Tour the Worldwide Economic Crash for 39 Seconds

by Gary North
by Gary North

So, you want to know how bad this crash will get. Fine. Spend 30 seconds to see the magnitude of what it is today. It's going to get much worse.

The Manchester Guardian published 13 photos from around the world that show the extent of the disaster. Spend just 3 seconds per photo. (You won't see these on Tout TV.)

I have never seen anything like these scenes. Yet we are in only the early stage of the crash. The British banking system is close to collapse. There is serious talk at the highest levels of the nationalization of all British banks. The currency markets are acting as though this is likely.

Nouriel Roubini, the man who predicted this recession in 2007 (a little late, but better than most academic economists), recently gave a speech in Dubai. He said that he has estimated U.S. capital losses of $3.6 trillion, half at banks and broker-dealers. The total capitalization of U.S. banks is $1.4 trillion. In short, he said, the American banking system is bordering on insolvency. The story is here.

Think about this. Today, we are facing a situation in which all U.S. banks could go legally bankrupt. In the Great Depression, over 6,000 banks went bankrupt. These were mostly small rural banks and small-town banks. The Federal Reserve System saw to it that no major bank went under.

There are several ways to paper this over. One would be to do more of the same – more purchases by the Federal Reserve of toxic assets held by banks and brokerage firms. Another would be the creation of a government entity that will tap into Federal Reserve fiat money. It could serve as a gigantic holding company for the busted banks' depreciated assets. It is called an "aggregator bank." This would save the banks . . . for a while. The fiat money used to buy the assets would allow the banks to keep their doors open. The public could get access to their deposits. But the reality will be this: a government-run banking system. This approach is on the discussion list proposed by William Geithner, Obama's choice for Secretary of the Treasury.

Only the "oops" of his $34,000 missed tax payments will keep Geithner from being confirmed. Congress does not really care, but constituents may. Probably not. Senate Majority Leader Harry Reid dismissed this as "a few hiccups."

He failed to pay self-employment taxes for money he earned 2001 to 2004 while working for the IMF, according to materials released by the Senate committee. In 2006, the IRS notified him that he owed $14,847 in self-employment taxes and $1,885 in interest from 2003 and 2004, which he paid after an audit. The IRS waived penalties for those tax years.

Transition officials discovered last fall that Geithner also had not paid the taxes in 2001 or 2002. He paid $19,176 in back taxes and $6,794 in interest for 2001 and 2002 several days before Obama announced his choice, the committee documents showed. All told, Geithner had failed to pay $34,023 in self-employment taxes for the years 2001 to 2004.

No penalties, of course. For you or me, penalties. But not for him.

Initially, he told the committee that he had messed up because he used TurboTax. You can view the video of his testimony here. He can do a song and dance while sitting down.

Under questioning, he was unable to show how TurboTax caused this error. This is reminiscent of Hillary Clinton's inability to produce evidence of exactly how she made $100,000 by trading cattle futures. Nobody pressed the issue with her, then or now. The Senate, caught in an embarrassing situation in full public view, has not yet confirmed him. It wants another hearing session.

This is a man who was paid $398,000 a year at the New York Federal Reserve, the man who will officially be in charge of the Internal Revenue Service.

"Nice work if you can get it, and if you get it, tell me how." Of course, I know how. As soon as he was out of grad school, he went to work for Kissinger and Associates.

FRACTIONAL RESERVES

At present, banks hold excess reserves at the Federal Reserve because the FED began paying interest on reserves last fall. But with the federal funds rate now close to zero, banks are moving money back into the loan market. This will jump-start the fractional reserve system's creation of money.

The banking system already has sufficient legal reserves to allow a huge expansion of the money supply. Every time the FED buys an asset and does not offset the purchase by the sale of another asset of equal face value, the legal reserves rise for the nation's banks. The adjusted monetary base has increased from about $850 billion to $1.8 trillion since September of 2008. You can see the chart here.

I provide a link to the latest chart on my site. Monitor this chart: "Adjusted Monetary Base: Short Term."

The monetary base provides the foundation for banks to lend money. They do lend money. All reports on the banks' refusal to lend money fail to mention what should be obvious, namely, that the banks cannot pay interest on deposits if they do not lend the money deposited. This is why they lend every dime.

They have been lending to the FED, which does not re-lend the money. This is why the fractional reserve process has not done its work. This is why the money multiplier has been falling. But now that the FED is no longer paying more than a fraction of a percent interest, banks are moving the excess reserve money into the general economy.

You have been told that borrowers are afraid to borrow, and bankers are afraid to lend. Is this true? Is the United States Treasury Department afraid to borrow? When an outfit runs a $1.2 trillion annual deficit, I guarantee you that it is not afraid to borrow. Are bankers afraid to lend to the Treasury? No.

People ask: "If banks are afraid, to whom will they loan money?" Repeat after me: "The United States Treasury."

Do you think the people receiving monthly checks from the Treasury will go to their banks, withdraw currency, and hide it at home? Or do you think they are just barely making ends meet, and will spend the money?

I think they will deposit the money in their bank accounts. What will their banks do with this money? I think I know. The monetary base has doubled the banks' legal reserves since September 2008. The increase monetary base came when the FED bought assets. That money was deposited in banks. Banks will lend this money, now that they cannot afford to keep the money at the FED as excess reserves. They will lend to the Treasury. The Treasury is ready to spend.

If your local bank is still taking deposits, then it is still lending. The borrowers are spending this money. Whatever is not immediately spent by borrowers is kept in the borrowers' bank accounts, money which is lent short-term by the bank.

Conclusion (with apologies to Kevin Costner): "If Ben prints it, banks will lend."

Are you worried about price deflation? Really? Can you tell me why?

UNEMPLOYMENT

The news from the job markets around the world is grim. No matter how the various governments' statisticians have cooked the books, the unemployment rate is rising. The "recipe" does not often change, so the trend is what matters. The trend is ominous.

Demand for discretionary products is falling. Food is not very discretionary, given the fact that people find it difficult to change their diets. Food costs have been rising. The CPI was up by a minuscule 0.1% in 2008. But the CPI minus food and energy was up by 1.8%. Energy costs rose in the first half of 2008, then fell. So, the bulk of this increase came from food.

We should expect to see this pattern continue. Those industries that are based on discretionary spending, most notably the auto industry, will continue to experience depressionary conditions. Anyone whose livelihood depends on the sale of new cars is in a difficult position. Nobody needs to buy a new car. He can buy a used car. I know. My wife bought one last Saturday. So did I. We paid less for two minivans, a 2006 Toyota Sienna and a 2006 Chrysler Town & Country, than what a new stripped-down Dodge minivan costs.

Americans are finally beginning to save. This began in the second quarter of 2008. The rate of household saving as a percentage of disposable (after-tax) income rose a little above 2%. It's about time! This is likely to continue. Economic recovery depends on capital formation.

When people save, they turn money over to a bank or to an investment fund that deposits the money in a bank. The money saved does not go under the mattress. It gets spent. Again, when analysts say that saving is deflationary, they don't know what they are talking about. There is only one form of saving that is deflationary. You go to your bank, withdraw currency, and hide it under a mattress, or else send it to your wife in El Salvador, where she spends it. There, it circulates as a black market currency. This reverses the fractional reserve process. Nothing else does.

So, unless some analyst shows you evidence that this is what savers are doing with their money, don't believe him when he says that the increased rate of saving is dangerously deflationary. The only way that increased saving lowers prices is by increased production: "more goods chasing a fixed supply of money." There is nothing dangerous about increased production. If there were, the West's high-tech economy would have collapsed in the 1990's because of the fall in the price of computers and software.

It is true that unemployed people spend less money. But never let things stop there. Don't fall for the fallacy of the thing not seen. What does the unemployed laborer do? He collects unemployment insurance, which he spends. His employer cuts prices. Consumers save money. What do they do with their saved money? (1) They spend it on something else. (2) They invest it. What does the bank do with the saved money? It lends it.

The analysis that we hear about unemployment's causing deflation is silly. Other than the contraction of the money supply, the only thing that causes mild price declines is increased production. Once produced by the central bank, the money remains in someone's bank account. If it gets lent, it gets spent.

What about the Great Depression? Didn't unemployment cause falling prices? No. What caused falling prices was the contraction of the money supply. How did this happen? All those banks that went under. There was no FDIC until 1934. A busted bank not only stopped the fractional reserve process, it reversed it. The money supply shrank.

If you are employed by a company that sells discretionary products or services, you are in trouble. You will soon be in much bigger trouble. The contraction of this zone of the economy will continue. If you work for a restaurant, you are in trouble. If you work for a supermarket that sells low-cost food, you will do just fine. You will survive.

What matters is demand for your product, not aggregate demand for the entire economy. Aggregate demand depends on individual production. If you are productive, and if you produce something for the non-discretionary zone of the economy, you will do well.

Keynesian central planners want voters to hand more tax money over to them, so that the planners can keep aggregate demand high. The best way to keep aggregate demand high is to reduce corporate taxes, reduce graduated income taxes, reduce Social Security taxes, reduce government spending, and stop trying to regulate what people do with their money and their skills.

CONCLUSION

This economy is going to get worse. The inflationary policies of central banks from 1995–2006 set the trap. Their disinflationary policies from 2007-mid-2008 sprang the trap. Now their inflationary policies will set a new trap: price inflation.

They do not know what they are doing. Neither do commercial bankers and Congress. The public pays for this shared confusion.

January 26, 2009

Gary North [send him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

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