What You Simply MUST Understand
The Market Ticker - Commentary on The Capital Markets
2011-10-18 10:22 by Karl Denninger
in Editorial , 568 references Ignore this thread
What You Simply MUST Understand*

I linked a Youtube presentation a couple of days ago by a professor who explained the exponent thing.  It was dry and I bet nobody went and watched the whole series; it was basically an hour long.

Yet if you don't understand this, you understand nothing when it comes to economics and the lies told by both the left and right.  You are not stupid, however: you are ignorant.

That ignorance is intentional.  Our "educational system", our bankers and our politicians intentionally fail to explain the fundamental concept explained in this Ticker for one and only one reason: Once you understand it - truly understand it - you can never fall victim to a ponzi scheme.  Not only that, you will never allow any society you are a member of to fall victim to one either, as you will recognize the inherent danger and demand that they be stopped and the people responsible either locked up or burned at the stake (after a proper trial, of course.)

Ignorance falls to education.  It is why we learn, hopefully, so we become less-ignorant.  As such I was prodded in email this morning by someone who said "you get this well for a non-scientist" and I had to reply in riposte: Ah, but I am a scientist you see....

Anyway, here we go.... pull yourself a nice Espresso and sit down for a short story that will explain why we're utterly screwed if we don't act and why acting to stop the progression of what is going in our economy right now is not an option - it is an imperative.

There happens to be a particular species of pond lily that is extremely prolific.  In fact it grows so fast that it doubles in size through both growth and reproduction in just one day.

We will start with a pond of a surface area of 4096 square feet, or about 64 feet square.  We will place within that pond one lily with an area of of one square foot; that is, a lily that is a square of 12 x 12".

This pond contains fish, which would like to live in symbiosis with the algae and other growing plant material within the pond.  In order to do some part of the pond's surface must be exposed to the air so that oxygen and carbon dioxide can be exchanged, and some part of the pond's surface must be open to the sun, or the algae that make up a good part of the food the fish eat (we will assume they do not eat the lilies directly) can survive.  The lilies will conveniently consume the urea (nitrogen) that the fish excrete, preventing the pond water from becoming poisonous.  So long as this symbiosis is maintained all is fine.  But if this symbiotic relationship fails all the fish will die.

We are the fish, incidentally, and the lilies are debt.

Now here's the question: Will the fish inevitably die and if so how long, in days, will pass before they perish?

That's easy.

On the first day there is 1 square foot of pond that is covered.
On the second, 2
On the third, 4.
On the fourth, 8.
On the fifth, 16.
On the sixth, 32.

Note that on the 6th day just 0.8% of the pond is covered with lilies.  You would not detect any problem on the sixth day, I suspect.  More than 99% of the pond is open to the sky!

Now here's the nasty truth: If you're a fish you're halfway to being dead!

Wide awake yet?  I hope so; let's continue.

On the seventh day 64 square feet are covered.
On the eighth, 128.
On the ninth, 256.
On the tenth, 512.

The pond is now 12.5% covered.  More than 80% of the surface area is open to the sky.  When you hear someone say "we have 80% of our resource left; we can't be in trouble", consider exactly where you are.  Why?  You'll see in a moment....

On the eleventh day, 1024 square feet are covered.
On the twelfth, 2048.
On the thirteenth day there is no surface open to the sky and every fish in the pond dies.

When did you figure out you're in trouble?  Was it on the twelfth day?  Well if so you had literally less than 24 hours to commit mass lilicide or you're all dead!  You literally can't spend one day debating with your fellow fish even though you still have half the surface area open to the sky on that 11th day.

This is the nature of exponents folks.

When it comes to economics we need to consider what the doubling time is to figure out how soon our situation will get intolerably bad.  Math provides us the answer; we can use the natural logarithm to determine time, but most people's eyes fuzz at the beginning of the discussion of "e" and thus I won't explain it that way (those of you who were awake in high school and college math, however, should be perking up right about now.)

Years ago, long before calculators, bankers reduced the use of logarithms to a "rule" called "The Rule of 72."  Simply you can take the growth rate of anything and divide that into 72 to find the approximate doubling time.  So if we have debt growing at 7% a year in the economy we can divide it into 72 and find that it takes about 10 years for the debt in the system to double.  This is an approximation, but it's close enough to do in your head (72 is a convenient number for mental division as it is divisible by both 12 and 6 and 6 of course factors to 2 and 3, so most common multiples can be quickly figured in your head without pencil and paper.)

Now go back and read the lily example again, and remember that when you're one period away from being extinct half of the available resource, in this case the money you earn to pay interest and/or principal on your debt, remains available to you!

Yet even with a fifty percent current economic (in this case) surplus you're just one period away from certain destruction!

Do you see the problem more-clearly now?

All the so-called "economists" (cough-Krugman-cough!) and the various commentators both in the mainstream media and blogosphere either do not understand this or simply refuse to accept and discuss it. 

But it doesn't matter whether you choose to accept that you're inevitably doomed in three days when the pond is 12.5% covered with lilies.  You see blue sky and breathe easily, yet you are literally three days away from certain extinction and your refusal to accept mathematics cannot change what is about to happen to you!  You either start killing lillies FAST or you're dead!

These are facts folks.  They are governed by natural laws that are fixed and cannot be avoided.  I cannot change them, you cannot change them, Barack Obama cannot change them, the Republicans cannot change them.  Nobody can change them.

These facts are why this chart happened:

and why, if we don't cut that crap out right now, we are screwed with absolute certainty.

The willful refusal of politicians and financial types, the latter of whom absolutely know this and the former who have no excuse for not understanding it, to discuss this point clearly when it comes to all matters in the economy is why I wrote Leverage.

We cannot avoid the mathematical facts or their effects.  Unlike the laws of man that can be evaded through bribery and trickery mathematics cannot be. 

You either accept these facts or you suffer the consequences.

One final point and I will leave you to think this over: The World Economic Forum (WEF) said recently that for us to achieve a 3% GDP growth for the next decade we would have to double the total systemic debt.  That is a roughly 7% annual growth rate in debt, or a "spread" of about 4% over "growth".  In order to do this, the amount of earnings from everyone in the economy that will have to be diverted to interest payments will also have to approximately double.  Yet it is the inability to pay that interest (and principal where it is paid down) that is factually known as the trigger for the 2007/08 financial collapse and this growth in debt, at their assumed 3% growth rate in GDP, will produce only a 34% increase in output with which you must pay for that doubling!

We must accept what we have done.

The fact is that if the pond will be covered entirely with lilies on October 31st it is now October 30th.

We have two choices: We either start killing lilies and find a way to keep them from reproducing, even though it appears we have half of our pond still uncovered and all is fine, or we will all perish with certainty.

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