Monday, February 01, 2010

An Economic Prophecy for Engineers—And Everyone Else

"When a prophet speaketh in the name of the Lord, if the thing follow not, nor come to pass, that is the thing which the Lord hath not spoken, but the prophet hath spoken it presumptuously: thou shalt not be afraid of him."—Deuteronomy 18:22

"The rich ruleth over the poor, and the borrower is servant to the lender."—Proverbs 22:7

Without modern economies, engineering would be a shadow of its present self, if it existed at all. Huge capital investments in plant, equipment, and R&D needed for advanced engineering require equally huge, smoothly functioning economies. And anything that fundamentally threatens such economies is worth the attention of engineers and everyone else.

The two Old Testament excerpts above have been much on my mind the last week or so. The selection from Deuteronomy says prophets whose predictions don't come true can be safely ignored. One might expect also the converse to be true: that is, prophets whose predictions are verified deserve at least a little attention, although anyone can make a lucky guess from time to time. The context in which I have been thinking about borrowers being servants of lenders is the fact that for at least the last decade, the U. S. government's debt has been underwritten largely by foreign investment, from China to the sovereign wealth funds of numerous other countries. My worries on that score were allayed by the fact that China, for example, though it holds billions of dollars of Treasury bonds and other debt, has no motivation to do anything bad to us, since we are their largest market in many areas, and destroying one's main market is not a smart thing to do.

But then I read Aftershock by David and Robert Wiedemer (brothers) and Cindy Spitzer.

This writing team published America's Bubble Economy in 2006, which allegedly forecast the broad outlines of the 2008 financial crisis and real-estate crash pretty accurately. (I haven't read it, so I say "allegedly," but I have no reason to doubt this is basically true.) In Aftershock, the authors say that there are actually six bubbles, not just the real-estate bubble, and only four of them have popped or are in the process of popping: real estate, the U. S. stock market, private debt, and discretionary spending. All these areas fed on each other during the expansion phase of the last several decades. Similarly, the collapse of real-estate markets has cut off sources for private debt, discouraged discretionary spending, and put downward pressure on the stock market, leading to a complex vicious circle that is yet to finish its dirty work.

The other two bubbles yet to pop are the dollar bubble and the U. S. government debt bubble. And when these two go, life in many ways will never be the same, according to the Wiedemers and Spitzer.

Why? Because the supposedly safe haven of U. S. Treasury bonds, the place where smart money all around the world goes when things get bad, will turn into a rat hole. How? When non-U. S. purchasers of Treasury bonds quit buying them as enthusiastically as they have in the past, this will force the Federal Reserve to print dollars to keep the government running. This has already started to happen, and when it gathers steam there will be nothing to prevent a huge burst of hyperinflation—on the order of 100% a year. Places like Israel and Argentina have undergone such disasters, but not since the Revolutionary War has the U. S. experienced such a thing.

Of course, in a democracy the politicians can't let hyperinflation go on for long, or else their careers are toast. But the only alternative will be severe cutbacks in government spending, which will finish the inaugural phase of a multi-year worldwide depression from which the U. S. will emerge much chastened, but wiser.

When will all this start to snowball? In one to three years, according to Aftershock, which was completed in the summer of 2009.

What should the individual do if these folks are right? Their advice is to get out of debt to the extent possible, then get out of the stock market into cash or short-term equivalents (money market funds, U. S. Treasury funds), and when the inflation gets going, pitch all that and buy gold.

I am no financial expert, and I will state right here that my only venture into metals trading happened in 1980, when I managed to buy $500 worth of silver coins at $19 an ounce, the exact time when (unbeknownst to me) the Texas Hunt brothers were cornering the silver market and forcing it to a high which—thirty years later—it has yet to achieve again. A worse investment choice could hardly be imagined. So it will take a lot of confirmation and events going the way the Wiedemers say they will, before I will even consider fooling with metals trading again. But I am certainly going to keep my eye on things for the next few years, and if events start to match up according to the Aftershock scenario, I will take their dire forecasts more seriously.

For the sake of the U. S. economy and everyone who relies on it, and for the sake of young engineers just starting their careers, I hope that Aftershock is wrong, and things go back to normal or better soon. Getting a job these days is hard enough, and hyperinflation and the government going broke is not going to help matters. But as the authors themselves point out, money isn't everything, and those who survived the Great Depression of the 1930s went on to become the Greatest Generation who fought World War II. Still, I feel that once I read the book, I should let people know about it and allow them to draw their own conclusions. I am more than halfway convinced Aftershock is right. But the only way to be sure is to wait and see.

Sources: Aftershock is published by John Wiley & Sons (2010). I learned about the book from a review in National Review Online at http://article.nationalreview.com/420850/the-next-meltdown/stephen-spruiell.

1 comment:

  1. Living in Canada, I have always recognized our reliance on the US economy, and while, since the 1980's, we've been doing as much as possible to separate ourselves from it, we cannot separate by any great amount. We're just too small and too close, and you're just too big.

    Watching that attempted separation while also watching US debt (public and private) soar to a ridiculous level _and_ being involved in a couple of international organisations that take it for granted that the US engages in debts it has no intention of ever developing the ability to pay off, I came to the conclusion at least 20 years ago that there is a US dollar bubble.

    That bubble has been sustained by small countries who don't print their own currency using the US dollar as legal tender (so that their economies support the dollar), by a general belief (lived as a religion inside the US) that the dollar cannot fail, and, most recently, by China deliberately failing to call in your debt.

    Those small countries have been switching to the Euro as being more convenient - only to discover that, contrary to prior belief, it's actually more stable than the dollar. Even here in Canada, where the myth of dollar infallibility has been almost as strong as within the US, people have begun discovering that it isn't enough to compare our dollar to yours to know how we're doing internationally.

    In other words, the US dollar is no longer the standard against which all others are measured. Rather, it's only one among many - and it can fail.

    The Canadian dollar has been doing dramatically well internationally ever since the causes of the market crash were understood. Yes, we have the advantage of having the only banking system in the world that didn't buy heavily into the US sub-prime market - but I think people are looking at that and wondering why we didn't.

    We're your closest neighbours, your best friends (whether you always think so or not), and you are by far our largest trading partner, so why didn't we when everyone else did? Because our banks had better things to do than invest even more heavily in the US. In other words, that persistent unofficial policy of separating ourselves from you paid off. Which suggests to everyone else that maybe they should separate themselves from you, too.

    Personally, I consider that dollar bubble popped. China can't keep it up all by itself.

    You think the US will come out of this wiser. I don't. The first four bubbles were created by deregulation that the Republicans are still proud of. They popped first because they were least sustainable; but by their very existence they caused the dollar myth to fail, and the same blind self-serving internal politics that created them is going to pop the next one, too.

    Obama's detractors seem determined to find ways to blame him for everything from the Haiti earthquake to the messes he inherited, regardless of how that blame falls out on the US in general. They are (some of them) so fanatical that they are willing to suffer for the sake of pinning "something" on him, no matter how specious.

    Just wait until they start blaming him for the debt - that pin is going to pop that bubble, simply by finally drawing _everyone's_ attention to it. Slight of hand and misdirection have been the only things keeping that bubble up in the air for decades; it can't handle a spotlight.

    ReplyDelete