Written Down, Written Off, and Inflated Away

It was here in Manchester, England, that Europeans stole a march on the rest of the world. The Industrial Revolution made it possible for people to produce more wealth, more quickly.

But now, two things are happening:

First, the planet seems to be running low on easily obtainable energy. Cheap oil fired the furnaces, filled the pistons, and greased the gears of the whole machine. Now, oil is not so cheap… In fact, it hit a new record high last week.

Second, the non-Europeans have caught on to the magic of the Industrial Revolution. They’re building newer and better factories – and staffing them with cheaper, harder working labor. What’s more, they’re competing with the West for the raw materials to feed their factories. And, perhaps most important, they’ve got money – mountains of it. While Europeans – led by Anglo-Saxons – squandered their wealth on pointless wars and frivolous spending, the non-Europeans have been saving and investing. The Chinese, for example, are said to save more than 25% of their incomes.

And now, a kind of financial war seems to have broken out. We have opined that this is not merely a war between inflation and deflation…but a war of Total Liquidation…in which the huge debts built up during the expansion phase of the credit cycle – roughly, 1980-2007 – mostly in the West, especially in America and Britain, will be written down, written off, and inflated away.

Neither inflation nor deflation will be a clear winner, in other words. Instead, like WWI, both will do damage…and in the end, very few people will be better off. Some possible exceptions – gold miners, commodity producers, and emerging markets.

No one will benefit much from deflation. But commodities and gold will reap some gain from inflation.

On Friday, for example, we saw both in action. The Dow tumbled 256 points – after GE proved that it could was vulnerable too. Its shares lost 13% of their value in a single day. What provoked the run on GE was disappointing earnings – particularly, you guessed it, in its finance division.

Finance was the big winner in the expansion of 2002-2007; it will be the big loser in the contraction phase.

While deflation was battering investors’ wealth…inflation was aiming its wallops at consumers’ budgets. Rice and oil hit record highs. Corn and tin too.

Interestingly, $6 corn is too much for the ethanol business. The industry was a fraud from the get-go, requiring taxpayers’ money to justify turning corn into fuel. But now, even with subsidies, corn is too expensive and the ethanol producers are going bust.

They deserved it. But pity the poor people who have to eat. A handy chart on this weekend’s edition of El Pais shows what has happened to basic food prices. In the last two years, corn, wheat and rice have all more than doubled. And get this, in 2007, stockpiles of these grains fell to their lowest level in 25 years.

No wonder there are food riots breaking out all over the place.

But let’s return to our big picture view.

Inflation and deflation only appear to be “at war” with one another. Sometimes inflation has the upper hand. Sometimes, deflation. But over the next few years they will make common cause in the destruction of wealth in America, Britain and a few other economies.

Why do we single out the Anglo-Saxon economies? Because they were the ones that most feverishly embraced what became known as the “Anglo-Saxon model” of economic growth, what our friend Kurt Richebächer used to call “late, degenerate capitalism,” marked by a freewheeling financial industry, widespread securitization of debt, and overall debt at breathtaking levels.

One awkward feature of this model was the fact that the rich got a lot richer…while the poor stayed about where they were.

The Financial Times explains:

“After decades of ‘financialisation’ in the US and other Anglophone economies, whereby financial services have increased their share of gross domestic product, banks are being bailed out – using public money…

“From a political perspective the notable feature of the inegalitarian, free-market era that began in the 1980s is how little backlash there has been against the stagnation of ordinary people’s earnings in such a large portion of the developed world economy….This is potentially dangerous territory…

“Between 1979 and 2005 the pre-tax income for the poorest households grew by 1.3 per cent a year, middle incomes before tax grew by less than 1 per cent a year, while those of households in the top 1 per cent grew by 200 per cent pre-tax and, more strikingly, 228 per cent post-tax.

“The result of this lopsided distribution of income growth was that by 2005 the average after-tax income for the bottom fifth of households was $15,300, for the middle fifth $50,200 and for the top 1 per cent just over $1m.

“Looked at from another perspective, in 1979 the post-tax income of the top 1 per cent was 8 times higher than that of middle income families and 23 times higher than the lowest fifth. By 2005 those ratios grew respectively to 21 and 70. The process reached its extreme point with US President George W. Bush’s tax cuts. Emmanuel Saez of the University of California at Berkeley estimates that in the economic expansion of 2002-06 the plutocratic top 1 per cent captured almost three-quarters of income growth.

“Figures for wealth, derived from the Federal Reserve Board’s Survey of Consumer Finances, are less up-to-date but the picture is similar. The share of US wealth owned by the top 1 per cent of households rose steadily from 20 per cent in 1976 to 38 per cent in 1998.”

The backlash has already begun – just listen to America’s presidential candidates. They’re all bidding for the resentful voter – complaining about high executive salaries, kvetching about the Bush Administration’s bail out of the banks, and whining about tax cuts for the rich. They all want to soak the rich…and bailout the ‘little guy.’

But they can stop worrying. Wealth is self-correcting. Economic success is self-healing. In this new downturn, the rich will lose more than the poor – simply because they have more to lose. They were the big gainers from the Industrial Revolution…and then the late, degenerate financialization stage of capitalism. They will probably be its biggest losers too.

Bill Bonner
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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