The Economics of Disaster

"It is better to be vaguely right than to be precisely wrong."
- William Carr, the "Economic Journal", 1942

My goal is to be at least vaguely right. I spend a great deal of time reviewing the economic pornography that is increasingly available on the internet and subscribe to a number of economic journals, such as "The Economist", which when I was in college studying to be an Economist was a scholarly journal and has devolved over time to tripe.  As a result I am often asked what's going to happen with the US economy and the world as whole. It's an impossible task to get right, so I settle for 'vaguely right'.

Unfortunately, I am willing to bet large sums on my current conclusion that I will be better-than-vaguely right.

Here it is: Despite the encouraging signs in spending, unemployment and growth, the economy is heading for disaster, probably in the June 2012 time frame. I am so certain of this that I have told my accountant to move all of my substantial retirement savings to cash or cash equivalent securities. The stock market is going to fail, probably starting in May.

I hope I am completely mistaken. I want to be so wrong as to be a laughingstock.

But all indications are the opposite.

- SP futures are predicting losses in June
- the ECRI index indicates a declining business cycle and recession by November at the latest
- gas prices continue to rise, which will cripple any recovery
- housing prices continue to fall, and even though they keep falling, few people are buying
- Shiller predicts a large, if not massive, increase in foreclosures over the next few quarters
- velocity of money is at record lows, not just in the US but in Europe and China
- US exports have slowed and as things get worse the dollar will get stronger, making exports harder
- US savings have declined again -- people are buying more on credit

People note that there are encouraging signs also -- the S&P volatility index is low, indicative of growth and I was encouraged by this new news that maybe S&P futures are wrong, but the housing and gas prices are the true bellwether. As long as housing is low and gas is high, people will not spend. We see this in the velocity of money. People are NOT spending. We are heading to deflation despite the huge amount of money treasuries all over the world are printing to prime their economies. We're heading for a cliff and I don't know how far down it is, or even what is at the bottom. But I know it's not good.

People have noted that gold prices have fallen by record amounts. That seems to indicate stability since gold prices are driven by fear and inflation, but the conventional wisdom is that because Ben Bernanke has not mentioned a QE3 at his past 4 Fed meetings that he is either more upbeat about the economy or scared because the Republicans have called him a "traitor". I don't think it's either of those things. I think Bernanke is saving this bullet for when things start to tank over the summer. That's when he will pump a ton of money into the economy in a last gasp to get people spending. Then gold will rise again.

What does it mean? It means people will be pouring money into US bonds. Yields will collapse and it won't matter because even at 0 percent interest, having the same amount of money is better than losing it in the stock market. The dollar will get stronger, thus throttling the US export market, slowing the US economy further. Unemployment rises. Confidence falls. Housing collapses further. GDP shrinks. Recession results.

The economy is NOT going to improve until housing improves. Period. Housing is not going to improve as long as unemployment is high and people are scared.When people have confidence again, they will take risks. When they don't, they don't spend. It's self fulfilling failure. This was the true triumph of Ronald Reagan -- even though he actually made the underlying economics of the US much, much worse, he made people BELIEVE their lives would get better, and when they did, they spent and invested and created prosperity. Unfortunately, they were eating the seed corn of the future, but they didn't know that then. Here's a great quote from the Aeneid by Virgil, 2000 years old and sums up the situation: "Success nourished them. They seemed to be able and so they were able."

The problem is that Reagan and Bush, father and son, have spent all of the future seed corn we would otherwise be spending now to fix our problems. Our debts are way too large now to address the problem. Our options are limited. I will discuss them in tomorrow's blog.

It's important to note a couple of things about gold and this market as well. The big elephant in the room is Iran. Are the Israelis going to bomb Iran? Will the US join them? If any kind of aggressive action of this nature occurs then gold will hit record levels; gas will hit 6 or even 7 dollars a gallon and the US economy will collapse into recession if not complete depression. I don't think there will be an attack, at least not before September. Netanyahu has indicated he will wait a little while longer. President Obama's current sanctions don't fully come into force until July and already the Iranian economy is collapsing. The citizens are angry and new elections have been called. It might be possible that if the Iranian economy does collapse the Iranians will agree that no nukes is better than civil war and starvation. The wild cards are India and China who have agreed to pay gold for Iranian oil regardless. This gets around any Obama sanctions and provides hard currency for the Iranian regime. It also undercuts the US dollar as the reserve currency. This is a major shot over the bow. The US needs to be preparing for a time when the US is NOT the reserve currency, and all that entails -- higher prices for imports, slower economy, less prestige and power over world events. Russia and China are actively trying to make this happen, and I was surprised to see India sign on as well since they are an ally of the US, but the fact is, a crack addict does not make a loyal friend to anyone but the crack dealer and India needs oil badly, and Iran is their friendly crack dealer.

In the end, this will put a 12 - 20 billion dollar pressure on gold. Gold SHOULD respond by mid-summer by going up. It also increases the chances that Israel or the US will bomb Iran with all that entails.

That's all I have to say for today. I want to be wrong.