Thursday, February 2, 2012

The US presidential elections are essentially irrelevant

That's a heck of a thing to say in an election year, but it's nevertheless true. It no longer matters what either President Obama, or his Republican wannabe challengers, offer as policies for this country. All those policies depend on a functioning economy to underpin them . . . and our economy is teetering on the verge of ceasing to function. We're venturing into uncharted territory, dealing with numbers the like of which the world has never seen. Nobody knows for sure just how bad things might get, because no-one's ever had to deal with these levels of debt before . . . but we can be absolutely sure of one thing. This economic collapse will happen. It's as certain as the sunrise, because not one of the likely Presidential candidates in 2012 is facing this reality, and/or offering any workable solutions for it.

I've written about our economic problems before, but there are still many who don't get it. Let's look at the cold, hard facts of the situation. First, inflation. We've spoken before about how official US government figures deliberately underestimate the rate of inflation, for political reasons. John Williams at Shadowstats calculates inflation according to traditional measurements, before they were 'updated' due to political interference. Not surprisingly, his numbers differ sharply from the official ones. Here's how he sees inflation.

In January 2012, the US inflation rate was officially put at 3% overall. Mr. Williams believes it's closer to 11%. Based on my own experience of buying household necessities and watching the markets, I concur with Mr. Williams' figures.

What's caused that inflation? There's a very simple answer. There are far more dollars in circulation than there were a few years ago, because the Federal Reserve ('Fed') has been creating them out of thin air to fund the operations of the US government and bail out banks and corporations that would fail without them. Thus, more and more dollars are chasing the same (or, in some cases, a reduced) quantity of goods and services - so the price of the latter goes up. Take a look at the growth of the US money supply.

This expansion of the money supply is known as 'quantitative easing' or 'QE'. It no longer refers to 'printing money' as such: most of it is no longer printed at all - it's simply created on a central bank's computers, as digital entries in a database or spreadsheet. Here's a brief video explanation of QE from the Bank of England (BoE), that nation's equivalent to the Fed.

The BoE's explanation sounds very positive, but it leaves out many negative aspects of QE. For example:

  • If interest rates are kept low, yes, loans are cheaper: but those who save money earn less interest on their savings. That means they have less incentive to save - and those who rely on interest income (e.g. retired persons) find they have less money on which to live.
  • The 'assets' that the BoE (and the Fed) buy with their QE funds are, in many cases, so-called 'toxic assets' such as securitized mortgages, etc. There's little or no market for those 'assets' at present; so by buying them, a central bank is essentially saving private investors (i.e. banks and investment houses) from any losses inherent in them, by making the nation as a whole responsible for those losses instead.
  • QE funds essentially allow a government to live beyond its means (i.e. its income from taxation and other revenue sources) by borrowing money to fund its expenditure. In that sense, they can be seen as encouraging ongoing fiscal irresponsibility. Sooner or later, the bonds issued by governments, and purchased by central banks with QE funds, will have to be repaid. Where will the money come from to do so - particularly when the cumulative debt issued by governments amounts to such vast sums?

It's important to note that virtually all central banks in the industrialized world are engaging in QE to a greater or lesser extent. The worldwide inflationary pressures this has created - and continues to create - are frightening. Take a look at these charts, courtesy of James Bianco at The Big Picture. (Note: 'ECB' refers to the European Central Bank.)

You'll find much more information about worldwide QE and its implications in Mr. Bianco's article. He concludes:

Prior to the 2008 financial crisis, the eight central bank balance sheets were less than 15% the size of world stock markets and falling. In the immediate aftermath of Lehman Brothers’ failure, these eight central bank balance sheets swelled to 37% the capitalization of the world stock market. But keep in mind that the late 2008/early 2009 peak was due to collapsing stock market values combined with balance sheet expansion via "lender of last resort" loans.

Recently, the eight central bank balance sheets have spiked back to 33% of world stock market capitalization. This has come about not by lender of last resort loans, but rather by QE expansion (buying bonds with "printed money") even faster than world stock markets are rising.

. . .

Massive central bank involvement in the markets risks returning us to a de facto centrally planned economy. Those S&P 500 companies all have the same chairman; it is Ben Bernanke because his policies are affecting everybody. That is what makes money management so difficult. Correlations will ebb and flow; they always do. But what makes them go away? This will only happen when governments and central banks go away.

But if they go away, then does that not mean things get ugly? Maybe they do get ugly, but it also means that we sort out the excesses in the market. We reward the people that do the right thing and we punish the people that do the wrong thing. And we have an adjustment process that may be ugly, but then we have a period of long expansion.

Central banks are ruling markets to a degree this generation has not seen. Collectively they are printing money to a degree never seen in human history.

. . .

The tipping point between balance sheet expansion being bullish for risk assets versus bearish is impossible to know. Given the growth rate of central bank balance sheets around the world over the past few years, we might not have to wait too long to find out.

There's more at the link. Bold print is my emphasis. Highly recommended reading.

QE may be happening all over the world, but we need to return our attention to the USA. We've seen the problems inherent in QE - but right now, there's no alternative to it, as long as our government continues spending money it doesn't have. Here's a graphic representation of projected US government expenditure in 2011, a total of $3,818,000,000,000, or $3.818 trillion.

The larger pile on the left represents $2,173,000,000,000, or 2.173 trillion dollars - the amount the US government 'earned' in tax receipts, customs duties, etc. The smaller pile on the right represents $1,645,000,000,000, or $1.645 trillion - the amount the US government had to borrow to make up the difference between its income and its expenditure. (You can read - and see - more about the graphic here. Highly recommended reading.)

Why all this borrowing? It's simple - and a vicious circle.

  1. The US government panders to its populace by providing all sorts of 'freebies' (commonly known as 'entitlement programs'). The cost of these programs is the reason why government expenditure so greatly exceeds its income.
  2. The US government can't cut back its entitlement programs without causing those who currently benefit from them to turn against the politicians who voted to cut them. Therefore, they aren't going to be cut unless and until there's no alternative. Politicians don't want to risk their own jobs and salaries by telling the truth to their electorate.
  3. Because entitlement programs can't (or won't) be cut, the US government will continue to have to borrow almost half of every dollar it spends.
  4. There isn't enough money in the entire world to continue to fund US government expenditure at its present levels in the medium to long term. Already, investors such as the Chinese government have cut back their purchases of US securities, as they fear for the safety and future value of their investment. Europe has enough economic troubles of its own that they can't afford to buy US securities anyway.
  5. Therefore, the only source of money to buy the bonds the US government must issue to borrow money is the Fed. Its QE program is basically 'printing money' (fiat currency with no underlying value whatsoever) to buy other pieces of paper called 'government bonds'. The exchange of one for the other represents nothing more or less than a book-keeping transaction, with no assets of any value supporting it. It's a financial house of cards. It's as if I said, "I'm going to write a check to myself tomorrow morning, drawn on my own account; I'll deposit it into that same account; and the balance in that account will magically increase to reflect the 'deposit', over and above what I already had in it." It's financially nonsensical . . . but that's what the Fed is doing, right now.

Let Bill Whittle explain this vicious circle more clearly.

As mentioned earlier, all those newly-created dollars, generated to fund US government expenditure, are chasing the same amount of goods and services in the economy. The result is that prices are rising - and rising much more, and much faster, than official statistics would have us believe. That inflation is eating into the value of the savings of all those who put aside or invested money for their retirement. It's diminishing the value of cash holdings, whether individual or corporate. There are few, if any, inflation-beating investments available that don't carry with them a significantly higher element of risk than that offered by an inflation-vulnerable savings account.

The inevitable result of all this borrowing, and the accumulated national debt, must lead to two things. The first is that US government debt will grow too high, and foreign investors in US government securities will realize this: so they'll stop buying the securities, leading to the US government being unable to fund its spending. As Peter Schiff points out, this makes the collapse of the US dollar almost inevitable.

It's hard to pinpoint exactly when the dollar will collapse, but it will take a miracle to avoid that outcome in the near term. It really depends on when the creditors of the United States realize that they are not going to get their principal returned to them in real terms, but rather in grossly devalued dollars. We have already seen the average duration of U.S. Treasury debt drop below that of Greece. No one wants to buy a 30-year bond with negative real interest rates as far as the eye can see.

Such a collapse will force a halt to most entitlement programs overnight, plunging much of the US population into dire poverty, and crippling the economy.

The other inevitable result, as Mr. Schiff observes, is that inflation will eat into the buying power of the US dollar. This will destroy the value of savings, and cripple the economy through currency volatility; but it'll have the side effect of wiping out much (if not all) of the deficit by reducing the value of the dollars in which it's denominated. If we owe $15 trillion in 2012 dollars, where one dollar is worth (say) half a loaf of bread, we can pay it off in 2022 dollars, which will be worth only one slice of bread - if that!

The only way to stop these consequences is to cut back US government spending, right now, to a level commensurate with its income. However, that isn't going to happen: because the electorate, deprived of its entitlement programs, would immediately vote out of office any and all Congressional representatives, Senators and the President who passed such legislation. Therefore, we're going to go on inching towards the edge of the economic cliff until we completely lose our footing and fall over it.

All the Presidential campaigning that will plague us over the next year is completely and utterly irrelevant if it doesn't take this economic reality into account . . . but it won't. It can't, because none of the likely candidates, from either party, dares to face up to economic reality. They know they would never be elected if they did. As far as the Presidential election is concerned, we are truly screwed.

Our only recourse is to seek out, nominate and elect Congressional representatives and Senators who understand economic reality, and who will have the courage to work towards policies that acknowledge and address that reality. I don't care what party they're from. If they're honest people, who will do what's right, I'll support them. They'll have to understand that if they do the right thing, they'll see the electorate turn against them: but they have to have the moral courage to do it anyway.

That's our task in the coming year. It may not be enough to get us out of this mess . . . but it's the only hope we have.



Mikael said...

Actually I think Ron Paul is facing it... (and Gary Johnson, who doesn't have a snowball's chance in hell).

Peter said...

Agreed, Mikael: but I did say "likely candidates". Neither Ron Paul or Gary Johnson is a likely candidate (although I think Mr. Johnson is the most economically literate and realistic of the entire field, and I'd vote for him in a heartbeat).

Roy said...

The problem, Peter, is that any candidate who even attempts to address the problem in his campaign will *not* get elected in the first place. I give you Ron Paul as an example. He is the only one of the present presidential candidates who even comes close to addressing the issue, yet he is an "unlikely" candidate and gets called "crazy" for his troubles.

Peter said...

Roy, unfortunately Ron Paul doesn't "get it". His policies are economically literate (i.e. they take basic economics into account), but they're not economically realistic. As is the case with so many of his policies, he's great on theory, but falls very short indeed on practice. That's a great pity, because with greater practicality, he'd become a more viable candidate.


raven said...

It does matter who we elect.
And I agree completely with your assessment of the economy.
The question is who do we want at the helm when we hit the reef.
The "let no crisis go to waste" types would regard this as an ideal opportunity to enact all sorts of measures to "save" us, and end up putting chains on us.

Anonymous said...

Even if the electorate was able to get the "honest" congress in numbers large enough to address the issue it will still fail because no conress can bind a future congress. Wheen the reality of the loss of entitlements hits the populous in full force the "honest" congress will be swept aside by the candidates that promise relief in the very next election. Therefore there will only be a delay of the inevitable.

Roy said...

Okay, Peter, I'll bite. Which one of the front running, likely-to-get-nominated candidates does "get it"? Which one of them has policies that are both economically literate and economically realistic?

Personally, I'm beginning to wonder if I shouldn't just go ahead and vote for Obama. Since it seems we are going to go over the cliff no matter what, maybe it would be best for our posterity that we go over it with the Socialist Democrats in charge. At least then maybe the people who are left will finally "get it" at last. Because that is ultimately where the problem lies - with the people.

I've said it before, and I'll say it again: Our politicians are *not* the problem. They are only a symptom of the problem. The problem is that we have too many people in this country who would rather have "free-stuff" rather than "free-dom".

Roy said...

Upon review, I can see that my last comment came across a bit stronger than I meant it to be.

My most humble apologies to you, Peter. The fact is that I mostly agree with you. I just don't see a way out of the mess - at least not politically.

Peter said...

That's OK, Roy. I agree with you about the lack of political solutions - which is why I wrote this article to begin with. I think the only chance we have is to elect sufficient Representatives and Senators to be an obstacle to the 'business-as-usual' crowd, and to block the most egregious bills.

I think that massive, systematic, deliberate inflation of our currency is the most likely outcome of all this, as it's the only way in which the powers that be can pay off our enormous deficit, yet still claim to be providing the 'freebies' voters want. If they're providing them in debased currency, which doesn't cost as much in real terms, they can at least still argue that they haven't actually cut entitlements. It's a weaselly thing to do, but that's about all one can expect of the current crop of politicians.

I'm not sure you're wrong about voting for Obama so that the blame rests with him and his ilk. Certainly, I don't think Romney would be any better than Obama, and I don't trust Gingrich as far as I can throw him. At this point, I really wish Sarah Palin would run as a populist candidate - not because I think she'd make a great President, but because she'd shake up the race, and she couldn't possibly be a worse President than any of the other likely candidates! Who knows? She might be a whole lot better!


raven said...

Peter, you left out the best part- after inflation smashes everyone's living standard flat, the politicians will turn around and point their fingers at "the greedy businesses" raising prices.
But wait, it gets better- then they enact wage and price controls, and the shortages start-it does not make to much sense to produce when you can't make a profit. Then the real fun starts with nationalization of industries to provide "affordable" goods-(at this point, mostly food, as the country will be starving.Nobody who has ever visited this blog need worry about that, however, as we will be on the "no food list")

As a brief note of interest regarding how far governments will go regarding debasing the currency, France, in the 1792 hyperinflation , made it a capital crime to demand payment in coin instead of paper. The coins of course were gold and silver.
Of course, our own coinage act (also 1792?) made it a capital crime to DEBASE the currency.

Roy said...

Peter, I agree, because massive, deliberate inflation is the only outcome that is politically feasible.

People will get their benefits because programs like Social Security are politically untouchable. No politician - of either party - is going to risk his office by screwing around with it, even if it is for the good of our nation and our posterity.

But nobody can have what is not there. So what the politicians are going to do is keep running the printing presses to keep paying the promised entitlements until the entire monetary system finally collapses. When that happens – and it *will* happen – all benefits and investments - all of them, 401Ks, savings, stocks, bonds - all of it – will be worthless.

A_Nobody said...

Please, all of you. Quit harping on S.S. as an entitlement program. It is a PAID program for most. The problem is your heroes in government have put a burden on the program and have been doing so for years. There's plenty of waste in government that can be removed and start us down the right road if we can get some men in COngress instead of political lackys but I don't see that happening. IF you really want to drop S.S. and Medicare, I want every damn cent plus interest that would be stolen from me if it's done. I paid in good faith and expect the same of it was taken fraudulently.

Peter said...

@A_Nobody: I'm very sorry to have to inform you that SS is not, repeat, NOT "a PAID program for most". Politicians have repeatedly inflated the SS benefits they promised to voters, without increasing SS premiums to a level sufficient to pay for those promises. In order to pay the promised level of benefits, SS taxes would have to be almost doubled right now - which clearly isn't going to happen. The only alternative is to reduce SS benefits to what can be paid according to the current level of taxation, or delay the age at which those benefits are given so that more recipients die before they reach that age. That's the cold-blooded calculation that we face right now.

I truly sympathize with the position of those who rely on SS as their primary (or even sole) means of support in their older years . . . but that's the way it is. It isn't the way it was MEANT to be, and it isn't the way anybody in his or her right mind WANTS it to be, but it IS that way, whether we like it or not. Heaven help us all - because no politician can do so!