THE RESTLESS MISCREANT: HYPER-D PART II.

Those of you who read my column in the Spring issue know I’m not talking about some new super vitamin but rather the gathering storm of negative economic forces that I believe will, in spite of government interventions, result in a pernicious and long-lasting mega depression. The dreaded hyperdeflation.
 
Some have asked why inflation is not the greater threat given the enormous federal debt, which will no doubt be increasingly funded by Federal Reserve purchases of Treasury obligations (i.e. “printing money”). Well, Virginia, there is such a thing as a depression that’s both inflationary and deflationary. Just ask anybody who lived through the Weimar Republic fiasco in Germany in the 1920’s and, while I facetiously dubbed the coming U.S. problems as “The New Weimar Republic” in one of my 2006 articles (available online if anybody’s interested), it’s inconceivable that things would ever reach that degree of dislocation here given the size and scope of our economy. But there is much truth in the comparison. 
 
So, just what is an inflationary/deflationary depression? Simply stated, it’s when the value of your house and other assets collapse, your job is either lost or your income scaled back and your debts increase as the cost of living skyrockets.  Both parts of this Scylla and Charybdis are already well in motion but nobody yet expects the $50 pizza. 
 
That pizza will be the result of the differences between this coming depression and the Great Depression of the 1930’s (see the Spring article for examples), and the kicker is that way back then we were not only the
biggest kid on the block but also the only kid on the block. Essentially, the rest of the world then made wine or paper parasols but today we have a very different situation. Much of our industry and wealth has been relocated overseas to places which are apparently quite able to run with the ball on their own as their economies and populations grow like topsy, meaning that they are increasingly consuming many of the same goods and services we have grown accustomed to. But they produce these things at much lower wage costs than we can and there’s the rub: eventually we’ll have to effectively cut our wage rates in half or
have very limited overseas markets left, not to mention that their increased
consumption will further drive up the costs of the commodity materials used. Not a pretty picture. I am always reminded of something Victor Kiam (remember he
liked his Remington razor so much he bought the company?) said back around 1980. To the best of my recollection, it went something like this: “if some-
body doesn’t do something around here pretty soon, in 25 years we’ll all be sitting around selling each other hamburgers and life insurance policies.”  Quite the sage I would say.
 
Consequently, the essence of our problem can be summed up like this: in the face of declining incomes, asset values will continue to fall since the money necessary to buy them will increasingly be used just to pay for day-to-day expenses, and as the quantity of assets on the market rises, the greater the fall, the greater the deflation. So, you see, hyperdeflation doesn’t mean it costs you less to live, just that it costs you less to buy other people’s assets and so, by default, creates a long-term drag on the value of those assets since everybody is busy paying off their current debts while paying more and more for the things they need to live. And, to top it all off, this vicious circle eats up the possibility of
new job creation in the absence of new demand which, after all, has to start someplace. In the 1930’s it was WW2. In the 1990’s it was tech and IT that dragged us out of a hole only to put us back into it with the bursting of the stock bubble in 2000. We climbed out of that one through cheap money, which led to the housing boom that collapsed around ‘06 and continues to deepen as we speak. Now money can’t get any cheaper and there’s nothing on the horizon that looks like a ladder.
 
And so we find ourselves in this Godforsaken Garden of Eden of “systemic risk”, “moral hazard” and “stimulus”. We let the big banks and investment houses run amok, essentially steal our money and seduce us into debt, but they’re “too big to fail” and so guys like Paulson, Bernanke and Geithner arrange to steal more of it to keep them going and continue to pay out gigantic bonuses to the very people who created the problem. The most egregious of these “moral hazards” so far, to my knowledge, was the outrageous bailout, via taxpayer money, of AIG in the amount of $85B, $13B of which was used to pay off credit default swaps (CDS’s) held by Goldman Sachs at 100 cents on the dollar while similar non- AIG contracts were being liquidated at about 13 cents on the dollar. That means Goldman, which would not have even been in existence today were it not for an infusion of $10B of taxpayer money last year, got an undeserved windfall of $11.3B, the approximate amount slated to be paid in bonuses to its employees for 2009. Why people aren’t in the streets rioting over this is beyond me.
 
But, of course, we “saved” the system by building  an even bigger monster which will devour us one limb at a time rather than all at once. Had the big banks been allowed to fail, as they should have, the FDIC would have had to reimburse the depositors at an even greater cost. So, down the road this expediency will allow those banks to get even larger, with more depositors, thereby insuring that they will always be bailed out at our expense. (Bernanke has even recently hinted that smaller regional banks facing big losses from commercial real estate may be bailed out as well.) And the game will undoubtedly go on until generally deteriorating conditions reach a critical mass triggering massive corporate defaults and, consequently, a tsunami of the untold trillions of dollars of CDS’s  that even the government will be powerless to stop.
 

And so, as the mother of all bubbles pops, the politicians and the economists discredited, we’ll eventually return to a new era of financial responsibility and, later, renewed prosperity. But don’t hold your breath – Alice has gone through the looking glass and is going to come back out badly beaten and half-naked.  Bernanke and others, however, will continue to believe that you can inflate and spend your way out of a secular collapse but, when all is said and done, I think it will be shown that he just went Greenspan one better. A rotten core does not offer up a sweet fruit. 

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