Ferris Geithner's Day Off

by Gary North

(Note to future historians. If you want to understand how and why the United States collapsed, read this article.-RW)

In my previous report, "Why Should Your Children Pay for My Retirement?" I went through the logic and economics of Social Security and Medicare. I made the point that, at some point, the bill-payers are going to resist the payments that previous generations have legislated. What one generation can legislate, a subsequent generation can repeal.

The main political question is this: In which form will this repeal manifest itself?

The statistical facts of Social Security and Medicare make it clear that the funding of both programs has hit a brick wall. They are no longer funding 100% of the recipients' benefits. The money is coming out of the general fund, which is $1.5 trillion in the hole this year. So, the benefits are being paid by lenders. There is no way that they will get their money back. In the long term, they will get stiffed. They refuse to consider the statistical evidence. They believe they can get out of this obvious Ponzi scheme before it collapses. They stay in the program.

In the short run, U.S. Treasury debt is no-risk, or close to it. It sets the standard for financial economists on what constitutes zero risk. In the long run, it is a guaranteed loss.

Everyone knows this debt will not be paid off. Everyone knows that it will grow. Everyone knows that the only reason for buying U.S. Treasury debt today is to park money where it is safe. The debt is liquid. The long-term future is irrelevant for present decision-making, they believe.

The rate of return is close to zero. On T-bills, it is as close to zero as it has ever been. During the Great Depression, rates got to a tenth of a percent, but prices were falling. A tenth of a percent was, in some years, a tax-free rate of return of close to 10% in terms of rising purchasing power (falling consumer prices). Today, the rate of return may be negative, depending on whether the CPI is the standard, which has been rising, or the Median CPI, which has been flat for months.

The enormous size of the debt's monthly expansion indicates that there are not good opportunities for capital growth. No one would lend money to the Treasury for a tenth of a percent if he thought he could get a safe 4% in private markets. Bankers would not turn their depositors' money over to the Federal Reserve for 0.15% per annum if they thought they were not facing horrendous losses over the next year: commercial real estate losses, defaults by businesses, and a possible secondary recession.

Let us face reality: the Treasury is getting free money because Federal Reserve policies have produced an economic crisis that refuses to go away. The Treasury is the lender of last resort to the banking system through a $500 billion line of credit to the FDIC. It is the lender of last resort to home owners who are underwater in their mortgages. But it is the lender of last resort only because it is the borrower of last resort. To write checks, it must borrow an additional $1.5 trillion in fiscal 2010.

What do I mean, "borrower of last resort"? I mean that the Treasury is there to take lenders' money whenever they cannot think of anything else worth lending to. Because of the Federal Reserve, the economy is in such bad shape that lenders depend on the Treasury to park their money for them.

GEITHNER AS A VALET

Think of Timothy Geithner as a valet in some downtown parking lot. You drive your car to the little booth. You hand him the keys to your car. He says he will park it for you. He says you can get it back at any time. He holds the keys to your car, and you trust him. He hands you a ticket. It is an IOU to your car.

When I think of Tim Geithner, I think of the valet in Ferris Bueller's Day Off. It's joy ride time! He climbs into the car, and his buddy leaps in beside him. Off they go! The buddy, of course, is Ben Bernanke. Think about this situation. The lenders of the world are lending trillions of dollars to an agency that has a AAA rating, yet this agency is the most indebted organization on earth. It is on the hook off-budget for at least $75 trillion that it does not have for Social Security and Medicare. It is on the hook on its on-budget budget for $12.6 trillion. This will be $14 trillion before we know it.

Our government is not alone. All Western governments are on the hook for similar percentages. It is just that the United States is larger than the other governments. They, too, are lenders of last resort only because they are borrowers of last resort.

Asian governments are not on the hook to this extent. They have not set up retirement programs. They have not indebted future generations of workers in the name of retirees. Yes, they face debts. They will have to do something with their families' oldsters at some point. China will face this in about 15 years. But this is not a new problem in the history of families. It has been inherent from the beginning. What is different is the West's policy, begun in Germany in the 1880's by Bismarck, of politicizing this family obligation. This experiment in government debt is about to end in the greatest default in man's history: a domino effect of broken promises that will undermine the West's capital structure.

When the promises are finally broken to long-term lenders (oldsters), they will also be broken to short-term lenders.

Think of that parking lot again. A long line of car owners has formed. Each of the people in line has a valid parking ticket.

The lot is empty. The cars are missing. But everyone has an official parking ticket.

The valet is nowhere to be found. It's Ferris Geithner's day off.

Of course, it's more complex than this. It is a gigantic system of parking tickets, with tickets against tickets. Ultimately, it's the derivative system. There are IOU's by the hundreds of trillions of dollars' worth. Maybe it's a quadrillion dollars' worth. The system is more complex than anything in man's history.

Occasionally, it blows up. It blew up in 1998: Long-Term Capital Management. That took about three billion dollars of additional bank loans to fix. Then came 2008, just a decade later. That took over $3 trillion to clear up, just in the United States. This was a thousand-fold increase in lending. It was ticket-shuffling on an unprecedented scale.

There will be another crisis, but much bigger. There is nothing to stop it. Geithner and Bernanke want us to believe that this cannot happen again, that the government and the central bank have fixed the problem. Why should we believe them?

We were told by the previous valet, Henry Paulson, that the problem in October 2008 was toxic assets on bank balance sheets. They are still there, except for the assets that the Federal Reserve swapped for T-bills at face value. This and other bailouts saved Citigroup, J. P. Morgan, and Bank of America. They did not save Wachovia.

The Treasury can sell its 90-day debt for a small fraction of a percent per annum. It pays a little more for bonds. The buyers line up. They have nothing better to do with their money. This tells us that the recovery is a mirage. When the Treasury sells $229 billion in debt in one month, as it did in February, this sends a message to anyone who is not living in la-la land: there is no sustainable recovery. When investors think that a tenth of a percent per annum is the best available investment opportunity, they are in disbelief mode.

Who will finance the capital outlays that are necessary to produce sustainable recovery? If the smart money – bank money – is in excess reserves at the FED at 0.15% per annum, and not in the private markets, financing small businesses that provide most of the job growth, why should anyone believe that the job market is ready to add 150,000 jobs a month, which is what the United States needs to provide jobs for young adults entering the job market for the first time? Where will another 8 million jobs come from to put back to work those who have lost their jobs from early 2008 to the present?

THE CONFIDENCE GAME

In September 2001, Americans' confidence in the U.S. government's ability to protect them was shattered by the coordinated attacks. The government was exposed as utterly helpless. So completely implausible were the details of that attack that the public has never come to any agreement as to how or why it took place.

The media dismiss anyone who points to the impossible aspects of the government's vague account of what happened. Such people are called "truthers," due to their call for the truth about 9-11. There are millions of Americans who do not believe the government, and never will. The Web will keep doubts alive. The media want the Web to go away, but it is not going away. What is going away is the audience share for the networks and subscribers to day-old news printed on paper.

In September 2008, the quasi-private mortgage market collapsed in the United States. The government nationalized it. There is no suggestion in Washington that it can be, or should be, returned to the free market. Yet we are assured that the housing market is the largest and most important sector of the American economy.

The public thinks that the government can restore the pre-2008 world. The public is wrong. That world is gone for good.

Read the rest here.