(This is Part 3 of a series. Go back to Part 2.)
This process has not been limited to the corporate sector by any means. Governments, led by the U.S., have also been taking on lots of new debt to pay for unfunded expenses. Funding its expensive wars in Iraq and elsewhere is costing the U.S. a bundle, about half a trillion dollars so far. Meanwhile, U.S. government spending has increased 60% just since the year 2000. In general the U.S. government is spending way beyond its means. The U.S. is not alone in that, of course, but it is the most extreme case among developed countries.
If we measure the true U.S. federal deficit by the amount of net new debt instruments the U.S. is issuing each year, then the true federal deficit is about $800 billion a year, several times the reported figure. And that's not counting our trade deficit, another $800 billion. It's also not counting unfunded obligations, which add some $4 trillion (with a "t") each year. Unfunded obligations have increased from $20 trillion to almost $44 trillion in the last seven years. And mostly, the public has been blissfully unaware of this.
Then there's the consumer, who has added trillions in new debt in the last few years to finance an orgy of buying. As part of this, the percentage of subprime mortgages in the U.S. rose from 5% in 2001 to 20% in 2006, a 4-fold increase in five years. However, defaults in this area are now close to 13%. And even in the "normal" mortgage area, defaults have doubled just in the past year. That is, if by "normal" we mean 100% financing, interest-only, no-documentation, adjustable-rate, low front-loaded and other innovations of recent times.
Corporations, governments and consumers have all been borrowing like mad hatters. Adding to the melee are the hedge funds and private equity pools that, as noted above, have often been operating with leverage by borrowing $2 to $20 for each $1 of their own funds. And let's not forget junk bonds, emerging-market bonds, and not least, the "collateralized debt obligations" that have fueled the gigantic mortgage market since 2002. In the last 5 years, the global investment banking community alone is estimated to have added $30 trillion of debt.
Then there are derivatives (financial instruments which are dependent on other financial instruments). Some $72 trillion (with a "t") have been added just in the last six months—more than the total just five years ago. There is an estimated current total of some $410 trillion (with a "t") in global derivatives, approximately 8 times total global economic activity. And 90% of it is over-the-counter, away from public scrutiny.
The current degree of global leverage is completely unprecedented. The mind boggles. How to describe such a network of vast leverage all through the global system? Should we call it the Mother of all Credit Cycles? The Alice in Wonderland Great Global Credit Bubble? Personally, I like Ed McCarthy's invocation of Dante: In trying to truly describe the current situation, "Abandon all hope, all ye who enter here."
This bubble-blowing is the same phenomenon that happened in the U.S. Confederation in the 1780s, France in the 1790s, Germany after World War I, the U.S. and Europe in the 1920s and so on—all of which resulted in either hyperinflations or depressions. The only difference is that now this phenomenon of rampant money and credit creation has been occurring on a global scale, something which has never happened before.
As noted, monetary liquidity has been flooding the world, reflected in rising stock markets and GDP all over—Brazil, China, India, Russia, eastern Europe, the Middle East, Africa—everywhere. All the central banks and all of the various credit-creating and credit-using entities in the financial world have been participating. Profits rising to the sky. More and more money/credit created. And the game can't stop, because if it does the whole credit/debt pyramid will come crashing down, just like the withdrawal from any other kind of addiction.
Like a heroin addict, the injections of money and credit must keep increasing over time to get the same effect, which ensures that this process of money/credit creation must keep climbing higher and higher until the colossal debt bubble finally collapses of its own weight.
Until the process ends, welcome to more and more inflation. Here are some recent examples more or less at random: Gasoline in the U.S. is up roughly 150% in five years. Bread prices are up 15% in the last year. The price of a bee colony has increased from $55 to $135 in two years. The price of a ticket on the major discount airline has risen 29% in the last year. The newsstand price of the New York Times just went up 25%.
These events and others are supposedly unrelated. But they are very related. We have been living in the middle of a rising inflation, much greater than most of the public believes. As the analyst John Williams has demonstrated, if the U.S. CPI were computed today using pre-Reagan methodology it would be almost 11% a year. The official CPI released by the government, in contrast, has been hovering about 2-3% in recent years. That figure has been politically manipulated to make inflation look irrelevant.
At 11% inflation, the more accurate figure, the value of a dollar halves in 6 1/2 years. And this inflationary phenomenon has not been confined to the U.S. It has been a worldwide phenomenon directly related to the root cause of inflation—increasing amounts of fiat money and credit. (What does "fiat" mean? It means that the value of the money is not tied to anything—gold or anything else. It means it can be "created at will.")
Given this gigantic bubble of debt and leverage, it is inevitable that from time to time there will be financial panics, such as the one now occurring in the subprime mortgage market. If such a panic spreads and grows large enough, of course, it could bring about the gigantic crash to which the system has become prone. To prevent that, which has become unthinkable to policy makers, more and more money has been and will be injected into the system, ongoingly.
That's what has been happening. And it has been slowly—though at an increasing pace—destroying the value of money. As more and more dollars, yen, pounds, euros, yuans and so on are created, the value of each unit goes down. In fact, every currency in the world has been losing value in relation to gold, the historical standard of value. When we see prices increasingly rising around us, what we're really seeing is the ongoing destruction of a currency's purchasing power.
(This is the end of Part 3. Go to Part 4.)
—jim sloman, 3.12.07
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