Sunday, March 09, 2008

Train Wreck!

Ian Welsh at FireDogLake has it right. As he said, his list of economic predictions have been discussed at length over the last few years. We have been watching a slow-motion train wreck ensue right before our eyes, and now the two economic locomotives of cheap oil and ever-increasing home values are just now meeting-- head-on. Ka-boom!

Ian writes:

1) Housing prices and sales will continue to decline. Expect 3 years before the bottom, as a very optimistic best case scenario.

2) Commerical real-estate will suffer a steep decline as well.

3) Consumer demand will drop. Unemployment will rise.

4) The US will go into a recession at best, a depression at worst. Expect first stagflation (high inflation and high unemployment), both because of the increased price of imports and deliberate pump priming by the Fed, then deflation, as asset prices collapse so hard they take everything else with them. The other likely scenario is stagflation followed by hyperinflation. Formal inflation numbers put out will become not just a joke amongst market-watchers, but amongst the actual population. Same thing with unemployment numbers.

5) The Asian economies are not going to "decouple", they are going to have their own financial crises and recessions. Yes, this includes China.

6) China's stock market will collapse some time next year. China will go into a recession. There will be huge amounts of violence and the Chinese government will redirect anger towards the US and Japan.

7) Multiple banks will probably go insolvent. They are simply holding too much crap paper. There will be an extreme tightening of consumer debt of all kinds, including consumer loans, credit cards and mortgages (this is already beginning, but you ain't seen nothing yet). Even people with good credit will start having difficulty getting loans.

8) Protectionism is going to get stronger. Even if Clinton, a free trader, is put in power, by the time the 2010 Congressional elections are over no "free trade" bill will be able to pass Congress and in fact actual tariffs are likely to be put in place.

From a purely intellectual standpoint, this has been a beautiful portrayal of the way monetary policy can take down the world-wide economy, and I believe we are just at the outset of the calamity. Welsh's list is quite ominous, and hopefully all those predictions won't manifest, but even if just half come about we are in a world of hurt. As he said in the final paragraph, " Hope may not be a plan..." He should have just stopped there. Indeed, hope is not a plan. I'm no economist, but the problem I see is that nobody really has a plan to unwind all this bad debt-- and derivitives and leverage are compounding the negative consequences of all the bad decisions and lack of regulation made over the last 5-7 years.

Most market bulls hang on the meme that the Asian and US economies are "decoupled." That's bullshit. Either we have globalization or we don't; we can't recognize it's insidiousness one day and then claim it doesn't exist the next. If there is a recession or depression, then everyone is going down. Period.

Ian's most ominous prediction is:

9) I wouldn't be surprised, at some point, to see capital controls put in place to stop money-flight from the US.

I'll let you read his six other predictions at the link.

Who knows if any of this comes true, but I'm starting to believe that it might. Marc Faber, the renowned currency trader, recommends that US citizens keep some capital stashed overseas for the possible event of such closures of capital flight. From a timing perspective, the US election cycle is occurring at just the wrong time. Bush, Paulsen and Bernanke are staring at the two locomotives like deer in the headlights, frozen by Bush's lame-duckness and Bernanke's mistaken belief about the role of the federal reserve. For some reason Ben Bernanke seems to think the federal reserve banking system exists to preserve stock market value or something. (The role of the fed is to #1: maintain the value of the US dollar, and #2: maximize employment. Period.) Bush and Paulsen's lack of insight is somewhat understandable and even forgivable in a way when you think about the fact that Bush was re-elected with the voters having all the information available to connect the dots between his utter stupidity and all the problems we face that have been completely avoidable. We get what we deserve.

Bernanke, on the other hand, is an enigma. He is an ivory tower type who supposedly has studied the Great Depression. Hello! Isn't this is exactly what a Great Depression looks like in the early stages! WTF! While most recessions are a simple matter of over-supply and the need for demand to catch up, we currently have over supply (housing) leading to asset deflation, but lowering interest rates has not achieved the desired effect of increasing housing demand. Why? Because inflation in other assets (oil and food) have been grossly underestimated and slowing down the economy-- this is a (lack of ) demand driven recession. Thus, the fed has been enacting a completely wrong policy. As JD at the Big Picture notes, the current subprime crisis is a credit problem, not an interest rate problem. Lowering interest rates in order to "jump start" an ailing economy is a fool's errand. You may get away with it many times, maybe even most times, but when it doesn't work-- like now-- the economy AND the currency both tank together. Recessions in and of themselves are not necessarily bad; as Rick Santelli famously said, a recession is an enema for a bad economy. This should have been done 18 months ago in order to at least preserve the US dollar's value. Instead we have become Bernankeville: weak dollar, high inflation, poor employment and contracting GDP.

Depressions associated with a cratered currency, if that is indeed what we are experiencing, are dangerous things. While some of us may be tempted to high-five each other over our apparent insight in preserving capital by avoiding stocks and riding commodities lo these past several months, economic depressions can explode at any time and in toxic unforeseen ways. Only the lucky survive financially. Our paychecks have become devalued by 20% since 2006, and for many of us our largest assets-- our home and our IRA's-- have likewise been devalued. The indolent chronicity of the current devaluation, as disheartening as it may be, could be abruptly worsened by a sudden snap in the structures of our economy. A rapid rise in unemployment, as Friday's federal employment data has suggested, is not only possible but likely, and the consequences would be grave right now. The world's economies are too entwined to have any safe-havens. If the US consumer loses his or her job and stops buying Chinese toys or Korean computers or Guatemalan clothes, then their economies tank along with ours.

In such a scenario, oil would drop for lack of demand as factories worldwide shut down. Hard commodities like aluminum, silver and platinum would likewise crash due to the halting of end-product manufacture. Gold. Gold may be spared, but who knows? Capital flows to whichever haven is determined to be the safest. Those of us in middle class America may get by with a few less trips to Starbucks or a more austere vacation as our paychecks tumble in value or we collect unemployment, but an increasing majority of the world's population-- an unprecedented number-- depends for their daily survival on the interconnectivity of the world's economies to eat and live safely. Will the fabric of this interwoven economic cloth begin to unravel? Wars, rebellion and pestilence could occur.

Recently my posts about the economy have been depressing. Don't be misled, the worst case scenarios rarely come true and solutions may pop up unannounced (even if I don't happen to see one on the horizon.) The stock market has a way down to go-- who knows it might even crash. Be forewarned, but don't panic. Go to work, do a good job. Invest wisely in gold, foreign bonds and currencies, and US bonds and safe investments. If you have long positions in stocks, then hedge against a market meltdown with Ultrashort ETF's (DXD, SDS, QID or MZZ). Don't buy into the goldilocks fantasy by stock salesman and charlatans. Buy stocks ONLY when there's blood in the streets--and there is nary a drop so far. For a red-alert-save-the-family calamity, open an emergency currency account in Switzerland or at least keep a bag of solid silver dimes under your bed. Why the heck not?

Hang on it's going to be a wild ride!

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