Give Me Some Credit

Here’s a little historical question for you…

What caused the Great Depression?

Oh, I’m not asking for all the usual high school textbook answers: stock market crashes, trade protectionism, drought, indebted farmers. I’m asking about this from another angle. My question is more fundamental: How did a rich nation, in fact the world’s richest nation, grind to a halt?

Nothing real had disappeared. Everything tangible was still there. The workers were still available, the factories still stood, the banks and the farms hadn’t gone anywhere (excepting those that had been carried by a dust storm into the next state).

And then it all stopped.

What happened? Did America suddenly stop being rich? Did the factories disappear? Did the workers lose their skills? Did the resources run out? No. All those things were still there, just as they had been before. The Depression started for lots of reasons, but one simple and single factor links them all: the money stopped flowing, by which I mean that the credit dried up. No one would lend anyone any money anymore.

We say that America is rich. We are very rich. But rich matters a whole lot less than you think it does. A man with vast property is rich by definition, but that doesn’t necessarily mean that he can pay his bills. Wealth means little without income, and in the modern world, all income really depends on credit.

Credit is much maligned, and much misunderstood. While indebtedness is usually bad, credit is usually very, very good. Wonderful, actually, as it literally makes the whole system work. Using credit is not necessarily the same as going into debt. Think about your own household purchasing. Unless you use cash for literally everything, you are using credit all the time. If you use a check or card, even the supermarket “lends” you groceries until they get your money a few minutes, hours, or a couple days later. And absolutely all of the most expensive things you ever buy are bought with credit. Without credit, it might be years before you bought a house or a car, if ever.

Even the most successful business runs on credit, even if it doesn’t have any actual long-term debt. A business buys expensive capital equipment on credit, which is what makes it possible to make goods and services in the first place. It uses credit to stabilize its cash flow over time, so that it can meet day to day expenses. Without that credit, it is absolutely impossible to run a modern business, because an advanced economy requiring large capital investments and cash flows simply can’t depend on people physically carrying around cash. All of the things that are used to make everything else, the capital, labor, and resources, all are useless without credit.

The same is true for nations. They run on credit. America has a lot of physical capital, a lot of human capital, and a lot of resources. But none of those matter much without credit.

Some people say that America should do this or that important, ambitious, noble, or generous thing because we are rich. But rich doesn’t matter, credit matters. For one to borrow, another must lend. For another to lend to you, he must have confidence in your future. A lender is not interested in how rich you are, he is interested in whether or not you can pay him back. And he gets to make that decision, not you. You may think that everything is fine, but what matters is if he thinks everything is fine.

We spend a lot of time telling ourselves that everything is fine because we are rich. It is true that we own a lot of things, and it is also true that we do have a lot of money. But let me extend what I said above about "being" rich to the subject of "having" money. We have less money that you think, and what we do have matters less than you think it does.

I'll illustrate it this way. Do you remember the cartoons of Scrooge McDuck? He kept a big vault of money, and swam in it for pleasure. If Scrooge never made another dime in his duck life, he could have kept spending that money for a very long time before it would all be gone. Our money isn’t quite like that. Most Americans don’t have any money saved at all. If we tried to swim in our money like Scrooge McDuck, we would be painfully jumping into a big pile of consumer goods and/or the disposable packaging they came in, because that is what we spent all our money on. Actually, scratch that. We would be jumping into empty air, because half of that stuff we own hasn’t even been paid for with real money yet, it is getting paid for with future money that we expect someone else to give us right before we are due to pay the bill on the credit card we bought the stuff with.

Americans don’t actually have money, so much as we have a lots of movement of money. What comes around goes around, and no sooner do we get money then do we pass it along to the next guy. When it comes to our buying habits, we don’t really have the money today, we just always assume that we will have money tomorrow.

In an advanced economy, everyone is doing this, including individuals, businesses, and the government itself. Most, if not all, of our long term plans are actually based on tomorrow’s money. Therefore, all our projections are meaningless if the money doesn’t keep flowing, and once again, that all comes back to credit. Once upon a time, the credit necessary to run the U.S. government came from the savings of Americans, who used those savings to buy U.S. treasury bonds. We don’t do that much anymore. Instead, we mostly let the Japanese and the Chinese do it. They will keep giving us credit only so long as they believe in our future ability to pay. The moment they lose confidence, they don’t lend.

And when that moment comes, everything stops. It doesn't stop in that future year that we showed on our charts and spreadsheets. It stops at that moment. Then it no longer matters what factories, stores, infrastructure, human skills, or resources we have. The economy stops.

For the time being, we are still okay. The Japanese and Chinese haven’t lost confidence in our economy just yet. Luckily for us, they don’t really have too many other places to put their savings anyway. But ask yourself this question. Would you buy U.S. debt if you had other options?

Let’s look at just a few items from America’s balance sheet.

Social Security is supposedly going to run out in some year or other at some point in the future. I think I remember the exact year, but I’m not even going to bother to look it up. Last year’s biggest-in-American history “stimulus package” which was spent on virtually everything under the sun except those things that are generally considered to actually “stimulate” an economy, involved a specific amount that is supposed to be repaid by a certain time. I think I remember those numbers too, but I’m not going to bother to look those up either. I’m not being lazy, I’m making a point. Would it really matter if I told you the numbers anyway? They are already so big that we can't even visualize them as abstractions. They have no frame of reference. How do you describe a trillion, anyway? Do all those analogies about how deep the ocean is, or how many times around the equator, or how far away the moon is, really tell you anything? They might as well be imaginary numbers.

Actually, they pretty much are imaginary numbers. They change all the time, as they are purely based on predictions. Do you remember all that talk of surpluses when the Clinton administration ended? What happened to it? If you are inclined to be partisan and blame Bush for losing it (okay, fair enough, I'm also inclined to blame Bush for losing it), just think of it like this: If Bush lost our money, then Obama has found it and gone to Vegas.

But of course, in reality, there was no money to lose. That surplus wasn't cash in a Scrooge McDuck vault, it was only a prognostication for the future. And just like in those time travel science fiction movies, the future is always changing. Just today, news came out that as of this year, the government is paying out more for social security benefits than it is taking in from social security taxes. That wasn't supposed to happen until 2016.

And now comes our latest and greatest must-do-it-because-we-are-rich spending scheme, Obamacare. This bankruptcy in the making has been promoted with numbers that are worse than imaginary. This time, they are flat-out lies. They are based on the next ten years of tax collection, but only on a six year period of expenses that doesn’t even start for another four years. And for that matter, the promised cost "savings" over those ten years literally equals only about half of what the U.S. Federal government spent last month!

So forget all the numbers. Let's get back to credit. None of the numbers matter one bit unless the credit keeps flowing. And for that, we’ve got to keep selling government debt, and people have to keep believing that it is safe to buy it.

Is it still safe to buy it? Last week, it was announced that Moody’s Investment Services, is warning that the U.S. bond rating may be downgraded from AAA status. In fact, as far as the free market is concerned, it already has been downgraded, because it is now considered safer to invest in several private companies than it is to buy short term U.S. treasury bonds!

That is unprecedented. U.S. Treasury bonds have traditionally been the safest investment in the world, and now people trust them less than bonds from Berkshire Hathaway, Procter & Gamble, Johnson & Johnson, Lowe’s Home Improvement Warehouses, Abbot Laboratories, and the Royal Bank of Canada.

Investors now trust U.S. treasury bonds less than those of four major corporations, one more that you've never heard of, and a Canadian Bank. I wonder how investors got that idea?

Right now, foreign investors are still buying our debt and giving us credit. They still have confidence. Pray that they don’t lose it, because when and if they do, we will all find out very, very, quickly that being the “richest” country doesn’t really matter all that much.

-AzA