Casey Files:
The World as We See It
4 reasons why this may be
the worst crisis since the 1930s
and 4 projections for what's going to happen
Bud Conrad
The
Casey Report Webinar - Casey Research
Sep 4, 2008
I identify the foundational
forces now driving our economy to establish a basis for the investment
recommendations you'll read in this advisory in the months to
come.
The role of the U.S. as the
world's dominant economic superpower is now challenged by an
out-of-control growth in debt and a deterioration in its reputation
as a financial haven. The dollar is losing its special status
as the global "reserve currency," is leading, in turn,
to higher inflation, higher interest rates, weakening financial
assets (stocks and bonds) and runaway prices for commodities.
Let's get the charts
and let them speak for themselves, with some interpretation along
the way:
1. U.S. Government
Deficits: From Bad to Worse
Government deficits are the root source of the creation of money...
and its eventual debasement. Simply, when the federal government
spends more than it raises in taxes, it eventually has to create
more money (in complicity with the Fed) in order to pay the bills.
Of course, it can borrow the
money, but that often includes borrowing newly created money
from the Fed. The deficits remain and they accumulate and in
time. They must be resolved, either by payment or default, either
overtly or covertly through the mechanism of inflation.
While some level of government
deficits may be acceptable over modest periods of time, the U.S.
deficit is now well past the point of being acceptable. The deficit
will soon grow to monster proportions as the baby boomer retirement
obligations exceed the ability to tax the declining number of
workers contributing to the Social Security and Medicare funds.
Projections of the likely deficit
compared to GDP growth make it clear that the government is faced
with hard choices. The easy path of just letting the dollar fall
is the most likely.
2. The Expanding U.S. Trade Deficit
It is consumers who
primarily receive the money provided by U.S. government deficits.
In this globally interconnected world, they then spend a portion
of that money on foreign goods. An unintended consequence of
the ballooning government deficits, therefore, is a large and
growing trade deficit.
The foreign recipients of those
dollars - whether Chinese manufacturers or Middle Eastern oil
sheiks - have, in recent years, turned around and reinvested
those dollars in U.S. Treasuries. They have done so because of
the perceived safety of those instruments, and because of the
sheer volume of the dollars they have to invest. In addition,
it has been in their commercial interest to help finance the
U.S. deficit.
With the trade deficit now
running at $750 billion per year, and much of that money coming
back into U.S. Treasuries, the U.S. government has grown dependent
on foreigners to sustain the continuing deficits.
That level of debt would normally
cause extreme weakness in a currency - just as it would in the
value of debt owed by a deeply indebted individual. However,
the sheer magnitude of the foreign holdings provides something
of a bastion against a total collapse in the dollar.
Even so, some foreign holders
are easing toward the exits... through the purchase of an operating
company or resource deposit here, or a landmark New York building
there. They might make a billion-dollar equity investment in
a brand name company, or exchange some dollars for a basket of
currencies or a ton or two of gold. It's a delicate balancing
act, because if they get too aggressive, they risk triggering
a mad dash for the exits, a nightmare scenario where the value
of their trillions of dollars in holdings would be devastated
almost overnight.
3. Rising Oil Prices Affect... Everything
The growing global demand for oil, coming as it is against a
backdrop of limits being hit in production growth, is a major
contributor to today's big price rises.
The clear and present danger
is that we are now using several times more oil than we are discovering.
The world currently produces about 310 billion barrels of oil
per decade. That amounts to about three times the current discovery
rate of 100 billion barrels per decade.
According to the Peak Oil calculations,
we have already used about half of the energy stored over the
last 100 million years. Against that, we have a steady increase
in demand emanating from population growth and economic development,
especially in Asia. This, coupled with the dearth of major new
discoveries, assures that energy markets will remain at high
prices, for the foreseeable future. The current big drop from
almost $150 to $110 has happened from a slowing economy and from
some conservation at the extreme high gas pump prices, but the
long term view is that the lack of reasonable alternative to
petroleum argues for continued higher prices returning to the
previous peak in the year ahead.
As energy is a component in
the manufacture of all goods and services, this is of no small
consequence. Energy has been the basis of the abundance of our
current existence and has allowed human population to grow from
1.5 billion to 6 billion over the last century.
4. War Affects the Deficits and Hurts
the Dollar
The war in the Middle
East adds unwanted pressure on oil and ratchets up government
spending. Less obvious is the damage to U.S. prestige that is
important in the ability of the U.S. to attract much-needed foreign
investment.
The Congressional Budget Office
estimates the war will cost 3 to 4 trillion dollars, an amount
of sufficient size that it will affect the U.S. financial system.
Regardless of the short term
political ups and downs or even a new administration, the pressures
from war for big deficits and for dollar depreciation are inescapable.
Where Is the Economy Going in the
Next Six Months?
Projections
1. The housing decline is not
yet done, because we will need another year to unwind foreclosures
in the pipeline. The housing bubble still has another 10% to
20% to go to fully deflate.
2. Consumers in the U.S. are
not able to expand credit and are increasingly concerned about
the outlook for the economy, so they will slow spending both
at home and on imports, which means we are in a recession or
about to confirm one.
3. The financial/banking system
is weaker than understood. The global system and literally trillions
of dollars in derivatives has left the world's banks teetering
on the edge. Don't jump back into financials.
4. A slowing economy - recession
- coupled with inflation, creates a condition referred to as
stagflation, as the simulative bailouts compete with the debt
implosion of overleveraged financial institutions and real estate,
to leave us with stagnation and still high costs.
The result of this is that
the inflation rate, interest rate, food, energy and precious
metals are heading higher as the dollar is debased.
Higher rates are not good for
housing and stocks.
Finally, it is important to
recognize that the world remains in the throes of a deep and
serious crisis. While many analysts will express the view that
the worst is over or that, after a modest downturn, things will
bounce back just like they always have, our view is that what
we will actually witness going forward is a fairly steady erosion
of paper currency purchasing power and sluggish economic growth.
The crisis will accelerate, moving faster, even, than in previous
major shifts such as that witnessed in the 1970s.
While history may find
we are too pessimistic at this point in time, in our view it
is far better to prepare for a worsening crisis and hope that
it does not materialize, than to expect business as usual.
###
Bud Conrad is Chief Economist with Casey Research,
specialists in natural resource and precious metals investing.
And now, you can have the opportunity to sit in on a round-table
discussion of the economy, the market, and the best ways to profit
from this crisis - free and online. The Crisis and Opportunity
Summit is the first-of-its-kind event by Casey Research.. giving
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