Sunday, March 6, 2011

The Great Immoderation

In both 1960 and 1980, the American people were enduring their fourth recession in about 12 years. Each time they elected as President a man who pledged to get the economy moving again. Each had a program of tax cuts, Federal deficits, debt monetization, and increased military spending. In JFK's case, his Keynesian economists followed the theorizing of the Phillips curve that more inflation would imply more growth/lower unemployment. The decade-long boom was prolonged by the Vietnam War and increasing dollar-printing. The country then began its second cycle of four recessions in a dozen years and, now faced not with the price stability that Kennedy inherited but wild price instability, embarked on a more monetarist program of more predictable, lower inflation. Thus began "The Great Moderation".

One of the keys to the American economic successes of the 1983-2000 period was that the only important foreign war the U. S. engaged in, the 1991 Gulf War, was paid for by client states and thus required no money-printing. Combined with the collapse of the Soviet Union and the shift to state capitalism in China, the U. S. was able to go back to its historical roots and accept a balanced Federal budget. A decline in military spending meant that the decade was deflationary in certain ways. The price of gold began 1990 at $400. It ended 1999 at $300. This 25% decline was mirrored by interest rates, which averaged about 8% in 1990 and about 6% in 1999 and 2000.

The Establishment boasted that this period, extending into 2007 in their eyes, was The Great Moderation.

Unfortunately, this was all an illusion. We have now entered The Great Immoderation. Actual Federal outlays, both on-budget and off-budget (think Fannie-Freddie losses and student loans for the latter) will be about $2 T greater than revenues in 2011. This is a far greater irresponsibility ratio than seen even in WW II. This is being handled by manipulating interest rates toward zero. Amazingly, Federal interest expense is said to be little different from that of 30 years ago. Meanwhile, disparate sources such as Shadow Government Statistics and MIT's Billion Prices Project show the true pace of price increases is currently in the 7-10% range.

The Continuous Commodity Index has been making one all-time high after another.

Meanwhile, wages stagnate in the U. S. as prices rise, but they keep up with or beat inflation in Brazil and Malaysia. Moguls such as Ray Dalio (Bridgewater Assoc., the world's largest hedge fund other than the Fed), Sam Zell (the "Gravedancer"), and Charlie ("suck it up") Munger (Berkshire Hathaway) advise us to get used to a lower standard of living. This is of course simply a reprise of presidential candidate Obama's comment that the rest of the world wasn't likely to allow America to utilize such a large proportion of the world's resources as it had before.

If oil prices behave, so much new "money" has been created that the illusion of a healthy economy can continue a good while longer. Stock market valuations may already have reached their cyclical peak when properly adjusted for prices of consumer goods. The immoderately elevated price (call it a bubble) of short-term debt, with one-month T-bills selling at about 1000 times "earnings", which keeps on keeping on against all logic, appears fated to end unpleasantly. This is analogous to the tectonic forces that produce earthquakes. The imbalances will be resolved; timing is unpredictable.

The U. S. dollar is the non-barking dog of the recent Arab crises. To wit, the dollar's decline rather than its historical strengthening during this sort of event fits the above thesis. The world recognizes there is no safety in a currency tied to negative real interest rates. Even if the Fed stops expanding its balance sheet in June, other dependents of the State such as certain financial institutions and the Saudi/Kuwaiti rulers may be found to pick up the Federal budgetary void.

Gold, the anti-dollar debasement asset, continues to appreciate against the dollar at a rapid pace, reflecting the increasingly implausible spread between interest rates and behavior of prices in the real world; the same can be said for oil. Silver is gold on steroids. Bidding wars for houses are starting up again in Silicon Valley.

Just as Austrian economists predicted and as the Helicopter announced a while ago, a determined central government can guarantee no deflation. Doing so, however, could produce the final collapse of the currency system. How high the inflationary moon? The rise could be, over time, be quite immoderate.

The die is not, however, cast. There is time for change we can believe in.

Will the current cast of leaders effect such change?

It is quite possible that we ain't seen nothing yet.

Copyright (C) Long Lake LLC 2011

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