While much has been made of the levels of consumer indebtedness of the past several decades, and particularly over the past 5-10 years, not nearly as many have focused on the true debtors of our economy: corporations and the state.
This succinctly written piece addresses the issue and is worth a complete read. A few excerpts follow:
US businesses went in for “Cash Management” – which was supposed to minimize cash balances – short cash – and go long on purchasing short-term or overnight debt from banks to meet coming maturities. Holding plain cash or checking account balances was old fashioned.
Worse, businesses also wanted to expand at all costs. Extend more credit – short your merchandise and go long on accounts receivable – in order to increase sales. Car manufacturers had their own financial arm, to enable them to short their own excess production of autos, and to go long on debts due from customers up to six, seven years out.
The phrase ‘going long’ on debt accurately describes the position of not only financial institutions, but nearly all major corporations in the United States and, as we have found out, internationally. But financial institutions in particular are in a uniquely vulnerable position when they are ‘short’ cash. Why? Because of the dreaded ‘run on the bank’ – which we have seen transpire in fits and starts going back to when money market funds finally broke the buck, when several large depository institutions were run down (Washington Mutual and Wachovia come immediately to mind) and currently with the dwindling solvency of both Citicorp and Bank of America.
The squeeze on those who shorted cash is now tremendous. The figures on outlandish leverage in US banks and the figures on household debt illustrate the situation. The Fed and the ECB are trying to meet and overcome the short squeeze by providing enormous amounts of money, available at the banks, in an effort to provide funds to those who are trying to cover their shorts on cash by going long – obtaining cash – to cover their long positions on debts owed.
The enormous increases in cash available at the banks are insignificant in comparison with the prevailing enormous shorts on cash and long positions in debt. The squeeze is implacable.
In effect, everyone on God’s green earth is trying to obtain cash – going long on cash – in order to cover their long positions on debt.
What we now see is the opposite effect – the deflationary environment created when both corporations and individuals turn on a dime, moving from long debt/short case to short debt/long cash. The dramatic slowdown in the velocity of money creates a deflationary dynamic of depressionary proportions.
The author describes this as follows:
“Cash is being hoarded by banks and consumers alike” means “Banks are going long cash and shorting debt (trying to reduce their leverage) and consumers are saving cash (going long on cash) and shorting spending.”
Deflation and Depression are actually a manifestation of a massive short squeeze on cash in an attempt to reduce a gross and unsustainable long position on debt.
The problem, however, is that the United States central bank (the Fed) and the ECB have indicated they will stop at nothing in their attempt to get the credit bubble started again. And this is where I take issue with the long-term deflationists:
Bringing all the massive liabilities of the banking system onto the Treasury’s indebtedness – while the corresponding assets are worth far, far less than these liabilities – will solve nothing.
While I agree that the additional money creation and pseudo-nationalizations will solve nothing, I disagree with the implicit argument, as oft-repeated by many known deflationists (many of whom I greatly respect), that government cannot ‘print’ its way out of this current deflation. In a fiat-based, fractional reserve economy, the state can absolutely print its way out of a deflationary environment. In fact, our government, as I type this, is running the proverbial printing presses at record pace. The inevitable result of all this, of course, is price inflation. So while Peter Schiff may have got his timing wrong, and misjudged how poorly overseas economies and currencies would fare relative to ours, he is dead-on right in his warnings of the dangers of hyper-inflation.
The problem in the deflationist argument is not economics. The economics are sound. The problem is we are not dealing with an economy. Rather, we are dealing with a political economy. The differences cannot be overstated. Within the bubble of our fake-money fiat economy, even a contraction of the total supply of money and credit (the textbook economists definition of inflation) can still lead to price inflation, or even hyperinflation. This is known as an inflationary depression. How this might happen is something that the author and I can agree on:
The driving force behind the rise in the price of gold at this time is not the fear of inflation but rather the fear of placing cash where there is a possibility of default. Only physical gold in possession is free of this risk.
I may add that even national treasuries do default on their bond obligations (Nouriel Roubini just confirmed this) and can and do default partially by devaluing their currencies. The world is gradually realizing this and this is propelling investors into gold.
Could it be there is Method in the government’s Madness? Perhaps the unspoken idea is to save some critical institutions by bailouts at all costs and then – the Treasury defaults later on this year?
The big risk, and the one nobody in the Mainstream Corporate Media is talking about, is the risk of loss of confidence in U.S. treasuries. If this happens, you will see massive devaluation of the dollar – and all other fiat currencies. If the state, already in debt and spending at warp speed, can no longer borrow, its game over.
Money is not capital
We are already seeing this with the Euro as the storm clouds gather on the Eastern horizon. Should confidence in the dollar (soon to be the last remaining fiat currency of any value) crumble, you will see a flight to hard assets that makes the commodities bubble of last summer look like a hiccup. Capital will flow into precious metals, industrial metals and oil. The price of oil, even amidst declining demand and industrial output, will rise. The price of gold will double, or potentially triple. All this simply because the dollar (or the Euro or any other fiat currency) is not capital. MONEY IS NOT CAPITAL. It is a piece of paper representing a promise to pay. It is debt. And while the monopoly of this money domestically (due to legal tender laws) encourages its use, international capital is dependent on the dollar only so long as it is perceived as a convenient and liquid store of value.
Therefore, the price of gold, silver, oil or a number of other tangible assets does not really rise or fall at all. An ounce of gold is worth the same today as it was in Babylonian times. What changes is the perceived value of a given fiat currency note. In this manner do we ‘value’ gold, or any other hard asset, in terms of the dominant fiat paradigm.
As I have stated before, the problem with the deflationist position is not one of economics, but rather of imagination. Trust that the state has no such failure – legions of staff work day and night for our overlords in Washington to imagine new and creative ways to beg, borrow and steal in order to spend, inflate and protect not you, the American, but their positions of power.
The nature of the state
Such is the nature of the state. We underestimate the lengths the state will go to at our own peril. Remember that the modern American state, the strong federal government, is able to sustain itself only in cooperation with the central bank (the federal reserve). Through the creation and control of fiat money, the state exerts its control through confiscatory taxation and enforcement. This dynamic builds and feeds upon itself until the out-of-control state can no longer contain itself – it can only expand, at the expense of the States or, more specifically, the People. Make no mistake: this is a zero-sum game. Every time the state drafts new legislation, it costs us money. But with each act of the state, we lose much more than money – we lose liberty. We lose this liberty by ceding further power to the state to tax, collect and enforce. No longer do the States and the people stand as a bulwark against the expansionist state. This is a civic duty of every American – to fight against the inherently expansionist central state:
A Republic, madam. If you can keep it…. –Benjamin Franklin
As discussed earlier on this site, deflation adversely effects the very wealthy – the core constituents of our current crop of ‘politicians’ dependent, as they are, upon campaign donations and lobbying money. Inflation disproportiately effects the middle class. The simple reason why is that the wealthy own assets, and the middle class owns money. Do not fool yourself into thinking that the federal government will not, if pressed to make a decision, choose inflation –even hyperinflation- over continued, sustained asset price deflation.
Of course, nowhere have the two things that would empower the middle class – the group thing standing between a corporatist state and the full consolidation of its power. 1) A complete and long-term income tax holiday, thereby allowing the earners of wages to keep the fruits of their labor to do with as they see fit. 2) The elimination of the UNCONSTITUTIONAL central bank and, with it, fiat currency and fractional reserve banking. These two actions would return us to Constitutional economic principles. But suggestions to do so (other than Rep. Ron Paul) are nowhere to be heard.
Those who underestimate to what lengths the state will go to consolidate and expand their power in the event of continued economic crisis and collapse, including creating massive inflation through which the People must suffer, have not read their history, and have not been paying attention to current events. The central state is expanding at an alarming rate, and control of commerce, money and the overall economy are the tools of that expansion – tools sadly ceded to the state by the People. It is time to take them back. Lest we forget the true nature of any central state when threatened with its own survival, I share the following from Roberto Vacca:
The rapid return to universal penury will be accomplished by violence and cruelties of a kind now forgotten. The force of law will be scant or nil, either because of the collapse or disappearance of the machinery of state, or because of difficulties of communication and transport. It will be possible only to delegate authority to local powers who will maintain it be force alone.
… people will endure hardship, and for the greater part of their time they will be labouring to satisfy primitive needs. A few will have positions of privilege, and their work will not consist in… cultivating the soil or in building shelters with their own hands. It will consist in schemes and intrigues, grimmer and more violent than anything we know today, in order to maintain their personal privileges.