Living Within Our Means
Answering debt with debt risks a fresh crisis this fall...
AS SUMMER ENDS in North America, we are receiving mixed signals about the US and global economy, writes David Morgan in his latest Morgan Report.
The mainstream is speaking about the worst being behind us, both within the US and globally. However, we see things a bit differently.
The current financial crisis (a credit crisis) would not be taking place if every nation adhered to the principle of living within one's means on a national level. Alas, that is not reality and we need to examine where we are presently, and with that, we want to project the most likely road ahead so you can observe carefully for verification and take the correct action.
As the system continues to add more debt to a debt-based system, we know that this "fix" might help bring confidence back into the markets for a short time, but longer term it cannot solve the problem, because excess debt is the problem.
The Fiscal Year 2009 Financial Report of the United States Government was required to be submitted September 30, 2009. My thinking is that anyone who truly understands finance and compound interest will readily see just how difficult it will be for the US to ever dream of meeting many of the obligations that it has promised its citizens, foreign governments, and others. To me, this may be the moment of truth.
Earlier in the year, the Financial Accounting Standards Board (FASB) allowed many institutions in the US to bend the rules in order to preserve the economy. We know, however, that only by a clear assessment of the truth – or in this case, true financial picture – can we determine where we stand exactly and what can be done to address the problem. By allowing the accounting rules to be changed by bowing to congressional and financial industry pressure, many financial firms were given "flexibility" in valuing toxic assets. This was expected to boost bank earnings and improve their capital levels.
And the FASB voted unanimously to let banks exercise "more judgment" in using mark-to-market accounting that has forced billions of dollars in write downs and been blamed for worsening the recession.
Now beside the Federal Government, many financial firms are going to report at the same time, and perhaps this time, the mark to market will be more accurate. In other words, I expect to see the markets react to reality as the reports are issued this time. The largest money center banks are too big to fail – JP Morgan, Bank of America, Wells Fargo, and Citigroup. These banks hold about half of all mortgages and two-thirds of all credit card debt.
To fully understand the real situation, we can divide the economy into three main areas. First, the real or physical economy – this is your farming, mining, real estate, manufacturing and wealth creation. In other words, where real goods and services take place. For the United States, this part of the economy has been on a decline for quite some time as the manufacturing base has been moved outside of the country. Certainly new innovation and products are being invented and brought to market in the US and elsewhere all the time, but on a broad scale the trend has been down and many Americans have been displaced by foreign workers.
I cannot emphasize this part of the economy enough, as this is the real world and it is what every human on the planet is truly dependent upon. As the physical economy goes so goes the wealth and well-being of the vast majority of the people on the planet.
Now there are two other markets that are supposed to reflect the physical economy. The first being the financial markets, which is the stock market generally. This is where investors can become partial owners of business through stock purchases. The financial markets reflect the real economy but like all financial assets at times, this market (stocks) can be undervalued, fairly valued, or overvalued.
And we also have the money markets – this is the money supply measured in a broad sense by money in circulation and credit extended by loans. Think M3 or the broadest measure of money and credit.
What is actually taking place is that the money supply is climbing rapidly, while the financial market has already put in its peak and is falling. Yes, we have had a good bounce but the major trend is down, because sooner or later the equity market does reflect the true economy.
So, the physical economy is going down in the US, the financial markets have acknowledged this fact, and the authorities are trying to paper over the whole problem as if this can help.
Thus in a concise way, as much as some (mostly Wall Street) have "enjoyed" this recovery, we have based it upon fudging the truth. Once the real numbers come out, most likely in early October we may see the financial markets react in a very big way.
What will add credence to this outline is the breakdown in social services that even the most unaware Americans will be forced to recognize. As social services are cut back, schools become overcrowded, prisons release inmates early, and states go broke, the reality of the physical economy will reach nearly everyone. In our view, this is a watershed moment just ahead and we need to prepare our thinking.