It’s The End of the World As We Know It

There can be no prosperity without freedom. For now, and perhaps for decades to come, America’s best days are behind us.

For Americans who are economically literate, the events of this week are as significant as those of 9/11. The proverbial tanks have rolled in America this week in a bloodless coup. This is the end of America as we have known it. This country was built on the supremacy of rule of law, on the sanctity of contracts and property rights, on individual liberty, and on trust that most people will keep their word. For now, that America has ended.

I have told my students for years that when fears of economic troubles increase, politicians will be ready to exploit those fears. The public and the media seem collectively ready to justify the end of America that we have known; they are hypnotizing themselves with the mantra “it would have been so much worse if the Bernanke and Paulson had done nothing.”

A public that has lost touch with the principles that promote liberty and prosperity will always trade away freedom for the illusion of security. And they will wind up with neither freedom nor economic security. That day of reckoning has arrived.

Let’s make a few things very clear. The failure of the housing market, AIG, Fannie Mae, Lehman etc. is not what is damaging the economy; the damage to the economy occurred during the boom. The artificially cheap credit policy pursued by the Fed under Greenspan and Bernanke did the invisible (during the boom) damage. The failures we are experiencing today are the consequences of the distortions created in the boom.

Too many houses were built, mortgages were issued to those unqualified to receive them, housing prices were driven to unattainable levels, and Wall Street and the banks bought and sold these mortgages. Wall Street and the banks acted as if housing prices would go up forever and bailout them out of their mistakes. Cheap credit allowed Ford, GM, and Chrysler to sell enough cars to be complacent—complacent enough to not truly innovate and be competitive.

I could go on, but you get the picture. What we are now experiencing is the liquidation of damages that have already occurred—we are in the credit contraction part of the cycle. Again—the problem is not housing foreclosures, Lehman Brothers, etc. These are symptoms of what the Fed, fractional reserve banking, and out of control Congressional spending had already wrought.

The analogy of an alcohol or drug addict is helpful. The damage to the addict occurs when he is taking cocaine, heroin, or alcohol. When he is off his high he is recovering form the previous damage. No matter how much he screams for more drugs or alcohol, no reputable treatment center would supply him with more.

Those who have benefited by the past excesses are now screaming for more drugs in the form of cheap credit and bailouts. The amount of bailouts that our essentially bankrupt government is promising is staggering—it will easily run over a trillion of dollars. The productive sectors of the economy will be forced to foot the bill—we’ll be forced to throw good money after bad.

Again, let’s be clear. These bailouts will not save us from the terrible times ahead. The damage to the economy has already been done, and we are now transferring the good money of productive taxpayers into the hands of those who wrecked the economy. As Lila Rajiva, coauthor of the excellent Mobs, Messiahs and Markets, colorfully wrote, the attempt to portray the interests of Wall Street and Main Street as exactly the same is false:

We, of course, need to do nothing. There is no we here. This is a Wall Street crisis. And the usual suspects on Wall Street need to line up, bend over and get caned for their misdeeds. Barring that, they need to take the market’s medicine like men.

Instead, they were out in full therapeutic mode, pouting and whining for a change of their soggy diapers by dear Nanny Washington.

Andrew Jeffrey writing in Minyanville colorfully explains why the failures on Wall Street need to be liquidated and not subsidized:

When government invades free markets to the extent it has – specifically in the last 24 hours — the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.

Beltway bureaucrats have been trying to rewrite this country’s economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch (MER), AIG (AIG), Lehman Brothers, National City (NCC), Washington Mutual (WM) and Wachovia (WB).

According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.

The bailouts of the incompetent and corrupt may work for a while—read “a while” as in weeks or months—but then the inevitable will begin again.

When the stock market decline resumes, the ban on short selling will cause prices to fall even more than they would have otherwise. (More on short selling in another post.) Welcome to a no growth, capital starved economy of shrinking opportunity.

Jeffrey Tucker in his excellent essay The Rich He Hath Sent Away explains why the current reprieve will be short lived:

Market conditions change. A dramatic change can blow away a company with billions in assets in a matter of days. With communication technology moving information at lightning speed every second of every day all over the world, there is nothing anyone can do to stop this from happening. The secretary of the Treasury, the heads of the Fortune 500, and the governors of the Federal Reserve can meet in rooms and hammer out deals all they want. But they are powerless to stop a market that has turned.

Mostly what the powerful attempt to do is provide more of what started this mess to begin with: floods of paper money. What is the effect of that? It can postpone the day of reckoning sometimes. But at what cost? Every dollar that the Federal Reserve prints waters down the value of the existing dollar, which means one thing: inflation. Actually, it means one more thing: distorted market signals.

Even then, the market winds blow ever stronger. The injections of credit in the past didn’t stop the present crisis; it only worsened them by creating the illusion that life could go on as usual.

From today, for how long will life go on as usual? Clearly the time between each crisis and each “solution” is shrinking, and this rally, if it continues, will soon be rudely interrupted. One day the government will run out of funds that they can confiscate from the healthy sectors of the economy, or the new drugs administered will not work at all—the economy will simply seize up just as a young drug addict sometimes dies prematurely from a heart attack.

At that point, the Fed and the Treasury department will have a choice. They will have thrown way so much good money bailing out bad assets that either they will have to allow a full-blown deflationary depression to proceed, or they will have to print so much money as to generate hyperinflation.

The political pressure by demagogues to choose hyperinflation will be enormous; we can only hope for a deflationary depression. Why? Our economy is extraordinary resilient, but only if we allow it to be. Without government intervention, the market will dismantle our failed financial institutions and transfer the remaining assets to those who are better able to manage them. A deflationary depression, if it is allowed to proceed, can end relatively quickly; and prosperity can begin again. Many of us who played no part in creating the problem will suffer greatly, but the alternative is far worse.

Let us hope we don’t choose the more dangerous path of hyperinflation. A hyperinflation, such as Zimbabwe is experiencing today or Germany did in the 20s, will essentially destroy the market economy and it will threaten the survival of the country as we currently know it.

I fear for the future of this country, and I’m not just speaking in economic terms. There are many Americans who will lose everything in the coming years. No doubt future political demagogues will feed on their anger, and far more ruthless and despotic elements than we see today will likely rise to the top.

22 Responses to It’s The End of the World As We Know It

  1. frankvv says:

    Dr. B,

    You see what happens when you take a break from talking about economic matters and stray into such topics as the Android? The entire US economy falls into the Craper (you know Thomas Craper’s invention…. ) and we the tax payers now own an entire country’s worth of bad debt. And I must have a real whopper of an economic hangover, since I don’t remember enjoying any of these excesses that I am now paying for.

    I have been a US citizen for just over two years, and although this country has been very good to my family and I over the last decade, I am a little nervous about her future. I have never owned a gun nor do I wish to, but if we really do fall into deep economic distress, desperate people will do desperate things when they are hungry. Gee, I guess I better keep my Canadian passport up to date (I’m a dual citizen – once a Canuck always a Canuck in the eyes of the Canadian government).

    Although if the US economy collapses, Canada’s will follow suit, since the two countries are economically joined at the hip. But Canada is very resource rich (oil & gas) and there is a lot of vacant land in which one could homestead and start all over again if need be and not have to worry about being shot by a neighbor since you can still go someplace where there are none; guns or neighbors…… What a depressing thought!

    I think I’ll go down and watch an old rerun of The Three Stooges on my paid for plasma TV to take my mind off of things. This is a more intelligent form of entertainment then watching the current Four Stooges at work: Obama, Biden, McCain, and Palin.

  2. Frank,

    I can see from the timestamp on your post that you missed the closing ceremonies from Yankee Stadium. It was incredibly touching and one couldn’t but help to reflect on the lunacy of tearing down one of the symbols of the American Century. I grew up in the Bronx and I weep for Yankee Stadium and for America.

  3. frankvv says:

    Dr. B,

    Yes I missed the ceremonies: actually I forgot about them . Although I am not a huge baseball fan (grew up with hockey), I understand the importance of the symbols of our culture. After all, baseball is as much a part of America as, well, apple pie. It does seem a little ironic that an iconic symbol as important to the American psyche as Yankee Stadium was closed at the end of one of the saddest economic weeks that I have witnessed in my 28 years in the working world. I send my condolences to you and the rest of my fellow Americans. It is indeed a sad time. But with that said I am an optimist and I hope and pray that whomever ends up at the helm of our great nation sees the light and steers our economy in the right direction again, before it really is to late. I refuse to admit that it may already be past the point of no return. God Bless America. I hope to heck He is listening.

  4. Unknown says:

    This is a good article.

  5. E says:

    Several random thoughts. This whole thing is a joke. A very bad joke. There is now rumor of banks getting their lobbying teams ready for this week’s fight on the Hill — banks are standing in line for the bail-out. First, certain banks want to offload not only bad mortgage debt, but other types of debts. Second, other banks want to broaden the definition of “financial institution”. Still, foreign banks want to get in on this deal stipulating US subsidiaries. And not least of all, banks are getting in line to lobby for the right to administer this mess — which naturally they would charge upwards of $1B/year to bring an “orderly resolution” to this mess. They are also against Treasury oversight of their business process after they unload their destressed debts. The Fed and the Treasury this week have both simultaneously (1) crippled the respective markets, (2) decimated US financial security, and (3) just kicked the problem down the road. I can’t wait to see, when hyperinflation destroys the US Airline industry, the US Auto Industry, the US Agricultural products, US Trucking industry, etc, how the US government responds when each of these industries comes to it asking for an “orderly resolution” to imminent collapse.

  6. great post. though if you say most Americans will lose everything then what is your suggest to do now so you don’t lose everything? i’m an investor, but even all my rental properties will go down in price, money will be worth less, and the only thing i can do is trade the stock market going down (put options which i do currently) or side ways in a depression flat market. i’ve read many books and they all prophesize about this. i wish the government would just force big business to pay for bad business problems therefor almost creating a check system business 2 business. these CEO’s leaving with $300 million pension and then the fed bails their $600 billion out. how come the fed isn’t seizing that $300 million just as if a bank seizes a persons house if they can’t pay for it. i suppose that is why i am trying to work my way up to the richer 1% because the fact is the rich rule the country and if you aren’t rich then you WILL lose everything because you won’t be able to bribe the government to bail you out.


  7. to conclude i think businesses (just like myself) should be forced to pay off their bad debt just like any other consumer with a credit card even if that forces them to have zero cash in the bank and the income goes straight to employment, bills, reinvestment, and remaining profits going towards bad debt. i find it funny the government doesn’t learn from google or microsoft or apple or other large countries that have stashes of billions saved and invest smartly for real supportive advice. everyone considers bill gates evil, but shoot i’d put him on the fed reserve board!

  8. Well said. It’s been eight years of redistibuting the wealth. – robbing from the poor to give to the rich. Thoughts of moving to another country keep running through my mind. I already feel like I’m living in a foriegn land anyway.

  9. E,

    Yes, the brazenness of what they are asking for is amazing. And most members of Congress will simply vote for it without having the slightest understanding of the details.


    I’m just a humble economist—I can see from your trading blog that I should be asking you for advice. But anyway, short term at least cash seems like it will be king. How long that short term will last I have little idea. And for the time being, the safest cash holdings are treasury bills or money market funds that invest only in treasury bills (there is only one that I know of). Of course this is not investment advice.


    Not that easy to start over and in any case you live in a beautiful section of the country. Mish Shedlock has a recent blog post where he urges everyone to contact their Senator and ask them to vote against and filibuster the bailout.

  10. James D. says:

    We know what the financial institutions did was wrong. Gone are the days when their leadership would have acted with honor and said “We made bad decisions and now we’re going to pay for them.” We know that the government bailout is wrong and will likely end us in a depression that’ll make 1929 look like a financial hiccup, but we can’t expect Washington to do the right thing and not interfere. We know that the public feeding trough should never have been opened; but now that it has, the hopes of it closing before being forced to by a major meltdown are nonextistent.

    Maybe its the revolutionary in me, but isn’t this the point where we should be marching on Wall Street and demanding that the SOB’s who created this mess be held accountable? Shouldn’t we be sending a clear message to those in Washington that anyone continuing to support this lunacy will be out of a job? I’ve long since given up on any hope of honor or integrity in our elected officials, but where is our collective outrage? Why are we not doing more? I hate to be one to promote violence, but history teaches us pretty clearly that those in power and taking advantage of the masses will never voluntarily give up that power…Marie Antionette and King Louis had their heads chopped off; Mussolini got hung; we could go on with this list ad infinitum. At what point do we take up the call of the Declaration of Independence and change the government that does not serve the governed?

    Of course, looking at what happened after the October Revolution in Russia and the rise of Hitler after the penuries forced upon Germany after WWI, the rise of the Ayatollah and the ouster of the Shah in Iran, what we get after the meltdown and ensuing revolution might not be to anyone’s liking!

  11. Jim,

    Although there is much outrage on the internet, I don’t sense collective outrage. Too many have a stake in the current system in one form or another and many others simply don’t understand.

    You are right about revolution–it often results in some of the very worst elements in society gaining power (the American revolution being a notable exception). Education is a better choice. Education may take generations but I see little alternative.

  12. frankvv says:

    Ron Paul for President! Oh. That didn’t work. OK, Barry Brownstein for President! There is still time……

  13. Frank,

    All kidding aside–it is sobering to think how little support (in the ballot box) Ron Paul received. Education does take time.

  14. E says:

    The game’s over. While the gov’t debates about rules-of-the-road points to the $700 BB bailout, what they are not telling everyone is that, by some estimates, the actual iceberg is about $1.3 Trillion in bad mortgage debts. Even if they just pass the $700 BB bailout, there’s still about $200 BB for Bears, Freddie, Fannie and AIG. While we’re giving it away, the China Investment Corp has about $200 BB in reserves. China’s Central Bank waiting this whole thing out with a mere $1.8 Trillion Dollars in reserves. And if anyone says, “well, at least we’re better off than, say, Venezuela,” you might be wrong. “Third World” central banks like Brazil have about $200 BB of reserves (this might be dated data by now). So, taken as a whole, this whole idea of buying up bad debts for about $1 Trillion Dollars puts every man, woman, and child in the US in hoc for about $3,000 per person (in addition to the mindless $30,000 we each already owe).

  15. tat _t. says:

    Hi Professor Brownstein!

    I was waiting and waiting for this essay from you for a very long time. I talked to the friends that I mentioned about your thoughts over a year ago about how the economy will fall apart like it just did recently. You had all the right reasoning for this to occur and watching this all unfold is like being in one of your thoght provoking class discussions. You’ve openned alot of minds at our school to think more wisely and hopefully the next generation will read and understand what has happened here.

    I remembered your discussions about how New Zealand reformed their government but here, even as we speak I sense and sense that we are getting entangled further and further in the web called, “the government.” I guess we should have known it was coming since Treasury Secretary Paulson comes right from the Goldman Sachs elites. In some ways he is trying to create a company with all these bailouts called, “the government.” I feel more and more everyday that the best course may be to live in another country like New Zealand.

    Take care.

  16. E,

    I understand your point, but sadly the “game” is far from over. By the time it is our lives will be changed in ways that we can’t even begin to forsee.


    I take no pleasure in being right but the point is looking through the correct lens I and others were able to forecast this event. It is absurd that those who helped to create these terrible events will now be given more power.

    I truly hope that you don’t leave but the fact that you are even thinking about it brings up an important point. Although human migration is not easy, capital migration is. No doubt that billions of dollars of capital are fleeing the country right now.

  17. James D. says:

    Professor Brownstein and Tat,
    Capital, not caring where it goes, moves across borders as readily as is allowed. People on the other hand, generally have more motivations to stay where they are. Family, language, a culture and a society they understand, and play parts in preventing people from making a big move. But if America keeps going down this road, I can see it happening. The government has nationalized assets worth more than Communist China when it was formed. Even here in Howard County MD, the County Exec announced that the County Gov’t would by another condo complex to add to its portfolio so they can provide “affordable housing”. These trends fill me with a forboding I’ve never had before as an American Patriot. We know that all things change, but so far as America remained true to her roots of freedom and the rule of law, I didn’t worry much about it–in the end, any change would be for the positive. Now that we are rapidly shifting away from the rule of law and government is effectivley supporting wholesale socialism for the financial aristocracy, maybe a change of scenery is in order. Without a major revolution, the people in gov’t have no incentive to change things. Maybe its time to follow my money somewhere else.

  18. E says:

    Prof B,

    The “Game” is over as we know it. The US Dollar cannot be the US Reserve currency of the world with events occuring. Our lives will change, but we’re now into an era where “National Security” will mean whole new areas. We will be forced to “kindly ask” other nations to help prop up our currency. We will be forced to retool the economy, our expectations, and our capabilities. Beyond funding the next infrastructure project, the next health care initiative, or, God only knows, the next war; the system as we know it is over. The math on this bears the truth.

  19. Jim,

    I do think that the tide is against us in stopping this madness, but I will take the time to write an email to my Senators. In this thread alone there are three comments from individuals who have expressed the thought that moving could be a good idea. The depth of feeling against this bailout may be quite deep.

    I should add that this crisis has touched an international audience that cares about the future of America. For instance, one of my Australian readers has forwarded this blog post to his distribution list and urged them to read and reflect on the post.


    I agree!

  20. H says:

    Prof B,

    Pain, pain, pain…

    No one wants to face the harsh reality of bad behavior and the consequence of bad choices.

    So what mechanism will we use to numb the pain, ease the frustration and anger and distort reality as having fixed the problem?

    Alcohol, pills, narcotics, food or money?

    Hmmm, let’s see we are dealing with business and finance so let’s select MONEY. Surely you cannot use behavior modification in the world of business to fix the problem.

    What is that I hear – business behavior modification through the possible introduction of regulation and oversight? Okay, but what about the consumer behavior that needs to change?

    Whoa – who wants to change the economic model based on CONSUMPTION and CONSUMERISM? That means the nation will need to live within their means and only make purchases when they have cash in hand? This certainly would solve many of our economic, environmental, and health issues as it has been noted that CONSUMPTION and CONSUMERISM are linked to:

    1. Environmental degradation and global warming issues
    2. Exacerbation of economic class wars and poverty
    3. Overindulgent and destructive human behaviors – cancer, obesity, cardiac disease

    But let’s not do anything drastic because that will severely impact the BIG businesses ability to continue to fund the lobbyists, special interest groups and the personal endeavors of the government politicians. Is that why we are hearing analysts and investment specialists state not to worry, not to move our money out of the markets because we may miss the best 20 days?

    Now is the time for our nation and government to become responsible citizens by facing the music, admit to the problem and participate in a 12-step Spender’s Anonymous program. I think the average citizen actually has already started this process as noted in the August 8, 2008, posting The End of Credit Card Consumerism
    A new frugality could remake the U.S. economy—and American life, By Kimberly Palmer

    It’s about a clear perception of reality without the cloud of artificial containments, alcohol, pills, narcotics, food or money. And with a tough love attitude and participation in a 12-step program, America will resiliently rebound with great resolve.

  21. H,

    Very, very well said! The over-consuming consumer and the out-of-control financial institutions are opposite sides of the same coins. They may not even make up a majority but they sure are a powerful lobby.

    We may be at the tipping point for real change that you describe or we may just see the early stirrings of a movement that will gather steam later as the crisis deepens. I hope it is the former but I suspect it is the latter.

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