The New Empire of Debt: The Rise and Fall of an Epic Financial Bubble (51 page)

“I am confident that the Fed would take whatever means necessary to prevent significant deflation in the United States,” Ben Bernanke assured Congress, adding that “a determined government can always generate higher spending and hence positive inflation.”
³⁷

So determined was the U.S. Fed since 1970 that the dollar lost more than three-quarters of its purchasing power. But now, all over the world, prices were falling. Inflation was no longer a sure thing. For the first time since the 1930s much of the world ran the risk that inflation rates will turn negative.

Ben Bernanke was wrong about many things; but as to the Fed’s ability and determination to destroy the dollar, he will almost certainly be proven right. Having inflated so many bubbles—including the monster in private debt that had just blown up—the Fed chief was confident that he would have little trouble inflating another one in public debt. And then, when that blows up, it will wipe out two problems at once. Americans will be eager to spend their money again, rather than save it, and their debts will go up in smoke.

The feds were bailing out the bankers, the insurers, the mortgage lenders, the automakers, and half of Wall Street. But who would bail out the feds? What would happen when the feds’ credit got marked down? As we write, at the debut of 2009, that story will have to wait for a later book. Still, we will take a guess: In the firestorm that is coming, even the devil will sweat.

For the 15 years leading up to 2009, the U.S. money supply has grown about twice as fast as GDP. Federal government liabilities, meanwhile, grew three times as fast. In 1929, America’s debt was equal to about one and a half times its gross domestic output. During the ’30s, output fell and the debt peaked out at 2.5 times U.S. GDP. By 2008, total debt had risen to a record 3.5 times GDP. Meanwhile, the money supply grew at a 15 percent annual rate between 2007 and 2008—almost four times the growth in GDP. And by the end of the year, 2008, U.S. money supply was growing at a 10 percent annual rate, while output was actually shrinking.

While the empire is already effectively broke, nevertheless, the debit sides of its ledgers grow heavier and heavier.The deficit for fiscal year 2008 added half a trillion in new debt. And estimates of the bailout costs are growing rapidly.

Where will the government get that kind of money? There were only two possibilities—one honest and depressing, the other corrupt and alarming. We recall that there are only two ways to get what you want: by civilized means . . . or by barbaric ones. The U.S. Treasury is confronting that choice as we write. It can borrow honestly. Or it can print money. If it borrows, the world enjoys no net increase in financial resources. Borrowing for bailouts merely takes resources from projects that might have been worthwhile and diverts them to the losers. Interest rates rise, as a consequence of the extra borrowing; higher rates generally worsen the economic picture. If, on the other hand, the U.S. government prints the money—or if it created it “out of thin air,” to use Lord Keynes’s handy phrase—the results will be even worse. Inflating the money supply with new currency, a la Argentina or Zimbabwe, wipes out debts. But it destroys faith in the dollar and brings down the U.S.-dollar based imperial money system. Why would they do such a thing? Because they have no choice.The empire’s debts are too great. They can’t be paid . . . they must be liquidated.

If this were an earlier phase of the imperial cycle—such as in 1920—Americans would have taken their losses, liquidated their mistakes, and bounced back stronger than ever.

If it had been in the ’30s America—or even in Japan 60 years later—the losers would have taken their losses with good grace, occasionally jumping out of a skyscraper or stepping in front of a bullet train to obliterate the disgrace. The government would have contented itself with honest trickery and the usual harmful bumbles: lowering interest rates to zero and borrowing massive amounts of money to spend on wasteful public works projects.

But this is 2009 . . . not 1920 . . . nor 1929 . . . nor 1989. And it is America, not Japan. The Fed’s key lending rate is already at zero and the empire totters on spindly old legs. It has grown tired and has been burdened with so many fixes, rules, privileges, and safety nets that it cannot compete in many key industries. It is already the world’s biggest debtor with total debt of $33 trillion—a burden that is expected to increase by about $7 billion every working day.

At this stage, Americans do not boldly face the future—they want protection from it. Capitalism is separating the fools from their money, but fools vote. And in the late stage of an empire, they vote for bread, circuses, and bailouts.There are more debtors than creditors in the United States of America; and so, the feds flex every flabby muscle trying to protect them. How? By destroying their currency.

In the fall of 2008, it was as if the laws of nature had been suspended.

Exhibit A: a corporate bond from International Paper Company that, in November of 2008, had a yield of nearly 10 percent. Compare that to the yield on U.S. Treasury paper. A 91-day T-bill yielded practically nothing. Even yields on the 10-year Treasury notes were sinking to levels never before seen—approaching 2 percent, about half the official rate of consumer price inflation. The “spreads” between corporate bonds and U.S. government bonds were wider than at any time since America’s Great Depression.Why?

The cost of the world’s bailout efforts was soaring.Yet, the more bonds the U.S. government sold to finance the rescue efforts, the more the demand for them grew. The more determined the feds become to prop up losing bets, in other words, the more people lined up to lend them money. Never before were U.S. bond yields so low nor confidence in America’s credit so high. It violated common sense . . . as well as the law of supply and demand. Remarkably, the further in debt government went, the more the debt was worth. If the feds can get away with this, gravity will be the next to go.

But nothing is more remarkable than the credulity and gullibility of the world’s patsies. Bernie Madoff’s oldest friends would come up to him and practically beg him to take their trust funds. People joined his Palm Beach country club just to get close enough so they could stuff large wads of cash in his pockets. And now, investors practically trip over one another in their eagerness to lend money to world’s biggest debtor.

Once a bubble in one sector has burst, you can’t reinflate it. All you can do is to inflate other bubbles. After the bubble in the tech sector popped in 2000, for example, the feds manned the pumps. But they couldn’t get the tech stocks reinflated. The Nasdaq never recovered. Instead, they pumped up a huge bubble in private debt—with gassy bulges in housing, finance, commodities, emerging markets, and many other sectors. Now that bubble has burst and the feds are, once again, working up a sweat trying to reflate it.This time, they’re blowing up the biggest bubble in
public
debt the world has ever seen.

Even
Le Monde
noticed:

The governments of the entire world are beginning to create mountains of debts in order to finance their bailout plans, their stimulus programs and their budget deficits caused by the recession. Even so, the rate at which the U.S. and European countries borrow on the financial markets is near the lowest in history. It is only barely above 2% for 10-year loans to America and slipped under 3% for the German equivalent at the end of 2008 . . . . Some economists ask themselves if a bubble in government debt isn’t in the process of forming . . . and they ask themselves what will happen when it eventually explodes . . . .
³⁸

We think we know what happens. The whole system of imperial finance gets flattened.

In a broad sense, the social welfare economies of all the advanced Western nations are nothing more than Ponzi schemes. Typical is the Social Security system of the United States of America. It survives only as long as there are enough new contributors to cover the promises made to the old ones. As in any Ponzi scheme, the first ones into the system do very well. The very first beneficiaries put in little and got a lot out, depending on how long they lived. But as time goes by, the deal goes bad. Middle-aged people today would be better off with a private pension system, and the young are unlikely to see any benefits at all.

John Law never lived to see America’s system of public finance at work. Nor did Charles Ponzi. But even without a paternity test, each would have recognized it as his own.

Bernie Madoff is still alive as of this writing. He is the world’s reigning champion, title holder in the Ponzi league.Yet, compared to America’s system of public finance, his scheme was penny ante . . . chickenfeed. The nature of the scheme is most easily understood by looking forward rather than backward. President Obama announced two weeks before he was sworn in that Americans faced “trillion dollar deficits for years to come.” Already, the estimate of the deficit for 2009 was $1.18 trillion. Some experts predicted a deficit over $2 trillion. At least one guessed that it would come in over $3 trillion, if not in 2009 then the following year.

These huge deficits did not seem to disturb the sleep of the homeland bound citizens. A trillion-dollar annual deficit, over five years, would add about $50,000 to each family’s burden of debt. But some intuition assured Americans that they will never have to pay it. By instinct alone, they knew it was a Ponzi scheme.

Of course, every Ponzi scheme must end. The day is long past when Americans could say “we owe it to ourselves.” A large part of U.S. borrowing is taken up by foreigners. At least a quarter of America’s public debt is in the hands of non-U.S. citizens. China alone has bought a trillion dollars’ worth of it. And if the foreigners don’t continue to pony up the dough, the United States will run out of money.Why do the foreigners buy U.S. debt? They do so in the hope of getting the money back, with interest. But how can the United States pay back the money it borrows? It has no earnings. It has no surpluses. Instead, it must borrow more to service past borrowings. It must depend on bad money to come in so the good money can go back out. It is a scheme John Law would love, Ponzi would be proud of, and Bernie Madoff can envy, for its organizers never go to jail.

As we write, foreign lenders have still not wised up. But they’ve got less new money to lose. Americans are not buying the way they used to; world trade is contracting fast.

Trenton no longer takes. So Tianjin no longer makes. And Tianjin’s entrepreneurs no longer turn up at the central bank with piles of dollars to exchange for yuan. Which leaves China’s central bank with fewer dollars to buy up U.S.Treasury debt.

The whole system is breaking down. Most likely, it cannot be repaired. The empire of debt is collapsing.

Central bankers, as everyone now knows, are rascals and scalawags. Gideon Gono is no exception. But there is something heroically imbecilic about the man. While most economists hedge and weasel, Mr. Gono goes boldly, recklessly forward—where no central banker has dared to go, at least not since the worst days of the Weimar Republic. Mr. Gono stands tall . . . a colossus of error . . . an Olympus of bunglement.

It is easy to criticize the chief of Zimbabwe’s national bank. In fact, it is hard not to criticize him. Keynes warned that “there is a lot of ruin” in a nation. Mr. Gono’s contribution to economics is to show how much ruin there is.

What Gono wrought—as reported by the press in the autumn of 2008—sounded like Hell: The trash piled up in Harare and the water system no longer worked.Vendors sold bottles of water for $25 U.S. Cholera broke out, and anthrax too. Shops were empty. People were hungry. Nothing worked. Even the forces of law and order went on the rampage, breaking windows and looting what little remained in the shops. The soldiers and police had not been paid, at least, not with real money.

Between August 2007 and June 2008, the Zimbabwean money supply increased 20 million times. Naturally, this led to the kind of spectacular increases in consumer prices that modern economists had only seen on news-reels. Consumer price inflation was clocked at 2 million percent in mid-2008. By the end of the year, it was said to have sped up to 230 million percent.

Of course, Mr. Gono rolled out all the usual inflation fighting measures—all, that is, except for the one that works. Prices were controlled. Mr. Gono personally went around, found shop owners who had illegally raised prices, and had them arrested. Bank withdrawals were limited to 500,000 Zimbabwe dollars per day. If you wanted to buy 2 kg of sugar, for example, you’d have to stand in line for four days at an automated teller. But at the rate of consumer price inflation in November 2008, you could stand in line at the automatic tellers every day for eternity and never get enough money to buy a drink of water.

Still we salute Gideon Gono. He may be a moron, but at least he’s a useful one. Better than another bad theory, he has provided a bad example. In an age when central bankers all over the world desperately try to avoid a decline in the cost of living, Mr. Gono has proven that there are worse things.

But despite the news from Zimbabwe, Gonoism is gaining admirers in the rest of the world. Because the old “hair of the dog that bit him” technique isn’t working. The world has had too much credit; the feds want to give it even more.With $10 trillion in “stimulus” efforts all over the planet, they are not giving only a hair of the dog, they are throwing in the whole damned kennel. But you can’t help an obese man by giving him another helping of dessert.And you can’t cure an alcoholic by offering him free drinks. In short, you can’t help someone who is deeply in debt by lending him more money.

So, central banks are trying new techniques. Ben Bernanke is not yet dropping hundred dollar bills out of helicopters, as he once promised, but that cannot be far off.

Surely, Gideon Gono must feel his chest swelling with pride. He must be in line for a Nobel Prize . . . or a hanging.We quote his approving words: