Saturday, January 24, 2009

The Banana Republic on the Potomac

In The Wealth And Poverty Of Nations, David Landes writes:
... some Latin American countries were able to borrow ridiculously large sums from official lenders (World Bank, IMF) and from private commercial banks, acting with the encouragement of their governments and, no doubt, tacit assurance of a rescue safety net. Much of this money found its way back to secret private accounts in the United States, Switzerland, and other cozy shelters.

This combination of mismanagement, profligacy, corruption, and open-ended borrowing - development without efficiency constraints - cannot long endure. Such structures are intrinsically brittle, because everyone is straining to the limit and everything is interconnected. Sooner or later, someone gets worried; the balance sheets do not balance; the lenders get cold feet; it becomes impossible to pay old debts with new. Panic!

This happened in the Mexico peso crisis of 1994-95. [pp 493-4]
Chris Byrne puts the current economic situation in perspective:
So let me get this straight...

In order to "bail out" and "stimulate" our economy, the politicians have committed to, or are proposing, that we spend an amount equal to our entire current budget; in the process increasing our national debt to more than our annual gross domestic product; and imposing a debt load on every household larger than their median yearly income.
The most interesting question that nobody seems to be asking is who's going to lend us four trillion dollars?

I mean, the banks are broke. The economy is slowing down, to the point that it's basically free to ship goods around the world, because there are so many more ships than goods needing shipping. So forget China buying trillions in bonds.

Can we borrow 29% of our GDP? Are there enough people with money that are willing to lend it to us that this is even possible?

Now I'm sure that there are all sorts of smart finance people in the Administration who can explain to me where all this will come from. What they can't explain is how this won't push the cost of federal borrowing up: the laws of supply and demand say that when demand goes up, so does price. You demand more loans? Interest rates go up. We're already seeing this happen to long-term government bond rates.

As the cost of capital goes up, business investment falls. Employment is strongly linked to business investment, so if the Fed.Gov does not apply the "stimulus" cash very efficiently indeed, business hiring will be down - unemployment will rise. Where's the smart money betting on Fed.Gov efficiency?
... mismanagement, profligacy, corruption, and open-ended borrowing - development without efficiency constraints ...
That's not all. The economy is slightly down (it's a recession, not a depression), but this means that production is down; there's less stuff to buy. Now inject an additional 28% into the money supply*. I'm sure that the Administration's smart finance guys will be happy to explain to me that this won't be inflationary.

Sorry, I don't buy it, Scooter.

So what are we looking at? Higher interest rates, higher unemployment, and higher inflation.

But that's not the worst of it.

The USA represents about 28% of world GDP. We're about to borrow cash to the tune of 8% of the world's total output. What happens to their interest rates?
When the US Economy catches cold, the world's economies get pneumonia.
High interest, high inflation, high unemployment, that's what the Administration is fixin' to give to the rest of the world. Tired of having to pretend you're Canadian when you're in Paris? Just wait. Boy, howdy.

But that's not the worst of it, either.

We've seen government financial activity like this, over and over. Latin America has lived on it for decades. Ever wonder why? Landes again:
The heart of the matter is Latin America's need to go on borrowing, if only to pay the interest on the older loans. A research student from Latin America once complained to me about this burden of old debt and the vexatious, small-minded foreign insistence on repayment. "You don't have to repay," I pointed out; "a sovereign nation can always repudiate." "Yes," he replied, "but then where shall we go to borrow more?" Exactly.
But maybe I'm wrong. Maybe the "stimulus" spending won't be full of pork and political payoffs, and will be wisely directed by our Ivy League betters in a far-sighted and efficient manner. Maybe the laws of supply and demand don't actually apply to Barack Obama, so long-term government borrowing rates won't rise. Maybe there's so much money around that industry won't get crowded out by Fed.Gov borrowing, and employment won't go up. Maybe extra spending amounting to almost $50,000 per household won't drive up prices for all the rest of us. Maybe for a change, the rest of the world won't get hit twice as hard by this as we do.

And maybe we won't need to keep borrowing, because Congress' appetite won't grow with the eating.
Such structures are intrinsically brittle, because everyone is straining to the limit and everything is interconnected.
I think that the Unicorn that pees 89 octane into my tank is going to show up, any day now.

* Yes, I know that it's more complicated than this, and depends on whether you're using M1, M2, etc. But you can't argue that there isn't 4 trillion more dollars being spent, or you'll make the Baby Jesus Congress cry.

UPDATE 25 January 2009 09:55: Alan has pictures of the money supply. Can't say I'm happy to be right.

UPDATE 25 January 2009 10:02: Want to know why they call it the dismal science? SeekingAlpha has a chart of federal borrowing here. Make sure to read the comments. I'm not sure if I believe it, but if true, this is stunning:
The cost of the bailout ($4.6165 trillion) exceeds the inflation adjusted cost of the Marshall Plan, New Deal, S&L Bailout, Nasa's Lifetime Budget, the Korean, Vietnam, and Iraq wars and also the Lousiana Purchase, combined ($3.92 trillion).
UPDATE 25 January 2009 10:13: There's a link in the SeekingAlpha comments to boingboing, which has the breakdown of the bailout cost vs. inflation-adjusted other costs. It seems pretty plausible:
Marshall Plan: Cost: $12.7 billion, Inflation Adjusted Cost: $115.3 billion
• Louisiana Purchase: Cost: $15 million, Inflation Adjusted Cost: $217 billion
• Race to the Moon: Cost: $36.4 billion, Inflation Adjusted Cost: $237 billion
• S&L Crisis: Cost: $153 billion, Inflation Adjusted Cost: $256 billion
• Korean War: Cost: $54 billion, Inflation Adjusted Cost: $454 billion
• The New Deal: Cost: $32 billion (Est), Inflation Adjusted Cost: $500 billion (Est)
• Invasion of Iraq: Cost: $551b, Inflation Adjusted Cost: $597 billion
• Vietnam War: Cost: $111 billion, Inflation Adjusted Cost: $698 billion
• NASA: Cost: $416.7 billion, Inflation Adjusted Cost: $851.2 billion
UPDATE 25 January 2009 11:22: And you think that I'm being negative?

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