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

Contemplate this chart a bit.

This shows you what the stock market (S&P 500) did, along with the expansion in both GDP and debt (leverage) during that time.  The debt expansion was a geometric series from roughly 1990 forward until it hit the wall in 2007.

It may not be intuitively obvious when you look at that chart, but this is what was happening.  The data is a bit “noisy” as the granularity is quarterly, and of course there are small recessions and such in there, but on balance this entire “expansion” was in fact false — during this entire period, from 1980 forward until the crash, we did not have one three month period where economic growth occurred at a faster gross dollar amount than did new debt.

To make it easier to see, I took the data and slightly rearranged it.  This is what the data looks like if you take a five year average for both GDP expansion and debt growth, starting with the period ending in the 4th quarter of 1977 and progressing forward in 5 year increments until the end of 2007.

This is the average quarterly growth in debt and GDP during each of those five year periods, and is exactly what happens every single time you try to run two compound growth functions (in this case, GDP and Debt) over a period of time — the larger growing one always runs away from the slower.

The next point in that series is some $950 billion dollars in new debt per quarter, or roughly $3.8 trillion per year.

The Federal Government has been adding more than $1.2 trillion in new debt per year in an attempt to prevent recognition of the ponzi-style debt bubble that it, our Federal Reserve and our commercial banks all conspired to blow in the economy.  The same Ponzi Scheme, run by a private enterprise (e.g. Madoff) will and does result in long prison sentences.

It is not going to work folks; the $1.2 trillion that our government is taking on is one quarter of what would be necessary on average for the next five years, and for the five following that we’d need to double it again, to more than $7.5 trillion annually.

The Ponzi Scheme has run into the wall.  We, as Americans, the people of Europe, and our respective governments have only two choices:

1. Face reality and cut back government spending to that which we can tax, allowing the credit bubble to deflate entirely.  This will produce a massive but short-term economic contraction back to sustainable levels.
2. Continue to refuse to accept reality and as the futile and ever-larger attempts to prop up that which cannot be propped up are continually attempted and fail the percentage of contraction that we must withstand both in government and the economy will, as a matter of mathematical inevitability, grow larger each and every day until both economies and governments collapse.

This is the beginning and end of it folks.

There are no other options.

The Market-Ticker

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The end of debt-based affluence: welcome to The Last Christmas in America (TLCIA).

Almost 35 years ago, as unemployment rose toward 10%, the January 1975 cover of Ramparts  magazine blared: The End of Affluence: The Last Christmas in America.(TLCIA)

The article wasn’t referring to the religious celebration; it was referring to the postwar concept of Christmas as the frenzied, exhausting  year-end pinnacle of our one true secular faith, Consumption, a final orgy of   buying and binging.

It is instructive to recall how the Federal government responded  to unemployment, high inflation and rising  budget deficits in the early 1970s: it began fudging numbers, manipulating data to mask the politically inconvenient realities of rising inflation, unemployment and deficits by playing switcheroo with Social Security Trust Funds, inflation data, etc.–games it continues to play in 2011 to cloak reality from the media-numbed public.

The market was not so easily fooled. The Bear market, reflecting the “real”  recession, lasted 16 years, from 1967 to 1982. Now statistics are echoing that last great recession: rising prices for essentials, systemically high unemployment and stagnant wages while the corporate media and the organs of statistical manipulation (a.k.a. the sprawling, putrid public-private cesspool of the Ministry of Propaganda) trumpet “the return of growth” and skyrocketing corporate profits.

(Today’s propaganda:housing starts blip up due to statistical noise, and though starts are less than half pre-recession levels, this is heralded as “evidence” that “strong growth is back.”)

The difference between the postwar boom of 1946 and the boom that followed 1982 is the last boom was based on the explosive expansion of debt.People didn’t save and invest in productive assets; they went into debt to consume more and to become a “bigger” persona via the miracle of credit.

I often use this chart to make this point: if credit had expanded along with GDP, then we’d be considerably less indebted.  Instead, it required a vast expansion of debt–some $30 trillion more than the rise in GDP–to fuel the 1982-2000 boom.

A funny thing happens when you depend on expanding debt to fund your consumption:eventually the cost of servicing your rising debt reaches the limit of your income, and you can’t borrow any more, unless interest rates decline so you can leverage your income into higher debt.

Here’s a chart of household debt: that little reversal in debt expansion sent the economy into a tailspin.

Lowering interest rates extends the era of debt-based consumption, but it only puts off the inevitable crash when the ability to borrow runs out. Eventually the cost of servicing this lower-interest debt absorbs all your disposable income, and the borrowing skids to an abrupt stop.

Two other bad things can make this dominance of debt servicing worse:your income can decline, and the value of your assets can decline.  In this unfortunate situation, you’re ability to service your existing debts is crimped by a loss of disposable income, and you’re paying for assets whose worth has fallen below the  debt taken on to buy the assets.

Income has declined significantly in the wake of the 2008 crisis/recession:

And here’s the key asset of the middle class, housing:

This double-whammy of lower income and lower asset valuations is exactly where we are now.This is why the Fed’s campaign to lower interest rates to zero and make it easy to borrow more have been as successful as pushing on a string; the economy is choking on over-indebtedness and overleveraging of stagnating income. There is no escape from this vortex except refusing more debt and writing off existing debt, wiping it off the balance sheets as an asset, driving lenders, banks and those holding debt as assets into insolvency.

As we saw yesterday, the velocityof money–that is, money actually being borrowed and spent or invested in the real economy–has plummeted to zero.

We all know the 16-year recession/malaise back in 1967-1982 had a “happy ending”:  huge new oil fields were discovered in Alaska, the North Sea, West Africa and elsewhere, ushering in a renewed era of cheap, abundant petroleum. President Reagan “saved” Social Security for a generation by raising contributions paid by employer and employees, and he heralded a “lower taxes, higher permanent deficits” ideology that is now accepted as the norm: deficits don’t matter, even when they reach the trillions, because our good friends the Gulf Oil Exporters and Asian exporters will buy all our debt forever, keeping interest low forever.

(And if they drop the ball, then the Federal Reserve will print money and buy the Treasury bonds. Sweet! We don’t need any external buyers, just the  Federal Reserve.)

Then the U.S. created and launched two revolutionary technologies which both created new wealth around the globe: the personal computer (microprocessor and cheap RAM) and the Internet (TCP/IP, Ethernet, and the commercialization of Tim Berners-Lee’s World Wide Web with free browsers) spawning the generation-long boom of the 1980s and 90s.

Beneath the surface of this innovation-driven boom, however, the real engine of growth was debt and the financialization and globalization of the economy.

But when the wheels fell off that debt-fueled boom in 2000, the U.S. did not create a new engine of wealth: it opted instead for a devilishly insidious simulacrum of wealth: debt which rose at an exponential rate throughout the economy.

Borrowed money and phony financial legerdemain (mortgage-backed securities, derivatives based on the MBS, etc. etc.) from 2000-2007 created what I have  termed a “bogus prosperity”: no actual new wealth was created, only a brief and doomed bubble of debt-based housing valuations was inflated which followed the classic model set down by the Tulip Craze in Holland hundreds of years ago: insane boom, crushing bust.

We have to revisit the early 1970s for a reality check.  In post-industrial America circa 1970, a huge surplus of food was grown by a mere 2%  of the workforce. The cornucopia of manufactured goods was produced by about 20% of  the workforce (hence the phrase “post-industrial”), and other than essential government services like the Armed Forces, police and the courts, the rest of society’s work was either service-oriented paper-pushing relating to affluence (insurance), do-good selfless work (Peace Corps, churches) or leisure-related: entertainment, films, travel, amusement parks, stereos, etc.

This was not all fantasy.A friend of mine supported an entire  house of hippies in  late-60s Pittsburgh on his union steelworker job, and had plenty of money left to save for his trip to San Francisco. (As I recall, the rent for the big old house was less than $200 per month.) Hippies were the first ardent dumpster-divers/scavengers, driven not by poverty but by the idea that since that our society generated so much waste and surplus, why bother working?

As noted here many times before, the purchasing power of American wage-earners reached a plateau around 1973 and has been declining ever since.

One key point which is usually overlooked when comparing “The Last Christmas in America” circa 1974 and TLCIA circa 2011: the wealth distribution in the U.S. was much flatter then.CEOs of financial institutions did not earn $10 million each; there were no hedge funds with chiefs pulling down $600 million each (yes, that was the average “compensation” for the top ten fund managers at the hedgies’ glorious peak), and even minimum wage ($1.60/hour in the late 60s, I know because my wage stub recorded it) bought far more goods (purchasing power) then than minimum wage does now.

Not only was gasoline cheap, but housing was far and away cheaper than it is today. Just about any G.I./Vet could buy a house with his/her V.A. benefits (3% down), and anyone else could scrimp and save for a few years and then buy a house for 2 or 3 times their annual wage at an interest rate around 6%.

Meanwhile, in TLCIA circa 2011, obscene “compensation packages” are defended as “free enterprise.” Well, what did we have in 1973? Unfree enterprise?Amidst all the ideologically convenient defenses of heavily skewed “compensation,” we have to admit that the dream of affluence combined with leisure was based on the presumption of society’s wealth being distributed somewhat evenly, not by a Communist central state but by the “free enterprise” system and modest common-sense government regulation  (limited work hours,  minimum wage, etc.) which protected employees from the excessive exploitation of the late 19th century and early 20th century Monopoly Capitalists.

That dream seemed at hand in 1970. Now, after “the limits to growth” were mocked by those expecting ever larger oil fields to provide endless abundant cheap oil, we find that Peak Oil was merely put off a generation; there have been no new discoveries of super-massive oil fields since the early 1970s, and the supposedly abundant alternative petroleum sources like shale oil are horrendously costly to exploit, for they require vast quantities of energy (mostly natural gas at the moment) to be consumed to extract the oil.

Now we face a future which might well be called the End of Work for up to a third of the current workforce.Since agriculture employs about 2% of the workforce, industrial/factory production about 11%, essential transportation and essential government each a bit more, we have to ask: in an economy in which 70% of GDP is consumer spending, how many jobs are actually essential? How much actual wealth is being created/produced in the U.S. and sold overseas? Is giving people with Medicare coverage handfuls of costly and often ineffective medications and endless MRI  tests actually creating wealth, or it mostly squandering it?

We might also ask: how much of the consumer economy is superfluous if wage-earners shift values and decide saving is more important than consuming? How many malls, storefronts, internet retailers, restaurants, fast-food joints, etc. can a newly-frugal economy support?  How many dog-walkers, derivative salespeople, nail shops, carpenters, financial planners, realtors, etc. does an economy need if the FIRE economy (finance, insurance and real estate) is shrinking?

Based on the tremendous size of the service economy, construction, finance and government, I have estimated that 30 million jobs out of the current 139 million-strong workforce are superfluous.  Many government positions are essential: police, meat inspectors, rangers, tax collectors, meter maids, etc., but as Mish so thoroughly illustrated in his detailed analysis of the California state budget ($120 billion or so), dozens of State agencies could be eliminated without any visible effect on the economy except to the wage-earners who lost their jobs.

If 20 million jobs disappear (7 million have already vanished since 2008), so do all the taxes  those wage-earners paid; if 5 million homes go through foreclosure, the inflated property taxes the owners once paid will disappear, too. Once businesses close, it’s not just wages which disappear: all the junk-fees governments levy disappear, too: the business taxes, the licensing fees, the permits, transaction fees, etc.

Does anyone think all these taxes and levies can fall and government employment will be funded by some other source?  Yes, the Federal government can borrow apparently limitless sums  at low interest rates; but soon, the surplus money which has piled up in exporters’ accounts will be gone, and the  endless borrowed trillions will actually start costing real money–money that will be diverted from government employment to pay the interest on all that wonderful debt everyone loved when they got a piece of it.

So how does a society deal with the End of Debt-Driven Consumerism, the End of Cheap Oil  and the End of Work when it also means The End of Affluence, even for many of those with jobs?  How does government deal with declining tax revenues and rising interest rates?

The death throes of the debt-based consumerist lifestyle are already visible beneath the glossy propaganda of “rising revenues this Christmas season.” Those revenues were obtained by selling goods at below cost, in the absurd hope that income-strapped, over-indebted consumers would make profitable “impulse buys.” As Mish has documented, the “impulse buys” are being returned even before Christmas to the tune of hundreds of millions of dollars.

The Fed is desperately attempting to re-inflate the debt bubble by lowering interest and mortgage rates and buying up all sorts of semi-toxic/impaired  debt. What the Fed dreads is the reality we all feel and see: fear of the future  due to diminished wealth and insecure incomes.If your assets have fallen in value,  you feel poorer because you are poorer. Borrowing more at any interest rate will not make anyone feel wealthier.

People who fear their income may plummet due to layoffs or their hours being cut are not in the euphoric mood to borrow more, and banks which cannot dare to lose more money loaning to people who will default have cut off credit to millions of  previously rabid consumers of debt.

Ask yourself this simple question: how much stuff could people buy if they could only spend surplus cash, after all their expenses and debt servicing payments were paid in full?

And let’s not forget that much of what is purchased in this consumerist frenzy is needless, superfluous crap.  My wife saves the most egregiously gift-buying-frenzy advertising circulars, and one from Bed, Bath & Beyond caught my eye.

There is no difference between this “1001 Best Gifts” from BB&B and a parody of consumerist excess.Hmm, how about an “executive standing valet” rack of wood and plastic for $99.99?

To make this poor-quality contraption, a forest somewhere in a Third-World kleptocracy  was cut down and precious, irreplaceable oil was burned shipping the lumber to China and from that factory to the U.S. across 6,000 miles of Pacific Ocean.

We know this spindly piece of garbage will break in a matter of days, weeks or maybe if the owner is especially careful, months; then the legs will break loose of the base, the towel bar will pull out, etc. and the “we cut down a priceless rain forest to make this” piece of human handiwork will be put on the curb where a diesel-burning garbage truck will haul it to the landfill along with all the spoiled food Americans throw out.

The 16-bottle wine cellar/cooler from China (labeled Cuisinart for your consuming pleasure) for $199.99 might come in handy storing something once it’s unplugged–but a cardboard box will probably do just as well.

I for one will not mourn the last debt-consumerist Christmas in America. Good riddance to the flaunting of borrowed money and the heedless, desperate purchase of valueless “goods” as gifts for an insolvent nation awash in too much of everything but common sense, integrity, gratitude, accountability and healthy living.

Charles Hugh Smith – Of Two Minds

Did you know that we buy about a half a trillion dollars more stuff from the rest of the world than they buy from us?  The U.S. balance of trade is not only mind-blowingly bad – it is the worst in the world.  It is being projected that the U.S. trade deficit for 2011 will be 558.2 billion dollars.  That would be an increase of more than 11 percent from last year.  As I have written about previously, the United States is the worst in the world at a lot of things, but as far as the economic well-being of our nation is concerned, our balance of trade is particularly important.  Every single month, far more money goes out of this country than comes into it.  Tax revenues are significantly reduced as all of this money gets sucked out of our communities.  The federal government, state governments and local governments borrow gigantic piles of money to try to make up the difference, but all of this borrowing just makes our debt problems a whole lot worse.  In the end, no amount of government debt is going to be able to cover over the fact that our national economic pie is shrinking.  We are continually consuming far more wealth than we produce, and that is a recipe for economic disaster.

The “current account balance” is one key indicator of how a country is doing economically.  The following is how the CIA World Factbook defines “current account balance”….

This entry records a country’s net trade in goods and services, plus net earnings from rents, interest, profits, and dividends, and net transfer payments (such as pension funds and worker remittances) to and from the rest of the world during the period specified.

If someone were to ask you what countries in the world have strong, thriving economies right now, what countries would you think of?

Would countries like China, Germany, Russia and Saudi Arabia come to mind?

Well, all of those nations have huge positive current account balances.  In fact, China has the best current account balance in the world at +$305 billion.

So who is on the other end of the scale?

The following information comes directly from a CIA World Factbook chart….

190 Turkey $ -48,420,000,000

191 Canada $ -48,500,000,000

192 India $ -51,780,000,000

193 France $ -54,400,000,000

194 United Kingdom $ -56,190,000,000

195 Spain $ -63,650,000,000

196 Italy $ -67,940,000,000

197 United States $ -470,200,000,000

The United States is rated dead last at number 197.

Just take a close look at those numbers for a minute.

The U.S. had a current account balance of negative 470 billion dollars in 2010.  That figure was almost 7 times worse than the next worst country (Italy).

Not only does the United States have the worst current account balance in the entire world, the truth is that no other country is even in the same ballpark as us.

We are bleeding wealth so fast that it is hard to even describe it.

But perhaps a real life example can help put this all into perspective.

One 22-year-old Saudi Arabian student has a collection of sports cars that is worth more than 12 million dollars.  Reportedly, his collection includes at least three Lamborghinis, five Ferraris and five Porsches.

And guess who paid for it?

You did.

Every month, billions of dollars go out of the United States to help pay for the insane lifestyles of the ultra-wealthy oil barons of the Middle East.

Meanwhile, dozens of major U.S. cities are degenerating into hellholes.

Once upon a time, Detroit was one of the greatest industrial cities that the world has ever seen.  It was the envy of the entire globe.

But now Detroit is an utter nightmare….

*An analysis of census figures found that 48.5% of all men living in Detroit from age 20 to age 64 did not have a job in 2008.

*If you can believe it, the median price of a home in Detroit is now just $6000.

*Only 25 percent of students in Detroit graduate from high school.

So what happened to Detroit?

Well, just as has been happening in so many other U.S. cities, industry has been leaving at an astounding pace.

As I have written about previously, an average of 23 manufacturing facilities a day were shut down in the United States during 2010.

Overall, the U.S. has lost a total of more than 56,000 manufacturing facilities since 2001.

This country is bleeding middle class jobs profusely, and neither major political party seems to care.

American family budgets are being stretched tighter and tighter these days.  There are not nearly enough good jobs to go around and yet the cost of everything just seems to keep going up.

Many families are going into massive amounts of debt in an attempt to make ends meet.  According to a recent CNN article, credit card use in the United States is experiencing a major upswing once again….

Purchases made with credit cards rose 8.2% in the first quarter of 2011, 9% in the second quarter and 10.6% in the third quarter, according to First Data.

Of course American consumers were out in force on Black Friday once again this year.  They gleefully filled up their carts with cheap plastic crap made overseas, and many racked up huge credit card balances in the process.

But most of us never stop to think about those that make all of these cheap plastic products for us.

Thanks to the globalization of the economy, big corporations and corrupt governments can make stuff in countries where it is legal to pay slave labor wages and then ship their products into the United States for free.

It is important for all of us to learn what actually happens to these people that are working so hard for slave labor wages.  The following comes from a recent article in the Guardian….

At the Hung Hing factory the researcher found that the 8,000 workers put in up to 100 hours of overtime a month, far in excess of the legal maximum. Workers say they have to sign a document agreeing to work additional overtime on top of the legal maximum. The basic wage was £132 a month (up to £250 with maximum overtime payments) but wages were paid up to three weeks late.

Workers complained of inadequate training with the factory machines and last year one worker died when he fell into a machine. They said there were frequent injuries and concerns over the chemicals used. There were also complaints about the standard of the dormitories, where water for washing and flushing toilets is turned off at 10pm.

How in the world are American workers supposed to “compete” for jobs at those wage levels?

As I have written about previously, Professor Alan Blinder of Princeton University is warning that 40 million more U.S. jobs could be sent offshore over the next two decades if nothing is done to stop this.

But instead, our “representatives” in Congress just keep pushing more “free trade” agreements as the answer to our problems.  Congress has passed new free trade agreements with South Korea, Colombia and Panama, and the Obama administration has made “the NAFTA of the Pacific” a very high priority.

Well, if “free trade” is supposed to create so many jobs, then why was last decade the worst decade for the creation of jobs since the Great Depression?

If you can believe it, zero jobs were created between 1999 and 2009.  The following comes from an article in Washington Monthly….

“If any single number captures the state of the American economy over the last decade, it is zero. That was the net gain in jobs between 1999 and 2009—nada, nil, zip. By painful contrast, from the 1940s through the 1990s, recessions came and went, but no decade ended without at least a 20 percent increase in the number of jobs.”

But our leaders don’t care about us.  In fact, even the members of Obama’s “jobs panel” have been shipping jobs out of the United States at a very rapid pace.

The U.S. has run a negative balance of trade with the rest of the globe every single year since 1976.  During that time, the U.S. has run up a total trade deficit of more than 7.5 trillion dollars with the rest of the planet.

That 7.5 trillion dollars could have gone to support U.S. workers and U.S. businesses.

But it didn’t.  Instead, it went out of the country and it made foreigners wealthier as our own cities slowly rotted.

Now we are actually passing laws that encourage wealthy foreigners to come in and buy up pieces of the United States.

For example, there is actually a bill in Congress that would automatically give residence visas to any foreigners that are willing to spend at least half a million dollars to buy houses inside the United States.

The idea behind the bill is that this will get the housing market moving again.

There aren’t enough Americans with good jobs to buy houses, so we have now decided to beg foreigners to buy them.

How bizarre is that?

Until our horrendous balance of trade is fixed, the employment situation in this country is going to continue to get worse.

Any politician that tries to sell you on a “jobs plan” that does not address our balance of trade is either totally incompetent or is straight out lying to you.

The economic infrastructure of America is crumbling a little bit more every single day.  If something dramatic is not done, we will continue to bleed businesses, bleed jobs and bleed wealth.

Please share this information with as many people as you can.  The American people need to understand what is happening to the economy.  We need to work to wake up as many people as we can before it is too late.

The Economic Collapse

The European debt Bubble has burst, and the repricing of risk and debt cannot be put back in the bottle.

It’s really this simple, Europe: either rebel against the banks or accept decades of debt-serfdom. All the millions of words published about the European debt crisis can be distilled down a handful of simple dynamics. Once we understand those, then the choice between resistance and debt-serfdom is revealed as the onlychoice: the rest of the “options” are illusory.

1. The euro enabled a short-lived but extremely attractive fantasy:the more productive northern EU economies could mint profits in two ways: A) sell their goods and services to their less productive southern neighbors in quantity because these neighbors were now able to borrow vast sums of money at low (i.e. near-”German”) rates of interest, and B) loan these consumer nations these vast sums of money with stupendous leverage, i.e. 1 euro in capital supports 26 euros of lending/debt.

The less productive nations also had a very attractive fantasy: that their present level of productivity (that is, the output of goods and services created by their economies) could be leveraged up via low-interest debt to support a much higher level of consumption and malinvestment in things like villas and luxury autos.

According to Europe’s Currency Road to Nowhere(WSJ.com):

Northern Europe has fueled its growth through exports. It has run huge trade imbalances, the most extreme of which with these same Southern European countries now in peril. Productivity rose dramatically compared to the South, but the currency did not.This explains at least part of the German export and manufacturing miracle of the last 12 years. In 1999, exports were 29% of German gross domestic product. By 2008, they were 47%—an increase vastly larger than in Italy, Spain and Greece, where the ratios increased modestly or even fell. Germany’s net export contribution to GDP (exports minus imports as a share of the economy) rose by nearly a factor of eight. Unlike almost every other high-income country, where manufacturing’s share of the economy fell significantly, in Germany it actually rose as the price of German goods grew more and more attractive compared to those of other countries. In a key sense, Germany’s currency has been to Southern Europe what China’s has been to the U.S.

Flush with profits from exports and loans, Germany and its mercantilist (exporting nations) also ramped up their own borrowing–why not, when growth was so strong?

But the whole set-up was a doomed financial fantasy.The euro seemed to be magic: it enabled importing nations to buy more and borrow more, while also enabling exporting nations to reap immense profits from rising exports and lending.

Put another way: risk and debt were both massively mispriced by the illusion that the endless growth of debt-based consumption could continue forever.The euro was in a sense a scam that served the interests of everyone involved: with risk considered near-zero, interest rates were near-zero, too, and more debt could be leveraged from a small base of productivity and capital.

But now reality has repriced risk and debt, and the clueless leadership of the EU is attempting to put the genie back in the bottle.Alas, the debt loads are too crushing, and the productivity too weak, to support the fantasy of zero risk and low rates of return.

The Credit Bubble Bulletin’s Doug Nolan summarized the reality succinctly: “The European debt Bubble has burst.” Nolan explains the basic mechanisms thusly: The Mythical “Great Moderation”:

For years, European debt was being mispriced in the (over-liquefied, over-leveraged and over-speculated global) marketplace. Countries such as Greece, Portugal, Ireland, Spain and Italy benefitted immeasurably from the market perception that European monetary integration ensured debt, economic and policymaking stability.Similar to the U.S. mortgage/Wall Street finance Bubble, the marketplace was for years content to ignore Credit excesses and festering system fragilities, choosing instead to price debt obligations based on the expectation for zero defaults, abundant liquidity, readily available hedging instruments, and a policymaking regime that would ensure market stability.

Importantly, this backdrop created the perfect market environment for financial leveraging and rampant speculation in a global financial backdrop unsurpassed for its capacity for excess. The arbitrage of European bond yields was likely one of history’s most lucrative speculative endeavors. (link via U. Doran)

In simple terms, this is the stark reality: now that debt and risk have been repriced, Europe’s debts are completely, totally unpayable.There is no way to keep adding to the Matterhorn of debt at the old cheap rate of interest, and there is no way to roll over the trillions of euros in debt that are coming due at the old near-zero rates.

Never mind actually paying down debt, sovereign, corporate and private–the repricing of risk and debt mean even the interest payments are unpayable. Consider this chart of one tiny slice of total EU debt:

There is no way to push the repricing genie back in the bottle, and so there is no way to roll over this debt and add to it–and to support the high-cost structure of Euroland’s welfare-state governments and their astounding debt, then debt must be added, and in staggering quantities.

Austerity won’t put the repricing/bubble burst genie back in the bottle.A funny thing happens when more of the national income is diverted to debt service (making interest payments and rolling over existing debt into new higher-interest debt): there is less surplus available for investment and consumption, which means that both productivity based on investment and consumption based on debt will plummet.

This leaves the nation with lower productivity and lower GDP, which means there is also less tax revenues being collected and more bankruptcies as companies and individuals accept the reality that their debts cannot be paid.

The repricing genie responds to this decline in national income, surplus and taxes by repricing risk of default even higher, and so the interest rate is also repriced higher. This makes servicing the mountain of existing debt even more costly, and so even less national income is available for consumption, investment and taxes.

This is called a positive feedback loop: each action reinforces the other, i.e. a self-reinforcing feedback loop.Debt and risk are repriced higher, the burden of debt service reduces national income available for investment, consumption and taxes, which further reprices risk higher, and so on.

So you see, Europe, there is only one choice:either accept the endless debt serfdom of ever-rising interest payments and lower income and productivity, or rebel against your pathetic lackey leadership and renounce the entire mountain of unpayable debt. Grasp the nettle and renounce the euro as the fundamental cause of your fantasy and collapse, and revert to national currencies which enable the market to discover the price of your underlying productivity and ability to borrow money.

Renouncing the euro does not mean renouncing the freedoms of the European Union: the two are only bound at the hip in the minds of your enfeebled leadership, who are in thrall to the leveraged-26-to-1 banks that are poised on the edge of insolvency.

Let the banks implode in bankruptcy, clear the worthless “assets” of debt from the books, and let the market price currencies and everything else.The only other choice is debt-serfdom.

All the other schemes and proposals are simply variations of one single fantasy: that the feckless leadership can fool the repricing genie with parlor tricks. They can’t.Everybody with any understanding of the situation knows that the debt bubble has already burst, and risk and debt cannot be repriced back to fantasy levels.

That repricing has already occurred, and cannot be revoked or shoved back in the bottle. The Great European Debt Bubble has already burst, and so now it boils down to a simple choice: debt serfom or open rebellion against the banks that profited so handsomely from the euro-fantasy.

There is no middle ground, as the debt cannot be repaid, not now and not in the future. It cannot be reshuffled, masked, or hidden; it can only be renounced.

It’s your choice, Europe; choose wisely.If you want a model for sanity and growth, look to Iceland. They renounced their unpayable debts and debt-serfdom, and let the market reprice their currency, debt and risk. The nightmare is past for them; they chose wisely. Now it’s your turn to choose.

The debt-serfdom will fall to you, not the banks or your Elites.

Charles Hugh Smith – Of Two Minds