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THE
ECONOMIC REFORMATION COMING TO AMERICA
Part 3: What Crises Are Pending in the Scenario?
by Richard
Brawn
December 16, 2005
An assessment of
what the Federal Reserve must do to meet the challenges facing America.
The assessment is in three parts.
Reformation.
To return to an original form. To remake in a different form. To
rediscover lost truths.
Part 3 - What Crises Are Pending in the Scenario?
Because
the events always unfold in chaotic ways, a precise prediction of events
cannot be made. However, one can identify possible events and
circumstances. In doing so, one MUST remember that predictions are
underwritten by assumptions. And, an assumption is that which must be
true in order for the end result (prediction) to happen. Because some
event may be possible, does not mean one will be able to predict when it
will occur or even if the event(s) will occur. The underlying
assumptions may never become reality. So, I need to give a bunch of
caveats and feed the reader some small print.
Comparing
the political pressure on government during good and bad times offers
some insight into possible scenarios. First, expenditures by government
are not driven by the needs of the people but the needs of the office
holders to please their constituencies. Government operates on a cash
basis, not an accrual basis. If money is available, spend it. The powers
of office last only as long as office term. So, money burns a hole in
the collective government pocket.
Legislative
self-discipline is all that holds back spending all of the money that
can be made available each year (new debt and tax revenues). The result
is not what one would really expect. In good times, the pressure is on
to spend all available money because next year tax revenues can be
projected to go up. Spending discipline is weak in good times. In bad
times, the opposite is true. However, the needs of the people are
greatest in bad economic times. In bad economic times and if no
government savings are available, the projections point downward and so
there is an implied need for fiscal self-discipline. But, if that period
lasts too long, too many people enter the category of those hurt by the
economic conditions and the conditions themselves pressure government to
spend.
The
economist, John Maynard Keynes was a proponent of government saving in
good economic times and spending in bad economic times. The economic
theory contains a highly questionable assumption. It assumes that the
incumbents of political office will and can shoulder the fiscal
self-discipline that is necessary to make this happen. The political
will to do so is very dependent upon the political cycle of elections.
Unfortunately, economic cycles and political elections do not coincide.
This means the assumption is, for the most part, invalid. In short, it
is a nice idea but does not work in practice.
The
depth of any economic bad times to come can usually be measured by the
degree to which the various sectors of the economy deviated from the
mean/average in good times. The occurrence of economic bad times is
different in each economic sector. For example the construction sector
has a 3-5 year cycle. It progresses from project design, to project
feasibility, to project governmental approval, to project financing, to
project construction to project operation. Once a project is financed,
it virtually cannot be stopped. The reason is that a partially completed
project has significantly less value than the money put into the
project. So, the depth of economic bad times in the construction sector
depends upon how much over-building occurred during the good times.
“Over building” is a somewhat subjective term as it depends on the
rest of the economy to absorb new facilities and remove the old
facilities from the inventory of usable facilities. The US economy is
composed of thousands of such sectors and each has its own cyclic time
span.
This
all means that if, as Dr Greenspan states, the economy will be
overburdened with demands that it cannot meet, then the economic
disruption we will see will vary from sector of the economy to sector.
This will be particularly visible as the cycles reach their economic low
points. In other words, the economy will not crash. It will seem to
slowly disintegrate, sector by sector. At any point in the process,
fiscal and political bandages maybe sufficient to stop the
disintegration and possibly even to repair it. Now that I have given all
the caveats and small print, we can look at the scenario events. Below
is a socio-economic-political assessment of possible scenario events. I
have tried to put them in an order that maybe most meaningful to
investors. But, again, I want to emphasize that I am not predicting
economic collapse as if the US were to be hit by an asteroid.
If
some degree of collapse were to occur, it would be the sum total of many
years of mistakes and failure of governance. Each scenario event, below,
can have a degree of severity from virtually zero up to 100%. Since the
financial and equity markets employ leverage, they exist as fleas on the
dog’s tail. So equity markets can be heavily affected by minor changes
in the economy. You will see this as a divergence between media coverage
of the human toll and the coverage of the toll on our
pocketbook/savings/investments.
So
here we go.
1.
Increased essential government services will require additional
money. These needs and the consequences are:
a.
Welfare demands escalate due to unemployment, health
needs, welfare cycle, and transfer of retirement programs the PGC
(Pension Guarantee Corp. and institutions that failed to plan for bad
times.)
b.
Defense budget increases are needed to protect overseas US
interests that come under pressure because enemies recognize a weakened
US.
c.
Money is diverted from long term capital improvements to
immediate needs. Over time, this results in
i. An increasing effect on the economy caused by deteriorating
governmental infrastructure (roads, hydro-electric, regulatory
competence, police competence, etc.).
ii. Deferring maintenance and deferring capital expenditures.
(These are easy short-term fixes with long term adverse effects.)
iii. Financial
inability to keep people and equipment technologically up-to-date. This
is done by cutbacks in training government employees and suspending
acquisition of new products.
d.
Social crises resulting from adverse economic conditions
drive up costs to operate the Judicial, Executive and Legislative
branches of government.
e.
Increasing economic risks to investments cause an
escalation of the funds needed to service public debt obligations.
- Return
of offshore dollars to the USA.
- Price
inflation is caused by the re-entry of foreign held dollars into
the USA to purchase items that are globally scarce and now cheap
in the US due to currency depreciation.
- Fear
that the FED will monetize debt works in tandem with return to the
USA of foreign held dollars to devalue the dollar.
- Fear
by foreign holders of US private debt that the US Government will
refuse to enforce credit/debt collection by foreign holders.
- Fear
of the imposition of capital/currency controls.
- Interest
rate inflation due to these heightened risks to
capital/investments.
- Social
impact exacerbates economic problems.
- Poverty/hunger
caused by the use of foreign held dollars to buy food, raw
materials, etc. in America (See item 2a, above.) make food
increasingly expensive.
- Unemployment
caused by a dearth of homegrown investment capital to invest in
production efficiencies needed to remain competitive.
- Disposable
income growth is reduced by tax increases and job losses.
- As
asset prices fall and interest rates rise, the combination makes
it impossible for retirement funds to generate cash flows to pay
benefits.
- As
the international balance of payments shifts toward balance,
expect a loss of value for those equities whose businesses were
part of the balance of payments deficit cash flows. (That balance
of payments cash flow can be calculated to show that it
capitalizes about $10 trillion of equity.)
- FED
agrees to guarantee payment of US Government debt by monetizing
debt. Public outcry over reduced benefits (retirement, welfare and
services) creates sufficient pressure on the Executive and
Legislative branches to force FED policy changes.
- FED
declares its mission to include maintenance of the price/value of
financial market assets.
4. Contraction of
international trade
a.
Unwinding of debt makes fewer Americans able to buy
imports
b.
Poor economic conditions within the economies of our
trading partners and dollar devaluation cause them to protect their own
economies from new found US competition by imposition of tariffs
c.
Competitive devaluations of currencies among trading
partners occurs in order to save jobs for the unemployed
5. Wars.
a.
To protect overseas sources of essential raw materials (energy,
metals, food, etc.)
b.
Political leaders succumb to ‘denial’ and refuse to
believe that the macro-economic shift has changed international
political power. Miscalculation of military strength by civilian leaders
puts US forces in un-winnable wars for natural resources.
c.
Military “teeth” cannot be used because the economy is
unable to support the financial expense of the military lift requirement
and logistical ‘tail’.
d.
Adverse economic conditions in the US spread worldwide and
provide a good justification/excuse to substitute authority for
democratic processes (Impose internal controls and thus preserve order.)
6. Rise of the
Apocalypse in poor countries
a.
Non-competitive countries cannot sell to the rich
countries and therefore cannot buy from them. The rich will buy /seize
world natural resources.
b.
Halt to life support technology transfers to poor
countries because foreign aid has to be cut.
c.
Despotism replaces the rule of law in order to maintain
“order."
d.
Poor countries will be unable to protect whatever
resources they have. Rich countries will support whoever will deliver
the poor country’s resources to them.
In
politics, change that is “too fast” is, change that people notice.
Nothing
of this magnitude happens overnight.
In fact, it is the slowness of the changes lulls people into thinking
that the adverse course change is an aberration and the next course will
change for the better. History is replete with examples of simply
throwing away the time to prepare. In the 1930s-1940s a whole faith, the
Jews in Europe, suffered from what psychologists call ‘denial’. With
20/20 hindsight, it is amazing that Jewish people did not respond to the
clear signals being sent by the growth of Nazism in the 1930s. They were
certainly not fools. But, like us, they were afflicted with disbelief
that their neighbors could and would act in such a way. We must expect
to succumb to the same form of denial. Right now, even though we know
with absolute certainty that our political leaders put their personal
political ambitions ahead of those of the country, we just cannot bring
ourselves to really acknowledge this as fact.
While
Nazism may not be about to rise in the USA, various elements of tyranny
are never that far below the surface. Limiting highway speed to 50 mph
in order to save fuel is a minor act of tyranny cloaked in the ‘public
interest’ (claiming safety and saving for the disadvantaged, etc.)
Intimidation by street gangs is a form of tyranny not at all unlike
Hitler and Mussolini’s street gangs. Some religious groups want to
impose their beliefs on the rest of us by the undemocratic means and,
others even want to use homegrown terrorism. Tyranny comes from people
who see wrong and will not act against it.
Summary
Issues
to be considered.
-
In
the global economy, currencies have been separated from that which
gave them intrinsic value. Fiat currencies possess only utility.
What we think of as ‘value’ is due to how we perceive the
billions of individual transactions using currencies as the medium
of exchange. The term ‘money’ is anything you want it to mean
that acts a medium of exchange between transactions.
-
Infinite
quantities of any currency can be produced. Currencies can be
further parsed by creating classes among the holders of the
currency. (Foreign holders vs. domestic, government vs. private,
etc.)
-
Economic
re-formation or change engineered by the FED must happen in order
for people to accept an economic future characterized by declining
expectations. The alternative is that the government will lose its
legitimacy.
-
Crises
that result in ‘emergencies’ are a mechanisms that allow
government to usurp individual rights.
-
Think
ahead and take small precautions so you avoid finding yourself like
a deer caught out on a freeway in the midst of rush hour traffic.
© 2005
Richard K. Brawn
Editorial Archive
CONTACT
INFORMATION
Richard K. Brawn, CCGA, MPA
Petaluma, CA USA
Email
California Certified General Appraiser (CCGA)
Master Public
Administration (MPA)
The
opinions of FSU contributors do not necessarily reflect those of
Financial Sense.
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