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The Daily Reckoning | Wednesday, March 17, 2010 The Alcohol-Induced Debt Crisis And Other Barroom Philosophies of Modern Finance Joel Bowman It is better to spend money like there's no tomorrow than to spend tonight like there's no money! - Irish toast. So the Irish have their excuse for the lamentable state of their nation's economic affairs. They can blame it on the drink. But what say the Greeks...and the Portuguese...the Spaniards...Britons...Italians and, indeed, all the other nations signatory to the boneheaded European single currency experiment? To what barroom philosophy do they attribute their disastrous finances? No doubt the politicians will come up with something - or someone - to blame other than themselves... "It was the ouzo!" the Greeks will scream... "The Chianti!" the Italians will echo... "The sodden weather!" the Brits join in. We can hardly wait to hear the rest... Yes, fellow Reckoner, the state of the European Union is not good. Of course, you wouldn't guess that from looking at the stock markets there. The Stoxx Europe 600 Index rallied to a 17-month high overnight. Apparently, investors are delighted by the future economic prospects of the embattled continent. The cost of insuring against losses on European corporate bonds using credit-default swaps fell during the session too, signaling either that the worst may be over, or that the crowd has it all wrong. We'll side with the latter, history-tested assumption. Even the Hellenes got a bit of reprieve overnight. BusinessWeek reports: "Greek bonds rose after Standard & Poor's said yesterday it isn't reviewing the nation's BBB+ rating for a downgrade as the government pushes ahead with efforts to narrow its budget deficit, the biggest in Europe. The yield on the two-year note dropped as much as 20 basis points to 4.52 percent." Well...if the ratings agencies aren't downgrading it...it must be a buy! The European Commission, however, does not appear to be so confident. The EU has asked France, Spain and Ireland for more details on their so called "austerity plans" and even suggested that several European countries were being too optimistic on their respective growth outlooks. "The main risks to consolidation stem from somewhat optimistic macroeconomic assumptions and the lack of specification of consolidating measures," EU Economic and Monetary Affairs Commissioner Olli Rehn said in a statement before adding that deficits may be "worse than targeted." The commission also asked for "more details" from Belgium, the Netherlands, Austria and Germany, the latter widely held to be the best of a bad bunch. Could it be that the EU is acutely aware of the systemic weakness within its own ranks? Or is it simply covering its behind in advance, affecting to have "done something" before every last thread unravels? It's hard to say. One man who makes no bones about his opinion on the situation is Harvard University Professor Martin Feldstein. Two decades ago, Feldstein warned that the euro would wind up being an "economic liability" for the 16-nation bloc. Five years ago he observed that the rules governing the single currency generated a "very strong bias toward large chronic fiscal deficits." And, in 2008, he predicted that the eurozone may even eventually splinter. So, now that chronic fiscal deficits threaten to drag the entire single currency experiment asunder, and as Greece faces calls for expulsion, what does European Central Bank President Jean-Claude Trichet have to say about the possibility of a splintered union? "Absurd." We'll let the readers decide what constitutes "absurd." We're out of time in today's leader to get into that debate... But before we get into our guest essay, below, a quick heads-up... You might have heard that our resident penny stock specialist, Greg Guenthner, is now taking questions for an upcoming online Q&A. So, if you have any queries for our man, send him an email here. Then, simply tune into the free event to hear them answered. We'll let you know the moment it's live. The Daily Reckoning Presents Is Your Money What You Think It Is? Doug Casey Louis: Doug, last time we spoke, you said quite a bit about debt, in the context of your expectation that the euro is on its way out. At the end of that conversation, you mentioned, of course, that the problem is not limited to Greece, nor the eurozone. America as a country has become a world-class debtor, and many Americans seem to think a maxed- out credit card is a reason to get a higher credit limit, not to economize. It's like a global epidemic. Let's talk about debt. Doug: Sure. This is a story that's going to end very badly for a lot of people. I've said this before, in many different ways, but I think it's worth saying again...Most people just don't get what money really is - and what it isn't. They take it as a given, as part of the cosmic firmament. But it's not. A prime example of this is the mistaking of debt for money. This is why the entire world's monetary system today is headed for a disastrous failure. And this is absolutely inevitable. There's no way around it. Louis: Why? Doug: Because you can't use debt as money. As I've pointed out before, Aristotle, in the fourth century BC, was the first person to define what money is. And what is it? It's a store of value and a medium of exchange. The paper we use today is a medium of exchange - it got that way because governments made it illegal not to accept it - but it's not a good store of value. And it's rapidly and radically becoming less of a store of value. What we use as money today is actually not money; it's currency. Technically, that's simply a word that indicates a government substitute for money. What does make for good money? Again, Aristotle gives us the answer. It's something that has five characteristics: it's durable and divisible, consistent and convenient, and has value in itself. And for these reasons, gold is almost certainly the best thing to use for money. Not because I say so, nor because Aristotle said so, but because, over time, people have found it to be the most durable, divisible, consistent, convenient, and inherently valuable thing to use. Silver is also good, but it's less durable because it corrodes. And less convenient, in that it takes about 60 times more of it - at the moment - to offer the same value as gold. Copper is the next traditional step down the ladder. Louis: That, plus one reason that's pertinent today but was not a problem in Aristotle's world: gold can't just be printed up on the arbitrary whims of those in power. Doug: That's the big one. Using metals as money takes the whole matter out of the hands of the government and its bureaucrats. Louis: But we don't use gold today... Doug: No, it's as though a bunch of friends without any real money started exchanging IOUs for money, and then after a while forgot that the IOUs were supposed to represent, and be redeemed in, real money. The problem with this is that, in the case of the IOUs between friends, paper is based solely on hope and trust. One can move away, or die, or turn dishonest, or become insolvent - many other things could happen. A guy stuck with a dead man's IOU has nothing. With government IOUs, or currencies, it's worse, because they can increase the number of IOUs in circulation without telling anyone - that's what inflation is. Since the government creates the IOUs, it gets the benefit of spending them before the inflation they create raises prices, which is basically stealing from the people. And, of course, sometimes governments do "die," leaving the holders stuck with nothing, just as with the IOUs between friends. In fact, it's arguably far more likely that such problems will arise from trusting a government to print IOUs than from trusting a friend. Louis: Most people feel that they should do right by their friends - government's don't have friends, and most see their citizens as being property, like cattle. Therefore, inflating the currency isn't a crime in their view, just a tool for controlling the dumb masses. But it's really taxation without representation. Doug: Sadly so. And since the institution of government is based on force, on compulsion, they feel they have every right to do what they want. They sanitize all types of criminality by saying it's in "the national interest" or some such poppycock. Louis: Okay... but these currencies have worked for a very long time. Why are you right about this and the rest of the world wrong? Why is it inevitable that government currencies will fail? Doug: [Chuckles] Because governments are not living persons who care and can be motivated to do the right thing. They are collections of individuals - politicians and bureaucrats, not exactly the most desirable types - who pursue their own interests. Regardless of the rhetoric, their interests coincide with the public good only on occasion, like a broken clock being right twice a day. Even in the most enlightened times - even in the best of times - governments have huge incentives to spend more than they take in. These are not the best of times; the population has been trained for generations to expect subsidies and freebies as their due, without regard to who pays or how they will be paid. I'll give you an example. When I was on the Phil Donahue Show, the day before the national elections in 1980, I was making the same philosophical points I am now. I explained how they, the taxpayers, would pay for all the goodies - like Social Security and unemployment compensation - that they wanted. A middle-aged guy in the audience asked: "Well, why can't the government pay for these things?" And the rest of the audience roared approval. It was then that I first realized that resistance was futile and the situation was basically hopeless. And that someone who can seem perfectly sensible when he's discussing sports, or the weather, or the state of the roads, was likely to be a moron when it came to economics. And that when he became part of a crowd, it was even worse: he might transform into an imbecile or even an idiot. Anyway, the dollar has existed for many years, even though it's degraded over time - first with the creation of the Federal Reserve in 1913, then with the repudiation of domestic gold redeemability in 1933, then with the repudiation of international redeemability in 1971. Even though the government has created trillions of new ones, the dollar is still thought of as some kind of a cosmic standard. In point of fact, it's no better than the Argentine peso and will have the same fate. These IOUs have a quite ephemeral reality and are far too easy to create - there's literally no limit at this point. We don't even have to actually print them anymore, they're created by computer strokes - so it's unrealistic to expect fiscal restraint on the part of any government over time. It's just too tempting to spend money to make people feel richer than they really are, buying votes. Louis: Looking at the deficits and national debt, it certainly seems so. Doug: The national debt - when was the last time you heard any average person worry about the national debt? Americans have become so used to carrying huge loads of debt around - right out of college with student loans - that it doesn't even occur to them that there could be any reason for concern over the national debt. It's an abstraction, like the number of light years to the Andromeda Galaxy. People used to at least pay attention, though most would say, "It's not a problem, we owe it to ourselves." But that was always a delusion. Some people, organized in a club called the government, borrowed it from some other people. But now it's even more dangerous, because the US government owes it mostly to foreigners: the Chinese, the Japanese, the Taiwanese, and so forth. Americans, who at least theoretically have some interest in keeping the US government straight, are tapped out. So they've gone to borrow from other societies. Louis: As dire as the scenario you paint may be, is it enough to cause currencies to stop functioning as means of exchange? Doug: They probably won't stop functioning as means of exchange. At least not right away. Even during Germany's infamous hyperinflation of the 1920s, or Zimbabwe's more recent one, in which there were so many zeros after the ones on the bills you couldn't even count them - people still used the governments' paper currencies. They still used them! When I was last in Zim, three years ago, we already had to pay for gas with backpacks full of notes; most inconvenient. In the case of Germany, there were still ten- and twenty-mark gold coins available, if not exactly in circulation. People forget that the mark, the franc, the lire, the dollar all used to be names for a certain amount of gold. [Like the pound, all were measures of weight. - ed.] When World War I started, Germany went off the gold standard - it used to be about five marks equaled a dollar. By 1923 there were trillions to the dollar. Only the Germans who either kept those gold coins under a mattress or had foreign bank accounts still had liquid capital by 1923; everybody else was wiped out. So people didn't spend their gold if they could avoid it. That's what Gresham's Law is all about. If there is a "legal tender" money - a paper money - floating around, you try to pay your obligations in it. You try to get rid of the hot potato. But you try to get paid in the good stuff and hold on to it. The Weimar inflation of Germany was an utter disaster for that country; it led to all kinds of nastiness. Louis: So many people think of Weimar Germany and Zimbabwe as aberrations from far lands, if they think about them at all. Interesting that Germany is at the heart of the euro now, facing Gresham's Law again. Doug: It's been true since at least the days of Rome. But I wonder if it won't be much more serious this time. All the world's major currencies are issued by governments of countries that are much more urbanized, with economies that rely mostly on services. In the US, the UK, the eurozone, and Japan - all of their currencies are in big trouble for various reasons, and there's relatively little production of what you might call the basics. Back in the 1920s, or even a few years ago in Zimbabwe, half of the people still lived on farms, and a lot of people didn't even have bank accounts, let alone credit cards and pension funds. The demise of the dollar and other paper currencies has got to be much, much more serious than these episodes in the past. To be continued... Doug Casey and Louis James for The Daily Reckoning Joel's Note: We'll have Part II of Louis and Doug's conversation in tomorrow's edition. In the meantime, you can check out the fine work Louis does with International Speculator right here. International Speculator covers the kind of small, precious metals stocks likely to explode during any wide scale sovereign debt crisis. Bill Bonner Declining US Household Debt Signals the Beginning of the End Bill Bonner Financial Times: US Household Debt Falls for First Time Since WWII Yes, dear reader, we have been a voice howling in the wilderness. First the wilderness around the Café des Dames in Paris's 19th arrondissement...recently the wilderness of Bethesda, Maryland...and lately the wilderness near the Taj Mahal Hotel in old Bombay. Reading the TIMES of India is a delight. We see that a politician has been given a colorful, over-the-table bribe...a garland made up of 50,000 thousand-rupee notes (about $1 million)... ..a headless body has been found in Kandivli...26 people were killed when their bus fell off a bridge... ..and that more than half the population defecates in public. In fact, India is Number One in outdoor Number Two, if our dear, delicate readers know what we mean. It has 10 times as many people defecating in public as the runner up, Indonesia. The US didn't even make the top ten. The poor Indians. They can't handle alcohol. Research shows that Indians suffer higher rates of heart disease if they drink. Even light drinkers face a 40% higher risk of heart trouble, according to the study. Heavy drinkers' risk of heart problems is twice that of non- drinkers...still, well worth it, in our humble opinion... "110,000 killed on India's roads and railways," says another news item. "Is that all," we asked a colleague. Every time we cross a road we narrowly escape death. And we're being careful. Other pedestrians seem to ambulate in the middle of highways...beg between lanes of busy rush- hour traffic...and make daredevil dashes across chaotic intersections. It's amazing more aren't killed. There's also an item that shows how India's civil justice system works. A landlord has finally won an eviction - thirty-three years after he went to court! The unauthorized tenant lived in the apartment for an entire generation before finally being booted out. But wait...our beat is money. So back to the big money story... Mainstream economists and mainstream financial media tell us that the worst is over...that the 'recession' has passed...and that things are getting back to normal. Nope, we reply. Not a chance. The old economy that existed since the end of WWII is dead. No way could it recover; you can't revive a corpse. It was beginning to look as though we would have to eat our words: the cadaver was sitting up in bed and watching TV. Everything was beginning to look eerily normal, after all. A year after the stock market hit bottom, it still has not resumed its downward slope. Businesses that should have gone bust are still in business. Politicians who should have been run out of town on a rail are still putting their earmarks on everything. Bankers who should now be parking cars are still making loans. The government is still misleading... Economists are still mis- interpreting... Investors are still mis-understanding... ..it sure seems like things are back to normal! But something important has changed. And here comes the proof from the good ol' FT. The FT, by the way, has the same dim economists as everyone else. While we wouldn't trust a government employee to manage a coffee shop, the FT's leading economist, Martin Wolf, thinks they can manage the whole world's economy. It's just a matter of getting the balance right, he thinks. But beneath the surface of the flow of silly opinions and distracting noise, there is a powerful tide...an undertow that is sweeping everything out to sea. For the first time since 1946, household debt in the US is actually going down. This is what de-leveraging is all about. The credit expansion is over. The tide has turned. Credit flowed for 61 years. Now it ebbs. No more increases in household credit. No more increases in consumer spending, over and above wage gains. No more extra sales. No more 'growth' at the expense of private sector debt. It's over. Regards, Bill Bonner for The Daily Reckoning