My Two Cents - "Follow the Money"

12/12/2008

In the current climate, where the overriding opinion of most mainstream financial commentators is that deficit spending is a good thing and the only thing better than one bailout is two bailouts, it is time to inject a bit of logic and sanity.

Sure, I made the argument in last week's edition that IF the Feds are going to throw over $8 Trillion at the financial system which produces nothing, why not throw Big Auto a bone? At least they produce something. However, this line of reasoning should not be taken as any kind of endorsement of our Bail-o-Matic Congress or its actions.

The thing that gets me is that we still haven’t gotten an answer from anyone in charge telling us where all this money is going to come from. Sure we know, but it would be nice to hear it. As the crisis deepens and bailouts become a common word, the real danger is that the American public will become desensitized to the sheer magnitude of these short-sighted, but long-lasting commitments. There was a time not too long ago when a million dollars was a lot of money. Someone who had a million dollars was thought to be set for life. The sad fact: today, a freshly minted (sarcasm mine) millionaire could earn a whopping $30,900/year on his money if he invested in 30-year Treasury Bonds. Or he could have put it into DOW index funds last year and would now have around $620,000. No, a million dollars certainly doesn’t seem like a lot of money these days.

More recently, we have shifted to discussing things in terms of billions. The Bear Stearns problem back in March cost us $30 Billion. The taxpayers were assured we’d get a good return on that money. However, as of 12/4, Maiden Lane, LLC which was created to house the Bear Stearns mess has seen its value drop from nearly $30 billion to just a tad over $21 Billion. The US taxpayer has lost nearly a third of its investment already. AIG started out at $85 Billion and has grown to double that in just a few months. All in all, Congress has pledged $700 Billion, and the Federal Reserve has, to date, cranked around another $7.6 Trillion at the problem. And that number gets bigger every day. Looking at news headlines, it would seem that even a billion dollars is not a lot of money these days.

Let’s take a second and put this into a perspective that everyone can understand. The analogy is especially fitting at this time of year. Let’s send the average family of 4 to the mall for a shopping trip. Let’s assume they can each spend $1000 every hour. If they set out to spend a million dollars, do you think they could finish before Christmas? Even if they shopped for 16 hours a day, they’d finish on 12/26 – too late!

How about the same family trying to spend a billion Dollars? Spending at the same rate, it would take them nearly 43 years, shopping 16 hours a day, 365 days a year, spending $1000/hour each. 43 years to crank through a billion dollars.

How about a trillion? We’d better add the aunts, uncles, and cousins for this one. Let’s say we can get 20 people spending $1000/hour each, 16 hours a day, 365 days per year. How long do you think it would take for them to spend $1 trillion? A whopping 85,616 YEARS.

To put it in perspective, the bailout of the S&L crisis in the late 1980’s was envisioned to cost around $80 billion total at the time. We have already pledged 100 times that amount to fix this mess, and if you’re thinking the same way I am, you know that this is nowhere near over.

Obviously, our government doesn’t have any of this money. The National Debt Clock has gotten quite a bit of publicity recently in that they had to shut it down for a while so they could figure out how to add another digit because we’d crossed the $10 Trillion mark. I made the rather snide remark at the time that they should probably just add a couple more digits while they were at it. Now it doesn’t seem so snide anymore especially given the situation that already exists with unfunded liabilities from Social Security and Medicare. We’re going to need an awful lot of money while having precious little of it.

Which brings us full circle to the news of the day. Oil demand will plummet over the next few years says the World Bank. So will the price of commodities. They are predicting a global recession that will be the worst since the Great Depression. And I totally agree with their prediction of a severe recession. However, it is very clear from their position on prices that these people with impeccable credentials, education, and status as world renowned economists don’t know the first thing about how money works. They don’t understand even the most basic immutable laws of economics, the most important being that inflation is a monetary, not an economic event. They fail to understand that creating money and credit from nothing causes general price levels to increase regardless of the level of underlying economic activity.

Demand alone cannot cause general price levels to rise. Sure, demand can cause the price of one or even a few items to rise, but in a disciplined monetary system, money to pay higher prices for one product must be taken from the price paid for somewhere else. So as one price goes up, the price of something else will fall because the money simply doesn’t exist to support higher prices across the board. Also, demand is relatively constant when you think about it. People will always want things. The check and balance is the supply of available money and credit. Monetize demand and prices will rise regardless of underlying economic activity. If you want proof of this, go to an auction sometime and start handing out millions of dollars then watch what happens to the prices paid.

Now, consider the monetary environment within which we are operating at the present time. Much like the yields on short-term Treasury bills there is zero discipline. None. Money is being created on a massive and unprecedented scale. This is precisely why the banks are sitting on it. If this money were released en masse into the real economy, we would have hyperinflation at the precise time when economic activity is grinding to a halt.

The most useful thing that can be taken from the World Bank’s forecast is that they expect this money to remain penned up in the banking system for the foreseeable future. While this prediction, if true, would bring welcome relief in terms of prices, it is a rather dire prediction in that our economy relies on cheap money for its growth.

Disclosures: None

Graham Mehl is a pseudonym. He is not an ‘insider’. He is required to use a pseudonym by the policies of his firm when releasing written work for public consumption. Although not an insider, he is astonishingly bright, having received an MBA with highest honors from the Wharton Business School at the University of Pennsylvania. He has also worked as an analyst for hedge funds and one G7 level central bank.

Andy Sutton is a research and freelance Economist. He received international honors for his work in economics at the graduate level and currently teaches high school business. Among his current research work is identifying the line in the sand where economies crumble due to extraneous debt through the use of economic modelling. His focus is also educating young people about the science of Economics using an evidence-based approach.