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The Great Moderation of Debt


The coaches on the field still refuse to cut their losses and admit defeat: save your resources for the next game.

I have been travelling. I even went to Hawaii, which I call Japan Jr., where my yen go much farther than my dollars do.

The Japanese are better than anyone at devaluing their currency, but alas, unless they confiscate their populace's savings and burn it, even their government can't fight the forces that will eventually drive the yen higher. You can see it happening as liquidity around the world is dropping and real savings are gradually returning home. I'll be picking my next home when the dollar yen hits 80.

There is a good article on the front page of today's New York Times about the possibility that all this economic expansion of the last ten years (I think longer) has been a mirage. I have described this long ago.

Economic growth, especially over the last seven years, has been based almost exclusively on expanding credit or inflation. As money became easier and real interest rates even became negative, people went on a spending spree. Now that credit is contracting (deflation), we are seeing that the party wasn't about productivity or technology, but about being able to borrow money and spend it. I can't overstate this: today we have more debt in the system by any measure than at any time in history.

Many people have just now come to this conclusion. Where were these people before? Why didn't all the money managers, financial advisors, market pundits, and treasury secretaries with all their professed experience warn us of this before now? Many that were doing just that were fired or drowned out for having such drastic opinions. What we had left were merely cheerleaders and profiteers. But even cheerleaders eventually have to admit they are losing the game. The problem now seems to be that the coaches on the field still refuse to cut their losses and admit defeat: save your resources for the next game.

As economic growth expanded as money became free (not free as we now see because those that took it now have the consequence of risk), central bankers incorrectly labeled the economic growth nirvana. We had finally reached a place where governments could control the economy and everyone was going to march together into paradise. This is and always was a non-sequitor. By its nature an economy and its markets are tied together: controlling them is socialistic and will always slow growth. Why?

The reason is resources are scarce and economic activity allocates those resources. In order for an economy to grow that must be done efficiently, which governments don't do well. If resources are infinite then everyone can live in paradise, but until that time we are stuck with the markets to allocate resources.

And the market is saying there is too much debt. It is that simple. The Great Moderation that Mr. Bernanke spoke of in 2004, which smacked to me right away by the way of a very socialistic remark, was merely the growing and looming debt fostered by central banks being spent. Now the process of that debt being either paid back or destroyed is revealing the Great Moderation as the Great Debacle.

So the Fed being under great pressure collapsed yesterday and gave the economy not medicine but drugs. It gave it just what ails it: the sickness of debt. Mr. Paulson and Mr. Bernanke want banks to lend and people to borrow what they can't afford to, more debt, to correct the problem. But if successful they will only exacerbate and prolong the inevitable. But I don't think they will be successful. All the debt they just made cheaper will only go to two places: those that can afford to borrow it and thus don't need it and directly to banks that can't lend it. The rich will use it to again speculate or cheapen their debt. Banks will use it as capital to finance their ever declining asset values. Neither use will do any good to the real economy.

As I said, the coaches on the field refuse to do the right thing. They should let markets correct the imbalances, as painful as that might be, and set the stage for new entrepreneurship to grow the economy in the future.

Hopefully by now Minyans are out of debt and out of risky assets in order to weather this storm. The storm is still off the coast and is just beginning, so don't open the hurricane shutters yet.

Not for a while.
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