An Often Overlooked Issue!
Professor von Braun
The Rocket School of Economics
May 22nd, 2009.
What I have referred to before in earlier articles as the great credit contraction is now well and truly underway. The credit expansion period is over and what we are seeing now is the effects of what happens when a fiat monetary system reaches the limits of its ability to both inflate the value of non productive assets and defer settlement, via the ongoing renewal of existing debt.
Attempts by governments and central banks to reinflate declining asset prices via large infusions of psuedo capital into the banking system so that the issuing of credit can be ‘kick started’ are doomed to fail.
House prices will continue to decline, unemployment will rise, tax revenues will decline further, government debt levels will continue to rise and peoples net worth will also decline. This is a given!
This is what happens when you get a major credit contraction. In simple terms it is like the tide going out prior to the tsunami coming in.
Since a monetary debacle of this size has not been seen before, there is nothing to compare it with, for not even the depression of the 1930’s comes close. Then people still had savings and the US $ was, until late 1933, pegged to gold at $20.67 per ounce.
Today all debts are now due, since the banking system can no longer lend its way out of its own dilemma and this is what needs to be clearly understood by investors. The dollar is a liability and as such being in cash is also a liability. Government securities are also liabilities but the issue of liabilities versus real assets is more widespread than that.
The precious metals are not a liability and ownership of them is a very wise move given the uncertainty surrounding everything else that is happening. We have seen calls by some market analysts for the Dow to be at 400, 600 and ‘under a 1000.’ What does that mean you may well ask?
It means that you have a collapsed banking system along with massive unemployment and no cashflow of any consequence being generated within the system itself. What will happen to brokerage houses if you have the Dow at 400? What will stock exchanges look like if there is a collapse through to these levels? How will capital be raised when there is no capital left?
Cashflow during the credit expansion period was ‘created’ by the banks themselves via home equity lines, credit cards, and a series of market bubbles. Productivity, which should have been the benchmark by which to measure cashflow went off to all sorts of different places such as Asia, India, China and now we have a situation that the holders of US dollar denominated ‘reserves’ are located outside the US. There is little by way of actual ‘reserves’ within the US itself, hence the need to issue more debt.
In addition money that has been spent within in the US by its residents has mostly been spent on items that have little, if any, appreciative value. On the contrary electronic gadgets tend to depreciate, as do autos, as do fridges, freezers, washing machines and dryers. The real estate bubble has now clearly demonstrated that house prices can and do decline. Those who have been saving for their retirement are in a double bind, since in most cases what they believed was assets are now being seen as liabilities. That second house purchase is now a liability and even the primary residence is, in many cases, under water.
The root cause of all of this is the banking system itself and its mismanagement, with some not so little help from both Congress and the Senate, along with the failure of the deregulation of the systems put in place during the 1930’s to stop this from happening. There still seems to be a complete lack of understanding of what the problem actually is, which is clearly demonstrated by the attempts so far to fix the banking systems dilemma.
The often overlooked issue is CASHFLOW! Where is your income going to come from now that the capital gains machine is broken? Even if you are sitting in cash and own high quality government securities (whatever they are), with a 3% return, what can you buy into that can offer a cashflow that is reasonably safe and secure?
What is going to be left to buy when the music stops, when Mr. Fiat finally succumbs to Alzheimer’s disease and you are left holding his empty bag of promises to pay?
Anything that has debt attached to it is a liability that won’t go away. Any sector that is dependant on people spending money on goods or entertainment that provides revenue to service their debt has a problem and all aspects of the economy are at risk. Real estate, both residential and commercial, travel & leisure, retailing, the auto industry, even the medical profession will be facing lower revenues. The economy is not something that can be easily isolated into safe & unsafe sectors as it is all interconnected via the banking system which can no longer inflate the value of the underlying assets, regardless of what they are.
The example given by President Roosevelt’s revaluing of gold in 1934 is of interest and contains pointers to the issue of cashflow. Small mining operations sprung up in many parts of the US. The reworking of tailings dumps from previous operations became common and with the increase in price gold mining became one of the few sources of consistent cashflow. Employment for miners was assured and towns that were close to producing mines did not nearly suffer the downturns and bank closures of areas that were not.
The production of gold is as close to guaranteed cashflow as you can get, even if gold is confiscated and a new ‘official’ price created, the gold that is being mined does have to be purchased and paid for by somebody. Will there be a resurgence of small privately owned gold mines?
Very few have understood the predicament the banking industry is in. The banks have been in the business of asset inflation and for a while it seemed to be working. But when it became the only game in town, everybody joined in and the ability to keep a lid on the issuance of debt was lost. Productivity was forgotten about as the technological advances gave people access to what appeared to be the goods, but was nothing other than an image.
The need for savings was ignored and now we have a compounding to the downside as assets continue lose their value. Ownership of debt is now being seen for what it is, something that can become problematic very quickly. Investors with capital are few and far between and assets that have strong cashflow potential are also few and far between.
The coming cashflow shortage will affect all entities from the Federal Government, to the states, the counties, pension plans, investors and homeowners alike.
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