About Those "Fundamentals"...

They say that a “gaffe” in politics is when a politician tells the truth. It would be more correct to say that a gaffe is when a politician says what he thinks is the truth. True, this formulation gives politicians more credit for thought than they normally deserve, but I didn't say they were serious thoughts. Nevertheless, Phil Gramm was quite serious when he called the Americans “a nation of whiners.” It is easy to understand why Senator Gramm is sensitive these days. Aside from being the McCain Campaign's vice-chairman, he is also the vice-chairman of the UBS investment bank, one of the major culprits in the current financial crises. You would think that is enough chairs of vice for any man, but there is more. As a senator, he passed the infamous “Enron Exception” while he wife was serving on the board of Enron. He also pushed through a bill deregulating the banking industry in 1999, leading directly to many of the problems we have today. He is also a lobbyist for UBS, working on mortgage matters, among other things. So it is easy to think that the nation “whining”; thinking anything else would mean having to admit to some involvement in the current crises. And whatever politicians think, they never think about their own responsibility. That is simply unthinkable.

But Gramm, and those of like mind(-lessness) like to say that the “fundamentals are sound.” Yet here one wonders what they are thinking about. The dollar is certainly “fundamental,” yet it has lost nearly 50% of its value against the Euro in recent years. Energy is fundamental to any economy, yet it is running at record prices. Manufacturing is fundamental, yet it has shrunk since the free trade dogma has become official policy. Certainly the credit system is fundamental, yet it is in disarray. George Will says that Gramm must be right, because unemployment is only at 5.5% and that's a fundamental. But what Will doesn't say is that the labor force is shrinking; that is, fewer people are looking for jobs, and are thus not counted in the “unemployment” statistics (see Physics Envy and Unemployment by the Numbers to see how this works.) Housing is a disaster, and that is a fundamental part of the economy. Government debt is out of control, as are state budgets, as is household debt. And of course, wages are fundamental, but the median wage has been stagnant for 30 years. The most fundamental thing to any economy are the great cultural institutions, things like the family, education, the churches, but don't even get me started on those subjects. So what are the fundamentals that Phil & Company are sounding? Have I missed any? I don't wish to whine, but it's better than weeping, and I don't hear any sounds but agony coming from the fundamentals.

Of course, not all whining is equal. When Wall Street whines, the White House listens. And Wall Street has been whining for a long time. Each time, the receive the care and concern of the Federal Government, and especially of the Federal Reserve Bank. For some time, that bank has accepted the bank's riskiest loans as collateral for short-term loans. The rates the banks pay for these loans are well below the rate of inflation. This means that this is essentially “free money,” and it would seem that you don't need to be much of a businessman to make money by borrowing at below the rate of inflation and lending above that rate. But no, an irresponsible loan tends to lose money, no matter what the interest rate spread. You would think by this time that the banks had learned their lesson, and would be more responsible about their lending. But I can tell you, as a real estate agent, that the same funky loans that created this problem are still the norm today. In fact, I will close on another one this afternoon and did one yesterday. Why should the banks continue to do this? Because they have an implicit promise from the government that they will be rescued from whatever foolishness they undertake.

When the banks began to have “liquidity problems,” that is, finding money to lend, the government responded by expanding the role of the “GSE's” (Government Sponsored Enterprises) like Fannie Mae and Ginni Mae. The GSEs increased their borrowing from $4.9T in 2001 to $7.5T (and rising) today. The GSEs buy loans from the banks and sell them as securities. The GSEs could raise money by selling bonds because these bonds, coming as they did with an implicit promise from the government to pay them off, were treated by the market as quasi-government bonds, but at a half- to three-quarter-point rate above the treasuries. Further, even when the GSEs sold the loans, they still guaranteed that they would take them back if the loans failed. Question, if you “sell” a loan, and still guarantee it, in what sense have you “sold” it? It still appears on the books as a liability. This is a clear case of privatizing the profits and socializing the losses; the “private” sector takes all of the rewards and none of the risks. The risks are borne by the taxpayer. But there is a limit even to that. Soon, the debts will have to be paid off, debts that cannot be paid off. The only solution is to inflate our way out of the debt, pay it back in dollars worth far less than the ones that were lent.

Is hyper-inflation a possibility? I don't know, but we certainly cannot ignore it. It happened to Germany in the 20's after the banks were privatized and the job of money creation turned over to the private sector. The stamps below (from http://ingrimayne.com/econ/EconomicCatastrophe/HyperInflation.html) tell the whole story.

Mailing a letter went from 5 Marks to $50,000,000,000 Marks. If we did that, we could wipe out the entire national debt (and all other debts) with a few postage stamps. There might, however, be some negative consequences. It might be a bit disconcerting to look at your retirement fund and think, “I could almost mail a postcard with that.” That might even cause some whining.