A Bubble That Broke The World

A Bubble That Broke The World:
Lessons From The Great Depression When Credit And Debt Are One.
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By Dr. Housing Bubble | 18 May 2008

We are swimming in a world of debt. Somewhere in the past decade debt lost the negative connotation of being a four letter word. In fact, the language of so many things has changed and the ultimate ramifications now have sweet language to soften the utter destructiveness of the underlying instrument. 'Junk' bonds are now looked at as "high yield" bonds. I don’t like junk, but I sure love the sound of "high yield"! The most profound change has been the idea that current connotations of 'credit' has now supplanted the former connotations of 'debt' [[and, in fact, is used iterchangeably with 'money', aka, 'Federal Reserve notes', (which, after all, is only the debt of the Federal Reserve to the government of the US!): normxxx]].

We talk about the worldwide 'credit' crisis, when what we are really talking about is the global 'debt problem'. When you think of 'credit', the connotations are invariably positive. You received 'credit' for completing the assignment. 'Hey Joe, I give you great credit for working so hard on the project.' 'We credit you sir for the excellent job here!' It would be extremely different if 'credit' cards were titled 'debt' cards. Or, what if we called them "instant layaway" cards instead of calling them 'platinum premium member cards'.

The psychology of this housing bubble is absolutely fascinating and disturbing. When you really boil it down, you have to wonder what people were thinking. These were folks who were reluctant to place a $100 bet in Vegas, yet they readily purchased a grotesquely overpriced home, and many are now sitting on $100,000 or more of negative equity. Many would like to think they weren’t 'speculating' (a nicer name for 'gambling')— because it was real estate [[and real estate never goes down in price, right? : normxxx]]— but there was no fundamental reason for home prices to reach the level that they did. The irony of all this is that we still keep hearing that this is a 'credit crisis'.

The fact is that Americans were unable to keep this economy going without massive amounts of debt [['funny money' created by the banks outside of the Federal reserve system by selling those 'credits' in the commercial paper market! : normxxx]]. 'Debt' in all forms that fueled spending and accounted for a large percentage of our GDP. In reality it was a gigantic Ponzi scheme [[on a truly world-wide scale! : normxxx]] and in the end, like all Ponzi schemes, it come crashing down of its own weight when the markets ran out of suckers.

Today in our "lessons from the Great Depression" series, we are going to look at a book written in 1932

A Bubble That Broke The World (Paperback)
by Garet Garrett

It is a fascinating look at the social reasons why bubbles form and ultimately collapse. It is worth a full read but we’ll go through some important passages here and parallel them to our current situation. This lesson is part IX in our continuing series.

A Bubble That Broke The World

"Mass delusions are not rare. They salt the human story. The hallucinatory types are well known; so also is the sudden variation called mania, generally localized, like the tulip mania in Holland many years ago or the common-stock mania of a recent time in Wall Street. But a delusion affecting the mentality of the entire world at one time was hitherto unknown. All our experience with it is original. This is a delusion about credit. And whereas from the nature of credit it is to be expected that a certain line will divide the view between creditor and debtor, the irrational fact in this case is that for more than ten years debtors and creditors together have pursued the same deceptions. In many ways, as will appear, the folly of the lender has exceeded the extravagance of the borrower."

I think it is important to note that in this current bubble it does take two to tango. Many borrowers bought in many cases as speculators even though they thought they were making a prudent decision. It can be said that this is no more logical than buying a luxury car and expecting more than what you paid for it 5 years later. Ultimately when you go to sell the market will dictate the price. But not everyone participated in this mania. Look at these sobering numbers and I’ve tried to word it to change your perspective on what is going on.

According to the U.S. Census Bureau, 31.8 percent of all U.S. owner-occupied homes have no mortgage. 32 percent of the country rents. The vast majority of those remaining with mortgages have been financially responsible. Why should it now be the responsibility of those who managed their finances prudently to bailout the few who speculated— including irresponsible lenders who made loans to people who had no chance of ever paying it back?

Let us continue with the article:

"The general shape of this universal delusion may be indicated by three of its familiar features. First, the idea that the panacea for debt is credit. Debt in the present order of magnitude began with the World War. Without credit, the war could not have continued above four months; with benefit of credit it went more than four years. Victory followed the credit. The price was appalling debt. In Europe the war debt was both internal and external. The American war debt was internal only. This was the one country that borrowed nothing; not only did it borrow nothing, but parallel to its own war exertions it loaned to its European associates more than ten billions of dollars. This the European governments owed to the United States Treasury, besides what they owed to one another and to their own people. Europe’s attack upon her debt, both internal and external, was a resort to credit. She called upon this country for immense sums of private credit-sums which before the war had been unimaginable-saying that unless American credit provided her with the ways and means to begin moving her burden of debt she would be unable to move it at all. Result: The burden of Europe’s private debt to this country now is greater than the burden of her war debt; and the war debt, with arrears of interest, is greater than it was the day the peace was signed. And it is not Europe alone. Debt was the economic terror of the world when the war ended. How to pay it was the colossal problem. Yet you will find hardly a nation, hardly any subdivision of a nation, state, city, town or region that has not multiplied its debt since the war. The aggregate of this increase is prodigious, and a very high proportion of it represents recourse to credit to avoid payment of debt."

How the tables have turned. We are now a largely debtor nation. We owe money to China, Japan, Europe, and many other foreign players [[HUGE amounts; amounts so huge they are probably unrepayable!: normxxx]]. We are no longer a lender but the world’s greatest borrower. We are now a debtor in this game. In fact, each day we have to borrow large sums of money to keep consuming at current levels. Our trade deficits show this unnerving fact clearer than anything else. Simply looking at cargo coming into our large ports in San Pedro and Long Beach, we see that 3 cargo containers come in loaded with produced goods and we send out barely 1 full container; many times when we export items it is raw materials. This imbalance is harming us. And of course, what we learn from Europe from the early part of the 1900s is that war debt drags an economy down into the abyss.

"Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life. If they cannot immediately afford them, that is, if out of their own resources these betterments cannot be provided, nevertheless people are entitled to them, and credit must provide them. And lest it should sound unreasonable, the conclusion is annexed that if the standard of living be raised by credit, as of course it may be for a while, then people will be better creditors, better customers, better to live with and able at last to pay their debts willingly. Result: Probably one half of all government, national and civic, in the area of western civilization is either bankrupt or in acute distress from having over-borrowed according to this doctrine. It has ruined the credit of countries that had no war debts to begin with, countries that were enormously enriched by the war trade, and countries that were created new out of the war. Now as credit fails and the standards of living tend to fall from the planes on which credit for a while sustained them, there is political dismay. You will hear that government itself is in jeopardy. How shall government avert social chaos, how shall it survive, without benefit of credit? How shall people live as they have learned to live, and as they are entitled to live, without benefit of credit? Shall they be told to go back? They will not go back. They will rise first. Thus rhetoric, indicating the emotional position. It does not say that what people are threatening to rise against is the payment of debt for credit devoured. When they have been living on credit beyond their means the debt overtakes them. If they tax themselves to pay it, that means going back a little. If they repudiate their debt, that is the end of their credit. In this dilemma the ideal solution, so recommended even to the creditor, is more credit, more debt."

Was this written yesterday? Talk about repeating history again. This psychological notion that one is entitled to a better life regardless of savings is not new. In fact, it seems that the mentality then was the same as today: if you can’t afford the artifacts of middle class life with your own saved [!?!] money then it is probably the fault of lack of credit. Forget that it should mean that you probably can’t afford it [[or, indeed, need it! : normxxx]]. And the solution offered at the time? More debt!

I can hear Bernanke saying, "more credit for liquidity" and we are back at square one. Remember that Ben Bernanke is a student of the Great Depression, so none of this is lost on him. Yet somehow he thinks the problem wasn’t too much 'debt' but not enough "credit" quick enough. Well he just saw how impotent the Fed was with their rate cuts. He bought a wee bit of breathing room, but we are still nowhere out of the woods. And, if we keep thinking that the only problem is the need for still more debt, we are going to spiral downward into a debtor’s hell. Many are already at this point.

"Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product. This inverted way of thinking was fundamental. It rationalized the delusion as a whole. Its most astonishing imaginary success was in the field of international finance, where it became unorthodox to doubt that by use of credit in 'progressive' magnitudes to inflate international trade the problem of international debt was solved. All debtor nations were going to meet their foreign obligations from a favorable balance of trade. A nation’s favorable balance in foreign trade is from selling more than it buys. Was it possible for nations to sell to one another more than they bought from one another, so that every one should have a favorable trade balance? Certainly. But how? By selling on credit. By lending one another the credit to buy one another’s goods [[still better, as today, lend the debtor the money to buy your goods with! : normxxx]]. All nations would not be able to lend equally, of course. Each should lend according to its means. In that case this country would be the principal lender. And it was. As American credit was loaned to European nations in amounts rising to more than a billion a year [[a billion? a billion? more like hundreds of trillions, today! : normxxx]], all in the general name of expanding our foreign trade. The question was sometimes asked: "Where is the profit in trade for the sake of which you must lend your customers the money to buy your goods?" [[where, indeed: normxxx]] The answer given was: "But unless we lend them the money to buy our goods they cannot buy them at all. Then what should we do with our surplus?" As it appeared that European nations were using enormous sums of American credit to increase the power of their industrial equipment parallel to our own, all with intent to produce a great surplus of competitive goods to be sold in foreign trade, another question was sometimes asked: "Are we not lending American credit to increase Europe’s exportable surplus of things similar to those of which we have ourselves an increasing surplus to sell? Is it not true that with American credit we are assisting our competitors to advance themselves against American goods in the markets of the world?"

Welcome to our new world. Guess where these foreign nations are putting their money? Does the idea of sovereign wealth funds ring a bell? Not only are they placing it back into their own countries building stronger internal economies but they are also buying the best businesses in the United States on the cheap. This is all well and good if you look at it from a strictly economical stand point[!?!] but what about countries like Russia or Venezuela that clearly do not have the same political ideologies as we do here. In fact, in some cases, they are in direct opposition the values of this country that is sending them loads of money. Therein lies the problem. The solution would be simple say, in the case of Venezuela— we just stop buying oil from them. But do you think the American people would go for that and see prices sky rocket [[or, perish the thought, even tighten their belts and reduce consumption: normxxx]]? Of course not. They jumped in elation over a $30 gas tax break for the summer [[actually they didn't; most saw through the ploy!: normxxx]] so you really have got to be kidding when it comes to the masses. If we are unwilling to reshape our economy and see the interconnectedness of the problems that debt brings with it, are we really going to wake up and see that America is up for sale to the world, pennies on the dollar? In fact, this may already be unavoidable— you need only look at the state of the dollar for this to resonate.

"The answer was: "Of course that is so. You must remember that these nations you speak of as competitors are to be regarded also as debtors. They owe us a great deal of money. Unless we lend them the credit to increase their power of surplus production for export they will never be able to repay us their debt." Lingering doubts, if any, concerning the place at which a creditor nation might expect to come out, were resolved by an eminent German mind with its racial gift to subdue by logic all the difficult implications of a grand delusion. That was Doctor Schacht, formerly head of the German Reichsbank. He was speaking in this country. For creditor nations, principally this one, he reserved the business of lending credit through an international bank to the 'backward people' [[aka, "undeveloped" or "third" world nations: normxxx]] of the world for the purpose of moving them to buy American radios and German dyes. By this argument for endless world prosperity as a product of unlimited credit bestowed upon foreign trade, we lent billions of American credits to our debtors, to our competitors, to our customers, with some beginning toward the 'backward people'; we loaned credit to competitors who loaned it to their customers; we loaned credit to Germany who loaned credit to Russia for the purpose of enabling Russia to buy German things, including German chemicals. For several years there was ecstasy in the foreign trade. All the statistical curves representing world prosperity rose like serpents rampant. Result: Much more debt [[indeed, MOUNTAINS of debt: normxxx]]. A world-wide collapse of foreign trade, by far the worst since the beginning of the modern epoch. Utter prostration of the statistical serpents. Credit representing many hundreds of millions of labor days locked up in idle industrial equipment both here and in Europe. It is idle because people cannot afford to buy its product at prices which will enable industry to pay interest on its debt. One country might forget its debt, set its equipment free, and flood the markets of the world with cheap goods, and by this offense kill off a lot of competition. But of course this thought occurs to all of them, and so all, with one impulse, raise very high tariff barriers against one another’s goods, to keep them out. These tariff barriers may be regarded as instinctive reactions. They do probably portend a reorganization of foreign trade wherein the exchange of competitive goods will tend to fall as the exchange of goods unlike and noncompetitive tend to rise. Yet you will be almost persuaded that tariff barriers as such were the ruin of foreign trade, not credit inflation, not the absurdity of attempting by credit to create a total of international exports greater than the sum of international imports, so that every country should have a favorable balance out of which to pay its debts, but only in this stupid way of people all wanting to sell without buying."

Our trade imbalance is a danger to our country’s long-term prosperity and has global implications beyond economics. It is certain that if we continue on this path there will be a worldwide meltdown. Yet, there has been no desire from any political party to reign in the manic spending of the American people. Somehow they thought prosperity lay in a decade of trading paper back and forth to one another, flipping houses, and taking money out of homes to add upgrades was the idea of a healthy economy. What we ended up doing was simply rearranging the deck chairs at home, while the 'backward nations' of the world built up an ever stronger production and intellectual capital, and have since siphoned off enough for a more than competitive advantage in many areas.

Spending more than you earn impacts the world more than you think. It is time to get serious about this and make it a national priority to get our books in order. Former Federal Reserve Chairman Paul Volcker knew this and jacked up the Fed Funds Rate into the double-digits to reign in inflation. People did not like this but in the end it made us more productive in the 80s and 90s. Who will be the next person to reign in spending before this bubble breaks the world back to barter?

  M O R E. . .

Normxxx    
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