Things are worth what people think they’re worth. It’s all psychology. It was psychology that had the stock market trading at unprecedented multiples of earnings in 1929, and people believing there was no end to profts to be made, and psychology that caused a collapse that created widespread human suffering that lasted a decade and was only resolved by governments spending billions (they did not have) to fight the second world war.
Why are people willing to pay $25 for a CD, or $4 for a box of brand name breakfast cereal that costs only pennies to make? Because they think the price is fair, reasonable. That can change in an instant. The fact that used house prices soared to an average of over $300,000 (and much higher in many cities) despite the fact that you could build a house yourself for a fraction of that cost, was due entirely to psychology. People believed that prices would keep rising forever, so it was a good investment to pay 300% of replacement cost, because someone else would soon pay 500% of replacement cost. Especially when lenders would give you 110% of the money you needed to buy that house, with no payments or no interest for six months, even though you had no collateral for the loan except the house itself.
The Fortune 500 has been able to increase profits by double digit percentages for several years, mostly by buying up smaller companies and competitors, offshoring the labour costs, Wal-Mart-squeezing their suppliers for price reductions on materials every year, lowering quality and eliminating service. Pull off this magic trick enough years in a row and people will think you can do it forever, so they’ll pay more and more for stocks. Just like in 1929.
In order to fund all that offshoring, you need to either pay cash, or get the foreign manufacturers to loan you the money, denominated in your own currency, at next to zero interest rates. If you have no cash (because you aren’t producing anything yourself) you need to keep rolling over those debts. The countries doing all your manufacturing need to be confident that the dollars you’re promising, one day, to pay back, are worth something, and that there isn’t a safer or higher-yielding investment for their money than a big receivable from you in your currency. Or else they need to be so heavily invested in your currency that they don’t dare call in the debt, because they know that you couldn’t pay it — so they become co-dependent on you. Psychologically, you reach the stage where you both have to keep lying to each other, and to yourselves, that the risk is manageable, that everything is OK, as long as both of you keep your story straight.
And in order to keep the cost of oil, which drives your economy, down, you need to wage staggeringly expensive wars to secure most of the oil that is left. And to keep the stock market going when options to squeeze a bit more cost out of each product and keep profits rising run out, you need to massively subsidize the large corporations with taxpayer dollars, and reduce their taxes and regulations. To do that you need to convince the world that the staggering debts you’re piling up can be repaid from future increases in taxable income, that your insolvency is temporary. So you need to project endless huge increases in taxpayer wealth so that people aren’t panicked by how maxed out you are now. And the people have to believe that these future taxpayers — the current taxpayers’ children and grandchildren — will somehow be able to repay the monstrous debts you are burdening them with today. And of course, that interest rates will remain perpetually low, so that those debts don’t suddenly balloon even higher.
It’s all like a tightly wound spring, with all the screws holding it together ratcheted ever tighter, and the presumption that as the stresses on it increase, not only will it hold forever, but we’ll be able to squeeze ever more tension out of it. If one of those screws pops, the whole thing flies apart and comes undone. The bubble bursts. The dominoes fall. Just like in 1929.
The screw that is popping is the value of the US dollar, shown above. It is plummeting against all other global currencies, even though they are all increasingly interconnected. No one benefits from the collapse of any major currency, so it is in everyone’s interest to keep them all ratcheted up, in relative balance.
The problem is, the currency speculators, who don’t care who might suffer in a collapse as long as they get theirs, can see that the US dollar has nowhere to go but down. The US economy is dependent on Middle East oil and Chinese labour, on low interest rates and on citizen ignorance. Its national debt and its foreign balance of payments deficit are both unprecedented in the history of civilization, and both are soaring ever-higher by the month. If OPEC were to abandon the US dollar in favour of the more stable and solvent Euro, or if China were to want to refinance its huge receivable from the US in the new Asian currency, it’s game over for the dollar — the spring comes unsprung. There is then no limit to how far the US dollar could fall, and how fast, because there would no longer be anything propping it up. Panic selling would ensue. Just like in 1929.
So the currency speculators, like the child pointing out “the Emperor has no clothes”, are taking their money and running. That’s what’s slashed the value of the US dollar by 12% over the last year, and by over 1% in one day on Friday. Suppose you’re a supplier in the Middle East or China and your investments, denominated in US dollars, lost 12% of their value last year, and 1% on Friday alone, for no other reason than the weakness of that foreign currency. At what point do you say “enough is enough” and insist on being paid in a currency that has some fundamentals supporting its value?
I think that point is imminent. The panic reduction by the US Fed in interest rates to try to calm fears about the collapse of the housing market and the reckless lending practices that this collapse uncovered, will, I believe, be seen as the trigger — the acknowledgement that the bubble of the entire US economy is bursting. It was a desperation move, and investors around the world have seen right through it. It’s no accident that Greenspan’s book of economic ‘deathbed confessions’ has been rushed out now.
So let’s suppose the US dollar collapses, from its level of 87 a year ago to 77 today to, say, 67 by year-end and 57 by next Spring. What does that mean? First, it will mean that the US dollar will no longer be a monetary standard. The Euro will take that role, and perhaps the Asian Currency Unit (ACU) which has been proposed for years but which could take the place of the Asian currency ‘basket’ quickly if the Asian nations needed a hedge against the dollar’s collapse. That will continue the collapse, and ensure that the US will have to start buying in these stronger currencies. This will quickly produce (as has always been the case with currency collapses) runaway inflation in the US, so prices of many goods, and of energy, will be reposted upwards daily. Panic buying will ensue (as is always the case with hyperinflation), leading to empty store shelves and long lineups. That will be followed by an abrupt halt to consumer spending, since nothing will be affordable at the new prices.
When inflation soars, so must interest rates, so double-digit interest rates will quickly become commonplace for mortgages, consumer loans, corporate loans, and government debts. Foreclosures and corporate bankruptcies will soar, there will be runs on the banks, and the government will have to step in to bail out the banking system.
The problem is, the US treasury has no reserves to bail out anything. It will have to institute large tax increases, and slash spending (including war spending) and services to keep from falling into total bankruptcy. It may have to ask for IMF forgiveness on its debts, which may cause the Middle East and China to refuse to trade with it at all, except on a cash basis.
Where it gets complicated is that so many economies are so dependent on the US economy, that they will collapse as well. As usually happens in struggling non-democratic nations when their economies collapse, the result in the Middle East and China will likely be civil war, and substantial cessation of trade with other nations as war disrupts transportation and production.
Canada, whose governments have recklessly allowed our economy to become totally dependent on the US economy, will be sucked down into precisely the same cycle of crisis the US will be facing, probably within months. Europe will fare better, but not much better — so much of the economy is globalized now that to some extent we’re all co-dependent. We might be able to absorb the meltdown of the Argentine economy, but not the American.
With consumers unable to buy, and debtors unable to pay their debts, the stock markets will collapse, taking with them the lifetime savings and pensions of billions, and billions of jobs. The first few million families to default on their mortgages will suffer foreclosure, and lose everything. After that, the banks will realize that it makes sense to let delinquent homeowners stay in, secure and maintain their homes, since there will be no buyers to take their place anyway, so those who can afford to pay their mortgages a bit longer will probably be spared eviction. Just like in 1929.
There will be no winners in this. The people who will suffer least will be those who are self-sufficient (living in communities that are able to produce much of their own food, and whose members can look after themselves and each other) and who are debt-free. You can forget about your investments and pensions — there will be no safe haven. Even gold is worth only what people think it is worth, and if no one has money to spend on it, it will drop in value too. Those who depend on the automobile to get to work will, if they still have work, have to find another way to get there. Those who don’t have work will have to learn to make a living themselves. Very few of us have the skills to do so. Perhaps, like in Argentina, we will learn by occupying abandoned factories and figuring out how to run them as collectives.
I’m sure most readers think I am wildly exaggerating the dangers here. I used to believe that those who warned of a second Great Depression were simply fear-mongers, angry and jealous at being left out of the economic boom. The more I study the lessons of history, and the way economic systems work, the more worried and more pessimistic I become. We have been operating our economy at a level of reckless excess for most of the last half-century. We have come to believe that what we have known in our lives will continue forever, that it can continue forever. It’s that psychology of recklessness and groundless belief in unlimited growth and endless prosperity that is ratcheting the screws ever tighter, blowing the bubble ever larger, moving the dominoes closer to the tipping point, and blinding us to our economy’s terrible fragility and our lack of resilience. I hope I’m wrong. I don’t think Iam.
Category: Understanding Economics
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