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United States Coming Greek Moment, Collapse, No. Huge Losses, Guaranteed

Economics / US Debt Jan 12, 2012 - 12:22 PM GMT

By: Gary_North


Diamond Rated - Best Financial Markets Analysis ArticleI did a search on Google for "economic collapse" and "2011." I got over 7 million hits.

I read a short piece on the probability of social collapse. The author argues that complex systems require more energy. At some point, there is not enough energy to sustain the system. Then it collapses.

This argument is implicitly based on the second law of thermodynamics, which teaches that energy moves from kinetic (stored) energy to dissipated energy, never to return. The system moves from complex back to simple. It moves from low entropy to high entropy. It moves from order to disorder.

The argument became popular briefly in 1983 when far-left gadfly and perpetual co-author Jeremy Rifkin co-authored a book titled Entropy: A New World View. He argued that the world's economy is running out of energy, so the environment cannot sustain economic growth, and therefore the U.S. government must intervene to stop economic growth. He surely called on the correct institution to stop economic growth. No other institution comes close in this specialization.

You can buy a used copy of this book on Amazon for a penny. It's overpriced.

I wrote a book refuting Rifkin in 1988, Is the World Running Down? You can read it free here.

First, the argument from entropy must always define the system under consideration. Energy may be obtainable from outside the system at some price. Second, the argument must also make estimates regarding the rate of entropic decay within the system. Any discussion of a collapse should be specific on these two factors. It must also specify why there must be a tipping point, as distinguished from erosion, as when a room cools. Water freezes at zero degrees centigrade. But why is society like water?

In his great book, Human Action, Ludwig von Mises argued that it is always a conceptual error to explain social arrangements and their outcomes in terms of the categories of physical science. Human action is not the equivalent of physics. Inanimate objects do not act. They are acted upon. So, Mises argued, the social theorist should discuss society in terms of the outcomes of responsible individuals who seek to better their condition. Modern economics is universally taught in terms of pseudo-physics. There is a funny line that gets to the point. "A good economist is reincarnated as a physicist. A bad economist is reincarnated as a sociologist." Bad as sociology is, I would rather be a sociologist explaining economics, such as Max Weber, than a disappointed would-be physicist, such as Paul Samuelson. Weber read and respected Mises' great essay, "Economic Calculation in a Socialist Society." Samuelson dismissed Austrian economics. He was the first influential economist to promote the idea of economic science as a subdivision of thermodynamics.


The essence of society is an increase in efficiency, based on (1) an increase of capital, (2) an increase in the division of labor, (3) an increase in specialization, and (4) a better use of decentralized knowledge. As societies advance, they increase in complexity. This is the very essence of social order.

The crucial social question is not "more complexity vs. less complexity." The question is the origin of the complexity.

Why is this question important? Because of the cause of increasing complexity: increasing capital. This is what funds the production process. It does so by adding complexity, meaning specialization. This capital must be replaced constantly by new investing. If the replacement capital is withdrawn, the specific capital market declines. It does not collapse.

Similarly, if the market for the output of specific capital collapses, the specific capital market collapses. But why should a final market collapse? Because of a collapse in final demand. Usually, this is because of a widespread overnight change in taste. But this is very rare. People at the margin change their tastes. Existing users do not. The iPhone may replace the Blackberry, but this will take years.

It pays entrepreneurs to forecast such changes in final demand. If a capital market is really free, then entrepreneurs can buy and sell. The capital markets will adjust. There is no collapse of the markets. Some rise; some fall. (This is the economists' version of the only known law of sociology: "Some do. Some don't,")

The less free any capital market – the more government intervention – the more likely a collapse. This is why the origin of social complexity is so important.

The free market makes far better use of knowledge in society than central planning does. This was F. A. Hayek's argument in his crucial 1945 essay on knowledge in society. It appears as chapter 4 of his book, Individualism and Economic Order (1948). He argued that the lure of profit induces people who possess accurate and highly specific knowledge to make it available to others who can put it to good use in serving customers.


The main economic problem we face today is the widespread use of Keynesian central planning by government bureaucrats and central bankers. Keynesianism has increased the level of government subsidies to various parts of the economy. This has made economic systems more fragile. They are being tinkered with by committees of government experts. Here, we can have something that resembles collapse. The best case in recent history is the USSR. But the Keynesian system is not Soviet-like in its intensity. It is a middle-of-the-road policy. It can lead to serious economic disruptions, and it has. But to speak of outright economic collapse is misleading.

The free market compensates for bad policies. Better (profit-seeking) knowledge is constantly being substituted by individuals for poor (bureaucratic) knowledge. This process happens at the margin, "little by little, line upon line." This means that economic losses produce individual allocation responses that benefit customers.

Warfare produces collapse. Liberty doesn't.

All talk about all large, complex systems using too much energy, which in turn causes an unexpected collapse, is inherently statist. It implies that the free market has created a self-destructive social order. It implies that liberty of association and the right of contract have created a sociaty-wide accident waiting to happen.

Keynesianism creates very large accidents that are waiting to happen. Keynesian black swans are very large and fly very high. It is best to stay out from under them.

But there are few signs outside of fractional reserve banking that Keynesianism has created a society at the edge of collapse. There is too much freedom remaining for that to happen, short of biological warfare or an EMP.


To see what I am getting at, let us take the recent collapse of the stock price of Netflix. In July 2011, it hit $300. Shortly thereafter, Netflix announced a new policy. It was going to divide its services into two companies. One company would deliver DVDs by mail. The other would deliver streaming video. Previously, a subscriber got both.

That decision popped what had been a speculative bubble. Investors in July 2011 thought that Netflix was unbeatable, unstoppable, the wave of the future. Today, the whole world knows that Netflix had a flawed business model, and it is unlikely ever to recover to its high-flying days of July 2011. Netflix shares bottomed in late December at $68. The company lost 75% of its capitalized value. That, by any investor's standard, is a collapse. Netflix investors got dumped on by a black swan. Its recent recovery to $90 was good news for those few who bought at $68. It is not good news for those who bought in July and held.

This was a replay of the company Netflix displaced, Blockbuster. Begun in 1985, Blockbuster at its peak in 2009 employed 60,000 people. It went bankrupt in 2010. I would call that a collapse.

The company had been under long-term competition from Netflix. It rented DVDs in a store setting. Its venture into DVDs by mail, in imitation of Netflix, was a disaster. Today, the corporate shell that remains faces walk-in competition from Red Box. Red Box installs DVD kiosks in high-traffic stores like Wal-Mart. It's great for these stores, because people have to come into the stores twice within 24 hours. The kiosks take up space that was not previously used to sell anything, usually along a wall on the exit side of the registers. The square footage is maybe six square feet. There is no fire insurance to pay. Red Box rents high-rental recent DVDs that are the bulk of Blockbuster's revenue.

So, Blockbuster was doomed by its inability to respond to competition. It had its money tied up in real estate. The delivery of the product no longer depends on real estate. But it could not get out of its leases. The commercial real estate market has collapsed.

Has this had any effect on customers? Hardly any. Customers switched. Some (like me) canceled their DVD rental subscription. They keep the streaming video service. Others did the reverse.

Red Box seems to be doing well. If I want a specific DVD, I can get it by driving five minutes. I can use the Web to check to see if it's in the kiosk. It will cost me $1 to rent. The big cost is the time I take and the gasoline. I'll probably ask my wife to pick it up. Or I can rent it when I buy my veggie Subway sandwich, also sold in Wal-Mart, which I buy at least twice a week. Then the marginal cost is my time spent in front of the kiosk: minimal. Netflix will never get me back. Blockbuster did not have me for at least 13 years.

So, the free market allows collapses in response to changing customer demand. But most customers are not harmed. The social order becomes more complex. Because the transition is governed by profit and loss, society comes closer to meeting customer demand. Society experiences a net gain.


People think bankers are smart. They are smart. They skin the investors by skimming off enormous bonuses. I call this "skim and skin." They are also incompetent as managers of depositors' assets. But they do very well personally.

I wrote a story on this recently. To see how the shares of the world's largest banks have done, click here.

Incredible, isn't it? Yet the poor schnooks who held onto bank shares after 2007 have yet to catch on to the game bankers play. We still see stories in the financial media about rallies in bank shares. This sucks in the suckers.

The largest banks are in need of huge infusions of capital. Consider just Europe's banking system. We read this in Business Week. The requirement for the end of 2012 is in the range of two trillion euros, or at least $2.7 trillion.

Banks in France, the U.K., Ireland, Germany and Spain have announced plans to shrink by about 775 billion euros ($1.06 trillion) in the next two years to reduce short-term funding needs and comply with tougher regulatory capital requirements, according to data compiled by Bloomberg.

This will exacerbate the looming recession. But the banks are trapped. They need massive infusions of new capital. If they do not get this, they will be forced to sell assets. To whom?

"Asset sales are impractical in the current environment," said Simon Maughan, head of sales and distribution at MF Global UK Ltd. in London. "Every bank is selling, and no bank is buying. It just won't work. Beyond that, the magnitude of the cuts the banks are talking about is nowhere near the likely required amount of deleveraging. They need to reduce hundreds of billions more to adjust to the new world order. There has to be a recapitalization."

Who would be silly enough to offer banks the hundreds of billions of dollars in capital that they need in order to decrease their vulnerability? Only politicians. But large governments are running huge deficits, except for Germany. Who would be so silly as to loan governments money? Bankers. And so it goes.

Could there be a true banking collapse? Only if the European Central bank refuses to inflate. Will the ECB inflate? Of course. It's #1 unofficial assignment is to save the largest banks.

Bank share prices indicate in what bad shape the West's banking system really is. Everywhere, bankers have promoted bubbles, made huge losses for investors, and have lived high on the hog through government bailouts. This is not going to change. The bankers are running the show. They pocket the profits, leave little for shareholders, and call for bailouts by the government whenever their bonuses are threatened. The politicians comply.

Why should anyone expect this to change? It is not in the interest of senior managers of large banks to change it. They can deal with regulation. This stifles competition. But they will not tolerate free market competition.


Bank shares have collapsed. Bankers' bonuses have not. This is how the system works.

We will see government bailouts whenever banks are threatened with bankruptcy (bank + rupture). The central banks will always intervene, even if politicians stand on the sidelines. Politicians are not in the loop to be told what is happening. They don't want to know. This is why Congress resists auditing the Federal Reserve System. "It's none of Congress' business," says Bernanke implicitly. Congress meekly agrees.

The system will not be reformed until the Great Default arrives, i.e., when the Federal Reserve finally refuses to buy government debt. We are years away from that day.

We hear of an economic collapse as being imminent. But this ignores the ability of the Federal Reserve to keep bailing out big banks. Congress may resist the next bailout request, but it will not resist a request by the FDIC to make money available. It is politically acceptable to fund the FDIC. It is politically imperative. The voters depend on the guarantee by the FDIC. They will resist another TARP. They will not resist a bailout of the FDIC.


We will see a continual erosion of productivity. The banks will refuse to lend. The government will continue to absorb $1.3 trillion a year of capital. The public does not care. It senses that this cannot go on, but it has gone on so long that politicians can always kick the can. So, this is what they do. Nobody loses his seat in Congress because of this.

Erosion, not collapse, is in our future. But this erosion at some point will start increasing much faster than Keynesians expect. This will be our "Greek moment."

Gary North [send him mail ] is the author of Mises on Money . Visit . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

© 2012 Copyright Gary North / - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Dr Ray
13 Jan 12, 12:50
free maket goes tits up

Gary, an interesting read but I disagree that the unregulated workings of the free market don't hurt the consumer as your example on DVD rental illustrates. I think the basic problem is that a free market can only really be free when there is a symetry or knowledge. Now that is easy enough with DVD rental but not possible for the average person for more complex services such as complicated financial products or, as we have seen in Europe, breast implants. Here a manufacturer went bankrupt but people were harmed in the process. We have seen the same with Madoff and MF Global. As it happens the financial products or breast implants were regulated but regulation was ineffective or insufficient. Should we respond with more regulation or less to prevent this happening?

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