Wednesday, April 1, 2009

A Twenty-First Century Idyll

Here's the bad news:

Our country is living beyond its means. It has been for a long time, though it spiraled out of control in the last decade. There is a sense of magic, as if the government can keep taking more debt and, since it hasn't failed yet, it never can. But of course that is silly. "Too big to fail" is a moralism, not a statement of fact: we may desperately want big things not to fail, but ultimately the only way to save them is to appeal to something bigger. Unfortunately, the buck stops with Uncle Sam: who can bail out the bailer?

Without someone to bail him out, an individual (or an institution) eventually has to pay his debts. At some point, even the most bogus credit card will no longer lend me money. I will have no more to spend, and those to whom I am obligated will want to be paid back. Without someone to bail me out, I will certainly never have money of my own again -- the lenders will make me pay back the last cent. And perhaps I will suffer violence, from those who are frustrated.

Yet the lenders themselves face the same predicament. If the bank keeps lending money to people who cannot pay it back, the bank itself will not be able to pay back legitimate investors. The bank itself will fail. The investors will lose their money, the bank will lose its good name -- and perhaps there will be violence, from those who are frustrated.

This is the truth in the bail-out mentality: bad debt is a social disease, because it always involves a lender. If I cannot pay back my debts, that hurts me -- but it also hurts everyone who loaned money to me. And if it gets out of control, and even my lenders are bankrupted, it hurts everyone who loaned to them, too. We have to do something!

But there is a lie in the bail-out mentality, too. That lie is that government evades the logic. Government lends money to bail out bad debt. Uncle Sam is giving money to those who made bad mortgages, to those who invested in those who made bad mortgages, etc. But where does Uncle Sam get the money? One source is investors: Uncle Sam just acts like another bank. But when a bank lends to debtors who can't pay back, the bank fails. The US can sell a lot of Treasury Bonds, but ultimately, people want to get their money back, with interest. Whether it is down the street or in Washington, if a bank borrows money from Tom, lends it to Harry, and then cannot get it back from Harry, then Tom will not get his money back. Tom suffers -- and he stops putting his money in the bank. The flow of Treasury-Bond revenue may be fine for now (maybe), but it will not last forever. We have to do something about our debt problem, that is true -- but taking more debt, or passing the debt around, does not fix the problem. Lending money to people who can't pay it back is the problem.

Of course, the difference between Uncle Sam and any other bank is that Uncle Sam can just print more money. But this is purely a ruse. Printing more money devalues money. If I get my $200 back, but now it doesn't buy a week's groceries, I'm in trouble. Investors know this: when it becomes apparent that Treasury Bond yields will be paid back only with massive inflation, people will stop buying Treasury Bonds. But more to the point, all the people who have bought Treasury Bonds will be in need of a bail-out themselves. If I think I can fund my retirement on funny-money inflationary Treasury Bonds, I'm going to be in big trouble when I retire.

We have a debt problem. We are living beyond our means. There is a limit to how many times Daddy can bail us out -- and there is a limit to how many people can bail Daddy out. At some point, bail-out ceases to be an option. At some point, we run out of money. At some point, we lose the house, and the SUV, and we have to work instead of retiring. The only solution to living beyond our means -- the only solution to bad debt -- is to work more and cut spending. I am not talking about only at the federal level. Uncle Sam will have to cut spending, sure -- but so will we.

Being a recent Ph.D., I have no investments, no savings, no assets, so all of this doesn't affect me. Except that it affects my employers. Bad debt is a social disease. I was just hired at a university -- and I need that income! But if all the parents who pay for kids to go to college -- and pay my salary -- have to cut back, it may be me who gets cut. If Uncle Sam no longer has money to hand out for scholarships and financial aid, my salary dries up. Bad debt is a social disease. Eventually we all have to cut back our life styles, and learn to live a more meager existence. We can't just keep taking loans we can't pay back.

If I make $50k a year, but spend $75k, eventually people are going to stop lending me that extra $25k. First, I will have to cut back, and start living at $50k. But then I will have to pay back my debts, and live on less than $50k. Government doesn't evade this logic. Shell games make it all complicated, so that the debt gets shoveled around so quickly that we think it's disappeared: but it hasn't. Everyone eventually wants their investments back, and if they don't get them back, they will stop investing. And if it turns out that, in a great shell game, everyone has loaned everyone else money they didn't have -- why, we all end up in a big mess.

That's the bad news. Eventually we will have to cut back.

But here's an idyllic possibility -- not necessarily likely, but possible, and hopeful. Perhaps when the reckoning comes, when the debt bubble bursts, and we all have to come to terms, perhaps we will take stock of what's really important. Hitting rock bottom can do a person a lot of good. When the debt-collectors come for the McMansion, and the big screen tv, and the SUV, there's always the possibility that we'll say, you know, what really matters is my dog, my kids, and the softball league. (Or whatever.) You move to a much smaller house, sell the SUV, make the kids share a bedroom, and focus on what really matters.

What would this look like on a social level? Here's a trivial example. Right now, our society spends an awful lot of money on food. There's the whole organic movement -- leave that aside for a moment -- but there's also things like grapes from Chile. Now, I like grapes, and I'm glad to have them year round. And in current circumstances, they aren't expensive at all. But it isn't easy to get grapes from Chile to Minnesota. On the most basic level, they have to get on a plane and fly, with refrigeration. But it is far more complicated than that. Thousands of people are employed by the airline, making reservations, fixing planes, fixing runways, making sure that the airplane travels to where a commodity is wanted from where it's available. We do that very efficiently now, so Chilean grapes are cheap -- but only because there is a huge system in place.

This transaction is maintained, moreover, by a massive financial sector. People are busily shuffling money around, from investors to firms, from grocery stores to Chilean-grape middlemen to farmers to farmworkers, etc. This isn't as easy as it sounds. Grapes are cheap now, because there's an enormous industry, countless people working hard, to keep this whole system lubricated. But what happens if the financial system collapses?

For example, the grocery store has to buy the grapes before it can sell them. It does that through investment: I lend money to the grocery store (probably through some Wall St. firm), trusting that a month from now, the grocery store will have used that money to buy grapes, then sold those grapes at a big enough profit to pay me back with interest. But it's a lot of work to figure out where to invest, what airline is profitable, how much interest to expect. Imagine if the manager of the grocery store had to meet with each individual potential investor, personally process each investment, no matter how big or small, keep track of it all himself, make payments, etc. And imagine if he had to call the guy in Chile, and the airline, and promise them money based on all these individual transactions? This is a lot of work. And it can work only because there is a massive financial sector dedicated full-time to handling these transactions, and guaranteeing that each month the grocer has enough money to buy grapes.

And it is all based on trust. I give my money to the financial sector because I trust they will pay me back. The grocer and the airline and the Chilean grape dealer all trust that contracts will be fulfilled, that the financial guys will put up the money, etc. Imagine if every one of these people demanded cash? It would be impossible. It all relies on trust.

We may be coming to the end of that trust. We may be coming to the end of Chilean grapes. And that is, in itself, bad news.

The good news is, that doesn't mean we have to starve. We put all these people to work so that we can have the specific kind of grapes we want, when we want them, even out of season. But if we ate locally -- I'm not trying to be crunchy here, just economical -- we could cut out an awful lot of middlemen. We could pay cash, and deal with individuals that we really did trust.

We'd lose a lot of processed foods, because they require an enormous network of trust: trust that we'll get what we're supposed to, trust that the factory in Arkansas will actually deliver food to Minnesota, trust that the grocery store will pay back its debts after it sells the frozen lasagna, trust that the financier will come through. We would replace that with a much more local trust: I ask the farmer to deliver me potatoes in the winter, and we trust each other to seal the deal. We would lose a tremendous lot of choice. But we gain more personal business relationships, a more thoughtful consideration of what we value (sell the tv, or the dog? are those Cheetos worth more than the steak?), and more tangible contact with our world.

This would put a lot of people out of work, of course. But here is a central fallacy in many discussions of the free market. It is often said that the free market depends on consumerism, greed, lavish spending. But quite the opposite is the case. The free market is, rather, a way of delegating resources to those activities that are valued. It says nothing whatsoever about what those activities are.

Imagine this: the financial sector falls apart, as do many systems of national trust; the nation as a whole is much poorer, and people radically cut back their spending, to live at, or even below, their means, since debt is no longer an option -- and Hollywood goes out of business. Film, of course, requires a massive financial sector, to invest money before the film starts selling tickets, to get goods, and people, from point a to point b, to distribute the film to where it will be watched, etc. And -- is this too optimistic? -- it's one of the first expenses to be cut. We watch too much television as a nation, but if movies cost $50 a ticket, and all tv was pay-per-view, and expensive, would people really pay? I think not.

So Hollywood goes out of business. Lots of people lose their jobs. But that frees up a lot of hands. Brad Pitt seems to be making between 10 and 30 million dollars per movie. That is an awful lot of work that our society puts into supporting this one man's lavish lifestyle, and pet interests (he recently spent $100,000 fighting for gay marriage in California). Eliminating his job does not hurt the economy as a whole. If he went to work, say, on a local farm, we could all save money not paying for his movies, and he could actually contribute to the local economy. It's not a zero-sum game, even for the minimum-wage stage hand: if he starts making hand-crafted boots, then more hand-crafted boots are available for all of us -- and we have more money to spend on those boots, since we're not paying for stage hands or big-shot actors.

We could spin this out in many ways. But here's my point: first, a reckoning is coming. Our debt problem can only end by all of us spending less money. But the more it flies out of control, the more national systems of trust will collapse: trust in the federal government, in the financial sector, in the grocery industry, etc. That will hurt. But it could mean a positive readjustment, as we shift resources from lavish lifestyles to more basic, and perhaps more human, investments. Perhaps we could eat locally-grown potatoes instead of Chilean grapes or Cheetos, and walk the dog instead of watching Brad Pitt. I don't think that would be such a bad thing.