August 24, 2012

Too Much of a Good Thing, Continued...

The Daily Reckoning Presents

Bill Bonner

Economists cannot know what is ‘better.’ They can only know what is ‘more.’ They have numbers. They can count. They can add up ‘more’. As for ‘better,’ they have no idea. So, in their little minds, more is better.

That is the thinking that has driven the profession...and much of the world absurdity. Throughout the last 50 years, more looked so much like better, no one worried too much about the difference. More cars. More houses. More food. More gadgets. What was not to like?

But the cost was more debt. And by the 21st century the burden of debt had become so great that the system could no longer move forward. Here is how it worked, up until the early spring of 2007:

The Chinese, and others, made more stuff. The Arabs, and others, pumped more oil.

Americans, and others, created more credit and used the money to buy more stuff.

Rather than demand payment — in gold — for their excess dollars, as they would have before 1971, the exporters took the money and lent it back to the Americans. In this way, the US never really had to settle up. Approximately $8 trillion of purchasing power — the accumulated trade deficits between 1970 and 2007 — was created in this way. There is supposed to be ‘no such thing as a free lunch’ in economics. But for years Americans ate breakfast, lunch, and many of their dinners too at foreigners’ expense.

Not needing to redeem the old credits, new ones were made available to Americans. Cheap credit drove up housing prices...and gave them the collateral to borrow more money and buy more stuff.

But when subprime mortgage market collapsed in ’07-’08, suddenly, US real estate prices stopped rising. This left millions of households in a bind. They could no longer borrow against rising house prices because housing was going down. They had to cut back on spending...which meant less stuff could be sold to them...and it left producers with bulging warehouses with unsold goods.

Economists looked at this situation, after the crash of subprime mortgages in ’07 and ’08, and came to the same conclusion they had on the occasion of every other slowdown over the previous 60 years. The economy needed more “stimulus” to encourage consumers to buy more stuff. They did not notice that consumers already had too much stuff...and that they were now paying the price for buying more stuff than they could afford. Nor did they wonder whether consumers’ lives might be better if they focused more on quality and less on quantity. ‘More’ is all they know; it is all they can do. So they called for ‘more stimulus,’ more debt, more credit, more spending, and more stuff.

But more is not always the right answer. There are times when less is better.

One of those times was in the mid-1930s...when Germany faced a critical decision. More? Or less?

Adam Tooze, a British historian, has written a marvelous book on the Nazi economy, The Wages of Destruction. He shows that, far from illustrating the success of intelligent central planning, the German economy of the Third Reich was a disaster. The National Socialists — or “Nazis” — had their plans for Germany. They were determined to put them into practice, regardless of what the Germans may have wanted for themselves. They fiddled with one sector after another. When one fix failed to produce the desired results, actually bringing unintended and undesired consequences, they tried to fix the fix with a new fix. Most of these fixes involved spending money — if not on actual output, then on bureaucracies that regulated output. And most of them were directed towards a goal that only a demagogue politician or a lame economist would find attractive — making Germany self-sufficient. Imports cost money, they reasoned. Besides, trade forced a nation to behave. Neither was attractive to the Nazis.

Like America in the 2000s, by the mid-1930s Germany had already spent too much money — with the military as its biggest single expense. It faced enemies much more real and dangerous than America’s ‘terrorist’ adversaries. And under Adolph Hitler’s leadership it had decided to invest heavily in armaments. This created a sense of purpose for many people and a source of ‘demand’ that got people working again. Germany was still a relatively poor country, with a standard of living only about half the US equivalent. An autoworker in Munich, for example, could not expect anywhere near the same lifestyle as one in Detroit. Henry Ford paid his workers so well they were able to afford large houses with hot and cold running water and electricity. They could buy automobiles too...which gave a huge boost to America’s heavy industry. When war began, the US could fairly quickly convert its auto factories to production of jeeps, tanks and trucks. Germany could not.

In Germany, automobiles were still a luxury item. Few people owned them; certainly not the people who made them. Military orders made up for the lack of demand from the civilian population.

In this regard, many economists looked at Germany and labeled the rearmament program — from an economic standpoint — as a central planning success story. It ‘put people back to work.’ It ‘got the economy moving again.’ More stuff was being produced. ‘More’ worked! From all over Europe, people came to admire the revival in Germany. American Congressmen praised Hitler. So did many magazine editors and other leaders in France and Britain too.

Besides, compared to what was going on in Russia, Japan and Italy... Germany looked positively benign, if not a perfect role model. Stalin was purging or starving his enemies — millions of them. Benito Mussolini had invaded Abyssinia and was busily massacring the locals. The Japanese were beginning their bloody war against the Chinese. Hitler may have sounded mad from time to time, and he may have murdered many of his rivals on the ‘night of the long knives,’ but now — by 1935 — he was beginning to sound reasonable, at least in comparison.

But vast spending on the military brought problems for the Nazi leadership. The German economy was still recovering from the destruction of WWI, the loss of the Ruhr heavy industrial area, the Great Depression and the reparations payments. Germany. While other economies had been forced off the gold standard, Germany held to its strong mark policies. It lacked the raw materials needed to build heavy military equipment and the fuel needed to power a modern economy and modern war machine. Those could only be bought with foreign currencies, which it could earn by trade, or by drawing down its own hard currency reserves of gold.

By 1936, it was clear that the government would run out of money in just a few months. The Nazi leadership had already ‘fixed’ the farm sector — with various jury rigs and many unintended consequences. The market system had largely been replaced by a system of bureaucratic meddles and price controls which, naturally and predictably, led to shortages that had to be reconciled by rationing.

Now, this same sort of meddling was causing shortages in the manufacturing sector too. If something were not done, the whole rearmament effort could come to a halt. Germany was not rich enough to be able to afford guns and butter — at least not on the scale promised by the Nazi Party. And with their spreading system of bureaucratic management, neither the guns nor butter were likely to last long.

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