The Forest Fire
by Eric Andrews | March 24, 2008Print
Once upon a time, there was a forest. As it grew, the needles and branches would fall and build up on the forest floor. As there was no one to collect the wood, eventually lightning would strike, a fire would start, and the forest would be burned clean. The forest would blossom from the new light and fertile ashes, certain trees would open their cones and shed their seeds, and the whole process would start over again.
This can be said to be the �natural state� of the economy. In a very simple economy, economic cycles depend on the reality of successful harvests, richness of an ore vein during a given year, and the health and cooperation of the people in a very simple, decentralized sense.
After a while, the people realized that they could prosper by picking up the forest debris and using it. Some would burn it at home, some made ashes for fertilizer, some sold it to iron smelters and smiths in exchange for axes and tools. Although the use was inefficient and decentralized, it was free, allowing for full creativity in gathering, using, and delivering this resource to those who needed it, while the people made full gains of their successes and suffered the full loss of their failures.
This could be said to be the raw capitalist system, with free trade, free innovation, and increasing prosperity where once there was only a wasteland of unused resources. The necessary converse of this is that there was also free failures, with no handouts and no bailouts.
As the prosperity surrounding the wood collection grew, so arose a group of people who didn't wish to collect, to make, and to transform society, but instead worked to steal the prosperity created by others for themselves. They tried many ways, but at last through a fork of violence and reasonable argument, were able to bargain themselves into a secure place of taxing the wood collectors in exchange for the providing of modest services such as the upkeep of collective roads and communication, as well as mutual protection.
This could be said to be the �mature� capitalist system with a sizable government overseeing it, such as has been prevalent from 1750 through 1900.
This worked fine for a while, but there was one problem: however much the overseers wanted to receive in taxation, they could never collect more than grew in the forest in the first place. From where else could the energy or resources arise except from the earth and its people? If they taxed the people more, the overall production suffered which was worse than if they taxed too little. Palaces could not be built, wars could not be fought, because doing either simply diverted a fixed supply of wood and of work. What to do?
Although healthy land could only produce a certain portion of energy per year, the Overseers discovered that they could intensively over-produce on certain lands. This over-production didn't come for free, but devoured the fertile health that had collected in the soil for hundreds of years. By this means, they could now consume 100 years of production in a mere 10 years.
This is similar to the fiat money system. Although wealth appears to be increasing, in reality it is merely what economists call an �inter-temporal transfer�, that is, to steal tomorrow's health and prosperity from your children to consume it for yourself today. In the meantime however, any party or nation who does so will for a little while, have enough extra wealth to dominate the surrounding groups and nations. Therefore, if one nation ever begins to steal their wealth forward through time, all other nations must also do so or perish. This is roughly the Age of Imperialism. And so it is that we now have a fiat system worldwide, all of whom print money that devours the real productive capacity of the nations by slowly cannibalizing the root of that production: health of the soil, of the people and society, of their machines and factories, limb-by-limb. And like the over-producing land, this can only last a limited number of years until all the health is devoured and the land is deadened, with nothing left to extract. This is by definition, as the alternative would be a strictly �sustainable� economy, to which no nation ascribes.
With the new production coming from the over-producing lands, the Overseers no longer needed the real production of the forests to survive, and they grew both greedy and careless. They began to tax the people ever-harder on the free wood they used to collect, while at the same time creating new regulations as to who was allowed to enter the forest, and when, and what they could do. At first, this was just a way to collect additional fees, but soon it became a way to dispense favors to friends who could prosper at the expense of the wood-cutters who had been there all along. Also, with the fields being so productive, and the forests now a tiny percentage of overall income, and with up to 50% of the economy composed of regulators and regulations, they no longer had feedback as to which taxes were working and which weren't, and no incentive to find out. Eventually, everything was illegal for everybody except the few connected to the Overseers. The wood began to build up again but no one cared.
The wood collectors can be likened to the economic arbitrage that makes capitalism work. Under free capitalism, someone sees a resource, and through work and innovation, they figure out a means to transform it into something more valuable: wood into fertilizer, into cooking fires, into smelting charcoal, into turpentine and oil paints, into tannin and leather, pinoli nuts, and portabella mushrooms. The ways to capitalize, to transform, and to share resources are so various and most so marginal, that regulators cannot understand them all, much less intervene in each industry intelligently. Nevertheless, the greed and impulse to control others is so great that the Overseers cannot stop the class of regulators they've empowered. Nor can the regulators effectively understand and control the people's every action. Instead, most things are simply outlawed and all the wealth of fallen wood builds up with no one allowed to use and transform it, and all that economic potential energy goes to waste. And yet because they now live on the fields of fiat money which borrow forward, they don't realize the risk or the loss. This is roughly equivalent to a standing bureaucracy or Central Planning, as you like--they are too similar in action to tell apart. Neither can exist without a large government and vested interests.
Eventually, there is enough unused wood fallen to the floor of the forest that a forest fire starts. It doesn't matter how long it takes, nor what started it: if the wood is allowed to collect instead of being arbitraged cleanly and the economic potential energy used, then regardless of caution, or regulation, or watchmen, eventually a fire MUST start.
This could be the meltdown of portfolio insurance in 1987, or the Savings and Loan Crisis in 1991, or Long Term Capital Management in 1997, the Tech Bubble of 2001, or it could be today with the Mortgage Bond and Derivative implosion. In any case, if the tinder--the clean arbitration of price-differentials--is not consumed, then a fire is guaranteed to start.
But, say the Overseers, this is MY forest. Neither can the people go into it without paying me, nor can all that good wood, all that value, be allowed to burn up, to be wasted. They've marked it at great value on their books, whether it is used in the real economy or not. If the value of this economic potential energy were not on their books, they would not be rich. So they stop the fires wherever they begin.
Like any fire, there are a few principles used to contain them. Don't allow anyone into the forest, as with locking up the banking, auditing, and financial industries with monopolistic regulations that prevent natural diversification and innovation. Don't let the anyone find a place he can work and to make a buck, if that profit doesn't properly flow to the Overseers and their designates. Meanwhile, they keep the little guy out by arguing that he might drop a match, never noting that most others carry matches too.
You can isolate the fires, which is done with regulations like Glass-Steagal, keeping banks separate from brokers, separate from insurers, separate from raters and auditors. This worked well in the S&L crisis, where only banks--and only banks of a certain type�caught fire. The Dow, the bond markets, the insurers, the brokers, the currency, could feel the heat but were unaffected.
Likewise, if a part of the forest catches fire, you can cut off that portion and intentionally burn a firebreak as was done with LTCM in 1997. After the lightning strike of Russian Debt default, this hedge fund threatened to set fire to other banks, funds, and the markets through cross-party defaults. With the Fed acting as fireman, the banks decided to sacrifice valuable property by setting a firebreak around LTCM. They lost the properties outside that perimeter�billions of dollars worth, shared by several banks�yet the banks themselves and the larger system were saved.
However, the fact remains: if through the interventions and dispensations of monopoly, taxation, and regulation the natural tinder is prevented from being whittled away, and if natural fires such as bank runs, corporate failures, commodity prices, and currency levels are not allowed to burn occasionally and remove the economic potential energy, then that energy, the natural tinder, can only get higher and higher until most areas are man-high with it.
And that brings us to today.
There is so much tinder that a fire is inevitable, and should one start, then all this �value� held in the tinder-like paper assets will go up in smoke. This is Deflation, a contagious conflagration that unstoppably destroys money and �value� until nothing is left but a rudimentary economy again weighted toward the little people and their ideas and needs.
On the other hand, it is argued that the Overseers have the entire wealth of nations at their disposal. They have fire lines of regulation, fleets of helicopters and B-52 bombers at the ready, and that the water of �liquidity� is unlimited. With their coercive power they can even enlist the entire population into firefighting, perhaps even the cooperation of the entire world. With hundreds of aircraft and millions of shovels, with everyone wanting to fight the fires, what could stop them? This the argument for Inflation, that water will be showered down from the sky, and which list the myriad of ways that fires can be controlled and prevented, where the �values� of the tinder-like money will not burn up, but after some losses, continue to build up as before.
Those who argue for Deflation focus on the size and scope of the tinder and the inevitability of disaster in any process that is allowed to grow in only one direction. Those who argue for Inflation focus on the B-52s, the leadership and manpower, the endless water, and the wide body of knowledge which has conquered all fires for 70 years. The question of inflation and deflation is simple: is money being destroyed by the market faster than it's being created by the banks? One side only focuses on the near-hyperinflationary 16% M3 rate, while the other focuses only on falling M1 and the $5 Trillion burned up in the worldwide stock decline in the last two months, plus the $2 Trillion in housing capital decline in the US alone. There is also the argument about whether the Fed and other central banks are really fighting with all their might, and whether they are large enough to matter. Money is being created and destroyed. The bankruptcy/repricing fire is burning things up while liquidity is negating the blaze. But how do the the two balance out? Who's winning?
As we know, fighting wildfires is anything but a sure thing even with all the nation's men and machines at your disposal. Even if the Fed and other banks do everything in their power--and indeed as last Sunday, enlarge their power. Even with all the knowledge and an endless sea of liquidity. That liquidity must be delivered somehow, the fire must still be fought. Fires can cross lines, as we see with the subprime contagion we were promised was �contained�. Then prime mortgages flared. Then the bond insurers caught fire and are still burning. Without the 70-year firebreak of Glass-Steagal, banks and the stock market are now intertwined, with Countrywide and Countrywide bank going up in flames, followed by broker and Fed-designated bond dealer, Bear Sterns. AIG, an insurer, has issued warnings. Swiss bank UBS is affected, along with many German and several French banks, not to mention the effective death of England's Northern Rock. The housing market is going up in smoke, especially in the Anglosphere of UK, NZ, Australia, Ireland, and the US. Last, the real economy is burning, Bristol-Myers took a spark from the derivatives fire and lost over $550M in one quarter, while sales and earnings of GM, Ford, Wal-Mart, and other retailers are toppling from fires of their own.
In short, this is a wildfire that, while not yet having consumed much of any one area, is burning uncontrollably within nearly every economic, financial, and regional zone. If you are fighting fires, that is the worst possible scenario. You need to be everywhere at once and it can quickly overwhelm the best machines, the best resources, and the best crews, regardless of ability or strategy. Wildfires are very, very large. Even companies of trucks with firehoses that can roll a Brinks truck are not enough to stop one. Sikorsky Chinooks and C-130s are dwarfed by the size of a mountain of fire. An entire state's or national militia cannot reliably stop one. Fires can spread faster than men can know about them and the tinder is everywhere. On top of the wide-open firehoses of M3 at 16% and rising, firefighters at the Fed arranged another new credit drop for the end of this month. ...But a month, a week...even a day is far too long to respond to a fire, as we saw with the collapse of Bear Sterns on Friday, and its total consumption by Sunday. --Not even the equity of their Manhattan headquarters remains. All the liquidity in the world doesn't matter if its somewhere else, or arrives a moment too late.
No one knows which side will win this firefight and we're at the point where, as in every fire, many areas will be burned clean while others will be spared; so rather than pick a side I'd simply like to bring up a few points:
- One, the �tinder� involved here is a resource. The economic potential energy of these price differentials could have been profitably used a little at a time all along if only it were allowed. This can still be done even now by slowly reversing special access and privilege, and re-opening the free market.
- Two, it was not the free market, but the interference and prevention by government fiat and diktat that prevented the Free Market from working: for greed and power, the little people were prevented from picking up raw material in the forest and making something useful and profitable out of it, succeeding and failing as they could.
- Three, the forest fire is inevitable if the market is outlawed--if tinder is uselessly piled up while fires are prevented. It doesn't matter if what started it is subprime, oil prices in Houston, or the Thai Bhat, it will and must eventually happen if the market is prevented from working freely.
- Four, due to the nature of forest fires, it can only become a universal conflagration if the natural little fires have been prevented all along. Tinder builds up in Idaho at a different rate than Wisconsin, different than Spain and Australia. Only if costly government intervention has prevented all fires for generations can a world-wide crisis occur.
- Five, governments, overseers, and interveners would not have had the wherewithal to let the tinder build up, much less prevent all previous fires unless they were over-extracting resources and eating their own future via the fiat money system. As they would have been smaller and had to pay better attention to real production all along, they simply would not have the size and energy to do so. Thus fiat money and unlimited credit is pivotal if not necessary to create the leverage and tinder for a Depression-size disaster.
- Six, lastly, what has been gained overall? The people have not been allowed to be left alone and to work and to create freely. Their actions, lives, and free expression has been oppressed. The forest of the economy has been ill-managed and is in terrible condition�half tragically overused, half badly underused, and this is well-shown by the high unemployment rate vs the crippling taxation and long hours of the remaining workers. In addition, the cannibalization of resources and health by the fiat money system has created a desert of productive assets. There is no manufacturing remaining, nor R&D, mining, agriculture, not even construction, with finance and services now also collapsing.
This has not served the people, but neither has it served the Overseers: their kingdoms of wealth are now going up in smoke with nothing to replace them except hard work on a now-barren ground. Neither can they pass their legacy of wealth to their children as they wished. Surely a system that troubles everyone and benefits no one must be reformed.
So, without arguing which side will prevail in the present forest fire, we can clearly say that if you don't want a world-wide conflagration with no place to hide, then leave the people alone and tax and regulate them as little as possible, with as small a government as possible. Luckily for Americans, this is already our highest law as given by the Constitution. It simply needs to be followed. Leaving the people alone as already ordered by law will create sustainable wealth in-line with real physical and energy resources, while at the same time getting the most possible production and innovation, leaving no �arbitrage� or unused wealth lying around the economy to catch fire. Therefore by the work of the people there will actually be fewer disasters and forest fires than in a �interventionist� state, or even the �natural� economic state. Everything may not seem to move faster, or get wealthier, but it will. It will simply do so at the steadier pace of the 1800-1900 boom of the gold standard than at the unhappy boom-bust cycles of 1900-2008, which saw no less than three, and probably more than twenty critical crashes. To choose the former is to choose the boring and reliable plan of �get-rich-slowly� rather than a �get-rich-quick� scheme of booms, busts, and tragedies.
For those of you left, I can only say that the great forest fire of 2008 is not a rumor. It is everywhere and no one can tell where it might spread to. That being the case, be sure to fire-harden your household, cut back the brush around your homestead, and keep lots of liquidity on hand, for it can and probably will visit you next.
This is not wasted a effort, either, for as long as the Overseers prevent the people from naturally doing what is wise and free, you can count on one fire after another. --Ask Japan, they've been on fire for 18 years and still won't allow the people the freedom�through a non-intervening state--to put it out.
Copyright © 2008 Eric Andrews
Eric Andrews | Buffalo, NY USA | Email