We are getting a daily diet of doom and gloom. Crashing markets, key economic sectors imploding, mounting foreclosures, continuing bank failures and trillions in retirement savings wiped out. Is this the end of the world (or at least capitalism) as we know it? Are we in a full-blown depression and destined to revisit the 25% unemployment and food lines of the Great Depression? Yes and no. Yes, we’ve had a Modern Depression every bit as powerful as that of the 1930s and no, this will not go on for 10+ years. Although the headlines will continue to question our survival, the outcome has already been decided. Most of the damage has been done. Indeed, the eye of the storm has passed and 2009 will be a much better year than everyone expects.
Internet Time. Make no mistake, the credit collapse created a Modern Depression but it wasn’t allowed to metastasize. The fix, the only one known for depressions, is unimaginable deficit spending. That spending will only go up and is already baked into the recipe. It will work because the world is behind it. It will make more sense if you step back and take a macroscopic view of today’s events, because they are being compressed into “internet time”. The deflationary carnage of this Modern Depression has been not been mitigated; rather it has been accelerated - all the damage at a fraction of the time. Similarly, the reflation will occur much faster than anyone would guess.
Deflation = Depression. Deflation (the destruction of assets and wealth) is the factor that separates a depression from a garden variety, back-to-back, lack of growth recession. Deflation spirals interminably without some significant interruption. Look around to see the rapid adjustment to your financial wellbeing. US wealth is down in direct proportion to dollar denominated assets; virtually every big ticket item that dollars buy is down 35-45%. We’re in about the third twist of the spiral and the contractions have forced a decade of bank consolidation into as many months. When you go shopping for a car or house you’ll see how much your dollars have grown. This is a depression, not a recession and the majority of the deflation has already occurred.
The Sped-Up Death Toll. All that remain are nine (and counting) large commercial banks; albeit some only by continuing governmental transfusions. Our Investment Banking is now a cottage industry and our once-celebrated financial engineering, that maintained so many marginal businesses (see Autos), is reverting back to good old lay-away. We are a changed nation. To shore up this collapse, while American Capitalism is reshuffled, the Treasury has promised to significantly increase our money supply. That should mean the dollar is ready for a swan dive while gold takes off, right? Wrong.
This Size Deficit = WWIII. Contrary to common wisdom (which is usually wrong) it wasn’t FDR’s programs that broke the deflationary spiral of the 30s; it was the do-or-die-deficit spending of WWII. The deficit spending we are embarking upon is tantamount to financing a world war. It is do-or-die, but for capitalism and the world understands; that’s why they’re buying dollars and Treasuries. If the government manufactured inflation (adding money makes the existing money worth less) was getting out of control, our dollar would be falling and commodities like gold and oil would be soaring. They aren’t.
The World Agrees on a New Gold Standard. Treasury Bills that yield 0.00% interest are essentially large denomination dollars; large bets on the surest bank on Earth. Even though financial theory states that a currency is weakened by dilution, and we are sure going to do some dillutin’, the world continues to buy dollars with abandon. Why? If the world is confident about us, despite our outrageous deficit, despite the printing presses humming into the night, despite our almost leading them into a full-blown depression, it can only mean something substantial has changed. That something is a world already flooded with paper money, looking for direction as a tsunami of more money is created. It revisits Bretton Woods and knocks gold completely out of the loop as a monetary instrument. In a world nearly out of control, where an overabundance of paper money has made gold irrelevant, the value of the US franchise has elevated the US dollar to the position once occupied by gold, as the new “gold standard”.
If America Fails, It Takes the World With It. Mathematically, America is painfully bankrupt; however, our failure threatens global capitalism and stability. Consider how the world has changed since the Great Depression of the 1930s. Asia and Russia are now capitalizing rapidly because there is simply no viable alternative; Communism has failed. India as well was off the capitalist map but has now secured a prominent place. The Middle East is getting dragged into the present and largely embracing capitalism. In other words, American capitalism has won the world and no one is interested in reverting back to any other failed “ism”. The majority of the world has everything to lose and nothing to gain by staging a (justifiable) run on US assets, just because we must inflate our currency to stem the deflation. All currencies are in a deflationary race and we represent the highest and driest island of stability in an ocean of fiat.
In Summary: I have long ago seen this as a Modern Depression but have changed my opinion as to the government’s ability to stem the deflation. The events occurring today are very similar in size and scope to the past, however, they are moving much more quickly. We’ve experienced a Modern Depression and are now recreating the only known fix: over the top deficit spending. This knowledge was not greeted with the logical response of devaluation because all currencies are deflating and the system is on the brink. We aren’t slipping into a full-blown depression with uncontrolled deflation and we aren’t going in the opposite direction by triggering run-away inflation either. We are recovering even though the headlines won’t say it for months. The Depression and Recovery in Internet Time will rewrite economics forever. The world is agreeing that American capitalism has changed but must continue as the greatest show on Earth, for now.
Disclosure: I remain a seller of all currencies other than US Dollars and Japanese Yen and am an ever more aggressive buyer of US equities.