Friday, July 13, 2007

The Crack up Boom! A Special Report

If you mosey on over to the suddendebt blog, you will see some very interesting charts that portend much higher long term interest rates. How, you may well ask, can a wobbly economy sporting a first class housing bust, and a tapped out consumer, be due for higher rates? It doesn't make sense. Actually it does, if one considers the possibility, if not the likelihood that the powers that be are set to flood the system with credit at an unprecedented rate. It is about as ironclad a law as exists in economics that the more there is of something the less valuable that something becomes. With that in mind, some of you may have noticed that for some time, since roughly 2002, in fact, the dollar has been acting rather poorly against the rest of the world's fiat currencies. That's what happens when supply swamps demand. As this trend continues and even accelerates, borrowers of U.S. debt, who are generally foreigners, can reasonably be expected to demand higher rates as compensation for the falling greenback.

The "crack up boom", a colorful term coined by Ludwig Von Mises to describe a phenomenon seen in such diverse cultures as 1920s Weimar Germany, and 1980s Argentina, is one in which prices for many assets are bid through the roof as folks become desperate to trade in their rapidly depreciating currency for items that will maintain purchasing power. Purchasing power is the name of the game, which is why, though we should not get overly excited by the present action of, for example, the stock market, as it makes nominal new highs (After all, if we have, as I contend, experienced high single digit inflation year over year since, oh, say, 2002, then the Dow Jones would need to be closer to 17,000 then 14,000 to be equal in real terms to where it was at its highs in early 2000.) seemingly on a daily basis, we might equally worry that the market is going to go parabolic as people look for places that might conceivably compensate them for their rapidly eroding currency.

For years now, the monetary authorities have created an environment of revolving asset manias that have, to some degree, masked general economic deterioration. Alan Greenspan, and now, Helicopter Ben Bernanke, aided and abetted by all sorts of dodgy private sector credit schemes, have, for years, literally and figuratively papered over the structural hollowness of our burger flipping, consumer on steroids driven, domestic economy. Over the better part of the last fifteen years the U.S. ecomony has experienced several stock market booms and busts, and most recently one real estate boom and epic bust. And one of the prices we have paid, since approximately 2002, for official and unoffical financial profligacy, is that the dollar has been absolutely drubbed by every other major fiat currency and precious metals.

In truth, the greenback has been beaten down on a purchasing power basis since the inception of the Federal Reserve System, such that a dollar today will buy what a nickel would in 1913. But I only mention that fact to provide context. Fiat regimes, without exception, always end badly, because any system that abandons discipline, no matter what arena we are speaking of, political, military, or financial, is ultimately doomed to failure. However, we may now be at the point of acceleration of the dollar regime's implosion. The fact that we are staring at prospectively higher long term interest rates even as our domestic economy seems poised for a downturn, is merely the most recent and perhaps best sign that things are about to enter a new phase of deterioration.


DED said...

I think I understood everything except: "the powers that be are set to flood the system with credit at an unprecedented rate." And that's due to the fact that I'm a relatively "late bloomer" to the study of economics. It sounds like getting credit is going to become even easier, but we should expect interest rates to go sky high too. So, anyone who has two pennies to rub together can get credit but it's going to be at double digit rates. Do I have that right?

Anonymous said...

Thanks for the link ded, yeah that caught my attention. I think you may have meant past tense on that, at the least a continuation of the debauch, which, you noted began at the inception of the fed. I have been telling people to buy some durables as a hedge. Buy booze, tp, whatever, in bulk, because it will not be cheaper tomorrow. I don't care what the deflationist camp says. The PTB want you to believe deflation is around the corner so you'll hold your dollars. Crack up hyperinflationary stagflation. What was it Mish called it? Stagindeflation? Meaning the dollar will get more and more worthless but I will never get any.

Edwardo said...

Well, ded, that is a very interesting question, will anyone who has two pennies to rub together be able to avail themselves of credit, more accurately, will they be able to get into (greater) debt? My response is almost certainly not, as the number of players who are able to ride the next asset mania will likely be far smaller than have played the various manias to date.

This will be due to several reasons such as the reduced financial circumstances of the populace as a whole, more stringent lending standards, at least where low and mid range housing is concerned, and so on. And that is par for the course, as we have such an imbalance amongst the citizenry in economic and financial circumstances, such that a small number of the total population controls the lion's share of the nation's wealth.

So some entities and individuals will be able to avail themselves of credit, but I'm not at all sanguine about the fate of the folks with two pennies to pinch together. Whatever they do have though, will be traded for stores of value of some sort. As for rates, they are going higher, much higher in my view.

Edwardo said...

Thanks for dropping by edgar's sister. I think Mish Shedlock's scenario may well evolve, but after the smoke clears, deflation will have an excellent chance of playing out as all the leverage in the system delevers because the assumptions about the quality of the debt that supports the leverage are revealed to be rubbish. Likewise, on a longer term basis, the growth notions that undergird our entire economic system will be revealed to be equally as preposterous in the face of such phenomenon as Peak Oil.

As they say in Spanish, Vamos a ver.