Tuesday, February 17, 2009

The current credit meltdown and deep recession is necessary.

As Churchill knew, responsibility, thrift and taking risk is necessary for development.

by StFerdIII



Recessions are economic necessities. Contractions and even depressions are natural responses to imbalances be they 'bubbles'; over-leveraging; governmental incompetence or political meddling in economic affairs. The worse thing a society can do is to respond to a recession by doing more of what caused the contraction by increasing debt and debasing a currency to inflate its way into stability. It might be mindful to recognise that this recession is really about debt, credit, over-leveraging and living beyond our collective and individual means. In the rush to save unions, preferred companies, national champions, wealthy Wall Street brokers, and those connected to the largesse of big government 'aid', we should heed the warning of Churchill who once remarked, "We must beware of trying to build a society in which nobody counts for anything except a politician or an official; a society where enterprise gains no reward and thrift no privileges." Indeed. A society in which there is no risk, no moral hazard and ultimately no individual responsibility is one not worth living in.

Churchill's was a laissez faire orthodox liberal - a man who rightly believed that capitalism might share wealth unequally, but that socialism would share miseries equitably. Life is inherently unfair. There is no equality in one's short earthly existence, except before the law, of opportunity and in the expectation of reward for hard, smart or even lucky endeavour. You can't socialise life's risks, nor its unfair character.

If the above is true than constructing massive government along the lines of the EU-topia, or the current BushBama predilection [it is impossible to tell when GW's penchant for huge government and bailouts stops and Obama's, blessed be the prophet, begins], and for Keynesianism does not make a lot of sense. Government does not produce anything, it can only take. When BushBama announces that $5-6 Trillion of new debt and printed money will be used to 'jump start' the economy, they are lying. The $5-6 Trillion is simply debt to be paid by higher taxes and government appropriation of incomes. If you want to stimulate the economy, you would do the following: have low but not zero interest rates; guarantee bank transactions but not socialise the banking sector; cut taxes; engage in more trade; cut regulations and make the existing ones sensible and transparent; and make it illegal for regulated firms to pay off regulators. You would not bail out unionized firms; selected national champions or banks.

The core of the existing crisis is housing collateral and the socialisation of housing finance over 60 years. Debt and credit were created from bad loans. On top of this insane strategy of socialising housing we have credit cards and credit lines and various forms of unsecured debt. Credit cards were started in 1950 by the Bank of America. Credit lines followed about 20 years later. They were buy now, pay later instruments and were vital to create a consuming middle class. The problem is that over time consumer debt became 120% of net annual income, meaning that any temporary income loss could result in defaults and bankruptcy.

We thus have a 50 year credit 'boom' building a culture of excessive consumption and 'wants'. When debt exceeds income by necessity credit failures must follow. So what do governments do ? They of course 'bail out' those who take or took, unnecessary risk. If you speculated by buying 4 condos in Miami because the media told you that this is what everyone is doing, and prices decline, your reaction is not one of remorse, learning and probably insolvency, but to ask the mommy state to fund your excess and your poor judgement.

A credit meltdown is necessary in order to re-balance the economy and indeed re-configure society.

What excess credit does is to distort reality. Instead of waiting to pay cash, people prefer to buy now and worry about paying later. Credit usage thus has deep cultural impacts. Instead of thrift and rational living, people are now used to instance gratification, buying above what they can afford, and imitating the ludicrous life styles and images paraded in movies, on tv, and in sexualised and idealised advertising. The consumer culture leads inevitably to pop culture, and just as inevitably to a decline in good character traits, knowledge and cognition.

Allowing the excess in credit to burst is painful but mandatory. It is like lancing a boil, severing a cancerous limb, or performing painful surgery. You need to sacrifice the diseased area to save the rest. Credit spending has been a disease in both personal and corporate affairs. Firms borrowed money against devaluing assets and hired workers, built plants and produced product - all of which was built on credit, not income. Households did the same - upscaling, buying 2nd and 3rd homes, borrowing to buy 2 or 3 cars, and going into debt to pay for education, vacations and unneeded consumer goods.

It was a mirage and now we are paying the price for profligacy and fantasy.

Churchill stated once that, “Attitude is a little thing that makes a big difference.” How true. Our current consumerist attitudes is at odds with reality. Thrift, saving, individual responsibility and reaping what one sows, is necessary in life. Nothing in life is easy and easy credit is only a temporary drug that will destroy the user over time through repeated usage. This is why recessions and even depressions are necessary. They educate a generation about the real world - about risk, reward, frugality and proper money management.

Recessions and depressions are natural and vital processes in society's development. But of course that is not the lesson that the media, the schools, and the politicians take away. They will wail and scream that the markets have failed; that speculators and Wall Street are criminals; that capitalism is immoral and that only the nanny-mommy state is benign, caring and capable of saving us. They will elevate silly politicians like Obama as messiahs, and engage in pleadings and infantile projections that government must save unions; preferred firms or individuals who did not live frugally or properly. Even worse, the vast majority who live within their means, who pay their bills, who accept risk and reward will be told that unless they transfer their wealth to those who did not follow proper economic management, the world will end, ATMs won't work and sea levels will rise - not to mention the deaths of millions of cute polar bears.

The whole scenario now unfolding with governments bankrupting the future to save those firms and individuals who ignored reason, basic economic laws and responsibility for their own actions is a travesty. Recessions are positive in that they teach and remind each generation of what not to do. If you use government to shield people and companies from reality you will only prolong and extend economic trouble, and more importantly destroy the economic cultural underpinnings that allow civilisation to develop. Moral hazard, risk and reward, reaping what you sow, and accepting responsibility are not just Biblical injunctions of good behaviour, they are literally the cultural contracts of a truly progressive society.