Revising My View

Can you deal with the most vital matters
by letting events take their course?

–Lao Tzu

We’re standing together, deliberating over the asparagus at the farmer’s market, and I want to know how the internet service company he started a couple of years ago is doing. “We’re still in the game,” he offers, “but if I’d known the economy was going to be this bad for this long, I would have thought twice before doing it.”

Not a very good answer. If he he’s got it hard now, he’s gonna be toast in a very short time. The Dow Jones Industrial Average may have topped a week ago and both the Transports and the S&P 500 looked to have completed ending diagonal triangles, implying a dramatic decline ahead. Is this the start of the C wave? We shall see.

The shear dimension of the next wave down wakes me up at 4 AM with the yips these days. The Wave Principle tells me that the second leg of this Grand Supercycle bear market is going to crush not only stocks but the mountain of IOUs that the global economy depends on for its existence. Anywhere I look, the numbers are beyond comprehension. Example: the notional value of derivative instruments that exacerbated the 1987 crash was about $1 trillion dollars. Today, we have an estimated $1 quadrillion dollars in notional value of derivatives, which is 1,000 times the 1987 level. Can the risk to the world markets be 1,000 times what it was in 1987?

The extent of our entitlements is another one. Until recently, I was persuaded by Harvard Business School professor Thomas K. McCraw’s argument that the nation could successfully run deficits and even expand them during a deflationary depression. McCraw cited Alexander Hamilton’s expansion of the deficit in 1790 and the experience of the 1930s. But Hamilton was dealing with debt that had been incurred by the colonies during the Revolutionary War, which had ended and there was no follow on to that debt.

The 1930s doesn’t seem to compare with the present because there were no entitlements in the 30s.  Social security was created in 1935, but the first ongoing payments did not start until January 1940. Today, 90% of the nation’s revenues go to pay entitlements (EWT, Oct. 2013), and we have to borrow for everything else. Dr. McCraw, like most economists, is forecasting a continued gradual recovery in the economy, rather than the most severe deflationary depression since the eighteenth century.

In short, I think that it’s a near certainty that the deflationary depression that accompanies the final wave down in the stock market will play havoc with the Federal government’s finances, and that bankruptcy is a very real possibility.

It is clear to me that there is a lot of work needed to keep this from happening. Unfortunately, it is not likely to be accomplished by the fanatical element presently running amok in Washington. Fanatics are not good at solving problems. Le Bon pointed out long ago that they are only good at smashing things. When Harry Reid claimed that the GOP was on a fanatical mission to pull a Thelma and Louise and drive the country off the cliff, he said a mouthful.

The next few years will be intense. Buckle your seatbelts.

Cheers,

Rod

 

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