Borrowing, Interest Rates, Federal Reserve, Globalization
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There is a lot of stuff being written about the “fiscal cliff.” Frankly, it is becoming somewhat tiresome. The last we heard was about a “temporary” solution; in other words, kicking the can further down the road. The problem is simply “we are living beyond our means.”
You may think it perfectly alright to be able to borrow someone else’s savings for next to no interest expense. After all, that’s what the Quran prescribes. The Fed (Federal Reserve Bank) thinks so too. What does this policy really mean though? It is a prescription to steal from both past and future generations.
Theoretically (that is in the past), you could only borrow funds if someone else had saved them earlier. Well, that idea got nixed by Obama, Geithner and cohorts. If there are not enough greenbacks left “in the bank” to borrow, let’s just print some more. Voila, problem solved!
Oh yes, we are living in a capitalist system. Interest rates are set by demand and supply, also for money. But it is against Islamic principles to charge interest at all. Again, no problem, we’ll just increase the amount of money to the point where everyone has all they need. Then, interest rates will be next to zero, and everyone is happy, especially the Muslims. Voila, problem solved!
In the past (un-enlightened age, a few years ago), young people starting out on their journey of life and aspiring to owning an abode of kind, saved like crazy. They did forego many a pleasure to save for a down-payment. When they figured that they had accumulated enough savings and had jobs that could allow them to be able to carry a mortgage, they went for the plunge and acquired a home with all the obligations. They were fully aware of the potential pitfalls and benefits accruing from it.
All the bailouts of recent years were designed solely to help keep banks from failing. Little if any of the money went to the public at large, at least not directly. So, the banks became encouraged to lend even more, massive amounts on the (implied) premise that they were too-big-to fail. In the past, banks caught in that game were toast. Don’t worry; we now live in the present.
These days, the idea of saving – for whatever purpose – is old-fashioned, to put it mildly. Why would you want to do that? The cost of borrowing is next to nil, prices of many goods and services are rising constantly and, after all, “we want to live NOW.” So let’s get all the consumer products, hi-tech gadgets, fancy resort holidays, tickets to sport and other entertainment shows, a new car on multi-year next-to-nothing borrowing costs, and so on NOW. If you don’t have the resources to pay for all your “needs,” no problem either, the banks and credit card companies are just too happy to lend you all the money you need.
The problem, as I see it, is that the cost of borrowing is too low. If you have a good cause to borrow funds and have saved in the past to accumulate a reasonable down payment to buy, for example, a house for your growing family, it is well justified in most cases, but if you borrow nearly all the funds to buy a house strictly as an “investment” (because “prices can only go up”) you are a speculator.
Speculation is essentially an overall neutral game. Some win and some loose, but when government gets involved in determining as to who should win or lose everything changes. If the government rewards the losers (spenders) by punishing the winners (savers), things have definitely gone out of control in the market place. How far the problem of debt versus production has gotten out of hand is demonstrated by the figure below, showing the sum of private and public debt as percentage of GDP.
Already back in 2010 debt approached 380% of the GDP. By now, I am certain, it is substantially higher. As long as there are lenders willing to lend the funds at next to no interest, you may think it is alright to just keep on borrowing. However, history (and your own experience) ought to have told you that there is no “free lunch.”
Eventually, your credit-line runs out no matter how credit-worthy you may think you are. All of history shows that. Like the laws of nature, there is no getting around it. You may be able to fool the creditors for a while, perhaps even a long time, but the day of reckoning will come. No system has ever been able to live beyond its means forever and none ever will.
Many potentates have learned that too late and their peoples suffered heavily. Even some countries blessed with nature’s abundance such as available energy and mineral resources have become decimated by excessive spending; the examples are numerous. Anyone claiming that “this time, it is going to be different” is just another fool, irrespective of his or her title. There is no free lunch.
The globalisation of markets in recent years (or decades) has brought entirely new aspects to the demand for and supply of products and services. Much of the western world has “farmed out” the production of labour-intensive items to countries with burgeoning populations and, therefore, cheap labour costs. That has enabled the West to concentrate on the development of more higher-margin, knowledge-based products. As a consequence, many companies in the technology fields are doing quite well while those in traditional manufacturing fields are less fortunate. In fact, some of them would not have survived the last economic downturn without massive government intervention, loan guarantees, stock purchase, assumption of legacy pension liabilities and the like.
To compete, labour-intensive industries have moved much of that work overseas. That is where Mohammed meets Marx. More on that later; for now, let’s look at the path forward.
The Path Forward
The path forward out of the current morass, contrary to common belief, is not more of the same, i.e. low/no interest policy. The best path forward is a return to market-driven rates of interest for borrowing, together with a stiff review on expanding debt ceilings, reckless deficit spending and the like.
The Weimar Republic experience, or more recently, the currencies of Argentina or Zimbabwe should demonstrate that need beyond any doubt. Money does not grow on trees, and the “free lunch” is not free at all.
Savers cannot be expected to carry the state forever. A temporary discordance between inflation and interest may be tolerable for a short while. The longer it lasts, the stronger the discordance becomes and the more violent the eventual return to the norm. Any government excluding the costs of any of the vital human expenditures (housing, food, energy, and borrowing money) in its measure of inflation is only deluding itself and (temporarily) its populace.
No matter how much you cook the books or try to delay the inevitable, eventually, the piper will have to be paid.