Learning From A Communist

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“Panel will tackle national debt,” says a headline in this week’s Washington Post.

Would anyone like to bet?

Who writes these headlines? What are they thinking? Are they thinking at all?

While the bi-partisan group of bumblers may do something; tackling the national debt – or even slowing it down – is not one of them. It would be going against the tide of modern financial history, which rolls debt into bigger and bigger piles and turns small problems into huge ones.

Let us look back. What has been the major trend of the entire past 50 or so years? Government has played a larger and larger role in the US and most western democracies. Only in the formerly (and for many, still) communist countries has government been rolled back.

The communists learned their lessons. They proved that government spending does not make people rich. But now…what’s this…? The US and other countries are greatly increasing the percentage of GDP spent by the government.

The communists proved that central planning didn’t work. But again, the US and others are now planning their economies more than ever – managing interest rates, directing capital to one industry while denying it to others, raising taxes on this…subsidizing that…regulating everything that moves…

The communists also proved that state ownership of industry was a bad idea. But the US and others now own banks, insurance companies, almost the entire mortgage business, and one of the world’s largest automakers.

Perhaps most importantly, almost all the ‘old’ democracies – notably the US – are taking on much more debt. Bankers do stupid things – the feds take over the debt. Homeowners do stupid things – the feds give them more low-cost credit. Politicians do stupid things – and the feds run up even more debt.

And it’s killing them. They can’t raise enough money through taxation to fund their spending plans, so they have to borrow. And borrowing exposes them to big risks.

In a few days, America’s first time house buyers’ tax credit program expires. It’s been a great success, say supporters.

Let’s see, how did it work? According to the news reports, the government gave away $12.6 billion in tax credits. Of course, some people would have bought a house anyway…and could have afforded one without the tax credit.

Wait…that means that the only additional sales came from people who 1) didn’t really want to buy a house or 2) couldn’t really afford one. According to economists’ estimates, each one of these people cost the feds $30,000 worth of tax credits.

And according to the results of an audit, $139 million was paid out to people who hadn’t bought a house at all. And one of the people who got the credit was only 4 years old.

A perfect federal program – it accomplished nothing at great expense…

And it adds to the debt!

Yesterday, the Dow sold off 213 points. Gold rose $8. In the aftermarket it soared even more.

What’s bugging the markets? Debt. Specifically, the debts of Greece…and Portugal…and Spain…

Last Thursday was “Black Thursday” for Greece. News reports told the world that Greece’s budget problems were bigger than people had thought. Traders dumped Greek bonds.

Greece’s debt is now ‘junk’…the rating agencies say that if the country is forced to reschedule creditors could get back only 30% of their money. Naturally, lenders are nervous. And investors fear that Greece’s problems are not limited to the Hellenes. Sovereign debt problems are as ‘contagious’ as HIV. All it takes is a little hanky panky of the wrong sort…and you’ve got it!

Greece’s budget deficit is 8.7% of GDP.

Portugal’s deficit is the same.

Spain’s is higher – at 10.4%.

Where’s the US deficit? Last time we looked it was projected to be as high as 12% of GDP.

By many measures, the US is actually in WORSE shape than Greece. And the rating agencies have already warned about a possible downgrade of US debt too.

And by all measures, the US has the biggest pile of debt in the world… Just wait until the sparks hit it. You’ll see the world’s biggest blow-up!

And more thoughts…

“Ask me how insurance works.”

“All right, how does insurance work?”

“Well, okay, you give me your money…”

“Is that all there is to it?”

“Yes.”

“Is that a joke?”

“Not exactly…”

Fire insurance works by sharing out the risk of a fire among hundreds of homeowners. In effect, if one house burns down, the others have already put aside enough money to rebuild it.

It’s a kind of voluntary socialism…freely collectivizing the risk of a house fire.

But just because you have fire insurance doesn’t mean you will leave a can of gasoline on the kitchen stove. You know it would be a big pain to replace the house and its contents – even if you were made whole financially. That’s why it works, because it doesn’t change human behavior. So, actuaries can calculate the odds of a fire fairly accurately.

But suppose you could insure against losses in the stock market? Or suppose you were guaranteed health care…or a comfortable retirement…no matter what you did? Wouldn’t you at least be tempted to live a little? To take chances? To spend a bit more?

And wouldn’t the whole economy change as a result?

For the last 50 years – or more – we have been taking part in a vast experiment. What will happen as more and more risks and costs are socialized?

We already saw what happened in the mortgage market. Bankers used to take their risks one by one… If they thought a man was a good credit risk, they lent him money. Sometimes they were right. Sometimes they were wrong. Being wrong from time to time was just a cost of doing business.

But then the financial industry collectivized the risk. The banker lent, earned a fee, and then sold the mortgage on to Wall Street, where it was securitized, packaged and resold. What was the consequence? Well, mortgage lenders stopped worrying about individual risks. They changed their behavior and stopped using their own judgment. All they wanted was to close the folder, collect their fees, and move the paper on. Soon, they were lending without asking questions – using low-doc, IO mortgages. House buyers changed their behavior too. Easy mortgage credit pushed up demand…which pushed up prices. Pretty soon, the whole town was on fire.

But then the feds stepped in and collectivize the risk even further. Now, Fannie Mae and Freddie Mac are arms of the US Federal Government. And now we’re all partners in the insurance company! Now, when houses burn down WE ALL have to pay.

We’ve seen what happened when government collectivized other parts of the financial system too. You can collect Social Security whether you saved for your retirement or not. And you could get unemployment compensation whether you saved for a rainy day or not. And you can get food stamps whether you tried to find a job or not.

And now, if you’re a major Wall Street bank, you can get a bailout from Washington whether you deserve it or not.

How about that? The feds have spread the risk around so much that everybody pays for everybody else’s mistakes.

Is that a good system, or what? Government insures everybody against everything. Only the government doesn’t have any more money…

..So, then you give your money to government…

..and that’s all there is to it.

Regards,

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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Comments

  1. “And by all measures, the US has the biggest pile of debt in the world… Just wait until the sparks hit it. You’ll see the world’s biggest blow-up!”

    Unlike Greece, Portugal, Spain et al there is no impediment whatsoever which prevents the US, UK or any other government sovereign in its own currency from paying all its debts as and when they fall due.

    So how is it that S&P or anyone else can consider US Treasuries anything other than AAA? You WILL get your money back when the bonds mature.

    Of course the value of the currency relative to others and relative to other assets may suffer, but that’s hardly a sovereign default risk.

    Why does NO ONE, not even the entertaining scribes at the Daily Reckoning EVER point this out?

    Reply
  2. 100% correct Bruce,

    Its an “Inconvenient Truth” for many when you extend that fact to its logical conclusions. Suddenly conventional wisdom doesn’t stack up being terribly wise at all.

    Reply

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