The Shrinking Capital Base and Our Very Grim Future.

Abstract: The world supply of capital is limited and just printing money will not produce enough of it to keep our global society running. The warning signals are out. Defaults in Europe are most probable in the near future [watch the PIGS: Portugal, Ireland Greece and Spain] and some of our US states will also default. The US economy cannot grow without capital [this is not just money—it is money that must go into efficient production and clever business enterprise] so we cannot pay back either the debt or face the dreaded inflation or stagflation that will accompany this debt without more capital. We are contracting with a -6% growth rate at this time with no real reason to believe that we can get back to positive growth in 2010. We are still in a debt-driven deflationary downward spiral and the “stimulus packages” we supposedly instituted last year have not helped. Our current social spending does not offer capital formation but only more problems, debt and inefficiently. We are spurning cheap energy in the phony quest for a ‘green’ society created in the tortured minds and nostrums of the far left anti-capitalists that lies years or decades away. Our debt is so high now that it may consume all of our tax revenues [at the 2008 level] just to pay the interest. Our future is very grim.

Somewhere there is some knowledge that could be formulated in such as way as to tell our governments that there is actually an upper limit to spending. This knowledge must either be hidden well or government officials, obediently waiting their in the queues, construct instructions so as to pump the subservient media with disinformation and propaganda about the bare facts of capital creation, debt and finance.  At a dinner party Saturday night in a trendy bistro in Kennett Square, PA, I heard that ‘government spending creates wealth and prosperity’ and that we need to spend more. I also heard that the government must ‘do’ something about house prices such as subsidize mortgages or other wild ideas. I heard that high taxes are just fine and that the auto industry must be saved at all costs ‘to save the economy.’

The facts are sadly at odds with these notions. The problem is that capital [not money] is formed in such a way as to generate business and create wealth. The Chinese tested the trendy leftist notion that if we print more money we will have more wealth back in the Ming Dynasty and other times.[1] Argentina[2] is the expert on hyperinflation, or was, until Zimbabwe[3] started printing notes in trillion units.

Somewhere, there is the leftist political backup point about taxes in that we can just ‘soak the rich’ and get them to handle the debt when government finances finally go out of kilter. The problem now is that we really do have a global financial system—like this or not—and that the supply of capital is limited. Places like New York City had a ‘sugar daddy’ in that they could always borrow more money. This notion morphed into what I call the California Disease[4] where all notions of financial responsibility have been outlawed and now the state faces bankruptcy or worse. We have to realize what capital is: “Capital is said to be "formed" when savings are used for investment purposes, often investment in production.[5]”  Notice that printing money that goes for food and such and that is not funneled into investment does not form capital. Our best citizens are saving money in self-defense because of the falling economy and the massive debt and falling house prices [deflation]. This means wealth is just lost, for now.

We need to point out some salient facts about capital formation, debt and where the world  supply  currently is. I usually rely on Ambrose Evans-Prichard, among others, for an explanation of just where we are on the shrinking capital base:

“Unless this capital is forthcoming, a clutch of countries will prove unable to roll over their debts at a bearable cost. Those that cannot print money to tide them through, either because they no longer have a national currency (Ireland, Club Med), or because they borrowed abroad (East Europe), run the biggest risk of default.”[6]--The capital well is running dry and some economies will wither. The world is running out of capital. We cannot take it for granted that the global bond markets will prove deep enough to fund the $6 trillion or so needed for the Obama fiscal package, US-European bank bail-outs, and ballooning deficits almost everywhere.”-- By Ambrose Evans-Pritchard Last Updated: 8:49AM BST 26 Apr 2009 [Emphasis is mine in all quotes.]

“It looked easy for Western governments during the credit bubble, when China, Russia, emerging Asia, and petro-powers were accumulating $1.3 trillion a year in reserves, recycling this wealth back into US Treasuries and agency debt, or European bonds.

The tap has been turned off. These countries have become net sellers. Central bank holdings have fallen by $248bn to $6.7 trillion over the last six months. The oil crash has forced both Russia and Venezuela to slash reserves by a third. China let slip last week that it would use more of its $40bn monthly surplus to shore up growth at home and invest in harder assets – perhaps mining companies.”-- Ambrose Evans-Pritchard  26 Apr 2009

Note that the world capital sum is now down to about 6 trillion. Japan and China hold about 1/4 of this or so. To think that bonds can be floated to cover this is lunacy. Read The Ascent of Money by Niall Ferguson.[7]

China is very afraid that the US is inflating their currency [by printing money thus monetizing the debt[8] or printing enough to pay the interest on loans] and that their reserves will sink in value. They intend to invest in production and research and move ahead while we experiment with a green society and print money.

Obama needs $6 trillion.

“So where is the $6 trillion going to come from this year, and beyond? For now we must fall back on the Fed, the Bank of England, and fellow central banks, relying on QE (printing money) to pay for our schools, roads, and administration. It is necessary, alas, to stave off debt deflation. But it is also a slippery slope, as Fed hawks keep reminding their chairman Ben Bernanke.”-- Ambrose Evans-Pritchard  26 Apr 2009

Let us dwell on this aspect of capital formation again: if we print money and it is converted into capital and that encourages growth then we might be able t pay back the debt before it turns into wild inflation.  This plan is based upon growth of the US economy. The economy is not growing at this time. Thus inflation or hyperinflation waits until the trillions of bailout monies circulate through the banks. Then the multiplier is about 10—and off we go into inflation.

Defaults and worse:

“The G20 deal to triple the IMF's  fire-fighting fund to $750bn buys time for the likes of Ukraine and Argentina. But the deeper malaise is that so many of the IMF's backers are themselves exhausting their credit lines and cultural reserves.”

“Great bankruptcies change the world. Spain's defaults under Philip II ruined the Catholic banking dynasties of Italy and south Germany, shifting the locus of financial power to Amsterdam. Anglo-Dutch forces were able to halt the Counter-Reformation, free northern Europe from absolutism, and break into North America.”

“Who knows what revolution may come from this crisis if it ever reaches defaults. My hunch is that it would expose Europe's deep fatigue – brutally so – reducing the Old World to a backwater. Whether US hegemony remains intact is an open question. I would bet on US-China condominium for a quarter century, or just G2 for short.”

This notion, from an Englishman, is astonishing. He seems to suggest that China and the US will somehow tie the financial knot and proceed forth in capitalism and leave the rest of the world behind.  Great Britain has set up a collision course with reality in that they are burdening their transportation and manufacturing facility with carbon caps and horrendous taxes led by their Princeling of Wails,^[9] with an accompanying astonishing government vote by Parliament--they have voted 648:5[10] to destroy their economy with phony EcoNazi taxes.   This is just the kind of inefficiency that will prevent the precious growth necessary to cover their massive printing of money known as ‘quantitative easing’ or just QE.

Defaults are a real possibility here in individual states [and abroad] and the rescue money would have to be printed from nothing but our good wishes for the Left Coast and the Rust Belt. California, New York, New Jersey and probably Michigan are in the tank now with nobody to turn to. Among this group we have nearly 20% of the population on the brink of going into the financial latrines.

So, to this problem we have instituted a ‘stimulus’ program that involves putting money into something other than capital formation and those other things will burden our economy and waste money and resources.  Get set for some ugly times.  Our future is very grim now. Brace yourselves for some state defaults and some massive taxes that will essentially halt business. The taxes will be unbearable.

rycK

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