The United States is in the third and fatal stage of a great country’s life-cycle – the political stage. In this stage, money and power migrate from the financial community to the political community. The politicians get away with taking trillions out of the productive economy and spending them on their pet projects and private corruptions.

“Politics is about what works,” someone once said. Someone said it…someone who is an imbecile. Politics is not about what works, it’s about what you can get away with. And what you can get away with is often exactly what doesn’t work at all.

What the United States is getting away with, from a financial point of view, in addition to counterfeiting, is grand larceny on a Super-Madoff scale. It is borrowing trillions of dollars even though it has no way to honestly pay back the money.

Still, so eager are the lenders to part with their money that the 10-year T-note yields a miserly 3.46%. The more the feds borrow, apparently, the more lenders are willing to lend. But this is a story that will end badly.

Warren Buffett described the America of the bubble years as “Squanderville.” Private citizens were living beyond their means, he pointed out. But he hadn’t seen nothin’. Now, government does the squandering. The politicians are spending trillions they don’t have on projects nobody was willing to pay for even when they had some money in their pockets.

What the government can get away with now – under cover of a financial crisis – is a big grab for money and power. It ‘works’ in the sense the feds are able to get away with it. But it will prove fatal to the dollar…and to the US economy.

The Fed is intervening in markets as no Fed ever has. Its balance sheet – a measure of how much intervention it has done – has shot up in a way that is not only unprecedented, but also almost unbelievable. In an effort to provide liquidity, the Fed has bought up the contents of every neglected refrigerator on Wall Street. This smelly, furry stuff enters the Fed’s books as an asset, along with various not-so-pungent assets like US Treasury bonds. Altogether, the Fed’s balance sheet shows more than $2.7 trillion worth of this unappetizing hodgepodge.

“It’s not sound economics – nor is it ethical – to trash the US dollar and bail out incompetent investors who poured billions into CMBS at the peak of the bubble,” says Strategic Short Report’s Dan Amoss. “There is no longer a ‘systemic risk’ argument for The Fed to be propping up the price of such securities.

What happens next?

We don’t know. But it is far too early to expect the Fed to withdraw its easy-money policy. The Fed will have to stay on this road for much, much longer. Why? Because the “green shoots” are shriveling up. There is no real economic revival. And there can’t be one until the underlying problems are corrected.

One of the big problems is too much capacity. During the Bubble Epoque the squanderers would buy anything. So, you could make an almost unlimited amount of money by providing them with things to buy. This meant building factories…buying trucks…and renting retail space. Now, however, the squanderers have come to their senses…or maybe they’ve just come to the limit of their credit lines. The squanderers now want to save their money. So, no need for so much retail space in the malls, so many trucks on the highways or so much retail space.

There are a number of sit-down restaurant chains that cater to the middle class – Applebee’s…Chili’s…Ruby Tuesday and a few others. They expanded greatly during the ’90s and ’00s in order to meet the desires of the big-spending masses. But now that the masses aren’t so free and easy with their money, the New York Times reports that these chains are in desperate competition for remaining diners. This competition is manifesting itself as price deflation.

Applebee’s offers dinner for two for only $20. Chili’s advertises entrees for just $7. Ruby Tuesday’s is going for a 2-for-1 deal. Buy one meal, get one free. All of them are making heavy use of discount coupons.

Oversupply is producing deflation. Prices are falling as suppliers fight for demand by offering more for less. And over at the Red Roof…the roof has already caved in, as the chain has defaulted on its mortgage debt.

This is what you’d expect at the end of a long period of credit expansion. EZ credit brought forth too much demand and too much supply. Now, the demand is disappearing…and the suppliers struggle to hold on.

Even now, we’re facing an economy in which 70% of our economic output depends on consumer buying. And consumers are in no condition to consume. Ergo, no buyers, no recovery.

Economic contraction is natural, normal and perhaps necessary to a market economy. And the current contraction will take years to sort out. Roofs have to fall in on thousands of enterprises, speculators and households. Then, the rebuilding can begin.

But the Bernanke Fed is not about to let nature take her course. Don’t expect any tightening from the Fed anytime soon, dear reader…it is far too soon for that.

Governments are essentially parasites on productive activity. So the best governments are the smallest – meaning, the least parasitic. As has been said before, “That government is best which governs least.”

But now we are in the third and fatal stage of a great country – the political stage. In this stage, the parasites take over. Government governs a lot. And governing a lot costs a lot of money. In England, the government budget is bumping up against half the total GDP of the nation. In America, health care is still largely a private matter, so the government spends a smaller percentage of GDP…but it is a percentage that is rising quickly.

Where will the money come from? Taxes? Gordon Brown has already put the income tax rate up to 50%. Michael Caine, an English actor who moved from the U.S. to England to escape the high taxes of the ’70s, says he will tolerate 50%…but not a penny more.

“If it goes to 51% I will be back in America,” he says.

Ahem…he might have to try somewhere else. Everybody’s gunning for the rich – in America as well as in England. Obama has pledged to raise taxes on the rich. The states, notably California, are desperate for more revenue too. Add federal, state and local levies…and private health care costs…and you could easily be over the 50% bracket in America too.

The history of European monarchies is largely a history of debt. Kings and queens squeezed what they could out of the turnips. Then they turned to the moneylenders. These lenders had to be careful. They were happy to extend monarchs credit, because in this way they gained a measure of control over them. But there were many dangers. Kings lost their heads…or went broke. Or, often, the monarchs could turn the tables on the moneylenders…and have their heads cut off. Reading the history of the loans to the French crown is eye-opening. It is amazing anyone wanted to lend at all. The risks were great; the rewards were few. Rarely were the loans settled honorably.

Government raises money. Sometimes it repays the loan with revenues from other taxes. Sometimes, it is the lender who pays the tax himself – either because the government defaults…or because inflation reduces the value of his money. What you come to see is that lending to the government – which always has the power to betray the loan and behead the lender – is merely another form of taxation. But the lender can blame no one but himself for his losses. The wounds he suffers are self-inflicted.

This is a story that often ends badly, if not disastrously.

Regards,
Bill Bonner

August 26, 2009

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries.  A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America's most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed and internationally recognized. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance.

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