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November 21, 2008

Financial Armageddon Follow-Up

by Brad Warbiany

Back in March of 2007, I posted this:

So here’s what I see. The slowdown in the subprime mortgage and building industries will increasingly push the default and foreclosure rate up. As a result, the mortgage-backed securities market and other housing-based stocks, which are reaching insane levels of “irrational exuberance” and are often highly leveraged (particularly derivatives), will crater, increasing the pressure. I think recession is on the way, and perhaps worse.

The above doesn’t sound very pretty. I don’t see any way out of it, though. The problem occurs with what happens after this, which is where it has the potentially to get really ugly. As I said, what I wrote above is what I predict. What sits below is a worst-case assumption of what might happen.

After the 2001 recession, when the government was coming off small surpluses, we had very low interest rates, and the political will to cut taxes, we were able to protect against a major economic crisis. We don’t have the same situation now. The government is running enormous deficits (and has added several trillion to the debt), the politicians are debating raising taxes, and interest rates likely won’t be able to hit the rock-bottom levels we had in 2002.

What does this mean? I don’t think we can spend our way out of this. I don’t see any way for us to have liquidity in a stagnant housing market and a tight credit market. In a tighter credit market, with rising interest rates, the cost of borrowing to cover deficit spending will not be feasible for the government. I don’t see an engine for economic growth appearing to cover the recession. There’s only one way for this liquidity to arrive, and that’s for the government to print money. Loads and loads of money. Helicopter drops of money. And the result is stagflation. This is quite possibly the worst thing our government can do, but I don’t trust any politicians to take the tough medicine– I expect them to print money.

Further, if things get bad, you can expect a quick increase in the level of socialism in this country. In an effort to placate both American big business and American voters, you’ll see the government take over health care. As a result of the inflation government will cause, you’ll quickly see them try to institute price controls and wage controls, like the 1970’s. All the while, they’ll blame scapegoats like outsourcing companies, while their own inflationary policies are causing the problem.

It looks like most of my nightmare scenario is already coming true.

I was wrong on a few things, of course. I suggested that the Fed wouldn’t be able to cut rates. What I didn’t expect was that credit markets wouldn’t simply tighten, but would disappear completely, making the enormous rate cuts ineffective. I chalk that up to some lack of understanding that I had on monetary issues, that I [hopefully] have significantly improved in the last year and a half.

Then, I talked about inflation. I have to temper that. We’re not going to see inflation. We’re either going to see a deflationary crash, or a hyperinflationary depression. I just don’t see us having a smooth way out of this one.

But one thing about sitting where I do today and looking back on that struck me… I was a lot more optimistic then than I am now!

We’re screwed, folks. There are going to be economics textbooks written about what we’re going through — assuming we don’t all go Mad Max instead.

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2 Comments

  1. Social Conservative = pessimist
    Libertarian = realist

    Thanks for the truth Brad.

    Comment by LinuxTX — November 21, 2008 @ 9:12 am
  2. We’re screwed, folks. There are going to be economics textbooks written about what we’re going through — assuming we don’t all go Mad Max instead.

    Way to cheer us all up there ;)

    Comment by Doug Mataconis — November 21, 2008 @ 11:42 am

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