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I really dislike sounding inflammatory. Saying that things are going to go terribly wrong runs a risk of being classed with those who think the world will end in December 2012 because of something Nostradamus or the Bible says, or because that’s what the Mayan calendar predicts.
This is different. In the real world, cause has effect. Nobody has a crystal ball, but a good economist (there are some, though very few, in existence) can definitely pinpoint causes and estimate not only what their immediate and direct effects are likely to be (that’s not hard; a smart kid can usually do that) but the indirect and delayed effects.
In the first half of this year, people were looking at the U.S. economy and seeing that some things were better. Auto sales were up — because of the wasteful Cash for Clunkers program. Home sales were up — because of the $8,000 credit and distressed pricing. Employment was up — partly because of Census hiring, and partly because hundreds of billions have been thrown at the economy. The recovery impresses me as a charade.
Let’s get beyond what the popular media parrots are telling us and attempt to derive some reasonable assumptions about how things really are and where they’re headed.
A Brief Summary of Our Story So Far .
Before we get to where things stand at the moment, let’s briefly look at where we’ve come from.
That a depression was in the cards has been foreseeable for decades. The distortions cranked into the system in the 60s — the era of guns and butter spending by the government — resulted in the tumult of the 70s. Things could, and one could argue should, have come unglued then. But they didn’t, for a number of reasons that have only become clear in retrospect:
- Interest rates were allowed to rise to curative levels;
- The markets were non-manipulated and so, as they became quite depressed, were left to send out real distress signals;
- The U.S. was still running a trade surplus;
- The dollar had only come off the gold standard in 1971 and was still relatively sound.
Then, starting with Reagan and Thatcher, the world’s governments started cutting taxes and deregulating. The USSR collapsed peaceably. China, then India, made a shift toward free markets. And on top of it all, the computer revolution got seriously underway. All told, a good formula for recovery and a sound foundation for a boom.
But sadly, taxes, government spending, and deficits soon started heading much higher. Despite the collapse of its only conceivable enemy, U.S. military spending continued to skyrocket. Monetary policy encouraged everyone to take on huge amounts of debt, much more than ever in the past, and everyone soon found they could live way above their means. The stock, real estate, and bond markets got pumped up to ridiculous levels. The main U.S. export became trillions of paper dollars. Worst of all, the U.S. devolved into just another country, undistinguished by anything other than a legacy of a high standard of living.
The standard of living in the U.S. is now going down for these reasons, and others. But most disturbing to the average American is the falling position of the U.S. relative to the rest of the world. In brief, Americans won’t take kindly to the notion that they can’t continue earning, say, $10—40 an hour, for doing exactly the same thing a Chinese will do for $1—4 an hour.
What’s going to happen is that the Americans’ earnings are going to drop, while those of the Chinese are going to rise, meeting someplace in the middle. Especially when the Chinese works harder, longer, saves his money, and doesn’t burden his employer with all kinds of legacy benefits, topped off with lawsuits. This is a new threat, one that can’t be countered with B-2 bombers. It’s also something as big and as inevitable as a glacier coming down a valley during an Ice Age.
This, along with other problems presented by the business cycle have ushered in the Greater Depression.
How Long Will the Greater Depression Last?
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Let’s briefly recap two definitions of a depression, along with a couple of examples, with an eye to seeing how things may evolve from here.
One definition is that a depression is a period of time when most people’s standard of living drops significantly. Russia had this kind of depression from roughly 1917 to 1990, so more than 70 years. A second definition is that it is a period of time when economic distortions and misallocations of capital are liquidated. Russia had this kind of depression from 1990 up to about 2000. It was very sharp but relatively brief.
The difference between these two examples is that, during the first, the state was in total — or even increasing — control. By the time of the second, the country had greatly liberalized. As a result, the depression was a period of necessary and tumultuous change, rather than drawn-out agony. A depression can be a bad thing or a good thing, partly depending on which definition applies.
Today, things are problematic in Russia for a number of reasons that aren’t germane to this article. But people can own property, entrepreneurs can start businesses, and the top tax rate is 11%. The depression of 1990—2000 resulted in greatly improved conditions in Russia.
Let’s look at a couple of other examples: Haiti and Mozambique.
Haiti has been a disaster since Day One and has no current prospect of improvement. The billions of dollars Obama is idiotically about to send them will evaporate like a quart of water poured into the Sahara — just like the billions of aid and charity that have gone before it. Worse, it will eliminate the necessity of Haiti making meaningful reforms. Additional aid actually precludes the possibility of liquidating distortions, misallocations of capital, and unsustainable patterns of life. It’s counterproductive.
Mozambique went through a long and nasty civil war from about 1970 to the early 90s. The war made conditions worse than anything even Haiti has seen. But when it came to an end, the Mozambicans changed things simply in order to survive. The place is hardly a beacon of the free market today, but duties and taxes have been reduced, most parastatals have been privatized, and entrepreneurs can operate. It’s a good sign that the country is drawing foreign investment but very little foreign aid, which always just cements people in their bad habits while ensuring government officials stay in office.
Why do I bring up these examples? Because it’s clear to me the U.S. is heading in the direction of Russia before 1990, or Haiti today. Not in absolute terms, of course. But everything the U.S. government is doing — raising taxes, increasing regulations, and inflating the currency — is not only the wrong thing to do, but exactly the opposite of the right thing.
This is really serious, because the government is the 800-pound gorilla in the room. What governments do makes all the difference — actually the only difference — in how countries perform. How else to explain that Haiti and Singapore were on pretty much the same level after World War 2, and look where they are now.
To my thinking, the U.S. is now clearly on the path Argentina started down with the Peron regime. Cause has effect. Actions have consequences, and the result will be much the same. Except I believe the descent of the U.S. will be much faster, much scarier, and will end in a much harder landing than that experienced by Argentina.
I say this because there’s no realistic possibility the Obama regime is going to change course. To the contrary, they’re likely to accelerate in the present direction. They believe the government should direct society — as do most Americans at this point. They feel government is a magic cure-all and not only can but should do something in response to any problem. Most complaints aren’t that they’re doing too much, but that they’re doing too little. Everything on the political front, therefore, is a disaster. There’s absolutely no prospect I can see that it will get better, and every indication it will get worse.
I’m not going to try to predict what will happen in the 2012 elections, but it’s fair to say the last several elections are indicators of the degraded state of the average American. What are the chances they’ll make a 180-degree turn, in the direction of someone like Ron Paul? I’d say close to zero, and libertarianism will remain a fringe movement, at best. Will Boobus americanus vote for someone who says the government should actually do less — much less — in the middle of a crisis? Especially if the current wars expand, which is quite likely in this kind of environment? No way.
Simply, the chances of a reversal in what passes for the philosophical attitude of this country are slim and none. And Slim’s left town. While there are some who hope for an improvement on the political front, I think that’s very naïve.
The Tea Party movement? Its ruling ethos appears to be a kind of inchoate rage. I sympathize with the fact that many seem to be honest middle to lower middle-class Americans who see their standards of living slipping away and don’t know why, or how to stop it. They feel bad that it’s no longer the America portrayed in Jimmy Stewart and John Wayne movies, but many are quick to blame the changes on swarthy immigrants. They’re desperately looking for a political solution. These folks tend to be highly nationalistic and atavistic, with a tendency to worship their preachers and the military. I just hope some popular general doesn’t get political ambitions
The only bright spots — but these are very major bright spots — are in the areas of individual savings and technology.
As things get worse, the productive members of society will redouble their efforts to save themselves by producing more while consuming less; the excess will be savings. Those savings create a pool of capital that can be used to fund new businesses and technologies. The problem here is that with the dollar losing value quickly, the savers will be punished for doing the only thing that can really improve the situation. And they’ll be discouraged by wrongheaded propaganda telling people to consume more, not to save. Funding new business and technologies will be harder with more regulations. But still, people will find a way to set aside a surplus. And that is a factor of overwhelming importance.
As are breakthroughs in science and technology. Don’t forget that there are more scientists and engineers alive today than have lived, altogether, in all of previous human history. These are the people that will wind the main stem of human progress. And their numbers are going to grow. So there’s real cause for optimism.
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The problem is that most young Americans now go in for things like sociology and gender studies, whereas the up-and-coming scientists and engineers are primarily Chinese and Indians who, even if they get advanced training in the U.S., tend to go back home afterwards. Partly because the U.S. discourages hiring non-Americans for good jobs, but mostly because they can see more opportunity abroad.
So, how long will the Greater Depression last? Quite a while, at least for the U.S.
But wait. Aren’t there other bright spots? How about the dollar?
Over the years I’ve been agnostic as to whether this depression would be inflationary or deflationary. Or both in sequence, with inflation first, followed by a credit collapse deflation; or a deflation followed by a runaway inflation. Or perhaps both at the same time, just in different sectors of the economy — e.g., prices of McMansions collapse because people can’t afford to live in them, while the prices of rice and beans skyrocket because that’s all people can afford.
At the moment I’m leaning towards a deflation in most areas. Why? Because the purchasing media in the U.S. is primarily credit based. If a mortgage defaults, what happens to the dollars it represents? They literally disappear, which is deflationary. If a bond defaults, the same thing happens. If stocks and property prices crash, the dollars they represent vanish. If people or businesses don’t borrow, the money supply fails to expand; in fact, many are trying to pay back loans, which is deflationary. Even so, contrary to popular opinion, deflation is much better than inflation.
Because today’s dollar is just paper and credit, and because deflationary conditions will create a clamor for many more of them, the government will eventually succeed in its inflationary efforts. It’s true, as Bernanke has said in a moment of wry wit, that they can dump $100 bills from helicopters to prevent deflation. But it’s not likely since, in our fractional reserve banking system, the primary way the money supply is expanded is through the granting of loans, not the printing of paper, the way it was done in Weimar Germany and Zimbabwe. One problem with credit-based inflation is that at some point, banks become afraid to lend, and people afraid to borrow — a time like right now. In fact, people may even become too afraid to leave their dollars in banks. They’re coming to realize the FDIC is thoroughly bankrupt.
Here’s a speculative scenario. To solve these deflationary problems and resolve Ben’s helicopter conundrum, maybe the Fed will go into the retail banking business by directly taking over the hundreds of institutions that are now failing. The average American would feel safe depositing directly with the Federal Reserve. And the Fed could lend as much as they want, without the restrictions imposed by actual capital or pesky shareholders.
Ridiculous? I think not, certainly not after GM, Fannie, and the rest. Certainly not when you consider that this depression is still in only the second inning. It would be one way to head off deflation.
Be that as it may, or may not, at some point after the deflationary waters have receded as far as possible, an inflationary tsunami is going to wash ashore, to the surprise of all.
Everybody knows how bad things were in Weimar Germany, and what a catastrophe hyperinflation has been in Zimbabwe. But those were agrarian economies, with people still quite close to the land. If it hits in the U.S., as highly specialized and urbanized as it is, it will be an unparalleled disaster. And not just for the U.S., because the reserves of almost all governments are mostly U.S. dollars. And dollars are used as the de facto currency by the average man in about 50 countries. All told, there may be as many as seven trillion of the things held outside of the U.S., and, at some point, everybody will be trying to unload them at once. At which time they’ll lose value very, very quickly.
So, far from being something to rely on, and very far from being as good as gold, the dollar is going to be a lead player in the catastrophe called the Greater Depression. And all the other paper currencies are going down with it. Pity the fool who doesn’t see this coming. Or, for that matter, what’s going to happen to interest rates.
The government is doing everything in its power to keep interest rates as low as possible. There are many reasons for this. Low rates make it easier for people to support their debt burdens and borrow more. Low rates inflate the value of stocks, bonds, and real estate — and the last thing the government wants to see is a meltdown of the markets. But, perhaps even more important, it’s a lot easier for the government to service $12 trillion of official debt at 2% than at 12%. That much of a rise in rates alone will add over a trillion to what they need to borrow to keep the giant Ponzi scheme going.
Of course it’s a fool’s game. Eventually (I’ll guess between six and 24 months), when their creation of dollars eventually overcomes the credit markets’ destruction of dollars, consumer prices will go up. That evidence of inflation will cause interest rates to rise, with all the short-term negative effects the government so fears. But higher rates are absolutely necessary to get out of the depression. Remember, it was the high rates of the early 80s that set the stage for the boom that followed.
Rates — the price of money — shouldn’t be controlled by the state, up or down, any more than the state should control the price of oil, or bread, or toothpaste. One of the major reasons the USSR collapsed was an inability to make correct economic calculations, and much of that was due to their arbitrarily fixed interest rates. One reason why Japan has been fading into the economic background over the last two decades is that the government has artificially suppressed rates, in the vain hope of stimulating the economy. All they’ve gotten is excessive levels of government debt, which will result in the destruction of the yen. And what will be tens of millions of impoverished, and very angry, Japanese savers.
The same thing is in process of happening in the West due to suppressed interest rates.
The Next Steps Down in the Markets
With interest rates depressed to near zero, stocks, bonds, and property in the Western countries are as good as they’re going to get — especially after a very long boom in all three. When rates inevitably go higher, stocks, property — absolutely bonds — are likely to head much lower. That’s entirely apart from the fundamentals under them, which are truly ugly. In turn, that will bankrupt pension funds across the economy, many of which are already severely underfunded.
These pension funds are likely to be the centerpieces of the next leg down of the evolving crisis. Will the government bail them out? Perhaps, although after the misadventure of poor taxpayers throwing money at rich traders at Goldman and AIG, the public doesn’t like the ring of that term. More likely it will nationalize them, assuming their assets in exchange for a special class of its paper. In the interest of fairness, that will happen to small and solvent funds as well as large and bankrupt ones.
After that, the next problem area will be insurance companies. And not necessarily because they’ll suffer from the same problems, like derivative trading, that sunk AIG. Even the well-managed ones have their assets invested primarily in commercial loans, commercial property, bonds, and stocks.
How This Will End
Nassim Taleb has popularized the concept of the Black Swan: an event that no one thought was possible, actually happening. Naturally, it takes everyone by surprise. To that lesson from zoology, let me suggest one from astronomy. Let’s call it the Financial Asteroid Strike theory.
It’s well known that there are millions of pieces of sizable space debris floating around the solar system. It’s just a matter of time before something crosses our path at an inopportune moment, as has happened so many times in the past. Unlike the Black Swan, it’s well known that Financial Asteroids exist. It’s just that really serious ones appear so rarely that people conduct their lives as if they never will. It’s been such a long time since the last depression that people see it as something distant and academic — like the Chicxulub or Tunguska asteroid strikes. Until the actual moment it hits, everything is completely normal. Then everything changes radically.
I’d sum it up by saying that a Financial Asteroid Strike takes much longer to happen than you might expect, but once it actually gets underway, it happens much more quickly than you could have imagined. We had a strike in 2008. But they tend to come in clusters. I expect more to enter the atmosphere fairly soon.
The question is whether the next one is going to wipe out all the economic and financial dinosaurs or just flatten the trees for some miles around.
Either way, it’s far from being all gloom and doom.
How This Could Be a Good Thing
Everyone, certainly including myself, prefers good times to bad times. But much of the good times of the last two decades were a result of an entire civilization living above its means. It was great fun while it lasted, but the party is over. The result will be massive unemployment, lots of business failures, and huge investment losses. These things are most unpleasant, but inevitable. That said, I always like to look at the bright side.
And what might that be?
Let’s restrict ourselves to just one of the lead actors in this drama: the United States of America.
The bankruptcy of the U.S. government will, at least at some point, lead to a big drop in the number of government employees. This is a good thing, since little of what they do serves a useful purpose; most are an actual impediment to production.
With some luck it could result in the sale of agencies that have some value, e.g., NASA, the Smithsonian, and the National Parks — to private enterprise. It will also force a vast retrenchment of the military, although only after more costly wars make that necessity very obvious. It will force a decentralization of power, with more devolving to the states and municipalities. It will mean much less regulation, since there won’t be the personnel or money to enforce it. It will also mean much less taxation for the same reasons, even though the state will try desperately to collect more, and will absolutely succeed in the near term.
Internationally, it seems to me a sure thing that organizations like the UN, the IMF, the OECD, and so many more, will be totally hollowed out or even disappear. At a time when governments are straining to maintain themselves, they’re unlikely to ship scarce capital abroad. So the people who are worried about the UN taking over the U.S., One World Government and such, will have to find something different to fret about.
As domestic currencies the world over are inflated away, some medium of exchange and store of value will have to be agreed on. I don’t see any realistic alternative to gold. China is going to be a focus of change in this regard (among many others). The stupidity of the Chinese government buying U.S. government paper in order to enable Americans to continue consuming the things Chinese factories produce will come to an end. That will be an impetus to demands for an alternative medium of exchange.
But if the U.S. and governments of other advanced countries lose power, governments in places like Africa (in particular) will collapse; Somalia is a model of things to come there. That may sound like a horrible thing, but — notwithstanding teething pains — it’s a big step forward. Deprived of free money, free weapons, and lots of free bad advice that have entrenched kleptocracies, the Africans are likely to make real progress after the Greater Depression plays itself out.
The transition period, however, is likely to be messy almost everywhere.
Can we prevent the status quo from falling apart, and preclude these messy changes? Further, should we, if we could?
Entirely apart from the fact that change is an essential part of life — and I think the status quo is in dire need of some real change (although absolutely not the kind Obama and his posse might have in mind) — I actually don’t think there’s a realistic solution to the problems the world is facing in this decade.
Yes, there are solutions that the government could proactively bring about — almost entirely by doing less, rather than more. But the odds of the U.S. voluntarily defaulting on its debt, abolishing the Fed, using gold as money, abolishing all agencies not specifically designated in the Constitution, eliminating the income tax, and cutting back on military expenditures by about 90% — among other things — are so small as to be considered a fantasy.
In fact, the concept of invoking changes of that scale are too scary for most to even contemplate. But they’ll happen anyway. Which means these things aren’t going to happen voluntarily, under some kind of control, and in a more or less orderly manner. Even so, because anything that must happen will happen — all these things and more will actually happen and, in the happening, will be most unpleasant and dangerous.
It seems to me that the upset we’re looking at could be the biggest thing since the Industrial Revolution. Or perhaps the French Revolution is a better analogy, although I expect it’s going to be a bit of both. It seems entirely possible to me that we could have another American Revolution, as unlikely as that seems among a nation of commuters and suburbs-dwelling reality TV watchers.
But it’s hard to see how it could be anything like the first one, which was led by thoughtful, rich, free market-oriented farmers and merchants. More likely this one will center on people like Sarah Palin and Sean Hannity on the one side, and Michael Moore and Nancy Pelosi on the other — strident, antagonistic, and bent, but also full of charisma and certainty. I don’t see much chance of collegial and reasonable compromise.
The best advice is not to be around the watering hole when two antagonistic groups of chimpanzees are hooting and panting at each other, getting ready to fight for control of it.
I’m afraid the current state of affairs is corrupt through and through. From the top of the financial world in New York, to the top of the political world in DC, right down to the average man on the street, 50% of whom aren’t obligated to pay income taxes but feel entitled to be net recipients of government largesse at the expense of others. Even among those that have assets, there’s no feeling of shame in gaming the system any way possible. There’s no longer any onus to being one of the 40 million people on electronic food stamps, or defaulting on one’s mortgage and continuing to live in the house, and collecting indefinitely extended unemployment benefits. Bankruptcy is just something you do when needed.
Frankly, it’s a mystery to me how the U.S. in particular, but most of the developed world, is going to escape from the very unpleasant consequences of its very stupid past — and current — actions.
I’ve just scratched the surface of the possibilities for the next ten years here. What’s clear is that some patterns of production and consumption are unsustainable; they will stop. What’s not clear is what new patterns will replace them. But that’s not so worrisome; what’s a matter of more concern is what forms of political and social organization will appear.
But let me leave you with a final bit of good news. Most of the real wealth — science, technologies, capital and consumer goods — will still be here. There’s just going to be a change in ownership. And it’s possible to position yourself to get more than your share. Based on the above, what looks good to me — on a long-term basis — over the years to come? In general, stocks, bonds, and property are dead ducks, and headed much lower. But when a real bottom arrives, perhaps even in this decade, fortunes will be made buying back into them. Gold and silver, even though they’re no longer cheap, are going much higher; they’ll be what you’ll trade for things that are cheap. Agricultural commodities are going to do well. The trillions of currency units being printed all over the world will definitely ignite more bubbles, which should present fantastic speculative opportunities. And because the political situation will be hairy, diversify your assets outside of your home country.