Which brings me to the crisis. Everywhere we look to understand this crisis we see two views. One (rare) view is based on Mathematics, and the other on Morality. Do they overlap? I think so. But let's separate the two for a moment to better understand the issue(s) we are faced with.
The Morality issue in this Crisis
The Morality issue in this crisis has been excellently handled by many well respected academics, analysts, and politicians. And when I speak of the Morality issue, I speak of the Bank Bailouts, the socialization of private sector losses, political corruption, Wall Street control of the government, etc... We do have a crisis of Morality - that is not something that is up for debate, in my view, unless you are the CEO of a large bank.
The Movie "Inside Job" tackles this issue. And although I have not seen it yet, I have read enough reviews to understand that its primary focus is on the Banking Sector's capture of the US Government and Academia for its own benefit, but unfortunately to the detriment of the general economy. Here is the trailer:
It looks like a great movie, and I plan to see it. However, this movie, or rather, the pure focus on the Morality and Political view of the crisis has a fundamental flaw: It ignores the Mathematics of the crisis. It ignores the foundational problems of the underlying monetary system.
Most analysts accept the current monetary system as being sustainable, and instead focus on the Morality or Political issue. Simon Johnson, Economics Professor at MIT and former Chief Economist at the IMF, recently wrote:
Our leading bankers looted the state, plunged the world into deep recession, and cost us 8 million jobs. And now many of them stand by with sharpened knives and enhanced bonuses – also most willing to suggest how the salaries and jobs of others can be further cut. Think about the morality of that one.SOURCE
Simon Johnson is correct to a degree. However, I have yet to see him challenge the current monetary system, or at least seriously criticize its shortcomings. He accurately describes the beast (Wall Street), but he ignores the beast's diet, if you will. How did this beast get so powerful? How does it exist? And is this beast the only thing we should worry about?
Don't get me wrong, Democracy is threatened by the capture of Big Banks. Actually, let me be more clear - Democracy has already been captured, and so too has Capitalism. The large Banks have succeeded. They own governments and they are immune to the Darwinistic Laws of Capitalism. They don't fail, others do in order to support them. They feed on everyone and everything else to the detriment of society as a whole.
But that is the Morality view - a correct one, but not the complete picture, in my view.
Mathematics and the Crisis
We cannot ignore the Mathematics of the issue - the underlying paper debt based monetary system that requires perpetual and ever increasing year over year growth, even if that growth needs to be speculative and non productive when productive growth is lagging. It's growth however, also creates global trade imbalances as there are no early checks on trade deficits until it is too late (as there were under a gold standard) and its growth also creates a corresponding growth in unsustainable interest costs. It reaches a ceiling, and then collapses.
We have reached that ceiling and have already organically collapsed, and so, we need to continue to deficit spend (see my prior post) and the Federal Reserve needs to continue to create money. Yet many commentators once again revert to the Morality issue. They demonize Ben Bernanke and the US Congress for being "irresponsible." Technically, they are not. They are merely playing the game as it exists, hoping for a miraculous period of organic growth in the economy to get us out of the crisis. Their actions should not be debated per se, the underlying economic system needs to be up for debate. But that won't happen. Next time you see a commentator you agree with, ask yourself: are they looking at the big picture? I bet that the vast majority are not. And that's what worries me.
Michael Hudson once combined the two, in my opinion - Mathematics and Morality, emphasis mine:
A crash occurs at the point where this disparity is widely recognized. To bankers, the antidote is to lend enough new credit to re-inflate prices real estate and other assets, enabling new buyers to borrow the credit to buy property from defaulters. Rather than scaling back the U.S. economy’s over-indebtedness, for instance, the Treasury and Federal Reserve have bailed out the banks to save them from taking a loss on debt write-downs.  The dream is to keep the compound interest scheme expanding ad infinitum. But the pretense that fictitious finance-capital claims can be paid must be dropped at the point where financial managers desert the sinking financial ship. Their last act before the bubble bursts is the time-honored practice of taking the money and running – paying themselves as large bonuses and salaries as corporate treasuries (and public bailouts) allow.SOURCE
But how has the current system evolved into such a Pyramid Scheme? It was through incremental change, over decades. This is how I see the last forty years, since the end of Bretton Woods, and the advent of the paper money debt-based monetary system:
At the end of the 1960s, a limit to productive economic growth was reached in the US. The post World War II reconstruction rebuilding based growth era was ending. The new and increasing costs of Vietnam and Great Society social programs were too burdensome for this "new normal" to support and so the US went off the gold standard and adopted a purely government debt based system. In order to support this new system, banks, over time, were greatly de-regulated. To combat the inflation inherent in a change in monetary system from hard assets to paper, interest rates increased, and at the same time, manufacturing was shipped off to cheaper countries. Offshoring always existed, but this new era required the acceleration of it. A FIRE economy began to grow to fill that void. FIRE is Finance, Insurance, and Real Estate. It is purely speculative in nature, and it is not geared to producing things as much as it is in owning things whose value increases. Debt based consumption followed. And as in the early stages of any Ponzi or Pyramid Scheme, extreme "wealth" was produced.
But this wealth required ever increasing asset values just as manufacturing wages were being depressed by offshoring, outsourcing, and de-industrialization. More debt based consumption followed. Lending guidelines were weakened to continue the debt game. After all, the more people exposed to debt, the better. Even a janitor can buy a large house now. This was not a symptom of a greedy, decaying, immoral society - mathematically, the system required this. The mathematical requirements of the new monetary and economic system required society to change its morals and views on consumption and debt - not the other way around, as many suggest.
But eventually, a limit was reached in the private sector. Just as wages have limits, debt loads too, can only grow for so long. The FIRE economy collapsed in the Fall of 2008. Having nothing else to "grow" the economy, the US Government and Federal Reserve stepped in to maintain FIRE's growth. Fannie Mae and Freddie Mac were nationalized. Long term debt and other securities were purchased to keep rates low and asset values artificially high. Price discovery was interfered. The game has continued, but the economy is no longer growing organically, it is growing purely on the Government's ability to create money.
So we have a debt ownership game. The debt started in the private sector until it could no longer grow - then to a large degree, it was passed onto the Government sector. But is that sustainable? And what of malinvestment and its consequences? Yes, the US Government does not need to technically "finance" its debt, as it creates money whenever it spends. But it does need to manage the value of its currency.
And so, we have reached the end of debt transfers. No other entity exists that is larger than the US Government for that debt to be passed on once again. And at this stage, those with the most power grab what they can, while they can. The rest debate topics such as irresponsible government spending or Wall Street greed, and no one thinks about a basic mathematical concept: compounding interest.
So why did I write about Mathematics and Morality today? I think it is important to understand the two individual components, yet use both in analyzing the crisis. But unfortunately, when the endgame comes, when economies collapse due to prior unsustainable malinvestments, very few will understand why, and I fear the blame game can become a dangerous one. The political and societal fallout will be severe.