Saturday, January 24, 2009

Fake Economy

This is sustainable:
  • When our economy is expanding, our government should be running a surplus to build up a reserve.
  • When our economy shrinks (recession), our government can tap into the reserve, run a deficit and pay for stimulus, unemployment insurance, lower tax revenues, etc.
Instead, this is what we have been doing for approximately 45 years:
  • When our economy is expanding, our government runs a deficit.
  • When our economy shrinks (recession), our government runs an even bigger deficit.
Below is what the government's budgets should look like on charts.  The government  should be building up a reserve with surpluses during economic growth years, as shown in Year 2 and 3.  When the economy goes into a recession in Year 4, the government can tap into and spend the $30 in reserve from Year 3, to stimulate the economy, resulting in a $30 deficit in Year 4.  Once the economy starts growing again in Year 5, the government budget should go back into surplus and start accumulating a reserve again:

Instead, below is what the budgets look like for most Western, debt-based governments.  When they should be running surpluses during economic expansion, they run deficits.  During economic contractions (recessions), they run even bigger deficits.

The government never has a reserve.  It always has a debt, and has deficits for most years which keeps growing the debt.  Is this sustainable?  What happens when the government hits a limit on how much more they can borrow?  What happens when one of the main contributors of economic growth, such as government borrowing, is removed?  Most likely the economy will stop growing, or shrink.

Most of the deficits and debts are a result of ever-increasing spending on socialist programs. (Read Socialism vs. Capitalism)

In the future, the economy will have a tougher time growing.  It might very likely be sluggish and have frequent recessions.  This is what happens when you have a fake economy that has been fuelled and supported by debt for approximately 45 years.  When you run out of fuel (debt), it stops growing.

In addition to our economy being fuelled and supported by government deficits, it has also been fuelled and supported by U.S. trade deficits, which in turn were supported by growing consumer/private debt.

For the past several years:
  • The Chinese economy grew because they were able to sell to the growing Western economies.
  • The Western economies, especially the US (and Britain), grew because Americans were spending like crazy.  They did this by:
    • massive borrowing through sub-prime mortgages, ABCPs, second mortgages and credit card debts.   Americans were using their houses as ATMs by borrowing against them.
    • massive consumption through trade deficits.
    • stealing from their children (governments drove up debts even more).
  • The Canadian economy (and housing market) grew because their biggest customer (USA) was growing (artificially).
Therefore, the worlds' economies probably would not have grown so much and for so long if the West didn't borrow so much (that they never could pay back).

Now, the politicians want to save the economy.  Save it from what?  Save it from reality?

The politicians want the economy to return to the artificial level.

How will the politicians save the economy?  They will spend money to "stimulate".  Where will they get this money?  They will steal even more from our children to stimulate OUR generation's economy.  Where is the money going to come from to stimulate the next generation's economy?

When an economy is in equilibrium, it produces as much as it consumes, regardless if the economy has 300 Million people or 1 person.  In equilibrium, it has zero trade deficit or surplus.  This is illustrated below:

Here is an example of an non-equilibrium economy that consumes more than it produces:

The above is analogous to a farmer who produces 10 bushels of wheat but consumes 20 bushels (in year 2).  To do this, he imports 10 bushels from another farmer, resulting in a trade deficit of 10 bushels.  The farmer's economy may appear to be growing, because Consumption is increasing and is included in the calculation of GDP.  In year 3, he still produces 10 bushels of wheat, but he consumes 30.  To do this, he imports 20 bushels from another farmer, resulting in a trade deficit of 20 bushels.  Again, the farmer's economy is growing because Consumption is still increasing.  However, is this sustainable?  When will he ever repay the other farmer for all of the imported bushels?  Is this economy real or fake? In year 4, he still produces 10 bushels of wheat, but he consumes 20.  Because he is consuming less than the previous year, his economy is considered to be in a Recession.  Because he still has a trade deficit, his foreign debt continues to grow.

What is the right course of action here?  Should the government step in?  If so, to do what?  Should the government stimulate the economy?  If so, how?  Should the government try to get the economy back into equilibrium?  If so, how?

Below is what might happen if the government lets the economy get back to equilibrium on its own by not interfering with the free market and capitalism:

In year 5, the amount produced might equal the amount consumed.

Below is what most elected officials want to do, because they want the economy to be growing on their watch:

They will stimulate and grow the deficit and debt.  This is what Bush did in 2001.  The economy was growing in an unsustainable way through debts.  Below is actual US trade data.  It shows that in 2001, the Trade Deficit was decreasing:

Government spending, such as a stimulus, is also included in the GDP.  Therefore, the government debt partly reflects the amount of stimulus spent on the economy.  Below is US federal government debt (2009 to 2012 are forecasted data).  It shows that in 2001, the debt (as a % of GDP) was decreasing:

Canadian Gross Federal Debt vs Canadian Population (Source:
According to Peter Schiff (who accurately predicted the housing bubble, housing collapse, financial collapse, Fannie Mae and Freddie Mac bankruptcies, and government bail outs), recessions are not the problems.  Recessions are the consequence of government actions that artificially inflate the economy.  Essentially, the government creates bubble economies and recessions are when the bubbles pop.  The cycle keeps repeating because governments keep creating bubble economies.

Instead of letting the economy come down to equilibrium in a needed recession in 2001, Bush did not want a recession on his watch.  To do this, he stimulated the economy by increasing deficit spending and increasing credit and debt to consumers through Monetary Policy (low interest rates), Fannie Mae, Freddie Mac and other mechanisms.  This enabled American consumers to consume even more (with borrowed money) domestic and imported products, which resumed the increasing trade and budget deficits.  Consequently, this grew the fake economy even more and created the housing bubble.

In the above "US Trade" chart, you can see that the Trade Deficit is decreasing in 2007.  Year 4 in the same chart below can be used to represent 2007 and 2008 as well as 2001.

Instead of letting the economy come down to equilibrium in a needed recession and to enable people to save (saving enables investments and production), governments want the economy to go back to the previous artificial and unsustainable levels.

In the long run, these trade deficits and budget deficits are unsustainable to not only the US, but every country that sells to the US as well.  If the US cannot sustain their Consumption and Import levels, this means they will eventually import less.  This means other countries cannot sustain their Export levels to the US.  This is why the economy may be fake for most countries around the world.

Even if the stimulus causes the economy to grow again, it will make the debt bubble even bigger.  The next time it pops, the pop will be even bigger.

These are the sources of wealth and economic growth for most countries:
  1. Hard Work
  2. Innovation
  3. Natural Resources
  4. Killing and Robbing (for a few countries)
  5. Steal from children (through deficits and debts)
As mentioned, elected officials want to grow the economy.  The hard way to do this is to foster more Hard Work and Innovation.  Hard Work and Innovation increases production and exports.  However, an easier way is to borrow and spend (government deficits and debts, consumer debt, etc.).

Every politician is more motivated to grow the economy during his/her term in office than for the long run, as future terms are not his/her concern.  Therefore they usually choose the easier way.  Consequently, the debts tend to increase from one term to the next, as politicians pass mounting debt problems to future governments/administrations.

Consumers like borrowing and spending because they want immediate gratification.  Businesses like this because they want the revenue today instead of tomorrow.  Lenders love this because lending is one of the most lucrative industries in our economy.

Check out New York Times' article on debt.  Appended below are a few screenshots from the article.

Debts are a result of socialist programs.  When these debts accumulate, it means that we have fake wealth.

Most debt-based economies are fake and paid for by foreigners or by stealing money from children.  There is also inter-generational transfer through housing, which is the most manipulated market in the world.  When mortgages and home prices continue to rise, it means that each subsequent generation has to pay more and more for homes to the previous generation, which makes each future generation poorer.

Consumer debt has been going up mainly because of mortgages.  Mortgages have been going up because price of homes keep going up.  However, easier mortgages (lower down payments and longer terms) have fuelled the demand for homes, which in turn raises home prices.  This has proven to be case in the US up until 2007.  We need to reverse this trend.

To reverse the trend, we need to make it harder to get mortgages, such as increasing down payments and shortening the term.

In other words, to reduce the amount of debt that we hold, we need to reduce the size of our mortgages.  To do this, we need to reduce the price of homes.  To do this, we need to make mortgages harder and harder to get.  If we extrapolate this to the point of banning mortgages, it may benefit the majority in the long run.

Read more:

Housing, the most manipulated market in the world

Fake Wealth

Stealing from Children

Bubbles - Extreme Maker and Breaker of Wealth

Housing, the most manipulated market in the world


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