May 08, 2008

Triangulating Financial Armageddon

"Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news...[however] if we don’t fix the system now, there’s every reason to believe that the next crisis will be bigger still — and that the Fed won’t have enough duct tape to hold things together." Paul Krugman writing in the New York Times, May 5, 2008.

"The U.S. economy is in an intensifying inflationary recession that eventually will evolve into a hyperinflationary great depression. Hyperinflation could be experienced as early as 2010, if not before, and likely no more than a decade down the road. The U.S. government and Federal Reserve already have committed the system to this course through the easy politics of a bottomless pocketbook, the servicing of big-moneyed special interests, and gross mismanagement...The U.S. has no way of avoiding a financial Armageddon. Bankrupt sovereign states most commonly use the currency printing press as a solution to not having enough money to cover their obligations. The alternative would be for the U.S. to renege on its existing debt and obligations, a solution for modern sovereign states rarely seen outside of governments overthrown in revolution, and a solution with no happier ending than simply printing the needed money. With the creation of massive amounts of new fiat (not backed by gold) dollars will come the eventual complete collapse of the value of the U.S. dollar and related dollar-denominated paper assets." John Williams writing in his "Shadow Statistics" newsletter.

Maybe the reason that such disparate statements of essentially the same problem can exist side by side, one in the highly-modulated, business-as-usual language of an Establishment economist, Paul Krugman; and the other in the inflammatory, sky-is-falling style of a maverick outsider (Williams), owes to the hallucinatory nature of the subject in question. That is, to the unreal basis of the American monetary system. This seems to be Williams's underlying thesis; once the United States abandoned the gold standard under Franklin D. Roosevelt, the fiat system provided an open invitation to the federal government to monetize its way out of all difficulties. As the national debt exploded; as foreign sovereign wealth funds acquired huge stakes in debt instruments such as T-bills; as the trade deficits incurred through mass importations of oil and foreign-manufactured goods ranged out of control, the United States has been left only with the option of default on its internal (Social Security & Medicare) and external (obligations to domestic and foreign bond holders) debts, or running the printing presses full time to create the cash to handle its finances. It is Williams's contention, of course, that the second option leads inexorably to Weimar-style runaway inflation where the dollar becomes essentially worthless.

A precipitating event for financial meltdown could be the decision by a critical mass of foreign governments to replace the dollar as the world's reserve currency. In essence, this would break the trance of the dollar's dominance, and the U.S. would experience the collapse presaged by Germany in the 1920's and Russia after the break-up of the Soviet Union. Certainly it's difficult to argue that the preconditions are not already here. The government publishes an artificially low inflation rate in order to keep Social Security CPI increases within the realm of plausibility, but this masks the reality that the inflation-adjusted GNP is already in recession and has been for about two years. It stopped publishing the M-3 money supply figures in 2006 to hide the 17% annual increase in newly-printed cash, a figure which far exceeds any increase rationally based on growth in the GNP. Basic expenses, such as fuel, are becoming unaffordable in large part because the pricing of oil is in a currency (the dollar) which is rapidly losing its value. Airlines are going out of business because fuel is too expensive. Independent truckers can't afford long-haul routes. Residential foreclosures are at an all-time high rate. We lose sight, often, of how extraordinary all these changes are, and attribute them to a "cyclical" problem that will simply resolve as all recessions have before it. I can't tell if Krugman is saying that needed "reforms" in U.S. financial regulation could right the ship and avoid a catastrophe. It may be that he is, but he isn't very insistent. His reluctance reminds me of an old cartoon I saw long ago which stands in for a lot of things that would take too much time. Two archaeologists are standing by the exposed tip of a pyramid, shovels in hand. One says to the other: "What do you say we cover the whole thing up and just forget about it?"

Yet Krugman's approach dominates in discussions of the problem because it is "reasonable." The preference is for worldwide collusion in the faith that all is actually okay with the doughty greenback. To undermine the dollar is seen as some sort of global financial Jonestown; why would the Chinese, and the Russians, and the Saudis want to bring the house down around their own ears by destroying the American economy and its workhorse consumers?

I think that's probably how it always works. It accounts for the reluctance of many Jews in Germany to leave even after passage of the Nuremberg Laws and Kristallnacht. For the French and Russian aristocrats to await their fate in 1789 and 1917. The psychology of inertia lulls us into a complacent belief that even if obvious calculations show no way out, we will cling to an irrational belief in the survivability of the status quo, and, as part of our unconscious defense of that very irrationality, will shout down those who refuse to express fealty to the same delusion.

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