“How You Got Screwed: The End Game”, Final Excerpt
Thursday, May 24, 2018 6:17
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“How You Got Screwed: The End Game”, Final Excerpt
by Crimson Avenger
“Chapter 16: The End Game: Let’s be clear: I don’t know how things are going to play out in the future, nor do I know when we’ll hit any sort of a breaking point that would welcome in a crisis. (No one else does, either, so be cautious of people who say they know what’s going to happen in the coming months or years.)
But I do know that we’re not on a sustainable path. All of the problems described in this book are growing and build on one another to create a sort of “pressure cooker” environment that cannot go on forever. Just think about how the trends we see today feed off each other to create the ideal conditions for some sort of economic or social disruption:
•Despite the government’s claims of low inflation, the price to consumers of most things – including but not limited to food, housing, medical care and education – continue to rise.
•Debts of all kinds – personal, corporate, and government – are rapidly increasing. The federal government’s debt is sitting at the $20 trillion mark, making America the greatest debtor in the history of the world.
•After a 35-year decline in interest rates, allowing more and more borrowing, we have bottomed out and started to move back up, making borrowing more expensive and killing the longest-running bond bull market in history.
•Wages have not risen in real terms since 1979.
•We have a huge percentage of the population moving into retirement age, where they will stop contributing to the tax base, start requiring more government services, and depress asset prices as they sell their investments.
•Income equality is at the highest level since the Great Depression, and movements such as Occupy Wall Street show an increased awareness – and resentment – of that fact.
•Our social tapestry is fraying, with trust in various institutions at or near record lows and domestic movements ranging from the Tea Party to Black Lives Matter.
•The economist Herbert Stein offered Stein’s Law, which said that “If something cannot go on forever, it will stop.” With that truth in mind, think about whether any or all of the trends above can go on forever.
•How long can prices continue to increase while wages remain stagnant? Can debts continue to rise forever as interest rates climb? What will those happen to the federal deficit as interest rates go up?
And what happens as some of these trends reverse? If the government cannot keep on borrowing $1 trillion per year, what happens to the wave of retirees who need Social Security, Medicare and other government services? If wages continue to stagnate, how long before peoples’ resentment of record income inequality leads to an active response?
What Would a Disruption Look Like? As I said, I don’t know what will happen: There are a lot of very smart people who differ on even fundamental questions, like whether these factors are more likely to lead to inflation (or even hyperinflation) or deflation. A lot of it depends on what some powerful players, like the government and Federal Reserve, do in response to early crises, and there’s no way to predict with certainty how they’ll act.
But I’ll go out on a limb and tell you what I think might happen.
For context, remember that in 2008, the Federal Reserve got caught flat-footed as people failed to make loan payments and the resulting defaults spread throughout the system, crushing both lenders and investors. The Fed poured a flood of liquidity into the system, removed many of the rules that were causing problems (such as “mark to market”), and directly bought up trillions of dollars of bad debts and other assets to create demand in a market that sorely needed it. Finally, to spur confidence, they directly intervened in the financial markets to levitate the price of assets, hoping to create a wealth effect that restored confidence and investment.
Rightly or wrongly, their response worked – but what was supposed to be a temporary intervention turned into a permanent state of intervention. The markets knew that there was a Fed “put” and investors, mostly institutional investors, piled back into the market. The day was saved, at least for the time being. But the absence of any real reforms left a financial system that looked good on the surface but was continuing to rot on the inside.
Like the military, I think those in power tend to prepare for and fight the last war. And in this case, the Fed is ready to prevent widespread defaults by again pumping money into the system and further relaxing rules. A case in point is the fracking industry, which borrowed tremendous sums of money when oil prices were high, and found themselves in deep distress when the bottom fell out of the market: Banks significantly relaxed loan terms to allow firms to avoid defaulting, and there are rumors that this was done at the insistence of the Federal Reserve.
In the big picture, the fracking industry is small potatoes in terms of default amounts. What happens when a larger market hits a stress point? Suppose the housing market crashes again (keeping in mind that prices are higher than they were at the 2007 peak)? Suppose we acknowledge the nonpayment issue in the $1.2 trillion student loan market? Suppose a major financial institution, such as a pension firm or an insurance company (both crushed by low interest rates), goes under? I think there are several ways in which another financial crisis could kick off.
Given the Fed’s refusal to allow defaults or market declines, we can expect that they’d respond by again pouring money into the system and removing even more rules. But that trick can’t work every time. The United States is the world’s reserve currency, despite the fact that we’re the world’s largest debtor and that we severed any real backing of assets for the dollar when Nixon took us off the gold standard in 1971.
If the U.S. was a closed system, they could probably get away with this for a long time: We don’t have any alternatives to the dollar. But the world’s view is very different. People in other countries already know that there’s nothing backing the dollar, and they already hold a lot of dollars and dollar-denominated assets (like Treasury bonds) based on the idea that it still serves as a store of value. If they see the Fed make another large-scale move to shore up domestic markets with a further infusion of dollars created from thin air, they have a strong motivation to get rid of those devaluing dollars – and to do so quickly, before they lose more value.
If foreign markets start to abandon the U.S. dollar, the effect at home would be cataclysmic. First, people overseas wouldn’t want dollar-denominated assets anymore, leading to a sell-off in Treasury bonds and a refusal to buy more American debt, largely eliminating our ability to run deficits; as a result, interest rates would rise rapidly to make them more attractive to the few buyers left. If the Fed stepped in to buy that debt the problem would get exponentially worse. Even beyond the debt issue, foreigners would try to get rid of any dollars they had left, resulting in a flood of dollars coming into the country as people tried to exchange them in a panic for real goods.
The result of this huge influx of dollars will be hyperinflation, with the dollar rapidly losing what little value it had left. Our days of running deficits will be over, since no one will accept devalued dollars for their products, which will be a problem particularly for things like oil. (Despite what you hear from the media, we are not energy independent.)
With all those dollars flowing back in, you’d think we’d all be awash in money; we won’t. As prices rise rapidly, demand falls off, which means people will lose their jobs. We’ll end up with hyperinflation in the things we need, and since few will be able to afford luxury items, we’ll see widespread deflation in the things we want, such as all those assets that retirees need to sell.
The social impact of these changes will be severe. There’s already quite a bit of resentment against the rich and powerful; that will increase as they’ll be blamed for these problems, and that may turn into some unpleasant actions. Government programs like Social Security and Medicare will fail to provide for people’s basic needs, and those who cannot provide for themselves, like the elderly, will find themselves in severe distress. The rest of us will struggle to get by with little money and out-of-reach prices. It will be the Great Depression all over again, even though the Fed was specifically trying to avoid that outcome. And what’s worse, we’ll be living in a Great Depression without the skills and self-sufficiency that allowed our forebears to survive it.
I want to reiterate that this is just one possible scenario; it’s just what I personally see as being likely, and the future may play out in a completely different fashion. But I think when you consider all of the challenges listed at the start of this chapter, it’s hard to envision a scenario where everything turns out just fine.
An Alternate View: A disruption doesn’t have to come from government overreaction, and it doesn’t have to be caused by an inflationary spike. It could also come from an extension of existing consumer behavior, leading directly to deflation without the extra steps suggested above.
In economic terms, deflation refers to a reduction in the money supply; in practical terms, we would experience it as a vicious spiral with purchasing ability and product pricing ratcheting lower and lower. (Imagine consumers spending less, which leads to lower prices as companies try to capture any remaining customers, which leads to consumers spending even less as they either lose their jobs or wait for prices to drop even further.)
The elements for a deflationary slide are largely already in place. The labor participation rate hasn’t been this low since the 1970s, meaning there are a lot fewer people generating income than there have been in recent decades. And with the prices of a handful of needs continuing to rise rapidly, particularly healthcare, those people who do have incomes have far fewer dollars to spend on other things.
We’re already seeing a muted level of deflation now, with intense price competition for goods and services along with a shakeout in the retail sector. To kick off a more pronounced and rapid deflation, all we would need is a continuation of trends, such as a continued increase in healthcare premiums (which would also lead to more employers dropping plans and leaving employees to shoulder the entire burden) or a sudden additional stress on purchasing power, such as lower wages from a recession or a move to tighten credit standards, leaving people with less credit.
Once you enter a true deflationary cycle, it’s very hard to escape. People with less income not only spend less, hurting the commercial economy, but pay less in taxes, hurting government revenues (which in turn again hurts the economy through lower levels of government spending and less money available for public welfare payments). After a few rounds of this type of deflationary cycle we would end up in a second Great Depression, traveling a different path to the same outcome from the previous hypothetical example.
When Will Something Happen? Imagine that it’s 2002, and you live in New Orleans, in St. Bernard Parish. You know your Parish sits below sea level, and you know that storm activity has increased over the past few years. You start to do some research, and it becomes clear to you that it’s only a matter of time before a big storm hits your area and, thanks to your location, the effects could be extremely bad.
Armed with that information, what would you do? Would you make plans to move from an inherently dangerous situation, even if you don’t know when that danger might occur? Would you warn your friends and neighbors, or worry that they would think you an alarmist – or worse? If someone offered you an opportunity to invest in local real estate – making a long-term investment in the area – would you do it? Or would you dismiss what you had read and just go on living your life, reasoning that since nothing bad had happened so far, everything was probably fine?
If you tried to tell people what you learned, you might forgive them for not believing you – life went on, Mardi Gras came and went every year, and nothing actually happened. Nothing, that is, until August 29, 2005, when New Orleans was hit by Hurricane Katrina – and St. Bernard Parish, your home, was under 12 feet of water within minutes of the levee breaking.
This may be a dramatic analogy – but I think it’s a fair one, and it makes an important point. No one can predict when something bad will happen. But if you see all of the trends leading inevitably to that point, then you have time to prepare for it. You don’t know how much time you have – it could be a day, it could be ten years – but you do have time, and it’s your responsibility to use it wisely. The question of “when” is of lesser importance if you have a clear sense of “what.” Every day is a chance to do something to help you weather the storm that you know is coming.
As the old saying goes, “Better a year early than a day late.”
○
Author’s note: This is the third chapter excerpted from “How You Got Screwed,” posted courtesy of The Burning Platform. (You can find the first two chapters here and here). If you liked these samples, note that there are 14 more chapters in the book, which is less than $10 on Amazon. While much of this may be old news to TBP readers, I hope you’ll agree it could serve as a good eye-opener to people who don’t frequent this site. Buy in bulk, and buy often.
Source: http://coyoteprime-runningcauseicantfly.blogspot.com/2018/05/how-you-got-screwed-end-game-final.html
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