“How bad is it going to get?

Yesterday, a reader wrote me and asked:

“I have been wondering how bad the current economic “crisis” will get. Depending on who I talk to I have been told everything from “this is simply part of the normal cycle of economics” to being told to invest heavily in ammo”

Ok, here’s my take on it.

Short term? Not too bad. Unemployment and the credit crunch are going to creep up a bit more; but for the most part the recovery has actually already started.

Though, if the government (Democrat and Republican) continue their spending spree, they could double hump this recession…. actually, I think there’s a very good chance of it at this point.

The “stimulus” and “bailout” won’t be doing any real stimulating (except maybe in the auto industry); and could very well end up pushing us into the doublehump recession by preventing the efficient allocation and reallocation of capital and labor resources.

I have said from the beginning, this was a manufactured crisis. The banking shock and housing crash would have been serious, but relatively minor bumps; if they weren’t blown up all out of proportion by the media and government.

Through this deliberate manipulation (and yes, it was deliberate), the sectoral recession became a self fulfilling prophecy of general recession.

This was done intentionally, to create political opportunity for a plain and naked power grab (Rahm Emmanuel publicly admitted that much); and an explosion of graft, “legitimate” bribery, and vote buying not seen since Tammany.

In the long term, there could be some serious repercussions to our economy as a whole. Partly, it depends on how successful the democrats are at pushing us into socialism; or at the least, their manipulation of markets, and incentive structure.

Mostly however, it really depends on what the Chinese do.

Yes, we’re going to see an inflation hit from all this (should be a big one actually, though not 1979 big); but our RELATIVE inflation is actually far less than most other currencies around the world (and considerably less than the euro). Because of this, even with our mess right now, we’re actually gaining in value against most major currencies (excepting of course the Yuan).

The Chinese are holding the line on relative currency valuation by buying up as much of our debt as possible, because their trade and current accounts depend on the value of the dollar; but they can’t do it forever, or THEIR economy will tank from the other side of things (especially if we keep inflating, and accumulating debt; which is the current Democratic “plan”).

A debt sell off (unlikely, because it would destroy their economy as well), or a recession in China (much more likely) would stop them, and us, flat; and then the entire world will go into a true depression.

We need to avoid that at all costs; but it’s not something we have much control over; and the current government in this country seem hell bent on pushing us over that cliffs edge.

What needs to happen here to allow us to rebalance and make a true long term recovery, is a massive deleveraging, and moderate deflation for a year or two.

If we allowed that to happen naturally (and it’s too late to do so really, given the stimulus and bailout, but we could still salvage something); it would mean perhaps two years of negative growth, and a spike in unemployment, with a lot of bankruptcies, mergers, consolidations and writedowns. However, it would be followed by a period of rapid growth and expansion as capital gets more efficiently reallocated.

It’s called the business cycle, and it works, and it’s historically proven.

Unfortunately the government is actively and aggressively preventing that natural rebalancing from happening. We should be trying for a short sharp shock, and instead they are trying to move us into the European/Japanese style social protectionist stagnation.

If China holds strong, we will slowly recover, and Europe will slowly sink. If China falters, everything goes into freefall for a while, but we come out on top because of our structural strengths (again, presuming the government doesn’t try to destroy those strengths through more socialism and market distortion).

…That may take 20 years though; and what happened in the mean time would be unpleasant.

Oh and that’s not even taking into account the coming “retirement bomb” for Social Security and Medicare… that one makes this one look like a minor hiccup.

I am a cynically romantic optimistic pessimist. I am neither liberal, nor conservative. I am a (somewhat disgruntled) muscular minarchist… something like a constructive anarchist.

Basically what that means, is that I believe, all things being equal, responsible adults should be able to do whatever the hell they want to do, so long as nobody’s getting hurt, who isn’t paying extra

  • http://www.persnicketycurmudgeon.com persnickety curmudgeon

    Great Analysis!

    How bad ? I dunno but…

    Lets not forget that the government is already quite socialist – subsidizing one way or another – Car Companies (which lose money), Airlines (which have never made money) and hence Airplane makers, and Mass Transit (which loses lots and lots of money), and Banks(but only big ones that lose money), Postal Delivery(no comment), Amtrak, NEA, NPR, Milk prices, Corn prices etc. I mean what isnt already subsidized?

    Now we are even bailing out moronic Governors like Jennifer Granholm, The Terminator and David Patterson who run their states into the ground and expect others to pay for it.

  • Miko

    Let’s not (exclusively) blame the Democrats. The Republicans can’t because they don’t have the power, but their plan is to “keep inflating, and accumulating debt” as well; they just want to direct the pork in a slightly different direction.

  • http://www.persnicketycurmudgeon.com persnickety curmudgeon

    Miko…not exactly true…Republicans Borrow and Spend – Democrats Tax and Borrow and Spend…is not burning a candle at 2 ends rather than 3 does indeed them more conservative – but what good is that eh?

    But until we stop the government borrowing period we will never get this thing under control. This not only includes debt financing but unfunded mandates to the states and counties, and loan guarantess as well. It works so well til one day it doesn’t and it seems that day is here.

  • http://doublethinkblog.blogspot.com Jono

    Oh and that’s not even taking into account the coming “retirement bomb” for Social Security and Medicare… that one makes this one look like a minor hiccup.

    Glad you brought that up. $54 trillion in unfunded future liabilities. Thats gotta destroy the dollar’s status as the world’s reserve currency.

    Reach for your gold.

  • http://doublethinkblog.blogspot.com Jono

    Alan Greenspan suggested we could never locate a bubble, even if we looked at it.

    Yet common sense dictates its actually not all that hard to see where each bubble forms.

    A bubble is unsustainable levels of euphoria resulting in high asset prices.

    The tech crash seemed reasonable, since so many tech stocks without any earnings were valued highly only on future earnings guess-timates.

    The property collapse, and the general credit market collapse seems reasonable after so much credit expansion and such high property prices.

    And clearly, the level of US government debt should be the next domino to fall. China isn’t the only holder of US debt, you’ve also got Russia and the Middle East, both of whom face upcoming budget problems due to falling oil prices.

    There may be a game of chicken to see who flinches first, but once one player starts dumping US treasuries, the avalanche will begin.

  • tfr

    Ok, so China tries to cash in its treasuries, the dollar collapses, the world goes into depression.

    Then what? Every time someone has said “Then we’ll starve”, I have come back with, “But WE still have 1/4 of the world’s food production here in the US. It won’t magically transfer to China.” Where am I wrong here?

  • Peter

    How bad can it get? … treasuries are cahsed in but they cannot be redeemed, so US (govmnt) goes bankrupt … World economy colapses …

    tfr: “WE still have 1/4 of the world’s food production here in the US.”

    … Chinese start starving, conscript everybody into the army … war breaks out as populations try to take control of food producing areas …

    I say get the ammo ready. We should, as a country, really look into relocating our armed forces closer to home.

  • jimmy

    Hi, can you give me your advice on should we build our dream house now here in Florida Flagler County,the builder oringinally wanted $289,000 to build it now about $240,000.I’m looking to spend about $200,000 is that a posobility with the economy heading down? P.S. we have the money from selling our home 3 years ago at a nice prifit,just sitting in the bank.Thank you, Jim..