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Life and Cash-flow Accounting
  (Eric Andrews, December 29, 2008)

There’s something tickling the back of my brain about the whole reporting of the economic crisis and the “solutions” offered. That’s not just mainstream commentators either; it’s equally visible among contrarians, deep thinkers, critics and so on, but it’s something I’d like to share with you today.

Generally, the economic crisis is presented as a “budget shortfall”; for example, among corporations or the example I will use, Social Security. According to a recent speech by Fed Governor Richard Fisher, unfunded liabilities for Medicare, Social Security, and associated programs are around $99,000Billion. That’s a big number; even an impossible one. However that’s not my focus today.

Usually when such numbers are thrown about—in Congressional Budget meetings for instance—it’s stated that all we need to do is save more. Simply put the required money into this Fund, fill the Social Security shortfall with real dollars instead of IOUs, and the problem would be fixed, if only we could get the money to do it.

I’m sorry, but that is NOT what would happen.

I’m not arguing with actually funding programs as opposed to promising them without funding. I’m not arguing with it being the definition of a Ponzi scheme. I’m not arguing with those who rightfully argue that such a debt can only be repudiated with default or inflation. All those things are true. What I’m after is the assumption it's founded on to begin with.

Let’s assume that instead of a completely unfunded accounting book, the government HAD filled Social Security et al with its very best asset, one that has retained sound fundamental value for 5,000 years, that is to say with gold. Suppose the Government had been perfectly responsible and saved every dollar required in the world’s best cash. What would happen?

The first thing is that over the last 50 years of retirement pay-ins, the value of gold would have slowly risen to unimaginable levels and its availability would have dropped relentlessly. But--you say--the Post-War years were a boom time, surely saving would have been easy? No. The increasingly high price of the asset of last resort would most probably have constrained other credit as well as diverting effort into mining instead, preventing the boom.

That’s because the real reason we had the post-war boom is because we got to spend our money twice: once with the government spending phony IOUs and once with the government promises making us feel so safe about the future and our retirement that we spent the real money without saving for our own future. We were both rich on paper AND rich in reality--in short, a sort of wealth effect. Unfortunately, only one of these accounts was real and it wasn't the paper one! In the real world, cash can only be spent once; all other money is strictly debt; a unfounded book entry. The boom of the last 30 years has been not only the explosion in debt, but the constant falling of both savings and interest rates, neither of which would have occurred in a let’s-save-everything-in-hard-cash environment. If instead of deficit spending, personally, locally, nationally, we had saved only in gold instead, this constant savings would have created a $99,000Billion headwind, a 30 year recession in order to put away the required capital.

But once you retire, surely all this hard work would pay off, right? The account is now fully funded. Wrong again. All we have created by saving $99,000Billion in gold—however many ounces that might turn out to be—is the world’s biggest bubble in gold. The moment the demographic switched from net savers to net liquidators, the price of gold would then FALL for 30 years as the retirees sell gold for daily expenses. Before long, the price of gold would collapse vs food, health care, or Miami rent, leaving nothing for the later retirees. In short, using the best cash in history, with full fiscal responsibility, we would still have the same impossible, unfunded system we have today.

What I’m saying is that NO savings medium can tolerate a 30 year demographic influx of savings, then a 30 year demographic draw. It doesn’t matter if Social Security is unfunded, funded by debt, or if we funded it with almighty gold—it was ALWAYS an illusion. The question of whether Social Security is “funded” is useless; in fact, worse than useless because it diverts attention from the real problem: You cannot have a whole society work one decade then take the next two decades off and expect the lights to stay on and the food to arrive.

And that’s my point.

Let’s look at this from another angle. Given that no monetary solution is even possible when it comes to this sort of question, let’s remove the money from both sides of the equation: As a society, every day people work to get things done, and every day, those things get done. It's a sort of homeostasis. The analogy would be a strictly cash-flow situation, an ecosystem, or a living organism.

Despite our focus on finance and savings, life is inherently a cash-flow system, where the food you eat is picked a day or a few weeks before you eat it, the oil you use is pumped a few months before you use it, and the shoes you buy are made a year or less before you wear them. Even in the best case—saving the grain of the seven fat years for the seven lean years—when applied to a 30-year cycle--would require unfathomable storage, planning and expense. Financial savings are an illusion. Only real, needful things--grain, energy, equipment, improvements--are true wealth.

Financial instruments pretend to store real wealth, but they only are a proxy for real wealth, not the wealth itself. Because of this fact the value of those financial proxies may vary wildly over time and changing conditions. Just as in the above example with gold, a savings proxy only has value in relationship to something else. Financial savings are types of derivatives, little better than the fabrications we read about. When everyone is saving, naturally the value of the saving medium goes up: we appear fabulously wealthy in stock and paper terms and have nothing to worry about. Later, when everyone is selling their savings medium, the value of real goods rise while the value of savings falls and we discover we are just as poor in reality as we had appeared wealthy before. So when are we wealthy? And if we can't tell using numbers, how can we tell?

We only know if we are rich or poor by looking at the real world, by measuring our ability to create and deliver the goods we need day by day on the cash-flow basis. Our factories, our fields, our infrastructure, our workforce, our health and safety—only their condition can tell you whether we are wealthy or not. I argue that on this basis we are systemically and measurably NOT wealthy. We are gravely impoverished. We just had in a 30-year Depression in the value of useful things. That is the flip side to having a 30-year bull market in financial engineering.

What to do then? To me it’s simple: if you want to have food in the future, with a workforce that will be markedly smaller, then you need to put plans into effect today that allow you make more food with fewer people. if you want apples, you need to plant an orchard—10 years before hand. If you want a viable electric car, you need to start designing one—15 years before hand. If you want oil, you need to drill—6 months to 15 years before hand.

Looked at this way, am I telling anyone anything special? I doubt it. But the fallacy of pop economics is that “if you raise prices, the goods will appear. This may be true in ordinary times, all else being equal. But life never occurs under such pristine conditions. In the real world, it won’t matter what the price is, because regardless of price we cannot reap the fruit of price’s economic response for months or years depending on the scale and difficulty of the industry in question. For example, in the 70’s, the US suffered through decades of energy crisis and its corresponding depression, leading to the opening of giant nuclear plants 15 years later. After 35 years, these still provide the backbone of US generating capacity, but it took 15 years for the REAL economy to respond to the price signals and through all that time there were high prices and shortages. Imagine that the shortages had been in food or heating oil, and that you're now 70 and unable to work, and you’ll see the danger. For example, when the fall of Soviet Russia raised their prices, interrupting food and energy, the average male life expectancy fell from 65 to 59!

This danger is somewhat avoidable, but by thinking about it as an economic problem, we fail to address what is fundamentally a real problem and to focus on real solutions. Believe me, economics works, but if you focus on the MONEY aspect of it, you’ll find that rather than becoming a planning and DELIVERING mechanism, the price signal becomes a RATIONING mechanism akin to the Soviet Era—useful only to define WHICH sort of shortage we prefer. Would you prefer food OR water? Would you rather heat OR light? You can then take comfort in the knowledge that the invisible hand of the market will indeed provide for you…15 years in the future. Only 5,475 meals to go.

Real, useful capitalism requires not a response to the belated price signal but visionary action. And since it is already too late to alter large, long-term issues at the Governmental level—say, mass transit, zero-energy homes, or building the transmission and generation capacity to support wind-fueled electric cars—the best any of us can do is to think ahead to make sure that we ourselves are insulated from unnecessary trouble. That is to say, if you want pickled herring on Friday, would you save in strawberry jam and hope to trade? So if you want a retirement that includes food, energy, and security, wouldn't it make more sense to invest directly in those things? The working of the price signal depends on somebody else thinking ahead and saving for you, anticipating what you may need and making it. But we already know those needs will not be met in the macro sense. So if you want them and want them reliably, shouldn't you buy them now while they're cheap? Things such as a low-energy/low money input house. Things such as ways to provide and produce your own food: a greenhouse, a mushroom log, a garden, a chicken coop. Perhaps become a marginal producer of energy with investment in wind, PV, or whatever other creative solution takes your fancy. As you will have far less to buy later, higher prices and shortages will have less effect on you while the yearly savings of non-buying accrue year after year. You thereby use your retirement savings far more wisely, with far more certainty and control.

But wait you say, in the last Depression in Japan there were no shortages. In demographic cycles the retirement boom tends to cause depressions and not inflations. Overcapacity, not undercapacity. What do I mean by high prices and shortages? Just this: the top of the Nikkei bubble was at 40,000; 20 years later the price is under 9,000. If you had used the Nikkei as your savings proxy, your daily expenses would have risen 4.5x compared to your savings—and I'm not counting inflation. Imagine a world of effective $16 milk and $9 gasoline and you'll see how it doesn't matter what the number is, only the relationship. --It could even be 50c gasoline with a 2,000 Dow. I cannot guess the number, but in using Japan as the example I'm being irrationally generous: apart from the many advantages Japan had going into their Demographic depression, the value of worldwide paper proxies is in the multi-Quadrillions. There are perhaps $1.4 Quadrillion in derivatives alone—while the world GDP is a mere $0.065 Quadrillion. $65 Trillion divided by the outrageously generous assumption of $2 Quadrillion is an Proxy to reality ratio of 30:1. If even some of the 30x value in paper rotates back into reality, then you can imagine $120 milk and $60 gasoline. (For an introduction to the strong impact of demographics on the economy see Chris Puplava's Secular Signposts )

Wouldn't the high price prevent shortages? In economics there are never “shortages”: everything is available at SOME price. But if the price is too high for you then it doesn't much matter if it is theoretically “available” or not. And when the price becomes too high for too many people, an item can drop from general circulation. That's what I mean by shortages and you can see them in Zimbabwe or any other nation which has high inflation or a severe monetary disorder.

And once this shift begins out of paper and into the real, it's a positive feedback mechanism. It's really only rotating asset classes, real to paper, paper to real; but it's not healthy to either the economy or to mankind to move everything into first one asset, then out of it into another. It's like a madness, a sickness, because it comes from chasing after something-for-nothing, this dream of profiting-without-working. Why not work honorably and well?

Like a living organism, what defines a healthy system is balance. The system needs adequate real production, matching consumption, it needs real savings of real food and productive material...and it needs a properly-sized financial system as well. They are like a liver, a heart, a lung: should we allow one to grow at the expense of the others? If so, we have a name for that disease: it's called cancer. And we don't cure it by removing the organ; we simply reduce its size and growth back to a normal level so the organism can live in harmony again. Can the heart expect to live without work, perhaps on the reserves of the stomach? After it works does it keep all the blood to itself, starving the liver? No, a healthy system is in balance, where all parts work together to make every one stronger and better. In a body that balance and motion is health, and in an economy it is wealth.

That is cash-flow-accounting and real life. The financial sphere is simply an organ that has outgrown itself and needs to shrink, while the real economy that makes and produces useful things has deteriorated markedly and needs to recover in size and strength. This makes their relative values change, sometimes sharply. This is normal and it's healthy. To provide our real needs in the real world they each need to work together and be correctly sized. Everyone needs to be justly compensated according to the value they create for the health of the whole system. Luckily, the system is self-righting and if we respond to it instead of forcing our wills on it with useless intervention, it would quickly return to health.

Getting lost in the minutia of accounting won't help here—who got the bailout, whose was bigger, was it fair. Not only is it not real, it doesn't get real work done. We need to look out for the whole system and not just ourselves. Our focus should not be the sickness of the system but how to return it to health. What does health look like? What does it feel like? What can we do now to take a step in that direction?

Good accounting is important, but accounting doesn't turn the wheels of the fire engine: men do. Meanwhile, the fire smolders. We need more men and less accountants. If you believe this, then you need to pick up a bucket. Not somebody else. Not government. You.

Knowing that the price of paper will fall and real work will rise should help make it easy.

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