Busting Out of Rehab

A female drug addict entered rehab. She didn’t want to do it – it was forced upon her. She could not bring herself to quit on her own. Far too many people surrounding her (her suppliers, her addict “friends”, her pimp) all had a vested interest in keeping her addicted. But she could no longer afford her growing habit, she was repeatedly in trouble with the law, and it was taking an increasingly heavy toll on her health, so external factors (a courtroom judge, her family physician and loved ones) forced her into rehab to save her life. Deep down she knew it was her only hope. She knew if she didn’t enter rehab now it would be twice as difficult to quit later. But she still had to be dragged there, kicking and screaming.

Once in rehab it was not pleasant for our addict. The withdrawal symptoms were horrific. In fact, it was so bad that our addict needed a doctor to administer a few more drugs just to keep her from entering a death spiral from which she would never recover. Even with this limited amount of new drugs, withdrawal was awful. Some experts said giving her the drugs to help her through was a mistake – the sooner she went cold turkey on everything the better. Others said she needed more drugs or she wouldn’t make it through the night. The truth was that nobody really knew for sure either way. And either way, quitting would still be a long and painful process. She had been an addict for a long time.

But the addict made it through the night. She started to feel a little bit better each day. So the doctors started to eliminate the drugs they had been giving her in rehab. They had served their function; they had saved the patient’s life. The patient would have to make it the rest of the way through recovery on her own. She wasn’t clean yet.

That night in rehab was a rough night for our recovering addict. As she lay suffering in a nightmarish half-sleep half-waking state, there was a tap on the window. It was her old pusher, her old pimp, and some of her old wasted “friends.” “Come on out,” they beckoned. “Don’t stay in here suffering. We have plenty of good stuff. You can feel great again. Ditch this rehab place and party with us.”

***

The United States, or more accurately our economy and financial system, is also an addict, only in this case the drug of choice is debt, and its close cousin, excess consumption. Known on “the street” as leverage, it comes in many forms, ranging from home equity loans to credit cards to government bonds to commercial paper to asset-backed finance. But it is really all the same thing – debt. And like the addict in our story above, the US has many enablers surrounding it that want to keep the addict addicted. The Chinese and Japanese need to fund the US debt habit so that the US will keep buying their exports. In addition, those debt pushers both have huge inventories of the drug (US Treasuries) and they don’t want to devalue their own inventory. The other addicts out there (all of the other developed debtor nations – the UK, France, the rest of Europe) want to keep the party going as well. They can’t admit the US has a problem, because that would mean they themselves have a problem.

But our addicts got in a little trouble here recently. They want on a bender of historic proportions. They loaded up on the debt drug every which way they could get it. When the party ended they too found themselves involuntarily committed to rehab. Economists have a name for this rehab – it is called a recession, or for really bad addicts a depression. It is painful, but it breaks the addict of their drug (debt and excess consumption) habit.

Immediately our addicts began feeling the painful symptoms of withdrawal – plunging stock market values, corporate bankruptcies and unemployment just to name a few. In fact, like the addict in our prior story, it looked like these patients could also spin out of control in a death spiral if something wasn’t done. The resident doctors at the rehab clinic (doctors Bernanke and Obama) decided that to save the patient they needed to administer controlled doses of the drug (TARP, the stimulus package, Federal Reserve lending, etc.) to wean the addicts off of their dependency. Again, some said it was a mistake to give addicts in withdrawal any drugs at all, while others said it was not enough, but no one really knew for sure. But either because of it or in spite of it, these addicts also made it through that first dark night without spiraling downward out of control. Even the worst addict of the bunch (some guy named “Greece”) made it through, although for him it really was touch-and-go for a while.

So now our group of addicts is facing the tough task of making it the rest of the way through a long and difficult rehab without any more help from any drugs at all – no more TARP, no more stimulus, expiring tax cuts, etc. It will be painful. It will require our addicts to suffer much pain and sacrifice, which unfortunately has not been their strong suit in the past. They are used to having a good time partying. They are not sure they can do it.

But wait! There’s a tapping at the window. It’s the addicts’ old pushers – China and Japan. “Don’t worry,” they say, “We are here for you. We will supply your habit no matter what! In fact, we have some new really good stuff for you – better stuff than we have ever given you before. Remember when all we had for you was ten year five percent stuff? Well now we’ll supply with you with ten year two percent stuff!” Also outside the window are the addicts’ old friends from a place called “Congress.” Some of them say, “Hey, come on out – I’ve got some more of that stimulus stuff for you.” Others from Congress say, “Forget that nasty stimulus stuff. You know it leaves you with a nasty hangover. What you really need is some more of these tax cuts! That’s the good stuff!” (Those Congress guys fight a lot with each other, but the one thing they have in common is they all just want the addicts to come out and party.) Then the addicts look outside and they can’t believe their eyes. It’s Dr. Bernanke and Dr. Obama. They’ve gone over to the dark side. “We’ve got even more good stuff for you,” they say. “I’ve got some quantitative easing that you’re going to love” says Dr. Bernanke, and Dr. Obama adds, “And I can help those Congress boys get you even more stimulus and tax cuts!”

This all looks pretty appealing to our addicts. After all, who wants to suffer through months or even years of more rehab?

***

A few months ago I actually thought there was a decent chance the US was going to stay in rehab and get better. Not intentionally perhaps, but since the Republicans and Democrats can’t seem to agree on anything, it seemed possible, perhaps even likely, that the stimulus would run out, the Bush tax cuts would end, and the Fed balance sheet would start to shrink back down. This would likely cause a double-dip recession, unemployment would rise a bit more, the stock market would fall or tread water, and it would last for years. It would be a long sluggish deflationary time period for markets and the economy while everyone (and the government) cut back on consumption and paid down their debts. It would be painful, but in the long run it would be for the best, and it would be easy for investors as well. All one needed to do was buy high quality corporate and government bonds, and indeed that was what we saw in the markets.

The past week or so has changed all of that. It has become clear that the US is intent on busting out of rehab, long-term consequences be damned. The fed voted not to let their balance sheet start to wind down as securities they hold mature, and “Helicopter Ben” made it clear that he is more than ready to expand the Fed’s balance sheet without bounds through quantitative easing (i.e. buying more securities, or lending more money, in the debt markets). Furthermore, it seems that this fall the democrats are about to get a painful lesson in how much the American public appreciates being in rehab, so now it looks like they are getting religion on extending the Bush tax cuts. And once the Republicans win a bunch of seats in Congress they won’t like rehab any better than the democrats, so if the quid-pro-quo for extending the tax cuts is a bit more stimulus spending then they will probably go along with that.

As a result, it suddenly appears that the party may start again. Clearly the markets realized that as well this week as stocks jumped and high-grade corporate debt retrenched. The party will likely be subdued, for a while at least. The addicts are still far from healthy. They can’t party like they used to, and besides, they will claim they have all learned their lesson. In fact, if the addicts aren’t careful they may end up right back in rehab very quickly, or even worse (that Greece guy really doesn’t look healthy enough to be partying again!). And even if the addicts keep the party going for a long long time, they will still be addicts. Eventually the day of reckoning will come, and it will be all the worse for having been postponed this time around. But that could be years, maybe even decades, away. After all, pretty much everyone and every government on earth has a vested interest in keeping this party going. So for now, the addicts say, “Let’s eat, drink and be merry! And put it on our tab.”