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The Daily Reckoning

Hidden cause of great recession and next financial crisis? Debt

On the surface, global economic rescue efforts appear to have been successful, but they've only worsened the original problem – too much debt.

By Guest blogger / March 16, 2010

A bank clerk counts US 100 dollar bills near bundles of Chinese renminbi notes at a bank in Hefei, in central China's Anhui province. Concerns about the growing US deficit are mounting.

AP Photo/File

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Beware the Ides of March…and the rest of the year too!

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This is the day Caesar was assassinated. What’s it to us?

Well, it just reminds us that things go wrong. Even when you’re on top of the world. There are always countercurrents…undercurrents, beneath the surface, where you don’t see them…plots…conspiracies…and just bad luck.

On the surface, the US economy is recovering. Well, not even. It is stabilizing.

The Dow has been creeping up. It rose 12 points on Friday. Gold fell $6. Oil held at $81.

The most recent figures show the consumer becoming a little freer with his money. But look beneath the surface and you find government statisticians juking and jiving with the numbers. They seasonally adjusted downward the figures for January…which boosted the figures for February. Had they not done so, the figures for February would have been negative!

Still, consumers are not as lifeless as they have been…and on the surface, this is good news.

And who can blame consumers for being a little more ready to spend money? The newspapers tell us that the Great Recession is over…and that we’re in a recovery. The lumpen consumer probably thinks he’s going to find a job soon…and that his house is going up in price.

But beneath the surface, there are powerful downtrends still underway. These trends began in 2007. They were misinterpreted, naturally, by leading economists and policymakers as a “liquidity crisis.” In fact, they were signs of a debt crisis. The private sector had far too much debt.

Economists who never expected trouble, reacted to it in a predictably moronic way – they rushed to the rescue with more debt. Now, they think they’ve triumphed… They’ve prevented another Great Depression. They’ve saved the world!

We’re written so much about that; you surely don’t want to read any more on that subject.

But here’s the interesting point: by failing to address the real causes of the crisis, the feds only allowed those undercurrents to grow more powerful and more dangerous.

Instead of reducing the world economy’s reliance on debt, they increased it!

On the surface, the rescue efforts look vaguely like a success. The private sector stopped spending. Government increased its spending to make up for it. Okay so far.

Alas…net, the world’s debt is still increasing – by a huge margin. Over the next 3 years, the biggest 20 economies in the world – the G20 – are expected to slip over the 100% mark, with more debt than GDP.

Now, let’s do a little math. The US has total tax receipts equal to about 15% of GDP. If the interest on the debt is only, say, 3%…that means you’re spending 20% of tax receipts on debt service. But suppose inflation rises…and interest rates go back up to where they were in the late ’70s. Back then, the feds had to pay 15% interest to borrow money for 10 years. At that rate, financing the whole federal debt would take 100% of tax revenues – just for the interest.

Obviously, that’s not gone to happen. Something else is going to happen. What? Hard to say. Some combination of default and inflation, most likely…

Of course, this doesn’t bother the feds. That story is still beneath the surface… It’s a crisis that hasn’t happened yet. They couldn’t see the crisis in the public sector coming in ’07. They can’t see the next one coming either.

Economists can’t tell a government job from a private sector job…and can’t tell $1 of government spending from a dollar spent by the private sector…and can’t tell a dollar’s worth of GDP from a dollar’s worth of real prosperity…

…which means, they can’t tell the difference between what’s happening on the surface to what’s happening underneath.

In a sense, this is just another manifestation of the same “battle” we wrote about years ago. On one side are the feds. On the other is Mr. Market.

The feds want to inflate. Mr. Market wants to deflate. The feds want a boom. Mr. Market wants a bust. The feds want to inflate another credit bubble. Mr. Market has a knife in his hand.

On the surface, the feds are winning. At least, that’s the way it looks if you get your information from reading the newspapers or listening to CNBC. And in a sense, these reports are correct. Superficially, the battle is going the feds’ way.

But deeper down…the debt is still there…and it is growing bigger. And Mr. Market sharpens his dagger.

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