It seems pretty well accepted by the markets that Greece is going to default on its debt. Yes, I know it is called “restructuring” – but the new structure is one where Greece pays less. Probably a lot less. That’s a default. The problem is that it isn’t just Greece, or even the PIIGS as a group. They are just the “subprime” sovereigns – countries that can’t pay their debts and don’t have access to a printing press to inflate the debt away. The real problem is that the moderate socialist model of government practiced in most Western countries is failing. The more extreme socialist model of government – communism – has already failed in the Soviet Union and China, while its lingering zombie states such as North Korea and Cuba provide ongoing object lessons of futility. Karl Marx, arguably the spiritual originator of these ideas, had a lot of things right. But unfortunately he was an idealist and failed to take into account the willingness to plunder the “commons.”

Let’s be clear. We’re all going to “restructure.” But it is the societies that will restructure, not just the debt. For example, just look at the US where large constituencies have staked out claims – Social Security, Medicare, government employee pensions and so forth – to a “commons” made up of money that doesn’t exist and will not exist. The sums are so large that I don’t think anyone seriously believes that they can be found. These competing claims will need to be sorted out into something that is do-able and many people will need to re-organize their lives to adjust to the reality that those payments will not be coming.

Those money claims can be related to claims on future goods and services. In order to meet them, either the supply of those goods and services will have to be substantially (and amazingly) increased, or the claims discounted to fit the available supply. The supply of goods and services can be increased by increasing employment – putting more people to work – and by increasing the productivity of those working by means of capital investment, education and training, technology and so forth. Current government policy is directly antithetical to these goals, focusing on maximizing consumption while minimizing investment.

Yes, I know things seem more or less fine as the can keeps getting kicked down the road. But as John Hussman and others have pointed out, current policy has led to a precarious and unstable position where any kind of exogenous shock has the potential to cause a catastrophic change (in the mathematical sense of the word). In implicit agreement, Bill Gross, manager of the largest bond fund in the world, has decided to stand aside from the instability by entirely divesting his portfolio of US Treasuries. Hopefully I can be a little more agile as I’m not dealing in size like Bill, who necessarily must move early and slowly because even the Treasury market is not big enough to sustain sudden moves on his part.

The next big trade, in my opinion, will be to sell stocks and commodities and buy bonds and the U.S. dollar. I’m waiting.

We know how this ends, don’t we?

This nonsense is the direct result of the Fed’s monkeying around in financial markets. Asset price increases – including, but not limited to, commodity prices – are slowly strangling the economy. Even mainstream (neoclassical, Keynesian) economists, normally completely oblivious to actual economic conditions when they differ from their forecasts, are now beginning to acknowledge the reality:

“What has it done? It has eased credit conditions, it has pumped up the stock market, it has suppressed the dollar,” said Mickey Levy, Bank of America’s chief economist. “But does the Fed think that buying Treasuries and bloating its balance sheet is really going to create permanent job increases?”

Well, in a word, yes. Because it can’t possibly be fixing the markets for the direct benefit of the wealthy asset holders who are the only beneficiaries of such a strategy? Can it? Surely no public employee would so abuse the public trust, would he?

When this bubble pops the downside will be truly brutal. Look out below as the herd runs for the exits.

Thanks to naked capitalism for passing along this key extract from S&P’s commentary supporting its warning about the US’ debt rating:

Additional fiscal risks we see for the U.S. include the potential for further extraordinary official assistance to large players in the U.S. financial or other sectors, along with outlays related to various federal credit programs. We estimate that it could cost the U.S. government as much as 3.5% of GDP to appropriately capitalize and relaunch Fannie Mae and Freddie Mac, two financial institutions now under federal control, in addition to the 1% of GDP already invested (see “U.S. Government Cost To Resolve And Relaunch Fannie Mae And Freddie Mac Could Approach $700 Billion,” Nov. 4, 2010, RatingsDirect). The potential for losses on federal direct and guaranteed loans (such as student loans) is another material fiscal risk, in our view. Most importantly, we believe the risks from the U.S. financial sector are higher than we considered them to be before 2008, as our downward revisions of our Banking Industry Country Risk Assessment (BICRA) on the U.S. to Group 3 from Group 2 in December 2009 and to Group 2 from Group 1 in December 2008 reflect (see “Banking Industry Country Risk Assessments,” March 8, 2011, and ” Banking Industry Country Risk Assessment: United States of America,” Feb. 1, 2010, both on RatingsDirect). In line with these views, we now estimate the maximum aggregate, up-front fiscal cost to the U.S. government of resolving potential financial sector asset impairment in a stress scenario at 34% of GDP compared with our estimate of 26% in 2007.

This seems reasonable. In other words, “Extend and pretend” is concealing a continuing deterioration in the true state (as opposed to the government-sanctioned deception of the reported state) of the financial system. We are now just waiting for the trigger of the next crisis. This one will not be so easily papered over.

Yesterday, S&P took the first step towards downgrading the US’s debt rating, for the stated reason that there was no agreement on a strategy for controlling or even reducing the fiscal deficit. This is probably a contrarian buy signal on US debt, given S&P’s track record, but of course they do have a point.

The US is funding roughly half of its federal government spending by debt, almost entirely monetized by the Federal Reserve. The side effects of this monetization are seen daily in asset prices, which are now flowing through to consumer prices. The big question is, how long can this continue?

Austrian economist Ludwig Von Mises warns:

“‘This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services. These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.’

“But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against ‘real’ goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.

“It was this that happened with the Continental currency in America in 1781, with the French mandats territoriaux in 1796, and with the German mark in 1923. It will happen again whenever the same conditions appear. If a thing has to be used as a medium of exchange, public opinion must not believe that the quantity of this thing will increase beyond all bounds. Inflation is a policy that cannot last.”

The last election was a resounding vote to stop the policy of inflation, at least it seems that way to me. Of course, as Von Mises also pointed out, if the government chooses to stop the deficit spending which causes the inflation, the economy will shrink rapidly, as we are seeing in various European countries which have either decided to stop, or been forced to in order to obtain bailout loans. At this point, there are no good choices. The administration and the Fed have backed themselves into a corner from which there is no good exit. They merely have to choose between two bad paths to the collapse of the economy. Will they choose to stop, and if so, when? Of course, not making a choice means taking the path of currency destruction.

Government is disintegrating because it is, from an economic point of view, a “tragedy of the commons.”

When the democratic State has the ability to take as much money as it likes from whomever it chooses, it will necessarily and eventually turn the entirety of society against itself. It will foster, through the public trough, a mad rush for each political interest group to acquire as many resources as they can, as quickly as they can, before those resources are expropriated by other interest groups. Of course, the largest and most powerful interest groups will always get the biggest slice of the pie.

The tragedy of the commons explicitly shows us that modern democratic States are ALWAYS unsustainable if they are allowed to use violence against the population in order to make the money supply of the population common property.

Remember, democracy never lasts long. It soon wastes, exhausts, and murders itself. There never was a democracy yet that did not commit suicide. –John Adams (1814)

To illustrate the point, one merely needs to consider the current statistics (well, more or less current, the reality is actually worse):

Statistics vary slightly but it can be argued that the top five percent of US households pay 60% of federal income tax. Ten percent account for over 75%. Another two-fifths make up the rest. And half are exempt. And yet…twenty percent of US households get 75% of their income from the federal government. Another one-fifth receives 40% of their financial support from Uncle Sam.

And that’s just the legitimized transfers and doesn’t take into account the stealing from the public trough. It continues to amaze me how people can attribute some kind of collective wisdom to government and maintain the image of the neutral public servant, when the individual behavior of government employees is no better and arguably worse than that of the rest of the citizenry.

But anyway, the commons is over-grazed. There is no money, other than the Fed’s daily printing. Almost half of federal government spending is freshly printed money as tax revenues fall far short of expenditures. No-one seems to point out that printing money to fund government is the last death rattle of the fiscal system. Take a look at the future as the conversion of government from a service organization to a vote-buying redistribution mechanism causes its collapse.

A sign taped to the entrance of police headquarters says it all: “Closed weekends and holidays.” Every weekday, the doors are locked at dusk.

It’s not that the cops here are scared; it’s just that they’re outmanned, outgunned and flat broke.

Flint is the birthplace of General Motors and the home of the U.A.W.’s first big strike. In case you didn’t know this, the words “Vehicle City” are spelled out on the archway spanning the Flint River.

But the name is a lie. Flint isn’t Vehicle City anymore. The Buick City complex is gone. The spark-plug plant is gone. Fisher Body is gone.

What Flint is now is one of America’s murder capitals. Last year in Flint, population 102,000, there were 66 documented murders. The murder rate here is worse than those in Newark and St. Louis and New Orleans. It’s even worse than Baghdad’s.