Deja Vu All Over Again

We have essentially gone full circle since the financial collapse of 2008, and in the process have squandered tremendous financial resources without any significant result, other than to prove that the liberal Keynesian progressives are tragically misinformed. We are getting closer to observing the collapse of Bank of America.

Shares in Bank of America closed yesterday at $6.30 per share. The shorts have moved in, betting that the shares will drop even more, and once they decline to $5.00, the game is over as mutual fund managers typically can not hold shares of lesser value, thus the selling pressure is going to increase. Now we will get to see how Frank-Dodd really works in the presence of a Too Big To Fail bank failure. One can only hope that the federal government lets BOA fail, takes it over and reorganizes the operation, rinsing out equity owners and bondholders in one huge teachable moment, and sells new shares to the public down the road. Any attempt to commit the taxpayer to another bailout should be greatly resisted.

Despite the Keynesians trying every trick in the book to put lipstick on this depression, attempting to make it look like a typical inventory adjustment/business cycle recession, the economy is now in worse condition than it was three years ago, by virtually any measure you choose. Government unemployment statistics are confusing, but the size of the workforce continues to decrease. Applications for early retirement Social Security benefits are up. On top is this, the public debt being incurred by the federal government to cover up this depression is increasing the likelihood of a currency collapse that will wipe out the value of fixed-income investments held by pension funds, insurance companies and other financial institutions. If this happens, the survivalists presently stockpiling necessities will look like geniuses.

The private sector was decimated by the collapse in 2008. Private sector GDP fell by $1.3 trillion, making debt service more difficult. Clearly, decades of households and firms accumulating debt, at the encouragement of political parties interested in the semblance of growth and social stability, created the problem that we now need to deal with, but keep avoiding. The U.S. economy needs to extinguish trillions in debt, just as it did during the Depression of the 1930's.

During that Great Depression, household debt decreased from 100 percent of GDP in 1929 to 20 percent of GDP at the end of World War II. Despite all of the Keynesian mumbo jumbo about Franklin Roosevelt curing the Depression, with an assist from World War II, it is likely that Roosevelt prolonged the Depression. It was the extinguishing of household debt, and increasing household savings because of rationed consumer goods during the war, that created the conditions for growth after conclusion of the war.

We have to extinguish private sector debt now. Household debt presently stands at $17.1 trillion, about 120 percent of GDP, comprised of mortgage debt, consumer debt for items such as cars, and credit card debt. Credit card debt is increasing, whereas mortgage debt is decreasing as mortgage lenders write-off foreclosed debt. The increase in credit card debt is concerning given the decrease in labor force, suggesting that desperation is forcing credit card debt upwards.

There is no easy way to get rid of this debt - public or private. Somebody is going to get gored. And that somebody is creditors like Bank of America - being consumed by bad mortgage debt, bad European sovereign debt and exposure to soon-to-be insolvent European banks. And the long-term result will the re-pricing of risk. The cost of money will increase, as well it should, as creditors begin to understand that the lending of money is a risky proposition.

The transition of society from one of debt fueled spending to one of work ethic, savings and investment is going to be fascinating. It will take a generation or two, but it will happen with ramifications for the liberal social welfare state. The welfare state will be modified to protect only the truly needy, while encouraging others to embrace personal responsibility for their own financial security and independence.

November 2012 is coming soon. Get involved now.