Gary North

June 30, 2009

Modern man believes in government-funded safety nets. He thinks that other taxpayers can and should be taxed to bail out those taxpayers who make bad economic decisions, so long as those taxpayers being bailed out are people like themselves. They don't want bailouts for bankers, and they don't want bailouts for people who got into no-money-down mortgages to buy in neighborhoods "above their station."

Politicians feed this faith in government safety nets. They promise to bail out the poor man who fell into trouble through no fault of his own. Then they bail out bankers and the financial industry. Those are the people who screen who gets nominated. They have controlled American politics from behind the scenes since 1914. Franklin Roosevelt targeted them in his first inaugural address, but that was purely for public consumption. He was one of them in terms of his family origins, and he had worked for them selling corporate bonds from his defeat as Vice President in 1920 until his victory as governor of New York in 1928. This is covered in detail by Antony Sutton's long-neglected masterpiece of a monograph, Wall Street and FDR.

This faith in safety nets has sustained men's faith in the expansion of central governments all over the world. Voters have called for guaranteed retirement and guaranteed medical care for the aged. Now this is about to be extended in America to the poor through a system of national health insurance. The voters are supportive.

For two thousand years, Western man had faith in God, in private charities, in local churches, and above all the family to provide safety nets. But he has steadily surrendered his faith in all of these in favor of the state. The state is seen as a healer. It is seen as the provider of reliable safety nets. The state uses coercion to construct these nets. It consumes capital.

These nets are now stretched thin. Why? Because the largest banks needed the money. They got use of the safety nets while there was still capital to confiscate in the name of the People. Meanwhile, actual voters overwhelmingly opposed the big bank bailouts. They were ignored by the politicians.

Betrayed by civil government. Again.

THE WORST RECESSION

This recession is consuming the private capital necessary to provide the economic safety nets for an entire civilization. National governments are tapping private capital that is needed to fund the recovery.

We need economic growth to replenish these capital reserves. But the magnitude of this capital-siphoning operation is greater than anything seen since World War II.

This recession is the worst global recession since the Great Depression. It is showing no green shoots. Some European countries are in free-fall, especially France and Italy. The rest are suffering the worst declines on record since 1946.

Trade has collapsed. This indicates a dramatic worldwide contraction of the division of labor. This is not due to tariffs or quotas -- not yet, anyway.

Three economists with the International Monetary Fund have described this recession in terms of a baseball analogy: "Out of the Park." There is nothing in the post- war experience to match it. There have been only four global recessions since 1945: 1975, 1982, 1991, and 2009. This is by far the worst in every major category: unemployment, industrial production, trade, and capital flows.

Unemployment is especially troubling. This is because it has previously continued to rise for a year after the recession's trough. So, when green shoots really do appear, the unemployment rate will continue onward and upward.

This means that what happens in the United States is heavily influenced by the rest of the world. American economists say that the United States will recover first. But how far and how fast can it recover if the rest of the world is continuing a slide into even greater recession? The authors conclude:

The 2009 forecasts of a 2.5 percent decline in world real per capita GDP, if realized, would qualify this year as the most severe global recession of the postwar period. Almost all indicators of economic activity are expected to register sharper declines than in previous episodes of global recession. In addition to its severity, this global recession also qualifies as the most synchronized -- all the advanced economies are in recession, and many emerging and developing economies are as well. (IMF, "Finance and Development" [June 2009])

This is merely the beginning. Alice Rivlin was formerly the director of the Congressional Budget Office, later the head of the Office of Management and Budget under Clinton, and later still a member of the Board of Governors of the Federal Reserve System. She now works for the Brookings Institution, a mildly Left-wing Washington think tank. On June 25, she testified to the House Budget Committee. She used language rarely heard in committee testimony. She minced no words.

The long term budget outlook: impending catastrophe

No one needs to remind this Committee that the outlook for the federal budget is worrisome -- indeed, scary. Long before the financial crisis and the current deep recession, this Committee was anxiously pointing out that current federal spending and revenue policies are on a risky, unsustainable course. Promises made under the major entitlement programs (especially Medicare and Medicaid) will increase federal spending rapidly over the next couple of decades, as the population ages and medical spending continues to rise faster than other spending. Federal expenditures are projected to grow substantially faster than revenues, opening widening deficit gaps that cannot not be financed.

Every Western country is running a huge fiscal deficit. The U.S. will hit 13% of Gross Domestic Product this year. Great Britain's deficit is similar in magnitude. Other European Union countries are expected to run deficits around 6% in 2010 -- twice as high as the 3% limit of the EU's sound budget rules.

The EU's sound budget rules are dead and gone. The governments of the West have made it clear to everyone that they have adopted deficit spending at levels far in excess of anything considered reasonable as recently as a year ago. There is now little restraint.

The longer this recession drags on, the less capital will be available for the private sector.

Who will fund these simultaneous deficits? The national governments' competition for funds is intense. The money to buy U.S. Treasury debt will come from foreign central banks, the private sector, and the Federal Reserve. The unanswerable question is this: For how long will these massive deficits prevail? From the looks of things today, most economists say at least another three years. Yet these are deficits that would have been inconceivable a year ago.

There has been no political resistance. This has sent national politicians a message: they do not need to balance their nations' budgets. So, they won't.

SAFETY NETS FOR OLDSTERS

As we get older, we become less resilient to major changes in our lives. This is why we look for safety nets.

The two most widely believed safety nets in the United States are Social Security and Medicare. Both are going bust. The general public knows this. But people hope for the best. They do not change their behavior or their plans in terms of what they mentally understand. The cost of personal change is too high, they think. "The government will come up with something. It always does."

As we become less resilient, we should go looking for real safety nets. Household savings serve as safety nets, but not in an era of Federal Reserve expansion of the money supply. The long-term effect of FED policy is price inflation and currency depreciation. This is why the dollar purchases less than 5% of what it did in 1914, the year the FED opened for business.

What other safety nets do we have? The main one for most Americans under age 62 is a job. The job provides most of their income. Then there is insurance. This is one of the greatest inventions in man's history. Then there is a person's network of contacts. Then there are memberships in voluntary associations.

A job often provides both income and health insurance. If you lose your job, you get hit with a double-whammy. You can buy temporary health insurance under the COBRA program, but it's expensive. You make the payments at the time that your income ceases.

UNEMPLOYMENT WILL RISE

Almost no commentator thinks that the unemployment rate has peaked. Month after month, the rate rises. In summer months, the job market is flooded with college graduates and people who have dropped out of college. This means more people are looking for jobs. This increase in job searchers would raise the unemployment rate even if the number of jobs were stable. It is not stable. It is falling.

The reason for this increase in unemployment is Federal Reserve policy. It was inflationary under Greenspan. Then Bernanke's FED extended a reduction in monetary expansion in early 2006. That has produced the present recession.

The recession may be lessening in intensity. But this has no immediate effect on the unemployment rate. That rate is a lagging indicator. It will rise for months or even years after the recession has officially ended. This is why people are in danger of losing their safety nets: their jobs and their health insurance.

For those whose jobs disappear, it will not matter if the official indicator of recovery from recession is retroactively announced in mid-2010 by the National Bureau of Economic Research.

WHY IS THIS A THREAT TO YOUR CAREER?

The competition for jobs at the top is becoming intense. This is not going to change. It is a permanent condition. The era of sustained long-term economic growth relied on private capital. The governments of the world are now competing for this money. There is no way that the private sector will be able to compete with governments. They promise safety. They pay whatever interest rate they must to roll over their debts. Then their central banks intervene and buy.

Capital formation is the source of private-sector jobs. With percentage decreases in private capital formation, good jobs will become increasingly scarce.

This creates a career roadblock to anyone wanting to move up. It creates an even bigger roadblock to anyone who has lost his job and who wants to keep both his career and his salary.

When you are fired, you are stigmatized. You are regarded as a loser. This should not be the case, but it is. The person who is seeking a job after being fired is considered to be defective goods. To get a similar job, unless you have personal contacts in the hiring firm, you will have to take a pay cut. Employers are trying to save money. They will not pay a newly hired person what his predecessor was paid. They know they don't have to. The firm will use that money elsewhere in the system.

It is a matter of the division of labor. He who has money has the most marketable commodity. A firm has money. A laid off worker doesn't. The worker wants to exchange a less marketable asset -- specialized labor -- for the most marketable commodity: money. In this competition, money talks. The person offering money can offer less than before because of the intensity of competition for money by workers.

Your #1 safety net is your job. That net is being tattered by the rise in unemployment.

CONCLUSION

The public does not yet perceive the threat to its lifestyle posed by rising unemployment, massive government deficits, and Federal Reserve monetary inflation. The leaders have reassured the public that there is no threat, that the safety nets are in place, and that there is no need to worry about the siphoning off of capital by the state. The voters still go along with the system.

This will continue for as long as the unemployment rate stays in single digits. That will not be for much longer. As unemployment rises, all chatter about green shoots will fall on deaf ears. People will be able to see that their futures are threatened by high and rising unemployment. They will see that their hopes for the future are being undermined. They will not understand why: the siphoning off of capital by the state.

The Congress of the United States is no longer willing to restrain itself. Congress sees the rise in the debt as no big problem. Congress has been doing this for a generation. There is no will to resist, because there is no sense of impending crisis, when the government absorbs all of the new capital of the nation.

The United States government must roll over its debt every 48 months.

This is the government's siphon hose into the capital markets. This is forever. This on-budget debt is at $11.5 trillion and will grow by a trillion dollars a year for the foreseeable future. That requires a siphoning off process of $240 billion a month, plus whatever new debt is added by the annual deficit.

Congress does not care. It will kick the can down the road until the can is too big to be kicked. Then it will roll back down the hill, crushing those voters who were unwise enough to trust Congress.

I hope you will not be in that group.