In order to understand the “bubble” in the present economy, one must understand how such “bubbles” are created.
In simple terms, the value of something is always relative to the availability of a similar substitution product.
This did not occur in real terms within the American economy for the last 30 years. America, the land of the free, was the recipient of massive infusion of foreign labor.
The availability of dirt-cheap capital infusion due to the availability of low-priced foreign bonds made it preferable to the Manufacturing Community to reinvest in these bonds rather than making the return on their manufactured product. This meant that the international credit system was buoying the purchase-power of the American public to unreasonable levels.
The Investment Banking community reveled in this: The deregulation begun in the 70’s and galvanized under Milton Friedman and Ronald Reagan were but the result of the previous deregulations (see Carter and deregulation of airlines, railroads, telephone companies, natural gas, and banking.)
Without regulation, these industries were free to act under their own impulse, and I can tell you that the single most predictable human impulse is greed. Their impulse was to create ever-growing gyrations of debt-instruments that rely on someone shouldering the risk of non-payment, and they could do so due the omnipresent figment that the US tax-base was insurmountable. Same with their production base, although that withered away years ago. According to the American’s, even that would come back, they just had to suppress their workers the wages they had negotiated over time.
Some facts: Germany has a higher-paid labor force than the US. As does France. As does Sweden, Australia, etc. But we are told we have to suppress our “greedy” workers even as their companies farm offshore labor to create an alternative source of the same product (see Gillette and German Production.)
With the benefit of the largely inflated belief that the US was the most efficient system of production on the planet, foreign markets took the plunge. Production units like Japan came to see the growing US buying power as their main source of revenue. China expropriated land and people to feed an ever-hungry American population, to the detriment of their own native people. Investment Bankers made a fortune off what they knew was a scam: If the comparative price weren’t a consideration of their equation (after all, 1$ a month wages cannot last forever) then the capacity to produce a good of equal value will surely become a factor.
Eventually, China will be as good at producing a widget as any other nation.
Well, where does that leave the American Advantage? Nowhere. Goods of equal value have become, despite the American optimism that this will never happen, available worldwide. So how did this crisis come to be?
The factors mentioned above provided the breeding-ground for this epidemic. The only polar advantage held by the US, whose production skills and advantage have only deteriorated over the years, was its reputation as a refuge. Huge buying power of foreign investments allowed the free-flow of funds without the necessity of meddling with the central banking system. Companies and investment bankers were allowed to freely exchange (and amplify) the available cash in the system.
Basically, they created inflation through thin-air. The balance on your credit-card is not debt owned by your bank – It was resold to some foreign firm who thought you were the president of Dupont, and is only now realizing you are actually a greeter at Wal-Mart.
It was a time when the credit-rating of your company was increased by the complications on your balance-sheet. Those days are gone. This is similar, in fact identical, ton the savings-and-loan scandal that happened in the 90s: Small banks had bankrolled their debt-to-equity ratios to disastrous proportions, companies had leveraged themselves to the point where they were bankrupt (on paper) and yet still maintained the highest ratings. Now we know why: The ratings agencies themselves were being rated by the firms they were rating!
Sarbanes-Oxley and Basel 2 were attempts at reigning this in, but it was too late. The over-leveraging had already taken hold. The comparison is easy: You, as an individual, must pass a “cash-flow” rating, which will determine whether or not you get the loan.
If it’s a mortgage, you must have no more than 37% of your gross revenue to pay for your net debts, 41% if fixed expenditures such as taxes, electricity and heating are included. This will affect you in a yes/no from the bank.
In commercial finance, you must maintain a certain amount of “equity” on your balance-sheet in order to maintain a proper credit-scoring. This will include your inventory on hand, number of days this inventory has been held, cash reserves, goodwill (dependable repeat sales,) equity in other holdings, minus provisions for loss, comingled provision for loss (which is reduced from goodwill), availability of cash-surrender from insurance, etc. All this will result in your credit scoring.
Which is important because this and only this allows you to use credit as a kind of silo. Farmers use silos to cover the weak spots in a harvest. Companies use borrowing as a silo to cover cyclical changes in their cash-flow.
Right now, because of comingled risk, credit-ratings are plummeting. Banks do not want to lend even to other banks, because they no longer can anticipate the latter’s borrowing-power. A downgrade from a Moody’s AAA rating to BBB could mean billions in cost of borrowing, and this is the single biggest expense of some to these companies.
Therefore the drive to bailout is simply the wrong move. The media will hype this as unappealing on a romantic basis: The old should make way for the new, inefficient companies should make way for the more efficient but the truth is we don’t know that the replacement companies will be more efficient, we only know they will be new. If the current economic paradigm maintains its hold, even those are doomed to economic collapse.
Companies will take the bailout money and do what makes the most rational (not just) sense to their organizations: They will stick this money on their balance sheets and hope for a different outcome despite identical circumstance. It is the circumstance that makes the difference, and that is why a global economic shift is impending. Where that will leave the US is anyone’s guess, but I am sure it will not be any better than it has been in the last 30 years.
Continuing to inflate the money-supply merely re-inflates the bubble. Unless all comparative markets do the same, we simply have “re-flation”, priming the bubble to where it was to before the burst.
How does this make any sense? When I have a bad debt, the last thing I do is lend more money. Bad money after bad. No PHD required, that is stupid.
There are ways to re-structure companies/banks that do not involve bankruptcies and that are already written into law. In Canada we have the process of the Creditors Arrangement act (CCAA). No money is injected, the only onus is placed on the creditors and the companies to come to a common agreement as to the value of continuing the business as a going-concern. The company has to adjust its costs, and the lenders have to adjust the return on their injections.
This becomes complicated when you have foreign investors involved. But what is being done now is to use the US tax-base to some form of “ransom” to accomplish the same end. Play by our rules, or we’ll default on foreign bonds.
The ransom only lasts as long as it is credible.
Doug
posted by Zygon @ 9:23 PM
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