U.S. in Crisis Mode - What's Next?

The party really is over. We are facing hard times, no matter what the government does. If it continues to prop up the sick markets, it will only delay and worsen the inevitable deep recession. Casey Research’s Olivier Garret explains…

In the last few weeks, it has become clear that the current financial meltdown is not our usual, run-of-the-mill crisis. It’s supersized, inexorably linked to the rest of the world, ruled by chaos, and precariously perched atop a mountain of debt. "What makes this crisis different from some of the earlier ones," says IMF Historian James Boughton, "is that the interlinkages among financial institutions are much greater now than they used to be."

Daily efforts to "thaw credit markets," "provide liquidity," and "support financial stability" only add to the myriad market dislocations. And despite what we may hear from politicians and the news media, recovery is unlikely to be "just around the corner."

The party really is over. We are facing hard times, no matter what the government does. If it continues to prop up the sick markets, it will only delay and worsen the inevitable deep recession.

To survive the current financial crisis and the accompanying economic downturn, we must understand the big picture, and how it will be affected by the slew of "support" from the federal government.

Casey Research accurately predicted the specifics of the crisis in its International Speculator edition of March 2007:

For one thing, at the point that falling prices leave homeowners with mortgages exceeding the value of their homes, default rates will soar. This, in turn, will put lenders that hold large amounts of mortgage debt at risk, and possibly jeopardize the solvency of Fannie Mae and Freddie Mac, since they guarantee much of this debt. If these mortgage giants faced collapse – and they are already in well-documented trouble – a government bailout involving hundreds of billions of dollars would be a likely next step.

The impending calamity – mass housing foreclosures, failing banks, Fannie Mae and Freddie Mac in ashes, millions of personal bankruptcies – is so dire… most people can’t even conceive of it. And indeed it may not hit us this year, or next, but the market always corrects itself, and this time will be no exception, sooner or later.

We have said before, and we repeat again: Rig for stormy weather.

Now the Casey Research team forecasts something outside the realm of any recent experience: the Greater Depression may be looming on the horizon.

Doug Casey coined the term "Greater Depression" in his best-selling book Crisis Investing, published in 1979. Today it resounds throughout the land; even CNN’s Glenn Beck recently used it in an op-ed piece. And the signs are increasing that a depression may indeed be what we are moving towards.

On September 30, 2008 (end fiscal 2008), the Congressional Budget Office reported a record federal budget deficit for the year of $455 billion, up $293 billion (or 181%) from fiscal 2007.

And that does not yet include the Fed’s bailout package for failing banks, Fannie Mae and Freddie Mac, and various other "economic stimuli." The chart below shows that the $700 billion agreed to by Congress may have been a very optimistic estimate.


On October 3, President Bush signed into law the Emergency Economic Stabilization Act of 2008. With this Act, Congress and the president have ensured a runaway government deficit next year…one sure to exceed $1 trillion. Along with total federal debt outstanding already around $10.3 trillion, unfunded liabilities of at least $50 trillion, and many new programs and tax rebates promised by both presidential candidates, this does not bode well for the global economic outlook.

As if that was not enough, during the past few weeks, the Fed increased the country’s monetary base by as much as 20% to shore up the financial systems.

Federal budget deficits facilitate "loose" (expansionist) monetary policies, and these policies set in motion the business cycle. As the economy enters the cycle’s "bust" phase, massive federal deficits have left the government with only one option – to try to inflate itself out of the current crisis, regardless of the impact on the value of the dollar.

A rapidly growing money supply at the same time the biggest credit bubble in 25 years bursts makes for a less than desirable scenario – one that could make the stagflation of the ’70s look like a walk in the park. In March 1975, industrial production fell by nearly 13% while the yearly rate of CPI growth jumped to around 12%. It took another seven years and a second recession before the U.S. was able to break from the stagflation cycle.

What we are likely in for now is an unprecedented period of price inflation, economic depression, and high unemployment, i.e., not just stagflation but depflation (inflationary depression).

Depflation will affect the entire population, and its effects on people’s personal finances will manifest in multiple ways.

? Purchasing power declines as prices for consumer goods increase faster than wages.
? Taxes levied on businesses and individuals increase when nominal incomes rise.
? Late recipients of new money incur cost of additional hidden tax.
? Cost of money (interest rates) increases, hurts investments in capital goods, stocks and bonds.
? Once expectation sets in, it becomes a self-feeding phenomenon, taking years and a severe recession to work itself out.

Just like a shot of adrenalin administered to a sick patient generates an apparent revival, only to have the patient collapse as soon as the injection wears off, the artificial monetary injections by the Fed will do the same. Paraphrasing former Fed chairman Paul Volcker, "Once you have a little [monetary] inflation, you need a little more". As with any medicine, its effects wear off and become less potent the more "injections" are received.

At this stage, your primary goal should be asset protection. Once that is in place, you will be in a better position to hunt for the opportunistic profits one can only find in times of crisis.


Olivier Garrett
for The Daily Reckoning
October 21, 2008

P.S. We at Casey Research have long foreseen what is unfolding right now…and those investors who followed our recommendations have successfully preserved their wealth.

We believe in making the trend your friend…otherwise it can be a fearsome enemy.

Which is what The Casey Report is all about – giving you the pertinent and well-researched information on big economic trends unfolding at this moment, and how best to invest to make them work for you, instead of against you.

Yesterday, prices went up on Wall Street… The Dow rose 413 points. There was no follow-up this morning, as investors eyed a mixed bag of 3rd quarter corporate earnings.

But, investors are in a pretty good mood, all things considered. After all, Warren Buffett is bullish on stock prices… Warren is putting his money and his mouth in the same place – equities. He says he’s sure they will do better over the next 10 years than cash.

Here at The Daily Reckoning, we are not rich enough to argue with the Sage of the Plains. Besides, we think he’s right. Or, almost right.

Stocks will probably do better than cash over the next 10 years; but mostly because cash will probably do very badly. Our guess is that everything will do better than cash. Except bonds – which represent cash deferred into the future.

And here, for the benefit of new readers and long-time DR sufferers alike, we give our view:

When Mr. Market goes into a sulk, he takes a long time to come out of it. Real bear markets last 10…15…20 years. And judging by the meltdown in the financial sector…and the rapid losses we’ve seen over the last three weeks…we have a real bear market on our hands.

This bear market actually began in January 2000 when the tech sector crashed. But it was reversed when the feds opened a Hoover dam of liquidity, beginning in 2001-2002. Stocks floated higher…and consumers, business and Wall Street actually increased their indebtedness.

Every bubble expands until it finds its pin. The bubbles in housing, debt and the financial industry began deflating in 2006/2007. But the big popping noise was only heard in September/October of this year, when Wall Street itself imploded.

And now, the feds are out of easy options. They can’t push more credit on the poor consumer; because the credit pipes burst along with the bubble in the financial sector. Besides, if they were to lend the consumer more money, what would they lend against? House prices are falling.

With no more easy credit available to them, consumers are doing what they have to do – they’re cutting back. How much? For how long?

No one knows the answers to those questions but our guess is this: more and longer than you thought.

Why so?

"The real deterioration in the economy is only just beginning," said a London banker.

Every businessman we know is sharpening his pencil. He’s looking at his list of expenses and circling items that he thinks can be cut. Most of those items have someone’s name connected to them. Unemployment is going to rise more than expected. As it does, consumer spending is going to fall more than expected.

As to what to do about the weakening economy, says the New York Times, a consensus is forming. As might be expected, the mob wants more bread. And as might be expected, the feds are eager to give it to them.

Today’s headlines tell us that another stimulus package is being prepared in Congress. The pols are getting out the lights, the shiny balls, and the garlands – they’re going to Christmas tree this one even better than the last. Earmarks, nosemarks, cheekmarks – this new bill will have the marks of every greedy S.O.B. in Washington on it. Your town need a bridge? Better get the request in soon, so your Congressman can hang it on the tree. How about a new ‘community center?’ Got any indigenous people around…any victim group…any bunch of layabouts or n’er do wells who need handout? Cripples? Half-wits? Republicans? Kiwanis? Butchers? Car dealers! Yes, give the poor car dealers a break. They’re not even selling Japanese cars, according to the news.

Yes, dear reader, the fix is in. Ben Bernanke said he backs another stimulus bill. And this new measure should stimulate just about everyone; it’s sure to include more ‘rebate’ checks…infrastructure spending…and giveaways to anyone with a decent lobbyist.

But where does the government get more bread? More below…

*** And the financial crisis is not just contained to the United States.

"China is slowing down," explains Chris Mayer, "There are a lot of ways to tell this, but one of the best ways is to look at the China operations of international companies. For example, Best Buy reports its China same-store sales fell 7%. Kingfisher, which is a do-it-yourself chain, reported sales fell 19%. Yum! Brands, which runs KFC restaurants in China, said sales were up 5% – which is not so bad, but they were up 11% in the same period in 2007.

"So as China slows, that will have a big impact on commodity markets. And it may also be a bellwether for the rest of the emerging markets. Anyway, it’s another development we’ll watch closely when our businesses report. We have several companies whose international operations were a big part of the appeal and were growing much faster than the rest of the company.

"I still believe overseas markets will grow faster than the more mature Western markets and that we’ll be glad we have exposure to these markets over the long haul. As I say, we’ll have a better idea of a lot of these things soon."

*** Where do the feds get more bread? Their granaries are empty. And they’re already borrowing at the highest level in history.

"Where is the Treasury getting $700 billion?" asks Jane Bryant Quinn.

"It will borrow worldwide, by selling Treasury securities. Right now, there’s a strong demand for them, so it’s selling into a welcoming market.

"It is remarkable how much capital the U.S. has been able to attract to finance its borrowing needs," says Brian Sack, Washington-based senior economist at Macroeconomic Advisers. That might change, he says, "but there are no clear signs yet.”

When the clear signs appear, it will probably be too late. That’s just the way things work. Crises build…and build…like pressure in a volcano. Unless you’re paying close attention, the whole mountain explodes before you know what is happening. Then, it’s amazing how fast things happen. And it’s astonishing how often you say to yourself…’I knew that was going to happen" and wonder why you didn’t do the obvious thing to protect yourself.

As political columnist David Yespsen said in I.O.U.S.A., "I think it’s going to take a crisis before America responds to [the financial crisis]. This is America, we don’t do anything until something reaches a crisis; whether it’s military re-armament before World War Two or whether it’s this question now. We’re not going to be willing to take this pain until it gets to be a real problem."

And it has become a real problem. Eventually, the feds will find it harder to raise money. Lenders will not be so kind. Investors will be not so dumb. And the full faith and credit of the United States of America will not be such a sure thing.

A dear reader poses a good question:

"Can you give your readers an idea what portion of a $3 trillion annual budget must be earmarked (bad word?) to service the debt annually on a $9 trillion national debt? Also, if every thing remained static, how long it would take to pay down the debt?"

As to the first question, the writer is behind the times. The official national debt is now over $10 trillion. And for ease of calculation, let’s say it bears an interest coupon of 4%. That would put the annual interest charge at $400 billion…or 13% of a $3 trillion budget.

But remember, the U.S. government does not take in enough in tax receipts to pay current costs. With a falling tax take and rising social costs – not to mention rising bailout bills – the deficit is expected to come in above $1 trillion. Or, to look at it differently, the entire interest payment has to be borrowed too – in fact, more than 2 times the interest charge.

So, in 2010, the interest charge would be another $1 trillion x 4%, or $40 billion more. Imagine that the deficits go to $2 trillion…or beyond. Or that a $1 trillion deficit persists for a few years. It wouldn’t be too hard to imagine a national debt greater than the GDP in just a couple of years.

But it’s not just the deficit that matters…it’s also how much the feds have to pay to borrow the money…and how much new money, "out of thin air," they create. We will pass over the monetary theory and go right to the point. We recently saw a chart of "money aggregates." The chart roughly measures the supply of "money." After being nearly flat for the last few years, it has suddenly begun to shoot up. The feds are not just innocently borrowing, in other words; they’re inflating too. As expected.

*** If we’re right about inflation, you might want to buy some gold at today’s low prices.

Of course, we asked our old friend Issy Bacher, from South Africa, what he thought of the pullback in gold prices. In short, he thinks gold could pull back even more:

"Cycle analysis of the gold price doesn’t look encouraging at present. I gave an interview on CNBC some time back when I gave a forecast of $ 750. Gold was around $ 950 at the time.

"It got to $ 750 on 12/9/2007 Cycles again suggest that it could test support round the 750 dollar level. As the cycles are dynamic, we re-examine the cycles if it gets to that level. The strong support for gold is around $650."

We don’t know where the price of gold is going. But we know what we’ll be doing if it goes to $650; we will be buying more.

Until tomorrow,

Bill Bonner
The Daily Reckoning

The Daily Reckoning