Dear Diary,

A man puts a single bullet in a revolver and spins the chamber. He puts the gun to his head. He pulls the trigger. Nothing happens.

He spins the chamber again. Gawkers watch. Speculators take bets on whether he will live or die.

Again, the man pulls the trigger. The gun clicks. But no discharge. He spins the chamber again.

Again, the speculators make their bets. They bet that he must be getting closer to the end of his game. Although the actual odds stay at 6-to-1, the speculators are now happy with 5-to-1 odds.

Again, he pulls the trigger without effect. The tension mounts. Another spin. More bets. Odds have fallen to 4-to-1.

Once again, he is lucky. Speculators are betting heavily now. Spotting an opportunity, he puts his little game on YouTube. Now, it’s all over the Internet.

More of the Same?

He gets paid $3 per ad view on his site. Millions of people are watching and making their bets.

And now, after three tries on a six-shooter revolver, they’re betting his luck is running out. Odds fall to 3-to-1.

But one more time he pulls the trigger and nothing happens.

Now, speculators are beginning to wonder. He’s awful lucky. Too lucky.

Maybe the bullet wasn’t live? Maybe there’s some trick involved? Or maybe he is being protected by divine intervention?

The odds stick at 3-to-1 on the fifth try.

“How lucky can this guy be?” people ask.

Another spin. Another round of bets. Another trigger-pull. And still… nothing.

This goes on for several more tries. Now, speculators begin to feel a pattern that they can’t quite explain.

“More of the same” is beginning to seem more and more likely. They shift the odds. They give 10-to-1 odds that nothing will happen. Later, they are up to 20-to-1. More of the same seems almost inevitable.

Smart people don’t know what to think. Dumb people don’t think at all. And a shrewd speculator reasons as follows:

“If the player spins the chamber before every trigger pull, the odds each time are 6-to-1. They don’t change. But I’ve been losing money betting on the real odds. That is, I’ve been losing money betting rationally.

“This is one lucky SOB. I’m not betting on the math. I’m now betting on how lucky he is.

“Even though the real odds don’t change, I don’t know when his streak of luck will end. In the meantime, I can’t stick with my losing bets. I’ll go over to the other side and make some money until his luck runs out.”

The next time, the fellow puts the gun to his head and blows his brains out.

“Too bad,” says his accountant. “He was getting rich.”

Unpayable Debt

Yesterday, the Dow went down another 130 points, or 0.7%. Gold held above $1,200 an ounce. No biggie. But sooner or later (as we keep saying) the hammer will find the live bullet.

Deadhead student debt, malinvested emerging market debt, oil slick debt, corporate buyback debt, government stimulus debt, household overspending debt – none of it produces a dollar’s worth of extra output.

Without more real income growth, it is unpayable. So, it will all go bad, eventually.

Already, 30% of US student debt is in arrears. This debt was taken in the belief that education would increase earnings enough to pay for itself. This proved false.

Here is the evidence from Tyler Cowen:

How can people earning less money pay more money to service the debt that was supposed to lead to higher earnings?

You may ask the same question to the people who bought $500 billion of subprime debt from the energy sector. Or those who bought $1 trillion of European periphery government debt. Or those who “invested” in $4 trillion of emerging market debt?

The answer is everywhere the same: They can’t.

Free Money!

Polls show that most student debtors believe their debt will be forgiven.And why shouldn’t it be? Where did it come from? The sweat of man’s brow? The forbearance of the saver? The creativity of the entrepreneur?

No. It fell like manna from heaven… upon the just and unjust alike… through no effort on the part of the former and no prejudice against the latter.

For God’s sake, don’t you understand? It is free damn money!

Which makes it highly likely that it goes as readily and easily as it comes.

But that is still to come… and we’re sitting on the edge of our seats, along with every other curious spectator, to see how the show turns out.

US stocks have gone up and up and up over the last six years without a break.

Your correspondent has watched with amazement. During this time, the developed world economy has not grown much in real terms. And real household consumer incomes for most Americans have fallen.

Why then would companies be so much more valuable?
Mathematically – and logically – it didn’t add up. The real economy doesn’t seem to justify such high equity prices.

Why the higher prices?

You already know the answer: central bank intervention. They offer the only thing they have: more “liquidity.”

Take Germany out of the picture and almost every developed economy has followed the same path – from debt to more debt.

Ex-Germany, the developed world added $50 trillion to its debt burden in the first eight years of the 21st century. This has pushed the debt-to-GDP ratio up from 260% to 390%.

In the six years since, households have tried to shuck the burden of so much debt. But government and corporations have borrowed more than ever. Now, the debt-to-GDP ratio is 415% – representing another $15 trillion, give or take a few trillion dollars.

Logic, math and experience tell us that an overburden of debt – unsupported by higher real earnings – will collapse onto the heads of the people beneath it.

But how? When? On whom?

We wish we knew, dear reader, we wish we knew.

Regards,

Bill