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WARNING: Deflationary Collapse Dead Ahead

Karl Denninger
Market Ticker
Sep 17, 2009

You have heard me talk about this before...

I have written Tickers for more than two years.

I have sent multiple petitions to our Congress, and you have signed them.

I raised an unbelievable amount of Hell when TARP was under debate, arguing that we must allow those banks that are underwater to collapse and we must force the bad debt from the system.

The fact of the matter is that you have been lied to for the last decade about our economic state, and if we do not divert from the road we are on our economy, our monetary system and our government WILL COLLAPSE.

Not "might collapse."

Not "might get bad."


It is a mathematical certainty, and here is the proof.

First, I present the graph of our economy - GDP and Debt, from the 1950s onward. This chart you've seen before (click any of these for a larger copy)

Now I want to present two charts - the first being a simple mathematical chart of two functions - a GDP that grows at 5% annually and debt that grows at the actual compound rate it has grown since 1953, 8.7946%.

I started both debt and GDP at the same value, $10,000, for the purpose of this series (even though in fact debt was higher than GDP.)

You'll notice that due to the fact the debt isn't a constant (and neither is GDP) these are not exact matches - but they're pretty close!

Now let's go forward 20 years, maintaining the same assumptions. That is, if you and your wife or husband, boyfriend/girlfriend sleep together tonight and conceive a child, this is what our economy will look like in terms of debt and GDP at the approximate time they go to college:

You think so eh? Debt outstanding will be six times greater in 20 years. GDP will be three times greater, but having started from a much lower level, will of course continue to lag.

Do you really believe that those interest payments can be made?

Look at that chart.

Now look up above at the top chart.

That is reality right here, right now, today.

Tell me it doesn't turn into the bottom chart.

I didn't make these numbers up folks. That compound annual debt growth rate is real.

More importantly, Geithner, Paulson, Bernanke, Bush, Obama: all have emphasized that "we must get more credit to consumers and businesses" as their primary mantra ever since this crisis began.

They are pressing this position because if we do not expand credit further the existing banks and other institutions that have bad debt on their books will collapse - and they know it.

The correct action to take in 2000 was to force the bad credit from the system and accept the impact on GDP. It would have caused about a 10% contraction in GDP at that time - a mild Depression (or a really nasty recession, depending on how you count it.)

Now, having instead blown another credit bubble, we essentially doubled the debt in the system over the last ten years, while GDP grew by about 40%.

The result of this was a horrible stock market crash, 6.7 million jobs lost (and underreported), personal income tax receipts are down 21%, corporate tax receipts are down 58%, the deficit is tracking at $1.8 trillion this year alone (and $9 trillion more predicted over the next decade), government is now spending nearly 200% of taxes taken in, 13% of mortgages are either delinquent or in foreclosure, more than 20% of all FHA loans are delinquent or in foreclosure, home prices have fallen by half in many places and are not done declining and the rest of the world is wondering if we're going to try to hyperinflate and destroy our currency.

If we try to double our debt once again over the next ten years we won't make it there. The available free cash flow cannot support the interest payments now, and won't be able to if we add more debt to the system.

I understand the political difficulty of closing all the major banks in the United States, selling off their assets and making good on their deposits when required. I recognize the damage this will do to pension funds and bond investors. I am fully cognizant of the fact that this means taking an intentional depression here and now.

But if we don't it will in fact be worse later.

Not "might" be worse.

WILL be worse.

The odds are high that if we attempt to add more debt to the system, instead of clearing debt through defaults and bankruptcies, that we will precipitate not only a Depression but a full-on monetary collapse.

Such an outcome would destroy our economy, result in almost everyone who is currently middle class and has any debt whatsoever being rendered penniless, unemployment could easily reach 30% or more and the government would be unable to fund any of its social programs, including Social Security and Medicare.

Now think that through - 100 million homeless, penniless, angry Americans searching for the people responsible for what amounts to a "sudden stop" in the economy along with the cessation of all social assistance payments. What sort of odds would you like on civil disorder (at best) or a revolution (at worst)?

I ask Congress: Is either of those possible outcomes an acceptable risk? If not, then we cannot stay on the path you are following today.

We must take the right path.

Policymakers must have demanded of them an explanation for how they intend to get away from the simple laws of exponential growth when debt is 375% of GDP, has expanded faster than GDP and must continue to do so to avoid the deflationary outcome. They will not be able to do so, as the mathematics render such an explanation impossible to provide.

In order to prevent the immediate creation of asset bubbles the interest rate charged must always be greater than the risk-free rate of return in the economy - that is, the growth rate. Always. Yet this guarantees, as a direct consequence of the laws of exponential growth, a fundamental mathematical concept, that debt defaults and thus "clearance" of the system, along with the contraction of GDP and the economy and failure of both lenders and borrowers, must occur on occasion in order to clear the system. The longer you try to avoid these normal business cycles in any debt-based monetary system the worse the crashes are, and if you try to avoid them for too long you get a collapse instead.

This is basic, fundamental, sixth-grade math and that the leaders in this country refuse to accept it is an outrage against the people and an intentional act of deception that we must not allow to stand.

We are one cycle away from a collapse - if we're lucky.

We must change our economic course now and accept the contraction that MUST COME in order to save our economic and monetary system.

Sep 15, 2009
Karl Denninger


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