The Hard Way or the Harder Way

[EJ]

The Hard Way or the Harder Way

Two Options for Correcting Global Economic Imbalances

By Eric Janszen

September 28, 2006

In one of my previous commentaries on this subject, "The Coming End of the US Foreign Investment Bubble" I make the case that foreign investment in the US is mostly driven by belief versus fundamentals. In "China vs USA: Economic M.A.D." I describe the unstable and unsustainable economic interdependency between the US and its major goods trading partners, especially China. I occasionally run across thoughtful arguments to the contrary, such as the Deloitte Research Study, Global Economic Outlook 2007: "Is a crisis imminent, or are things better than we thought? (pdf)."

The Deloitte study makes the argument for a benign correction of global imbalances, what I will call the Easy Way. They frame their case like this.

The US invests far more than it saves (its current account deficit) and the rest of the world saves far more than it invests (a current account surplus). This is the big imbalance in the global economy. It involves a massive flow of capital to the US from the rest of the world. The magnitude of this transfer is unprecedented in recent history and probably cannot be sustained indefinitely. Therefore, when it ends, it could have a destabilizing effect on the global economy, if only because of the shifting of gears.

Some pundits argue that financial market participants recognize this fact and will ultimately move exchange rates and interest rates in a direction that will lead to a decline in the imbalance. The pessimists argue for a sudden decline, the optimists for a gradual decline. In either case, the imbalance has persisted far longer than anyone expected, and a correction, with or without onerous consequences, has not yet happened. Perhaps we have entered a "New Era"–a rhetorical red flag if ever there was one–which massive one-way capital flows can take place for long periods without any serious consequences.

The Deloitte report does not argue that the imbalance is sustainable, but asks: "Is the terrifying hard landing imminent or not?" In other words, is there an Easy Way?

They describe two schools of thought, the "Pessimists" and the "Optimists":

Pessimists

1. The imbalance is due to the sins of Americans. That is to say, American consumers save too little and borrow too much, while their elected government does much the same. The result is a need to import capital from overseas in order to maintain the American standard of living. The argument is that the imbalance will become unsustainable once the rest of the world becomes reluctant to finance America’s largesse. At that point, the dollar will drop and interest rates will soar, pushing the US into a recession and wreaking havoc on the global economy. Indeed Deloitte Research has warned of this outcome in past publications.
2. There is historical precedent for this scenario. In the late 1970s and again in the late 1980s, a large US current account deficit was ultimately unwound through large dollar depreciations, rising interest rates, and recessions. This was followed by financial crises in emerging markets.
3. The pessimists believe that this could happen again, but possibly on a larger scale.

Optimists

1. Believe that the imbalance is principally due to excessive saving in Asia. For a variety of reasons, Asian consumers and businesses save far more than the demand for investment in their countries. They must therefore find outlets for this excess savings. The US is only too happy to import the excess savings given its propensity for budget deficits and consumer debt. Importing this capital enables the US to run large budget deficits combined with low personal savings without having to endure higher interest rates. The imbalance is Asia’s fault and that it will persist as long as Asia continues its excessive saving.
2. There is historical precedent for large, sustained, one-way capital flows. In the late 19th century, massive amounts of capital flowed from Great Britain to the New World (US, Canada, Australia, and the rest of the British Empire). These flows, as a share of GDP, were much larger than what we see today and persisted for decades.
3. There is nothing so bad about the current situation and that it can persist for much longer.

There is one glaring problem with this framework, and most long time iTulip readers no doubt caught it. The "historical precedent for large, sustained, one-way capital flows" between Great Britain and the US, Canada, Australia, and the rest of the British Empire" were capital flows going in the opposite direction. The standard of living of Great Britain's citizens did not depend on its colonies' need to fund the consumption of the goods they produced with the savings they earned through trade. The relationship between the US and its trading partners is not between an empire and its colonies. The relationship is a reverse variant, best described as global vendor-finance, with the US in the role of a national "company town" owned by its goods exporting, financial assets purchasing trading partners.

The Deloitte study asserts that there are elements of truth in both the Optimist and Pessimist arguments. "Asia is certainly prone to excess savings, while the US seems prone to excess borrowing. Perhaps the best explanation of the current situation is that the US and Asia have a comfortable symbiosis." The report concludes: "The US can engage in wanton profligacy largely because Asians have so much savings to dispose of."

They are wrong. There is no Easy Way. This proposal of the Easy Way reminds me of the "soft landing" arguments I'd get back in the late 1990s when I was writing about the stock market bubble and the "soft landing" arguments I got in 2004 and 2005 when I was writing about the housing bubble (see some of the nasty-gram comments).

I understand why. Bubbles are belief systems. You cannot reason a person out of a belief that he or she did not arrive at by reason, particularly if they have money, reputation, or employment–or all three–that depend on the asset in question: dot com or telecoms stocks, or housing, or dollar denominated assets–or all three. A man or woman with everything on Number Seven has got to believe that Seven is their lucky number. Or that they are not betting at all but are "investing" in the latest New Era.

But there is no Easy Way. There is only the Hard Way and The Harder Way. Here's why.

Asian countries and their citizens have a lot savings. That begs the question: Why? Top three reasons:

1. With respect to national savings, Asian economies are organized around production and export; goods flow out and money flows in.
2. National income earned from trade is used by Asian central banks to purchase US debt to the extent necessary to keep US interest rates low and the dollar strong so that US consumers can borrow money to buy their exports, and keep those exports cheap by exchanging their own currencies for dollars when they buy US financial assets.
3. With respect to household savings, history and culture are the main cause. According to this December 2004 McKinsey report: "In China... the savings rate climbed to 44 percent of GDP last year, as opposed to 26 percent in Taiwan and 32 percent in South Korea. In big cities, such as Beijing and Shanghai, savings rates are as high as 50 percent, reflecting the consumers' propensity to save a higher proportion of their growing household income." The reason? "Few Chinese consumers, unlike their Western counterparts, are afraid of losing their jobs. Thanks to a booming economy, members of China's middle class are confident they can secure new employment almost at will and often at higher salary levels. But they do worry about a potential increase in health care, pension, and private-education expenses. Many estimate these potential costs to be much higher than they are likely to be. The instincts of these people have told them to save against the extreme case rather than the more likely outcome. As a result, they are over-saving for future events given what they would really have to pay if they could share risk through quality pension programs or health insurance products."

The US is running the largest trade and fiscal deficits in history, and its citizens have a negative savings rate. But, why? Top three reasons:

1. With respect to national savings, the US economy is organized around domestic consumption, the inflating and trading of inflated assets among its citizens and the sale of financial assets to foreigners–the asset-based economy.
2. Much of the resulting international obligations are denominated in our own home currency. This means that when international debts are paid to foreigners they are paid in US currency rather than foreign currency. This relieves the US from the need to sell products abroad to acquire sufficient foreign currency to repay its debts. The status if the US dollar as the world's reserve currency is the other reason why the US economy has gotten away with running the levels of trade deficits it has to date, besides the desire by exporting countries to continue to grow their economies via exports.
3. With respect to household savings–again–history and culture are the main cause. As readers know, during the housing bubble, household savings in the US turned negative for the first time since The Great Depression. The official reason is that home owners came to believe that they didn't need to save income–all they had to do to build savings was sit on the couch and let the house do the saving for them. But the real historical and cultural reasons are the same that cause so many US citizens to go into debt, home or not. Unlike their counterparts in Asia who "worry about a potential increase in health care, pension, and private-education expenses" and whose "instincts ... have told them to save against the extreme case rather than the more likely outcome," US citizens simply cannot imagine a time when having debt and no savings can mean real hardship. The US has had only a couple of minor recessions since the early 1980s. That means that if you were born in the US since 1970 or so, you likely have no personal experience with economic hardship. Even if you were born earlier, you've likely forgotten what it was like because the last truly painful recession happened twenty five years ago. In the mean time, fresh credit seems to always be available, and while the job market can get tough, it has not left thousands of people camping on the White House lawn.

A nation of financially fearless citizens is both good and bad. Good, because it encourages the risk-taking that has made the US the engine of innovation. Bad, because–when the imbalances correct–either the Hard Way or the Harder Way, many citizens are woefully unprepared.

The US government doesn't provide incentives for its citizens to save. Instead, it demands that its trading partners–China especially–motivate its citizens to save less and "allow" their currency to appreciate.

US politicians claim that Chinese currency appreciation will solve everything: Chinese households will save less and consume more. They will buy more, cheaper US exports. US households will consume fewer, more expensive exports, and thus save more.

But as explained in this paper by Stanford professor Ronald MacKinnon "Exchange, Wage Rates and International Adjustment" in December 2004, currency appreciation by key US trading partners China and Japan will not solve the US trade imbalance.

Currency appreciation by China will expose it to the kind of deflation that Japan suffered in the 1990s. Japan fell for the same bad advice from the US in the late 1980s, and for the same reasons: the US was running a huge trade deficit with Japan because Japan exported and saved, and the Japanese people worked, produced, and saved, while the US government spent and borrowed, and its citizens borrowed and borrowed some more.

MacKinnon's paper predicted that the US policy of dollar depreciation undertaken around 2002 to help re-start the US economy after the post stock market crash recession was not going to help improve the US trade imbalance, as the US government believed. MacKinnon warned that the policy might make it worse. It did. While a euro went from buying $0.78 worth of US exports in 2001 to $1.12 in 2005, the US trade deficit grew from $436 billion in 2001 to $651 billion in 2005.

That's not how it's supposed to work.

The answer to the global savings imbalance is as complicated as it is painless–it is neither. The imbalance will correct, sooner or later, the Hard Way or the Harder Way.

Professor of economics Laurence J. Kotlikoff in his paper "Is the United States Bankrupt? (pdf)" explains the Hard Way.

Many would scoff at this notion. They’d point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries. Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mis-pricing securities; and that financial implosion is just around the corner.

This paper explores these views from both partial and general equilibrium perspectives. It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future. The paper offers three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized Social Security, and a globally budgeted universal healthcare system.

The Hard Way is comprised of policies that encourage saving.

What's the Harder Way? As the IMF stated in its Global Financial Stability Report last week: "A low-probability but potentially high-cost risk to the global financial system is that a dollar decline could become self-reinforcing and hence disorderly.'' Rapidly rising inflation, interest rates and unemployment, attended by series of recessions at least as severe as those that happened between 1980 - 1983.

The idea that there is an Easy Way, as the Deloitte Research Study suggests, is politically convenient but requires a new New Era in global economics and trade. Even to buy the Hard Way argument you have to believe that intellectual honesty will return to the political establishment and that the political will to legislate Hard Way policies will emerge before Mr. Market fixes the imbalances the Harder Way.

I contributed to America\'s Bubble Economy: Profit When It Pops because I do not expect to see intellectual honesty and strong political will–from either Republicans or Democrats–return without a crisis to motivate it, and I want iTulip readers to have a specific, actionable plan to address the risks posed to them and their families.

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[BK]

Re: Harder Way - More likely

I expect the harder way - to be the only way

Many of my fellow citizens of this country are completely clueless about finances and will never get behind a Political Party or candidate who proposes fixing fiscal problems without a full blown crisis.
I look at the local community spending issues to demonstrate who dumb voters are. Schools or new ball fields the voters merely focus on the cost of acquiring the new asset (there is never a discussing about the cost of maintaining debt or maintaining the new building or cost to maintain the new ball fields).
It scares the heck out of me.....but, my fellow citizens have absolutely no self descipline.
Many had parents (like mine) who lived pay check to pay check - and when you are a Union worker with a pay check that often works out. But, when you are managing your own 401K Pension and need to save for Healthcare Insurance payments - that don't work out so good!

[Uncle Jack]

Re: The Hard Way or the Harder Way

You cannot reason a person out of a belief that they did not arrive at by reason, particularly if that person has money, reputation, or employment–or all three–that depend on dot com or telecoms stocks, or housing, or dollar denominated assets, or all three.

I think this is biblical, but not sure:

"A man convinced against his will is unconvinced still."

[fountainhead]

Re: The Hard Way or the Harder Way

[quote] While a euro went from buying $0.78 worth of US exports in 2001 to $1.12 in 2005, the US trade deficit grew from $436 billion in 2001 to $651 billion in 2005. .........
[quote] The US is running the largest trade and fiscal deficits in history, and its citizens have a negative savings rate.

It's getting worse - top with the Cost of Iraq War.

07/13/06 -- Information Clearing House (http://informationclearinghouse.info), Washington D.C.- We are spending $8 billion a month in Iraq. That equates to $2 billion a week, or $267 million a day, or $11 million an hour.

Iraq War calculator is set to reach $318.5 billion September 30, 2006, the end of fiscal year 2006.
(http://nationalpriorities.org/index....per&Itemid=182)

[quote] But there is no Easy Way. There is only the Hard Way and The Harder Way.

[jk]

Re: The Hard Way or the Harder Way

deloitte creates a straw man by saying the trigger for a correction in the pessimistic scenario is a sudden change of heart by our vendor financiers -- they suddenly stop buying u.s. debt instruments. that drops the dollar, raises rates and precipitates a recession. surely, they would not be so self-destructive as do any such thing in a precipitous manner.

the more likely arrow of causation is runs the other way: a housing led recession causes a drop in the trade deficit by reducing american consumption; our vendors can no longer sell as much to us. global commodity prices will drop along with american consumption.

what will china, for example, do when it can no longer export nearly as much to the u.s.? china is sitting on enormous productive [over]capacity as well as an army of redundant workers in the state operated enterprises, and suddenly its main customer won't be buying so much.

china will be forced to stimulate consumption. one possiblity is government consumption such as a military build-up - this is easy to legislate and helps keep centrifugal social forces under control via its stimulation of nationalism. this seems like an inevitable component of the chinese response. the other possiblity is somehow stimulating chinese consumer demand. this could be done by providing more in the way of social safety nets - unemployement benefits, pensions, health care - which would serve the purpose of both consuming inputs and at the same time reduce the chinese need and propensity to save for a proverbial rainy day. such a gearing up of chinese consumption is at the heart of schiff's scenario.

a different form of chinese consumption involves spending from the chinese hoard of u.s. dollars - a global buying spree spending down the pboc's involuntary "savings" heretofore locked up in treasuries. the dollar is the old maid - whoever has it will want to get rid of it. this is the harder way, i suppose.

[EJ]

Re: The Hard Way or the Harder Way

what will china, for example, do when it can no longer export nearly as much to the u.s.? china is sitting on enormous productive [over]capacity as well as an army of redundant workers in the state operated enterprises, and suddenly its main customer won't be buying so much.

china will be forced to stimulate consumption. one possiblity is government consumption such as a military build-up - this is easy to legislate and helps keep centrifugal social forces under control via its stimulation of nationalism. this seems like an inevitable component of the chinese response.

You have explained, in one post–never mind the WWIII nonesense we heard during the Israel/Lebanon war a few weeks ago from others, now ancient history–how real world wars start. Congratulations.

[jk]

Re: The Hard Way or the Harder Way

You have explained, in one post–never mind the WWIII nonesense we heard during the Israel/Lebanon war a few weeks ago from others, now ancient history–how real world wars start. Congratulations.

thanks ...... i think. i was hoping i was just talking about a buildup, and not a war.

[sparki]

Re: The Hard Way or the Harder Way

hello from germany,

thank you for the beautiful post.

it should be clear to almost everyone that all the political talk to revalue the yuan and other currencies against the $ and the problems for the us are gone is just to calm down the people before the elections.

your comment is spot on and unmasked yet another spinn that is repeatet without thinking day in and day out even here in germany.

this site is really WUNDERBAR!

jan-martin
http://immobilienblasen.blogspot.com/

[metalman]

Re: Harder Way - More likely

I expect the harder way - to be the only way

Many of my fellow citizens of this country are completely clueless about finances and will never get behind a Political Party or candidate who proposes fixing fiscal problems without a full blown crisis.
I look at the local community spending issues to demonstrate who dumb voters are. Schools or new ball fields the voters merely focus on the cost of acquiring the new asset (there is never a discussing about the cost of maintaining debt or maintaining the new building or cost to maintain the new ball fields).
It scares the heck out of me.....but, my fellow citizens have absolutely no self descipline.
Many had parents (like mine) who lived pay check to pay check - and when you are a Union worker with a pay check that often works out. But, when you are managing your own 401K Pension and need to save for Healthcare Insurance payments - that don't work out so good!

this guy's got a rant on!

citizendebtrantmov

[Slow Bear]

Re: The Hard Way or the Harder Way

Hello Eric,

I used to post on the Bear Forum under the name "SLO Bear", when I lived in San Luis Obispo. Now I'm a slower bear, thanks to suffering a "cerebral accident", a couple of years back. I think I'm a little dumber now, but the world seems to have gotten a lot dumber more quickly, so on a relative basis, I seem to be OK!!

I read Von Mises' "Human Action" over thirty years ago, and I am still guided by "Austrian" theory in making sense of current events. Thus I am a little perplexed when I read that the U.S. current account deficit is equated in the Deloitte Research Study to the statement: “The US invests far more than it saves". Back before Newspeak, it was impossible to invest more than one saves. The US is drawing down its savings and buying more than it sells abroad, but it is NOT adding to its domestic productive capability, which is what "invest" used to mean.

Another sentence from that study that kind of irked me was: "It [the current account deficit] involves a massive flow of capital to the US from the rest of the world." “Capital” is one of those multivalent words that can be used to mean (1) “capital goods”, i.e. goods used in the production of consumer goods or of other capital goods (recursively), (2) “money”, or, more particularly, (3) “money intended for the production and/or purchase of capital goods”. In the quoted sentence, it certainly means (2) in the non-(3) sense. Exported dollars are being repatriated to purchase US Treasury bonds. (Treasury bonds, by the way, are not capital goods. Purchasing them does not add to productive capacity, but rather, in the late A. J. Galambos’ words, only “contribute to the delinquency of a bureaucrat”.)

Later, Deloitte says “In the late 19th century, massive amounts of capital flowed from Great Britain to the New World . . .”, where the word “capital” is certainly being used in sense (3) above. I mean, really, were Americans borrowing British Sterling in the 19th century to buy big houses? I didn’t think so. Definitely sense (3).

Another thing that makes the two cases of long-term “capital” flows not comparable: Who owned the “capital” sent to America? Private investors (in Great Britain in the 19th century) or governmental entities (PRC banks in the current situation)? The former rationally estimate the expected return on their investment, whereas the latter do what they do for whatever political reasons.

I could have some more fun with the phrase “excess savings”, but this reply is long enough already. I have no bones to pick with you about the Hard vs. the Harder Way. Excellent analysis as usual. The reigning complacency is making me get my umbrella out.

[jk]

Re: The Hard Way or the Harder Way

i believe housing is counted as a capital good. [you might think it was a consumer durable, but that's not true since we're all renting from ourselves via owner's equivalent rent.] for a long time the u.s. has overinvested in housing to the detriment of other investment. it's just gotten a lot more extreme the last few years.

[Jim Nickerson]

Re: The Hard Way or the Harder Way

Hello Eric,

I used to post on the Bear Forum under the name "SLO Bear", when I lived in San Luis Obispo. Now I'm a slower bear, thanks to suffering a "cerebral accident", a couple of years back. I think I'm a little dumber now, but the world seems to have gotten a lot dumber more quickly, so on a relative basis, I seem to be OK!!

I enjoyed your thoughtful comments Slow Bear, but the above has got to be one of the best remarks I've seen anywhere. Hope you continue to get better mentally, physically, and financially.

[EJ]

Re: The Hard Way or the Harder Way

Hello Eric,

I used to post on the Bear Forum under the name "SLO Bear", when I lived in San Luis Obispo. Now I'm a slower bear, thanks to suffering a "cerebral accident", a couple of years back. I think I'm a little dumber now, but the world seems to have gotten a lot dumber more quickly, so on a relative basis, I seem to be OK!!

I read Von Mises' "Human Action" over thirty years ago, and I am still guided by "Austrian" theory in making sense of current events. Thus I am a little perplexed when I read that the U.S. current account deficit is equated in the Deloitte Research Study to the statement: “The US invests far more than it saves". Back before Newspeak, it was impossible to invest more than one saves. The US is drawing down its savings and buying more than it sells abroad, but it is NOT adding to its domestic productive capability, which is what "invest" used to mean.

Another sentence from that study that kind of irked me was: "It [the current account deficit] involves a massive flow of capital to the US from the rest of the world." “Capital” is one of those multivalent words that can be used to mean (1) “capital goods”, i.e. goods used in the production of consumer goods or of other capital goods (recursively), (2) “money”, or, more particularly, (3) “money intended for the production and/or purchase of capital goods”. In the quoted sentence, it certainly means (2) in the non-(3) sense. Exported dollars are being repatriated to purchase US Treasury bonds. (Treasury bonds, by the way, are not capital goods. Purchasing them does not add to productive capacity, but rather, in the late A. J. Galambos’ words, only “contribute to the delinquency of a bureaucrat”.)

Later, Deloitte says “In the late 19th century, massive amounts of capital flowed from Great Britain to the New World . . .”, where the word “capital” is certainly being used in sense (3) above. I mean, really, were Americans borrowing British Sterling in the 19th century to buy big houses? I didn’t think so. Definitely sense (3).

Another thing that makes the two cases of long-term “capital” flows not comparable: Who owned the “capital” sent to America? Private investors (in Great Britain in the 19th century) or governmental entities (PRC banks in the current situation)? The former rationally estimate the expected return on their investment, whereas the latter do what they do for whatever political reasons.

I could have some more fun with the phrase “excess savings”, but this reply is long enough already. I have no bones to pick with you about the Hard vs. the Harder Way. Excellent analysis as usual. The reigning complacency is making me get my umbrella out.

Welcome, Slow Bear. Yes, I do recall you and your thoughtful, articulate posts. I'm delighted to have you pull up a chair at the iTulip Bar & Grill and join us. Sorry to hear about your accident, but it doesn't appear to have impared your reasoning abilities–sharp as ever.

Remember the endless arguments on that forum in the late 1990s about inflation/deflation? The end of the stock market bubble was a fait accompli among forum members and we were all trying to figure out if we'd have a big deflation. At long last I decided on Ka-Poom Theory as the transition to which we are inexorably headed, and was trying to figure out how close we might get to actual deflation before the inflation, and then how big the inflation might get.

Thinking back, I don't recall that it ever occurred to any of us–even crossed our minds–that the Fed would permit a housing bubble to happen. But we should have known. If the Federal Government were RJ Reynolds, the Surgeon General would be shipping cartons of cigarettes to ten year olds if that's what it took to keep "the company" from going out of business.

I especially appreciate your attention to the meaning of words. The loss of this discipline is causing a lot of the problems we're seeing. Low interest rates, creative mortgages, and lax lending standards made a $500K home in 2000 affordable on the same monthly payment at $1M in 2005. Not surprisingly, in fact, the price of that house grew to $1M. The $500K profit that the guy made selling it after five years was not taxed, not even a dollar. (By the way, we call the US dollar the US bonar here, again trying to maintain discipline in our use of language; the unit of US currency formerly known as the dollar is no more, so we had to come up with another name for it.) Further, this $500K was then put on the nation's books as economic output, counted as part of GDP. Over the past several years, I made almost as much money sleeping in my home every night as I made at work all day.

It's all very modern, just like the stock market bubble that was happening when you and I met...

Some in clandestine companies combine;
Erect new stocks to trade beyond the line;
With air and empty names beguile the town,
And raise new credits first, then cry 'em down;
Divide the empty nothing into shares,
And set the crowd together by the ears.

- Daniel Defoe (1660 - 1731)

Welcome back.

[Jim Nickerson]

Re: The Hard Way or the Harder Way

Thinking back, I don't recall that it ever occurred to any of us–even crossed our minds–that the Fed would permit a housing bubble to happen. But we should have known.

EJ,

Five or 10 years from now some will be thinking back to now. Might they then be saying, "But we should have known."?

If greater inflation is the most likely prediction for our futures, where will the money and credit go?

[jk]

Re: The Hard Way or the Harder Way

EJ,

Five or 10 years from now some will be thinking back to now. Might they then be saying, "But we should have known."?

If greater inflation is the most likely prediction for our futures, where will the money and credit go?

i'd be very interested in ej's, and others', thoughts on this question, too.

my own are that it will go to commodities. if you assume the answer to the inflation/deflation debate is inflation, then you have to assume a weaker dollar. [the alternative is global inflation of all currencies, in which case people all over the world will be looking for stores of value - commodities and especially pms.] so, given a weaker dollar you have americans looking for stores of value domestically, and also competing for global resources with their weaker dollars. sounds like commodities including, but not necessarily "especially," pms.

alternatives 1 - if we assume low, low rates, then housing can be pumped up to a degree, softening the housing decline, but can it become a repeat bubble? it is hard to see speculators jumping right back in after their recent scare. but perhaps i am crediting people with too much rationality. i'm thinking of the people in the anecdote related at safehaven, in a link supplied by jim nickerson: these were ordinary folks, with not a lot of income, who had leveraged themselves into 5 properties around the san diego area, with a total mortgage debt of $3.6million. i think the psychology isn't right, though. a bubble has to build to a widespread belief in the inevitability of ever rising prices. there have been too many newspaper articles about the housing bubble popping: it would take years for that to reverse.

alternatives 2 - stocks? this seems somewhat more plausible for a repeat performance. a lot depends on what happens in the stock market between now and then. there is apparently some noise being made even now about the dow approaching its old high. if the stock market isn't hit too badly between now and when the pumps get turned on, then i could see equities moving up a lot. it's been several years since people were swearing "never again" about the stock market. it seems more likely, however, that stocks will be hit hard BEFORE the pumps are turned on. their decline will be one of the triggers that elicit the inflationary response. in that scenario, in which the stock market will be hit hard AGAIN before the inflation, it's hard to see the public wave of enthusiasm settling on stocks.

alternative 2b- foreign stocks. this seems more plausible. if the dollar is weak but we don't have global runaway inflation, then other economies may be growing in a relatively healthy way. [could they really? with a sick economy in the u.s.? let's assume so.] also, the declining dollar will translate into rising foreign equity prices from the american viewpoint. it's hard to see a broad interest in foreign stocks, americans are in general too insular, but foreign stocks will have a following. american demand for e.g. asian stocks will add to the currency effect and push up those stocks even in terms of their base currencies. so there will be substantial bull market in foreign stocks. the strength of this move will depend on how fast the dollar declines- if the dollar drops too quickly it won't work.

the recent commodity moves are most likely a precursor to the big commodity wave to come. looking at multidecade charts the recent peaks are not all that high. for all that some commentators have labelled gold's move, for example, as "a bubble," it never got close to widespread public ownership and enthusiasm.

i think commodities have completed stage 1 of a 3 stage move. their ownership to date has been restricted to enthusiasts and speculators. the great majority of day-to-day market participants never touched them.

the slowdown or recession which we are now entering, along with the pullback in commodity prices, marks the shift to stage 2. stage 2 will be the institutionalization of the commodities markets. commodities will be legitimized as mainstream investments. ownership will broaden significantly, but will not reach the man in the street. thus the rise should be relatively orderly.

another slowdown or recession, accompanied by another pullback in prices, will mark the shift to stage 3. in stage 3 there will be a wave of new mutual fund offerings, helping the public get on board. fraudulant junior mining companies will be floated on smaller exchanges around the world. the price of gold will again be announced every half hour on the radio business reports. the newsweeklies will run articles on the commodities markets [but not a cover, yet].

the last part of stage 3 will be a wild acceleration for precious metals in particular. that's because, to quote richard russell, gold is unique because it is moved first by greed, but then by fear.

these processes will take many many years to play out. i just took a look at ej's ka-poom chart, which puts a peak in 2014. whenever it happens, we get the magazine covers, the last peak and drop for commodities, the re-incarnation of paul volcker [if we're lucky], and the worst recession since the 1930's. time to buy bonds.

that recession, with its pullback in prices, may well mark the clear end of u.s. global hegemony, and a shift to a different global system.

that's my science fiction story. i feel a little dumb, or limited, for not being able to think of other alternatives: stocks, real estate, bonds, commodities. and? and this is just the replay-of-the-'70s model. not too creative. other ideas?