* One of the bad side-affects of the US running a perennial trade deficit, which has totaled $7.5 trillion over the last 30 years, is that at some point, it has to result in a falling standard of living in the US. Digressing for a moment to a world on a gold standard, if the world was on a gold standard, then the US would have to ship gold to countries running a trade surplus, and in turn, would have to take currency, which is backed by the gold, out of circulation. In turn, this would reduce economic activity within the US (as the money supply shrinks) and our national wealth would decline consistent with a drop in GDP. Accordingly, we would import fewer goods, and as our currency drops in value, would become an exporter, and the trade deficit problems would self correct.

However, we live in a world where we can print money at will (Federal Reserve credit is up $1.3 trillion) over a few years, and our foreign trading partners are content to take our IOU's. Accordingly, we have been fooled into thinking that we can print money to alleviate the natural consequences of what a gold standard cause. Are we fooling ourselves, or have we in fact figured out a way to defy gravity? 

If you are from the Austrian School of Economics, then you will say that ultimately there will be a crash, as the effects of printing money will result in a need to restore the value of the currency to its intrinsic underpinnings. This can occur through inflation, the easiest to implement, or through a crisis as the effects of easy money results in over-leverage, and the subsequent crash which has so far played out on a modest scale in the US housing market. I say modest scale, because the mother of all crashes would be a collapse of the US dollar, and a US debt crisis, including dramatically higher interest rates on an exponentially growing debt.

And this brings me to the political imperative of the Obama administration, as well as an ominous foreshadowing of what could come to the US. A reader has sent me an article about the effects of chronic unemployment which the US now faces, from the March edition of the Atlantic. Here is the link:

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It's a rather lengthy article, but here are a few excerpts which encapsulate the undesirable effects of chronic unemployment, which the country is going through. This is despite the apparent recovery in the stock market and the level of GDP:

"According to the National Association of Colleges and Employers, job offers to graduating seniors declined 21 percent last year, and are expected to decline another 7 percent this year. Those who start their career during a recession make 25% less than those who start during a boom time. They also switch jobs less often" (because they are more fearful about getting another job).

"Forty years ago, Glen Elder, a sociologist at the University of North Carolina and a pioneer in the field of "life course" studies, found a pronounced diffidence in elderly men (though not women) who had suffered hardship as 20- and 30-somethings during the Depression. Decades later, unlike peers who had been largely spared in the 1930s, these men came across, he told me, as "beaten and withdrawn-lacking ambition, direction, confidence in themselves." Today inJapan, according to the Japan Productivity Center for Socio-Economic Development, workers who began their careers during the "lost decade" of the 1990s and are now in their 30s make up six out of every 10 cases of depression, stress, and work-related mental disabilities reported by employers."

"_in his book, Children of the Great Depression, Glen Elder wrote that adolescents who experienced hardship in the 1930s became especially adaptable, family-oriented adults; perhaps, as a result of this recession, today's adolescents will be pampered less and counted on for more, and will grow into adults who feel less entitled than recent generations."

I included the last quote because it offers hope for the future, despite the otherwise depressing forecast which this article makes.

What I draw from this article, as encapsulated by these quotes is that the US is sowing the seeds of future problems. In the 1930's the US was sling-shotted out of the depression and into World War 2. With much of the worlds productive capacity ruined in WW2, the US provided the main growth engine for the new world order. The imperative of history enabled the US to avoid many of the adverse effects of the chronic unemployment which characterized the 1930s.

Which leaves me to ponder the question: "What will alleviate the problems of joblessness today?" The labor department tracks a truer measure of unemployment which also accounts for people who are part time (under-employed) employees and marginally attached to the labor force. This reading sits at 16.8%, and I believe this is this is the highest (this cycle) that this has been since this data was collected going back to 1948. When I overlay the non-economic effects of our abysmal employment situation, it occurs to me that Obama, at some point in time, will resort to desperate measures to get the country working again. 

And this brings me to Germany in the 1920s. Following their loss in WWI, Germany embarked on a series of government sponsored work programs to gain full employment as a means to restore the participation in the economy by a dis-enfranchised population. This was also with a backdrop of having to make war reparations to the winners of WWI, who were understandably pissed off at them for their part in the war. This put the German leadership between a rock and a hard place. The only way they knew to accomplish their twin goals of domestic cohesiveness and to repay war debts, was to run the printing presses to fund government spending programs. For a while, all seemed to go well, unemployment was near zero (while the rest of Europe had a 5% unemployment rate), the German economy was running full speed forward, and Germany was making enough money to begin repaying their war debts. Ultimately, this strategy proved to be ill-founded.

And this brings me to ponder what our government will do if unemployment stays at high levels. Those folks out there who are making the precious metals bet are convinced that the US government will print money and come up with more stimulus programs to counteract the problems of chronic unemployment. Otherwise, the summary headline of the Atlantic article will come true:

"The Great Recession may be over, but this era of high joblessness is probably just beginning. Before it ends, it will likely change the life course and character of a generation of young adults. It will leave an indelible imprint on many blue-collar men. It could cripple marriage as an institution in many communities. It may already be plunging many inner cities into a despair not seen for decades. Ultimately, it is likely to warp our politics, our culture, and the character of our society for years to come."

The Fed has a Congressional mandate to promote economic growth and price stability. We are likely to come to a cross-road in the not too distant future, where we will have to decide between economic growth and inflation. Knowing the inclinations of Obama, I will bet that he will sacrifice inflation in exchange for economic growth. Currently, the Fed has said they will not allow inflation to come back, and seemed poised to raise rates if inflation and or economic growth come back to a larger degree. However, there are 4 vacant seats on the Federal Reserve which need replacements to be appointed. If Obama appoints people who would tolerate inflation in favor of economic growth, then we risk a repeat of Germany's policies in the 1920s. This is the risk today. If we allow inflation to take hold, then most every asset category, except cash and fixed income securities, will do well.

At the end of the day, the current unemployment problem is a reflection of the fact that, as a country, we spent way more than we should have, extracting the fleeting levels of equity from our now declining housing stock. Many of these expenditures made their way overseas, and in turn, our trading partners now hold much of our debt. Eventually, there needs to be some process of equalization, which means the US as a country, needs to consume less, save, and pay off our debts to those who hold our paper. In a very macro-economic context, this means our standard of living needs to drop. The sharp rise in unemployment, in a very back-handed way, forces national savings by virtue of lower spending. The equalization process of our national debt has started, and is likely to continue for some time to come. Therein lies the danger and allure of printing our way (money) to a false sense of prosperity.

I will conclude this section with a comment from the 20 something reader who sent me the Atlantic article:

"I acknowledge the obstacles that remain ahead, economically and generationally speaking, are formidable, and I hope that my generation can come up with a solution (maybe even learn a few important lessons along the way).  The real issue - the main fact here is that in economic hard times, you absolutely need to have a skill (a real one, BS-ing is no longer valid). A close friend once defined skill as an extension of a blend of your inclinations, intellect and dreams. Usually it is right in front of your face. Sometimes it takes a while to harness and point in the right direction.  I was too young to catch the coattails of the 'ride up' in our (financial) industry, but I have witnessed people around me ride the falling rocket back to earth. Some of them still seem surprised that this happened, which is scary. I do believe that going forward there will undoubtedly be a decreasing lower and upper-class (the poor will get poorer, and the rich will get poorer), and an increasing middle class. I guess my question is, after you have confiscated wealth from the rich, who do you go after next, (certainly can't be the poor)? What if we stall for a long time?" (end of readers comment)

This is where printing money comes in.

Stock market follow-up - Here is something I forgot to include in yesterday's blog: one of the reasons why I am on alert for the potential for an additional rally in stocks, is that the rally on Friday, occurred with a strong ratio of winning stocks out-numbering losing stocks. The S&P the ratio was approximately 15:1 and on the broader NYSE, it was 7:1. While not conclusive in their own right, this is a measure of underlying strength in a market, and accordingly, this puts me on alert that the stock rally could have more room to run. Nonetheless, I am holding onto my long dated (December 2010) Put options; I have just closed out my leveraged short positions.