By Dr. Gary North
for Gary North’s Q&A forums: www.GaryNorth.com
Last week, former Senator Phil Gramm, an economic adviser to John McCain and a Ph.D. in economics, assessed the present state of American voters’ opinion regarding the economy. He called them whiners.
The press immediately went ballistic. How could he have said such a thing? Shame! Shame! McCain quipped that Graham was high on his list to become ambassador to Belarus.
Graham was correct. Americans are the richest people in history. The economy has barely slid into economic recession.
Yet they are complaining of a heavy burden. They haven’t a clue of just how heavy this burden can become, and how fast.
Americans are like small children who fall down and scrape their knees. They want Mom to make it all well. Mom is the Nanny State.
When the economy is in an extended recession, as it will be, what will voters do? What pressure with they put on Congress to solve the problem? What will Congress do?
We know what it will do. It will spend. It will regulate.
It will go looking for victims.
It already is.
PROSPERITY AND THRIFT
We are the richest nation in history. We have been made rich by the self-discipline of savers, who today are a tiny fraction of the American public. American households 25 years ago saved over 10% of their discretionary income. Today, American households save nothing. They borrow instead. See the chart from the Grandfather’s Economic Report: http://GaryNorth.com/public/3759.cfm
In 1983, the American economy was recovering from the worst post-war recession, the result of the wildly inflationary policies of the Federal Reserve in the 1970’s, made possible by Nixon’s abandoning of the gold exchange standard in 1971. When Paul Volcker’s FED stopped buying Treasury debt in late 1979, the recession was guaranteed.
In hard times, Americans used to save at high rates. Today, after 17 years without a major recession, they plead poverty.
“We just can’t save any more. We’re too poor!”
As recently as 1999, academic economists and mutual fund salesmen said rising stock prices made saving irrelevant. The new technology would make us rich. Greenspan was one of the loudest cheerleaders for this nonsense. The new technology has brought us prosperity. His most famous speech to this effect was delivered on January 13, 2000:
Then, when the stock market bubble burst, eight weeks after his speech, the economists sang a new tune: rising housing prices would make us all rich. That bubble popped in 2006, much to the surprise of the economists.
Now, nobody says what will make us all rich. But serious economists have known ever since Adam Smith’s “Wealth of Nations”
The productivity of capitalism has always been based on two
things: (1) the public’s willingness to save and (2) entrepreneurs’ willingness to bear the uncertainties of the future. Savers have funded entrepreneurs, and the result has been unprecedented economic growth for over two centuries.
Americans who are in the bottom 10th of income distribution live better today than kings lived in 1800. They have better health care, cheaper entertainment, cheaper books, longer life expectancy, air conditioning, central heating, and much more.
This has come as a result of the private property system, the future-orientation of a broad mass of savers, and the willingness of entrepreneurs to invest their time and money to meet the wants of consumers in the future.
All three are under attack today. The whiners are looking for victims. Congress will find them. That is what Congress does. This is its specialty in the social division of labor.
The economy is probably in a recession. I believe this recession will get worse.
The reason why we are in a recession is that Alan Greenspan’s Federal Reserve System pumped fiat money into the economy, beginning in June 2000, and continued to pump in money at escalating rates until mid-2002. Then the FED slowed somewhat, but not enough. When Ben Bernanke came in as Chairman in February 2006, he ended the still high rate of monetary inflation — his legacy from Greenspan. As a result, the American economy has slowed down sharply.
It was the prior monetary inflation by the Federal Reserve System that led to this recession. Recessions are caused by prior monetary inflation. This is the insight of Austrian School economics, and it is by far the most hated insight of Austrian School economics. The politicians hate it, the rival schools of economics hate it, and the voters hate it, to the extent of the voters suffer from the results of the original policy and do not blame the FED.
People want subsidies. The government cannot pay for the subsidies. It has no productive assets. It only has a gun. It can tax, but this creates resistance. So, part of the subsidies have come from the Federal Reserve System, which creates money in order to lower short-term interest rates to stimulate a boom or prevent a bust. These lower interest rates lure businessmen into starting projects for which there is insufficient capital saved by the public. These low rates also encourage borrowers to take on debt that they will not be able to afford when the recession hits, or when interest rates rise, or both.
We are trapped in a crisis created by the Federal Reserve System. We must now pay the piper, but nobody wants to pay.
Borrowers don’t want to pay. Lenders don’t want to suffer the losses that they are going to suffer because borrowers are not going to repay all of their loans. Politicians don’t want to suffer the consequences at the polls at the next election.
Voters don’t want to suffer the consequences of unemployment.
So, everybody looks for a legal gun.
Everybody wants to have a gun to stick legally in the belly of the other person, in order to force that person to pay his “fair share” — higher than the voter’s — to bail out the system, which is the joint product of (1) the central banks of several countries, (2) the United States Congress, (3) the present Presidential administration, (4) the fractional reserve banking system, and (5) tens of millions of American voters who demanded something for nothing and now face getting nothing for something.
Recessions expose the true costs of the politics of plunder.
Voters are committed to the politics of plunder, and they don’t want the lunacy exposed. They want the other guy to pay for their mistakes. So, Graham is correct: we have become a nation of whiners. But we are whiners with a gun: civil government.
Specifically, voters whine about the costs that economic liberty imposes on people who have taken risks that were greater than borrowers and lenders supposed. People don’t want to bear the costs of their own actions. So, they go looking for someone with a fat pocketbook. They want Congress to stick a gun in his belly. Congress is usually quite willing to do this. An economic recession makes Congress even more willing.
Twenty years ago, with respect to cutting government spending, Graham quoted the title of an old gospel song:
“Everybody wants to go to heaven, but nobody wants to die.” This is exactly the case today. Everybody wants stable money, but nobody wants a recession. Everybody wants government benefits, but nobody wants to pay the taxes. Everybody wants an economic boom, but nobody wants the inevitable bust.
WHAT DID THEY EXPECT?
Recently, I received a letter from a woman who took umbrage at the fact that I publicly referred to the fact that Americans have ceased to save. She wrote this:
“You seem to think the problem is that Americans can’t
save money or budget properly, and that we will be
forced to cut our budgets to deal with rising energy
prices. Well, you can’t save money if there’s none
left over after paying bills. I know my budget, but it
doesn’t mean anything if I do not have enough cash.
Right now, if I pay all my utility bills on time, I
have barely enough for food (or for some medicine, but
not both). I’m handicapped and on a fixed income.
And when I go shopping–which I do only once a week to
save gas–I see 10-30% inflation, not 3%. My biggest
worries right now are (1) the electric company in
Pennsylvania is asking for an increase of 50-75%, and
(2) I know the cost of my propane heat will also go up
accordingly. That will leave me with two winter bills
guaranteed to wipe out my entire monthly Social
Security check, even though I will close down most of
the house and live in just two rooms. I will be eating
bark if I manage not to freeze to death.”
She is on Social Security. She is a ward of the state. She lives on the taxes paid by others. Yet she complains mightily.
She resorts to rhetoric of poverty — eating bark. Anyone this skilled at self-pity will always find a way to get by through the kindness of strangers — and the voting booth.
I fully understand her current problem. A tiny handful of Americans are handicapped. She has no reserves. This is a terrible situation to be in. This is the famous rainy day she was supposed to save for. She was not content to tell me her problem. She spoke on behalf of middle Americans in general.
“Most of my neighbors are very frightened, even the ones
with jobs. I don’t think economists–and certainly not
the politicians–have a clue as to what Middle America
actually contends with. And Phil Gramm, who thinks
this is all in our minds, is a perfect example of a
government lackey who ought to be facing a firing
Their problem, like hers, began decades ago when they did not adopt a systematic program of saving. Their bad habit has now caught them, with lots of help from the Federal Reserve System. My generation was taught to save for a rainy day. This generation did not heed that ancient advice. A level-3 hurricane is approaching, and they say they cannot save.
Why did they refuse to save when the good times were rolling?
I replied to her by stating the obvious: as this recession accelerates, she and tens of millions of other non-saving Americans are going to cut their budgets. They will have no choice but to cut their budgets. They will be losing jobs, suffering reduced income, and paying higher prices than they want to pay, at least until energy prices fall in response to the recession. In other words, she is going to have to cut her budget in the near future.
Why doesn’t she cut her budget today? She’s going to have to cut back in those sections of her household budget which will have to finance the rising cost of energy, the rising cost of food, and anything else that is still rising in price. But she says she just can’t.
Yes, she can. And she will.
“I just can’t save!” No; they just won’t save, and haven’t saved, at an accelerating rate for 25 years. Members of each income group refuse to move down to the one below them and save the difference. They deeply resent having to pay for their own unwillingness to budget. They all want to be Congress.
They refuse to count the costs of their own unwillingness to save. They are present-oriented people, meaning lower-class people. They are not willing to save, because they think that Uncle Sugar is going to bail them out.
UNCLE SUGAR SPEAKS
On Sunday, Uncle Sugar’s economic spokesman, Secretary of the Treasury Henry Paulson, announced exactly that. He is going to recommend to Congress that Congress put the entire American electorate at risk for the failure of Fannie Mae and Freddie Mac.
Once again, a politician’s appointee, a member in good standing in the investment bankers’ club (Goldman Sachs), to whom insolvent debtors owe their enormous debts, comes to the public in the name of the senior politician and says that Congress has just got to bail out the bad decisions of short-sighted lenders and short-sighted borrowers, of whom Congress is chief.
He announced this on a Sunday, which means that the government was convinced that a collapse of the stock market was quite possible on Monday morning. This was a replay of the Bear Stearns’ bailout announcement.
A Sunday announcement is the sign of total panic in Washington. It is the sign that the politicians at the highest level do not want the housing market to collapse. This is an election year, and voters who suffer housing losses tend to vote for the rival party.
His announcement may have averted the bankruptcy this week of these two overleveraged, scandal-ridden institutions, but it did no good for the banking sector. On Monday, the banking sector suffered its sharpest one-day decline since 1989: http://GaryNorth.com/snip/606.htm
Washington Mutual, already considered by many as the next bank to follow IndyMac, fell by 35%. It was not alone. National City Bank was down 25%.
Over the past year, the Standard & Poor’s Bank Index has fallen by two-thirds. This chart ought to send chills down the spines of every stock market investor. It was at 400 a year ago.
It is under 150 today: http://GaryNorth.com/snip/609.htm
Banking is the central institution in the modern economy.
American banking is in a bear market of unprecedented severity.
The Secretary of the Treasury can issue lots of weekend assurances, but they no longer have much effect.
THE TOOTH FAIRY IS ARMED AND DANGEROUS
Americans believe in the tooth fairy. The tooth fairy comes in several costumes. One is the costume of the Federal Reserve System, which promises to make available fiat money in order to bail out lending institutions that lent money at interest rates that were too low, because the Federal Reserve System under Alan Greenspan forced down these interest rates.
If the FED refuses, then the central banks of Asia and Russia are supposed to rush to our rescue and buy our debt, so that we can continue to spend $850 billion a year more than we produce. They are supposed to create more money and buy dollars and use the dollars to buy more Freddie Mac and Fannie Mae bonds.
Then there is the tooth fairy of Congress. It is accepted on faith that Congress can create wealth out of nothing, simply by taxing the rich.
The rich also want their bailout, so they applaud Paulson and Bernanke. They continue to buy the bonds of Fannie Mae and Freddie Mac. Freddie issued $3 billion worth yesterday. It found takers, as a result of Paulson’s suggestion. They may even be willing to buy shares of these two doomed enterprises, although the initial rally ended within an hour. They assume that they can kick the can down the road for another quarter.
The voters agree with them.
Everybody wants the bailout, but nobody wants to pay. Phil Gramm was right years ago, and he is correct today. He has put his finger on the pulse of America, and the pulse is still strong. He then listens to what Americans are saying, and he hears endless whining. All of this is the result of the same phenomenon: everybody expects the other guy to pay for his mistakes. Everybody expects to keep all of the profits from his own wild speculation, such as borrowing money at below-market interest rates, and then, when his plans blow up in his face, he whines. If politicians don’t listen, he screams.
Screaming catches the attention of the incumbent administration. It catches the attention of Congress. So, the Secretary of the Treasury says that he will ask Congress to put the entire country on the tab for Freddie Mac and Fannie Mae.
The public cheers. The media cheer.
This is why the financial crises never end. We say we want them to end. We really do, but only at a below-market price.
Everybody wants to go to heaven, but nobody wants to die. So, we insist that the politicians and the Federal Reserve System kick the economic can down the road for another quarter or year. The bills mount up. We expect to be able to pay off those bills by telling the rich to pay them off. But the rich are not going to pay them off. The middle class will not pay them off.
The Federal Reserve System will pay them off. The FED is the ultimate guarantor of the debt system, the lender of last resort in an international economy based on debt. The Federal Reserve will create sufficient funds to buy the bonds, the stocks, and the large institution assets that are falling in value. When it runs out of Treasury debt to sell or swap — possibly next year — it will use fiat money to make the purchases. This is what it has always done; this is what it will continue to do.
The public believes in something for nothing. That is, the public believes in the tooth fairy. The only question is: Who is the preferred tooth fairy? That depends on who the preferred target is into whose belly Congress is expected to stick its collective gun.
The most important investment decision you can make is this:
avoiding Congress’s gun. Congress wields the gun, and its members constantly are in search of solvent bellies. Politics is the art of holding the gun and thereby avoiding becoming the target. There is no question that both parties are running this year on the question: “Whose belly?”
Ultimately, the Federal Reserve will create the money to pay off the debts and keep the institutions officially solvent. This will lead to the destruction of the dollar. This is just a matter of time. We know this, because nobody is willing to accept the painful consequences of prior inflations and prior decisions made in terms of those inflations. Nobody is ready to pay the piper. This means that everybody plans to pay his personal piper with fiat money.
We are in a period in which the Federal Reserve has stabilized the money supply. This has led to a recession, and the entire housing structure of the Western world is beginning to totter. The debts are about to overwhelm the capital system that has made available long-term mortgages at interest rates that are not sustainable.
THE MORTGAGE MARKET
In 2008, Freddie Mac and Fannie Mae have supplied 80% of all new mortgages written in the United States:
They already hold or guarantee close to half of all U.S.
mortgages. Bloomberg estimates that Fannie Mae has issued $830 billion in bonds, while Freddie Mac has issued $644 billion. The total of bonds plus guarantees is over $5 trillion: http://GaryNorth.com/snip/604.htm
What this means is that the private mortgage markets, apart from the assumed government guarantee behind Fannie Mae and Freddie Mac, have ceased to provide mortgages at today’s low rates. The government is desperately afraid that without Fannie Mae and Freddie Mac, the free market will raise interest rates on mortgages. This will depress the market price of existing Fannie Mae and Freddie Mac bonds, which are held by all the major investment institutions, and by foreign central banks and foreign commercial banks. Already, over 20% of Freddie Mac and Fannie May bonds or guaranteed mortgages are held by foreigners, mainly by foreign central banks: $1.3 trillion. These institutions want assurances of repayment: http://GaryNorth.com/snip/602.htm
A rise in mortgage rates will drive the housing market into
a depression. Millions of additional homeowners will lose their homes. They will not be able to sell their homes to pay off their debts because new buyers will not be able to pay the higher interest rates in a free market mortgage environment.
This is why Treasury Secretary Paulson issued his Sunday afternoon emergency announcement. The government is desperate to save American housing, because if American housing prices truly collapse, the economy could move from a recession into a full-scale depression. The senior decision-makers fear this.
They fear it for good reason. The housing market has been the engine of economic growth in the United States for over a decade, and certainly since 2001. That engine has gone off the tracks.
The cars behind it threatened to follow. The government and the Federal Reserve System are desperately trying to get the engine back on the tracks.
Investors believe that Uncle Sugar, by sticking its gun into appropriate bellies, can bail out the housing system, and keep the recession from turning into a depression. Investors still have not panicked. Voters have not panicked. Congress is scared witless, and is likely to do whatever Paulson and Bernanke recommend. But the result is going to be another round of indebtedness which forces the Federal deficit even higher than it is today.
We are looking at a Federal deficit exceeding $500 billion in fiscal 2009, and maybe $700 billion or $800 billion, for years on end. The only reason why American investors should buy such Treasury debt is that they think all the rest of the markets are going to fall with such rapidity that it still will pay to own Treasury debt. For a time, this will be true. But at some point, it is not going to be true.
When will that be? When the Federal Reserve will have to intervene to serve as the lender of last resort. At that point, the inflation scenario will return with a vengeance. I think this will be before the Presidential election of 2012. I think whoever is President during the next four years is going to go through the economic wringer.
What about you? What is your personal solution? One thing is crucial: saving. You have got to cut your spending now, since you are going to have to cut it over the next year anyway. Get used to cutting it now. Save your money. Put it into the bank.
The FDIC insures your bank, and for a few more months, the FDIC will still have Treasury debt to sell in order to bail out failing banks. It may even be able to survive three or four bank failures, given the fact that the failure of IndyMac over the weekend depleted FDIC assets by around 10%:
The problem is, one estimate places the number of banks that may fail over the next three years at 300. This is up from a “mere” 150 in February: http://GaryNorth.com/snip/601.htm
Where will the FDIC get more assets after it runs out of Treasury debt certificates to sell? The FDIC has very limited resources to deal with the magnitude of the banking crisis that has begun to unfold.
Who will bail out the FDIC? Who will ensure the insurer?
This question will have to find an answer sometime over the next 12 months. The answer will determine the shape of the economic recovery, so-called. It will force the hand of the Federal Reserve System. The clock is ticking louder and louder.
You had better decide now what you’re going to do then, since you’re not going to want to have to make a decision of how to restructure your family budget after you have lost your job, or after your investment portfolio has fallen by 20% or 30%.
Start making the revisions now.
Gary North’s Economic Edge™
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