Tuesday, January 27, 2015

Debt and the Apocalypse

Click [HERE] to get right to the point...

Money is weird.  I don't fully understand it.  But here is what I understand.

  • Money is a certificate of debt labor.  If you give me 10 dollars, what you are giving me is 10 dollars worth of general debt that somehow relates back to the economy.  I should be able to trade that 10 dollar debt certificate for some kind of "labor" return from the economy.
  • In theory, money should be worth the total "value" of the economy divided by the amount of money in circulation.  This however does not play out in the real world.
  • If I print or e-print more money, since in theory money ties back to the economy, if the economy is a fixed size if I print more money each monetary unit should be worth less, if I take money out of circulation each monetary unit should be worth more.  Note economies are not static though, they grow and shrink so this affects the value of money as well.
  • Money is also a commodity that is traded and it's value is also derived by perceptual value.  Money is open to all the standard manipulations that happen in commodity trading. 

Why is there so much debt?

  • The idea is that if you borrow money to make investments in things that will provide a higher return than the cost of paying back what you borrow, then debt is a good thing.  
  • Banks can roughly loan out 100 dollars for every 10 dollars of "real" deposits they have on hand.  They essentially create money through loans for free that they can earn interest on.
  • Derivatives, which I don't understand at the moment, enable investment brokers to sometimes leverage 100x or more per "real" dollar that they have, which is extremely lucrative, as long as most of those leveraged investments pan out.
  • Politically it is much easier to take loans which do not immediately affect taxpayers but immediately allow governments to spend on things.
  • There is a lot of pressure on governments to both provide a lot of services, both legit services and "pork" projects to special interest groups that got governments elected.
  • Everyone likes to play today and pay tomorrow, and because debt is so lucrative for banks they are willing to loan out money through credit cards and other vehicles even if they know there is a decent chance that those loans will not be paid back.  These are "sub prime" loans.
  • With a few lobbying dollars, banks can have politicians pass laws guaranteeing that future tax earnings will cover bonds, bad loans, derivatives, etc... that financial institutions make if those investments turn belly up.  This provides even more of an incentive for banks to make high risk investments and generate a lot of debt that the taxpayers are on the hook for.
  • The USA after WWII was the de facto guardian of the West.  It helped rebuild war torn Europe, it's military provided security against the East, and it crafted global financial institutions so that they operated in global finance in United States dollars.  

Now the weird part...

  • So if you look at the US debt...trade debt per year, government overall debt, municipality and state debt, there should be huge pressure for the US dollar to become of less and less value as there is so much e-printing going and creation of debt going.
  • The US Dollar's value relative to other currencies, though declining for many years, has recently gone way up in value...which unless we account for the perceptual value of money, makes zero sense.
  • Many people who look at money without taking into account all the perceptual variables with the value of money so they predict an impending financial apocalypse that never comes (yet).

So why no financial apocalypse (yet)?

  • The USA is in a unique position where since it's dollar has been a defacto global currency, it can get away with more printing and e-printing than other nations because in some sense the dollar represents more than the USA's economy, but in some ways the global economy.
  • People want a value store that is "liquid", i.e. easily transferable from various value types.  That is money.  People do not want to see their relative value of the money they hold go down in value so they resist it, being willing to value money of a higher value than it "should be" if you relate money back to slices of the economy only.
  • The rest of the world holds trillions in US dollars in reserves.  If they all started to "dump" their dollars all at once out of frustration with US monetary "over printing" the rest of the world would risk their holdings becoming of significantly less value before they could get rid of them all.  Thus we are seeing some moves by countries to move away from the dollar as a reserve currency, but they are doing this carefully, and the downward pressure on the dollar value by doing this is mitigated by other factors.
  • The rest of the world's monetary policies are almost worst than America's.  America's debt is high, but there are in theory many ways America's financial system is more stable than the Euro or other competing currencies.  Safety and stability of your investments is desirable, and although many countries are angry at the USA for it's monetary policies, the USA is still has the strongest financial system around (which should frighten everyone).  
  • The USA's military is declining bother relatively and absolutely compared to many rising foreign powers, but it is still the top dog.  The USA still fills in the roll of global police...at least for the moment.  I can't explain it that well but having a strong military and a relatively strong financial (comparatively) system makes the USA a good investment, so the dollar is perceived to still be of a high value even though maybe it shouldn't be.
  • The USA is trying to have the dollar lose value, as if the dollar loses value relative to the economy but the economy stays the same or grows, it is easier for governments to pay off loans especially fixed interest ones.  However, because there is a global recession / depression right now, there are huge pressure for money to increase in value because many have less of it, and governments around the world, especially America's, are taking advantage of these pressures to e-print like crazy so the effects of e-printing are mitigated somewhat.  The problem here becomes that economies generally are cyclic, and even if bad decisions cause economic down turns, eventually those down turns will reverse.  When the do, the effects of past and current e-printing will force inflation/loss of value for the dollar, but so far there has been enough depressionary pressure for states to e-print without causing huge amounts of inflation.

So what are the consequences of debt?

  • There is some downward pressure on the US Dollar's value.  Last year the dollar rose in value, and I expect it will continue compared to other currencies as many of America's competitors face huge financial policy problems.  Yet the anger towards American e-printing, which in some ways is exporting inflation and sometimes deflation to other countries which can throw their economies a negative curve ball, continues.  Efforts to replace the dollar as the reserve currency of the world will continue and as they are successful, some of the perceptual things that are propping up the dollar's value will be undermined as time goes on.
  • Debt acts as an "oscillating restrainer" to economic growth when it is used poorly.  I would argue that most of the United States government debt has been used poorly and the return on investment, although not always quantifiable (like spending billions on the military actually helping prop up the dollars value, which is not obvious to most economist).  The more debt you have to pay back represents less resources to spend on new things.  This gives governments five options.  

So what options do societies have in dealing with debt?

  • Fiscal responsibility...making hard choices, which is neither popular with special interest or the voters who rely on services funded by debt.  I don't see this happening much.  
  • Printing or e-printing more money to pay the debts with, or what I like to call kicking the can down the road.  This is a good option for politicians as they most likely will be long gone by the time the consequences of their actions come home to roost, plus they keep their constituents happy. 
  • Loot private savings.  This can include banks looting depositor accounts which has already begun to happen in several places in the world.  The government seizing 401K accounts (remember Obama's my40K plan?)  Instead of you getting anywhere from 8-20% on your 401K's the government will now manage them, guaranteeing a small return (but at least it is guaranteed right? Expect this pitch during a big stock market crash).  The the government will have a massive pile of cash to write IOU's against kind of like the social security retirement fund.  Your savings will essentially just be another tax being sold with the benefit of giving you an additional social security payment based on how much you put into the 401K, and that might be tweaked to make things more "equitable" down the road. 
  • Default or a "rebalancing" this will happen when everyone finally has to acknowledge that their is no way debts are going to be repaid.  This is already the mathematically truth but no one wants to admit it yet, so the play a make believe game to keep that perceptual value of the dollar high, and it seems to be working, for now.  
  • Lastly, governments can pursue policies that deliberately cause inflation (the forcing of your currency to lose value).  The idea is that you owe money to a lot of people, it is easier to pay them back if you deliberate make the debts that they hold worth less.  Remember when people floated the idea of printing a trillion dollar coin and handing them out to people who the government owes the most too?  It is the same idea just done on a much slower scale.  

What debt does to certain groups of people?

  • Debt causes both overt and hidden inflation.  Those who pay the price are generally the poorest members of society.  Their savings are generally in the least returning / most vulnerable financial assets that when inflation hits their real returns drop.  Also pay raises and wages tend to lag behind inflation, so in real terms many lower and middle class Americans are losing economic ground as their real buying power is not keeping up with inflation.
  • Those who benefit from the debt spending obviously win.  Right now the federal reserve is offering certain types of financial brokers and the federal government access to newly created e-money as zero interest rate loans (perhaps it should always be this way...why are we paying interest to a private institution...the "Federal" reserve for our own money...but I digress).  Most of the rest of society does not have access to this "cheap" money.  And in order to "stimulate" the economy, the federal reserve and many governments are giving away a lot of this e-money.  Those who receive it can trade this money in at its current value for other goods and commodities (farm land, gold, companies, industry) that will retain most of their value even if the dollar's value dramatically loses a lot of it's value.  Remember that this e-money in the form of government debt and banker high risk loans are backed by the American taxpayer.  So essentially elites are using your future earnings as a bank to buy assets that will retain value when their actions cause the dollar to lose value.  Essentially all this debt even if it isn't causing the inflation that many seem to think it should is still causing wealth transfer from the bottom rungs of society to the top.  Think of it.  A middle class person say saves in a 401K 3000 dollars a year (most are saving nothing right now and actually withdrawing from their 401K).  Let's say you make 8% on that, with a real inflation rate being 5%.  So you clear 3% on your savings.  Now let's take the elite who have access to zero interest government money.  They can take that money to "stimulate" the economy and buy up the most productive assets that generate huge returns.  So say they take out a 200 million loan and make 20% on that for five years before repaying the loan back (if they do at all, they might lobby Congress and spend some of that 200 million on bribes...excuse me, "lobbying" and get the government to absorb that 200 million as a loss because the institution that borrowed that money threatens to fold if they don't get that debt relief and that institution is deemed "too big to fail".  Essentially they blackmail / bluff their way into a free 200 million dollar gift.  I lay out these scenarios so so you can see the disparity between the middle class (making if lucky 3% on their meager investment, with no safety net if those investments go belly up) to those with access to government debt money.  Even worse are the majority of Americans who are not saving at all and whose wages are stagnating.  The big boys are running away with the show, and if they mess up the average American pays for it by being the the hook for further debt.

So when is the apocalypse and what happens in the mean time?

  • The short answer.  I don't know when it is coming, but I think it is farther out than people think.  I know I'm being coy but I can't see the future, only the trends.  The negative trends will continue until they can't anymore, and that might be farther out than people think.  I do have my own reasons for fearing an event this year around the October/September time frame (another post), I don't think this will be "the big one."  I'm tempted to say things can remain out into the late 2020's and even 2030's, but I am not an economist nor prophet.  However prepping for a finance upheaval now or soon is probably not a bad idea (if you are rich enough to do so, many of us poor slobs can't). Because the world needs a reserve currency, and because the world hold's so many US Dollars that they fear will become worthless, there is a lot of perceptual pressure to hold the value of the dollar higher than maybe it should be.  That being said, the world will continue efforts to unwind from the dollar, and eventually those efforts will cause pressure on the dollar to lose value.  But not as quickly as people think.
  • The government will (and already has) change the way it calculates both GDP growth (to mask the impediment of debt repayment on the economy) and how it calculates inflation (so inflation pressures that are coming through can be hidden).  Real inflation will increase, so if you can even though everyone advises not to, get into the types of areas where cheap e-money flows (like the stock market).  One day it probably will crash, and have a few mini crashes before then, but all the easy money is flowing into commodities and stocks, you want to if you can be in on that, so you can come close to getting the same returns as the big boys do that is well over the real inflation rate.
  • The gap between the poor and middle class and those with access to cheap e-money will continue to grow dramatically.  
  • The government will continue to stock up on debt as this is the least painful choice for society, to ignore it's problems and keep running up debt till it can't anymore.  Where economist that say one day the bill for all this will come due screw up is that we are dealing with a Super Power that controls the monetary system of the world (for now). America can get away with e-printing for a lot longer that people think, so I don't expect any immediate financial apocalypse like people have been predicting for a long time (Remember the book Bankruptcy 1995? I do). 
  • More taxes (tax by the mile anyone?), and more efforts to "manage" private savings accounts by the government.
  • Lastly, when do I think the big hit will come?  It will come when private banks loot their depositors...something along the lines of "to keep the banking system stable anyone who has an account over x dollars is going to lose x percent of that to stabilize the bank."  I think this will be tried in the future, I think it being done in other smaller countries is actually a dry run for this to be done in the West.  They are trying to gauge if they can get away with this or not.  Americans are already pretty down on financial institutions.  I think once this is tried, it will be the straw that breaks the camels back, and confidence in the banking system will die, and as it dies so confidence in the dollar will with it.  
What comes next...is a different post.  A teaser though...martial law, limits on ATM spending, lot's of civil unrest as many safety nets go belly up, a lot of pain for a brief period followed by the introduction of a global currency scheme, which in turn will be short lived.  After that it gets interesting.

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