Five Things: Do We Need Debt to Recover?
Why attempting to solve the crisis with the very same policies that caused the crisis is doomed to failure.
This is a good question. Do we? According to the Wall Street Journal, citing a recent study of all nine post-World War II U.S. recessions by Barclays Capital, the answer may be, not really.
According to the study, in the first year of recovery net new borrowing almost always lags behind the increase in nominal gross domestic product, incomes and profits so that debt as a proportion of GDP falls. The article also points out that "stripping out residential mortgages, private-sector borrowing -- both by households and the corporate sector -- actually fell in the first year of recovery in each of the nine recessions." (More on that in today's Number Three Item.) And so the conclusion reached in the article is that, "the lack of availability of bank credit is clearly a problem -- but not necessarily the disaster some people think."
I disagree, and the chart below, from the same article, is the reason why.
The premise of this chart is "Back From the Brink." After disastrous GDP prints in the U.S. and Euro zone during Q1, the fact that Q2 showed marked improvement, even while still negative, is chief among the reasons for this newly found optimism about the economic recovery. The third and fourth quarters will also likely add significant fuel to the optimist's fire.
The reality, however, is more grim because this glimmer of optimism is grounded in a false premise; namely, that foreclosures, defaults and delinquencies (debt destruction) are accurately stated.
Because the government and the Federal Reserve are either directly or indirectly supporting so much debt, the destruction of it is being under-reported. And so a false picture of economic health and recovery has emerged. Let's see what this entails by looking a bit closer at the disease this debt destruction is trying to cure.
2) By Definition, the Disease Cannot Also Be the Cure
Yesterday Austrian economist Patrick Barron wrote a terrific essay, "The Real Cause of the Current Economic Crisis and Its Cure," clearly describing what is taking place in simple terms.
"The government's attempt to solve and/or ameliorate the current crisis will only make matters worse, because it is attempting to solve the crisis with the very same policies that caused the crisis--namely, excess fiat money credit expansion," Barron writes.
And I agree. The critical thing to understand about bailouts and the government-led rescue of industries ranging from finance to autos to housing is this:
"Since the government can spend only what it takes from the people, its increased spending will drive the people to poverty even if the spending is on what many might consider worthy infrastructure projects."
By definition, the government can only spend what it gets, or takes, from the people. Think about that. If you understand what that means, then you can understand the long-term consequences of everything that is happening today, which leads us to today's Number Three item... because no discussion of government intervention can be complete without a run-down of the ongoing Deflation vs. Inflation debate.
3) Inflation vs. Deflation... Again
This morning I caught two competing headlines that, at first glance, seem puzzling.
Safeway Lowers Prices
Grocery chain Safeway (SFWY) follows competitors as consumers look to cut expenses in recession
- Baltimore Sun
Monsanto to Charge as Much as 42% More for New Seeds
Monsanto (MON) plans to charge as much as 42 percent more for new genetically modified seeds next year than older offerings because they increase farmers' output.
Ok, so what can this possibly mean? Inflation and deflation at the same time? Stagflation? Let's take a look.
Inflation is an increase in the money supply. When the effects of that increase are rising nominal prices then the real value of money is eroded. We have had inflation for decades now, which necessarily sows the seeds for deflation, and which can only occur after a prior inflation. Stagflation is a stopping point in that transition.
Deflation, however, occurs when the money supply EVEN IF INCREASED fails to exceed the demand to hold dollars at the prevailing price level. This is important to understand. Following nominal price levels alone will never yield an accurate view of whether we are experiencing deflation. Over the past two years, the money supply has increased dramatically, but the velocity of transactions has continued to decline because people are using those increased dollars to destroy debt, or simply saving them.
This can clearly be seen in the monetary aggregate charts. (See the charts here via St. Louis Federal Reserve). Pay particular attention to the chart of M2, because that is the area where Fed expansion policies have the least impact. If you want to understand what keeps Federal Reserve Chairman Ben Bernanke up at night, then all you need to do is consider how much Fed activity it has taken to simply prevent M2 from totally collapsing.
But back to our two stories, Safeway and Monsanto. Again, following nominal prices alone is at best misleading, and at worst irrelevant to understanding REAL deflationary effects. Prices are merely one symptom of inflation and deflation, not in and of themselves predictors or indicators.
In order to understand deflation it is necessary to tear yourself away from price levels and focus on 1) declining asset values, 2) availability of AND DEMAND FOR credit, 3) real liquidity and 4) debt destruction and balance sheet repair.
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