I have been reading and posting in economics-related diaries for months now. I also appreciate the instruction I have received from other Kos members and I hope that this diary is useful to someone at least and continues in their tradition.I thought that I would take this diary to explain my view of some things about the current crisis and hopefully put it in context.
Paulson, Bernanke, CNBC, and most of Congress on both sides of the aisle are lying. They are saying that this crisis is about loans, and that the key to starting the economy back up again is to kickstart the 'frozen' credit machine and extend more credit to millions of consumers. Others believe that there is a solution in stopping home values from falling. Others think that the key to avoiding a Depression is bailing out bankrupt financial or other companies. I do not believe that any of these solutions will be very effective and I will attempt to analyze why.
I will try to identify when I am expressing merely my own opinion. In the process, I will slaughter many sacred cows and will say some things that are anathema to progressives and conservatives alike.
Stick with me through the carnage.
I have been reading and posting in economics-related diaries for months now. I also appreciate the instruction I have received from other Kos members and I hope that this diary is useful to someone at least and continues in their tradition. For more info on many topics, I advise people to check out Calculated Risk, The Market Ticker, and Mish's Global Economic Analysis, among others. These guys aren't lefties, but are very knowledgeable, and I thought I'd give them a shout out.
Paulson, Bernanke, CNBC, and most of Congress on both sides of the aisle are lying to you and have been since this crisis began. (Remember when Paulson said that "subprime is contained"? Or all the claims that the economy was A-OK? The highest people in the government have an interest in deluding you about the situation here.) They are telling you that this crisis is about loans, and that the key to starting the economy back up again is to kickstart the 'frozen' credit machine and extend more credit to millions of consumers.
This type of thinking has become mainstream even here on DKos. Many diarists and commenters bemoan recent cutting of credit card limits (how will people buy Christmas presents now?), and advocate different methods of arresting the collapse of home prices or various companies through government incentives, foreclosure forbearance, and various forms of bailouts and other schemes. If we don't stop home values from falling, credit lines from being cut, or companies from going bankrupt, we are going to have a Depression, so the argument goes.
It is a very seductive and persuasive argument to progressives who have been out of power for years. "We're going to show the Republicans how it's done. We are going to show them and the American people how the government can be used for good. We're going to save the economy!" I sympathize in so many ways and consider myself a progressive, too, but I realize that there isn't much that can be done here.
Progressives' hearts are in the right place, but many of them are wrong and most of these schemes will simply make the problem worse, not better. There are appropriate governmental responses to this crisis, but massive trillion-dollar stimulus packages are not going to help and will just make things worse.
This crisis is a debt and solvency problem, not a credit and liquidity problem.
First, lets talk about what the difference between a solvency issue and a liquidity issue.
Wikipedia defines solvency:
Cash flow insolvency: unable to pay debts as they fall due
Balance sheet insolvency: having negative net assets: liabilities exceed assets.
A person with $20,000 in immediate debt on a Sunday to a loan shark (today, buddy, or I breaks yer knees) and $20,000 sitting in a safety deposit box in a bank has a liquidity problem. Let's call him Joe. Joe is cash flow insolvent: he needs $20,000 but doesn't have access to it because it's Sunday! He isn't balance sheet insolvent, though, since the money is physically there.
Alright, lets give our questionable-judgment friend a break. He gets a credit card that lets him borrow the balance from the loan shark to a (much less violent) credit card company. The loan shark goes away, happy, and now Joe owes the credit card company $20,000. He pulls the money from his safety deposit on Monday and pays the company down. Now he has no debt.
But Joe here has gotten a taste for credit cards now. He makes $48,000/year after taxes, he figures, so lets live the good life, you're only young once, right? He buys $12,000 worth of fun stuff interest-free (we'll say), and the credit card requires repayment in a year, so his payment is $1,000 a month. No problem, Joe makes $4,000/mo, right? So he becomes a good consumer and keeps stimulating the economy by buying stuff. Spends another $12,000 on a big Vegas trip. Now his debt is $2,000/mo. No problem!
A curious thing starts to happen now, though. As he approaches $4,000/mo in debt service, the credit card company starts to become skittish. Our friend is already balance sheet insolvent, and as his debt service approaches his income, his cash flow solvency is starting to look dicey as well, because there comes a point when even if the guy has a million dollar credit line, he mathematically cannot service his debt. Any amount of debt over $48,000 cannot be paid down by him by any force on earth. He must either make more money or default some of the debt. THERE IS NO THIRD OPTION!
This is the state that many American citizens find themselves in as of now: they literally cannot service their debt currently, or are perilously close to that point! Attempts to stimulate consumption through cheap loans and the like will not help this situation, they cannot help it, because it would be like trying to entice our friend up there to buy more stuff. He cannot: and if he does, it simply spells doom for his credit card company. Our friend is paying 0% interest on his loans, and he still cannot afford the debt service! "Getting lending started" will not work and can not work because it is simply a recipe for default!
Well why can't the government bail these people out? Won't that kickstart the economy?
The US government can't bail out Joe because the government is Joe, three hundred million of him. We The People have been running a massive government deficit for twenty five years, and using that government deficit to finance our trade deficit. The result has been thousands of ships coming here delivering oil and manufactured goods while our own manufacturing base has withered and the ships return empty. The government debt and all our own private debts have been existing in an odd mutual parasitism while our manufacturing economy (producing things of value) has been hollowed out and replaced with a service economy.
The net result of this is that we require two billion dollars a day in foreign goods and services to be imported to keep our economy running. If this stream is cut off for any reason, our economy will collapse tomorrow! The only way to keep that stream of goods and services coming into the country is by keeping up the idea that in the future, a similar stream of goods and services (not worthless paper money) is going to flow the other way! As soon as other countries get the idea that they will never receive equal value in goods and services back for the goods and services we provided them, it's CHECKMATE and our economy goes up in smoke. All efforts must be made to prevent this from happening!
Already we have thrown trillions of dollars into the maw of deflation and it has shown little effect. The more we spend, the greater our government debt will get and the more likely it will be that our creditors balk because just like Joe, we cannot mathematically service our debt. At that point, there will be a catastrophic bond market dislocation and US government bonds won't sell for a 3-4% yield, it could be 10%! The government will not be able to raise new debt, and that will be a complete catastrophe that will make this crisis look like a walk in the park! If we can't service our debt and look likely to either default or to inflate it away, T-bills aren't going to go for low yields and that stream of stuff coming from lands far away gets cut off quickly.
When you consider a particular stimulus or bailout program, consider: what will it do to convince China and other nations that they will get fair value for the money they have invested in us, that we will be able to turn the ships around and send them useful goods and services? Will bailing out banks do this? Will bailing out automakers do this? Will giving money to underwater homeowners do this? Will a gigantic consumption-stimulus package do it?
The only solution is to create local industries that produce valuable and exportable goods and services, and in the meantime, to start living within our individual and collective means, even if it means living at a lower standard of living. Like Joe, we've already spent the money, it's gone, and we're stuck with a mountain of debt service. This recession is going to be about working off that debt and living within our means, and it's going to happen, no matter what.
There is no magic bullet here, and I encourage people on this site to resist calls from the right and from the left that claim easy solutions to these difficult problems. There are no easy solutions, as there are not for Joe. The money is already spent, and the losses have already occurred. We only have the option of how to deal with the aftermath.
What can we do?
This has been a long diary and already does not include a lot of stuff I wanted to talk about, but perhaps I will leave that to future diaries.
There are things that we can do to help alleviate the crisis, but I'll leave that stuff to Part II.