Prosperous times as well as depressions are natural phenomenon that has been around since man started to trade goods. It is a natural part of economic evolution and the sequence of 5 steps forward and 3 steps back.
Economic booms are the effect of an increase in the money supply and economic bust are the effect of a decrease in the money supply.
An economic cycle starts when prices are depressed. A boom is created from an expansion of the money supply. The boom ends when society is saturated with debt and either starts paying down the debt or defaulting on the debt. Either way results in a decrease of the money supply and the beginning of the bust. The cycle ends when weak debtors have been cleansed from the system and prices once again are depressed. The cycle length is between 50-60 years with an average length of 54 years.
Earlier economic cycles usually topped out and began their busts 10-20 years before the economic cycle were about to bottom. Natural consequences of excessive debt started to take their toll on the economy with bankruptcies and other debt defaults. This started the inevitable bust.
The last economic cycle the one we are in right now have been different from earlier cycles. What separates it from earlier cycles is that this cycle was not allowed to have its natural bust. I believe that the only industrial country that had a natural bust was Japan. Japan started its bust 1990 and has since then erased about 75% of its stock market value and has been in almost constant deflation despite extreme fiscal and monetary stimulus.
Because of the interconnected global economy it is my belief that the entire industrial world "should"; have entered their natural busts about the same time as Japan did. What actions did United States and Europe take to escape the beginning of the natural bust?
The answer is that they put the pedal to floor and started increasing the money supply and re-inflated their economies and postponed the bust. Nature has tried several times since 1990 to send different shocks against the world economy to start the bust.
1990 The start of Japans bust and deflation.
1994 Mexican financial crisis.
1997 Asia and Brazil crises.
1998 Debt default in Russia and LTCM failure.
2000 IT and Telecom crisis.
2002 Corporate scandals such as Enron and WorldCom.
2003 The SARS epidemic.
Despite all these shocks the world economy as a whole has continued to prosper. How?
The US Federal Reserve Bank has met every shock with an increase in the money supply to bail out the affected country or institution to avoid a bust of the world economy. The result is that the excess debt of the boom has never been corrected. On the contrary the money supply has kept increasing and total debt has mounted as a result.
Has the US Federal Reserve Bank found The Holy Grail of economics and a way to make economic busts and depressions obsolete? Has mankind found a way to conquer natural economic cycles?
Yes, this is fantastic! By the way I must also inform you that the Earth is actually flat, gravity has been lifted and Santa Claus really exists!!!
No! There is no economic Holy Grail and the economic cycle still exists and bust will follow boom!
The only thing the economic policymakers have been able to do this time is to postpone every negative impact to the bitter end. The system is now rotten to the core. Instead of slowly descending into the economic abyss policymakers has assured the world economy a freefall into the abyss with instant economic death as result.
What will start the freefall into the economic abyss?
Some horrible exogenous event will rock the economic system so badly that it will set off the economic avalanche that has been sitting on the cliff for so long. The destruction will be instant and total.
You will go to bed at night in a prosperous and wonderful world and wake up the next day in outright economic depression and a new horrible world! The point I am trying to make is that if you have not prepared before it hits there will be no escape. You will not be able to liquidate your financial assets at fair prices because liquidity will dry up in a matter of hours. Prices will come crashing down.
We will have an Instant Economic Depression!
What kind of exogenous shock will it be? It can be anything. An assassination of some influential person, a pandemic (avian flu?), a failure of some important company (Fannie Mae or Freddie Mac?), a natural disaster or a major terrorist attack. The important thing is that it rocks the economic system enough to trigger the economic avalanche.
Unfortunately, I believe the most likely shock would be a terrorist attack on US soil with weapons of mass destruction. Don’t believe that? Well both CIA chief Porter Goss and defense minister Donald Rumsfeld recently said it is only a matter of time!
Conclusion: The bust of the economic cycle has been postponed to the bitter end. The economic system is now rotten to the core. The trigger that sets off the economic avalanche will be some exogenous event, most likely a terror attack on US soil with the use of WMD.
Will the world economy escape Instant Economic Depression in 2005? Not very likely!