One more time – hoping for clarity

I am having the hardest time making people understand the absurdity of our predicament and the inanity of the solutions we are applying.

Let’s start by reiterating that the US$ today is the reserve currency of most global central banks. Thus, what happens to the US economy and to the US$ affects us all to a very significant degree.

That being the case, you want to also keep in mind that the US economy is composed of 70% consumption. This is a fairly important consideration to remember throughout this essay.

First off, let me show you a chart of what is known as Long Term Interest Rates. Of course, we all know that in the West we ostensibly live in a society steeped in personal freedom and free markets. If that is the case, then someone explain to me how free can a market be when interest rates are set by an independent body that acts as it sees fit. If you have a hard time picturing why interest rates are important, think of it as the price of money. Since money is upstream of any human endeavor bar none, once you set the price of money, you are effectively running a command economy. But let’s not get ahead of ourselves just yet.

Look at the chart below. This is not my opinion. This is official government data. Interest rates have been manipulated lower for thirty years.

FRED Graph

Manipulating interest rates lower means that, amongst other things, a government is willingly discouraging savings – in other words, governments are inducing the public to spend. But manipulating interest rates lower also has a myriad collateral effects. For example, corporations are induced to borrow money which not only allows them to invest in more capacity but, for example, also allows them to buy their own company stock. So, as a for instance, company X borrows 100 million at 8% and buys in the open market its own company stock. This may seem a harmless stunt and we’ll talk more about it later.

The rationale of lowering interest rates is that by lowering the price of money, individuals and corporations will be induced to spend more therefore creating more industrial capacity and hiring more workers, thus increasing the purchasing power of individuals, so inducing greater consumption thus soliciting more production…. rinse, repeat.

That’s the theory of course and it sounds sensible.

But here is one of the problems. Look at the chart of GDP progression year on year:

FRED Graph

Despite progressively lowering interest rates, GDP progression only really bounced around 4% to 6% year on year. This means that even though we have encouraged people and corporations to spend progressively more, the effect of every Dollar spent diminishes over time. If by observing the two charts above you cannot see the connection, check out the next two charts.

The first chart shows GDP progression in absolute terms:

FRED Graph

OK… that looks impressive. In the past 30 years, US yearly GDP grew from US$6Trillions to currently about US$14Trillions. So, we’ve more than doubled GDP over thirty years. To be precise, GDP is now 125% greater than in 1980

Now look at the following chart:

FRED Graph
This is the chart of Federal debt in absolute terms over the same 30 years period. You will notice that government expenditure has grown from US$1Trillion to about US$12Trillion.
By my count, that makes an increase in government spending that is about 1100%
So, over thirty years, the US government has increased spending by1100% to achieve an increase in GDP of 125%
BUT WAIT!! That’s not all. So far we are only talking about government spending – i.e. the money government takes from you in the form of taxes (licenses, stamp duty, fees, VAT, inheritance taxes…) to spend as it sees fit for health care, the military, public infrastructure, covert projects and so on and so forth.
For a more accurate picture of the amount of money that has been spent, we must add the expenditure of individuals and corporations.
Here’s individuals’ expenditure:
FRED Graph
I am unable to pull up a chart of corporate expenditure but Federal and Individuals’ expenditure combined already show the point I am trying to make. Combined, the Fed government and individuals account for well over GDP value. If you are wondering how that can be, you must keep in mind that not all Federal expenditure takes place within the borders of the country. However, any expenditure the Federal government makes overseas is supposed to bring back some benefit at some unspecified date in the future back to the country.
So, effectively individuals’, corporate and Federal Government expenditures have increased geometrically and still GDP potters about a 4% to 6% range year on year. Talk about running faster just to stay in place.
As an alternative measure to see whether what I am saying makes sense, let’s take a look at the following chart:

Graph: Household Financial Obligations as a percent of Disposable Personal Income

The above chart portrays the increasing financial burden on individuals over the past thirty years. The above chart is testament to the obliteration of peoples’ savings by intentional government mandate. If you don’t think that financial obligations of 19% of disposable income is excessive, you’ve probably never had to make a budget and plan your life. Financial obligations are only those expenses necessary to service debt (overdrafts, credit cards, mortgages, car loans…). On top of your financial expenses, you still have to factor in food, clothing, schooling, health insurance, utilities, transport and leisure for example.

So, today we are where we are. Great.

Now our governments are telling us that in order to get out of this crisis, we need to do more of what we’ve already done for the past thirty years. We must spend more; MUCH MORE… and we must give it to the banks first and foremost.

At this point, you may ask why not spend even more and keep GDP plodding about at 4% to 6% year on year? After all, things seemed to be all right till recently so why not carry on doing more of the same right?

If you remember the charts at the top of this essay, you hopefully remember, and now realize, the diminishing-effect nature of every new single Fiat Dollar spent.

The reason I say that doing more of what we’ve done in the past 30 years is now going to be counterproductive is this:

Graph: M1 Money Multiplier

That there chart, is the Money Multiplier. Very succinctly, for as long as the MM is above 1, every Dollar spent has a multiplier effect on the expansion of GDP. That’s because every Dollar bill can be used repeatedly for several transactions. However, the nature of Fiat money is such that it conforms to the law of diminishing returns. The point at which the MM is below 1, even the geometric expansion of debt no longer stimulates GDP growth.

And that, is as clearly as I can explain the predicament we find ourselves in at present and the reason why I am certain that our governments will plunge us in a world war.

For more on Fiat money, do a search on my blog and you’ll find dozens of essays about it.

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7 Responses to “One more time – hoping for clarity”

  1. Debt ceiling (re-post) « Guido's temple of the absurd Says:

    […] you read this essay and this essay, you will know I contend that we have reached the limit of how far we can expand inflation and that […]

  2. Jus’ checkn’…. « Guido's temple of the absurd Says:

    […] https://guidoromero.wordpress.com/2009/08/19/one-more-time-hoping-for-clarity/ […]

  3. Where we are today (a follow up to “Background of my contention”) « Guido’s temple of the absurd Says:

    […] and artificially induced inflation into the system. For more on this dynamic, you can look up this previous post. So now, why is the first chart above so important. We’ve established and proved that by […]

  4. guidoamm Says:

    Big hat tip to Karl Denninger for putting this chart together. What can I say. This chart says it all.

  5. guidoamm Says:

    Oh! And the Taliban; the model of sophisticated organized society dwelling in modern technologically advanced caves and commanding cutting edge weapon technology that is a threat to the West’s way of life.

  6. guidoamm Says:

    Thank you for dropping in. Like you, I find a certain degree of comfort in knowing what the eventual conclusion will be. What I strongly reject however is our governments’ intentional deception and misdirection.

    We can all agree we need a monetary system and we can all agree that a value based monetary system is necessarily limiting. Fine. Let’s all agree to make use of a fiat monetary system consciously and willingly and let’s manage it sensibly. Above all, since we are talking about ostensibly democratic societies, lets ask the people how they feel about the choice of monetary system.

    We are being herded into a world war on deception, false premises and absurd claims. I mean; how long would North Korea last if the West ceased all diplomatic and commercial relations with the country? That is, how long till all North Koreans would starve to death if the West stopped grain shipments? Same with Iran. How long till the entire country grinds to a halt if we stopped giving them refined petroleum products?

    And these are the countries that are threatening the security and well being of the West????

    The truth is our governments are bankrupt and in very quick succession will be unable to make good on our financial obligations internally or externally. Do you think any politicians could admit to that? If you do, then we should not fear a world war. My bet is they will not because psychologically and/or intellectually they cannot.

    Tic, toc, tic, toc…

    http://www.tuscaloosanews.com/article/20090818/NEWS/908189977/1007?Title=Bachus-discusses-Social-Security-health-care

  7. SoYouThink Says:

    You are an excellent writer and have a great site. In one sense it is terrible realizing what is coming and not being able to do anything about it. Those that are in a position to change course do not even recognize that we are headed for disaster and thus are in no shape to fix things. At the same time, it can also be comforting to know that the destination is inevitable. We can still enjoy seeing how the unknown details play out along the way. In the end we will experience tragedy followed by farce and back again several times over.

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