Capitalism Has to Do its Work


Our phone rang yesterday. You know, the hotline we set up to help Treasury Secretaries and Finance Ministers cope with the problems of the global financial meltdown?

We picked it up…it was Tim Geithner!

Imagine our surprise. But we explained that we were delighted to help and proceeded to outline the problem he faced and suggested a course of action. What follows is merely a recitation of our conversation:

“Tim,” (we were on a first-name basis right away) “look, we know it’s tough. You were called in to do an impossible job. And now everyone’s taking shots at you – blaming you for the whole thing…

“As if you could have known that things would turn bad, just because every clown on the street was making multi-billion dollar mistakes…

“As if you should have said something when you were watching the crisis build from your perch at the Federal Reserve Bank of New York…

“As if you might have used your regulatory power to prevent the banks from making catastrophic speculations…

“Yes, it’s all very unfair…terrible…but let’s look at what’s really going on and see what we can do about it.

“We need to recognize, first, that this is not just a regular recession. So you can forget the usual recession remedies – a few points off the Fed funds rate…a little counter-cyclical fiscal spending. This is much more serious.

“What we have here is a depression. It’s a depression because it requires a fundamental restructuring of the international financial model. You know how it worked during the Bubble Epoch; Asians made things…Americans bought them. Asians made money; Americans spent it. Asians saved; Americans borrowed. And now the Asians have money; and Americans have debts. Not really very complicated, is it?

“Well, these programs of trying to bailout businesses…and the banks…and the economy…you can see how they are all a waste of money. All of these efforts are trying to revive the old model. They’re trying to free up credit so that Americans can buy more! Now, we don’t really have to explain why that won’t work, do we? More debt won’t do Americans any good; more IOUs from Americans won’t do China any good.

“Instead, the model has to be taken apart and reconstructed. China needs to sell more to people with money – its own people, mainly. Americans need to pay down their debts before they can take up serious consumption again.

“But wait, Bill,” Mr. Geithner interrupted. “Won’t that cause serious disruptions? When Americans save, in order to reduce their debts, they take away the single primary source of demand for the world economy. If they don’t begin buying soon, businesses all over the world will go broke. That’s why I’ve spent so much money trying to bail out the banks. Americans have no money. So the only way they can spend is if the banks provide credit. So, we have to save the banks first…then they’ll begin lending…and then the economy can begin growing again.”

“Uh…no. That’s not how it works. Even if you make all the banks solvent, whom are they going to lend to? Who’s going to borrow? Americans have too much debt already. Right now, if they get any money, they’re holding onto it…and using it to pay down their debts. They’re not going to start spending just because a bank offers them a loan. They’ll only want to spend money if they think inflation is returning…”

“Well, Ben is working on that…”

“And maybe he’ll eventually succeed. But it doesn’t matter. The old model – where the Chinese lend us money so we can buy their products – is broken. It can’t be fixed. Because the more Bernanke causes inflation…the less the Chinese want U.S. dollar assets…meaning, the less they want to lend to us. And if Bernanke doesn’t cause inflation, Americans won’t want to part with their money. So, they’ll buy fewer Chinese products – and China will have less money to lend back to us. We’re trapped in both directions. Forget it.”

“Well…what’s the solution then? I’m new to this job. I’ve got to do something…”

“Tim, get a grip on yourself. There isn’t really anything you can do. Capitalism has to do its work. It’s got to destroy the businesses and the investments that were built up on the false promises of the Bubble Epoch. The faster it does it, the better. A number of banks need to go broke…and a lot of big businesses, too. You can try to hold it off with taxpayers’ money…but you’re just making the whole process of restructuring longer, and more expensive, than it needs to be.

“Tim, have faith. Let it be. Give capitalism a chance.”

“I can’t do that. I’d be fired.”

“Maybe…but at least you’d go out with a little dignity.

“Wait…how about this…? Take your case directly to the American people. Go on TV for 10 minutes at a time, once a week. Each week, explain to them what is going on. Gain their confidence by telling them the truth about what went wrong, and about why the bailouts don’t work.

“Then announce a program of Dynamic Restructuring. Drag a few bankers and businessmen into a public square and have them beheaded. Force Wall Street employees to go to re-education camps, where they will be taught how to do simple math. Tell the auto industry to come up with a prototype with five wheels, in order to give a boost to the tire manufacturers. Tell the nation that the national language is changing to Swedish – because the economy there seems to work better. Start a campaign to encourage tourism from Europe by making the nation more authentic and different. Getting people to dress in buckskin outfits like Native Americans. Then, get all those people who are living in tents because of the crisis to switch to teepees…”

“Sounds crazy…”

“Well…of course, it IS crazy. Completely ineffective too. But at least it wouldn’t be harmful. It’s just meant to distract the yahoos while capitalism does its work.”

“Good thinking…I’ll get right on it.”

No matter how much sense we try to talk into Mr. Geithner and whoever else may call our hotline looking for advice, the money for these bailouts have already been spent…and it came directly out of your pocket, as an American taxpayer.

Now, we turn to Addison and Ian in Baltimore for more news….

“Stocks just finished their first positive month in since August,” writes Addison in today’s issue of The 5 Min. Forecast.

“On March 11th, by order of the commander, we took down the Crash Flag. The rally had begun just two days before. After yesterday’s 1.2% gain, a healthy rebound from Monday’s selloff, the Dow ended March with a 7.7% gain – one of the best March performances since 1928, second only to March 2002.

“For the month, the S&P 500 and NASDAQ fared even better.”

Each weekday, Addison and Ian bring readers the The 5 Min Forecast, an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments – in five minutes or less.

And back to Bill, with more thoughts…

The rally seemed finished on Monday. Yesterday, we weren’t so sure. The Dow rose 86 points. Oil is holding at $49. The euro has fallen to $1.32. And gold has dropped to $918.

“Cramer calls the bottom,” says a headline. Jim Cramer says its time to BUY! If we’re not at the bottom now, he says, we’re only a couple percentage points away.

We doubt he is right. The Dow will probably fall to 3,000 before we’re finished – so it has a long ways to go.

And the economy is still weakening. Seven states now have jobless rates higher than 10%. And housing prices are not only falling – they’re falling faster than ever. In January, according to Case-Shiller, prices fell 19% from a year before, the highest rate ever recorded. Overall, house prices are down 26% from their highs.

“Russia backs return to gold standard,” says another headline. Enemies of the dollar system are joining forces. The Chinese, the Russians…the Europeans… Pretty soon, they will be irresistible.

But probably not before Bernanke’s efforts to produce inflation bear a surprising and bitter fruit.

Our Dollar Crash Flag remains up.

And finally, a question from a dear reader:

“Back in the ’70s Jerome Smith claimed we were exporting our inflation to foreign countries and it was the reason that gold did not rise. Could this be the reason why gold is not rising in price above $1000 now in the U.S.A.?”

During the ’80s, ’90s and ’00s, the United States exported dollars. Those dollars caused a huge inflation – in asset prices. That was the major source of hot air for the Bubble Epoch.

In the present time, the Bubble has burst. The United States inflates the money supply… but now, the money goes right into bank vaults, drawers and cashboxes. The worldwide financial meltdown has eliminated about $50 trillion of nominal wealth globally. Even if the feds have put back in $14 trillion – in various forms, little of it actually reaching peoples’ pockets – it is a small and futile gesture, compared to what has been lost.

So, no…the United States is no longer exporting inflation. At least, not yet. Right now, it has no inflation to export. And when it attempts more monetary inflation on a grander scale, it risks having to re- import all those dollars it once exported.

In other words, when the world finally takes fright over the declining value of the dollar…the green paper is likely to come pouring forth from vaults and mattresses all over the planet. People will be eager to get rid of it, triggering a big drop in the dollar’s value – almost overnight.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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