Monday, May 16, 2011

Our Peculiar State of Suspended Animation

Three long years of extend and pretend have left the nation in a state of suspended animation, frozen in a moment of crisis.

The U.S. is in a peculiar state of suspended animation: nothing is actually moving, we're all frozen in an extended moment of disbelief, denial and crisis, waiting for something to finally break loose.

We know the present isn't sustainable, but we go through the motions of phony "reforms" and "trimming the deficit" as if another 1,000 pages of "reforms" will fix what's broken in the economy or that trimming $50 billion from $1.7 trillion annual deficits will actually matter.

The wheels visibly fell off the bubble-debt-fraud economy four years ago in mid-2007. It's worth recalling that the U.S. won a global war (World War II) in less than four years, yet now we are pleased to borrow and and squander an extra $1 trillion a year just to keep our fragile state of suspended animation from being disrupted by unpleaseant reality.

In a nutshell, here's the reality: the entire "prosperity" of the past decade was a false prosperity, constructed entirely of money borrowed by the private sector based on the rising value of McMansions and strip-malls that made no sense except as speculations based on the Federal Reserve's credit-bubble policies and Wall Street's systemic financialization of that debt based on fraud and misrepresentation of risk.

The private sector borrowed and spent an extra $1 trillion a year in the "boom years" of the bubble decade. This debt-based stimulus vanished with the implosion of Wall Street's fraud machine (CDOs, mortgage-backed securities, etc.) and the collapse of bubble-era housing valuations.

As overleveraged households and businesses found they could no longer borrow $1 trillion extra a year to spend, then the Federal government stepped in and borrowed and spent $1 trillion a year to replace the private borrowing which had dried up.

This $1 trillion is incredibly obvious. Federal spending rose by exactly $1 trillion from 2007 to 2010, while revenues fell by $400 billion:

2007 $2.72 trillion
2010 $3.72 trillion

2007 $2.56 trillion
2010 $2.16 trillion

2007 –$160 billion
2010 –$1.56 trillion

This is how you get an annual structural deficit of $1.5 trillion. This sum will never go down, it will only go up, as the estimated deficits for 2011 and 2012 show:

2011: $1.5 trillion (est.)

2012: $1.6 trillion (est.)

This doesn't even count off-budget borrowing for bailing out our Moral Hazard Twins Fannie Mae and Freddie Mac and for additional war expenses.

Add off-budget borrowing and the structural deficit is 12.5% of GDP. This is only one comparable period of Federal borrowing and deficit spending: World War II, which ended in less than 4 years (December 1941 to August 1945).

Here we are, borrowing 12% of GDP every year for four years, with no end in sight. All we're doing is propping up the Status Quo.

The private economy cannot support an additional $1 trillion in borrowing and spending every year. Housing assets and household earnings continue to decline even as basic household expenses for energy, food education and healthcare continue to rise.

Housing is still overvalued, ( Housing Losses Are a Financial Disaster) a reality that will become abundantly clear once interest rates begin their inevitable rise. Household earnings will continue to stagnate or decline ( Capital Exploits Labor: the U.S.-China Trade and Beyond).

Households cannot borrow an extra $1 trillion a year, and that will not change in the foreseeable future. This is not the warm and fuzzy stagflation of the 1970s, when wages and interest income rose along with prices: in this Fed-engineered stagflation, wages remain flat-to-down and savers earn nothing for their capital, while taxes and costs for essentials steadily rise. The primary asset for 2/3 of the nation's households, housing, continues to fall. The rising stock market increases the wealth of the top 10% of households, but does little to nothing for the bottom 90%.

The Fed's policy of a top-down "wealth effect" is widening an already unprecedented gap between the "haves" and the "have-nots" in the nation. This widening divide is no secret; it is simply another feature of our suspended animation.

Simply put: the present set of policies is a recipe for household and national insolvency.

Readers forum:

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