If you’re within one astronomical unit of a TV, by now you’re convinced that we’re in a Credit Crunch. If only those nasty financial institutions would just loosen credit things could get right, right? Not at all; this is a deflation. First, let’s think about this logically in its simplest terms. If you were a lender and asset prices were falling, unemployment rising (inability to repay) and many of your existing loans failing, would you be in a hurry to make loans? Of course not, and pointing a finger at them is ludicrous. Even if they wanted, they haven’t a fraction of the ability to stem this deflation.
In 1913 we hired an agent to oversee our economy, to maximize employment and moderate our animal spirits. When we created the Federal Reserve we opted out of truly “Free” Market Capitalism by making the pact that if they maximized employment, we’d accept the terms – inflation, and the risk - deflation. Inflation has worked like a charm, since the deflationary accident know as the Great Depression, because it compensated for interruptions to organic growth. Like an out of shape distance runner using cocaine to keep going, we deluded ourselves into thinking more credit would always work to mitigate a slow down; that a medicinal “line” of cocaine inflation could grant us perpetual prosperity. It can’t and, under this system, deflations aren’t accidents, they’re axiomatic. The lure of cheap money is always too tempting in a tight spot. Ask any of the central banks throughout history, their track record has a perfect 100% failure rate.
We are experiencing a massive deflation to adjust for 1) the latest & greatest credit bubble’s implosion and 2) a GDP no longer artificially subsidized with financing shenanigans. We aren’t as wealthy as we thought, and our standard of living has been adjusted down as a result of this reality check. Deflation has evaporated half the market’s value and a third of the real estate market’s value, which I estimate to be about 18 trillion or a year and a half of our GDP! Now all the funny mortgage money, created to shore up the funny internet IPO money, has lost its value and the US dollar is reciprocally regaining its value. It must again become “real” in terms of its buying power. Since most of us are largely invested in assets, we are all feeling the pain and the more deflation spirals, the greater the intensity. If it is not arrested, bankruptcies will skyrocket.
Now what? There is no intrinsic value to any country’s money anymore. They are all deflating and the world has no choice but to support our currency (as the new gold standard for now), despite our having only made a down payment on the task so far. There is only one cure for a deflation and that is massive deficit spending; for it was only the deficit spending of WWII that broke the deflationary spiral of the Great Depression. Then, the spending necessarily grew our country’s productivity, not our social net. No war is forcing this fix and only if it effectively addresses the deflated housing market* will the dividends of higher productivity lead the world to a quick recovery. If, however, the deficit concentrates too much on expanding the social net, the recovery will be short-lived and the fallout will be like that of LBJ’s well-intended but misguided Great Society: stagnation and eventual high inflation. One can only hope at this point that valor is not mistaken for discretion.
Disclosure: I remain a buyer of US Dollars and am aggressively buying more US equities.