Back when old steam trains were being “retired” from service because their energy efficiency was about half that of a a diesel locomotive, Hollywood had quite a number of old steam locomotives to use in crash scenes. The pity is that half a century later many railroad fans have been smitten by the restoration bug and there were so few left. Most were melted down as scrap metal to be added to the steel making processes. So many of the old steam locomotive manufacturers have failed and been scraped just as their old locomotives. I still remember seeing quite a few movies where the two trains on the same track are traveling towards each other at high speeds. When I was a kid my friends and I use to stage our own train wrecks using Lionel or American Flyer models. Now days, when there are head on collisions in real life on the train tracks it is not due to Hollywood need to film such accidents.
Since late 2007 we have been seeing a slow motion train wreck in the various world economies. True, we saw the Federal Reserve Bank buy MBS, more treasuries, and even student loans. Then came the quantitative easing that was suppose to provide a boost to the economy and create new jobs, lower unemployment and more consumer spending. It was the old Keynesian trick of spending your way towards wealth. Some have called it borrowing your way to wealth, but not much difference between the two. The effect was the same, the money never reached the average consumer. Instead it went into high risk and high yield investments, although one might call them wagers at the roulette table. As for the average middle class individual and family, wages tended to decline relative to inflation and prices rose, particularly in those asset classes that many middle class individuals consider an investment, their homes. Asset prices in housing dropped precipitously leaving those who were the last to buy with mortgages on property that the value of such an asset would no longer qualify as security. But the price of automobiles rose, except that these are not really assets but expenses. Food prices have increased with beef leading the way. Back in 1998 one could buy boneless rib steak for about $4 a pound. Now that same steak is around 14 dollars a pound. That is quite an increase. Even chicken has gone up in price although not as rapidly or as much.
The average consumer in America, Canada, Mexico, Europe, and even South America is tapped out. The rise is credit issuance to the middle and lower classes has created a glut of debt, most of which cannot be repaid unless employment grows and employment won’t grow because the consumer can’t spend as much as he did before. Most of the developed and underdeveloped economies in the world are sixty to seventy percent consumer spending. Well, economics 101 never discusses that factoid, does it. Most economic growth comes from the growth in consumer spending. And for the last fifty years the explosive growth in the various national economies has come at the expansion of credit. That is, consumer credit, corporate credit, and public or government credit. We normally don’t think of the government as needing the extension of credit to its many agencies, but when the various local, state, and federal governments spend more than they receive in revenue from taxes and fees imposed upon business and individuals, then they need to obtain the money from somewhere. All those municipal bonds for the building waste water treatment plants, public swimming pools, recreation centers, sports stadiums, art museums, and the like must come from some one, Certainly if taxes were raised to levels that would permit the immediate spending on such projects then the property owners would revolt. Renters don’t understand that they pay the property taxes of the property owner, else they would not be so eager to push for more municipal, county, and state spending. But if we look at states like Illinois and the city of Chicago, these states are effectively bankrupt. Every year the payments for pensions, healthcare, state employment keeps increasing. Each year there are fewer funds to pay the future liabilities. Now some would say that the debt that cities, counties, states, and the federal government owe in the future doesn’t count. By that same reasoning, those future car payments, mortgage payment, student loan payments don’t count, until they become due. Debt is debt, whether it is immediate or future. What you spend today doesn’t change what you owe tomorrow. Get the picture?
So what happens when the consumer is tapped out with too much debt? Well, if the financial markets are lucky, the consumer repays such debt. If not, the consumer files bankruptcy and defaults on such debt. Understand that debt consists of two parts, the principle to be repaid and the interest or rent on the capital borrowed. When one defaults, one stops paying both principle and interest. For the debt owner, it is a loss of both income and capital. For the individual who declares bankruptcy, it is only the loss of any claim on future earnings. There is a difference and most economists fail to realise the difference. There are those who love to point to their Modern Monetary Theory and tell us that any country that issues its ow currency can never go bankrupt, except for Argentina, which is a special case for the MMT people. Actually, that is not the case. MMT fails to understand credit creation. You see, in any country with its own currency, the problem with a government that over spends is that it crowds out savings and investment. That is, the spending of the government results in a competition for resources with the private corporations and the consumers. That means that the scares resources are bought by the government to the disadvantage of the private corporations and the consumers. Inflation results. One has only to look back at that period in US history when Federal government spending put extreme pressure on the consumer side of the economy. We saw the War on Poverty (public spending on social programs that were, to many a mind, excessive), the War in Vietnam ( which cost us a very pretty penny economically), and the NASA Space program which ended with the moon landings. Those were expensive adventures by themselves. But combined, they robbed the consumer of resources and greatly increased the rate of inflation from 1962 through to 1986, if memory serves. Federal, state, and local government debt comes at a cost, it is not a free ride as many MMT advocates would exclaim.
We stand at that point in time where excessive debt is all around us. Consumer debt is at an all time high in most developed countries and in many underdeveloped countries. Unemployment is very high around the world. But corporate debt is at an all time high, due mainly to the chase for performance. That is, earnings per share. How do you increase earnings per share if your revenues and sales are down? Buy back shares in your corporation, even if buying the shares comes at a premium, meaning that you are paying a high price for them. We can see that a number of companies such as IBM exceed the analyst expectations even though sales had decline precipitously, net income had declined accordingly, but earnings per share had risen because IBM issues bonds to collect the capital, or money, to buy their shares openly on the market. Who benefits, the shareholders? Not on you life. It’s the executives who benefit through higher compensation and stock options. Thus the debt rises because the easy credit was given for such stupidity. On the other hand we see the federal deficit as only 16 trillion in current liabilities. That is like saying that your current liabilities are the year’s mortgage payment, the year’s auto payment, and all the year’s credit card payments. It ignores future and immediate liabilities of that debt you contracted. You have twentuy years left on your mortgage, that is twenty years worth of liabilities that you owe. The same is true for the federal government. All future Social Security payments are liabilities, that is, unless Congress passes legislation that ends such liabilities, that money is due in the future and must come from some source. You see, the problem with liabilities is that one needs income sufficient to cover them. There was the old accounting rule that when one acquired a mortgage one put aside money in what was known as a sinking fund. One paid the interest payments but one also paid into the sinking fund an amount each month or year to retire or pay off the loan or mortgage. It is a very sound policy and one that hasn’t been used for at least thirty years or more. Modern finance says it is too old fashion, one needs to borrow other people’s money to be successful. When all things are equal, one can carry thirty percent debt, no problem. But all things never stay equal, that is the false assumption. All things never stay equal, never.
Our own federal government debt is well over 100 trillion dollars. Add in consumer debt, state and local debt and that figure rises greatly. China has a 28 trillion current debt problem. Now that does not include future liabilities, of which there are many. You can get the figures from McKinsey, but the figures are on the web, just search and find. As far as financials go, China had a greatly increasing non performing debt on its hands. There will be quite a few bankruptcies of state owned enterprises unless the central government intervenes and secures the debt. But can it do so in the future? All around the world we find similar problems. Greece is another problem. The so called aide that was given in 2009, 2010, 2011, and so forth was to rescue the bond holders, mostly the foreign banks in the EU, as well as the ECB. The loans were negotiated to favor the ECB and all the non Greek creditors. Not one euro went to the people of Greece. Now the EU is pushing Greece to make good at the cost of its people, the bonds that it was forced, under a previous administration, to assume. The so called Greek crisis is really a crisis of over issuance of credit. Germany has gamed the system by keeping union wages lower that its neighbor states and exporting far more that it imports. It has suched the economic blood out of Greece, Spain, Italy, even France. The current war on Greece is the attempt to make them slaves to the EU bankers. Yet if one looks at the EU banks in general, they are all over leveraged, They have all fallen prey to the greed of issuing too much credit for the promise of too much riches in return.
China invest in Africa not to help those countries to develop but to rob them blind. It has been documented that they establish state corporations that use Chinese management and Chinese technicians to extract the wealth of an African country at the expense of its citizens. China has committed the ultimate colonial extraction of native wealth for China’s good. That means that the national government is bought and paid for by China. Unfortunately, all colonial operations usually end badly. It affects the economic of the home economy the most. It creates an inflation that is insidious, not easily detected. Follow British economic history from 1800 to modern times and see what I mean. Of course we have the ultimate irony in this financial world. That is the engineered financial product, the derivative. Credit default swaps, Interest rate swaps, currency swaps, all manner of of financial “insurance” and not a penny to back any of it. We would not permit an insurance to issue fire insurance against buildings unless they had some pool of capital ready to pay claims. That capital we call reserves against claims. Self insurance decrees that one establish a pool of money sufficient to replace any vehicle, machine, building, or life insurance claim. Usually such pools of money are invested in safe low to medium risk assets that can be rapidly converted to cash. These things call ed derivatives constitute an “insurance policy” of some 700 trillion dollars. And there is no capital reserves against those claims. Worse still, one may take out an “insurance policy against a government defaulting on its bonds and never own a bond. Wait a minute, isn’t that a naked bet? Yep, and perfectly legal. Sort of like taking a life insurance policy on someone whom you don’t know, isn’t family, and have nor connection with. Insurance companies don’t allow such policies. Such a policy would allow you to game the system.
So what happens when the Greeks finally default on their obligations? Ah, the dreaded credit event may be declared. Except last time the governing body for derivatives declared no such event. Not a good sign. But understand that the one percent’s wealth is tied up in these things. None of them have bags of gold sitting in vaults. It’s all paper. They own stocks in companies that may fail due to the stupidity of management buying back shares at high prices. They may lose due to the exceptional debt loads associated with stock buybacks or other activities such as dumb acquisitions that would never have made any money. These people own bonds of corporations that may default. They may own municipal bonds of cities like Chicago that will eventually default. The fact is, so many of the one percent, including Warren Buffer and Charlie Munger may find themselves merely multimillionaires instead of billionaires. Big deal, the price of steak won’t be any higher for them. People, it starts out as a small trickle and ends as a roaring torrent. We see the train wreck as a slow motion event until they are almost head on and then the speed increased to a blur. We are picking up speed as I write. It starts with a small number of defaults and because most of the events have little reserves, it starts to cascade faster and faster. Then comes the blur of events. What is left is a broken dam and an empty lake. What you have left is an ugly memory. All that will be left is to take the pieces to the wrecking yard where they will wait their turn to be reused.