.8 percent in the fourth quarter of 2011 (that is, from the third quarter to the fourth quarter), according to the “advance” estimate released by the Bureau of Economic Analysis.  In the third quarter, real GDP increased 1.8 percent.

Sounds like improvement, right?

Well, not quite so fast….

First, this report has a habit of overstating the truth as it’s the “advance” estimate.  But the real problem is that a huge part of this came from inventory:

The change in real private inventories added 1.94 percentage points to the fourth-quarter change in real GDP after subtracting 1.35 percentage points from the third-quarter change.

This is a problem because it’s transient; to get the real GDP change you have to back it out.  Last quarter it hurt, but this quarter it helped.  So we have a net-net slowdown, which isn’t so good.  In other words, last quarter it was 1.8% + 1.35 = 3.15% annualized, this quarter was 2.8% – 1.94 = 0.86%.

At this rate we will print negative next quarter on a net-adjusted basis by about 2%.

The issue appears to be in services, which had a precipitous slowdown being up only 0.2%.  With the majority of the economy being services….

Federal government spending was down 7%, all national defense — non-defense spending was up 4.2%.  State and local spending decreases accelerated from 1.6% to 2.6% (they’re broke folks.)

The trade deficit was up from last quarter, now 582 billion on an annualized basis, with exports increasing only slightly but imports going up more.  Thank Chinese labor and environment exploitation for that (again.)

The personal “savings” rate (income minus spend) was down again, and it appears we’re back to trying to finance our living rather than decreasing spending.

This is the same pattern we saw in 2008 as the economy started to roll over.

This is tiring – and predictable.

Europe is now haunted by the specter of debt. All European leaders quail before it. To exorcise the demon, they are putting their economies through the wringer.

It doesn’t seem to be helping. Their economies are still tumbling, and the debt continues to grow. The credit ratings agency Standard & Poor’s has just downgraded the sovereign-debt ratings of nine eurozone countries, including France. The United Kingdom is likely to follow.

To anyone not blinded by folly, the explanation for this mass downgrade is obvious. If you deliberately aim to shrink your GDP, your debt-to-GDP ratio is bound to grow. The only way to cut your debt (other than by default) is to get your economy to grow.

WRONG.

The only way to cut the debt is to have GDP grow faster than the debt does (or, if GDP is shrinking, debt must shrink more)

Here’s the problem in a nutshell — we’ve not done that for 30 years:

Or, if you prefer this in 5-year “chunks” to average it all out…

Here’s the theoretical curve that fits that second chart quite-closely, don’t you think?

That latter one by the way is right out of the book Leverage.  It illustrates what ultimately must happen when you try to run this scheme — eventually interest payments exceed the total amount of GDP available and then you must default.

Of course actual default happens long before the theoretical limits, because whether you’re a government, a company or a household there are things you have to spend money on besides interest.  As such you cannot continue this charade to its mathematical conclusion.

First, governments, unlike private individuals, do not have to “repay” their debts. A government of a country with its own central bank and its own currency can simply continue to borrow by printing the money which is lent to it. This is not true of countries in the eurozone. But their governments do not have to repay their debts, either. If their (foreign) creditors put too much pressure on them, they simply default. Default is bad. But life after default goes on much as before.

This is the mother and father of all frauds and those who suggest it should be taken to town square where they are flogged, drawn and quartered with their remains used to feed feral cats.  The reason is that when you emit more “money” you are increasing the denominator of currency in the system.  When you increase the denominator the value of every unit of currency decreases.  That is, you are directly and immediately taxing everyone in the economy that uses that currency by stealth — an intentional and malicious act of fraud.

You are stealing from each and every one of those people and when a common man does such a thing we call it what it is: Counterfeiting.

This, incidentally, under the original Coinage Act (of 1792) was punishable by death.  That was a proper punishment as it was literal theft from the body politic by stealth.  We should bring back such a penalty and impose it upon those who try to demand that the public be robbed through counterfeiting, which is exactly what this “policy” amounts to.

The actual problem is that governments love to make political promises they cannot find the money to pay for with current taxes.  That is, they promise what they cannot deliver as they are making promises to spend more than the economy is expanding on a percentage basis.  This in turn leads them to “borrow” money they have no intention of ever paying back.

Then, having committed this sin, they go looking for a Unicorn that crap out pretty colored candies so they do not have to admit that they defrauded the voters who put them in office by uttering bald-faced lies with the full knowledge and intent of screwing the citizenry down the road — after, of course, they’ve gotten rich and left office.

But Unicorns are mythical creatures and that thing you’re about to bite into is not candy.

These promises are a classic Ponzi Scheme.  They’re felonious when put into practice by anyone in the private sector and invariably (and justly so) lead to long prison sentences.  The law in the United States once recognized that this crime when committed by government officials was even more severe than that executed by private parties, because the “remedy” that people would propose (as Robert has done) would inherently be to screw literally everyone through debasement.

As such the penalty for such an offense was set as death.

Bring back the Coinage Act of 1792 and harness the horses. 

The feral cat population is hungry.

The Market-Ticker

Discussion (registration required to post)

On April 1st 2007 the very first Tickers were written.  In just a bit over two months, The Market Ticker will be five years of age.

And through that time The Market Ticker has pointed out one central fact behind everything published here: You cannot spend more than you take in on an indefinite basis.

This, of course, is anathema to a nation — and a world, really — that has done exactly that for more than three decades.  Many of the citizens of the world — those under about 35 (as your first few years of life have little direct connection in a cerebral sense to economics) have never known a world where overspending and ponzi economics was not practiced.

You can’t exactly flaw people for not understanding that a thing is broken when they’ve never experienced life in any other way.  And for those who are somewhat older, those of us who remember the 1970s, the oil shocks, gas lines and 5 gallon purchase limits along with grocery store prices that seemed to double every six months (it wasn’t quite that bad — but it was bad!) it is easy to get the mistaken impression that what we’ve had for the last 30 years “fixed” what was broken in the 1970s.

It didn’t, of course.

The world had run on it a simple fraud covered in various layers of complexity to hide it from the common man, just as has been done many times before.  The 1920s were the same thing, basically, minus the computers but also minus fast information sharing.  The land swindles of the day in Florida were almost identical to the condo-flipping schemes here in the Panhandle when you boiled them all down; tiny down payments on construction not yet initiated, the promise of ever-higher valuations, carnival-style barkers spinning rags-to-riches stories and you only needed $10,000 to get in “on the ground floor” of an elevator that would take you to the sky.  Sign right here mister, and your life of luxury and privilege will begin.

Uh huh.

Last night the yarn-spinning continued on Greece.  Bloomberg said:

Greece and its private creditors said early today they had made progress during talks in Athens on a debt-swap accord needed to lower the country’s borrowings and clear the way for a second round of international aid.

“The elements of an unprecedented voluntary private-sector involvement are coming into place,” according to an e-mailed statement from Charles Dallara, managing director of the Institute of International Finance, a Washington-based lobby group representing creditors negotiating with the government.

Sure they did.  Sure Greece is going to pay debts of more than 100% of its GDP — even after the “restructuring.”  And sure this is “voluntary” — in more-or-less the same way that it’s “voluntary” that you hand over your wallet when there’s a gun up your nose.

The real problem is that people — and governments — borrowed money they couldn’t pay back off their economic surplus.  For a private-sector entity (a person or company) economic surplus is easy to define — it’s what you have left after you spend on the bare necessities of life.  When those necessities (such as your house) become part of the overborrowing then the situation appears more complex but it really isn’t — you just “upscaled” your view of what was a “necessity.”

But let’s face facts — a trashy trailer on a 100×50′ piece of rented land with utility connections is more than the “bare necessities” when it comes to housing — by a lot!  I lived in a little 400sq/ft one-bedroom apartment for a good while when I was just getting started and that was more than “bare necessities” (by a lot) for even modern comforts.  A studio would have been sufficient, since I had no dependents and was single.

The same applies to transportation.  Most people today in the United States are driving around in vehicles that have values that are two, three, five or even ten times the cost of “basic necessities” for the required task (getting to work, the grocery store, etc.)  It was in fact in the recent-enough past that I owned said vehicles that the “basic car” had an AM radio with one speaker, a manual transmission, no air conditioning, no power door locks, no power windows, no power steering, no power seats and the seat coverings were vinyl.  You could also see (and work on) all sides of the engine and the road under it when you popped the hood.

In fact, one of the pieces of said “basic transportation” that I owned in my earlier years (and drove to work every day) was one of these:

Before that I had one of these in considerably worse condition than pictured (it was gray and had a smashed-in passenger side door from a collision prior to my acquiring it for a literal cost of $100.)

THOSE were “basic transportation” and not only where they cheap to buy they cost almost-nothing to insure because there was no reason to have collision or comprehensive coverage on them!  The Vega, incidentally, consumed a quart of oil per tank of gas on good days (and worse on bad ones) along with having a habit of slowly eating coolant.  Yeah.

I’m not saying you shouldn’t own this, incidentally:

IF you can afford it without debt, and without spending more than you make.  That is, if you can pay for it using your personal economic surplus.

But recognition of these facts is rather jarring for most people.  Some of us grew up understanding it; our parents owned one car that was much nicer than the other (and was used to get to work) while the other was, literally, “basic transportation” (with no power anything and no air conditioning) if we had a second car at all.  We rode bicycles to our friend’s home rather than being carted around by “soccer moms” in no small part because driving the car cost money; the bike cost only human power.  Nice bicycles (which most of us could not afford) had 10 speeds; the more-ordinary ones that nearly all of us actually owned had coaster brakes and one speed.

Let’s put this in a slightly-different perspective.  The poverty level income for a single person in the United States today (as of 2011) is $10,890.  Many people reading this, perhaps most, spend more than 1/10th of that on their cellphone bills.  A further significant proportion of the population spends more than 1/10th of this on their cable or satellite TV bill and the overlap between the two is significant.

That is, a very significant percentage of the population spends more than a quarter of poverty level income on two luxury and entertainment items which are utterly unnecessary.

Again, none of this is a problem if you can afford it.

But what should you have paid for first?

Well, for one, a very significant financial reserve.  Your retirement, for example, never mind a cushion in case something goes wrong (like losing your job.)

With governments its equally-simple: Government gets all of its money by taxing it.

Yes, all of it.

I know, some people will say “they can print it!” or “they can borrow it!” but in fact on a long enough timeline all of that is taxed.

If the currency is debased the taxation happens immediately and hits everyone at once.  If it’s borrowed then the taxes fall on you tomorrow, assuming it’s ever paid back.  There’s no real difference, when you boil it all down, other than the immediacy of payment.

All of it, in the end, comes down to taxing you — taking your money and giving it to someone else.

That’s all government does.

This weekend dawned with the news that Greece’s creditors have walked out of their meeting.  That in and of itself is probably not all that important.  What is important, however, is the rising tide of speeches coming from various government officers in Europe recognizing that deficit spending has to end.

It’s not just there — Fed President Dennis Lockhart has said the same thing about the United States.  What was just a few lone bloggers in the wilderness a few years ago, myself included, has now turned to policy-makers inside and outside of the government itself.

At the core of this problem is the buying of votes with money that doesn’t exist.  It’s very popular to do things like that, as having the necessary adult conversation regarding the sustainable level of spending by government — and the adjustment that comes to GDP and thus overall consumption when overspending stops — tends to bring revolt at the ballot box.

But there comes a time when the political expedience of vote-buying and other chicanery simply cannot be sustained any more.  We’re within sight of that cliff, and if we do not act we will go over it.

If you remember the speeches from Bernanke in the 2008/09 time frame he counseled that we must get our budget deficit under control in the “intermediate term.”  But exactly what is “the intermediate term?”  This again leads back to the fundamental nature of exponential growth and how badly you’re screwed if you ignore it.

In 1980 the Federal Government spent $53 billion on health care all-in. Last year it was about $820 billion.  That’s a roughly 9% compounded rate of increase.

The rule of 72 says that this means the spending will double again in roughly 8 more years (2019) to $1.64 trillion, then in 8 more (2027) to $3.28 trillion, which is approximately the size of the entire federal budget today.

Obviously that won’t happen as you can’t raise that much money, but that’s exactly what our politicians are promising people over the age of 50 when they say “Medicare will not change for those over 50” as that rate of expansion simply gets you to where you qualify at age 65!  There will be two more doublings required to get you to 80 years of age, which (if it was possible) would rack that number to over $13 trillion dollars — close to the size of the entire economy today.

Bluntly: Such claims are a lie.

What’s worse is the curve when you look at government debt.  Let’s chart it:

Pick a point on that graph.  Even at the most-optimistic number — 2006 or 2007, when we were creating massive amounts of private credit to prop up an about-to-explode housing bubble — federal debt was still growing at over 6% a year.  That means it was doubling every 12 years!

In 2008 and 2009 we grew it at 15% or more a year.  That means it was doubling every 4.8 years.

Does anyone really think we’ll get away with either of those statistics given what we now know is happening in Greece and elsewhere in Europe?  Remember, Japan, which is the common poster child for this, came into their government debt binge with massive private savings — savings that have been essentially all consumed by that binge.  We never had the private savings in the first place, which means we have nothing to consume in previously-earned economic surplus!

Folks, there is not one year in the last decade during which we can point to a sustainable level of debt.  If you go back into the 1990s there were a few years during which federal debt expanded at a much-more-modest rate, but those were years during which private credit creation was expanding exponentially in place of the government (through the Internet bubble.)

There isn’t any way out of this through more government debt.  It has to stop, and stop now, because the nature of exponential growth is that the rate of damage accelerates.

If you read (again) my Ticker from 10-18 of last year, you should understand what’s going on — and what we face.  This is simply not about what I want, what I’d like, what pundits would like to do or anything of the sort.

It is about mathematical reality.

Think about exactly how much further we can expand government spending in this regard and not have the entire economy collapse around us.  Then reduce that percentage of increase to “doubling times” and you know where the wall is, in your best estimate.  Nobody who does this exercise can come up with a number that is larger than the number of fingers you have on one hand.

Look, I don’t like what taking our medicine means, and the reason I wrote Leverage was because I had gotten very tired of people saying “nobody could have seen this coming.“  In addition, there are a whole host of people who have sounded the warning horns for a while, yet they have no cogent plan to resolve the problem or help buffer the inevitable (and severe) pain that must be endured.  Some of them, including some political candidates for President this time around, understand the problem and even propose massive budget changes (e.g. $1 trillion a year in spending cuts) yet have no plan to buffer the economy and the people from what will, left alone, be a contraction in overall GDP of up to 25% and the Depression that will inevitably come with it — a Depression worse than the 1930s!  That is outrageously irresponsible and worse it will never get passed because without those buffers it is not only unnecessarily harsh but could lead to the collapse of both civil order and our government.

But irrespective of what I would like to see, or what politicians promise, this adjustment — the necessary adjustment — is coming.  It cannot be stopped.  It is mathematically certain, whether people like Bernanke, Obama, Romney and others wish to face it or not.

Your choice is whether to face these facts in your personal and economic life, preparing to the extent you’re able, or whether you will be one of those who claim that you were “blindsided” by the inevitable that you were simply unwilling to face.

The Market-Ticker

Discussion (registration required to post)

The “big story” of the U.S. economy is that we have substituted expansion of debt for meaningful increases in productivity.

For the past 30 years, the U.S. economy has become increasingly dependent on explosive debt expansion for its “growth” rather than on meaningful rises in meaningful productivity.Growth is in quotes because growth based on secular increases in productivity–that is, the same investment of labor and capital produces goods and services of greater value–is qualitatively different from “growth” based on a pyramiding of debt.

Real growth based on rising productivity is sustainable, “growth” based on ever-greater expansions of debt is not.

What has kept the Status Quo from falling off the debt cliff over the past four years is the substitution of exploding Federal/public debt for no-longer-rising private debt.  If Federal borrowing were to return to 2006 levels, the economy would immediately experience a severe contraction.

We can understand this reaction as that of a debt junkie economy suddenly deprived of massive infusions of fresh credit.

This substitution of public debt for private debt is simply an attempt to fool Mother Nature.The justification of the Status Quo for impoverishing future generations is the massive expansion of Federal debt is needed to “kick start” the economy, i.e. “get us through a rough patch.”

After four years of kick-starting and muddling through rough patches, the economy has yet to recover benchmarks set in 2007, much less grown.  Meanwhile, the kick-starting added $6 trillion in visible public debt and trillions more in off-balance sheet obligations and backstops.

Substituting debt for productivity is also an attempt to fool Mother Nature.Here’s how the substitutiion works: when productivity is flat, then “growth” can be created by leveraging the economy’s surplus into greater amounts of debt, which can then be squandered on mal-investments and consumption to foster an illusion of “growth.”

Note that I use the phrase “meaningful productivity.”If a highrise tower is built in the middle of nowhere and sits empty, the construction and related costs (inspections, transport of goods, utilities, etc.) are added to the gross domestic product (GDP) as “growth,” even though the empty building is not adding any real value to the economy.

The same can be said of millions of unneeded medical tests, millions of doses of medications that don’t work as advertised, etc.–all the costs of sickcare that rarely add productive value to the economy but which are all added to the GDP as “growth.”

If you leverage $100 per month in surplus capital in a household into a $100,000 home equity loan that is squandered on luxury cruises, a new kitchen, boats and dining out, then that explosion of spending boosts “growth” like a shot of cocaine.

But then what happens when the borrowed money has all been spent? What happens when the borrower defaults?  The underlying assets–the boat, home, etc.–can all be auctioned off, but a massive loss remains to be swallowed by the lender.

Needless to say, the bankrupt borrower will be unable to borrow another $100,000 any time soon, even if interest rates are lowered to near-zero.

That’s what happens when you try to fool Mother Nature by substituting debt expansion for increases in meaningful productivity.Eventually the surplus that is being leveraged into debt reaches the point where it cannot leverage any more debt, and the over-leveraged borrower defaults at the first financial bump.

An economy that is dependent on constant massive increases in debt to fund its “growth” is not sustainable.  In a very real sense, the U.S. has been fooling Mother Nature for 30 years.  Now we’ve overleveraged the nation’s shrinking pool of surplus capital and assets, and the last rabbit has been pulled from the magician’s hat.  Mother Nature (i.e. reality in the form of a transparent, marked to market balance sheet) is about to take her revenge on all those who reckoned she could be fooled forever by ever-expanding debt.

Charles Hugh Smith – Of Two Minds