Mainstream media and government officials confidently tell us that the worst of the economic crisis is behind us. Undoubtedly, the current environment seems calmer than the free-fall that characterized the early part of this year. However, I would argue that, far from being finished with the crisis, the present situation is akin to the calm at the center of a storm. We have experienced the violence of the first wave of the tempest, but anyone who mistakes this temporary lull for an indication of smooth sailing will soon suffer a rude awakening.
Real estate is nowhere near a bottom, our nation’s largest banks are insolvent, gas prices are heading back up in a hurry, and two of the “Big Three” are in bankruptcy. Twelve percent of all mortgages (not just subprime) are either in foreclosure or behind on payments. Commercial real estate is just beginning to crumble. Forget about what the talking heads tell you, just look around. Does this look like the beginning of a recovery?
Unfortunately, government officials consider it to be their jobs to be perpetual cheerleaders for the economy. The previous administration resisted admitting that the economy was in trouble until it was already obvious to anyone with a pulse, while the current administration confidently predicts that the economy is full of “green shoots” and that recovery is just around the corner. None of these people have any credibility whatsoever.
A good analogy for the present state of the economy is that of a ski racer who catches an edge and must execute progressively more radical maneuvers just to make each successive turn. The racer may be successful in making one, two, or three more turns, but it is obvious to the viewer that he’s not going to make it to the bottom of the course.
I would point to the internet bubble of the late-90s as the point at which the economy first “caught an edge”. It was obvious to anyone who was paying attention that a situation in which companies with no revenues were commanding billion dollar valuations was not sustainable. When the inevitable correction occurred, we were faced with two options. We could have let things take their natural course and allowed those who made imprudent decisions to suffer the consequences of their actions. If we had done this, many people would have gotten hurt, and maybe even a bank or two would have gone under. But this is not what happened. Instead, the Federal Reserve under Alan Greenspan flooded the economy with dollars. That was when the real trouble began. At that point, the ski racer went beyond the point of no return.
Greenspan’s loose money policy in the early part of this decade fueled an orgy of real estate speculation, and everyone is familiar with what happened from there. It seemed like the final crash was upon us late last year. However, the government and the Federal Reserve stepped in with every weapon at their disposal and temporarily managed to halt the free-fall. However, anyone who thinks that it is possible to bail out banks, auto manufacturers, and print trillions of dollars out of thin air without dire consequences is living in a fool’s paradise. I would argue that what we have just witnessed was the last successful turn of the ski racer, and the final crack-up is now imminent.
Obama, Geithner, and Bernanke are not primarily to blame for our current predicament. They inherited a system that was in critical condition. I would argue that once the collapse began last year, it was a foregone conclusion that one of the following two outcomes was inevitable. Either the US economy would go into a depression, or the US dollar would suffer a complete collapse. I believe our top financial officials understood this and decided to accept what they considered to be the lesser evil – i.e. the demise of the US dollar.
Unfortunately, due to a deeply flawed stimulus package, President Obama has probably already squandered the political capital necessary to make fiscal policy the mechanism for bailing out the economy. As a result, the only tool remaining is monetary policy. As Ben Bernanke famously explained in a speech which earned him the nickname “Helicopter Ben”, it is always possible to prevent a deflationary collapse. All you have to do is print enough money. Eventually people will realize that it is too risky to keep holding onto their money because its value becomes shakier and shakier. Print enough money, and people will have no choice but to spend. So, yes, it is possible to prevent a depression by printing an endless supply of money. Unfortunately, the consequence of doing so is rampant inflation, which is every bit as destructive as a depression (but far more politically palatable). Not to mention that, unlike a stimulus plan, flooding the economy with dollars does not require congressional approval.
The writing on the wall is becoming clearer with every passing day. A year ago it would have been unthinkable for China to question the position of the dollar as the world reserve currency. Due to their enormous dollar reserves, they have a lot to lose if the dollar collapses. Nevertheless, we continue to hear louder and louder voices from China (and other nations) calling for a new reserve currency. In fact, our own Treasury Secretary stated publicly that he would consider such a possibility.
Economists as prestigious as Nobel Laureate Paul Krugman tell us that inflation is not a concern. They observe that the price level is stable or falling. While this may be true, it completely overlooks the most basic principle underlying paper currency. Given that our money has no “intrinsic value”, its ability to serve its function is predicated upon the monetary authorities restricting its supply in order to keep the price level stable. The Federal Reserve has completely abandoned this directive in order to stave off an economic collapse. They may succeed in averting a depression, but they will do so only by signing the death warrant of the US dollar.