Here are the three stages of crises Puplava defined.
The first...
Let's take a look at – this will make reference to Bank Credit Analyst’s Waiting For Reflation. And I think one of the things that you have to understand here is this is probably the least experienced Federal Reserve boards that we've had, at a time of one of the biggest financial crises that we've experienced in this country for, John, almost the last two decades. And if you take a look at this, when you have a debt-prone and debt-ridden economy as we have today, there are three kinds of financial crisis.
The first type of crisis is a fear of panic. Something happens kind of like what we had in 1994 with the Peso crisis, what we had in 1997 with Asian crisis and then also what we had in 1998 with the Long Term Capital Management and the Russian debt default. What happens is there is a fear that grips the market. Something happens out of the blue and everything freezes up because everybody is worried about more selling and losses. And usually what happens with this type of crisis, the response is the central banks come in and they inject a large amount of liquidity, drive down interest rates to a penalty rate and basically inject money back into the system. Once they do that, the market responds. And once that happens, the market is assured that there is no more dumping of assets, the panic subsides and then we go on and up and away. And you saw that in 1994 with the Peso crisis, you saw it in 1997 with the Asian crisis and you saw it again in 1998 with the Long Term Capital Management hedge fund and Russian debt default. We had a crisis that appeared out of the blue, took the markets by surprise. The markets freeze up, the central bank comes in, slashes interest rates, injects a lot of money, and all of a sudden the panic and the fear subside and it's up and away and they sort of reinflate.
The second...
The problem that they are dealing with –and this is the second type of financial crisis – and I think eventually they are going to realize this is the kind of crisis that they face. In the second crisis assets fall because investors recognize the value of these assets were way out of proportion to where they should be – whether it's technology stocks in the year 2000 or real estate prices in 2006 and 2007.
And the danger of the second type of crisis is that this impacts the banking system. And if you look at the banking system, it is leveraged 20, 30 to 1. So the banks have a small capital base. And the real danger here is as that capital base erodes, because of defaults of the assets of the losses that they experience on their loans, what happens is the financial system becomes technically insolvent. And they are insolvent because of the prevailing interest rates. And the only way that you can get out of this situation is the central bank lowers interest rates and they keep them low in the future much in the same way that Greenspan did between 2001 and 2004. And what happens is the collateral, which backs up the banking system in those loans, asset prices eventually begin to rise as a result of this reflationary effort and low interest rates, and it makes the problem go away.
Now, the side effect of that is it causes inflation and it creates a moral hazard, which is exactly what we saw between 2001 and 2006. They lowered interest rates. They kept the markets liquid. Assets were reflated. In this case bonds reflated, real estate reflated. And then the moral hazard – look at stupid things that lenders did during this period of time: No money down; no doc loans; 125% financing; interest only; negative amortization loans. I mean you name it, we've written about this. This is the second crisis and this is the crisis that the Fed is facing today. The only trouble is inflation is much higher today than it was in 2001. [30:15]
And the third...
JIM: And that's where we are heading between 2009 and 2010. In the third crisis, you have bursting asset bubbles that drive insolvency in the system. Asset values fall and they fall so much it's too large of a fall to be solved by lower interest rates. It's not going to cut it. So what you have is wide spread insolvency very much like you did in the Savings and Loan crisis in 1991 where the government came in, took over these failed S&Ls, took the assets, rolled them over into the RTC and liquidated.
So when you get to this third stage, you can have various alternatives in terms of which way the government goes. Lowering interest rates isn't going to cut it. Number one, you can nationalize assets or liquidate them like they did in the S&L crisis. Or two, you inflate away massively and the consequences are a severe inflation. And that's where I think we're heading between 2009 and 2010.
And I think at around 2010, I think that is the end game for the debt Supercycle. And also I think you're going to see what I call the Perfect Financial Storm, which will be three perfect storms: One perfect storm in politics; one perfect storm in economics – meaning the economy and financial markets; and another perfect storm in the area of energy. And that, I think, is going to unfold in the year 2010. It's not going to happen overnight. It's going to be a result of a series of events, one event compounding the previous event. And it will start to build and build and build much like, let’s say, the force of a hurricane or a major storm. And that's where we're heading. So by 2010 we are going to be in a full-scale depression. [32:38] |
