Oliver Wyman Group has released a very interesting piece about the potential for a future financial crisis (thanks to the FT). They make the case that the next great financial crisis will occur around 2015 and will be the result of a massive bubble in commodity markets that results in widespread economic collapse and sovereign defaults.
I’ve described in recent reports how the financialization of the USA is helping to drive commodity prices higher (see here for more) and generate economic instability. This, combined with the other two major structural imbalances in the global economy (China’s flawed economic policy and the inherently flawed single currency system in Europe) are creating an environment that is ripe for disequilibrium and turmoil. The potential for bubbles is not only likely, but now appears like a near certainty.
Wyman describes how the bubble will form in commodities and ultimately collapse:
“Based on favorable demographic trends and continued liberalization, the growth story for emerging markets was accepted by almost everyone. However, much of the economic activity in these markets was buoyed by cheap money being pumped into the system by Western central banks. Commodities prices had acted as a sponge to soak up the excess global money supply, and commodities-rich emerging economies such as Brazil and Russia were the main beneficiaries.
High commodities prices created strong incentives for these emerging economies to launch expensive development projects to dig more commodities out of the ground, creating a massive oversupply of commodities relative to the demand coming from the real economy. In the same way that over-valued property prices in the US had allowed people to go on debt-fueled spending sprees, the governments of commodities-rich economies started spending beyond their means. They fell into the familiar trap of borrowing from foreign investors to finance huge development projects justified by unrealistic valuations. Western banks built up large and concentrated loan exposures in these new and exciting growth markets.
The banking M&A market was turned on its head. Banks pursuing high growth strategies, particularly those focussed on lending to the booming commodities-rich economies, started to attract high market valuations and shareholder praise. In the second half of 2012 some of these banks made successful bids for some of the leading European players that had been cut down to a digestible size by the new anti-"too big to fail" regulations. The market was, once again, rewarding the riskiest strategies. Stakeholders and commentators began pressing risk-averse banks to mimic their bolder rivals.
The narrative driving the global commodities bubble assumed a continuation of the increasing demand from China, which had become the largest commodities importer in the world. Any rumors of a slowing Chinese economy sent tremors through global markets. Much now depended on continued demand growth in China and continued appreciation of commodities prices.”
The bubble bursts Western central banks pumping cheap money into the financial system was seen by many as having the dual purposes of kick-starting Western economies and pressing China to appreciate its currency. Strict capital controls initially enabled the Chinese authorities to resist pressure on their currency. Yet the dramatic rises in commodities prices resulting from loose Western monetary policies eventually caused rampant inflation in China. China was forced to raise interest rates and appreciate its currency to bring inflation under control. The Western central banks had been granted their wish of an appreciating Chinese currency but with the unwanted side effect of a slowing Chinese economy and the reduction in global demand that came with it.
Once the Chinese economy began to slow, investors quickly realized that the demand for commodities was unsustainable. Combined with the massive oversupply that had built up during the boom, this led to a collapse of commodities prices. Having borrowed to finance expensive development projects, the commodities-rich countries in Latin America and Africa and some of the world's leading mining companies were suddenly the focus of a new debt crisis. In the same way that the sub-prime crisis led to a plethora of half-completed real estate development projects in the US, Ireland and Spain, the commodities crisis of 2013 left many expensive commodity exploration projects unfinished.
Western banks and insurers did not escape the consequences of the commodities crisis. Some, such as the Spanish banks, had built up direct exposure by financing Latin American development projects. Others, such as US insurers, had amassed indirect exposures through investments in infrastructure funds and bank debt. Inflation pressure in the US and UK during the commodities boom had forced the Bank of England and Fed to push through a series of interest rate hikes that forced many Western debtors that had been holding on since the subprime crisis, to finally to default on their debts. With growth in both developed and emerging markets suppressed, the world once again fell into recession.”
Of course, this scenario is already largely playing out in real-time. We are seeing investors drive up the prices of commodities as the global economy recovers and speculators look for the next big boom. Wyman elaborates:
“However, it is already apparent that increasing commodities prices are also creating inflationary pressure in China, which is exacerbated by China holding its currency artificially low by effectively pegging it to the US dollar. This makes commodities look like an attractive hedge against inflation for Chinese investors. The loose monetary policy in developed markets is similarly making commodities look attractive for Western investors. This "commodities rush" is demonstrated in the right-hand chart below, which shows the asset allocations of European and Asian investors. A recent investor survey by Barclays also found that 76% of investors predicted an even bigger inflow into commodities in 2011.”
Ultimately, they conclude that the imploding commodity bubble will lead to another financial crisis and sovereign defaults. Their “base case” scenario involves mostly European nations experiencing defaults. This looks not only likely, but probable. It is likely that the periphery of Europe will remain mired in recession for several years as austerity measures put downward pressure on their economies and the Euro governments fail to enact a true fix to the flawed single currency system. Persistent weakness in Greece and Ireland will cause continual political turmoil and ultimately the scenes of Egypt would not be surprising throughout many parts of Europe as citizens demand real change. The Euro would likely remain the primary European currency, however, several periphery nations would reconsider their involvement.
Now, where I disagree with the Wyman analysis is in their “worst case” scenario. Any regular reader knows that it is highly flawed analysis to conclude that the USA could potentially default on its obligations – all of which are denominated in the currency in which it alone has monopoly supply of. This simple point eludes even the brightest minds in economics today. A default of the USA is impossible. The only form of default could come through hyperinflation. Considering the deflationary collapse that would likely result during the Wyman “worst case” scenario I think it’s likely that we would once again see the USA become the global safehaven and the USD would not collapse, but surge as it did in 2008. Still, the economic impacts would be deeply negative for the entire global economy though a collapse of the USA is not on the table.
We continue to see increasing disequilibrium in the global economy. The flaws in the Euro, China’s misguided economic policy and the endless financialization of the USA are the three primary factors contributing to what is unavoidable future calamity. It’s clear that none of these countries are willing to risk any sort of near-term pain that would be required to fix these structural imbalances so it’s not a stretch to assume that we will continue the boom/bust cycle that has become a trademark of the last 25 years of global economic growth. The commodity bubble will merely be a symptom of these imbalances.
Wyman concludes that this event could be several years away, however, I fear that this event could easily occur sooner than 2015. We remain in one continuing balance sheet recession with rippling waves that could cause these imbalances to resurface sooner than anyone believes. The resulting impacts will be broad and have the potential to forever change the way we approach future economic growth and the way governments intervene in markets. I would expect the Bernanke Fed to be in the middle of the ensuing storm. Such a crisis would likely result in wide ranging policy changes that will finally clear the imbalances of the credit crisis and create a foundation for truly sustainable economic prosperity.
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icBrokerWidget('pragcap', 600, 55); Comments prescient11I agree, 2015 seems to be a panic year.
Reply 01/31/2011 at 9:12 PM prescient11I disagree that it will be a commodities bubble though.
The biggest bubble ever being blown in a DEBT BUBBLE. It will become a currency crisis, plain and simple. These government whores will simply not stop adding to the debt load. And then we will no doubt have some clown in the image of “Volcker” act as the responsible one.
Doesn’t everyone see!! Volcker doubled the debt all by himself and his crazy interest rate policy. So, if the pubs take back power they will mirror Volcker’s mistakes and then raise interest rates. This is exactly the wrong policy!!! And worse of all, guess who gets paid off for holding all those treasuries, the banksters!!!
It’s just a debacle and you can see it happening down the road. sigh.
Even though the deficits will be significantly reined in, these morons will not appreciate how much raising interest rates appreciably will do to America’s debt burden. So-called fiscal responsibility will CAUSE the upcoming currency crisis.
Reply 01/31/2011 at 9:21 PM first“guess who gets paid off for holding all those treasuries, the banksters!!!”
Raising rates ? They make there money on the spread and at 0% they are in haven.
Reply 02/01/2011 at 10:54 AM AlexIn the past, bubbles have taken a while to build up, develop, and eventually pop. However, I think this is changing – the speed the market moves nowadays is incredible. Judging by the ups and downs of the past 2 years, a new bubble could emerge within a shorter period than previously.
Reply 01/31/2011 at 10:39 PM Cullen RocheAnd with the Fed’s explicit intervention you have all of the ingredients for a bubble….
Reply 01/31/2011 at 10:58 PM DerfemYes, but they say 2013 as the year of the burst of the commodity bubble, which lead to a financial crisis in 2015. 2013 is 2 years from now.
TPC, have you read the Pettis of this week about China GDP ?
Reply 02/01/2011 at 2:42 AM Cullen RocheI have not read it. Good?
Reply 02/01/2011 at 3:06 AM nottpcAnyone being honest knows this is coming. Its just a matter of when not if. Not much new ground here other than time stamping it. Heck 90% of zero hedgers commentators are calling for the same analysis as above.
Reply 01/31/2011 at 11:33 PM nottpcP.s. I disagree with your last paragraph that it will cause change. If I told you 5 years ago what would happen in 2008 you would swoon and say something so epic would cause wholesale change in the country. After we flush the taxpayer will ge raped again, the congress will pass empty regulation, and goldman sachs will become more powerful. After the Yellen Put is in place the market will rebound 100% by 2017 and we will be ready for the housing bubble of 2019. We are as corrupt as any 3rd world nation but our footprint and corruption causes waves that effect the world.
Reply 01/31/2011 at 11:37 PM Cullen RocheI guess I am just being hopeful…but you’re probably right.
Reply 02/01/2011 at 12:04 AM Matt Blackman“Now, where I disagree with the Wyman analysis is in their "worst case" scenario. Any regular reader knows that it is highly flawed analysis to conclude that the USA could potentially default on its obligations "“ all of which are denominated in the currency in which it alone has monopoly supply of. This simple point eludes even the brightest minds in economics today. A default of the USA is impossible. The only form of default could come through hyperinflation. ”
Congratulations! This has to be the single most obtuse comment I think I have ever read on the current financial situation of the US and the US dollar. You are clearly either completely ignorant of, or have a very poor understanding of the history of fiat paper currencies throughout history.
I grant you that fiat paper reserve currencies are relatively rare but in the multitude of incidences of fiat paper currency collapses since its first occurrence in Song Dynasty China (circa 1100AD) fiat paper currency economies have suffered daunting similar fates: hyperinflation followed by ultimate economic collapse. If you think such an outcome is impossible in the US, I’d like two of what you are drinking.
Reply 02/01/2011 at 12:33 AM Cullen RocheIf you’re implying that the USA is going to suffer hyperinflation then you must recognize that you are arguing in favor of one of two outcomes:
1) A massive collapse of US output which crashes faith in the sovereign currency. 2) Government spending well in excess of our productive capacity that leads to spiraling inflation ultimately leading to a collapse in faith as govt is seen as corrupt and inept.
I think the first scenario is highly unlikely given the fact that our corporations are extremely strong right now and global demand for US goods and services remains quite strong. If you’re betting on the collapse of companies like Exxon, Apple, J & J, etc then I guess I should wish you quite a bit of luck because you will probably need it.
#2 is more likely, however, we’re nowhere close to spending in excess of productivity capacity. Capacity utilization is just 75%, unemployment is 9.4%, the output gap is 8%, etc. While our spending appears excessive at the moment the truth is that it is nowhere near the levels that would generate substantial wage inflation and full employment.
If you have another scenario (plausible) then I am all ears.
Reply 02/01/2011 at 12:45 AM Matt BlackmanWhere do I start?
First you need to forget all that economic crap you were shoveled in university. Most of it was Keynesian economics anyway which makes it all the more suspect. For some reason, Mises and Austrian school economics got lost (or thrown out) by those who set academic curricula along the way which is a real shame.
My argument is based on an understanding of the histories fiat paper currencies over the last two millennia. You make the mistake that the vast majority of economists and monetary policy strategists have made and continue to make, a poor or non-existent understanding of the history of fiat paper money. Books like This Time Is Different (Rogoff and Reinhart) and Fiat Paper Currency (Ralph T. Foster) are great places to start. If more people understood similarities between the US (and other fiat paper currencies) and extinct fiat currencies throughout history, there would be far less tolerance of the policies that are leading us down the same road today.
Your comment, “A default of the USA is impossible. The only form of default could come through hyperinflation.” Every fiat paper collapse that has occurred in history, has come as the result of first hyperinflation, followed by economic collapse. Its like saying we can’t have another financial crisis without a recession. Technically possible perhaps, but practically non-existent from a probability standpoint.
You also appear to have a high respect for the accuracy of statistics such as GDP growth, unemployment, and CPI. You like many, fail to realize that they are not designed to tell you what is really going on with the economy, they are electioneering tools plain and simple. (Tell the people what they want to hear so they will re-elect the incumbent party. Why do you think 93% of all Dow gains since 1902 have come in the 2 year leading up to elections? (See http://tradesystemguru.com/content/view/305/61/ )
Govt stats have been so heavily manipulated in the last thirty years (thanks to a bevy of statistical tricks such as imputations, substitutions and hedonics) as to make them virtually worthless as real econometric measures. For example we are being told that unemployment is 9.4%. BS, the real figure (U6) says its north of 17%. Those who pay them other than passing interest, do so at their peril. It is up to every serious trader and investor to find their own more accurate economic indicators unmolested by political motive.
You are also ignoring the fact that companies like Exxon, Apple etc are not US companies, they are multinationals with operations around the globe. Yes, what happens in the US (like a general and widespread crisis of faith in the USD) would impact them but it probably would not be fatal unless the whole global economy collapses which is extremely unlikely.
Corporations are strong now because they were bailed out en masse and are the beneficiaries of endless amounts of virtually free (or at least artificially cheapened) money at taxpayer expense (and risk) but very little risk to themselves. Pretty hard not to do well in that scenario.
In a fiat currency scenario, commodity prices skyrocket as real currency values fall and those who understand what is going on, seek the relative safety of intrinsic value so although commodity values will fluctuate, they will remain strong as long as fiat paper monetary policies are allowed to continue.
The major US (and developed nation) challenges now are the levels of debt and reliance on consumer spending to drive economic growth. Maybe the latest round of stimulus in the form of QE2 will work temporarily. But at no time in history has an economy printed its way to lasting prosperity. Many have tried but none have succeeded more than a few years.
“While our spending appears excessive…” You tell me how excessive it is. US total credit market debt now exceeds $55 trillion. For those unfamiliar with the term, TCMD is total government (all levels), corporate and household debt. That works out to more than $680,000 per US resident family. The figure also does not include unfunded liabilities for medicare, medicaid, social security etc to the tune of another $60 trillion.
Please do the math and check those numbers. But by my calculations, those totals exceed $1 million per family. How is the average household going to pay that back? They can’t.
That leaves two outcomes. Inflate the problem away, which is the current solution or default.
Those who trivialize or ignore these issues, without taking some action to insulate themselves and their families from these risks, put themselves in harms way. An understanding of the history of currencies that have graduated to fiat status like the US dollar in 1971(and nearly every other national currency by default) is a great place to start to prepare!
Reply 02/01/2011 at 1:53 AM Cullen RocheThere’s a lot to cover. I don’t know if there’s much use in the forecast that “every fiat currency fails”. That’s kind of like saying “everyone dies”. Of course all fiat currencies eventually fail. No civilization lasts forever so it would be foolish to assume that all sovereign fiat currencies last forever. If there are two things I know with 100% certainty it is that I will die and the USA will not exist forever. I am betting on the fact that the latter will outlast the former. Are you claiming that the USA is on the verge of imminent demise?
You are highly skeptical of the government’s CPI data. I think that’s fine, however, there are more than a few independent and reliable sources of inflation that currently corroborate the government’s inflation measures. Two notable ones are the ECRI’s data and the Billion Prices Project. Both show inflation in the low 2% range. The google price index, which is soon to be released, is showing highly deflationary forces right now according to the recent google press release on the index. So, while it’s fine to be skeptical of the data the govt releases, I think there is poor evidence currently showing that their data is far from accurate.
You’re not separating household and the government balance sheet. Like most investors, this is where you’re making your mistake when you discuss debt. The truth is, the US government, as a monopoly supplier of currency in a floating exchange rate system, never really has debt. Its “debt” is denominated in a currency which it alone can print. Saying that they might “default” is like saying that an alchemist will run out of gold. It’s impossible. By definition. The US govt can never be late on a payment. So default is never even a problem. This is very different from a household or business. The US govt is never revenue constrained.
I have studied past cases of hyperinflation in vivid detail. I assume you think we are the next Zimbabwe or Weimar. If so, would you mind detailing how the USA will actually fall into hyperinflation? What will occur? How will it occur? Do you have any numbers that back up your claims? I have yet to see a single legitimate argument in favor of USA hyperinflation. If you have it I would love to see it.
Thanks,
Cullen
Reply 02/01/2011 at 2:11 AM Scott FullwilerEvery non-fiat currency fails. Every non-fiat currency HAS failed.
Reply 02/01/2011 at 8:42 AM first“Every non-fiat currency fails”
No way.
The economy yes, but not the non-fiat currency. You can lose your gold and go bankrupt but the the Gold Currency is still valuable. I am no Gold bug but If you have any hold Spanish coins I’ll take them against paper any day.
Reply 02/01/2011 at 11:18 AM Scott FullwilerNew flash . .. gold hasn’t been currency for decades now.
Reply 02/01/2011 at 12:20 PM Cullen RocheGold is an investment in the belief that people will still believe it’s important in 50 or 500 years. To me it comes down to two options: can I buy pieces of paper that represent human ingenuity or can I buy a rock that people may or may not think is pretty in 50 years? Better yet, if you have the ability to do so, start your own company. Invest in your own growth….
Gold is a fine hedge for a small portion of someone’s portfolio, but on the whole you’ll do a lot better over time by betting on the fact that man will continue to grow, innovate and improve. Because, the second that stops, no one will give one damn about rocks since it will likely mark the end of the human race.
Reply 02/01/2011 at 12:50 PM KingPawnMost believers of the dollar collapse/US default outcome point out that every "fiat" currency in history has failed, while praising the intrinsic value of gold, never have I heard one point out that all gold standard regimes have failed.(if I am incorrect point me to an example)
Reply 02/01/2011 at 2:39 AM KingPawnWait….
“Yes, what happens in the US (like a general and widespread crisis of faith in the USD) would impact them but it probably would not be fatal unless the whole global economy collapses which is extremely unlikely.” So the US dollar collapses and the global economy wouldn’t? (By the way I don't believe the dollar will collapse)42% of public debt is held by US individuals and institutions, how would that not precipitate a banking crisis? Those multinational companies you speak of, include US banks who lend to well all corners of the world? The interconnectedness of the world would mean every nation would be affected. The collapse of US demand would not have serious consequences for global trade? Not to mention you say commodity prices would spike…..that wouldn't wreak havoc on emerging markets or anything? You believe the reserve currency of the world is toast but investing outside of the US is going to preserve your capital?
Reply 02/01/2011 at 3:13 AM nottpcU.S. banks have little impact on India and China and Indonesia. That is fast approaching 40% of the worlds population. So if goldman fails they would not collapse despite your western world views. Would their export markets be hammered? Yes but people still need to eat an d consume. If Morgan stanley was not there tomorrow life would go on. Other tha HSBC there is not much western banking influence in these countries. Obviously the world would be in turmoil but in a relative sense the west would be crushed and the east would pick up rather quickly.
Reply 02/01/2011 at 5:05 AM KingPawnYou are right that “if” and i was speaking in the hypothetical because I dint understand his logic, that the power would shift. But the impact in emerging markets would be huge. 40% of the population may be concentrated in those three countries but the US is the largest consumer in the world, throw in Europe and Japan(which I think he is saying would also go down the rabbit hole)and that a whole lotta hurt. The world is not decoupled as we saw three years ago. And commodity spikes would be massively disruptive in lower income countries. My point being there would be so much chaos not sure investing would ever matter.
Reply 02/01/2011 at 5:28 AM Klaus Bohm…seems like Mr. Blackman belongs to a group of investors called ‘gold bugs’, who believe that -gold as money- is a safe investment. This group of investors Hope that eventually, the world will return to a gold standard, a highly delusional view because it ain’t gonna happen.
This group of people easily forget, that their apparently safe investment has now failed twice within a century due to political degree
…anyway, -gold as a commodity- appears to be a different story in terms of a valid investment
Kind Regards
Reply 02/01/2011 at 2:46 AM Matt BlackmanKlaus said, “This group of people easily forget, that their apparently safe investment [gold] has now failed twice within a century due to political degree.”
FDR pulled a fast one in 1933 devaluing the dollar from $20/oz to $35/oz almost overnight while making gold ownership by US residents illegal. It remained illegal until Nixon took the dollar off the gold standard in 1971.
Please tell us, what other nation made a similar move to make gold illegal in the 20th century?
It is also noteworthy that the US is the only nation to do so as far from what I understand. The question is, would such a move be tolerated now?
I also don’t see how gold “failed.” Investors in the rest of the world could and did still buy
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icBrokerWidget('pragcap', 600, 55); Comments prescient11I agree, 2015 seems to be a panic year.
Reply 01/31/2011 at 9:12 PM prescient11I disagree that it will be a commodities bubble though.
The biggest bubble ever being blown in a DEBT BUBBLE. It will become a currency crisis, plain and simple. These government whores will simply not stop adding to the debt load. And then we will no doubt have some clown in the image of “Volcker” act as the responsible one.
Doesn’t everyone see!! Volcker doubled the debt all by himself and his crazy interest rate policy. So, if the pubs take back power they will mirror Volcker’s mistakes and then raise interest rates. This is exactly the wrong policy!!! And worse of all, guess who gets paid off for holding all those treasuries, the banksters!!!
It’s just a debacle and you can see it happening down the road. sigh.
Even though the deficits will be significantly reined in, these morons will not appreciate how much raising interest rates appreciably will do to America’s debt burden. So-called fiscal responsibility will CAUSE the upcoming currency crisis.
Reply 01/31/2011 at 9:21 PM first“guess who gets paid off for holding all those treasuries, the banksters!!!”
Raising rates ? They make there money on the spread and at 0% they are in haven.
Reply 02/01/2011 at 10:54 AM AlexIn the past, bubbles have taken a while to build up, develop, and eventually pop. However, I think this is changing – the speed the market moves nowadays is incredible. Judging by the ups and downs of the past 2 years, a new bubble could emerge within a shorter period than previously.
Reply 01/31/2011 at 10:39 PM Cullen RocheAnd with the Fed’s explicit intervention you have all of the ingredients for a bubble….
Reply 01/31/2011 at 10:58 PM DerfemYes, but they say 2013 as the year of the burst of the commodity bubble, which lead to a financial crisis in 2015. 2013 is 2 years from now.
TPC, have you read the Pettis of this week about China GDP ?
Reply 02/01/2011 at 2:42 AM Cullen RocheI have not read it. Good?
Reply 02/01/2011 at 3:06 AM nottpcAnyone being honest knows this is coming. Its just a matter of when not if. Not much new ground here other than time stamping it. Heck 90% of zero hedgers commentators are calling for the same analysis as above.
Reply 01/31/2011 at 11:33 PM nottpcP.s. I disagree with your last paragraph that it will cause change. If I told you 5 years ago what would happen in 2008 you would swoon and say something so epic would cause wholesale change in the country. After we flush the taxpayer will ge raped again, the congress will pass empty regulation, and goldman sachs will become more powerful. After the Yellen Put is in place the market will rebound 100% by 2017 and we will be ready for the housing bubble of 2019. We are as corrupt as any 3rd world nation but our footprint and corruption causes waves that effect the world.
Reply 01/31/2011 at 11:37 PM Cullen RocheI guess I am just being hopeful…but you’re probably right.
Reply 02/01/2011 at 12:04 AM Matt Blackman“Now, where I disagree with the Wyman analysis is in their "worst case" scenario. Any regular reader knows that it is highly flawed analysis to conclude that the USA could potentially default on its obligations "“ all of which are denominated in the currency in which it alone has monopoly supply of. This simple point eludes even the brightest minds in economics today. A default of the USA is impossible. The only form of default could come through hyperinflation. ”
Congratulations! This has to be the single most obtuse comment I think I have ever read on the current financial situation of the US and the US dollar. You are clearly either completely ignorant of, or have a very poor understanding of the history of fiat paper currencies throughout history.
I grant you that fiat paper reserve currencies are relatively rare but in the multitude of incidences of fiat paper currency collapses since its first occurrence in Song Dynasty China (circa 1100AD) fiat paper currency economies have suffered daunting similar fates: hyperinflation followed by ultimate economic collapse. If you think such an outcome is impossible in the US, I’d like two of what you are drinking.
Reply 02/01/2011 at 12:33 AM Cullen RocheIf you’re implying that the USA is going to suffer hyperinflation then you must recognize that you are arguing in favor of one of two outcomes:
1) A massive collapse of US output which crashes faith in the sovereign currency. 2) Government spending well in excess of our productive capacity that leads to spiraling inflation ultimately leading to a collapse in faith as govt is seen as corrupt and inept.
I think the first scenario is highly unlikely given the fact that our corporations are extremely strong right now and global demand for US goods and services remains quite strong. If you’re betting on the collapse of companies like Exxon, Apple, J & J, etc then I guess I should wish you quite a bit of luck because you will probably need it.
#2 is more likely, however, we’re nowhere close to spending in excess of productivity capacity. Capacity utilization is just 75%, unemployment is 9.4%, the output gap is 8%, etc. While our spending appears excessive at the moment the truth is that it is nowhere near the levels that would generate substantial wage inflation and full employment.
If you have another scenario (plausible) then I am all ears.
Reply 02/01/2011 at 12:45 AM Matt BlackmanWhere do I start?
First you need to forget all that economic crap you were shoveled in university. Most of it was Keynesian economics anyway which makes it all the more suspect. For some reason, Mises and Austrian school economics got lost (or thrown out) by those who set academic curricula along the way which is a real shame.
My argument is based on an understanding of the histories fiat paper currencies over the last two millennia. You make the mistake that the vast majority of economists and monetary policy strategists have made and continue to make, a poor or non-existent understanding of the history of fiat paper money. Books like This Time Is Different (Rogoff and Reinhart) and Fiat Paper Currency (Ralph T. Foster) are great places to start. If more people understood similarities between the US (and other fiat paper currencies) and extinct fiat currencies throughout history, there would be far less tolerance of the policies that are leading us down the same road today.
Your comment, “A default of the USA is impossible. The only form of default could come through hyperinflation.” Every fiat paper collapse that has occurred in history, has come as the result of first hyperinflation, followed by economic collapse. Its like saying we can’t have another financial crisis without a recession. Technically possible perhaps, but practically non-existent from a probability standpoint.
You also appear to have a high respect for the accuracy of statistics such as GDP growth, unemployment, and CPI. You like many, fail to realize that they are not designed to tell you what is really going on with the economy, they are electioneering tools plain and simple. (Tell the people what they want to hear so they will re-elect the incumbent party. Why do you think 93% of all Dow gains since 1902 have come in the 2 year leading up to elections? (See http://tradesystemguru.com/content/view/305/61/ )
Govt stats have been so heavily manipulated in the last thirty years (thanks to a bevy of statistical tricks such as imputations, substitutions and hedonics) as to make them virtually worthless as real econometric measures. For example we are being told that unemployment is 9.4%. BS, the real figure (U6) says its north of 17%. Those who pay them other than passing interest, do so at their peril. It is up to every serious trader and investor to find their own more accurate economic indicators unmolested by political motive.
You are also ignoring the fact that companies like Exxon, Apple etc are not US companies, they are multinationals with operations around the globe. Yes, what happens in the US (like a general and widespread crisis of faith in the USD) would impact them but it probably would not be fatal unless the whole global economy collapses which is extremely unlikely.
Corporations are strong now because they were bailed out en masse and are the beneficiaries of endless amounts of virtually free (or at least artificially cheapened) money at taxpayer expense (and risk) but very little risk to themselves. Pretty hard not to do well in that scenario.
In a fiat currency scenario, commodity prices skyrocket as real currency values fall and those who understand what is going on, seek the relative safety of intrinsic value so although commodity values will fluctuate, they will remain strong as long as fiat paper monetary policies are allowed to continue.
The major US (and developed nation) challenges now are the levels of debt and reliance on consumer spending to drive economic growth. Maybe the latest round of stimulus in the form of QE2 will work temporarily. But at no time in history has an economy printed its way to lasting prosperity. Many have tried but none have succeeded more than a few years.
“While our spending appears excessive…” You tell me how excessive it is. US total credit market debt now exceeds $55 trillion. For those unfamiliar with the term, TCMD is total government (all levels), corporate and household debt. That works out to more than $680,000 per US resident family. The figure also does not include unfunded liabilities for medicare, medicaid, social security etc to the tune of another $60 trillion.
Please do the math and check those numbers. But by my calculations, those totals exceed $1 million per family. How is the average household going to pay that back? They can’t.
That leaves two outcomes. Inflate the problem away, which is the current solution or default.
Those who trivialize or ignore these issues, without taking some action to insulate themselves and their families from these risks, put themselves in harms way. An understanding of the history of currencies that have graduated to fiat status like the US dollar in 1971(and nearly every other national currency by default) is a great place to start to prepare!
Reply 02/01/2011 at 1:53 AM Cullen RocheThere’s a lot to cover. I don’t know if there’s much use in the forecast that “every fiat currency fails”. That’s kind of like saying “everyone dies”. Of course all fiat currencies eventually fail. No civilization lasts forever so it would be foolish to assume that all sovereign fiat currencies last forever. If there are two things I know with 100% certainty it is that I will die and the USA will not exist forever. I am betting on the fact that the latter will outlast the former. Are you claiming that the USA is on the verge of imminent demise?
You are highly skeptical of the government’s CPI data. I think that’s fine, however, there are more than a few independent and reliable sources of inflation that currently corroborate the government’s inflation measures. Two notable ones are the ECRI’s data and the Billion Prices Project. Both show inflation in the low 2% range. The google price index, which is soon to be released, is showing highly deflationary forces right now according to the recent google press release on the index. So, while it’s fine to be skeptical of the data the govt releases, I think there is poor evidence currently showing that their data is far from accurate.
You’re not separating household and the government balance sheet. Like most investors, this is where you’re making your mistake when you discuss debt. The truth is, the US government, as a monopoly supplier of currency in a floating exchange rate system, never really has debt. Its “debt” is denominated in a currency which it alone can print. Saying that they might “default” is like saying that an alchemist will run out of gold. It’s impossible. By definition. The US govt can never be late on a payment. So default is never even a problem. This is very different from a household or business. The US govt is never revenue constrained.
I have studied past cases of hyperinflation in vivid detail. I assume you think we are the next Zimbabwe or Weimar. If so, would you mind detailing how the USA will actually fall into hyperinflation? What will occur? How will it occur? Do you have any numbers that back up your claims? I have yet to see a single legitimate argument in favor of USA hyperinflation. If you have it I would love to see it.
Thanks,
Cullen
Reply 02/01/2011 at 2:11 AM Scott FullwilerEvery non-fiat currency fails. Every non-fiat currency HAS failed.
Reply 02/01/2011 at 8:42 AM first“Every non-fiat currency fails”
No way.
The economy yes, but not the non-fiat currency. You can lose your gold and go bankrupt but the the Gold Currency is still valuable. I am no Gold bug but If you have any hold Spanish coins I’ll take them against paper any day.
Reply 02/01/2011 at 11:18 AM Scott FullwilerNew flash . .. gold hasn’t been currency for decades now.
Reply 02/01/2011 at 12:20 PM Cullen RocheGold is an investment in the belief that people will still believe it’s important in 50 or 500 years. To me it comes down to two options: can I buy pieces of paper that represent human ingenuity or can I buy a rock that people may or may not think is pretty in 50 years? Better yet, if you have the ability to do so, start your own company. Invest in your own growth….
Gold is a fine hedge for a small portion of someone’s portfolio, but on the whole you’ll do a lot better over time by betting on the fact that man will continue to grow, innovate and improve. Because, the second that stops, no one will give one damn about rocks since it will likely mark the end of the human race.
Reply 02/01/2011 at 12:50 PM KingPawnMost believers of the dollar collapse/US default outcome point out that every "fiat" currency in history has failed, while praising the intrinsic value of gold, never have I heard one point out that all gold standard regimes have failed.(if I am incorrect point me to an example)
Reply 02/01/2011 at 2:39 AM KingPawnWait….
“Yes, what happens in the US (like a general and widespread crisis of faith in the USD) would impact them but it probably would not be fatal unless the whole global economy collapses which is extremely unlikely.” So the US dollar collapses and the global economy wouldn’t? (By the way I don't believe the dollar will collapse)42% of public debt is held by US individuals and institutions, how would that not precipitate a banking crisis? Those multinational companies you speak of, include US banks who lend to well all corners of the world? The interconnectedness of the world would mean every nation would be affected. The collapse of US demand would not have serious consequences for global trade? Not to mention you say commodity prices would spike…..that wouldn't wreak havoc on emerging markets or anything? You believe the reserve currency of the world is toast but investing outside of the US is going to preserve your capital?
Reply 02/01/2011 at 3:13 AM nottpcU.S. banks have little impact on India and China and Indonesia. That is fast approaching 40% of the worlds population. So if goldman fails they would not collapse despite your western world views. Would their export markets be hammered? Yes but people still need to eat an d consume. If Morgan stanley was not there tomorrow life would go on. Other tha HSBC there is not much western banking influence in these countries. Obviously the world would be in turmoil but in a relative sense the west would be crushed and the east would pick up rather quickly.
Reply 02/01/2011 at 5:05 AM KingPawnYou are right that “if” and i was speaking in the hypothetical because I dint understand his logic, that the power would shift. But the impact in emerging markets would be huge. 40% of the population may be concentrated in those three countries but the US is the largest consumer in the world, throw in Europe and Japan(which I think he is saying would also go down the rabbit hole)and that a whole lotta hurt. The world is not decoupled as we saw three years ago. And commodity spikes would be massively disruptive in lower income countries. My point being there would be so much chaos not sure investing would ever matter.
Reply 02/01/2011 at 5:28 AM Klaus Bohm…seems like Mr. Blackman belongs to a group of investors called ‘gold bugs’, who believe that -gold as money- is a safe investment. This group of investors Hope that eventually, the world will return to a gold standard, a highly delusional view because it ain’t gonna happen.
This group of people easily forget, that their apparently safe investment has now failed twice within a century due to political degree
…anyway, -gold as a commodity- appears to be a different story in terms of a valid investment
Kind Regards
Reply 02/01/2011 at 2:46 AM Matt BlackmanKlaus said, “This group of people easily forget, that their apparently safe investment [gold] has now failed twice within a century due to political degree.”
FDR pulled a fast one in 1933 devaluing the dollar from $20/oz to $35/oz almost overnight while making gold ownership by US residents illegal. It remained illegal until Nixon took the dollar off the gold standard in 1971.
Please tell us, what other nation made a similar move to make gold illegal in the 20th century?
It is also noteworthy that the US is the only nation to do so as far from what I understand. The question is, would such a move be tolerated now?
I also don’t see how gold “failed.” Investors in the rest of the world could and did still buy and sell gold which would have been a heck of a lot better investment than owning USD in 1933.
I also don’t understand the statement that “all gold standard regimes have failed.” They only failed because governments removed their currencies from the gold standard in times of war, to replace them with fiat currencies so they could more freely devalue them to accrue greater levels of debt. In every case of which I am aware, gold standard removal occurred in times of war and in every US and UK case but one, the currencies were returned to the gold standard when the wars were over.
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