I’m sure that you’ve been reading about the current liquidity crisis. But I’m not sure that the average citizen realizes the full implications. Twenty years ago, borrowed money was a lubricant for the American economy. Now it is the economy. Without credit at all levels–consumer, corporate, and government–America as we know it would cease to exist. We live in what economist Bill Bonner calls The Empire of Debt. Because of the lending crisis, the U.S., economy is teetering on precipice. Writing in his Reality Check e-newsletter this week, Dr. Gary North pointed out: “On August 15, the 90-day T-bill rate was 4.21%. The next day it fell to 3.79%. That was a one-day drop of .42 percentage points. As a percentage, it was a 10% drop. We rarely see 10% moves in one day. The next day, Friday, it was down to 3.76%. On Monday, August 20, it fell to 3.12% . That was another 17% decline. This is not a merely rush for safety. It is bordering on panic.”[Emphasis added.] This crisis can have huge, unforeseen macroeconomic effects.
I think that the term “panic” is a good description for current credit market conditions. In fact, I won’t be surprised if the current credit crisis is someday remembered as The Panic of 2007. Hopefully it won’t be followed by the Depression of 2008 to 2028.
I’ve been asked by several readers for a projected outcome on the current credit crunch. Since no one, not even Helicopter Ben Bernanke can say for certain what will happen, in this article I’m offering a range of potential outcomes. I will also assign a speculative percentage likelihood of each outcome. To assuage the Pollyannas, I will first offer the best case outcome:
1.) Best Case: The Credit Market Staggers Back to Business As Usual
If the recent massive injections liquidity the Federal Reserve and the European Central Bank are successful at calming credit market fears, and if congress steps up and starts issuing blanket loan guarantees, then perhaps the credit market will recover, and stagger back to some semblance of normalcy. But unless or until that occurs, the credit markets will continue to be petrified by fear, uncertainty, and doubt (FUD). Even in this best case, there will probably be a global recession, while order is restored to the marketplace
As background, let me explain: When in FUD mode, credit does not flow, regardless of low interest rates. Presently, the bankers are beFUDdled: They are reluctant to make loans-to even the heretofore most “credit worthy” corporations because they are uncertain of the true credit worthiness of any borrower that has either primary or secondary (derivative) exposure to sub-prime loan investments. Bankers have a long and worthy history of being risk averse. In situations where one or more risks cannot be fully and properly gauged, their default answer is, was, and always will be, NO. As in: “No, I won’t approve this loan.” The only way that they will get out of FUD mode is if the risk can be either be removed (through loan guarantees), or if risk can be properly gauged, through new accounting practices that reveal underlying risks being borne by the borrower. The latter may be difficult to accomplish, because in the past five years the derivatives market has ballooned to gargantuan proportions. There are many trillions of dollars of derivatives in play, with only some very flaky accounting to back them up.
Even this “Best Case” is not a real solution to the Debt Bubble problem. A speedy return to a credit-driven economy is essentially just forestalling the inevitable. The Powers That Be will only be sowing the seeds for an even bigger, more painful unwinding of debt in another few years. Likelihood for this outcome: 5%
2.) Lower Interest Rates, Then Recession
As previously noted in SurvivalBlog, Ben Bernanke and the Fed Board of Governors are stuck. If they lower rates then they will crack the critical support level for the US Dollar Index, which appears sacred at about 80. And if they raise rates, then it will put Wall Street into a tail spin and possibly plunge the economy into depression. In the short term, the Fed will likely yield to political pressure and continue to lower interest rates. But this will be to the detriment of foreign investment, and inevitably to the value of the US Dollar on the FOREX. So I doubt that the Fed will drop the prime interest rate more than 80 basis points (0.8%), including the recent 50 basis point (0.5%) drop. Any further drop could precipitate a full scale dollar panic–a global flight from the US Dollar. After moving within this narrow range of motion, Bernanke, et al will be truly struck–inextricably stuck. Starving for liquidity, the economy will plunge into a deep recession. This recession could last 2 to 5 years. And there could be some variations on this theme (See 2A, 2B, below.) The stock market will decline at lest 20% and corporate layoffs will be be even larger than in recent recessions. Likelihood for this outcome: 60%.
2A.) Coastal Suburban Real Estate Declines to Desperation Price Levels
Regardless of whether or not Bernanke and company pull off a miracle for the bankers, the coastal suburban real estate market will continue to decline. It was so badly inflated–all with easy money courtesy of “Easy Al” Greenspan and his successor–that it may fall by as much as 60% in some overvalued markets like Palm Beach, Phoenix, Las Vegas, and Seattle before the market bottoms. Meanwhile, the price of rural real estate in inland regions will probably remain fairly solid–except for resort areas like Hot Springs Arkansas, Sun Valley, Idaho, Vail, Colorado, and Lake Arrowhead, California.
As the market falls and ARMs reset, some home owners will go to extreme measures to save their McMansions. They will sell off at a loss their second homes (mostly in resort locales), sell off their “spec” and rental houses, their fancy cars, fine art, and various collections. One nice fringe benefit: The price of some guns may actually come down for a while. Consider any good quality gun in a common caliber a good choice for tangible investing.
Not all owners will continue to psychologically latch on to their unaffordable houses. Some owners will simply walk away when they get upside down in their mortgages. This will be compounded by corporate layoffs that force families to relocate to live with relatives and/or to seek work. When they realize that the remaining unpaid mortgage principal is far greater that what they if they sold their house, they will do as the Lord Humongous suggested to Papagallo’s band of survivors: “Just walk away.” A lot of them won’t even bother dropping off their door keys at the bank.
2B.) Sequential or Simultaneous Deflation and Inflation
We might see some real economic oddities in the next few years, as the debt spiral unwinds and people are forced to liquidate some assets at a loss. There might be a wave of deflation followed by mass inflation, or even simultaneous inflation and deflation of some prices, such as:
* Precious Metals Up… and Base (Industrial) Metals Down
* Inland Rural Farms Up… and Coastal Suburban/Resort Houses Down
* Groceries Up… and Timber/Lumber, Yachts, and Fine Art Down
* Disney and Coleman Stock Up… and Home Depot, Microsoft and Most Other Stocks Down
* Pickup Trucks Prices Up… and Sports Car/Luxury Car/Classic Car Prices Down
* Imported Goods Up… and Domestically Manufactured Goods Down
* Farm Machinery Up… and Textile, Plastics, and Metal Stamping Machinery Down
* Commercial Greenhouses Up… and Urban Office Buildings Down
Depending on how deep the industrial recession gets, and how much travel is curtailed, we might even see oil and gasoline prices come down to pre-2005 levels. (Of course, if the US Dollar Index slips substantially, then oil prices will remain high since most oil is imported, and less of it will be denominated in US Dollars in the coming years.)
3.) Lower Interest Rates (Within Limits), Then Depression
Picture outcome #2 (above) only worse. The recession doesn’t end. It only gets worse. Corporate layoffs escalate to the point where 30% or more of American workers are out of work. Lower interest rates, loan guarantees, and government job programs are ineffective. The stock market keeps going down. The dollar continues to lose buying power versus foreign currencies. Coastal real estate remains in the doldrums. After three or four years, the anchormen on news networks stop calling it a recession. They call it what it is: a Depression. Similar in some way to the Great Depression, they might call it The Greater Depression. It could last from 5 to 20 years. Likelihood for this outcome: 20%.
3A.) The Cure Worse Than the Disease: HRC Channels FDR
If Hillary Rodham Clinton (HRC) is enthroned in the midst of a deep recession or a depression, I predict that in partnership with the Democrat party-controlled congress she will take the typical New Deal Democrat approach, and begin a massive round of Federal spending to help “revive” the economy. Channeling the spirit of Franklin Delano Roosevelt (or should I say Eleanor Roosevelt, who really ran the show), HRC’s answer will be to throw money at the problem: A whole raft of new “Alphabet Soup” agencies, wage and price controls, currency changes, pork barrel road projects far and wide, massive expansion of Federal job programs, more welfare, you name it—more, more, more government spending.
4.) Global Depression and World War III
Everyone know that if you buy a car on credit and you stop making your payments, the bank sends someone to tow your car away. Nation states do the same thing. I call it kingdom towing. Most people just call it war. In the event of a major Depression, the chance of war will increase dramatically, either because of perceived vulnerability, or because politicians will see wartime spending and national resolve as a means to rouse a dormant economy. Likelihood for this outcome: 10%
5.) Worst Case: Depression, Hyperinflation and Total Socioeconomic Collapse
The Depression and inflation are so severe that law and order completely breaks down and long distance commerce ceases. You’ve read about it before in SurvivalBlog and in my books, so I don’t need to explain it here. Likelihood for this outcome: 2%.
Again, I don’t pretend to have a crystal ball. Take all of the foregoing as educated guesswork. Formulate your own pet scenario and extrapolate outcomes. But above all, be prepared. Tailor your preparations for your climate zone and for the population density and water availability in your area. Quit hesitating. If you have the means to do so, move to a lightly populated retreat area. Even if you decide to stay in the suburbs, get your beans, bullets, and Band-Aids squared away, muy pronto.