Root Cause

by | Sep 15, 2017 | Economy, Keith, Politics | 0 comments

“Entitlements and other mandatory spending alone is projected to reach $2.566 trillion or 63% of total FY 2018 outlays. Another $307 billion will be required for interest on the nation’s $20 trillion public debt, while upwards of half the $1.22 trillion for so-called “discretionary” or appropriated programs also reflects funds appropriated years ago. Altogether, $3.5 trillion, or 85% of outlays, will be essentially baked into the cake before a single Congressional vote is taken on anything regarding the FY 2018 budget. The Federal spending machine is almost entirely on autopilot and heading for disaster owing to ballooning populations and debt. Ten years from now the combined cost of mandatory programs and debt service will reach $5.12 trillion compared to just $2.87 trillion during FY 2018.” – David Stockman, former congressman and former Director of the Office of Management and Budget

“Rational people recognize this $20 trillion for the supernatural scale of obligation it represents, and understand that it will never be paid back, so, what the hell? Why not just drop the pretense, but keep on working this racket of the government borrowing as much money as it wants, and the Federal Reserve creating that money (or “money”) on its computers to infinity. Seems to work so far. Rational people would also suspect that at some point, something might have to give.” – James Kunstler

Meanwhile the Census Bureau reports that real inflation-adjusted earnings for men are less than they were in 1973. Earnings for males are basically unchanged from what they were in 1968. In other words, on an apples-to-apples basis, i.e. real inflation-adjusted earnings for men, we have been static now for decades.

We have failed as voters to grasp how deceit, war, debt, net wealth and wages are connected. Here is a short history of how we accelerated into disaster (and why wages have been stagnant for 45 years!): JFK and LBJ created more dollars than the United States had gold to cover. France accumulated an immense number of physical dollars. After Nixon was elected, France having accumulated all of these dollars, demanded to exchange their dollars for gold (as they were entitled to do). The United States, not having the gold reserves to cover the dollars that had been printed, left the gold standard in 1971 in order to avoid insolvency in not being able to redeem the dollars that France held.

Understand what happened.

Additionally and of no less significance – LBJ increased Federal spending via launching the Great Society at the same time he was fighting the Viet Nam War. LBJ fully intended to run for re-election in 1968 and the deficits and increases to the Federal debt that sourced in the war and the Great Society was bound to be an election issue in 1968. LBJ in true LBJ fashion simply ordered the Federal government to abandon Generally Accepted Accounting Principles (GAAP). In other words, LBJ directed the Federal government to only count the financial burdens that LBJ found politically convenient and ignore those that would be a detriment to his re-election efforts.

Let me summarize where we are in this history lesson – by 1968 JFK and LBJ had gone on a printing spree to artificially goose the economy and printed far more dollars than the United States had gold to redeem. LBJ also stopped the United States Federal government from using Generally Accepted Accounting Practices. Nixon then took us off of the gold standard.Notice the wage growth in the male inflation-adjusted earnings has been stagnant since 1973 – that it is not a coincidence! But wait – there is more!

In 1971 Nixon removed the United States from the gold standard due to there being more dollars than gold to redeem the dollars. The United States moved to a fiat currency – but more importantly the United States moved to fiat credit. The volume of credit that could be introduced was no longer tied to and limited by gold and savings. Those of you old enough to recall may remember the 1970’s stagflation that was the immediate result of these events. In response to the stagflation congress passed Humphrey-Hawkins in 1978. This legislation basically outsourced congress’s job to the Federal Reserve. It provided the Federal Reserve with the twin mandates of controlling inflation and stimulating full employment – in a fiat credit environment. See the problem here? The United States congress made the disastrous decision to manage employment and inflation via monetary policy – not fiscal policy.

The only tools the Federal Reserve possesses in order to achieve the twin mandates are manipulating interest rates and introducing additional credit – in other words creating financial bubbles, That is what they do for a living.

What is more, when Nixon took the United States off of the gold standard it presented the potential problem of why anyone would purchase fiat credit from the United States in the volume needed to support the deficits being generated by the Great Society programs plus the additional government programs that Nixon introduced.. The solution devised by Nixon and Kissinger was the petrodollar system. Simply put the petrodollar system is an agreement by many of the worlds leading oil-producing nations that they will only accept U.S. dollars in exchange for oil exports. By only accepting U.S. dollars for oil, the nations that purchase the oil must have U.S. dollars on hand to pay for the oil. The easiest method to acquire U.S. dollars is by purchasing United States debt – hence our ability to continue to borrow is primarily dependent on the oil production of middle-east nations – and their demanding only U.S. dollars for oil. In exchange the United States provides military and political security to these nations – this is the primary reason that we have the worlds largest defense budget and most powerful military and why we are constantly militarily engaged defending these regimes in the middle-east.

Understand how all of this is tied together.

Now let us return to LBJ removing us from Generally Accepted Accounting Principles. The obligations that LBJ removed from being counted as part of the official deficit and the debt were primarily entitlement obligations. No President since LBJ has seen fit to return to GAAP. It is simply too politically inconvenient to have honest accounting. However the Congressional Budget Office has calculated the actual Federal debt using Generally Accepted Accounting Principles and the debt number the CBO arrived at is not the $20 trillion that has been in the headlines the last few days – but $210 trillion. The actual debt is ten and half times greater than the debt the Federal government officially claims.

Let us quickly review – the United States left the gold standard shortly after the Federal government ceased calculating the actual debt. In order to replace the discipline that should have been inflicted by the gold standard (but that JFK and LBJ failed to adhere to) the petrodollar and then Humphrey-Hawkins were put in place. These actions had a profound effect on how the United States operated. Prior to LBJ credit was a limited and valuable resource to be provided primarily in situations that would result in increased productivity and consequently increased profits that fed into a growing economy – and an improved standard of living and wage growth. Understand how these are connected – by market incentive.

In the previous model credit was regulated by the amount of savings on hand and the volume of gold in possession – hence it was limited and only provided in the most profitable of situations.

In the current system we have fiat credit – there are no limits on how much credit is available and consequently credit is nearly valueless in terms of only being provided in the most profitable of situations. Previously the only means that creditors had to make money was if the borrower paid back the loan – hence creditors were invested in the success of their borrowers be it with a home mortgage, a business expansion or a business start-up. In the current system the collateralization of the debt is much more profitable than an individual debt being repaid. Grasp that fact and you will understand much in regard to why wages are stagnant and why we have such sub-par growth and most importantly why we have ever expanding gaps in net wealth between the many and the few.

It is popular to advocate for a return to Glass–Steagall in order to address this situation. That is not only impractical at this point but it would simply provide a band aid on the gushing of a severed artery. Glass–Steagall does nothing to address the root cause of why we are bleeding to death. There are many people, notably Trump and Sanders supporters, who advocate for a return to policies of the 1950’s that favored labor and favored manufacturing and all of that. Once again, you cannot have that or anything resembling that if you do not fix the root problem.

The root cause is that with endless fiat credit it can be rolled into a bundle and subject to collateralization and there is no longer an incentive to grow any part of the economy other than the financial sector. Fiat credit with collateralization is being able to create free wealth via the mere introduction of credit. Those who are in a position to introduce the credit or invest in the credit grow wealthy for nothing more than a few keystrokes on a computer – while producing nothing. These people at the top receive the wealth from the credit and the rest of us receive the debt. This is the root cause of the $15 trillion net wealth transfer from the bottom 93% to the top 7% that occurred during the Obama years. What people do not want to grasp is that every government program introduced is funded with credit – hence every Obamaphone and every person receiving government healthcare amounts to a wealth transfer to the wealthy. Do you not ever wonder why the wealthy are overwhelmingly in favor of larger and larger government acquiring more and more debt? This is why.

“If socialist understood economics they wouldn’t be socialist.” – Hayek

That these government programs lead to the enriching of the few and the impoverishing of the many is the root cause of the failure of the -ism’s. I have attempted to explain in this post why that is and what decisions caused us to reach this disaster. At this point people typically argue to raise taxes in order to not have to borrow more money. Using GAAP accounting the Federal government is running a deficit of $5.5 trillion or more. If you were to tax everyone making more than $200K a year at 100% you would raise about $750 billion – so still $4.75 trillion short. If you took every asset everyone making $200K a year had you would raise another $750 billion – so still $4 trillion short.

In other words there are simply not enough tax dollars out there to even approach covering what the United States is on the hook for today – let alone increasing those obligations. In order to balance you would have to tax everyone making $20K a year at 100%. You could only do that once though – after that no one would bother to make more than $20K ever again. What is the point?

When you hear Bernie Sanders argue for Medicare For All – understand that knowingly or not he is arguing for wealth transfers to the 1%. That is the net result of that plan. Furthermore let me connect the dots for you – Medicare (and every other government program) is funded by debt, that debt is dependent on the petrodollar, the petrodollar is dependent on United States military engagement in the middle-east. Not to put too fine a point on it – but innocent people will be killed in other countries in order for you to have that government benefit. I understand that society has abstracted the connection in such a convoluted manner that most people are obtuse about this – but that is the ugly truth. You might want to recall this fact the next time you argue for a government benefit – and leave your moral superiority complex in the dumpster where it belongs.

This model we have moved to the past fifty years has a logical end – aside from the fact that other countries are getting fed up with our willingness to kill innocent people with brown skin so the government can provide Obamaphone’s. If we reach that logical end it will be painful beyond what any of us has ever experienced. Is there time to avoid that pain? Perhaps, each passing day reduces the chances of avoiding the pain. However our real enemy is that we ignore this problem in favor of whatever the talking heads, social media and politicians tell us we should care about today. That is not to say that there are not ten thousand other things that happened the last fifty years to contribute to our predicament – there are. However those things are not the root cause of our disaster but rather unintended consequences and reactions to the problem.

This is our most serious problem and it is a lethal problem.

“But but but statues…”

“Sometimes societies just collectively go insane.” – James Kunstler