With the markets fluctuating so wildly, the Dow going up and down hundreds of points per day, that’s very likely to spook the government, investors, business managers, and consumers even more than they already are. Normally I don’t pay much attention to consumer confidence; it’s an emotional state, and emotions can change in a New-York second. But at this point the economy rests on nothing more substantial than confidence. It’s a confidence game. And confidence can blow away like a pile of feathers in a hurricane.
L: So what we’re looking at is not just a bump in the road. It’s going to change priorities and marching orders for market participants – and for those who interfere in the markets in various ways.
Doug: Yes. It’s the kind of thing that accelerates a negative spiral, in good part because everybody wants the government to “do something,” in the idiotic belief that it can improve things by doing more. Actually it can only help by doing less.
L: So… the economy slows more. Why can’t the government reanimate the corpse one more time, turning up the juice on the stimulus heart-shock paddles?
Doug: They’ve already created trillions more currency units. Most of these are currently sitting in banks rather than circulating. That’s partly because people are afraid to borrow and banks are afraid to lend, but also because the Fed is paying banks interest to keep what are considered to be excess reserves locked up. So these trillions of dollars that were created to bail the banks out are sitting there, but they’re not going to sit there forever. Once those dollars start circulating in the economy, prices will rise rapidly.
The other way for prices to really explode would be for the foreigners holding some six or seven trillion hot-potato dollars to start dumping them. With the U.S. government clearly unable to deal with its debt and the consequent credit rating downgrade – which was both inadequate and long overdue – those foreigners are getting pretty nervous holding dollars. Almost any sort of financial calamity could spook some central bank into exiting its dollar position wholesale. And once one of them starts, the race will be on, because no one is going to want to be left holding the bag.
These are two time bombs that are ticking away right now – the trillions of dollars outside the U.S. that could come pouring back in, and the trillions of dollars inside the U.S. that were created to paper over the leading edge of the storm. Either of those things could bring on the end of the dollar as we knew it, and both may well happen at once.
L: Okay … But the state has been very good at convincing people to pay no attention to the man behind the curtain. If the markets settle down, why can’t people go back to imagining that everything’s fine?
Doug: I’m not sure that many people really ever believed there was a recovery under way. Wall Street acted like there was – but only somewhat, since banks never started lending again. But unemployment has remained high; it’d actually be about twice the official 9% level, if it was calculated the same way it was 30 years ago. And outside of the price collapse of certain asset classes – like real estate – the cost of living has increased greatly for most people; the calculation of the government’s CPI is as corrupt as its unemployment numbers. I think it’s a mistake to talk about a double dip in the economy; we entered the Greater depression in 2007 and are still in it. A “jobless recovery” is not a recovery. The only thing that’s recovered is the stock market, to some degree. Aside from government hocus-pocus, the mirage of corporate earnings, and foolish investors wanting to believe it was safe to get back in the water, things have not gotten better. And they are about to get much worse.
L: That may be so, but the government, the press, and corporate America have all been talking about a recovery. With the Fed promising easy money, if the markets calm down, couldn’t the illusion of recovery be reestablished?
Doug: I don’t think so. The economy isn’t going to stay in the eye of the storm for much longer. The stab of panic we saw last week gave lie to the emperor’s new recovery clothes. It’s not just the losses on the stock market, but gold hitting significant new all-time highs in nominal terms, and Bernanke saying that the Fed would hold interest rates close to zero for another two years. That’s huge – and a huge mistake. It tells me that Bernanke has truly panicked. The impact this will have on the dollar cannot be overstated; it’s a guaranteed disaster. It assures that people will do all sorts of things they would not do without that artificially easy money.
L: Okay, but if they go into debt to buy houses and cars, they’ll create jobs and there will be more appearance of recovery, won’t there?
Doug: That’d just be digging the hole deeper at this point. What needs to be done is to let the market raise interest rates, to encourage savings – the accumulation of the capital needed to start moving forward on a solid basis. Instead of encouraging people to work, spend less than they make, and save the difference, these low interest rates encourage profligacy. They encourage people to liquidate savings and live above their means. As usual, the government isn’t just doing the wrong thing, it’s doing the exact opposite of the right thing.
Doug: Because of the false belief that printing money stimulates the economy. The artificially depressed interest rates of today will result in very high inflation and very high interest rates in the near future. A healthy economy gets naturally low interest rates as a result of a lot of savings, a lot of capital creation. A healthy economy has stable interest rates that relate to the amount of new wealth being created, typically just above the natural rate of inflation that results from real money – gold – being mined out of the ground. Artificially low interest rates stimulate malinvestment.
The Fed is also keeping rates low because of the government’s massive debt problem. The U.S. is already running trillion-dollar deficits – if interest rates go up, say, to 12% like back in the ‘70s, that would add another trillion to the deficit right there. Financing a $16 trillion debt at 12%, rather than 2%, equals another $1.6 trillion of spending – just for interest.
This really means they have no choice. The situation is completely out of control – the U.S. financial house of cards is irredeemable at this point, even with interest rates at close to zero. The whole financial structure is close to collapse, and that’s why I think we’re exiting the eye of the storm.
L: The Titanic has been struck, but Captain Obama just doesn’t yet realize how badly?
Doug: Exactly. And – adding insult to injury – not only are they doing the opposite of the right thing, they are actively punishing people who did the right things, who worked hard and saved. Pensioners living on fixed incomes are being forced to reach for higher and higher yields, which means they are being forced to put their nest eggs into riskier and riskier investments. This guarantees that the pensioners and the savers will be wiped out.
L: Unless they put their savings into gold.
Doug: Sure, but nobody but crazy goldbugs even thinks about that. And it gets worse: The current course guarantees the total destruction of the U.S. dollar. Again, I cannot emphasize enough how serious this is. People all around the world save in dollars. If the dollar is destroyed, it won’t just be Americans who’re hurt, it will be all the hard-working people around the world who’ve struggled to scrimp and save and put money away for future needs. All these people who were wise and frugal, they are going to be wiped out. They are going to be left with absolutely nothing. This is criminal – it’s the stuff revolutions are made of. And that’s exactly what I expect we’ll see plenty of, all around the globe.
L: Seems so clear – what could they possibly be thinking?
Doug: Perhaps Bernanke’s making the same mistake people with maxed-out credit cards make, when they think hyperinflation will wipe out their debts. They forget how nasty, brutish, and short life can be in a society in a hyperinflationary collapse. And think about it: What happens if you wipe out these debts? Who are the debtors? They are the most profligate people in society. So these artificially low interest rates reward the most irresponsible and punish the most responsible people in society.