Major Premise That Government Economists Can Improve Workings of a Free Economy

We write every day. Occasionally, we think too.

We did some thinking yesterday, on our trip to Uruguay. Why Uruguay? We thought we should have a look around. Montevideo is a cheap place to live. It’s on the sea, with beaches near the downtown area. It is an old town, with many fine buildings. It is clean. It is safe. It has history too. When the English invaded Buenos Aires, the Spaniards launched a counterattack from the fortress at Montevideo and got it back.

“It looks like a nice place,” we said to our local contact. “But it seems a little like a resort town out of season; it’s very quiet.”

We were having dinner in the best restaurant in town, next to the opera house. The restaurant was large and well fitted out. But it was almost empty. A French group sat at one table. An American group sat at another. The only other diners were sitting with your editor. Outside on the street, it was as if everyone else had been warned of an approaching tsunami; there was no one.

“Well, it’s out of season all year round,” our host replied. “It’s a nice place to live. But it’s not very lively.

“Montevideo used to be a lot richer. You can tell that just by looking at the public buildings. They’re very grand. We couldn’t build those places today. We don’t have the money. But during the war years, Uruguay was booming. We were leading exporters of beef and grains. We’re still leading exporters…but the margins are no longer there. You can make money in farming, but not enough to get rich.”

We wonder what people are going to be saying a century from now.

“Yeah, Manhattan used to have the richest real estate in America…back in the financial boom. Wall Street was the center of the financial industry. People made fortunes from high-margin financial products. But then, the financial industry went into decline…and new financial centers in Shanghai and Singapore took the business.”

Could New York have already passed its peak? Perhaps not quite. The papers are reporting record bonuses on Wall Street. But the story has an undertone of desperation about it…like the wild parties in Berlin in 1945, just before the Soviet Army arrived. Maybe that’s why the bonuses are so high. Get it while you can! This could be the last hurrah for the US financial industry.

Private sector credit is still contracting. In fact, it’s shrinking faster than at any time in the last 35 years. And this trend is not likely to change. As we keep saying – you’re probably getting tired of hearing it – the private sector has 7 to 15 years of de-leveraging to do. The financial industry will be forced to downsize, along with the economy.

Wall Street’s leveraged debt bombs are still blowing up. Banks are going under. As we reported yesterday, the ‘second wave’ of residential mortgage defaults may be just beginning. Commercial real estate debt isn’t far behind…with no Fannie Mae to help the wounded or pick up the dead.

And how about all those private equity deals Wall Street financed? Of the top 10 deals from the bubble years, 6 are in trouble…and 4 have already defaulted.

The idea of private equity was that the hotshots were so smart they could take over a company, re-organize it, restructure it, and sell it back to the public market at a higher price. What they actually did was merely to load up the company with debt – using the money to pay themselves lavish fees.

And as we know…and maybe we alone know it…debt hurts. Run up enough debt and sooner or later bad things will happen. But not necessarily to the borrower!

Right now, the dollar is at a 15-month low. The speculators borrow dollars. Then, it doesn’t matter what they do with them. Everything is going up against the greenback.

But that’s why our Crash Alert flag is flying. Mr. Market doesn’t like it when morons make money. We wouldn’t be at all surprised to see these carry trades go bad in a big, big way. All of a sudden, stocks…bonds…emerging markets…commodities…and even gold…could go down against the dollar. Watch out!

The Dow rose another 20 points yesterday. It is now only 54 points below the 50% retracement level…where the bounce of 1930 peaked out.

Gold, meanwhile, held above $1,100.

As we were saying…once in a while, we think. The last few days have been so busy, we didn’t have any time to think. But, now things are settling down, so we’ve had a chance to put our thinking cap on.

What are we thinking about?

Well, of course, we’re trying to understand the basics… George Soros had the right idea: Find the story whose premise is false…and bet against it. What premise is false?

The major premise that almost everyone believes is that government economists can improve the workings of an otherwise free economy. That leads people to believe that the feds have pulled off a save…they’ve now got the economy well along on the road to recovery…the recovery is getting stronger as time goes by…and soon, the feds will begin to exit from their stimulus efforts.

The big question in most investors’ minds is this: how quickly will the feds exit? As long as they keep up their stimulus efforts, investors expect rising prices for everything but the dollar.

Those who think the feds will be able to exit quickly believe growth will come without too much inflation. Those who think the exit will come slowly expect higher rates of inflation.

Well, guess what? The whole premise is false. From top to bottom. From beginning to end. Even the air it breathes is tainted with the smell of fraud and self-delusion.

The theory behind the recovery concept is that government spending and stimulus from the Fed has a “multiplier” effect. That is, the feds spend…the money goes into the economy…and then, the private economy multiplies the spending by growth in consumption and investment of its own. If there were no multiplier effect the whole exercise would be a waste of time, because we know that government spending in itself is a cost to an economy, not a source of real wealth. Government spending, generally, is a drag on prosperity. The Soviet Union proved that. The question remains however, can extra government spending at critical moments “prime the pump” so that it is multiplied by the private sector?

Answer: no.

“Our new research,” writes economist Robert Barro in The Wall Street Journal, “shows no evidence of a Keynesian ‘multiplier’ effect…the available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise the GDP by less than the increase in government spending.”

Now, we turn to the current situation. Is there any evidence of growth beyond the government’s own stimulus efforts? From what we can see so far, again, the answer is ‘no.’

The premise of recovery/multipliers/growth/and exit is false. We want to bet against it. Tomorrow we’ll talk about how.

Real economists know that there are no secrets. You work hard. You invest carefully. You save your money. That’s the best you can do. There are no multipliers. There are no miracle cures. There are no easy exits from trouble.

That’s why the world has little use for honest economists; they tell you what you don’t want to hear. So, people turn to the phonies…the charlatans…the imposter economists who say “yes we can!”

Trouble is, they can’t.

Until tomorrow,

Bill Bonner
for Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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5 Comments on "Major Premise That Government Economists Can Improve Workings of a Free Economy"

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wait… Keynes proved that water runs uphill if you hold your breathe long enough…. just like the rascals are “growing the economy”. “The major premise that almost everyone believes is that government economists can improve the workings of an otherwise free economy.” sort of a condrum: proof in and of itself that the american people are incompetent or drunkards or both, and need Big Brother to tell them how much toilet paper to use…at least we know when they turn on the printing presses there will be plenty of gov’t issue. well with the wall street crowd turning into the… Read more »

Wow, great post! The brutal honesty hurts so good –

Vestan Pance
The idea of a multiplier assumes that there is someone to lend to. And as you’ve rightly pointed out, everyone in the US is busy deleveraging, and so not taking on any more debt. So giving cash to the banks has little or no flow-on effect, and is just adding to their reserves – no wonder they can afford to give their execs big bonuses! The fact that a good portion of the Australian stimulus went straight into the hands of people to immediately spend meant that this had a greater effect in the economy. Maybe this just means we’ve… Read more »

I think the workings of the US economy are a little different from Australia. If a “good portion of the Australian stimulus” at least “went straight into the hands of the people immediately” it would have a much greater effect than bailing out ‘to big to fail banks’ which then turned around and stuck it straight to the US consumer with higher fees. The US govt believes in so called “trickle down,” which for the consumer is more like getting peed on.

Vestan Pance

The very idea of multipliers seems silly anyway. Do you think a bank would wait to be credited by the reserve before lending money? Not a chance. They’d lend to anyone they think could pay it back (with interest and fees, of course) and then sort out whatever cash reserves they need for Basel II (or whatever) later. Why is this ‘new research’?

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