Deflation and the Upcoming Economic Problems

The US economy is not ready to collapse... yet. But it looks bad. It looks like big economic problems are in the future for the USA (and everyone else, since the dollar is the world's reserve currency). Here are some of the more interesting articles around.

The deflation time-bomb, by Mike Whitney
Whitney predicts more a depression with the sub-prime mortgage collapse spreading to all mortgages and then to all credit, resulting in a rash of foreclosures, bankruptcies, and bank failures. He hints at the cause when he says the currency deflation will only be stopped by refusal of lenders to lend and borrowers to borrow, or by a sell-of of the dollar. He doesn't really say why it is happening, other than blaming Bush, or how to make the best of it when it comes.

If deflation is the problem, and I think it is, then it didn't start with Bush. It started with Reagan and has only gotten worse ever since. Even Clinton with his "surplus" only ran a surplus if you completely ignore the debt the USA was racking up for Social Security and Medicare at the same time.


CDS: Phantom Menace, by Hellasious (Hell as IOU's)
Credit Default swaps (CDS) allow hedgers and speculators to bet on credit events (like defaults, etc) by big borrowers (governments, large cap corporations, or big funds). They are a form of insurance that is completely unregulated. They are a craps game with hedge funds and speculators (mostly speculators) betting on derivatives and indices and other stuff. Lots of speculators are about to lose their shirts, because as of the second half of 2007 the combined value of all the CDSs is up to about $45 trillion. That is three times the USA's GDP and over twice the capitalization of the entire US stock market. It is nearly as large as the total amount of debt outstanding in the entire world, and might exceed the total amount of debt worth buying. The speculators who are lending on these CDS instruments are highly leveraged (approaching zero margin), and if their CDSs go bad they will lose the whole leveraged value, not merely their investment. Hellasious explains:

But selling a CDS requires zero margin and even produces immediate and regular income from payments received for underwriting the credit insurance. Theoretically the sellers should maintain adequate reserves on their balance sheets to cover their credit risk exposure, but does anyone believe that hedge funds and traders actually do? Not a chance... The result is a highly volatile equity exposure, carried at zero margin in a completely unregulated over the counter market. Recipe for disaster? You bet...

Not only that: CDSs create these infinitely leveraged equity positions out of thin air. Unlike options, single stock futures or other equity derivatives that require the delivery of actual securities at settlement, CDSs do not. They are pure bubble-air and can be created regardless of the amount that is outstanding in the underlying securities.

Government-Industrial Complex, by the Wall Street Examiner
This article points directly at motive:

Businessman enters politics via the candidacy or contributor route. Politican gets elected and appoints his contributors and supporters to key governmental or advisory positions. Politician leaves office with a plush gig to make up for the years of meager earnings.

Even Tony Blair, labor leader, has joined the post-elective-office gravy train working for JP Morgan/Chase.

The Bernanke Paradox And How To Overcome It, by Hellasious
Hellasious is back with what he thinks is the likely failure mode for the economy, that US consumers stop spending money even at a nearly zero percent interest rate. His solution is more and better jobs in a government-targeted industry. Energy and environmental mitigation are Hellasious' preferences. I certainly agree on energy, and agree again on a massive energy project of even greater scope than the Manhattan or Apollo projects, with tax and other incentives for private companies to build the infrastructure for the new sources of energy. An energy project of heroic scale is needed. However, it is not the answer to the deflation-caused depression that looms in the future.

More government spending is not the answer to deflation that was caused by uncontrolled government spending and loose money. Abolishing Income and Corporate Tax and instituting a Fair Tax might actually get rid of a lot of the perverse incentives that have led the economy into its present straits. Maybe a solution to the insolvency of Social Security and other government wealth transfer programs could follow. But that is a really radical answer.

Still, it is not as radical as the current course, which appears to be to stabilize US incomes at the same level as Chinese or Mexican incomes. That'd solve the illegal immigration problem! Chinese incomes are in the $.50 an hour range, and the US minimum wage is almost $6, twelve times as much.

The US has a long way to fall to reach parity with China or Mexico. That would be a collapse!

Radical solutions are to be preferred to that.


Technorati Tags: Deflation, Economics, Depression, Recession, Collapse