“We are dealing with waste and extravagance, incompetency and inefficiency, the only way we have in a free society is to take losses from time to time. This is a loss economy as well as the profit economy.”
-1958, William McChesney Martin
As Nietzsche might have said if he’d thought of it, little corrections leave us stronger and smarter.
Why do we need corrections? Because people make mistakes.
Are corrections beneficial? Yes, they get rid of the mistakes, the dead wood, the weak businesses, the poor investors, the misfits, the maladroit and the unfortunate mutations. What survives is better adapted to current conditions.
What happens when we avoid or repress a correction? Then, the mistakes continue.
How does this eventually resolve itself? Disastrously.
Mistakes are not like head colds. They don’t go away if you ignore them. Bad money doesn’t turn into good money because you add more to it. If you turn the wrong way when you are driving, the longer you go on the further you will be from where you want to go. Or, if you drink too much on Monday night, you won’t feel better if you drink too much on Tuesday and Wednesday too.
Repetition doesn’t make mistakes disappear, it just makes them worse. Nothing gets worse forever, so there must be a day of reckoning. Then, what must happen ‘sooner or later’ does happen. And it isn’t very pretty. And the longer the correction has been dodged and denied, the uglier it is.
But uncorrected mistakes don’t simply get ‘worse and worse’, gradually and obviously. Instead, often the damage is not apparent… until, disaster comes.
Imagine that you have had too much to drink and you are driving too fast through a busy, crowded city. That is a mistake. Your wife warns you to slow down. Annoyed, you step on the accelerator and go even faster. Keep it up and the chances of a disastrous outcome multiply. Every additional minute that you speed may have exactly the same risk component as the minute that preceded it. But the odds of an accident accumulate. Keep making the same mistake and a terrible result is almost guaranteed.
In other words, the negative feedback goes from zero to 100% in the bat of an eye.
This phenomenon is like the consequences of another mistake: jumping out of a 30th-storey window. The first few moments are probably uneventful. As Percy Sledge put it, “but it’s not the fall… that hurts him at all… it’s the sudden stop.”
The stop is when the mistake is corrected. The further you fall without correction, the faster you’re going when you hit the street.
Negative consequences are exponential. They do not rise regularly. They rise suddenly. And hugely. Viewed on a graph, you would see a flat line leading to what looks like a brick wall on the right hand side. That is the brick wall into which all uncorrected mistakes eventually run.
The average moment of your descent may be more or less agreeable. It’s the final moment, however, that ruins the adventure.
And, as the scale of the mistake increases, the eventual collision with reality becomes much more dramatic. It is one thing for a single business or single household to make a mistake. When millions of them make the same mistake, it is a very different sort of problem. Not just bigger… different.
You may look at it this way. People die all the time. In a nation of 300 million people, you can assume that more than two million a year must go to their graves. And over a period of about 100 years, almost all of them will. They can do so in an orderly fashion, with no disruption to the rest.
Suppose the death rate suddenly went up. Suppose 20 million died in a single year? Or 100 million? At two million deaths a year, the pain is local and private. Acceptable. Those who have no death in their immediate families are not especially affected.
At 100 million deaths, it’s an entirely different thing. Trains stop running; restaurants shut down; the post is no longer delivered. The whole society is whacked.
And so we turn to another example: debt. Today, the fact there are no visible bad consequences to America’s growing public debt is widely celebrated. In the words of France’s great post-war economist, Jacques Rueff, the US enjoys “deficits without tears.”
Thanks to the willingness of people all over the world to take in dollar credits and hold them dear, as if they were worth something, they are in fact worth something. And they will continue to be worth every penny as much until they are no longer.
Bonds have been going up for 32 years. The long dated T-bonds yielded 15% in 1981. Since then, US government debt has gone from $1trn to $16trn. But the price of bonds has gone up too, so much that they only yield 3% today.
So too is the stock market delighted. The S&P has gained 120% since March ’09. The self-same leap of faith on the part of the central banks is responsible for it. LTRO, ZIRP, QE I, QE II, QE III, the Twist – and now Japan’s new government, led by Shinzo Abe, has pledged to join the print fest. Together, the more Abe, Bernanke, Draghi and the others defenestrate investors, the more investors seem to like it.
The accumulation of debt is accelerating. Total US government debt is 16 times what it was a generation ago. It took 64 years for the feds to build up $1trn in debt by 1981. They added another $1trn in the following four years.
A person jumping out of a skyscraper would notice the same thing. The first few floors go by relatively slowly. Lower floors go by in a blur.
In his eight years in office, George W Bush added $800bn of debt per year. And the first term of Barack Obama saw a $1.2trn annual increase. Federal debt has been growing more than twice as fast as tax receipts for the last ten years, and four to five times as fast as the economy itself during Obama’s first term.
When you look at the debt in real terms, that is on GAAP-basis accounting terms, as any publically traded corporation would be required to do, including unfunded liabilities as well as cash in and out the door, the velocity of the debt build-up increases rapidly.
Instead of a deficit of about $1trn for 2012, you find one of $7trn. And instead of a national debt of $16trn, as widely reported, you have total debt and unfunded financial obligations of $238trn. And instead of growing four to five times as fast as GDP, debt is growing 20 times as fast.
Still, though the ground is rushing up to meet them at a faster and faster pace, neither investors nor economists are alarmed. Consumer prices are still barely rising. Stocks and bonds are high. The economy is growing. Bond buyers, aided by the Fed, which is now buying more bonds than the US government needs to sell, show no sign of panic.
But that is how a real disaster works. Uncorrected, it runs flat and fast, unstoppable, until it finally meets its immoveable object. Now, fluttering past perhaps the 8th or 9th floor, no pain is registered by bond holders or stock market investors. On the contrary, they find the whole thing a delicious hoot.
For now. But when it ends, the weight of so many bodies in freefall will crack the sidewalks.
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