United States Heading for Economic Depression and Dollar Collapse
Economics / Economic Depression Nov 03, 2008 - 02:23 AMBy: Eric_deCarbonnel
The US headed for a depression AND a currency collapse. Americans will see their wealth wiped out as stocks and home values plunge, their cost of living soar as food and oil prices spike up, and their taxes increase as the government struggles to fund itself. To understand where the US is heading, we need to step back and take a look at the deep problems afflicting the US economy:
Problem #1: Dependence on Foreign Debt
Over the last few decades, foreigners have been buying up an increasingly large amount of US debt, propping up the dollar. The dollar enhanced buying power has allowed America to consume a disproportionate amount of the world's resources (i.e.: 50% of the world's oil). The inflows of foreign money into the dollar has been due to its status as the world's reserve currency and the desire of exporting nations to maintain a weak currencies. Unfortunately, the dollar has lost the attributes that established it as the world's reserve currency more than 60 years ago (we are no longer a creditor nation), and exporting nations incentive to subsidize the dollar is disappearing along with consumer spending. A collapse of the dollar is imminent as foreigners stop funding America's consumption binge.
Problem #2: Massive derivative bubble
With large amounts of money flowing into dollars and looking for investments, the US financial sector took on the role of selling debt to foreign investors. In the beginning, this involved making loans to Americans and then bundling those loans into complex financial instruments (CDOs, SIVs, ABSs, etc). However, as time went on and the inflows of foreign money into dollars increased, financial institutions became reckless in their efforts to manufacture AAA products. They made loans to subprime borrowers (subprime CDOs) and used financial wizardry to create securities out of thin air (synthetic CDOs). Towards the peak of this financial greed and insanity, banks added large amounts of leverage to their exotic investment products (subprime CDOs squared and CPDOs), and built complex, highly leveraged, off-balance sheet vehicles which funded themselves with short term debt (SPVs, VIEs and SiVs). Through financial engineering and the mispricing of risk, the value of derivatives now far, FAR exceeds the amount of real assets and economic resources in the US .
Problem #3: 55 trillion CDS market
In addition to the derivative bubble, financial institutions used leverage to sell insurance on an enormous amount of debt, creating today's 55 trillion CDS (credit default swaps) market. In order to deleverage and close out their positions, CDS issuers are being forced to buy back huge quantities of insurance, driving up the cost of insuring corporate debt. The higher premiums for CDS translate as higher loan rates for companies and governments.
Problem #4: Structurally unbalance economy
The strong dollar and easy credit conditions over the last two decades have warped US economy, making it structurally unbalance. Here are a few examples of how the US economy has become unsound:
a) Oversized financial sector . While packaging US debt into exotic vehicles for foreign investors, the financial sectors grew until it earned 27% of corporate America's total profits. As credit crisis causes our oversized financial sector disintegrates , it leaves a gapping whole in the economy.
b) Automakers dependent on cheap gas. Automakers are heavily invested in producing fuel guzzling cars and SUVs. When the dollar's collapse pushes oil back up over $100, a large part of America's automobile industry will shut down and cease to exists.
c) Leveraged Stock Buybacks . Taking advantage of low interest rates, companies like GE issued large amounts of debt (commercial paper or corporate bonds) to fund share buybacks to juice profits and prop up stock prices. These companies are now having to roll over all that debt in a tightening credit market while consumer spending goes off a cliff, and their odds of long term survival are not good.
d) Outsourced manufacturing . In order to cut costs, companies have outsourced large parts of their manufacturing operations to lower cost labor markets overseas. Unfortunately, as the dollar collapses, the cost of oversea labor will increase in dollar terms, dealing a crushing blow to companies whose primary market is in the US.
Without a continuously increasing inflow of foreign money to keep the dollar strong and interest rates low, the US economy will disintegrate.
Problem #5: Bankrupt consumer
The "resilient consumer" is dead. His wealth has been wiped out by deflating home and stock prices. Outsourcing and competition with cheap oversea labor have prevented his salary from keeping up with the cost of living. Tightening credit is limiting his ability to borrow, and his liability as a taxpayer has reached $516,348 per household. With hundreds of thousands in job cuts in the pipeline and America's middle class already sinking into poverty, consumer spending is heading over a cliff.
The Financial Apocalypse
As it becomes obvious that consumer spending will not to pick up and that US will never be able to repay its mountain of debts, investors will begin dumping dollars. The selling of dollar holdings to transfer the money to gold or other currencies will accelerate the collapse of US assets prices. With the deflationary/dollar collapse worsening, a large part of corporate America will become insolvent. Automakers are bankrupt at +5 dollar gas. Companies who outsourced their manufacturing and whose primary market is the US will face bankruptcy. Companies who used excessive amounts of debt for stock buybacks will go bankrupt. Financial institutions will be wiped out by the crashing value of the assets in their balance sheets. As a result of the massive economic dislocation, unemployment will soar. With the falling dollar, oil and food prices will move higher in US dollars despite slowing worldwide demand. I am not sure how the government will react to all these problems, but it will be hugely inflationary and it will accelerate the dollar's collapse…
I believe the US is on the verge of a downward spiral that will rapidly intensify into an economic collapse the likes of which has not been seen in modern economic history . I advise buying gold and keeping a close eye on the yield of long term treasuries. If the yield on the 10-year note goes up while stocks fall, it will be a sign that confidence in government debt and the dollar is failing.
By Eric deCarbonnel
http://www.marketskeptics.com
Eric is the Editor of Market Skeptics
© 2008 Copyright Eric deCarbonnel - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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