Economic Perspective

Tough times may be ahead for U.S. economy

By Tim Reaves & Craig Dixon
LiveWire

The streets are silent, blanketed in snow and ice.  They have not been plowed.  No one has anywhere to be because most residents are out of work.  Tents full of homeless residents fill the parking lot of the now abandoned Boone Mall.  Many of the rest of Boone's residents are squatting in their foreclosed homes.

Boone’s economy stayed afloat a little longer than most of the state.  But then the college bubble burst.

First it was the housing market.  Then the so-called retail giants began to fall.  The banks gobbled up the bailout money but credit was not extended.  Businesses could not afford to keep paying for their space.  They closed in droves.  Unemployment soared.

At the end of 2009 North Carolina declared bankruptcy - following the lead of 14 other states.  At the end of 2009 the tax revolt began.

Students could not afford college anymore.   Taxpayer-supported universities like Appalachian State University sank beneath the waves.  The university ceased its operations until further notice in 2010.  Boone's population dipped dramatically and money stopped coming into local businesses.

Now no one can afford to travel anymore.  Boone no longer has tourism revenue, because there is no tourism.

Boone is in a depression.

The above scenario is fiction, but it is, according to some analysts, a very real possibility.  The financial crisis that has escalated over the last year could be the catalyst for just such a scenario, and some experts are predicting just that.

“We’re going to see the economic collapse the likes of which the world has never seen before. It’s not only in the United States; it’s going global,” said trend forecaster Gerald Celente, in a Feb. 2009 interview with Russia Today (RT).

There may be the temptation to write off such talk as that of crack-pot, but when Celente says “gloom and doom,” there may be reason to listen.  Celente, the CEO of Trend Research Institute has been credited with predicting both the fall of Soviet Russia, and the 1987 stock market crash.

Celente told Fox Business in a  Nov. 2008 interview that he believes America will become the world's first “undeveloped nation” by 2012; a nation torn with marches, revolts, food riots, and rebellions.  Violence, he predicts, will escalate dramatically.

“There's not going to be any magic bullet here, there is no swift resolve that can solve the crisis,” he said. “America’s going to go through a transition the likes of which no one is prepared for.”

How would the United States, the world's most powerful nation, fall to such hard times? How would this chilling scenario mushroom cloud into a reality?  To understand how this could happen, it is necessary to understand where the current crisis came from.

Cause of the crisis

The financial and economic crisis originally came from the subprime mortgage bubble, said Matthew Martin, an economist for the Charlotte branch of the Richmond Federal Reserve Bank.  More and more investors put money into the housing market, which grew greatly over the earlier part of this decade.  All the while, subprime mortgages (loans given out to people with questionable credentials) became a larger piece of that growing pie.

Additionally, the government insisted that the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corp. (Freddie Mac) support the housing market. This led to a lot of questionable bonds, backed by these mortgages, which were then sold by Wall Street around the world, said Harry Davis, the professor of banking and economist for the North Carolina Bankers Association and professor of finance at Appalachian State University.

Investment Consultant and Director of Communications for Euro Pacific Capital Andrew Schiff said that the cause of the housing bubble was easy credit pumped into the system by the Federal Reserve Banking System (Fed).  The Fed lowered its interest rates to stave off recession in 2001, and kept them low, which allowed investors to put this cheap money into the housing sector, leading to its rapid growth.

This led to rising real estate prices, and people and companies bought up the mortgage debt as an asset instead of a liability.

“All the lending was based on fictitious home values,” he said of the money that flowed into the financial system to cover the cost of the mortgage bonds.

When the bubble burst, when homeowners could no longer afford their mortgages, defaults began to pile up; the mortgage bonds became worthless.  Many banks and investment firms that owned a large portion of the bad mortgage bonds fell, Schiff said.

All the industries tied to housing began to bleed money.  Construction, carpeting, cabinetry, plumbing, tiling, roofing, and lumber are just a few industries that have been affected by the crash of the bubble.

Thus the financial crisis led to a deeper economic crisis, the effects of which are just beginning to be felt, namely through unemployment and pending inflation, he said.

Unemployment

Unemployment in North Carolina rose from 4.9 percent in Jan. of 2008 to 8.7 percent in Dec. of 2008, a 3.8 percent increase in less than a year.  And joblessness is one of the sure signs of a recession, Davis said.

“We lost an incredible amount of [jobs] in December,” he said, referring to the 523,000 jobs lost nationwide in that month alone.

But that isn’t the worst news.  Davis said that unemployment could continue to rise throughout the recession and even continue into the recovery, a much longer time period than most people currently anticipate.

“The average recession is about 10 months,” he said.  “This one is already at 13 months.”

Martin believes that the recession should break within a year, but he warns, “Near-term prospects for job opportunities are not good.”

Schiff said that Obama’s plan to create four million jobs may bring some employment to North Carolina, but without a strong industrial base the jobs would be temporary.

Americans need to stop consuming, start saving, and build the industries that could make the country strong again, he said.

Celente believes the recession may melt into a depression, however; starting with tax revolts.  Rising taxes, coupled with rising unemployment, would infuriate Americans.

 “That’s going to be the big one because people can’t afford to pay more school tax, property tax, any kind of tax.  You’re going to start seeing those kinds of protests start to develop,” he told Fox Business.

 “People are one job away from losing everything.  We’re seeing more and more closures.  People are being laid off.  People are stretched to the limits.  And what do they do in New York State?  Some 130 new taxes are being proposed; they’re raising sales taxes,” he told RT.

Inflation

The new Obama administration promises trillions of dollars in new government spending, but what will the effect of this new spending be, and where will the money come from?

“Government doesn’t have any money to spend,” Schiff said.  He believes many people have an assumption that the government has money tucked away for a rainy day; that is simply not the case.

When the government spends money, they get that money from taxes, borrowing from foreign nations, or from printed money borrowed with interest from the Fed.  Right now the government is not increasing taxes and is finding fewer foreign governments to finance its spending, so they are resorting to printing it out of thin air, Schiff said.

When the newly printed money is added to the money already in circulation, it devalues every dollar that already exists, a concept known as inflation.  Inflation causes the price of goods to rise, sometimes rapidly.  Hyperinflation occurs when inflation breaks free of the mechanisms the Federal Reserve uses to control it.

How does the Fed attempt to control inflation?  It can raise the Federal Funds Rate (FFR, which indirectly controls how much banks can lend out), or it can buy treasury securities, which are the collateral that the U.S. government gives the Fed in exchange for its monetary notes (dollars).

Matthew Martin said that inflation is not really a big concern for the Fed right now.  Therefore the Fed is currently inflating the currency to pump credit into the system to unfreeze it.  They have done this by lowering the Federal Funds Rate to 0-0.25 percent, and by selling treasury securities on the open market in larger and larger numbers, hoping people and foreign governments will continue to buy them and finance the government debt.

The problem is that the first option, lowering the FFR is impossible, since it is already next to zero.  And selling treasury securities depends on having a constant stream of buyers.

Davis said that people will always buy treasury securities, as they are one of the safest investments on the market right now.  But Schiff disagreed.  He said that people are buying treasury securities for short-term gain and not as a real long-term investment.

“Just because people are stupid now doesn’t mean they’ll be stupid forever,” he said.  “Over time it’s a guaranteed loss.”

Schiff said that the flood of treasury securities into the market and the subsequent buying frenzy constitute a bubble that, just like the housing bubble, will collapse.  If this happened it would lead to hyperinflation and a deepening downward spiral.

“We’re in a situation that’s going to rival the Great Depression and could surpass it,” he said.

Celente agreed.

“When I say it’s going to be worse than the Great Depression, we call it the Greatest Depression,” he told RT.

But he said that comparing the current crisis to the Great Depression is not entirely correct.

“Back then when we first crashed most people didn’t have homes, there was no such thing as home equity loan, and back then, people didn’t have credit cards,” he said.

“The consumer wasn’t $14 trillion in debt.  We had a manufacturing base that built the world out of the Great Depression following World War Two.  We no longer have that,” he said.

The Future

The Obama administration and the Fed are taking the steps they insist will avert a deepening of the crisis.  The Democrats passed a nearly $900 billion stimulus package made up in part of government spending to try to create jobs.

The Fed is making loans to banks and buying bad assets from them, Martin said.

But all this spending by the government and the Fed could lead to a massive influx of money into the economy, sparking hyperinflation, Schiff said.

When massive amounts of money are injected into an economy without a growth in goods or services, hyperinflation can be triggered due to an imbalance of supply and demand coupled with a loss of confidence in the currency.

            A $2 loaf of bread today might be $200 or even $200,000 if hyperinflation kicks in. This occurred in the 1920s in Germany's Weimar Republic, where even postage stamps eventually cost 50 million German Marks (the German Republic's currency at the time).

In such a scenario, job losses combined with expensive goods would create economic chaos and mass suffering.  This would lead to social unrest and, ultimately, political unrest.  If this scenario unfolds Boone would be in for cold winters in the years ahead.