Digging a Deeper Hole

I’m not given the shadendfreude ( especially when the stakes are so high. I still want this president to succeed, but I share the growing doubts and concerns about his economic policy that the polls are now showing.

Check out the piece published by the Wall Street journal on Friday the 13th, under the headline


Pollster Scott Rasmussen and former Clinton pollster Douglas Schoen describe the growing disconnect between the popular wisdom and Mr. Obama’s “grand gesture” approach to economic policy. For the reasons that I outline in this article and the one to follow, I urge Mr. Obama to listen more to the moderates in his own party and to the hundreds of economists who are ringing the alarm bells even as I write this.

Here are a few highlights from the referenced Wall Street Journal piece:


The American people are coming to express increasingly significant doubts about [this president’s] initiatives, and most likely support a different agenda and different policies from those that the Obama administration has advanced.


Eighty-three percent say they are worried that the steps Mr. Obama is taking to fix the economy may not work and the economy will get worse. Eighty-two percent say they are worried about the amount of money being added to the deficit. Seventy-eight percent are worried about inflation growing, and 69% say they are worried about the increasing role of the government in the U.S. economy.


Fifty-six percent of Americans oppose giving bankers any additional government money or any guarantees backed by the government.


Only less than a quarter of Americans believe that the federal government truly reflects the will of the people. … [J]ust 19% of voters believe that Congress has passed any significant legislation to improve their lives. While Congress’s approval has increased, it still stands at only 18%. Over two-thirds of voters believe members of Congress are more interested in helping their own careers than in helping the American people. When it comes to the nation’s economic issues, two-thirds of voters have more confidence in their own judgment than they do in the average member of Congress.



Keynesian wealth creation: The Egyptian slave model

Recall the ancient Pharaohs who drafted idle agriculture workers off-season, putting underutilized labor resources to the task of building the Great pyramids. Many economic authoritarians see this period as the good old days.

But there was more than a grain of sense to the notion. When underutilized idle labor is looked at as a resource or profit center, it represents a particularly fleeting one. Like the Pharaohs’ winter labor, the efforts of underutilized idle workers cannot be recaptured after the opportunity has passed. Their jobs belong to the class of time-linked assets, much like those unsold airline seats that can’t be utilized after takeoff or all that unused electricity from the grid (not captured by batteries) that is either used as and when delivered to the user, or is forever lost for any economic purpose. If you replace the notion of slavery with a motivated and able labor force, sitting idle because the movers and shakers of finance have screwed things up, John Maynard Keynes had a valid point. [Sketch at .]

Conservative Keynesian road kill

At its best, Keynesian theory represents a rational economic strategy to avoid losing labor value due to temporary dysfunctions in the financial system. The conservative version of Keynesian economics had two key elements:

(1) Small scale deficits designed to ameliorate an economic downturn were to be balanced by coequal surpluses in better times to avoid the accumulation of long term public debt.

(2) Large public works projects were to be coupled with tax relief so that the private sector could swiftly recover in order to fund the deficit repayment [See (1).]

If you’ve been paying attention to the period since 1963, a series of undisciplined political leaders have thrown conservative Keynesian economics under the bus. John Kennedy was the last of the conservative Keynesians.

The replacement of traditional capital formation with rampant borrowing

From 1700 through 1929, all major undertakings in the US economy (I’m thinking of the railroads and the innovations of Thomas Edison and Henry Ford) represented the traditional capital investment pattern in which accumulated capital was recruited to fund new ventures.

Credit mechanisms were not primarily utilized to finance new business ventures.

But from 1929 through 2000, the major pools of accumulated capital sources became little ponds or dried up entirely. They were replaced by borrowed money. Why did this happen? The shift to credit-supported investment did not take place because lending and borrowing are inherently superior as funding mechanisms for new commercial ventures. It happened because the traditional methods for the accumulation of capital, based on the retention of profits were relentlessly taxed to the degree that they were virtually driven out of existence.

The personal income tax, the taxes on corporate and business profits, the excise taxes on sales and capital gains taxes resulted in the successive taxation of the profits won through productive economic activity. [See US Treasury Fact Sheet at , The 1997 Congressional Joint Economic Study , among other sources.]

The multiple taxation of the same income, coupled with the normal losses from failed investments, was so confiscatory that the substantial depletion of all accumulated capital over time was inevitable.

Traditional bankers became business partners, then were replaced by non-traditional, increasingly imprudent lenders. These were the new creatures on the financial planet, those men, women and their institutions for which “paper” profits became the measure of wealth. This transition was a big deal indeed, and it initiated a self-reinforcing drive towards an unattainable goal: unlimited profits based on the unlimited growth of paper assets based on a credit bubble that was sustainable as long as it was in continuing expansion. This game could go on. Only as long as it wasn’t recognized as just one more bubble,


The transition to credit-financed economic growth floated to the top of the economic lake, supported by two radically simple, and radically beguiling concepts: paper assets based on the notion that money manipulation could create wealth, and asset leveraging which became the clever financial instrument by which all things were possible.

Or so it seemed at the time.

Most of our grandparents would laugh at the notion of paper assets, the transparently fanciful notion that real wealth can be measured by a set of fleeting volatile numbers the connection of which to “real stuff”, food, transportation and the like, is a matter of blind faith. The jailed billionaire con-man, Bernard Madoff and his thousands of duped victims, many of whom have been driven from paper wealth into real poverty, are the perfect metaphor for paper assets.

We’ve been there before. Recall the buzz-word of the dot com boom? Many of those promising startups were selling software products that had about the same solidity as the balance sheets of Freddy Mack and Fanny May. Remember the term vaporware?

The term “leveraged assets” is particularly revealing because it refers to a loan and its security as an asset class that can be multiplied like one’s expected winnings at the gaming tables of Las Vegas. In this fantasy construct, where all loans are actually paid, a lender’s balance sheet, a loan balance on paper, is as good as gold. Inflated American real estate used as security for increasingly unpayable loans gradually became the gold standard of world commerce from about 1980 until the great crash of 2008.

In this context, leveraging meant this: You (the clever trader and financial manipulator) used assets (like California residential real estate) to support the value of unpaid loans. This enabled you to sell these loans in large packages designed to conceal and disguise the inherent weakness of their constituent elements. As this world-wide scheme started to unravel, the ratio of real assets to loan value in the conservative lending institutions was revealed to be ten-to-one. In other words, the paper value of the real estate security was, say 10 million, but the aggregate loan value was 100 million.

But a mere ten-to-one leveraging ratio was child’s-play in the larger market. Many of the big players were leveraged thirty-to-one, forty-to-one, even fifty to one. You come away with the impression that the more audacious the risk, the larger the stakes, the less critical were the investors. Again, Mr. Madoff and friends are the metaphor.


But the picture was actually worse. These bundled, under-secured loan packages became the security of additional loans. We’ve heard the bromide, “too big to fail”. Recall the Titanic? The lesson here is: too big to bail out.

The brutal fact is this: The sheer size of the inflated credit market now dwarfs the fiscal activities (defined as appropriated, tax-supported spending) of all governments by a huge number. This is why our leaders seem to be stumbling, dissembling and concealing. They have seen the truth and they are frightened out of their frigging minds by the staggering scale of the problem. They are particularly fearful because they still cling to the illusion that failure is not an option.

Here’s the dirty little secret: The failure of the imprudent financial institutions is the only option. We can afford to let this happen because not all of the lenders were idiots or criminals. The end game here is to stand ready to shore up the smaller, well-run ships that could be swamped in the wake of the sinking behemoths.

This article is part of a series that began on “The Human Conspiracy Blog” with “The Collapse of the Optional Economy”. The other articles remain posted there.

In the next post, I’ll sketch out a practical, but challenging recovery path. Stay tuned for “Climbing Out of the Crater”


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