Three catastrophic scenarios

January 6, 2008

America produces nothing and can only sustain its standard of living because every fabricated fiat dollar spent on imported goods eventually gets recycled back into Wall Street as investment. Those investments filter down throughout the country and the end result is a cycle that sustains a service and consumption based economy with a dwindling manufacturing base.

This can continue indefinitely because Wall Street has the deepest and most liquid markets in the world, everyone invests in America, right? Well, not anymore. Over the past few years people abroad have begun to invest some of the dollars they took from American consumers in other markets. As those markets started to rise, even Americans started to follow suit and invest their dollars abroad. Over time the result was a gradual decline in the American dollar and a gradual loss of capital by American financial institutions, relative to their international counterparts. By some measures, London has actually surpassed New York as the #1 financial center in the world.

After years of artificially low interest rates and shady lending practices the US economy is so leveraged with debt that any further reduction in the amount of capital available would almost immediately cause significant bankruptcies among not only individuals but the largest corporations in the country. The fact is, there just isn’t enough wealth in the country for every individual and corporation to pay back their debts plus interest and the Federal Reserve can no longer create the required extra liquidity with impunity. Conditions have changed and the money doesn’t exist, period.

Ignoring reality, the Federal Reserve has been pumping hundreds of billions of dollars into the US economy and lowering interest rates, which is like feeding a heroin addict his next hit, it will do the job for now, but eventually they will come back for more. The fundamental problem is that America produces nothing and creating more debt and more fiat dollars to be exhausted by consumption will never change anything until that problem is resolved.

There are serious long term consequences to this situation and three possible scenarios:

(1) The Federal Reserve will continue to print money and the result will be ridiculous amounts of inflation, maybe eventually hyper-inflation Zimbabwe style, and millions of Americans will go hungry when they can no longer afford to eat. Many immigrants and wealthy Americans will leave and the country will be reduced to a third world nation for at least a generation.

(2) America will stop printing money and the result will be a significant economic recession, probably depression, while Americans consolidate resources by ending the current military empire and working to re-build a lost manufacturing base. While the entire planet continues to develop rapidly Americans will struggle and the country will have difficulty attracting the world’s brightest talent. But if the country restores civil liberties there will still be a residual demand for visas and US investments and the US dollar will slowly recover part of its strength. America will eventually recover to become a large but normal power, rather than a superpower, ala UK post WW2. Maybe with time America will return to global prominence only because the population is still so large relative to most other nations, but never again be a superpower.

(3) America will convince foreign governments to intervene and invest their foreign exchange reserves in the American markets, and the entire collapse scenario will be delayed altogether. However, American consumers will still suffer for many years as nobody is willing any longer to create easy credit. Since 70% of American GDP is consumer spending and the consumer savings rate is negative, although the country will survive as a super power for another 2-5 years, it will still be difficult for middle income Americans. There will be less severe recession and job losses in the short term, but coupled with political instability (possibly new wars) as politicians struggle to find ways to save the nation’s status, there could be an even larger sudden and collosal collapse in a few years. Regardless over time the US dollar will decline, as Asia rises.

Whichever scenario or combination of scenarios takes place, in each case the American consumer is broke and recession, or worse, is likely.

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