Aftershock Economy by Wiedower

Ref: Robert Wiedower (2011). Aftershock Economy.

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Summary­

  • Six Co-lined market bubbles dominate the 2010’s US Financial Market; Real Estate, Stock Market, Private Debt, Discretionary Spending, the Dollar, and Government Debt. The latter two are predicted to collapse with devastating results on the US and World Economy.

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Market Bubbles

  • Beginning with our decision in the early 1980s to run large government deficits, six co-lined bubbles have been growing bigger, each working to lift the others, all booming and supporting the US Economy.

    • Real Estate: Income between 2001-2006 grew 2% while home prices grew 80%.

    • Stock Market: The Dow rose 300% from 1928-1982 (54 years). Yet in the next 20 years the Dow increased an astonishing 1200%, growing 4x as fast as before, but without 4x the growth in company earnings or our GDP.

      • The Dow Rose 14 fold from 1982 to 2007, while company earnings rose only three fold for the same period. Earnings rise about as fast as GDP.

    • Private Debt

    • Discretionary Spending

    • Dollar: Our dollars rose in value because of rising demand for dollars to make investments in our bubbles. Now the falling bubbles will eventually create falling-value dollars.

    • Government Debt

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Investment in USG

  • We currently receive about $2 billion of foreign capital every day.

  • Net capital inflows to the US went negative at the beginning of 2009, with a net outflow of $143 billion in January and $91 billion in February.

  • The Federal Reserve is forced to buy nearly $1 trillion worth of government bonds, Freddie Mac Bonds, and Fannie Mae bonds this year. The Fed is acting as an enormous buyer of last resort. This will help boost international investors confidence in the dollar in 2009 and 2010 since it guarantees there will be no confidence shaking failed treasury auctions.

  • As of May 2009, 46 cents out of every dollar spent by the USG is being borrowed.

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Predicted Collapse

  1. USG Debt Rises.

  2. Demand for US assets falls a bit and their prices decline.

    1. Foreign Investors shift their Investments to less-risky choices, buying a little less US Stock, bonds, and other dollar denominated assets. Buying a little less is perfectly reasonable. Of course, buying a little less means a little less demand for these assets.

    2. More and more investors lose interest in buying US assets. Dropping demand for these assets will put increasing downwards pressure on the value of the dollar, creating a negative feedback loop of falling demand leading to falling prices leading to falling demand.

    3. The future value of the US Dollar depends entirely on future demand.

  3. Investors began selling US Assets which further lowers demand.

    1. At first, some foreign investors will decide to end their wait and see approach and will want to sell some of their US holdings. Some of that early selling is by foreign pension funds and life insurance companies that have to be somewhat risk-averse in their investments because of the nature of their fiduciary responsibility to protect the assets of their retirees and beneficiaries.

    2. Early selling will lower demand even further and prices will drop even more, motivating some investors to flee. Fairly quickly, the number of investors selling their US assets will hit critical mass, and a perfectly rational panic will kick in, bringing down the already bursting asset bubbles, including the dollar. It’s all about falling demand.

    3. The US will reach its Credit Limit when foreign investors stop or dramatically reduce their lending to the USG because they are concerned about the risk of not being repaid with dollars that have the same value as the dollars they are lending.

  4. USG will attempt to correct by buying dollars and supporting Its price.

    1. Governments will manipulate the value of the dollar the best they can, for as long as they can, by buying dollar (lowering supply) and supporting its price.

  5. Inflation of the USD occurs.

    1. Normally it takes about 6-18 months for an increase in the money supply to create inflation. With the money supply (M1) having increased 15% from August 2008-April 2009 to help fund the bailout, and being likely to increase further, inflation is a near certainty.

    2. True inflation occurs when the Fed increases the money supply at a faster rate than the economy needs it.

  6. Interest Rates Rise to stay above Inflation.

    1. Interest Rates always have to be above the inflation rate in order to get anyone to lend money.

  7. Rising Interest Rates, rising inflation, and maturation of adjustable rate loans.

    1. According to the US Treasury, almost 40% of its debt has a maturity of less than 1 year. As interest rates rise, the government is forced to pay out more and more interest on its debt every time it has to refinance this short-term debt. 

    2. The combination of high inflation, rapidly rising interest rates, and rapidly rising perceived risk of any lending will quickly put the USG, the world's biggest borrower, in the crosshairs. 

  8. Dollar Bubble Pops.

    1. The dollar bubble pops with the rapid rise in interest rates and inflation. This put into motion a rapid chain of events. The most noticeable link in the chain will be failed Treasury auctions. This doesn't mean the government can't sell any of the bonds it needs to finance its operations, but it means that it can't sell all of them. To help out, the Fed may come in and buy what others don't buy, as it already has. At this point, the world is starting to perceive greater risks in USG bonds. Refinancing of past government debt will start becoming difficult since they are increasingly being viewed as toxic assets. Once these assets go toxic, they start to freeze very quickly and cannot be traded, and new issues cannot be sold. At that point, treasury auctions will begin to fail completely, meaning no one will buy our debt. If no one will buy our future debt, we will have no way to make payments on our past debt. The USG will be in default on its debt, and the big government debt bubble will fully pop. When treasury auctions fail completely, the government will have no way of funding the $2 not firmly pinned to some underlying real economic driver is not sustainable.

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