Apr 01 2008
U.S. Great Depression?
Leave it to the British to hit the economy with such a bold declaration. Granted, in the United States all policy makers are very fond of saying something to the effect that this situation and the subsequent policy reactions are the most drastic since World War II. World War II? We think this is a polite way of saying “since the Great Depression,” while hoping folks won’t go all panicky on the situation as they load their bunkers and prepare for the worst.
Granted, contemplating the concept of “bunker” has been more or less what Vigilant Investor has been doing since April 2005 — which by the way, today marks our 3rd anniversary since going full bore on the internet. Prior to that we published to our client base only as the Ernharth Wealth Report discussing the emerging Great Credit Bubble with issues dating back to 2001.
But what of this Great Depression talk the British press had jumped on? Let’s take a look.
We knew things were bad on Wall Street, but on Main Street it may be worse. Startling official statistics show that as a new economic recession stalks the United States, a record number of Americans will shortly be depending on food stamps just to feed themselves and their families.
Well… Of course this is an issue, but what’s new about food stamps? So, it would look as if this alarming headline really does not address the issue of Depresssion and Unemployment in a more relevant fashion other than to lament for the poor … so we will address this issue briefly. Is another Great Depression a reality? Let’s start from where this article begins: with the unemployed — a figure that hit 25% during the 1930s.
America has slowly been subsidizing an underclass for decades. One wouldn’t know this is happening using the official unemployment figures because, as we’ve reported over the years, the unemployment stats published by the government have been so politicized that the chronically “not working” are simply removed from the official figures, categorized instead as discouraged workers. Those folks are not unemployed, since unemployed, you see, implies someone is actually looking for a job. So, if you’re not looking for a job, you can’t be unemployed. So you must be something else. Discouraged perhaps? Discouraged it is!
The last real figures calculated using older methods like those used during the depression put U.S. unemployment (meaning those capable of working and not) closer to 13% vs. the official number running dramatically lower. And that does not account for the only employer with long term growth strength in the U.S. — the government, which has also done a slight of hand by hiring otherwise unemployed folks in various welfare to work schemes — reminiscent in its own way to FDR’s give a man any job routine.
Of course, such government slight of hand is not good for an economy. It only drags resources out of the functioning economy where it would expand growth and create jobs, and instead moves them to the other side of the balance sheet where proverbial ditches nobody needs are dug and refilled with comparatively little to show for it. Yet the clowns promoting these programs will tell us all the good they do by putting the unemployed to work, oblivious as they are the very basic common sense inherent in the economic concept of that which is seen vs. that which is unseen, which was made famous by economist Frederic Bastiat:
Nothing is more natural than that a nation, after having assured itself that an enterprise (e.g. stimulus) will benefit the community, should have it executed by means of a general assessment (tax). But I lose patience, I confess, when I hear this economic blunder advanced in support of such a project. “Besides, it will be a means of creating labour for the workmen.”
The State opens a road, builds a palace, straightens a street, cuts a canal; and so gives work to certain workmen - this is what is seen: but it deprives certain other workmen of work, and this is what is not seen.
The road is begun. A thousand workmen come every morning, leave every evening, and take their wages - this is certain. If the road had not been decreed, if the supplies had not been voted, these good people would have had neither work nor salary there; this also is certain.
But is this all? does not the operation, as a whole, contain something else? At the moment when (politicians) pronounce the emphatic words, “The [Congress] has adopted,” do the millions descend miraculously on a moon-beam into the coffers of [the bills sponsors]? In order that the evolution may be complete, as it is said, must not the State organise the receipts as well as the expenditure? must it not set its tax-gatherers and tax-payers to work, the former to gather, and the latter to pay? Study the question, now, in both its elements. While you state the destination given by the State to the millions voted, do not neglect to state also the destination which the taxpayer would have given, bat cannot now give, to the same. Then you will understand that a public enterprise is a coin with two sides. Upon one is engraved a labourer at work, with this device, that which is seen; on the other is a labourer out of work, with the device, that which is not seen.
Of course, this sort of robbing Peter to pay Paul provides a fat government unionized job with benefits and pensions far exceeding anything in the private sector to employ the middle men in the transaction. And, of course, such slight of hand makes politicians appear to be magicians rather than the dispensers of stolen loot they really are. Keep in mind, taxes are hardly voluntary and much spending is paid for by the hidden tax of currency printing debasement (inflation), which few citizens comprehend.
Which takes us to the question of the current economic environment, April 1, 2008 — which clearly ain’t so pretty. Here’s my list of concerns (in no particular order):
- Housing will continue to deteriorate;
- Retail real estate is over-expanded amid consumption bubble instigated by credit flowing through to equities (late 90’s) and into home equity / related loans. The latter has dried up after contributing well in excess of $ 1 trillion of spending into the economy from 2002-2007;
- Commercial Real Estate is set to have issues due to over development;
- Derivatives counterparty risk guarantees are falling apart (credit default swaps);
- Excess use of leverage still has much to unwind;
- Currently, the dollar is still suffering inflationary pressures of past sins — $ trillions in reserves in foreign nations have yet to find a home;
- Fed is facing choice of further damaging dollar or supporting the house of cards in the credit markets;
- Fed is running out of inflation neutral and unprecedented) tactics to keep the current regime liquid;
- U.S. interest rates are at 50-year lows; foreign nations can only absorb so much U.S. dollar inflation before they must diversify away from U.S. debt, implying higher rates for U.S. borrowers;
- The U.S. Government is in a situation of implied long-term insolvency, so says the Federal Reserve’s own research and recently retired Comptroller General, David Walker. Clearly politicians have set the train speeding 90mph towards the cliff! This hardly makes U.S. debt securities more attractive over time at current low rates;
- Forced sale situations from leverage and unexpected shocks to quantitative risk models used in managing money will continue to stress system;
- Asset inflation in asset classes that are beneficiaries of programmed trading: Programmed trading based on risk / return formulas / models accounts anywhere from 75% to 90% (depending on estimate source) of all trading. When models are required to rebalanced, they are forced to sell some assets and buy other assets. Such models have exhibited many faulty input variables on Risk, as revealed in assumptions made about mortgage securities, etc. While models are being tweaked, many continue to operate with assumptions that are on the old, structurally flawed foundation that is collapsing. This leads us to contemplate the race to buy for conventional “low risk” assets for safety amid 2008’s market volatility and credit issues because “the model says so.” Are U.S. Treasuries at 50 year lows paying well below the official CPI rate (which itself is grossly understated / politicized) really a risk free trade given all the other variables? This depends entirely on your fundamental analysis, about which the great majority in contemporary analysis have been proven blindsided and unable to correctly navigate for several years. ( e.g. They failed to see the bubble in advance, then when signs indicated it was breaking, they denied it was, and then when it clearly was breaking, they failed to comprehend its severity time and time again.)
- U.S. consumer is overly indebted and lacks savings or resources to “pull the nose up” on the reckless-consumption and debt-addicted / structured economy;
- Consumption and debt focused official policies treat only symptoms of problems and further exacerbate core dislocations serving to compound current massive cluster of business errors attempting to clear the system;
- Municipal governments’ profligacy is catching up with them at a time when credit markets no longer accept 3rd party insurance guarantees from them. In other words, they have to rely on their own finances exactly at a convergence of three serious problems: The very old practice of being allowed to place promised above-market-rate (e.g. exceptionally generous, vote-buying) union-employee pensions and benefits off-balance-sheet has come to an end by GAAP standards and must be disclosed, revealing massive shortfalls. This comes at a time when local governments are already seeing projected and current tax revenue collapse along with housing prices they are tied to, when just a few years ago most politicians were “betting on the come” as they committed to ever-more extravagant community luxuries / spending projects.
- Economy has grown overly dependent on unsustainable and long term structurally depleting policy.
- Expanding money supply and credit dislocates wealth from producers / creators and gives it to hot-money hands and government waste / largess (for evidence look no further than the housing bubble!);
- Policy action and stimulus are focused on consumption and away from savings — getting the cart before the horse for a structurally sound economy. (Can we really consumer ourselves to riches?)
- Policy action encourages debt / believes all debt is good for economic growth. (Can we really indebt ourselves to wealth?)
- More and more private citizens and companies rely on government stimulus to “save the economy.”
Unfortunately, we worry that we’re still in the first half of this ballgame, with perhaps “extra innings” to go! That said, let this replace our list of worries from late 2006! Which leads us to our expectations: Another Great Depression or not?
We’ve in the past described our present predicament is as if 1930 got together with 1973, started taking fertility drugs, “got busy,” and had sextuplets. On face value that does not imply a Great Depression. It does, however, portend the seriousness of our situation.
It should be clear to our readers by now, however, that the conventional wisdom has it backwards. The Great Credit Bubble — the big party and all its record Wall Street bonuses and get rich condo-flipping schemes — and its causes are the problem, and the current collapse is merely a well needed and long overdue correction to what was unsustainable. Nonetheless, conventional wisdom is absorbed in seeing to it that the pain associated with this corrective phase is actually the problem. When the ontology of the prevailing wisdom is absorbed in seeing the solution as the problem, and it then consumes itself with stopping the solution with yet more doses of the policies that created the actual problem — well — you are merely taking what was a really bad problem and making it worse! Consider, if you will, that the current phase of the crisis is really the consequence of policy makers refusing to allow the correction earlier this century to complete between 2000-2002! Greenspan and crew pulled out all the stops to ward off that crisis, and this larger one now is collapsing in its place!
At the crux of this crisis is the reality that decades of excessive and abusive money and credit policies associated with fiat and fractional reserve banking using currency backed by zilch, zero, nothing have created an economy littered with multiple and massive clusterings of business errors thanks to said policies functionally crushing the pricing mechanism. What the economy currently suffers from is a relational disorder — what is the real value of a home in California? Or an unoccupied condo in Miami? Or the securities backing them? Credit guarantees applied to them? And therefore the dollar backing the system? And by inference, therefore, the relationship of the oil in the ground, the gas in your car, and the Wheat in the field, the Bonds of Governments? Etc. Etc. ETC! What is reality?
That said, we’re far from optimistic about what lies in the future for the U.S. economy as policy engineers at the Fed and Treasury scramble to derail this correction from taking its natural course and doing what must be done so that the economy can be returned to normalcy. But it is our opinion that Great Depressions don’t just happen on their own, they are (in most cases) inadvertently engineered by the powers that be by policies described above. As such, we must watch what policy makers do. The article referenced above from the Independent in the U.K. is clearly an issue — how will Congress attempt to ward off the pain that lies ahead? Will they repeat the mistakes of Hoover and FDR, which are sorely misunderstood given they merely turned what was a sharp correction to the excesses of the 1920s into a severe depression? (One need only read of the meddling policies that diverted productive wealth from the functioning economy and into the morass of public spending!)
Our fears are that political expediency will win the day. As H.L. Menken observed, Democracy ultimately is the theory that people deserve to get what they want… And good and hard! That said, with election 2008 looming and cries of “save us” emerge more and more loudly from the populace as they suffer under the consequences of prior poorly conceived policy, expect the lowest common denominator. After all, why should we expect the collective wisdom of voters who are generally economically illiterate and otherwise groomed to demand to expect and demand immediate material gratification to somehow vote in any way that might place in power the people who will actually understand and therefore be capable of solving the problem? (If you have any doubt, consider pop-culture barometers of collective attention such as top yahoo searches. )
As such, our economy, our citizens, our voters, as well as those on Wall Street and in Washington D.C. and every seat of government across the U.S., have never wanted to suffer the consequences of a the small economic earthquakes that unsustainable policy invariably begets. Rather than allowing the inconvenience of a these smaller economic tremors to do what they must, they cut them off with policy actions believing this eliminates the problem. However, such panaceas are short lived as the tension that wanted to escape only is compounded by further policy stupidity. Each time a release is warded off with fresh policy tactics, the tension builds — and exponentially so, much like the intensity builds on the Richter Scale that measures earthquakes.
That said, the policy being used to ward off inevitability is a finite game only liable to make the consequences worse. Unfortunately, while history never repeats exactly, it sure tends to rhyme an awful lot. Expect mistakes to be repeated until reality beats policy-makers and voters over the head. Prepare for this situation to just grow worse if policy-makers get their way entirely. And while we’ll admit it is a distinct possibility that policy makers will be able to wring out one more daring “rescue” of the economy, consider the implications of such “success.” At best, we find the structure of the economy to be far too imbalanced to offer a whole lot based on such stimulus. Unfortunately, its just too strung out on the junk created by the Fed and Congress and all those parasitically feeding from what’s legitimately left.
The 37 year experiment of ma-managed currency appears to be coming to a closing thud. Prepare accordingly and don’t let yourself be suckered by the sunny eye of the storm.
