Global Reset

As we are in the heart of the holiday season, people start to think about the new year and the potential it could bring. This blog tends to be technical ideals for the layperson, but this post is on a something that influences everyone, the economy. My wishes may seem demented initially. Think it through, they make rational sense. My wish is for our economic institutions to face their bankrupt reality and begin defaulting on their debt. This will force leaders everywhere to make decisions that are significant and lasting.

We are in economic trouble because of excessive debt levels at all levels of society. The main debt sources are mortgages, credit card debt and auto loans. Compounding this fact is in the US (all Western societies) we no longer manufacture many items. In essence, we consume more than we produce. Since the initial stages of the crisis appearing in July 2007 (two Bear Sterns MBS hedge funds collapsed), almost all policy has been kick-the-can-down-the-road type ignoring reality. The US federal government backed by the Federal Reserve and the banking industry backed our financial industry in the depths of the 2008-2009 financial crisis. The result was more debt was accumulated on the books of government agencies. US federal government debt stands at $13.8 trillion or ~90% GDP and is quickly rising. Our deficits are unsustainable and will make this debt burden impossible to pay in the next few years. If this was a US problem alone, rest of the world would continue on while we solve our problems. Unfortunately, this is a world wide problem with Europe and Japan in even worst conditions. There is more debt than the ability to pay, thus, it will not be paid. I predict by the next presidential election, much of the debt will be defaulted upon.

The defaulted debt will cause a Great Reset. If our leaders want a society worth living in, they will be forced to make hard decisions about a variety of topics including economics, government spending and social order. Why do I want this to occur? As the way thing are, the debt load is consuming available capital into useless support of an over sized financial industry along with other less productive pursuits like the war-machine and etc. Good portions of this capital could be put to more productive uses like dealing with replacing declining Crude Oil stocks are our main transportation source. Many other good social/economic forces could also be financed. One positive result would lead to the eventual reduction in unemployment since more people would be allowed to work. The other reason is it could bring about the next big thing in technology. The way it is now, future technologies are not emerging due to a lack of will from funding sources. I would like to join the next big thing, but it requires funding and societal support.

This is my wish. It would result in a beautiful renewal or rebirth. Happy holidays everyone!

Cause of Great Recession?

This post is the second of a series covering an event that is going to strike the world economy over the next year or so. Inflation and deflation was the first posting in this series giving a definition of several economic terms for readers. Now, I am going to discuss what is the root cause of our current economic issues often referred to as the Great Recession. The link gives the Wikipedia explanation to our protracted downturn, but, I would not put too much faith in the details. The basic reason why our economy is having problems comes from excessive amounts of debt.

Debt is the result of credit. It is the lifeblood of an economy. Businesses are able to open and expand quickly with access to capital through credit. Consumers can purchase big ticket items such as homes or cars. These two examples would take years for most people to save enough money to execute these tasks without credit. In most cases, it would never be done. Credit expansion is good as long as it is limited to the point debtors can pay back their creditors. It becomes a problem when the debts are NOT paid back. We all know of the family who buys an enormous house, several vehicles and other items they can not afford. We never talk about the creditors taking back possessions.

Reading over several sources, the accumulated private and public debt of the USA is on the order of $54 to $59 trillion. Yes, that is a "t". In comparison, the gross domestic product (annual economic output) of the US is on the order of $14.5 trillion. We may ask, in what forms are the debt? I do not have an exact breakdown, but the main sources are:

• Federal, state and local government
• Housing
• Automobile
• Corporations
• Student loans
• Credit card.

This list is not exhaustive, but covers the biggest categories. Most are familiar with mortgages, auto loans, student loans and credit cards. The debt not familiar to most people are bonds. BondsIOUs issued by either governments or corporations to borrow money.

The government accumulation of debt is obvious. Taxes were cut over the last couple of decades as no one wants to pay while politicians refused to cut spending. Governments issued massive amounts of bonds to keep the social spending going. Debt was accumulated to keep people happy. The amount of debt issued by governments before 2007 was not that significant though. It does contribute to the overall problem now as the amount grows quickly. We will discuss this in the next installment why.

Large amounts of private debt is much more a problem. If everyone (businesses included) spend a significant amount of their earnings on repaying debt, there is not much left over to purchase new items or the demand within an economy decreases. In effect, the money was already spent on items consumer already own or past events. It becomes an even bigger issue if consumers can not keep up payments and default on the debt. This would limit the ability of an economy to grow. The US economy is based upon ~70 % consumer spending by the simple fact that we are not longer a major manufacturer. If consumer spending decreases, the economy contracts and the result is a recession. During normal economic cycles, this occurs every ~8.5 years or so which can be expected. Normal recessions last 6 to 9 months typically with a turn around caused by credit/economic growth.

The Great Recession is different. The number of jobs have not returned with the official unemployment rate U3 at ~9.6 % and true unemployment U6 is at 16.5 %. In a nut shell, U6 is all of the people who want to work but cannot find full time employment. 1 in 6 currently fit into this category folks! This is not your daddy's recession. It all comes back to excessive amounts of debt.

How did we accumulate this amount of debt? It has to due with a new financial innovation that began to appear in the '90s known as securitization. I will simplify this complex phenomenon for laymen. Securitization is the process in which banks take loans on their balance sheets and place them into new structured securities. These new securities are then sold to other investors who make money off of the payments from within the investment vehicles. Banks then remove the loans and risk from their balance sheets. The risk is passed onto the investors within the securities. The result is banks passed on loan default risk to others while in the past banks held onto the loan portfolio (risk). Final results of these new instruments were a credit explosion since the banks had greater incentives to make risky loans. Too much debt was then accumulated over a small time frame outpacing the economic realities underlying the loans.

Next post we will talk about where this is going to lead us.