oftwominds-Charles Hugh Smith

This Week's Theme: The 3P Economy (Propaganda, Pandering, Posturing)

America's Financial Joyride

We all know what a joyride is--some irresponsible teenagers pile into a car and drive it with carefree zest until the gas runs out--then they abandon it on the roadside. The U.S. economy's joyride is ending.

Who piled into the debt-fueled car for the wild spin? Let's see:
The President
the Federal Reserve
the regulatory agencies (FDIC et al.)
Congress
Treasury
our foreign central banker pals
banks, mortgage lenders, brokers, appraisers, realtors
the great army of American real estate speculators and consumers

Did anyone checks the brakes on the debt-mobile? Nope.
Did anyone ask how much gas was in the tank, or where it came from? Nope.
Did anyone ask how the next tank of debt-fuel would be paid? Nope.

So what exactly is the difference between a bunch of irresponsible adolescents and those in charge of the world's largest economy? Nothing, except the "leaders" have done trillions of dollars worth of damage during their joyride.

Now that the ride is over and the U.S. economy is laying upside down in a ditch, then guess who gets the call to "rescue" the dumb, foolish adolescents, oops I mean "leaders" and banks? The U.S. taxpayer, presuming a few are still making enough money to pay taxes.

And if we can't nail taxpayers, hey, we'll just borrow another couple trillion from our foreign "friends." They never seem to run out money or the willingness to loan trillions more to us for pathetic returns and a high risk of default.

Is this what is called "financial rationalism"? That if someone is dumb enough to loan you unimaginably large sums, no questions asked, for absurdly low rates of return, then why not just take the money and run?

That's what any adolescent would do, of course. But once you enter adulthood, then you're supposed to develop maturity and judgment. Too bad the U.S. is a nation of adolescents. Don't make me exercise, I hate it, Just pay for my new hips, knees, heart valves, etc. Don't tell me junk food is bad for me, I can do what I want. Don't tell me I have to save up to buy a house, I want it right now and I hate saving. Don't tell me my house isn't my retirement, I want it to be my retirement so I don't have to put off buying everything I want, right now! (Cue teenage tantrum.)

Lest you think I exaggerate: consider Exhibit One:
Please go to www.oftwominds.com/blog.html to view the horrifying charts.

Exhibit Two:

Exhibit Three:

Think "the worst is over? Ha. Check Exhibit Four:

Astute reader I.M. recently posed the critical question thusly:

Since you're on the subject of national fiscal psychology this week, do you have thoughts about why it is that we as a nation can convince ourselves that our situation is not as dire as it really is? The official debt is more than $50K per worker. The unofficial debt including future social welfare outlays is much higher, perhaps closing in on half a million per worker. How can we as a society continue to think that our current situation is sustainable?

I ask as a concerned citizen who wrote my first letter about social security sustainability as a 17-year-old in 1986. I thought then that social spending was unsustainable and that we were facing a near-term financial crisis, but here we are 23 years later and no such crisis has occurred (though our situation has vastly deteriorated since then). How much longer can we continue to fool ourselves?

I certainly don't want a national financial crisis, but I just can't understand why it hasn't happened here yet. Why do we as a nation continue to believe that our situation is fixable without drastic changes? And perhaps even more importantly, why do our creditors seem to think that we will continue to be credit worthy? Maybe our debts have finally reached the critical mass of instability/insolvency.

Knowledgeable correspondent C.V. sent in this article which describes how the illiquidity and losses in "agency paper" i.e. Fannie Mae and Freddie Mac, are infecting foreign bankers' ability to raise dollars to "adjust" their own currencies:

South Korea heads for black September with won problems American investments threaten currency

The deepening woes at Fannie Mae and Freddie Mac, badly stretched central bank reserves and a losing battle to support the won are pushing South Korea towards a full-blown currency crisis this month, analysts have said.

Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem - perhaps $50 billion (£27.4 billion) - in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea - increasingly desperate-looking verbal and financial measures to fight the market trend - cost about $20 billion in July alone.

Attempts to prop up the won come as South Korea’s household and corporate sectors are wincing from the pain of high energy prices and inflation. A summer of strikes by lorry drivers and mass street demonstrations calling for President Lee to resign reflect rising public concern that the economy is in trouble.

C.V. added this comment, which has mind-boggling potential repercussions:

Maybe we're seeing a 'flight' to the US$ right now. The fannies and freddies will gain value when converted back to the host currencies, or even sell them back to the US Treasury at fire sale prices in a bailout. The Fed will buy any and all Treasuries if necessary which is commonly referred to as "monetizing the debt" which is what foreign CBs (central banks) have done by issuing their own currencies (inflationary) by buying Treasuries in the first place. In essence (as I understand it), as foreign central banks try to sell non-Treasury securities to raise dollars, then they will be forced to sell Fannie Mae and other agency paper back to the U.S. Treasury at whatever rate the Treasury deems "fair."

If central banks start dumping their vast hordes of U.S. Treasuries, then the Treasury will buy all of that, too. But where will the Treasury get all the money to buy all this debt? What effect will that have the dollar's value?

I don't have an answer, but I do know the charts posted above have already sealed the fate of the U.S. economy. Plummeting housing values means the money spigot of borrowed money based on real estate assets is closed for good. And with that spigot closed, and with consumer and government debt already at unprededented levels, consumer spending--69% of the economy-- is shriveling, and will continue to shrivel in a self-reinforcing feedback loop of lower asset values, less borrowing, less spending, less profits and fewer jobs--which all lead to lower spending.

The joyride's over, folks; unfortunately, the car is a total loss. Maybe "the kids" learned something. Too bad it will take a generation to repair the damage done by the 1996-2006 joyride.

Thank you, C.N.F., for suggesting the excellent analogy of a joyride.

Readers' comments:
Chuck D.

Just a comment on part of your entry for today. You wrote:
If every mortgage statement came with 4-inch high bold letters stating how much was paid for financing and how little was paid on principle, it would certainly modify our belief in the "affordability" of 30-year mortgages.

To a considerable extent we already have that. It seems to have made no difference.
(A) If you finance a house purchase with a bank mortgage, the bank has to give you a disclosure required by the Truth-In-Lending Act. It states how much is being financed (principal of the loan) as well as the total cost of the loan over the term of the mortgage. The numbers are side by side across the top of the sheet for you to compare.

(B) You as the borrower will receive every year from the bank a 1099-INT form that shows how much you have paid that year in interest so you can deduct it off your income tax return. All you need to do is divide that amount by 12 and you have a monthly approximation. It's not completely accurate -- it gives you a monthly figure as a straight line amount, whereas it's actually a descending parabolic curve, but it's close enough.

(C) I am acquainted with a lady who for years before it became fashionable used her house as an ATM. She ended upside-down in a predatory loan at 13% interest. Then her health failed when she was fairly young. She is in a care facility. The house is going into foreclosure. Every month she received a statement from the lender listing her monthly payment and how much went to principal and interest. Her monthly payment was $2100.00. Of that, $15.00 was going to pay down principal. I know this because I saw the statements.

I think there are two reasons for this indifference to reality.

(A) Everyone has been relentlessly sold the efficacies of home ownership. It is an "investment". It is patriotic. It is nirvana. It is the social norm that everyone expects and is expected to conform to. The buyer is so focused on achieving this goal that he or she has been taught is "desirable", that if these costs are considered at all, they are simply accepted as the cost of achieving that desirable goal. This is the con you are talking about.

(B) Buying a house is like marriage. It is far easier to get into it than out of it. The consequences of doing so are unpleasant. In this case it is foreclosure, bankruptcy, loss of built up equity, and moving (which I have come to believe is God's True Punishment for the Fall of Man). Given these unpleasantries, it is simply easier to deny them in favor of focusing on the "positives" listed in (A). The first reaction of a "mark" is often to deny the fact that they just got conned.

Michael S.
"As I see it, the benefit that we get by operating in a fiat money world (where central banks and fractional reserve banking allows financiers to create money out of thin air) is that we get a rapidly expanding economy, so that in the span of a human lifetime, we see 'progress.'"

The big benefit seems to be that the government can redistribute wealth using inflation; conversely, with gold, the government would have to seize it first.

Mark P.
To add to your example of real time monitoring of the cost of driving, how about taxes? If people had to write a check four (or more) times a year rather than having taxes deducted automatically, I expect we all, regardless of political beliefs, would be clamoring for greater spending control and efficiency.

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An excerpt from For My Daughter (novel)

I believe she stayed with me out of kindness, and my admiration for her grew. For kindness is everything piety is not; where piety is all appearance, a brittle play-acting well-loved by treachery, kindness is spontaneous and true. Piety is easily falsified, so evil never tires of exalting it, while kindness cannot be feigned, and so evil rejects it. Piety serves self-pride, while kindness serves another.

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