Devil Debt Will Have His Due

Here at The Daily Reckoning we may hate the devil and renounce all his works…but we’re betting on him anyway…

Let’s begin with the headlines:

“Financials Slam Wall Street,” says a headline. The Dow fell 92 points. Makes us think the financials didn’t slam it very hard.

Gold rose. Oil rose. And the dollar sank below $1.50 per euro…another milestone.

As we reported yesterday, investors think the recovery is for real…and that it will boost up prices of commodities and stocks. The dollar, on the other hand, is chopped liver.

But we have a feeling that the devil is on the side of the dollar. Let’s us explain.

“How Wall Street Will Kill the Recovery,” is a headline at BusinessWeek.

Finally, everyone is catching on to how it works. The big banks take the feds’ money…then they speculate with it …or lend it back to the Fed for an easy 400 basis points of gain.

At Seeking Alpha, they’re talking about “the return of Japan’s zombie finance.” Over at The Wall Street Journal they’ve talking about America’s own “Zombie banks.”

But these monsters are only reacting to the jolt of juice given them by the Dr. Frankensteins at the Fed and the Treasury. It has become very unprofitable to hold cash; the feds are creating more of it by the boatload. You get a minimal rate of return on cash…while other assets go up. And the feds can’t stop…or change course…not without sinking the whole economy. They may talk about an ‘exit strategy.’ But the exits are blocked.

Remember cash is created when the feds “monetize the debt” by buying US Treasury bonds. In order to exit…that is, in order to reduce the monetary base…they’d have to sell those bonds back into the open market.

Are you kidding, dear reader? After being the single largest buyer on the planet? Imagine what will happen to the bond market when investors realize that the Fed is selling! It’s not going to happen. Instead, that $1 trillion increase in the monetary base is more or less permanent…and it’s eventually going to turn up as inflation.

The feds have no idea what is going on. They consistently misunderestimate the devil…the market…and the economy. And they consistently misoverestimate themselves.

In short, the old timers were right. To them, an economy was a natural thing…like an eco-system…or a language. It followed natural rules…rules that no man could change. It was like a living organism. It needed to breathe in and breathe out. And like all things under heaven, it was subject to moral laws. Do the wrong thing and you (an economy…as well as an individual) will pay the price. You don’t get what you want from markets…you get what you deserve.

This seemed intuitively correct to generations of economists. Not only that, it was proved correct time and time again. Each time people borrowed too much and spent too much money, they came a cropper.

You may ask: “How much is too much?” According to the record, compiled and analyzed by professors Reinhart and Rogoff, it’s impossible to say exactly. One nation can support public debt of 200% of its GDP (Japan comes to mind)…another cracks up at 50% (think of Argentina). A man like Donald Trump can carry millions in debt…another goes broke if you lend him 20 bucks.

(At one point Donald Trump was the poorest man in the world. His net worth was negative by 10s of millions (we don’t recall the figure). All over the world, hundreds of millions of people could have said: ‘I’m richer than Donald Trump.’ Even if you didn’t have a dime, you were richer than The Donald.)

So, how much is too much debt? It depends on what you use the money for…how much you have in assets…whether your earnings are shrinking or growing…and a number of other questions. But while the answers aren’t simple, the questions should still be asked: If you run up a debt, how are you going to pay it back? What will happen if you don’t pay it back?

A professor at the University of Basel, Peter Bernholz, thinks he has the answer. He studied instances of hyperinflation. He believes that you get hyperinflation any time the government spends 166% or more of what it receives in revenues. This should set off alarm bells. The US budget is now about 170% of tax receipts.

The feds can’t repay the record amounts they’re borrowing – not without a major political crisis. They’d have to cut spending and raise taxes so dramatically it would cause a backlash. The parasites would revolt. It would probably unseat the ruling party and break the repayment plan. Generally, people prefer inflation…or default…to actually paying their public debts.

One way or another, however, the devil debt will have his due. Somebody is going to pay – if not the borrower…then surely the lender. There’s a bullet out there. Someone has to take it.

But who believes it? The old economists are dead. John Maynard Keynes denied that debt mattered very much. Then, his successors forgot that it mattered. Dick Cheney told his party to stop worrying about it. And now a whole plethora of modern economists and politicians believe that the problem with today’s economy is that there is not enough of it. Debt that is. They think the government should borrow and spend even more. To them, the whole secret to a healthy economy is how much money people spend. Yes, it’s absurd, but that doesn’t make it unpopular. People like spending money. And they welcome economists who tell them that they’re doing the right thing.

Since Keynes, economists pretend the devil doesn’t exist. They believe they are not part of nature…controlled by natural laws. Instead, they want to take control of nature. And the only way they can get a grip on economies is to break the boom-bust business cycle. And you can’t do that unless you pretend that debt doesn’t matter.

The trouble with real markets is that they are always subject to human emotions and human calculations. It is a quality that George Soros describes as “reflexivity.” Markets act differently, depending on what people believe. And when the authorities try to turn their knobs and yank on their levers, it changes both what people believe and what they do – but not necessarily in the way the feds want.

It is much easier to manipulate speculative markets than it is to manipulate the real economy. Want to drive up prices? Just give speculators some free money to play with! Guarantee their debts! Bail them out of their stupid positions! That’s what the feds have done. And that’s why the banks – the recipients and conduits for the free money – are making profits. Goldman allocated $527,000, per employee, in compensation for the first 9 months of this year. An increase of 46% over last year.

Gold, oil, copper, stocks – all are in government-induced speculative booms. But the underlying economy is harder to move. In order to get consumers to spend, the feds have to put money into their hands…and raise prices so consumers will want to get rid of it, rather than hoard it. But that is proving very hard to do.

Why? Because of the debt. Consumers have to pay down their debt. They have to cut back. They have to spend less. So, the economy shrinks.

And now The Wall Street Journal is talking about another downdraft in the housing market. It could get “even uglier” it says. Why? The mortgage debt that still have to be reset and rescheduled. Apartment rents are falling as unsold units are put up for rent.

Sales at luxury stores go down as consumers work their way back down the price chain. Why? They have to spend less as they pay off their debts.

Yes, you can ignore debt…until you go broke!