 The Cassandras and the Optimists
Nelson Hultberg
hultberg@afr.org
May 11, 2004
In response to a question about
an upcoming pennant race back in the 1950's, Leo Durocher of
the New York Giants once replied, "Whom knows?" This
charmingly crude retort pretty much sums up our best answer today
to how the great economic upheaval looming ahead of us will unfold.
The thousands of convoluted variables shifting in and out of
importance daily, that comprise the global economy, make human
efforts at forecasting about as reliable as our predictions on
the weather. Still, despite the exasperating uncertainty over
it all, there are several strong probabilities that we can glean
from the political-economic tea leaves if we are good enough
students of history and human nature.
I engaged in debate the other evening about these probabilities
with some acquaintances who held the view that I was an unreasonable
Cassandra spreading undue alarmism. As they saw it, deflation
was impossible, the economy was robust, America had endured far
worse before, and she would do so again. What follows are some
answers to their optimistic scenario.
Deflation Not Possible
Their first objection to my "alarmism" was that deflation
is not possible with a paper currency.
This is probably true, I replied. It would be difficult for the
money supply to deflate as long as the boys at the Fed have access
to a printing press and the willingness to use it. But bubbles
can, and will deflate. For example, Basic Investment 101 says
that the bond and Dow bubbles must burst and deflate in the face
of intense dollar inflation on the part of the Fed. (The real
estate bubble is a wild card in this scenario and could go either
way). The problem that many people have with this issue is that
they see the clash of inflation and deflation as an either-or
kind of thing. This is a false picture brought on by viewing
deflation in only its narrow monetary definition and ignoring
its relation to prices (more on this later). In my last
article I said we would see both Scylla (inflation) and Charybdis
(deflation) in tandem, which is a more accurate picture of what
must unfold.
How precisely the tandem will come upon us we can't say with
precision, of course. But as I see it, there will be wild dollar
inflation from the Fed because that is all they know how to do.
And they will feel that they have to do something in the face
of a melting down economy. But their dollar inflation will not
sustain the Dow; it will kill the Dow and send it to the bottom
of the charts around 4000. Thus, we will have dollar inflation
and Dow deflation. The same scenario will take place with Treasury
bonds. As the dollar inflates, bonds will deflate. Greenspan's
two major bubbles (the Dow and Treasuries) will burst in a slow
motion collapse that grinds down over the next 5-10 years. And
since the Dow is such an integral aspect in the people's perception
of how wealthy they are, there will be a catastrophic transformation
of mood among the millions of investors that look to the Dow
as the indicator of "how we are doing economically in America."
This second bursting of the Dow (and the dramatic mood change
it evokes) will bring on a painfully STAGNANT economy along the
lines of the 1970's stagflation. Only this time it will develop
into hyper-stagflation, or what Franklin Sanders has termed a
"hyperinflationary depression." This will be the Kondratieff
winter of 2000-2015. It will manifest differently than the last
Kondratieff in the 1930's, just as that one in the thirties manifested
differently than the prior winters of the 19th century. This
difference of manifestation is due to the cultural and technological
differences of our era and also to the fact that we have learned
from the past. Unlike our predecessors in the 1930's, we now
know about the Kondratieff cycle. And because we do, we will
take defensive action to try and avoid its winter season as it
descends upon us. All we will accomplish, however, is to delay
and exacerbate the winter's ultimate intensity. We will not prevent
it from its highly deflationary, debt-purging role.
A final crushing blow will be some sort of ruinous restructuring
of Social Security that will be painted by our government as
a "new realistic plan for America's seniors in the 21st
century." But the public will perceive it for what it is
-- a royal screwing by our oleaginous windbags in Washington.
And their mood will further reflect such a perception by turning
darker still.
Therefore, inflation is coming in a big way because the manipulative
charlatans at the Fed have nothing else in their arsenal. But
their "dollar" inflation will NOT keep the ravages
of deflation from afflicting the various bubbles of our economy.
The Dow and Treasury bonds are headed south to Antarctica. The
jury is still out on real estate; it might escape deflation in
the meltdown because the public will have to have some place
to funnel their depreciating dollars that the Fed is so benevolently
printing for them. Of course, gold will
benefit greatly (and probably silver also).
So we will have an economy in which some sectors are deflating,
while other sectors are inflating. The key is to get our money
into the ones that are inflating. While the establishment lemmings
will get fleeced by the Wall Street-Washington touts hawking
the idiocy of bonds and equities to the bitter end, those of
us in the hard money community know better than to listen to
snake oil spin to sell paper illusions. The choice for us will
not be difficult at all. We will stash our wealth in gold (and in silver for those who are certain it
will become the "poor man's money").
Why the Optimists Are Wrong
Part of the problem for today's punditry is that they define
the term "deflation" as only a shrinking money supply.
Consequently, they insist that a depressionary scenario is impossible
because the Fed can print money whenever it wishes and will dispense
that money to whatever extent it needs to. Therefore in the eyes
of the Keynesian establishment, no deflation can ever take place
with the Fed primed at the printing presses and their helicopters
gassed up at the airport.
The flaw in this kind of thinking is that deflation has other
connotations. There is "monetary" deflation, and there
is also "price" deflation. There are two types of deflation
just as there are two types of inflation. All free-market advocates
realize that monetary inflation brings on price inflation. It
is the prior increase in the ACTUAL SUPPLY of money that brings
on general price inflation. The monetary increase causes the
price increases -- elementary cause and effect that sadly escapes
the Keynesians. Deflation operates in a like manner, only in
the opposite direction.
There is a far more essential point about all this, however,
that is vital to understand. The strict cause and effect relationship
between money creation and prices that leads to general price
inflation does not always apply to the deflation scenario. For
example, once an economy has reached an advanced stage of monetary
inflation, it can experience a "price deflation" without
a decrease in the ACTUAL SUPPLY of money. All that has to take
place is a decrease in the RATE of monetary expansion on the
part of the Fed, and prices will start nose-diving. The actual
money supply itself does not have to decrease; there just has
to be a slowing of the speed with which the Fed is expanding
the money supply. For example, if the Fed has been expanding
money at an average annual rate of 6% over several years and
then slows the expansion to an average rate of 3% for several
years, it will bring on price deflation in sectors that are vulnerable
(i.e., asset classes such as real estate and equities).
Since monetary creation today is primarily debt creation, the
Fed's monetary policies to regulate the economy are putting the
American people deeper and deeper into debt with each passing
year. The speed of this debt creation is increasing at an alarming
rate, yet it is bringing less and less increase in national income
and GDP.
For example, Michael Hodges shows us in The Grandfather Economic
Report that the amount of debt creation needed to generate national
wealth today is almost 2 times what it was just 20 years ago.
In 1983, it required $11.5 trillion in debt to generate $5 trillion
in national income. Today it requires $37 trillion in debt to
generate $8.7 in national income. [click]
What this means is that debt has to be created at a faster and
faster rate in order to keep the economy growing. If the Fed
does not continually increase debt at a faster rate every decade,
it runs the risk of the economy slowing to a halt. The vulnerable
sectors of equities and real estate will start to deflate. The
bubbles will start to burst.
Twenty years ago, we needed $2.3 in debt to create $1 in growth.
Today we need $4.3 in debt to create $1 in growth. How much debt
will we need next year? Next decade? This is a monstrous debt
spiral trap that we have climbed onto. This is why the Fed has
to keep inflating the money at prodigious levels. If it doesn't,
we face an economic meltdown.
More and More Credit Needed
The question is: How much more debt can be loaded onto the American
people? The Keynesian credit train that we boarded in 1936 is
no longer just chugging along creating mild amounts of debt as
in the fifties and sixties. The train is now streaking down the
tracks in order to keep the economy afloat. At some point the
debt load it is creating will become insufferable to the consumers
and businesses of America. They will then undergo a dramatic
change in mood. They will then stop borrowing and start saving.
They will start paying off debt instead of incurring more debt.
This will slow the rate of monetary expansion and bring on price
deflation in those asset sectors that are vulnerable.
It is at this point that the Fed will be forced to ratchet up
its "liquidity injections" to a fever pitch in order
to induce enough monetary growth to avoid crashing the economy.
They will have to start monetizing heavily. They will have to
gas up the helicopters. They will have to run the risk of bringing
on hyperinflation and the terrible fate of Germany's Weimar Republic
of the early 1920's.
Eventually the Fed's choice will be either to continue onto Weimar,
or attempt to slow the speed of credit expansion so as to avoid
collapse of the currency. But if the Fed engineers do attempt
to slow monetary growth, then just the slowing itself will induce
the prices of various sectors to DEFLATE. Thus serious price
deflations are coming to our economy in the upcoming years even
though the Fed will be pushing credit/debt expansion and outright
monetization to ever-higher levels.
This is what I mean when I talk of deflation visiting us in tandem
with inflation. I mean that prices will be seriously deflating
in various sectors, not the actual supply of money throughout
the economy. The two most crucial sectors susceptible to price
deflation will be the asset classes of equities and bonds.
Does this mean then that an actual deflation of the supply of
money is impossible? Not at all. Actual monetary deflation could
take place also. For example, if things get bad enough, if prices
deflate far enough in such sectors as equities, bonds, and real
estate, then all businesses and consumers could draw in their
horns drastically. There would take place a catastrophic mood
change throughout the economy. Velocity of money would slow to
a crawl. People would cease to borrow and spend. They would become
very cautious and rush to pay off debt. Those who couldn't handle
their debt load would default. Bankers would tighten up their
loan qualifications to protect their bottom line. If severe enough,
these actions could bring about an actual shrinking of the money
supply because modern day money is basically credit/debt. It
is not cash. It is all merely computer entries of promises to
pay. When those promises dry up, then what we now consider to
be money dries up.
This would be a classic deflationary spiral in which the total
money aggregates for the economy actually shrink. It would be
a disaster. While unlikely, it is not impossible. The collective
mood of the billions of spenders and investors that make up modern
day economies cannot be predicted with certainty. Monetary deflation
could happen. It all depends upon how vigorously the Fed is willing
to pursue the outright printing of new money, and then how vigorously
the people will be willing to spend it.
The Terrible Choice We Face
What are we to conclude from all this? The level of credit and
debt that we are now creating CANNOT continue to be increased
at a faster rate indefinitely? Eventually the credit/debt expansion
on the part of the Fed will encounter what a runaway freight
train with ever-increasing speed must encounter. Either its engineers
slow the speed, or the train flies off the tracks. It will be
the same for the Fed; either it slows credit expansion, or it
flies off the tracks into a Weimar-style oblivion. But if it
slows the speed of money/debt creation, it puts the economy in
terrible jeopardy because the Dow cannot survive such a slowing.
The fact that all optimists think it can is one more example
of how men hide their heads in the sand in face of uncomfortable
truths.
The paramount question before us then is how long before the
Fed's money/debt train must begin to slow in speed so as to avoid
a Weimar-type scenario? Impossible to say, but hopefully the
reader can see the dilemma we are now in. The Fed must continue
to expand credit and debt at an ever-increasing rate because
just slowing the "speed of expansion" will bring on
price deflation in the crucial asset sectors such as equities
and real estate that have been expanded into bubbles.
This is why Scylla and Charybdis will descend upon us in tandem,
and why eventually the crisis will be horrendous. Contrary to
the grand Keynesian illusion, the Fed cannot just moderately
inflate and maintain a steady expansion of debt in the economy
over time! Credit/debt creation loses its power to stimulate
over time as the total debt of society increases. This leads
eventually to the necessity of helicopter money, i.e., massive
printing of new money that doesn't require the multiplier effect
of fractional reserve banking to be effective. It is just injected
straight into the economy via monetized deficits for military,
pork and welfare spending. It is actual cash that ends up in
the pockets of consumers and doesn't require them to apply for
a loan. This is the last straw grasped for by a desperate Fed
trying to maintain a decent GDP growth rate. This step will,
of course, lead to rapidly rising prices, and if done too vigorously,
runaway inflationary prices and the complete collapse of the
currency.
The only alternative will be to bite the bullet and accept the
necessity of a ravaging meltdown in order to work off all the
debt. The reason why the meltdown must be ravaging is because
the level of "debt creation" we have engaged in for
the past 30 years has been gargantuan, and its growth is now
accelerating like a heroin addict's dosage levels. This must
bring a severe corrective phase to balance such insanity. This
is the way the laws of nature work; actions bring reactions in
proportion to the size and intensity of the original action.
This is the horrific dilemma that now confronts the boys at the
Fed. This is Scylla and Charybdis starkly staring them in the
face, and saying, "Which one of us do you prefer? You must
choose; you cannot have an inbetween scenario! You have broken
the laws of nature with too much abandon for far too long! Your
greed and power lust are now coming home to roost. You must pay
with suffering."
Not Yet Rome
This type of talk did not endear me to the optimists at all,
so they changed tactics and zeroed in on what they felt was the
real lunacy of the Cassandra scenario. They protested that even
if we are in for some hard times, we are not yet Rome and we
will not see that happening anytime soon.
I agreed. But what we will see, I said, is a velvet-glove dictatorship
taking over America in the next 20 years under the guise of a
"new kind of freedom" that will very subtly attempt
to smuggle us into a one-world tyranny. Yes, we will get through
this massive debt problem. But the question we must ask is, "In
what form will we get through?" As I see it, martial law
and a rewriting of the Constitution to accommodate the jack-boots
natural propensity to bang down doors is quite possibly the way
in which we will "get through the debt problem."
Optimists must sooner or later come to realize that there is
no moderate, soft-landing scenario that we can bring about between
Scylla and Charybdis. It is too late for that! We must choose,
and both alternatives bring with them a high probability of some
kind of ruthless dictatorial takeover of our country. This, a
rational person gleans from history and human nature. Men will
opt for tyranny when chaos is clawing at the edge of their survival.
They will forfeit their liberty in hopes of establishing stability.
This is why our role in the gold community
is not just to try and profit from the meltdown scenario, but
also to educate the people as to how we must climb out of the
maelstrom. We, who have been blessed with a sounder grasp of
the cause and effect relationships taking place here, must try
to help our fellows understand the nature of the crisis descending
upon our society. We must try and explain to them the true nature
of the chaos and its Federal Government-megabank origin. We must
educate them that liberty and economic chaos do not go together.
On the contrary, liberty and economic order go together as Adam
Smith and the Founding Fathers understood. It is our centralized,
manipulatory government that has brought us to the chaos. It
is government that is obliterating the harmony of our economy
in the way that a bear disrupts an industrious beehive in pursuit
of the honey that those bees are producing. Government's paws
are large and clumsy, and they wreck everything they touch in
the path of their greedy reach.
Thus it is a fallacy to say that we must bring about a more centralized
and more interventionist government in order to alleviate the
chaos that is descending upon us. A true free-market will alleviate
the chaos and still allow us to retain our rights and our freedom.
It is not capitalism that has wrought our misery; it is government
intervention into capitalism throughout the 20th century beginning
with the Fed and World War I that has brought us to such a chaotic
dilemma. Government is not the solution; government is the problem!
Can such a message be accepted in time? Whom knows? But a man
must try to fight the forces of evil that he sees rising up around
him. Even if he is doomed to defeat, he must fight. What kind
of life have we lived if we let the black limousine boys win
by default? If we have to go down, let us at least go down fighting
with all the intellectual vigor that we possess, all the activist
passion that we can muster.
May
10, 2004
Nelson Hultberg
Americans for a Free Republic
www.afr.org
hultberg@afr.org
 Nelson
Hultberg is a freelance writer in Dallas, Texas and the Executive
Director of Americans for a Free Republic www.afr.org. His articles
have appeared in such publications as The Dallas Morning News,
Insight, The Freeman, Liberty, and The Social Critic, as well
as on numerous Internet sites.
He is the author of Why We Must Abolish The Income Tax And The
IRS (amazon.com), and he has a forthcoming
book, Breaking the Demopublican Monopoly, to be released this
summer.
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321gold Inc
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