No
Bang for the Keynesian Buck by Gary
North - April 2, 2010
You
may not have watched my video seminar, "Retirement Armageddon."
It's here.
Let me explain why you should.
In fiscal 2010, the Federal debt will increase by an estimated
$1.5 trillion, give or take $100 billion.
Have you estimated your share yet? Probably not.
Divide $1.5 trillion by 300 million Americans. The figure
is $5,000.
Every American resident, from oldsters to infants, just got
hit with an extra $5,000 tab. This is on top of what he already
owes. What does he already owe? Something in the range of
$300,000: a $90 trillion total debt divided by 300 million.
It will happen again next year. And the next. We are told
that the deficit over the next decade will be in the range
of $900 billion a year. That is $3,000 per person. This is
a low-ball estimate.
We are talking about the on-budget debt, which is in the
range of $12.7 trillion this week. What about the off-budget
debt of the two trust funds: Social Security and Medicare?
The estimated unfunded liability is about $75 trillion this
year. Some say it is more. I will be conservative.
This will not be funded. Congress will kick the can, as always.
In a mortgage in which the debtor pays nothing – interest
or principal – each missed payment is added to the principal
owed. This is sometimes called a backward-walking mortgage.
Option ARM mortgages are backward-walking. The trust funds
are comparable to mortgages. They are therefore backward walking.
If we assume that the interest rate on these obligations
is in the range of 5% over 75 years, and principal repayment
is 1.33% (100% divided by 75), then the amortization rate
is about 6.3%. Let's be conservative. Call it 6%. If you multiply
$75 trillion by .06, you get $4.5 trillion. This is the unfunded
liability for fiscal 2010. It is tacked onto the existing
$75 trillion.
So, the increased debt per person of the two forms of Federal
debt totals $6 trillion ($4.5t + $1.5t). Divided by 300 million
Americans, that is $20,000. In one year. This will continue
until the debt is paid off.
It will happen again in fiscal 2011. But in fiscal 2011,
the "mortgage" will be $79.5 trillion, not this
year's $75 trillion.
How many Americans understand this? The infants do not understand.
The oldsters don't care. Neither do the people in the middle.
As we all know, most Americans pay relatively few taxes.
The tax burden is borne by others. So, your share is way above
$20,000 this year. It will be way above $20,000 next year.
Will these debts ever be paid off? No. Will there be a default?
Of course. Do the politicians factor this into their plans?
Of course not. Do the economists sound a warning? Only Austrian
School economists.
Do you believe this scenario? I mean, really, truly believe
it? Sit down with a copy of Quicken or your financial software.
How much money did you invest last year in assets that will
not be wiped out in the inevitable default? That exercise
will tell you how much you believe it.
THE GDP/DEBT RATIO
We are now facing a monumental debt crisis. We were warned.
From the recession of 2001 until his death in August 2007,
Dr. Kurt Richebächer warned in his monthly newsletter about
an ominous development in the U.S. economy. The level of increased
debt necessary to produce one additional dollar in GDP was
rising. He said repeatedly that this would eventually produce
a major financial crisis. The increased debt would require
increased production to finance it, quarter by quarter, let
alone repay it. If economic output per dollar of increased
debt is declining, there will come a day when an increased
dollar of debt will lead to negative returns.
We are there. We reached that point in 2008. It continued
through 2009. GDP fell, yet total debt increased. Here is
a chart that describes this falling ratio, GDP to debt, 1965–2000.
The problem is debt financing. If creditors see that their
loans will not be able to be funded by the borrowers, quarter
by quarter, they will cease lending money at low interest
rates. They will demand a higher return in order to compensate
them for the increased risk of default. Borrowers will have
to pay rising interest rates in order to persuade lenders
to continue lending. The cost of capital will rise. The return
on investment will fall.
At that point, rolling over the existing debt will become
a matter of institutional survival for borrowers. Corporate
borrowers use banks as a way to keep the doors open. Governments
rely on non-bank lenders, such as insurance companies and
retirement funds. But all of them are in the same ship of
debt. They cannot afford to have the flow of funds cut off.
If this were to happen, they would have to shut their doors
and declare bankruptcy.
Small businesses are already facing a crisis. Commercial
banks have ceased lending. Banks are actually contracting
their loan portfolios.
Borrowers are still able to get lenders to lend at low rates.
This is because of the state of the economy. It is no longer
suffering from the threat of immediate price inflation. Interest
rates have fallen. Lenders have decided that T-bills are safe.
They are letting the Treasury borrow at rates well under two-tenths
of a percent. This has affected other rates. They are lower.
Lenders are not yet ready to consider the long-run implications
of the incredibly low return on investment in terms of economic
output – negative in 2008 and 2009. The rate of return may
have been slightly positive since mid-2009. We will find out
next quarter, when the report is published.
THE KEYNESIAN BUCK
The phrase, "More bang for the buck," became popular
in Washington during the Vietnam War. It referred to Defense
Secretary McNamara's attempt to increase the efficiency of
the military forces in Vietnam. He wanted larger kill/budget
ratios. He demanded that all assessments be accompanied with
objective data. He used this phrase to filter all assessments
not based on objective data: "I'm not interested in your
poetry." The commanders got the message. They supplied
him with impressive information on kill ratios. The dead were
always military forces, never civilians, by definition. Then
the North Vietnamese won the war. The kill ratio kept rising,
but the war was lost. The North Vietnamese turned out to be
exceptionally good poets. They won the war in the American
media and in undermining the will to resist in South Vietnam's
troops.
Keynesians are equally committed to data. They believe that
an economic downturn can be reversed by increased debt, especially
government debt. They argue that the recession is the result
of insufficient aggregate demand. The Federal government must
step in and supply this demand. How? By borrowing money. But
won't this borrowing reduce the supply of capital to the private
sectors? No, say Keynesians. Then where does the money come
from? From people who would have converted their money to
currency and hidden it under the mattress.
Keynesian theory is based on 1936 models of how people behave.
People withdrew currency from banks, 1931–34, before the FDIC.
Therefore, they will do it again if the Federal government
does not increase spending by increasing its debt. Forget
about the FDIC. Forget about the fact that money saved is
invested.
You may think I am exaggerating for effect. I wish I were.
I have discussed this Keynesian outlook elsewhere.
Keynesians view increased government spending/debt as a way
to increase aggregate demand, despite the fact that the money
lent to the government comes from private savers, with this
exception: when it comes from central banks. These days, about
half of the Treasury's debt is bought by foreign central banks,
which create domestic fiat money, buy U.S. dollars, and purchase
U.S. Treasury debt.
To the extent that foreign central banks do this, and would
not otherwise buy the U.S. dollar, the Keynesians have a legitimate
point. There is an increase in demand. But this increase keeps
prices higher in the U.S. than they would have been. Without
this increased demand for Treasury debt, the Federal government
could not have spent the borrowed money. Then Americans would
have purchased either consumer goods or production goods.
When they put money in a bank, the bank lends it. Historically,
this has meant lending the deposits to borrowers.
This time, however, there has been a change. Commercial banks
have deposited over $1 trillion in their excess reserve accounts
at the Federal Reserve. This sterilizes the money. It does
not get spent. This is the fault of prior Federal Reserve
policies. Commercial bankers are afraid to lend money in this
economy.
This is why prices from January to February this year were
flat. The CPI did not change. Neither did the Median CPI.
In a free market with stable money, prices would generally
decline as output increases. Central banks have not allowed
this in the modern world. But now, because of excess reserves,
it is happening.
INCREASED DEBT INCREASES THE GDP,
SAY KEYNESIANS
The basis of Keynesian fiscal policies in an economic slump
is a theory that increased government debt will increase aggregate
demand, which will in turn lead producers to hire more people
and buy more resources in order to meet future rising demand.
The increased debt gives the economy a much-needed shot in
the arm – or, these days, a shot in the ARMs. The government
stabilizes demand, and this increases the confidence of producers.
The commercial bankers are not yet persuaded. They refuse
to lend. They see big trouble ahead: commercial real estate
loan losses. They want liquid reserves available to keep them
from having to call in commercial loans to cover the expected
losses in their portfolios.
We are told repeatedly that the recovery is weak. Bernanke
keeps telling anyone who will listen that the FED will keep
rates – meaning the federal funds rate – at or below 0.25%.
The market is doing this, not the FED. The FED need only do
nothing to achieve this result. Banks are not lending overnight
to other banks, because they have such high excess reserves
at the FED that they do not need overnight loans to keep from
exceeding their legal reserve requirement.
As the increased output per dollar of increased debt has
gone negative, the Keynesians have called for even more debt.
They have said that the $787 billion stimulus passed in October
2008 was not enough. But the trend of the GDP to debt has
been falling for decades. This was not some overnight problem
in late 2008. The ratio went sharply negative. This was a
surprise to everyone except Austrian School economists. But
this was merely the result of the severity of the recession
in relation to the massive Federal stimulus. The numbers got
much worse very fast. But this was an extension of a long
trend.
The Keynesians have taken credit for the recovery, such as
it is. They have argued that things would have been much worse
if Congress had not ignored the voters and passed the bailout.
But the weakness of the recovery and the size of the Federal
deficit indicate that the Keynesian prescription for prosperity
is about to produce undeniably negative results.
The size of the predicted annual Federal deficits is so large
that the economic recovery must be unprecedented in its rate
of increase and sustained for a decade if the decline in the
GDP to debt ratio is to return to pre-2008 levels. No one
in authority in Washington is predicting either outcome. On
the contrary, they are predicting a weak recovery.
Keynesians are facing a crisis in faith. If the GDP/debt
ratio continues to hover around 0, the Keynesian prescription
will not solve the problem: massive escalating debt without
an even greater percentage increase in output. That will mean
that the U.S. economy cannot grow its way out of the present
crisis. Such a failure will call all school of economic thought
into question. The exception is the Austrian School.
CONCLUSION
We are way beyond the point of return economically. There
is no possibility that the economy will grow its way out of
this level of debt. There is no way that there will not be
a default. The experts keep telling us that the economy can
grow its way out, but they do not say how. They talk as if
growth were automatic, as if capital accumulation were automatic,
as if the Treasury were not absorbing $1.5 trillion in additional
capital this year, as if the numbers really did add up. The
numbers do add up: to default.