Plausible Scenario
financialsense.com
[well here is a sceanrio that you and Russ will find plausible but I do not. Crashing home prices, crashing stock prices, and hyperinflation just absolutely 100% do not mesh in my book. If he was anywhere close to being correct (and read what he says about fertilizer), then how the F are corn and bean prices near historic lows after this rise in oil prices? IMO he starts off OK but just can not contain himself and ends up with the same hyper-inflationary nonsense he has been preaching that just has not happened yet, and sure as hell is not going to happen in a housing crash. Mish]
It is possible that stocks will head higher in the short run spurred on by mergers and IPO’s. As the markets become more speculative the Fed’s resolve should increase. The Fed will continue to raise rates until the fed funds rate reaches 3-3.25%. At that point spreads between 2-yr and 10-yr notes should narrow to within 20 basis points. We should then see visible signs that the U.S. economy is rolling over. Debt defaults should be on the rise and delinquency rates should start to rise on home mortgages. The financial markets should start to see signs of duress in widening credit spreads and in lower stock prices. Perhaps there will be major fallout triggered by a troubled hedge fund or financial intermediary that shakes the markets out of their complacency.
Meanwhile, the trade deficit should continue to expand because of its structural makeup. The dollar will begin its next leg down as it dawns on the rest of the world that the U.S. economy is headed for trouble. High interest rates, the usual method of defending the dollar, will prove to be too painful. The economy and its most important constituent, the consumer, are far too leveraged as are the financial markets. Higher interest rates will undermine asset values and consumption. Deficits will begin to balloon even higher as high short-term rates make it more expensive for the government to borrow. In addition to higher financing costs the impact of a growing war, and growing social costs triggered by an aging baby boom generation will cause budget deficits to spiral out of control. The open-ended war on terrorism and the looming social costs of a baby boom generation will eclipse the cost of the Great Society and make it look cheap by comparison. As government deficits begin to skyrocket they will also become more expensive to finance as interest rates rise. Close to 70% of all federal debt matures by the first quarter of 2007.
At some point soon foreigners will begin to lose their appetite for U.S. debt, making it more difficult for the U.S. government to finance without hyperinflating. As the economy weakens and deficits mushroom, the Fed will begin to panic. By the end of summer or late fall we’ll begin to hear talk about Fed rate cuts. Money supply growth has historically turned inflationary when the rate of money growth exceeds GDP growth as it did between 2001-2003. Up until this point consumers and the government have benefited from the Fed’s credit inflation of the last 10 years. Money supply growth financed the consumers spending binge of the late 90’s and this new decade. It also helped fund the capital spending boom of the late 90’s. Corporations today are more leery to spend money on building new plants and equipment. Instead they are using the rising value of their paper to buy other companies. This doesn’t expand the economy; it causes it to contract. Mergers usually spawn layoffs as staff, plants and equipment is consolidated. Look for increased layoff announcements ahead as merger mania takes hold.
Rising energy prices will also begin to take their toll as costs feed into the economy. As developing nations industrialize, material consumption growth increases. Developing economies consume more energy. This means the demands of an energy- starved Asia will butt up against the energy needs of the developed world. China alone needs to increase its oil imports by over 5 million barrels a day by 2015. With zero production growth coming from the world's industrial nations, where will that extra supply come from? If energy investment banker Matthew Simmons is right, Saudi oil production, which all future supply estimates are based, is about to peak. Regardless if Simmons’s is correct or not, the world is transitioning from a period of slack to tighter oil supplies. This will make all industrial and developing nations heavily dependent on Middle East and Caspian oil. It will also reorient security and economic alliances.
Higher energy prices will also feed itself through to food commodity inflation. It will cost a farmer more to buy fertilizer, more to power a tractor and more to process food. Energy is the core of inflation as David Hackett Fisher has pointed in all past inflations. All production of either manufactured goods or basic commodities has an energy component added to it. It takes energy to produce things. The combination of new emerging market consumers and the hoarding of commodities to keep costs down will continue to push up commodity prices in a cycle of shocks. In our present environment where capital is cheap and commodity prices are inflating, tonnage growth is decreasing and hoarding or inventory building is increasing.
What all of this means is that the next inflationary wave is about to begin. It will begin during the next downturn in the markets and the economy. It will be caused by explosive money growth with the Fed operating the printing presses in a way never seen before in history. Each new economic cycle over the last fifty years has required more money and credit to fuel it. As for the deflationists among you, it is time to rethink your position. Debt may be a catalyst for deflation when money has a value as it did when we were on a gold standard. Today under our present fiat money system currencies have no value other than the faith of the beholder. When most debt is backed by government guarantees and that same government is in possession of a printing press, debt produces an inflationary response. |
