Steady as she goes, toward the cliff

Everybody else gets to sound off about the global financial crisis without actually knowing much about it, so I was pleased when a reader invited me to take my turn:

What's your take on the global financial crisis? You've never indicated you know anything whatsoever about finance, but you're usually "pretty on the ball" about everything else, so I though maybe you'd feel like blogging on this.


Indeed I do not know a lot about economics. My knowledge pretty much stops at how tax brackets work, and that copper is not a precious metal. But since readers of this blog know pretty much everything, I presume there will soon be some +5 Insightful comments at the bottom of this page, correcting the ghastly errors I am surely about to make.

(Or maybe there'll just be one guy saying that this is what we get for not listening to Lyndon LaRouche.)

I've no real opinion about what's going to happen to the US and/or global economies in the short term. Fortunately for me, I'm in Australia, which doesn't look like being squashed too hard. Australia has a healthy commodities sector, and major Australian financial institutions don't seem to have much exposure to the US problems. Yet.

In the long term, though, the USA and countries that depend upon it economically - which means just about all of them - are going to have to feel a lot of economic pain.

Both Presidential candidates know this, on account of how they're not idiots (so yes, I do suspect that only one of the vice-presidential candidates knows it too). But they wouldn't say a word about it even if you tortured them, on account of the great American allergy to ever paying more than about half of the tax that people in much nicer countries seem quite happy to pay.

Because the USA is taking on such colossal government debt, for the war(s) and the various bailouts, it seems to me to have only three options.

1: Just keep doing what it's doing, paying interest on the old debt by taking on new debt.
2: Jack up taxes and/or reduce spending so it doesn't have to increase its level of indebtedness, or may actually be able to pay the debt down.
3: Say "screw it", get drunk, and print more money.

The second approach is a sure-fire vote-loser. If it were me then I'd start out by taxing the absolute balls off the owners of any house of worship that seats more than a thousand people, but the USA is a country where 21% of the atheists apparently believe in God, so that probably wouldn't work too well.

The third option is what people often seem to think the USA is doing now - "creating" new money to bail out the financial sector. It's an awe-inspiringly dumb thing to do, though, and even the Bush administration isn't stupid enough to try it. (Robert Mugabe seems just fine with it, though.)

What the USA is actually doing, and what I presume they'll continue to do, is option 1, steady-as-she-goes. As long as people are reasonably confident that the government isn't going to fall on its sword by refusing to pay up when bonds mature, and that inflation isn't going to start running fast enough that a bond with a lousy 4% return will be worth less than you paid for it when it matures, then people will keep buying bonds, and the Treasury can just issue more and more of them and hope there's enough of a market to get 'em all sold. China is as addicted to selling stuff to Americans as Americans are addicted to buying it, so I presume it'll keep that economic perpetual-motion machine rolling, even if inflation does make bonds lose real value over time.

The borrow-more-to-pay-your-loans-off approach is an obvious loser for normal personal finance, but I think whole countries - and businesses, for that matter - can actually make it work, if their increase in national productivity means that their debt is not increasing, proportionally speaking. If you used to owe a million dollars and make 20 million dollars, and now owe two million and make 50 million, then proportionally speaking you've reduced your debt. You should find it easier to service, or pay down, the second debt than the first one.

During the terms of Republican presidents since Reagan, though, the USA has been taking on debt much faster than it's been increasing production, no matter which way you look at it (some people apparently regard this as a good thing).

The exact numbers are squirrelly - like unemployment statistics, they get harder and harder to measure the closer you look - but the cost of the wars and the 2008 bailouts will unquestionably greatly exceed Reagan's Savings and Loan "jackpot".

All of this has just got to shake through into a serious quality-of-life reduction for the average American some time soon. Either jacked-up taxes or a severely devalued currency, I think. The US national debt is overwhelmingly in US dollars, so if the $US drops to five Euro cents, it'll be much easier to dig enough stuff out of the ground to pay off the debt. (But a Toyota Camry will cost half a million dollars.)

There are ways in which the USA could spectacularly reduce governmental spending and thus make the situation far easier to handle, but I strongly doubt the most obvious one - giant military cutbacks, including closing many of the USA's more-than-700 military bases all over the world - has any chance of flying. The USA could cut four 400 billion dollars out of its annual military budget and still be spending twice as much as anyone else, but this sort of thing is so far-out that you won't even find the option to do it in "budget simulators".

Sci-fi writer Charles Stross wrote a very interesting essay about the current situation the other day. I agree with him that the USA's determination to not bend before the economic hurricane means we may see the world situation change far faster than anybody would have predicted only a few years ago.

(This Gawker piece is excellent, too.)

23 Responses to “Steady as she goes, toward the cliff”

  1. dr_w00t Says:

    ... we may see the world situation change far faster than anybody would have predicted only a few years ago.

    Except this guy. Then people like him were just alarmist chumps; they now looking less chumpish. He contends that personal debt and over inflated asset prices mean the US was/is headed for deflation on par with the Great Depression.

    I'd love to see an alarmist Australian assessment like his early articles..

    Home prices are skyrocketing. Gas costs $2.79 a gallon. Health care costs are getting out of hand. College tuition is rising to infinity...and beyond! Even interest rates are trying to edge up.

    Sounds like Australia to me... and we are apparently one of the most personal debt laden countries in the world, greater than the US and UK.


  2. Mohonri Says:

    It's at a time like this that I'm glad that 1) we paid 20% down payment on our house when we bought it 3.5 years ago, 2) we bought a house in an area of the country that didn't see high-double-digit property value growth over the last several years, 3) we had no debt coming out of college, and 4) I work for a company that isn't going anywhere for a very long time, since we're the ones digging the valuable stuff out of the ground.

    I'm in the "get rid of the debt" camp. And I have a plan, too! My proposal for getting rid of the debt is this: starting now, everyone's eventual Social Security benefits will be decreased in proportion to current age from retirement. Current and soon-to-be retirees get the benefits currently expected. Twenty-five-year-olds can expect nothing. Put all the extra money toward the debt. Why do I think this will work? Because people are used to paying Social Security taxes, and none of my twenty-something friends expect Social Security to exist, let alone pay significant benefits, when they retire in 40 years.

    Unfortunately, a lot of voters seem to be thinking "which candidate is promising more chickens in every pot?" instead of "which candidate is proposing legislation that will actually improve the economy?"

    Of course, as a young person with many years before retirement, I'm actually enjoying the recent ...struggles...of the stock market. The further it goes down, the more I buy. If history is any indication, I'll be making some rather nice returns in a few years.

  3. Red October Says:

    TAX THE CHURCHES! Best idea I've heard all day. I'm for a flat tax (something like 40% of people in the US don't pay taxes) with no loopholes and very few exeptions. I'd also go for matching tarrifs on import goods -i.e. in Japan there is a huge tarrif on American cars. Either we levy the same against the Japanese, or they lift it on our goods. This would either boost the domestic industry or increase sales abroad. Can't go wrong.

    As to defense spending cutbacks; they don't seem like the smartest thing to do. Yeah, other countries spend less. First of all, the US is huge. Second of all, plenty of people want to take a poke at us. That said I don't think cutbacks are impossible; just that it would take massive re-organization to impliment them and it would be a helluva lot easier to say "a'ight, all you feckers wot's not payin' taxes, party's over. Start writin' checks or get outta the pool."

  4. dr_w00t Says:

    I don't think it would be a good idea for the US to raise tariffs right now.

    But yeah, tax the shit out of the Church.

  5. james Says:

    did you really mean to say only 4 billion dollars in military cuts? that seems like such a small amount, unless you mean a long billion (10^12)?

  6. james Says:

    actually looking at the numbers perhaps 400 billion, which would take them to $183b, 2.4 times France who is second on the list

    [Yes, that's what I meant - I've fixed it. -Dan]

  7. Darien Says:

    I'd say not spending a trillion dollars to save people from their own bad investments would be a good start, followed up by not continuing to invade and occupy middle eastern countries. Entitlement spending is also wildly out of control -- I'm with Mohonri on getting rid of social security, but I wouldn't stop there. Medicare and Medicaid are massively expensive boondoggles, so out they go, along with all the other government cruft that's gotten us multiple trillions of dollars in the hole.

    Not that, of course, anything like that's going to happen. What will actually happen is taxes will go up.

    Oh, and Dan, you're overestimating the number of vice-presidential candidates who aren't stupid (I'm assuming that, like everyone else, you're on the "Sarah Palin is stupid" bandwagon -- if not, hey, I'm clearly overestimating the number of *me* who aren't stupid ;-)) -- Joe McCarthy 2000 there on the Democrat side is the one who recently said "Article I of the Constitution defines the role of the vice president of the United States, that’s the Executive Branch." Apparently blissfully unaware that Article I defines the, uh, legislative branch. And this is on top of all those degrees he rather famously claimed to have but did not.

  8. bigiain Says:

    Here's the best explanation I've seen so far about what sub-prime mortgages are, how and why they became a problem, and why that's lead to this "credit crisis":


  9. bmorey Says:

    "account of the great American allergy to ever paying more than about half of the tax that people in much nicer countries seem quite happy to pay."

    Only if you count income taxes. The total tax burden is pretty close to that of Australia if you take the size of the government sector as a % of GDP. And I'll take our medical and education costs any day.

    I have a friend who has modest residential properties in Arkansas and Texas and his local government taxes (euphemistically called 'rates') are triple what ours our. Ditto with insurance. I happened to be present when he opened his contents insurance renewal. He pays $2,000 (for a property in a gated community in rural Arkansas) when I pay $500.

  10. Stuart Says:

    You'd be able to get blood from a stone faster than money from a church. Remember, nothing is more pleasing to the Lord than hard cash.

  11. Bern Says:


    The comment by Darien, proclaiming that there are (or have been) stupid democratic VP candidates just seems to point out the "politics is black & white" attitude many people in the US seem to have.

    A friend of mine, who is staunchly Republican, has busily been pointing me to opinion pieces by far-right columnists and bloggers, many of which are now claiming that the current financial crisis was partly caused by Clinton de-regulating stuff, but mostly by Obama and the organisation he worked for in the 70s or 80s, and how they sued banks until they offered 'sub-prime' mortgages to minorities...

    "Yup, it's all the fault of those dang Democrats, nothing us honest God-fearin' Republicans did could have caused any of this..."

  12. jaypeabey Says:

    @dr_woot: The Australian equivalent is over here. And he's been popping up everywhere on the media of late.

  13. Itsacon Says:

    I really loved that image you linked to. Really shows the impact war has on a nation's economy (or the impact having a Bush as president can have).

  14. Matt W Says:

    You need to see this.
    Warning - poor drawings and some coarse language.

  15. rndmnmbr Says:

    Every time I think of our poor, broken country, I think of this Clay Shirky article. It makes an amazing amount of sense when carried to it's logical conclusion.

  16. MichaelWright Says:

    Print money and inflate the debt away is a stronger candidate than you put it, I imagine. I think it's J.K. Galbraith who explains post-WW II inflation as a way of paying for that conflict. If it was especially the US$ that got inflated, it would be a slow and masked way of doing something about trade imbalances, too.

  17. dQx Says:

    Some comments, just to dispell some common media misconceptions. I'm not going to get into the larger problems with the US (or global economies) - just stick to banking.

    A typical bank operates by lending for longer terms (eg home loans) and borrowing at short terms (eg customer deposits). Generally, in most western economies, the amount put on deposit with banks is significantly less than the amount borrowed by customers. So the banks fill the gap by borrowing themselves, in the wholesale markets. The need for wholesale borrowings is particular significant in Australia - the majors here need to fund 35%+ of their balance sheet this way.

    The current "crisis" has very little to do with subprime lending. Total losses globally for subprime have been estimated at approx USD 300bn. Total new equity issued by banks globally in the last 12 months exceeds USD 500bn. So the actually losses from subprime, or related issues are not going to cause that big an issue.

    The actual problem is lack of confidence in the system. Once people stop lending to banks, they can very quickly get to a situation where they are unable to pay the bills when they come due. It is not about suffering losses - just about the cashflow. That is what has taken out every bank that has failed in the last 12 months.

    You can see this lack of confidence in the rates that the wholesale markets are charging the banks to borrow. 18 months ago it cost an Australian bank approx 35bp above swap rates (why we measure costs this way is an essay in itself, but trust me here). Now (assuming people will lend at all), the costs are 140bp+.

    Of course once the bank is liquidated you'll see real losses get passed through. Once you are dumping assets, they become worth a tiny fraction of the original value. eg, I've seen media comments that Lehmans creditors will only get 35% or so of their money back.

    This contributes to the problems too - once somebody starts dumping assets at 50% of their value, everyone else has to mark the value down too. That is the sort of nasty feedback loop that really caused the subprime crisis - the assets started getting dumped and all of a sudden they are worth much less than everyone expected. Actual losses on that lending become kind of irrelevent.

    The bailout packages that governments are announcing globally are about making sure that banks can borrow enough money to keep operating.

    Once all the political blah blah dies down I expect these governments will actually make very large returns on their lending. So long as the system survives. If the system dies then we are all in a very nasty situation.

    Hope that diatribe makes sense.

  18. Jonadab Says:

    In the big picture, the economy always has ups and downs over time. Some of the down cycles are larger than others, of course. The long-term average is more up than down, but the down cycles serve an important role. (Among other things, down cycles have an important impact on expectations, helping to check or curb certain kinds of extremely unrealistic and harmful thinking.) People who don't understand this often get very upset about even the small down cycles, and of course nobody is a very big fan of the larger ones. But we have to have them, and in the long term things would actually be worse without them. There also isn't a great deal that the government (any government) can do to prevent them.

    It is however still interesting to ask how big this downturn will be and how long it will last. There are two really noteworthy large downturns you can look at in modern history, if you're looking for examples of how the larger downturns play out. The Great Depression is probably the less interesting of the two, because the key factor that brought it to an end was a world war of the type we hope not to repeat. However, the stagflation in the seventies was also a pretty significant downturn and yet did eventually come to an end more or less on its own, when it had run its course. (Yes, there were actions that governments took that had some impact on it, but they didn't create it and couldn't end it either.)

    And don't worry about your investments (if, you, erhm, have any; all I've got is a normal savings account...) Unless you've made *foolish* investments (e.g., all your eggs in one basket, or putting money into long-term investments such as the stock market when you're going to need the money in the short term, or taking out a mortgage without a downpayment adequate to cover minor reductions in the property value), you shouldn't have a problem. These things work themselves out over time. Even the Great Depression came to an end, and people who had made sound, sane investments before the crash, and didn't knee-jerk and pull them out when it hit, found that after 10+ years their investments *were* profitable.

    A lot of people want to believe that we shouldn't ever have any downturns in the economy, that everything should just always be up, up, up. But that's naive, unrealistic, impractical, and childish.

    And as far as atheists believing in God, the truth is that most Americans don't have any idea what they believe about such things, because their attention is welded to other issues entirely.

  19. swalve Says:

    Couple of points:

    1) Deflation is indeed the potential problem. The stock market has lost (at last count) something like $7 TRILLION in value. Printing $700 billion to try to fix that problem is a drop in the bucket, inflation-wise.

    2) The republicans like borrowing and spending because they are the ones who profit- first in the initial spending payouts, and then on the interest they pay on the borrowed money. Which are just the various government bonds rich guys keep their money in. On one hand, borrowing costs less than taxing because borrowed money gets paid back in future dollars, generally worth less than current dollars. On the other, it costs more, because constantly generating excessive inflation costs everybody.

    3) It is simply incorrect to say that 40% of Americans pay no taxes. They may not pay very much income tax, but there are tons of other taxes out there. Social Security is 13.5% of all income up to about $100,000. So the poorer pay significantly more of their income on that. Half of that is paid by the employer, but that just hides the cost from the taxpayer. If one is self-employed, they pay the whole weight. Medicaid and medicare is another percent or two. State income taxes vary state by state. In Illinois, it's a flat 3%. I happen to live in the Chicago area, where the sales tax is over 10%. There's even a nickle tax on retail fountain beverages. I buy a delicious 32oz CocaCola, and the City takes a nickle from me. If someone has a large family, they pay less tax on the same income as someone who doesn't- they take more and pay less. If I buy a car, I have to pay sales tax. I have to pay a transfer tax. I have to pay $65 to transfer title- just for a piece of paper that says I own the car. Every year I have to pay $78 for the license plate, $26 for a village tax. Then fuel taxes. And a $2 tax to dispose of a tire should I need new ones. Every year, I pay about 2% on the value of my home. That's a neat trick they do- instead of raising real estate taxes, they just reassess the value of my home. "Congratulations to you, citizen! Through hard work and good government, we maintained the low, low tax rates. And increased the value of your property! Please give us more money. [Jedi handwave] We didn't raise your taxes."

    Oh, and after calculating my income taxes every year, I have to run that through a formula to figure out whether I've paid enough. If I haven't, I am subject to an alternative minimum tax. Instead of raising tax rates (the horror!), they just put a parallel tax system in place.

    I'm not complaining- it's still pretty low. But not the cheap and easy paradise it might seem to be. It's just a lot more nickle and diming that's obscured by seemingly low income tax rates and checks for $600.

    4) Subprime loans weren't the problem. Subprime borrowers paid quite handsomely to get in the home ownership game. Heck, my first loan was subprime. I paid a nearly 2% premium because I was a risky borrower. The vast, huge majority of mortgages do not fail. Something like 99%. The bubble popped because that dropped to something horrific like... 98%. The problem was in overleveraging. If real estate didn't pop the leverage/credit bubble, something else would have. And it wasn't caused by any deregulation- the deregulation people talk about is removing the barrier from investment banks and retail banks entering each others marketplaces. That should increase competition and increase banks' desire to only engage in sound lending practices. No, the failure was that the derivative (leverage) marketplace literally innovated its way past all regulations, and was an opaque, unregulated wild west.

  20. Jonadab Says:

    I should note that, when I said government can't prevent economic hardship, I did NOT mean that what the government does is unimportant. There are *plenty* of things that the government can do to exacerbate the situation, and, as you note, one of the worst is to drastically grow the money supply by printing increasing amounts of ever-less-valuable currency. Fortunately, I believe the current US government knows better than to take that particular road.

  21. Malcolm Says:

    I was googling haphazardly last night, trying to work out if hired goons would evict me from my flat when St George goes bankrupt, when I happened on this strangely prescient discussion -- on a forum for actuaries, no less!

    I guess by 12-18 months ago, the writing was truly on the wall...

  22. Maverick Ronin Says:

    I second swalve. A lot of people outside the US don't quite understand federalism and think its the same old unitarian (Not the religion) government with some labels slapped on it and it's slowly turning into that (omit rant on why I hate this direction) but every two-bit government you run across still has the power to tax and they always do. (Omit rant on why taxes are bad...) In the US you don't run get one giant 50%+ Scandinavian style nation tax bill (generalizing here, don't shoot me...) but you may get nickled and dimed to a similar amount. First sales tax. Start with the state rate, add the county, and then the city. Right now the total in Chicago is 10-ish%+ and the highest in the country because recently Cook County (where Chicago is located) raised its rates. A few towns in the area are actually trying to secede from Cook County so people don't drive 5 minutes into the next county to save 4%.
    After the base sales tax they can pile more taxes on specific goods like gasoline, tobacco, alcohol, & apparently even soda pop at all thee levels plus federal taxes for the gasoline, tobacco, and alcohol. You might have to pay property tax on all three levels as well although not to feds unless maybe you live in D.C. or something. I'm not sure on that. Now we get to income tax. First is the federal tax which is what people are talking about raising, is seen as low because it's probably only abut half of all the taxes someone will actually pay to various levels of government. After that most states have their own income tax which can range from "nothing at all" to "I should have moved this year"

    This is really just scratching the surface and I know there's oversimplification and ignorance on both sides but I can naively hope that someone, somewhere actually learns anything new from from this small comment of mine.

  23. Coderer Says:

    I skimmed some of the latter comments because HOT DAMN that's a lot of text, but I wanted to make a few quick bullet points:

    * Brand me a stupid hick Republican, but somehow it seems that every time the marginal federal income tax rates go down, net takings by Treasury go up. Every. Time.

    * CRA absolutely is responsible for a big chunk of this mess, in tandem with Sarbanes-Oxley/mark-to-market. The funny link above about the crisis (with the swearing stick figures) is pretty accurate, but they leave out one crucial problem. The post-Enron accounting rules require that if a mortgage is repackaged and resold through five levels of indirection (buyer to bank to security to another security and so on), and it loses value, each of the 5 levels has to record the same loss separately. Now a 10k loss in the home value becomes a 50k loss on paper. This is stupid, but that's not unusual for acts of Congress. Swalve above said something about 99% of mortgages getting paid -- it actually fell to something like 94-95%, and most economists agree that the change is because the CRA required risky loans.

    * I don't know a lot about the budgets of churches, but I rather suspect that even if you taxed churches at standard corporate rates (see below), you'd be lucky to get 10% of this bailout paid for. Could be way off, though. Also, why churches specifically, rather than all non-profits?

    * There's a big, fat hole in the international tax jiggery, and we're too dumb to do anything about it. Those socialist utopias in Europe you're so in love with ("much nicer countries" indeed!) tend to charge *much* lower corporate income tax rates than we do here in the US of A, very often 0%. They make up the difference in VAT (or whatever they call it locally). This has the effect of a double-whammy for US exports and a get-out-of-taxation-free card for US imports -- pay no income tax and no sales tax if you manufacture in Europe and sell in the US; pay both income *and* a big fat sales tax for manufacturing in the US and selling in Europe. IMHO, the answer is to adopt the European model of taxing consumption instead of productivity, but that doesn't get a lot of attention these days.

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