How The USA Turned Assets Into Liabilities

February 19, 2010

Stick with me on this one. Last night I was reading a 2,300 year old economics book. Its title is Oeconomicus and it is a Socratic dialogue principally about household management and agriculture written by the Greek philosopher Xenophon. It is mesmerizing in its original Classical Greek but quite telling even in translation. Socrates of course never wrote anything and it was left to his students and others around him to preserve his wisdom.

In the silence of 2.00am I felt a chill run down my spine. I was reading the words of a philosopher explaining the difference between assets and liabilities and how "assets" turn into "liabilities" when not used or managed correctly. "Assets", I was taught could be written-off, but to turn them into "liabilities"? This was something new. "Why", I thought to myself, "aren't these words to be found in the economics, business and political science text books of universities? Why aren't Chairmen of Central Banks and Finance Ministers as well as Presidents and Prime Ministers reading these words?"

I should add that the City State of Athens (another great superpower of its time) finally poisoned Socrates with hemlock because his truths were too hard to swallow and threatened the establishment. No doubt had he lived today, his fate would have been similar, as this is what they do to honest men everywhere.

Man has tried through alchemy in all its forms (from chemistry to quantitative easing) to create wealth. In other words he tries to create something of much greater value out of something with much less value. He has however always failed. We are now confronted, though the bizarre spectre of reverse alchemy, with the metamorphosis of people, talents and resources into liabilities.

Reading the timeless passages you are struck by the parallels with how the USA as a nation and economy has fallen into the traps described by Socrates and turned so many of its assets into liabilities. But let us take stock of what has been happening in the USA before examining how the abandonment of the gold standard led to this situation.

First point of call is the defence forces. No doubt the large, well equipped and proud Defence Forces of the United States are an asset given that since Pearl Harbour in 1941 there has never been an attack on the nation by a foreign army. But since that date the USA has also invaded, undermined or attacked numerous other nations or governments. The soldiers, who were once assets, now return home either in a coffin, or with psychological and physical problems requiring pensions to the living and the families of the dead, special medical treatment, whole bureaucracies and unending legislation. Don't generals understand that the most successful armies are those that do not have to fire a single bullet to achieve victory? Yes; the assets have now become liabilities. What do you expect when almost 19% of government expenditure is directed at defence?

The presence of the United States by way of embassies and consulates in various nations across the globe is an asset for diplomacy and trade, a reminder of the USA's reach as well as a safe haven for US citizens abroad. But war makes these embassies targets requiring more security personnel, thicker walls, bomb proof glass and huge perimeter walls. Yes, the asset is now becoming a multiple liability as nations who would never attack the USA end up becoming hostile. As an example, it has been reported that the running costs of the Iraq Embassy will exceed $1.8 billion in each of 2010 and 2011. At the inauguration ceremony of the $700 million edifice the US officials said that the state-of-the-art-complex would usher in a new era of relations with Iraq. Go figure that one out.

Once upon a time the people of the USA also enjoyed great freedom and privacy and the word "AMERICA" was uttered by foreign lips as if it was some distant paradise they hoped to some day visit. But 911 has proven to be an even greater disaster in its aftermath than its occurrence, as the people of the USA now find themselves under greater surveillance than the Russian people experienced under Communism. The budget for running Homeland Security ($42.7 billion) now threatens to overtake the Federal Budget allocated to the Department of Education ($46.7 billion). The "asset" of the initial international support and sympathy for the USA has subsequently turned into a liability both in terms of running Homeland Security as well as dealing with accusations arising from the so-called weapons of mass destruction excuse. This curtailment of freedom is also manifesting itself internally in connection with commerce.

At home, the consumer aided by cheaper interest rates and increasing home values, borrows to buy a bigger house, a second car and a third TV. These are all assets until we realise that the teaser rate is at an end, that cable TV carries a subscription and cars lose value at a rate exceeding the loan repayment. The assets are fast becoming liabilities which still need repairing, replacement and insurance. Rather than bore you with too many zeroes, you yourself can draw up a personal balance sheet to see the damage over the last three years to the value of your home, share portfolio and retirement account.

The parents of America, on the other hand, save and borrow to send their children to college and university. They graduate with degrees and are the family's pride and an asset to their community. But then many discover that the course they undertook in some esoteric field of human learning does not have a job opening unless the lecturer dies. They take lesser paying jobs and are stuck at home. The asset of an education is now just a liability because the Student Loan just won't go away. Worse still, the government creates another government job which produces nothing at a higher rate of pay than private enterprise.

At the other end the clever ones who studied economics and law go into jobs with six-figure salaries working for brokers, investment advisers and merchant banks and advise their mum and dad to leverage themselves. Ah yes, this lot are true assets no doubt. But then we discover that they are the ones who devised credit default swaps and mortgage backed securities. Suddenly the world finds itself in the chaos of a global financial crisis and mum and dad's nest egg on the stock market has become an empty shell. Better still there is a huge margin call on their leveraged investments. There goes that asset and here comes the liability.

But fear not, the mighty banking institutions endeavoured with altruism to house every soul with a pulse (even if it was only in one arm) and gave the borrower just the right loan to enable the purchase. The borrower was an asset, the mortgage was an asset and the house was a constantly inflating asset. But the end of the teaser rates and the start of the Global Financial Crisis hit, and house values headed for hell. Moreover, the repayments were not made and the house after being repossessed also required renovation. The aggrieved borrower would clean up by taking the air-conditioning system and often even the copper piping. Once again the assets turned into liabilities as the expression "sub-prime" became the name of the new epidemic sweeping the financial world.

The borrower more often than not had lost his or her job. As a result they went from being tax payers, consumers and cohesive family units to welfare recipients, food stamp beneficiaries and divorce cases. In short they went from being assets to liabilities.

But the munificent hand of government is there to catch all. For years it had wisely collected the social security contributions of workers and placed them in a Trust Fund so as to pay for retirement in the future. This was truly an asset. Money went in so that in the future government would not have to shell out as much money to retirees. It was a win-win situation. But lo and behold the government in its wisdom put the money to good use buying the people's votes through pork barrelling while engaging in wars wherever the industrial-military complex smelled an opportunity. The wars have paid the people back with "widows, wooden legs and debt" and the pork barrel projects have still left the nation with crumbling infrastructure. Above all, the government still has the responsibility of paying pensions but has no money with which to pay. Yes folks, another asset to liability story.

But which is the greatest asset to liability story?

Well, once upon a time the US dollar was backed by gold and foreign governments could with surety present their dollars to the US for the equivalent of 1oz for every $35. The US had become the master of the financial universe. But then it printed and printed some more and then quietly went from being a creditor to a debtor nation in 1985 where it has remained since. From earning interest it started to pay interest. The asset of having the premier currency of the world turned into a liability, because those dollars still represent claims on the US in the final analysis. More importantly they hang like the sword of Damocles over the head of the nation. China does not need to match US military expenditure; instead it can more easily invest in its adversary's Treasuries and threaten to detonate the US economy if it chooses to do so.

Dear readers, this is by far the greatest asset to liability story, because money backed by a printing press and confidence can enable a nation to do many things which in the short run seem incredible but which in the long run come close to being fatal. The analogy that comes to mind is the body-builder who makes long term use of steroids.

Printing dollars enabled the US to buy and borrow more cheaply from China. This was so clever until too late in the peace the US discovered it had sold-out its manufacturing prowess to the Chinese for a song. Once again the fishing rod was exchanged for a fish.

When you cannot print dollars and instead are forced to pay in gold for your imports, mistakes and decisions, you quickly realise that you are headed for disaster and you change course. This is where the value of a gold standard lies, - the discipline it instils in both the nation and its citizens. In fact none of the developments discussed above could be financed on an ongoing basis in the presence of a gold standard. With a printing press at home and a credit card from abroad, the period of lunatic living and governance can extend for quite some time. Suddenly we now find ourselves sitting on the edge of a geo-political volcano that could erupt at any time and with untold consequences depending on which way the lava flows.

Just remember that a wise old philosopher had already given us the rules for rational economic thought and action more than 2,300 years ago. Before we go further, I think we need to go back. The time for transforming the American nation before it totally deforms itself is fast running out.


Sydney Australia

Pure gold is non-toxic when ingested.

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