"Shit keeps going down here. Nothing is getting better. Life is becoming miserable. I remember your predictions back in 2005. So what's your prediction for the next year or for America's future."
This is a topic that has come up many times, both here in Romania and from friends back in the states. I was going to write a little essay on the topic, discussing it all in better detail, but never got around to doing so. However, I rather liked my "quick" response to the question above and thought I'd share it on my blog. Feel free to comment or generally make fun of my ideas here... :)
My response to the question above:
"As for the economy, the mess is everywhere of course, but for most of the world it is just another normal recession, those that come and go every few years. However, for the U.S. this is a major “re-adjustment” and nothing will be the same afterwards as US has to get accustomed to living within its means; and those means aren't near as high as many Americans think, so it will be an unpleasant experience. The US has not seen the bottom of this yet, not even close.
In the private sector, the next bubble waiting to pop is the commercial real estate market, i.e. office buildings, store fronts, shopping and strip malls, &c. Before the crisis, more savvy investors didn't invest in residential real estate as investment property, but in commercial property, but they could not have seen how much of a mess the housing real estate would cause. So now that the economy has taken a dramatic downward turn, new businesses aren't starting, small businesses are going under, and large businesses are reducing their operations; meaning that there is no longer a market for all this commercial real estate that has been developed. Now the owners of the commercial real estate are having to pay their bank loans out of their own pockets which even wealthy people can't afford to do for too long. The hope is that the “stimulus” will lead to a bounce back for small and medium range business, BUT the banks still aren't lending for new start-ups and existing businesses are remaining very cautious, so this probably isn't going to pan out. The result: “pop” goes the next bubble which will launch a whole new spiral of action and reaction.
However, of far more importance to the overall global economy and to the US and its ability to maintain the empire is the currency situation. Basically the same Catch-22 that the US had to deal with in 2006, when they started the lowering the interest rate, is still in play now; but the stakes have gone up enormously. Essentially the US is broke, and has been for a long time, the country as a whole – from individual citizens to the Federal government – owe vastly more money then they can hope to make anytime soon. Therefore if the US wants to maintain the status quo or launch new initiatives that cost money, they have to borrow this money. For the government, this basically developed under Reagan & Bush I. What Clinton did to stave off disaster was adopt fiscally prudent measures: balancing the budget, reducing spending, and so on. This encouraged lenders – both domestic institutional investors and international investors – to continue lending. Baby Bush took advantage of this and shot it all to hell, borrowing vastly more than all US governments prior to his combined and essentially channeling all this money off to his friends: Halliburton, Bectel, &c. While this really pissed off the lenders, it also basically tied his successor's hands. The ONLY responsible option Obama had was to follow the Clinton model of financial responsibility in order to assuage the lenders.
Then came the collapse of the residential housing market (thanks to Bush's anti-regulation policies coupled with Republican deregulation in the Congress), the CDOs that bundled all the bad mortgages, and CDSs which insured the CDOs (re: AIG). The crisis meant that Obama had two choices; he could move to help mitigate the effects inside the US (his constituency) or he could move to placate the investors (which enable continued operations of the government and country). He chose to mitigate the domestic effects at the expense of the investors: the stimulus package, continuing Bush's policy of bailing out the banks and insurance companies (and even car companies, which makes no financial sense whatsoever) and so on. To do this, not only could he not follow the Clinton model of fiscal responsibility, quite the opposite, he had to act enormously irresponsible as far as the investors are concerned by following Bush's strategy of massive borrowing.
Well the investors have had it now. With the huge new flood of US Treasuries (gov't debt) being dumped on the market and with interest rates so low; US debt is not only no longer a safe store of value, it is in fact a losing investment because the yield doesn't even cover the natural inflation. To buy US Treasuries is now to throw away money and so people have stopped buying them. This is why you saw the Fed step in last week and buy $300 Billion in US Treasuries, because no one else wants them. However, the Fed by itself doesn't really have the money to do this, so where does it come from? The printing presses, i.e. increasing the money supply, inflation. This in turn devalues the dollar (the day the Fed announced it was buying the Treasuries, the dollar suffered one of its biggest single day drops in years). China and a UN working group in Brussels are already calling for dropping the dollar as the global reserve currency (i.e. the basis of the Bretton Woods II system and the ONLY reason the US has been allowed to live so far above its actual means).
The government still has essentially the same two choices it had before, but now the stakes have gone up dramatically. On the one hand the government can placate investors – both foreign and domestic – by significantly raising interest rates, thereby making the return on US Treasuries a worthy investment and encouraging a huge influx of foreign capital which then fuels the US economy and empowers the government. However, keep in mind that the entire US is also in debt, so increasing interest rates means that your mortgage, your car payment, your credit card bill, and all other debt payments will dramatically increase as well; inevitably resulting in a lot of domestic turmoil (bankruptcies, unemployment, homelessness) and thus political pressure which will lead to Congress (even if there is a Democratic majority) turning against the White House and demanding lower interest rates and probably getting them. [This is basically what Reagan did in 1982, increasing the interest rate and decreasing the money supply, and though it worked, it caused an enormous amount of suffering for poorer Americans; but the situation is VERY different today and the results would be much more dramatic.]
On the other hand, the government can keep interest rates low to placate the American public, but this means that the foreign investors will simply dump the US. The US loses its status as sovereign over the global reserve currency (a fundamental pillar of the empire), it loses its global financial clout and all that entails, and most importantly the government runs out of money. However governments always have an answer to this, specifically they can print more money, i.e. increase the money supply. Since all US debt is denominated in US dollars, inflation would actually be helpful as by decreasing the value of the dollar you decrease the real value of the dollar denominated debt. This is the option I think they will choose.
The “spark” to really get this trend moving will be a recovery in some other relatively stable market somewhere in the world that looks desirable to investors. The one thing that has somewhat held this process in check is that US Treasuries still have the reputation of being a relatively safe “refuge” in times of financial uncertainty. Institutional investors, looking for a “safe” place to put their money – even if there isn't much of a return – still view US Treasuries as such a place. Anyone following the recent Treasuries auctions will notice that virtually all the purchases (excluding the Chinese who have ulterior motives) are now in extremely short-term instruments; which is why the Fed had to step in to purchase allegedly “benchmark” ten year notes. No one wants their money locked into dollars for very long.
It is important to note that I am NOT predicting hyper-inflation, like Zimbabwe or the Weimar Republic. The US dollar will always be worth something but it will have to adjust from the being the world's primary reserve currency to just one more benchmark currency, like the Euro, the Pound, the Yen, the yuan, &c. Nevertheless, assuming they do not significantly raise interest rates, it is virtually inevitable that there will be a global “dollar dump” whereby many of the excess dollars held in reserve banks around the world will be dropped (not all, as the dollar will remain one element within a basket of currencies) which will couple with the Fed's increased money production leading to strong inflationary pressure. Nevertheless, the Fed can remove money from the money supply as well, so while I think inflation at somewhere between ten to twenty percent is a given (think of 1979 for example), hyper-inflation isn't in the cards anytime soon.
One big difference domestically between the coming inflation and the last time the US had inflation in this range (the late 1970's) is that today most of America's manufacturing base is gone and virtually everything except food is imported. This reality means that dollar devaluation will have a direct domestic effect in that the cost of most imported goods will rise (the exception being industries that are strictly denominated in dollars, commercial aircraft and many military industries for example). Nevertheless, dramatic price increases within the US for many goods will again lead to domestic political pressure, though probably not on the same level as increasing the rates of debt servicing mentioned previously.
So either way, the US is going to be facing quite a rough patch for the next few years the worst of which has not hit yet and will have to adjust to living somewhat closer to its actual means. This will inevitably be a painful process.
