The Death Spiral of Debt, Risk and Jobs (May 9, 2012)
Debt, risk and employment are in a death-spiral of malinvestment and debt-based consumption.
Standard-issue financial pundits (SIFPs) and economists look at debt, risk and the job market as separate issues. No wonder they can't make sense of our "jobless recovery": the three are intimately and causally connected. An entire book could be written about debt, risk and jobs, but let's see if we can't shed some light on a complex dynamic in a few paragraphs.
Risk: As I described in Resistance, Revolution, Liberation: A Model for Positive Change, risk cannot be eliminated, it can only be shifted to others or temporarily masked.
Masking risk simply lets it pile up beneath the surface until it brings down the entire system. Transferring it to others is a neat "solution" but when it blows up then those who took the fall are not pleased.
Risk and gain are causally connected: no risk, no gain. The ideal setup is to keep the gain but transfer the risk to others. This was the financial meltdown in a nutshell: the bankers kept their gains and transferred the losses/risk to the taxpayers via the bankers' toadies and apparatchiks in Congress, the White House and the Federal Reserve.
Risk is like the dog that didn't bark. In the story Silver Blaze, Sherlock Holmes calls the police inspector's attention to the fact that a dog did something curious the night in question: it did not bark when it should have.
When scarce capital is misallocated to unproductive uses such as duplicate tests that can be billed to Medicare, sprawling McMansions in the middle of nowhere, etc., "the dog that didn't bark" is this question: what productive uses for that scarce capital have been passed over to squander the scarce capital on Medicare fraud, McMansions, Homeland Security ("Papers, please! No papers? Take him away"), etc.
Once the capital has been squandered, it's gone, and the opportunity to invest it in productive uses has been irrevocably lost.
Debt: Debt has a funny cost called interest. If you have a corrupt, self-serving central bank (a redundancy) that can lower interest rates by printing money to buy government bonds, then this funny thing called interest can be lowered to, say, 1%.
At 1% interest, the government can borrow $100 and only pay 1% in annual interest. That is almost "free," isn't it? The key word here is "almost." If you borrow enough, then that silly 1% can become rather oppressive.
Let's say the Federal Reserve is willing to loan you $100 billion at zero interest. You have an incredible sum of cash to use for speculation, and it doesn't cost anything! Wow, you must be an investment banker....
Now what happens when the interest rate goes from zero to 1%? Yikes, you suddenly owe $1 billion a year in interest. That is some serious change. You can of course pay the interest out of the borrowed $100 billion, unless you've spent it building bridges to nowhere and supporting crony capitalism.
Yes, we're talking about Japan--and Greece, the U.S., China, and every other nation that piled up staggering debts to fund an unproductive Status Quo. If you play this "borrow at low rates" Keynesian game for 20 years, then you end up with a debt that far exceeds your national output (GDP). That funny cost is now so large all your tax receipts generated by your vast economy only cover the interest and your Social Security tab. That's Japan today: all its tax revenues only cover its gargantuan interest on its unimaginably vast debt and Japan's social security outlays. The rest of its government expenses must be borrowed and added to the already monumental debt.
Interest creates a death spiral when the borrowed money was squandered on unproductive bridges to nowhere and consumption.
Jobs: Jobs have an interesting feature called productivity. If you pay me $1 million for a manicure (OK, you're an investment banker and can afford it), that money funds consumption, interest and taxes (presuming I pay taxes, which I might not if I hire the right Wall Street law firm). Once the money is spent on consumption (housing, energy, entertainment, hookers for the Security Guys, etc.), interest and taxes, then it's gone. It cannot be invested in productive assets.
If I invest the $1 million in software and robotics that produce equipment for the natural gas industry, then I will hire a software person to manage the software and technicians to maintain the machines, a few more to transport the raw materials and finished goods, a few more to oversee the accounts, and so on. The $1 million funds a number of jobs that will be permanent if the products being produced meet a real market demand and can be sold at a profit.
The $1 million spent on consumption pays for some labor, but it doesn't create any value. If we track where it went, it ended up in the government coffers as taxes, in the five "too big to fail" banks as interest, and in various agribusiness, food services and energy corporations. A few bucks were distributed as tips and donations.
Now imagine if that $1 million was borrowed. If the $1 million was squandered on consumption, interest and taxes, then it's gone in a short period of time--but the interest remains to be paid forever. If you're an investment banker and the Fed loves you (and of course it does), then you can roll that $1 million into a new $2 million loan. You use some of the $1 million in fresh debt to pay the interest, and then you blow the rest on unproductive consumption.
The causal connection between debt, risk and jobs is now visible. Debt is intrinsically risky because the interest accrues until the debt is paid in full. If the debt will never be paid--for instance, the $14 trillion in Federal debt--then the interest is eternal, or at least until the system implodes and all the debt is renounced.
If the money has been squandered on consumption (marginalized college degrees, medical procedures with minimal or even negative results, $300 million a piece F-35 fighter jets, etc.) then there are two risks: the interest that piles up must be paid, meaning potentially productive investments must be passed over to pay the interest, and productive uses that could have been funded by the borrowed capital have been passed over.
Consumption funds temporary labor, but there is no wealth created or sustainable employment created. When you borrow $100K for a marginal MBA, the money paid some staffers at the Status Quo educrat edifice and some overhead/profit, but when it's gone, the debt remains and the staffers need another debt-serf to fund their pay next semester.
If the borrowed money were actually invested in a marketable product (in our example, equipment for natural gas production), then jobs and wealth are created by the increase in productivity and output created by the enterprise.
What we have instead is a Central State and an economy that has borrowed and squandered trillions of dollars on consumption and malinvestment in unproductive "stranded" assets. The debt and risk pile up, while the labor that results from consumption is temporary and does not create wealth or permanent employment.
Figuratively speaking, we're stranded in a McMansion in the middle of nowhere, a showy malinvestment that produces no wealth or value, and we're wondering how we're going to pay the gargantuan mortgage and student loans.
Debt and the risk generated by rising debt create a death-spiral when the
money is squandered on consumption, phantom assets, speculation and malinvestments. Sadly, that
systemic misallocation of capital puts the job market in a death spiral, too.
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We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.
If this recession strikes you as different from previous downturns, you might
be interested in my book
An Unconventional Guide to Investing in Troubled Times (print edition)
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