Historic events are going to come together into the perfect economic storm in the coming years. The confluence of record deficits, record numbers of retiring American consumers, record commodity prices, and a disorderly unwinding of all of these events as they re-balance into new long-run, sustainable equilibrium of supply and demand are going to unfold in dramatic fashion. What will follow is, for all intents and purposes, an Economic Apocalypse as the value of no asset will be safe in the re-balancing.
As far as most observers are concerned, this doomsday scenario is just a myth, promulgated by purveyors of economic doom who have been wrong before about imminent destruction. What makes this such a dangerous scenario for everyone who counts himself an investor or owner of capital, is that the signs are right in front of our noses, but it will take a series of events to conspire in order in order for this doomsday scenario to play out and that makes the evidence it is coming rather easy to ignore.
Here’s how it’s going to play out:
The First Horseman of the Economic Apocalypse: Gasoline
The surprising precursor to the downfall of values of overinflated assets worldwide is going to be something so many of us depend upon, yet at the same time completely take for granted; the price of a gallon of gas. There is no more emotional purchase that Americans are forced to make and as the biggest group of consumers as a percentage of GDP of any developed nation, they have the most to lose as the price of this commodity reaches record highs.
Rising gas prices are a catch-22 problem for the US Federal Reserve. In response to frozen markets, the Fed eased monetary policy to encourage confidence and borrowing following the 2008 sub-prime crisis that nearly took down world financial markets. A necessary evil that developed in response to their unprecedented easing of money was the debasement of the US Dollar relative to other currencies. In a shift from a strong dollar, the price of all dollar denominated commodities have what is now becoming the last leg of a marathon run towards high prices not seen in history.
At the same time, geopolitical events have not cooperated. Iran, Iraq, Nigeria, and Libya are all in a state of upheaval. As major producers of the light sweet crude needed to produce the gasoline consumed by the US and other demanding buyers, the losses to production in these volatile time has been a major cause for the increase in prices. At the same time, the closure of several refineries and the shortage of refinery capacity has touched off a speculative rush in gasoline, which threatens to push the price well over $4 per gallon. Once this happens, a chain of events will unfold that will bring about unprecedented revaluations of all asset classes.
Inflation that Creates Deflation
Nothing is more destructive than inflation, when it comes to the purchasing power of consumers. Nothing, that is, except for major deflation, like that which took place during the Great Depression of the 1930s. While the US Central Bank and central bankers around the world have done everything in their power to stimulate the growth of loan demand and thus inflate their currencies, the unintended consequence of their actions has been crushing the purchasing power of commodities. As these commodities have risen relative to the purchasing power of the consumers who demand them, there exists a price point, and beyond this point, consumers begin to demand less gasoline and their consumption behavior for all goods changes as well.
American consumers have seen high prices at the pump before. In 2008, at the peak prior to the sub-prime crisis, the cost of gasoline caused many people to have to make important choices, one of them was whether to pay for a tank of gas, or to make a ballooning mortgage payment as their adjustable rate loans climbed with monetary tightening by the Fed, concerned about overheating inflation. While following it’s dual mandate of promoting full employment and maintaining inflation at a target rate, the Fed has been tasked with a conundrum. As monetary conditions are eased to accommodate expansion in the money supply, the relative value of the dollar has weakened, causing inflation in commodities, resulting in stronger inflation, which in 2008 was growing faster than employment.
As a result of rising gasoline costs, consumers typically cut back on non-essential expenditures. These discretionary costs make up nearly 2/3 of GDP in the US and when they decline, so too do the revenues of the businesses employing them. The negative feedback loop that occurred when this happened in 2008 forced employers to cut their payrolls and lay off as many people as they could. This in turn exacerbated the shrinking demand for discretionary goods and caused more companies to lay off even more people. Behind the scenes of layoffs and inflation, US consumers are aging into retirement en mass, nearly 80 million baby boomers are one step closer to retirement, and in a natural progression, are in the process of deleveraging and buying less goods and services.
Gas prices are the fulcrum for the beginning of deflation because they destroy disposable income, the lifeblood of the US consumer. Despite it’s best efforts, the central bank cannot fight this process by lowering interest rates to recreate additional growth in demand because once higher gas prices get into the system, they impact the prices of so many other goods and services that inflation becomes a chief concern; not unemployment. In a situation where the prices of food, transportation, shipping, and anything else with a petroleum product input in its production becomes just slightly inflated in value, the demand for that good or service will fall incrementally. This incremental decrease in demand has a cascading effect on the demand for all other goods and services consumed and suddenly the process takes on a mind of it’s own and cannot be reversed.
The Second Horseman of the Economic Apocalypse: Debt Default
2008 was a preview for what is next after gas prices begin to destroy demand and jobs in the US and elsewhere. As economies contract and incomes shrink, the next victim of this vicious cycle will be the repayment of debt in all of its forms. As workers are laid off, their credit cards, home loans, student loans, auto loans, and other secured and unsecured lines of credit will go unpaid first. As in the sub-prime crisis, any large wave of defaults in loans tied to assets will have cascading effects. In the case of real estate, there is currently a massive constipation in the system of properties pending foreclosure. Adding many more distressed properties is going to do serious damage to all of the properties left where homeowners owe money to lenders. As many, many more neighborhoods are swallowed up by falling valuations due to vacant foreclosed homes, there won’t be nearly the number of investors swooping in to buy these distressed properties as in recent years because of a perception that they will become much cheaper in the future will return as more people lose their jobs and continue to default on loans.
In the case of the Economic Apocalypse, the reason that homes and other assets tied to debt will be left in free fall, is because central banks like the Federal Reserve will be forced to halt monetary easing or face additional inflation risk as a result. In the face of higher interest rates, as the US Central bank is forced to combat inflation by tightening monetary supply, interest rates will sky-rocket. Programs like TARP, TALF, or Operation Twist, which require the expansion of the balance sheet of the Federal Reserve will be unavailable to policymakers because growing underfunded liabilities such as Medicare, unemployment assistance, and national defense priorities will sap all available demand for American debt. As the 60 Trillion dollars in debt that the US has created in the past 10 years grows and needs to be refinanced, it is easy to picture harsh austerity measures that will lay off government employees and force more unemployment and debt defaults onto the world economy.
Foreign and Domestic Sovereign Debt Defaults
As the world’s largest debtor, the US has the most at stake if interest rates begin to rise. Not to be overlooked, Japan and Italy have the world’s second and third largest debt markets respectively and as global unemployment balloons with the rise in inflation caused by a gasoline shock, growth and the tax receipts collected to finance debt obligations is going to shrink. When economies as large as the US, Japan and Italy struggle, their over-indebted governments are going to pay heavy burdens in the form of higher interest rates as the risk premium on repayment of capital skyrockets. Add to the equation, the massive debt loads of State governments who will find it even harder to finance budget gaps than currently, and you have a recipe for wholesale defaults and destruction of capital as investors lose assets and the financial house of cards created by lenders begins to fall in on itself.
As the growing number of retirees and unemployed Americans will be a burden on entitlements in the US, so too will the aging populations of China, Europe and Australia, drag down the budgets of those major economies with them. China, with its export oriented economy will begin to experience major problems as Europe, it’s largest trade partner struggles with unemployment and an over-burdened debt load for it’s member nations. As investors flee the European currency with the threat of default hanging they will have few other places to hide their currency than commodities like Gold and Oil, and investing in China and other developing economies. All of this commodity inflation will begin to unravel as the demand for these commodities shrinks with rising prices. The collapse of the values of commodities and commodity exporting countries like Brazil and Russia will further contribute to the global depression that will ensue.
The 3rd Horseman of the Economic Apocalypse: Taxes to close massive budget holes
As the US falls into economic despair as a result of underfunded liabilities, high interest rates, and destruction of money and wealth, the response from policymakers will be to pull out all stops to regain as much solvency as it can. In the face of mushrooming demand for entitlement spending in all forms from Medicaid to Medicare and unemployment benefits, the government will be unable to borrow it’s way out of the next financial crisis. As a result, the only place it can find income will be to raise taxes and levy new ones on all forms of commerce that it can. This means that economic activity will suffer further, employment will shrink and investors will sell as many assets as they can in order to make up for lost income.
In this climate of rising taxes, consumers will behave much differently than they do today, with regard to how they save and invest. Currently the taxation system in the US rewards investment, which unfortunately will be where lawmakers will look first to increase tax revenues. As history has shown, in times of crisis, the last place elected officials will want to look to raise taxes will be the pockets of constituents, especially when they are dealing with record unemployment and foreclosures. Corporate balance sheets, on the other hand are as healthy as ever, and with the prospect of default sitting on the table, governments of developed nations around the world will engage in concerted efforts to close loopholes and levy taxation on the trillions of dollars that corporations have amassed over the past decade on their balance sheets.
As the prospect of default looms over taxpayers, an all-out class war will be declared and movements like the Occupy Wall Street protests will find new life. As these grass roots supported campaigns meet resistance from armed police, expect riots and lots of them to take place in cities everywhere. With so many unemployed, disgruntled Americans fighting for survival amidst deepening recessionary conditions, the prospect of civil discord, and even civil war will grow. With so much anger and resentment building, expect the political establishment in Washington D.C. to be replaced en mass by new representatives of growing movements outside traditional parties. When the people are forced to take back their government they will direct their anger at those in the position of privilege first, and the companies and assets they own second.
In the period of unrest that follows major increases in taxes, expect accelerated deflation to take place as markets crash, economic activity falls further, and consumers in the lower stratus of the economy form a popular uprising that further saps resources from the Federal, State, and Local governments that are forced to try to maintain order. In this period, if major structural reform does not take place through any means necessary, the prospect exists for the Federal Government to lose it’s control over several states, and the prospect of there being one or more secessions from the Union may take place.
The 4th Horseman of the Economic Apocalypse: Natural Disasters and Nuclear War
Just when you think it’s safe to go outside, if and when the proverbial brown stuff starts hitting the fan and unemployment and massive defaults on public and private debt start to reach critical mass, the next major threat facing the world economy is one that is inevitable; natural disasters. No single artificial event, with the exception of all out war, has the potential to destroy economic progress like a major hurricane, earthquake or volcanic eruption in a developed nation. With the cycle of natural disasters seen recently including the earthquake in Japan on March 11, 20011 and the Tsunami that accompanied it, we saw a glimpse of what can happen when a major industrial nation gets a direct hit from mother nature.
With the prospect of natural disasters effecting economic activity, there is very little slack in the system to make up for both lost production and infrastructure needing repair. In recent years, areas that are most at risk such as California for Earthquakes, and the East Coast of the US for hurricanes have experienced lighter than normal incidents. Given that we are in what is anticipated to be more highly active period for both types of natural disasters, expect the resources of disaster responders to be less than adequate given all of the other strains on budgets. Without the resources to rebuild, scenes like post-Katrina New Orleans where most residents without insurance simply picked up and walked away from their property will play out in many devastated areas. Given the relatively small population that was affected by Katrina, a direct hit on a city of much larger population will serve as a more horrendous blow on the regional and international economy.
As we saw with the financial devastation to the New York Financial district in Lower Manhattan following 9/11, any major disruption will cause unanticipated aftershocks in world markets. With the US equity markets closed for several days after the collapse of the twin towers, investors fled for safer assets causing a temporary imbalance in the price of all asset classes. With fewer weapons at it’s disposal, fighting deflation and unemployment, the US Government will be unable to ease it’s way out of a major disaster hitting New York City the way it did in 2001. If major natural disasters begin to hit areas of extreme urban density with any regularity like New York or Los Angeles, expect a massive exodus of the population into rural areas which will put strain on water, food and energy supplies.
The Nuclear Problem
The 2011 Earthquake and Tsunami in Japan exposed fatal design flaws in the Nuclear facilities that were damaged by a wall of water and power outage of backup systems. With so many of the world’s major nuclear power plants poised near water and fault lines, in an environment of greater incidence of natural disasters, it will only be a matter of time before one or several suffers a major meltdown on the order of the Fukishima Daichi plant in Japan. As these man-made disasters compound natural disasters, the threat of damage to crops, water supplies and a lack of energy production for the power grid is heightened.
Areas at the greatest risk for suffering a major meltdown of nuclear facilities in the US all tend to be located in the places where several million people live. As we have seen with the responses to moderate to severe disasters like Katrina in New Orleans, the available resources of the US Federal Government’s disaster response capability is limited. Severe lawlessness, looting and widespread panic were all symptoms of a densely populated urban environment in absence of electricity and communications infrastructure. Despite all of the recent disasters, the Federal Government has done little to improve it’s ability to maintain order and control over these types of situations and with the greater possibility of devastation growing in time, coupled with fewer resources to invest in beefing up infrastructure, these cracks will cause major destruction to the overall public.
The Prospect of a Nuclear Terrorist Attack
All it took for the Japanese to surrender after years of war and vowing to never relinquish their grip over territories seized during World War II was the detonation of 2 nuclear devices. If America’s enemies learned anything from it’s tactics, they know that mutually assured destruction is not necessary to bring a powerful nation to surrender to their will. As daunting as the prospect of a nuclear armed, terror sponsoring state is to America in times of relative prosperity, the prospect of a well placed attack on a major city such as Washington D.C. or New York and the detonation of a nuclear device in each of those cities would wreak havoc in times of economic duress.
With so many rogue states disseminating nuclear technology to other hostile actors, the prospects for one of them to finally detonate a high yield nuclear device in the Continental United States is a growing threat. Even if an attack happened in the resource rich Middle East, the fallout of the loss of production from such a vital resource in the carbon based world economy would have lasting effects. While there is no way of telling whether this will happen for sure or not, the risk of such an event is enough to cause the first horseman, gas prices going up, to appear. The actual occurrence of such an event would leave a lasting impact on the world, and although it may not destroy it, there will be an awakening to a new level of consciousness in a world shaken to its core by such a devastating event.
The deceptive calm before the storm
As we sit on the verge of all-time highs in the values of commodities equities, and debt in the public and private sector, the signs are everywhere of an impending collapse. As in the case of the financial crisis of 2008, the same asset bubbles that make billionaires of some will bring the downfall of many others, despite all institutional safeguards and safety nets designed to prevent just such a catastrophe. Even with the warning signs everywhere, the notion that a return to prosperity is just around the corner is a siren’s song sung by politicians and investors whose very survival is dependent upon the return of those conditions. In absence of real growth resulting from expansion in the population and natural resources, the artificial creation of money through debt expansion has created a fantasy world of valuations that no longer matches the reality of intrinsic values.
The Post Apocalyptic World
In many ways, the coming destruction of wealth and asset values is a necessary rebirth in the life cycle of the world’s economy. Despite centuries of periods of growth and contraction as evidence that the system both needs and wants deflation of asset values, efforts of policymakers to pull every lever possible to prevent the natural cycles from occurring are even more detrimental to the overall health of the economy as the prospect of natural cycles of unemployment and deflation. When the dust settles and the last of the 4 horsemen has made it’s appearance that brings about the Economic Apocalypse, the institutions of the world government that have forever made the rules by which economic activity plays out, will be forever changed. Gone will be the inherent misconceptions of perpetual increases of asset values being an intrinsic trait of economies, and so will the prospect of perpetual prosperity. In it’s place a new prosperity will form, as technology and a new sense of universal belonging to a human race takes the place of infighting amongst races, cultures and nation-states, we will all find it necessary to ensure the protection and survival of all humanity through innovation and cooperation in the face of dwindling resources on this planet.