The Cusp of a New World Order

I want to begin by going back to claim I made that we would see hyperinflation in the coming decade.  In all honesty, this is a highly unlikely outcome.  What led the Weimar republic to hyperinflation was set of unique circumstances that will not be duplicated this time around.  The age of information allows for instantaneous dissemination of data and were that the case in post WWI Germany, I doubt the same outcome would have come to pass. 

Yet at the time of the great depression Keynesianism was in its infancy.  One could argue that Keynesian policies led the US out of the great depression but is those same misguided principles that have put us in our currently dire economic situation.  John Maynard Keynes’ theory is based on the idea that governments can control the economy my through tightening a loosening of monetary policy.  This means raising or lowering short term lending rates and adding or removing money supply.  Tight policy implies higher rates and less money while loose policy means more money and lower interest rates.  The idea is that in times of duress, the government can lower rates and add money into the financial system.  The goal is to stimulate lending and by extension further growth.

Right now, the FED has lowered rates to virtually zero and in theory we should be witnessing increased lending and a return to higher growth.  The last time we witnessed such a shift in policy was right after the tech bubble burst.  At the time, FED chairman Alan Greenspan began lowering rates and even came out and recommended individuals refinance loans into Adjustable Rate Mortgages.  This led to the last part of the housing boom.  Interest rates were low, and home values could only go up.  It only made sense to do exactly as he suggested.  This boom in housing led the mortgage industry to begin selling and reselling these loans in packages called Mortgage Backed Securities (MBS).  In effect a bank could lend money to an individual then repackage the loan with a bunch of others and sell the group as interest bearing security.  Of course the success of an MBS is based off everyone’s ability to pay off those loans.  As long as the loans performed, the money kept flooding in.  Yet when the teaser rates on the ARM loans reset higher, many homeowners were left unable to meet their monthly payments.  Since the MBS’ had been repackaged and resold so many times over, it was difficult for even industry professional to know how to handle these new securities, many of which ended up in pension and retirement funds.  A lot of them ended up in money market accounts.  You know the accounts that give you higher return on your savings?  Well the money markets collapsed when Lehman Brothers was allowed to fail.  It seems the money market accounts had been buying the MBS’ that we now know to be toxic.  What happened was that money market accounts started posting negative returns.  The means that a guaranteed return on deposits was not actually guaranteed.  What was once seen as the safest type of investment was now giving you 80 cents on the dollar.  Not the outcome most were looking for. 

The Day the World Almost Fell Apart

What happened next was possibly the scariest thing ever to happen to the financial system.  On September 18^th, 2008, the world almost fell apart!  See this.  Investors, institutions, mom and pop, began withdrawing funds from the money markets.  Around $550 billion over the course of an hour or two.  The link above is for a commentary on the topic that was never covered in the mainstream media.  In fact it wasn’t until almost three months later that even the most astute blog sites were able to report on the event.  This was run on the banks ala 2010.  Don’t be surprised if you never heard of this.  In fact, I would be surprised if you did.  This is not the kind of thing that gets talked about.  Ever.  If this kind of event were to have been made public the entire system would have collapsed.  In the end, the FED stepped in, threw about $105 billion dollars at the problem and halted redemptions in the money markets.  They put a guarantee on $250k per account and that seemed to stem the tide.  But the FED was not done, and was essentially forced to become the de facto short term lender as banks were now too scared to lend to each other.  And with good reason.  Who would be the next to fail and who would they take down with them?  Well we have not seen another major bank fail since.  Nor will we.  The systemic risks to the entire financial system are too high for another Lehman Brothers type episode.  This means the FED has now eaten mountains of bad debt.  The powers that be have also let the banks pretend that any of these toxic securities they may still hold are worth more than they are.  Bank balance sheets have now become a total sham and are being used to perpetuate the biggest Ponzi scheme in history.  Thus was the end of the housing boom.  But the cycle of deleveraging is not over.

Recovery Reshmovery

The recovery that our government hopes you believe in lays in the faith of investors the world across.  Our own government has taken in so much debt to bail out the banks, states, and everything else that there is no way it will be able to pay off those loans.  Except by issuing new debt.  As interest accrues, even at today’s low rates, the government will be forced to borrow more and more just to pay off current liabilities.  The only way out this mess is through a substantially lowered US dollar.  This means hard assets like gold, silver, and agricultural products will be some of the only sectors to retain value.  Today we watch in awe and horror as Gold sets another record high.  Silver is at a 30 year highs as well.  You know what isn’t at new highs?  The US Treasury market.  If this isn’t the clearest sign that the world is now starting to shun US dollars I don’t know what is. 

The next decade will bring about a radical shift in the way the world sees the US.  No longer will we be the bastion of health and prosperity we once were.  The US dollar will lose its reserve currency status and foreign central banks will no longer hold US Dollars in their coffers.  As we continue down this dark road I urge you to take a look at your investments and life goals.  If you were planning on starting a new career in a few years, maybe do it now.  If your money is in a stock fund, don’t just let it be, start to put some of it into the hard assets that may actually hold value over time.  Whatever you do, don’t lock up your money in long term treasuries.  I fear inflation could get to such an extreme that even a high yield on your money may not provide enough return to offset a loss in purchasing power.  Sadly, this probably won’t mean that the price of your home will go up.  In times like these it is the demand of necessary goods and inflation tracking investments that will appreciate.  Food, metals and energies.  People don’t need to own a home, but everyone needs to eat.  

Bust to Bust

To tie everything together we go back to the boom and bust cycles which are at the core of Keynesian theory.  After the tech bubble burst the housing boom ensued.  So where does the next boom come from?  Some argue that bond bubble is the next one to burst and I will not argue that fact.  If the FED can pull off another boom cycle into the bond market in this current environment I will very shocked.  This would mean that the US will need to show signs of stabilization for the world to feel safe in US dollars again.  The opposite is happening right now and I very concerned for our future.  We may be on the cusp of a new world order.  The underlying problems in the financial sector have been swept under the rug in the hopes that the storm will pass.  My fear is that we are now sitting in the eye of the storm and the worst is yet to come.