Thursday, August 12, 2010


Barack Obama and Congress simply do not get it. They think they, along with The Fed, can "prime the pump" with "stimulus", just as the meth-head thinks he can "stimulate" recovery with "just one more hit."

He's wrong, as is Congress, Barack and The Fed.

The excess capacity in the economy cannot be sustained. It simply doesn't matter whether policymakers like this or not. An economy that can only run at its former rate when mainlining speedballs cannot continue to operate in this fashion without killing the host. Detoxification and a slowing of the economic metabolism to sustainable levels is the only way you survive.

Along the path to perdition we allowed a tapeworm to take up residence in the bowels of our economy: "financial innovation". It was not that long ago - indeed, within my lifetime and experience - during which bankers earned $50,000 a year and bank stocks returned 7% dividends - and no capital appreciation at all. Banks made loans and held them to maturity, consuming the ~2% spread they needed to survive and paying out the entirety of the rest of it to shareholders in the form of dividends. They were stodgy, old-school businesses that performed a vital intermediation function - and consumed ~5% of the economy in doing so.

Now financial innovation has gone from 5% of the economy to 20%. But as the tapeworm grows larger, it consumes more and more of the fuel that the body takes in. Soon the tapeworm not only consumes enough of the fuel to cause you to starve even though you're eating like a horse, it in addition gets so large that it blocks the intestines - and can produce life-threatening stoppages and infections.

There is no way to reason with such a tapeworm. It, like all organisms, will seek to survive, grow and reproduce - and it doesn't care if you like it or not. Your only choices are to kill it - or, if you don't - die.

We as a nation must eradicate the tapeworm. We must relegate the financial system to its former status as an intermediator - the old stodgy bank - and dismantle the complex and intertwined institutions that are sucking the economy dry. We have refused for two decades to do this, believing in the Alan Greedscam and Turbo Tax Timmy mantra that a strong and diverse financial system is inherently necessary to a strong economy.

These statements are lies. That they're lies is trivially proved: financial innovation in all of its forms is inherently parasitic - that is, it produces nothing in the economy. In it's role of distributing risk it inherently must siphon off some portion of actual production to itself.

That means that the productive portions of the economy must produce more to feed the beast within. But the beast inexorably grows - it reached 25% of the "earnings" in the S&P during the bubble years.

But that 25% wasn't the bank's earning power - it belonged to other actors in the economy and was stolen from them as a form of "tax", just as the tapeworm steals your nutrition.

This in turn goaded CEOs to take on more and more leverage so they could "make their numbers" with that inherent 25% siphoned off. And that, in turn, resulted in the market and economy as a whole levering to unsustainable levels.

Our error in 2007 and 2008, as I have repeatedly said, is that we refused to force these firms to face the music for their actions. Actions that, in many cases, were outright fraudulent - and where they weren't, they were unsound and unsustainable.

New York City has grown addicted to the tax and business revenue from these firms, but that doesn't mean the rest of the nation can sustain New York City, any more than the rest of the nation can sustain California's insistence on giving sanctuary to the 4% of our population that are illegal immigrants - who give birth to 8% of our babies, and who pay 0% of their hospital bills.

This is the result:


We've blown 14% of GDP in new debt to maintain the tapeworm, attempting to mainline speedballs into the arm of the economy. It's not working. The reason is that the tapeworm is consuming nutrition faster than the economy can take it in, and as a consequence we are now in economic death spiral, exactly as I noted in 2007.

One way or another that parasite will be removed. We either do it ourselves and suffer the pain required to heal or the market will do it for us with horrific and destructive results.

Those are the only two options folks.

The Fed cannot fix this. Nor can Congress so long as the debate is focused on taxes. We are running structural deficits of fourteen percent of GDP - nearly half of the federal budget is being borrowed. This is akin to someone who is bringing home $2,500 a week but spending $3,800 - there is no reasonable way to increase one's earnings by that amount - they must instead stop spending or they will go bankrupt.

I know that the government at all levels has made promises to people. We don't have the money. It doesn't matter if we want to keep the promises or not when we are physically unable to do so, and the tapeworm is continuing to eat more and more of the nutrition that flows past it.


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