Warning: this is a long one. I’ve been at it for a while, but I didn’t really see any good breaking points.
Unfortunately, it is a difficult thing to make meaningful predictions about the economic future. The main problem lies in that there is the economy itself, and then there is the accounting. The accounting is supposed to be the eyes and ears and input of economic decision makers and calculators, but is forever subject to the delusions of people who would like to see other than what is actually there and to political whim, which are not necessarily different things. As a result of this interplay, we now have a monetary and accounting system that completely fails to accurately represent the economy situation it is supposed to be describing. This “information” is then used to make actual economic decisions, which leads to economic distortion, and even further accounting distortion, and more skewed decision making, and so on.
Such is the sorry state of things. The whole affair has now come to a head in a spectacular financial and economic crisis, and we find ourselves called upon to make decisions in an environment where even the “experts” don’t know which way is up. The economy is, after all, the way we earn our daily bread. This isn’t just a cerebral exercise. It’s important even on an individual level to make the right decisions.
In looking into my crystal ball, I would like to first note that
-- It is very cloudy.
-- I’m a layman, too. Don’t take what I say as the gospel.
-- Your decisions are your own.
-- I could be wrong. Spectacularly so.
Even my own knowledge is limited mostly to the monetary arena. Politics and other forces will have strong influence as well, and I confess to having lost interest in these topics and do not keep up. I usually go on to other reading material upon encountering words like “Obama,” “healthcare,” and “Congress.” Other sources, (Fran and Aaron come to mind) would be far better to consult where these are concerned.
In planning for the future, your future, you will be responsible for the consequences, no matter how you made your decision. So, with that in mind, I’ll just give my approach. I’m exercising my right to freedom of speech, only expressing my opinion, and not providing financial advice.
The Accounting is Wrong
I think the place to start is with the fact that the accounting, as it now stands, is completely wrong. Prices are inaccurate. Financial statements do not reflect reality. Further, they are subject to being manipulated and massively readjusted on a whim, as we have seen.
Because of this uncertainty, trying to draw any concrete conclusions with absolute numbers is folly. Trying to do things like predict what the DOW will be in 6 months or a year is to have your forecasts subject to the whims of politicians and accountants. In other words, you are making more of a political prediction than an economic prediction. You may have noticed a similar effect if you ever listen to the finance talk shows on AM radio. Almost every question revolves around “how can I keep from paying taxes?” Rarely is an actual economic question proffered, or answered, because for the most part financial questions are no longer questions of economics.
The politicians will try to force house prices and stock markets up, interest rates and consumer prices down, and whatever else is necessary for re-election to take place. That is the way of things. Even a simple prediction like rising interest rates, which present conditions scream is a near certainty, isn’t necessarily a sure bet, as one can never be sure just how far the FED will intervene, and when or if it will stop.
So, we are stuck. Absolute, quantitative predictions are hazardous at best, and virtually all information, even a basic statistic like interest rates, is misleading. Unfortunately, these are the decisions that you will be making in the real world. You must venture specific quantities of money at specific prices, not relative to other things. Good luck with that.
For my part, I think it best to “ignore the money” – e.g., the accounting, -- and focus on “the stuff,” what the situation is, what players are involved, how they understand their situations, and how they are likely to act. I will divide my views into three categories: “relative certainties,” likely, and distinct possibilities. I will also look at what is mostly uncertain.
I’m trying to base "relative certainties" on relative quantities, leaving out absolute quantities like prices. That way, the accounting tricks and politics have much less impact on whether or not these particular predictions will actually happen.
-- Relative Prices Will Correct. Capital goods prices are too high relative to consumer goods prices. This is the natural consequence of the business cycle. A correction of this fundamental problem was what was responsible for the run-up in commodity prices a couple of years ago and for the falling stock market. It has not finished, in my estimation, and will continue. The specifics of how it will be achieved, however, will depend on political events and their influence on monetary policy. Prices of the two classes of goods could move up or down together at different rates, or they could “meet in the middle.” Moves may be very volatile, in the short term the pattern may not be apparent, and specific goods may become exceptions, especially if new bubbles develop. But eventually, this phenomenon should be the overall determinant of pricing behavior. The DOW/Gold ratio is one of the better known descriptors of this process, though the DOW may no longer be very representative of capital prices as it is no longer very representative of the economy. Gold is also not a consumer good. They are both capital goods, but the two are off different classes, and the cyclical nature of their relationship is a pretty good illustration of the idea that there are very stable fundamental price ratios that periodically reassert themselves even in the face of massive economic interventions.
-- The Division of Labor Will Contract. Until prices are allowed to correct, capital and labor cannot be put to work in a wealth-producing fashion with any degree of certainty. This is clearly visible in the present high unemployment rates. In addition, market uncertainty, especially uncertainty created by political events which arbitrarily rearrange property ownership and financial obligations, works to erode the division of labor as well. Economic actors which cannot be certain that they will benefit by entering into economic relationships with one another or in taking risks will remain paralyzed. As government continues to “take action,” this will likely continue to grow worse. At this point, even a change to “good” policy would have negative effects in the short term, as actors liquidate positions that were rendered profitable by the present, artificial circumstances.
-- Trade Will Decline. This effect comes part-and-parcel with the contraction in the division of labor. Reduced specialization, reduced capital accumulation and unemployment, and lower trade are all interrelated phenomena. They are the opposite of economic growth.
-- Standards of Living Will Suffer. As trade and the division of labor decline, productivity will suffer as well. The numbers may not reflect this, however. It will probably be most visible as a decline in the standard of living. But don’t expect government or bureaucrats to admit this until it is well underway and there is little one can do to compensate.
-- The Boomer Generation Will Not Be Able to Retire. The economic promises implicit in government balance sheets, i.e. Social Security and especially Medicare, as well as most pensions, cannot possibly be kept. Unless a Boomer has made very good arrangements for himself, it will not be possible for him to retire. Continual earnings will be needed to sustain the average person until death comes knocking.
All of these predictions are based on a consideration of relative circumstance, not absolute numbers. There doesn’t seem to be much to me that could dislodge these events from taking place at this point, apart from very, very drastic circumstances far worse than what these imply. Theoretically, the division of labor, et. al. could be driven up by yet more of the kind of goosing in the wrong directions that has driven it to this point. For example, if the several major governments of the world were to try mass-employment schemes, such as the armament efforts for WWII, there might be a temporary extension of the division of labor and higher productivity and trade on paper. However, even this would not improve living standards as the “goods” produced would not be generated in response to consumer demand and would essentially be wasted, kind of like foreclosed houses and shopping centers sitting empty, rotting away. It would be enormously destructive, and is not politically likely. I would imagine most politics will concern itself with individuals’ more immediate concerns, like trying to keep their claws firmly dug into things they shouldn’t have owned in the first place (see “default” below) and evading creditors than on some bizarre mass movement to replace the monetary goosing of the past several decades. However, it is not impossible that things could go that way. They have before.
If we take a few liberties and assume that people will behave in the future pretty much as they have behaved in the past, we can arrive at other predictions which are “more likely than not” to happen.
-- Massive Government Deficits Will Continue. The government will not be able to collect enough tax money to pay for its commitments. This is both due to “politicians being politicians,” but more subtly, to misleading accounting and consequent misunderstanding of the economy and political overreach. It has long been assumed that economic growth could sustainably be much higher than is actually the case, thanks to the economic illusion created by long-term monetary goosing by the FED. It has also been assumed that government could sustainably borrow at lower rates than is the case in reality. This is due both to FED subsidy of Treasury interest rates, as well as to mercantilist policies by foreign economies attempting to subsidize exports. The result has been overwhelming growth in government that economic growth cannot possibly sustain. Unfortunately, it has taken many decades for this effect to really come to a head, and now the country is far past the point of being able to turn things around. I do not think that annual deficits can fall substantially lower than $1 trillion anytime soon. Government spending is now an enormous fraction of GDP. Lower government spending will lower GDP and tax receipts and cause markets to correct. So, it likely won’t be done. At some point, a day of reckoning will come.
-- Inflation. Because present economic conditions require inflation to persist, and because the government is in need of borrowing vast amounts of money, inflation is “highly likely,” approaching “relative certainty.” How bad it will be is uncertain, however, and is highly dependent on political discipline and the actions of far too many actors, particularly politicians, the FED, and the banking system. The time frame is nearly impossible to guess as well. However, even if the FED failed to buy a single asset going forward, there are enough reserves now built into the banking system that a great deal of monetary inflation is possible even with no further action on its part, and a great deal of Washington’s deficits could be financed without intervention by the FED or foreign central banks, provided the private banks were willing to lend. That remains to be seen. But I suspect that political “necessity” will spur actors in the inflationary direction whatever the case may be. This is easily seen in the grotesque levels of deficit spending, which in this case is actually inflationary because the borrowing comes from banks and the FED. This can be seen by looking at M1 and noting that private lending and debt levels are in overall decline. Default does not reduce the money supply, but paydown of debt should result in a decline in M1. Therefore, it is federal borrowing that is increasing the money supply. (BTW – the decline I noted in M1 a month or so ago has reversed. So has the fall in copper prices and stock prices. Checking the AMB confirms that the FED is still in inflation mode. Thus far, the talk of reining in the stimulus appears to be just that – empty talk, with the occasional minor jiggering to make people like me look stupid. Once again, I jumped the gun…)
-- “Default.” The overreach of a great many parties as a result of the previously discussed misleading accounting and overestimation of economic growth must inevitably result in widespread default of many forms. Which is to say, much worse than what we have seen so far. The threat of default is the major spur for further political interventions into accounting, including and especially inflation. Avoiding default in a legal, if not a “real,” sense through accounting manipulations such as inflation allows economic actors to retain ownership when bankruptcy and liquidation would have been the normal course of events, and prevents the repricing that would lead to sustainable recovery, however painful it might be for those who got their stuff repriced. However, these violations of basic property rights will nevertheless have far reaching consequences, especially in the form of a contraction of the division of labor as discussed before.
-- Decline of the American Military. As entitlements and especially debt service eat up ever larger portions of the Federal Budget, the logical target of cuts would be the military. Up until this point, inflation and subsidized financing has allowed government to pursue guns without much sacrifice to butter. But that is coming to an end, and I suspect that when push comes to shove, the guns will go before the butter. This may simply mean a stabilization of spending while inflation works its “magic,” or outright abandonment of previous military commitments if things get too dicey. But in any case, I do not think we will see the same levels of armament or military development that we have seen in the past. This could be a time for other nations to play “catch up,” or we might all turn into basketcases and enter a kind of time warp in which nobody develops. Supposing they do catch up, this would be a very disturbing shift in the balance of power, with far reaching consequences. I'm not sure I want to think about that. As far as World War III scenarios go, I think that is a separate concern, and I do not have much opinion as to its likelihood. But if the economy is not growing and developing, the military isn't likely to, either. Great military prowess can only be sustained by a first class economy.
These are not actual predictions on my part. But they are possibilities whose likelihood cannot be ruled out and which would have far reaching consequences if they were to actually occur. Long term economic stress will tend to slowly increase their probability over time, in my estimation. Things to keep in the back of your mind, in other words.
-- Hyperinflation. If things go particularly badly, we could see hyperinflation. I think this is more likely in China than here, but it is still a possibility. Hyperinflation is extremely destructive, and would probably result in mass deaths in the United States, which is now dependent on a very high division of labor and therefore on a certain level of market stability. At the very least, it would contract the division of labor down to the bare bones, with mass impoverishment. This is a Mad Max type scenario. I hope it doesn’t happen, and I don’t think it will. But it might.
-- Nationalization of the FED. I am very afraid that the whole Ron Paul movement to “End the FED,” much as I agree with it, will nevertheless result in something more or less its complete opposite: nationalization of our central bank. Practically speaking, I doubt whether the political system, even if citizens are overwhelmingly persuaded that the FED has caused all the trouble, will respond by abolishing it and returning to gold/private money systems. Typically, the political response when citizens get angry about something perceived to be doing them harm is more regulation, more government intervention, more “oversight,” more “control.” Examples abound. As much as I hate the FED and all that it stands for, nationalization would be a disaster. It would increase the odds of hyperinflation, and vastly reduce monetary discipline, if you can imagine such a thing. This may be the quickest route to third world status. It would be the height of ironies if this were the actual result of Ron Paul’s efforts.
-- Deflation. This is a longer term possibility, after significant inflation. Once the inflation has had the effect of making debts “payable” by enough actors of political clout and has gone a significant way towards producing the necessary relative repricing, it is possible that there will be monetary tightening to stabilize the dollar. The political drive for inflation will have been greatly lessened, and new political forces may emerge in the other direction. Not necessarily certain, but a possibility.
Some things you just can’t know, mostly because there is too much finagling by the powers-that-be. Certain aspects of the economy, particularly with respect to accounting, are especially notorious for being objects of manipulation.
-- Interest Rates. Interest rates are easily manipulated by the FED. There is a good chance that no matter how indebted the government gets, the FED will finance the Treasury’s deficits with printed money. In this case, there will be rapid inflation, and the seemingly incongruous juxtaposition of low interest rates for Treasury debt and high interest rates in private markets. It is also entirely possible that the FED will refuse to finance these deficits, and the Treasury will see rates rise dramatically. Or the FED could fund specific, politically sensitive markets, such as the mortgage market as it is now doing. We can’t really know, although it would seem a reasonable bet that most private rates would rise. Other than that, it’s all up to the politicians.
Disagreement between Congress and the FED over the issue of financing of the Treasury’s deficits is the most likely trigger for FED nationalization.
-- Time Frames. It is almost impossible to know the time frame for these events. It could take a month, a year, ten years, or half a century. I would go with the middle two estimates, but that is still rough and covers an order of magnitude of time differences. There really isn’t much point in guessing, in my opinion.
-- Exchange Rates. Unfortunately, almost every government and currency in the world faces the same “challenges” (sneer quotes) as the United States. So, at any moment, any could collapse, and take others with it. Or not. It is impossible to know what the order will be, or how long any will take to “correct,” although currencies do tend to move rapidly once a correction is underway. It is possible that one massive currency correction could take the whole ship down with it. It is also possible that they could limp along for a long while yet.
As much as I’d like to predict a specific scenario, I really don’t think it is possible. There are way too many wildcards, too many variables, too many actors, too much at stake. Besides that, I’m a lowly little limited human being who is a tiny part of the massively complex network that I’m trying to understand. This kind of thing is a bit akin to asking a single nerve cell to understand the entire brain. I’m not sure it is appropriate to think that it is possible. Seems to me a human would need at least the same order of magnitude of complexity as the system he was trying to understand if were to stand a chance of understanding it. I’m fairly unsophisticated.
My best guess is that the government will continue to run high deficits, private levels of debt will continue to contract, mostly through default, and we will continue to grind along like this for a while to come. During this time, those who are both financially and politically weak will see their property liquidated and sold off to those who were either prepared for the crisis, or just lucky, or privy to government connections. The politically well connected and powerful (too big to fail) will not lose their holdings. The government will continue to expand and replace the private sector. Price inflation will be modest. That is basically where we are now.
Some commentators predict massive tax increases and ballooning welfare state. I do not think so, at least with respect to the taxes. This prediction is based on a look at other, more socialized societies which presumably predict America’s future. America, however, has typically not tolerated high tax rates on average households. A look at tax rates on typical middle class incomes shows that it has not changed much since just after WWII. And since budget cuts are at least as unpopular as tax increases, I don’t think there will be any of that, either. Instead, I think that tax rates will not increase substantially, or at least dramatically, and ever higher spending will be financed by deficits until that route of financing becomes unavailable.
The deficit appears untouchable, methinks. The Republican’s can’t afford to cut it much without punching a big hole in GDP. I don’t think they’ll do it. They’ll just try to route it to their own pet projects, probably.
At some point, a turning point should be reached. Once private debt has been substantially eroded and fiscal deficits have done the dirty work of finally pushing up the circulating money supply, the grinding, puttering along will give way to an ugly bout of price inflation. Capital will be unavailable for private markets, having been mostly soaked up by government borrowing, so additional money printing and interest rate suppression will be of little avail to capital goods markets (i.e. the stock market, housing, etc). Capital markets will likely not see prices rise at near the rate of consumer prices.
Here is where things will get very dicey. Social Security and other such obligations are supposed to adjust for cost-of-living (COLA), so the government can only escape so much debt through inflation. I do not know how this will play out politically. Will the statistics-mongers just start lying, at least more than they already do? Will they sneak cuts past seniors? Or will the AARP sound the alarm? Will there be a tax revolt? Or will the whole thing go up in one big mushroom cloud, the dollar and the global economy the primary victims? I don’t know.
There will be a lot of politicking over this. I don’t know what will happen to the FED. I don’t know what will happen to the budget. I do expect big changes, but probably not for the better, at least for a while.
So basically, it looks like the government displaces the private economy, primarily by borrowing everything there is to borrow, then the government dies and doesn’t pay anybody back. I don’t know what that looks like. My guess is probably more French Revolution than 4th of July, and not too many people come out well, again supposing it happens. Most likely this grinding timeline will be interspersed with various acute emergencies, especially currency collapses and mass defaults, with post-facto bureaucratic jury-rigging to keep the accounting limping along. I don’t know what that looks like either, or if one in particular, maybe the euro, maybe the dollar, takes down the whole fleet in one go. Some people think a global currency is in our future. But such emergencies tend to tear things apart more than bring people together. Will China really want to throw its lot in with the US after all of this? I don’t think that will happen. I’m not even all that sure that both of our nations will emerge in one piece.
It is possible that the inflation will wipe out just enough debt and bring about the necessary repricing, at which point things may stabilize. That is probably our best hope at this point. Still not a good scenario, but at least not too many people die.
How to Cope
First of all, let me say that there probably isn’t a lot you can do. But, supposing the most basic things pan out as expected – inflation, contraction of the division of labor, etc. – there are some steps one can take to at least mitigate risks. Note again, this isn’t really advice, just me thinking aloud. If it all happens the way it looks like it might, these are just some ideas to keep in mind.
The absolute first thing to give up in such a scenario is the materialist mentality that dominates modern culture. I listen to Dave Ramsey a good bit, and he’s a good and decent man, but his basic suggestion to work your tail off as the method of first resort to solve financial problems, I think, will not be good advice going forward. The tables will reverse as the American economy faces such enormous changes, and the reward to participating in the formal economy will rapidly drop off. Unfortunately, this is the way most Americans, or at least the Americans likely to read a column such as this, deal with such difficulties – just work harder, and find ways to increase your income. It would probably be better to have other lines of attack. Look for ways to rearrange your life, deal with people and problems in different ways than our socially atomized culture has thus far pushed on us, or you will eventually find yourself a hamster running in a wheel that is perpetually accelerating. I think shrewdness and frugality will be better tools going forward than brute earning power.
Once you’ve recognized this, the next important thing to realize is that in such a scenario your savings and investments probably won’t do you much good. So, do something more-or-less prudent with them and stop worrying so much, because it probably won’t matter anyway. There aren’t many targets that escape the inflation tax. Even gold will not hold your purchasing power, because you’ll have to redeem it to spend it as money, at which point you’ll pay a tax on your “gains.” That, I think highlights the key: avoid as many transactions as possible, and work for yourself first. Some suggestions:
-- Learn to do as much as you can for yourself without resorting to cash transactions. Learn to fix your car, maintain your house, start a vegetable garden, cook your own meals, etc. The more your work directly benefits you and your family, the less is available to the grasping hands of government.
-- Extend the division of labor informally where you must. Always, always remember: the key to real wealth generation is extending the division of labor to increase productivity and efficiency. Cash transactions help immensely in this regard, but it can be done by other means. Get things done through family & friend connections. By creating a back-scratching community among people you trust, you can accomplish your goals and avoid the deadening hand of government.
This probably sounds a lot like the family relationships I talked about before among people of less-developed economies. That’s because it is. They already know how to deal with exactly the kinds of problems that Americans will likely be facing. In a way, it’s “when in Rome, do as the Romans.” Except that Rome is coming here, rather than the other way around.
As far as present conditions go, an “investing” plan for this scenario would take such possibilities into account. A good set of tools and how-to-books may do you a lot more good than Bank of America stock. A house with a garage to work in, a yard with room for a garden, and decent neighbors nearby is probably better than a nice condo, etc.
Be warned: under such a scenario – e.g. contraction of the division of labor – those higher up the division of labor will face the most pressure. If your company makes “higher-order capital goods,” e.g. industrial machinery and manufacturing, high-finance, etc., you might be in trouble. Within the company, if you are high up the division of labor, e.g. management, R&D, or a highly specialized position, you’d better watch out. You’ll be cut first. These positions profit most in the boom, but in the bust, they become expendable.
Most of all, try to find sources of meaning and happiness in life outside of material pursuits. If that is the basis for measuring happiness and success, there might not be a lot of it in the future.
How to Save the World
Whatever happens, I do not think it is avoidable at this point. The present is not sustainable, so it will not be sustained. That’s just the way it is. Many are unhappy with the changes they see taking place, politically, culturally, and otherwise, but I don’t think anyone needs to contemplate ways to “put a stop to all of this” because I don’t think it can continue. For the disgruntled, that’s at least a little bit of good news.
How to make a positive difference in the aftermath going forward, however, is a more interesting question. The reason I think any modern revolution would be more French than 4th of July should be pretty obvious: America isn’t exactly ruled by space aliens. Today’s conditions, economic and otherwise, are the result of Americans’ own past decisions. If things are going to be different tomorrow, we are going to have to change.
Here is my four point plan to pick up the pieces, broken down for men and women. It is pretty simple, but hopefully if enough people pitch in, it might just work.
-- Support your family. That’s your job anyway. Isn’t this easy?
-- Resist evil. You don’t have to save the world. That’s a good thing, because you can’t anyway, so give it a rest already. On the other hand, you do have to hold it at bay. Don’t be a hero, but do fight your own battles. Be a stick-in-the-mud, old-fashioned, ornery, and irascible. Make the bad guys work for it. At every opportunity, crank it up a notch. Sooner or later, they’ll give up and look for better pickings.
-- Have babies. As others have said, the future will only be there for those who bother to show up. Send as many of the best representatives that you can.
-- Raise them at home. Nobody will love them and take care of them better than you can. No lessons are more important than the ones that only you can teach.
This plan will likely take a very long time to work its magic, but thanks to a protracted economic malaise, it will be much easier to focus on these simple priorities, since most people likely won’t be all that tempted by the prospects of employment anyway. With any luck, the two-parent, single-income household will come back in vogue out of sheer economic necessity if nothing else. But really – it is a waste of time trying to prop up the system by working your fingers to the bone just so the government can squander it all away. So don’t. Let the folks in Washington support themselves.
Just give up. Focus your ambitions closer to home and family. It’s easier than you think, and probably more rewarding. You’ll be doing everyone a favor, and the great thing is, that’s the kind of plan that can actually work: one where everybody wins.
Maybe we have a shot at this thing after all.