In my previous report, "Why Should Your Children Pay for My Retirement?" I went through the logic and economics of Social Security and Medicare. I made the point that, at some point, the bill-payers are going to resist the payments that previous generations have legislated. What one generation can legislate, a subsequent generation can repeal.
The main political question is this: In which form will this repeal manifest itself?
The statistical facts of Social Security and Medicare make it clear that the funding of both programs has hit a brick wall. They are no longer funding 100% of the recipients' benefits. The money is coming out of the general fund, which is $1.5 trillion in the hole this year. So, the benefits are being paid by lenders. There is no way that they will get their money back. In the long term, they will get stiffed. They refuse to consider the statistical evidence. They believe they can get out of this obvious Ponzi scheme before it collapses. They stay in the program.
In the short run, U.S. Treasury debt is no-risk, or close to it. It sets the standard for financial economists on what constitutes zero risk. In the long run, it is a guaranteed loss.
Everyone knows this debt will not be paid off. Everyone knows that it will grow. Everyone knows that the only reason for buying U.S. Treasury debt today is to park money where it is safe. The debt is liquid. The long-term future is irrelevant for present decision-making, they believe.
The rate of return is close to zero. On T-bills, it is as close to zero as it has ever been. During the Great Depression, rates got to a tenth of a percent, but prices were falling. A tenth of a percent was, in some years, a tax-free rate of return of close to 10% in terms of rising purchasing power (falling consumer prices). Today, the rate of return may be negative, depending on whether the CPI is the standard, which has been rising, or the Median CPI, which has been flat for months.
The enormous size of the debt's monthly expansion indicates that there are not good opportunities for capital growth. No one would lend money to the Treasury for a tenth of a percent if he thought he could get a safe 4% in private markets. Bankers would not turn their depositors' money over to the Federal Reserve for 0.15% per annum if they thought they were not facing horrendous losses over the next year: commercial real estate losses, defaults by businesses, and a possible secondary recession.
Let us face reality: the Treasury is getting free money because Federal Reserve policies have produced an economic crisis that refuses to go away. The Treasury is the lender of last resort to the banking system through a $500 billion line of credit to the FDIC. It is the lender of last resort to home owners who are underwater in their mortgages. But it is the lender of last resort only because it is the borrower of last resort. To write checks, it must borrow an additional $1.5 trillion in fiscal 2010.
What do I mean, "borrower of last resort"? I mean that the Treasury is there to take lenders' money whenever they cannot think of anything else worth lending to. Because of the Federal Reserve, the economy is in such bad shape that lenders depend on the Treasury to park their money for them.
GEITHNER AS A VALET
Think of Timothy Geithner as a valet in some downtown parking lot. You drive your car to the little booth. You hand him the keys to your car. He says he will park it for you. He says you can get it back at any time. He holds the keys to your car, and you trust him. He hands you a ticket. It is an IOU to your car.
When I think of Tim Geithner, I think of the valet in Ferris Bueller's Day Off. It's joy ride time! He climbs into the car, and his buddy leaps in beside him. Off they go! The buddy, of course, is Ben Bernanke. Think about this situation. The lenders of the world are lending trillions of dollars to an agency that has a AAA rating, yet this agency is the most indebted organization on earth. It is on the hook off-budget for at least $75 trillion that it does not have for Social Security and Medicare. It is on the hook on its on-budget budget for $12.6 trillion. This will be $14 trillion before we know it.
Our government is not alone. All Western governments are on the hook for similar percentages. It is just that the United States is larger than the other governments. They, too, are lenders of last resort only because they are borrowers of last resort.
Asian governments are not on the hook to this extent. They have not set up retirement programs. They have not indebted future generations of workers in the name of retirees. Yes, they face debts. They will have to do something with their families' oldsters at some point. China will face this in about 15 years. But this is not a new problem in the history of families. It has been inherent from the beginning. What is different is the West's policy, begun in Germany in the 1880's by Bismarck, of politicizing this family obligation. This experiment in government debt is about to end in the greatest default in man's history: a domino effect of broken promises that will undermine the West's capital structure.
When the promises are finally broken to long-term lenders (oldsters), they will also be broken to short-term lenders.
Think of that parking lot again. A long line of car owners has formed. Each of the people in line has a valid parking ticket.
The lot is empty. The cars are missing. But everyone has an official parking ticket.
The valet is nowhere to be found. It's Ferris Geithner's day off.
Of course, it's more complex than this. It is a gigantic system of parking tickets, with tickets against tickets. Ultimately, it's the derivative system. There are IOU's by the hundreds of trillions of dollars' worth. Maybe it's a quadrillion dollars' worth. The system is more complex than anything in man's history.
Occasionally, it blows up. It blew up in 1998: Long-Term Capital Management. That took about three billion dollars of additional bank loans to fix. Then came 2008, just a decade later. That took over $3 trillion to clear up, just in the United States. This was a thousand-fold increase in lending. It was ticket-shuffling on an unprecedented scale.
There will be another crisis, but much bigger. There is nothing to stop it. Geithner and Bernanke want us to believe that this cannot happen again, that the government and the central bank have fixed the problem. Why should we believe them?
We were told by the previous valet, Henry Paulson, that the problem in October 2008 was toxic assets on bank balance sheets. They are still there, except for the assets that the Federal Reserve swapped for T-bills at face value. This and other bailouts saved Citigroup, J. P. Morgan, and Bank of America. They did not save Wachovia.
The Treasury can sell its 90-day debt for a small fraction of a percent per annum. It pays a little more for bonds. The buyers line up. They have nothing better to do with their money. This tells us that the recovery is a mirage. When the Treasury sells $221.9 billion in debt in one month, as it did in February, this sends a message to anyone who is not living in la-la land: there is no sustainable recovery. When investors think that a tenth of a percent per annum is the best available investment opportunity, they are in disbelief mode.
Who will finance the capital outlays that are necessary to produce sustainable recovery? If the smart money — bank money — is in excess reserves at the FED at 0.15% per annum, and not in the private markets, financing small businesses that provide most of the job growth, why should anyone believe that the job market is ready to add 150,000 jobs a month, which is what the United States needs to provide jobs for young adults entering the job market for the first time? Where will another 8 million jobs come from to put back to work those who have lost their jobs from early 2008 to the present?
THE CONFIDENCE GAME
In September 2001, Americans' confidence in the U.S. government's ability to protect them was shattered by the coordinated attacks. The government was exposed as utterly helpless. So completely implausible were the details of that attack that the public has never come to any agreement as to how or why it took place.
The media dismiss anyone who points to the impossible aspects of the government's vague account of what happened. Such people are called "truthers," due to their call for the truth about 9-11. There are millions of Americans who do not believe the government, and never will. The Web will keep doubts alive. The media want the Web to go away, but it is not going away. What is going away is the audience share for the networks and subscribers to day-old news printed on paper.
In September 2008, the quasi-private mortgage market collapsed in the United States. The government nationalized it. There is no suggestion in Washington that it can be, or should be, returned to the free market. Yet we are assured that the housing market is the largest and most important sector of the American economy.
The public thinks that the government can restore the pre-2008 world. The public is wrong. That world is gone for good. The mortgage market still functions only because investors do not know what else to do with their money. They have not thought through how the Treasury will be able to serve as borrower of last resort at today's low interest rates. They have not thought through the inevitable rise of interest rates and the effects that this will have on the market value of 30-year IOU's at under 5%. They are desperate to do something with their money, and mortgages look good to them.
The confidence that Americans had in the capital markets has been undermined by September and October of 2008. This is why they are willing to put money in banks for 1% per annum. This is why they lend money to home-buyers at under 5% in an age of inflation.
They have not thought through their futures. A recent report by the Employment Benefit Research Institute revealed that a majority of Americans still have confidence that their retirement plans are on track. Yet 46% of them have never sat down to estimate what it will take for them to retire comfortably. The percentage of those who are less confident than they were in 2007 has risen. But most of them think that they are on track to build up enough capital to retire, along with Social Security income.
In 2009, the same organization, EBRI, published a report on the American households' median retirement portfolio. The figure in mid-June was $29,000.
Confidence continues, but it is confidence based on a stunning disconnect between hope and reality.
I think it is confidence by default. For someone to lose confidence in what appears to be the central institution of society, the national government, he must then search for a plausible alternative. Not to begin such a search is to abandon hope.
The central institution of the United States has always been the free market. But this is not an organized market. There is no visible chain of command. It has been under constant assault by intellectuals and the media ever since the Great Depression. The typical American does not perceive the extent to which the free market, not civil government, provides him with whatever protection he enjoys.
So, as he steadily loses faith in the Federal government, there is no replacement institution. He therefore clings to whatever remnants of the confidence he once possessed.
I grew up in a world in which most people had enormous confidence in the Federal government. The Kennedy assassination was a shock to that confidence. Then came the Vietnam war. The economy began to unravel in the 1970's: rising unemployment and rising prices. Reagan's rhetoric restored some faith in the system. The collapse of the Soviet Union in 1991 seemed to be the dawn of a new era. A few intellectuals announced this. It sounded good. But 9-11 overturned this optimism as the new century began, and the crash ended the decade in waves of bankruptcies and default.
Confidence is cumulative. It adds up over long periods of time. To reverse it takes bad news for many years. People do not want to abandon hope in what they regard as the central institution. Yet it is clear to most people that the government is no longer functioning coherently. There was great hope in Obama, which is indicative of widespread foolishness regarding the power of Presidents, a foolishness that extends back to the New Deal.
The government is becoming irrational, as top-down, tax-subsidized operations always do. The government suffers few negative sanctions for its blunders. It bails itself out, just as it bails out its support institutions, the banks. The public has no systematic explanation for this irrationality, but the fact can no longer be concealed. The price of skepticism is falling. The Web has undermined the ability of the intellectuals to contain skepticism. The economists' rule is correct: "As prices fall, more is demanded." The price of skepticism is falling. The representative case was Matt Drudge's exposure of the decision of Newsweek to spike the Monica Lewinsky story in 1998. The digital floodgates opened.
The central fact of every Ponzi scheme is that the targeted victims keep rolling over their on-paper earnings. If they would cash in these earnings, the scheme would collapse long before it rose to front-page status. The scheme would not spread far. But people say "let it ride." They look at their above-market earnings and let the promoter keep the money owed to them.
The Ponzi operator has only one profitable way out: to move to a country with no extradition treaty with the United States. Other than this, the Ponzi scheme's designer will get caught. The scheme will fail. Yet promoters keep designing new ones.
Because the Federal government's various Ponzi schemes are compulsory, the victims cannot withdraw their money. Also, new participants are compelled by law to buy into the scheme. So, the original players did do well. Ida Fuller paid $24.75 into Social Security, retired in 1940, and pulled almost $23,000 out of it before she died in 1975. It was a sweet deal for her. It was a sweet deal for politicians who spent Social Security excess revenues. They bought the votes that kept them in power. But those days are drawing to a close.
The Ponzi schemes are now a major source of employment. Think of the health care industry. The schemes are keeping the unemployment rate from climbing. They are still vaguely trusted, not because the optimists have looked at the figures, but because they haven't. They do not intend to. To examine the numbers would point out that they have been conned. This would make them look foolish in their own eyes. People will do whatever is required to avoid such self-inventorying. The main thing that is required is to suspend disbelief. The media and the government systematically exploit this widespread moral weakness.
But reality eventually intrudes. The people eventually come back to the parking lot, tickets in hand, demanding their cars. Maybe Geithner will be in another line of work, just as Paulson is. But his replacement will have to face the ticket-holders. What will he tell them? How will he explain that their cars were sold to China?
China's central bank holds more marketable tickets than anyone else does. Chinese officials still act as though they believe the Ponzi game has years to go. One of them recently announced that China trusts the dollar and has no use for gold. That means that China is preparing to unload the dollar to buy gold. The question is this: timing.
The Chinese central bank cannot get out of its pile of IOU's. It can get out of some of them. It is operating its own Ponzi scheme, namely, telling urban workers that there will be plenty of employment because of Western purchases of goods. The average Chinese worker does not ask this: "What would China's standard of living be if Chinese, rather than Americans, were spending the newly created yuan?" Economics is not widely understood. The average worker sees only the assembly line and his monthly paycheck. He associates the two. He wants the assembly line's belt to keep moving. He doesn't care who buys his output, just so long as someone with money does. The central bank then creates the new money.
Think of Timothy Geithner as Ferris Bueller's valet. Ferris was not driving his own car. He was driving his buddy's father's car. The valet was not driving his own car. All it took for the valet to have a swell afternoon was to hand Ferris a ticket.
The movie was a delightful male fantasy. We knew it was fantasy, from start to finish. Yet the key fact of the entire script was an objective fact: the mileage on the car's speedometer. That was objective reality. It could not be escaped. They tried to reverse reality by putting the car on a stand and putting the transmission in reverse. When the stand tipped over, the car went out the back of the garage and smashed into the yard below.
Ferris had a great day. His buddy had to face his father alone. We are never told what his father did or said. The movie implies that the father deserved everything he got — or had taken away.
The car was forever ruined.
There was a price to pay for Ferris Bueller's day off. The script writers did what they could to keep this fact from occurring to anyone.
So does Timothy Geithner.
March 20, 2010
Copyright © 2010 Gary North