Posted on September 29, 2008 - by Venik
Why Bailout Will Not Work
People who believe that America’s economic problems will be cured by the “cash-for-trash” bailout bill right now stuck in the Congress are in for a huge disappointment. There is little doubt that the size of this bailout will grow well beyond the initial $700 billion and in the end all this money will help very few outside the Wall Street elite. Simply put, the US government is too poor to save the country’s economy by directly infusing money into the financial sector. When we hear of one trillion dollars, we can’t even begin to comprehend the vastness of such incredible wealth. Viewed against the backdrop of America’s failing financial system, this colossal amount is little more than a roll of duct tape, with which we are trying to keep our Titanic afloat.
To compound the problem, the politicians started fixing our economic collapse at the wrong end. They are counting on the “trickle-down” effect: pouring money into high-level Wall Street structures in hopes of some of it reaching the source of the problem: high rate of bankruptcies and foreclosures on the consumer real estate market. If you watch TV and read newspapers, you probably already know that the vast majority of respected financial experts interviewed by the news networks do not believe the bailout will be effective. They have various reasons for their skepticism. Some say that the money would have been better spent helping the troubled homeowners directly. Others point out the absurd notion that the free market can be corrected using Socialist planned economy methods. And most agree that the $700-billion sum is a drop in the bucket.
How much exactly does the US federal government owes to the citizens and foreign creditors? If you count everything, including Social Security and Medicare, the amount is roughly $50 trillion. The entire US GDP is “only” $14 trillion. There is no possible way for the US to pay off its debts without printing an absurd amount of currency and turning the dollar into toilet paper. American economy has been able to survive this long thanks primarily to the country’s AAA credit rating, resulting chiefly from the size of the US economy and the country’s consistent and timely payments to its great many creditors. The goal here is to make payments not to repay the debt, but to maintain the ability to borrow even more. Sort of like some of us are “repaying” out Stafford loans. On top of the $50-trillion of federal debt, there are nearly $40 trillion of corporate, state, and consumer debt. A single significant slip in debt repayment, and the US government’s high credit rating will fall, raising interest rates and sending the country’s economy into uncontrolled depression.
According to the report presented to the Congress by US Treasury secretary Henry Paulson and Federal Reserve chairman Ben Bernanke, we are “literally days away from a complete meltdown of our financial system“. The $700 billion requested by Paulson is what the US Treasury needs right now simply to keep the economy afloat. This is not a fix, but a short-term patch. The value of US currency in circulation is not backed by gold or any other reserves. The US government can print as much currency as it needs. You want your $50 trillion? They will print you your money! The value of the dollar will go down the drain, but the US can always cover its debt payments. Most countries are heavily invested in US currency and federal securities. Therefore, nobody wants to press the US to pay up, because nobody wants the value of their investments in the US assets to drop.
So what does this mean for you and I? I am not a millionaire. At the first signs of trouble two years ago, I started pulling money out of my savings and investments. If I haven’t done that, today my net worth would have been almost exactly 45% what it was in September of 2006. The value of my house decreased but only about 2-3% – a relatively low drop primarily due to the good location. Having lived through the economic collapse of the Soviet Union, I can immediately recognize at least some of the warning signs of a failing superpower economy. So far there are no significant limitations for the average Joe willing to buy foreign currency and precious metals. You can order foreign currency directly through your bank.
Wachovia bank, for example, will give you a good exchange rate and mail foreign currency directly to your home address for amounts under $1000. For anything more that this, the currency will be delivered to your local branch and you will have to pick it up in person. There is a small flat service/shipping fee ($15 per transaction) independent of the amount you are exchanging, so the more you exchange, the less overhead you pay. The same applies to buying gold. I recommend Canadian Maple Leaf 1/10 oz bullion. They are easy to buy and easy to sell. Generally, you save more by buying larger coins: a single 1-oz coin will cost you less than 10 1/10-oz coins for the same amount of 24-karat gold. However, having smaller denominations gives you more flexibility.
When buying currency, make sure you balance well among the four primary global markets: Europe, Asia, South Pacific, and Americas. The idea here is not to make a lot of money, but to make sure you don’t lose your pants if the US economy decides to follow the economy of its Cold War rival. Usually, a fall in currency values in one of these four regions is compensated by growth in the other three. Determining relative strength of national currencies is not a trivial task. Indexes like RSI are essentially meaningless statistics of how one currency performs on the market against some other currency. Such indicators are based on technical analysis (statistical analysis of past performance) and, by definition, are incapable of predicting major shifts in trends (such as economic collapse of a global superpower).
What you are after is stability. There is no simple equation to calculate stability of a national currency, especially under the circumstances of a major economic downturn in the US. Use common sense: economy of Mexico and China, for example, are heavily dependent on the US market, while economies of France and Russia – not so much. Look at the overall GDP, average GDP growth, average GDP per-capita growth, average rates of unemployment and inflation, average trade deficit, and average percentage of population living below the poverty line. Once again, you are looking for stable economic performance over a period of at least ten years. Preference should be given to countries with a healthy relationship between trade with the US and trade with European, Asian, and South Pacific markets.
Whatever you buy – gold, foreign currency, or something else – do it now. As the situation gets worse, the government will erect all kinds of artificial roadblocks to make sure you are stuck with your rapidly deflating dollars. They will limit gold trading or will make it unfeasible by introducing some ridiculous fees and taxes. The banks will put a hold on currency exchanges, increase service fees, or will severely limit the maximum amounts. Whatever the particular measures, rest assured: they will find a way to screw you over. People are asking what to do with their 401Ks. Various financial advisers on TV say that if you are under 50, you have nothing to worry about. The unspoken logical extension of this advise is that if you are over 50 – grab your money and run if you don’t want to spend your retirement living somewhere under a bridge in a cardboard box.
I’d say, regardless of your age, convert at least a portion of your savings into gold and foreign currency. Don’t count on the market to right itself: the government’s recent deep intervention into the US financial system automatically canceled any usual free market stabilization mechanisms. Just about the worst thing you can do right now in regard to your savings is to count on the almighty dollar and rely on the foundations of capitalism. There is no more capitalism, not when the government is injecting massive amounts of taxpayer dollars into the finance system and nationalizing major banks. Your savings are now at the mercy of several hundred politicians on the Capitol Hill, who, aside from taking a course or two in college many years ago, know next to nothing about economy, but who nevertheless will be playing economists at least for the next couple of years.
Pay very close attention to inflation numbers and to the relative strength of the US dollar. And keep in mind: if something goes down, it will go down very fast. Pay particular attention to any news that Russia or any other major hydrocarbon exporters are switching from trading in dollars to another currency. This may happen if OPEC finally decides to trade in gold dinars or Euros, or if Russia switches oil trade to rubles and moves its oil and gas trades to the St. Petersburg exchange. In case with Russia, this is not a question of “if” but rather “when”. Original plans called for the switch in early 2008, but these plans were delayed due to technical reasons. However, in light of America’s financial meltdown, Moscow is making this shift a priority. A move like this may cause a sharp drop in the value of the dollar. Russia and Middle Eastern oil exporters are suffering from high inflation rates because their primary export – oil – is tied to the value of the dollar. Switching to trading in a more stable currency is the simplest and most effective way for these countries to control inflation rates of their national currencies.
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September 30, 2008
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What a silly title!
Who says that the bailout is ever supposed to “work”?
Reply
Venik Reply:
September 30th, 2008 at 5:23 am
I am not sure I understand your question. Do you?
Reply
JLD Reply:
October 9th, 2008 at 1:53 pm
Then you don’t undertstand economics, that’s all…
Reply
Venik Reply:
October 9th, 2008 at 6:10 pm
You base your understanding of economics on a comedy sketch? What’s next, Monty Pythons, Mr. Bean?
JLD Reply:
October 14th, 2008 at 12:50 pm
Interesting!
That explains a lot about the tone of your blog, you’re a “true believer”.
What I meant is that, if comedians could make valid suggestions about the oncoming crash one year ahead (the video is from Aug 2007), don’t you think that quite many of the finance crooks were well aware of what “the market” was headed for?
There might be some purpose in crashing the world economy, like bringing down the price of oil, hmmm?
And BTW, Monty Python is spot on about , but if you are a real pro you know that already!
Venik Reply:
October 14th, 2008 at 9:15 pm
And it’s a great comedy sketch. I even put a link to it on my site, as you can see. But oversimplifying things is just about the worst thing you can do when looking at such a complex situation. Yes, it’s witty and funny. From a layman’s perspective, it even appears to make sense. It’s just wrong. It’s easy to blame the crisis on a handful of greedy, panicky traders and on the poor black man who bought a home he could not afford. But the truth is, majority of subprime mortgages in the US don’t involve blacks. Most of these borrowers are white, make good money (or at least used to), and they willingly took risk to capitalize on the perceived housing boom primarily in California and Florida. And that’s where we see most of these foreclosures.
But the problem is not even with subprime mortgages. This is just where the first signs of trouble appeared, because subprime mortgage lenders are so sensitive to subtle changes in financial status of the borrowers. High oil prices preceded the subprime crisis, and so did growing unemployment, ballooning national debt, enormous expenses on the war in Iraq, and Afghanistan, as well as huge amounts spent on “security” in the year following 9/11 and the resulting first wave of bankruptcies among airline companies, which were followed by layoffs in the aerospace industry. All these negative trends were building up over the years and the economy eventually developed a tear at its weakest point – you guessed it, subprime lending.
JLD Reply:
October 15th, 2008 at 3:02 am
Ok, ok, I agree with (most of) your analysis but you still seem curiously deaf to what is really my point which is that some players in the economy game may very well be keen to crash it for geopolitical purposes.
Venik Reply:
October 15th, 2008 at 11:40 am
If you mean that someone benefits from the crash, then, yes, you are right. Regardless of what happens with the economy, there is always someone who makes money on it somehow. However, if you mean that someone purposefully crashed the global markets on purpose, then I would have disagree with you. Nobody has that much power. I suppose certain individuals and organizations have enough influence to cause a momentary panic on the market, but without underlying problems the situation will correct itself quickly.
In our case these underlying problems have been built up over the years. The root cause of the crisis, of course, is America’s enormous debt, which it cannot repay and has no intention of ever repaying. The catalysts for the crisis were, without a doubt, the events of 9/11 and the war in Iraq. On the one hand we have the enormous expenses associated with these events and on the other hand – increasing global instability and rising hydrocarbons prices. Until recently, at least, the US economy was the cornerstone of the global financial system and oil is the cornerstone of the US economy, which consumes a quarter of global production.
Look at the growth of oil prices and consumer gasoline prices over the past few years: https://venik4.com/?p=63 And the look at the Oil Price vs Consumer Gasoline Price index. This unusual trend was bound to end in disaster. America’s economic troubles started in September of 2001. They never really recovered. As I mentioned, the first signs of trouble were airline bankruptcies and Boeing laying off some 30,000 employees in 2001-2002. This was a direct result of events of 9/11, and these problems were compounded by all the White House stupidity that followed. In physics this is called sympathetic resonance.
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November 15, 2008
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[...] gas and Belarussian transit charges) will be done in rubles and not in dollars as before. I briefly mentioned this possibility over a month ago. This is not a major development yet, but it is a big step toward [...]
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January 28, 2009
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[...] in September I wrote a short piece on Bush’s bailout plan – Why Bailout Will Not Work. The bottom line of my rant was: the US economy is so massive and the US national debt is so high [...]