It is Different this Time

The world functions upon a greatly different world chessboard compared to seven decades ago. Conditions inside the United States are as different nowadays versus the 1930 decade, as that Great Depression Era was compared to the Roman Empire. Well, not really. We are more similar today to the Romans, with our Wall Street aristocrats, our babbling US Senate, our military aggression, our sovereign coins debased of gold, our exclusive clubs as baths, our protection of the ultra-wealthy corrupt in collusion, our sexual bacchanalia parties (see Tyco), our growing tax burden of the middle class, our stock & bond markets as the financial Coliseum, our reality television shows as the household living room Coliseum, and the sports arenas as the outdoor Coliseum. Try to tell me that NFL football players, in full equipment garb, do not resemble the great Roman gladiators, rather than players equipped with those flimsy padded uniforms & leather helmets used several decades ago!!!

Many are the differences between now and the Great Depression era. So vast are the cited differences, that the present day has almost no resemblance. Versus that historic era,

• Powerful hedge funds with $1000 billion are capable to move markets up or down, based in New York City, London, Tokyo, the Caribbean, and elsewhere. Their activities are not widely tracked, but their influence is significant.
• Hyperactive central banks routinely intervene, provide liquidity to bond markets, to currency markets, and without doubt to stock markets, while altering interest rates in contradiction to extremes. Their anticipated movements disrupt markets.
• Vast secretive derivative pyramids (sometimes illegal) function to prop or contain prices of bonds, currencys, metals, housing, and someday perhaps energy. They grow in size to greatly contribute to risk.
• Sloshes of fiat money on each continent have no gold backing, which is printed liberally, as debt is exchanged to relieve imbalances. Lack of accountability has produced a series of crises since 1971, with no desire to turn back.
• Powerhouses China & India have emerged as manufacturing and service centers, with cheap labor, strong commodity demand. These two nations exert influence in many markets, as they demand seats on the geopolitical stage.
• Household participation in financial markets is huge, as the new "sheep" feebly counter the professional groups, with pension funds and personal savings in the balance. Public retail investors typically push the losing extremes.
• Broadband high-speed interconnectivity among computers (peer to peer and internet transactions) has become an enabling force to send business to other continents. It has made possible the entire export of functions in the growing information-based portion of economies.
• Debt foundation has become shifting sands to the economy, and the principal device to promote commerce, to make for a highly leveraged economy. The consequent instability has brought great risk to entire systems, both economic and financial.
• Size of the financial sector has grown to become a dominant force in the economic framework, in speculation, debt investment, debt service, and asset management. It has grown like a cancer from the inflationary forces, and threatens economies from both displacement and risk of widespread default.
• Asset bubbles exist almost everywhere to wreck havoc on the economy, but whose byproduct is price volatility. Inflated assets have subsidized both spending and investment, which adds to economic risk.
• Shortages and declining production have become the norm in several key commodities, after two decades of negligence and preoccupation with paper. A race has begun both to acquire asset properties and to discover & produce from them.
• Massive statistical disinformation has become the norm, widely distrusted, but acted upon nonetheless, to promote a picture of US Economic health. That view is false, reminiscent of the Age of Orwell. Snapshots have recently been joined by stretched forecasts to distort the truth, which has become like a shifting fog.
• Revisionist history of the 1932 precedent has been studied, debated, and conclusions arrived at with full influence of bias toward the politically favored "inflation" priority. The current financial power system has become entrenched, and has made grand partnerships with the political power structure.

Nobody of sober mind can legitimately claim that the above differences fail to change the landscape over which secular deflation runs its course. Forces might exert themselves toward debt contraction, but the climate is profoundly different from 70 years ago. The reverberating event to end the core expansion and begin the long contraction process was the 2000 stock bust and tech/telecom bust. The US Economy has not recovered since that event in any healthy or sustained fashion. Interest rates have fallen periodically since then, a sign that all is not well. The 2000 stock bust left an indelible mark on the financial world and on many businesses, such as the numerous firms which over-committed themselves to purchase companies at elevated prices. Historical analysts (at least those who choose not to employ politically motivated revisionism) will point back to 2000 as the seminal point where the secular deflation tightened its grip. We are heading toward an uncertain climax. The economic system has "wanted" to contract and rid itself of the colossal debt. In counter action, the human response has been to provide an avalanche of liquidity, the euphemism of government money off the printing press, i.e. inflation. The prescribed flow changes everything, distorts everything, and resolves nothing. For the first time since World War II, housing prices did not falter after the stock market decline, another sign that worse still, something is awry and corrections are coming.

It really is different this time, the economic depression, that is. Many astute analysts foresee a tragic repeat of the Great Depression. That is not my vision of the near future. Whether the air comes out of the US Economy, and world economy for that matter, in a fast-moving convulsion, reminiscent of what occurred 70 years ago, that is doubtful. What is absolutely certain, however, is that the human wizards will use in sequence gradually more powerful and desperate weapons to fight what might be called the Revenge of Economic Mother Nature. The location where nature's wrath is seen is far from known.

DEPRESSION IN THE REAL ECONOMY (K-WINTER)

The present day bears almost no resemblance the Great Depression era, although similar contraction forces are surely at work. Veteran analysts such as Ian Gordon prefer to point to that horrendous era as an inevitable outcome destination for our current de-evolving economic situation. He anticipates a depression. At the Calgary Conference last month we had the opportunity to have a conversation. He was thoughtful, charming, and inspiring. We initially discussed the secular deflation phenomenon, and how some similarities to the past Kondratiev Winter might be evident and showing themselves nowadays. My position was based upon a description of numerous profound fundamental differences which cannot be overlooked. Mapping out the pathogenesis from the current situation to its unfortunate degradation, that is where the intrigue and illumination can be offered. In our brief talk, my points were made succinctly and too briefly on those weighty and overpowering differences sure to lead to a different path with a queer rhyme. My expressed opinion was for a very confusing sequence of events to unfold, since so many different participants and factor forces are involved.

The real economy (where things are built, grown, mined) is without much dispute suffering on a grand scale. In fact, our core economy is almost voluntarily abandoned (except for mining ventures) in the mindless pursuit of the "low cost solution" found in Asia. My view has been all along that outsourcing services and offshoring manufacturing is but an avoidance (if not delay) of liquidation, shutdown, or bankruptcy for businesses. The immediate loss is to the workers, as the corporations shed commitments to the US Economy and establish beach heads overseas. If they cannot compete with operations located inside the USA, then dispatch those operations to Mexico in the last decade, and to Asia in this decade. The pursuit of lower costs slowly and perniciously impoverishes the USA, as our clueless leaders (like former White House Economic Counselor Mankiw) remain ignorant of lost cash flow, lost income, and lost business investment. The real economy indeed is suffering from a depression, as the manufacturing sector has shrunk in profitability. Mfg accounted for 53% of the US Economy earnings in 1965, and 39% of the economy in 1988, but only a mere 9% of the economy in 2004. Some more experienced economic experts, who rely upon more sound policies of the past, and less so upon new inflation policies, regard the real "core" economy as critically important. Old experts point to the general overall economy reverting to the condition of the real economy, its tangible core, its nucleus of reality. In the case of the United States, its core is typified by its manufacturing sector. That core is in a depression, confirmed by flat wage growth, job growth not keeping pace with the population growth, and fast rising debt burden to households.

It really is different this time. These have been dreaded words. Some in the gold community like to point to the 1929-1932 period to outline a sequence of events, sure in their minds to unfold as gold is elevated to a prominent position. Well, events will not unfold without enormous confusion, desperate actions, huge hidden forces at work, extensive conflict on the world stage, unexpected outcomes, grand distortions, and numerous accidents along the way. So far we have seen some puzzling developments, like declining long-term interest rates amidst rising federal debts and expanding trade gaps amidst a falling USDollar. The real economy portion of our national commercial marketplace might soon proceed down an unfortunate path, but our economy is much more than its commercial side. The financial sector has become very powerful, much like an overhanging casino perhaps set adrift like with rafts of money changers. It don't sit around. It is highly active, even hyper-active. At the top is national economic statistical distortion. Outposts boast of financial engineering, whose tools are inflation, leverage, accounting fraud, executive options, dividend grants, stock buybacks, unlimited futures short contracts (caps), offshore debt and trading activity, and interfered order systems. Last week, emails from a subscriber pointed to clogged Fanny Mae option put contract orders. Countless orders jammed the system for zero contracts. Theses are the very wooden shoes in the machinery that gave the word "sabotage" its original name.

Compared to 1932, nothing will be similar this time except perhaps the ultimate outcome. Who the heck knows when resolution might come? Who truly knows how we get there? Can we even be certain that the world will act in a unified manner, with all continents working in unison or even cooperation? My view is that the world economy is fast evolving into four zones, and conflict grows among those zones. Europe is moving toward an entrenched socialist system, with its many voices, immobile populace, and reluctance to abuse debt. Asia is moving toward a frenetic vibrant unbridled capitalist region, with formidable growth and cheap labor, loose regulatory controls, and few rights. South America is a palette of pursued stable systems, whose asset properties are being bid for by world powers. The United States is degrading toward both a vacuum and a lightning rod, neither marked by capitalism nor socialism. Its scatter of power centers govern over a monetary inflation colossus, growing material shortages, rising costs, accelerating debts, shrinking jobs, enormous profiteering, distortion of the truth, and a powerful military matched by a willingness to use it.

THE WORLD CHESSBOARD & OCEAN TIDES

How all the numerous cited forces and factors play out on the world chessboard is unknown. They are regularly discussed in my Hat Trick Letter publication, addressed wherever relevant and quantifiable. No, the post-bubble era is different this time, entirely unlike the 1930 decade. Some forces can call back the tide temporarily. Some factors can serve as obstacles to that tide. A water pipeline from a lake source can accomplish little when directed into an ocean bay, as the tide easily overwhelms the manmade volume input. A series of public bonfires can accomplish little when intended to warm a city during the winter cold. Central banks can flood the economy and financial markets with money (aka liquidity) all they want. When so much debt is exported from the USA to Asia and the rest of the world, wages are not advanced to service domestic debt. When so much debt pushes up inflated assets, a natural reversal is invited. When most of the new money of USDollar variety is devoted to new debts, production fails to create enough jobs. Spending is encouraged which cannot be sustained.

When the US Fed stops its rate hikes, the USDollar bear market and the commodity bull market will each return, and return with a vengeance. Actually, a market shift is likely when it is clear the US Fed is on the verge of ending the tightening cycle. Greenspan could signal the shift, or alarming weakness could emerge from the statistics. The USDollar will weaken for two reasons. First, the US Economy will have shown additional weakness. Second, the interest rate differential will diminish in its power relative to European bonds. In response to the historic over-supply of USDollars, and to the imbalanced requirement for capital to the US Economy, the US$ exchange rate will continue its tragic decline. Since commodities, led by crude oil, are priced in USDollars, the entire cost structure to the US Economy has risen, and will rise further. Expect the USDollar to be actively sacrificed in order to rescue US Treasury Bonds.

As the queer disquieted quilt known as the world economy becomes unraveled, the common consensus is sure to build that we are losing grip in the management of the system. Our insistence to inflate money and permit unbridled debt will surely come back to haunt us. The ongoing question is when. We have embarked on the New Weimar Age. Secular deflation can be described as the financial equivalent of a "Black Hole" in nature. Planets and stars cannot escape its powerful clutch when they come into its proximity. Central banks are sure to find it far more difficult to escape the clutch of the many stages of debt collapse, whose power is likewise hidden from view. A recession is the required ingredient to set off the process. A provided reference on black holes gives some background on the subject. Unwittingly, the Federal Reserve prescribes bond purchases in open market operations in the face of a slowdown in the US Economy, when lower rates actually slow the money velocity further. Twice as much bond interest is yielded in income as paid to service debts. So the Fed aids secular deflation by its actions, despite the bravado boasted by Greenspan to beat back the K-Winter in writings early in his career. Even as light is distorted in a black hole, economic perceptions through economic statistics are distorted by the USGovt, which oversees the most indebted and needy of nations. The economic statistics are passed through an Orwellian prism. See the black hole depicted below from the Virgo constellation.

EXTRAORDINARY REACTIONS

Back to our reality, chock full of multiple new mature forces and factors compared to the childlike exercise witnessed from 1929 at the breakdown to 1932 at the climax. It will surely be interesting to see:

• how hedge funds will shift their speculative investment on assets
• how steadily the hyper-active Fed will provide and accelerate money to the economy
• how increasingly fragile derivative pyramids will withstand changes and new stress (see Fanny Mae, General Motors, AIG, JPMorgan, Citibank)
• how gold will react to household debt default, corporate debt default, and the upcoming banking problems certain to occur
• whether China & India will falter before or after the United States, and the effect one will have on the other, as well as the world economy
• how household finances will fare during the storm, as the amateurs compete versus professionals and politically connected
• how the fast-acting computers will accelerate or hinder the pathogenesis, and how broadband transmission will continue to enable outsourced operations
• how gargantuan debt will default or be serviced or be repudiated or be forgiven.

The only certainties in my limited mind are eventual conflict escalation, starting with trade war sanctions, aggravated by competitive bidding for key commodity asset properties, coercion of governments by the United States to favor our debt-ridden and income-neglected nation, realization that scarce world resources cannot be shared nor properly allocated via price structures, compromised political systems in the face of strain and disorder, increased hostile reaction by the less defended (aka terrorism), gradual dislocation and systemic failure, and finally world war. All in time. What begins as a bidding war on asset properties will degrade into trade sanctions. Conflict is certain to widen and escalate. Later, wider war is extremely likely, the only strong parallel outcome with the 1930 decade era. Desperate nations take desperate actions, which invite hostile responses.

As sure as night follows day, supply chains and delivery lines will be disturbed, disrupted, and interrupted. Effective to the hilt, commodity denial and imposed shortage will be used as a weapon. The United States has not been on the receiving end of weapon usage since the World Trade Center attack. In sharp contrast, the USA will certainly be on the receiving end of the commodity weapons, since we own almost none but do control vital shipping lanes. As the world's largest debtor nation, offset by owning the world's most powerful military, the United States stands in a precarious position, never before faced in human history. The prescription for war is assembled as in a chalice. Tempests in teapots will grow into regional conflicts amidst the increasingly strained imbalances, which Chairman Greenspan naïvely labels as flexible.

THE UNITED STATES, OUTSIDE LOOKING IN

The chessboard is being realigned with each passing month. China, India, Russia, Iran, and the former Soviet Republics comprise almost half of the world's population. Together with Iran and a few nations that lie on the periphery of OPEC, half the world's population is forming alliances to secure their supply chains. Do not expect their trade to be denominated in USDollars. At first it will be in euros. Do not expect the USA to be a leading maestro in the dictation of flows of supplies, or in the establishment of large contracts for services involved. Fully expect for the newfound alliances, cooperatives, and consortiums to plan either to work around the heavy handed US influence, or to actively exclude the overshadowed imperial nation from its network. The Shanghai Coop Group is just such an alliance. The above listed nations are in the process of firming their agreements, as they work to formalize a new alliance. OPEC might soon be marginalized. The protection offered by the USA to various Persian Gulf sheikdoms will fade in relevance if the new Coop takes firm root. The new alliance is courting Brazil, Venezuela, and Pakistan. Their products will extend far beyond crude oil. Behind the scenes, Russia (Putin) and China are pulling new strings. USGovt leaders are being outmaneuvered, outfoxed. Outside the military, US power is two drops short of bone dry.

The world is changing from under the nose of the United States, whose shadow extends far more from military might than economic might in recent years. The transition from world power is not to be a smooth one. China and India want a bigger seat on the geopolitical stand totally dominated in recent decades by the United States. The politics of change will be highly disruptive. The war for resources has barely begun.

Man oh man, gonna be exciting. One must wonder, with the Fed on the tightening warpath, whose economic system will crack first, the USA or China ??? We might not be aware of the increasingly disarray inside China. To be sure, gold & silver prices, energy prices, industrial metal prices, the steel price, building material prices, foodstuff prices, they will be released to rise when the cracks are opened up. Their prices will resume the upward path established in 2002, 2003, and 2004. The great commodity bull market will go back on track. Hard asset prices will rise as paper security assets erode in value. The combination of black hole forces in secular deflation, combined with powerful new participants, and powerful new forces, will make for a very interesting and at times confusing chaotic path.

With each hike in Fed Funds interest rates, we suffer the ratcheting force of financial suffocation, reduced oxygen supply, and withheld grease to the system. On the second week of April, with US income tax payments due, we suffered a stumble. An ebb & flow of monstrous hedge fund purchase & sale must be endured regularly, like with crude oil and natural gas now. Laws will continue to be circumvented in financial rooms where the big levers are located. Computers will fight the good fight. Rights will be shredded. Surveillance will be heightened. Social order will be challenged. This is only beginning, and in no way will this resemble anything seen before in modern history, not the Great Depression of 1932, not Black Monday of 1987, not the Asian Meltdown of 1987, not the LTCM debacle of 1998, not the Stock Bust of 2000.

The listed forces and factors grow more different with each passing year, are growing far more powerful than anything witnessed before, and are functioning in more clandestine fashion than ever before. So why on earth would the outcome be orderly, forecastable, or similar ??? Prepare for a wild ride. The upramp on this roller coaster seems quiet as the Fed tightens. When they finish, the downramp will be next. Explosive change will arrive. Get ready !!!

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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.