Saturday, 20 September 2008

Looking into the abyss

Several months ago, I was listening to the podcast of the Thom Hartmann radio show on Air America Radio and became exceedingly anxious.  His guest was Dr. Ravi Batra, the (in)famous economist from SMU, who is known for making doom and gloom predictions, AND BEING RIGHT.  Dr. Batra was predicting that the economy was going to go to Hell in a handbasket in July or August, and made such a logical case that I started doing some research. I read two of Batra's books--Greenspan's Fraud, and The New Golden Age.

Here is an audio YouTube of the interview. Listen to the other parts, too.

I am a politics and economics junkie by nature, and already had some background in the subject, but I delved deeper into his case.  When I was finished, I called all of my friends and relatives and told them I was getting out of the stock market, and into gold, Euros, Short-term US Treasuries, FDIC- insured CDs, and inflation-adjusted bonds (TIPS).  They thought I was a bit crazy at the time, but after Black Monday they paid a bit more attention.

How did we get here?
Under the mantle of "free trade" and deregulation, the Republicans in power since the Reagan administration have been dismantling the structures, regulation and oversight that created the middle class after WW2, and kept our economy productive and wages high.  Reagan began a war on labor when he broke up the air traffic control union, and with only a slight pause under Clinton, the Dept. of Labor has served corporate interests, NOT the interests of workers.  As a result, we have seen real wages decline, tax incentives for corporations to ship jobs overseas, a decline in union membership, and the erosion of our manufacturing base.

The current mortgage and bank crisis is down to the Gramm-Leach-Bliley Act, which destroyed the firewall between commercial and investment banks set in place by the Glass-Steagall Act in 1933.  Phil Gramm (McCain's main economic advisor) also wrote the Commodity Futures Modernization Act.  This allowed banks to gamble with bank deposits, and led directly to the disasterous invention of mortgage-backed securities.  Poor oversight also allowed banks to pursue sub-prime mortgages, naked shorting of stocks, and speculation in oil commodity markets, etc.

What's happening now?
Bush's military adventures and profligate spending have turned a $200+ billion surplus under Clinton into a $800 billion deficit. The debt is now close to $9 Trillion, up $5 trillion from 2000. The bailout of investment banks is essentially mitigating the risk the fattest fat cats in the world took with our money, while doing nothing to fortify the foundation of the economy--the demand fed by a healthy working middle class.  These bailouts will come in the form of further borrowing, mainly from China and the Middle East, further driving up our debt.

The way we have recently gotten out of recessions is by lowering interest rates.  This is what Greenspan did in 1982, 1991, and 2001. That will not work this time.  Lower interest rates are designed to encourage people to borrow money to spend, thereby stimulating consumption, production, jobs, etc.  The problem now is that people are tapped out. They have little or no collateral for further debt. I read that the AVERAGE credit card debt in the US is more than $9800. They are using credit to buy food and pay off other debt. People are upside down on their mortgages, and are losing their jobs.  Without the stimulus normally caused by rate cuts, these will just lead to more inflation.

The statistics seem to show that inflation is still historically low, but that is because the Bush Administration has been monkeying around with definitions and methodology, and reducing the information fed to the public.  Here is a great article on that:

The Political angle
I believe that Bush, Paulsen, and Bernanke are now attempting to kick the can down the road.  They know that the economy is crashing down around us, and hope that they can prop it up long enough so they can blame it on the Democrats after the election.  Notice that oil prices have mysteriously dropped, just two months from the election. This despite depreciation of the dollar, two damaging Gulf hurricanes, the threat of war with Iran and Russia, sabre rattling by Hugo Chavez, and potentially devastating revelations about oil reserves in the Middle East and elsewhere (Peak Oil).

I am not convinced that they really want McCain to win.  Conservatives hate McCain, and I do not find their feigned enthusiasm for Palin convincing.  The alternative view, which I don't find persuasive, is that they think they can get richer if McCain continues the current policies.  No, I think they secretly want Obama to win this time, even though it will hurt their short-term interests.

What's coming?
I think that we are in for a real catastrophe.  I fear that this might be WORSE than the Great Depression.  Now, before you accuse me of wearing a tinfoil hat, think about this.  The conditions that lead to the Depression were VERY similar to those today.

The problem is that we do not have the manufacturing base we had in the 1930s to backstop the slide.  We also have FAR more debt, which means that we have less capacity to borrow money to fund public works
and infrastructure improvements, which were FDR's primary tools for ending the Depression last time.

My opinion is that the bailouts being discussed this week will only buy a few weeks or months, and then the doodoo is really going to hit the fan.  Consumption will drop precipitously, which will cost jobs. Lost tax revenues will kill state and local government budgets, forcing them to reduce expenditures on services like fire, police, etc.  If foreign governments decide to stop buying our debt, or if oil-producing countries start denominating oil in Euros instead of dollars, we are SCREWED.

By the way, I am not convinced that Americans will be willing to stand in long lines for jobs and soup, and live in Hoovervilles, as they did in the 1930's.  I think there will be lots more violence and crime this time.

What to do?
I am writing because I think it is important to batten down the hatches. This coming depression will probably last several years. Dr. Batra's advice is to downsize your life as much as possible.  Get out of debt as much as possible. Stay far far away from the stock market.  Buy "refuge" assets, like gold.  Buy Euro-based assets, because the EU is more fundamentally sound, and the Euro should hold up if the dollar crashes further (I own FXE--an ETF that invests in Euros).

Batra also recommended selling your house and renting before the mortgage crisis hit.  I don't know if this is still good advice, but I am not going to do it.  I think we got our house for a good price, and that our area of London was lightly touched by the bubble here.  Our interest rate is 5.24%, and we will be able to make payments as long as I keep my job and the variable rate doesn't go above 10%.

Silver linings?
If you are in a position to maintain cash during this catastrophe, you may be able to profit handsomely on the other side.  Real estate should become very cheap.  You can bet that whomever wins the election in November will try to stimulate growth by investing in infrastructure.   So, there may be buying opportunities for infrastructure companies. Better to go for the picks and shovels companies, rather than the gold mines, to borrow a CA Gold Rush
analogy.  I have some shares in Mueller Industries (MWA), which sells water pipes and valves. It seems that both McCain and Obama will invest in alternative energies, so look there as well.  Energy efficiency will also be big.

That is enough for one post. Looks like a Kos post!  There is much more to be said. If you have any persuasive arguments to the contrary, I would be happy to hear about them.  Things are pretty grim from where I am sitting, and I am feeling increasingly anxious about my ability to provide for my family.

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