Or... Of Bubbles and Crystal Balls

If the this article's title rings familiar, it is a take off on the name of that old Timbuck3 hit from the early days of MTV, "The Future's So Bright, I Gotta Wear Shades". When I first recalled this song I mistakenly remembered that the reference was to sunglasses rather than shades. But no, that was "I Wear Sunglasses at Night", by Corey Hart. Or perhaps I was thinking of ZZ Top's, "Cheap Sunglasses". But a quick online check confirmed that the Timbuck3 lyrics talk of the need for shades to protect ones eyes from the very bright future described in the song. Oh, my failing memory.

Interestingly, and fundamental to the point this essay attempts to articulate, is that the perception by most who heard that Timbuk3 song was that its message was positive and uplifting. A casual listening to the chorus could easily lead one to assume the song was pointing to happy days:

...
I study nuclear science
I love my classes
I got a crazy teacher
He wears dark glasses
Things are going great, and they're only gettin better
I'm doing all right... getting good grades
The future's so bright... I gotta wear shades,
I gotta wear shades
...

But that is an incorrect impression. The tune in fact, as explained in this Wiki article, portrayed a future gone terribly wrong, when an overly-greedy society triggers a nuclear holocaust whose explosive flash blinds all those who fail to shield their eyes.

No, we are not going to the horrible place suggested by the true meaning of that song. But, it's a good example of how a catchy chorus and an upbeat melody could create a misperception.

Hmmm. Memory. Perception. We rely heavily on those two facilities. Yet as we all know... perception is subjective, and memories are short. With regard to the present state of our economy, the perception by many, if not a few more than many, is that we can expect things to get better sooner rather than later. That point of view is reflected for example in polls, in a survey of economists last May, and in a sharp decrease on Google for the search term economic depression. The perception of better times ahead is also being reflected in the stock market, which is in fact gettin' much better grades lately. You can see where I'm going with this. With all the exuberance and elation associated with the recovery of the stock market - and by inference, the economy - it may be wise to insure we are not wearing our rose colored glasses before breaking out the booze and reaching for the lampshades. Because if we take a moment to recall a little economic history of this fine country, our perception of the actual state of affairs may turn out to be decidedly different then the one that those with vested interests would have us believe.

Point being, rumors of the economy's rebound have been greatly exaggerated. And that's the thrust of this article. I wish to argue that we are not now, nor will we soon be, in a recovery. This point will be made simply by demonstrating that we are not actually in a recession. Rather, we are in a depression. I present this thesis on the basis that information is power, and that being forewarned allows one to become forearmed. And if you happen to become convinced of this point of view, do not despair... I think there's a happy ending here. But first I should note that I am not an economist, just a simple investor (although I did stay at a Motel 6 last night). Therefore you may wish to refresh your recollection of the story of the Blind Men and the Elephant before reading further.

Yep...We Seem To Be In a Depression.

Depressions, by definition, take longer to recover from than the time spent so far in our current 'recession'. That's the basic difference between a recession and a depression: Time. Depressions run longer and deeper than recessions. So in a way we need to look a bit forward in time to prove that we are in a depression now. Not an easy thing to do... the future having all its vagaries and what not. It's hard to know exactly how the economic bombshells of the past few years are going to shake out. How do we peer around the corner with any certainty? Do we employ a psychic and a crystal ball? Probably not. Several well know psychics predicated Hillary would win the last presidential race. Hmm. Should we believe they will have better luck with economics than with politics? Nope. As a really good psychic once told me, psychics only see possibilities. The future is malleable. The distant future is composed of a pool of unthought thoughts. The near future is wet cement, constantly in flux as people project their intentions, hopes, and fears onto its matrix.

No, what we are going to attempt here is to use facts to accomplish the goal of glimpsing into our economic future. Admittedly, 'facts' can be open to interpretation. Still, this is the firmest ground that I am personally aware of. And if, upon examination of the facts, our perceptions shift such that we embrace the idea that we are indeed in a depression, we can conclude with some degree of certainty that the economy is in fact not yet recovering. Ergo, we can recognize that the markets have probably gotten ahead of themselves. Ergo, we can adjust our expectations, investment portfolios, and lifestyles accordingly. It's that simple.

Keep in mind that the most common topic of conversation regarding the future of our economy normally revolves around whether America is about to experience massive inflation, whereby the cost of things will soon spiral upward due to all the money being injected into the system... or rather that we will instead get massive deflation with prices spiraling downward due to money being sucked out of the system because of the credit collapse. It's a HUGE debate, and a question well worth addressing. The problem is, it's hard to prove which x-flation thesis is correct because we don't have all the facts. To take a shot at predicting when inflation will hit you need to know what the velocity of money is. This is an esoteric, yet easy concept to grasp, and can be explained in a couple of sentences. Assume you were able to perfectly counterfeit 100 trillion dollars and store it in your basement. How much affect would that 100 trillion dollars have on inflation?

Answer; none. Money sitting in a basement - or in a bank not being loaned out - generates 0% inflation. It's only when that 100 trillion gets into circulation that it stand a chance of forcing prices up as more dollars enter the economy. This is the ancient law of supply and demand. More dollars chasing the same number of goods tends to bid prices up. Most importantly, the factor influencing just how much inflation that 100 trillion will create is based on how fast the 100 trillion changes hands. The quicker people receive and then spend the money, the greater the upward pressure on prices. That's money velocity in a nutshell. Trouble is, we really don't have the tools to measure the velocity of money on any given day. And it's really hard to estimate how fast money will change hands tomorrow. Or the next day.

So to estimate velocity the experts speculate. Equations are created. Assumptions are made. Conclusions are drawn. But the experts disagree. Conclusions vary. From one point of view it can be argued that there is plenty of evidence indicating America will go the route of Zimbabwe and hyper-inflate its currency to death. On the other hand there is equal evidence indicating we could mimic Japan, which has basically been in deflation since its credit collapse about 20 years ago. We just don't have enough facts to pick our poison yet, so it serves no purpose for this essay to enter such a debate.

So, with the x-flation Ouija board off the table, yet still looking for some sort of view to the future, it seems more reasonable to instead address the recession vs. depression question. Here's the punch line; We are in a depression because a number of economic bubbles are still due to burst, and it's going to take some time for the affects of these bubbles to work themselves out. It's as simple as that. Factually speaking we know that these bubbles will burst. Look back in history; Zimbabwe, Japan, Weimer Germany, Rome.....you name it... financial bubbles always burst. So let's talk about the bubbles.

Calling All Cars....We Are In a Depression.

I will keep this part short, but if you really want to understand how we got into this mess, and where the housing bubble and all those other bubbles came from, you have to take note of a few historical events that have led us to where we are. To keep it simple I'm going to just throw a short bulleted list at you embedded with web links for those who wish to learn more or check my facts. Read this though... it's pretty interesting.

Mid-1800s: American corporations are granted the status of legal "person", which over time garners the corporation certain rights that limit legal remedies against it, in so far as a 'corporation' cannot be put in jail. The corporation obtains the right to place generating profits for its shareholders above all other interests. Some corporations take advantage of this legal architecture to evolve themselves into institutions of pure greed, with no legal, moral, or social obligations... making them some of the most powerful and dangerous entities on the planet (rent the movie 'The Corporation').

1913: The Federal Reserve Act is passed by Congress. In effect, this law transfers control of the Nation's money supply from public/government hands into the hands of private bankers, who from then on have the power to create money vis-à-vis the Fractional Reserve System, which basically allows dollars to be created "out of thin air".

1933-34: In 1933 President Franklin D. Roosevelt takes America off the (domestic) 'gold standard'. US citizens can no longer redeem paper currency for gold. On January 30th, 1934 the Gold Reserve Act is passed, which calls for all gold held by Federal Reserve banks to be seized by the Treasury, as well as most all gold owned by private citizens. A pre-existing international gold standard agreement is left intact. The following day though FDR devalues the dollar by changing the dollar's fixed rate of exchange to gold from $20.67oz to $35oz. The devaluation effectively wipes out a huge portion of America's national debt. These measures are all designed to pull America out of the depression. In addition, the Glass-Steagal Act is passed as a means to prevent a depression from ever occurring again, by restraining banks from making risky investments.

1971: President Richard Nixon signs an Executive Order that closes the 'gold window' to foreigners. America will no longer redeem US dollars for gold. The connection between the US dollar and gold is now fully severed, leaving nothing of material substance backing the dollar. Meaning, there is now no restriction other than the Federal Reserve's self-control on how many dollars can be printed.

Since the 1913 Federal Reserve Act was passed, and later exacerbated by the 1933 act that killed the gold standard, and further aggravated by the 1971 closing of the 'gold window', the value of the US dollar has lost 97% of its purchasing power.

1999: Under the Clinton administration the Glass-Steagal Act of 1934, the law designed to prevent another depression, is repealed. Certain banks - vis-à-vis the unregulated derivatives markets - have a field day as financial institutions are freed to delve into previously forbidden high risk investments.

2001: After years of stock prices being pushed beyond rational value, the dot-com tech bubble bursts, which should have headed us into an overdue recession. But due to a sharp drop in mortgage rates, coupled with other monetary policy shifts such as significantly relaxed lending standards, a housing bubble is commenced and the stock market bubble is re-inflated, forestalling the expected recession. There is good reason to believe the housing bubble was specifically contrived to avoid the expected dot-com recession. Along with the housing bubble comes the credit bubble, a far reaching phenomenon that powers every kind of spending binge from unqualified home loans to credit cards excesses. Federal deficit spending ramps way up.

2007: The housing bubble bursts as a slight drop in home prices initiates a chain of events leading to a cascade of defaults in leveraged mortgages. The country starts into the recession averted in 2001. Few acknowledge it's a recession at this point though.

2008 The credit bubble bursts as home prices trend downward, interest rates tick upward, and more buyers fail to repay loans... adding momentum to the recession snowball. The Federal government steps in to re-inflate the bubbles by lowering short-term interest rates to near zero. The government also commences to replace the deflated private debt bubble with a public debt bubble vis-à-vis bailouts, handouts, stimulus plans, and various other programs. The plans fails to produce the desired results, and in the fall of 2008 the stock market bubble bursts. A massive stimulus bill designed to get banks lending and consumers spending is passed.

2009: The stimulus bill fails to stimulate and the nation finds itself in the deepest recession most people now alive can remember.

20?? The highly leveraged commercial real estate bubble bursts. At some point the public debt bubble bursts when the bond bubble bursts. This causes the trust bubble to burst (people stop trusting in the financial system), all of which triggers a panic bubble. To avoid a prolonged economic downturn, the Powers That Be trigger a _______ bubble. Whoops. Out of bubbles. Next stop...a recession so lengthy and so deep that at some point it simply fits better to refer to it as a depression.

Sorry. We're getting ahead of ourselves on that last item. But you see the point. Without even digging into the morass of financial statistics, a quick recall of Newton's law of motion, "For every action there is an equal and opposite reaction", tells us we have stretched the economic rubber band too far, and it's either going to break, and can't be used again... or its going to snap, and sting really really hard. The mechanism that allows for the gentle unwinding of an overheated economy - periodic and mild recessions - was long ago disabled.

Circle The Wagons... We Are In a Depression.

Reasons abound supporting the depression thesis. Unemployment is still on the rise. In fact the real unemployment rate is far higher than what is generally reported. Housing has not come anywhere near bottoming. Not with a record oversupply of empty homes to the tune 19 million at last count. And not with 1 in 5 homeowners now 'underwater' on their mortgages. And certainly not with a new report indicating that foreclosures are actually higher this year than in 2008. Foreclosures are now running four times the pace they were in the 1982 recession.

Also, GM does not normally go bankrupt in a standard-issue recession. Bankruptcy rates are still on the rise. For those who like charts, the ones here and here provide compelling evidence. The first link connects to an article that counters assertions by some that our current recession is not as bad as The Great Depression by injecting an "It's the global economy, stupid" argument (playful insulting remark mine), demonstrating that on balance things are unfolding as they did back in the 1930's. The second link showcases a number of charts painting a not-so-pretty picture of falling consumer spending and increasing unemployment. Government programs cannot reverse these trends overnight. In fact the action taken so far is actually aggravating the situation. Funds have mostly been spent on the wrong things; more bailouts than infrastructure. The Powers That Be aren't wearing shades, but rather, blinders.

The reason these trends will not reverse in the near future is because the biggest bubbles have yet to burst. The really big bubble... the mother-of-all bubbles... is the T-R-U-S-T bubble. The trust bubble has evolved over the past couple of hundred years. We have developed a consumer driven economy based on the belief that all that was built up yesterday... will be here tomorrow. Trust is the substrate upon which this whole inverted financial pyramid - which sits on little pieces of paper called dollars - is resting. We already know this bubble has sprung a few leaks. That's reflected in the credit collapse, a.k.a. the we're-scared-you-won't-repay-the-money-we-lend-you syndrome. Trust will decay even more however as the remaining bubbles pop. First, the credit bubble will deflate further when the next wave of loan defaults hit. Example; more and more people unable to pay their mortgages and credit card bills due to layoffs, no home equity, and/or unemployment insurance running out. Bigger example; commercial real estate properties defaulting on loans thanks to skyrocketing vacancy rates in offices and shopping malls. Even bigger example; states and municipalities that can't pay their bills due to greatly reduced tax revenues. State and local governments in particular have a huge day of reckoning coming because unlike the Feds, they don't have printing presses. We are dreadfully close to the point where lenders will not only shy away from lending more money to certain states, they won't even want to refinance existing debt coming due.

Some states may be headed for their own special form of bankruptcy, however that manifests itself.

The only potential savior for some states is the Federal government.

Mmmm. That's comforting. The Feds of course have a printing press. It's all gased up and ready to go. And there's certainly going to be pressure to use it. It's either that - print money out of thin air for the next round of bailouts - , or borrow the funds from overseas. Neither strategy will work. The bond market, which is the mechanism for financing Federal debt, is stretched to the limit, and in fact is hanging by two scant threads. Thread #1 is the world's willingness to finance our debt...and thread #2 is the world's ability to finance our debt. Both are in jeopardy. The world-wide economic downturn hitting all developed countries provides less and less money for the purchase of American debt. Moreover, our debt load is so high the world may at any time cancel our credit card on the basis that America is a bad risk. We simply can't grow our economy fast enough to pay our bills. Federal debt is massive and must periodically be refinanced. Moreover, an unrelenting stream of trillions in new debt must also be financed on an ongoing basis (see this Congressional Budget Office report). Think of the Federal deficit as the 'Blob' from that old Steve McQueen movie. It just won't stop growing. And, there is NO sign of this trend reversing. This is the public debt bubble. To make matters worse, Federal tax revenues are down a staggering 34%. For the first time ever, the Federal government paid out more than it took in for the month of April, its biggest revenue month. From the perspective of our creditors, the we're-scared-you-won't-repay-the-money-we-lent-you-with-anything-of-value syndrome is strongly in play here.

Conversely, if the Feds fire up the printing press and issue get-out-of-debt-free cards for all the too-big-to-fail institutions going down in the next round of de-leveraging, such action will be perceived as highly inflationary (whether it actually is or not). Here again, the world may lose faith in the dollar. In which case I am reminded that just as the junk yard dealer Watto in StarWars/The Phantom Menace wanted something more 'real' than Republic Credits for his spaceship parts, so too the world may begin asking for something that holds its value better than $$.

What is being described now is the bond market bubble. The ultimate trust barometer, the bond market, which finances our public debt, and whose interest rates are based on trustworthiness of repayment, will simply crash at some point as the confidence in the dollar collapses and bond holders run for the exits (Warren Buffet and other financial luminaries have called the bond market the biggest bubble of all). A collapse of the bond market equates to a massive spike in interest rates (higher rates must be offered to entice people to buy what bonds can be sold) and a possible freeze-up of the credit markets (trust bubble deflates), which will in turn accelerate the decline in the economy and further throttles tax revenues.

Break Out the Storm Shutters... We Are In a Depression.

Even after hearing all the above there are some who might ask, "Can't we do as in past recessions and simply spend our way out of this downturn?" Uh... we've been doing that for more than a decade. It's why we're in this jam. We have "stimulated" the economy for so long now, additional stimuli at this point would actually do more harm than good. It's analogous to adults who have ingested sugar for so many years they develop something called glucose intolerance, wherein the body fails to properly regulate blood sugar regardless of how much insulin is released.

We are now locked in a cycle of reduced consumer spending, which begets the production of fewer products/services, which in turn begets layoffs, which themselves beget defaults on loans and further reductions in consumer spending. This cycle will not end in the foreseeable future. There is to much excess yet to work off. When you collect all the facts and do the math it all adds up to one thing; we are by no means out of the woods yet.

Ok, Ok... We're Stuck in a Depression. Now What?

Right. Now what? The future gets hazy here because there are a number of ways things might go as the last of these remaining bubbles pop. In general I think it's fair to say that uncertainty and volatility will continue to be major players in our not-so-distant future. The trends are in place and as more bubbles collapse uncertainty and volatility will be exacerbated. There will be less money and fewer goods to go around. Many people will become anxious, as the decades of relative stability we have experienced in this country continues to dissipate. Some will become desperate as the social safety nets continue to shrink. And... desperate people tend to do desperate things.

The way to best handle whatever comes is simply to prepare as best you can. We prepare ourselves psychologically by not being surprised when surprising events occur. If you are calm, people around you will tend to remain calm. The smart family today is thinking more along the lines of self sufficiency than has been the tradition. It would be wise to prepare for shortages. Given that this is a consumer driven, credit driven economy, impairment of these two engines will have far reaching consequences in the manufacturing of goods, the production of food, and the pricing of both. I'm not suggesting that the flow of food and goods will stop. I am suggesting that it would be foolish of us, given all that was noted above, not to take precautions. It wouldn't take actual shortages to propel folks into the stores to clean out the shelves. All it would take would be a perception that shortages may occur. Think about the rice shortage scare in 2008. Or the ammunition shortage in 2009. So now might be a really good time to stock up on food, medicine, expendables, etc. You might want to do that now, before everyone else does. Enough said? It's all about perception you know.

How about personal finances? You of course need to rely on your licensed financial planner, but here are some strategies my research has uncovered that seem to make sense. Think in terms of the cost of money going up dramatically. Any interest rate sensitive holdings one has should be examined carefully. One would certainly do well to insure they are free of any kind of floating rate loans such as an ARM mortgage and/or floating credit card rates. Regarding investments, it's a very, very tricky marketplace out there right now, and it's difficult to know the best place to keep one's money. Certainly any sort of longer term bond investment is highly suspect. Market volatility will become more pronounced as the markets continually update their perception of which version of x-flation is next, with the stock market possibly moving sideways or heading down after the current temporary uptrend runs its course (only a hyper-inflation of the currency would likely negate this statement). Remember, it's a depression, not a recession. Many companies will be making less money, and the price of their stock will ultimately reflect that.

For the time being, a triad of cash, short term US Treasury Bills, and bullion might just be the safest places to store wealth. The cliché "cash is king" is likely to remain true unless and until we get extreme inflation. Why? Because fewer and fewer people have cash these days. Therefore its purchasing power is currently going up. Until that trend reverses, cash is a good thing. Short term Treasury Bills (not longer term T-Notes & T-Bonds) are the next best thing to cold hard cash, and may be safer than your bank. It's now easy to directly purchase T-Bills here. And of course gold and silver coins are still a cornerstone for weathering this storm. Although at the time of this writing the prices of most things, including gold/silver, are currently holding or trending downward, it is almost inevitable, given current economic policy, that serious inflation lies in wait somewhere down the road. And if you invest in gold and silver you will be in good company.

The caveat of the aforementioned triad of safety - cash, T-Bills, and gold/silver - is that even these conservative investments are subject to risk. It might surprise you to know that the greatest risk is not from the gyrations of the free market, but rather the capricious nature of the government. Although the future is indeed unpredictable, there is one eventuality that I would bet every last dime I own on. In fact, I would give you odds. It's that the government will exercise its formidable and ever growing power to keep things 'orderly'. In the future you can expect some very broad interpretations of the phrase "for the good of the country", as government intrudes further and further into the free market. Such intervention is the greatest uncertainty! For example, recent government sponsored changes in the way financial institutions report their earnings allow the banks to conceal massive losses. The banks are not anywhere near as solvent as they look. The next round of bubbles collapsing could easily trigger a government sponsored bank 'holiday' to forestall a stampede of customers attempting to redeem their accounts. Such a closure might affect not only banks, but also brokerages, and perhaps even a temporary freezing of Treasury accounts. This is why I am suggesting 'cash'. Not money in the bank...cash in hand. Regarding gold, the risk here is that private ownership could be made illegal again if the government gets the idea that returning to a gold standard might restore economic stability (which is why I like the idea of holding both gold and silver). Or, the US dollar could suddenly be devalued in order to mitigate the national debt, making all dollars suddenly worth less. We just don't know what our government may do to 'protect' us, which is why one must be diversified.

Anyway, those are some thoughts on what we can do at home. In the bigger picture, we need to focus our thoughts, our voices, and our vote on doing what we can to keep nations at peace. Governments have an unfortunate tendency to make war in order to extract themselves from depressions, and we certainly don't want a future that requires shades. Think peace.

So, when is all this financial gloom and doom due to occur? Who knows? I have reason to believe we may be living in a very different America by year's end. Such a statement though moves us away from 'facts' and back toward crystal ball gazing. You know, the biggest mistake I have seen predictors of the future make is in timing. A lot of people called this financial fiasco we have fallen into clear back around the turn of the century. It's just that they were a few years off on their timing. Now the crisis is here, and it will continue to unfold. But the folks in charge, the string pullers, the ones with a vested interest in keeping things how they are... have done an amazing job of delaying the inevitable. So the remaining bubbles might be contained a while longer. However, all bubbles inevitably burst. That is a fact of history. So why not get prepared now?

At the end of the day, I personally see the entire process that is unfolding around us as mostly good news. Truth be told, we are living in a sick society. We know it. Our inspired, finely crafted system of government no longer represents us. We gave the hen house keys to the foxes, and they have spent their time looting America's wealth for decades ... sticking their heads up from the trough only long enough to assure us everything was ok. Why didn't we notice the BBQ sauce on their faces?

So, here we are. We turn on the TV and are assaulted with empty, mindless programming, dumbed down stories of the important happenings in the world, and a plethora of prescription drug commercials half filled with disclaimers about their disastrous side affects. Come on. We need to flush this stuff. We want America to be true to her purpose again. We want the rampant corruption and insatiable greed to stop. Only thing is, we feel powerless to affect it. Well, natural processes are about to give us a hand with that.

As already alluded to, it's probably a good time to start thinking and acting locally. Meaning, global economic circumstances are likely to have us focusing more and more on our own locale as a source for foodstuffs, energy, governance, and security. Big brother is about to be downsized (the best investment at this point in history might well be an investment in self-sufficiency). Greed and animus are on their way out... compassion and tolerance will be coming in. Depressions, 2012, gloom and doom...are not signaling the end of the party. The human experience is just getting warmed up.

You are informed now. You now know that the inevitable next round of stimulus packages won't work. You know that if the stock market goes up further, it won't hold. You know that if the prices of precious metals fall, it is a buying opportunity. You know that if California is miraculously pulled back from the abyss, it will likely fall back in. You no longer believe the 'happy talk' coming from the government talking heads. Do something with this knowledge. Get prepared. Be the leader in your family and community.