Sunday, April 3, 2011

The Economy: Karl Denninger, "The Stark Choice Before Us"

“The Stark Choice Before Us”
by Karl Denninger

“Is it possible to perpetually live beyond your means via piling on more and more debt? That is, those who propose that we should not balance the budget today must be asked to justify exactly when they will support that path, how they will get there, and what guarantee they'll offer that it will actually happen.  They must also have demanded of them some evidence that in the time between "now" and that point they will be able to continue on their present course of action without interruption.

If all of those elements, most-particularly the last, cannot be met then we must instead choose to take our medicine now and slash the budget, telling those who claim to be "too big to fail" and not only are they not in that club any more, they're also not too big to jail. If this results in the cutting up of our collective credit card, then so be it.  Yes, that results in much pain.  But we have a model for this - 1920-21, in which Warren Harding did exactly that and the economy, while suffering an extremely sharp deflationary recession cleared and rebounded smartly within 18 months.


How far are we into our Depression now?  Three years. For more than three years our government has spent more than 10% of GDP.  Our real GDP growth rate has been negative since 2007 - sequentially - when one removes artificial government stimulus.  In 2008, the contraction was about 8%.  The contraction in 2009 and 2010 was over 10% and about 7.5%, respectively.  That is a 28% contraction top-to-bottom thus far, which dramatically exceeds the economist definition of "Depression", a 10% cumulative decline.

The problem with the path we are on now can be seen in that chart.  In 2000, following the meltdown of the Internet Bubble, you can see the same policy response.  In 2001 onward government "stimulated" via borrow-and-spend to try to pull the economy out of its funk.  They failed - we never recovered in real terms, we never saw even a 2% adjusted growth rate again. This is why the debt bubble hit the wall.  We failed not only to put up actual 7% GDP increase numbers that were necessary, but we faked the numbers we did put up with government borrowing.  That borrowing, however, was not supported by actual output.

The path we are on cannot work.  It is mathematically impossible for success to occur.  We are seeing that impossibility play out in nation after nation, beginning with Iceland, Greece and now Ireland.  This cancer will spread unless we excise it. Excising it means telling the bankers to go stuff it, and refusing to pay.  It means governments doing so where necessary - ceasing borrowing and running a primary surplus.  It means governments refusing to backstop bad debts and allowing those who are bankrupt to be recognized as bankrupt, forcing their bad debts into the open and liquidating them.  It means spending less than you make personally and spending less than you tax as a government, actually paying down debts.

We cannot continue on the path we are on.  We have over $100 trillion in actual liabilities in the Federal Government when one looks not only at public marketable debt but also the forward promises for Medicare, Medicaid and Social Security.  This exceeds the net worth of households and corporations by some 40%.  That is, it's not possible for us to pay, even if government was to confiscate all privately-held wealth.  We would still be in the hole by nearly half.

That which cannot be paid will not be paid.  This is not a matter of opinion or politics, it is mathematics.  Mathematics does not care about the political landscape or whether you are Democrat, Republican or Martian.  The only truth in Mathematics is that all equations balance - always.  That which is on the left side will balance that which is on the right.  If you have on the left (debt) that which exceeds what is on the right (assets), and production cannot possibly all be diverted to pay the left, then some part of that debt will default.

We choose only how long we would like to pretend, and while doing so the balance shifts ever-more-unfavorably against us. We must do the right thing, no matter how painful or distasteful it might be. There is no alternative - we choose only between taking those steps on our own initiative today or having them grow and become worse tomorrow.

In 2000 the total contraction in GDP necessary to clear the system was approximately 10%.  Today, it is in excess of 30%.  If we continue on the path we are now on through "one more cycle" we will reach the point that Ireland is in, where banks will be demanding bailouts of over two and a half trillion dollars - just as occurred last week in Ireland. Remember too - the Irish demand for more bailouts as a result of these "stress tests" came just one year after the banks there were all declared "healthy" through the previous round of stress testing.

This is what a debt spiral does; the black hole of ever-compounding obligations swallows your ability to pay and, unsatisfied, demands ever-larger capital injections until quite-literally the entire wealth of your nation is consumed - or you tell the banksters to pound sand.”

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