The Make Believe World of Economists

In the years 2007-2012, Nobel Prize winning economists Paul Krugman and Joseph Stiglitz — along with celebrity economist Jeffrey Sachs and practically all their colleagues — failed to notice the most- important thing to happen in their field.

But not noticing things came naturally, easily to them. In fact, you might say they had built their careers on not noticing things, especially the most- important thing in economics.

It was part of their professional training. It was what allowed them to be economists and to win coveted prizes and key posts in a very competitive occupation. Had they been more reflective…and more observant…they would probably be teaching at community colleges.

But that is just a part of our story. By the late 20th century, economists — especially leading economists — had ceased being useful. They had become a nuisance. They closed their eyes to what an economy actually is…and to how it works…and focused on their own world — a make-believe world of numbers and theories, with little connection to the world that most people lived in.

And now in the 21st century, they are up to mischief. And part of the mischief involves not noticing things that are right in front of their noses.

The most-important single feature of modern economies is growth. Without it, neither businesses, households nor governments can pay their bills. Without it, pension funds…private and public…go broke. Without it, the stock market is doomed….and bonds get crushed when debtors can’t pay.

In fact, without growth, every government in the economically developed world faces catastrophe. Its revenues stagnate while its costs — largely driven by open-ended health and pension obligations to aging populations — continue to expand.

By the year 2012, in fact, every major government in the developed world is already in trouble. Some more than others, depending on their ability to borrow money… or to print it.

The US, Japan and Britain are still technically “solvent” because they control the currency in which their debts are calibrated. They can always print money to pay their debts; creditors do not have to worry about a simple default.

Greece, Italy, Spain, Ireland, Illinois and California, on the other hand, are already keeping lenders up at night worrying that they will not and cannot pay their bills.

Even on these terms, Japan and Britain stand out, each with total debt of more than 500% of GDP. But even this Everest of debt was overlooked by most economists. Rather than look out the window, they hunched over their computers and studied their formulas and their numbers, apparently unaware of the avalanche that was headed their way.

Ultimately, an economy must pay its bills. And it can do so only by drawing on its own savings and output. Debt is money that has already been spent. It is like sin; it may be fun when you are doing it, but there’s always a price to be paid later on.

Debt repayment is a painful part of the cycle. And sometimes it is so painful…so enormous…that the bill can never be settled.

Britain and Japan had had their spending sprees. They had their carefree days. How will they now pay their debts? You can forget paying them “off”; no one even imagines that such a thing is possible. But they must be serviced. A lender must get something for his trouble, even if it is a pittance.

Typically, lenders demand a pound of flesh for every 20 or so pounds they lend. The present period is unusual in that regard. Growth rates are so slow, savings rates so high and lenders so fearful, that they no longer require much in the way of yield.

They are happy to take no real flesh at all. The U.K. 10-year bond yielded all of 1.68% in mid-August 2012, well below the rate of consumer price increases. As for the Japanese equivalent, investors were content with 0.8%. If there were any consumer price inflation at all, investors would lose money.

Inflation rates have been going down for more than 30 years. Ever since the CPI hit a high of 11% in 1980. Investors must think they will continue going down forever. If that is so, nations such as Japan and Britain will continue to carry their debt at vanishingly low interest cost.

But it would be a strange world in which markets went only in one direction. And it will be an even stranger world in which foolish investors fail to get what’s coming to them.

The word normal is in the language for a reason. It was coined to describe what usually happens after something very extraordinary has happened. It is rare for lenders to lend below the rate of consumer price inflation.

In effect, they are consenting, at the get-go, to a loss. What normally happens after investors do such a thing is that they do lose money — far more than they expected. Interest rates normally give lenders a 2-4% real return on their money.

So if inflation rates were to hit the mark central bankers have set for them — about 2% — and if lenders were to want the interest payments that they normally expect, Japan and Britain would have to devote about a quarter of their entire annual output just to service debt.

That’s another way of saying that one out of every four dollars of GDP must be used to pay for things that were consumed…used up…and probably already amortized…years ago. There’s another word, in English, that describes the likelihood of that happening — zilch.


Bill Bonner
for Markets and Money

From the Archives…

Staring Down the Barrel of Bad Debt
17-08-2012 – Greg Canavan

Taking Over From the US Dollar With Organic Finance
16-08-2012 – Greg Canavan

Australian Banks on the Run
15-08-2012 – Bill Bonner

The Secret Investment to Buy When GDP Falls
14-08-2012 – Nick Hubble

Will the Latest Data From China Cause a Rally in Aussie Stocks?
13-08-2012 – Dan Denning

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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2 Comments on "The Make Believe World of Economists"

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Here in the uk Zilch minus 20% tax is what us ordinary mortals have to look forward to, even those on a pension like myself. Currant account rates are 0.04% and to lock your money away for 12 months or more start at 2.4%. The banks are having a great time as the bonus rates show, but some shareholder groups are reacting to this hitherto pastime of ‘my bonus is bigger than yours’, and realizing that these banksters are not worth the paper their contract is written on. Bob Diamond ex honcho of Barclays, has denied himself last years bonus… Read more »

Newsflash!! It seems that ex honcho Diamond is to front a new committee to expand on his forgetful memory. With £30mill+ in his pocket whats the betting he’s ducking for cover somewhere, like Peru, or Argentina, or Australia. If its good enough for Ronnie Biggs!!!

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