Saturday, February 07, 2009


With bailouts going further and further into private industry, capitalism as we have known it is dying. The debt fueled consumer fire has ended and now people of this country are looking to the government for the solution. Unfortunately, government does not know how to create productive value. It only knows how to tax, spend, and be bought by lobbies.

So the stimulus that will be passed will raise the national debt by another trillion dollars in a single day, burdening the future citizens of this country with another $30 billion/year or so in interest payments to the coffers of money center banks throughout the country.

The problem that our financial system faces is that the business models that were reliant on debt to maintain decent profit margins do not work any longer. Prices were too high to be sustainable. Wages were too high to make a profit. Input costs crowded out other investment. Debt service became too much to repay. All of this was caused by too much leverage taken on by too many companies and individuals. What needs to happen, is for prices to fall, wages to fall, for bad companies to go bankrupt, to be replaced by less leveraged companies. But humans face the problem of hindsight bias. This bias tells us that we should return to the prices and asset values of the past regardless of what it takes, because the past was normal. Psychologically, it is easier to believe that the past is normal rather than the present is normal, especially if the present is bad like it is now. Unfortunately, prices now are more "normal" than they were in the recent past because we have deleveraged. In fact, I don't see how valuations could return to the past levels without massive printing, which I expect to see.

The stimulus that is being passed is taking a mortgage on our already debt laden future. It is simply pushing the problems we are facing now maybe 5-10 years away. Only next time it will be worse. Our banks will be controlled by government bureaucrats funneling money to big political donors. Goldman has already indicated that it wants to repay its debt to the government to be out of the clutches of political expediency.

We are saving bad business models to avoid the pain of moving back to a saner, less leveraged economy; an economy that is more "natural" and less dependent on a centrally planned economy based on manipulation of interest rates by the central bank. All of this is to save the skin of politically connected bankers and their shareholders. The good thing for us is that every country is making the same stupid mistakes we are in varying degrees. So our dollar will not crash relative to other currencies, but it might crash against gold and other commodities as the economy gets flooded with funny money.

As funny as this may sound, I do not think it is a good idea to pay off debt at this point. Cash is king in this market. Every day I watch people with liquid reserves buy real estate at fire sale prices while other people are struggling to pay off debt. If inflation is the theme for the future, which I believe is true, then we will see asset prices rise. Debt as a percentage of income will tend to fall, relieving the strain of debt service.

The printing presses will be off to the races across the globe over the next few years, fueling an inflationary and illusory economic boom. Banks will be able to hide their true losses for several years due to changes in accounting rules and be able to lend against bad reserves. Government contracts for centrally planned projects will be awarded to the companies with the best lobbyists.

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