Wednesday, March 16, 2011

The Shadow Knows: Part Two

The Shadow Knows

Additional Economic Background

After last night’s introductory post, I had originally planned to launch straight into a more detailed analysis of one of the seven shadow functions. However, based on some of the comments that appeared on the post, further background material is necessary to help explain the main thrust of this topic.

Two general areas of explanation need to be covered. One is easy, and I’ll tackle that first: a reader named “TequilaKid” left a comment (and a challenge) for me. He posted it on the news feed by mistake, and many readers may not have seen it, so here it is in its entirety:

Dear Baron Bodissey:

I read your note in Gates of Vienna today and was inordinately puzzled by two broad historical claims you formulated:

1. “The Western welfare state is built out of enormous, unthinkable quantities of debt. It is the greatest Ponzi scheme in history, and its demise is mathematically inevitable.”
2. “… Socialism … weakened Western culture and allowed Islam to establish … a massive beachhead.”

I scoured my head for hours trying to guess what historical events had persuaded you of the accuracy of these peculiar notions. I strongly suspect they are random products of your imagination. I hereby challenge you to produce any sensible argument or fact in defense of these two remarkable theses, which I have no hesitation in qualifying even now as patently fraudulent.

Sincerely, TequilaKid

Since #2 is a considered evaluation, and therefore constitutes my personal opinion, I can no more prove it than I can “prove” a statement such as: “This country is going to hell in a handbasket.” (Which it is; I just can’t prove it.)

#1 is more susceptible to demonstration, since it depends on data which are readily available, although the material is quite complex. The current welfare state is the greatest Ponzi scheme in history, and its demise is mathematically inevitable within about a generation, at the outside.

Let’s review the definition of a Ponzi scheme. Bernie Madoff’s scam was an enormous Ponzi scheme, but a simpler and smaller model can be found in the standard chain letter. A recipient is asked to add his name to the bottom of a list of names and send an amount of money to the name at the top of the list, which he is instructed to cross off. He is then required to forward a copy of the new list and its instructions to ten more people. After that he sits back to wait for the money to flow in.

The earliest participants in a chain letter really can make a lot of money off the scheme, but as the number of recipients rises exponentially, the pool of potential new suckers rapidly dwindles. Those who are late to the game lose their money as they help enrich the earlier players.

A mathematical formula of moderate complexity — which includes parameters for the total population available, the estimated proportion of recipients who are willing to participate, and the average time it takes to receive and resend each letter — provides a rough guess as to when any given chain letter or other Ponzi scheme will collapse. But the math is not really necessary — common sense and a reasonable native intelligence leads to the intuitive conclusion that any Ponzi scheme must eventually crash. No population is infinite, so the supply of suckers must run out, and the last ones in are the big-time losers.

Bear all that in mind as you examine the graph below:

National debt through 2009

These figures only take us up to 2009, and we have added two or three trillion dollars to the national debt since then. The last figure I heard was that the debt currently stands at about fourteen trillion dollars — a sum that is scarcely imaginable to an ordinary schmoe like me.

The graph bears a remarkable resemblance to the progression of a typical Ponzi scheme, but instead of an ever-increasing pool of money being sent out by the suckers, it shows the ever-increasing amount of money borrowed by the United States government so that it can continue to give out all the free goodies that its citizens and corporate friends have come to expect.

In other words, instead of voluntary suckers — rubes who, although stupid, surrender their money of their own free will — the feds are forcibly extracting money from future taxpayers. When the scheme collapses, as it inevitably must, the citizens of that era will be de-pocketed of their money, and will receive little or nothing in return.

Congress is even now rearranging the deck chairs on its own fiscal Titanic, tinkering with the trivial edges of the gargantuan deficits that its serial profligacy has created. Defund NPR. A pay freeze for federal employees. Cut back on military expenditures.

Those are all eminently worthy goals, but they don’t touch the elephant in the room, which consists of three major entitlements: Social Security, Medicare, and Medicaid.

Consider this graph:

Tax increases for SS, Medicare, Medicaid

The above estimates don’t include all the effects of Obamacare, which is expected to increase Medicare costs significantly (even while reducing delivered benefits). I don’t know the full methodology behind the figures, but I presume they also don’t factor in fully the persistent stagflation which is now expected over the next few years. That will tend to erode the tax base, and will require even further tax increases.

Or the government can borrow even more money — assuming it can still find governments that are foolish enough to lend it to us.

Finally, take a look at this graph:

Aging population

This is why the other graphs rise so steeply — all those Beautiful People from my generation who are about to enter their Golden Years and cash in on all that retirement “insurance” that they’ve been paying the feds for the last forty years or so.

This is why the government has to continue its borrowing spree — for all those years it took in all those FICA payments and spent them, “borrowing” the money from itself using accounting tricks to keep the debt off the federal balance sheet and thus conceal the extent of the real deficit. Now the bill is coming due, and it can only increase in size over the next few decades.

And while the Baby Geezers suck their “fair” share out of the system, the missing children — the ones that so many of them didn’t have — are not around to pay their sucker’s contribution into the scheme. We are near the peak of the Ponzi graph, and it will begin its collapse relatively soon.

Let’s be conservative and assume that the national debt is now only $12 trillion.

Let’s be hallucinatory, and assume that that Obama will tighten the country’s belt far enough to keep the debt from rising any higher.

And let’s suppose we’ll be able to take a hundred years to pay it off — without taking into account the additional interest that would accrue in the meantime.

This repayment schedule would require us to remit $329 million per day. For a century!

It’s glaringly obvious that we will never repay this debt, not ever. It doesn’t matter if we start rutting like rabbits tonight and produce a whole new crop of compliant taxpayers — those little rugrats will be unable to contribute their “fair” share for another quarter century.

It doesn’t matter how many illiterate mestizos we import from south of the border — they cannot possibly provide enough tax revenue to fill in the gap, even assuming they were somehow able to start contributing more to the system than they take out of it.

The welfare state is done for. It’s a dead man walking, and it doesn’t even realize it. The Ponzi scheme will soon collapse, and the bill will come due for those of us who are left holding the bag.

If the debt cannot be paid, there are only two choices: sovereign default or massive inflation.

The Chinese are rumored to have the hacking capability to take out most of our major computer systems — banking, the defense networks, utility command and control operations, and so on — and China holds a huge portion of America’s paper. For this reason (and others), I consider sovereign default very unlikely.

So inflation is the way to go. This may happen gradually or suddenly, and the longer it is postponed, the worse it will be. To drain the debt pond, the dollar will have to lose somewhere between 80% and 95% of its current value. This will deprive the average citizen of most of his wealth. Since the very rich generally have the knack of avoiding the catastrophic effects of inflation, we must presume that the ordinary taxpayer will bear the brunt of the damage. People will effectively lose their savings, their 401(k)s, and the bulk of their pensions. We will become very poor in a relatively short period of time.

This is the easiest way for the government to take care of the problem. It doesn’t have to pass a bill and raise taxes. All it has to do is print more money continue with “quantitative easing”.

How this catastrophe will play out in detail is anybody’s guess. With the inevitable mass discontent it will engender, it seems unlikely that the existing political system can survive in its present form.

Whether it happens slowly or quickly, violently or peacefully, the Ponzi scheme will collapse. The end of the welfare state in its current form is inevitable.

*   *   *   *   *   *   *   *   *   *   *   *   *   *   *

The cheerful outline above applies to the United States, but the same general process will have to unfold more or less simultaneously in Canada, Europe, Australia, and Japan, all of which have similarly unsustainable Ponzi schemes. The euro and sterling are facing the same bleak future as the dollar.

The rest of the world is heavily dependent on the prosperity of the Western democracies. Trade, foreign aid, military protection, technical assistance — all of these will be hard-hit when the crisis finally arrives. The catastrophe will truly be a global one, and no country will be immune. Those at the margin — impoverished countries like Bangladesh or Haiti — will fare the worst. The consequences are frightening to contemplate.

Despite the fact that various countries have been through massive inflation in the past — Revolutionary France, Weimar Germany, Argentina, Zimbabwe, and others — the coming crisis will be unprecedented. There has never been a global currency collapse before; there have always been nations outside the inflationary economies whose systems were unaffected. In this case, no political entity is likely to escape unscathed.

We have never been down this road before, so no one can do more than guess how events will actually unfold.

This is the full background on the economic situation as it pertains to the Shadow. The next background topic is why this issue is about much more than survivalism. I’ll leave that for a later post.

Many thanks to all our commenters and emailers for their input.

22 comments:

Hesperado said...

My potshot only targets Baron when he wears the hat of doomkneller (which, I am glad to note, is not often), and not the reportorial hat which he wears well -- the potshot being that it's a wickedly felicitous coincidence to have this post right next to one titled Shazam!

I.e., just as there may be "voodoo economics" there is also "voodoo apocalyptic". History, meanwhile, will keep on truckin'.

mace said...

Baron,

I can't comment on your analysis of the size and consequences of US public debt. Australia's public debt is much smaller as a percentage of GDP, despite having a more 'socialistic' welfare system. So I don't think you should include Australia as a full member of the club of state sponsored Ponzi schemes. The country's problem is external, not sovereign debt.

Baron Bodissey said...

mace --

I'll take your word for it about Australia's debt.

However, Australia shares the demographic crisis with the rest of the West. This is the ultimate limiting factor to the welfare state, and the outside limit for all Western nations is about 25 years. None of our welfare states will be sustainable in their current form after that time. All of them are Ponzi schemes.

And that's best-case, of course. A lot of things -- Iranian nukes, a Muslim Brotherhood takeover of Saudi Arabia, earthquakes, droughts, etc., etc. -- can influence how quickly the denouement arrives.

Baron Bodissey said...

Hesperado --

To quote Fjordman, "This isn't the end of the world, but it's the end of the world as we know it."

The welfare state must fail within 25 or 30 years at most. Check out the demographics of the Western democracies, and the impossibility of maintaining the current system -- especially as it applies to care for the aged -- becomes obvious. It simply can't be done.

Mark Steyn has the most comprehensive statistics, and I recommend his articles on the topic.

Our leaders thought they could fix all this through immigration -- that's how the current policies originally began. Import Turks, Moroccans, Mexicans, etc. to supply the missing tax revenue.

Now it has become obvious that this can't possibly work. But there's no Plan B -- FAIL is our only option.

Anonymous said...

There's a silver lining here. If the entire developed world's economic system is based on several lies, the system that replaces it eventually, will no longer be based on those lies.

People in the future will have the opportunity to be more like the founders of this country: literate small farmers and craftspeople. That's my ideal, and those are the very people who don't have a chance against the Walmart-type system.

Also, the United States will be too poor to run the world and support the bad guys in every conflict. A broke USA is a good thing. Even though I myself won't have a comfortable retirement, it's still worth it, because the current system is just wrong and shouldn't be supported. I hope for a relatively soft landing for everyone in the West, but I'm glad things can't go on as they are, because they shouldn't go on.

jlevyellow said...

I disagree with the cataclysmic scenario that has been described. When the currency collapses people who live in cities will find it very difficult and may resort to looting, rioting and murder. All systems will break down and older people will die off quickly, as will children and all non-productive people. These are the expensive populations that are dragging us down. As the population decreases, the jobs per person will increase and people will go back to work to remain alive. The population will then be filled with lean and mean people who are willing to work to survive. Chaos will give way to productivity and everything will be fine again.

4Symbols said...

In hoc signo vinces

Baron,

Looks to me like we are witnessing the fall of capitalism not because of welfare but because of the corruption of capitalism that is neoliberal laissez-faire economics, the only welfare label that can be applied is the champagne welfare of those running the Ponzi Schemes which are in fact corrupt laissez-faire capatilist in construct - redistribution of wealth to the scum at the top of the pyramid not to the investors and producers at the base hardly a concept resembling socialism or even moral capitalism.

It is the Ponzi Schemes of laissez-faire capitalism that is being consigned to the dustbin of history.

Rollory said...

"So inflation is the way to go. This may happen gradually or suddenly, and the longer it is postponed, the worse it will be. To drain the debt pond, the dollar will have to lose somewhere between 80% and 95% of its current value. This will deprive the average citizen of most of his wealth. Since the very rich generally have the knack of avoiding the catastrophic effects of inflation, we must presume that the ordinary taxpayer will bear the brunt of the damage. People will effectively lose their savings, their 401(k)s, and the bulk of their pensions. We will become very poor in a relatively short period of time."

It will do more than that. There is NO mechanism in the current economy tying wages to inflation, which has been the case in the classic hyperinflation scenarios - Weimar and Zimbabwe. The closest there is, is renegotiating pay each year come raise time. That's not nearly responsive enough.

Food and energy are a global market.

This means that high inflation principally has the effect of making it impossible to buy groceries - you spend a month's budget in a week. Then, Egypt.

At this point I am willing to believe that Bernanke will go that route because he really is that stupid.

Also, it would not surprise me to see the USA encounter the crisis within 10 years. It _could_ last longer, but there is zero political will to do the jury-rigging necessary. Interest payments on the debt are going to hit 20% of total federal revenues by 2020. There's no way that will work.

jlevy: in the long term, sure. Your grandkids' generation, maybe.

Baron Bodissey said...

jlevyellow --

The scenario you describe may well be what lies ahead. Unfortunately, my wife and several members of my immediate family are almost certain to be among the "expensive populations that are dragging us down" who die off.

That makes it difficult for me to share your sanguine assessment that "everything will be fine again".

Whether things will in fact be "fine" depends very much on where you happen to be sitting when the scythe comes sweeping through.

sulber nick said...

Isn't 'proof' a scientific term in the same way that 'equality' is? That said, surely there's a load of evidence to support the statement, “… Socialism … weakened Western culture and allowed Islam to establish … a massive beachhead.”

Anonymous said...

re: jlevyellow

Jobs and businesses only exist where there are markets and revenue. Your prognosis envisions most of the customers being killed off. No customers = no markets = no businesses= no jobs = no way out for anybody. When a big ship sinks, it sucks diown everything and everybody in its vicinity. So, sorry mate, you and yours are not going to be spared either.

Zenster said...

No population is infinite, so the supply of suckers must run out, and the last ones in are the big-time losers.

Far too much of modern marketing — and government, for that matter — relies upon the "infinite market" concept; of which no such thing exists or ever has existed.

This perversion of honest free-market Capitalism will go down as one of history’s great economic tragedies. Look for endless experiments to follow with variants of Socialism or Stateism despite them being discredited by numerous failed states and countless millions of corpses.

latté island: There's a silver lining here. If the entire developed world's economic system is based on several lies, the system that replaces it eventually, will no longer be based on those lies.

There is absolutely no guarantee of such a seemingly desirable outcome. Far too many warlords and despots are waiting in the wings just drooling to inflict upon us their own sadistic visions of utopia.

Even if we were to handily rid ourselves of those lies our economic systems are based on; would the resulting, seriously degraded world economy be one at all worth living in? Who here would like returning to a pre-industrial era, replete with a lack of bulk water purification, indoor plumbing, pest control, antibiotics and a host of other taken-for-granted yet vital modern services?

Be very careful about what you wish for…

jlevyellow: These are the expensive populations that are dragging us down.

More than one sinking ship has been known to drag down with it several perfectly functional and fully occupied lifeboats.

Again, be very careful about what you wish for. You may be in one of those lifeboats.

Chaos will give way to productivity and everything will be fine again.

Even after all the factories have rusted and fallen into decay? Contrary to its appearance, modern industry is the result of an exceptionally complex and astonishingly fragile supply chain that can be shattered by even a few months of dysfunction.

How do you think that Detroit's autoworkers were able to extort such usuriously high wages even as they drove their own employers out of business?

4Symbols: Looks to me like we are witnessing the fall of capitalism not because of welfare but because of the corruption of capitalism that is neoliberal laissez-faire economics, the only welfare label that can be applied is the champagne welfare of those running the Ponzi Schemes which are in fact corrupt laissez-faire capitalist in construct - redistribution of wealth to the scum at the top of the pyramid not to the investors and producers at the base hardly a concept resembling socialism or even moral capitalism.

Thank you for at least mentioning "moral capitalism". Increasingly, it is the plutocracy and political elite that drain our world's lifeblood. Petty corruption — no matter how damaging it once was and still is — simply cannot compete with the endless consolidations of middle management that never work but render redundant huge swaths of working professionals. Disloyal Multinational conglomerates have wrung dry their original home markets and moved on to greener international pastures, outsourcing jobs and off-shoring into tax shelters whenever they see fit, regardless of the societal mayhem they wreak.

Too late will shareholders finally learn that the bottom line is not all it seems. Wall Street's obsession with impossible-to-maintain quarterly profitability has resulted in generations of book-cooking accountants and cosmetic CEO "turnarounds" that have plundered American industry and rendered it a shell of its former self.

There's Hell to pay and, as usual, it will be the little guy who bears the brunt of it. Some serious consideration needs to be devoted towards ensuring that the elite drink a full measure of the economic hemlock they have industriously bottled for common consumption … even as they sip at Grand Cru wines in their gated estates.

Zenster said...

al-ttt: When a big ship sinks, it sucks down everything and everybody in its vicinity.

Congratulations on nailing the precise metaphor for this scenario. Call our economy the Titanic for all you will, we still need to find some way of steering clear of the iceberg.

Simply sitting back and watching the ensuing chaos is not an option.

4Symbols said...

In hoc signo vinces

@Zenster,

This perversion of honest free-market Capitalism will go down as one of history’s great economic tragedies. Look for endless experiments to follow with variants of Socialism or Stateism despite them being discredited by numerous failed states and countless millions of corpses.

Profound statement Zenster, I have always thought that the perversion of Capitalism came from a narcissistic sense of entitlement a corruption that is closer to Socialism than Capitalism, this being realised by the people then the fall into the abyss of Socialism or Stateism can in part be averted.

Peter said...

"The next background topic is why this issue is about much more than survivalism."

Since I'm really bad at prediction, I won't presume to comment on a piece that you've not yet posted. Yet I would ask that you not dismiss survivalism, which the above quote would seem to suggest. Any community that perserveres, or is founded during the collapse will have at its' core survivalists. They're a necessary ingredient, and integrating them into the emerging new reality is vital.

jlevyellow said...

Re Al-ttt and Zenster,

As I responded to the Baron, I have made a poor job of communicating my sense of irony. Please forgive my clumsiness.

What I meant to say is that there is going to be a lot of suffering before things get better.

gxm said...

The first graph you exhibit is a typical exponential process. Many economic processes are exponential in nature and a debt driven monetary collapse is one of them. Just look at the data for any country that destroyed its currency – Weimar Germany, Zimbabwe, Hungary et al. There are many, many examples. A simple example of an exponential function is compound interest, i.e. F = (1 + i)^n. This is the factor that you can multiply times a given principal amount at interest to get the final amount after n periods. But you can use it for a lot of simple growth situations. Using this simple approach I have clocked the national debt growth at around 1% per month, that’s about 12.7% per year. It looks like that percent is also growing at possibly 5% per month (the second derivative) which would mean that after a year the monthly growth would be around 1.8% per month or 23.9% per year. I am less sure about that 5% number however. Suffice it to say that we have a serious problem.

The Fed is boxed in and I have a hard time seeing how they will exit. That’s because the massive immediate debt (the $14 trillion) is becoming more and more short term, i.e. it rolls over in shorter and shorter time periods. Also the Fed has now become the largest purchaser and holder of U. S. sovereign debt. If the Fed backs off on purchases interest rates go up otherwise there will be no buyers and then the only outcome is to go back to QE and bring on massive inflation or for the U. S. to default. The only real way out is to cut spending drastically. How drastically? I think Marc Faber has it about right – fire half the government workers. I think he was talking about the federal government but I think it would have to be done at all levels of government. I just don’t see that happening so the worst of all economic worlds, a hyperinflationary depression, is a real possibility.

Is this a Ponzi scheme? It isn’t a typical one but it has a very similar effect as you point out. That certainly is how Peter Schiff characterizes it. One thing I would caution you on is how an exponential process can fool you before you hit the knee of the curve which I might add will in this case take your breath away. An example would be the Weimar Republic. I would bet that in the summer of 1922 even though the economic situation was bad in Germany probably no one had a clue that by November of 1923 the mark would be totally worthless and people would be burning bundles of them for heat. IMHO this sort of outcome is not years away we probably don’t have much more that 18 months before there is a very serious dollar crisis. The choice at that point will most likely be to try to negotiate a restructuring of the U. S. sovereign debt or to continue onward to an even worse fate a hyperinflationary depression which would follow very quickly.

Zenster said...

jlevyellow: What I meant to say is that there is going to be a lot of suffering before things get better.

That is, as they say, a BGO (Blinding Glimpse of the Obvious). No harm, no foul though but I do hope you might direct your attention to ways of minimizing the destructive nature of this coming economic collapse.

There is much worth saving about Western culture and preserving it may well be one of the only ways to avoid the ascendancy of Islam both here and elsewhere.

Let's all do our best to sort out this admittedly gruesome situation.

Reg T said...

jlevyyellow,

While visions of sugarplums dance in your head, you might consider the fact that A) a lot of us older folks have skills you younger folks don't have that enable survival when normal economies and modes of exchange fail. Grown a garden lately, young man? Milked a goat or a cow? Hitched a team of horses and plowed or logged? Hunted for food, reloaded your own ammunition, done any veterinary work? Built a house, or even a cabin, done any stonework, built a springhouse? The list goes on, and you might be surprised by how resilient some of us older folk are. A community that survives the initial damage of an economic collapse might find a lot more use in keeping me around than you.

B) We aren't so easy to kill off. In spite of the infirmities of old age, we still manage. Many of us have prepared for hard times, putting away the things that might be needed with the same amount of money younger folks have spent on their iPads, iPhones, speedboats and Seadoos, health club memberships and mochachino lattes. And those of us with a little foresight have been doing it for a lot longer than even the smarter younger folks.

I have read posts from a few of the younger folks who have also spoken of how - when times get tough - they won't let their family starve. They'll take what they need from the folks who "hoarded" (who saved and scrimped to put aside the food and things they knew they might need) while those younger folks spent their money on cars and toys and vacations. They feel that htose "hoarders" certainly don't need as much as they have all just for themselves. Not when their family is starving (due to their poor planning and refusal to do what was necessary.)

Wonder of wonders, those older folks also put their money towards the guns and ammunition needed to see that those who want to "help themselves" to their property end up sucking dirt. And those same old folks spent time in the military and in law enforcement, and got the training to prevail over those foolish enough to think buying a gun would enable them to simply take what they wanted from whoever had "hoarded" it.

So, don't count us out too quickly. Don't color us gone too soon. We just might surprise you.

jlevyellow said...

Reg T wrote, "While visions of sugarplums dance in your head, you might consider the fact that A) a lot of us older folks have skills you younger folks don't have that enable survival when normal economies and modes of exchange fail. Grown a garden lately, young man?"

Thanks for the compliment. I am 67 and yes I have been growing a garden since my retirement. No goats yet, however, I am looking at the possibility of 2-3 Boers! Very pretty!

By the way, you should have known that I was older, since I can write a coherent sentence.

Jim said...

Spot-on analysis Baron. To flush out the exponentially increasing worldwide debt, either we will face a default and the resulting massive depression, or the opposite - and equally destructive - massive inflation (ie, a loaf of bread costs $5000). There are no other alternatives at this point that I can see. Pick your poison.

Having a trustworthy clan in the wings with useful basic skills, along with enough land capable of providing necessities, would seem to be the only way to mitigate both possibilities. Basically what Reg T said. If you have neither clan, skills, or productive land, then it might pay to practice not eating.

Cheers.

Reg T said...

jlevyyellow,

True you do write with fair eloquence, but your judgment argues against experience. That is why I knew you are younger. We older folk don't write of ourselves as surplus, non-productive people. So, I question your veracity as well as your judgment. I seriously doubt you are over thirty, young man, no matter what you pretend in your post. You display youth's mistaken equivalence of education with intelligence and maturity.

Nice try. Massive fail.