August 17, 2010

The Main Thing

By Vasko Kohlmayer

That the world economy is in turmoil is quite obvious. But it is less obvious what the problem is and where it will lead. The wise men are not very helpful; some of them tell us that things are getting better and we will pull through, while others lament that things are critical and all is lost. The president's financial wizards assure us that the situation is under control.

They all offer erudite analyses to prove their point, most of which contain concepts and data that are difficult to grasp. Very often, these yield contradictory results.

So how does one know whom to believe? How are we to make sense of this jungle of abstruse analysis and conflicting material?

As we try to cut through the confusion, we would do well to take a cue from Lee Iacocca, former President and CEO of the Chrysler Corporation, who once said, "The main thing is to keep the main thing the main thing."

Here is the thing: A number of Western governments have contracted more fiscal obligations than they can conceivably cover. It is this immense burden of government debt that will drive global economic events in the years to come.

Strictly speaking, government debt is not an economic issue, but a fiscal one. But fiscal excesses always have economic consequences. This is because they invariably weaken currencies by inflationary pressures.

Since money is the lifeblood of the economy, weak and unstable currencies inescapably produce economic disruptions. The larger the debt, the more severe those disruptions are. If debts are too overwhelming, the currency falls apart, and economic pandemonium ensues. This has happened many times in history. The more recent examples include Argentina in 2001, Russia in 1998, and Mexico in 1982.

The obligations carried by the American federal government are more than overwhelming. Boston University finance professor Lawrence Kotlikoff opened his recent column on Bloomberg with this: "Let's get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills."

The professor is right. He estimates that the government's real obligations are $202 trillion over the long run. Given that the current size of our economy is some $14 trillion, it does not take a rocket scientist to understand that we are bankrupt. Our government will never be able to catch up with its obligations. It cannot even come close. It is mathematically impossible.

Some people hope that as the economy expands and tax receipts increase, we will outgrow our debts. But this will not happen. Anyone who takes a look at our fiscal history will quickly see that as the American economy grows, so does our indebtedness.

The more money government has, the more extravagantly it spends. We are not outgrowing our debts; our debts are outgrowing us. And they are doing so at a frightening rate. Last month alone, $165 billion was added to the budget deficit. This is more than the whole yearly deficit in 2007. This is just plain insane.

The upshot of it all is that the dollar will crumble. And since the dollar is the lifeblood of the world economy, there will be global economic breakdown. No other major currency can take over as a substitute to save the day. The euro, the Japanese yen, and the British pound are all badly over-indebted. Even as we speak, we are already in the midst of a serious currency crisis. This will eventually spawn a deep and painful economic crisis.

It is not possible to know how long the house of debt will continue to stand. We can only conclude that we will sputter along as long as humanly possible. This is because all the major players are working hard to keep the Titanic afloat. National governments are coordinating their monetary policy to soften the currency turmoil. Mega-holders of U.S. dollars are dutifully buying U.S. Treasuries to prop up the world's reserve currency. And central bankers and finance ministers are feverishly putting out fires and plugging up holes. Given the circumstances, they are doing a reasonably good job of it. After all, Ben Bernanke, Timothy Geithner, and Jean-Claude Trichet are no dummies. The ship, however, is going down. It simply cannot stay afloat with the immense debt load it carries.

As we head toward that point, things will go up and down. The dollar will strengthen one day against the euro as the viability of the eurozone comes into question again. The following week, the pendulum will swing as the desperate fiscal situation of the U.S. government comes to the fore. Gold will fluctuate with the ebb and flow of fears and hopes. But underlying it all will be a steady weakening of money as major currencies continue their inexorable downward slide. Eventually, the situation will become increasingly turbulent and unstable. At that time, the warning announcement should go off in our heads: "Brace for economic impact! Brace for economic impact!"

So the next time you find yourself drowning in competing and conflicting analyses, just keep in mind Lee Iacocca's wise admonition:

"The main thing is to keep the main thing the main thing."

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