The Economy: Karl Denninger, "The Ugly Side Of Exponents"
"The Ugly Side Of Exponents"
by Karl Denninger
"Here's something to think about this weekend as you go about your business. The 2008 Federal Fiscal Budget (running from October 07 to October 08) expended approximately $2.9 trillion. It produced a budget deficit (actual) of approximately $500 billion. In 2007, when the financial mess began and The Market Ticker originated publication, I pointed out that in order to bring the government into balance and stop the ponzi finance we would have to cut government spending ("G" in GDP parlance) by approximately 18%. This $500 billion in deficits represented approximately 3.5% of GDP. I was ignored.
Today, the Federal Government is running a deficit of approximately $1,700 billion dollars, or 12% of our now-current GDP of $15 trillion. The "budget" (there hasn't been an official one for the last two years) is now roughly $3.8 trillion, or 31% higher. To bring the ponzi under control now we must cut federal spending ("G" again) by some 43%, or about 2.4 times as much as we had to in 2007. We also must accept a contraction in GDP that is almost four times greater than we had to in 2007. Now let's add some other ugly - very ugly - facts.
* Despite the financial crisis of 2008 banks have not been forced to stop lying about asset values - and not just here in the United States. Morgan Stanley has its stock price under attack as nobody believes their balance sheet. Worse, European banks have been doing the same thing with sovereign debt and we have no idea what the interdependency is between their institutions and ours. That is, the sovereign Ponzi finance game is being "covered up" by banks claiming values that do not represent reality on their balance sheets.
* There is no evidence that our lawmakers give one good damn about the above fact regarding how much our government - and GDP - must contract to restore balance. We continue to hear the lie about "growing out of it" but the fact of the matter is that even if we could generate 5% GDP growth - and we obviously can't, as we've tried and failed - it would not close the funding gap. The government expanded by 31% in four years. That's a seven percent compounded growth rate. You would have had to generate more than 7% in economic growth annually, four years sequentially, to keep up. That's not only isn't going to happen, it didn't happen.
* The market has figured this out, and it's larger than the government. By definition it has to be. Government can never be larger than the entire economy, obviously. Private actors in the economy have come to the conclusion that the government is literally clawing at the cliff-edge trying to avoid going over. They've come to this conclusion in Europe and here and will soon simply "sell everything" and throw up their hands. You only thought the 2008 crash was bad - you've seen nothing to prepare you for what's coming if we do not act now.
* This is not a US-centric phenomena. We're currently benefiting, if you can believe that, from being the hooker with crabs instead of AIDS. It won't matter. China's stock market is collapsing as their ponzi was bigger than anyone else's, lending money for ridiculous projects that will never be profitable. Europe blew their ponzi up on social spending and that is now collapsing - in Greece government workers desperate to demand a paycheck the government cannot fund through taxes blockaded the "Troika" meetings. The ugly part of this is that these people came to believe they could "earn" this amount of money, both in employment and retirement, because the government lied to them and they lapped it up like good little dogs. Now the dog is being led to the chopping block to be served as dinner! This is coming here with our Senior Citizens ladies and gentlemen, and you had damn well better wake the hell up today or you will suffer the consequences!
I wish there was a way to be "bullish" about the intermediate-term future given these facts. There's not. If we do not take our government contraction that is required today - right now - we're going to get to the point where we can't take it as it will be effectively a 100% reduction (ex-interest.) It is already more than half, assuming you intend to pay the interest bill - more than double what it was just four years ago.
In four more years at present rates it will be an effective 100% and the game will be over. There's your timeline. We fix this now or we go off the cliff.
It will suck severely to fix this now. Seniors will not get what they were promised and it doesn't matter who they are - yes, this includes military veterans. Others on various forms of public assistance will have their giveaways, from "earned income" credit to food stamps to "free lunches for kids", cut in half or more. We have to withdraw from Afghanistan and Iraq - whether we deem it operationally correct or not to do so. Our economy will contract - mathematics guarantees a 12% contraction, and due to the knock-on effects it will be much worse - probably 20, maybe even 25%. Unemployment will go up by 50% from where it is now at minimum (that is, to 15%) and may reach 20%. Government workers will have to have their salaries and benefits slashed - by 30% or more.
We will recover from this, but only after the excessive debt - half or more of it in total - is flushed out of the system. Most of that is in the private sector, believe it or not, and it has to go away. This means mass-bankruptcies, failed large banks and the collapse of corporations that are levered monstrosities. We must accept mathematical reality and stop trying to interfere with it before we reach the point where the necessary contraction exceeds our ability to absorb it without political and social system failure. There is no "EASY" button nor are there incremental changes we can make that will solve the problem. We're 20 years too far down the road to do that - we deluded ourselves serially for three decades and the only resolution short of implosion is to accept that which occurred along with the economic damage that must be absorbed.
Along with these inescapable outcomes, however, we must also take steps to mitigate the cost of living and support the economy - or we could find ourselves in the throes of severe civil unrest, perhaps even political system failure.
Housing must have the supports ripped out from under it. House prices will find a natural level where a majority of people can save and pay cash for them. That's as low as 1x incomes. Ludicrous? No. Reality. Will this means adjusting expectations? You bet - that granite countertop won't be the mainstay in "middle-class" homes, it will be present only in those houses where the owner is truly wealthy. The average home size will shrink to around 1,000 square feet for a family of four. A lot of the crackerjack boxes we built in the last 20 years are literally worth nothing in terms of resale price as their carrying costs exceed their utility value without the financial ponzi that enabled them to be built.
Municipal and state finance must shrink by half - or more. Lots-a-cops and firefighters? Nope. Few cops, volunteer firefighters. And those who do stay on will have their pay and benefits cut too - again, by a third or more. We simply have to return to "community protection" where you and your neighbors take most of the responsibility - which means getting rid of the idiocy that one calls 911 when there's a burglar in the house and your neighbor (or you) is a member of the volunteer fire department to respond to a fire call. When the burglar arrives you stop him - and yes, this means the odds of him getting shot need to go up - a lot. When your house is on fire you (or your neighbor) answer the volunteer call and do your level best to put it out. We accept that we cannot afford high-brow paramedic ALS services in our neighborhoods - we may like them, but we don't have the money. That's the only way we can keep the crime rate under control and provide basic protection for fire and similar in a way we can afford. It doesn't matter if you like this or not, it's (again) mathematics.
Schools? No more Wiis in the gym and no more BS administrators with cushy $200,000+ salaries and gold-plated health care and retirement. Ditto on the benefits for teachers. Teach because you love it, and for no other reason. Yes, salaries will go down. But so will cost of living (see above on your new housing expectations - you'll be able to afford it.) Oh, and no more technology spending either - we need to return - right now - to phonics for basic reading, 4-function math done with a pencil and paper (no calculators!) and language competency demonstrated through writing, and we must get all of that basic instruction done by the end of fourth grade. All this "new math", "whole language" and "integrated classrooms" for disruptive students must go in the garbage right now - they are luxuries we can neither afford in educational results or in money terms.
Retirement? We can't pay for what you were promised. We can fix Social Security but Medicare is basket case and cannot be fixed in its current form, as the underlying medical system is broken and full of cost-shifting and subsidy we cannot pay for without ponzi credit expansion. If you're a fat-ass and refuse to fix that we're not going to be able to do anything about the consequences any longer. I personally have dropped nearly forty pounds since March of this year and am in the best overall shape of my adult life. Levels of exertion that would have literally led me to collapse six months ago are no longer even moderately difficult; I can labor outdoors now for hours and while I still sweat like a pig in the heat it's no longer "hard." The simple fact of the matter is that if you're a fat-ass the solution is to eat less and move more and while it's hard when you start the longer you do it the easier and more-rewarding it gets. Be honest with yourself - if you're a man and when standing naked with your back flat against the wall and tilting your head down until your chin strikes your neck cannot see your flaccid wee-wee without sucking in your gut, you're a fat-ass. It's a choice ladies and gentlemen but with that choice is going to come forced consequences everyone understood 50 years ago but we've now forgotten as there's always a magic pill or some magic thing a doctor can do to fix it. We simply can't pay for it any more, so those of you who wish to take the risks are free to do so, but you soon won't be able to charge off the cost on anyone else. If you're not stinking rich (not ordinary "well off" but stinking rich) electing to remain a fat-ass will mean that if you lose the dice roll on the consequences society will not be able to prevent you from suffering those consequences, including death. We must level with the American people: 80% of your health care dollars are spent in the last year of your life, and the majority of health spending has at its root lifestyle choices. We must accept our mortality and that if we cannot afford that "end of life" expense we won't get it. We must also accept that self-inflicted medical expenses will either be ours if we have the money, or won't be provided if we don't.
Likewise, for those who wish to coddle the illegal immigrants in this nation, you are going to be the ones who take care of them - plantation style if you must - or they have to go. Right now. I don't care if this considered politically correct or not. We simply don't have the money to play "english as a second language" to a bunch of Mexicans who come here to pick strawberries. We lose three ways: We have to educate their kids who start at a severe disadvantage, we have to cover their health expenses as they earn an insufficient amount to do so on their own and our people don't have the jobs picking those strawberries. To those who say Americans won't do these jobs they sure as hell will when the alternative is to starve, and we're not able to fund the "funemployment", "food stamps" and other similar programs any longer. That day has arrived.
We must stop the narco-war. We can't afford it and we need the tax revenue. I know this will be sacrilege to many, especially on the right, but the drug war has massively driven up the cost of government through imprisonment expense, permanently blemishing people's records with felonies for non-violent consensual conduct and the dramatic and outrageous expansion of policing costs - we simply cannot afford it any longer irrespective of the frothing-at-the-mouth lies told by those who promulgated this policy going all the way back to Harry Anslinger. Never mind the civil liberties issues raised, this is first and foremost an economics issue. To those who claim that dropping the drug laws will lead to monstrous societal health expenses born by the taxpayer see the previous point - no it won't because we don't have the money. If you wish to smoke crack until your heart explodes, that's fine - but when you have that heart attack as a consequence you will die. This must be respected as a choice while we remove from the budget that which we cannot afford. For those who get trapped but really don't want to be dopers we should (and can) establish a tax system on these substances and sell them in pharmacies (no pharmacist is going to risk his very-nice-income job to sell to a kid) and fund voluntary treatment options with that tax revenue. Let us remind ourselves that marijuana was made illegal originally on the back of the claim that smoking it would turn white women into "trash" that would sleep with black men. Yes, it really was a racist thing.
We must fix our trade and energy policies. No nation can survive running trade deficits into the indefinite future. Trade deficits drain capital and ultimately destroy your productive base - and we're the poster child for the bad effects of these policies. Look to the right - this is featured prominently in Leverage, due out in November. You'll be able to read the details soon - in the present tense, however, you must come to grips with the fact that we must have energy self-sufficiency (and we can) and that we cannot allow wage and environmental arbitrage to be the focus of our trade policies (and we do.) These things can be changed and we must change them right here, right now, today.
I recognize that many people will resist these points. Go right ahead and resist, but if you wish to comment on why these are not inevitable changes, with the only other alternative being political and social system collapse on a scale never seen in this nation, not even during the depths of The Depression, bring your math. Claims that "we can muddle through" without evidence - or worse, backed by nothing more than political lies - are no longer sufficient or "in-bounds" in this debate.”
* Despite the financial crisis of 2008 banks have not been forced to stop lying about asset values - and not just here in the United States. Morgan Stanley has its stock price under attack as nobody believes their balance sheet. Worse, European banks have been doing the same thing with sovereign debt and we have no idea what the interdependency is between their institutions and ours. That is, the sovereign Ponzi finance game is being "covered up" by banks claiming values that do not represent reality on their balance sheets.
* There is no evidence that our lawmakers give one good damn about the above fact regarding how much our government - and GDP - must contract to restore balance. We continue to hear the lie about "growing out of it" but the fact of the matter is that even if we could generate 5% GDP growth - and we obviously can't, as we've tried and failed - it would not close the funding gap. The government expanded by 31% in four years. That's a seven percent compounded growth rate. You would have had to generate more than 7% in economic growth annually, four years sequentially, to keep up. That's not only isn't going to happen, it didn't happen.
* The market has figured this out, and it's larger than the government. By definition it has to be. Government can never be larger than the entire economy, obviously. Private actors in the economy have come to the conclusion that the government is literally clawing at the cliff-edge trying to avoid going over. They've come to this conclusion in Europe and here and will soon simply "sell everything" and throw up their hands. You only thought the 2008 crash was bad - you've seen nothing to prepare you for what's coming if we do not act now.
* This is not a US-centric phenomena. We're currently benefiting, if you can believe that, from being the hooker with crabs instead of AIDS. It won't matter. China's stock market is collapsing as their ponzi was bigger than anyone else's, lending money for ridiculous projects that will never be profitable. Europe blew their ponzi up on social spending and that is now collapsing - in Greece government workers desperate to demand a paycheck the government cannot fund through taxes blockaded the "Troika" meetings. The ugly part of this is that these people came to believe they could "earn" this amount of money, both in employment and retirement, because the government lied to them and they lapped it up like good little dogs. Now the dog is being led to the chopping block to be served as dinner! This is coming here with our Senior Citizens ladies and gentlemen, and you had damn well better wake the hell up today or you will suffer the consequences!
I wish there was a way to be "bullish" about the intermediate-term future given these facts. There's not. If we do not take our government contraction that is required today - right now - we're going to get to the point where we can't take it as it will be effectively a 100% reduction (ex-interest.) It is already more than half, assuming you intend to pay the interest bill - more than double what it was just four years ago.
In four more years at present rates it will be an effective 100% and the game will be over. There's your timeline. We fix this now or we go off the cliff.
It will suck severely to fix this now. Seniors will not get what they were promised and it doesn't matter who they are - yes, this includes military veterans. Others on various forms of public assistance will have their giveaways, from "earned income" credit to food stamps to "free lunches for kids", cut in half or more. We have to withdraw from Afghanistan and Iraq - whether we deem it operationally correct or not to do so. Our economy will contract - mathematics guarantees a 12% contraction, and due to the knock-on effects it will be much worse - probably 20, maybe even 25%. Unemployment will go up by 50% from where it is now at minimum (that is, to 15%) and may reach 20%. Government workers will have to have their salaries and benefits slashed - by 30% or more.
We will recover from this, but only after the excessive debt - half or more of it in total - is flushed out of the system. Most of that is in the private sector, believe it or not, and it has to go away. This means mass-bankruptcies, failed large banks and the collapse of corporations that are levered monstrosities. We must accept mathematical reality and stop trying to interfere with it before we reach the point where the necessary contraction exceeds our ability to absorb it without political and social system failure. There is no "EASY" button nor are there incremental changes we can make that will solve the problem. We're 20 years too far down the road to do that - we deluded ourselves serially for three decades and the only resolution short of implosion is to accept that which occurred along with the economic damage that must be absorbed.
Along with these inescapable outcomes, however, we must also take steps to mitigate the cost of living and support the economy - or we could find ourselves in the throes of severe civil unrest, perhaps even political system failure.
Housing must have the supports ripped out from under it. House prices will find a natural level where a majority of people can save and pay cash for them. That's as low as 1x incomes. Ludicrous? No. Reality. Will this means adjusting expectations? You bet - that granite countertop won't be the mainstay in "middle-class" homes, it will be present only in those houses where the owner is truly wealthy. The average home size will shrink to around 1,000 square feet for a family of four. A lot of the crackerjack boxes we built in the last 20 years are literally worth nothing in terms of resale price as their carrying costs exceed their utility value without the financial ponzi that enabled them to be built.
Municipal and state finance must shrink by half - or more. Lots-a-cops and firefighters? Nope. Few cops, volunteer firefighters. And those who do stay on will have their pay and benefits cut too - again, by a third or more. We simply have to return to "community protection" where you and your neighbors take most of the responsibility - which means getting rid of the idiocy that one calls 911 when there's a burglar in the house and your neighbor (or you) is a member of the volunteer fire department to respond to a fire call. When the burglar arrives you stop him - and yes, this means the odds of him getting shot need to go up - a lot. When your house is on fire you (or your neighbor) answer the volunteer call and do your level best to put it out. We accept that we cannot afford high-brow paramedic ALS services in our neighborhoods - we may like them, but we don't have the money. That's the only way we can keep the crime rate under control and provide basic protection for fire and similar in a way we can afford. It doesn't matter if you like this or not, it's (again) mathematics.
Schools? No more Wiis in the gym and no more BS administrators with cushy $200,000+ salaries and gold-plated health care and retirement. Ditto on the benefits for teachers. Teach because you love it, and for no other reason. Yes, salaries will go down. But so will cost of living (see above on your new housing expectations - you'll be able to afford it.) Oh, and no more technology spending either - we need to return - right now - to phonics for basic reading, 4-function math done with a pencil and paper (no calculators!) and language competency demonstrated through writing, and we must get all of that basic instruction done by the end of fourth grade. All this "new math", "whole language" and "integrated classrooms" for disruptive students must go in the garbage right now - they are luxuries we can neither afford in educational results or in money terms.
Retirement? We can't pay for what you were promised. We can fix Social Security but Medicare is basket case and cannot be fixed in its current form, as the underlying medical system is broken and full of cost-shifting and subsidy we cannot pay for without ponzi credit expansion. If you're a fat-ass and refuse to fix that we're not going to be able to do anything about the consequences any longer. I personally have dropped nearly forty pounds since March of this year and am in the best overall shape of my adult life. Levels of exertion that would have literally led me to collapse six months ago are no longer even moderately difficult; I can labor outdoors now for hours and while I still sweat like a pig in the heat it's no longer "hard." The simple fact of the matter is that if you're a fat-ass the solution is to eat less and move more and while it's hard when you start the longer you do it the easier and more-rewarding it gets. Be honest with yourself - if you're a man and when standing naked with your back flat against the wall and tilting your head down until your chin strikes your neck cannot see your flaccid wee-wee without sucking in your gut, you're a fat-ass. It's a choice ladies and gentlemen but with that choice is going to come forced consequences everyone understood 50 years ago but we've now forgotten as there's always a magic pill or some magic thing a doctor can do to fix it. We simply can't pay for it any more, so those of you who wish to take the risks are free to do so, but you soon won't be able to charge off the cost on anyone else. If you're not stinking rich (not ordinary "well off" but stinking rich) electing to remain a fat-ass will mean that if you lose the dice roll on the consequences society will not be able to prevent you from suffering those consequences, including death. We must level with the American people: 80% of your health care dollars are spent in the last year of your life, and the majority of health spending has at its root lifestyle choices. We must accept our mortality and that if we cannot afford that "end of life" expense we won't get it. We must also accept that self-inflicted medical expenses will either be ours if we have the money, or won't be provided if we don't.
Likewise, for those who wish to coddle the illegal immigrants in this nation, you are going to be the ones who take care of them - plantation style if you must - or they have to go. Right now. I don't care if this considered politically correct or not. We simply don't have the money to play "english as a second language" to a bunch of Mexicans who come here to pick strawberries. We lose three ways: We have to educate their kids who start at a severe disadvantage, we have to cover their health expenses as they earn an insufficient amount to do so on their own and our people don't have the jobs picking those strawberries. To those who say Americans won't do these jobs they sure as hell will when the alternative is to starve, and we're not able to fund the "funemployment", "food stamps" and other similar programs any longer. That day has arrived.
We must stop the narco-war. We can't afford it and we need the tax revenue. I know this will be sacrilege to many, especially on the right, but the drug war has massively driven up the cost of government through imprisonment expense, permanently blemishing people's records with felonies for non-violent consensual conduct and the dramatic and outrageous expansion of policing costs - we simply cannot afford it any longer irrespective of the frothing-at-the-mouth lies told by those who promulgated this policy going all the way back to Harry Anslinger. Never mind the civil liberties issues raised, this is first and foremost an economics issue. To those who claim that dropping the drug laws will lead to monstrous societal health expenses born by the taxpayer see the previous point - no it won't because we don't have the money. If you wish to smoke crack until your heart explodes, that's fine - but when you have that heart attack as a consequence you will die. This must be respected as a choice while we remove from the budget that which we cannot afford. For those who get trapped but really don't want to be dopers we should (and can) establish a tax system on these substances and sell them in pharmacies (no pharmacist is going to risk his very-nice-income job to sell to a kid) and fund voluntary treatment options with that tax revenue. Let us remind ourselves that marijuana was made illegal originally on the back of the claim that smoking it would turn white women into "trash" that would sleep with black men. Yes, it really was a racist thing.
We must fix our trade and energy policies. No nation can survive running trade deficits into the indefinite future. Trade deficits drain capital and ultimately destroy your productive base - and we're the poster child for the bad effects of these policies. Look to the right - this is featured prominently in Leverage, due out in November. You'll be able to read the details soon - in the present tense, however, you must come to grips with the fact that we must have energy self-sufficiency (and we can) and that we cannot allow wage and environmental arbitrage to be the focus of our trade policies (and we do.) These things can be changed and we must change them right here, right now, today.
I recognize that many people will resist these points. Go right ahead and resist, but if you wish to comment on why these are not inevitable changes, with the only other alternative being political and social system collapse on a scale never seen in this nation, not even during the depths of The Depression, bring your math. Claims that "we can muddle through" without evidence - or worse, backed by nothing more than political lies - are no longer sufficient or "in-bounds" in this debate.”
- http://market-ticker.org/
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