I’ve had several consulting clients contact me in recent weeks, all with notes of fear in their voices. They realize that something is horribly wrong with the economy, but they cannot properly isolate and articulate the problem. I haven’t been able to calm them, however, because to an extent I share their anxiety. In my estimation, the “something wrong” that we sense is nothing short of a monumental shift in the economic climate.
America is clearly headed for a recession. Most economic recessions are simply a product of the business cycle. These recessions are relatively mild and they often last just 12 to 24 months. The economic engine just readjusts and everything soon gets back to normal. But this nascent recession in 2008 is something radically different, and it won’t be short-lived. The current slow down was triggered by a collapse in the global credit market. For decades, the global credit market grew and grew, in an enormous debt spiral.
Our neighbors to the south saw trouble coming decades ago, because their economies were at the time more debt-dependent than our own. As far back as the mid-1980s, their newspapers featured political cartoons that portrayed enormous, insatiable monsters that were invariably captioned “La Deuda“–“The Debt”. Our cousins in Latin America saw it coming first, but the dark side of the debt nemesis will soon be clear to everyone.
Because modern banking in the western world is based on interest charges that create continuously compounding debt, credit cannot continue to grow indefinitely. At some point the excesses of malinvestment become so great that the entire system collapses. This is what we are now witnessing: a banking panic that is spreading uncontrollably as wave after wave of ugly debt [1] gets destroyed by margin calls and subsequent business failures.
Some economists are fixated on reading charted histories–and unrealistically expect that by doing so that the can reliably predict future market moves. (They can’t do that any more than I could predict the bends in the road ahead by keeping a chart of the preceding left and right turns of my car’s steering wheel. My apologies for any offense to my friend The Chartist Gnome [2], but you are fooling yourself.) Although they are working from a flawed premise at the micro level, the chartists do have some things right on the macro level: There are major economic “seasons” and even climate changes. The most vocal chartists like Robert Prechter [3] hold to what is called the Elliot Wave Theory.
The big bad nasty in this school of thought is a Kondratieff Winter [4]. This “K-Winter” is an economic depression phase that the world has not fully experienced since the 1930s. An economic winter does not end until after the foundations of industry and consumer demand are rebuilt. This can be a painful process, often culminating with war on a grand scale. (It was no coincidence that the Second World of the early 1940s was an outgrowth of the Great Depression of the 1930s.)
The US Federal Reserve and the other central banks are furiously pumping liquidity to the best of their ability, but in the long run they will not be successful. At best, dumping billions in cash on the economy will delay a depression by perhaps a year or two. But inevitably, a K-Winter depression will come. And the longer that it is delayed, then the worse the depression will be. Further inflating the debt bubble will only make matters worse. I think that veteran market analyst Jim Rogers had it right, in a recent interview [5]. Take a few minutes to watch that video. Jim Rogers sees the big picture. I wouldn’t be surprised to hear that he has gone off somewhere to hunker in a bunker.
“Big Picture” Implications
As I’ve mentioned before, hedge funds are presently most at risk in the unfolding liquidity crisis, because they use lots of leverage in lending funds that they themselves have borrowed. They borrow short and lend lon, effectively use debt compounded upon debt. Many, many hedge funds will be bankrupted before the end of 2008 [6].
Even more alarming is the scale of global derivatives trading [7], particularly for credit default swaps (CDS). Derivatives are a relatively new phenomenon, so derivatives contract holders have not yet experienced a major recession or a depression. Thus, it is difficult to predict what will happen in a genuine K-Winter phase. In a perfect world, derivatives are a nicely balanced mechanism, where there are parties and counterparties, and every derivatives contract equation balances out to have a neat “zero” at its conclusion. But we don’t live in a perfect world: Companies go bankrupt. Contracts get breached. Counterparties disappear and disappoint. We have not ever experienced a derivatives full scale “blow up”, but I predict that when it happens, it will be spectacular.
The scale of derivatives trading is monumental, and the vast majority of the population is blissfully ignorant of both its scale and the implications of a derivatives crisis. There are presently about $500 trillion of derivatives contracts in play. That is many times the size of the gross product of the global economy, but the average man on he street has no idea what is going on. It won’t be until after the giant derivatives casino implodes that the Generally Dumb Public (GDP) awakens and asks, “What the heck happened?” Since the credit market began to collapse last summer, the number of new derivatives contracts has dropped precipitously. But whether the aggregate derivative market is $400 trillion versus $500 trillion, when a crisis occurs there will undoubtedly be some very deep drama.
The next decade will likely be characterized by successive waves of inflation and deflation, and perhaps some of both simultaneously, at different levels [8]. Countless corporations, and perhaps a few currencies or even whole governments will go under as this tumult plays out. The current low interest rates will soon be replaced by double-digit rates, much like we saw in the late1970s. The dollar will lose value in foreign exchange, and may collapse completely. The Mother of All Bailouts (MOAB [9]) will result in mass inflation. The bull markets in silver and gold will surge ahead, propelled by economic and currency instability. (Investors will be desperate to find a safe haven, when currencies and equities are falling apart.)
Risk Mitigation
Be ready to “winter over” the coming K Winter depression. That will require: 1.) Prayer [10]. 2.) Friends that you can count on (a “retreat group”). 3.) A deep larder [11], and 4.) An effective means of self defense [12] with proper training [13]. (For each of those four factors, see the hundreds of archived articles and letters at SurvivalBlog.com for details.)
Since large-scale layoffs seem likely, it would also be wise to have a second income from a recession-proof home-based business [14].
In the event of a “worst case” (grid down [15]) economic collapse, it would be prudent to have a self-sufficient retreat in a rural area that is well-removed from major population centers [16]. Get the majority of your funds out of anything that is dollar-denominated, and into tangibles, as soon as possible. The very best tangible that you can buy is a stout house on a piece of productive farm land [17]. It will not only preserve your wealth, but living there may very well save your life.