Runaway Train

by Peter Asher © Feb. 8 ‘09

Imagine the largest freight train ever assembled, careening down a mountainside without brakes and 90% of the cars, allegedly bearing gifts, are carrying lumps of coal. Should it be let free to plunge into the terrain below or should it be derailed?

This freight train that we are metaphorically standing in front of is, of course, The Stimulus Bill whose debt impact will sweep away $780 billion dollars of energy from the economy and deliver a tenth of that to replace it.

Those who have loaded this cargo lack the understanding and comprehension of the economic mechanics that have created this current debacle because they rely upon alleged historical comparisons that are in fact contrasts. They do not observe the empirical data that is before them. In the great depression, less than half the population had consumer debt; and in1929 that amounted to $7.6 billion

The Hyperinflation of Germany took place in the environment of “the banks extended their swollen deposits and bank notes almost entirely to small group of entrepreneurs,  for the most part the officers and directors of the cartels who frequently owned or controlled the banks themselves.” Also, this was a domestic, not global economy and barely recovering from WWI. In this case, there was an extreme shortage of goods and productive capability to be “chased” by the expanding money quantity. Neither example from the past could be a model for policy in the present

At the zenith of the recent boom, there was neither a shortage of jobs nor an excess of inventory; the economy had risen in a state of equilibrium. The capability to produce goods and services expanded to the money supply allotted to it. What followed was that the economy that had attained equilibrium on the advancement of purchasing power inevitably contracted when that advancement could no longer continue. What had expanded to fulfill the demand of earnings-plus-advanced-payment, is now contracting to the demand of earnings-minus-cost-of-debt-service. What for decades was an economy built on, “Buy now, pay later,” has become, “Pay now, buy later!”

The magnitude of the shortfall of purchasing power is only understood when all the factors contributing to it at the peak are recognized. The debt bubble is common knowledge but the transfer of spending power through asset turnover is not quantified nor recognized for what it really is.

From the earlier post: The amount of economic expansion built on advanced credit will be followed by an equal and opposite amount of economic contraction.

“The stock market crash is not just a loss of asset value; it represents a contraction of the spending derived from wealth transfer. Monetary velocity is a phenomenon of goods and services being delivered in return for currency; ergo, no commerce, no velocity. Velocity is slowed down due to falling asset prices because those wishing to sell assets (savings) so as to become spenders reluctantly remain savers. They do not want to spend their assets at a depressed value.”

Any economic activity suffering from insufficient income, absent increased sales or reduced costs of production, must look to reduce the cost of overhead. The two forms of consumer overhead are debt service and taxes. While cutting taxes would be a stimulus as future after-tax earnings become higher, spending power would only come from whatever future earnings continue to be generated. At this juncture, this would be too little, too late.

Cutting the costs of debt service, however, generates instant purchasing power and continues for as much as thirty years. Under quantitative analysis it is by far the most powerful re-boot! The way to create new purchasing power without creating new debt is to refinance existing debt at lower interest.

Senator Mitch McConnell proposed such a plan a week ago.

Quote — “Under the mortgage plan, any “credit-worthy borrower could get a government-backed 4 percent loan. Details were not available, but Republicans have talked about having the government guarantee the 30-year loans for a year or two. Thirty-year fixed rates recently have been around 5 percent.”

“McConnell estimated Saturday that under his mortgage plan, the average family would see its monthly mortgage payment drop by $466 a month, or $5,600 a year.  Over the life of a 30-year loan, that’s a savings of $167,760.” I posted an almost identical version on Newt’s American solutions on Dec 8th which can now be seen in the post ” A Stimulus That Keeps on Stimulating.I added there, “those who lost their jobs or had major business setbacks could be given a year’s grace by amortizing a year’s interest into the loan which, in McConnell’s plan, would only raise a 4% interest rate to 4.13%”

McConnell’s plan was immediately attacked by Harvard economist Ed Glaeser and others by “false flagging” it as a plan to re-establish the housing bubble. Then there was Gov. Mark Sanford, R-S.C. with the inane statement “In the long run, it ain’t going to solve the problem. You can have a loan at 4 percent, you can have a loan at 7 percent, but if you’ve got too much debt, at the end of the day, there’s going to be an adjustment.”  He dismisses it as irrelevant whereas in fact an ongoing $466 per month X 50 million households would turn the economy around in a heartbeat.

We have a lenders bubble! They, the lenders, have “invested” in debt instruments in such quantities that at the existing rates the systemic economy cannot repay them. As in stock market, housing and tulip bulb bubbles, when there is no longer new capital to sustain them they collapse.

The nonpartisan Congressional Budget Office estimated that about two-thirds of McConnell’s proposed bill, which included cutting 10 percent tax on income up to $16.700 to 5 percent, would pump money into the economy by Sept. 30, 2010. If my proposed amortized 1 year grace period were included we would recover in a much shorter time. Reportedly, McConnell’s plan would cost $135 billion a much more workable sum for us to pay down in the future.

If enough awareness is quickly generated to bring public opinion and understanding to bear on enough members of Congress we might be able to derail this Runaway train. Simultaneously, as a society, we will hopefully not “forget history and become doomed to repeat it.” A new, rational consumerism could unwind the unserviceable debt load and Take America Forward into an era of renewed prosperity.