Tuesday, 3 February 2009

Smaller Piece of a Smaller Pie

We would just like to summarize the macro picture of the era we are leaving in order to understand the era we are entering. We have been blogging about the credit dangers on Financial Jenga since 2007 and warning about them even longer than that. The global scope of the financial crisis should surprise no one. Didn't we hear all about "globalization" for many years during the synchronized boom? That level of integration virtually guaranteed that any bust would be synchronized as well.

Nearly all other economic ills stem from the mainspring of a deformed and distorted credit system. For many years now, the foundation of the entire world economic system has been the willingness of the average American to spend their entire income - and more besides. This blog described the magnitude of that "more" in its very first entry. That foundation is collapsing and the global system is flying apart as American households suddenly realize that they are in a hole and stop digging. Savings rates have rebounded from negative territory almost back to 3% per the Bureau of Economic Analysis. The fact that Americans are saving again is viewed as a disaster by the Keynesian orthodoxy, which seems oblivious to the need for savings as a source of capital. They are going to have an absolute coronary when US savings rates begin to approach the historical norm of 10% +/- 2%.

The renewed interest in savings certainly will impose short-term pain on a distorted economy based on excessive consumption. The foundation of the economy will have to shift to something more balanced. The simultaneous and related desire to reduce debt is going to accelerate the shift. The pie of funds available to spend is shrinking as income falls in real terms and willingness to take on debt disappears. In addition, the slice of the pie going to consumption is shrinking (it couldn't exactly grow much beyond 100%) as a tiny piece is actually being allocated to savings again. Activities dependent on profligate spending are suffering badly. It was this insight that led us to forecast the consumer spending collapse and the subsequent implosion of the export-dependent economies.

As the cure of a mountain of debt, our government now proposes to borrow in OUR name thus fitting our children and grandchildren for the chains of debt slavery. We must exert ourselves to stop the madness. Though it is financial rather than political, this quote from George Orwell's 1984 seem utterly apt. As Inner Party member O'Brien explains to the protagonist:
If you want a vision of the future, Winston, imagine a boot stamping on a human face forever.

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