Grow Up To 1,000% Richer In The Great Stock Panic Of 2002

Chapter 17

The Debt Hearings

The greatest unresolved mystery still facing historians to this day is how, in the post-Einsteinian era, the majority of Americans could have believed in the "absolute truths" of their day: That a banking disaster was absolutely impossible. That another Depression was absolutely out of the question. That the Dow Jones Industrials' collapse was absolutely unthinkable. That the technological revolution absolutely guaranteed economic prosperity. That the groundswell of support for the war on terrorism could be an absolute solution to domestic ailments.

By this time, however, these "absolute truths" were absolutely shattered. There arose a great demand for new truths, new words of wisdom that might somehow replace the old.

Americans still asked the same questions that were common throughout the panic: Could the government turn back the tech wreck? The derivatives blow-up? The interest rate spike? The consumer panic? The near-collapse of the banking system? What new tricks could be pulled from the hat?

Some Americans, however, finally began to recognize that even if there was some cure-all still available, the side effects would be more damaging than the disease. They also took another important step. For the first time, it was accepted that big debts — not terrorists — were the root cause of the Great Stock Panic and the ultimate question was finally asked: "How will we ever get rid of the excess debt?"

The Federal Reserve Board, the President's Council of Economic Advisors, the Department of Commerce — all had special research teams seeking an answer. The primary focus of the debate, however, was the US Senate, where a nationally televised Congressional investigation hammered at the problem day after day. Dubbed the "Debt Hearings," these meetings became a constant focus of the media throughout the worst months of the panic.

Spectators crowded the visitors' galleries of Congress to witness the spectacle. TV cameras were everywhere. Transcripts, sound files, and video clips were among the most popular downloads on the Internet. Solemn faces abounded.

On the first day, the Chairman of the Senate Finance Committee made an issue over savings. He complained that the savings rate of Americans had plunged to zero. So he embarked on a campaign of his own to find out how to get Americans to save more. "All we have to do is boost the savings rates somehow," he said, "and we'll be over the hump." He called expert witnesses and asked them one by one: "What would happen if America had a savings rate like Japan's?"

The first witness, the former Metrobank Chairman, replied: "Unfortunately, Senator, the question implies a great deal of wishful thinking. Rather than improve, the US savings rate has plunged. Furthermore, even if we suddenly shifted to a 10% or 15% savings rate — without the technological and cultural changes — the near-term results would be disastrous. When someone saves a lot more, he spends less; and when you have less spending, the entire economy suffers. The kind of change you want may help in the long run, but it won't stop the immediate crisis."

"What would happen if the Treasury issued gold-backed bonds?" asked a maverick Republican Senator from the Midwest.

"Excuse my bluntness," responded the next witness, John Hartman, "but here we go again — avoiding the real, hard solutions, looking for magic-wand approaches. Gold-linked bonds would only help as long as gold itself remains attractive in these times of fear from international threats. But as soon as gold weakens, it will be like two drunks trying to support each other — a struggling bond market and an erratic gold market."

"Is there no way of satisfying bond investors without an economic calamity?" the Senator from Illinois interjected.

"For argument's sake," Hartman continued, "let's say you find a good gimmick that sells new government bonds — variable rates, zero coupons, partial tax exemptions or whatever. What happens? To the degree that the new gimmick does attract buyers for new issues, it automatically damages the market for the old government issues. And it just so happens that there are trillions of those out there."

A new witness came forward. The Senator from Illinois leaned back and said, "Throughout these hearings, we have heard why this or that solution won't work. Are you here to suggest how we can get out of this mess? Or are you here, just like the others, to knock down our ideas?"

"Sir, there is no short-term solution. We are already in a money panic, and there is nothing you can do to turn back the clock. You must let nature take its course, intervening only to avoid disorderly markets and to keep the heartbeat of the economy—the financial centers—alive."

"What is the long-term solution?" the Illinois Senator insisted, raising his voice to a higher octave. "Here it is, Senator. First, we need a period of reduced living standards and increased savings rates. Hard work and sacrifice — not only to support our country's efforts to stamp out terrorists, but also to support our economy for the long term. Second, we must reorient our production priorities by retooling and recapitalizing. Third, we have to remove the social obstacles blocking further technological change. We have poor math and science education. We have virtually no preschool teaching by parents. The list of areas for improvement is endless."

The Debt Deficit

The last witness was the Secretary of the Sound Dollar Committee. He leaned forward, spoke softly but deliberately straight into the microphone. "To reduce the worldwide debt problem, you will need noninflationary growth over a long period of time — real wealth creation rather than just artificial money and credit. We would have to have both good times and tough sacrifices. Americans would have to change their habits — work harder, spend less, and save more.

"Instead, every time we get some kind of growth in the economy, we do the opposite. We live it up still more. We pile new debts onto our old debts. And we set ourselves up for an even bigger fall soon thereafter!"

"If that's the case," asked the Senator from Illinois, "then how will the debts be liquidated?"

The witness paused, hesitating to say what he believed.

"Well? Don't you know the answer to the question?"

"Yes, sir, I certainly do. A more drastic method of liquidation will predominate."

"Such as?"

"A chain reaction of corporate bankruptcies and reorganizations. A massive shrinking in the banking system. A shutdown in key sectors."

With rumors flying around Washington and Wall Street of more major corporations and banks going under, this last statement had a ring of truth which stunned the Senate Committee into a momentary silence.

After a brief pause, a Senator asked, "You're saying that the best solution is to let the system collapse, and with our blessing? Who's responsible for putting this witness in the line-up?" he exclaimed, glancing back at Congressional staff members.

"Wait, Senator," said the Sound Dollar Committee Secretary calmly. "I believe deeply in the ultimate strength of our country. But bankruptcy for the weakest links in this country is not the end of the world. In fact, there are beneficial housecleaning effects that can later accrue."

As politicians, none of the Senators could see the advantages. All they wanted were suggestions on ways to stop the crisis dead in its tracks. Almost reading their thoughts, the witness continued, echoing the dilemma brought out months earlier at the White House meeting.

"Yes, you could bail out the borrowers. But if you do, it will pump up the money supply and the lenders will panic. Yes, you could then bail out the lenders by squeezing the money supply. But then the borrowers would scream in agony! There is simply no more room on the tightrope between these two options."

Another Senator queried:

"How much longer will this last? When do you think this crisis will be over?"

"The longer you try to fight it, the longer it will drag on. The sooner you recognize its inevitability — and work with it — the sooner we can put it behind us."

"Can't you give us a better feel for the timing?"

"No, sir, I cannot. The timing and degree of this crisis — what will happen to unemployment, GDP, or inflation — are almost impossible to predict. In their GDP model, for example, economists now estimate an average unemployment rate of 10%. But it's just a guess they plug into their formulas to try to arrive at another guess. Anyone who says he can make solid, long-term forecasts in today's environment is just fooling himself."

"Why's that?"

"Because the computer models used are based on a smooth working system that no longer exists. There is no way of plugging in catastrophic events like bank failures or terrorist attacks. Your models, by definition, must assume there will be no tech wreck, no major market disruptions, no blow-up in derivatives, no large bank failures, no unusual disasters. And yet we know that these events are occurring."

"Is there no economic theory, then, that can handle this crisis, that can give us an inkling of what happens next?"

"Well, sir, there is one, but ..."

The Senator from Illinois sat up in his chair. "Really? Tell me about it."

"It's the 'catastrophe theory.' But it's just in its infancy, with few economists or mathematicians trained in its intricacies."

"Please explain."

Only the advanced mathematical approach — catastrophe theory — accurately represents the full expanse of the long-wave cycle. By definition, current economic theories and tools cannot account for the "catastrophic" plunge of a depression from points 4 to 5. Unfortunately, however, catastrophe theory is so new, it is not readily available to solve economic problems at this time.

Source: Hyperinflation or Depression?
By Richard G. Zambell
"When you blow up a balloon, it expands. If you measure how much air is pumped in, you can predict how big the balloon will grow. This is what economists do with their models. But to predict when the balloon will burst — and explain precisely why it happens at that particular moment — is another matter entirely. Most difficult of all is the task of predicting what shape it will take after the bust. Computer models simply cannot do it!"

"Why not?"

"Our knowledge and application of mathematics hasn't advanced that far. The behavior of the continuous processes — like the expanding of the balloon or of our economy — can be understood by using calculus, invented 300 years ago.

"But no one has invented an equally effective form of mathematics for explaining and predicting discontinuous phenomena such as a stock market crash or a bank collapse. One exception might be Rene Thom and the 'catastrophe theory.'"

"Tell me more."

"I can't. Very few have ever pursued that line of research. The prevailing view of economists was that the Great Depression was an accident of history caused by the Fed's policy errors. If it couldn't happen again, why worry about economic theories for predicting it?"

"I see."

"Only now have some people begun to recognize that such depressions are recurring phenomena after all. Unfortunately, it's too late to start constructing new computer models for this crisis — let alone invent the new mathematical theories we'd need to run those models. If we start now, maybe we'll have something ready for the next panic, perhaps fifty or sixty years from now."

The Senator was flabbergasted. "So that's it? We're doomed to near-eternal darkness?"

"Sir, for whatever it's worth, I have constructed a diagram that shows why the entire theory of business cycles may have to be revamped. In the first phase (points y1 to y3 in the chart), we progress from stage to stage in a relatively smooth cycle as our capital stock, our wealth, and our gross national product increase over time.

"But at the tail end of the boom, problems begin to emerge. Yes, the overall size of the economy and the total wealth accumulated continue to increase. But capital does not. Rather than building capital for future growth, we borrow capital from future generations.

"On the surface, it may appear that we are progressing on an upward path, but in terms of the economy's underlying structure, we are actually moving backward, up a mountain from which there is no return path.

"Finally, at some point, there occurs a sudden break — a gap of enormous dimensions. We fall over an invisible cliff. GDP contracts sharply. Citizens suffer a sudden decline in their wealth and standard of living. Everything contracts in unison."

"Very interesting," responded the Senator. "But this model does little more than explain the events. It does nothing to help resolve the immediate crisis."

The Secretary of the Sound Dollar Committee nodded. "Of course not, which is why we have been so active in recent months, seeking real, practical solutions."

"What do you mean?"

"The Sound Dollar Committee was founded to lobby for balanced budgets and to help prevent the bust that we are now witnessing. Ever since the final years of the Eisenhower Administration, we have been warning against the excesses in government, in the banking industry, in the stock market, and throughout the economy. But the more we warned the worse it got. In retrospect, despite some victories, it is obvious to us that we failed."

The Senator's expression showed both fascination and frustration. "So you've given up?" he asked.

"No. We have merely changed our priorities. At this juncture, it would be foolish to concentrate on preventing something that has already taken place.

"Rather we are now seeking to achieve a different goal. We are using informal personal networks to pool together the few remaining liquid resources around the world. These funds will then be applied, at the right time, to help bring about a recovery in the financial markets. Those who join us in our efforts will benefit by buying undervalued assets near the very bottom, while helping their country at the time of its greatest need."

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