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El error de Diciembre
Commentary on the News
Monday, April 19, 2010
Ed DeShields

What if everything we imagined about our future was suddenly all wrong?   Could it happen?

In December 1994, while on a business trip to Mexico City, I was awakened to the news. My Spanish is not that good but one thing was certain; the television news people were really ramped up about something and the pictures showed Federal authorities running around wielding automatic weapons.  A few blocks away I saw what looked like a hundred thousand people gathered in the Plaza de la Constitucion in full protest.  They were burning effigies of President Salinas and Uncle Sam.

Over night the Mexican government had decided to devalue the peso.  It happened like a thief in the night stealing two-thirds of the wealth from every Mexican.  Breakfast costing 100 pesos the day before, cost 300 pesos that morning.   There was no warning. 

On the way to the airport I saw protesting farmers pouring their milk from bottles into the streets.  The empty bottles were kicked around angrily. The tortilla bakers were burning their bread with kerosene.  The cab ride to the airport had tripled in price. 

The prior evening seemed perfectly normal. As I recall, we had a delightful dinner with executives representing Cervecería Cuauhtémoc discussing the art of bull fighting -- something I knew nothing about.  We dined at a swanky Mexico City restaurant that had been beautifully restored from a 19th century hacienda where I paid with my credit card.  In retrospect, I should have paid in dollars.  But, who knew?

The peso crisis became known in Spanish as el error de Diciembre — The December Mistake.  The Mexican government had a history of economic mismanagement.  But, that morning its politicians decided to inflate-away their debt problems on the backs of the people.   Here's the way Wikipedia describes that day: 

"The outgoing Mexican President had sought to stimulate the economy, temporarily and unsustainably, which led to economic instability.  There were concerns about the level and quality of credit extended by banks during the preceding low-interest rate period, as well as the standards for extending credit. The Mexican government's finances and cash availability were further hampered by two decades of increasing spending, a period of hyperinflation from 1985 to 1993, debt loads, and reduced income from low oil prices. Its ability to absorb shocks was hampered by its commitments to finance past spending." 

Sound familiar? 

Our entire economic system, and our way of life, is founded on debt.  And, debt is based on a rule that the future must always be bigger than the past because our government never actually pays back our debt -- or at least not in modern times.   Say you decide to buy a new car but the only way to afford it is to count on next year's bonus.  But you decide to buy today and use the fruits of your labor next year to pay for what you consume today.  This economic theory is a basic rule of our debt-based economy -- the future must always be bigger than the past so you can afford today.  But what if the future is NOT bigger?  

Let’s expand this thought.   

What if the entire world awoke tomorrow to find itself in the midst of el error de abril (April) stimulated by the Iceland volcanic ash plume now crippling Europe – or some other similar tipping point?  Billions of people would suddenly find themselves angry and cheated that their way of life had evaporated within a few hours.  What if it happened in a chain reaction?  First it starts in Latvia, then Greece and the heart of Europe and Zimbabwe and then in the United States and on to Japan and then China who is pregnant with its own bubble.  Are these countries tied together in one giant ponzi scheme?  You bet they are. 

Economic guru James Galbraith observed that when multiple currencies are devalued in concert with one another it is the devaluers themselves that pre-determine the new economic order ahead of time.  Now who might that be?    

The pure debt obligations of the US Government as of April 2010 stand at $12 trillion, 888 billion and some change.  This is only the debt. Once we add in the liabilities of the US government, with Medicare and Social Security, we get a number five times larger than this.  And, remember we have never paid our debt in modern times and we don’t intend to start doing so.  The pain of austerity would not be tolerated by the people.  Willingly that is. 

Can debts forever grow faster than the incomes that service them?  No, they cannot.

We have reached our mathematical limit. American debt has grown by more in the last two years than in all the time since the Pilgrims landed on our shores through 2007.  And this has profound implications for the future. When viewed historically, and compared to gross domestic product, the current levels of debt are without precedent, and the facts suggest that we are living in the mother of all credit bubbles. The current total credit market debt stands at more than 350% of total Gross Domestic Product (GDP) -- debt that is now sputtering in the Treasury markets.  We are one Treasury auction away from lost faith in our currency system.  One failure and the whole deck of cards could come crashing down.  

Last week we arrived at an inflection point.  For the first time in world history a private bond buyer, Warren Buffet, paid less for money than did the United States of America!  Stop and re-read that last sentence.    

Readers, the next ten years are going to be completely unlike the last ten. I just cannot see how we can pull off another ten just like before because the future will be not be larger than the present as the baby boomers retire.

So the questions you need to ponder for yourself are: Have too many claims been made on the future? And if so, will we face inflation or defaults as the means of settling up?  It has to be one or the other.  You will arrive at wildly different life decisions depending on whether you answer “YES” or “NO” to the first question and “inflation” or “defaults” for the second question. So they are worth pondering.

Barack Obama has little-to-no appetite to reduce spending, especially seven months before an election cycle.   But, for that matter no modern President has either.  So, he is going to kick the bottle down the road.   Or, should I say the milk bottle. 

About Ed DeShields

Last week: Spend and Pretend: Why Obama will Pay my Mortgage

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