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By James R. Cook

“An overexpanded colossus of debts requires enormous amounts of new credit just to keep depression and a liquidity crisis at bay.”


Kurt Richebacher

I want to warn you about the future. Dark economic clouds are gathering on the horizon. Inevitably the tornadic force of financial ruin and national bankruptcy will sweep down upon us. Our time of testing will be long and arduous. There is no escaping it, no way out. What we don’t know is the exact timing of this event and the precise nature of the unfolding crisis. Will it be depression, hyperinflation or a combination of both?

The die is cast. Years of inflationary money and credit creation have fostered unmanageable levels of debt and spending. Now the debt is beginning to strangle us. An agonizing liquidation will sweep homeowners and mortgage lenders away on a tidal wave of foreclosures. Layoffs will mount as a general business collapse rolls across America. The falling dollar will force interest rates higher, squeezing the profits of over-indebted corporations and snuffing out the candle of prosperity. The cost of everything will rise as incomes fall. Stocks will swoon and ultimately nosedive to the depths of despair. The national mood will swing from optimism to dark pessimism. Lavish living will give way to tight budgets. The golden age with its gradual inflating of asset values, its rich speculation, its fantastic liquidity and its awesome financial boom is soon to be no more.

Money that can be created out of thin air by politicians and bankers is always unsound wealth. That’s the root of our problem. Eventually these so-called experts lose control of the process. Too much money and credit spark a bubble that must inevitably burst. Mr. Greenspan claims that the central bank does a good job of managing fiat money. But in reality, fiat money manages them. The critically low interest rates they have been forced to adopt have failed to re-ignite the boom. When the Fed’s monetary easing fails (with tax cuts and low energy costs), it’s because of villainous overspeculation, low savings, a profits decline, low capital investment, a huge trade deficit, corporate chicanery, overconsumption and overborrowing. These factors sap the strength of the faltering economy. They are not just boring economic concepts, these are flesh and blood realities that must wreak havoc on our financial affairs and our complacency.

The Housing Bubble

Artificially low interest rates sponsor economic activity that would otherwise not occur. The housing boom serves as an example. On the surface, new housing seems a big plus. Home values have soared upward. But low interest rates coupled with government mortgage financing and guarantees will eventually have lethal consequences. Most homeowners have geared their purchase and their financing to optimal economic conditions. The houses they buy are as large as they can possibly afford and they are financed to the hilt. Refinancing and second mortgages add to this maximum leverage. If the free market set interest rates, they would be higher and much of this high rolling personal finance and overheated real estate activity would be nonexistent.

Consider the risk if incomes fall and job losses mount. People stand to lose everything. Any rise in interest rates would increase payments for those with flexible mortgages. Home financing is priced for perfection. What happens if home prices fall rather than rise? The government’s role as lender has fostered extravagance and insured that risky borrowers have been able to secure housing. The private sector has shunted most of the risk onto Freddie and Fannie. The colossal size of mortgage debt and the high value of housing are responses to government manipulation. Low interest rates, federal guarantees and easy money are nothing that would have happened in markets free of intervention. Tremendous overbuilding and high home prices can’t last in a so-so economy. Once they tip over, the landslide begins. It’s impossible to overstate the risks inherent in the housing bubble. The day could come when the government issues a moratorium on mortgage foreclosures. You don’t even want to think through the consequences for the lenders.

Falling Dollar

The ease with which we create dollars means that we can flood the world with our money to buy goods. Furthermore, the government can spend virtually any amount it needs to police the world and attempt to insure the well-being and lifetime security of every citizen. Too many dollars, like too much of anything, means their value must drop. That downward trajectory has recently started. Low interest rates bear some blame for this unfolding drama and they may have to rise to support the sinking dollar. The impact of rising rates on both highly-leveraged corporations and the stock market will be devastating. If foreign investors desert the dollar, as prudence would require, our markets will shatter. The cost of imports would explode upward and domestic producers would have the freedom to push up their prices. The government will fight a declining dollar tooth and nail by supporting it in foreign exchange markets. Despite this, a dollar decline is in the cards because it’s a glut on the market. Its fall may be mandatory to help manufacturers and exporters establish some kind of foundation for recovery. The day is coming when the rest of the world will be less glad to get our money and we will be desperate to get theirs.

Overvalued Equities

The shocking level of optimism still associated with stock investment stems from those fat gains that everybody knew and loved during the NASDAQ boom. The wishful thinkers, the hopers and the dreamers will keep that mind-set until everything they own has diminished to a trifle. The cruel realities of today’s overvalued market mean a brutal retrenchment. It’s important to keep one thing in the forefront of your mind; it’s hard to make money. It’s incredibly difficult, stressful and arduous to make a profit. The inflationary rot in our currency has blinded us to that fact. Easy money temporarily alters this reality as assets climb in value and money is plentiful. But time will reintroduce reality and pain will replace gain. Easily won gains will evaporate and nothing will bring them back. A depression is just the thing to underline the fact that making money is a devilishly difficult undertaking.

High Finance

Corporate America continues its dance with debt as never before. Derivatives fuel speculation, hedge interest rate differentials and enable unsound borrowing practices to flourish. Mergers, acquisitions, downsizing, stock maneuvering and leveraged finance find far more favor than capital investment in new plants and equipment. In the months ahead, renewed layoffs, write-offs, losses, bankruptcies and falling profits will dictate a severe crisis for business. This unfolding horror story will shake America to its roots.

Savings, Consumption and Capital Spending

America’s savings rate is deplorable. Consumers blow their paychecks and borrow even more for the high life. In order to build factories and manufacture goods, people must save rather than spend. The difference between what people earn and what they consume provides the investment capital for building up a nation’s industries. The long-term weakness brought on by years of overconsumption shows up now as an additional negative in a stalled economy. It’s just another nail in the coffin.

Government Solvency

Tax revenues have fallen. They will fall more. Meanwhile, government expenditures are rising. Now throw in a government forced to bail out financial losers, subsidize the noncompetitive, invoke payment on a multitude of financial guarantees, and pay insurance claims for busted pensions, brokerage and bank failures. Add to that rising costs for unemployment, welfare and early retirements. Hard times are coming, not just for the people and for business, but also for the government. Who will get through it and who won’t is yet to be determined. But big spenders and big borrowers fail in the worst of economic times and government is the biggest at both.

It may sound to you that my warnings are overblown. They are not. The risk of a liquidity crisis has never been higher. Remember that it takes more and more money and credit to service our absurdly high debt levels ($29 trillion). If too many people need to sell stocks, real estate, antiques, or anything else, the price will collapse. All these things are intrinsically illiquid. Only a few people can sell at current price levels. Unfortunately, a growing requirement to sell assets for debt repayment may foster a liquidity problem. The credit collapse I warn about will reveal what an enormous house of cards we’ve built. Like it or not, you’re eyeball to eyeball with the greatest financial disaster in history.


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